South Africa: Selected Issues

This Selected Issues paper highlights that cautious monetary and fiscal polices of South Africa during 1997 resulted in a return of financial investor confidence and capital inflows during 1997 and through April 1998. These policies helped the South African economy emerge successfully from the exchange market pressures of 1996 and weather the contagion from the East Asian crisis in the second half of 1997. Throughout 1997 and up until May 1998, inflation and market interest rates fell considerably, net international reserves increased, and the net open forward position of the Reserve Bank was reduced sharply.

Abstract

This Selected Issues paper highlights that cautious monetary and fiscal polices of South Africa during 1997 resulted in a return of financial investor confidence and capital inflows during 1997 and through April 1998. These policies helped the South African economy emerge successfully from the exchange market pressures of 1996 and weather the contagion from the East Asian crisis in the second half of 1997. Throughout 1997 and up until May 1998, inflation and market interest rates fell considerably, net international reserves increased, and the net open forward position of the Reserve Bank was reduced sharply.

IX. The Southern African Development Community and Other Regional Initiatives

A. Introduction

292. There is growing impetus for regional integration in Southern Africa under the auspices of the Southern African Development Community (SADC). SADC, which comprises 14 members (Table 26), envisages cooperation between members on a wide range of areas, including intra-SADC trade liberalization, exchange and payments system, financial services, infrastructure, investment, human resource development, and sectoral development. The SADC treaty provides for protocols that will set out the principles and procedures for cooperation between member states in each of the areas.

Table 26.

Summary of Regional Groupings in Southern Africa

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293. The SADC Trade Protocol was signed in August 1996 and aims to create a free trade area (FT A) among member states.1 It envisages the dismantling of tariff and nontariff barriers between SADC members over an eight-year period. However, South Africa has espoused the principle of asymmetric liberalization, whereby it will reduce its barriers on imports from other SADC countries over a five-year period. The exact modalities of liberalization, namely, the phasing of the tariff and nontariff reductions and the treatment of certain sensitive sectors, will be decided during the course of negotiations scheduled for the second half of 1998, based on initial tariff offers made by SADC member countries.

294. SADC is only one of a number of regional integration initiatives in southern Africa. The others include the Cross-Border Initiative (CBI), the Common Market for Eastern and Southern Africa (COMESA), the Southern African Customs Union (SACU), the Commission for East African Cooperation (EAC), and the Indian Ocean Commission (IOC) (see Table 26). In addition, there are a number of bilateral agreements which provide for selective liberalization such as those between South Africa on the one hand and Zimbabwe, Malawi, and Mozambique on the other.

B. Features of SADC Trade2

295. Trade within the SADC region, although small relative to its overall trade, has been rising (Tables 2729). Between 1990 and 1996, intra-SADC trade as a share of total trade increased from 4 percent to 10 percent, and as a share of GDP from 2 percent to 6 percent.3 For Africa as a whole, intra-trade represents 8 percent of total trade and 3 percent of GDP. Thus, there appears to be some nascent dynamism to SADC trade even in the absence of preferential arrangements.

Table 27:

Imports of SADC countries

(in millions of US dollars unless otherwise indicated)

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Source: IMF’s Direction of Trade Statistics
Table 28:

Exports of SADC Countries

(in millions of US dollars unless otherwise indicated)

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Source: IMF’s Direction of Trade Statistics
Table 29:

Selected Indicators of SADC Trade

(in millions of US dollars unless otherwise indicated)

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Sources: IMF’s Direction of Trade Statistics and World Economic Outlook

296. Four features are noteworthy about intra-SADC trade in 1996. First, non-SACU SADC countries in aggregate rely to a great degree on SADC, and on SACU in particular (which is dominated by South Africa), for their imports, but to a lesser degree on SADC as a market for their exports (see Tables 27 and 28). Second, there is greater variation between these countries in terms of the importance of SADC as a source of their imports than as a destination for exports. Third, in absolute and proportional terms, SACU exports more to SADC countries than it imports from them, thereby running a large trade surplus on intra-SADC trade (in contrast, all other countries register a deficit on such trade). Fourth, for SADC as a whole, its dependence on the region for imports matches the importance of SADC as a market for exports (i.e., the share of intra-SADC imports in SADC’s total imports (about 11 percent) is roughly the same as the share of intra-SADC exports in SADC’s total exports).

