Address by Dr Chris Stals, Governor of the South African Reserve Bank, at an International Conference arranged by ABN AMRO Bank and Kagiso Financial Services, Johannesburg.   1. Domestic economy dominated by international developmentsDuring the past six months the South African economic scene was dominated by developments in the international financial markets. The East Asian financial market crisis, which already started with pressures in Thailand's foreign exchange market in June 1997, took some time before it spread to other emerging markets outside of the East Asian region, and also to the smaller industrial countries of the world. More recently, financial markets in major industrial countries also became contaminated.In the case of South Africa, the contamination took place through the disinvestment of foreign funds from the South African Bond Exchange. During the first four months of 1998, non-residents increased their holdings of South African bonds by R16,3 billion. During the next five months, that is from May to September 1998, they reduced their holdings of South African bonds by R22,4 billion. This major switch was directly linked to a reassessment made by foreign investors during April/May 1998 of their investment positions, and the decision to reduce their exposure in fixed-interest bearing bonds of the emerging market economies of the world.It is interesting to note that non-residents continued to increase their investment in South African equities. After increasing their investment in South African shares acquired through the Johannesburg Stock Exchange by R19,4 billion in the first four months of 1998, they added a further R17,3 billion during the following five months. The reversal in the investment trend on the Bond Exchange was, however, sufficient to change drastically the outlook for the South African economy, and some promising economic developments in the first quarter of this year were promptly aborted. 2. Adverse financial developments lead the downward trend in the economyThe sudden switch of foreign investors' sentiments had far-reaching effects in the South African financial markets:The immediate effect of the withdrawal of investment funds from the Bond Exchange was a sudden and sharp increase in the yield on long-term bonds. The average monthly yield on long-term government bonds rose from 12,9 per cent in April 1998 to 18,3 per cent in September.The withdrawal of foreign investments created pressure in the foreign exchange market and the average effective exchange rate of the rand against a basket of currencies depreciated by 21,4 per cent from  1998-05-22 to 1998-08-31, to bring the cumulative decline in the external value of the rand from the end of last year to 24,6 per cent.The depreciation of the exchange rate encouraged further capital outflows in the form of negative "leads and lags", and also led to speculative positions taken against a further depreciation of the rand. In the end, a net outflow of more than R13 billion in the form of private sector short-term capital exerted additional pressure in the foreign exchange market.The outflow of capital reduced liquidity in the banking sector and forced the banks to borrow more from the Reserve Bank on a day-to-day basis. The estimated daily liquidity needs of the banks increased from about R2 billion at the beginning of May to more than R13 billion early in June 1998.Other interest rates followed the yield on long-term government bonds on its strong upward surge. The rate for repurchase transactions from the Reserve Bank increased from 14,78 per cent on 1998-05-12 to 24 percent on 1998-06-22, before it settled early in July at a level just above 21 per cent. Banking institutions raised their prime overdraft rate from 18,25 per cent at the end of April 1998 to 25,5 per cent on  1998-08-28.In order to provide liquidity to the drained foreign exchange market, the Reserve Bank drew about R8 billion on foreign loan facilities and increased its outstanding hedge facilities in respect of future international balance of payments commitments fr