6 August 2007
Introduction
Article IV reports are a result of bilateral discussions between the
International Monetary Fund (IMF) and its member countries about economic and
financial information as well as the country's economic development policies.
The IMF currently has 185 member countries. The report provides crucial
information such as the country's macro-economic situation, including
developments in the monetary, fiscal and financial sectors of the economy. Of
critical importance to the discussions are six key elements namely: Growth
Domestic Product (GDP) growth, fiscal position, balance of payments, exchange
rate, labour market issues and monetary policy.
Assessment of the current economic environment
The overall assessment of the report is optimistic about robust growth,
rising employment and further improvement of the fiscal position and foreign
reserves. There is agreement between South African authorities and the IMF
about these economic prospects. Real GDP growth is projected by the IMF at 4,8
percent for 2007 and 4,5 percent for 2008, from 5,0 per cent in 2006. The
National Treasury has a more optimistic growth projection of about 5 per cent
based on stronger capital formation and employment growth as well as continued
strong total factor productivity (TFP) growth.
According to the Fund, the rapid growth in capital accumulation envisaged
in
Accelerated and Shared Growth Initiative for South Africa (AsgiSA) could
relieve the most pressing capacity constraints (particularly in electricity and
transport networks), whereas productivity-enhancing structural reforms could
further raise the potential growth rate of the economy. The National Treasury
projects GDP growth of around 5 per cent over the short to medium term. Over
the longer-term, we also expect the potential growth rate of the economy to
rise.
The report notes that the continuation of considerably more rapid growth in
domestic demand relative to domestic supply undermines the sustainability of
the current growth path. The mismatch between demand and supply is reflected in
South Africa's significant current account deficit and rising inflation. While
we generally agree with that view, inflationary pressures are also being driven
by adverse food and energy price developments. These should start to abate over
the next year, lowering the contribution of food and energy price inflation to
overall inflation. Government will also continue to raise its investment in
infrastructure, thereby helping to alleviate capacity constraints and product
price inflation. Furthermore, the South African Reserve Bank (SARB) has
frequently made public its approach to second round price pressures.
The Report noted that the current account deficit reflects a private sector
savings-investment imbalance and that rising investment (leading to capacity
constraints and rising imports of basic inputs such as cement and steel)
becomes an increasingly important driver of the deficit. Over the longer term
the increased capacity should reduce the demand for import goods, whilst
raising export competitiveness.
Government is confident that the higher current account deficit is a short to
medium term phenomenon caused primarily by rising domestic investment and
secondarily by healthy household consumption driven by rising real incomes. It
is expected that capital inflows will remain high in the medium term, as the
South African economy continues to grow rapidly.
The widening of the current account deficit and high reliance on portfolio
equity inflows relative to other emerging market economies have raised
vulnerability to external shocks (e.g. a weaker appetite for emerging market
assets, a substantial rise in global interest rates or a sharp decline in
commodity prices) and to a 'sudden stop' in capital flows. A deteriorating
international environment combined with South Africa's significant current
account deficit has led government to increase domestic savings through a
stronger fiscal position.
The report notes that South Africa's strong fundamentals (including a
flexible exchange rate regime and low external debt compared to other emerging
market economies) should mitigate the impact of adverse external shocks on the
economy. According to the IMF, external debt would remain below 30 percent of
GDP even if the current account deficit increased by 1 percent of GDP over the
next five years. South Africa and the IMF agree on the need to continue prudent
fiscal and monetary policies in order to improve external vulnerability.
The Report identifies the following causes of high unemployment:
* Rapid growth of female and unskilled labour supply, in combination with a
structural shift in labour demand towards skilled labour
* Long distances between places of residence and places of work, which raise
the cost of job search and (in combination with the system of social grants)
raise reservation wages
* Labour market regulations and practices that discourage job creation.
Assessment of current government economic policy
The IMF is supportive of the economic policies of the South African
government.
The report supports the government's efforts to address the challenges of high
unemployment and poverty while aiming to preserve macroeconomic stability. The
IMF supports targeted initiatives to reduce unemployment but suggests that
these initiatives should be evaluated to ensure the efficient allocation of
resources.
The Report favours the identification and revision of labour market regulations
and practices that limit job creation and recommended further initiatives to
liberalise and simplify the trade regime. Efforts to improve productivity,
raise employment levels, and improve real earnings levels are important goals
of policy. Trade and labour market policy initiatives, such as tariff
simplification or efforts to raise productivity should be identified by
government.
The IMF cautioned against the possible economic distortions that could arise
from the new industrial policy framework. The Fund noted that the framework was
too broad, with the potential of having unintended conflicting objectives and
too many interventions. The National Treasury recognises that interventions
should be directed at changing market incentives faced by private and public
firms, based on identified market failures or regulatory needs, subject to
independent evaluations, and limited in duration.
The government's continued sound fiscal policies and improved public
finances were commended by the IMF as a means of raising the level of
government savings in order to mitigate the risks associated with the widening
current account deficit. The Report is also positive about the focus of
government expenditure â the upgrading of infrastructure and relieving pressing
social needs. Continued revenue buoyancy, as the Fund indicates, should be
treated cautiously in future fiscal decisions, implying further increases in
public sector saving and a somewhat slower growth in real government
expenditure. The balance of allocations will continue to reflect the importance
of public infrastructure development to the economy over the long term.
The fund continues to support South Africa's approach to reserve
accumulation and the desirability of further accumulation. The Fund further
supports reforms aimed at strengthening old-age income security and initiatives
that reduce social and wealth disparities. These are important to improving the
potential for people to engage in economic activity and enter the labour
market.
The IMF notes that South Africa's financial sector is strong, resilient, sound
and well regulated. The Report regards the continued enhancement of regulation
and oversight in the financial sector as a useful means of maintaining
stability in the context of the risks arising from rapid credit growth and the
recent increase in household indebtedness. The IMF commended government's
attempts to improve access to basic financial services by the poor, especially
in non-urban areas.
The fund continues to support the use of the inflation targeting framework
as a means of anchoring inflation expectations in the economy. Whereas AsgiSA
identified the volatility of the rand as a potential constraint on growth in
exports, the IMF supports government's approach of allowing the exchange rate
to absorb negative economic shocks alongside a gradual and steady increase in
foreign exchange reserve accumulation. Government believes that this is an
important part of ensuring the stability and sustainability of growth in the
domestic economy. The IMF found little evidence of significant exchange rate
misalignment. Improving the competitiveness of the South African economy can
only be permanently achieved through efforts to raise productivity and reduce
costs of domestic factors of production.
The report also supports the continued gradual relaxation of exchange
controls which could improve the allocation of resources and help to reduce
exchange rate volatility through deeper foreign exchange markets.
A copy of the full report is available on the National Treasury website at
http://www.treasury.gov.za and the
International Monetary Fund's website at http://www.imf.org.
Issued by: National Treasury
6 August 2007
Source: National Treasury (http://www.treasury.gov.za)
