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Presentation by
Robin Marshall, Managing Director,
Economic Research,
& Taryn Rebeck, SA Economist
JP Morgan
November, 2002
South African Economic Outlook and
the MTBPS
Key Points

JPMorgan expects weaker growth in 2003 than official
budget forecasts given recent monetary tightening & a likely
slowdown in consumption

A tight budget suggests 1.6% deficit is easily achievable but
disappointing that govt. has not taken opportunity to reduce
tax burden further

Further inflation overshooting of official forecasts likely but
suspending inflation targeting more damaging

SARB policy regime close to best practice, but more
frequent meetings, employment stabilization clause & more
statistical data on transmission mechanism needed
2
Key Macro Forecasts
CPIX inflation, %oya, avg
JPMorgan
Reuters consensus
MTBPS
Real GDP growth, %oya
JPMorgan
Reuters consensus
MTBPS
Current account balance, %of GDP
JPMorgan
Reuters consensus
MTBPS
Prime lending rate, %, eop
JPMorgan
Reuters consensus
Prime lending rate, %, eop
JPMorgan
Reuters consensus
Source: JPMorgan, Reuters, MTBPS
2002
2003
10.0%
9.7%
9.6%
8.7%
7.4%
7.2%
2.5%
2.5%
2.6%
2.5%
2.8%
3.5%
0.0%
0.1%
0.1%
-0.2%
-0.2%
-0.3%
18.0%
17.0%
17.0%
15.3%
10.80
10.80
11.50
11.50
3
Government macroeconomic forecasts
2002 Budget
2001
2002 Medium Term Budget Statement
2002
2003
2004
2.7%
1.4%
3.2%
1.4%
2.1%
-1.2%
2.2%
6.9%
2.5%
2.3%
4.5%
2.2%
2.6%
2.4%
2.3%
6.6%
2.8%
2.6%
5.5%
3.0%
6.6%
6.1%
3.3%
5.7%
3.1%
2.7%
7.1%
3.4%
6.7%
6.3%
3.6%
4.6%
969.1
1,057.0
1,153.9
1,250.5
CPI inflation
CPIX (Metropolitan and urban areas)
6.6%
6.9%
5.8%
4.7%
6.6%
9.6%
7.2%
5.5%
4.9%
Balance of payments
Current account balance (% of GDP)
0.0%
-0.5%
-0.5%
-0.7%
-0.2%
0.1%
-0.3%
-0.6%
-1.1%
Real growth in demand
Final household consumption
Final government consumption
Gross fixed capital formation
Gross domestic expenditure
Exports
Imports
Real GDP growth
GDP inflation
Gross domestic product at
current prices (Rbillion)
2001
2002
2003
2004
2005
2.8%
1.4%
3.3%
1.8%
2.4%
0.4%
2.2%
7.5%
3.1%
2.5%
6.0%
3.1%
3.2%
5.6%
2.6%
9.2%
2.9%
3.6%
5.7%
3.2%
6.4%
6.1%
3.5%
7.4%
3.3%
3.6%
6.2%
3.5%
6.6%
6.5%
3.7%
5.3%
975.0 1,093.0
3.6%
3.8%
6.8%
3.8%
6.7%
6.9%
3.9%
4.5%
1,214.2 1,325.0 1,439.0
Source: SARB
4
Main uncertainties about growth forecasts

2003 Growth forecast looks optimistic given likely slowdown in
household consumption in response to recent monetary
tightening, lower income growth and higher inflation

Overall increase projected in domestic demand for 2003 looks
odd given 400 bp of tightening to date in 2002 & 12-15 month lag
in monetary policy impact – demand indicators are already
showing signs of slowdown (retail & auto sales)

Official forecast of 6.4% export growth in 2003 looks difficult to
achieve during subdued global growth recovery

Other traditional lead indicators of GDP growth – like inverted
yield curve – suggest growth will slow modestly in 2003

