South African Reserve Bank Annual Economic Report and Monetary Policy Review Parliamentary Portfolio Committee November 2007

Annual Economic Report 2007 Outline  The Annual Economic Report of the South African Reserve Bank presents the broad economic context within which South African monetary policy is conducted  Covers some longer-term trends and emphasises past 18 months  Focus in this presentation is a limited selection of developments which are exceptional or noteworthy – the full document must be consulted for the full story  Some of the graphs in the presentation have been updated beyond what was published  Quite a number of records have been set…

Annual Economic Report 2007 World growth in real GDP and range of growth rates for individual countries: Stronger and with less variability than before

Annual Economic Report 2007 World consumer price inflation and range of inflation rates for individual countries: More subdued and consistent than before

Annual Economic Report 2007 South African real GDP growth: Also stronger and more consistent

Annual Economic Report 2007 Real production and capacity utilisation in manufacturing: High levels reached

Annual Economic Report 2007 Manufacturing of textiles and clothing: Import penetration ratio record highs in second half of 2006

Annual Economic Report 2007 Real gross national income: Per capita gains

Annual Economic Report 2007 Real GDP and expenditure: Expenditure stronger than production

Annual Economic Report 2007 Real final consumption expenditure and disposable income of households: Tentative signs of consumption slowdown

Annual Economic Report 2007 Household debt and debt service ratios: Record high debt ratio, but slowing

Annual Economic Report 2007 Real gross fixed capital formation: Strong upward trend, investment now exceeding 20% of GDP

Annual Economic Report 2007 Wage settlement rates and headline CPI inflation: Acceleration

Annual Economic Report 2007 SA e SA exchange rate and inflation: Exchange rate depreciation and oil and food price misfortunes have bolstered domestic inflation Stronger rand=up

Annual Economic Report 2007 Consumer price inflation: CPIX above target…

Annual Economic Report 2007 Brent crude oil price: In high territory

Annual Economic Report 2007 Grain spot prices: Bad for food price inflation

Annual Economic Report 2007 Food price inflation: Highest since 2002

Annual Economic Report 2007 Current-account balances: Familiar pattern sustained

Annual Economic Report 2007 SA current-account balance as percentage of GDP: 6%-plus deficits

Annual Economic Report 2007 Exports of vehicles and transport equipment: Good performance

Annual Economic Report 2007 South Africa's export commodity prices and volume of mining exports: Slow volume reaction to favourable prices

Annual Economic Report 2007 Gold production: Receding

Annual Economic Report 2007 Real merchandise imports: Strong

Annual Economic Report 2007 Foreign debt and interest paid: Foreign participation comes at a cost

Annual Economic Report 2007 Commodity price indices and terms of trade: Export prices are rising more strongly than import prices

Annual Economic Report 2007 BOP net financial transactions as percentage of GDP: Strong, consistent inflows

Annual Economic Report 2007 Gross reserves and international liquidity position of the SARB: Substantial progress in becoming less vulnerable

Annual Economic Report 2007 Asset prices and M3: Positive wealth effects boost M3 growth

Annual Economic Report 2007 Growth in broad money supply in selected emerging- market countries: SA’s is fairly high

Annual Economic Report 2007 Total loans and advances extended to private sector Exceptionally strong growth despite record level of securitisation

Annual Economic Report 2007 Benchmark overnight rates and repurchase rate: Sabor introduced

Annual Economic Report 2007 Long-term bond yield: Partly an exchange rate story

Annual Economic Report 2007 Break-even inflation rate: Longer-term inflation expectations remain favourable

Annual Economic Report 2007 Share prices: Volatile in August 2007, nevertheless still an exceptional performance each year since mid-2003

Annual Economic Report 2007 House prices, mortgage borrowing and real interest rates: Understandable that house market remains buoyant

Annual Economic Report 2007 Conclusion  The international environment is fairly favourable…  …but not without risks and turbulence  SA inflation has been above the target range for 6 months in succession  Policy has been tightened, but takes time to work through  Household consumption growth has started to slow…  …but price and wage inflation continue to edge higher  Nevertheless, the SA growth performance has been exceptionally strong and consistent..  …and strong capital formation bodes well for the future

Annual Economic Report 2007

Monetary Policy Review November 2007

Introduction … n Inflation breached the upper end of the inflation target range for the first time since August 2003 when a year- on-year increase of 6,3 per cent was recorded in April 2007 n The pressures which were primarily responsible for the breach in the inflation target range were largely exogenous, emanating from oil and food price shocks n However, the breach of the inflation target is of significant concern to the South African Reserve Bank n The most important challenge for the MPC is to ensure that inflation is brought back to within the target range and that inflation expectations remain anchored within the range

Preview … n In the period since the previous Monetary Policy Review was published in May 2007, some of the key inflation risks have proved persistent, and there has been significant volatility and uncertainty in the international environment n However, there are some signs that the economy is responding to the changes which have been made to the monetary policy stance. n As inflation reacts with a lag to these changes, the task of the MPC is to assess whether the observed inflation response at a particular point in time is consistent with the desired return to within the target range in future.

