Journal Issue

IMF Policy Paper: South Africa - Staff Report For The 2012 Article Iv Consultation

International Monetary Fund
Published Date:
August 2012
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The Context

South Africa needs to build on its many policy successes to expand employment opportunities, secure better education and health outcomes, and build more efficient infrastructure to support inclusive growth, while maintaining macroeconomic and financial stability in a risky global environment.

1. The South African economic strategy adopted since 1994 has been successful on many dimensions. It has delivered macroeconomic and financial stability despite a volatile external environment. This has allowed South Africa to retain its ability to borrow abroad in its own currency at interest rates that reflect its investment grade rating. It has also achieved a nontrivial reduction in extreme poverty levels and an improvement in social indicators within a peaceful democratic process.

2. The challenge ahead is to deliver better outcomes on employment, education, health, and public infrastructure, while preserving macroeconomic stability.

The unemployment rate stands at 25 percent despite one of the lowest participation rates in emerging markets. Educational attainment is low and, reportedly, high school graduates lack marketable and practical skills to work or set up a business.1 A large share of the population lacks proper access to basic health care, and the degree of HIV infection is among the highest in the world. Shortfalls in public infrastructure have constrained growth opportunities.

3. If not addressed, the stubbornly high unemployment rate is likely to become politically and socially unsustainable. Job creation is rightly an urgent national priority. The New Growth Path (NGP) and the draft of the National Development Plan (NDP) have increased public awareness of the urgent need for planting the seeds that foster inclusive labor-intensive growth that reduces poverty and inequality.2 Achieving the job-creating targets in these documents calls for all key players, including government, business, and labor leaders, to put in place the needed policies and reforms.

4. The 2012 Article IV discussions centered on South Africa's policies for maintaining macroeconomic and financial stability under the uncertain and volatile global environment that has prevailed since the 2008-09 global financial crisis, while making firm progress on reforms that promote long - run inclusive growth. The discussions took place in the context of a significant slowdown in the global economy and higher tail risks. The authorities' macroeconomic policies have generally been consistent with staff's recommendations, although labor and product

A Slow Recovery

5. The 2008-09 global financial crisis tested the resiliency of the South African economy. South Africa's integration in global commercial and financial markets, which provides significant benefits during normal times, exposed the country to adverse spillovers. South Africa's countercyclical fiscal and monetary policy response helped protect the social spending envelope while maintaining stability. This was largely possible thanks to the prudent fiscal policies in the previous years, which provided significant fiscal space. Unlike major advanced economies, South Africa had enough room to lower the nominal policy rates without reaching the zero interest-rate bound. The flexible exchange rate provided a buffer to the economy. Admittedly, South Africa's integration in the world economy also allowed it to benefit from the countercyclical fiscal and monetary policies adopted around the world, and which facilitated a fast recovery in world trade and commodity prices. Although lagging behind peer emerging markets, by mid-2011, South Africa had already surpassed earlier GDP peaks and was on track to close the output gap by mid-2012.

6. Since the last Article IV consultation, however, renewed distress in Europe— South Africa's main regional trading

market policies have been less well aligned (Table 1).

Table 1.Authorities’ Response to Past IMF Policy Recommendations(Scale—fully consistent, broadly consistent, marginally consistent, or inconsistent)
IMF 2011 Article IV RecommendationsAuthorities' Response
Fiscal policyBroadly consistent
Tighten fiscal stance over the medium term. Rebalance the composition of public spending Limit annual (primary) real spending growth to around 2 percent.

Wage moderation in the public sector.
The 2012 Budget calls for rebalancing public spending and wage moderation. The implicit real annual primary spending growth is 2.7 percent over the 3-year budget horizon. However, in 2011, the wage bill exceeded budgeted levels and capital spending allocations remained unfulfilled. Growth in real public wages did moderate due to higher inflation.
Public enterprisesFully consistent
Expand electricity capacity in a timely fashion.Eskom is planning to ramp up its investment plan. In 2013 will start partial operations one of the two power plants that will increase installed capacity by [20] percent by 2018.
Monetary policy

Given high uncertainty to the outlook, delay the start of tightening monetary policy.
Fully consistent

The policy rate was kept unchanged while inflation expectations remained within the target band.
Reserve policy

Increase reserve buildup in the near term.
Marginally consistent

Reserves have fluctuated around a relatively stable level, partly reflecting valuation changes.
Capital flow managementBroadly consistent
Keep exchange rate flexibility and continued building reserves in the near term, and gradually recalibrate the fiscal-monetary policy mix over the medium term.South Africa has one of the most flexible exchange rate regimes in emerging markets. No capital inflow management measures have been added to the toolkit.
Labor reforms

Increase labor and wage flexibility. Endow the wage bargaining framework with sufficient flexibility to exempt smaller firms and reduce unnecessary regulatory burdens facing firms.
Inconsistent Labor regulations in South Africa play an important role in protecting worker rights, but may also impose rigidities and contribute to unemployment. Amendments to the labor laws brought to the attention of Parliament would constrain the role of labor brokers, which had given some flexibility to the labor market and accounted for a substantial increase in employment during 2005-2008.
Product market regulationBroadly Consistent
Remove burden of regulation and barriers to entry in key network industries.The new Companies Act makes it easier to start, sell, or close a business. The development of standards has enabled growth in new sectors. Tax thresholds to firms have been increased to encourage small businesses.
Financial sector policyFully consistent
Continue progress in adopting FSAP recommendations, adopting Basel III initiatives, and setting the institutional and regulatory infrastructure for the twin-peaks system.Significant overhaul in laws and regulations to reach the objectives.

partner—has delayed South Africa's recovery. Given the rapid transmission of global shocks, growth turned out to be roughly 1 percentage point lower than envisaged in 2011. Domestic factors contributed to the slowdown, including industrial action in mining and manufacturing. Domestic demand also slowed but continued growing faster than GDP. Consumption and inventory growth slowed; but fixed capital investment started to increase, taking advantage of a reduction in real interest rates. Although policy rates remained on hold, rising inflation and inflation expectations implied further monetary policy stimulus, which reactivated investment demand. Employment started to pick up but did not keep pace with the increase in working age population and labor participation.

7. The degree of rand overvaluation diminished and real wage growth moderated. Together with the currencies of peer emerging markets, by April 2012, the rand had depreciated by 10 percent in nominal effective terms and by 7 percent in real effective terms (year on year). Headline inflation briefly exceeded the 3-6 percent target band reflecting high fuel and food prices and rand depreciation early in the year. Core inflation rose but remained within the target band. Real wage growth slowed significantly and employment rose by about 3 percent, reducing the gap between real wages and labor productivity. The deterioration in the current account deficit ended up roughly as envisaged. Although portfolio flows sharply diminished in 2011, higher foreign direct investment helped fund the deficit.

8. In 2012, growth is likely to fall below 3 percent, lower than most estimates of potential growth. The authorities share staff's baseline view that the slowdown is temporary and growth will pick up over the next few years to close the negative output gap. A rebound in private sector demand is expected to take place under the relatively favorable external conditions of the WEO baseline. This would reflect a recovery in investor confidence that leads to higher private sector investment, demand for bank credit, and employment.

9. Nevertheless, GDP will take longer than envisaged earlier to reach potential.

The change in the external environment has resulted in a downward revision of the feasible growth rates in South Africa during the next few years, taking into account its effect on South African exports and income. Inflation rates and fiscal revenue should also be lower than earlier anticipated. In turn, fiscal deficits and public debt levels would be higher than envisaged earlier (Figures 1 and 2). Rating agencies have lowered South Africa's outlook questioning the government's ability to contain the deficit over the medium term as intended.

Figure 1.South Africa: Impact of Global Slowdown

Source: IMF's World Economic Outlook.

Figure 2.South Africa: Slowdown in Economic Activity

Sources: SARB and Haver Analytics, Inc.

Rising Risks, Still Moderate Vulnerabilities

10. Renewed concerns about the euro area and signs of a slowdown in China have recently tilted risks to the downside. The sources of risks to the outlook are mainly external, although domestic risks also are present (Table 2).

