Remarks at the release of the 2010 annual economic report and September 2010

Remarks at the release of the 2010 annual economic report and September 2010 quarterly bulletin of the South African Reserve Bank by Dr Monde Mnyande, Advisor to the Governor and Chief Economist, Pretoria

22 Sep 2010

Chairperson and Governor, Ms Marcus
Board of Directors of the South African Reserve Bank, members of the Press and colleagues

1. My task is to introduce the 2010 annual economic report and the September 2010 quarterly bulletin. Given time constraints, the intention is not to give a comprehensive presentation covering all aspects contained in these publications. Instead, only a few key points and themes will be touched upon, so as to whet your appetite for further reading.

2. The annual economic report presents the broader economic context within which the South African Reserve Bank (SARB) has had to operate and formulate monetary policy during the past year. My remarks today will mainly relate to this publication, with its focus more on medium to longer term trends.

3. As far as the global picture is concerned, the past year has been a period of recovery, fragile and uneven recovery across our major trading partners, in economic and or trade activity. The volume of global trade is currently back to its early 2008 pre-crisis peak level. However, led by countries such as China and India; the emerging market economies as a group, have managed to raise exports more vigorously than the developed economies. The developed economies' exports have not quite recovered to earlier peak levels.

4. To support the fragile recovery, monetary policy in the major developed economies has been expansionary. Interest rates have been very low, while quantitative easing resulted in strong expansion of central bank balance sheets. The abundance of central bank liquidity, however, did not result in much expansion of the private banking sector's credit extension, as lenders and borrowers alike remained very cautious.

5. Strong fiscal policy stimulus was also maintained. However, along with structural economic weaknesses, the rapid escalation of government debt (and in the case of Greece the discovery of a weaker fiscal position than previously presented or known) resulted in serious sovereign debt concerns. This was reflected in rising yields on bonds issued by the governments of Greece and a number of other European countries, which only receded once a large support package was announced in May this year by the European authorities and the International Monetary Fund (IMF). Fiscal stimulation was reduced and austerity measures introduced in a number of countries. However, it was clear from the renewed increases in yields on such bonds in the third quarter of this year that deep-seated concerns remained.

6. The improvement in global economic activity and in international commodity prices along with domestic monetary and fiscal stimulus resulted in a cyclical improvement in the South African economy.

7. Whereas the South African economy contracted for three consecutive quarters, from the final quarter of 2008 to the second quarter of 2009, positive growth was restored from the third quarter of 2009, accelerating to 4,6 percent in the first quarter of this year before moderating to 3,2 percent in the second quarter. Manufacturing production recorded brisk increases in both the first and second quarters of 2010. Output in the services sector was supported by expenditure related to the 2010 FIFA World Cup tournament.

8. Among the expenditure components, real final consumption expenditure by the household sector contracted for five successive quarters before resuming an upward trend from the final quarter of 2009. Expenditure on durable and semi-durable goods in particular, registered brisk increases, albeit from a low base.

9. One of the reasons for the recovery in household consumption expenditure is the rising net wealth of the household sector, brought about by an improvement in the prices of houses and shares. A note in this quarterly bulletin provides further information on developments in household wealth, and the ratio of household net wealth to disposable income will henceforth be published in the Quarterly Bulletin, in addition to the ratio of household debt to disposable income which has already been published for many years.

10. The level of real fixed capital formation declined somewhat over the past year, with increases in capital expenditure by the public corporations which were more than offset by lower capital outlays by the private and government sector. A marginal increase in overall real fixed capital expenditure was registered in the second quarter of 2010. Real consumption expenditure by government continued to rise firmly, reflecting improved service delivery and the acquisition of military equipment.

11. Not unexpectedly and as determined by tardy recovery in demand, private sector employment contracted significantly in 2009 and continued to do so in the first quarter of 2010 but at a slower pace than before. While the private sector continued to shed jobs, employment numbers in the public sector increased somewhat.

12. Wage settlements continued to moderate in the first half of 2010 though they remain above the upper limit of the inflation target range. Unit labour cost is also expected to fall in the third quarter. In the third quarter a salary dispute in the public service resulted in strike action.

