Report by Governor of South African Reserve Bank & Comments by Economists

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Finance Standing Committee

27 September 2001
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Meeting report

FINANCE PORTFOLIO COMMITTEE

FINANCE PORTFOLIO COMMITTEE
28 September 2001
REPORT BY THE GOVERNOR OF THE SOUTH AFRICAN RESERVE BANK & COMMENTS BY ECONOMISTS

Chairperson:
Ms Hogan (ANC)

Documents handed out:
Presentation by the South African Reserve Bank
Annual Economic Report 2001, South African Reserve Bank
Getting the Growth Equation Right (Noelani King)
Comments on the Annual Report of the South African Reserve Bank (Jac Laubscher)
[non-hyperlinked documents awaited]

Reserve Bank website:
http://www.resbank.co.za/

SUMMARY
The Reserve Bank drew attention to the fact that for a long time the economies of the world have been shrinking and that when we look at the South African economy we must look at it in a global context. The Governor appealed to the markets to look at SA’s strong fundamental macro economic principles because these were in line with international standards. The economists both agreed that if the Nett Forward Open Position is not wiped out there is always going to be negative speculation on the Rand. The wiping out of the NFOP is vital for growth. Ms King emphasised the fact that economics have changed and that fundamental principles are not the overriding factor, markets are fickle and follow sentiment. Social and economic circumstances need to be addressed was well. Both economists also agreed that SA’s macro economic policy is sound.

MINUTES
Report of the SA Reserve Bank presented by Mr De Jager, Deputy Chief Economist of the SA Reserve Bank
Global Position
The presenter said that because of attacks on the United States on 11 September 2001 the past is no longer an accurate reflection of what will happen in the future. But even before the attacks, the industrial output in richer countries was declining. The real GDP growth in the US reflects this. The annualised rate shows that the US economy grew by 0.2% in the second quarter. Though it is difficult to say what will happen in the third quarter, he ventured a guess that it could be below 0% even though the attack took place near the end of the third quarter. He said that a recovery cannot be expected in the fourth quarter but rather a further retraction of the US economy. They do not know when the economy will recover. The Gulf War can be used as a guide as to how the US economy will recover but the circumstances then were very different. This time the Federal Reserve bank is prepared to assist with financial aid such as helping out the airlines. With the Gulf War consumer confidence was down for about two quarters. He predicted that although they do not know how long it will be this time, it will not last long.

Before the attacks there was a rise in unemployment in the US and since the attacks unemployment can be expected to rise further because of the airline lay-offs.

The Japanese economy shrunk in the second quarter. In Europe growth was slow in the early half of the year with an annualised rate of 0.3% in the second quarter. The slow growth is true for the UK as well. Australia’s economy grew by 3.6% in the second quarter. This growth was helped by interest rate cuts, income and company tax decreases and increased government expenditure.

The emerging markets in Asia showed a general trend of shrinking economies. An exception was Indonesia despite all the instability in the country.

Latin America economies are also contracting as is the trend around the world.

The IMF yesterday released the World Economic Outlook which is a prediction of economic growth on a global scale and for individual countries. The figures predict that the global economy will grow by 3.5% for the year 2002. Mr de Jager said that it was unlikely that this figure would be achieved.

The latest inflationary projections suggest that inflation will come down in 2002 but he is also sceptical about this because of what is happening in the world.

In response to the attacks on the US, many central banks cut the interest rate. This is true for the central banks of the UK, US, the European Central Bank and the South African Reserve Bank.

Domestic Developments
The South African economy performed well until the first half of the year. The growth in real GDP rose from 2% in the first quarter to 2.5% in the second quarter. This was achieved by the boosting of exports and cutting back of imports. The exchange rate helped this along greatly.

Real gross domestic expenditure on the overall declined in the second quarter

The growth in real final consumption expenditure by households decreased from 3% in the first quarter to 2.5% in the second.

Real household disposable income growth slowed down from 2.5% in the first quarter to 2% in the second.

The household debt as a percentage of household disposable income decreased from 56.5% in the first quarter to 56.5% in the second. It was therefore easier for households to service debt and because of the interest rate cuts there was more money for consumables.

Prof. Turok commented that the aggregate of disposable income was no reflection of the lower category of income earners and asked if the figures could be broken up to reflect that category.

Mr De Jager said that he does not have the statistics to do this but that other surveys in the market are available.