Table 2.South Africa: Risk Assessment Matrix (RAM)1
Source of RisksRelative LikelihoodImpact if Realized
1. Strong intensification of the euroMediumMedium to High
area crisisSuch intensification would have global effects, including lower world growth, falling commodity prices, and higher risk aversion that leads to capital outflows and volatility. It would directly affect about Vith of South African exports, especially of manufactured goods. The indirect effect depends on associated decline in commodity prices and increase in global risk aversion, which would affect confidence and domestic demand.
2. Sharp slowdown in ChinaLowMedium to High
  A slowdown in China would reduce global commodity prices. It will directly affect about 12 percent of South African exports. Indirectly it would likely affect South Africa's exports to sub-Saharan Africa (about 15 percent of exports), which depends heavily on commodity prices. Low commodity prices would lower domestic income and demand.
3. Idiosyncratic adverse terms of trade shock resulting from lower non-oil commodity prices or a sharp increase in oil prices.MediumMedium
Slowdown in economic activity may lead to lower commodity prices.Adverse terms of trade would have adverse income effects on domestic demand and may on the margin reduce mineral exports. A sharp rise in oil prices would also increase headline inflation and could have second round effects on core inflation. Geopolitical tensions could affect South Africa's cost of refining, which depends heavily on Iranian oil.
 Oil prices may increase beyond cyclical levels for geopolitical considerations.
4. Sharp fall in nominal house prices.LowMedium
  Home mortgages account for a significant share of banks' loan portfolio, and a sharp drop may increase bank nonperforming loans, hurt profitability, and erode their capital base.
5. Large capital inflowsMediumLow to Medium
 Easy external financial conditions, characterized by low global interest rates, may result in high inflows into emerging markets once risk aversion subsides.Large inflows would ensure low interest funding of the current account and fiscal deficits, but the resulting real appreciation may affect growth, if not accompanied by booming economic activity abroad.
6. Ratings downgradeMediumLow
  A possible downgrade has already been priced in, and partly offset by the inclusion of South Africa in Citi's emerging market index.
6. Regulatory deleveragingMediumLow
  As currently defined, the BIS's net stable funding ratio may require South African banks to replace their domestic wholesale funding with more expensive funding, to increase their liquidity, or to deleverage. These may affect bank profitability and hurt credit growth.

The RAM shows events that could materially alter the baseline path—the scenario most likely to materialize in staff’s view.

The RAM shows events that could materially alter the baseline path—the scenario most likely to materialize in staff’s view.

11. External developments have a strong influence on South Africa. This partly reflects that export industries generate a significant amount of the wealth and facilitates the generation of value added in supporting industries and the provision of services. In addition, external savings (foreign funding) have helped fund both fiscal and external current account deficits. Although the flexible exchange rate and adequate international reserves help buffer in part the effects of positive and negative shocks on domestic income, changes in external demand have a strong effect on the real sector, and indirectly on the domestic financial sector. Finally, South Africa reliance on mineral exports makes it sensitive to movements in international commodity prices.

12. External sources of risk include slower demand for South African exports and a further decline in commodity prices.

Although the euro area remains the main regional trading partner, South Africa has been able to diversify its export markets through a significant increase in exports to China, and sub-Saharan Africa. Nevertheless, since the euro area and China are global players, disruption in one economy will likely have significant spillovers on the other and the rest of the world. Although the direct share of China is smaller than that of the euro area, it will likely have a strong indirect effect through its impact on commodity prices and other sub-Saharan African economies (Appendix I).

13. Adverse developments in one of these economies would be particularly damaging if it also gave rise to a sharp increase in risk aversion. Capital outflows, such as those arising from a global reassessment of the riskiness of emerging markets in general or South Africa in particular, could also force a sharp adjustment in fiscal spending and import levels. Large portfolio flows have helped fund the significant external current account and fiscal deficits although in 2011 foreign direct investment played a significant role. The impact on GDP of capital outflows would depend on the net effect of higher risk sensitivity, currency depreciation, and interest rates. The flexible exchange rate regime helps share the adjustment cost with foreign investors holding the mainly rand-denominated public debt.

14. Domestic sources of risk include increased labor unrest in a politically important year. In December 2012, the ANC, the party in power since 1994 and in a tripartite alliance with one of the main labor unions and the communist party, chooses its presidential candidate. Impatience with the high structural unemployment, particularly of the young, could lead to inappropriate responses that might threaten macroeconomic stability. In addition, adverse external developments and domestic shocks could increase further unacceptably high levels of unemployment.

15. On the positive side, a resolution of the uncertainty in Europe could give rise to an unexpectedly sharp expansion in demand on a global scale. This would foster demand for South African exports and would likely give rise to an increase in commodity prices. The prevailing low levels of risk aversion under low global interest rates could result in large flows to emerging markets. Under this environment, South Africa may find it easier to implement its ambitious public investment program and this may result in high growth rates. On the other hand, the inflows and repricing of risk would likely lead to strong rand appreciation.

16. Although low, South Africa's vulnerability to external shocks has increased over the last few years. Balancesheet effects are likely to be contained because prudential rules and capital controls keep low the exposure to exchange rate risk. Public debt levels are moderate and its composition bears little exchange rate or maturity risk. However, the fiscal position has worsened and lowered significantly the fiscal space available for countercyclical fiscal policy in a significant downward scenario. Although external solvency indicators remain sound, the net external investment position is weaker despite better international reserve coverage. On the other hand, the quality of portfolio investments abroad of the nonbank private sector, of about 30 percent of GDP in 2010, could suffer in a severe adverse scenario. Banks remain well capitalized and liquid, although a sharp change in investor sentiment is likely to further hurt their already low profitability. Moreover, the mortgage portfolio, the largest item in banks' balance

Policy Discussions

18. The temporary deterioration in the external environment under the baseline justifies the authorities' current policy mix.

This includes the decision to keep the policy sheets, may become vulnerable if the downward scenario gives rise to higher unemployment and house prices decline substantially. The recent sharp increase in unsecured lending, although from a low base, could give rise to additional stress.

Authorities' Views

17. The authorities expressed concern about the mutating nature of a five-year global financial crisis, which has been negatively affecting emerging markets such as South Africa. They were concerned that tail risks in Europe would hit emerging markets hard because policy space in advanced economies, and to a lower degree in emerging markets, had been eroded. In their view, lack of decisive and timely action by key policymakers in advanced countries could severely impair the global economic outlook. stimulus for longer than initially envisaged, by delaying the pace of fiscal consolidation and keeping interest rates on hold. However, fiscal space will be rebuilt in the medium term.

A. Broadly Adequate Pace of Fiscal Consolidation but Need to Change the Composition of Spending

19. The fiscal stance has provided further stimulus in the face of weak external demand and a negative output gap. In 2011/12, the cyclically adjusted fiscal deficit remained broadly stable at around 4 percent of GDP while the gross national government debt reached just below 40 percent of GDP.

20. The 2012 Budget reaffirms the authorities' consolidation plans. The 2012 Budget review envisages that the fiscal deficit in 2012/13 will fall by 0.2 percent of GDP (0.3 percentage point of GDP in cyclically-adjusted terms), mainly by reducing public spending (as a share of GDP), especially the government's wage bill. Staff is of the view that the budget strikes the appropriate balance between fiscal consolidation and supporting the economy.

21. The pace of fiscal consolidation over the budget horizon is broadly adequate under the baseline external environment (Figures 3 and 4). The cyclically adjusted deficit is projected to narrow gradually to just below 3 percent of GDP by 2014/15, with gross national government debt peaking at about 42 percent of GDP. The strategy is to achieve a gradual decline in the public spending-to-GDP ratio by controlling real spending growth while increasing the revenues-to-GDP ratio, primarily through improvements in tax collection as the economy recovers. Staff advised taking measures as soon as possible to rebuild some of the policy buffers lost in recent years to lower vulnerabilities and reduce the gross national government debt-to-GDP ratio to around 35 percent by 2017.I3, 4 Staff recommended that any revenue overperformance be saved.

Figure 3.South Africa: More Gradual Fiscal Consolidation

Figure 4.South Africa: Well-Managed Public Debt

22. The 2012 Budget Review recognized that rebalancing the composition of public spending is critical to promoting long-term growth. In recent years, the wage bill has grown to become the single largest component of government spending and one of the largest in peer emerging markets (Figure 5); and capital spending plans have been only partly fulfilled, reflecting to some extent limited implementation capacity in some local governments. Although the 2012 Budget Review clearly recognizes this issue and anticipates a rebalancing over the three-year budget horizon, staff reiterated this point during the discussions because in 2011 the government's wage bill ended up being higher, and capital spending lower, than budgeted, and because the wage bill is set to increase further this year. Raising real public sector wages during the peak of the recession contributed to one of the largest job shedding experiences among emerging markets during the global financial crisis.5 Staff urged the authorities to bring the wage bill back to pre-crisis levels and cautioned that further slippages could erode the government's credibility at a delicate global juncture when rating agencies are questioning its ability to rein in spending. Lowering the wage bill burden would provide greater room for capital spending, which would help improve and expand the delivery and quality of public services, especially in critical areas such as health and education. To increase capital spending, the implementation capacity at lower levels of government should be strengthened.

Figure 5.South Africa: High Government Wage Bill

23. Over the medium term, greater stability in public real wages would be desirable. Staff recommend that once the wage bill burden has been lowered as planned, real wage growth in the public sector be limited to 1-2 percent a year in line with estimates of long-term economy-wide average labor productivity growth.

