achieving sustainable optimum economic growth and development. recent improvements in the current account of the balance of payments, the firmer exchange rate of the rand, the increased inflow of foreign capital, and the rise in official foreign exchange reserves, provide sufficient evidence to the effect that the serious danger of a collapse in south africa ’ s external economic relations a year ago has been successfully averted. moreover, there are encouraging, although as yet still only tentative, signs, emanating from both the production and the expenditure sides, that the economy recovered slightly during the second quarter of 1997. this preliminary indication is also confirmed by some hopeful signs that the inflationary pressures which arose from the economic imbalances experienced last year are now subsiding. at the same time, however, the overall financial situation still provides reason for concern, particularly in view of the continued high rates of increase in bank credit extension and in broad money supply. for reasons that will be explained in more detail below, the monetary authorities must persist with their vigil against the threat of overall financial instability that can only lead to stagflation in due course. there are many examples in the world today, both among industrial and emerging economies, where this lesson is again being learnt the hard way after years of reluctance to apply appropriate but unpopular short - term disciplinary monetary policies in a timely fashion. the reserve bank is not prepared to consider any short - term expediencies and implement monetary policies that will in the long term lead to serious disruption of financial stability. the country just cannot afford unsound monetary policies for short - term gain. such policies would gradually undermine the value of the rand and lead to an eventual collapse of the financial system, with serious adverse implications also for the level of real economic activity. recent economic developments the reserve bank ’ s annual economic report released this morning serves as a background to the following brief summary of major economic developments over the past twelve months : a year of economic consolidation the pattern of developments in real economic activity over the past twelve months can best be described as the outcome of a necessary process of consolidation after three years of positive growth. the rate of expansion in gross domestic product reached a seasonally adjusted and annualised rate of 31½ per cent in the second half of 1996, but then slowed down to only 1 per cent in the first half of 1997, indicating a lower rate of growth for the full calendar year of 1997 compared with that experienced during any one of the past two years. during the first

the complex structures of some derivative instruments and investment conduits make it almost impossible to determine who is exposed to whom, and to what extent. the current turmoil and illiquidity in the major financial markets is largely attributable to this uncertainty and lack of trust. emerging markets, in particular, are vulnerable to the contagion effect, which is regularly illustrated. this has affected south africa on a number of occasions during the past year and contributed to volatility in domestic financial markets. in times where risk aversion increases and investors pull out of riskier assets, the rand tends to be in the basket of currencies that suffers the most. this can be related to some extent to the liquid nature of the rand market. nevertheless, despite the risks and complexities associated with financial globalisation, there are also clear benefits. speaking from a south african perspective, the central bank ’ s inflation targeting framework has been well supported by the benign global inflation outlook over recent years, as well as by conditions in global financial markets that led to increased foreign capital inflows to emerging markets. the combination of global liquidity, combined with favourable conditions in the domestic economy, caused demand for south african equities by non - residents to increase at an exceptional pace, recording net purchases of r33 billion in 2004, r50 billion in 2005, r74 billion in 2006 and a record r66 billion in the year to 20 september 2007. in the bond market, activity has been a little more volatile, with nonresidents purchasing a net r365 million in 2004, selling a net r10, 7 billion in 2005 and purchasing a net r34 billion in 2006. partly supported by these activities, but also in line with global trends, the jse ’ s all - share index recorded a succession of record highs, while domestic bonds hardly interrupted their five - year rally, despite a cumulative increase of 300 basis points in the reserve bank ’ s repo rate since june 2006. to date, the significant foreign portfolio inflows, combined with a favourable outlook for the domestic economy, have enabled the country to finance a relatively large current account deficit, which, in turn, was to a large extent driven by investment expenditure and infrastructural developments – hopefully efforts from which the country would benefit in years to come. capital inflows have also enabled the south african reserve bank to increase official reserves to a much healthier level, contributing to a series