T Mboweni: Microsoft Senior Information Technology Officer
Summit

18 May 2006

1. Introduction

Ladies and gentlemen, thank you for the invitation as keynote speaker at
this event in one of the most beautiful parts of our country. Please allow me
also to congratulate you on the selection of your theme for this year,
“Pathways to Growth,” which I think is most appropriate in the light of the
current state of the domestic and global economy.

Indeed, it is a pleasure to deliver a speech focussing on recent economic
and financial market developments in the current environment. In your sector no
one needs to remind you of the painful experience when the NASDAQ Composite
Index lost almost 70 percent of its value between 2000 and 2002. Giving a
speech of this nature at that time would have been considerably more difficult.
Fortunately, those times are now well past and the picture today is a much
rosier one.

2. Developments in the world economy and financial markets

The Ministers of Finance and central bank governors of the group of seven
industrialised countries issued a statement, after their most recent meeting on
21 April 2006, in which they confirmed that the strong global economic
expansion continues into its fourth year and that the outlook remains
favourable. Being then on a “pathway to growth,” we should not miss this
opportunity to take a step back and assess some of the recent developments in
international and domestic financial markets.

World output has grown by 5.3 percent in 2004 and by 4.8 percent in 2005 and
is forecast to remain close to the 5.0 percent level over the next two years,
according to the International Monetary Fund’s latest world economic outlook.
Growth in emerging markets has been particularly strong, staying well above 7.0
percent in 2004 and 2005, and forecast to remain in that region over the next
two years. Sub-Saharan Africa which has historically suffered from low or even
negative growth rates, managed to grow by close to 6.0 percent. Generally,
these growth numbers have exceeded expectations.

One of the clerks working in the SA Reserve Bank has over the past few years
qualified herself through part time study as an Advocate of the High Court of
South Africa under very difficult circumstances, whilst at the same time
raising two small children. She quoted Einstein as saying that: “In the middle
of difficulty lies opportunity.” To a large extent this wisdom can be applied
to the world economy and financial markets. There are numerous examples of how
it sometimes takes a disaster or a crisis for a structural improvement to
occur. It was only after the Asian crises of the late 1990s that Asian emerging
markets started to build foreign exchange reserves and strengthen their
macroeconomic fundamentals. Today emerging markets are the net savers of the
world and reap the good results of their macroeconomic discipline in the form
of low risk premiums and borrowing rates, ratings upgrades, increased foreign
investment and accelerated growth rates.

On a micro level, companies have behaved in much the same way. After having
been plagued by accounting scandals, downgrades to “junk” status, section 11
classifications and some verging on the edge of bankruptcy they have pulled
themselves together. Corporations have deleveraged their balance sheets and
became net savers, accounting standards have improved and corporate governance
has become a major focus area. In an environment of strong economic growth this
should definitely put them on a ‘pathway to higher growth’. Consistent with the
strength of corporate profits, improved balance sheets and diminishing excess
capacity, investment is expected to be strong, contributing to renewed
growth.

A positive development in the global economy that tentatively seems to be
emerging is that growth is becoming more balanced and broad based. In 2004, the
United States (US) growth rate was double that of Europe and Japan. Although
the US remains the main engine of growth among the industrialised countries,
the gap in growth rates is expected to narrow, with US growth moderating from
4.2 percent in 2004 to 3.4 percent in 2006, European growth remaining around
2.0 percent and Japanese growth accelerating from 2.3 percent in 2004 to 2.8
percent in 2006. Developing Asia is also likely to remain an engine of growth
with output expected to increase by 8.2 percent in 2006 and that of China alone
by 9.5 percent.

Another remarkable thing about the current cycle of strong global growth is
that it has been taking place whilst oil prices have been hovering between
USD60 and USD75 per barrel for some time now levels that would have been almost
unthinkable a few years ago and which would have caused market analysts to
significantly revise down their growth forecasts. Perhaps more surprising is
that high oil prices do not seem to have filtered through to other prices to
the extent that might have been anticipated. The so-called “core inflation”
which excludes energy and other volatile prices, remains subdued in most
countries.

