Economic Perspective: in A Nutshell

Economic Perspective
Fourth Quarter 2005
Contents In a nutshell
Focus article: The removal of Focus article: The removal of exchange controls
exchange controls and how this and how this could affect SA banks
could affect SA banks ........................... 2 Exchange control legislation came into effect in South Africa in 1961, and
has since affected businesses and individuals to varying degrees. Since 1995,
International economy ..........................8 the government has gradually relaxed exchange control measures, but ten
years after the first bold steps, onerous limitations still apply, mainly to
South African economy ...................... 11
individuals, but also to local businesses.
With conditions seemingly ideal, the scrapping of the remaining exchange
Investment overview ............................17
control regulations appears imminent, which could be beneficial for local
Residential property market ................21 banks. The entry of new foreign banks into South Africa, which might be
boosted by such a move, should enhance competition among banks and
Key variables and projections .............24 boost the efficiency of the local banking system.
International economy
Compiled and published by The rapid rise of oil prices over the past two years can be considered the
Absa Group Economic Research biggest problem facing the international economy. Inflation has been rising
Absa Group Limited
as a result of it and is also threatening global economic growth.
(Reg No 86/03934/06)
The longer-term prospects for the oil price appear bleak for oil consumers.
However, the goods news is that the expected slowdown of the global
2nd Floor – South
economy will help to ease global demand, which could translate into some
Absa Towers North
180 Commissioner Street relief in energy prices. This means that rising global inflation could prove to
Johannesburg be transitory over the next year, should lower energy prices materialise.
2001
Domestic economy
PO Box 7735 The rapid accumulation of household debt over the past two years, on the
Johannesburg back of very low interest rates, has raised questions about the ability of
2000 households to repay their debt in the event of an economic shock. Moreover,
Republic of South Africa the surge in international crude oil prices has put significant upward pressure
on domestic inflation in recent months, increasing the likelihood of an
Tel: +27 (11) 350-7249 interest rate hike over the next few months.
Fax: +27 (11) 350-7252 With our forecast assuming a slowdown in consumer spending, we have
E-mail: leonoraw@absa.co.za adjusted growth projections for 2006 marginally downwards from 4,1% to
Swift Address: ABSA ZA JJ
4,0%, although projections for 2005 were raised from 4,2% to 4,4%.
This publication is also available on the Investment overview
Internet at http://www.absa.co.za
With one of the best quarters on the JSE on record behind them, South
African investors are likely to have to contend with much lower returns on
Hierdie publikasie is ook in Afrikaans most asset classes in the coming year. The good South African market
beskikbaar.
performance was in line with the bullish sentiments that extended to most
other emerging markets.
The information in this publication is derived Earnings growth rates are expected to peak at more than 40% y/y in the
from sources which are regarded as accurate
fourth quarter of 2005 and should still remain strong during the first half of
and reliable, is of a general nature only, does
not constitute advice and may not be 2006. For 2006 as a whole, earnings growth is expected to amount to around
applicable to all circumstances. Detailed 23% y/y for the JSE all-share index, slowing to 7% y/y in 2007.
advice should be obtained in individual
cases. No responsibility for any error, Residential property market
omission or loss sustained by any person House price growth of 19,6% year-on-year was recorded in the third quarter
acting or refraining from acting as a result of of 2005. This was the first time since early 2003 that nominal y/y house
this publication is accepted by Absa Group
Limited and/or the authors of the material.
price growth dropped below 20%.
In real terms, house prices increased by 15,3% in the past quarter. During the
first three quarters of 2005, nominal house price growth came to 24,3% y/y,
Date of completion: 8 November 2005
whereas real growth of 20,4% y/y was recorded during this period.
Absa Group Limited 1 Economic Perspective – Fourth Quarter 2005

Focus article:
The removal of exchange controls and how this could affect SA banks
“Foreign-exchange control is today primarily a IMF welcomed the easing that took place over the past year,
device for the virtual expropriation of foreign including the removal of limits on outward foreign direct
investments. It has destroyed the international investment. According to the IMF report, the South African
capital and money market.” authorities “indicated that they were considering moving
Ludwig von Mises (1881-1973) from exchange controls to a system of prudential
regulations for institutional investors”. The IMF will
Introduction support this initiative and would also be in favour of a
Exchange control legislation came into effect in South further easing of restrictions on non-financial firms.
Africa in 1961, and has since affected businesses and According to the IMF, all these measures would increase
individuals to varying degrees. Since 1995, the government market liquidity and allow greater risk diversification, and
has relaxed exchange control measures on various could reduce currency volatility.
occasions, starting with the scrapping of the financial rand Arguments are often advanced to the effect that the
mechanism in March 1995. More recently, in the 2004 abolition of exchange controls should not really be a
Budget, it was announced that foreign companies, priority, and that the remaining controls should be retained
governments and institutions may list on South Africa’s or those that have been abolished even be re-instated. We
bond and securities exchanges. In October 2005, the would not concur with such a view. This article will
Minister increased the foreign exposure limits on collective highlight why we consider the abolition of the remaining
investments schemes, while banks will be allowed to hold exchange control regulations to be a desirable and long
foreign assets up to 40% of their domestic regulatory capital overdue step. The article will also highlight the anticipated
in Africa. effects that the abolition of exchange control regulations
But ten years after the first bold steps, onerous limitations might have, especially on the banking sector.
still apply, mainly to individuals, and there are
administrative barriers with regard to local businesses. The scope of current exchange control regulations
Limits apply to overseas investments by institutional Most of the remaining restrictions are on portfolio outflows.
investors and portfolio investment abroad by non-financial In particular, institutional investors are permitted to invest
firms is prohibited. in foreign securities – subject to an overall limit of 25%
There has been much debate over the past decade as to the (15% prior to October 2005) of their total retail assets for
pace and extent of exchange control liberalisation that retirement fund managers, long-term insurers and
should be taking place. The government has consistently investment managers registered as institutional investors;
proclaimed its intention to eventually remove exchange and 25% for collective investment scheme management
controls entirely, but to follow a paced approach and not to companies (20% prior to October 2005). Corporates may,
abolish controls with a “big bang”. on application, be permitted to establish primary listings
With conditions seemingly ideal, the scrapping of the offshore under certain conditions. Private individuals are
remaining exchange control regulations appears imminent. allowed to invest up to R750 000 offshore.
The amnesty process, reprieving citizens who remitted In addition to the above, there are restrictions on travel
funds offshore without the knowledge of the authorities allowances (R160 000 for private individuals), the transfer
from prosecution if they declared such assets, has been of funds abroad by emigrants (blocked funds), the
completed. Once the penalties of either 10% (for residents investment of currency proceeds from exports (which must
wishing to retain their funds offshore) or 5% (for residents be repatriated within 180 days of accrual) and the like. The
deciding to repatriate their offshore funds) have been paid, transfer of blocked funds in excess of R750 000 for
the government might announce the final abolition of individuals and R1,5 million for families is allowed,
exchange controls. This could happen during the Minister’s provided a 10% exit levy is paid. Larger amounts may be
Budget speech in Parliament in February 2006. staggered to manage any impact on the foreign exchange
A recent International Monetary Fund (IMF) report1 noted market. Dividends and interest payments on the blocked
that the South African government has continued with its funds are freely transferable abroad and travel allowances
gradual approach to relaxing capital controls in 2004. The can be augmented if bona fide need is documented.
In 2004, exchange controls on outward foreign direct
1
South Africa – Staff Report for the 2005 Article IV Consultation; investments by South African corporates were abolished.
International Monetary Fund; 10 August 2005.

However, application to the South African Reserve Bank’s up during 2004. However, from the perspective of
Exchange Control Department is still required for approval developing Johannesburg as an international financial
and monitoring purposes in terms of existing foreign direct centre, the complete removal of exchange controls is
investment criteria, which include “demonstrated benefit to desirable. Even the new listing dispensation is half
South Africa”. The South African Reserve Bank reserves baked in the sense that foreign companies still have to
the right to stagger capital outflows relating to very large apply to the exchange control authorities for permission
foreign investments to manage any potential impact on the to list on the JSE , and this will only be granted if certain
foreign exchange market. conditions are met.
Certain politicians might argue that, since exchange
The case against exchange control regulations controls on foreigners have essentially been abolished,
Although the government has kept stating its intention to the remaining exchange control measures do not impede
remove exchange controls, the process has slowed down to the functioning of the economy or the markets, and
such an extent that many observers complain it is like could just as well be retained. This argument loses sight
watching paint dry. The IMF report has put some renewed of two important aspects impacting on the decisions and
focus on this aspect and there have been numerous reasons perceptions of foreign investors:
all along for ridding the country of the remaining exchange • Whenever some downward pressure is experienced
control regulations: on the currency in future, foreign investors will again
The time is opportune. The rand is strong, SA financial point out, as has happened in the past, that the actual
markets are performing well relative to international currency value is not known, and that the further
markets and their future prospects are also promising, liberalisation of exchange control could put even
given low domestic inflation and relatively high more downward pressure on the rand. This could
economic growth. Since the ultimate aim of exchange again reinforce any downward pressure or extend a
control is to keep funds from leaving the country, little if downward cycle, and in general cause higher levels
anything is being gained from keeping such measures in of currency volatility.
place. The grass does not, at present, look greener on the • Foreign investors also argue that the mere fact that the
other side of the fence. administrative capacity to enforce exchange controls
All previous events of exchange control liberalisation still exists in the hands of the state implies that that
were noticeable for their lack of impact on the markets. there is a greater risk that foreign-owned capital could
Specifically, there was usually very little, if any, at any time again be subject to exchange control. Once
negative impact on the currency market. But even if the this capacity is entirely destroyed, the risk of such
rand should come under some pressure because of controls being re-introduced within a short period is
exchange control abolition, this could only be helpful in essentially eliminated.
restoring some of the loss of international competitiveness The existence of foreign exchange control constitutes a
brought about by the appreciating currency of the past sizeable cost on the economy in terms of skills,
three years. However, any such currency weakness will computing capacity, time, and administrative capacity,
most likely turn out to be temporary. Over the longer both in the public and private sector.
term, the abolition of exchange controls should enhance Most true democracies do not have exchange control in
the levels of confidence (both locally and abroad) place. Although it is still a criminal offence for an
thereby increasing net capital inflows and reducing individual to invest his or her after-tax capital or income
currency volatility. offshore without obtaining permission or exceeding the
Measures that have been in place for more than forty R750 000 limit, such actions are seen as a normal part of
years have not stopped South Africans from remitting life in other countries. This implies a serious
substantial funds offshore without the knowledge of the infringement of economic freedom.
authorities. During the recent amnesty process, South Many sources have credited South Africa’s economic
Africans declared offshore assets worth R65 billion. It is policymakers for having been able to restore discipline
not known what value of such assets remains undeclared and confidence. Their policies have been successful in
or has already been disposed of. supporting higher levels of growth and lower levels of
The government is aiming to make South Africa an inflation. Tariff reform and efforts to improve
international financial centre for Africa. In line with this competitive forces have mostly been successful. The
strategy, the Treasury has relaxed exchange controls in level of foreign reserves has been increased and the
the sense that a stock market listing dispensation for burden of the net open foreign currency position has
foreign owned companies keen to list on the JSE was set been removed. This prompted credit rating agencies to

