South African Reserve Bank briefing on International and Domestic Economic Developments

FINANCE PORTFOLIO COMMITTEE
29 March 2006
SOUTH AFRICAN RESERVE BANK BRIEFING ON INTERNATIONAL AND DOMESTIC ECONOMIC DEVELOPMENTS

Chairperson: Mr N Nene (ANC)

Documents handed out:
Presentation by the South African Reserve Bank

SUMMARY
The South African Reserve Bank gave the Committee an overview of recent developments in the international and domestic economies. The main risk to South Africa’s inflation rate remained the price of oil. The main drivers behind the oil price in the first months of 2006 continued to be concerns about unrest in Nigeria’s oil region; concerns about possible United Nations sanctions against Iran, as well as speculation about the adequacy of supplies in the United States. The recent developments in the domestic economy saw the real gross domestic product increase at an annualised rate of 3.5% in the fourth quarter of 2005, which was slower than the rate of 4% in the third quarter. The slower growth was mainly as a result of a decline in the real value added by the primary sector and slower growth in the secondary sector.

Growth in real final consumption expenditure by households accelerated to an annualised rate of 7% in the fourth quarter. This was the highest annual growth in real consumption expenditure registered since 1981. The implication of this expenditure was an increase in household debt as a percentage of disposable income and resulted in the decline in gross saving as a percentage of GDP. It was at only 13%, and had been on a downward spiral since 2002. Employment increased by 102 000 people but the unemployment rate was still high at 26.7%, which was higher than in March 2005 because even though more jobs were created, the labour force grew even more.

There had been continued success in achieving the inflation targets for the last 29 months and the Reserve Bank had seen significant moves in the share markets since May last year. The all-share index had increased by 60% since then, and reached an all-time high last month. The economy had been growing robustly at rates of 4% and 5%. The discussion around the need for a growth rate of 6% had given the impression that the current rate was too low. This was not the case.

Members asked whether price increases for local consumption services would add to the inflationary rate; whether the Bank’s exchange rate policy was to the detriment of local exporters and whether foreign direct investment inflows were dominated by one transaction.

MINUTES

South African Reserve Bank (SARB) briefing

Mr B Kahn, Senior Deputy Chief Economist said that the main risk to South Africa’s inflation rate remained the price of oil. The monthly average spot price of Brent Crude Oil increased from $56.75 per barrel in December 2005 to $62.89 in January 2006, before declining moderately to $59.91 in February. The main drivers behind the oil price in the first months of 2006 continued to be concerns about unrest in Nigeria’s oil region; concerns about possible United Nations sanctions against Iran, as well as speculation about the adequacy of supplies in the United States.

Despite these concerns, the International Monetary Fund (IMF) forecast that the world economy was expected to grow at about 4.3% this year. The advanced economies had slowed down since 2004, but they were expected to grow a little more this year. The main growth emphasis was coming from the developing and emerging world. Africa’s growth was expected to be 6%, while Asia’s was 7.2%. The world inflation rate had also not been seriously affected by the high oil prices either. It was expected to come down slightly from 3.9% to 3.6% this year. Japan for instance, had just come out of its deflation with the higher rates being found in developing countries. The highest rates were concentrated in the Southern African Development Community (SADC) region, with the highest Zimbabwe with inflation over 600%. Global monetary policies were generally being tightened, with America increasing its interest rates on 28 March.

The recent developments in the domestic economy saw the real gross domestic product (GDP) increase at an annualised rate of 3.5% in the fourth quarter of 2005, which was slower than the rate of 4% in the third quarter. The slower growth was mainly as a result of a decline in the real value added by the primary sector and slower growth in the secondary sector. Growth in real value added accelerated in the sector supplying electricity, gas and water as well as the construction sector. However, these increases were not sufficiently strong enough to offset the decline in manufacturing production. Even though the South African economy lost some growth momentum in the final quarter of 2005, real GDP grew by 5% as a whole, following an increase of 4.5% in 2004.

After having recorded growth at an annualised rate of 6% in the third quarter of 2005, growth in real final consumption expenditure by households accelerated to an annualised rate of 7% in the fourth quarter. This was the highest annual growth in real consumption expenditure registered since 1981. Most of the expenditure was on durables rather than non-durables and services. The implication of this expenditure was an increase in household debt as a percentage of disposable income. At present it was about 66%, which, though it was high, was offset by the low cost of servicing the debt due to the low nominal interest rates. This high level of debt was reflected in higher credit extension to the private sector. This was primarily in mortgage advances and other asset-based credit such as motor vehicles.

Real gross fixed capital formation rose at a brisk annualised rate of 8% in the third quarter of 2005 and 7.5% in the fourth. This reflected solid expansion of real capital outlays by private business enterprises and public corporations, whereas real gross fixed capital formation by the Government recorded no growth in the fourth quarter of 2005. Real gross domestic final demand increased from an annualised rate of 6% in the third quarter of 2005 to 8.5% in the fourth quarter. This was a result of faster growth in real final consumption expenditure by households and Government, as well as real gross fixed capital formation. All of this resulted in the decline of gross saving as a percentage of GDP. It was at only 13%, and had been on a downward spiral since 2002.

