The global economy in crisis implications for South

The global economy in crisis: implications for South Africa National Treasury October 2008 1

Overview • The global economy in crisis • Impact of the international environment on South Africa • Economic scenarios • What is to be done?

Crisis unleashed in August 2007 with sub-prime losses • Share prices fall as sub-prime exposure becomes clearer • BNP Paribas suspends three funds with € 2 bn exposure • Global Central Banks in coordinated liquidity injection: Fed = US$43 billion, ECB = US$214 bn, Bo. J = US$8. 4 bn • Run on UK bank, Northern rock - £ 2 bn withdrawn in 3 days. • Bo. E offers additional reserves • Mark-to-market losses of $200 bn predicted on US mortgage-related securities October • Merrill Lynch loss of US$5. 5 bn, later revised to US$8. 4 / November • Write downs announced at UBS, Deutsche Bank, Merrill Lynch, Nomura and Citigroup. December • Fed, ECB, Bo. E, Bank of Canada and Swiss National bank announce coordinated action to address short term funding markets and establish temporary currency swap arrangements. • Sovereign Wealth Funds provide funding for UBS, Morgan Stanley and Merrill Lynch. August September

…and steadily deepens through 2008 January • • • Investment banks announce further losses Largest one day losses on stock markets since 9/11 US Fed cuts rates by 125 bps in two steps over nine days March • • More coordinated interventions by CBs Bear Stearns acquired by JP Morgan Chase for $2 a share September • • Fannie and Freddie taken into ‘conservatorship’ by US govt. Lehman Brothers files for bankruptcy Remaining investment banks apply to become bank holding companies US Fed loans $85 bn to AIG October • • • DJIA loses 22. 1% in one week and highest day’s volatility in history World central banks make coordinated interest rate cuts G 7 agrees on five point plan of action, including capital injections, provision of liquidity and guarantees of bank deposits G 20 Finance Ministers and Central Bank governors called to extra-ordinary meeting, addressed by President Bush G 7 interventions precipitate stronger flight of capital away from emerging markets • •

Financial crisis turning to real economy crisis • IMF estimates that US losses will amount to $1. 4 trillion • Financial market crisis affecting several other sectors in the real economy as credit becomes harder to obtain • Danger signs: • In the quarter to September 2007, Volvo sold about 42 000 trucks. In the same period this year, they sold just 175 • House sales in the UK have fallen by close to 70 per cent from a year ago • Costs of dry bulk charter rates plunged 71. 9 per cent in October • The General Motor’s share price has fallen 88% this year, to US$3, its lowest since 1946 • GM, Chrysler and Ford have requested a US$ 25 billion bailout

… and deteriorating economic growth prospects • • Industrial production in the U. S. fell by 2. 8% (m-o-m) in Sept • Industrial production in China slowed to its lowest level in a decade • Growth in the US slowed to -0. 3% in the 3 rd quarter • Germany and the UK formally in recession • World output to fall from 4. 8% in 2007 to 2. 5% in 2008 to 2. 4% in 2009 • Advanced economies GDP growth at 0. 3 in 2008 and 2009 • African growth expected at 5. 2% for 2008 and 4. 7% for 2009 • 6 Unemployment in the US and the EU has risen to 6. 5% and 7. 5% All growth in 2009 set to come from emerging markets

Policy responses have been unprecedented • Initial responses dealt with preventing financial markets from seizing up Governments have already committed to $4 trillion to support the financial system Individual country actions may be optimal for that country, but harmful from a global perspective Guarantees of bank deposits can cause withdrawals on banks in other countries Impact of G 7 decisions impacts on emergent countries ( eg currency depreciation) – Chinese package aimed at investment in infrastructure – Globally coordinated interest rate cuts Extensive currency swap arrangements between large central banks and the US Fed • Different fiscal stimulus packages in different countries – – 7 US and UK packages aimed at reducing tax rates and supporting social security Some countries looking at supporting key sectors

Resulting in rapidly falling commodity prices Platinum and oil prices 8

…and major capital outflows in the near term hitting share prices 9

… resulting in large exchange rate movements worldwide • Reduced risk appetite creating flight to the dollar and the yen Exchange rates vs. the dollar and rand/euro and rand/sterling 10

China’s contribution to world growth still high • On average, China has contributed about a fifth of world output growth • Growth in Chinese imports has started to moderate, putting downward pressure on commodity prices • Chinese GDP growth has also moderated to 9. 0% in 3 rd quarter 2008 from 11. 9% in 2007 and 11. 6% in 2006 • 11 The IMF forecasts Chinese growth of 8. 3% in 2009.