upgrade South Africa’s sovereign risk rating earlier in broking services banks furnish. This could well be further
2005. Yet, there seems to be some reluctance on the part enhanced by a continued boom – and even a rerating – in
of the government to take the final step to remove the equities, which may accompany the removal of exchange
remaining exchange control measures. At some level, it controls. Rising share prices would also benefit unit trust
may be perceived that the government itself remains businesses operated by the banks.
unconvinced that its policies are and will be conducive In addition, profits from the foreign exchange business of
to attracting and retaining capital. banks should rise, since turnover in the local foreign
exchange market would increase appreciably as larger inflows
Impact of the removal of exchange controls on banks and outflows of capital to and from the country materialise.
Over the past decade or so, South Africa’s advanced There should also be increased profits for banks emanating
banking system has developed considerably. This sets the from greater activity in the bond market and the South
country apart from many other emerging market economies. African futures exchange. The 1990s saw explosive growth in
The total assets of the South African banking system rose the volumes of trading in the local financial markets, partly
from R724 billion at the end of 1999 to R1 436 trillion at attributable to relaxations in exchange controls.
the end of October 2004. Several important challenges face The emergence of South Africa as an international
the local banking system. These include the need to comply financial centre in the wake of the abolition of exchange
with the revised capital adequacy requirements of the New controls should also be a boon for local banks. Foreign
Capital Accord or Basel II, as well as adherence with the companies could well list on the JSE, which would benefit
anti-money laundering measures, the Financial Sector investment banks acting as sponsors and advisers for such
Charter (FSC), and corporate governance and reporting listings. These banks would also benefit from rights issues
standards. Any abolition of exchange controls would add to by such companies. In addition, banks would be able to
these challenges, but would simultaneously create new offer international trade finance for companies in the rest of
banking opportunities, which could benefit the cost-to- Africa. Also, in the absence of exchange controls, the
income ratios of banks. enhanced credit status of the country could well enable
It would, firstly, relieve the banks of the onerous burden banks to gain access to foreign capital at a cheaper rate.
of helping to administer exchange controls on behalf of the Banks would likewise be able to expand their private
Reserve Bank, although this burden has eased as exchange banking activities. They would be able to offer their wealthy
controls have been relaxed. It would also eliminate private clients greater facilities with regard to investments
difficulties for banks arising out of the contravention of the in foreign markets if exchange controls were abolished,
exchange control rules. These can occur unwittingly, simply since the present strict limits on such investments would be
because banks may interpret them differently or because scrapped. Foreign banks operating in South Africa could be
they may not be aware of all the applicable rules. At times at a particular advantage in this area, since they would have
in the past, there have been shortages of staff to administer access to the services of offshore investment banks, which
the controls, and this problem will not be eased by the they own. In the absence of exchange controls, some
administrative burden banks face in trying to combat money foreign banks with representative offices in South Africa
laundering activities might upgrade these into subsidiaries or branches.
It should also be noted that the morality of exchange These comments serve to illustrate that following any
controls has been questioned ever since they were abolition of exchange controls the financial sector in general
introduced in 1961. The administration of these controls by in South Africa would expand, in the process creating new
the banks has also been involuntary and has led to friction job opportunities. This trend is already in existence to some
between the banks and their customers. The latter often find extent as a result of the progressive relaxation of exchange
the restrictions irksome, and can direct their frustrations controls since March 1995. This conclusion is furnished with
somewhat unfairly at the banks. Members of the general further credence since the complete liberalisation of the
public can also be annoyed at the delays associated with capital account of the balance of payments should generate
exchange control applications, which the banks have to higher economic growth in South Africa. This should arise
submit to the Reserve Bank. From the banks’ perspective, because, although domestic interest rates may rise as a
these negative features would disappear if exchange precaution to protect the capital account in the wake of
controls were abolished. removing the controls, the investment environment for both
Abolishing exchange controls could augment the non- foreign and domestic investors should improve, and the risk
interest income of banks in various ways. Turnover on the premium for investment in South Africa should be lowered.
JSE should increase as a result of greater participation by The potential for some enhancement in banks’ profitability
foreign investors, thereby raising the profits of the stock should not be a source of concern. As mentioned earlier,

banks will have to incur more costs to comply with new are attractive in the sense that they employ state-of-the-art
regulations, the FSC, and Basel II. High profitability is in any technology and operate a strong payments system and
event essential in banking because of the potential for extensive retail outlets. In addition, there is the largely
systemic risk in the industry if banks should fail. What is untapped potential of the emerging banking segment. Add
more, enhanced profits could well encourage the entry of in the attractive profitability of local banks as well as some
new foreign and local banks, boosting competition in the benefits to be derived from the abolition of exchange
South African banking system. From the last quarter of 1999 controls, and the result is strong consideration of entry into
to the end of March 2005, some 22 banks exited the South the South Africa market on the part of foreign banks.
African banking system, often owing to liquidity and Such interest could be further boosted since the abolition
solvency problems. This trend could be reversed in coming of exchange controls could lead to new foreign investment
years if exchange controls are abolished. in general and higher economic growth in South Africa. In
such circumstances, foreign banks may be keen to enter the
Exchange controls and the entry of foreign banks South African market partly to cater for the banking
The removal of exchange controls could exert a significant requirements of their own business customers who have
effect on the ownership pattern of South African banks. decided to invest in South Africa.
International companies have in the past been deterred from It should also be noted that the banking industry in the
investing in South Africa, partly because of the stringent outside world is consolidating at such an extraordinary pace
exchange controls relating to the JSE. Foreign companies that, before long, around ten banking institutions will most
have found it difficult to buy South African companies by probably dominate world finance. Most of the banking
offering their own shares in exchange. This was because systems of Latin America and Eastern Europe have already
foreign companies were debarred from listing their shares been bought up by the big European and American banks.
on the JSE because of exchange control regulations. Plans Many commentators expect Asia and Africa to be the next
to open the JSE to inward listings by foreign companies targets, with South Africa seen as the obvious base for an
only came to fruition in October 2004, and thus one African banking franchise. This consideration again renders
regulatory barrier to foreign banks entering the South South African banks targets where their foreign
African market has been partially removed, as previously counterparts are concerned. This factor will be even more
indicated. Foreign banks may now seek to acquire local apparent if local exchange controls are abolished.
banks by issuing their own paper. Many countries have found that the presence of foreign
Spokesmen for several of the big local banks have owned banks has a significant potential to enhance the
indicated that they would seriously consider any approach efficiency of banking systems. This occurs through the
from a foreign bank and Barclays Bank acquired a enhanced competition brought about by such banks, new
controlling stake in Absa Bank in 2005. In addition, the expertise, different business practices, financial innovation,
Reserve Bank has revealed that a number of international and the introduction of fresh foreign capital. The efficiency
banks are interested in acquiring one or two of the four of any banking system can be determined by expressing
major commercial banks in South Africa2. Apart from operating expenses as a percentage of total income.
Barclays, Standard Chartered (UK) and Citibank (USA) are Currently, the international benchmark for efficiency is
rumoured to be interested in increasing their retail banking around 60%, whereas at the end of 2004 the efficiency of
presence in South Africa. the local banking sector was 63,9%3. The entry of foreign
Standard Chartered and Barclays both conduct banking banks may be instrumental in boosting this efficiency ratio.
operations in other parts of Africa, and for many years, There are therefore grounds for arguing that the
until the late 1980s, owned large retail banks in South government should promote the entry of foreign banks by
Africa. International banking groups like Barclays and removing hurdles such as exchange controls. In this respect,
Standard Chartered are looking for acquisitions in the Banks Act sets out a number of regulatory hurdles. If a
emerging markets, because growth opportunities in foreign bank wants to buy between 15 and 49% of a local
developed country markets are limited. They are generating bank, it has to obtain the approval of the bank supervision
large amounts of surplus capital and are looking at authorities in South Africa. However, if a foreign bank
investment opportunities in emerging markets rather than wants to acquire more than 49% of a local bank, such a deal
returning this excess capital to shareholders. needs to be approved by the Minister of Finance, which
Despite strong gains of late, local bank shares remain means that banking policy in this area risks becoming
relatively cheap by international standards, and local banks hostage to political considerations.
2 3
The South African Banking Sector: An Overview of the Past Ten Years; Annual Report 2004 – Bank Supervision Department; South African
Address by T T Mboweni, Governor of the SA Reserve Bank. Reserve Bank.

