Mr Mboweni's address on the occasion of the
seventy-ninth ordinary general meeting of shareholders
of the South African Reserve Bank
Address of Mr T T Mboweni, Governor, at the South African Reserve Bank's seventy-ninth ordinary
general meeting of shareholders on 24 August 1999.
* * *
Introduction
The South African economy has recovered remarkably from the contagion effect of the financial
turbulence in Asia and Russia. After being seriously affected by the volatility in global financial
markets during the four months from May to August, tentative signs of a return to financial stability
already began to appear during the last few months of 1998. The recovery of the financial sector was,
however, attained at the cost of lower economic growth because of the restrictive measures that the
authorities were forced to apply, the impact of a slowdown in international economic activity in many
parts of the world and a slump in international commodity prices. Currently the economy seems to be
poised for higher growth in production, provided that it is not again affected by setbacks in other
countries.
At the beginning of the financial turmoil the thinking was that it would only have a limited impact on
domestic economic conditions through a lower demand for South African exports from the Asian
region. Later it became apparent that the crisis would not only be restricted to certain countries in
Asia, but would affect many countries around the world. The international financial system was dealt a
further blow when Russia de facto devalued the rouble, imposed a moratorium on foreign credit
repayments and unilaterally restructured public debt in August 1998.
As a result of these circumstances, international investors lost confidence in emerging markets and
withdrew investments from developing countries to higher quality, but lower yielding, financial assets
of industrialised countries. Interest rates rose to high levels, equity and bond prices fell sharply and the
currencies of many economies depreciated considerably. Many banks and other financial institutions
suffered losses, especially on highly leveraged investment positions, which induced systemic risks in
the financial sectors of some emerging-market economies. The financial turmoil spilled over to real
economic activity, with serious consequences for growth in world production and trade.
All these developments once again demonstrated that in a globalised financial system the mobility of
capital has serious consequences for financial stability. In a closely integrated financial world it has
become even more important for monetary policy to be focused primarily on financial stability. The
lack of a credible commitment to that objective by the monetary authorities could intensify the risk of
market overreaction and systemic instability. Such a policy approach does not, of course, provide
unconditional protection against speculative capital outflows. Decisions by international investors to
withdraw capital from a country, based on developments in other emerging-market economies, are
beyond the control of any central bank. The best approach that the South African Reserve Bank can
follow is to pursue financial stability in a transparent way so that it can forestall uncertainties.
Monetary policy will be more successful in avoiding imbalances and disruptive capital flows if
measures are in place to address structural weaknesses in the economy. Crisis prevention requires
close coordination between the various spheres of macroeconomic management to ensure market
confidence. In addition, domestic financial systems should be closely monitored and made more
transparent and thus more robust.
While it is essential for South Africa to maintain these disciplines, the recent crisis has illustrated the
need to adapt the international financial system to the realities of global markets to reduce the
frequency and size of crisis situations. International organisations have made considerable progress
with the improvement of the financial architecture. Standards or codes of good practice have been or
are being developed in many financial disciplines to allow market participants to compare the
practices of countries with internationally agreed benchmarks. The Reserve Bank regards this work as
essential for the creation of more stable conditions and is accordingly willing, wherever possible, to
participate in these endeavours.
If a financial crisis does occur despite the efforts of the monetary authorities to prevent it, monetary
policy has to accommodate the market. Intervention in financial markets can assist in smoothing the
adjustment process, but should not oppose market trends. The authorities have to allow interest rates
and the exchange rate of the currency to move to new levels. Such adjustments increase the cost of
speculation, reduce inflationary pressures and contribute to an improvement in the balance of
payments position of a country.
Unfortunately, the adjustments required in a crisis also adversely affect real economic activity.
However, experience in many of the emerging-market economies during the recent financial crisis has
shown that where monetary policy had not been tightened quickly and sufficiently, instability persisted
with an even greater negative impact on those economies. Pursuing a tighter monetary policy led to a
quicker return to currency stability and market confidence. This, in turn, provided room for a lowering
of interest rates which helped to mitigate the negative results of the earlier tighter measures.