297. On the import side, Malawi, Mozambique, Zambia, and Zimbabwe exhibited a high degree of reliance on the region for their overall imports in 1996, from 44 percent in the case of Zambia to 64 percent in the case of Mozambique, compared with a figure of about 11 percent for the region as a whole. These figures themselves mask the disproportionate importance of SACU for supplying the SADC countries. For all non-SACU countries, SACU supplied between 65 percent (Malawi) and 97 percent (Zimbabwe) of all imports from SADC countries. A very small proportion of the imports of Tanzania, Mauritius, and Angola (between 10 and 17 percent) originate within SADC. SACU sources an even smaller proportion of its imports (1.5 percent) from other SADC members.

298. On the export side, SADC represents an important export market for Zimbabwe (and to a lesser extent for Mozambique and Malawi), For other non-SACU countries, SADC accounts for less than 10 percent of each country’s exports. For most countries, it is actually SACU that absorbs the bulk of goods exported to the SADC region (82 percent in the case of Malawi, 60 percent in the case of Zimbabwe, and 50 percent for Mauritius). SACU exports close to 10 percent of its total exports to the region.

C. The Welfare Economics of SADC

299. The static gains and losses from preferential trade liberalization are well-known (Viner 1950). When preferential liberalization leads to inefficient domestic production being replaced by efficient production in the partner country, there is a gain (to constituents and to the arrangement as a whole) in welfare; conversely, when efficient production from the third country is substituted by inefficient production in the partner country there is a loss in welfare. On balance, either of these effects could dominate, and the assessment of net benefits is ultimately an empirical one. The discussion below elaborates on the likely effects in the case of SADC.

300. Summers (1991) and Krugman (1992) have forcefully argued that there is a presumption that countries that are natural trading partners—defined as when two countries trade more with each other than suggested by their underlying income—will benefit when they enter into an FTA. Further, countries that are geographically close or contiguous should, ceteris paribus, be natural trading partners given the lower transportation costs. A crude, albeit indicative, index proposed by these authors for gauging natural trading relationships is to compare actual trading patterns with “geographically neutral” trade, in which country A’s share of B’s exports is equal to A’s share of gross world product. If the index is greater than 1, A is a natural trading partner because B is exporting more to A than is suggested by A’s share of world income.

301. Table 29 contains calculations for this index for the SADC region. Surprisingly, the relevant indices all exceed one by a large margin, suggesting natural trading relationships within the region. Two inferences may be tentatively drawn from Table 29. First, that SADC countries’ trade links are intensifying as manifested in the rising value of the index. Second, and as suggested by the trade numbers presented above, the relationship between SADC and SACU is asymmetric; while SACU may be a natural trading partner for non-SACU SADC countries, the converse may be less true.

302. More recent theoretical work (Bhagwati and Panagariya (1996)) casts considerable doubt on the natural trading partner hypothesis, enough to even reverse its basic conclusions. This work shows that the more two countries are natural trading partners, in the sense of trading a lot with each other, prior to the formation of an FTA, the greater the likely loss from the FTA because of the large adverse impact on fiscal revenues, including from diverted imports (which is not compensated by reduced prices and higher consumer surplus). The second important conclusion is that the more a trading partner is an inefficient supplier, compared with third countries, the greater the likelihood that an FTA with that partner will be welfare-deteriorating because of inefficient trade diversion (see the Appendix for an analytical elaboration of these propositions).

303. These results have strong implications for SADC countries. For non-SACU countries that import a large proportion of their total imports from within the region, an FTA is likely to lead to substantial revenue losses, not only on the initial volume of imports but also the newly diverted imports. These countries will therefore need to enhance their domestic tax base to offset these losses. Second, insofar as South Africa, which is the predominant partner within SADC, is an inefficient supplier relative to third countries, non-SACU countries as well as SADC as a whole stand to lose from the FTA. The enhancement of South African efficiency thus holds the key to ensuring that SADC is a welfare-enhancing proposition for SADC. Although South Africa’s imports from SADC are very small, it would stand to gain from an FTA in those labor-intensive products (such as textiles, clothing and footwear), which are currently heavily protected, because partner countries are likely to be relatively efficient suppliers of these products.

