T Mboweni: Dinner for Ambassadors and High Commissioners

30 November 2006

Your Excellency, the Dean of the Diplomatic Corps
Your Excellencies, Ambassadors and High Commissioners
Your Excellency, the Chief of State Protocol
Your Excellencies, Heads of International Organisations represented in the
Republic of South Africa
Deputy Governors of the South African Reserve Bank
Senior officers of the South African National Defence Force
Senior Management of the South African Reserve Bank and their spouses or
partners
Editors and other media representatives
Ladies and gentlemen

Introduction

It is an honour to welcome you once again to the South African Reserve Bank
for what has become an annual event on our calendar. Every year I am humbled by
the turnout, and this year is no exception.

This past year has been an extremely challenging one from a monetary policy
perspective. Some of the challenges have emanated domestically, but external
economic and geopolitical events have also provided challenges to us as well as
to many other central banks around the world. This evening I will give a brief
broad-brush review of some of these developments. Further details can be found
in our publications, including our Quarterly Bulletin which will be released
next week.

I am aware that one of the issues that are close to your hearts in the
diplomatic community is the behaviour of the exchange rate of the rand as your
purchasing power in this country varies inversely with the fortunes of the
rand. I have noticed that many of you are looking a lot happier tonight than
you were this time last year!

The external environment

The recent World Economic Outlook published by the International Monetary
Fund (IMF) characterised the global economic environment as robust, with
economic activity exceeding expectations. While the global expansion has in
general been broad based, the improved growth performance of developing and
emerging economies compared to that of developed economies has been most
noteworthy.

This improvement has taken place across all regions, including sub-Saharan
Africa. As a group, developing countries now account for more than half of
total world Gross Domestic Product (GDP) in purchasing-power parity terms. This
past year has been overshadowed by a high degree of volatility in the
international oil markets, which posed a risk to the outlook for world growth
and inflation.

During the course of the year, the price of Brent crude oil reached new
highs of almost US$80 per barrel as a result of tight supply and demand
conditions as well as geopolitical developments. Since then the markets have
stabilised somewhat and prices are currently around US$60 per barrel. The
pressures on world inflation have also been reinforced by high levels of
capacity utilisation and strong global consumer demand.

Consequently, we have seen the adoption of a general monetary policy
tightening cycle in many countries. During the past year, most industrialised
and emerging market central banks have raised interest rates at some point.
These actions are expected to keep world inflation under control. The global
imbalances which have persisted over the past few years have been topical
issues in the IMF, World Bank and G20 forums.

The anomaly of the current global imbalances is that developing countries,
particularly those in Asia are now the financiers of the current account
deficits of the United Sates and other industrialised countries. A major
concern is whether or not the elimination of these imbalances will take place
in an orderly fashion. Although the dominant view is that the process will be
orderly, the risk remains that the international economy could be in for
turbulent times should a disorderly process emerge.

It is probably too early to assess whether the current volatility we are
observing in the international currency markets is the beginning of this
adjustment process, or to predict how this process will unfold. Until May this
year, emerging markets had enjoyed an extended period of investor exuberance
and search for higher yield, which, combined with a generally supportive
environment of strong global growth and high commodity prices, caused emerging
market currencies to appreciate, equity prices to increase and bond spreads to
narrow.

However, in May, uncertainty regarding future inflation, interest rates and
growth in the major economies contributed to some repricing of these assets.
Following the anxieties caused to the markets by the widening current account
deficits of Iceland and New Zealand earlier in the year, those countries which
were perceived to have greater external vulnerability as a result of either
high current account deficits or higher levels of external debt were most
affected. South Africa was among these and as a result the rand depreciated
significantly during the second and third quarters of 2006.

Fortunately this episode was relatively short-lived and the latest
indicators suggest that emerging markets have generally recovered and are
enjoying renewed appetite among global investors for higher yielding assets. On
the positive side, it seems as if emerging markets have become more resilient
to sudden changes in investor sentiment than they were at the time of the Asian
crisis in 1997/98. A major disappointment during 2006 was the inability of
trade negotiators around the globe to conclude or, at least, continue with
discussions in the Doha Round of the World Trade Organisation.

There is no doubt that the major reason for the Doha breakdown is to be
found in disagreements over agricultural sector protection. The failure of
these trade negotiations came as a major disappointment to developing countries
in all regions, but the ultimate cost could be borne by both developed and
developing nations. Apart from the foregone opportunities for both developed
and developing countries that a successful conclusion would have provided, of
greater importance are the losses that all will be incurred if the world
trading system is allowed to deteriorate with a reversion to protectionism.

Domestic economic developments

On the domestic front, 2006 has proved to be an eventful and challenging
year, which has been influenced to a significant degree by the international
developments that I have made mention to above. From a monetary policy
perspective, we have continued to achieve our mandate, which is to keep
Consumer Price Index (CPIX) inflation within the target range of 3 to 6
percent. Inflation has been within this range since September 2003, which
enabled us to reduce nominal interest rates by a total of 650 basis points
between June 2003 and April 2005. In recent months the trend of inflation has
been rising, and in October CPIX inflation measured 5 percent compared to 3,7
percent in April of this year.

Furthermore our forecasts suggest that inflation could reach the 6 percent
level by the second quarter of next year. In response to the deteriorating
inflation outlook, the monetary policy stance was adjusted in June of this year
when we increased the repo rate by 50 basis points. The repo rate was increased
further by 50 basis at each of the subsequent meetings in August and
October.

