T Manuel: South African economy

9 October 2006

Thank you for inviting me to address you today.

We find ourselves at a particular juncture of longer-term economic trends
specific to the South African economy and some shorter and longer-term dynamics
arising from the global economic environment. I want to speak today about some
of those trends and how they interact with the South African economy. I also
want to explore how the further development of Sub-Saharan Africa as an
economic region helps the South African economy to weather the storms of the
global environment and expand our markets.

Prudent fiscal and monetary policies have contributed to a vastly improved
economic climate, while government's expenditure programmes have lowered the
costs of economic activity and broadened access to the economy for the
disadvantaged. Over the past two years, stronger growth in the world economy
and rapidly rising commodity prices have contributed to South Africa's improved
growth performance. Low yields on developed country assets have further
strengthened capital inflows to South Africa and the developing world more
broadly, and enabled us to borrow from the rest of the world to finance
consumption and investment.

Over the very long-term, the growth rate of the economy slowed from about
1975 through to 1993, and has accelerated since. From 1994 to 2000, growth
averaged 2,9 percent per year, and has accelerated to 3,8 percent from 2001 to
2006.

The Medium Term Budget Policy Statement (MTBPS) forecast, which will be
published on 25 October, will take into account short-term effects on the
economy, such as interest rate changes (repo now at eight percent) and money
supply growth (+24% in August), and longer-term effects, such as the impact of
real depreciation on net exports.(1)

Looking at growth by sector, the most rapid advances have been in
construction, wholesale and retail trade, and financial services. Manufacturing
growth has been more variable, with recent good rates (4,1 percent for 2005 and
4,5 percent for the first half of 2006).(2)

The economy's robust growth has been propelled by private and public
investment, which grew by 9,2 percent in 2005 and by 10,3 percent in the first
half of 2006. Investment has averaged growth of nearly 10% from 2003.

As a percentage of Gross Domestic Product (GDP), gross fixed capital
formation rose from 17,3 to near 18% over the same period.(3)

Robust growth in investment has been matched by household spending that has
been propelled by historically low inflation and interest rates and greater
access to finance. Household consumption spending averaged 3,5 percent from
1995 to 2000 to 4,7 percent from 2001 and reaching 7,3 percent in the first
half of 2006. Some commentators have pointed to a rise in a new black middle
class to explain part of this rise. Our official employment statistics, which
we all recognise need work, seem to bear out an increase in employment in the
economy. Real wage growth, averaging 1,0 percent a year since 2001, is also
supportive.

We need to remain mindful of the limits of our labour market statistics,
however, in part by noting that the ratio of household debt to personal
disposable income has climbed sharply in the last two years from 52,8 percent
in March 2001 to about 70 percent today.(4)

Climbing household debt reflects a broader trend of persistently weak saving
across the economy. Household saving as percent of GDP has fallen to 1,5
percent this year.

Our overall saving and investment performance is reflected in the current
account deficit, which averaged 6,1% of GDP in the first half of 2006. In
itself the deficit does not present financing difficulties. Our foreign
exchange reserves have increased to over US$24 billion and our fiscal deficit
is low. Net inflows of capital have remained strong, with about R54 billion
into equities and R19 billion into bonds in the year to date.

Current account balance:

* 2003: -1,3
* 2004: -3,4
* 2005: -4,2
* 2006 (H1): -6,1

Unfortunately, the current account deficit also reflects a weaker trade
balance, with imports of consumer goods, petroleum, motor vehicles and some
capital goods especially high.

Much of this import content contributes to improvements to productivity over
the long-run, and reflects stronger growth in investment by public and private
corporations, but there is a clear need to consider how to boost South Africa's
export performance and develop stronger and more permanent exporting
relationships.

The import content of investment is also high, with a minimum of about 40%.
The Gautrain and World Cup infrastructure projects, plus the many other capital
spending programmes underway throughout national, provincial and local spheres
of government, will put pressure on imports and also contribute to economic
growth.

Stronger investment will result in future improvements in saving; better
growth rates, and will strengthen capital inflows and dampen movements in the
exchange rate. Nonetheless, overshooting of the exchange rate by financial
markets will continue to be a common feature of commodity exporting
countries.

Uncertainty about the trajectories of major world economies will continue to
add volatility to the international environment and flows of capital between
developed and developing countries. At root is a pattern of large current
account deficits and surpluses in major economies, caused by:

* negative shifts in saving, positive but mild shifts in investment, in the
United States (US)
* positive shifts in saving, and negative shifts in investment, in the rest of
the world
* portfolio shifts towards US assets, by both private and public (accumulation
of dollar reserves by central banks) investors.