The efforts of individual governments and the international financial community to re-establish
financial stability are proving successful. The implementation of flexible exchange rate regimes and
other structural adjustments in emerging-market economies seemed to have stabilised financial
markets during the first seven months of 1999, and are also improving the prospect of a gradual
economic recovery. Interest rate cuts by central banks in virtually all major industrialised countries are
helping to improve liquidity and to rebuild investor confidence. Although there are still risks and
uncertainties in the world economy, conditions are far better now than they were during 1998.
The contagion effects of the international financial crisis on South Africa
The effects of the international financial crisis spilled over into the South African economy in May
1998 when foreign fund managers began withdrawing portfolio investments. The well-developed
capital markets and the relatively free convertibility of capital in the country provided an easy source
of liquidity for fund managers who wished to reduce their exposures to emerging markets. From May
to December 1998 non-residents reduced their holdings of South African bonds by R26 billion. In the
first four months of the year they were net buyers on the South African Bond Exchange to the amount
of R16 billion.
This reversal of portfolio investments in bonds by non-residents was difficult for the South African
economy to absorb because it occurred at a time when South Africans were also making direct and
portfolio investments in other countries following a relaxation of exchange controls. Moreover, the
reversal created leads and lags in other foreign payments and receipts related to an expected
depreciation of the rand. However, non-residents continued to invest large sums in the equity capital
of South African enterprises, with the result that the net outflow of capital not related to reserves
amounted only to R0.4 billion in the second half of 1998, compared with an inflow of R8.3 billion in
the first half of the year.
The international developments also affected the current account of South Africa's balance of
payments because they brought about a substantial drop in international commodity prices and
depressed world trade. The volume of merchandise exports declined in the second half of 1998, while
higher rand proceeds for exports mainly reflected a depreciation of the currency. In addition, the gold
price in terms of United States dollars declined further and the value of imports rose steeply because
of infrastructural investments by public corporations. These developments led to an increase in the
deficit on the current account of the balance of payments and a marked decrease in the gold and
foreign exchange reserves of the country. As could be expected under these circumstances, the
exchange rate of the rand depreciated to a level at the end of 1998 that was nearly 20% lower than its
weighted value at the end of 1997.
The volatility in international financial markets generated substantial increases in the turnovers of
financial markets in South Africa, including the markets in foreign exchange, shares, bonds and
derivatives. The large outflow of foreign funds on the Bond Exchange contributed to an increase in the
daily average yield on long-term government bonds from a low of 12.67% on 17 April 1998 - its
lowest level since May 1994 - to 20.09% on 28 August 1998. So much liquidity was drained from the
South African banking sector that the banks had to borrow large amounts from the Reserve Bank on a
daily basis. The liquidity shortage in the market pushed up short-term interest rates by about
7 percentage points, forcing the banks to raise their prime overdraft and mortgage lending rates to
more or less the same extent. These higher lending rates had a dampening effect on real-estate
transactions. Share prices also dropped sharply, even though the market was supported by a strong
demand from foreign investors.
The high turnovers in the financial markets and a desire for precautionary money balances resulted in
an exceptionally strong growth in the money supply. The growth over twelve months in the broadly
defined money supply (M3) reached 19.4% in June 1998 and declined only fractionally to 18.9% in
August 1998. These high rates of increase were recorded despite a slowdown in the growth of nominal
gross domestic product and apparently formed part of the rise in the nominal value of financial asset
portfolios. This latter factor, together with an increased demand for working capital by the corporate
sector and some borrowing by companies to tide them over a period of slack demand in the economy,
were prominent forces behind a continued steep rise in total bank credit extension. The increase in the
demand for bank credit was reinforced by speculative opportunities in a period of heightened volatility
in the securities markets.
The international financial turmoil halted the downward movement in the rate of increase in both
production and consumer prices from the beginning of 1997. Over the six months to September 1998,
growth in production prices accelerated considerably as the rand depreciated. The consumer price
index, in turn, was strongly influenced by a sharp rise in the prices of consumer services, notably the
rise in mortgage lending rates. Core inflation, which excludes certain food prices, interest costs,
valueadded tax and municipal rates, was far more subdued, rising from 6.9% in March 1998 to only 7.7% in
September 1998.
