Statement by Peter Gakunu, Executive Director for South Africa and Goolam Aboobaker, Senior Advisor to Executive Director July 25, 2007

This 2007 Article IV Consultation highlights that real GDP in South Africa grew by 5 percent in 2006 and continued to grow vigorously in early 2007. Growth was driven by strong domestic demand, with private consumption and investment spending supported by continuing robust consumer and business sentiment and low interest rates until late 2006. Asset prices continued to rise rapidly in 2006 and early 2007. Executive Directors have considered that the economic outlook for South Africa remains broadly positive.

Abstract

This 2007 Article IV Consultation highlights that real GDP in South Africa grew by 5 percent in 2006 and continued to grow vigorously in early 2007. Growth was driven by strong domestic demand, with private consumption and investment spending supported by continuing robust consumer and business sentiment and low interest rates until late 2006. Asset prices continued to rise rapidly in 2006 and early 2007. Executive Directors have considered that the economic outlook for South Africa remains broadly positive.

July 25, 2007

1. The South African authorities would like to thank the Staff for a constructive report and an issues paper rich in information. The authorities would also like to indicate that they appreciate the frank engagement on the challenges confronting the country.

2. Prudent macro-economic policies over the past decade have resulted in impressive economic growth that is helping the country to make a serious impact on reducing unemployment and poverty. Poverty eradication and employment creation remain serious challenges going forward. Buoyant growth in South Africa has also been good for the Southern African Development Community (SADC) region as a whole and has greatly benefited members of the South African Customs Union (SACU).

Recent Economic Developments

3. The last three years in particular have seen the economy growing at an average rate of 5% but has slowed down marginally because of the general decline in mining. The higher rate has begun to impact on employment, which has grown in the past year by over 4%, although the numbers of unemployed continue to be unacceptably high.

4. The current account deficit widened to 6.5 percent in 2006 and increased to 7.0 percent of GDP in the first quarter of 2007 and continues to be funded via capital inflows into portfolio investments on the Johannesburg Securities Exchange (JSE). However the authorities believe that this deficit reflects rising investment rather than a growing fiscal imbalance. While they are concerned that such an unusually high deficit level exposes a country to a sudden stop in capital inflows, they consider that the relatively low external liabilities and the fact that fiscal policy is aimed at increasing the level of government savings should mitigate the risks posed by the current account deficit.

5. Further, the authorities share the view of Staff that sound macro-economic fundamentals, particularly the low external debt together with a well managed and stable financial sector and a flexible exchange rate regime would assist in mitigating this risk.

Monetary Policy Developments

6. The key development regarding monetary policy was the breach of the 6% inflation target, the first since the introduction of the inflation targeting framework in 2003. The Monetary authorities are conscious of the fact that there is an upside risk to inflation and that it has acted promptly recently when inflation, fuelled largely by buoyant oil and food prices, rose to 6.3 per cent in the past quarter with a 50 basis points interest rate hike; and is ready to tighten policy further if necessary.

7. The South African Reserve Bank (SARB) has continued with its policy of gradual reserve accumulation, and is committed to increasing reserves in line with other emerging market economies. At end June 2007, gross reserves stood at $28.3 billions and net reserves at $25.9 billions. The authorities see that there is room for sterilized reserves purchases to improve external vulnerability and mop up excess capital inflows.

8. The flexible exchange rate system had served the authorities well and as recognized by staff is not misaligned. However, it is difficult to estimate an equilibrium value for the rand. The volatility of the exchange rate has been reduced significantly and the accumulation of reserves has reduced exchange rate risk. Remaining exchange controls, including capital outflows by residents and portfolio investments, continue to be relaxed, while the National Treasury is also assessing the approaches of other countries to benefit from best practice.

Fiscal Policy

9. Public finances remain healthy as robust economic performance and improved revenue administration have led to increase in revenues. This, together with reduction in debt service costs has enabled the announcement of a budget surplus in the current financial year as well as a balanced budget over the Medium Term Expenditure Framework (MTEF) cycle despite projecting a significant increase in spending over the period.

10. The strong fiscal position has allowed the authorities to allocate substantial resources to social and economic programmes over the three year cycle. The public sector would continue to maintain an upward trend in investments in gross fixed capital formation as part of the ASGISA initiative, with the objective of modernizing crucial economic and social infrastructure and improving basic household infrastructure.

11. A central plank of government programme continues to be the eradication of poverty and the reduction of inequality and, in the light of both stronger economic performance and the greater fiscal space, the authorities have decided to embark on further reforms of the social security system. The reforms have several objectives, including lowering the costs of job creation, extending basic social security benefits to a larger number of workers and their families, and building on existing government-funded social assistance and social security programmes. Before finalization and launching of the proposed reforms, the authorities intend to enter into substantive discussions with principal stakeholders including organized businesses and trade unions.