The presenter continued and said that the growth in real fixed capital outlays slowed down from 6% in the first quarter to 5% in the second. The private sector made less financial investment but made other forms of investments.

Manufacturers and traders reduced their inventories because they expected demand would weaken in the near future. This is normally an indication that consumer activity will slow down in the latter half of the year but this is not true.

Savings in the economy declined from 15.5% in the first quarter to 15% in the second. This was as result of the decline in corporate savings due to the paying of dividends and dividends going abroad. Saving by government improved but household saving remained weak.

Unemployment in the formal sector showed a decline in the overall unemployment figure. Annual remuneration growth slowed from a year on year rate of 10.3% in the fourth quarter of 2000 to 9.4% in the first quarter of this year. It is expected that growth could increase in the fourth quarter because of all the wage negotiations taking place.

Labour productivity growth is rising which means the output per worker is growing.

The cost of labour per unit of output (unit of labour cost) is declining steeply to a level of below 1% in the second quarter. This helps with the containment of inflation because it directly relates to the production cost. Unfortunately wage growth in the fourth quarter can push the cost of labour per unit of output higher.

As far as inflation is concerned SA has not been doing all that badly. The overall inflation is 4.6% and the CPIX is 6%

The best indicator that the Reserve Bank follows for production price inflation is the production cost of locally produced goods. A slower pace in the increase in endogenous inflation has been seen in the most recent months.

The strong performance of exports and the contraction of the value of imports led to an improvement in SA’s trade balance in the second quarter. Because of the increased dividend payments that left SA, the deficit on the services and income account widened. Consequently, the surplus on the current account of the balance of payments decreased from R6.9 billion in the first quarter to R6.3 billion in the second.

Despite the slowdown in the global economy the total volume of exports increased and the total value of merchandise imports declined. Export prices increased considerably faster than import prices. Because of this the current account balances improved.

The financial account had a healthy surplus in the second quarter. SA’s foreign exchange reserves improved because of dealings with the rest of the world and amounted to R96.6 billion at the end of June 2001. Gross gold and foreign reserves of the Reserve Bank increased from R62.8 billion at the end of June 2001 to R62.8 billion at the end of August. Because the Reserve bank utilised its short term credit facilities during this period the total international reserves fell from R40.9 billion to R29.2 billion.

The net open position in foreign currency (NOPFC) is the Reserve Bank’s oversold forward position in foreign currency reduced by its net holdings of spot international reserves. Because of the strong inflows of foreign currency the NOPFC was reduced from US$9.4 billion at the end of March 2001 to US$ 5.3 billion at the end of June. In July the figure decreased to US$4.8 billion because of the Reserve Bank purchasing the proceeds of governments bond issue in the Samurai market.

For the period December 1999 to March 2001 the nominal effective exchange rate of the Rand fell by 13.3%. Despite the depreciation of the Rand, the economy is still doing nicely and the short term money market interest rates are stable.

In the SA economy and particularly in the Capital Markets, government is not borrowing as much as in the past. But the decrease in government borrowing is offset by the increase in borrowing by the private sector. Outstanding bonds of the corporate market are on R14 billion.

The value of shares traded on the JSE security exchange remains high. The turnover values are not showing a sign of decline. Share price movements show no significant changes except on the 11 September 2001 but did rebound shortly thereafter.

Because the entire public sector is living within its means, there has been a decline in the bond yield. The borrowing requirement in the quarter April – June 2001 was R6.7 billion less than the corresponding quarter last year. This means that the borrowing requirement as a ratio of gross GDP was 0.9% in the second quarter of this year in comparison to the ratio of 4.1% in the same quarter last year.

Address by Governor of the Reserve Bank, Mr T Mboweni
The governor noted that the whole economy was slowing down even before 11 September due to the slowdown in the US economy. Everyone thought that Europe could whether the storm and a provide a counterweight to the US slowdown but subsequently Europe also started to slow down. Attention is drawn to Europe because it is an important trading partner of SA and a European slowdown is likely to have an effect on the demand of exports. It is important for people to take cognisance of the slowdown.

The governor also painted a negative picture for Asia and Latin America and emphasised the need to look at the global picture and ask where are we likely to go. Looking at other factors, you then get a better picture. The real GDP is increasing but this increase must be looked at in the light of the world slowdown because everyone thought that Europe would cope but the economies are in fact slowing down.