In comparison to other emerging-market economies, the South African banking sector proved
remarkably resilient during the global financial turmoil. Banks were able to weather this storm better
than some of their counterparts in other countries because of good management, strict legislative
requirements, low international credit exposures and diligent risk management. The level of the net
external liabilities of banks is low, in other words their exposures to exchange rate risks are minimal.
In addition, our banks eased the increased burden of high interest rates on borrowers by extending the
repayment period.
The non-performing loans of banks nevertheless increased by more than R8.2 billion over one year to
R27.4 billion at the end of June 1999, but the gross overdues of banks as a percentage of total loans
and advances amounted to only 4.7% on this date; a level which is still low enough not to be of
concern. Many of the banks have in any case also increased their provisions for bad and doubtful
debts, which amounted to 2.7% of loans and advances at the end of June 1999.
The banks in South Africa are well capitalised. The average risk-weighted capital-adequacy ratio for
the system as a whole reached 11.6% at the end of June 1999, compared with the required minimum
ratio of 8% stipulated by the Basel core principles. Moreover, more than half of the banks had a
capital-adequacy ratio of 15% or better. The disruptions internationally did not materially affect the
profitability of banks, and their return on equity reached approximately 15% at the end of June 1999.
Cost control and an expansion of the business of banks into new areas helped to sustain profit levels.
Banks have successfully developed alternative non-interest-bearing sources of income, and
transaction-based fee income and investment income now represent nearly half of their net revenues.
The return to financial stability
The way in which the banking sector coped with the international financial crisis, together with a
prudent monetary policy approach, were important factors that contributed to a relatively quick return
to financial stability in South Africa. By the fourth quarter of 1998 there were signs that the storm was
abating. The strain on the South African situation slackened so much in the last part of 1998 that the
exchange rate of the rand against the United States dollar eased from about R6.66 on 28 August 1998
to R5.70 early in January 1999. Domestic interest rates declined by about 3 percentage points over the
same period.
Although problems in Brazil temporarily created new pressures in the South African market for
foreign exchange in January 1999 and interrupted the decline in interest rates, the nervousness in the
financial markets gradually evaporated when it became apparent that the contagion effects of Brazil's
problems would be limited. Non-residents again became net buyers of South African bonds, while
they continued to invest large amounts in shares listed on the Johannesburg Stock Exchange. In the
first seven months of 1999 the portfolio investments of non-residents in South Africa amounted to no
less than R33.8 billion, compared with disinvestments of R3.2 billion in the last eight months of 1998.
Direct investment by foreigners in domestic enterprises came to R3.7 billion in the first half of 1999.
These investments were neutralised to some extent by South African investments in other countries,
with the result that the net inflow of capital not related to reserves, or the surplus on financial
transactions with the rest of the world, totalled R7.4 billion. At the same time, a lower level of final
demand, significant further reductions in inventories and an increase in the cost of imported goods,
depressed the value of imports. By contrast, exports rose strongly as the Asian economies began to
recover, the decline in international commodity prices levelled out and domestic producers began
expanding into other markets. Expressed in terms of seasonally adjusted and annualised rates, the
current account of the balance of payments accordingly turned around from a deficit of R19.1 billion
in the last half of 1998 to a surplus of R0.6 billion in the first half of 1999.
The improvement in South Africa's overall transactions with the rest of the world led to a sizable
increase in the international reserves of the country. The total gross gold and other foreign reserves
improved steadily from a lower turning point of R40.9 billion at the end of November 1998 to R47.2
billion at the end of June 1999. The nominal effective exchange rate of the rand nevertheless decreased
somewhat in the first seven months of 1999. At the end of July 1999 the weighted average level of the
exchange rate of the rand was no less than 38.4% below its level at the end of 1995, clearly indicating
a marked strengthening of the international price competitiveness of domestic producers.
The greater stability in the exchange rate of the rand and the containment of domestic cost increases
relieved inflationary pressures. As a consequence, a slowdown in inflation in consumer prices was
observed from the end of 1998. However, higher oil prices contributed to a rise in production prices
from the very low levels reached in the first half of 1998, while core inflation increased from 7.1% in
April 1998 to 8.2% in July 1999.