The path of adjustment needs to be a gradual depreciation of the United
States (US) dollar to avoid international financial contagion.

The South African economy can support a larger current account deficit, in
part because of its improved growth performance itself and in part because of
the policy underpinnings we have put in place over the last 10 years.

Fiscal policy is supported by a transparent and robust budget process.
Increased expenditure is further helping to sustain economic growth by
broadening its base and drawing people into the formal economy.

Nonetheless, more work needs to be done to improve expenditure performance.
As real budgeted allocations have increased strongly since 2001, limits to the
ability of departments, provinces and municipalities to spend have become
apparent.(5)

Shift in deficit targets in 2006 Medium Term Expenditure Framework (MTEF)
from around three percent to below 1,5% signals a policy stance towards
reducing government dissaving, decreasing pressure on the real exchange rate,
and lowering the current account deficit.

Monetary policy anchored by inflation targeting framework, which allows an
exchange rate cushion for the economy, enables increasing reserves, and has
contributed to historically low interest rates.

The recent upturn in inflation primarily reflects a state of nature. South
Africa is a small open economy, meaning that those producer prices affected by
external price developments and from changes in the exchange rate will tend to
be more volatile than others.

An indication of the strength of the inflation targeting framework in
anchoring medium and long-run expectations, changes to inflation expectations
have remained muted, despite the fairly sharp increases in the prices of
imported fresh meat and grains, and of petroleum products in recent months.
Price volatility in commodities generally and non-ferrous basic metals and wire
and cable in particular, have driven up the domestic component of Production
Price Index (PPI).

Similar factors, particularly food and transport prices, have pushed up
consumer prices.

A number of factors suggest that the present deficit on the current account
will fall of its own accord, including the rise in interest rates which will
slow consumer spending and construction somewhat and a drop in the value of oil
imports. The weaker rand will further feed through into stronger exports in due
course.

The central question facing government is how it can contribute to growth by
boosting investment, saving, productivity and employment or what is the effect
of government policies, broadly defined, on the potential growth rate of the
economy?

A range of economic opportunities are available to us over the next few
years, including the development of major transport infrastructure and
efficiency improvements, the upgrading of our energy production industries, and
major infrastructure and tourism growth related to the World Cup in 2010.

There are also some areas where government needs to improve the regulatory
framework and needs to think more clearly about how to develop the country to
be a major exporter. Trade reform and industrial policy needs work, as do our
systems for assisting firms and workers to adjust to economic change. As
government, it is critical to keep our short and medium run policy adjustments
focused on the longer term gains to economic growth and employment.
Co-ordination within government is facilitated by the Accelerated Growth
Initiative for South Africa (AsgiSA) project.

It also seems important in a more unstable international environment to
strengthen regional economic development to help realise the ambition of
rapidly growing Sub-Saharan economies. Our region is a vitally important aspect
of our growth path. We need economically vibrant neighbours that enable all of
us to diversify our economies and create far greater gains from regional trade
than we have experienced so far. Africa's population presents, next to China
and India, one of the largest potential commercial markets in the world.

While poor, Africa's population presents next to China and India the largest
potential commercial markets in the world. Because of the catch-up needed to
meet best practice in economic governance and the current low density of
infrastructure, Africa's growth rates have the potential to rise rapidly for
many years. Of course, as African governments we need to ensure that the
economic gains to be made from policy reform, better governance, expanded
infrastructure, and rising incomes of our populations are realised.

Historically that has not been a simple matter, either in Africa in the last
few decades, or is other parts of the world over a longer time frame.
Timeframes and history are critical elements of vision and leadership.

We speak about 40 years of African history and slow economic growth. We
should occasionally remind ourselves of the extreme poverty that existed in
most European countries only 100 years ago.

Just as Europe and Asia discovered over time the complex set of political
institutions, social balances, and economic policies that enabled rapid
economic growth and rising incomes, so too will Africa. And, indeed, I believe
we have made great strides in the last 10 years in that direction.

We have a far better understanding today of the economic and social
constraints facing us and how to address them. We understand far better also
the international trade and financial environment within which Africa must grow
and interact with other economies and regions. We also understand how natural
impediments to our growth, from disease to geography, constrain us.