The consumer price index shows a downward trend. The Reserve Bank focuses on the CPIX for inflation targeting purposes. The governor said that the Reserve Bank must be held accountable to the CPIX because it relates to the fulfillment of the basic mandate of the Reserve Bank.

The net open position in foreign currency was reduced which means the liability of the country was reduced. This is a positive factor in the market.

Since the end of December 2000 until the 26 September 2001 the Rand has depreciated by 15.9%, the Brazilian Real by 39.5%, the Turkish Lira by 132.7%, the AUS$ by 12.3% and the $NZ by 8.4%. The South Korean Wog also depreciated.

The most dramatic developments have occurred since the beginning of July. Until the end of July the exchange rate was doing fairly well and there were even concerns that the Rand was over appreciated. Then in July uncertainty crept in about the Telkom intial public offering (IPO) and "things slowed down a bit". The Bredell Land invasion occurred and concerns about Argentina arose. At the beginning of August Zimbabwe was a big concern and in mid August NUMSA went on strike. There was a cooling-off period in early September but on 11 September SAA announced a postponement of its listing and the US was attacked.

From the end of last year to date there have been changes in stock exchanges around the world and therefore it is important to look at the global position as opposed to just looking at the JSE.

The Governor appealed to markets to focus on the fundamental economic factors:
- growth was good
- inflation is under control
- the fiscal position is firmly under control
- there is a nett inflow on share and bond markets
- the NOFP is reduced
- the reserve position is good
and note that the general picture is a good picture. If markets look at these positive fundamental economic factors then it should reflect on the exchange markets, but the markets rather reflects sentiment and this is part of real life.

Referring to the newspapers, he said that it is reported that he has declared war on speculators. This is not accurate and the only point the Governor was making is that it would be fair if banks could verify all trades as being legitimate and not just punting. The Governor merely wants the rules to be obeyed, if rules exist.

Discussion
Dr Rabie (NNP) commented that the Rand is very vulnerable, especially in the past couple of weeks. Investors also see the Rand as being vulnerable. He asked what they can do to change this.

Mr Mboweni asked to which party the member belonged and thereafter said that the comments of the leader of his party did not help at all. Those comments involved giving political reasons as to why the Rand is performing so badly. "We need to look in-house before we start pointing fingers. We need to peruse the programs agreed to; we cannot promise that there will not be strikes but the manner in which they are managed is important. South Africa is painted with the same brush as all emerging markets. If something happens in Argentina it affects all of us. There is nothing we can do about this. Maybe the emerging markets can come together to discuss the issues. More than anything else we must maintain our position on macro economic policy, the policy is the correct one. Business, international organisations have praised the policy".

Again the Governor appealed to the markets to look at the macro economic numbers. But even with depreciation of the Rand, there are opportunities for business people due to the exchange rates making the export markets attractive.

Dr Koornhof (UDM) said that speculators are messing up the lives of millions in SA. Should one not think about ways of discouraging this? His second question related to the escape clause. He asked at what stage the escape clause will be invoked because eventually the weakening Rand will impact on the inflation target.

Mr Mboweni in reply to the first question said that for a long time there has been an idea by a former economics nobel prize winner that foreign exchange transactions should be taxed to give government better control and discourage speculators. There is no position on this at the Reserve Bank. At the end of the day taxation is a question for National Treasury not for the bank. Sometimes the effects of speculators are not negative but they do want real and fair trades on the foreign exchange markets.

In response to the second question the governor said that the Reserve Bank will be concerned if the depreciation shows a significant second round impact. At the moment it is too early to be talking about escape clauses and the bank will not invoke them at the slightest signs of trouble.

Ms Taljaard (DP) asked what is the planning and projections around the setting of the inflationary targets next year. She referred to the rumour that the first targets were set by the Minister without consultation and therefore wanted to know to what extent the Reserve Bank is involved in determining the targets. Secondly, she asked why the COSATU strike was not mentioned as a factor by the Governor.

The Governor replied that targets setting is done by a working group. The group consists of National Treasury and the Reserve Bank. A preliminary report has been made and a final report is due. Hopefully when the Minister presents the mid-term review the targets will be released. The process is a joint process and whatever targets are released have been jointly agreed upon.

He said that the COSATU strikes were not mentioned because they did not have as big an effect as the motor industry strike because this strike was longer and involved major export orders.

A member (ANC) asked if the increased gold price will contribute to job creation and fewer mine closures.

