T Manuel: Stellenbosch Business School Bursary Fundraising
Dinner

12 September 2007

Introduction

Thank you for the opportunity to address you this evening. I address you
today on an historic day for our country. It was thirty years ago today that
Steven Bantu Biko was killed by the South African police. He was just 30 years
old, at the prime of his life; passionate about literature, academia, identity,
equality and human rights. If Biko were alive today, I am pretty sure that he
would either be a member of the government or a prominent theoretician on the
dynamics of our society.

Yet, history is curious way of testing who we are the chances are that more
people in this audience recall the events in New York of 11 September 2001,
than the profound tragedy of the death of Steve Biko. That is an important
discussion we should preserve for another day. Members of a university
community are in the fortuitous position where they can develop and engage with
the theories of society and at the same time reflect on their experiences from
their own backgrounds. Biko was able to combine passion for the rights of
people with an ability to understand society that belied his tender age.

Over the past month, global financial markets have experienced heightened
turbulence driven by a tightening of credit conditions and an increase in the
price of riskier assets in global credit markets. The wave of turbulence was
triggered by rising defaults in the United States (US) sub-prime mortgage
market and has directly affected hedge funds, investment funds and the
commercial paper market, and had knock-on effects on equity and currency
markets around the world.

This volatility should be seen in the context of the slow unwinding of
global imbalances, the pattern of large current account deficits in some
countries such as the United States and surpluses in China, oil exporting
countries of the Middle East and elsewhere. Open to the back page of The
Economist Magazine in any given week and marvel look at current account
balances, United States of America (USA) has a deficit of 5,8% of Gross
Domestic Product (GDP) at a staggering $804 billion; China has a surplus of
10,7% of GDP valued at $250 billion, or Saudi Arabia's surplus is 25,8% of GDP
valued at $99 Billion, or our own, a deficit of 6,2% of GDP at 16,6 billion
dollars. There are these huge imbalances with no international agency to deal
with or regulate them. Truly, this is globalisation without global institutions
of governance.

Rising interest rates in the US, which are needed to increase saving there,
have revealed the inability of many households to continue to finance large
mortgages. Sub-prime debt has been packaged and sold to foreign investors,
creating the link for international financial contagion from the US economy to
the rest of the world. These contagion effects indicate how advanced the
process of financial globalisation has become. In the 1980s, problems in the US
housing market might have resulted in a run on one or two large US banks.
Instead, the current US sub-prime mortgage crisis is having an impact on
financial markets across the world, including South Africa.

Current market developments unfold against the backdrop of a spectacular
build-up of global liquidity in recent years referred to by Chairman Ben
Bernanke of the US Federal Reserve as the global savings glut. The savings glut
was said to be "driven by the transformation of many emerging market economies,
notably rapidly growing East Asian economies and oil producing countries from
net borrowers to large net lenders on international capital markets." According
to Bernanke, the glut in global savings helped to explain a number of related
developments in the global economy, including the substantial rise of the US
current account deficit, the huge expansion in current account surpluses in
emerging market economies and the world wide decline in long-term interest
rates. We might further add the role played by the US monetary system as lender
of last resort in the successive financial crises of the 1990s and 2001 as
contributing to globally low interest rates. Asset price inflation in major
world economies, especially the US housing market, further elicited credit
expansion as household debt to asset ratios fell over time. This increased
liquidity and the savings glut introduced a degree of comfort and in some
cases, complacency in financial markets not seen in decades. This complacency
in turn led to more complex and riskier financial instruments, at times out of
touch with reality. Financial analyst appeared to be driven by their
computer-based models rather than real economic variables.

The current market correction may be part of a process of reducing the scale
of global imbalances, which would require a combination of slower US
consumption growth, a weaker dollar, a slower build-up of savings in emerging
markets and a repricing of Asian exchange rates. As this process unfolds,
various markets will experience volatility, especially those that have
exhibited asset price inflation in recent years. We need to recognise that
while the process of rebalancing will lead to temporary changes in global
growth, an orderly unwinding of imbalances is necessary in order to maintain
the unprecedented strong global growth path over the longer term.

