IMF Survey: Sound Policies Shield South Africa from Worst of Recession

IMF News, September 25, 2009

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Sound macroeconomic policies cushioned the impact of South Africa's first recession since 1992.
The IMF stresses the importance of progress on structural reforms to remove long-standing barriers to growth and employment.
South Africa’s prudent macroeconomic policies have been underpinned by a consistent and transparent policy framework, including a credible inflation targeting regime.

South Africa enjoyed a buoyant economy in the mid-2000s:
- Growth raised to 5 percent on average in 2004–07.
- Unemployment rate lowered by 5 percentage points during that period.
The global financial crisis of late 2008 sharply changed the outlook; South Africa entered its first recession since 1992.
The authorities need to calibrate policy to maintain price and external stability, mitigate systemic risks, and advance structural reforms to boost growth and employment.

Fiscal policy:
- Building on past prudent fiscal management that lowered national government debt from around 48 percent of GDP in 1998 to just over 27 percent in 2007.
- The government implemented a large front-loaded easing of 4.5 percent of GDP in fiscal year 2008/09, primarily aimed at upgrading infrastructure.
Monetary policy:
- The South African Reserve Bank reduced interest rates by 450 basis points between December 2008 and May 2009.
- Inflation target band is 3-6 percent.
- The monetary policy committee left the policy rate unchanged at its June 2009 meeting, and cut rates by 50 basis points in August.

Short-term fiscal pressures:
- Budget deficit for fiscal year 2009/2010 is projected to be 5.7 percent of GDP.
- Revenue growth is weaker than expected and interest costs are rising, implying public sector debt levels and the cost of debt service are likely to rise sharply in the near term.
Medium-term risks:
- Slow improvement in public service delivery and rising public pressures could trigger demands for faster spending growth.
- The country’s structural fiscal deficit could be higher than currently projected over the medium term, limiting policy flexibility, potentially raising domestic interest rates, and exacerbating external current account vulnerabilities.
- Authorities intend to run a disciplined and pragmatic fiscal policy, acting before net government debt reaches the government’s debt limit of 50 percent of GDP.
Policy priority:
- Restrain growth in public expenditures, especially the public sector wage bill, to contain public sector debt at prudent levels.

Infrastructure:
- Despite a sizeable public infrastructure investment program, infrastructure needs remain large.
- Creating conditions for private sector participation in infrastructure investment and service provision could help relieve fiscal pressures and improve efficiency.
Product and labor markets:
- Limited competition in many product markets and rigidities in the labor market limit employment creation and propagate supply-side shocks, slowing disinflation and hampering monetary policy effectiveness.

Resilience during crisis:
- Money markets remained orderly and financial institutions were stable when the global crisis intensified.
- Interbank interest rate volatility remained within normal bounds in late 2008 and early 2009.
- South African banks’ low leverage, high profitability, and limited exposure to foreign assets and funding allowed them to remain liquid and well-capitalized without extraordinary liquidity or state support.
Emerging risks as economy weakens:
- Impaired loans as a ratio to total loans have risen to a multi-year high.
- Banks’ profits have declined.
- Important supervisory actions include ensuring provisions and capital buffers remain adequate, strengthening consolidated supervision through formal analysis of systemic linkages within large financial conglomerates and regular reporting to senior policymakers.
- Explore ways to reduce banks’ reliance on short-term wholesale funding, including analyzing potential effects of introducing deposit insurance on the stability of banks’ funding bases.

Maintain price and external stability while mitigating systemic risks.
Run disciplined and pragmatic fiscal policy, restraining public expenditure growth and acting before net government debt reaches 50 percent of GDP.
Advance structural reforms to:
- Remove barriers to growth and employment.
- Promote private sector participation in infrastructure investment and services.
- Increase competition in product markets and reduce labor market rigidities.
Strengthen financial sector resilience by:
- Ensuring adequate loan-loss provisions and capital buffers.
- Enhancing consolidated supervision and analysis of systemic linkages.
- Reducing reliance on short-term wholesale funding and assessing deposit insurance implications.

IMF Survey: Sound Policies Shield South Africa from Worst of Recession — Rodney Ramcharan, IMF African Department, September 25, 2009.