JPM believes that a larger fiscal stimulus could have been made
in budget statement
5
Growth – Stable with relatively subdued
domestic demand
SA GDP vs HCE Growth
%q/q, saar
8
GDP Growth
6
4
2
0
-2
-4
HCE Growth
-6
Forecast
-8
90
91
92
93
94
95
96
97
98
99
00
01
02
03
Source: SARB, JPMorgan estimates
6
Main uncertainties about inflation forecast
• Inflation forecasts for 2002/3 look optimistic, given
evidence of 2nd round effects in wages and broadbased increase in 2002
• Combination of declining inflation and stronger GDP
growth next year is possible but unlikely
• Given scale of inflation overshoot in 2002, and to
prevent deterioration in inflation expectations, SARB is
likely to tighten a further 100 bp in November
7
BER survey of CPIX inflation expectations
3rd Quarter 2002 (2nd Quarter in parentheses)
Percent
2002
2003
2004
Finance
9.2 (8.5)
7.1 (7.0)
6.2 (6.0)
Business
8.3 (8.4)
7.9 (8.2)
7.5 (7.9)
Labour
7.9 (7.6)
7.9 (7.4)
7.3 (7.4)
Average
8.5 (8.2)
7.6 (7.5)
7.0 (7.1)
Source: Bureau for Economic Research, University of Stellenbosch
8
Inflation - Close To Peaking But Underlying
Picture Less Favourable
SA CPIX Inflation
Peak of 12.2%oya
in November
%oya
13
12
11
10
9
8
7
6
5
4
3 (Metropolitan & other urban areas)
2
1998
1999
2000
2001
Target
range
Forecast
2002
2003
Source: StatsSA, JPMorgan estimates

CPIX forecast 2002 y/e : 12.1% (10.0% ave)
2003 y/e : 6.6% (8.7% ave)
9
Food price inflation remains the major cause
for concern
SA CPIX vs PPI Food Inflation
%oya
%oya
25
30
PPI Food Inflation
20
24
15
18
CPIX Food Inflation
10
12
5
6
0
0
2000
2001
2002
Source: StatsSA

Food price inflation has been increasing steadily at both
the producer and consumer level in the past year –
JPMorgan does not expect it to unwind just yet
10
Also Note Current inflation is broad-based
CPIX goods vs services inflation
%oya
13
Goods
12
11
10
9
8
Services
7
6
5
4
2000
2001
2002
Source: StatsSA

Although inflation was initially driven by exogenous
shocks, it has become very widespread
11
Further petrol price increases remain a major
risk
%oya
%oya
180
Gauteng Petrol Price
Rand Oil Price
150
36
30
120
24
90
18
60
12
30
6
CPIX Transport
0
0
-30
-6
-60
-12
98
99
00
01
02
Source: Bloomberg, I-Net, StatsSA

JPMorgan forecasts Brent to average $25.7/bbl in 2002
and $26.6/bbl in 2003 – but risks are on the upside
12
A further key risk is more pass-through from
rand depreciation
PPI and CPIX Inflation vs Rand/$
%oya
18
Forecast
Rand/US$
15
R/$
12.5
11.0
Overall PPI
12
9.5
9
8.0
6
6.5
CPIX
3
5.0
0
3.5
-3
2.0
90
91 92
93
94 95
96
97 98
99
00 01
02
03
Source: StatsSA, Bloomberg, JPMorgan estimates
 Both directly (although behavior of corporate margins makes the
extent difficult to predict) & through second-round effects via
deterioration in inflation expectations and wage settlements.
13
Much of the strength earlier this year was
propped up by portfolio flows, which have turned
Total Portfolio Flows vs Rand/US$:Rate
R billion
15
12
Rand/US$
(inverted scale)
9
6
3
0
-3
-6
Portfolio Flows
-9
1996
1997
1998
1999
2000
2001
R/$
3
4
5
6
7
8
9
10
11
12
13
2002
Source: I-Net
 Both bond and equity portfolio flows turned negative in 02H2.
14
And outflows have picked up as expected
SA Services Account vs Net Dividend Payments
R billion
8
0
-8
-16
-24
-32
-40
Services Account
-48
Net Dividend Outflows
-56
92
93
94
95
96
97
98
99
00
01
02
Source: SARB
 After falling in 02Q1, outflows have picked up again now that
the Myburgh Commission is out of the way
15
Strong trade performance has supported the
rand, but fading with subdued global growth
SA Trade Balance
R billion
10
8
6
4
2
0
-2
-4
1998
1999
2000
2001
2002
Source: SARS