12. With over 5.5 million people living with HIV (18.8 per cent of adult population, with women between the ages of 25-29 years worst affected), combating HIV/AIDS continues to be one of the major challenges confronting the authorities. Building on the Comprehensive Plan and earlier initiatives, the authorities launched a revised strategic plan in May 2007 with a budget of over R14 billion over the MTEF cycle. The plan has four main elements: prevention programmes; treatment, care and support of patients; monitoring, research and surveillance; and Human and legal Rights. Currently, there are over 282,000 patients enrolled for public sector anti-retro viral treatment and over 300 facilities accredited to implement the comprehensive strategy.

Financial Sector

13. South Africa is served by a well run and managed financial system that is highly concentrated and profitable, but dominated by a few large banks and insurance companies. The system is also well regulated, with strong oversight shared between the Central Bank and the Ministry of Finance. The SARB undertakes regular reviews of the financial system using stress tests, analysis of corporate balance sheets and debt burdens. The results of the review are published twice a year.

14. The authorities acknowledge that the rapid credit expansion, particularly household debt, posed certain risks and highlighted the need for further enhancements to the regulatory and monitoring framework. They have therefore promptly effected the National Credit Act to provide some protection to consumers and simultaneously slow down the rate of credit extension. Consequently, non-performing loans had declined while household debt had started to decelerate. However, debt service costs remain at historic lows.

Structural Reforms for Accelerating Economic Growth and Competitiveness

15. Achieving higher and shared growth (ASGISA) is based on unlocking the six binding constraints which have been identified, namely, volatility of exchange rate; inadequate infrastructure and logistics; skills shortages; barriers to entry and competition; regulatory burdens on SMEs; and capacity limitations within the state. Significant progress has been made in addressing these constraints in the context of implementing the ASGISA initiative. Some of the policy responses also include undertaking a comparative study of the experience of some inflation targeting countries in interventions in foreign exchange markets; implementing dedicated projects at the DBSA and in the office of the Deputy President under the JIPSA, aimed at improving the capacity of sub-national governments for infrastructure development; identifying and acquiring priority skills both internally and externally; evaluating the skills development and public works programme to assess their effectiveness; and addressing competitiveness concerns in the economy through measures to increase productivity and reduce the cost of doing business.

16. Significant progress has also been achieved in the implementation of other key elements of the ASGISA initiative. The number of capital projects behind schedule has decreased; the programme to increase the numbers of artisans supported by businesses and trade union leaders is beginning to bear fruits; and, in close consultation with higher education authorities, a programme to produce an additional 1000 engineers has been launched.

17. For promoting industrial sectors, the ASGISA initiative places a sharper focus on tourism with an emphasis on an airlift programme, increasing safety and security of tourists and support for SMEs; on bio-fuels - concentrating on maize and sugar cane as fuel source with a target of 4.5 per cent of oil requirements to be met by bio-fuels by 2013; and on business process operations and outsourcing - reducing the cost of telecommunications and skills development.

18. Furthermore, the South African government takes quite seriously the practice of monitoring and evaluation, both through the ten year review exercise and by insisting that Ministers report on the implementation of government’s programme of actions on a bi-monthly basis.

Regional Development

19. South Africa, with 6% of the population accounting for over a third (on a PPP basis) of SSA GDP has made significant impact on the African economy. Trade linkages with the rest of the continent, though starting from a small base, has begun to see significant increases. South African direct investments in other parts of Africa have started to take off, doubling since 2000 and standing at about $3.7 billion in 2004. There has been a marked increase in the number of South African companies operating on the continent. Sixty of the top 100 companies listed on the JSE have direct ownership of foreign affiliates in Africa, while another 26 are holding companies that have investments in Africa; South African banks operate in 17 countries.

20. South Africa belongs to a Common Monetary Area (CMA) that includes Lesotho, Swaziland and Namibia, the SA Customs Union (CMA plus Botswana) and the Southern African Development Community. It accounts for over two thirds of the combined SADC GDP and for about 60% of intra-SADC trade. The determined economic growth has had significant spillover effects, particularly to the SACU members with a significant increase in revenue receipts by the BLNS countries. The authorities are in favor of stronger regional integration and the broadening of the Customs Union. The country also attracts a large number of migrants from neighboring countries as well as from afar. These developments reflect both the demand-pull effects of South Africa’s strong growth and skill shortages, as well as the supply-push effects of economic turmoil in some countries.

21. The authorities are discussing with SACU members regarding the revenue sharing formula and they have given assurance that they would not make any uni-lateral changes to SACU or to its revenue sharing formula.