The surplus balance on South Africa's transactions with the rest of the world eased the total liquidity
requirement of banking institutions and prompted a steady decline in money market rates in the first
seven months of 1999. Sentiment in the market for fixed-interest securities became more positive in
view of the slowdown in the inflation of consumer prices, an easing in money market conditions and
declining short-term interest rates, a conservative fiscal policy which reduced government's funding
requirement for the fiscal year ending 31 March 2000 and positive credit assessments by international
rating agencies. Consequently, the yield on long-term government bonds declined from 20.09% on
28 August 1998 to 15.18% at the end of July 1999.
As normality returned to financial markets and the turnovers on these markets came down from the
exceptionally high levels that they had reached during the international financial turbulence, growth in
the monetary aggregates finally started to decline after four years of high rates. The general downturn
in economic activity, lower inflation and a decline in liquidity preference, were other factors that
caused the growth in M3 to move within the guideline growth range of between 6% and 10% from
February 1999. The growth in total domestic credit extension by banks also slowed down significantly
in the first half of 1999. Despite these favourable developments, it is important that monetary policy
takes into account that the ratio of the money supply to gross domestic product was still very high at
53.5% in the second quarter of 1999.
All in all, the financial markets have rallied remarkably during 1999. Internationally, the turbulence
prevailing during 1997 and 1998 seems to have calmed down. Provided that there are no serious
setbacks in the international economy, we are confident that real economic activity in South Africa
should begin to recover.
Adverse financial conditions depressed economic growth and employment
At the beginning of 1998 it was expected that the downswing in economic activity experienced during
the preceding year would come to an end and that the economy would turn around before moving into
a recession. However, the measures that the authorities were forced to take to stabilise financial
conditions led to sharp declines in the components of domestic demand that are sensitive to
interestrate costs, such as inventories, consumption expenditure on durable goods and private-sector fixed
investment. Domestic production was also harmed by a lower demand for exports, with the result that
real gross domestic product contracted sharply in the third quarter of 1998. Fortunately, this setback
was short-lived and aggregate output began to increase again, albeit at low rates.
The downturn during the middle of 1998 spread to most of the economic sectors, with the notable
exception of financial services which benefited from price volatility and high turnovers in financial
markets. From the fourth quarter of 1998 the secondary sectors and some of the other tertiary sectors
started to record small positive growth, but the value added by agriculture and mining continued to
contract. Gold production, in particular, decreased sharply in reaction to the effect that increased gold
sales by some central banks had on the price of gold.
The gold mines have had to contend with rising costs of production and a generally depressed market
price since the mid-1980s. This has not only had serious consequences for the domestic economy, but
also affected developments in neighbouring countries through the loss of employment opportunities.
From the beginning of the 1980s the number of people employed on the gold mines has been reduced
by almost 250,000 because of mine closures and the introduction of cost-saving production methods.
The substitution of capital for labour in other sectors of the economy further contributed to high
unemployment in South Africa and other negative social effects. The low production growth in the
past year aggravated this problem as employment was slashed further.
The decline in employment was accompanied by a marked increase in labour productivity. At first the
growth in output per worker could not contain an acceleration in the rate of increase in nominal unit
labour costs. From the beginning of 1999 the growth in unit labour costs has slowed down
significantly, which could help to curtail inflation because labour is still the single most important
component of overall production cost in the economy.
Unlike the decline in production, the domestic demand for goods and services continued to expand in
1998, but the rate of increase in aggregate expenditure slowed down. The main reason for the
expansion in final demand was the solid growth in fixed capital formation, largely owing to
investment expenditure in telecommunication and transport activities by public corporations. Contrary
to these developments, the rates of increase in the consumption expenditure of both the public sector
and households slowed down considerably during 1998, while private-sector real fixed investment
declined sharply. Inventory levels were reduced significantly in response to the slowdown in domestic
economic activity and the high costs of carrying stock.