South Africa has posted trade surpluses of R2.9 billion on average in the
ten months year to date thanks to a weak currency, but export
performance is starting to come off due to an uncertain global outlook.
16
Interest rates – globally rates appear to be on
hold for now
Percent of total
United States
Euro area
Japan
United Kingdom
Canada
Current
Dec 02
Mar 03
Jun 03
Dec 03
1.75
3.25
0.00
4.00
2.75
1.25
2.75
0.00
4.00
2.75
1.50
2.75
0.00
4.00
2.75
1.75
2.75
0.00
4.25
3.00
2.00
3.25
0.00
4.75
3.50
Source: JPMorgan
17
In South Africa, one more 100bp rate hike
forecast for November
Prime Lending Rate
%
26
Nominal
23
20
17
14
11
8
Real (using CPIX Inflation)
5
Forecast
2
95
96
97
98
99
00
01
02
03
Source: SARB, JPMorgan estimates
 And Morgan looks for a 100bp rate cut in 03H2 once inflation
is clearly falling towards the target range.
18
JPMorgan Annual
SA Economic Forecasts
GDP Growth (%oya)
HCE Growth (%oya)
GCE Growth (%oya)
GDFI Growth (%oya)
Current Account (R billion)
Current Account (% of GDP)
CPIX Inflation (average, %oya)
CPIX Inflation (eop, %oya)
Prime Lending Rate (eop, %)
R153 Yield (eop, %)
Rand/$ Exchange Rate (eop)
Source: JPMorgan estimates
2002(f)
2003(f)
2.5
3.0
2.8
5.5
0.0
0.0
10.0
12.1
18.0
12.20
10.80
2.5
2.4
2.6
4.5
-2.0
-0.2
8.7
6.6
17.0
11.10
11.50
19
South Africa: Medium-term budget policy
statement: Main Points
 Budget deficit target FY2002/03 and 2003/04
unnecessarily tight at 1.6% and 2.2% of GDP, given
infrastructure spending and tax reform needs
 Statement suggests a modest fiscal tightening…
 …given government caution on revenue assumptions,
which makes another undershoot likely
 Very low debt/GDP ratio and debt service costs gives
government more scope to ease fiscal policy further
20
Government cautious again on revenue
projections
 Government revenue collection assumptions are very
conservative for 2002/03; growth in government
revenue is forecast to be 10.1% for the year
 Revenue growth so far this fiscal year is 17.5%
– Very strong growth in corporate tax revenue (especially
mining )
– Strong retail sales have helped VAT collection
– Continuing improvement in efficiency of tax collection
 JPMorgan expects revenue growth close to 13% for
full fiscal year 2002/3
21
Government expenditure control remains
tight…perhaps unnecessarily so
 Year to date government expenditures up 12%…
 …. expenditure over-runs modest and due to impact of
higher inflation especially on public sector wages
 Overall Government target for FY2002/03 looks
excessively prudent
 JPM’s weaker growth forecast for 2003 suggests govt.
has more scope to increase public expenditure
22
International comparison of fiscal positions
Czech
Poland
Hungary
Yield - 10-year govt bond
4.2
6.0
7.1
CPI, avg 2002
2.1
1.9
5.3
Budget deficit, % of GDP, ESA meth.
6.4
4.4
8.7
20.0
48.0
53.0
Public debt, % of GDP
Source: JPMorgan
23
SA official budget projections
2002 Budget
R million
2002/03
National Revenue Fund (main budget)
Revenue
265,217
Expenditure
Interest on debt
47,503
Percentage of GDP
4.4%
Contingency reserve
3,300
Allocated expenditure1
237,106
Total
287,909
Percentage increase
9.6%
Surplus (+) / Deficit (-)
-22,692
Percentage of GDP
-2.1%
2002 Medium Term Budget Statement
2003/04
2004/05
2002/03
2003/04
2004/05
2005/06
288,708
313,211
273,281
302,102
330,338
358,323
49,845
4.2%
5,000
256,386
311,231
8.1%
-22,523
-1.9%
52,434
4.1%
9,000
273,128
334,561
7.5%
-21,350
-1.7%
47,236
4.2%
–
244,517
291,753
11.1%
-18,472
-1.6%
51,463
4.1%
2,000
275,955
329,418
12.9%
-27,316
-2.2%
54,599
4.0%
4,000
299,825
358,424
8.8%
-28,085
-2.1%
57,853
3.9%
8,000
322,247
388,100
8.3%
-29,777
-2.0%