… cools demand for commodities and results in rapidly falling prices 13

… even as income accruing to South African exporters remains relatively high for now 14 • • Terms of trade refers to the ratio of our export prices to our import prices If it is going up, we earn relatively more from trade

… and inflation is likely to fall resulting in lower interest rates over time CPIX inflation & its components Second round effects & electricity raise core inflation 15

…as household debt levels continue to moderate 16

… slower growth would lower the current account deficit. Policy aimed at maintaining investment in future and sustaining financing. Gross savings & investment 17

The critical question for SA is… where should we be when the global cycle turns? • Financial crisis giving way to real economy slowdown… for some countries = lending & borrowing seizing-up • Effects on South Africa: – ▼ commodity prices & ▼ foreign demand for exports = ▼ GDP – ▼ food and oil prices = ▼ inflation – But as ▼ rand = ▲ inflation. • Short-term adjustments on the demand side: Fiscal deficit supports consumption & investment, even as both slow relative to recent years. • In the long-term, need to be more productive, more export-oriented, with higher saving and investment, and with more rapid growth at a sustainable current account… How do we get there? 18

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

What is to be done? Monetary and fiscal options to sustain growth and macroeconomic stability What we have done in recent years: • Monetary policy focus on keeping inflation low over the long-term and sustain capital inflows. • Fiscal policy to raise saving in the economy & future economic growth. • Fiscal space created to address prolonged slowdown in growth. Where we are heading: • With growth slowing now, more difficult to maintain positive saving rate > focus on public investment. • A prudent fiscal deficit to offset weakness in exports and keep long-term interest rates low. 20

…and sustainably boost exports and investment 22

Sustaining domestic economic growth in the near-term and growing the economy for future generations • Use fiscal policy to offset short-term economic slowdown while maintaining positive saving rate. • Focus on government contribution to reducing costs of economic activity and expanding markets with infrastructure. • Monetary policy to achieve low and stable inflation and attract foreign savings. • Exchange rate flexibility allows SA to re-price lower to keep in line with other emerging market economies and maintain competitiveness. • Global economic weakness places renewed emphasis on promoting productivity growth, domestic competitiveness, and efficiency gains… implement growth recommendations. 23

… and requires addressing the international economic environment with a renewed commitment to multilateralism and mutual accountability • Monetary policy support and fiscal measures, while maintaining fiscal sustainability. • Access to finance for emerging and developing economies including through liquidity facilities and program support. • Support of the development agenda by the World Bank and other multilateral development banks (MDBs) and new facilities in the areas of infrastructure and trade finance. • Ensuring that the IMF, World Bank and other MDBs have sufficient resources to continue playing their role in overcoming the crisis. 24

Key Principles for Reform undertaken by G 20 • • Enhancing Sound Regulation • Promoting Integrity in Financial Markets • Reinforcing International Cooperation • 25 Strengthening Transparency and Accountability Reforming International Financial Institutions.

G 20 Action Plan to support Common Principles for National Plans • Enlarging participation to emergent economies in Fin Stability Forum/Standard-Setting institutions – Reviewing and aligning global accounting standards • Greater Co-operation between regulators • Reviewing mandates, governance and resource requirements of the IFIs • Agreement on the Doha Development Round moving forward • National plans must – Addressing pro-cyclical regulatory policy – Strengthening transparency of credit derivatives markets and reducing their systemic risks – Reviewing compensation practices – Defining the scope of systemically important institutions and determining their appropriate regulation or oversight – 26 Reviewing the mandates, governance, and resource requirements of the IFIs