SECOND QUARTER REVIEW OF THE SOUTH AFRICAN ECONOMY WITH KEY

UNCLAS SECTION 01 OF 06 PRETORIA 002072 DEPT FOR AF/S; AF/EPS; EB/TPP USDOC FOR 4510/ITA/IEP/ANESA/OA/JDIEMOND TREASURY FOR TRINA RAND DEPT PASS USTR FOR PCOLEMAN SIPDIS E.O. 12958: N/A TAGS: ECON EFIN EINV EMIN ENRG ETRD BEXP KTDB SF SUBJECT: SECOND QUARTER REVIEW OF THE SOUTH AFRICAN ECONOMY WITH KEY ECONOMIC STATISTICS ¶1. (U) Summary. South Africa's real GDP rebounded in the second quarter of 2008, reflecting a recovery in mining and manufacturing production as electricity supply improved. Export volumes benefited from the increased production, higher international prices of key export commodities increased, and the depreciation of the rand. Consequently, the current account deficit narrowed in the second quarter and was easily financed by the inflow of portfolio and other investment capital. This in turn improved South Africa's gross reserve position and enabled the rand to recover some of its first quarter-losses. Unemployment also dropped from 23.5 percent in the first quarter to 23.1 percent in the second quarter. CPIX-inflation accelerated to 13.0 percent in July 2008, driven mainly by supply-side factors. Responding to the deteriorating inflation outlook, the Monetary Policy Committee (MPC) raised the repurchase rate (repo rate) at its April and June meetings. The repurchase rate was left unchanged at 12 percent in August. End Summary. Sources are from the South African Reserve Bank (SARB),Statistics SA, and the Customs Department of the South African Revenue Service. Some figures from previous months may have changed as the result of statistical revisions. -------------- ¶I. MONTHLY FIGURES -------------- ¶2. EXCHANGE RATES Rand/US Dollar Exchange Rate (monthly average): 2007 2008 May 7.02 Sep 7.13 Jan 6.99 May 7.62 Jun 7.17 Oct 6.77 Feb 7.64 Jun 7.92 Jul 6.97 Nov 6.70 Mar 7.98 Jul 7.64 Aug 7.23 Dec 6.83 Apr 7.79 Aug 7.67 Trade-Weighted Rand (monthly average; 2000 = 100): 2007 2008 May 79.53 Sep 76.68 Jan 75.78 May 67.41 Jun 78.20 Oct 79.51 Feb 69.03 Jun 65.03 Jul 79.16 Nov 78.67 Mar 63.95 Jul 66.87 Aug 76.49 Dec 77.99 Apr 65.31 Aug 66.32 Comment: The rand recovered some of its first quarter losses during the second quarter. On balance, the rand depreciated by 11 percent against the dollar and 15 percent against the weighted average exchange rate of the rand in the first eight months of 2008. The rand declined sharply in the first quarter as the risk premium demanded by non-resident investors increased. This decline was also influenced by factors such as electricity supply disruptions, slowing growth and negative perceptions arising from attacks on foreigners. The rand recovered some of its first quarter losses during April and May following an aggressive reduction in interest rates by the US Federal Reserve in conjunction with higher South African interest rates, buoyant commodity prices, and significant direct investment inflows arising from corporate deals. The value of the rand declined in June in response to a lower-than-anticipated interest rate increase and the announcement of a larger-than-expected current account deficit for the first quarter. The depreciation in June was further aggravated by the Fitch rating agency's decision to change the outlook for South Africa's long-term issuer default rating from positive to stable. The strengthening of the rand in July and August was supported by the rebound in domestic output during the second quarter. Analysts expect the future value Qoutput during the second quarter. Analysts expect the future value of the rand to be shaped by South Africa's ability to fund its current account deficit. End Comment. ¶3. INFLATION (year-on-year, not seasonally adjusted) 2008 Mar Apr May Jun Jul CPI 10.6 11.1 11.7 12.2 13.4 CPIX 10.1 10.4 10.9 11.6 13.0 PPI 11.9 12.4 16.4 16.8 18.9 Comment: Many inflation-targeting economies overshot their inflation targets during the last year due to rising food and fuel prices, and South Africa was no exception. CPIX-inflation (CPI less mortgage interest) breached the upper limit of the inflation target range of 3 to 6 percent in April 2007 and accelerated to 13.0 percent in July 2008. The acceleration resulted primarily from higher food prices, high international oil prices and mounting broad-based price pressures or second-round effects. The SARB's Monetary Policy Committee (MPC) expects inflation to peak at an average rate of around 13 percent in the third quarter of 2008. PRETORIA 00002072 002 OF 006 Thereafter, inflation is expected to decline in the first quarter of 2009, in part because of the introduction of new inflation basket weights. Inflation is than expected to decline gradually, and to fall below the upper end of the inflation target range in the second quarter of 2010. PPI-inflation scaled new