Includes transfers to provinces and local government, the National Skills Fund and sectoral skills development funds.
Source: JPMorgan.
1.
24
Official SA budget projections
R billion
Main budget deficit
Extraordinary payments
Extraordinary receipts
Main budget borrowing
Other government borrowing1
General government borrowing
percentage of GDP
Plus:
Non-financial public enterprises
Public sector borrowing requirement
percentage of GDP
Outcome
Budget
2001/02
2001/02
2002/03
2003/04
2004/05
2005/06
14.4
2.1
-4.7
11.8
-5.3
6.5
0.7%
22.7
1.6
-12.0
12.3
3.1
15.3
1.4%
18.5
8.6
-12.0
15.1
3.1
18.1
1.6%
27.3
7.0
-5.0
29.3
1.5
30.8
2.5%
28.1
7.0
-5.0
30.1
2.0
32.1
2.4%
29.8
7.0
-3.0
33.8
2.5
36.3
2.5%
-2.3
4.2
0.4%
-0.5
14.9
1.3%
-0.5
17.7
1.6%
0.3
31.1
2.5%
1.1
33.2
2.5%
1.2
37.5
2.6%
Revised Medium Term estimates
Social security funds, provinces, extra-budgetary institutions and local government.
Source: JPMorgan.
1.
25
International experience with inflation
targeting
 International experience suggests – monetary policy should be carried out by independent central
bank, even if choice of inflation target rests with govt./Finance
– credibility gains from announcing and implementing inflation
targeting (lower borrowing costs, reduced inflation expectations)
– implementation of targeting should be stable & predictable, but
policy responses also involve judgment
– optimum central bank implementation depends on structure of
economy, nature of shocks and welfare judgments
– successful inflation-targeting regimes generally employmentfriendly, enhancing political credibility by minimizing output
losses in achieving inflation target
– open economies, subject to international capital flows and
shocks, can still benefit from successful inflation targeting (UK)
26
Difficulties with inflation targeting for an
emerging economy
 Inflation targeting means inflation forecast targeting due to
lags in impact of policy (SARB estimates lags at 12-15
months)
 Inflation forecasting must be accurate, reflecting stable
structural relationships
 Thus for a Taylor rule, or variation, to work, where interest
rates are set to minimize deviations of inflation from target
and output from trend, these relationships should be stable
 Smaller, open economies may be subject to de-stabilizing
shocks from international capital flows & exchange rate
moves, with uncertain inflation consequences
27
South Africa’s evolving monetary policy
framework
Years
Monetary policy framework
1960-1981
Liquid asset ratio-based system with quantitative controls over interest
rates and credit
1981-1985
Mixed system during transition
1986-1998
Cost of cash reserves-based system with pre-announced monetary
targets (M3)
1998-1999
Daily tenders of liquidity through repurchase transactions (repo
system), plus pre-announced M3 targets and informal targets for core
inflation
2000
Formal inflation targeting
Source: JPMorgan, SARB
28
South African experience with inflationtargeting
 Much of South African policy regime conforms with
industry best practice, but 2002 experience suggests – more frequent meetings desirable to reduce risk of “
getting behind inflation curve “ (inflation data monthly)
– uncertainty over inflation forecasting due to structural
change in economy
– more information required on transmission mechanism &
inflation pass-through from rand to improve accuracy
– a secondary objective for stabilizing employment; current
escape clauses deal only with shocks
– missing targets in 2002/3 not a mortal blow to regime..
only repeated target misses & evidence of unstable
inflation expectations would justify suspension
– difficult to specify longer term path for target until SARB
becomes more confident about transmission mechanism
29