24. Staff welcomes the renewed drive for building public infrastructure.

Investment in infrastructure has been held back largely due to limited implementation capacity. The resulting bottlenecks in electricity generation, transport, and port infrastructure means South Africa has not benefited as much as other resource intensive emerging market economies from its large terms of trade gains of the last decade. This in turn has discouraged investment in South Africa's natural resource industry, and some key exports have seen substantial volume declines despite high commodity prices. Public enterprises increased their fixed capital formation in the late 2000s and owing to gestation periods a new large power plant will start partial operations only in 2013. In 2012, a presidential commission identified key infrastructure projects to be rolled out over the coming decades. Enhancement of key infrastructures would help remove existing supply-side bottlenecks in important network industries, which have constrained exports and domestic economic activity in recent years.

25. Large-scale projects, such as those identified by the presidential infrastructure coordinating commission, need to be subject to rigorous but prompt assessment and prioritized to maximize long-term benefits. To contain fiscal risks, tariffs and user fees should reflect service and investment costs while ensuring efficiency in running these enterprises, which often have a dominant market position. Options to involve the private sector in network industries dominated by state-owned enterprises need to be explored.

26. Staff supports the government's intent to introduce a National Health Insurance (NHI) scheme and social security and retirement reforms. The NHI reform rightly aims to improve access to public health services, while improving its quality and coverage (Box 1). Staff endorses the authorities' gradual and cautious implementation, and stresses that careful attention should be given to design issues, which determine incentives and ultimately the cost of the programs. Although financing options are still under debate, the chosen financing package should keep the fiscal consolidation plan intact and preserve fiscal sustainability.

Box 1.Toward a National Health Insurance System in South Africa

South Africa has one of the largest disease burdens and lowest life expectancies among emerging markets, yet access to health care services is low for a large share of its population. In 2011, the government made the political decision to extend access to health care services to the population as a whole by implementing over time a National Health Insurance (NHI) scheme. Although the details are still being fleshed out, the approach is to pool the risks and the funds so that equity and social solidarity will be achieved through the creation of a single NHI fund.

The NHI is planned to be implemented gradually over 14 years in three phases. The first phase (2011-15) mainly includes organizational changes to build capacity and pilots projects to assess the preliminary design. In the second and third phases (2016-2020 and 2020-24), the NHI will progressively take over the administration for the health functions.

The cost of the NHI is difficult to predict given the large uncertainties regarding the "utilization" levels of the insured population, the disease burden, some possible changes in the coverage of the medical benefits package, and the price evolution of the health care services. Preliminary estimates from the National Treasury suggest that public health spending could increase by 2 percentage points of GDP to reach 6.2 percent of GDP in 2025. This would require new sources of financing, and the authorities are considering various options, including a payroll tax (payable by both employees and employers), a higher value-added tax rate, a surcharge on taxable income, or some combination of these. In choosing among the funding options, care should be taken not to further increase labor costs that could have an adverse effect on employment.

But beyond the need to identify the financing measures, the authorities acknowledge the need to contain public health spending and maintain fiscal sustainability. Lessons from other countries suggest that this would require both macrolevel instruments (such as budget caps and central oversight) and microlevel measures to improve the efficiency of spending. Strengthening market mechanisms, among other things by allowing more competition between health service providers and insurers, and relying on a greater degree of private provision, as well as increasing the level of cost-sharing have been successful in containing spending growth.

Public Health Spending, 2008-091

(Percent of GDP)

Source: FAD database.

1 Latest available data.

27. The forthcoming report on South Africa's long-term fiscal dynamics will further improve fiscal transparency. It will raise public awareness of longer-term fiscal policy implications and options and the associated fiscal risks. It will also be a useful tool for communicating the medium-term costs involved with the NHI and social security reforms and highlight the fiscal tradeoffs involved in different design options. These trade-offs could be assessed under the fiscal guidelines on intergenerational fairness, countercyclicality, and sustainability. Although financing options have not been finalized, the 2012 Budget Review mentioned as funding options an increase in the VAT rate, a payroll tax on employers, and a surcharge on the taxable income of individuals.

28. There remains some scope for further improving fiscal management.

Although South Africa has the most transparent budget process according to the International Budget Parnership's (IBP's) Open Budget Index, the IMF study on budget institutions in G20 countries identified areas for further improvement, including external scrutiny of the treasury's macroeconomic assumptions and forecast and independent evaluation of fiscal policies, beyond the current activities of South Africa's fiscal commission. There was also scope for more systematic monitoring, reporting, and management of fiscal risks.

B. Policy Rates on Hold for Now

30. The inflation targeting framework has been crucial in South Africa's resilience

to the large shifts in the global external environment. It has allowed the monetary authorities to provide stimulus while keeping inflation expectations well anchored (Figure 6).

Figure 6.South Africa: Continued Monetary Support

31. Staff supports the decision to keep the policy rate on hold for now. The policy rate has remained unchanged at 5.5 percent since November 2010, and one-year-ahead inflation forecasts suggest the policy rate has become negative in real terms. This accommodative monetary policy stance has appropriately provided stimulus given the negative output gap and well-contained core and inflation expectations. The sharp drop in fuel prices observed by mid-2012 is likely to exert downward pressure on inflation given the full pass through of fuel prices.

Authorities' views

29. The authorities are firmly committed to careful fiscal management, which is crucial for maintaining macroeconomic stability. At the same time, they are trying to strike a good balance between providing stimulus and maintaining fiscal sustainability. They are aware that fiscal space for facing any future stress diminishes as the government debts continues to increase. They recognize the merits of wage moderation in the public sector, including for making space for needed public infrastructure.

32. But, given the high uncertainty, staff supports the South African Reserve Bank's (SARB's) readiness to move the policy rate in either direction as needed. In principle, the policy rate could remain on hold as long as the one-year-ahead inflation forecast remains within the inflation target range. But, with the balance of risks tilted to the downside, the SARB should be ready to cut the policy rate to support the economy, especially given the limited fiscal space. The target band gives flexibility to provide monetary stimulus (Appendix II). Forward- rate agreements are already pricing this possibility. On the other hand, monetary tightening could be brought forward if inflation forecasts exceed the target range or balance-sheet vulnerabilities build up.

C. Flexible Exchange Rate, but Lingering External Competitiveness Problems

33. The highly flexible exchange rate regime has helped smooth external shocks.

The exchange rate helps rapidly transmit news about the external environment, but also means high volatility in nominal and real exchange rates. The rand responds rapidly to changes in the VIX, whose surges give rise to shifts away from risky assets and activities (Figure 7).

Figure 7.South Africa: Volatile Asset Prices

34. Despite recent rand depreciation, various indicators point to enduring problems with external competitiveness.

High wage bargains have contributed to high domestic costs of production, including high unit labor costs. Export volumes remain below their historically high precrisis levels and have continued to recover more slowly than partner demand, although in part they reflect a substantial decline in gold production. South Africa's market share in global export markets has increased modestly since the mid-2000s, in contrast to rapid gains by other emerging markets and commodity producers. Competitiveness problems could intensify if easy external financing conditions lead to a resumption of capital inflows to emerging markets (Figure 8).6

Figure 8.South Africa: Enduring Problems with External Competitiveness

Unit Labor Costs in Manufacturing and REER (ulc)


Source: South African Central Bank.

35. Model-based estimates suggest the rand was overvalued in real effective terms by 5-15 percent in March 2012 (Box 2).

Box 2.South Africa: External Sector Assessment

External sector risks are relatively contained. South Africa's exchange rate regime is one of the most flexible among emerging markets. The net IIP position at -18 percent of GDP in 2010 is not seen as a major source of risk. Both external debt and the net international investment position are moderate, with a large share of liabilities either in equity and/or denominated in rand. Although portfolio flows have increased, the associated risks they pose are mitigated by the free-floating exchange rate. Reserves are currently adequate according to the IMF metric. In the current environment, the quality of portfolio investments abroad of the nonbank private sector, of about 30 percent of GDP in 2010, is a possible source of vulnerability.

However, competitiveness and the elevated level of the underlying current account deficit have been more enduring sources of concern. The dollar-rand exchange rate has traded in lock-step with risk aversion indicators such as the VIX. The real exchange rate has been marginally less volatile, dampened by offsetting movements in euro-dollar exchange rates. Inflation differentials have also diminished the extent of real depreciation, but the real exchange rate was nevertheless 7 percent below its year-earlier level in April. At the same time, the increase in risk aversion has put downward pressure on commodity prices, partially unwinding the terms South African Rand of trade improvements of recent years, which if sustained would imply a depreciation of the equilibrium real exchange rate.

