The South African Investment Climate in a Global Context

The South African Investment Climate in a Global Context presented by Lumkile Mondi Chief Economist AFRICA INVESTMENT CLIMATE CONFERENCE 5 October 2006

Contents • Global economy • (Economic growth, inflation, balance of payments, commodities) • South African economic overview • GDP growth • Fixed investment • Balance of payments • Inflation and money supply • Consumer confidence • Employment • China • Implications for IDC

GDP growth for advanced economies: 2.7% p.a. Global economic growth Long-term average = 3.7% • The global expansion in recent years has been broad-based, with activity in many regions exceeding expectations. • The long-term outlook for the global economy remains very positive, with real GDP growth forecast to average just over 4.8% p.a. over the period 2006-2011. • Growth in developing countries is expected to continue at a fairly rapid rate, well in excess of GDP growth in advanced economies.

Global economic activity The global expansion continued for the fourth consecutive year, based on: A substantial rise in consumer spending, particularly in emerging economies Higher levels of industrial production A rapid increase in fixed investment activity Increasing trade volumes

Economic growth by region • Developing Asia, including China, has reported the fastest rate of economic growth in recent years. • For most advanced economies a slowdown in economic activity is forecast for 2007. • Africa is the only region for which a higher GDP growth rate is projected in 2007.

Africa’s economic performance • Africa is experiencing its best economic performance in almost a decade: • GDP growth increased from 2.5% in 1994 to 5.4% by 2005. • Inflation continued to decline and measured 8.5% in 2005, compared to 50% in 1994. • A substantial inflow of foreign direct investment (FDI) into the continent, with FDI inflows increasing from about USD2.4 billion in 1990 to just over USD18 billion by 2004, mainly into exploration and production facilities of commodities such as oil and other mineral resources. • Sub-Saharan Africa is currently enjoying its strongest period of sustained economic growth since the early 1970s. GDP growth of 5.2% in 2006, increasing to 6.3% by 2007. • Oil-exporting countries such as Angola, Chad, Equatorial Guinea, Nigeria, Sudan and the Republic of Congo (Brazzaville) were amongst the best performing economies on the continent in 2004 and 2005, due to the surge in global oil prices and increasing global oil demand. • Africa's strong economic growth trend in recent years is underpinned by a sharp increase in exports (mainly oil), favourable weather conditions in general, as well as fairly robust domestic demand.

Africa’s economic performance Inflation continued to decline in recent years, but is forecast to increase marginally Strong GDP growth is expected to be sustained over the next 5 years Forecast Forecast Substantially lower debt levels due to debt relief under the HIPC initiative Substantial inflow of FDI, mainly into oil and other commodities Forecast

Inflation • The sharp rise in oil prices has been reflected in increasing inflationary pressures around the globe. • Nevertheless, a rather benign inflation outlook is forecast by the IMF in its latest World Economic Outlook (September 2006).

Balance of payments Forecast • Global imbalances are likely to persist throughout the forecast period. • As oil prices are forecast to decline, oil exporting countries are also expected to experience a reduction in the surplus on the current account balances. • The depth and sophistication of U.S. financial markets has facilitated the financing of recent large current account deficits. • Despite an acceleration in export growth, the U.S. current account deficit is expected to deteriorate even further to around 7% of GDP in 2007. • Surpluses in oil exporting countries and a number of Asian countries are expected to stay high, with China’s surplus remaining in excess of 7% of GDP.

Commodities • A sharp increase in non-energy commodity prices occurred in recent years. • Higher non-fuel commodity prices have largely been driven by strong demand, particularly from China, as well as supply bottlenecks in certain cases. • Metals prices are expected to come down over the medium term as new production comes on stream to meet rising demand. • In total, non-fuel commodities represent almost twice as large a share of world trade as is the case with fuels. Hence they have an important impact on the global economic environment, both for consumers and the exporters.