Mr Mboweni said that the Gold Crisis Committee has not been meeting and the national Union of Mineworkers (NUM) is quiet so this says something about the gold industry. The exchange rate is good news for mining because mines that are under threat can survive longer. The Governor said that he was not in a position to comment on job creation.

Ms Mahlangu (ANC) commented that little focus had been given to developments in African countries especially in the light of the New Africa Initiative. There are only a few comments on the SADC countries.

Mr Mboweni replied that the unfortunate truth was that economic development in Africa does not have a global impact. This is sad but true. Part of the New African Initiative is to improve the economic performance of African countries. Congo approached the bank a few years ago for assistance in establishing a central bank and financial infrastructure. A team was set up to discuss assistance but it seemed as if the Congo was not taking the matter seriously. Rwanda also requested assistance and within two weeks of the request, a team was in Rwanda to assist. Rwanda was serious and focussed about getting a financial infrastructure in place.

Prof. Turok pointed out that Chile is doing quite well and referred to the mechanism whereby the Central Bank holds a 10% deposit of all investment coming into the country. Malaysia abandoned this mechanism and now it is doing badly. He asked if there was some kind of connection or if it was coincidence.

Mr Mboweni said that it was more coincidental than deliberate. The mechanism involves keeping 10% in the Central Bank for one year interest free, but this was never used in Chile. Chile has a resilient economy with major mineral explorations that are not affected by the developments in Argentina.

Prof. Turok referred to a quote in the newspapers stating that ‘globalisation limits independence’ and asked if it was correct.

Mr Mboweni said that more accurately, the quote stated that ‘the advent of globalisation limits the independence of nation states to set domestic policy’ and that it was correct. Internationally it is assumed that certain international macro economic factors must be followed. On a domestic level either you play ball or get left behind. If investors do not like what they see, they simply do not invest.

Mr Bekker (IFP) said that SA is on the top of the heap of emerging markets and wanted to know what is the possibility that SA would move to the next category and what are the international requirements in this regard.

Mr Mboweni replied that SA is a developing country and to move up, the GDP and the per capita income must be improved. Only then a move to the OECD category is possible. But at the same time "we must remember that we are an African country and that we cannot change our geography. So even if we move up, our obligations to the rest of Africa remain".

Mr Mnguni (ANC) asked if there are any contingency plans in place for the depreciating Rand and also if the Rand is properly valued.

Mr Mboweni replied that he had said enough about the exchange rate that day. "Our currency is not the only currency that is depreciating". The factors influencing the depreciation has nothing to do with the fundamental economic development but everything to do with sentiment. The mandate of the Reserve Bank is inflation targets and this must be the focus. The exchange rate only becomes important if it has a second round effect on inflation.

In conclusion the Governor said that when he goes shopping people ask him about the depreciating Rand. They say that because of the Rand, they feel weak. The Governor replied that if they want to feel strong, then SA must win the Tri Nations or a World Cup. The Reserve Bank focuses on whether your money can buy all the goods and services here in SA and not in London.

Presentation by Ms Noelani King, Group Economist, PSG Investment Bank
Ms King approached the SA economic situation from a psychological point of view.

As an introduction she pointed out the contributors to economic growth. These include high quality human capital, government’s overall policy approach, institutional factors, external factors, socio-political stability and sufficient savings.

She said that long periods of stability can be broken by trivialities and in the real world, serious problems like Japan have no impact but smaller problems like the Asia currency crisis of 1998 had a huge impact.

Conventional economic theory views the economy as a machine with predictable and controllable behavior while they are in fact like living organisms that are difficult to predict and manage. The conventional theories of economics fail to provide explanations or solutions to economic disasters. Even before the terrorist attacks, they were unable to explain and understand why domestic markets operate the way they do.

There are international policy rules and SA passes this test with flying colours yet investors are not flocking to SA. The reason for this is that investors have changed their focus. Even when African countries have met IMF requirements there has not been a growth in investment. Markets do not consider conventional economic theory. Instead of focussing on macro economic fundamentals, they focus on the structural and socio – political factors. These factors include the broader political environment, slow pace of privatization, HIV/AIDS, regional instability, crime, corruption poverty, immigration laws, inflexible labour market etc.