In September 2004, Reserve Bank governor Tito predominantly foreign owned, yet this has not prevented the
Mboweni cast doubt on the prospect of a foreign bank country from maintaining a sound financial system.
buying one of South Africa’s big four banks, by asserting
that the government would prefer the country’s top banks to Removal of exchange controls, banking supervision
remain locally owned. However, the report on Competition and systemic risk in banking
in South African Banking issued in August 2004, which was If exchange controls are abolished and foreign ownership of
commissioned by the Treasury, recommended a change of South African banks increases, the supervisory regime would
rules to allow foreign banks easier access to the local need to adhere to the internationally agreed framework of
market. The present rules require banks to set aside at least “home-host” banking supervision. This is already in
R250 million in capital reserves held in South Africa, operation in the sense that South African owned banks have
whereas the report urged the government to allow foreign separate operations abroad and internationally owned banks
buyers of local banks a greater reliance on their home have a presence in South Africa. For such a system to operate
country capital. smoothly, both the home country and the host country
In assessing the case for encouraging foreign banks to regulators need to ensure that there is compliance with the
enter the local market, account should be taken of the Basel Core Principles of Effective Banking Supervision. This,
argument that, because the deposits of a bank are supplied in turn, means that regulators must seek to ensure that their
by local residents, investors in South Africa should have a requirements do not obstruct home country requirements and
substantial, if not sole, equity stake in the banks. The funds are consistent with meeting their responsibilities in this regard.
of domestic banks may be perceived to be part of the Structures for co-ordinating home and host supervision are
national savings of a country, and therefore the banks that therefore essential4.
raise and lend these funds should themselves be locally The supervisory environment for banking may also need
owned, at least in part. to be changed if exchange controls are abolished, in the
However, this argument is just as unconvincing today as sense that the supervision apparatus may need to be
it was in the 1960s, when the South African authorities strengthened. It can be argued that the systemic risk in
sought to justify a policy of restricting the presence of South African banking would be higher following any
foreign banks in the country. If the funds of banks are abolition of exchange controls. Domestic banks could well
regarded as part of the nation’s resources, it could equally deal in the various domestic financial markets, such as the
be asserted that foreign ownership of mining resources and foreign exchange market to a greater extent under such
companies in South Africa should be banned. Restrictions circumstances, unless strict limits on open positions
placed on the foreign ownership of South African banks remained in force. What is more, domestic banks might
would also raise questions concerning South African banks’ become operators in foreign financial markets if there are
ownership of foreign banks. The authorities have indicated no exchange controls. In addition, with a liberalised capital
that they will judge applications by any foreign banks to account and thus greater inflows and outflows of capital on
take over local banks on a case-by-case basis. the balance of payments, more abrupt fluctuations in money
Although the authorities were perfectly willing to see one market shortages could emerge. All these factors suggest
new foreign bank (Barclays) enter the local market, they that the danger of a bank or banks getting into difficulties
may still find it unacceptable to have most, if not all four, could be higher in the absence of exchange controls.
commercial banks fall into foreign hands. It remains to be However, greater fluctuations in foreign exchange flows
seen whether the authorities will sanction the entry of on a daily basis need not alter money market shortages if
additional major foreign banks. the rand continues to float on a largely clean basis with little
Large-scale foreign ownership of banks in South Africa intervention in the foreign exchange market on the part of
would, of course, pose new challenges for the local the Reserve Bank. What is more, banking problems can be
monetary authorities. Such an ownership pattern might be caused by numerous factors, and attributing troubles in
criticised on the grounds that foreign banks operating in banks to the liberalisation of the capital account alone may
South Africa could be less sympathetic than locally owned be wide of the mark.
banks to the wishes and policies of the South African In one respect, systemic risks in the South African
monetary authorities. However, such concerns do not banking system may be reduced by the removal of exchange
appear to be justified. It has long since been widely controls, if this would attract new foreign banks into the
accepted that central banks and private banks are country as suggested earlier. Such banks can be perceived to
complementary institutions that do not compete. Thus be safer than domestic banks, because they can form part of
privately owned banks have no reservations about co-
operating with central banks. New Zealand’s banks are 4
Ibid pp 6-7.

large international banking groups. In certain countries, as previously mentioned. Standard Chartered has recently
such as Zimbabwe, foreign banks can monopolise the entered local commercial banking via the Saambou Twenty
banking system partly because of this consideration. 20 internet banking venture and its possible bid for one of
In certain developing countries, problems experienced in the the big four banks, whereas Barclays has already acquired
wake of the removal of exchange controls have stemmed in control of Absa. In addition, the entry of foreign banks
part from inadequate preparation for financial liberalisation, should be stimulated by any abolition of exchange controls.
which left bank supervisors to face new risks before the This raises the question whether the four pillars banking
supervisory framework had been adequately strengthened. policy will perhaps need to be revised.
This should not apply in South Africa, since financial
liberalisation has been proceeding for roughly a decade. Conclusion
The positive domestic bond, equity and property market
Exchange controls and four pillars bank policy in conditions, together with a relatively strong currency
South Africa environment and weakish prospects for similar markets
Although there are 22 operating commercial banks in South abroad, are unlikely to prevail indefinitely. The government
Africa, the local banking system rests on four pillars in the would do well to use these favourable conditions to put
sense that four major banks – Absa Bank, First National prudential requirements in place for institutional investors
Bank, Standard Bank and Nedbank – dominate the with regard to their offshore exposures and abolish the
commercial banking sector in the country. These four banks remaining exchange control regulations on its citizens. The
account for around 84% of commercial bank deposits in abolition of exchange controls is unlikely to have any major
South Africa. The financial authorities adhere to a policy of negative market impact and will be beneficial to the country
not allowing any mergers or take-overs between the four big in the longer term.
banks. In other words, further consolidation involving the The abolition of the remaining exchange controls in South
big four is not viewed with favour by the authorities. This Africa could also be beneficial for banks, offering them some
oligopolistic nature of the South African commercial respite from the additional cost they will be incurring as a
banking sector is of long standing, is modelled on the result of the growing regulatory burden. The entry of new
British banking system, and is not unlike the situation in foreign banks into South Africa, which might be boosted by
numerous other emerging market economies, where a such a move, should enhance competition among banks and
coterie of banks dominates the banking systems. boost the efficiency of the local banking system.
The current policy relating to the dominance of the It is possible that most, if not all, of the big four
commercial banking sector in South Africa by the big four commercial banks could fall into foreign hands in the next
banks is partly driven by competition concerns. Competition few years, helped by the globalisation process and the
is important in any industry, since it acts as a spur to removal of exchange controls, unless this process is blocked
efficiency, innovation, consumer choice, high quality and low by the authorities. Such foreign entry into South Africa
prices. If competition is weak, these advantages may be lost. would, in turn, call into question the suitability of the
The fear of such an outcome probably explains the reluctance present four pillars commercial bank policy in South Africa.
of the authorities to countenance any further concentration in The abolition of exchange controls would also have an
commercial banking by means of a reduction in the present impact on banking supervision in South Africa, and
four pillars of the commercial banking sector. possibly have a positive effect on systemic risk in South
However, intensified competition is now on the horizon, African banking.

International economy
Oil, inflation and prospects for growth capacity and technology gains can provide some explanation
The rapid rise of oil prices over the past two years can be for the sustained absorption of higher input costs. In addition,
considered the biggest problem facing the international global manufacturing has been experiencing deflationary
economy. Inflation has been rising as a result of it and is conditions over the past few years. Over the longer term,
also threatening global economic growth. Already, signs of continuing to absorb rising energy and commodity costs
slowing growth have emerged in key countries such as the could prove to be more challenging.
US, the UK and China. These developments leave central banks with a dilemma.
The rise in oil prices has been symptomatic of the primary The question is whether to continue raising interest rates in
trend in commodities in general. This means that oil prices the face of slowing economic growth to stave off the threat
may continue to rise over the next few years owing to the of second-round inflation, or to ease monetary policy on
change in the supply-demand balance. growth considerations, accepting some inflationary risk.
With commodities in general, a depletion factor has Monetary policy has virtually no effect on the first round
developed on the supply side owing to the lack of success in effects of higher oil prices but can be considered essential to
exploration over the past few years. At the same time, a containing second round inflationary effects. So far, the
structural upward shift in demand has developed owing to Bank of England (BoE) has cut rates, the US Federal
sustained and substantial emerging market economic growth Reserve (Fed) has continued hiking rates and the European
led by China and India. Central Bank (ECB) has left rates unchanged.
Demand for commodities and oil is expected to continue The longer-term prospects for the oil price appear bleak for
expanding in emerging markets over the next several years oil consumers owing to the supply-demand profile and future
and could overtake that in developed market economies trends. However, there could be some good news over the
within the next ten to fifteen years. Already, China is the next two to four quarters. The further expected slowdown of
largest consumer in the world of a number of commodities the global economy will help to ease global demand, which
such as steel and cement. could translate into some relief in energy prices. This means
The shift in the supply-demand profile of oil and that rising global inflation could prove to be transitory over
commodities in general suggests that the long-term trend of the next year, should lower energy prices materialise.
prices will be to move higher in real terms. The global slowdown currently unfolding has important
However, over the shorter term, prices may have risen too implications for the dollar. The dollar recovery since the
far for the global economy to absorb and this has now started start of 2005, following a protracted decline over the
to impact negatively on growth. Central bankers across the previous three years, has been based on two pillars – the
globe have started to warn about the effects of higher energy growth and yield advantage the US currently has over the
costs on their respective economies. Inflation has risen so far euro zone. Rising US yields over those of the euro zone
owing to the first round effects of higher oil and commodity have been supporting the dollar in 2005. In previous years,
costs. However, second round effects of high energy costs the reverse was true. US growth has only been well above
have not yet materialised to any significance in either that of the euro zone in the past two years. In other words,
developed or emerging market economies. the strength of the dollar has depended on both growth and
The globalisation of manufacturing, excess industrial yield for its strength. If the US growth differential with the
Monetary policy dilemma: US and Euro zone growth and

% change y/y
Growth or inflation % change y/y yield differentials Spread
6 5 2
4
5 3 1
2
4
1
1
0
3
-1
0
-2
2
-3
-4 -1
1 US real GDP US and Euro growth
US CPI -5 Yield differentials
0 -6 -1
Mar-96 Mar-98 Mar-00 Mar-02 Mar-04 Mar-96 Mar-98 Mar-00 Mar-02 Mar-04

euro zone narrows over the next two to three quarters, the Germany
US dollar is very likely to resume its weakness owing to Low growth and high unemployment continue to be the
the overhang of the US current account deficit, now at main problems facing the German economy.
6,4% of GDP. Unemployment, at 11,7% for September 2005, remains
close to the record of 12% reached in March and April
US and UK 2005. Prevailing levels of unemployment are the highest
Economic growth has slowed over the past few quarters and since the depression years of the 1930s.
a reversal of this trend is unlikely in the face of higher High unemployment combined with stagnant wages have
interest rates and higher energy prices. Although domestic been major causes of depressed consumer demand. Volume
demand has been unusually strong in recent months, there in retail trade had been flat for 10 years to 2002 but
have been recent indications of slowing momentum. Low contracted over 2003 and 2004.
savings and a softer housing market are expected to place However, in recent months, the depressed level of
pressure on consumer demand and confidence has been consumer demand appears to have been improving.
falling rapidly. Much higher interest rates could prove to be Consumer demand could gain momentum over the coming
overkill and result in growth converging on that prevailing months owing to a high saving rate and an expected fall in
in Europe. the unemployment rate.
In many ways, the situation in the UK has mirrored that in A recovery in consumer demand along with continued
the US. A year after the rate-hiking cycle started in the UK, satisfactory growth in exports and manufacturing could
the economy still appeared to be strong, but the combined result in German economic growth exceeding expectations
effects of higher interest rates, high consumer indebtedness in 2006.
and expensive energy started to bite and the result was a Economic growth for 2005 is still only expected to be
slowdown, the speed of which was not anticipated. around 1%, slightly below the 1,1% growth achieved in
In May 2005 the a majority of analysts was still expecting 2004. Amongst the G7 countries, Germany has the lowest
the Bank of England to hike rates, with most of the rest expected growth rate after Italy, which is currently
expecting rates to remain unchanged for the remainder of experiencing a recession.
the year. By August, this had shifted to an expectation of a A further problem for Germany is that the 18 September
rate cut, which did, in fact, transpire. election did not produce a clear winner and the new “super
The US has a very similar economic profile to that of the coalition” poses a problem in terms of gaining agreement in
UK and if a similar pattern were to emerge, the current government over essential reforms. Economic reform, some of
expectation of further multiple interest rate hikes taking the which has been effected by the previous government, still
Fed Funds rate to 5% may also not transpire. The US needs to be taken further for the German economy to cope with
economy could also slow down more rapidly than anticipated tax and regulatory competition from its Eastern neighbours.
owing to a drop in consumer demand and this could result in Apart from the election being a disappointment with regard
a premature end to the current rate hiking cycle. to possible progress over economic reforms, the euro has also
The BoE decided to cut rates at its August 2005 meeting lost ground against the dollar following the stalemate.
in the face of an economy slowing faster than anticipated. However, despite the election result, there are still
The UK was the first amongst the G7 to start raising rates. grounds for optimism. Although an unstable government is
Although rates were raised only modestly, the effect a possibility, the most probable outcome is a working and
appears to have been magnified. Indeed, the effects of the
previous rate hiking cycle were not as severe as those of the
present one. The reasons probably lie with the significant German business sector:
rise in consumer indebtedness over the past few years and Index
Strengthening recovery Index
110 9 000
the persistently higher energy costs accompanying the
8 000
current rate hiking cycle. 105
7 000
A recession has now become a strong likelihood by the
100 6 000
end of 2005 or the beginning of 2006. Manufacturing is
5 000
already in recession and retail sales have slowed to the 95
4 000
lowest level in almost seven years. The housing market has
90 3 000
cooled and high energy prices have also taken their toll on
2 000
the economy. Energy prices have raised the risk of higher 85 IFO Business Climate
1 000
inflation, which implies a significant constraint on monetary Xetra DAX Index
policy with respect to any rapid interest rate relief. 80 0