This Monetary Policy Review … n Also presents 3 boxes: 1. sets out the key points contained in a recent discussion document published by Statistics South Africa on proposed changes to the consumer price index 2. considers the implications for monetary policy of the turmoil in financial markets that has arisen from spill- over effects of the subprime lending crisis in the US 3. provides an international perspective on the impact of biofuels production on food prices

Recent developments in inflation

Consumer price inflation: CPIX and CPI

CPIX and food inflation

Contributions to CPIX inflation Percentage change over twelve months* and percentage points 2007 Mar Apr May Jun Jul Aug Sep Total*5,5 6,3 6,4 6,4 6,5 6,3 6,7 Of which: Food2,1 2,3 2,4 2,5 2,7 3,0 3,2 Housing0,6 0,7 0,7 0,7 0,9 0,8 0,8 Medical care and health expenses 0,5 0,5 0,50,5 0,5 0,50,5 Household operation 0,4 0,5 0,5 0,4 0,4 0,4 0,4 Transport 0,7 1,1 1,1 1,0 0,6 0,2 0,4 Education 0,40,40,40,4 0,4 0,4 0,4 Clothing and footwear -0,2 -0,2 -0,2 -0,2 -0,2 -0,2 -0,2 Fuel and power 0,3 0,3 0,3 0,3 0,4 0,4 0,3 Other0,7 0,7 0,7 0,8 0,8 0,8 0,9 Source: Statistics South Africa

The effect of food and energy prices on CPIX inflation

CPIX and administered prices

Production price inflation

Factors affecting inflation

Annual percentage change in real gross domestic product and consumer prices Real GDP Inflation* (estimate) (estimate) (estimate) (estimate) World 5,4 5,2 3,6 3,9 Advanced economies 2,9 2,5 2,3 2,1 United States 2,9 1,9 3,2 2,7 Japan 2,2 2,0 0,3 0,0 Euro area 2,8 2,5 2,2 2,0 United Kingdom 2,8 3,1 2,3 2,4 Other advanced economies 4,4 4,3 2,0 1,9 Other emerging-market and developing countries 8,1 8,1 5,1 5,9 Africa5,6 5,7 6,3 6,6 Central and eastern Europe 6,3 5,8 5,0 5,1 Commonwealth of Independent States 7,7 7,8 9,4 8,9 Developing Asia9,8 9,8 4,0 5,3 China 11,1 11,5 1,5 4,5 China 11,1 11,5 1,5 4,5 India 9,7 8,96,1 6,2 India 9,7 8,96,1 6,2 Middle East 5,6 5,9 7,5 10,8 Western hemisphere 5,5 5,0 5,4 5,3 * Inflation data exclude Zimbabwe Source: IMF World Economic Outlook, October 2007

Price of Brent crude oil

Selected central bank interest rates Per cent Countries 1 Jan Nov 2007 Latest change (percentage points) (percentage points) United States 5,25 4,50 31 Oct 2007 (-0,25) Japan 0,25 0,50 21 Feb 2007 (+0,25) Euro area 3,50 4,00 13 Jun 2007(+0,25) United Kingdom 5,00 5,75 5 Jul 2007 (+0,25) Canada 4,25 4,50 10 Jul 2007 (+0,25) Denmark 3,50 4,00 7 Jun 2007 (+0,25) Sweden 3,00 4,00 30 Oct 2007 (+0,25) Switzerland1,50 – 2,50 2,25 – 3,25 13 Sep 2007 (+0,25) Australia6,25 6,50 8 Aug 2007 (+0,25) New Zealand 7,25 8,25 26 Jul 2007 (+0,25) Israel 4,50 4,00 30 Aug 2007 (+0,25) China 6,12 7,29 15 Sep 2007 (+0,27) Hong Kong6,75 6,00 1 Nov 2007 (-0,25)

