January 15, 2004

The pace of local economic expansion picked up over the third quarter, with real gross domestic product (GDP) growing at a rate of 1.1 percent, following growth of 0.5 percent over the preceding quarter and peak growth of 5.1 percent over the second quarter of 2002.

Production remained weak as key sectors, such as manufacturing, suffered from the strong rand, lacklustre global demand, interest rate hikes in 2002 and bad weather.

Local demand remained buoyant. Real spending by households expanded 3.9 percent over the third quarter compared with 2.8 percent the preceding quarter

Real spending on durable goods, such as cars and furniture, grew 17 percent compared with 4.7 percent the preceding quarter.

Real spending on semidurable goods, such as clothing, footwear, and household textiles and furnishings, grew 7.8 percent compared with 2.9 percent.

Real gross fixed capital formation - a measure of fixed investment spending - was up 7.2 percent compared with 2.4 percent. Real investment spending by private business grew 10 percent compared with 5.8 percent.

GDP growth is likely to accelerate over 2004, with demand continuing to outperform supply. This imbalance will add to the deterioration of the current account balance but fortunately the deterioration may be tempered by a recovery in global demand. The question will then become whether the deficit is fundable.

On a year-to-date basis, the economy has been saved by large portfolio inflows, as foreign investors sought the higher yield offered by our market. But a global recovery may reduce the relative attractiveness of riskier yield.

On a risk-adjusted basis, yields in the more developed economies are becoming more attractive.

We expect the rand to weaken over the medium term. Even if a shaky dollar limits the rand weakness, the local currency is likely to remain volatile. This is damaging to price stability.

The ability to finance the current account deficit remains a major risk over the next few quarters.

Inflation continued its sharp decline from the fourth quarter of 2002, largely driven by lower food prices and the sharp appreciation of the rand.

Producer prices slipped into deflation in September, and the trend bottomed in November.

In November the inflation rate fell to 2.5 percent. Consumer inflation, as measured by CPIX - the consumer price index excluding mortgage rates - was 4.1 percent in November from a peak of 11.3 percent in October and November 2002.

In the face of lower inflation, the Reserve Bank cut the benchmark repo rate by 50 basis points to 8 percent in December. However, it has also signalled that rate-cutting might be at an end.

The rate-setting monetary policy committee (MPC) has cut the repo rate by 550 basis points since June and commercial banks cut their key lending rates in sympathy. But inflation risks seem sufficient to necessitate a more cautious policy going forward.

The latest MPC announcement highlighted four key risk areas as far as inflation is concerned:

Strong demand growth could put upward pressure on prices and hurt the current account of the balance of payments.

The strong disinflationary food price trend may be at an end, especially with the impact of weather conditions on local crops.

The external value of the rand remains vulnerable.

Increases in nominal unit labour costs are putting upward pressure on costs.


Adenaan Hardien is chief economist at African Harvest Fund Managers