In the first half of 1999 the real domestic final demand for goods and services declined markedly when
the capital spending of public corporations contracted. In addition, a decline in interest-rate sensitive
household expenditure on durable goods and the strict discipline applied to government expenditure
resulted in a decrease in consumption expenditure, while private-sector fixed investment continued to
move to lower levels. Real gross domestic expenditure contracted even more sharply than final
demand, due to a reduction in inventory levels as businesses economised further on inventory
holdings.
The reduction in consumption expenditure and efforts of households to bring down high debt levels
led to a marginal improvement in the savings ratio of households in the first half of 1999. Moreover,
the resolve by government to adhere to sound fiscal policies was reflected in a decline in the net
dissaving by general government as a ratio of gross domestic product from 5% in 1997 to 3% in the
first half of 1999. The corporate sector succeeded in lifting retained earnings by more than the growth
in production over the same period. As a consequence, the ratio of gross saving to gross domestic
product rose somewhat from a low of 13% in the fourth quarter of 1998 to 15% in the first half of
1999. Although this is a welcome change in the declining trend of the savings ratio, it is still well
below the levels needed for sustained higher economic growth. Serious attention will have to be given
in economic policy deliberations to promoting saving and inward direct investments in order to create
job opportunities.
Prudent public finance
The government persisted with a well-managed conservative fiscal policy stance. The public-sector
borrowing requirement, i.e. the deficit before borrowing of the central government, provincial
governments, local authorities, non-financial public enterprises and public corporations, has been
brought down systematically from an upper turning point of 9.3% of gross domestic product in the
fiscal year 1993/94 to a ratio of 3.4% in the fiscal year 1998/99.
In the past fiscal year there was a decline in the absolute value of the public-sector borrowing
requirement. What made this an even more remarkable achievement was the fact that the revenue of
the government increased at a lower rate than in the preceding year. Total expenditure by general
government, however, rose at a rate of only 5.3% in the fiscal year 1998/99, i.e. significantly below
the inflation rate. General government successfully contained growth in expenditure mainly through a
decisive slowdown in current spending on goods and services.
The financial turbulence and monetary policy
The conservative fiscal policy stance assisted in countering the contagion effect of the international
financial turbulence during 1998. However, the brunt of the adjustment process fell on monetary
policy, as it takes a long time to make changes in fiscal and other policy measures. The strains that
developed in the foreign exchange market in 1998 caused the exchange rate of the rand and domestic
interest rates to adjust automatically to the changed supply of and demand for foreign exchange and
the impact of these developments on bank liquidity. In these volatile and uncertain circumstances, the
monetary authorities could only influence the speed of the adjustments required by the market.
The Reserve Bank's response was to underprovide in the liquidity requirement of the banks and to
intervene in the foreign exchange market so that financial stability could be restored at the least cost in
terms of inflation and economic growth. As a result, the repo rate moved sharply upwards by about
7 percentage points from the beginning of May to 21.85% on 28 August 1998. The accommodation
system was made more effective to cope with the crisis by phasing in a wider spread from 1 to 20
percentage points between the repo rate and the marginal lending rate. These measures led to
corresponding steep increases in other short-term interest rates, which eased the adjustment in the
exchange rate of the rand.
In tandem with the rise in interest rates, the Reserve Bank at first intervened heavily in the foreign
exchange market in May and June 1998 in an attempt to create some order in a market that had
become extremely sensitive to any negative news or rumours. The intervention consisted mainly of
swaps in the forward market, which increased the Bank's net open foreign currency position from
US$ 12.8 billion at the end of March 1998 to US$ 23.2 billion at the end of September 1998. The
Bank returned this foreign exchange liquidity to the market which had been obtained previously from
large inflows of portfolio investments.
In view of the large risks and potential costs associated with a net open exposure, the Reserve Bank
stopped using this intervention technique when it became apparent that the contagion impact of the
emerging-markets' crisis would be more severe and longer lasting than originally expected and when
the purchases of foreign exchange preceding the crisis had been fully reversed. This decision was
validated when it became known that highly leveraged funds had built up speculative positions against
the rand through forward foreign exchange transactions. Later, when these leveraged funds incurred
losses in emerging markets and were forced to buy back their short rand positions, these transactions
contributed to the retracing of some of the rand's earlier losses.