Selected central bank interest rates Countries 1 Jan Nov 2007 Latest change (percentage points) (percentage points) Indonesia 9,75 8,25 5 Jul 2007 (-0,25) Malaysia 3,50 3,50 26 Apr 2006 (+0,25) South Korea 4,50 5,00 9 Aug 2007 (+0,25) Taiwan2,75 3,25 21 Sep 2007 (+0,125) Thailand 5,00 3,25 18 Jul 2007 (-0,25) India 7,25 7,75 30 Mar 2007 (+0,25) Brazil 13,25 11,25 6 Sep 2007 (-0,25) Chile 5,25 5,75 13 Sep 2007(+0,25) Mexico 7,00 7,50 26 Oct 2007 (+0,25) Czech Republic 2,50 3,25 31 Aug 2007 (+0,25) Hungary 8,00 7,50 24 Sep 2007 (-0,25) Poland 4,00 4,75 29 Aug 2007 (+0,25) Russia 11,00 10,00 19 Jun 2007 (-0,50) Turkey 17,50 16,75 16 Oct 2007 (-0,50) Source: National central banks

Exchange rates of the rand

Remuneration per worker, labour productivity and unit labour cost in the formal non-agricultural sector

Average annual inflation and wage settlements

Growth in real gross domestic product and expenditure components Per cent* nd qr 3rd qr 4th qr Year 1st qr 2nd qr Final consumption expenditure: Households 8,1 7,6 7,8 7,3 7,4 5,5 General government 15,7 -4,4 4,75,4 13,9 -3,1 Gross fixed capital formation 12,8 14,0 16,4 12,7 21,8 14,2 Change in inventories (R billions)** 16,3 9,0 21,8 15,8 11,8 10,5 Gross domestic expenditure 9,0 1,4 12,3 8,7 5,8 1,1 Exports of goods and services 24,9 19,4 38,7 5,5 -11,2 4,0 Imports of goods and services 34,4 5,5 58,3 18,4 -5,0 -5,8 Gross domestic product 5,5 4,5 5,65,0 4,7 4,5 * Quarterly data refer to quarter-on-quarter growth at annual rates of seasonally adjusted data ** Constant 2000 prices

House prices

Share price indices

Public finance data R billions* and per cent 2006/ / / / / /11 Actual Budget Revised Medium-term estimates estimates Nat. government*: Revenue481,2 544,6 553,1 616,0 679,6 740,5 Expenditure 470,2 533,9 542,4 599,9 665,6 726,2 Budget balance 11,0 10,7 10,8 16,2 14,0 14,3 As % of GDP: Budget balance 0,6 0,6 0,5 0,7 0,6 0,5 Total net loan debt 26,7 24,3 23,0 20,3 17,9 15,8 Debt service cost 2,9 2,7 2,6 2,3 2,1 1,9 PSBR** -0,2 0,3 0,3 0,8 1,1 1,2 ** PSBR: Public-sector borrowing requirement Source: National Treasury Medium Term Budget Policy Statement 2007

Growth in the monetary aggregates

Growth in loans and advances

Monetary policy

Monetary Policy … n Since the previous Monetary Policy Review there have been further changes in the stance of monetary policy

The repo and other short-term interest rates

Monetary Policy … n At the past three meetings of the MPC, the focus remained on ensuring a return of the inflation rate to within the target range n However, it was stressed that the actions of the MPC were not predicated on the actual breach but on the expected path of inflation

Monetary Policy … n By the June 2007 meeting there had been some deterioration in the inflation outlook compared to the previous two meetings n The risks to the outlook were seen to be strongly on the upside n Oil and food prices, household consumption expenditure growth and changes in inflation expectations were all factors in this regard n The forecasts of the Bank also showed a further deterioration compared to the April forecast n It was decided to increase the repo rate by 50 basis points to 9,5 per cent per annum

Monetary Policy … n At the August 2007 meeting, the international environment had become increasingly volatile and uncertain n The MPC felt it was still too early to assess the longer- term implications of these developments, and that it was appropriate to remain focused on the inflation target and react to financial market developments insofar as they impacted on the inflation outlook n The upside risks to the inflation outlook identified in June remained in place, and the central forecast of the Bank indicated a slight deterioration n the repo rate was increased by 50 basis points to 10,0 per cent per annum

Monetary Policy … n At the October 2007 MPC meeting there were signs that the economy was responding to the higher interest rate environment n The challenge for the committee was to assess whether these developments would be sustained and sufficient to bring inflation comfortably within the inflation target range n The view of the MPC was that despite this moderation, the risks to the outlook were still on the upside n On balance, it was decided that a further upward adjustment of the repo rate was required and it was accordingly increased by 50 basis points to 10,5 per cent per annum

