LATEST DEVELOPMENTS
With the exception of the primary sectors, widespread growth took place in the fourth quarter of 1994.
Growth in the gross domestic product was 2.3% for 1994 - considerably lower than the 5.9% increase in gross domestic expenditure.
The increase in the real gross national product in 1994 exceeded the population growth for the first time since 1988.
Real consumption expenditure rose at a fast rate throughout 1994, mainly as a result of increased expenditure on durables and semi-durables.
Consumption expenditure is increasingly being financed by the drop in private savings and a sharp increase in consumer credit.
Real fixed investment increased by 7% in 1994. This is a positive development for future growth.
The surplus on the current account of the balance of payments changed into a fairly large deficit in the second half of the year.
The capital account swung from a net outflow to a net inflow in the course of 1994.
The country's net gold and other foreign reserves increased sharply in the second half of 1994, causing the exchange rate of the rand to stabilise. However, the year as a whole saw a weakening in both the nominal and the real effective exchange rate of the rand.
The rand is performing reasonably well against the dollar, mainly because of the weakness of the latter. However, the rand has been weak against the other major currencies over the past months.
Long-term rates are moving sideways, while a rising trend is evident in short-term rates. A rise of one percentage point in the Bank rate and more stringent monetary policies were announced in February.
The Budget should have a neutral to stimulating effect on the economy. Personal disposable income of especially the middle- and high-income groups will be adversely affected, while the low-income group stands to benefit.
The rate of increase in the production price index continues to rise, reflecting pressure in domestic capacity levels, and the rate of increase in the prices of imports has accelerated considerably.
PROSPECTS
Expenditure is expected to remain in excess of production levels, which will keep imports at high levels.
Real personal disposable income will remain under pressure owing to higher prices, the raising of the marginal tax rate and bracket creep, and a decidedly worse agricultural year.
The increase in consumption expenditure in the current recovery phase will probably be less than in previous ones, and the increase in purchasing power will gradually gravitate towards the low-income group.
The manufacturing industry - and not agriculture - will be this year's major growth sector. A growth rate of 3% is foreseen for the non-agricultural sectors, but this figure will be closer to 2.5% if agriculture is included.
Short-term interest rates may tend to firm.
The deficit on the current account of the balance of payments is growing owing to the stronger import propensity, which is in line with the surge in expenditure. Exports are expected to improve in 1995.
A large net inflow of foreign capital will be necessary to finance the deficit on the current account.
The pressure on domestic capacity levels and higher import prices because of the weaker rand exchange rate will force prices upwards.
BALANCE OF PAYMENTS POSITION
The balance on the current account of the balance of payments (annualised) swung into a deficit of R5.4 billion in the third quarter and R7.0 billion in the fourth quarter, From an average quarterly surplus of R2 billion in the first half of 1994.
The primary reason for this was a substantial increase in goods imports, the value of which rose by 27.1% (17.3% by volume) in 1994. In particular, capital goods destined for certain major investment projects contributed to this sharp increase. Imports are expected to increase further as a result of anticipated higher economic growth.
The total value of goods exports rose by 17.5% in 1994. The decline of 11% in real net gold exports contributed to the turnabout in the balance on the current account. The export performance should nevertheless improve thanks to positive international growth prospects and the benefit of high commodity prices, expected to rise further over the next few months.
The weakening in the current account of the balance of payments is particularly alarming if capital imports should fall below consumption goods imports. In this regard the extent of capital flows and the reserve position are of vital importance. The net inflow of capital for 1994 as a whole was R5.2 billion, compared with a net outflow of R15.0 billion in 1993. Although R1.4 billion of this was of a long-term nature, the greater portion of the capital inflow (R3.8 billion) consisted of short-term capital - which does not necessarily boost the reserve position.
Owing to the total net capital inflow, the net gold and other foreign reserves increased by R3.0 billion in the fourth quarter of 1994. In February this year the reserves could pay for approximately six weeks' imports, which is far below the international standard of three months.
The nominal effective exchange rate of the rand dropped by 8.5% in 1994, and the real effective exchange rate by 3%. The financial rand was discontinued in March, and the possible effects of this will only become evident in the course of 1995. Although the repeal of non-resident exchange control holds long-term benefits for the economy, one should bear in mind that the combined rand will be the future barometer of international confidence in the South African economy. This renders the balance of payments highly vulnerable to political and social instability, since foreign investors are now much more able to shift funds from market to market. Should the exchange rate weaken drastically, a more stringent monetary and fiscal policy, supported by less dramatic wage demands, will have to be applied.
GOVERNMENT FINANCES
Issues increased by 2.3% in the 1994/95 financial year. The budgeted increase in expenditure for fiscal 1995/96 is 9.5%, which, if expressed as a percentage of the expected gross domestic product, comes to 30%. This indicates a still significant government share in the economy. Although capital expenditure comprises a larger portion of government expenditure, it is mainly on social programmes and rather less on the establishment of economic infrastructure. In fact, expenditure on economic services has dropped to only 10.2% of total expenditure, compared with 12% in 1994/95.
Receipts for fiscal 1994/95 are 13.5% higher, while the budgeted increase for fiscal 1995/96 is 11.3%. This relies mainly on improved economic growth and a heavier tax burden on individuals in especially the middle- and high-income groups. Government receipts as a percentage of the gross domestic product will come to approximately 24% in 1995/96. The sharp increase in taxes will detrimentally affect individuals' productivity and ability to save - both important building blocks for greater prosperity as set out in the Normative Economic Model of two years ago.
