T T Mboweni: An annus horribilis?
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Annual
Dinner in honour of the Ambassadors and High Commissioners accredited to the Republic of
South Africa, Pretoria, 27 November 2008.
* * *
Your Excellency, the Dean of the Diplomatic Corps
Your Excellencies, Ambassadors and High Commissioners
Your Excellency, the Chief of State Protocol
Your Excellencies, Heads of International Organisations represented in the Republic of
South Africa
Deputy Governors of the South African Reserve Bank
Senior officers of the South African National Defence Force
Senior Management of the South African Reserve Bank and their spouses/partners
Financial Editors and other media representatives
Esteemed Ladies and Gentlemen
This has been an eventful year. Some might even say it was an Annus Horribilis! The impact
of the US subprime crisis, which became evident in August 2007, deepened and spread
since then. At the time there was much speculation as to whether or not this crisis was going
to remain confined within the financial sector, or spill over into the real sector. Initially, many
analysts thought that the crisis would be relatively contained and there was also a view that
there would be limited if any impact on the emerging market economies, the so-called
decoupling hypothesis. Here again, the initial dominant view was that decoupling would
occur and as such emerging or developing economies would emerge relatively unscathed.
This view was predicated on the fact that China and India have emerged as new sources of
global economic growth. Nothing could have been further from the truth. Maybe we should
have thought this out better.
Whatever views existed on these decoupling hypotheses has been proven to be horribly
wrong. The financial market instability has spilled over into the real economy, and the
emerging market economies have not been spared. In fact, it is also probably true to say that
many emerging markets are more vulnerable as they are less able to ameliorate the negative
consequences of the current crisis. The previously optimistic forecasts for global economic
growth have been revised downwards in the most dramatic fashion. More and more
developed economies are forecasting imminent and prolonged recessions, with downward
growth revisions almost on a weekly basis. These include the UK, the forecasts of the Euro
area, Japan and the US economies to name but a few. These are significant trading partners
of South Africa. These countries account for more than two thirds of our manufactured
exports. Even the previously fastest growing emerging market economies in Asia are
expected to experience some significant moderation in economic growth. In the past days,
for example, the World Bank has downgraded its forecast for the economic growth rate in
China for 2009 to 7,5 per cent, compared to the current economic growth rate of around 9,4
per cent.
With regards to the financial sector crisis, South Africa appears to have reasonably
weathered the storm, as our financial sector remains broadly robust and stable. The South
African Reserve Bank has not been compelled to make any special liquidity provision, and
the domestic interbank market remains fully functional.
This does not mean that we have been spared the full impact of the fall-out from the slowing
global economy. Apart from the direct consequences on our equity market s and the rand
exchange rate, we have also witnessed a dramatic decline in commodity prices. It is almost
hard to believe that as recently as July this year, the price of North Sea Brent crude oil had
reached a level of almost US$150 per barrel, whereas today it is trading at approximately
US$50 a barrel, a level last seen in early 2005. The lower fuel costs and significantly lower
volumes of world trade have resulted in a major decline of the Baltic Dry Index (an indicator
of economic trends which tracks the cost of shipping goods such as coal, iron ore and grain).
The index recorded a high of 11,793 points in May this year, but declined to 815 points last
week.
While these developments are good news for oil-importing countries such as South Africa,
particularly in the developing world, it should not be forgotten that the decline in the price of
oil is part of a general decline in commodity prices. South Africa, as a commodity exporter is
experiencing the negative consequences of these developments. The price of platinum, one
of our main export commodities, reached a level in excess of US$2,250 per ounce in early
March 2008, but has since declined to the current levels of around US$840 per ounce.
Platinum, which is used in the production of catalytic converters in motor vehicles, is highly
sensitive to the fortunes of the global automobile industry whose fortunes have changed
significantly due to the slowdown. Domestic steel prices have declined by 25 per cent in the
past weeks, and at the same time a major South African steel company announced a one
third reduction in steel production in South Africa. While the gold price has also moderated
somewhat, the extent of the decline has so far been relatively limited.