heights (well above those of consumer prices) due to widespread increases in the prices of both domestically produced and imported goods. End Comment. ¶4. MONEY AGGREGATES (percentage change over 12 months) 2008 Mar Apr May Jun Jul M1 15.46 10.11 12.39 14.33 7.63 M2 19.94 20.07 19.43 18.07 13.93 M3 20.98 21.10 20.90 20.28 18.50 Comment: Growth in the broadly defined money supply (M3) continued to decelerate during the first seven months of 2008, restrained by the tighter credit and the general economic slowdown. Despite the slowdown, growth in M3 remained high, supported by accelerating inflation with its impact on nominal income and expenditure. Weak share, bond, and real-estate prices also triggered a stronger precautionary and speculative demand for money balances. End Comment. ¶5. DOMESTIC CREDIT EXTENSION TO THE PRIVATE SECTOR (percentage change over 12 months) 2008 Mar Apr May Jun Jul 22.62 19.63 19.74 20.39 19.81 Comment: The tightening of credit conditions contributed to a moderation in the growth of credit to the private sector during the second quarter of 2008. Tightening monetary policy increased the debt-service costs for an already indebted private sector, while lending standards for the household sector were raised in accordance with the National Credit Act (NCA). Furthermore, consumers' purchasing power was eroded by inflation, and household balance sheets were undermined by stagnant house prices and increasingly volatile financial markets. The deteriorating economic climate was evident in weakening business and consumer confidence. Economists believe this downward trend will continue in the second-half of ¶2008. End Comment. ¶6. KEY INTEREST RATES (at end of month) 2007 Apr May Jun Jul Aug SARB Repo Rate 11.50 11.50 12.00 12.00 12.00 Prime Overdraft 15.00 15.00 15.50 15.50 15.50 Rate Comment: The MPC has hiked interest rates ten times (for a cumulative 500 basis-points) since June 2006, making the current tightening cycle the longest since South Africa adopted an inflation-targeting framework. This has reversed most of the 650-basis-point reduction between 2003 and 2005. The repurchase rate (repo rate) was left unchanged at 12.0 percent in August 2008. Most analysts believe that interest rates have peaked and that the first interest rate cuts can be expected from the second quarter of ¶2009. End Comment. ¶7. MERCHANDISE TRADE ACCOUNT (R millions) -------------- 2008 EXPORTS IMPORTS TRADE BALANCE Jan 39,356.8 49,573.2 -10,216.4 Feb 46,946.3 52,766.1 -5,819.8 Mar 51,150.9 56,181.0 -5,030.1 Apr 56,174.3 66,169.0 -9,994.7 May 56,240.5 57,900.0 -1,659.5 Jun 60,159.9 60,343.8 -183.9 QJun 60,159.9 60,343.8 -183.9 Jul 61,268.2 75,599.6 -14,331.4 TOTAL (1) 367,761.0 418,431.1 -50,670.1 JAN - JUL 2007 TOTAL (1) 275,760.0 316,683.8 -40,923.8 (1) Total After Adjustments (year-to-date) Comment: Strong international prices and demand for South African mining products, alongside the depreciation of the rand, caused merchandise exports to increase by 32 percent in the first seven PRETORIA 00002072 003 OF 006 months of 2008. There was a rise in the volume of manufactured exports such as chemical products, machinery and electrical equipment, and vehicles and transport equipment. Imports were boosted by an even greater amount by the government's capital expansion program as well as strong fixed investment spending by the private sector, high international oil prices and the weaker rand. End Comment. ¶8. FOREIGN RESERVES ($ billions) -------------- 2008 Mar Apr May Jun Jul SARB Gross Gold and Foreign Reserves 34.39 34.28 34.41 34.85 35.00 SARB Net Open Forward Position 33.13 32.97 33.23 33.76 34.17 Comment: South Africa's gross reserve position improved from $25.6 billion at the end of 2006 to almost $33.0 billion at the end of 2007, and by a further $2 billion to $35.0 billion by the end of July 2008. Analysts believe the SARB has adopted a more cautious approach to reserve accumulation to avoid unnecessary downward pressure on the rand. South Africa's reserves remain low as a percentage of exports, when compared to other emerging market economies. Furthermore, import coverage decreased from five-and-a-half to four weeks of imports as imports surged in July. This is regarded as a source of weakness by the major international credit rating agencies. End Comment. -------------- II. QUARTERLY FIGURES -------------- ¶9. REAL GROSS DOMESTIC PRODUCT (percent change, seasonally adjusted and annualized) -------------- -------------- 2007 2008 Q2 Q3 Q4 Q1 Q2 -------------- -------------- Primary Sector -4.5 1.9 -1.1 -13.9 16.9 Agriculture 8.3 4.4 11.2 17.2 19.6 Mining -9.1 0.9 -5.8 -25.1 15.6 Secondary Sector 2.0 0.6 8.1 1.0 12.3 Manufacturing -0.1 -2.5 8.2 -1.0 14.5 Electricity 2.8 3.0 -1.8 -6.2 -1.3 Construction 11.8 14.7 14.2 14.9 10.6 Tertiary Sector 5.9 6.8 5.1 