20 March 2008
The South African Reserve Bank’s latest quarterly bulletin, released on Wednesday, points to a challenging global economic environment in the aftermath of the turmoil caused by the US sub-prime crisis, as well as South Africa’s ability to withstand the resulting fallout.
In a statement accompanying the release of the bulletin, Reserve Bank Governor Tito Mboweni said that while some growth momentum might be sacrificed as a result, robust activity seemed likely to continue in large parts of the world, for instance in China and India, while oil and commodity producers also stood to benefit.
He went on to explain that the crisis in the US centred around bad investments in sub-prime mortgages and a broad range of financial assets structured around such mortgages, and that South African financial institutions had little exposure toward such “exotic” structured products.
Mboweni pointed out that while local banks had very little direct exposure to write-offs arising from the turmoil, indirect exposure to the sub-prime crisis was unavoidable. This included falling domestic share prices, decreased industrial exports and a rising gold price.
“Nevertheless, South Africa’s banks are well-capitalised and supervised, its financial system is robust, and liquidity in the domestic financial system is adequate,” he said. “Although bad debt in the banking system is rising, it is predominantly on account of the preceding rapid increases in credit extension and tighter monetary policies, and remains well-contained and closely monitored.”
Mboweni said that South Africa was further protected from such external shocks due to a slowdown in household consumption coupled with a strong rise in real fixed capital formation, especially in the electricity sector.
“The current ratio of capital formation to gross domestic product (GDP) of 21% compares favourably with the ratio of 15% recorded only six years ago.”
He explained that the capital expenditure had a significant import component and this was contributing to the country’s current account deficit of 7.5% of GDP in the fourth quarter of 2007, and 7.3% for the year as a whole.
“As before, the deficit on the current account was more than fully financed through inflows of financial capital, and the Bank continued to build up international reserves during the fourth quarter,” Mboweni said.
The form in which South Africa attracted capital also changed from portfolio investments to other types of investment, with South African banks repatriating part of their substantial foreign currency holdings overseas, possible to benefit from the prevailing interest rate differential that is in favour of South Africa.
“Further scope for attracting foreign saving is considerable: South Africa’s foreign debt is low, its private banking sector owned more than R225-billion in foreign exchange at the end of 2007, and interest rate differentials, both nominal and real, continue to favour South Africa,” Mboweni said.
In addition, sound economic growth prospects, an extensive infrastructure programme, and responsible fiscal policies were likely to sustain confidence and investor interest.
“These factors contributed to ample liquidity in the domestic market for foreign currency, making it possible for the South African Reserve Bank to accumulate more foreign reserves,” he explained.
The bank’s gross international reserves rose from US$33-billion at the end of December 2007 to $34.2-billion at the end of February 2008.
Floating exchange rate
An important element of South Africa’s resilience in the face of current-account imbalances was its adherence to a floating exchange rate, Mboweni said, with market forces jointly determining levels of the current account deficit and of the exchange rate.
He said a substantial depreciation of the exchange value of the rand had already taken place in the first quarter of 2008, though the depreciation would help to narrow the current account deficit.
In the short run, however, such depreciation raised the prices of imported items and might prolong the period during which inflation – also being driven by high food and fuel prices – exceeded the Reserve Bank’s target range.
He added that the bank had already tightened its monetary policy stance, and that while instant solutions were impossible, the resolve of the bank to bring inflation back within the target range over time should not be underestimated.
“An environment of low inflation is supportive of robust economic growth, enhanced infrastructure development and sound fiscal policies,” Mboweni said.
“The South African Reserve Bank is closely monitoring international and domestic developments as they unfold, and consults with relevant stakeholders and will be ready to take appropriate steps to ensure stability and a smooth functioning of our financial markets, should that become necessary at any point in time in the future.”