South African Rand

To disentangle the relative effects of these two forces on the external assessment, we start by assessing the underlying level of the current account deficit. This involves adjusting the realized level of the current account balance to strip out temporary factors such as output gaps in both South Africa and its trading partners. As a proxy for this, we take our medium-term projection of the current account (a deficit of 5.9 percent of GDP) in 2017, by which time all such transitory factors should have dissipated. The substantial widening expected in the deficit expected over the medium term reflects in large part: (i) the transitory nature of recent terms of trade gains, (ii) higher expected deficits on net income once interest rates normalize, (iii) and transfers to other countries in the South African Customs Union (SACU). More fundamentally, they reflect South Africa's low saving rates for its large investment needs.

Application of a range of techniques, including two based on our estimate of the underlying current account, suggests that real exchange rate remained misaligned in the first quarter of 2012. In particular, CGER approach suggests misalignment of 13 percent in February-March, while preliminary estimates based on the IMF's pilot external balance assessment (EBA) approach imply that the current account deficit in 2011 was 2.5 percent of GDP higher than predicted, which is consistent with misalignment of 11 percent. Taking into account forecast uncertainty, staff assess that the real exchange rate was misaligned by 5-15 percent during this period.

The CGER methodology is based on an average of three complementary methods:

  • The first of these approaches, macro-balance, compares the underlying current account with a current account norm (at minus 3 percent of GDP), implying that the underlying current account deviates from the level implied by medium-term fundamentals by around 3 percent of GDP, which is consistent with misalignment of around 17 percent.
  • The External Sustainability (ES) approach compares the underlying current account with a level that would stabilize South Africa's external liabilities around the average for all emerging markets (34 percent of GDP).1 This approach implies an even larger degree of misalignment, slightly exceeding 20 percent.
  • Finally, the equilibrium exchange rate approach implies that the real exchange rate is fairly valued. The application of this approach to South Africa is complicated by the extent of structural change after the fall of Apartheid, and the need to assume that the exchange rate is in equilibrium on average over the sample period.
Assessment of Competitiveness , Feb-March 2012
Current AccountMisalignment
Deviation from norm
Equilibrium exchange rate-2.90
Macro balance-4.317
External sustainability22
  • Other structural indicators, while more backward looking in nature, broadly support the conclusion of a chronic but moderate competitiveness problem. South Africa's share of global export markets has expanded since the mid-2000s, but less rapidly than that of most large EMs. Export performance has remained weak in volume terms, with export volumes growing at a slower pace than import demand in trading partners, whereas most EMs have seen faster volume growth than trading partner demand during the same period.
1 As in past Article IVs, the external sustainability for South Africa is based on the EM average for the net international investment, as the current level seems low for its development needs.

These models aim to control for changes in fundamentals, including fiscal variables. Low structural savings and substantial investment needs justify large current account deficits but may also require significant real rand depreciation over the medium term to help service the increasing foreign liabilities, even if largely rand denominated.

Authorities' Views

36. The authorities agreed that South African firms faced high domestic costs of production, which negatively affected their external competitiveness. They also acknowledged that low domestic savings requires relying on foreign savings for investment needs. Their models also led them to believe that the rand is somewhat overvalued, but that the precise magnitude was difficult to pin down given the high volatility in fundamentals, which implied large rand volatility. Therefore, assessments may vary by the specific date they were conducted.

D. Further Reserve Buildup Needed to Maintain Adequate Coverage for Precautionary Purpose

37. Further buildup of gross reserves will likely be required in the coming years to ensure reserves remain adequate for precautionary purposes. The substantial strengthening of South Africa's reserve position in recent years has contributed to investor confidence and dampened the country's vulnerability to tail risks, although at significant fiscal (sterilization) cost, borne in large part directly by the treasury.7 Maintaining an adequate stock of safe and liquid assets will be especially critical in the current environment. Because the capital inflows needed to fund the structural current account increase financial risks, South Africa would benefit from building up further reserves for precautionary reasons. Although reserves are adequate under traditional metrics, the IMF's risk-weighted metric for reserve adequacy suggests that, under the prevailing macroeconomic outlook, further buildup might be warranted over the medium term just to remain within the adequacy range.

Gross Reserves vs. Measures of Adequacy

(Billions of U.S. dollars)

Sources: IMF and country authorities.

Portfolio Flows

(Billions of U.S. dollars, cummulative since 2007)

E. Reliance on Monetary Stimulus in Severe Adverse Scenario

39. Global uncertainty and the narrower fiscal space may require difficult decisions.

Staff supported the monetary policy stance. However, the SARB would have room to lower nominal policy rates if the outlook worsens given the resulting decline in economic activity and the expected moderation in inflation. The limited fiscal space would likely require policy measures to ensure fiscal sustainability (Figure 9). This could include reassessing spending limits and possible measures on the revenue side to ensure fiscal sustainability in light of the impact of the global stress on fiscal dynamics. It would not be feasible to adhere to a nominal expenditure ceiling while allowing automatic stabilizers to operate through the revenue side. Public spending should be prioritized to protect the envelope for social transfers.

Figure 9.Fiscal Space South Africa and EM 20 Peer Countries: 2007 and 2012

Source: World Economic Outlook.

40. Under a severe adverse scenario that could lead to a substantial deceleration in economic activity, the policy mix may need to rely more on monetary policy. The fiscal space would be very limited while, under such circumstances, monetary space would be available.

Job Creating Policies

41. The structure of product and labor markets has contributed to preserving inequality and high unemployment. South Africa's high unemployment is the result not only of chronic skill and geographical mismatches (legacies of Apartheid), but also of policies, product market structure, and labor market arrangements that end up protecting insiders at the expense of the unemployed. High margins in product markets and wages in labor markets have resulted in uncompetitive domestic costs of production, eroding external competitiveness and excluding part of the population from formal economic activity. This has constrained South Africa's ability to diversify its exports into areas that go beyond its comparative advantage of exploiting its mineral endowment. The relatively high wages and profits for insiders have resulted in higher consumer price levels and unemployment for outsiders. In addition, labor market arrangements have set entry-level wages above the productivity of inexperienced workers with little marketable skills, including through relatively high minimum wages. The struggle for dividing rents between highly concentrated, oligopolistic firms and strong and politically influential labor unions has resulted in large economic losses associated with frequent labor strikes. Although real wages and labor productivity are cointegrated in the long-run, episodes of large wage increases like those that took place during 2008-10 tend to have long-lasting effects on unemployment and firms' incentives for hiring (Appendix III). The relatively high labor cost discourages labor demand, especially for newcomers to the labor market, and help explain the low share of labor income on GDP, which has declined in South Africa over the last two decades in line with the experience of peer emerging markets.

42. A durable pickup in job creation that reduces mass unemployment seems unattainable without major labor and product market reforms. Reducing the skills shortages of the unemployed is a gradual process that would take time to yield fruit. But, within any given distribution of skills, the ability of individuals to find jobs depends in part on the labor and product market structures. Structural policies of the types discussed below are needed to raise potential growth and make it more labor intensive.

43. Increasing product market competition will help reduce margins in consumer products (Figure 10). Significant progress has been made in recent years in strengthening the antitrust legal framework and its enforcement. Continued efforts to enhance competition in product markets would include strengthening the competition commission to crack down on abuse of market dominance and collusive behavior. Penalties for market misconduct needs to rise and timeframes for due process should be shortened. Product market regulations could also be improved, especially those for setting up new firms.8 Also, the public sector can contribute in promoting competition in the markets in which its state-owned enterprises have a presence. Where applicable, the authorities could consider opening the sector reserved for public enterprises to private sector competition. Crossborder cooperation between jurisdictions where cartels operate could also help contain anticompetitive practices in South Africa.

Figure 10.South Africa: Product Market Highlights

44. More flexibility in the wage-setting mechanism, supported by well-designed and targeted active labor market measures, can support employment by better aligning wages with productivity levels at the firm level. A more flexible wage bargaining mechanism, for example for small, and medium enterprises (SMEs) or newly created businesses, as well as more flexible labor laws and regulations are essential to improve the business environment and increase employment opportunities, especially for newcomers with limited skills. In that regard, draft labor law amendments in Parliament may reduce employment as they imply restrictions on the flexible contractual arrangement that led to large increases in employment during 2004-07 (Figure 11).

Figure 11.South Africa: Labor Market Highlights

45. In the short run, employment can also be supported through active labor market policy (ALMP) measures. These could include temporary youth wage subsidies, transport subsidies for job seekers, and other schemes to provide working experience and on-the-job training. Staff noted such schemes should be carefully designed to prevent abuse and create net employment, with spending in this area tightly controlled given the fiscal cost of such schemes. Temporary public work programs could also provide an important safety net for the unemployed, would be self-selecting if wages are kept low, and would not permanently increase the public wage bill.9Staff argued, however, that the recent increase in public sector employment is not a cost effective or efficient way to increase employment. It may crowd out critical health and education spending and tend to put upward pressure on wages in the economy, thereby limiting the impact on aggregate employment.