The deficit before borrowing as a percentage of the gross domestic product was 6.4% in 1994/95 and is budgeted at 5.8% for 1995/96. This represents a deficit of R29.1 billion. The concomitant dissaving by the government will once more make inroads on net private investment. The necessity of new capacity additions by the private sector and the uncertain foreign capital inflow position mean that the relatively large budget deficit may lead to higher interest rates.
The 1995/96 Budget is regarded as accommodating from a foreign investor's point of view; however, domestic stability will be the decisive factor if foreign investors are to be attracted to South Africa.
REAL ECONOMIC ACTIVITY
Domestic production in the fourth quarter was 2.1% up on a year ago, and an average growth rate of 2.3% was recorded for 1994. The growth rate in agricultural production slowed in 1994 and is expected to drop sharply in 1995. Crops in the summer rainfall areas could be as much as 60% smaller than in the previous season, and the financial loss to farmers is estimated at approximately R3 billion. If the multiplier effect is taken into account, the total production loss in the economy could reach about R5 billion.
Mining production rallied slightly in the second half of 1994, to rise in both third and fourth quarters at an annual rate of 0.5%. The goldmining industry - South Africa's largest single foreign exchange earner - last year returned the lowest production in many decades (6% less than in 1993). By contrast, the world coal market has recovered well.
In the second half of last year physical volume of production in the manufacturing industry increased at an annual rate of 11.9%, compared with the first half. The improvement in this sector was widespread. This sector will have to provide the boost for further growth in 1995 and 1996.
As a result of the growth in the real domestic production and a healthy improvement in the terms of trade, the real gross national product increased by 3.5% in 1994.
Real gross domestic expenditure rose sharply in the fourth quarter of 1994 for the sixth consecutive quarter. Consumption expenditure has been relatively high in the past few months and is increasingly being financed by means of bank credit. Net saving by households as a percentage of the gross domestic product decreased from more than 3% in the first quarter of 1993 to 1.5% in the fourth quarter of 1994. It is generally expected that the increase in consumption expenditure in the present recovery phase will be slower than in previous ones, and that purchasing power will continue downward on the income scale.
Real gross domestic fixed investment increased by 7% for 1994 as a whole - the first year-on-year increase since 1989. Sustaining the present upswing momentum is therefore heavily dependent on investment. The current schedule of capital expenditure projects shows a significant increase for 1995.
The economic situation in 1995 will be determined mainly by confidence. Both investors and consumers would like the assurance that stringent fiscal policy and a stable socio-political environment will be maintained.
Along with faster economic growth for this year, even greater unemployment is foreseen. The Department of Labour estimates the jobless at 43% of the labour force. In spite of the economic upswing, employment in the non-agricultural sectors during the first half of 1994 stood at the lowest level in more than ten years. Moreover the agricultural sector, traditionally one of the major employers, is suffering the worst drought in years.
INFLATION
The average rate of increase in the production price index in 1994 was 8.2%. In January this year it stood at 10.5%.
As manufacturing production and fixed investment increase, the price index of domestically produced goods will see increased pressure. The prices of imported goods are rising faster as well.
Real remuneration per worker is estimated to have risen by some 3.5% in 1994, while the 4.4% growth in labour productivity in the fourth quarter of 1993 slowed to 3.1% in the second quarter of 1994. As a result real unit labour costs in the non-agricultural sectors have increased. Higher wage demands without a matching increase in productivity will push prices further upward.
The rate of increase in the consumer price index in 1994 was 9.0%. Some of the factors putting upward pressure on the inflation rate are the sharp growth in the money supply, high wage demands and high food prices. The core problem, however, is expenditure rising faster than production. An average inflation rate of around 10.5% for 1995 and 11% for 1996 is anticipated.
MONETARY MAGNITUDES, INTEREST RATES AND FINANCIAL MARKETS
The M3 growth rate from March has been constantly higher than the upper limit of the guideline band of 6-9% for 1994. Growth in the M3 money supply nevertheless fell back in January to approximately 13% from the previous high of 16.9% in July 1994.
Credit extension to the private sector was chiefly to blame for the acceleration in money supply growth. In February the Reserve Bank imposed stricter monetary policies, including a one percentage point rise in the Bank rate and an adjustment of the guideline band for growth in the money supply, to 6-10%. In addition, the cash reserve requirements for the private banking sector were raised by one percentage point.
As a result of an expected acceleration in the inflation rate, higher international interest rates, the need for foreign capital and great demands on the local market on account of the government's financing needs, a further rise of two percentage points in the Bank rate is foreseen for 1995.
The rise in long-term rates has largely discounted the abolition of the financial rand over the past few months. The government's intended utilisation of offshore loans could temper upward pressure on rates to some extent. However, indications that international long-term interest rates would remain high in the foreseeable future should cause local rates to fluctuate between 15% and 17%. This may result in a flatter yield curve.
Industrial share prices declined by about 10% since the end of last year, but have firmed again somewhat since the abolition of the financial rand. Although companies' earnings growth may be quite vigorous this year and the next, a cyclical upswing in the economy usually points to a revaluation of shares. Price/earnings ratios are therefore expected to tend lower in the coming months. Gold shares have been dented somewhat by the demise of the financial rand. The weakness in the gold price and goldmines' continued production cost increases reduce the possibility of a marked rise in gold share prices in the near future.
Report completed on 22 March 1995
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Quarterly South African Economic Monitor April 1995