13. The targeted consumer price measure of inflation decelerated to below the six percent mark from February and remained within the inflation target band in the six months to July 2010. By July, inflation had receded to below the midpoint of the target range, notwithstanding high administered price inflation.

14. The appreciation of the exchange value of the rand and low food price inflation managed to offset high administered price inflation. In recent months the real effective exchange rate approached levels previously observed in the early part of 2006.

15. On the external front, it is also worth noting that in the past year China has risen to the number one position as destination for South African exports, a position that was previously a preserve of the United States.

16. Overall export volumes remained lusterless in the second quarter of 2010 partly due to temporary setbacks to mining output. During the past year the favourable prices of South African export commodities nevertheless helped to contain the deficit on the current account of the balance of payments. It fluctuated higher from around three percent of gross domestic product in the second half of 2009 to 4,6 percent in the first quarter of 2010 as domestic demand picked up. However, it then narrowed to 2,5 percent in the second quarter of 2010 as expenditure by visiting football supporters soared during the 2010 FIFA World Cup tournament, and inflows of capital continued to assure the financing of the deficit.

17. The repurchase rate has been reduced from 12 percent to six percent since December 2008, initially quite rapidly but at a slower rate since late 2009. The rate was reduced by 50 basis points on each occasion in March and in September 2010, reflecting a more favourable likely future trajectory for inflation foreseen by the Monetary Policy Committee (MPC). With the repurchase rate at six percent from 10 September 2010, the banks' prime overdraft rate came to 9,5 percent, the lowest in three decades.

18. Despite the substantial reduction in interest rates over the past 21 months, credit growth remained weak during this period. Although banks' credit extension returned to positive growth in 2010, rates of increase remained moderate as lenders and borrowers remained cautious, affected by high debt levels, elevated impaired advances, weak employment prospects and uncertainty caused by the fragile global economic recovery.

19. During the past year the Reserve Bank continued to accumulate foreign currency. The money market effects of this action had to be offset by liquidity draining mechanisms in order to maintain orderly liquidity conditions in the money market. Over the past year, raising the level of government deposits with the Bank was an important avenue towards such sterilisation. Apart from the instruments routinely used so far, the Reserve Bank to this end also started using longer-term foreign currency swaps from August 2010. The spread of the Reserve Bank's standing facility rates above and below the repurchase rate was increased from 50 to 100 basis points with effect from the end of August.

20. After a notable recovery from March 2009 to April 2010, share prices receded somewhat and subsequently fluctuated broadly sideways.

21. House price inflation gained some momentum in the first half of 2010, but subsequently started to decelerate.

22. Fiscal policy remained expansionary during the past year, continuing to play a strongly counter cyclical role. Government expenditure levels remained high while tax receipts were subdued on account of the wide output gap. In recent months the economic recovery has had a favourable impact on government revenue, with the result that tax collections have moderately exceeded earlier projections and the deficit, while large, has started to narrow. This is consistent with government's aim to gradually reduce the deficit, broaden the tax base and improve tax compliance.

23. Finally, let me highlight further observations regarding the football tournament, as contained in a box and a note in the quarterly bulletin. In the second quarter of 2010, travel receipts from non-residents associated with the sport event amounted to roughly R3,5 billion (almost R15 billion when annualised). This raised travel receipts by almost 26 percent from the first to the second quarter of the year. It may also be pointed out that the tournament had a quite limited impact on the demand for notes and coin, an experience shared with other countries hosting major sport events in recent years. However, card transactions by non-residents did rise significantly on account of the football tournament.

24. In summary, the past year has brought some recovery in activity, although not in the country's key critical factor, i.e. employment, as well as lower inflation and improved inflation prospects, which have made it possible for the Bank to further reduce policy interest rates. Fiscal policy has remained expansionary. The past year has also been characterised by appreciation of the external value of the rand.

Questions are welcome.

Source: South African Reserve Bank

Issued by: South African Reserve Bank
22 Sep 2010