Nov-95 Nov-97 Nov-99 Nov-01 Nov-03

effective coalition, given the traditional and valued German German inflationary pressures have also remained low,
reputation for order and stability. with consumer inflation remaining mainly below the ECB’s
The economic reform dynamics will probably change for 2,0% target level. Producer inflation has been higher, but
the better, but may not be optimal. The previous improved productivity has succeeded in keeping consumer
government was a reluctant reformer, with left wing inflation at a more subdued level. Higher oil prices have
elements retarding and obstructing the agenda. This element consequently had a subdued effect on the overall economy.
has now been weakened and the left’s ultimate effect will Euro zone inflation as a whole is above the 2,0% target,
only be to slow the process down. The new leadership will but sluggish economic growth means that there is a low
most likely be enthusiastic reformers and the reformist likelihood of the ECB raising interest rates in the near
element in the previous government will serve to reinforce future. However, by next year, the ECB may well consider
this agenda. The reform debate could therefore be one of raising interest rates slightly if higher oil prices should feed
nuance rather than substance, with the marginalisation of through into higher inflation numbers.
any anti-reform elements.
If the reform agenda is not derailed in substance, then Japan
greater willingness to compete on tax and regulatory issues There are a number of indications that the Japanese economy
could see the German economy regain its place as an may have started to improve on a more sustainable basis.
economic powerhouse in the global economy. Although export dependency on the US market had been
Despite prevailing pessimism over the short-term reduced by diversification in recent years, total exports have
performance of the German economy, there are already nevertheless grown, despite Chinese competition.
signs that it may be starting to stir once again. Tax and Internal demand has been strengthening to the point
regulatory competition from Eastern neighbours has spurred where retail sales growth is now the strongest among the G7
some progress in improving the competitiveness of German countries after the US. The dearth of consumer demand has
industry. Some of the larger firms have achieved longer been at the heart of the Japanese economic problem and the
working hours along with pay freezes or cuts and labour recent recovery in demand has been remarkably robust.
flexibility has improved, with a greater proportion of The property market has also shown signs of stabilising
workers now employed part time or on a contract basis. after more than a decade of falling prices. Deflation has
The improvement in competitiveness has started to pay slowed and prices could start rising modestly by early 2006.
dividends and corporate profitability has improved. At the The possibility of an end to the Bank of Japan’s zero
same time, export growth has been able to keep the interest rate policy is now a prospect that could materialise
economy going. This despite the strength of the euro by the end of 2006.
between 2002 and 2004. The Japanese election result was unlike German result.
Productivity has been growing faster than the European The Japanese incumbent won a resounding election victory
average and wage growth has been the slowest in Europe. on a strong reformist platform. The opponents of the reform
Relative to the euro zone, unit labour costs have fallen initiatives in postal savings were defeated, opening up the
significantly as a result. Industrial production growth has prospect of sweeping reforms over the next year. Japanese
largely compensated for sluggish consumer demand over ascendancy has come at a time of slowing growth
the past two to three years. momentum in the global economy.

South African economy
Macro-economic implications of rising household debt disposable income growth of households, which averaged
In the statement of the Monetary Policy Committee (MPC) 3,9% over the same period.
following its October 2005 meeting, the MPC, for the first Household debt, after initially falling owing to the high
time, referred to household debt directly. Although the MPC levels of interest rates that prevailed towards the end of the
did not express any serious concerns about household debt, it nineties, has picked up markedly over the past few years.
was noteworthy that it has it on its radar screen. (Admittedly, After a period of consolidation, during which consumers
the MPC previously noted the high level of private sector took advantage of the accommodative monetary conditions
credit extension and expressed its concern about that.) to pay off their debt, household debt rose as consumers used
Household debt as a percentage of disposable income debt financing, combined with higher real wage growth, to
contracted for five consecutive years following 1998. sustain their spending. As a result household debt as a
However, at the start of 2003, it picked up, reaching its percentage of household’s disposable income rose from
highest level ever in the second quarter of 2005. This rapid 49,1% in the fourth quarter of 2002 to an all-time high of
accumulation of debt, on the back of very low interest rates, 61,8 in the second quarter of 2005.
has raised questions about the ability of households to repay Debt has increased from its 2002 lows for a number of
their debt in the event of an economic shock and whether reasons:
this accumulation foreshadows an economic slowdown. Firstly, the increased spending was in part owing to
The surge in international crude oil prices, which is pushing increased spending on durable goods and rapidly rising
local fuel prices higher, has put significant upward pressure house prices that led to increased household wealth. The
on inflation in recent months. This, combined with the high bulk of the increase in household debt can be ascribed to
level of credit demand, strong consumer demand and above- increased borrowing for housing. It is clear from the graph
inflation wage settlements, has considerably increased the risk below that the primary driver of household debt over the
of higher interest rates within the next few months. past few years has been the rise in mortgage debt.
Such a change in circumstances could have negative The second reason is also related to housing, and is called
consequences for certain consumers, with a rising probability of “housing equity withdrawal” by some analysts. When the
debt defaults. cost of debt is low, there is a tendency to take housing
equity and renovate the house, make it bigger, or to
Measuring the consumer debt burden finance consumption or the purchase of other assets. This
method of financing other consumption has played a
Why has debt increased? significant role in boosting consumption expenditure in a
South Africans have been enjoying thriving economic number of countries, including the United States,
conditions since the turn of the century, with the economic Australia and the United Kingdom. Of course, the danger
growth rate averaging 3,4% per annum during the past is that a contraction in the demand for such financing
five years compared with 2,6% during the period from could potentially act as a major drag on the economy.
1995 to 1999. Thirdly, the rise in house prices reflects the structural
Growth in household spending, averaging 4,1% per changes in the domestic economy over the past few
annum during the past five years, has been in excess of the years, with inflation and interest rates at levels
SA real GDP Private credit extension vs

% change y/y % change y/y
mortgage growth
6 30
5 Total private credit extension 6 mma

25 Mortgage growth 6 mma
4 3,4%
2,6%
3 20
2
15
1 0,2%
0 10
-1
5
-2 Real GDP growth
-3 0
1990 1992 1994 1996 1998 2000 2002 2004 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04

unfamiliar to consumers. Furthermore, circumstances indebtedness relative to earning power. Currently, at 61,8%,
were ideal, with the pick-up in economic growth coming this ratio signals the willingness of consumers to take on more
at a time when inflation was low and prices of imported debt than ever before. The rate of increase in this ratio
goods falling in some instances. However, it must be outpaced that of disposable income, pointing to potential
noted that the lower inflation came largely as a result of problems ahead if this rate of increase is maintained over a
the strength in the rand, accompanied by prudent long period.
monetary and fiscal polices. An often-used and simplistic measure of the cost or
Fourthly, these conditions were amplified by the affordability of household debt is the household debt
increased ability of households to borrow, further servicing cost indicator. This method is widely used to
driving up house prices. This, in turn, increased the calculate the share of household disposable income that
amount that needed to be borrowed. Various must go to debt repayment. Debt servicing cost fell from
circumstances, including political pressure to finance close to 9% of household disposable income in the first
lower income groups, favourable economic conditions, quarter of 2003 to 6,5% in the second quarter of 2005 owing
higher real income growth and the prevailing lower to the lower interest rate environment.
interest rates, made access to credit easier than before. Another approach to measuring the consumer debt burden
Fifthly, the “investment motive” increased debt. A is to look at more direct measures of financial distress, such
number of households bought second houses as holiday as civil cases for debt. The total number of civil summonses
homes and for speculative or profiteering purposes. issued for debt in August 2005 rose by only 0,9% year-on-
A sixth reason relates to the emergence of the black year (y/y) whereas for the three months to August, it fell by
middle class, which resulted in an increase in the overall 3,3% compared with the corresponding period in 2004.
demand for housing and other goods. Insolvencies fell by 26,8% y/y in August and by 2,5%
Finally, longer-term demographic changes also explain quarter-on-quarter (q/q) for the three months to August.
the increased borrowing levels. The life-cycle model of However, companies are apparently starting to take some
Ando and Modigliani (1963) explains how most strain. Although the number of liquidations for September
households experience a rising income through their was down by 32,0% y/y, for the three months to September
working life, with debt tending to be high relative to it rose by 9,8% compared with the preceding three months.
income early in life and then gradually declining with
age. With South Africa’s average age getting lower, What are the implications of higher debt for economy?
more people are currently taking on debt than Given that household debt is at an all-time high relative to
previously, resulting in a higher debt-to-income ratio. the disposable income of households, the question arises as
to whether this high level of debt will lead to financial
Vulnerability of households problems for households.
Although several household debt service burden ratios have Rising household debt is not necessarily problematic if
been developed internationally, including the financial the disposable incomes of households grow at the same rate.
obligation ratio and consumer vulnerability index, a lack of However, as indicated in the graph below and mentioned
reliable data in South Africa has made the use of these previously, disposable income growth slowed down in the
methods difficult. first quarter of 2005, although it picked up slightly in the
The most frequently used indicator is the ratio of household following quarter.
debt to household disposable income, which measures It could further be argued that this rising trend in
Household debt to household disposable Household debt to household disposable