According to the Quarterly Employment Statistics (QES) survey by Statistics South Africa, formal non-agricultural employment increased by 7.8% in the second quarter and 5.9% in the third. Over the four quarters, employment increased by 102 000 people. However, the Labour Market Survey showed that the unemployment rate was still high at 26.7%, which was higher than in March 2005 because even though more jobs were created, the labour force grew even more.

There had been continued success in achieving the inflation targets for the last 29 months. The figure for January was 4.3%, with the market expecting it to rise to 4.6% for March. Production prices were on an upward trend to 5.5% in January. The higher expenditure had an impact on the balance of payments of the country. Notwithstanding the contraction in the trade deficit, the larger deficit on the net services, income and current account transfer account caused the deficit on the current account of the balance of payments to widen further from R68.4 billion in the third quarter of 2005 to R71.6 billion in the fourth quarter. The net capital inflow on the financial account of the balance of payments amounted to R98.4 billion: the largest annual inflow ever to be recorded, which meant that South Africa could finance its current account debt.

The Rand exchange rate had been fluctuating quite a bit against the dollar but the nominal rate had been a lot more stable. On balance, the Rand declined slightly by about 2%. There had been no major developments in the short-term money markets where the repurchase rate had stayed the same since April last year. What was significant was that the long-term rates had come down from 10% in 2004 to about 7.5% last year. This in part was an expectation of lower interest rates, and partly a decline in the public sector borrowing requirements.

The SARB had seen significant moves in the share markets since May last year. The all-share index had increased by 60% since then, and reached an all-time high last month. This reflected an expectation of the increased growth of the South African economy.

Mr T Mboweni, the SARB Governor, said that although compared to some of the emerging markets, the household debt as a percentage of gross income was not that much of a burden for people now, there was the danger that if the debt servicing costs changed, some households would be in serious trouble. He wanted to communicate a message to the public to ensure that their debt did not take up too much of their income.

He also wanted to emphasise that the economy had been growing robustly at rates of 4% and 5%. The discussion around the need for a growth rate of 6% had given the impression that the current rate was too low. This was not the case; the economy was growing at a very fast rate right now. The country should be happy at the current rate, especially as research had shown that the potential output for South Africa’s economy was a rate of 4.5%. This meant that the economy had been working exceedingly well. Unfortunately, this high rate of growth meant that there could be inflationary consequences “down the road.” There was also growth in the employment numbers, which meant that the economy was producing jobs. This was good, and proved many detractors wrong.

South Africa’s current account deficit was at about 4.2%. The number of variables that created this imbalance would begin to correct themselves in the future, and the SARB would have to keeping watching them to the extent that they had inflationary consequences.

Discussion
Mr B Mnguni (ANC) said that since the international community was raising interest rates and South Africa was not, did this not mean that South Africa would be ill-prepared for inflation? Would the proposals of the Department of Public Enterprises to increase the price of electricity, and the Department of Provincial and Local Government to increase the salaries of its employees have any effect on inflation in the country?

Mr Mboweni replied that countries like the US were raising interest rates from very low levels. South Africa’s rate had been at about 7% for a while, and in the last meeting of the Monetary Policy Committee it was decided that it should be left at that rate. The bias of the committee was towards tightening the rate, and he would be very surprised if anyone on the Committee would argue for a reduction in the rate. He said that the increase in salaries and electricity prices would have a once-off base effect for about six months, and the monetary policy could not be changed in reaction to this. What would be an issue was if these increases led to a rise in salaries across the whole economy.

Mr K Moloto (ANC) said that some people had called for a weakening of the Rand since it adversely affected the value of exports. What was the SARB’s position on this issue?

Mr Mboweni replied that the SARB’s official position was that it wanted a competitive and stable exchange rate, “nothing more and nothing less.”

Ms J Fubbs (ANC) said that as a figure the amount of foreign direct investment (FDI) was considerable, but the Barclays/ABSA deal brought in most of the money. This distorted the true picture of FDI. What was his opinion on this?

Mr Mboweni replied that the inflow from the Barclays/ABSA deal was substantial but it involved a complex system of deal structuring. The SARB also ‘creamed-off’ a substantial portion of the foreign exchange brought in. A number of other FDI deals were concluded last year by Vodacom and another by Ford Motors.

Mr Y Bhamjee (ANC) asked if the behaviour of estate agents contributed to the high property prices in any way. Was any investigation being done into their conduct?

Mr Mboweni replied that he had a meeting with one of the Chief Executives of a large bank and they agreed that there were a number of issues that had to be dealt with regarding estate agents and mortgage originators. These two groups may be collaborating in pushing up house prices, but this was a matter that had to be dealt with primarily by the Department of Housing.

The meeting was adjourned.