The outlook for Inflation

IMF projections of world growth and inflation for 2007 and 2008* Real GDP (growth) Inflation rates** World (4,9) 5,2 (4,9) 4,8 (3,5) 3,9 (3,5) 3,6 Advanced economies (2,5) 2,5 (2,7) 2,2 (1,8) 2,1 (2,1) 2,0 United States (2,2) 1,9 (2,8) 1,9 (1,9) 2,7 (2,5) 2,3 Japan (2,3) 2,0 (1,9) 1,7 (0,3) 0,0 (0,8) 0,5 Euro area (2,3) 2,5 (2,3) 2,1 (2,0) 2,0 (2,0) 2,0 United Kingdom (2,9) 3,1 (2,7) 2,3 (2,3) 2,4 (2,0) 2,0 Other advanced economies (3,8) 4,3 (3,8) 3,8 (2,0) 1,9 (2,2) 2,3 Other emerging-market and developing countries (7,5) 8,1 (7,1) 7,4 (5,4) 5,9 (4,9) 5,3 Africa (6,2) 5,7 (5,8) 6,5(10,7) 6,6 (10,4) 6,0 Central and eastern Europe (5,5) 5,8 (5,3) 5,2 (4,8) 5,1 (3,7) 4,1 Commonwealth of Ind. States (7,0) 7,8 (6,4) 7,0 (9,0) 8,9 (8,3) 8,3 Developing Asia (8,8) 9,8 (8,4) 8,8 (3,9) 5,3 (3,4) 4,4 China (10,0) 11,5 (9,5) 10,0 (2,2) 4,5 (2,3) 3,9 China (10,0) 11,5 (9,5) 10,0 (2,2) 4,5 (2,3) 3,9 India (8,4) 8,9 (7,8) 8,4 (6,2) 6,2 (4,3) 4,4 India (8,4) 8,9 (7,8) 8,4 (6,2) 6,2 (4,3) 4,4 Middle East (5,5) 5,9 (5,5) 5,9 (10,6) 10,8 (8,7) 9,2 Western hemisphere (4,9) 5,0 (4,2) 4,3 (5,2) 5,3 (5,7) 5,8 * IMF projections for 2007 and 2008 as at April 2007 in parentheses ** Inflation data exclude Zimbabwe Source: IMF World Economic Outlook, October 2007 Per cent

Domestic outlook n Domestic growth is set to remain robust. According to the September Reuters consensus forecasts the South African economy is expected to grow by 4,8 per cent in 2007; 4,7 per cent in 2008 and 5,1 per cent in 2009 n However, although consumer and business confidence remain at relatively high levels, both have moderated in Measures of trade, manufacturing and fixed investment activity have also decelerated recently (although the PMI did rebound in October)

BER surveys of CPIX inflation expectations

BER survey of CPIX inflation expectations: Third quarter 2007* Per cent Financial analysts (5,5) 6,1 (5,0) 5,7 (4,7) 5,0 2. Business (5,3) 5,7 (5,4) 5,8 (5,4) 5,8 3. Trade unions (5,5) 5,7 (5,5) 5,9 (5,4) 5,9 Average 1 – 3 (5,4) 5,9 (5,3) 5,8 (5,2) 5,6 * Second-quarter 2007 results in parentheses Source: Bureau for Economic Research, University of Stellenbosch

Reuters survey of CPIX forecasts: September 2007* Per cent Mean (6,1) 6,2 (5,7) 5,8 (5,1) 5,1 2. Median (6,1) 6,2 (5,7) 5,8 (5,3) 5,2 3. Highest (6,4) 6,3 (6,1) 6,4 (5,5) 5,7 4. Lowest (5,9) 6,0 (5,5) 5,3 (4,6) 4,6 Number of forecasters (15) 16 (15) 16 (11) 13 * August 2007 survey results in parentheses Source: Reuters

Break-even inflation rates

CPIX forecast

Assessment and conclusion

n The past six months have been challenging from a monetary policy perspective. n The inflation outlook deteriorated somewhat despite the tighter monetary policy stance adopted in 2006 n However, there have been some signs of moderation in consumption expenditure. The outlook for monetary policy will depend to a significant degree on whether these signs of moderation are sustained and sufficient to bring about the desired inflation outcome

Assessment and conclusion n Monetary policy in South Africa will remain focused on bringing inflation back to within the inflation target range.

Thank You!