Unpacking the crisis

A prolonged period of low interest rates around the world has led to a surge
in global portfolio flows and encouraged increased risk taking and borrowing by
investors. Assets under management of institutional investors more than doubled
in the decade between 1995 and 2005 from US$21 trillion to US$53 trillion.
Investment in alternative vehicles such as hedge funds has also increased
sharply, with assets under management by hedge funds reaching US$1,4 trillion
at the end of 2006 from US$30 billion in 1990.

It is estimated that roughly 50 percent of oil revenues in the current
commodity cycle are saved and reinvested into the global financial system,
which has led to a quadrupling of reinvested oil revenues from US$90 billion in
2002 to over US$400 billion last year. Reserves accumulation by emerging
markets, in particular Asian countries, has also contributed significantly to
global capital flows. And, as these huge positions built up, few considered the
risk of fall out and Alan Greenspan's counsel against "irrational exuberance"
appears to be advice to an earlier generation.

Turning to the specific events playing out in the US the anatomy of the
credit crunch can be explained in the following way. Between 2001 and 2006, the
US housing boom encouraged excessive risk-taking by lenders, who sharply
expanded loans to marginal borrowers. Financial innovations such as automated
underwriting and securitisation were key components in lowering the costs of
sub-prime lending. These financial innovations combined with historically low
interest rates fuelled US house purchases, reaching even those who previously
could not afford property. During the peak of the market six months ago,
sub-prime loans accounted for more than 13 percent of the total US mortgage
stock.

The rapid rise in mortgage defaults initially affected specialist mortgage
lenders in the US. But, as Warren Buffet once said and I paraphrase when the
tide goes out, you can see who has been swimming naked commercial and
investment banks also declared losses from holding sub-prime mortgages outright
or interest in securitisation transactions they arranged. Further liabilities
held by a range of pension and hedge funds and foreign banks also went into
default, spreading the losses to foreign markets. Indeed, the current crisis
was sparked by the need for liquidity by a French bank.

The financial innovations that fuelled the sub-prime mortgage market in the
first place, also contributed to the swift transfer of the costs associated
with default to investor institutions around the world. As broad portions of
the credit market became subject to extreme risk aversion and low levels of
liquidity, it became necessary for central banks in the US, Europe and other
developed markets to inject liquidity into the overnight money markets.

During three high-pressure weeks in August, over US$400 billion was provided
to the markets by central banks in the USA, Europe, Japan and Australia. These
actions by central banks have been crucial to maintain confidence in the
banking system and to reduce the potential impact on the real economy. Apart
from providing additional liquidity to money markets, central banks in Europe
and Japan have also held off on monetary tightening despite earlier intentions
to hike interest rates. However, the response of central banks to the current
market crisis has raised the issue of moral hazard in financial markets.

While there appears to have been a mispricing of risk in credit markets for
some time prior to the current troubles, there is an expectation that central
banks will step in to ease potential losses on bad investments. Has the
response of monetary authorities papered over the cracks in the financial
sector? Chairman Bernanke has emphasised that it is not the responsibility of
the Federal Reserve to protect lenders and investors from the consequences of
their financial decisions, but central banks also have a responsibility to
respond to potential spill over effects of financial market troubles to the
broader economy. A huge debate has been unleashed amongst economists some, such
as Martin Wolf, the respected Financial Times columnist argued strongly that
"Central Banks should not rescue fools", the fools being those financial
institutions who engaged in dodgy practices others like Nouriel Roubini argue
that we should work past the institutions and bail out the individual
homeowners. I would hazard that the debate on moral hazard will rage for some
time yet.

Investors have also lost confidence in traditional methods of assessing risk
and the lack of accurate information. Ratings agencies in particular have come
under fire for inadequate disclosure of information and understating the risk
of sub-prime mortgage paper and collateralised debt obligations (CDOs), making
potential buyers suspicious of structured products.