A third factor that distinguishes growth in the current and next few years
from previous years is that while the period of expansion started in an
environment of highly accommodative monetary conditions worldwide, it (growth)
is now forecast to continue in an environment of higher interest rates. The US
fed has increased the fed funds target rate to its current level of 5.0
percent, from 1.0 percent at the start of the tightening cycle and the general
expectation is that it might be close to its peak. The Electrical Contractor
Board (ECB) started to increase rates in December 2005 with further increases
expected and market expectations are that the bank of Japan would follow suit
later in the year, having ended their policy of quantitative easing (pumping
liquidity into the banking system) in March 2006. Nevertheless, global
financial market conditions remain favourable, characterised by unusually low
risk premiums and volatility. Despite monetary policy tightening, long term
rates remain below average. The relatively flat US yield curve is a “conundrum”
which even Mr Greenspan could not solve before going into retirement!

Given this favourable environment, equity prices have risen significantly.
Since the beginning of 2003 until the end of April 2006, the Dow Jones has
risen by 35 percent, the NASDAQ by 77 percent, the German Dax by no less that
117 percent and the Japanese Nikkei 225 by 104 percent. In this bull run,
equity markets experienced an unprecedented flurry of activity with regard to
mergers and acquisitions, which further boosted investor sentiment. (Some
re-tracement in equity prices occurred in the first part of May 2006; let us
hope that it is temporary and that share prices will continue to be supported
by positive economic fundamentals).

Low bond yields in industrial countries caused funds to flow into
alternative investment opportunities and into emerging markets. Despite a
recent warning by the Bank for International Settlements (BIS) in its quarterly
bulletin that emerging market assets might be becoming overvalued, investors
continued to favour these assets. In South Africa, non-residents increased
their holdings of domestic bonds and equities by a net amount of R48.4 billion
in 2005 and by a further R49 billion in the year to the end of April 2006. Some
sell off in emerging market assets occurred during May 2006, due partly to
three factors: seasonal position squaring ahead of the holidays in the northern
hemisphere; developments in specific emerging markets and higher returns now
being possible in developed markets. It is too soon to judge the possible
extent and effects of this sell off hopefully it would not disrupt financial
markets in affected countries.

However, having painted such a rosy picture one cannot help but also
highlight the risks and uncertainties that currently face the world economy and
financial markets. At the forefront of everyone’s minds is most definitely the
behaviour of the oil market. It remains to be seen for how long the general
level of inflation can withstand the current high oil prices and recent
comments by prominent central bankers the world over seem to point to increased
concern about the impact of oil on inflation, going forward. South Africa is no
exception and in the most recent statement of the Monetary Policy Committee
(MPC) of the SA Reserve Bank, rising international oil prices were once again
highlighted as a key risk for inflation. The effects of the very high oil
prices are likely to increase if inflationary expectations start to react.

Secondly, the world remains plagued by geopolitical uncertainties in the
Middle East and other parts of the world. Partly as a result of these tensions
combined with inflationary concerns starting to increase the gold price has
recently surpassed a series of 25 year highs, trading above USD730 per fine
ounce early in May 2006 before retracing to just below USD700. There are some
in the market whose forecast is that the gold price might test the USD1000 per
ounce level in the near term.

A third risk to the global economy is substantial further increases in
interest rates. Despite various degrees of monetary policy tightening in
industrial countries during the past two years, monetary conditions can still
be described as relatively accommodative. Any exogenous or endogenous factors
that could lead to a sharper increase in rates could well threaten the strength
of the global economy. In such circumstances, volatility and risk premiums are
likely to pick up.

A fourth concern that again surfaced recently was the issue of rising global
imbalances and in particular the widening current account deficit in the US,
combined with significant surpluses in most of the Asian countries in
particular China. The fact that the US has to date found it relatively easy to
finance the current account deficit through capital inflows has to some extent
obscured the risks associated with this imbalance. However, the US current
account deficit which according to the latest numbers amounted to 6.5 percent
of US gross domestic products (GDP) cannot keep growing indefinitely. One can
only hope that the inevitable adjustments in global imbalances will occur in a
controlled and synchronised manner and that it will not lead to increased
protectionism. Such an adjustment would require the participation of all
regions and countries. The IMF was mandated at the recent April meetings to
focus on the issue of resolving these global imbalances (the so-called
multilateral survey during the article IV country consultations).