Authorities' Views

46. The authorities emphasized the need for product market reforms to complement those of the labor market.

They felt that greater emphasis should be placed on the former, and cautioned that the political economy of South Africa makes it difficult to carry out radical labor market reforms, given the historically difficult hard-won rights of the labor movement. The largest umbrella labor union, Congress of South African Trade Unions (COSATU), emphasized three main points. First, greater emphasis should be given to temporary public works programs. Second, in its present form, the youth wage subsidy would not lead to a net increase in permanent employment. Third, the current labor protection laws does allow for SMEs to be exempted from certain collective bargaining agreements. With regard to the last point, the authorities clarified that this was, in practice, very difficult to achieve.

Regional Integration

47. South Africa's de facto economic and financial integration with the sub-Saharan Africa (SSA) region has significantly expanded over the last few years. With the large reduction in external demand from Europe, South African firms have further diversified their export markets into SSA. South Africa's exports to the region amounted to about 15 percent of exports in 2011. SSA accounts for a third of South African manufacturing exports. These increased linkages increase the scope for inward and outward spillovers (Appendix I).

48. South Africa has also expanded its foreign direct investment to the region.

South African banks already have an important Pan African presence, and, in 2012, some of the largest ones have announced significant expansion plans into SSA. South African firms also have important presence in developing mining projects in the region (Figure 12)).

Figure 12.South Africa: Regional Integration and Interlinkages

49. Progress in multilateral trading arrangements has continued, with the emphasis on removing nontariff barriers to trade, including red tape and infrastructure shortfalls. With three country exceptions, the free trade agreement under the Southern African Development Community (SADC) should be fully implemented in 2012 with almost all tariff lines traded duty free. In addition, the June 2012 SADC summit highlighted a regional infrastructure development master plan for implementing infrastructure networks in the key sectors such as energy, transport, among others. The negotiations for a free-trade area covering the 26 member countries of SADC, the East African Community (EAC) and the Common Market for East and Southern Africa (COMESA) that started in 2011 have also continued with a view of concluding negotiations by 2014 and implementation by 2015. The work plan on this tripartite arrangement also focuses on building infrastructure for regional trade.

50. In the South African Customs Union (SACU), further integration continues along the five priority areas highlighted in the 2010 summit. The reform of the 2002 revenue sharing formula has identified the principles that would underpin the formula to improve the predictability of these revenues. In addition, SACU countries are working toward promoting industrial development among SACU members, improving trade facilitation, developing common SACU institutions, and engaging in joint trade negotiations with third parties.

51. The increased integration of South Africa with the region also increases the scope for inward and outward spillovers.

Typically, South Africa exports more to SSA countries than vice versa. Although developments in individual SSA countries may be small for South Africa, as a whole the region plays an important role in South Africa's external demand. In practice, because SSA depends crucially on commodity prices, which in turn depend on developments in China, South Africa's intraregional trade essentially increases its exposure to China.

Strengthening Financial Stability

52. South African banks proved resilient to the 2008-09 global financial crisis.

Financial soundness indicators remain at comfortable levels and have partially recovered from the effects of the global financial crisis. Banks have increased their capital adequacy ratios and their liquidity buffers, which are currently well above regulatory limits. Profitability has started to increase from a low base as a decline in impaired loans has offset large increases in operational costs (Figure 13).10

Figure 13.South Africa: Resilient Banking System

53. A limited dependence on external funding and low direct exposure to euro area periphery countries have so far allowed South African banks to remain largely unaffected by the recent increase in global financial stress. Although UK financial institutions own two of the largest banks, their subsidiaries fund their operations with local deposits. Nevertheless, banks are likely to be affected through real sector channels, as financial conditions affect real sector developments with a lag (Appendix IV). The large nonbank financial sector—closely linked to the banking sector through cross-ownership structures—also appears to have weathered the crisis well, partly due to high capital levels in the insurance sector, the predominance of defined contribution pension funds, and conservative investment strategies.

54. Some risks remain. Banks are heavily exposed to fluctuations in house prices through the collateral value of their mortgage portfolio, the main asset in their balance sheet.11 Banks are also subject to risks associated with the business cycle, which would increase impaired loans and compromise profitability, especially if unemployment rises. South African banks are also subject to liquidity risk through their dependence on short-term domestic wholesale liabilities, although in practice this source of funding has been very stable because it largely corresponds to contractual savings in pension and insurance schemes. The low profitability exposes banks to the temptation of looking for higher yields taking increasing risks. Prolonged period of easy money could eventually lead to high credit growth and a gradual buildup of balance sheet vulnerabilities. The rapid expansion in unsecured lending, albeit from a low base requires close monitoring.

Institutional reforms and Basel III implementation

55. Staff welcomes the ambitious program to strengthen the legal framework for bank supervision and improve crisis management frameworks. These legal reforms (including the twin peaks regulatory structure that consolidates power for prudential regulation and supervision on one end and market conduct on the other) would lead to significant progress in adopting FSAP recommendations and attaining the Basel III liquidity requirements and other G20 initiatives.12

56. Progress has been made toward achieving Basel III benchmarks. South African banks already meet the more stringent capital requirements. In addition, the authorities have adopted the alternative treatment to meet the Basel III liquid coverage ratio requirements, and the SARB has created a liquidity facility for this purpose and allowed banks to count their statutory reserves as high quality liquid assets. However, difficulties meeting the net-stable-funding ratio (as currently envisaged by the 2018) implementation date could result in higher interest rates (as banks try to attract longer term deposits) or deleveraging. To avoid this, it will be important to engage in a constructive dialogue with the Basel Committee on the stability of rand wholesale funding while looking for opportunities to extend the duration of bank liabilities.

Macroprudential and capital flow measures

57. Staff supports the gradual and cautious pace in liberalizing capital controls and replacing them with prudential regulations addressing the underlying risks.

Staff emphasized that liberalization of limits on foreign investments of domestic nonbank institutional investors should proceed slowly to give time to address the liquidity risk for banks that depend on domestic wholesale funding.

58. The authorities have decided not to add capital inflow management measures to their policy toolkit at this time. This follows careful examination of the experiences of other countries, but also reflects that pressures for adopting such measures have subsided with global stress arising from Europe. Various concerns about the use of capital flow measures (CFMs) may have also played a role, including South Africa's large reliance on foreign savings, doubts about the effectiveness of CFMs, and their possible

Staff Appraisal

59. South Africa's economic and financial policy frameworks have reliably delivered domestic and external stability.

Despite a highly uncertain and volatile external environment, the inflation targeting regime has anchored inflation expectations within the 3-6 percent target range. In turn, the flexible exchange rate regime has helped cushion the large real and financial external spillovers to which a small open economy such as South Africa is exposed. Credibility in the government's ability to pay back its mostly rand-denominated debt has allowed South Africa to maintain its public spending plans despite the decline in its fiscal revenue. This credibility depends not only on the government's ability to generate surpluses to honor its future debt payments, but also on the SARB's ability to maintain a predictable value of the rand.

unintended effects, especially if inadequately designed and calibrated. However, if South Africa were to add CFMs to its policy toolkit in the future, staff recommended that they complement rather than substitute macroeconomic policy adjustments. In practice, the authorities' response to earlier capital inflow episodes has been eclectic, including allowing the exchange rate to appreciate, maintaining an accommodative monetary stance, liberalizing capital outflow controls, and building international reserves.

60. Distress in Europe has delayed South Africa's recovery. Although the slowdown should be temporary before growth picks up over the next few years to close the persistently negative output gap, risks are tilted to the downside. For example, South Africa would be negatively affected, mainly through real sector channels, from a severe intensification of the euro area crisis, especially if it were to affect global risk aversion and investor confidence.

61. The monetary policy stance has appropriately reacted to the slowdown.

Although nominal rates have remained unchanged since November 2010, the pickup in inflation expectations toward the upper end of the band have de facto implied additional stimulus from lower real interest rates. The large degree of uncertainty requires close vigilance from the SARB to provide as much stimulus as possible while keeping one-year-ahead inflation expectations within the target.

62. Although the more gradual fiscal consolidation is broadly appropriate, rebalancing the composition of public spending remains a priority. Essentially, within the overall spending envelope envisaged, the wage bill needs to fall and capital spending to increase, especially for priority areas such as health and education. The new drive for public infrastructure in network industries should help remove the bottlenecks that have been holding back growth opportunities. Given the large uncertainties in the world economy, any revenue overperformance should be saved to reduce the amount of debt accumulation.

