t t mboweni : economic developments and monetary policy speech by mr t t mboweni, governor of the south african reserve bank, at a dinner of the south african institute of electrical engineers, rand club, johannesburg, 22 july 2004. * 1. * * introduction ladies and gentlemen, i thank you for the invitation to attend your dinner in these illustrious surroundings. it is indeed always an honour to attend a function at one of the oldest clubs in south africa, and even more so because of the role that it played in the history of our country. i appreciate having the opportunity to talk to your institute on this occasion because of your role in the development of our economy. as a topic for discussion i thought it may be useful to briefly look at recent economic developments in the world and in south africa and conclude my address with a few remarks on monetary policy and exchange rates. 2. global economic developments the global economy started to recover at an accelerated pace during the course of 2003 and the first quarter of 2004 and then growth seems to have slowed down somewhat in the second quarter of this year. this was mainly due to slower growth in the united states and china. the softening in the economic growth of the united states'economy is probably a temporary phenomenon related to the spike in the international price of oil, which affects consumer expenditure. it is, however generally expected that business investment in the united states will pick up strongly in the second half of 2004 and give further impetus to the world economic recovery. the slowdown in the chinese economy was the result of deliberate policy actions taken by the chinese authorities to cool down the rapid growth that they have experienced over the past years. although the slower growth in china will occur from a very high level, it could have a significant impact on other asian economies. a slowdown in china's energy, steel and chemical production could also affect demand in international commodity markets, resulting in a decline in international prices. china has become a major player in the world economy and is also now the fifth largest trading partner of south africa. however, it seems unlikely that this slower growth will be a lasting feature of the world economy and most international organisations such as the international monetary fund and the bank for international settlements are still projecting a marked recovery in the global economy in the rest of this year and in 2005. another important risk that the world economy is facing is the substantial increase in international oil prices. brent crude oil prices have increased from levels around us $ 24 per barrel in may

a year - on - year rate of increase of about 24 percent in the first half of 2004. 4. monetary policy as already indicated considerable success was achieved with the monetary policy measures during the past year and cpix inflation has been within the target range since september 2003. this has allowed the sa reserve bank to keep the repo rate at an unchanged level of 8 percent per annum in 2004. the major threats to the inflation target in this year have come mainly from exogenous factors. at first the drought experienced in the country was regarded as an important risk because of the negative implications that it could have had on food prices in general. fortunately, this threat dissipated when widespread rains in february and march improved the outlook for the maize crop, leading to a fall in maize prices. increases in international oil prices then increasingly became the major negative factor for the inflation outlook. at the mpc meeting in april 2004, developments in nominal unit labour cost were also singled out as a risk to the inflation projection. the rate of increase of these costs declined from 6 percent in 2002 to 5 percent in 2003, but the salaries and wages per worker still increased at a rate of 8, 7 percent. other threats to the inflation outlook that were identified included the stronger trend in monetary growth, the rapid rise in domestic demand, and the threat of increased international instability. these threats to the inflation outlook still exist today. however there are also many positive factors which should assist us in containing inflation in the coming months. the most important of these is perhaps the decline in inflation expectations. other factors supporting a favourable inflation outcome are the strength in the external value of the rand, the decline in production prices, low expected world inflation, low levels of capacity utilisation and the fiscal discipline of government. against this background, our projections of inflation showed that the year - on - year rates of increase in the cpix could temporarily breach the upper level of the target band towards the end of 2004 and early part of 2005. any such breach is nevertheless expected to be short - lived, with the stronger likelihood that cpix inflation would return to within the range shortly thereafter. the inflation outlook in general is still regarded as favourable. this view is supported by inflation expectations of business, labour, analysts and households. in view of the success achieved with an inflation - targeting monetary policy framework, i find it surprising that so many people still seem to be very critical of this framework. this is probably related to the recent strength of the rand. monetary