The decline in commodity prices has not been confined to industrial commodities. Global
food prices, which along with oil prices were responsible for part of the inflation pressures
experienced in the recent period, have also declined in the past few months. Both the
Economist Food Price Index and the IMF Food Price Index have declined by about 30 per
cent since July of this year.
The unfavourable global economic growth and commodity price developments suggest that
while South Africa has managed to escape any untoward impact on its banking system, the
real economy will not be immune to global developments. The South African economy has
experienced positive economic growth since 1999, and growth in excess of 5 per cent per
annum was recorded in the four years from 2004 to 2007. However, in 2009 the economy
showed signs of slowing down. The year started off in not such a good way, when capacity
constraints in electricity provision resulted in the period of load-shedding and electricity
supply reductions to the major mining and manufacturing companies. This culminated in a
revised annualised economic growth rate of 1,6 per cent in the first quarter of the year. The
second quarter saw a rebound to a revised 5,1 per cent, but this was off the low base of the
previous quarter. Third quarter annualised GDP growth measured 0,2 per cent, and reflected
significant contractions in mining, manufacturing, and wholesale and retail trade. Agriculture
and construction on the other han d remained buoyant. The South African Reserve Bank's
leading indicator of economic activity has continued its downward trend, and business and
consumer confidence indicators also show that the outlook is not viewed as being particularly
favourable. Despite an inevitable slowdown in GDP growth, we do not expect a recession in
South Africa at this stage.
During the past two years or so, there has been a rebalancing of the sources of economic
growth from consumption to investment. The past few years has seen a significant increase
in gross domestic fixed investment, from 15 per cent of GDP in 2002 to over 22 per cent of
GDP in the second quarter of 2008. This has been a major achievement. The challenge will
be to maintain investment at these levels in a world of heightened uncertainty. Part of this
impetus has come from the strong infrastructural push from the public sector with respect to
transport, telecommunications and electricity infrastructure to name a few. These projects will
continue, but no doubt there will be challenges with respect to funding, in terms of both the
availability and the cost, given the difficult global financial market conditions we are going
through. Private sector investment has played its part as well over the past few years, and
the big question that will confront us will be whether or not private sector investment will be
able to stay the course during the coming months. We certainly hope so.
The higher economic growth rate experienced over the past few years had resulted in some
improvements in the employment picture in South African society. According to the official
statistics as published by Statistics South Africa, employment growth has averaged almost 3
per cent in 2006 and 2007, and measured 3,9 per cent in the first quarter of 2008. The
unemployment rate declined to 23,2 per cent in September 2008, down from over 30 per
cent in 2002. While this unemployment rate is still too high, the direction has been pleasing.
Financial stability considerations have probably increased over the past year. Monetary
policy remains focused on achieving price stability whilst taking full cognisance of the
changed global situation. Inflation in South Africa has exceeded the upper limit of the inflation
target range since April 2007. In response to this, the monetary policy stance has been
tightened, and between June 2006 and June 2008 the repurchase rate was increased by a
cumulative 500 basis points. The most recent measure, published yesterday, showed that
CPIX inflation declined to 12,4 per cent in October compared to the recent peak of 13,6 per
cent seen in August. We are hopeful that this is the start of a consistent downward trend.
Currently our forecasts indicate that we should be back in the target range by the second
quarter of 2010.
The inflation outlook has been improved to some extent by a number of variables that
previously were seen as upside risk factors. As mentioned above, the international oil price
has declined significantly and global food price inflation appears to be moderating although is
yet to feed through to domestic consumer prices. Domestic demand pressures have also
subsided as household consumption expenditure has responded to the less accommodative
stance of monetary policy.