income vs debt servicing cost income vs household disposable income
Ratio % change y/y Ratio % change y/y
65 16 65 12
HH debt to disposable income
Household disposable income 10
14
8
60 60
12 6
4
55 10 55
2
8 0
50 50
-2
HH debt to disposable income 6
Debt servicing cost -4
45 4 45 -6
Mar-95 Mar-97 Mar-99 Mar-01 Mar-03 Mar-05 Mar-95 Mar-97 Mar-99 Mar-01 Mar-03 Mar-05

household debt is an indication that households are lead to falling house prices, less employment creation, and a
progressively spending future income to increase their loss of consumer and business confidence.
current standard of living. When viewed against the It is also fair to state that the increased personal borrowing,
background of a sizeable and rising current account deficit which was used to finance consumer spending, coupled with
and dwindling savings, one might even argue that corporate borrowing, led to the rise in the current account
households are starting to live beyond their means. deficit as a percentage of GDP. The strong business and
At some point, when a large share of the household consumer confidence in the economy resulted in South
income is devoted to debt repayments, households are left Africa becoming a spendthrift nation, fuelling imports.
with less money to spend on goods and services, which Furthermore, apart from some consumer goods (such as
could imply a drag on economic growth. electronic goods) that need to be imported, the supply side
The larger magnitude of household debt has increased the of the economy has not been able to lift production
sensitivity of the household sector to fluctuations in income, sufficiently to meet consumer demand. This has resulted in
interest rates and house prices. Although low inflation has an even larger imbalance on the current account. The
allowed for a reduction in interest rates and therefore balance on the current account moved into a deficit
borrowing costs, which in turn resulted in increased borrowing, (measured as a percentage of GDP) at the same time as
consumers may find that the value of their debt will not erode household spending started to pick up in early 2003.
as fast as it did when inflation was high. As a result, After an average surplus of 0,7% of GDP in 2002, the
households will be constrained for a much longer period by current account balance recorded a deficit of 3,2% of GDP in
high debt repayments, which will impact future consumption. 2004, widening to 3,4% in the second quarter of 2005. With
While the higher debt-to-income ratio means that continued strong demand and high international oil prices, the
consumers will be more sensitive to job losses, it increases current account deficit probably widened further in the third
the possibility of defaulting on debt such as mortgages. quarter, if the sizable trade deficits since July are indicators.
Distressed selling of houses would lead to lower prices, As the housing market cools and high fuel prices take
implying that the value of a house could, in some instances, effect, consumer spending should ease as well, reducing the
fall below the outstanding mortgage. pressure on the current account. If one takes into account
Although the primary sectors appear to have adjusted that the growth in consumer spending, which makes up over
quickly to a stronger rand environment, it is not 60% of GDP, had been fuelling economic growth during the
inconceivable that a much stronger rand (caused by severe past few years, a slowdown in this component could have
dollar weakness) could depress conditions in manufacturing significant implications for overall economic growth over
and mining, leading to job losses. However, we do not the next year or two. In the event of an economic shock,
foresee the rand appreciating to levels seen at the start of such as the loss of employment or rising interest rates, the
2005 over the short to medium term. ability to service debt would be reduced. When confronted
However, households could also be forced into financial with economic uncertainty, consumers may reduce
distress by a sudden rise in interest rates. With international spending, which could also impact GDP.
oil prices still high and inflation moving upwards, the South Fortunately the outlook remains favourable at this stage
African Reserve Bank (Sarb) could be forced to raise the and we do not expect a hard landing. But consumer
repo rate in early 2006. Although the rate increases during spending could slow down from current growth levels of
2006 are expected to amount to only one percentage point, around 6% per annum to just below 5% in 2006 and 2007.
an oil price shock could call for more rate hikes, which may Much of the increase in household debt stock can be linked
to the underlying assumptions about the structural changes in
HCE vs current account as % of GDP the economy. The structurally lower inflation and interest
% of GDP % change y/y rates have boosted consumer and business confidence,
4 12
resulting in increased spending. However, if this “new
10
economy” turns out not to be sustainable, it will cause
2 8
significant hardship and consumers will rein in spending so
6
0
that growth reverts to its long-term average of around 3%.
4
It remains difficult to judge the sustainability of debt levels
-2
2
as much depends on these underlying expectations. Consumer
0
spending is now more sensitive to negative shocks, and in
-4
Current account balance
-2
particular interest rate increases. Sarb needs to be aware of
Household consumption expenditure -4
this, and recognise that it will perhaps require smaller
-6 -6 increments in interest rates to achieve the desired outcomes.
Mar-90 Mar-92 Mar-94 Mar-96 Mar-98 Mar-00 Mar-02 Mar-04

Developments in the third quarter of 2005 Manufacturing output data from Statistics SA points to
solid growth in the third quarter, although it may be slightly
Demand still strong weaker than the second quarter growth of 7,3% q/q,
Household consumer demand continued to surprise on the annualised. Manufacturing growth during July and August
upside during the second quarter of 2005, although there was 2,6% and 3,5% y/y, respectively.
have been signs of some weakness emerging in the third Mining output remains fragile, rising by 1,7% y/y in
quarter. After growing by 6,1% on average in 2004, August after falling by 3,8% in July. The main culprit was
household spending has slowed to 5,5% q/q, annualised, in gold, with gold output continuing to dwindle. Excluding
the first quarter of 2005, gold, mining output rose 7,0% y/y in August and fell by
However, buoyant spending on durables such as motor only 1,1% in July. Gold production volumes fell by 21,5%
vehicles has resulted in consumer spending increasing to y/y in August.
5,9% in the second quarter of 2005. Spending was
supported by the 50 basis point cut in interest rates in April, Inflation unsettling Sarb
which took the prime interest rate to its lowest level since After reaching a low of 3,1% y/y in February, the CPIX
the early eighties. inflation rate began a steady climb, moving closer to the
Durable goods purchases rose by 26,7% q/q annualised in upper limit of the inflation target band. Surging fuel prices
the second quarter of 2005 after growing by 12,1% in the first during the third quarter pushed the CPIX inflation rate to a
quarter. This category was supported by the strong upward twelve-month high of 4,7% y/y in September.
momentum in motor vehicle spending in the second quarter. Supply disruptions causing significant capacity
Sales of semi-durable goods levelled off somewhat, rising constraints at global oil refineries during the past few
by 9,0% q/q annualised versus 14,3% in the preceding quarter. months have caused oil prices to skyrocket. After the
Growth in the non-durables remained lethargic, picking destruction of hurricanes Katrina and Rita in the Gulf of
up by 3,3% q/q after growth of 4,1% in the first quarter. Mexico, where most of the US oil activity takes place, crude
Growth in services rose by 2,4% versus 2,6% previously. oil prices reached record levels in early September, with
Although consumer spending is still buoyant, signs of a Brent crude averaging US$63,41 per barrel in August (an
slowdown in momentum were evident in the retail sales increase of 51,2% y/y) and US$64,05 per barrel in
data during the past few months. Real retail sales slowed September (up 50,6% y/y).
down to 3,2% y/y in July, but rose again in August, As a result, petrol prices (Gauteng 93 octane) rose to
although mainly as a result of base effects. For the three R5,62 per litre in August (up 30,4% y/y) and R5,91 per litre
months to August, real retail sales grew at 5,6% y/y, in September (up 30,2% y/y). During October, prices rose
compared with growth of around 11% at the end of 2004. further to R6,03 per litre. These fuel price hikes put
Moreover, new motor vehicle sales for October were 19,5% significant upward pressure on inflation during the past few
higher than the same month a year ago, which is lower than months, adding 0,3 percentage points to both July and
September’s 26,5% y/y. The growth in passenger vehicles sales August’s monthly increases.
slowed to 18,1% y/y compared with 25,3% in September. The cushion provided by the strong rand exchange rate
Rising fuel costs are shrinking purchasing power, which during the first quarter has disappeared, with the rand
could prove to be a drag on consumer spending and overall trading around 8% weaker than at the beginning of the year.
economic growth over the next year. We expect international crude oil prices to remain above $50
per barrel level, despite new investment in refinery capacity by
Supply-side growth fragile Opec, which could boost production capacity by 500 000
Manufacturing recovered in the second quarter of 2005, barrels per day by the end of this year and further in 2006.
adding 1,2 percentage points to the overall GDP growth rate Of further concern, food prices also seem to be turning,
of 4,8% q/q. Capacity utilisation during the second quarter although growing at only 3,2% y/y in September. Food
also rose to 84,7%, with capacity utilisation in major makes up nearly a quarter of the inflation basket, so any
categories such as motor vehicles, food, petroleum and increase in food prices will put significant upward pressure
chemical products advancing rapidly during the quarter. on consumer price inflation.
The pick-up in activity came after a dismal first quarter, CPIX goods inflation has remained fairly subdued during
during which manufacturing subtracted 0,3 percentage the past twelve months, but has risen from 2,4% y/y in
points from the quarterly economic growth rate. The January 2005 to 4,4% in September, largely owing to rising
turnaround could be ascribed to the weaker rand exchange fuel costs.
rate during the second quarter and continued strong Nonetheless, prices in some categories, such as clothing
domestic and global demand. and footwear and furniture and equipment, were either