4.2 1.4 Trade & catering 4.7 4.5 2.1 3.6 -2.2 Transport & Comm. 6.1 4.4 3.6 3.5 4.1 Finance 10.2 12.3 8.5 4.9 2.3 Government 1.2 3.3 4.4 4.6 1.1 -------------- -------------- TOTAL 4.0 4.6 5.1 2.1 4.9 -------------- -------------- Comment: South Africa's real GDP rebounded in the second quarter of 2008 and expanded at an annualized rate of 4.9 percent, following a sluggish growth rate of only 2.1 percent in the first quarter. The improvement in growth in the second quarter reflected increased output in the primary and secondary sectors, which offset a further moderation in output growth of the tertiary sector. Primary sector: Growth in the agricultural sector edged higher in the second quarter of 2008, primarily due to favorable weather conditions for field crop production, combined with a marked increase in the acreage planted. The mining sector recovered some of its first quarter losses. Production of gold, diamonds, coal and platinum increased in the second quarter of 2008, even though mines Qplatinum increased in the second quarter of 2008, even though mines had to operate at power levels of between 90 and 95 percent of their earlier electricity requirements. The more stable supply of electricity and favorable commodity prices more than offset the loss of production due to continuing, but fewer, safety-related shutdowns over the period. Secondary sector: Growth in the secondary sector expanded in the second quarter primarily due to the improved performance of manufacturing. The strong manufacturing performance was partly attributable to base effects as the availability of electricity supply improved considerably in the second quarter. The increase in manufacturing production was especially pronounced in food and beverages, and petroleum-related products. Electricity output contracted only marginally in the second quarter of 2008 as the PRETORIA 00002072 004 OF 006 availability of electricity improved considerably and the export of electricity to neighboring countries declined. The construction sector remained buoyant in the second quarter of 2008, although the increase in output was lower than in the first quarter. This moderation in growth reflected deteriorating conditions in the residential and non-residential building sectors, as developers increasingly felt the strain of higher interest rates and mounting inflationary pressures. Tertiary sector: The slower pace of growth in the tertiary sector reflected a slowdown in the trade sector. The contraction in the trade sector was the first since the third quarter of 2001 and was primarily due to slower output growth in the retail and motor trade subsectors. Tighter credit conditions and inflationary pressures negatively affected consumer spending and consumer confidence levels in the second quarter of 2008. Likewise, growth in the finance sector also tapered off. End Comment. ¶10. BALANCE ON CURRENT ACCOUNT (R millions) -------------- -------------- 2007 2008 Q3 Q4 Q1 Q2 -------------- -------------- Merchandise Exp. 124,858 132,032 138,702 172,558 Net Gold Exports 10,239 11,268 11,516 11,877 Merchandise Imp. 150,425 152,374 161,339 188,055 Income Payments 29,752 31,868 31,607 28,862 -------------- -------------- Current Account -45,314 -38,072 -41,089 -39,133 -------------- -------------- Current Account Deficit/GDP -8.1 -7.5 -8.9 -7.3 (percentage) Comment: The second quarter output recovery after power supply disruptions in the first quarter, coupled with high international commodity prices and a more competitive rand, resulted in significant increaQs in both the volume and average price of South African exports in the second quarter. This improved export performance coincided with more subdued domestic demand and a marginal increase in imports, and resulted in the narrowing of the current deficit in the second quarter of 2008. End Comment. ¶11. BALANCE ON FINANCIAL ACCOUNT (R millions) -------------- -------------- 2007 2008 Q3 Q4 Q1 Q2 -------------- -------------- Direct Investment 10,880 5,528 35,169 981 Portfolio Investment 29,215 -6,055 -20,572 22,547 Other Investment 16,015 34,863 29,688 19,150 -------------- -------------- Financial Account 56,110 34,336 44,285 42,678 -------------- -------------- Comment: South Africa continued to attract capital inflows to finance the current account deficit in the second quarter of 2008. Unlike the first quarter of 2008, when portfolio investments turned negative, capital inflows in the second quarter were primarily portfolio and other investment capital. Foreign investor confidence in the country was positively affected by the recovery in output and high commodity prices, coupled with the government's commitment to address structural shortages. However, the South Africa economy Qaddress structural shortages. However, the South Africa economy would have to