T T Mboweni: Recent financial and economic developments in South Africa
Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the eighty-second
ordinary general meeting of shareholders, 27 August 2002.
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Introduction
The South African Reserve Bank was again confronted by many challenges during the past year. I am,
however, glad to say that, as on previous occasions, the Bank coped well. Although some ground was
lost in containing inflation owing to the exogenous shocks that affected the economy, remedial action
has been taken to bring the inflation rate down towards the targeted levels. A period of consolidation in
the banking sector was handled in an effective manner so as to ensure continued domestic financial
stability. Attention was given to the regulatory structure of the banking sector to continue protecting the
funds of depositors and to ensure that the intermediation of savings runs smoothly. The efficiency and
effectiveness of internal administrative procedures were improved further and considerable progress
was made with transforming the composition of the Bank's staff to better reflect the demographics of
the country.
Recent economic developments
The South African economy also did well in a rapidly changing political and economic world. A
comprehensive review of recent economic developments in South Africa is contained in the Reserve
Bank's Annual Economic Report, which was released this morning. In my address I therefore wish to
highlight only the following developments:
South Africa, like most other emerging-market economies, was affected considerably by the attacks on
the United States of America in September 2001, the uncertainties that this created politically as well
as in the business world, the continued relatively high levels of oil prices and the strong downturn in
world economic activity. The resulting decline in the volume of our exports in the second half of 2001
affected domestic economic growth. In addition, greater risk aversion to investment in developing
countries had a marked impact on capital flows to South Africa. In response to the weakness in world
economic activity, monetary policy in most countries became more accommodative and interest rates
were brought down significantly. In some countries, fiscal measures were also taken to stimulate
activity. These measures now seem to be bearing fruit and a world economic recovery should be of
significant benefit to South Africa.
The most important effect of world political and economic developments on South Africa was that they
contributed materially to the volatility in the external value of the rand during the past year. After the
value of the rand had been relatively stable in the first six months of 2001, it depreciated steeply in the
second half of the year. As a result, the nominal effective exchange rate of the rand decreased by
about 34 per cent in the second half of the year. Towards the end of 2001 the external value of the
rand began to recover and the weighted exchange rate recouped about 20 per cent of its losses up to
the end of May 2002.
In the following two months the rand fluctuated around this new level but, on balance, declined by just
more than 7 per cent. This brought the nominal effective exchange rate of the rand back to about
27 per cent below its level at the beginning of 2001.
A number of factors contributed to the depreciation in the value of the rand during 2001. These
included a weak export performance and a strong increase in imports and dividend payments to
nonresidents. The resultant deficit on the current account of the balance of payments was accompanied
by a net outflow of portfolio capital. This outflow stemmed from the perceived higher risk of investing in
emerging-market economies, the problems experienced in Argentina and later Brazil, instability in
Zimbabwe, and unfounded expectations of imminent exchange-control relaxations in South Africa.
Eventually, international investors began to regard the external value of the rand as a one-way bet,
exporters delayed repatriating their foreign-earned currency and importers switched financing from
foreign to domestic sources. In other words, there was a typical speculative bandwagon effect.
After the authorities had reminded the market about the sound economic fundamentals in South Africa
in a statement on 20 December 2001, and it became clear that the exchange rate of the rand had
over-reacted, this whole process was reversed. Exporters stopped delaying the transfer of their
proceeds, importers shifted back to foreign financing for purchases and international investors were
again willing to invest large sums in domestic shares and bonds. International conditions calmed down
somewhat and the world economy began to recover. At the same time the current account of South
Africa's balance of payments moved into surplus, mainly owing to a decline in dividend payments to
the rest of the world and a rise in exports.
The depreciated external value of the rand has undoubtedly strengthened the price competitiveness of
domestic producers and could lead to a strong export performance. Substituting domestically
produced goods for imported goods should further promote economic growth. The South African
economy also proved to be quite resilient to the world economic slowdown in the period under review.
Despite a synchronised decline in the growth of most of our major trading partners, the growth rate in
real gross domestic product only declined moderately from 3,4 per cent in 2000 to 2,2 per cent in 2001
and 2,3 per cent in the first half of 2002.
