South Africa’s potential growth has slowed over the last few years.
Considerable efforts will be needed to meet the Government’s goal of raising per capita income and to create 11 million new jobs by 2030. Moreover, inequality continues to be unacceptably high, suggesting that making growth more inclusive remains an important policy challenge.
Our government has diagnosed the key constraints to raising potential growth and recognise the need for deep-rooted structural reforms.
The key strategic output of the required reforms must seek to raise the share of private investment, including ‘green growth’ technologies as well as continuing to improve the level of education and skills in order to raise productivity levels closer to those of other emerging market countries.
Towards this end, the required policy reforms must envisage improvements in governance and inclusiveness, promoting catalytic investment projects – focusing on high value-added manufacturing and services sectors – as well as broader economic reforms to raise incomes of the poorest households and reform public finances to ensure their sustainability and remove distortions.
The New Growth Path (NGP) and the National Development Plan (NDP) support the government’s long-term goal of building a harmonious and prosperous society through livelihood improvement, and regionally balanced and environmentally sustainable growth.
The reforms mapped out in these two government ministries will be carried out to stem rising income inequality, address structural imbalances, and further open up the economy.
Public expenditure will be geared towards livelihood improvement, and strong support will be provided to education, healthcare, social security and public housing. Infrastructure remains a high priority with an emphasis on promoting rural development and emerging strategic industries, in particular modern clean energy and environment-friendly technologies, while piloting development of green and low-carbon cities. Resource conservation to combat climate change and improve natural resource management also remains a priority for government.
In terms of our country’s recent economic developments and outlook, economic activity is easing. Following the rebound in 2010, private consumption growth has remained strong through the third quarter of 2012 giving robust employment and wage growth. Manufacturing export growth has weakened, although commodity exports have nevertheless continued to grow at a healthy pace.
The output gap has widened slightly but inflation remained contained. This reflects the timely monetary policy tightening that began in 2010 and the easing of temporary supply side factors which had increased headline inflation up in the middle of 2011. Core inflation rose modestly, reaching 4.6% in May 2012, reflecting the recovery in domestic demand.
South Africa’s monetary policy stance has correctly balanced the risks to growth and inflation. Headline inflation is projected to ease towards the end of 2012 and the start of 2013 as domestic demand moderates.
As a result, policy rates should be maintained around current levels, but should be eased if growth prospects worsen significantly. Government should continue to allow two way flexibility of the exchange rate to allow the currency to move in line with fundamentals, while limiting intervention to smooth out excess volatility.
Notwithstanding the weakening environment, our country’s external position remains strong.
The real effective exchange rate remained broadly stable in the year through July 2012 before the recent episode of market volatility, and the current account surplus is expected to have remained roughly constant in 2012, heading in to 2013. This reflects stronger commodity exports being offset by robust consumption and capital goods imports.
South Africa’s fiscal policy continues to be counter-cyclical in support of growth and employment given the continued weakness in global markets. Barring significant spending shortfalls at the sub-national level due to capacity constraints, our country will likely miss the fiscal deficit target of 4.6% of GDP for 2012.
Government spending on wages is projected to be higher by 7% compared to the budget reflecting recent agreements with the unions. This is not offset by revenues which are estimated to grow in line with the budget at 27.4% of GDP.
Financial market volatility has also risen alongside higher global risk aversion.
Capital flows were robust through the first half of 2012 led by portfolio bond inflows. However, foreign investors subsequently scaled back their exposures, mainly in equity markets and Government securities, prompting a Rand depreciation of around 8% against the U.S. dollar since the beginning of 2012.
The risks to growth in South Africa over the medium term are tilted to the downside.
While a softening in activity is envisaged in 2013, the risks of a sharper slowdown are substantial if the Eurozone crisis continues to deepen. There is enough scope for monetary policy to be eased if the growth outlook weakens substantially, but fiscal space is more limited.
Domestic downside risks include the potential that households will be unable to sustain their consumption growth due to high levels of indebtedness, and that credit quality may decline with income. This could be exacerbated by a tightening of financing conditions. If downside risks materialise, temporary expenditure measures could be put in place but would need to be solidly framed within a credible medium-term consolidation plan.
On the upside, a swift and decisive resolution of the crisis in Europe as well as faster growth in other major advanced economies would increase South African exports.