D. Revenue Dependence

304. In the latest year for which data are available, trade taxes accounted for between 3 percent of total government revenue in South Africa to about 40 percent for Malawi and Mauritius, with the average at about 20 percent (see below). Countries with high reliance on trade taxes are of course at greater risk from weakening their fiscal position, absent corresponding fiscal reforms to strengthen the domestic tax base. While the overall reliance on trade taxes tends to be high in SADC countries (with the exception of South Africa and Botswana), the actual collections from intra-SADC imports are not high, varying from 2 percent in the case of Tanzania to about 5 percent for Malawi, Mozambique, Zambia, and Zimbabwe. SACU countries collect less than 1 percent of their import revenues from SADC trade. It should be noted, however, that these numbers are pre-SADC numbers and understate the likely adverse impact of the FTA because they ignore the marginal response which, ceteris paribus, is likely to lead to a greater proportion of imports being sourced from within SADC, exacerbating the revenue loss.4

Importance of Trade Taxes for SADC Countries

(In percent)

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Sources: Fund staff estimates; and IMAM (1997)

E. The Challenges of SADC

Need for external liberalization

305. Regional trading arrangements can be beneficial in promoting efficiency and growth. However, to do so they must minimize the risks of inefficient trade diversion. Some principles that will help achieve this are: first, FT As should be comprehensive in their scope, applying to virtually all trade between partners without carve-outs for special sectors or products; second, transition periods for the phase-in should be reasonably short; and most importantly, regional liberalization should be accompanied by external liberalization.5 In a recent empirical study, Vamvakidis (1998) demonstrates that economies grew faster after nondiscriminatory liberalization, but slower after participation in an FTA. Economies also had higher investment ratios to GDP after nondiscriminatory liberalization but lower ratios after joining an FTA. As noted above, one of the biggest challenges facing SADC is to ensure that preferential liberalization does not lead to inefficient trade diversion, a real possibility if barriers to external trade are not considerably and simultaneously reduced. At this stage, SADC does not contemplate external liberalization.

Multiplicity of regional initiatives

306. SADC is only one of a number of preferential regional initiatives that are proliferating in the region with overlapping memberships (see Table 26), conflicting objectives and time schedules.6 For example, the Cross-Border initiative (CBI), unlike SADC envisages the elimination of barriers to intra-CBI trade and the liberalization of external barriers by October 1998.7 The Common Market for Eastern and Southern Africa (COMESA) envisages the liberalization of intra-trade barriers by 2000 and is working toward the objective of a common external tariff by an, as yet, unspecified date. The Commission for East African Cooperation (EAC) foresees internal and external liberalization by 2000. Adding to the multiplicity will be the FTA between the European Union and South Africa that is currently being negotiated.

307. This multiplicity poses a number of questions that need to be addressed relatively soon, given the schedules of some of these initiatives. Could SADC members treat non-members better under new or existing arrangements? For example, if South Africa enters into an FTA with the European Union, can it give better treatment to the EU than to its SADC partners? How will rules-of-origin be designed in the context of this multiplicity? Is there the capacity to monitor such rules? If the external tariffs are different for SADC and CBI, there will be scope for trade deflection (or transhipment) through countries that are participants in both. Customs officials will not only have to distinguish between goods originating in SADC and say the EU, but also between goods originating in SADC and CBI countries.8 If two countries are members of both CBI and SADC, will they be obliged to reduce internal barriers in accordance with the slower schedule of SADC or the faster schedule .of CBI? In either case, there will be a different pace of liberalization among countries within a regional grouping, creating the need for rules-of-origin even during the transition period.