falling or the increases were moderate, subtracting from in a 50 basis point interest rate hike during the first half
CPIX inflation during recent months. of the year.
However, services inflation has been high, already PPI inflation rate rose from 1,2% in February 2005 to its
running at just below the 6% level for a few months. In highest level in two-and-a-half years in September, coming
September, services inflation was 5,5% y/y, compared with in at 4,6% y/y. The major driver of this increase came from
5,9% in January. This high rate was mainly owing to the imported commodities component, which rose by 6,8%
increases in the prices of housing-related services and other y/y. The softer rand and higher oil prices are reflected in
services not related to housing and transport. import costs. Sustained high oil prices would continue to
Other factors that are being monitored by Sarb include impact negatively on imported inflation, pushing production
inflation expectations and labour costs. costs higher.
Inflation expectations, as measured by the Bureau of Domestically produced goods prices have also increased
Economic Research, have worsened somewhat, which may over the past few months, but increases were moderate. Prices
be the result of the high oil prices and associated fuel costs. increased from 1,8% y/y to 3,8% over the same period.
Average inflation expectations, as measured by the headline
CPI and CPIX, rose across the board during the third Current account
quarter of 2005, with expectations for 2005 rising from The current account balance has mostly been a reflection of
4,5% during the second quarter to 4,7%. Average changes in the trade balance, which has switched from a
expectations for 2006 inflation rose from 4,9% to 5,2% over surplus two years ago into a significant trade deficit.
the same period, whereas expectations for 2007 inflation Exports have declined largely as a result of the strong rand,
rose from 5,0% to 5,4%. whereas the strong currency also made imports much
The deterioration in expectations was reflected in the cheaper at a time when consumer demand was picking up.
above-inflation wage settlements during the third quarter, After a surplus on the current account was recorded
when strikes were widespread. Although second and third during 2001 and 2002, a current account deficit as a
quarter unit labour cost data are not available yet, early percentage of GDP of 3,2% was recorded in 2004. It
indications are that it may be around similar levels or higher widened to 3,8% of GDP in the first quarter of 2005, but the
than the 5,9% q/q recorded during the first quarter, with depreciating currency and concomitant improvement in
most wage settlements above 7%. exports resulted in a narrowing to 3,4%. However, this
Sarb remains concerned about the second-round effects of turnaround may be temporary.
higher fuel prices. In its MPC statement, it stated that the The trade account suffered large deficits during the third
CPIX inflation rate less fuel costs was 3,6% y/y in July and quarter, with trade deficits of R3,2 billion and R3,7 billion
August, compared with an average of 3,4% for the recorded during August and September respectively.
preceding twelve-month period. This indicates limited pass- Demand for imported goods remains firm, although the
through effects from fuel prices to the prices of other goods high oil prices and strong demand for machinery and
and services. However, this rate has already edged up from equipment may have had the largest impact on the trade
a low of 3,1% y/y in February to the current 3,5%. account. Although import volumes for crude oil so far this
Sarb expects CPIX inflation to peak at just below 6% year (January to July) have been down by 20% y/y, the
during the first half of 2006, while we expect the peak in high price means that the value of imports was still 5%
the third quarter of 2006. The CPIX inflation rate could higher y/y. Machinery and equipment imports increased
go as high as 5,8% y/y on average, but this view factors by 16,7% y/y during the first seven months of 2005, in
line with the strong overall fixed investment spending in
CPI, CPIX and PPI inflation the economy.
% change y/y The strength in domestic demand for imports and the
16
CPI direction of commodity prices and the rand exchange rate
14 CPIX
PPI will be important drivers of the current account deficit over
12
the medium term. Taking into account current projections
10
8
for the rand – which we believe will trade around current
6
levels during the next twelve months – and a continued firm
4 appetite for imported products by domestic consumers, the
2 outlook for the current account is somewhat negative.
0 Early indications of a weaker current account deficit in
-2 2005 come from the cumulative data for the first nine months
-4
of 2005. During the first nine months of 2005, South Africa’s
Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05

cumulative trade deficit nearly doubled compared with 2004, However, the softer rand provided less of a cushion
rising from R7,8 billion to R15,9 billion. against high oil prices and a further weakening could put
As a result of these factors, the current account seems set more pressure on inflation.
to weaken further over the next two years, widening from Although not the only determinant of the rand exchange
the expected 3,6% deficit as a percentage of GDP in 2005 to rate, the direction of the dollar over the next year will be an
4,6% in 2006. important driver for the rand. With the growing imbalances
in the United States’ economy, it is possible that the dollar
Interest rate risk on the upside could move weaker against the euro in 2006, which could
At its October meeting, the MPC kept the repo rate be rand-supportive.
unchanged at 7,00%, but warned about the inflationary impact A weaker dollar could translate into a stronger gold price.
of oil prices, despite little evidence of second round effects. However, the overall impact on the South African economy
It appears that the MPC also shifted its stance from a could be neutral, with the stronger rand counteracting the
more neutral position to an upward bias, stating its higher gold price.
willingness to take appropriate action to ensure that the In deriving the outlook for the rand, we have included
inflation targets are achieved. Although the MPC seems other factors such as inflation differentials, net capital
confident that CPIX inflation will not move above the 6% movements and interest rate differentials. We are expecting
upper limit of the target band, Sarb has already had to adjust a slightly higher inflation differential relative to our major
its expectations upwards from the 5,5% peak projected trading partners in 2006 and net portfolio inflows will
during its previous meeting in August. probably not match the strong flows of 2005.
With inflation expectations increasing, strong credit On average, the rand is expected to trade at USD/ZAR6,55
demand, above-inflation wage increases, rising fuel costs and in 2006.
no indication of a substantial decrease in oil prices over the
short to medium term, the MPC could be forced to make an Conclusion
upward adjustment in the repo rate over the next few months. Sarb may consider tightening monetary policy to avoid a
Given the aforementioned risks in the economy, it seems further build-up of inflationary pressures, but this may only
as if such an adjustment could come in the first quarter of happen after the full effects of the restraint on growth from
next year in the form of a 50 basis point hike. We do not high fuel prices become evident. With several economic
expect rates to rise more than a 100 basis points, as Sarb uncertainties at play, we expect Sarb to proceed cautiously
could achieve its aims with small adjustments in rates, in its efforts to achieve the inflation target.
taking into account that consumers have become more Though there is still some room for household debt to
indebted and may therefore be sensitive to relatively small shift higher, we expect higher fuel costs to cause significant
changes in interest rates. strain on households’ ability to take on more debt. Higher
interest rates should also cause the rise in their debt-to-
Rand exchange rate income ratio to subside.
Although the rand’s volatility decreased somewhat during This would have a somewhat dampening effect on
2005, it is too early to declare exchange rate volatility to be consumer spending, and also affect overall economic
structurally reduced. The rand depreciated from an average growth. With our forecast assuming higher oil prices having
of USD/ZAR6,00 during the first quarter of 2005 to USD/ a slightly negative influence on the domestic economy, we
ZAR6,42 during the second quarter, and USD/ZAR6,49 have adjusted growth projections for 2006 marginally
during the third quarter. This weakening in the exchange downwards from 4,1% to 4,0%, although projections for
rate boosted exports and resulted in increased employment 2005 were raised from 4,2% to 4,4%.
during the second quarter.

Investment overview
With one of the best quarters on the JSE on record behind them, South African investors are likely to have to contend with
much lower returns on most asset classes in the coming year. The exception may be cash, but even in that case, a rise in
returns may just be enough to counter the effects of rising inflation. Globally, there may be some value left in equities, but
valuations and risks remain high in the United States.
Equities The good South African market performance was in line

Investors on the JSE recently experienced one of the best with the bullish sentiments that extended to most other
periods on record, with the annualised return in rand terms emerging markets. Equity returns for all emerging markets
amounting to 114% in the third quarter of 2005. Because of amounted to an annualised 95% in dollar terms during the
a slightly stronger rand in the third quarter1, this return was third quarter of 2005. Bullish conditions, following higher
even higher at nearly 160% in dollar terms. GDP growth rates, lower inflation and more flexible
These exceptional returns were, of course, accompanied exchange rates, have been prevailing for some time in many
by a rerating of the overall market from a price/earnings of these economies. Emerging market equity returns have
(PE) ratio of 13,2 in early June to 15,6 in early September. consequently outperformed world equities, also on a one-
But the market also found support from strong earnings year and three-year basis (see graph below).
growth numbers, which measured 32,5% year-on-year in World equity market returns were an annualised 31,5% in
the third quarter. The solid earnings growth figures were the third quarter of 2005 and were also buoyed by still strong
evident in all major indices, with industrial sector earnings company earnings in the developed economies. In the US,
up 38,3%, financial sector earnings up 25,3%, and resources company earnings are expected to amount to 15% y/y in
up 29,6%. 2005, and both Europe (22% y/y) and Japan (25% y/y)
The high profit growth environment was also evident in should perform even better.
the continued good performance of the economy, with GDP Earnings growth rates are expected to peak at more than
growth of nearly 5% being recorded in the second quarter. 40% y/y in the fourth quarter of 2005 and should still
Based on credit demand and expenditure indicators, these remain strong during the first half of 2006. For 2006 as a
positive conditions continued into the third quarter. whole, earnings growth is expected to amount to around
The positive JSE performance was further supported by a 23% y/y for the JSE all-share index, whereas earnings
continued inflow of foreign capital. By the end of September growth could taper off to 7% y/y in 2007. This slowdown
2005, foreigners had, on a net basis, bought R39,5 billion’s in earnings growth during the latter part of 2006 is likely
worth of South African equities, which was 232% more than to occur as a result of the very high base established in
the cumulative figure at the same time a year ago. 2005 as well as the assumption of a slightly higher
interest rate environment in 2006. Therefore the total
1
Using daily closing figures, the rand actually averaged USD/ZAR6,49 in annualised return for the JSE all-share index is expected
the third quarter, compared with USD/ZAR6,42 in the second quarter. to average some 17% on a quarterly annualised basis for
However, the Barra model uses only month-end data, then annualises the
geometric means of these figures. Using only month-end closing figures, the period from the fourth quarter of 2005 to the third
the rand was USD/ZAR6,42 in the third quarter and USD/ZAR6,50 in quarter of 2006.
the second quarter of 2005.
Average JSE-sectoral returns to Average $-returns up to September 2005

September 2005 (annualised in rand) (annualised)
Resources Emerging markets bonds
Real Estate World equity 3 years

1 year
Mining World bonds Latest quarter
Insurance Emerging markets equity
Industrial SA Equity
Financials SA listed property

3 years
1 year
Banks latest quarter SA cash
All share SA bonds
0 20 40 60 80 100 120 -20 0 20 40 60 80 100 120 140 160 180

