The global economy in crisis: implications for South Africa

National TreasuryOctober 2008

Overview

• The global economy in crisis

• Impact of the international environment on South Africa

• Economic scenarios

• What is to be done?

Crisis unleashed in August 2007 with sub-prime losses

August • Share prices fall as sub-prime exposure becomes clearer

• BNP Paribas suspends three funds with €2 bn exposure

• Global Central Banks in coordinated liquidity injection: Fed = US$43

billion, ECB = US$214bn, BoJ = US$8.4bn

September • Run on UK bank, Northern rock - £2bn withdrawn in 3 days.

• BoE offers additional reserves

• Mark-to-market losses of $200bn predicted on US mortgage-related

securities

October

/ November

• Merrill Lynch loss of US$5.5bn, later revised to US$8.4

• Write downs announced at UBS, Deutsche Bank, Merrill Lynch, Nomura

and Citigroup.

December • Fed, ECB, BoE, Bank of Canada and Swiss National bank announce

coordinated action to address short term funding markets and establish

temporary currency swap arrangements.

• Sovereign Wealth Funds provide funding for UBS, Morgan Stanley and

Merrill Lynch.

…and steadily deepens through 2008

January • Investment banks announce further losses• Largest one day losses on stock markets since 9/11• US Fed cuts rates by 125bps in two steps over nine days

March • More coordinated interventions by CBs• Bear Stearns acquired by JP Morgan Chase for $2 a share

September • Fannie and Freddie taken into ‘conservatorship’ by US govt.• Lehman Brothers files for bankruptcy• Remaining investment banks apply to become bank holding companies• US Fed loans $85bn to AIG

October • DJIA loses 22.1% in one week and highest day’s volatility in history • World central banks make coordinated interest rate cuts• G7 agrees on five point plan of action, including capital injections,

provision of liquidity and guarantees of bank deposits • G20 Finance Ministers and Central Bank governors called to extra-

ordinary meeting, addressed by President Bush• G7 interventions precipitate stronger flight of capital away from emerging

markets

Financial crisis turning to real economy crisis

• IMF estimates that US losses will amount to $1.4 trillion

• Financial market crisis affecting several other sectors in the real economy as credit becomes harder to obtain

• Danger signs:

• In the quarter to September 2007, Volvo sold about 42 000 trucks. In the same period this year, they sold just 175

• House sales in the UK have fallen by close to 70 per cent from a year ago

• Costs of dry bulk charter rates plunged 71.9 per cent in October

• The General Motor’s share price has fallen 88% this year, to US$3, its lowest since 1946

• GM, Chrysler and Ford have requested a US$ 25 billion bailout

6

… and deteriorating economic growth prospects

• Unemployment in the US and the EU has risen to 6.5% and 7.5%

• Industrial production in the U.S. fell by 2.8% (m-o-m) in Sept

• Industrial production in China slowed to its lowest level in a decade

• Growth in the US slowed to -0.3% in the 3rd quarter

• Germany and the UK formally in recession

• World output to fall from 4.8% in 2007 to 2.5% in 2008 to 2.4% in 2009

• Advanced economies GDP growth at 0.3 in 2008 and 2009

• African growth expected at 5.2% for 2008 and 4.7% for 2009

• All growth in 2009 set to come from emerging markets

7

Policy responses have been unprecedented

• Initial responses dealt with preventing financial markets from seizing up

Governments have already committed to $4 trillion to support the financial system

Individual country actions may be optimal for that country, but harmful from a global perspective

Guarantees of bank deposits can cause withdrawals on banks in other countries

Impact of G7 decisions impacts on emergent countries (eg currency depreciation)

– Chinese package aimed at investment in infrastructure

– Globally coordinated interest rate cuts

Extensive currency swap arrangements between large central banks and the US Fed

• Different fiscal stimulus packages in different countries

– US and UK packages aimed at reducing tax rates and supporting social security

– Some countries looking at supporting key sectors

8

Resulting in rapidly falling commodity prices

600

1000

1400

1800

2200

2600

3000

40

60

80

100

120

140

160Platinum Price (lhs)Oil Price (rhs)

Platinum and oil prices

99

…and major capital outflows in the near term hitting share prices

Global equity markets

-31.0 -31.4 -33.3 -33.8-37.7 -37.9 -40.0 -40.7

-50.4 -51.5 -52.7 -52.8

-65.0-70

-60

-50

-40

-30

-20

-10

0

% c

hang

e si

nce

1Jan

200

8

1010

… resulting in large exchange rate movements worldwide

• Reduced risk appetite creating flight to the dollar and the yen

Exchange rates vs. the dollar and rand/euro and rand/sterling

14.0

-4.5

-10.2

-14.0 -15.0 -16.3-18.5 -19.2 -19.9

-22.4 -23.2-25.3 -25.7

-27.2-29.8

-33.8

-40

-30

-20

-10

0

10

20

% c

han

ge

sin

ce 1

Jan

11

China’s contribution to world growth still high

• On average, China has contributed about a fifth of world output growth

• Growth in Chinese imports has started to moderate, putting downward

pressure on commodity prices

• Chinese GDP growth has also moderated to 9.0% in 3rd quarter 2008

from 11.9% in 2007 and 11.6% in 2006

• The IMF forecasts Chinese growth of 8.3% in 2009.