63. After four years of monetary and fiscal stimulus, the policy space to deal with adverse shocks has significantly diminished.

This is particularly acute on the fiscal side, where this space will further shrink with the global stress, as fiscal revenue is likely to decline. In contrast, monetary space will likely widen under such a deflationary scenario, suggesting that the authorities may need to rely more heavily on countercyclical monetary policy to cushion the effect of the adverse spillovers arising from the global turmoil.

64. Despite recent currency depreciation, South Africa continues to face an external competitiveness problem. This reflects, in part, high domestic costs of production arising from inadequate public infrastructure, market power in product and labor markets, and burdensome regulations that inhibit labor and product market entry and flexibility. In addition, the structural imbalance that results from low domestic savings for the large investment needs requires a more depreciated rand in the medium-term to service the foreign liabilities, even if rand denominated.

65. High unemployment, especially of the young, could eventually become politically and socially unsustainable. A four-pronged approach is needed to improve external competitiveness and reduce structural unemployment:

  • Labor and product markets reforms to increase their flexibility, contestability, and access, which would contribute to reduce domestic costs of production;
  • Improved service delivery in health and education to improve human capital, marketable skills, and entrepreneurship of the currently unemployed;
  • Short-term active labor interventions to create first-time employment opportunities for the young; and
  • Better infrastructure in network industries that remove bottlenecks and support higher growth rates.

66. Although vulnerabilities remain low, risks have increased. External debt remains moderate and about half of it rand denominated. International reserves are currently adequate, but the expected increase in foreign liabilities warrants increasing reserve coverage over the medium term.

67. South African financial institutions remain sound, liquid, and profitable, and impaired loans have started to decline.

Although direct crossborder exposures are limited, South African financial institutions would be indirectly affected through real sector channels, which would tend to increase impaired loans.

68. Staff recommends that South Africa remains on the standard 12-month Article IV consultation cycle.

table 3South Africa: Selected Economic and Financial Indicators, 2008—17
(Annual percent change, unless otherwise indicated)
National income and prices
Real GDP3.6-
Real GDP per capita2.5-
Real domestic demand3.5-
GDP deflator8.
CPI (annual average)
CPI (end of period)
CPI (end of period) 1/
CPIX (period average) 1/
Labor market
Unemployment rate (in percent)22.923.924.924.922.722.522.221.721.220.7
Average remuneration (formal nonagricultural sector) 2/12.811.813.
Labor productivity (formal nonagricultural)
Unit labor costs (formal nonagricultural)10.910.
External sector
Current account balance (percent of GDP)-7.2-4.0-2.8-3.3-4.8-5.2-5.9-5.9-5.9-5.8
Overall balance of payments (percent of GDP)
Total external debt (percent of GDP)26.627.628.727.332.033.835.737.739.842.0
Gross reserves (SARB, in billions of U.S. dollars)34.139.743.848.948.948.948.948.948.948.9
(in months of total imports)
Merchandise exports, f.o.b. 3/12.0-22.729.520.5-
Merchandise imports, f.o.b. 3/10.2-26.724.423.
Export (goods and services) volume1.8-
Import (goods and services) volume1.5-
Terms of trade0.
Nominal effective exchange rate 4/-26.825.512.3-16.9
Real effective exchange rate 4/-16.322.110.1-13.8
Money and credit
Net domestic assets 5/
Broad money (including foreign exchange deposits)
Velocity (GDP/average broad money)
Bank rate/repurchase rate (period end, in percent)
Broad money (period average)/GDP (in percent)81817572737373747575
(In percent of GDP, unless otherwise indicated)
Investment and saving
Investment (including inventories)22.719.619.419.720.921.922.422.622.723.0
Of which: public fixed investment (incl. public enterprises)
private fixed investment15.213.512.211.812.012.312.713.113.513.9
Gross national saving15.515.616.616.416.116.716.616.716.917.2
Public (incl. public enterprises)5.11.2-
Consolidated budget and other fiscal indicators6/
Revenue, including grants29.827.827.527.527.627.928.228.629.029.4
Expenditure and net lending30.233.132.332.031.931.731.430.930.429.8
Overall balance-0.5-5.3-4.8-4.4-4.4-3.8-3.2-2.3-1.4-0.5
National government debt27.431.535.338.740.241.342.141.840.438.2
Sources: South African Reserve Bank; IMF, International Financial Statistics; and IMF staff projections.

Since January 2009, a reweighted and rebased CPI replaced the previously used CPIX (the consumer price index excluding the interest on mortgage loans) as the targeted measure of inflation.

At current prices; annual percent change.

U.S. dollars; annual percent change.


Contribution (in percentage points) to the growth of broad money.

Calendar-year figures are based on National treasury’s historical data and staff—s projections starting 2012.

Sources: South African Reserve Bank; IMF, International Financial Statistics; and IMF staff projections.

Since January 2009, a reweighted and rebased CPI replaced the previously used CPIX (the consumer price index excluding the interest on mortgage loans) as the targeted measure of inflation.

At current prices; annual percent change.

U.S. dollars; annual percent change.


Contribution (in percentage points) to the growth of broad money.

Calendar-year figures are based on National treasury’s historical data and staff—s projections starting 2012.

Table 4.South Africa: Consolidated Government Operations, 2008/09–2014/151(In percent of GDP unless otherwise noted)
Authorities' 2011 Budget
Total revenue and grants29.727.227.527.727.427.828.0
Total expenditure30.833.931.732.532.131.731.0
   Wages and salaries10.
   Other goods and services5.
 Capital expenditure2.
 Payment for financial assets0.
Overall balance-1.2-6.7-4.2-4.8-4.6-4.0-3.0
Memorandum items:
 GDP (billions of rand)2,3042,4422,7542,9963,3013,6223,997
 National government debt (gross)
 Cyclically-adjustment overall balance 2/-1.5-5.0-3.1-4.6-4.3-3.6-2.6
Staff estimates
Total revenue and grants29.727.227.527.527.628.028.3
Total expenditure30.833.931.832.131.931.731.3
   Wages and salaries10.111.211.311.311.010.710.6
   Other goods and services5.
 Capital expenditure2.
 Payment for financial assets0.
Overall balance-1.2-6.7-4.2-4.6-4.3-3.7-3.0
Memorandum items:
 GDP (billions of rand)2,3042,4422,7503,0313,3233,6253,961
 National government debt (gross)
 Cyclically-adjustment overall balance-2.6-6.3-3.9-4.1-3.6-3.2-2.8
Sources: South African authorities; and Fund staff estimates and projections.

For fiscal year beginning April 1.

For national government main budget only.

Sources: South African authorities; and Fund staff estimates and projections.

For fiscal year beginning April 1.

For national government main budget only.

Table 5.Statement of Operations—National Government Main Budget 2008/09–2014/151(GFSM2001 basis; in percent of GDP unless otherwise noted)
Proj. 2/
 Other revenue0.
   Of which : provinces10.712.111.711.511.010.710.3
      local governments1.
  Other expense11.812.411.912.712.712.813.9
 Net acquisition of nonfinancial assets0.
Gross Operating Balance (Revenue - Expense)-0.4-5.2-3.9-4.7-4.3-3.7-3.1
Budgetary balance (Revenue - Expenditure)-0.7-5.6-4.2-5.1-4.8-4.1-3.6
Extraordinary payments, net-0.2-0.2-0.1-
Net lending (+)/borrowing (–)-0.6-5.4-4.1-5.0-4.7-4.1-3.5
Net acquisition of financial assets
  Currency and deposits0.
Net incurrence of liabilities1.
Memorandum items:
  Fiscal year GDP (billions of rand)2,3042,4422,7503,0313,3233,6253,961
  Real GDP growth (percent)2.5-
  GDP deflator (percent change)
  Gross debt27.
Sources: South African authorities; and Fund staff estimates and projections.

For fiscal year beginning April 1. National government comprises the central government, including transfer to subnational government financed by the national revenue fund.

Staff projections base on the authorities' policy intentions as outlined in the 2012 budget.

Sources: South African authorities; and Fund staff estimates and projections.

For fiscal year beginning April 1. National government comprises the central government, including transfer to subnational government financed by the national revenue fund.

Staff projections base on the authorities' policy intentions as outlined in the 2012 budget.