Contents • 2. South African economic overview • GDP growth • Fixed investment • Balance of payments • Inflation and money supply • Consumer confidence • Employment • China • Implications for IDC

Some international comparisons GDP and Population Source: World Bank, 2003 data Wages and cost of living indicators Electricity Prices 1 – Hourly compensation for manufacturing workers 2 – A basket of goods $ services in major cities, excluding housing (New York City = 100) 3 – A 3-room apartment monthly rent in major cities, US$ Source: IMD – World Competitiveness Yearbook 2005 1 – Electricity costs for industrial clients Source:IMD - World Competitiveness Yearbook, 2005

Some international comparisons Long-term foreign currency debt ratings Investment grade decreasing risk

SA investment environment Abundant natural resources Economic stability & sound macro-economic management Excellent transport & Logistical infrastructure Competitive sectors/industries World class financial system Skills availability Favourable cost of doing business South Africa today is one of the most sophisticated and promising emerging markets globally, mainly because of …

Investment environment challenges Recent Investment Climate Survey* : • Survey revealed that overall conditions are conduciveto investment activity • However, certain obstacles remain … • Exchange rate volatility (negative perceptions) • Relatively high cost of skilled labour (shortage of specific skills) • Crime (is factor, however, widely accepted that the crime rate is declining as a result of better policing) • Lack of competition in specific sectors of economic activity where there are high levels of concentration and significant barriers to entry Commitment of SA government to engage business in improving any element of the investment climate * Survey conducted by Citizen Surveys, a private SA firm . 800 firms were surveyed between January and December 2004. 75% of sample were in manufacturing sector; 14% in the construction sector and the remaining 11% in wholesale and retail trade

Investment support by SA Government Small and Medium Enterprise Development Programme Aims to reduce the investment cost for small and medium investors, generate employment, develop entrepreneurship and promote empowerment. Offers training grants to local and foreign firms, aiming to encourage greater investment in training and create opportunities for the introduction of new skills. Skills Support Programme Industrial Development Zone Programme Aims to generate sustainable local and foreign investment and improve international competitiveness. Programme involves government provision of demand driven infrastructure. Companies operating in the manufacturing and tourism sectors qualify. Compensation includes costs incurred regarding freight expenditure, traveling expenditure, statutory requirements and local expenditure. Foreign Investment Grant Critical Infrastructure Programme Provides support for economic infrastructure required for committed productive investments.

GDP growth • The SA economy expanded at a brisk pace in Q2 of 2006, with GDP growth measuring 4.9% on a quarterly basis. • The manufacturing sector (the second largest sub-sector in the domestic economy) continued its strong performance, contributing 1 percentage point to overall GDP growth.

Fixed investment • Record high levels of investment in the residential building sector, with real growth of just over 23% in H2 of 2005 and 18.5% in H1 of 2006. • Increased investment in machinery and equipment in response to robust domestic demand and production capacity constraints. • A strong Rand also made imported capital goods more affordable. • Higher levels of economic activity in recent years resulted in more goods being transported throughout the country, thereby increasing investment in new trucks, whilst car rental companies also invested in the upgrade of their fleet.

Balance of payments • The high import intensity of fixed investment activity in SA and a substantial rise in imported consumer goods (a 60% increase over the period 2003-05) culminated in a further deterioration on the trade balance for the year to July 2006. • The trade deficit widened to a record monthly level of R7.8 bn in July 2006. • Imports increased by R47.9 bn over the first 7 months of the year, whilst exports only increased by R20.5 bn over the same period. • Import demand for capital goods (machinery and equipment) increased by close to R12 bn over the period January to July 2006.

Balance of payments • A close correlation exists between the exchange rate and the balance of payments. • The strong Rand in recent years has placed manufacturing exports under increased pressure, whilst permitting cheaper imported goods. • A widening trade deficit was accompanied by a further expansion of the deficit on the services account (increased dividend and interest payments, etc.). • The combined deficits resulted in a current account deficit of 6.1% of GDP over the first half of 2006.