The positive production growth in generally depressed world economic conditions could be attributed
to continued strong domestic demand for goods and services. Final consumption expenditure by
households and general government contributed to the pick-up in spending, but the largest
contribution came from investment, especially fixed investment by the private sector. After declining in
the second half of 2001, the volume of exports also began to rise in the first half of 2002.
As could be expected with the strong domestic final demand for goods and services, the saving
performance of the South African economy remained at a low level. In the past five years, gross
saving as a ratio of gross domestic product has continued to fluctuate between about 15 and 16 per
cent, which is too low to finance the growth performance the country needs for creating enough
employment opportunities. The consistently low saving ratio has persisted despite a substantial
improvement in government saving. After being a large dissaver a few years ago, government has
made a positive contribution to saving since 2001. Corporate saving, which still represents the
mainstay of the domestic saving effort, has weakened considerably over the past five years, while
household saving remained at low levels.
The steady growth performance in South Africa was accompanied by substantially higher labour
productivity. The real output per worker in the non-agricultural sectors had increased by only about
1 per cent per year in the period from 1985 to 1995, but rose at an average annual rate of nearly
41/2 per cent from 1995 to the first half of 2002. Higher labour productivity was the combined result of
an increase in output and a reduction in formal-sector employment. Producers preferred to employ
capital rather than labour. Economising on the utilisation of labour resources was in part the result of a
decline in the user cost of capital. But it was also brought about by factors such as a declining gold
price and the opening up of the economy to international competition, which made the use of
cost-saving production methods more urgent.
Concerted efforts by government to reduce the public-sector deficit contributed further to a decline in
formal non-agricultural employment. More than one million employment opportunities have therefore
been lost since the peak of the employment cycle in 1989. Employment growth has occurred largely in
the informal sectors of the economy and in other forms of self-employment. Unemployment in South
Africa nevertheless remains a major problem, with nearly 30 per cent of the economically active
population out of work.
On the monetary front, the broadly defined money supply grew vigorously during 2001 and the first
half of 2002, and reached a year-on-year level of 18,1 per cent in June 2002. Most of this growth was
in the form of increased short and medium-term deposits by corporates. This could imply that
companies are uncertain about the outlook for the economy and that investors are restructuring their
portfolios. It may, however, also be an indication that depositors are positioning themselves for future
spending. The risk for monetary policy is that in the long run, there is a close correlation between the
rates of increase in the money supply and the general level of prices.
The growth in total bank credit extension measured over twelve months moved into the double-digit
range towards the end of 2001, but slowed down again to 9,6 per cent in June 2002, compared with
6,9 per cent in June 2001. This increase occurred mainly in the demand of the private sector for funds
and arose largely from increases in trade finance, mortgage borrowing by households, instalment sale
credit and leasing financing.
In the financial markets the private corporate bond market expanded significantly in the past year as
the government financed most of its borrowing requirements on international capital markets. From the
beginning of 2002, part of the companies' needs for capital was financed in the primary share market
when the prices of shares improved considerably. New record turnover levels in the secondary bond
and share markets were attained in the year ended June 2002. The decline that has been discernible
in bond yields from the second half of 1998 was related to a dwindling supply of public-sector
fixed-interest securities and lower inflation expectations that came to an abrupt end in the last quarter
of 2001. The depreciation of the rand and resulting inflation fears drove bond yields sharply higher, but
the mood in the bond market seems to have turned more positive from the beginning of April 2002.
Monetary policy continued to be supported by fiscal policy in securing financial stability. In the fiscal
year 2001/02 the public-sector borrowing requirement amounted to only 0,6 per cent of gross domestic
product. In fiscal 1996/97 it had still been as high as 5,6 per cent. This substantial improvement in the
finances of the fiscus was achieved by more efficient tax collection methods and disciplined
expenditure programmes. As a result, the rise in public debt relative to gross domestic product was
stopped and the interest burden of government eased considerably. This afforded government the
opportunity to grant significant tax relief and to expand infrastructural development.