The foreign direct investment (FDI) in SA is dismal. Conventional economics says that first you have growth, then investment will follow. Ms King asked the question - whether the lack of growth is the only reason why SA cannot attract FDI. She identified structural adjustments, significant tightening in fiscal policy and a series of external shocks as contributing to weak growth. These factors depressed consumer, business and foreign investor confidence. Financial markets are driven by sentiment and sentiment towards SA is negative.

All the factors affecting the Rand are still around. Only 4% of the depreciation can be attributed to the terrorist attacks. Even if all the factors are removed from the equation, the Rand will still depreciate. The reason for this is the Nett open foreign currency position. "As long as we have a NOFP there will be speculation. We therefore need to eliminate the NOFP so that some of the capital that comes into SA must go into the SPOT market then the problem of speculators are addressed".

The overall GDP savings in the SA economy is at 15,5%. The international norm is 20% to actively promote economic growth. To stimulate domestic savings, sentiment would have to improve. Investment will only come if the potential returns exceed the risks taken. Investors will take more risks if certain conditions exist in the environment. These conditions include political stability, strong financial system, competitive currency and tax environment and a low inflation environment etc. Savings is important because if unfavorable it not only keeps foreign investment out but it encourages domestic investors to seek opportunities abroad.

Because of SA’s low level of foreign debt, low exposure to US imports and its healthy financial position, its economy is somewhat insulated but there is no doubt that the terrorist attacks did have an impact.

In conclusion, she said that the Reserve Bank must not only be inflation orientated but also growth orientated like the Federal Reserve Bank in the US.

Presentation by Mr Jac Laubscher, Chief Economist Sanlam
Mr Laubscher noted that SA does not achieve high rates of economic growth but it also does not slump to lows. There was only one period of negative growth in the past few years. Matters were on the whole looking good and were looking like improving. The terrorist attacks came at an inconvenient time so now, things do not look like improving any longer.

The presenter highlighted the following key points from the Reserve Bank Report:
- Economic growth is moderating
- Exports are performing well
- Inflation target to be attained
- National finances are sound
- Employment creation sluggish
- Productivity growth because of job shedding
- Capital account remains vulnerable
- Improvement in trade account cancelled out by the deterioration in services account
- Steep depreciation in the Rand

International Outlook
The National Association of Purchasing Managers (NAPM) Index when compared to the GDP growth in the US clearly indicates a relationship between the two. The NAPM is expected to go down. This however depends on consumer confidence that is in turn related to retail sales. The leading opinion is that consumer confidence will not be as bad as during the Gulf War but there is no doubt that it will decrease in the US and spill over to other countries.

Major banks like HSBC, UBS Waarlburg and Merryl Lynch forecast that by the second half of next year, economies will have healthy growth rates. Europe will weaken and then turnaround and the same for Asia.

The international economic outlook will be the following:
- further weakening is expected
- heavily dependent on consumer confidence
- lower turning point postponed
- commodity prices under pressure
- negative for emerging market economies
- further easing in monetary policy expected
- fiscal policy to become expansionary
- greater awareness of risk
- constraining international capital flows

Implications for SA
The implications for SA are the following:
- Rand weakness
- Lower export volumes
- Weaker current account
- Lower economic growth

The Rand is the fourth weakest currency in the world in relation to currency movements to the US$

Mr Laubscher concurred with Ms King that the NOFP must be removed. When it is removed, then the Rand will not be thought of as a one-way train going down. Speculators at the moment only thinks that the Rand will go down. Speculators must start to think that the Rand will go up.

As far as the monetary policy implications are concerned, one must beware of sentiment. Financial markets should not dominate thinking because markets are fickle especially since the emerging market crisis in 1998. There exists a relationship between the oil price and the US$. It is expected that the oil price will go down so the US$ will go down. The Reserve Bank has cut the repo rate as did many banks around the world.

The presenter felt that inflation targeting should be retained. Since inflation targeting has been used, the repo rate has been more stable. This leads to a more stable monetary policy and a stable environment for business to operate in. Until recently nobody knew that an escape clause existed. It is important that the everyone knows when it will be invoked.

In conclusion, Mr Laubscher said that it was not necessary to change the inflation target from the current range of 3% – 6%. At the moment the inflationary rate is at 6% but the average rate is not yet within the range. One must first have the rate in the middle of the range before thinking about changing it. If the range is changed to 3% – 5% then the Reserve Bank would have to adopt a tighter monetary policy.

The Chair thanked the presenters and closed the meeting.

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