Consumption expenditure has also been influenced by negative wealth effects, as housing
and equity markets have weakened. Since the beginning of the year, equity prices on the
JSE Limited have declined by 30 per cent, house prices have been flat or negative, and
personal disposable incomes have also declined. The lower economic growth rate has meant
that supply side cost pressures may also be subsiding.
Unfortunately, while there have been improvements on these fronts, we have to contend with
some upside risks factors to the inflation outlook. Inflation expectations are an important
driver of inflation, and we have seen a successive deterioration of these over the past year in
particular. These expectations may feed through to further inflationary pressures. Our hope is
that inflation expectations will respond quickly to the expected reversal in the inflation trend.
Despite the deterioration however, there is still an expectation that inflation will decline
significantly over the next two years.
A major risk factor is the exchange rate market which has also been buffeted by global
developments. The increased risk aversion in international financial markets has resulted in a
reversal of capital flows to emerging market economies in particular. Investors, fund
managers and hedge funds are liquidating their positions in emerging markets and moving
them to so-called safe havens. Some even call this a flight to quality. This is somewhat
ironical, given that capital is moving back to the source of the problems. During the year
there has been a significant realignment of exchange rates: the dollar has appreciated
against most currencies apart from the yen; sterling has depreciated significantly and most
emerging market currencies have also depreciated. Since the end of last year for example,
sterling has depreciated by around 23 per cent against the US dollar; the Australian dollar by
about 26 per cent; the Brazilian real by 19 per cent; and the Turkish lira by 26 per cent. At
the same time the rand has depreciated by about 31 per cent against the dollar and about 24
per cent on a trade-weighted basis. These are significant moves which clearly do not only
reflect the underlying fundamentals of these economies.
Part of the reason for the poor performance of the rand is related to the decline in commodity
prices. Other factors include simple risk aversion, and the concern about the current account
deficit on the balance of payments, which to date has been adequately financed through
capital inflows. In recent weeks, following the latest round of financial market turbulence,
particularly after the demise of Lehman Brothers, there have been significant sales of bonds
and equities by non-residents.
The ZAR and the domestic bond and equity markets were not the only casualties following
the failed attempt by Barclays to acquire Lehman, subsequently resulting in the latter filing for
bankruptcy on 15 September 2008. Emerging markets in general came under heavy selling
pressure as risk aversion escalated.
On 15 September, Romanian shares fell by more than 4 per cent to their lowest levels in
over three years while Czech and Hungarian stocks dropped to their lowest levels in over two
years, falling by 6 and 4 per cent respectively. Russian stocks also dropped by similar
amounts reaching their lowest level in two years, resulting in the authorities in Russia to
suspend trading on 17 and 18 September 2008. For that entire week, the stocks of most
emerging market countries showed significant declines. Those included Israel (-10,8 per
cent); Romania (-7,3 per cent); Thailand (-4.5 per cent); South Africa (-2,9 per cent); Hungary
(-2,1 per cent); Czech Republic (-2,0 per cent); Poland and Turkey (-1,9 per cent) and Korea
(-1,5 per cent).
Emerging Market Bond Indices (EMBI) spreads over US Treasuries widened sharply during
the week under review. The widest spreads were recorded in Russia (52 bps); Argentina (42
bps); Venezuela and Ukraine (30 bps) and China (28 bps). South Africa and Poland
registered the smallest movements with their spreads over US Treasuries widening by some
5bps.
The currencies of most emerging markets weakened considerably against the USD during
the week starting on 15 September on the back of major equity and bond selling in these
countries. The biggest depreciations were registered by Chile (-3,2 per cent) followed by
Brazil (-2,0 per cent) and Iceland (-1,5 per cent).
In the year to date, non-residents have been net sellers of equities to the value of around
R52 billion, while net bond sales have totalled almost R17 billion. However it is important to
note that these sales do not necessarily translate into actual capital outflows.