Monetary policy
After pursuing a relatively neutral monetary policy stance during 2000 and the first half of 2001, the
Reserve Bank relaxed monetary policy from the middle of 2001. The neutral monetary policy stance
was maintained in a period of low expected future rates of inflation and a slowdown in economic
activity. However, the twelve-month growth rate in the consumer price index excluding mortgage
interest cost (CPIX) continued to rise steadily from 6,5 per cent in October 1999 to 8,1 per cent in
September 2000. This rise in consumer prices was largely related to international developments, such
as rising oil prices, general upward pressure on international commodity prices and a depreciation in
the external value of the rand.
Although these exogenous factors became a threat to monetary stability, most domestic factors
remained positive for the containment of inflation. Greater stability in domestic interest rates also
seemed warranted to counter the heightened volatility in many financial markets.
This policy stance was highly effective as there were few signs of the secondary effects of the weaker
currency. In fact, inflationary expectations declined, nominal unit labour cost increased only
moderately and growth in the money supply slowed down. Internationally the oil price declined, world
economic activity began to slow down and interest rates were reduced aggressively. The
twelve-month growth rate of the CPIX was turned around and declined to 6,5 per cent in May 2001
and to 5,8 per cent in September.
Taking all these developments into consideration, the Monetary Policy Committee decided to relax
monetary policy. The repurchase rate was first reduced by 100 basis points on 15 June 2001 and by a
further 50 basis points on 20 September 2001. This brought the repurchase rate down to a level of
9,5 per cent, compared with its peak of 21,85 per cent in early October 1998. However, towards the
end of 2001 it became clear that the favourable environment for inflation had changed.
Subsequently, two important develop-ments led the Reserve Bank to reconsider its monetary policy
stance. Firstly, the inflation targets for the three years after 2002 were announced by the Minister of
Finance. The target for 2003 was kept unchanged at an annual average rate of increase in the CPIX
of between 3 and 6 per cent, but this range was lowered to an average of 3 to 5 per cent for the next
two years. This clearly reflected government's commitment to the adjustment of policies to bring the
inflation rate down to lower levels.
Secondly, the external value of the rand began to depreciate sharply in September. The pass-through
from the depreciated exchange rate to inflation had been surprisingly muted in 2000, but the sharp
downward movement of the rand in the last quarter of 2001 inevitably had a significant impact on
inflation. Before this change the challenge to monetary policy had been how to deal with external
shocks that had not been putting undue pressure on domestic inflation. The new challenges were how
to deal with external shocks that were now beginning to have a significant impact on current and
expected inflation, and to avoid an inflation spiral.
Inflationary pressures began to pick up during the last quarter of 2001. Food prices were initially the
main factor contributing to the acceleration in inflation. These food price increases were partly related
to the depreciated value of the rand as domestic prices approximated those determined internationally
since the deregulation of agriculture. In particular, maize prices were significantly affected by the
depreciation in the value of the rand. The maize price has wide economic significance in South Africa.
White maize is a staple food for many South Africans and 90 per cent of yellow maize is used as feed
in the meat, dairy, poultry and egg industries. Apart from the depreciation of the value of the rand,
supply and demand factors also contributed to the more than doubling of the spot prices of both white
and yellow maize between June 2001 and January 2002.
Later the increase in consumer prices became more broadly based, in line with the sharp depreciation
of the currency. Rising expectations of price increases became an important factor in the inflationary
process, as was clearly reflected by the pre-emptive buying of durable goods by households in the
fourth quarter of 2001.
As the depreciated rand pushed prices higher, the twelve-month rate of increase in the CPIX started
moving upwards from the psychologically important level of below 6 per cent in September 2001 to
9,9 per cent in July 2002. The quarter-to-quarter rate of increase in CPIX inflation was even more
pronounced, rising from a seasonally adjusted and annualised level of 6,8 per cent in the fourth
quarter of 2001 to 11,6 per cent in the first quarter of 2002 and 12,1 per cent in the second quarter.
The twelve-month rate of increase in the all-goods production price index accelerated from 7,8 per
cent in September 2001 to the even more alarming level of 14,4 per cent in June 2002.
These developments soon indicated that the inflation target for 2002 could be in jeopardy. Moreover,
given the lags between the implementation of monetary policy and its impact on inflation, estimated at
between 12 to 24 months, there was very little that monetary policy could do to rectify this. However,
the Bank remains committed to the objective of price stability and policy became focused on the
targets for 2003 and 2004.