Table 6.South Africa: Balance of Payments, 2009–2017
(In Billion of US dollars)
Balance on current account-11.5-10.2-13.5-18.9-21.2-25.4-26.7-28.2-29.2
 Balance on goods and services-2.5-0.7-2.5-6.3-6.1-9.0-8.9-6.3-4.6
Exports of goods and services77.999.4117.8116.1119.3123.0130.0137.6145.6
 Exports of goods65.985.4102.9101.4104.2107.5113.4120.0126.8
   Exports of services11.914.014.914.615.115.516.517.718.9
 Imports of goods and services-80.4-100.1-120.3-122.4-125.4-132.0-138.8-144.0-150.2
   Imports of goods-65.7-81.7-100.7-102.4-104.9-110.5-116.4-120.9-126.3
   Imports of services-14.7-18.4-19.6-20.0-20.4-21.5-22.4-23.1-23.9
 Balance on income-6.3-7.2-9.0-8.9-11.6-12.8-14.1-17.8-20.4
   Income receipts4.
   Income payments-10.4-11.9-14.3-15.0-18.5-21.0-24.7-29.4-34.4
 Balance on transfers-2.7-2.3-2.0-3.7-3.6-3.6-3.8-4.1-4.3
Capital flows (including errors and omissions)13.614.519.418.921.325.426.728.229.2
 Balance on capital and financial account13.511.119.418.921.325.426.728.229.2
  Balance on capital account0.
  Balance on financial account13.511.119.418.921.325.426.728.229.2
   Direct investment4.
   Portfolio investment11.110.90.314.514.216.017.719.421.4
   Other investment-1.9-
Errors and omissions0.
Overall balance of payments2.
Gross reserves (SARB) 139.743.848.948.948.948.948.948.948.9
International liquidity position of SARB 1239.
(In percent of GDP)
 Balance on current account-4.0-2.8-3.3-4.8-5.2-5.8-5.8-5.9-5.8
  Balance on goods and services-0.9-0.2-0.6-1.6-1.4-2.0-1.9-1.3-0.9
   Exports of goods and services27.427.328.829.329.028.428.528.728.9
   Imports of goods and services-28.3-27.5-29.4-30.8-30.4-30.4-30.4-30.0-29.8
Capital flows (including errors and omissions)
   Balance on capital and financial account4.
   Errors and omissions0.
Overall balance of payments0.
Gross reserves (SARB)
Gross reserves (including the banking sector)
International Liquidity Position of SARB 113.711.911.812.111.711.110.610.19.6
Memorandum items:
Total external debt27.628.727.332.033.935.737.739.842.0
Foreign currency debt14.812.412.814.715.816.617.718.920.2
of which: short-term (at remaining maturity)
Medium and Long Term External debt12.013.311.817.221.625.724.828.031.6
service (in Billion of US dollars)
Sources: South African Reserve Bank (SARB); and Fund staff estimates and projections.

End of period.

Gross reserves minus foreign loans and minus forward position.

Sources: South African Reserve Bank (SARB); and Fund staff estimates and projections.

End of period.

Gross reserves minus foreign loans and minus forward position.

Table 7.South Africa: Monetary Survey 2004–2011
(In billions of rand)
Net foreign assets141.4195.1274.3304.5390.5354.2356.8526.9
 Gross reserves229.6297.8409.8561.7847.4670.8671.5846.1
  Other monetary institutions146.7167.3231.5337.4530.4378.1380.9448.3
  Other monetary institutions68.480.4116.2245.2450.8314.0314.6319.0
Net domestic assets772.8906.01,075.01,363.11,523.71,594.11,726.31,728.4
 Credit to government, net42.60.8-29.5-32.544.785.663.937.1
  Claims on government116.1107.4112.4116.5179.5223.7252.1308.1
  Government deposits73.4106.6141.8149.0134.8138.1188.2271.0
 Credit to private sector954.21,140.21,434.91,743.91,981.01,978.42,086.82,215.0
 Other items, net-224.1-235.0-330.4-348.3-502.0-470.0-424.3-523.7
Broad money (M3)914.21,101.11,349.31,667.61,914.21,948.22,083.12,255.3
   Of which: M1421.5503.1605.7738.3753.6806.3862.8946.9
(Annual percentage change)
Net foreign assets11.638.040.511.028.2-9.30.747.7
Net domestic assets13.417.218.726.811.
   Credit to private sector13.819.525.821.513.6-
   Broad money (M3)13.120.522.523.614.
(Contribution to growth in M3, unless otherwise specified)
Net foreign assets1.
Net domestic assets11.314.615.421.
   Credit to government, net-0.4-4.6-2.7-
   Credit to private sector14.320.326.822.914.2-
   Other items, net-2.6-1.2-8.7-1.3-
Memorandum item:
   Income velocity of M31.631.551.421.311.241.241.331.38
   (GDP/average broad money)
Sources: South African Reserve Bank (SARB).
Sources: South African Reserve Bank (SARB).
Table 8.South Africa: Financial Soundness Indicators 2008–2011
(In percent, unless otherwise indicated)
Capital adequacy:
   Capital adequacy ratio13.014.114.915.1
   Regulatory tier 1 capital to risk-weighted assets9.510.211.011.812.2
Credit risk
   Impaired advances to gross loans and advances3.
   Return on assets (smoothed)
   Return on equity (smoothed)18.128.715.814.716.4
   Interest Margin to gross income (smoothed).44.649.548.850.3
   Liquid assets to total assets (liquid-asset ratio)
   Liquid assets to short-term liabilities8.79.813.015.516.6
   Effective net open foreign-currency position to qualifying
   capital and reserve funds0.70.50.7-0.30.8
Source: South African Reserve Bank.
Source: South African Reserve Bank.
Appendix I. South Africa: Inward and Outward Spillovers

South Africa is a prime candidate for studying spillovers. The largest sub-Saharan African (SSA) economy, accounting for over a third of SSA's GDP and about 40 percent of its exports, has strong financial and trade links to the global economy and other SSA countries. It is subject to inward spillovers from shocks to advanced economies and other emerging markets through financial and real sector channels (Canales-Kriljenko, 2011). South Africa has one of the most liquid bond and equity markets among emerging market economies and shocks to global financial conditions rapidly filter into South African domestic financial variables. South African GDP is closely correlated to world GDP, a correlation that has increased over the last few decades. Through trade and financial channels, it could in principle also retransmit some of those shocks to other SSA countries, giving rise to outward spillovers. Arguably, the scope for spillovers within the region has increased with the expansion of intraregional trade over the last decade. South Africa has also expanded its foreign direct investment in the region over the last decade, and South African banks are key players in many countries in the region, although cross-border flows are limited because their subsidiaries essentially manage local deposits.

South Africa is significantly exposed to adverse developments in Europe and China. Adverse developments in one would affect the other and, ultimately, world growth. A slowdown in China could have the additional impact of likely giving rise to a sharper reduction in commodity prices. Such a slowdown would also have an indirect effect on South Africa through its SSA trading partners, which heavily depend on commodity prices. Model simulations suggest that shocks to any of these countries would have a more deleterious effect on South Africa if they also lead to a sharp increase in global risk aversion, which tends to lower business and consumer confidence not only in South Africa, but also in other trading partners (Meyer-Cirkel and Canales-Kriljenko, forthcoming).

Adverse developments in Europe and China would hurt the Southern Africa Customs Union (SACU) members both directly and through spillovers from South Africa. The resulting slowdown in world growth and commodity prices would reduce SACU member's income and external demand, but the impact via South Africa of the crisis would be more likely felt in the smaller countries that trade more with South Africa. South Africa accounts for about 80 percent of exports and an even higher share of imports of Lesotho and Swaziland. Customs revenues heavily depend on South African imports and account for a substantial amount of fiscal revenue in most SACU countries. The formula for sharing custom revenues provides members in the region about two years to adjust their policies in response to the decline in customs revenues associated with a decline in global trade. It exposes the members' fiscal revenue to rand volatility. In addition, most SACU members, except Botswana, peg their currencies to the South African rand, in practice, adopting monetary policy decisions from the South African Reserve Bank. Anecdotal evidence suggests that remittances from South Africa to some SACU members may also be significant. Moreover, South African financial groups are the dominant players in the financial markets of the region, spanning banking, pension, insurance, and wealth management services, whose treasury and risk management decisions tend to be centralized in Johannesburg. These institutions may help channel the substantial foreign direct investment from South Africa into the rest of the region. Despite all spillovers on different dimensions, output correlation among SACU members is low and South African GDP does not enter into a panel explaining GDP fluctuations in the region after controlling for world variables and fiscal policies (Canales-Kriljenko, Gwenhamo, and Thomas, forthcoming).

Other countries with strong trade and investment links to South Africa that would suffer from outward spillovers include Congo Malawi, Mozambique, Zambia, and Zimbabwe.

* Canales-Kriljenko, J. I., 2011, "South Africa: Macro Policy Mix and Its Effects on Growth and the Real Exchange Rate—Empirical Evidence and GIMF Simulations," IMF African Departmental Paper No. 11/04.