Inflation and money supply • In July 2006, CPIX inflation (which measured 4.9%) reached its highest level in two years, mainly due to higher fuel and food prices, whilst administered prices also increased at a rate well above the 6% target range. • Imported prices have risen substantially on the back of higher oil prices and price increases in SA’s trading partners. • PPI reached a 31/2 year high in July 2006, measuring 8.1%. • The inflationary outlook is exacerbated by continued sharp increases in money supply and private sector credit extension. • Growth in credit extension to the private sector remains stubbornly high. • Sharp increase in credit extension is partially due to the previously disadvantaged entering the credit market for the first time. • Households will feel the squeeze of increasing debt installments, whilst rising fuel and food prices compound the problem. • This could place increasing financial strain on over-indebted households in coming months in light of more interest rate hikes.

Inflation and interest rates Recent inflation developments in South Africa • The Monetary Policy Committee (MPC), has expressed concerns about increasing inflationary pressures. • Concerns raised in the recent MPC meeting (3 August 2006) include: • Rising international crude oil prices to record highs and subsequent steep increases in domestic fuel prices • Higher food prices in recent months • Strong growth in credit extension to the private sector (measuring an increase of 26.2% in July 2006 - the highest monthly rate of increase ever). • An increase in nominal unit labour costs during the first quarter of 2006 (7.6% rise), compared to an average increase of 3.4% during 2005. • A substantial widening in the deficit on the current account of the balance of payments (6.1% of GDP in H1 of 2006)

Inflation and Interest rates Inflation outlook • According to the MPC, “The most recent forecast of the Central Bank projects inflation to peak above the 6% level and to remain outside the target range for the first two quarters of 2007”. • However, inflation is projected to decline again to a level of just over 5% by the end of 2008. Interest rates • As a result of developments on the inflationary front, the MPC increased the repo rate by 50 basis points at each of the meetings held in June and August 2006. • The repo rate now stands at 8%.

Emerging market crisis (1998) Inflation and Interest rates • In a lower inflation environment, associated interest rate cycles should be shallower than those previously seen during high inflation periods. • Interest rates are likely to be raised by another 50 basis points at the MPC’s October meeting, which could be the end of this tightening cycle. • However, if the inflation outlook deteriorates, more rate hikes may follow.

Long-term average real prime rate = 4.6% Inflation and Interest rates Negative real interest rates

Consumer confidence • Consumer confidence declined for the second quarter in a row amidst achanging economic environment with higher interest rates, rising inflation as well as a weakening currency. • A declinein confidence levels amongst high income earners could perhaps be seen as a slowdown in demand for credit and hence spending (particularly on durable goods). • Nevertheless, confidence amongstlow income earnersremains high. • A declinein confidence amongst white consumers, compared to a steep rise among black consumers.

Employment • Higher and sustained economic growth, especially since 2003, resulted in a welcomed improvement in the economy’s labour absorption capacity. • In the year to March 2006, 315 600 new jobs have been created. • Services-related sectors accounted for the majority share of all new job opportunities for the year to March 2006. • The labour-intensive construction sector reported a 22% increase in its workforce, with 87 000 new job opportunities.

SA: A catalyst for Africa’s revival With the most developed economy in Africa, a multitude of technical, logistical and financial advantages, plus a sophisticated infrastructure and a well established business sector ... … South Africa is playing a vital role in the repositioning of Africa in the global investment arena, and increasingly becoming a regional springboard for Transnational Corporations !

SA: A catalyst for Africa’s revival • No other country has matched South Africa in its success in reinventing itself • Even with a stronger currency, South Africa remains one of the least expensive countries in which to do business • Our infrastructure and professional services are world class and living standards are excellent • Crime remains a BIG challenge • Our country is rich in natural resources and investment opportunities are plentiful • Hard-earned, sound macroeconomic fundamentals have earned South Africa an investment grade rating (recently further improved) and the stage is set for robust growth • SA Government encourages investors to seek sound black empowerment partners in developing business and investment proposals

Thank You

The South African Investment Climate in a Global Context