The first response of the Bank to the rising inflationary pressures was to convene an unscheduled
meeting of the Monetary Policy Committee early in January 2002. Although the exact feed-through of
the depreciated value of the rand to inflation was still unclear at that stage, a number of developments
indicated that it might be prudent to adopt a more restrictive monetary policy stance. These
developments included a reversal of the downward trend in oil prices, indications that higher inflation
expectations were becoming entrenched, higher wage demands, a more rapid rate of increase in unit
labour cost and large increases in money supply and bank credit extension. In view of these
developments the Monetary Policy Committee decided to raise the repurchase rate by 100 basis
points in order to prevent an inflation spiral.
Monetary policy was tightened further at the March and June meetings of the Monetary Policy
Committee. In both cases the repurchase rate was increased by 100 basis points, bringing the rate to
12,5 per cent on 14 June 2002. By March it was clear that inflation expectations had been adversely
affected by the depreciation of the rand. In addition there was concern about the continued high rate of
growth of money-supply aggregates and bank credit extension, the state of the balance of payments
and the rising trend in unit labour cost. It was argued that a tighter monetary policy at that stage could
avoid more drastic interest rate increases in future if the stricter stance was successful in dampening
inflationary pressures.
By June, it was apparent that the upward trends of inflation and inflation expectations had maintained
their momentum, and that growth in unit labour cost and money supply developments remained
unfavourable. The Monetary Policy Committee, however, also identified some positive developments
that could reduce the pressure on inflation. These developments included the partial recovery of the
rand, the appearance of a surplus on both the current and financial accounts of the balance of
payments, the continued low level of capacity utilisation and the maintenance of fiscal discipline.
The latest forecasts of the Bank show that, given this tightened stance of monetary policy and barring
any unforeseen negative shocks, the inflation target for 2003 could be met. However, the average
annual rate of increase in the CPIX will probably be close to the upper end of the target range and the
risks to the forecast are on the upside. As such, it seems unlikely that monetary policy will be relaxed
in the foreseeable future.
Although the current stance of monetary policy may be perceived as negative for short-term growth
and employment creation, such a view must be compared with the alternative of even higher future
interest rate levels, if inflation is not brought under control. Furthermore, the tax concessions granted
in the last budget should benefit consumption, and the significant depreciation in the external value of
the rand should promote production, particularly of exported goods.
Exchange rate policy
As outlined earlier, the external value of the rand came under severe pressure during the second half
of 2001. The currency then stabilised in early 2002 and strengthened slowly but consistently until the
end of May. Since the beginning of June the exchange rate of the rand has fluctuated widely around
its newly established levels.
The rand has continued to be negatively affected by developments in emerging markets, and events in
2002 in Argentina and Brazil, for example, could hamper the short-term outlook for the rand. For this
reason the Reserve Bank strongly supports the government's policy that the remaining exchange
control regulations should be very gradually relaxed.
Despite the relatively volatile movements in the exchange rate of the rand and even when it became
apparent that the depreciation of the rand towards the end of 2001 was based largely on speculative
transactions unrelated to underlying conditions, the thrust of exchange rate policy remained
unchanged. The exchange rate of the rand is therefore essentially determined by the supply and
demand conditions in the market for foreign exchange.
At the same time, it remains a stated objective of the Bank to gradually close down the net oversold
open foreign reserve position. The existence of this net oversold open position has been perceived as
a source of weakness for the rand, and has contributed to negative sentiment towards the currency.
However, it is also recognised that if the net open foreign reserve position is reduced too quickly, it
could contribute to rand weakness. The Bank therefore announced in a statement on 14 October 2001
that we would in future not intervene by purchasing foreign exchange directly from the market to
reduce this position. The net open foreign reserve position would instead be expunged from the cash
flows derived from the proceeds of privatisation and the government's off-shore borrowing. This does
not imply that all the proceeds from these sources will always be used to achieve this objective. For
example, part of the proceeds from the sale of Transnet's interest in M-Cell was not used to reduce
the Bank's open position.