generate similar capital inflows in the second-half of 2008 to prevent the rand from depreciating further. End Comment. ¶12. KEY LABOR MARKET VARIABLES (thousand) -------------- 2007 2008 Mar Sep Q1 Q2 -------------- -------------- Employed 12,648 13,234 13,623 13,729 Unemployed 4,336 3,945 4,191 4,114 Total Labor Force 16,984 17,178 17,814 17,844 Not Econ. Active 13,211 13,235 12,794 12,861 Population 15-64 30,195 30,413 30,608 30,705 -------------- -------------- Unemployment rate 25.5 23.0 23.5 23.1 PRETORIA 00002072 005 OF 006 (percentage) Absorption rate 41.9 43.5 44.5 44.7 (Employed/population ratio) Comment: Unemployment in South Africa dropped from 23.5 percent in the first quarter of 2008 to 23.1 percent in the second quarter. The number of jobless persons decreased by 77,000 to 4.1 million people, while the number of employed persons increased by 106,000 to 13.7 million. The prospect of slower economic growth for the next year or two could slow down or even halt this progress on employment. End Comment. -------------- III. ANNUAL FIGURES -------------- ¶13. GROSS DOMESTIC PRODUCT (R millions, at market prices) -------------- -------------- 2005 2006 2007 -------------- -------------- Nominal GDP 1,541,067 1,741,060 1,993,894 -------------- -------------- GDP Growth Rate 5.0 5.4 5.1 (constant 2000 prices, y-o-y growth percentage) Comment: The strong growth in 2007 was due to high commodity prices, strong domestic consumer demand, and increased fixed capital investment. Economists expect economic growth to slow to between 3 percent and 4 percent in 2008. This slowdown is due to the sustained monetary policy tightening since mid-2006, energy supply constraints, and slower global growth. End Comment. ¶14. FINANCING OF GROSS CAPITAL FORMATION (R millions) -------------- -------------- 2005 2006 2007 -------------- -------------- Savings by Households 1,264 -5,164 -6,885 Corporate Savings 35,598 21,140 14,118 Savings of Government -10,836 9,032 19,636 Consumption of fixed 190,148 218,070 255,033 capital -------------- -------------- Gross savings 216,174 243,078 281,648 Foreign Investment 62,179 112,346 145,016 -------------- -------------- Gross capital formation 278,353 355,424 426,664 -------------- -------------- Gross Savings/GDP 14.0 14.0 14.1 (percentage) Dependence on Foreign 22.3 31.6 34.0 Investment Foreign Investment/GDP 4.0 6.5 7.3 (percentage) Gross Capital Formation/GDP 18.1 20.4 21.4 (percentage) Comment: The savings rates for households and corporations continued to decline, while the government increased its savings rate in 2007. The government's higher savings rate was mainly due to an increase in tax revenue collected which more than offset growth in expenditure. Notwithstanding the minor improvement in the national savings/GDP ratio, South Africa's dependence on foreign capital to finance gross capital investment increased to its highest rate ever in 2007. Investment programs by private business enterprises, public corporations, and the general government boosted growth in capital investment. The ratio of gross fixed investment to GDP increased to its highest level since 1985 and is approaching the SAG's target of 25 percent. End Comment ¶15. NATIONAL BUDGET (R billions) PRETORIA 00002072 006 OF 006 -------------- Fiscal Year Ending 31 March: 2005 2006 2007 2008 -------------- -------------- Total Revenue 347.4 411.2 481.2 560.1 Total Expenditure 368.6 416.8 470.2 541.6 Budget Balance -20.7 -5.0 11.0 18.5 -------------- -------------- Budget Balance/GDP -1.4 -0.3 0.6 0.9 Comment: The fiscal surplus in 2008, only the second since 1960, was the result of a large increase in tax revenue (owing to strong economic activity and stepped up revenue enforcement) that was only partly absorbed by additional expenditure. End Comment. ¶16. GOVERNMENT DEBT (R billions) -------------- Fiscal Year Ending 31 March: 2005 2006 2007 2008 -------------- -------------- Total Debt 501.7 528.5 551.9 571.7 of Which: -- Domestic 431.8 461.2 469.0 475.2 -- Foreign 69.4 66.8 82.6 96.2 -- Other debt 0.5 0.4 0.3 0.2 State Debt Cost 48.9 50.9 52.2 52.8 -------------- -------------- Government Debt/GDP 36.8 33.2 28.9 25.4 (percentage) State Debt Cost/GDP 3.4 3.2 2.9 2.6 (percentage) Comment: The decline in government debt as a percentage of GDP can be attributed to the rapid growth of the economy and the creation of a fiscal surplus. Debt service costs have shown a steadily declining trend since peaking at 5.6 percent of GDP in the 1999 fiscal year. The decline in debt service costs has created the necessary "fiscal space" to finance social priorities. End Comment. -------------- -------------- For additional information please consult the following websites: South African Reserve Bank South African Revenue Service Statistics South Africa National Treasury BOST