% pa % pa

Generally speaking, the outlook for emerging market cumulative amount stood at -R0,5 billion at the end of the
equities remains favourable, although these markets could third quarter.
be severely affected should investors become more risk Emerging market total bond returns were even lower than
averse. Such risk aversion could, for instance, be triggered South African bond returns in the third quarter at 16,2%
by a hard landing in US or China, a dollar or oil price (annualised in dollar terms) and world bonds recorded
shock, or sharply higher global interest rates. a -4,4% dollar return.
In 2006, earnings growth rates on global equity markets Although international oil prices have subsided
are expected to taper off to between 5% (US) and 15% somewhat, South African inflation is expected to accelerate
(emerging markets). Europe and Japan should have earnings further and could reach 6% early in 2006. This development
growth numbers somewhere in between. High valuations is likely to see bond yields rise further, which could limit
and further interest rate hikes are likely to restrain equity total returns on bonds to only some 5% in 2006. Over the
returns in the US, but Europe could fare somewhat better. next year or two, inflation is more likely to remain in a
range of between 4 and 6%, rather than falling further to
Bonds levels of, say, 2 or 3%. The following are some of the
The benchmark R157 bond yield has moved within a concerns (apart from higher oil prices) that may cause
relatively narrow range of between 8,2 and 7,7% in the third inflation to remain a low-level threat:
quarter of 2005. Total bond returns in rand terms amounted Low levels of fixed capital formation to GDP are
to only 4,5% annualised during this period, but a still very improving very slowly and higher growth has already
acceptable 26,8% was measured in dollar terms. lead to capacity constraints;
Rising inflation on the back of sharply higher oil prices Regulatory compliance costs for business are high and
and concerns about the growing possibility of a repo rate rising;
rise caused bond returns to weaken from the 13,6% and The government’s inclination to regulate and control is
15,7% recorded over respectively the past one-year and not always conducive to optimal price formation;
three-year periods. Whereas the cumulative net buying of Relatively high tax rates are further eroding the
South African bonds by foreigners amounted to more than competitiveness of South African companies;
R10 billion at the end of the second quarter, the net Privatisation no longer appears to be on the government’s
Stock market performance (using closing prices for the periods and in local currency)
Q3-2004 Q4-2004 Q1-2005 Q2-2005 Q3-2005
Index
% y/y % y/y % y/y % y/y % y/y
Nikkei (Japan) -7,0 4,7 1,3 -0,4 22,2
Hang Seng (Hong Kong) 6,8 8,5 -5,0 5,1 8,6
Xetra Dax (Germany) -3,9 8,9 3,0 6,1 10,4
Cac-40 (France) -2,5 5,0 6,5 4,0 8,8
FTSE100 (UK) 2,4 5,3 1,7 4,5 7,1
Dow Jones (US) -3,4 7,0 -2,6 -2,2 2,9
S&P500 (US) -2,3 8,7 -2,6 0,9 3,1
Nasdaq (US) -7,4 14,7 -8,1 2,9 4,6
Bovespa (Brazil) 9,9 12,7 1,6 -5,9 26,1
China (Shangai) -0,2 -9,3 -6,7 -8,5 6,9
Seoul Composite (South Korea) 6,3 7,3 7,8 4,4 21,1
JSE All Share (RSA) 16,3 7,6 5,1 6,4 19,2
PE ratios of FTSE/JSE sectors JSE and S&P 500
30 19 000 1 400
3 years
1 year
25 Latest quarter 1 300
17 000
As at 5 October 2005
20 1 200
15 000
15 1 100
13 000
10 1 000
5 11 000
900
0 9 000 JSE 800

Insurance
Industrial
Real Estate
Resources
Mining
Financials
ALSI
Banks
S&P 500
7 000 700
Jan.01 Jul.01 Jan.02 Jul.02 Jan.03 Jul.03 Jan.04 Jul.04 Jan.05 Jul.05

priority list and deregulation (for instance, in the Property market
telecommunications sector) is not happening fast enough; Listed property had another good quarter, posting an
Infrastructure overhauls and expansion imply that user annualised return of 71% (107% in dollar terms), making
charges will rise faster than overall inflation for some this the best performing asset class over both a one-year and
time to come; and a three-year period.
Rising unit labour costs and high levels of money The residential property market has already started to ease
supply and credit growth remain cyclical concerns. from the high levels of capital appreciation that prevailed
Spreads on emerging markets debt have tightened during the past three years. With rental yields still falling
significantly and this trend cannot continue for much and price increases still running at more than 17% y/y on
longer. Short-term rates are likely to rise – especially in average, direct residential property investments are fast
emerging Asia – and may cause some uptrend in yields, becoming less attractive.
implying little scope for capital gains. Valuations on listed properties have also risen to very
The US Federal Reserve (Fed) will aim for a soft landing high levels and returns should be negatively affected by
for the bond market in the hope that mortgage lending and higher inflation and interest rates in due course. Assuming
household debt will gradually ease. However, until recently, dividend yields of around 8,5% in 2006, the annualised
the rise in short rates has not really led to a rise in bond return on listed property is expected to average some 16%
yields. This is expected to change with inflationary pressure over the next year.
building, government spending likely to accelerate in the
wake of the hurricanes, and slower economic growth. Currencies
Bond yields in Europe and Japan are likewise expected to Having already reached 6,5% of GDP, the US current
rise during the course of 2006. account deficit is not likely to relent to any significant
degree soon. In addition, the $3 billion odd in capital flows
Money market that is needed daily to balance this deficit seems all the
SA cash returns in the third quarter of 2005 were 7,4% in more unlikely to be attracted, given the deteriorating
rand terms, slightly lower than the 7,8% registered over the outlook for economic growth, company profits, and bonds.
past quarter. The stronger rand meant that annualised dollar The dollar has remained strong in an environment where
returns on SA cash were 26,8% in the third quarter. the Fed has been upping rates since mid-2004, but this
South African money market rates have been very stable tightening is expected to end early in 2006, roughly at the
since April 2005, when the last repo rate decrease occurred. same time as the ECB might start to increase European
Inflation concerns, based mainly on global crude oil price rates. A narrowing interest rate differential may then offer
movements, a rising current account deficit, buoyant less support to the dollar. The US currency is expected to
spending conditions, rising household indebtedness and ease to USD1,35 against the euro by the fourth quarter of
rapid increases in credit demand, have all combined to 2006. The yen should likewise strengthen to JPY96 to the
convince the Monetary Policy Committee (MPC) to keep dollar by the end of 2006.
interest rates on hold at the past three meetings. A weaker dollar and slightly higher domestic interest
Conditions are not expected to relent easily into 2006, rates in 2006 should support the rand, but commodity prices
and second round effects resulting from the roughly 40% are not expected to continue increasing at the same rate as
y/y increase in fuel prices may soon force the MPC to during 2004/05. The South African current account deficit
consider an interest rate rise. However, any policy
tightening is not expected to be severe. At this stage, it
USD/ZAR exchange rate scenarios
would appear that a one percentage point increase in rates
during 2006 would be sufficient to ensure that inflation is 11
contained below 6%. By 2007, interest rates could, in fact,
10
move lower again.
Some emerging markets have already tightened interest 9
rates and rates in the US might still move higher to around
8
4,5% (currently 3,75%) before demand eases and
inflationary pressures subside. The European Central Bank 7
is also likely to increase its policy rate during the course of Strong rand
6 Baseline forecast
2006 and Japanese rates might edge up during the second Weak rand
half of 2006. 5
2001 2002 2003 2004 2005 2006 2007 2008

is also expected to widen and net capital inflows may very The rand is expected to remain fairly stable against the
well subside from the high levels experienced during 2005. dollar, ending 2006 at around USD/ZAR6,40. Some easing
On balance, the rand is therefore not expected to against the euro to around EUR/ZAR8,60 is expected by
strengthen to the full extent of the dollar’s depreciation. the end of 2006.
Note: Calculation of returns

In accordance with the international convention, returns on asset classes in this section are consistently based on the monthly changes in
indices in which income (interest or dividends) are included. The geometric averages obtained for, for instance, the three months of a
quarter, are then reduced to an annualised figure. Month-end figures are used for indices and exchange rates.

Residential property market
House prices in the third quarter of 2005 about R35 800, or 4,8%, in the past quarter. This is the
In the third quarter of 2005, the average price of houses in smallest difference since the second quarter of 1989, when
the so-called middle segment of the market (houses of it was 5,6%.
80m²-400m² and priced at up to R2,2 million) increased by
19,6% y/y to about R712 100 in nominal terms (up 24,8% Mortgage finance
y/y in the second quarter). This was the first time since the In the third quarter of 2005, commercial banks’ variable
first quarter of 2003 that nominal y/y house price growth mortgage rates were 10,5% on average after the repo rate
dipped below the 20% level. In real terms (after was left unchanged by the Reserve Bank at the Monetary
adjustment for inflation), house prices increased by 15,3% Policy Committee meeting in August this year.
y/y in the third quarter, compared with a growth rate of Based on an average house price of R712 127 in the
21% y/y in the second quarter of the year. During the first middle segment of the market in the third quarter of 2005,
three quarters of 2005, nominal house price growth came the monthly repayment on a new mortgage (100% over a
to 24,3% y/y, whereas real growth of 20,4% y/y was 20-year repayment period at a variable mortgage rate
recorded during this period. averaging 10,5%) amounted to R7 110. In the same
On a provincial basis, nominal year-on-year growth in quarter of last year, the comparable repayment was R6
house prices in the middle segment of the market varied 215, calculated at an average house price of R595 561
from 12,7% in North West to 39,5% in Limpopo. In the and a mortgage rate of 11,5% in that quarter. The
major metropolitan areas, nominal house price growth in the difference of R895 between these monthly repayments
third quarter of this year varied from 16,9% y/y in the can be ascribed to house prices being 19,6% higher in the
Durban metropolitan area to 25,9% in Bloemfontein. past quarter than they were a year ago, whereas the
mortgage rate was 100 basis points lower than in the third
Building costs and new and existing house price quarter of last year.
trends
In the third quarter of 2005, the cost of building a new Affordability of housing
house in the middle segment of the residential property Based on interest rate and house price trends in the third
market increased by a nominal 12,8% y/y compared with quarter of 2005, the mortgage repayment and the qualifying
the same quarter in 2004. gross income levels were 14,4% up on the same quarter last
Against this background, the average price of a new year (up 25% and 17,4% respectively in the first and second
house in the middle segment increased by a nominal 8,4% quarters of 2005). Although housing is, in general, still less
y/y to about R743 600 during the past quarter. The average affordable than a year ago according to this analysis, the
price of an existing house in the same market segment declining trend in the year-on-year growth rates of these
increased by a nominal 22,9% in the third quarter of 2005 variables is an indication that affordability has not
to about R707 800. As a result, the nominal price deteriorated during the course of 2005.
difference between new and existing houses declined to The house price-to-remuneration and repayment-to-
Average nominal price of houses Mortgage rate and inflation

Rand (80m2-400m2, ≤R2,2 million) % %
820 000 40 27
Real mortgage rate CPIX Mortgage rate
% change Price 35 24
720 000
21
30
620 000
18
25
520 000 15
20
420 000 12
15
9
320 000
10
6
220 000 5 3
120 000 0 0
96 97 98 99 00 01 02 03 04 05 96 97 98 99 00 01 02 03 04 05

remuneration ratios increased further in the first quarter of 5,6% in 2006 from an expected 4,3% in 2005. In an attempt
2005 (most recent remuneration data available). An to keep CPIX inflation within the target range of 3% to 6%,
increase in these two variables implies that house prices a moderate increase in interest rates of up to 100 basis
and mortgage repayments have increased at a faster rate points in total is projected for next year.
than remuneration and that housing has, in effect, become Against the background of nominal growth in house
less affordable. prices of 24,3% y/y in the first nine months of 2005, house
price growth of around 21% seems likely for the year as a
Outlook whole, compared with growth of more than 32% in 2004.
In view of recent trends in international oil prices, domestic In view of expected higher interest rates in 2006, the
fuel prices and the rand exchange rate, the Reserve Bank is current declining trend in nominal house price growth is
not expected to cut interest rates further in 2005. This forecast to continue into next year, with the affordability of
expectation is based mainly on the possible negative housing, especially for first-time and low- to middle-income
inflationary impact of these developments in the second half buyers, remaining an important factor over the next 12 to 18
of the year. months. As a result, single-digit house price growth of
CPIX inflation is forecast to increase to an average of between 5% and 10% is projected for 2006.
Average price of new and existing houses Affordability of housing

