New houses in Sebokeng, South Africa: despite sizeable investment program, country’s infrastructure needs remain large (photo: Odd Andersen/Newscom)
ECONOMIC HEALTH CHECK
In its regular assessment of South Africa's economy, 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 also contributed impressively to the country’s development—a significant achievement considering the challenges faced following the end of apartheid only 15 years ago. These policies have been underpinned by a consistent and transparent policy framework, including a credible inflation targeting regime.
Looking forward, the authorities need to calibrate their policy response in order to maintain price and external stability, mitigate systemic risks, and make progress on structural reforms to remove long-standing barriers to growth and employment.
South Africa enjoyed a buoyant economy in the mid-2000s. A favorable external environment and strong domestic demand helped raise growth to 5 percent on average in 2004–07 and lowered the unemployment rate by 5 percentage points. However, the global financial crisis of late 2008 sharply changed the outlook for an already slowing economy. South Africa is now in its first recession since 1992, and there are new priorities for macroeconomic policy.
Vigorous policy response
The authorities have responded vigorously to the downturn. Building on past prudent fiscal management, which helped lower national government debt from around 48 percent of GDP in 1998 to just over 27 percent in 2007, fiscal policy has been countercyclical. The government implemented a large front-loaded easing (4.5 percent of GDP) in fiscal year 2008/09 primarily aimed at upgrading the country’s infrastructure. This investment program is expected to relieve critical bottlenecks in electricity and transportation, while also supporting demand in the short run.
The South African Reserve Bank also aggressively eased monetary policy starting in late 2008. As economic activity weakened and the inflation outlook improved, the monetary policy committee (MPC) reduced interest rates by 450 basis points between December 2008 and May 2009. But with inflation remaining stubbornly outside the target band of 3-6 percent, the MPC has recently taken a more measured approach, leaving the policy rate unchanged at its June 2009 meeting, while cutting rates by 50 basis points in August.
Resilient financial system
Unlike the experience of some other countries, when the global financial crisis intensified last year, South African money markets remained orderly and the country’s financial institutions were stable. Interbank interest rate volatility remained within normal bounds in late 2008 and early 2009, reflecting generally adequate market liquidity.
South African banks’ low leverage, high profitability, and limited exposure to foreign assets and funding allowed them to remain liquid and well-capitalized, obviating any need for extraordinary liquidity or state support.
As the economy recovers, the authorities face the key task of restraining the growth in public expenditures, especially the public sector wage bill, in order to contain public sector debt at prudent levels. In particular, given the weak economy, the budget deficit for fiscal year 2009/2010 is projected to be 5.7 percent of GDP, but with revenue growth turning out to be much weaker than expected, and with interest costs rising, public sector debt levels and the cost of debt service are likely to rise sharply in the near term.
Moreover, the slow improvement in public service delivery and rising public pressures could lead to demands for faster spending growth over the medium term. Thus, the country’s structural fiscal deficit could be higher than currently projected over the medium term, which not only limits future policy flexibility, but could also raise domestic interest rates, and exacerbate South Africa’s external current account vulnerabilities.
The authorities recognize these risks to their medium-term fiscal position, and have emphasized that they intend to run a disciplined and pragmatic fiscal policy, taking action well before net government debt reaches the government’s debt limit of 50 percent of GDP.
Private sector participation
Structural reforms are also critical to accelerate growth and employment creation over the medium term in South Africa. Despite the sizeable public infrastructure investment program, South Africa’s infrastructure needs remain large, and creating the conditions for private sector participation in infrastructure investment and service provision could help relieve fiscal pressures and improve efficiency.
The limited competition in many of the country’s product markets and rigidities in its labor market also pose risks, as they limit employment creation over the medium term. These rigidities also help propagate supply side shocks, slowing the pace of disinflation and hampering the effectiveness of monetary policy.
The financial sector also faces growing risks as the economy weakens. Impaired loans as a ratio to total loans have risen to a multi-year high, and banks’ profits have declined. Thus, it will be important for the authorities to continue to engage with banks to ensure that provisions and capital buffers remain adequate to meet these risks.
In addition, efforts to strengthen consolidated supervision could be enhanced through formal analysis of systemic linkages within large financial conglomerates and regular reporting to senior policymakers. The authorities could also explore ways to reduce banks’ reliance on short-term wholesale funding, including analyzing the potential effects of introducing deposit insurance on the stability of banks’ funding bases.
Comments on this article should be sent to imfsurvey@imf.org