In accordance with this objective, the Bank reduced the net open foreign reserve position from
US$23,2 billion at the end of September 1998 to US$11,5 billion at the end of January 2000, i.e.
during a period of overall strength in the balance of payments. When the overall balance of payments
then began to deteriorate, the open position was brought down far more slowly to US$9,0 billion at the
end of April 2001. The net open position was reduced to US$4,8 billion at the end of July 2001 with
the proceeds obtained from the restructuring of the Anglo American Corporation and the De Beers
mining company, and from foreign borrowing by government.
The net open foreign reserve position was reduced further to US$1,8 billion at the end of July 2002
following the stated approach that the Bank adopted in October 2001. This reduction was basically the
result of three major sources, namely the transfer of a syndicated loan liability of US$1,5 billion from
the Reserve Bank to the National Treasury; the reopening of an existing dollar bond by the South
African government which raised US$274 million for delivery against the oversold forward book; and
the issuing of a new US$1 billion bond by the National Treasury for delivery against the forward book.
While the Bank remains committed to eliminating the net open foreign reserve position, at its current
level of US$1,8 billion this position should no longer be perceived as a source of vulnerability.
Financial stability
International developments also affected domestic financial stability during the past year. The attacks
on the United States of America on 11 September 2001 illustrated an enormous systemic risk to
financial systems worldwide as well as the key role that central banks must play in such
circumstances. The increase in the international linkages among financial institutions adds to the risk
in such events. The weakening position of Japanese banks also continues to be a source of
vulnerability for inter-national financial markets. Furthermore, corporate governance standards and
structures, as well as the credibility of the accounting profession, are being questioned after
revelations about the corruption in and resultant failure of a number of large and well-known
corporations in the United States of America. The corporate failures in the United States have
impacted significantly on markets worldwide, with many stock exchanges shedding considerable
value. This again demonstrates the importance of restructuring the financial architecture. Closer to
home, trade and financial links expose South Africa to the contagion effects of recent adverse
developments in Zimbabwe, which are closely monitored.
Domestically the South African banking sector was characterised by a process of consolidation
triggered by the difficulties of some small banks. This trend intensified after the announcement that
Saambou Bank Limited, the seventh-largest bank in South Africa, would be placed under curatorship
from 9 February 2002. As a result, there were significant withdrawals of deposits from some smaller
banks in general and BoE Bank Limited in particular. This spurred the Reserve Bank to take a
proactive and leading role in co-ordinating the actions of all key players in the banking sector, which
led to an agreement between the private and public sectors on the management of liquidity by
recycling cash flows and handling the orderly exit of Saambou Bank from the banking sector. The
withdrawal of deposits from some banks prompted the joint action by the Bank and the National
Treasury to restore the confidence of depositors, by guaranteeing all the deposits of BoE Bank
Limited. BoE also accelerated the planned sale of its mortgage book to FirstRand Bank to manage its
liquidity position.
The activities of Saambou Bank and BoE were merged with those of some of the big four banks in
South Africa. The liquidity problems of some of the smaller banks induced them to cancel their banking
registrations and to carry on with niche operations. Other smaller banks are redesigning their
ownership structures and in some cases downsizing their balance sheets.
Despite these developments over the past year, South Africa's banking system remains sound.
Domestic banks are well-managed and have sophisticated risk management as well as corporate
governance structures in place. Banks are well-capitalised, with an average risk-weighted capital
adequacy ratio of 12,1 per cent at the end of June 2002. This can be compared with the new and
higher required capital adequacy ratio of 10 per cent introduced in October 2001.
Total bank funding grew by 22,4 per cent during the year up to the end of June 2002. The growth in
total assets of 18,8 per cent over the same period to a level of R1 065 billion was mainly the result of
an increase of 21,4 per cent in total loans and advances. The assets of the four big banks as a ratio of
the total assets of the banking sector rose from 68,8 per cent on 30 June 2001 to 70,5 per cent on 30
June 2002. At the latter date the foreign banks operating in South Africa held 8,4 per cent of the total
banking assets, compared with 6 per cent the previous year.