The distrust of credit ratings today has parallels with the situation at the
time of the corporate accounting scandals in 2002, when investors felt that
they could not trust corporate financial reports. As we know, that crisis
eventually led to a comprehensive overhaul of corporate governance rules and
accounting standards. This has raised questions about the quality of oversight
and regulation in the US banking system and hedge fund industry. It is clear
that many investors had insufficient information to understand the underlying
risks associated with complex structured products being sold by banks and this
ultimately contributed to a mispricing of risk in credit markets.

Warren Buffet, when talking about similarly complex financial instruments
said the following, "Derivatives are financial weapons of mass destruction,
carrying dangers that, while now latent, are potentially lethal, posing risks
for the entire economic system." We live in a world where we have been led to
believe that markets are always right, that financial analysts know better and
that risk is transferred to those who can manage it best. The truth is often
far from this.

Implications for the rest of the world and South Africa

What is the implication of all of this for the world economy and South
Africa? The past four years has seen a period of unprecedented growth in the
global economy supported by low real interest rates and optimism in financial
markets. Between 2003 and 2006 world GDP growth expanded at an average pace of
5,0 percent after only 3,5 percent in the previous four years. The outstanding
feature of this performance is that growth has been broad based across
developed and emerging economies.

Macro-economic stability has been enhanced by the move towards floating
exchange rates and inflation targeting in many countries and has contributed,
alongside high commodity prices, to the flow of capital into emerging markets
and developing economies. Although global imbalances have persisted, the
current dislocation in financial markets could hold the key to future
rebalancing via slower growth in US consumption, a weaker dollar and reduced
capital flows to emerging markets. The global economy has displayed increased
flexibility to shocks of the size witnessed in recent weeks.

Improved macro-economic policies in a broad spectrum of emerging market
economies have played a key role in minimising damage so far. Although the
spill over effects to the global economy from tightening financial conditions
is still being assessed, countries with solid macro-economic fundamentals are
better placed to weather the market storm than others. In particularly, those
with high foreign exchange reserves and current account surpluses, as well as
those with flexible exchange rate regimes, inflation targeting and responsible
fiscal management are likely to perform better.

South Africa has done well so far and should continue to do so unless there
is a significant slowdown in global growth that leads to a rapid fall in
commodity prices. Such developments would be of concern given that we are
currently running a current account deficit in the order of 6,2 percent of GDP.
However, the macro underpinnings of the South African economy remain sound with
growth remaining broad-based and investment rising. South Africa also has
embedded in its immune system, lessons from previous crises, notably fallout
from the 1998 Asian crisis and the collapse of the rand in 2001.

Local banks have also indicated that they have little or no exposure to the
cause of the trouble, sub-prime lending or to hedge funds with sub-prime
assets. Furthermore, the banking system is well regulated with constant
supervision and adequately capitalised. Fiscal and monetary policies are also
flexible enough to address negative economic shocks should they occur. Prudent
budgetary decisions have created fiscal space and resources for countering
negative shocks. On the monetary side, the inflation targeting framework
provides the scope for the Reserve Bank to assess the sources of inflationary
pressures and the floating exchange rate creates a cushion for the real economy
when rand assets are sold by non-residents. In addition, the accumulation of
foreign exchange reserves significantly reduces our external vulnerability.

Conclusion

In conclusion, ladies and gentlemen, the correction in asset prices that we
are seeing presents both threats and opportunities to investors around the
globe and raises important questions for policy makers regarding the adequacy
of oversight and regulation in the banking sector and global hedge fund
industry. The combination of financial innovation and excess global liquidity
over the past few years has resulted in an ever more complex array of
structured credit products being made available to consumers and investors, but
there appears to have been inadequate disclosure by banks and ratings agencies
regarding the underlying risk to these investments.

For South Africa, we remain confident that our monetary and fiscal
frameworks provide sufficient and needed flexibility to maintain a healthy pace
of economic growth despite the financial turmoil. Should world growth slow,
South Africa will of course not be immune, but as global current account
imbalances unwind, the sources of world growth will continue to slowly
change.

Our policy approach continues to focus on building up our cushion both so
that we can benefit from globalisation and more importantly, so that we can
protect our people and our markets from turmoil in the global financial
markets. South Africa is well placed to weather this storm.

I thank you

Issued by: National Treasury
12 September 2007