The low and falling level of foreign exchange reserves dominates the economic scene during recent months.
In October and November the exchange rate of the rand came under renewed pressure; capital and money market rates rose further while the inflation rate accelerated.
Domestic expenditure relative to income remains too high, which tempers the reduction of the deficit on the current account of the balance of payments. The relatively high increase in expenditure is accompanied by a continued high rate of increase in bank credit to the private sector in particular. Economic growth is tending lower.
The increase in government expenditure is rising faster than the budgeted figure. Receipts may also exceed the Budget. The deficit before borrowing may well exceed the budgeted figure.
These matters compelled the Reserve Bank to take further steps to protect the foreign exchange reserves and to combat inflation. As a result the Bank rate was raised by one percentage point to 17% on 21 November. ABSA Bank followed this example on the following day, raising its prime rate to 20,25%.
The increase in real gross domestic expenditure will probably slow down further in the coming year. The real growth rate may also decline further.
The deficit on the current account of the balance of payments may shrink considerably over the next two years. An expected net inflow of capital, bolstered by expected privatisation receipts, should cause net reserves to increase.
The inflation rate may accelerate during the months ahead; however, it is likely to slow again by late 1997.
These developments may well result in greater stability, and even moderate firming in real terms, returning to the rand exchange rate.
The fiscal deficit relative to the GDP may continue declining moderately if the privatisation of public assets is accounted for as revenue.
Capital market interest rates may discount these developments and should decrease. A cut in the Bank rate should not materialise before late in the second quarter of 1997 at the soonest, with further small cuts thereafter not excluded.
Balance of payments
(See graphs 1.1 - 1.8 and tables 2 - 4)
The deficit on the current account of the balance of payments declined in the third quarter of 1996. Seasonally adjusted at an annual rate, the deficit decreased from R16,8 billion in the second quarter to R11 billion in the third quarter. The deficit on the current account for the first three quarters of 1996 amounts to R10,5 billion.
The trade surplus is increasing gradually, and this trend is expected to continue. This should lead to a much smaller deficit on the current account in 1997 and 1998 - anticipated at R5,5 billion and R5,6 billion respectively.
The net inflow of capital decreased markedly in 1996. Net inflows of R0,26 billion and R2,62 billion were recorded for the first two quarters respectively, followed by a modest net outflow of R0,2 billion in the third quarter.
This gave rise to the net foreign exchange reserves falling by R2,03 billion, R2,09 billion and R3,73 billion in the first three quarters respectively - a total of R7,85 billion. A further negative development was that the gross reserves of the monetary bank sector declined from R19,9 billion at the end of 1995 to R15,7 billion at the end of September 1996, while short-term foreign liabilities increased from R27,4 billion to R32,5 billion.
Against this background the sharp decline in the external value of the rand is not surprising. Based on a basket of currencies the average decline in the nominal value of the rand from January to September amounted to 18,9%, while the rand weakened in the period September to November by a further 4,5% - a total decline of 22,6%. In the period January to November the rand weakened 27,9% against the American dollar (direct quotation), 39% against pound sterling, 23,6% against the German mark and 20,3% against the yen.
The rand is currently undervalued. In 1997 and 1998 the deficit on the current account will probably decrease and a net inflow of capital may again be possible - especially in view of the envisaged privatisation of public assets. Some of these assets will also be sold to non-residents. We therefore foresee a more stable course for the rand exchange rate in the coming year, perhaps even an increase in real terms.
(See graphs 2.1 - 2.8 and table 5)
In the first eight months of fiscal 1996/97 both government expenditure and receipts have outstripped budgeted figures.
Expenditure for the year was budgeted to increase by 10,4%. After three months of the current financial year the increase came to only 5,1%, but since then it has accelerated considerably to 14,5% after eight months. Given among other things the higher level of capital market interest rates, the deterioration in the rand exchange rate, forex cover losses, and an accelerating inflation rate, we foresee that government expenditure could exceed the budgeted figure by two to three billion rand.
Revenue has also surpassed expectations. An increase of 13,8% was budgeted for; however, the increase came to 17,3% after eight months. A marked acceleration in receipts has been recorded since July, probably as a result of improved collection. It is therefore safe to say that receipts will be approximately R1 billion higher than foreseen - even if the rate of increase should decline in coming months.
The expected net result, as indicated in table 5, is that the deficit before borrowing will exceed the budgeted figure marginally. However, it's uncertain whether all government expenditure (eg forex cover losses and the proportional provision for government stock issued at a discount) will be disclosed; this could affect the deficit materially. Depending on how these figures will be treated as well as the expected excesses on the part of local and provincial authorities, we foresee the published deficit before borrowing as a percentage of the GDP to be somewhere between 5,4% and 7%.
Real economic activities
(See graphs 3.1 - 3.8 and table 1)
The advance in real economic activities is tending weaker. This is evident from both GDP and GDE figures, with expenditure decreasing faster than production. This trend is expected to continue for the whole of 1997 at least.
Agriculture is having a good year, with summer grains yielding above-average crops. This, together with the decline in real agricultural output of 14,9% in 1995, explains this year's substantial increases in production. Compared with 1995, agriculture recorded an increase of 18% in real GDP in the second quarter of 1996 and 44,6% in the third quarter.