As indicated, financial conditions became more stable from the fourth quarter of 1998. General
nervousness continued to prevail among international investors, and they withdrew funds from
emerging-market economies whenever there were signs of any pressure on exchange rates. In these
circumstances, the Reserve Bank deemed it prudent to guide the repo and other money market interest
rates gradually down to lower levels. With brief interruptions, the repo rate then moved lower from its
upper turning point of 21.85% on 28 August 1998 to 13.65% on 31 July 1999. Over the same period,
the net open foreign currency position of the Reserve Bank was reduced by US$ 5.6 billion to
US$ 17.5 billion at the end of July 1999.
Despite the initial wide fluctuations in the repo rate, the repo-based accommodation system that the
Reserve Bank had introduced in March 1998 is proving of considerable value in general and during
periods of instability in financial markets in particular. Most of the difficulties encountered shortly
after the implementation of the system were due to general nervousness in the market and teething
problems. The system was flexible enough to be adjusted easily to solve these problems. Changes to
enhance the efficiency of the repo system included the shortening of maturities, the introduction of
"square-off auctions" at the end of the daily settlement period, administrative adjustments to the
management of cash reserves and a refinement of the signalling procedures of the Reserve Bank. After
these changes had been made, short-term interest rates became more flexible without being too volatile
or too slow in reacting to signals.
The way forward
The liberalisation and international integration of financial services make it imperative for South
Africa to bring domestic inflation in step with that of the rest of the world and to maintain sound and
efficient financial institutions and markets. If these goals are not achieved, the economy could be
subjected to sudden reversals in international capital flows, exchange rate instability and volatile
interest rates. The thrust of monetary policy in these circumstances should therefore be to establish and
maintain financial stability, i.e. stability of prices, financial institutions and financial markets.
This does not mean that monetary policy ignores other objectives of economic policy, such as
economic growth, employment creation and improved social conditions in the country. On the
contrary, we regard financial stability as a precondition for balanced and sustainable economic growth
and improved living conditions, because it improves the efficiency of the pricing system and economic
decision-making; enhances the efficiency of financial intermediation; minimises the inflation risk
premium in long-term interest rates; reduces the incentive to hedge against inflation; promotes a more
equitable distribution of wealth and income; and facilitates investment decision-making. A monetary
policy that maintains financial stability in a credible and lasting way will accordingly make the best
overall contribution to improving economic growth, employment and living standards.
A market-oriented strategy will be followed to achieve this overriding goal of monetary policy
because financial institutions and markets function best in the national interest if they are competitive,
active and liquid, and if interest rates and exchange rates are flexible. The Reserve Bank will
accordingly continue to discuss with government the relaxation of exchange controls when underlying
conditions are conducive to taking such steps. The eventual removal of exchange control restrictions
should contribute towards dismantling the oversold forward book and reducing the net open foreign
currency position. Once residents have accumulated large amounts of foreign assets, they could use
these assets to counterbalance short-term currency volatility if they perceive this to be an opportunity
to profit from a temporary undervaluation of the exchange rate.
In pursuit of the primary objective of price stability it is essential, as stated in the Constitution, that the
Reserve Bank performs its functions independently and without fear, favour or prejudice. The Bank
will maintain an attitude of economic-professional objectivity, but will, of course, at the same time be
accountable to Parliament and the general public for its actions. Transparency in the interpretation of
economic data and the monetary policy stance will be promoted further. Regular reporting on
economic conditions and Reserve Bank operations to Parliament and the general public will receive
high priority.
Although the Bank will strive to achieve closer cooperation and coordination with the authorities
responsible for policy decisions in other macroeconomic and microeconomic fields, the autonomy of
the Bank will be preserved. There are structural deficiencies in the economy which impair saving,
investment, production growth and employment creation and increase the level of real interest rates. A
number of initiatives announced by the President at the opening of Parliament are aimed at easing
these supply-side constraints. The implementation of these structural changes could create further
scope for lower nominal and real interest rates. Closer cooperation and coordination between the
Reserve Bank and other national official bodies may expedite this process.
The Southern African Development Communi