South Africa

• Author: Vivek Arora
• Pages: 8-9

Page 8

A general strand of research has focused on issues related to the central longer-term economic challenge for South Africa of further raising growth and reducing unemployment. Success in meeting these goals depends in large part on maintaining a sound and stable financial environment, which will be supported by implementing the inflation-targeting strategy, maintaining fiscal restraint, and rebuilding international reserves; on following through with the structural reforms, including privatization and trade liberalization; and on addressing the spread of HIV/AIDS. These would improve growth performance both by their direct impact and by attracting foreign investment. Labor market reforms that reduce the statutory costs of doing business would help to ensure that investment absorbs labor.

The annual growth rate of real GDP in South Africa has risen from 1 percent on average during 1980-93 to 2 3/4 percent in 1994-2001. Arora, Bhundia, and Bagattini (2003) suggest that the growth pickup reflects a substantial increase in total factor productivity (TFP) growth rather than greater factor accumulation. ¹

TFP growth may have increased in part due to the greater efficiency associated with increased openness to trade and greater private sector participation in the economy. ²

Jonsson and Subramanian (2001) show that trade liberalization and openness raised TFP growth significantly during the 1990s. ³

The increase in growth has occurred against the background of prudent macroeconomic policies. The central government fiscal deficit declined from 9 percent of GDP in 1993/94 to 1 1/2 percent in 2001/02 through a significant increase in the primary balance, in line with what Fajgenbaum and others (1996) anticipated was needed in order to avoid a public debt "trap" (an upward spiral in the public debt to GDP ratio). ⁴

Using an analysis that examines the primary surplus, the interest-growth differential, other debt determinants, and the sensitivity to macroeconomic shocks, Barnett (2003) concludes that South Africa's debt dynamics are manageable. ⁵

This conclusion is supported by several of the alternative indicators proposed by Jacobs (2002) and Jacobs, Schoeman, and Van Heerden (2002) to gauge the stance and sustainability of fiscal policy. ⁶

The monetary policy regime has gained credibility with a reduction in inflation from the very high rates prevailing through the early 1990s, the adoption of an inflation-targeting framework, and reduced external vulnerability. Jonsson (2000) argues that South Africa has the main prerequisites for an inflation-targeting regime, including an independent central bank and relatively well-developed capital markets. ⁷

Bhundia (2003) and Jonsson (2001) find that a stable long-run relationship exists among prices, broad money, real income, and interest rate (the conventional "money-demand relationship"), which underscores the importance of continuing to monitor the rate of money growth in seeking to meet the inflation target. ⁸

External confidence, as reflected in sovereign risk spreads, has been bolstered by the virtual elimination of the central bank's net open forward position in foreign exchange, which was a key source of external vulnerability in the past. ⁹

Empirical analysis by...