Mining output is generally not shaping well. A decline of 3,1% in 1995 was followed by a decline of 1,2% in the first nine months of 1996. The culprit is the goldmining sector (the amount of gold produced in the first ten months has dropped a further 7%).
Growth in the manufacturing industry is disappointing. Despite additional production capacity on account of the completion of megaprojects, production volumes decreased in the first nine months. The GDP figures for the manufacturing industry also reflect the sharp deterioration in production. Calculated on a year-on-year basis, the rate of increase for the latter declined from 9,5% in the second quarter of 1995 to 1,4% in the first quarter of 1996, followed by actual declines of 1% and 0,8% in the second and third quarters respectively.
The construction sector is void of any fireworks, and the increase for the first three quarters of 1996 came to just more than 1%. Some slowdown in the growth rate of the tertiary sectors was also observed: from 4,1% in the fourth quarter of 1995 to 2,2% in the third quarter of 1996. Judging by the number of foreign visitors it would seem that the tourist industry is still performing satisfactorily. Following a sharp increase in the number of foreign visitors in 1995, the first nine months of 1996 saw a further improvement of 7,1%. The number of visitors from abroad in September was 16,9% up on the figure for September 1995. The hotel industry is also reporting healthy reservation figures for the months ahead.
The real growth rate in private consumption expenditure is steadily declining. Consumption expenditure by the government sectors for 1996 may well exceed that of 1995. The rate of increase in real gross domestic fixed investment is on a downtrend, while the buildup of trading and industrial inventories is declining. In total the real GDE in 1996 will probably advance by approximately 3% (5,2% in 1995) and it could decline further over the coming year (see table 1).
This will probably lead to a further rate decrease in real imports. Export growth may improve over the next year on account of expected more favourable international growth rates, weaker domestic demand and South Africa's more competitive position because of the decline in the exchange rate.
We anticipate a growth rate of some 2% for 1997 and 2,8% for 1998. Whereas domestic expenditure featured as the growth engine for the past two years, it is expected that exports will take over this role in the following two years.
Job opportunities in the formal sector are expected to decrease owing to weaker growth prospects and the continued sharp uptrend in salaries and wages. The number of insolvencies and liquidations is foreseen to rise markedly further.
(See graphs 4.1 - 4.3 and table 6)
As predicted previously, the inflation rate has accelerated. From a low of 5,5% in April the CPI jumped to 9,1% in October, calculated on a year-on-year basis. The PPI increased from 5,3% to 8,3% during the same period. Regarding inflation three matters need to be highlighted.
Firstly, the sharp increase in the CPI is driven by food price increases. Food prices went up from 3,2% in the first quarter 1996 to 12,4% in October.
Secondly, the relatively low increase in the imported component of the PPI up to and including September, despite the sharp weakening in the exchange rate, remains a mystery. However, the October figure went up sharply, pointing to a new turn in the battle against inflation.
Thirdly, a sharp increase in the local component of the PPI has occurred. This is particularly evident from the seasonally adjusted monthly increases. Annualised, this component rose from 3,9% in the months February to April, to 12,9% in the months August to October.
We foresee a further acceleration in the inflation rate over the coming months. A peak in the rate of increase of nearly 11% is anticipated in the third quarter of 1997, after which it should come down to approximately 8% by the end of 1998.
(See graphs 4.1 - 4.8 and table 7)
The growth in the M3 money supply is surging ahead at a rate of some 15% since mid-1994. In October the rate of increase came to 15,9%. With net reserves falling since February 1996, bank credit to the private sector was mainly responsible for the increase in the M3. In October the increase in bank credit to the private sector came to no less than 18,86%. Similarly, total bank credit granted increased from 11% in October 1995 to 17,82% in October 1996, which is an indication that bank credit granted to the public sector has also accelerated.
This development, together with the low and still declining level of net foreign exchange reserves (with the exception of October, when foreign loans by government resulted in a small increase), the acceleration in the inflation rate and a still too large fiscal deficit, has compelled the Reserve Bank to maintain a tight monetary policy as reflected in the level of interest rates.
The money market deficit has remained substantial during the past couple of months, and money market interest rates have risen further since mid-October. The call rate firmed by approximately 1,75 percentage points to 17,25% at the end of November. The 12-month NCD rate went up by 1,2 percentage points and the 3-month BA rate by some 1,35 percentage points. These events were the logical forerunner of the Bank rate hike of one percentage point to 17% on 21 November 1996.
Capital market interest rates increased as well. The RSA R150 rate advanced from 14,96% at 13 September to above 16% in November but, mainly because of the Bank rate increase, fell back slightly to 15,88% on 29 November. Since then, it has increased to higher than 16% again.
Share prices on the JSE are tending lower. The prices of industrial shares reflect the rise in interest rates and the poorer growth prospects for 1997, while the prices of goldmining shares react in the main to the weaker-tending dollar gold price and the diminished gold output. These trends are likely to continue over the next couple of months, followed by an improvement in industrial share prices by mid-1997 - if interest rates decline in line with our expectations.
Report completed on 13 December 1996
The information in this publication is of a general nature only, does not constitute advice and may not be applicable to all circumstances. Detailed advice should be obtained in individual cases. No responsibility for any loss sustained by any person acting or refraining from acting as a result of material in this publication is accepted by ABSA Bank Limited and/or the authors of such material.