There is little doubt that the traditional source of foreign capital inflows, that is flows into the
equity market, may remain under pressure in the coming months as a result of continued risk
aversion. Despite the global turmoil, the financial account in South Africa has remained in
positive territory. While the deficit on the current account of the balance of payments remains
at elevated levels, some pressure on the import side will be taken off by growth, lower oil
prices and the poor performance of the rand. Unfortunately, with a rapidly slowing global
economy, commodity prices are expected to remain subdued, and the export markets for
commodities and manufactured goods in the current climate will remain a challenge.
Conclusion
Your Excellencies
Esteemed Ladies and Gentlemen
Colleagues
We are living through the most severe economic crisis in our living memory. In response,
many governments and central banks have taken extraordinary measures to protect their
banking systems and their economies. However the past few months have shown that
increased global economic and financial integration has resulted in an increasingly
interdependent world.
Over the last three years, the focus has increasingly been turned to the G-20 to provide
leadership on international financial issues, and this was even more so the case during the
current financial turmoil. While the G-20 is still a relatively small grouping, it nevertheless
represents almost 90 percent of global trade and GDP respectively. On the other hand, the
G-7 has proven itself to be an increasingly necessary albeit insufficient forum in the changing
economic environment of today. Hence, the current financial global crisis provides us with a
fresh and unique opportunity to review what the role of global institutions and other
cooperative arrangements should be.
It is clear that the need to act with the necessary resolve and in a cooperative fashion
together with institutions such as the IMF, the BIS and the FSF and the G-20 is imperative in
order to come up with action plans which should be implemented urgently and
comprehensively. New global governance structures that are inclusive of all stakeholders are
needed.
Recently the G-20 Heads of states met in Washington DC to discuss the global financial
crisis. At this G-20 Economic Crisis Summit, the Heads of States resolved that countries
should work together to restore financial stability and economic growth. The key issues
agreed to at the summit were: the reform of the international financial institutions such as the
World Bank and IMF; the conclusion of the global free trade agreement; improvement in
financial market transparency; changing incentives so that excessive risk taking is no longer
rewarded; drawing up a list of financial institutions that could result in systematic failure; and
strengthening financial market regulation.
In the meantime, strong and significant actions have been taken in both advanced and
emerging market economies to stimulate economies, strengthen the financial sector, provide
liquidity and working to ensure that international financial institutions can provide support for
the global economy.
In addition, the leaders endeavoured at this summit to provide further assistance and to
support the global environment by stating the following and I quote:
"Against this background of deteriorating economic conditions worldwide,
we agreed that a broader policy response is needed, based on closer
macroeconomic cooperation, to restore growth, avoid negative spillovers
and support emerging market economies and developing countries. As
immediate steps to achieve these objectives, as well as to address
longerterm challenges, we will:
Continue our vigorous efforts and take whatever further actions are
necessary to stabilise the financial system.
Recognise the importance of monetary policy support, as deemed
appropriate to domestic conditions.
Use fiscal measures to stimulate domestic demand to rapid effect as
appropriate while maintaining a policy framework conducive to fiscal
sustainability.
Help emerging and developing economies gain access to finance in current
difficult financial conditions, including through liquidity facilities and
programme support. We stress the International Monetary Fund's (IMF)
important role in crisis response, welcome its new short-term liquidity
facility and urge the ongoing review of its instruments and facilities to
ensure flexibility.
Encourage the World Bank and other multilateral development banks
(MDBs) to use their full capacity in support of their development agenda
and we welcome the recent introduction of new facilities by the World Bank
in the areas of infrastructure and trade finance (and)
Ensure that the IMF, World Bank and other MDBs have sufficient resources
to continue playing their role in overcoming the crisis."
The next G20 Head of State summit to review progress will be held by 30 April 2009.
Hopefully by the time we meet next year, we will be able to report on more promising global
and domestic developments.
Please enjoy the rest of the evening, and may you have , in the period ahead, a wonderful
festive season and a prosperous New Year.
'Till we meet again! Adios Amigos!
Thank you very much.