** Canales-Kriljenko, Gwenhamo, and Thomas, "Spillovers into the SACU Region," IMF Working Paper (forth.).

*** Meyer-Cirkel, A. and J. I. Canales-Kriljenko, "Global Financial Stress Transmission into sub-Saharan Africa—A GVAR approach," IMF Working Paper (forthcoming).

Appendix II. Estimating the Implicit Inflation Target1

South Africa adopted inflation targeting (IT) as a formal framework for monetary policy in 2000, with an inflation target band of between 3 and 6 percent. The adoption of the IT framework has clearly strengthened the South African Reserve Bank's (SARB's) mandate to focus on price stability and increased the SARB's accountability toward its main objective. However, unlike many reserve banks with an inflation targeting framework, the SARB has refrained from announcing an official mid-point (Figure 1). While this provided the SARB with greater flexibility in implementing monetary policy in an environment of volatile inflation, it may have undermined monetary policy's efforts to anchor medium- and long-term inflation expectations and may have complicated market participants' projections regarding the future path of the SARB's policy rate and monetary policy stance more generally.

Figure 1.Inflation Targets in Selected Emerging Markets

The analysis aims to reveal the SARB's implicit inflation target by estimating a simple Taylor rule in a state space approach where the coefficients of the SARB reaction function are estimated alongside the inflation target.2 The results should be treated with caution given the large uncertainties regarding the "true" output gap level and natural real rate as well as the possibility that the SARB may have looked at a longer forecast horizon for inflation and output gap when it set its policy rate. With this caveat in mind, the estimation results indicate that the SARB aimed for the upper segment of the band (4.5-6 percent) for most of the period, despite the substantial variation of the output gap (Figure 2). Moreover, the estimation results show that the implicit inflation target varied over time, and in recent years it has shifted toward the upper limit of the inflation target range. This perhaps implies that since the outbreak of the financial crisis in 2008 the SARB has become more tolerant toward higher levels of inflation to better support economic activity in the face of an extremely challenging global environment.

Figure 2.The Estimated Implicit Inflation Target 1

1 Band indicates +/-1 standard error.

Sources: Author's estimation.

1 Based on Klein, N., “Estimating the Implicit Inflation Target of the South African Reserve Bank,” IMF Working Paper (forthcoming).2 The analysis builds on Leigh, D., 2008, “Estimating the Federal Reserve’s Implicit Inflation Target: A State Space Approach,” Journal of Economics and Control, Vol. 32 pp. 2013—30.
Appendix III. South Africa: Real Wage, Labor Productivity, and Employment1

The recent financial crisis hit South Africa's labor market severely. In 2009-10, South Africa lost about three-quarters of a million jobs—equivalent to about 5 percent of total employment at end-2008, and unemployment, which already hovered above 20 percent during the precrisis period, increased further to about 25 percent. In 2011, this trend was partially reversed; however job creation continued to be rather weak and insufficient to make a substantial dent in unemployment.

The massive employment loss in 2009-10 and the relatively weak job creation in 2011 may reflect several factors, including the weak employment protection of the large share of informal workers and the sluggish recovery in South Africa's traditional trading partners, particularly the United States and Europe. It may also represent the rapid increase in real wages, which outpaced the growth of labor productivity in recent years (Figure 1). Although empirical findings point to a clear long-term link between the real wage and labor productivity, the deviations from "equilibrium" are persistent and take about 10-12 quarters on average, with potentially negative repercussion on employment creation (Figure 2). And indeed, a sectoral panel analysis that focused on 2008-11 in South Africa, confirms that higher excess real wage growth (real wage growth above labor productivity growth) significantly contributed to the decline in the formal employment. The persistent deviation from equilibrium was also reflected in a high increase in the nominal unit labor cost, which increased during the 2009-2010 by about 20 percent on a cumulative basis. The back-of-the-envelope calculations suggest that the excess real wage growth accounts for at least 25 percent of the employment loss in 2008-2010.

Figure 1.South Africa: Cumulative Growth of Real Wage and Labor Productivity of the Non-Agricultural Sector

Source: IMF staff's estimations.

The analysis also examines the link between real wage growth and labor productivity growth from an international perspective. It confirms that labor productivity growth has, on average, a positive and significant impact on real wage growth; however, in South Africa, the link between the two is substantially weaker than in other emerging markets, even after controlling for labor market tightness indicators such as unemployment and labor absorption rate.

1Based on Klein, N., 2012, “Real Wage, Labor Productivity, and Employment Trends in South Africa: A Closer Look,” IMF Working Paper (WP/12/92).
Appendix IV. A Financial Conditions Index for South Africa1

Financial conditions are known to have an important influence on business cycles because they reflect not only the feedback of current and past economic conditions but also the markets' expectations about the economic outlook. The construction of financial conditions indices (FCIs) has become critical not only to better understand the macrofinancial linkages, but also to obtain some indications about the direction of the near-term economic activity.

Although there is wide range of methodologies to construct a financial conditions index, the application for South Africa involves two alternative approaches: a principal component analysis (PCA), which uses the methodology proposed by Hatzius and others (2010),2 and a Kalman filter, which allows for a smoother, auto-correlated statistical process. Both approaches aim to identify an unobservable common factor from a group of global financial indicators (the global risk aversion, the TED spread, S&P500 index, the emerging market bond index), as well as South Africa-related financial variables (sovereign spread, credit to the private sector, non-performing loans, the rate of negotiated certificates of deposits, JSE index, house prices, NEER).

The estimated FCIs were found to have predictive power for near-term GDP growth (up to 4 quarters), pointing to strong macro-financial linkages in the economy. And indeed, the economic boom in 2005-08, the contraction in economic activity in 2009 and the recovery in 2010-11 are well captured by the FCIs' trajectories (Figure 1).

In recent months, however, there has been some deterioration, on the back of the elevated stress triggered by the sovereign and banking crisis in the euro area. Based on the historical link between FCIs and GDP growth, this may suggest economic activity is likely to moderate in the period ahead.

Figure 1.Demeaned GDP Growth and the Alternative FCIs

Source: Authors' calculations

1 Based on Gumata, N., N. Klein, and E. Ndou, “A Financial Conditions Index for South Africa,” IMF Working Paper (forthcoming).2 Hatzius, J., P. Hooper, F. S. Mishkin, K. L. Schoenholtz, and M. W. Watson, 2010, “Financial Conditions Indexes: A Fresh Look after the Financial Crisis,” NBER Working Paper No. 16150 (Cambridge, Massachusetts: MIT Press).

The results of the standardized test given for the first time in 2011 to 8-year olds have been poor.


The independent National Planning Commission published a draft National Development Plan (NDP) in November 2011. This document proposes a strategy for reaching ambitious development goals by 2030 and calls for a broad array of deep-rooted reforms, including on labor markets.


Figures do not include the health and social security reforms, which have not yet been budgeted, except for pilot programs.


These measures could include a combination of revenue and spending measures, including increases in the VAT rate and reductions in the real wage bill. Restraint on fiscal spending alone as recommended by staff could reduce the public debt to about 38 percent of GDP.


Klein, N. (2012) "Real Wage, Labor Productivity, and Employment Trends in South Africa: A Closer Look" IMF working paper WP/12/92.


South Africa will be included in Citigroup’s World Government Bond Index (WGBI) in October, which will increase inflows at the margin.


The treasury holds significant deposits at the SARB for sterilization. It also covers the cost of the foreign currency swaps used to sterilize some official foreign exchange intervention, usually associated with lumpy foreign direct investment inflows.


In the OECD’s product market regulations index, South Africa ranks poorly compared to the OECD median because regulations remain a substantial entry barrier for new firms.


According to the Budget Review, the governments’ existing ALMP programs include training courses and apprenticeships to enhance skills, 125 labor centers offering job-search and job-matching services, public work programs that provide short-term jobs to the unemployed, a Jobs Fund to support projects with the potential to create a large number of jobs, and training layoff schemes to subsidize the temporary suspension of work in favor of training. Government spending on public work programs has increased from R4.2 billion (0.6 percent of consolidated government expenditure) in 2008/09 to R7.8 billion (0.8 percent of expenditure) in 2011/12.


Loans become impaired when the bank or supervisory authority conclude that the principal or interest of the loan cannot be collected as envisaged in the loan contract. 8 By May 2012, house prices had declined by 7 percent in nominal terms from their peak in August 2011. On the other hand, household debt and financing costs to disposable income have been steadily declining since 2008.


By May 2012, house prices had declined by 7 percent in nominal terms from their peak in August 2011. On the other hand, household debt and financing costs to disposable income have been steadily declining since 2008.


An ongoing peer review by the Financial Stability Board will focus on South Africa’s experience with (1) interagency coordination and the introduction of a “twin peaks” regulatory structure and (2) over-the-counter derivatives market reforms. The report will include a self assessment of progress in implementing FSAP and ROSC recommendations.

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