To get some sense of the macroeconomic improvement, the average inflation
rate for Sub-Saharan Africa from 1995 to 2005 was 18 percent.(6) By 2005 this had fallen to 11 percent, and is expected to be
about eight percent in 2007. The average budget balance in the region is
expected to be a surplus of 2,1 percent in 2006. And average GDP growth for
2005 was 5,5 percent and is expected to be 5,8 in 2006. Sub-Saharan Africa is
expected to grow faster in the next year or two than it has in decades.

Trade policy development in the Regional Economic Communities, such as
Common Market for Eastern and Southern Africa (COMESA) and Southern African
Development Community (SADC), seeks to lower tariff and non-tariff barriers to
intra-African trade and spur trade and cross-border investment. South Africa
invests about one percent of GDP annually in foreign direct investments in the
rest of Africa, most of which supports increased trade in goods and
services.

Yet Africa needs to sustain progress and avoid costly policy reversals.
Given the small sizes of our economies, we need to become more serious about
integrating our economies and sorting out the overlapping memberships of
regional integration arrangements.

Infrastructure development and deeper trade links between coastal and
interior economies are supplemented with the growing size of the African oil
industry. Between 2002 and 2008, Africa's oil production is expected to
treble.

All of these dynamics feed into a larger one, which is the potential for
Africa as a continental commercial market. While geography will remain a
stumbling block, the incentives for developing the infrastructure to make a
single market a reality are growing, particularly for some of our landlocked
economies that are growing more rapidly. For them, the incentives to develop
infrastructure appropriate to an African market will continue to
strengthen.

In sum, Africa's economies are clearly moving in the direction of sustained
growth and development. Macroeconomic stability has taken root in almost all
countries in the region. Renewed investment by regional governments in
appropriate governance structure, initiatives to develop cross-border and local
infrastructure, and rising spending on human capital, in part assisted by debt
relief, helps to develop the local skills base and create the environment to
attract Foreign Direct Investment (FDI) and take advantage of trade
opportunities.

Human capital creation, better public services create domestic economic
activity, reducing poverty and making more attractive markets for domestic and
international investors. Africa has a bright economic future. And it will take
time to reach our goals. But the fundamental political will is evident and the
resolve of governments and our international development partners to succeed
has strengthened greatly in recent years.

For South Africa, our economy's development is inextricably tied to the
broader world, our capital flows depend in part on events and policies in major
world economies just as they do on the policy decisions made here. We have
created policy frameworks to help us navigate an inherently turbulent
international environment and maintain a sustainable growth path. Further
attention on the region and realising a vision of a thriving Southern African
market is integral to that path.

Thank you

Footnotes:

1. Real depreciation (nominal adjusted for inflation) has a
negative effect on consumption in the short-term as it represents a real loss
of income in public-private partnership (PPP) terms and increases the cost of
imported goods. Over time, imports fall (or grow more slowly) because the cost
has risen and exports rise because they are more competitive. This is reflected
in the 'j-curve' effect, which shows a worsening the trade and current account
deficit before it begins to improve. The depreciation has to be real for it to
have real economic effects, so if inflation rises in the wake of the
depreciation, then it is only a nominal depreciation. There are no long-term
economic effects of this except higher inflation and a raised price level.

2 Growth in manufacturing in 2003 and 2004 was
-1,4 and 4,6 percent.

3 Investment grew most rapidly in sectors
needing to upgrade building stock, with the bulk of investment in machinery
coming through the manufacturing sector. Growth in residential buildings has
been exceedingly strong in 2006 at 21,8 per cent followed by non-residential
building and construction at 10,8 and 6,6 percent, respectively. In 2005,
investment expenditure in residential buildings was 16,6 percent. Investment in
transport equipment has also been robust at 19 percent in 2005. And while
growth in machinery was quite moderate (at about 5.5 percent in the first half
of 2006), it constitutes a large percentage of overall Gross Fixed Capital
Formation (GFCF), (about 45%).

4 Despite considerable improvement in growth,
recent improvements in employment, have been limited to non-traded goods,
services sectors (like construction), and the informal sector. Employment in
export sectors and import-competing sectors remains a challenge, as reflected
in relatively low increase in formal sector employment.

5. FY 2005/06 under spending of R5,6 billion of
available funds (2,4 percent).

6. Average inflation for the Sub-Saharan Africa
Authority (SSA) region peaked at 61 percent in 1994, International Monetary
Fund (IMF), World Economic Outlook (WEO) 2006.

Issued by: National Treasury
9 October 2006
Source: National Treasury (http://www.treasury.gov.za)