The impact of an FTA between South Africa and the EU on SADC members

308. An agreement between South Africa and the European Union (EU) is likely to have a number of effects on SADC member countries. For non-SACU SADC countries, there is likely to be a loss of export competitiveness in the EU markets because it would erode the value of the preferential access (relative to South African exports) that they currently receive in the EU agreement as a result of the Lomé agreement.9 This loss relates not only to trade but the potential reduction in investment that had located in these countries to benefit from the benefits granted under the Lomé agreement. In addition, it would erode the value of the preferential access (relative to European exports) that will be conferred on these countries in the South African market by SADC. Offsetting these losses will be the gains to the region and to the non-SACU SADC countries deriving from the increased efficiency that the FTA with the EU will induce in South Africa.10 As noted above, this increased efficiency is necessary for these countries to benefit from SADC.11

F. Conclusions

309. SADC is one of a number of initiatives in the southern African region. A number of questions arise from the multiplicity of initiatives, involving overlapping memberships, conflicting objectives, varied schedules for liberalization, and disparate sets of exclusions from liberalization. Steps need to be taken by SADC member countries (and by COMESA and the EAC) to rationalize these initiatives and make them mutually consistent; in this context, and in view of the benefits of more broad-based liberalization, they should strive toward achieving the external liberalization objectives of CBI.

310. SADC is more likely to be beneficial for countries other than South Africa and for the region as a whole, the more efficient is South Africa and the more the FTA is combined with liberalization of external trade barriers. This underscores the need for the region, and especially South Africa, to improve its efficiency levels, through more ambitious structural reform. SADC may prove to be welfare-enhancing for South Africa in those sectors such as textiles, clothing, and footwear, where regional partners such as Zimbabwe and Zambia are efficient suppliers. This benefit underlines the need for South Africa to avoid exclusions of the so-called sensitive sectors from SADC, thereby providing increased access for exports of regional partners.

References

  • Bhagwati, J., and A. Panagariya, 1996, “Preferential Trading Areas and Multilateralism: Strangers, Friends or Foes,Working Paper No. 22, Center for International Economics, University of Maryland.

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  • IMANI Consultants, 1997, “Impact of an EU-South Africa Free Trade Agreement on BLNS Countries.Report prepared for the Commission of the European Union.

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  • Krugman, P., 1992, “Regionalism vs. Multilateral: Analytical Notes,” in J. De Melo and A. Panagariya (eds.), New Dimensions in Regional Integration, Cambridge University Press.

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  • Summers, L., 1991, “Regionalism and the World Trading System,Presented at the Conference at the Federal Reserve Bank of Kansas City.

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  • Vamvakidis, A., 1998, “Regional Trade Agreements Versus Broad Liberalization: Which Path Leads to Faster Growth? Time-Series Evidence,IMF Working Paper, WP/98/40.

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  • Viner, J., 1950, The Customs Union Issue. New York: Carnegie Endowment for International Peace.

APPENDIX Two Impacts of an FTA with Reference to SADC

This appendix highlights two likely impacts of the formation of an FTA among SADC countries. First, the more SADC countries import from each other, the greater the welfare loss from the FTA. Second, the more efficient the trading partner relative to the rest of the world, the more likely the welfare gain to countries and to the region as a whole.

Let us assume that Malawi is planning to integrate preferentially with South Africa (SA) under SADC. In Figure 22, MM represents the import demand curve for a product imported by Malawi. The supply curve of the product available from South Africa, the potential partner, is EE. Supply from the rest of the world (ROW) is assumed to be perfectly elastic and represented by HR.

Figure 22.
Figure 22.

Welfare Calculus of an FTA When Partner Country is Less Efficient than ROW

Citation: IMF Staff Country Reports 1998, 096; 10.5089/9781451840940.002.A009

Under a nondiscriminatory tariff at rate t per unit, supplies from SA and ROW as perceived by the consumer in Malawi are given by Et Et and GB, respectively. Total imports into Malawi equal OQ3 of which OQ1 comes from SA and Q1 Q3 from ROW. Malawi collects tariff revenue equivalent to rectangle GHNS. The welfare gains to Malawi equal the tariff revenue (GHNS) and the consumer surplus equal to KGS. The welfare gain to SA is the area HDU, which is the producer surplus for South African exporters.

