t t mboweni : an overview of the economic challenges of 2006 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, 30 november 2006. * * * 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 editors and other media representatives ladies and gentlemen 1. introduction it is an honour to welcome you once again to the south african reserve bank for what has become an annual event on our calendar. every year i am humbled by the turnout, and this year is no exception. this past year has been an extremely challenging one from a monetary policy perspective. some of the challenges have emanated domestically, but external economic and geopolitical events have also provided challenges to us as well as to many other central banks around the world. this evening i will give a brief broad - brush review of some of these developments. further details can be found in our publications, including our quarterly bulletin which will be released next week. i am aware that one of the issues that is close to your hearts in the diplomatic community is the behaviour of the exchange rate of the rand as your purchasing power in this country varies inversely with the fortunes of the rand. i have noticed that many of you are looking a lot happier tonight than you were this time last year! 2. the external environment the recent world economic outlook published by the international monetary fund ( imf ) characterised the global economic environment as robust, with economic activity exceeding expectations. while the global expansion has in general been broad based, the improved growth performance of developing and emerging economies compared to that of developed economies has been most noteworthy. this improvement has taken place across all regions, including sub - saharan africa. as a group, developing countries now account for more than half of total world gross domestic product ( gdp ) in purchasingpower parity terms. this past year has been overshadowed by a high degree of volatility in the international oil markets, which posed a risk to the outlook for world growth and inflation. during the course of the year, the price of brent crude oil reached

inflation and moderate growth. meanwhile, the european central bank is still moving towards looser monetary policy, rather than away from it, as is the bank of japan. the result has been renewed global appetite for risk, leading to currency appreciation for most of the emerging markets which had previously experienced weakening exchange rates. domestic factors seem to have played only a supporting role in driving emerging market currency movements over this period. in south africa, markets appear to have welcomed the responsiveness of monetary policy to rising inflation ; the current account deficit also narrowed somewhat in the last quarter of 2013. but south africa ’ s economic fundamentals have on the whole not changed substantially, nor have markets assessed them differently : the current account deficit remains over 5 % of gdp and growth has deteriorated. it would be very rash indeed to assume that the rand ’ s long depreciation trend is now concluded, and that henceforth a strengthening rand will mitigate inflation. instead, south africa remains vulnerable to further changes in global sentiment, which could be sudden. the other aspect of exchange - rate linked inflation is pass - through. with certain prices, passthrough is quick and complete. the obvious example is petrol prices, which have exerted substantial inflationary pressure despite relatively flat international prices thanks to exchange rate depreciation. but many prices behave differently. in a weak economy, firms may choose to absorb higher import costs rather than pass them on to consumers, leading to a divergence between headline consumer prices and the exchange rate. this seems to have been the pattern from the start of 2011 until early 2014. however, at some point firms will judge that their profit margins have been eroded to an unacceptable degree, and they will start passing on these costs to consumers. we see evidence that firms are being squeezed in producer price inflation, which reached 8. 8 % in april, its highest level in two years. and we see evidence for higher pass - through in rising core inflation, which has picked up again after a period of stability in 2013. our conclusion is that pass - through has risen, pushing inflation above the target. this effect cannot be expected to abate just because the rand has recovered some lost ground. if the currency begins to trade in a stable band well above its old levels, stability will not necessarily moderate pass - through ; rather, it could convince firms to price in the new normal level. we should not assume that inflation will simply track the most recent movement of the exchange rate. bis central bankers ’ speeches 3