releases of the 2007 Article IV Report
6 August 2007
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; Gross
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 percent in 2006. The National Treasury has a more
optimistic growth projection of about five percent 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 five percent 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 one 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 � 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