1313

… cools demand for commodities and results in rapidly falling prices

0

100

200

300

400

500

600

700

800

2002

2002

2003

2003

2004

2004

2005

2005

2006

2006

2007

2007

2008

2008

Inde

x Ja

n 20

02=1

00

Gold

Crude

Platinum

14

… even as income accruing to South African exporters remains relatively high for now

95

100

105

110

115

120

125 Terms of trade

• Terms of trade refers to the ratio of our export prices to our import prices

• If it is going up, we earn relatively more from trade

1515

… and inflation is likely to fall resulting in lower interest rates over time

CPIX inflation & its components

Second round effects & electricity raise core inflation

2

4

6

8

10

12

14

16

Pe

rce

nt

(y-o

-y)

CPIX excluding food and petrolCPIX excluding petrolCPIXUpper target limitCPIX excluding food

Contributions to annual CPIX inflationJul-08 Aug-08 Sep-08

Food 5.1 5.3 5.0Transport 3.2 3.1 2.7Other 4.7 5.2 5.3Total 13.0 13.6 13.0

1.1 %pts due to electricity

16

…as household debt levels continue to moderate

Household debt and service costs

0

10

20

30

40

50

60

70

80

90

% o

f dis

posa

ble

inco

me

0

2

4

6

8

10

12

14

% o

f dis

posa

ble

inco

me

Household debt Household interest payments (RHS)

1717

… slower growth would lower the current account deficit. Policy aimed at maintaining investment in future and sustaining financing.

Gross savings & investment

Gross saving & investment

10

15

20

25

30

35

pe

r c

en

t o

f G

DP

GFCF Gross saving

18

The critical question for SA is… where should we be when the global cycle turns?

• Financial crisis giving way to real economy slowdown… for some countries =

lending & borrowing seizing-up

• Effects on South Africa:

– ▼ commodity prices & ▼ foreign demand for exports = ▼ GDP

– ▼ food and oil prices = ▼ inflation

– But as ▼ rand = ▲ inflation.

• Short-term adjustments on the demand side: Fiscal deficit supports consumption

& investment, even as both slow relative to recent years.

• In the long-term, need to be more productive, more export-oriented, with higher

saving and investment, and with more rapid growth at a sustainable current

account… How do we get there?

GDP growth slowing with world growth… a gap emerging between what we need and what we are likely to achieve

-3

-2

-1

0

1

2

3

4

5

6

7

% y

ear-

on

-yea

r

SA growth (NT estimates)World growth 6% growth target

SA vs. world growth

20

What is to be done? Monetary and fiscal options to sustain growth and macroeconomic stability

What we have done in recent years:

• Monetary policy focus on keeping inflation low over the long-term and

sustain capital inflows.

• Fiscal policy to raise saving in the economy & future economic growth.

• Fiscal space created to address prolonged slowdown in growth.

Where we are heading:

• With growth slowing now, more difficult to maintain positive saving rate >

focus on public investment.

• A prudent fiscal deficit to offset weakness in exports and keep long-term

interest rates low.

22

…and sustainably boost exports and investment

0

5

10

15

20

25

30

35

per

cent

of G

DP

Exports

Investments

23

Sustaining domestic economic growth in the near-term and growing the economy for future generations

• Use fiscal policy to offset short-term economic slowdown while maintaining

positive saving rate.

• Focus on government contribution to reducing costs of economic activity

and expanding markets with infrastructure.

• Monetary policy to achieve low and stable inflation and attract foreign

savings.

• Exchange rate flexibility allows SA to re-price lower to keep in line with other

emerging market economies and maintain competitiveness.

• Global economic weakness places renewed emphasis on promoting

productivity growth, domestic competitiveness, and efficiency gains…

implement growth recommendations.

24

… and requires addressing the international economic environment with a renewed commitment to multilateralism and mutual accountability

• Monetary policy support and fiscal measures, while maintaining fiscal

sustainability.

• Access to finance for emerging and developing economies including

through liquidity facilities and program support.

• Support of the development agenda by the World Bank and other

multilateral development banks (MDBs) and new facilities in the areas of

infrastructure and trade finance.

• Ensuring that the IMF, World Bank and other MDBs have sufficient

resources to continue playing their role in overcoming the crisis.

25

Key Principles for Reform undertaken by G20

• Strengthening Transparency and Accountability

• Enhancing Sound Regulation

• Promoting Integrity in Financial Markets

• Reinforcing International Cooperation

• Reforming International Financial Institutions.

26

G20 Action Plan to support Common Principles for National Plans

• Enlarging participation to emergent economies in Fin Stability Forum/Standard-Setting

institutions

– Reviewing and aligning global accounting standards

• Greater Co-operation between regulators

• Reviewing mandates, governance and resource requirements of the IFIs

• Agreement on the Doha Development Round moving forward

• National plans must

– Addressing pro-cyclical regulatory policy

– Strengthening transparency of credit derivatives markets and reducing their systemic risks

– Reviewing compensation practices

– Defining the scope of systemically important institutions and determining their appropriate

regulation or oversight

– Reviewing the mandates, governance, and resource requirements of the IFIs