For much of the year, international oil price developments posed a major
risk to inflation. The price of 95 octane petrol increased from R5,49 per litre
in January 2006 to peak at R7,04 per litre in August. Fortunately pressures on
inflation from this source dissipated somewhat with the decline in the
international oil prices and since August domestic petrol prices have declined
by a total of R1,07 per litre. Despite this recent moderation, we still see the
international oil price being vulnerable to global geo-political tensions and
therefore it continues to pose an upside risk to our inflation outlook.

Of concern to us during the year was the persistent rise in domestic
consumer demand which in recent times has been increasing at a year-on-year
rate of around 8 percent. This consumer exuberance has been financed by high
rates of domestic credit extension and has led to record levels of consumer
indebtedness of around 70 percent of household disposable income. Contributing
to these high levels of demand has been rising real incomes, increased
employment, lower interest rates and higher asset prices.

Both the housing market and equity markets have remained buoyant. The equity
market in recent weeks has reached new record highs, having recovered from the
reversal it suffered during the international market volatility in May and June
when the all-share index declined by as much as 16 percent. The rand exchange
rate was also not spared the fall-out of the emerging market jitters in May and
these developments have had an impact on the inflation outlook. Having traded
in a relatively narrow trading range for much of the first half of this year,
the exchange rate reacted to the global risk aversion, and between 11 May and
the middle of June it depreciated from R6,10 to the US dollar to around
R6,80.

Subsequently, concerns relating to the widening current account deficit on
the balance of payments in excess of 6 percent of GDP caused the exchange rate
to depreciate further. At one stage the exchange rate had depreciated to around
R7,90 to the US dollar in early October, but more recently it has been trading
at levels of around R7,20.

In part the depreciation of the rand during 2006 should be seen as an
element of the adjustment to the then widening current account deficit. Already
the trade account has improved in the third quarter of this year, and a stable
rand at current levels will help stabilise the inflation outlook. In addition,
the exchange rate adjustments are expected to be positive for export growth and
in conjunction with the adjustment of interest rates should help to ensure that
domestic growth is driven by exports and infrastructural investment, rather
than by strong consumer spending as has been the case in the past two
years.

International investor interest in South Africa has nevertheless remained
strong. Despite the repricing of emerging-market assets in the middle of 2006,
there has not been one month during the year to date in which non-residents had
not been net purchasers of South African bonds and equities. In the year to
date, the net amount of bonds and equities purchased by non-residents totals a
record of more than R100 billion, compared to R41 billion in the whole of last
year.

Consequently, the current account deficit continued to be adequately
financed. Although we are hesitant to become too confident too soon, it also
appears as if portfolio investments may be becoming a more stable source of
financing, as emerging market assets become a more integrated part of global
investment mandates, in particular those like South Africa which have
investment grade ratings. In 2004 and 2005 the South African economy grew at
robust rates of 4,8 and 5,1 percent respectively. This is in sharp contrast to
the 3 percent average annual growth experienced between 1994 and 2003. In the
first two quarters of this year, the economy grew at revised annualised rates
in excess of 5 percent. Although the third quarter growth slowed to 4,7 per
cent, this is still a very encouraging picture.

According to the National Treasury projections, a growth rate of 4,4 percent
is forecast for next year, rising to 5,3 percent by 2009. Growth is likely to
be underpinned by higher infrastructure expenditure. The impact of this can
already be seen in the strongly rising investment ratio. These higher growth
rates have also had a positive impact on employment growth. According to the
latest Labour Force Survey, approximately 1,2 million jobs were created over
the three-year period to March 2006. This is good news indeed.

This positive growth outlook suggests that with an appropriate policy
environment, the aims of the Accelerated and Shared Growth Initiative for South
Africa (AsgiSA) can be achieved; that is, to maintain GDP growth at around 4,5
percent until 2009, and 6 percent thereafter. Fiscal policy has remained
prudent to the extent that for the first time ever, provision has been made for
a budget surplus in the coming fiscal year. Monetary policy will continue to
play its role by providing a low inflation environment.

G-20 Developments

I would like to turn briefly to our role in the G-20 which South Africa will
chair in 2007. The G-20 was established in 1999 as a forum where central bank
Governors and Ministers of Finance of developed and systemically important
emerging and developing economies deliberate on issues relating to global
economic and financial stability in support of global growth and development.
The Bank and the National Treasury are currently making the necessary
reparations for hosting and arranging meetings and seminars of the G-20 next
year and three themes for the 2007 work programme have been identified.

The first theme relates to the reform of the Bretton Woods Institutions. As
I have said in the past, these institutions need to be thoroughly examined and
overhauled since their modus operandi no longer serves their diverse membership
in today's dynamic global environment. The second theme of fiscal elements of
growth and development, or fiscal space, is envisaged to obtain the
perspectives of G-20 member countries on how to create and use this fiscal
space in support of economic and social objectives. Finally, the third theme
will analyse the effects of commodity price changes on G-20 members from a
financial stability perspective.

Conclusion

As I noted earlier, 2006 has been a challenging year. Going forward, I would
venture to guess that 2007 will be no easier. The South African economy should
continue on its positive growth path and the Bank will maintain its focus on
keeping inflation under control. We remain committed to our role of providing a
stable macro-economic environment, which would mitigate the effects of negative
international developments if they were to occur.

Should you wish to have a further discussion on South African economic
issues tonight, I urge you to engage our senior staff members that have been
allocated to all the tables. Finally, please enjoy the rest of the evening and
may you have in the period ahead, a wonderful festive season and a prosperous
New Year.

Thank you.

Issued by: South African Reserve Bank
Source: South African Reserve Bank (http://www.reservebank.co.za)
30 November 2006