Suppose that Malawi integrates with SA by eliminating the tariff on SA’s supplies but retaining it on those from ROW. Imports from SA increase to OQ2 and those from ROW decline to Q2 Q3. The welfare consequences for Malawi are that its consumer surplus gains remain unchanged12 because the domestic price continues to be determined by supplies from ROW which still faces a tariff t; but its revenues have now declined (to the area FLSN) because no tariffs are applied to imports from South Africa (the revenue loss is the sum of the loss on Malawi’s initial level of imports from South Africa (OQ1) and the newly diverted imports (Q1Q2). This leads to the first proposition that the greater the level of initial trade between Malawi and SA, the greater the revenue loss. The gain to SA from the FTA is the area GFUH, which is the increase in producer surplus to South African exporters. However, SADC as a whole loses (by an amount represented by the area FLU) because the gains to SA are less than the loss to Malawi.

Suppose instead that South Africa is a more efficient supplier than ROW. This case is shown in Figure 23 below, where the perfectly elastic supply now represents SA’s supply schedule. With a nondiscriminatory tariff, the welfare gains to Malawi are the same as above. However, in the case of an FTA, the welfare consequences are different. The welfare gains to Malawi comprise (i) the increased consumer surplus (equal to RSN plus GHNS), which arises because the consumer price in Malawi has dropped by the full extent of the tariff; (ii) less the tariff revenue losses on imports from South Africa (WNSJ); the latter are outweighed by the former, and total welfare increases (by the areas RSN+HWYZ). This establishes the second proposition that the more efficient the partner country, the more likely the gains from an FTA. In this case, it is also true that the FTA as a whole also gains (equivalent to the gains to Malawi) because there are no losses to South Africa.

Figure 23.
Figure 23.

Welfare Calculus of an FTA When Partner Country is More Efficient than ROW

Citation: IMF Staff Country Reports 1998, 096; 10.5089/9781451840940.002.A009

Of course, it is also true that in both situations considered above, nondiscriminatory tariff reduction is superior to an FTA and remains the first-best policy option.

ANNEX South Africa: Tax Summary as of April 1, 1998

(All amounts in South African rand)

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Table 30.

South Africa: Expenditure on GDP, 1993-98

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Source: South African Reserve Bank, Quarterly Bulletin.

Contribution to GDP growth.

Table 31.

South Africa: Gross Fixed Investment and Capital Stock, 1992-97

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Source: South African Reserve Bank, Quarterly Bulletin.

Including transfer costs.

Finance, insurance, real estate, and business services.

End of period.

General government plus four departmental enterprises (Community Development Fund, Government Motor Transport Trading, Government Printing Works, National Housing Fund).

Table 32.

South Africa: Financing of Domestic Investment, 1992-97

(In percent of GDP at market prices)

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Source: South African Reserve Bank, Quarterly Bulletin.

Before inventory valuation adjustment.

Provision for depreciation at replacement value.

Table 33.

South Africa: Growth of Disposable Income of Households, 1993-97

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Source: South African Reserve Bank, Quarterly Bulletin.

After adjustment for net remuneration paid to the rest of the world.

After provision for depreciation and inventory valuation adjustment.

Table 34.

South Africa: Real Gross Domestic Product at Factor Cost, 1993-98

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Source: South African Reserve Bank, Quarterly Bulletin.
Table 35.

South Africa: Indicators of Mining and Quarrying Activity, 1991-97

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Source: South African Reserve Bank, Quarterly Bulletin.

In 1990.

Table 36.

South Africa: Indicators of Manufacturing Activity, 1993-97

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Source: South African Reserve Bank, Quarterly Bulletin.
Table 37.

South Africa: Nonagricultural Employment, 1990-97

(1990=100)

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Source: South African Reserve Bank, Quarterly Bulletin.

Central government, local authorities, provincial administrations, statutory bodies, and national and independent states (TVBC).

Transnet and the Department of Posts and Telecommunications.

Includes also construction, commerce, and private services sectors (e.g. banking, insurance, hotels, transport and laundary)