(Nominal) Index: 2000=100
Rand %
800 000 40 180
% difference Existing New Repayment/ Remuneration House price / Remuneration
700 000 35
160
30
600 000
25 140
500 000
20
400 000 120
15
300 000
10
100
200 000 5
100 000 0 80
96 97 98 99 00 01 02 03 04 05 96 97 98 99 00 01 02 03 04 05

House prices in the third quarter 2005 (nominal)
Small: 80–140 m² Medium: 141–220 m² Large: 221–400 m² All: 80–400 m²
Price q/q y/y Price q/q y/y Price q/q y/y Price q/q y/y
(rand) %∆ %∆ (rand) %∆ %∆ (rand) %∆ %∆ (rand) %∆ %∆
South Africa 504 563 2,3 15,1 676 059 3,8 20,9 993 548 3,5 23,0 712 127 3,0 19,6
Eastern Cape 449 737 3,3 31,2 653 927 5,0 23,7 975 642 2,0 23,2 686 181 3,8 24,3
PE/Uitenhage metro 445 018 2,0 34,3 644 400 3,2 22,1 1009 349 1,3 22,1 693 777 2,2 23,0
Rest of region 454 499 5,5 28,9 665 410 7,4 25,9 945 177 4,3 23,7 676 519 6,3 25,5
Free State 355 368 5,2 25,4 443 671 9,0 25,8 632 244 0,9 24,2 494 586 3,2 20,1
Bloemfontein 394 238 11,7 36,3 621 605 6,3 36,2 868 815 0,9 26,4 639 684 4,9 25,9
Rest of region 270 665 -8,5 4,4 343 139 8,1 34,1 469 002 0,7 29,1 379 195 1,0 21,9
Gauteng 458 508 2,8 12,0 690 272 5,8 22,1 1050 139 2,4 22,8 749 313 3,7 19,3
Greater Johannesburg 456 185 4,0 11,9 700 650 4,4 19,6 1052 466 1,6 21,3 751 530 3,7 18,2
Jhb Central & South 374 617 -3,5 3,0 648 917 4,9 15,2 1015 219 -1,8 18,8 663 486 -1,1 7,3
Jhb North & West 612 941 5,8 26,1 873 518 3,9 20,7 1248 405 3,4 15,8 971 033 3,9 23,2
East Rand 450 106 7,7 21,2 610 719 4,2 24,4 901 581 3,5 33,1 654 149 6,3 25,7
Pretoria 488 641 0,0 11,6 759 027 5,8 23,4 1129 117 3,3 22,2 814 016 2,6 18,6
Rest of region 353 211 2,0 17,8 496 758 11,7 39,9 782 818 1,9 30,6 552 791 5,2 28,2
KwaZulu-Natal 426 559 -4,6 18,9 668 471 3,5 30,0 1000 304 6,5 28,7 684 308 2,3 23,6
Durban metro 405 290 -10,8 16,8 759 611 7,8 26,0 1159 380 4,0 20,1 745 166 0,6 16,9
Rest of region 451 457 2,9 21,3 590 154 0,5 38,7 838 927 7,3 39,5 622 460 4,4 33,6
Mpumalanga 443 352 7,5 29,0 504 863 3,1 27,6 716 794 4,9 30,9 537 743 2,3 26,6
North West 395 061 2,1 6,5 449 348 -6,6 3,5 744 446 8,4 47,7 504 569 0,0 12,7
Northern Cape 322 608 2,2 8,5 408 484 -1,4 15,0 530 986 -5,5 6,3 432 994 -0,8 13,7
Limpopo 356 452 0,8 31,6 534 910 6,1 36,5 757 347 10,7 42,9 547 180 7,7 39,5
Western Cape 647 455 4,3 24,6 889 600 6,4 29,6 1255 096 5,8 20,2 863 413 5,9 25,8
Cape Town metro 670 154 5,2 28,1 910 969 8,9 31,0 1296 773 5,4 16,5 873 338 7,2 25,6
Rest of region 596 600 2,2 16,0 849 227 2,3 26,7 1193 021 6,4 26,4 843 403 4,1 25,8
House prices are based on the total smoothed purchase price of houses between 80m2 and 400m2, up to R2,2 million (including all improvements) in respect of
which loan applications were approved by Absa Bank.
Note: A more comprehensive analysis of the South African residential property market is published in the Residential Property
Perspective publication. This publication is also available on the Internet at www.absa.co.za.

Key variables and projections
2002 2003 2004 2005 2006 2007
International real output (GDP % ∆)
USA 1,6 2,7 4,2 3,5 3,1 3,1
Japan -0,5 2,6 3,7 2,2 2,2 2,0
Germany 0,1 -0,2 1,1 1,0 1,5 1,8
UK 2,0 2,5 3,2 2,0 2,1 2,3
International inflation (CPI % ∆)
USA 1,6 2,3 2,7 3,2 3,1 3,1
Japan -0,9 -0,3 0,0 0,0 0,4 0,6
Germany 1,1 1,0 1,7 1,9 1,8 1,9
UK 1,6 2,9 3,0 2,8 2,0 2,0
Commodity prices
Oil price ($/barrel, N.S. Brent) 25,03 28,50 38,04 55,98 58,00 57,06
Gold price ($/oz) 310 364 409 438 495 520
Exchange rates
EUR/USD 0,95 1,13 1,24 1,24 1,27 1,32
GBP/USD 1,50 1,64 1,83 1,84 1,88 1,85
USD/YEN 125 116 108 109 102 99
USD/ZAR 10,52 7,56 6,45 6,37 6,55 6,46
EUR/ZAR 9,92 8,54 8,02 7,92 8,29 8,50
GBP/ZAR 15,81 12,39 11,82 11,70 12,29 11,96
Interest rates (%)
USA long bond yield 5,5 5,0 5,1 4,5 4,7 4,6
Japan long bond yield 1,3 1,0 1,5 1,4 2,0 1,8
Germany long bond yield 4,7 4,0 4,0 3,2 3,8 3,6
UK long bond yield 4,9 4,5 4,9 4,5 5,0 5,2
SA prime rate 15,8 15,0 11,3 10,6 11,3 11,1
SA long bond yield 11,5 9,6 9,5 8,1 9,0 8,7
SA monetary variables (% ∆)
M3 money supply 19,0 14,4 13,5 15,5 9,2 8,4
Private sector credit 10,3 11,7 12,9 18,9 8,1 8,0
SA inflation rates (%)
PPI total 14,2 1,7 0,7 3,3 5,1 4,1
PPI imported 15,5 -4,2 -3,9 2,9 5,6 4,4
PPI domestic 13,6 3,9 2,3 3,5 5,1 4,0
CPI headline 9,2 5,9 1,4 3,7 5,9 4,9
CPI food 15,8 8,1 2,3 2,2 4,5 4,0
CPIX 9,3 6,8 4,3 4,3 5,7 4,6
SA balance of payments
Trade balance (R billion) 50,2 25,6 -0,2 -2,7 -13,5 -25,2
Current account (R billion) 8,0 -18,9 -44,4 -54,0 -73,0 -89,8
Current account (% of GDP) 0,7 -1,5 -3,2 -3,6 -4,6 -5,2
Foreign direct investment (R billion) 12,2 1,1 -6,6 25,5 32,6 27,7
Portfolio investment (R billion) -4,3 6,9 38,9 46,5 30,8 33,9
Total net capital flows (R billion) 29,1 70,7 96,5 109,4 113,5 112,4
Total net capital flows (% of GDP) 2,5 5,7 7,0 7,3 7,1 6,5
SA general government finance
Tax on income and wealth (% of GDP) 14,1 13,6 13,4 14,4 14,0 13,9
Tax on production and imports (% of GDP) 11,3 11,7 12,8 13,3 13,0 13,0
Deficit before borrowing (% of GDP) 3,3 4,7 5,1 4,0 4,5 4,5
Saving (% of GDP) -0,8 -1,6 -2,0 -0,9 -1,2 -1,2
Debt (% of GDP) 40,2 38,6 36,2 35,8 37,9 39,3
Interest on debt (% of GDP) 4,6 4,2 4,0 4,0 3,2 2,8
SA expenditure on real GDP (% ∆)
Final consumption by households 3,2 3,4 6,1 6,0 4,7 4,5
Final consumption by government 4,4 6,4 7,2 5,1 5,0 4,5
Fixed capital formation 3,7 9,0 9,4 8,3 6,5 5,4
Change in inventories (R billion) 6,8 9,2 11,4 2,3 3,9 6,2
Gross domestic expenditure 4,8 5,3 6,3 4,2 5,2 4,9
Exports 0,5 -0,9 2,9 6,5 2,4 2,4
Imports 4,9 8,5 12,9 5,4 7,0 6,6
Gross domestic product 3,6 2,8 3,7 4,4 4,0 3,8

Economic Perspective: in A Nutshell

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Economic Perspective: in A Nutshell

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Economic Perspective

Fourth Quarter 2005

Absa Group Limited 1 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 2 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 3 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 4 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 5 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 6 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 7 Economic Perspective – Fourth Quarter 2005

Monetary policy dilemma: US and Euro zone growth and

Absa Group Limited 8 Economic Perspective – Fourth Quarter 2005

policy with respect to any rapid interest rate relief. 80 0

Absa Group Limited 9 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 10 Economic Perspective – Fourth Quarter 2005

SA real GDP Private credit extension vs

5 Total private credit extension 6 mma

Absa Group Limited 11 Economic Perspective – Fourth Quarter 2005

Household debt to household disposable Household debt to household disposable

Absa Group Limited 12 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 13 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 14 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 15 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 16 Economic Perspective – Fourth Quarter 2005

Equities The good South African market performance was in line

Average JSE-sectoral returns to Average $-returns up to September 2005

Resources Emerging markets bonds

Real Estate World equity 3 years

Insurance Emerging markets equity

Financials SA listed property

All share SA bonds

0 20 40 60 80 100 120 -20 0 20 40 60 80 100 120 140 160 180

Absa Group Limited 17 Economic Perspective – Fourth Quarter 2005

PE ratios of FTSE/JSE sectors JSE and S&P 500

0 9 000 JSE 800

Absa Group Limited 18 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 19 Economic Perspective – Fourth Quarter 2005

Note: Calculation of returns

Absa Group Limited 20 Economic Perspective – Fourth Quarter 2005

Average nominal price of houses Mortgage rate and inflation

Absa Group Limited 21 Economic Perspective – Fourth Quarter 2005

Average price of new and existing houses Affordability of housing

Absa Group Limited 22 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 23 Economic Perspective – Fourth Quarter 2005

Absa Group Limited 24 Economic Perspective – Fourth Quarter 2005

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