Despite the difficulties encountered over the past year, the liquidity of the banking sector is generally
adequate. The average daily amount of liquid assets held in June 2002 exceeded the prescribed
prudential minimum by about 9 per cent. However, the reported profitability of the banking sector has
continued to decline as margins on earnings decreased and operating expenses increased.
Non-performing loans amounted to R26 billion in June 2002. This represents only about 3 per cent of
total loans and advances, which compares well with international standards. The provisions made by
banks for non-performing loans were adequate, even in terms of international best practice standards.
The debt-servicing capacities of households also showed no signs of fragility. The ratios of household
debt to disposable income and of household debt to financial assets both decreased over the past
year.
The single regulator
The problems encountered in the banking sector earlier this year illustrated in the most definite
manner that it is important that banking supervision in South Africa should remain part of the functions
of the Reserve Bank. The blurring of boundaries between the financial services provided by banks,
insurers and securities traders has prompted certain developed countries around the world to
consolidate the different supervisory agencies under one roof. It is commonly recognised that the
potential benefits of assessing the risk management functions of financial conglomerates on a holistic
basis are very attractive for developed countries with integrated financial markets and ample
regulatory resources.
In South Africa the banking supervision function was transferred to the central bank in 1987 because it
was regarded as the institution most suited to carrying out this function. Since then, even in the face of
many abnormal circumstances, banking supervision has been carried out to the highest international
best practice. Over this period, experience has shown that banking supervision is closely aligned with
the other functions of the Reserve Bank. With the recent liquidity problems of some small banks, it was
again evident that a least-cost resolution of a banking crisis would always depend on a special
collegial interaction between the Registrar of Banks and at least four other departments in the Bank.
The policy formulation, decision making, co-ordination and rapid execution of the many interventions
that were necessary would have been almost inconceivable in a situation where the supervision of
banks was not part of the Bank.
Stability in the banking sector is so integral to the monetary policy transmission mechanism, that a
central bank must always be involved in banking supervision. Unlike other financial institutions, banks
potentially pose a systemic risk because of the nature of their contracts. Their assets are typically long
term and uncertain in value, whereas their liabilities are generally short term and certain in value.
The banking sector is therefore prone to contagion as soon as confidence in any bank is undermined.
These characteristics give rise to the commonly accepted approach of regulating banks in a
discretionary manner. A rules-based approach to banking regulation would be inappropriate because
every case of distress in the system is unique. Supervision consequently has to be risk-based and
proactive.
The banking supervision function in the Reserve Bank has caused many problems and frustrations,
and the temptation to pass the responsibility on to another agency is great. However, the capacity to
perform effective banking supervision is crucial to price and financial stability. After careful
consideration of the issue, I am therefore convinced that it is in the best interests of the South African
economy that banking supervision should remain in the Bank.
At the same time, I also realise that close co-operation should exist between the different regulatory
authorities to address the need for consolidated supervision. Co-operative working arrangements
between regulators are essential to address the ever-increasing demands of sound regulation, the
hallmark of which consists of decisiveness, timely action and proactive intervention when required.
Regulating the banking sector
The different approaches adopted to handling the liquidity problem of banks in the past year have
created considerable uncertainty about the principles applied in regulating the banking sector. This
again emphasises that the execution of this function should be made as transparent and business-like
as possible.
The objective of bank supervision is to ensure stability, efficiency and depositor protection in banking.
A stable financial environment is essential for the working of the economy and the attainment of price
stability. A sound banking system contributes to the effectiveness of intermediation, maturity
transformation, payment facilitation, credit allocation and financial discipline. Moreover, banks play an
important role in collecting savings, allocating resources and providing liquidity.
The registration of banks is the first step to achieve stability in the banking system. Stability is
promoted by preventing applicants with potentially destabilising weaknesses, such as unqualified or
unscrupulous manage-ment or insufficient capital, from entering the system. Unfortunately, there is no
reliable formula to determine whether a bank will fail or succeed. The regulator can only apply
international regulatory and supervisory norms to the supervision of banks. The South African
authorities have adopted the 25 principles contained in the Core Principles for Effective Banking
Supervision of the Basel Committee for Banking Supervision, to construct an effective supervisory
structure in the country.
In deciding on whether a banking licence will be granted to an applicant, an asses