As a necessary step to start addressing global imbalances, the most keenly
awaited event in the currency markets finally came to pass in July 2005 the
revaluation of the Chinese renminbi (RMB) when the People's Bank of China
(PBoC) finally abandoned its decade long peg of the RMB placing it under a
managed float against an un-specified basket of currencies. Subsequently, more
steps were taken by the PboC to liberalise the foreign exchange market such as:
announcing the currencies in the basket, widening the daily band of the
renminbi against non-dollar currencies, abandoning quotas of foreign currency
for domestic companies to invest abroad and allowing more instruments to be
used in the foreign exchange market.

3. Developments in South Africa

Let me then briefly turn to developments in our own economy.

Against the background of a growing global economy, the South African
economy has continued to grow at a healthy pace since 2004 with the GDP growth
rate of 4.9 percent in 2005 exceeding the 4.5 percent registered the year
before. Continued sound fiscal and monetary policies have resulted in good
budgetary and inflation outcomes. Consumer Price Index (CPIX) inflation has
been within the target range of between three and six percent for 31 months.
The outlook for inflation continues to be generally favourable with CPIX
inflation expected to remain inside the target range until the end of the
forecast period in 2008, although risks and challenges remain. Vigilance is,
therefore, required as is always the case in these matters.

Financial markets have also performed well. Yields on domestic government
bonds declined to record lows in February 2006 and have only moderately started
to increase since then. The All-share index of the JSE reached record highs in
April 2006 and has already gained around 18 percent in the year to the end of
April before retracing somewhat in May following trends in the global markets
and lower commodity prices. It is particularly encouraging that share prices
performed so well despite the resilience of the exchange rate. This is true
even for sectors that have historically been very sensitive to exchange rate
fluctuations. Part of this buoyancy is, of course, attributable to high
commodity prices. However, in the bank we like to see this also as a sign that
in general companies have adapted to a relatively robust exchange rate.

As for developments in the South African foreign exchange markets, the
exchange rate of the rand remains resilient and liquidity remains high relative
to other emerging markets despite the retracement in recent days. We have seen
the average net daily turnover (in respect of transactions involving the rand)
increase from around USD8bn in 2004 to just below USD10bn in 2005. In addition,
the volatility of the ZAR exchange rate has also subsided. From the most recent
peak of around 30 percent and 25 percent in January 2004, the one month
historical volatility and one month implied volatility were at a level around
10 and 12 percent respectively in March 2006.

It is this positive environment that has attracted substantial investment
flows into South Africa, allowing the central bank to build up the official
gross foreign exchange reserves from USD 8.0 billion in January 2004 to
slightly more than USD 23 billion in April 2006. It is partly owing to this
increase in the reserves in recent times that the country was awarded credit
ratings upgrades by all three rating agencies in 2005, to BBB+ with a stable
outlook. This has also contributed to a decline in sovereign risk spreads.

A more stable currency is critical to an attractive investment environment.
Exchange rate volatility has in the past made the rand vulnerable to
speculation and discouraged direct investments. The recent build up in
reserves, together with some structural impediments that have now been dealt
with (e.g. the Net Open Foreign Currency Position), should over time add to the
stability we have already seen and reduce uncertainty for both domestic as well
as non-resident long term investors.

The sell off in emerging market assets and currencies during the first part
of May 2006 and the effect that it had on financial markets and exchange rates
including our own has once again reminded us of the vulnerability of emerging
market economies to a sudden and sharp change in sentiment by non-resident
investors. In the case of South Africa, the effects could be even greater
against the background of a current account deficit of around 4.5 percent of
GDP. In the past sell offs of emerging market assets had been triggered by a
wide array of events, which were infrequently related to actual developments in
the domestic economy.

Conclusion

Despite these risks, let me conclude by reiterating that the world and South
Africa seems to be well set on a “pathway to growth.” It is conferences such as
this one that are likely to sustain this growth. It is also conferences such as
this one that will contribute to overcoming obstacles, reducing uncertainty and
managing risks. Let us not be discouraged by those but use a position of
relative strength to plan for the future and be mindful of the risks that
undoubtedly exist.

Thank you for your attention.

Issued by: SA Reserve Bank
18 May 2006
Source: www.resbank.co.za