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Cablegate: High Marks for South Africa's Economy: The Imf's

VZCZCXRO7423
RR RUEHBZ RUEHDU RUEHJO RUEHMR RUEHRN
DE RUEHSA #3092/01 2471206
ZNR UUUUU ZZH
R 041206Z SEP 07
FM AMEMBASSY PRETORIA
TO RUEHC/SECSTATE WASHDC 1511
INFO RUCNSAD/SOUTHERN AF DEVELOPMENT COMMUNITY COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDC/DEPT OF COMMERCE WASHDC

UNCLAS SECTION 01 OF 03 PRETORIA 003092

SIPDIS

SENSITIVE
SIPDIS

DEPARTMENT PASS USTR FOR PATRICK COLEMAN
TREASURY FOR TRINA RAND
USDOC FOR 4510/ITA/IEP/ANESA/OA/JDIEMOND
AF/S FOR RMARBURG

E.O. 12958: N/A
TAGS: ECON EFIN ETRD SF
SUBJECT: HIGH MARKS FOR SOUTH AFRICA'S ECONOMY: THE IMF'S
2007 ARTICLE IV REPORT


1. (U) Summary: The IMF's 2007 Article IV report for South
Africa reports that the country is experiencing record levels
of growth on account of strong domestic demand and favorable
external conditions. Planned investments in infrastructure
should expand the growth potential even further in 2007-12.
In the meantime, the strong performance is causing inflation
and has led to a large current account deficit. The current
account deficit is financed by inflows of portfolio capital,
leaving the country exposed to shifts in global investor
sentiment. The exchange rate is not seriously misaligned.
Surveys of competitiveness rank South Africa slightly above
large Latin American economies such as Brazil or Mexico.
Trade liberalization has stalled as South Africa awaits the
outcome of trade negotiations and implements a new industrial
policy. With the economy growing above capacity and
inflation rising, the SAG must decide whether to raise
interest rates further, or wait to see whether interest hikes
after mid-2006 will cool growth without further action. End
Summary

-------------------------
The IMF Article IV Report
-------------------------

2. (U) Experiencing record-high GDP growth, South Africa is
reaping the benefits of sound macroeconomic management and
favorable external conditions, according to the International
Monetary Fund (IMF). The IMF is concerned, however, that
inflationary pressures are building up in the economy and
that South Africa's large current account deficit leaves the
country exposed to a "sudden stop" in capital inflows should
investor sentiment toward emerging markets turn negative.

3. (U) The IMF's views can be found in the report of its
2007 Article IV consultations with South Africa, available at
www.imf.org/external/pubs/scr/2007. Published in July, the
report was based on consultations between IMF staff and SAG
officials and private sector representatives in South Africa
in May 2007.

--------------------------------
The Good News: Growth is Strong
--------------------------------

4. (U) Driven by strong domestic demand, South Africa's
economy is undergoing its longest expansion on record, with
GDP growing by 5 percent in 2006 for the third year in a row,
the IMF reported. Household consumption is being fueled by
growing disposable income, low interest rates (until late
2006), and wealth effects from rising asset prices. Private
and public sector investment is buoyant due to high levels of
business confidence and SAG infrastructure spending.

5. (U) The sustained expansion lifted total employment by
4.1 percent in the year ending September 2006. However, the
unemployment rate declined only modestly, to 25.5 percent, as
labor force participation rose significantly.

6. (U) As a result of investments in electricity, ports and
railways, the IMF projects that potential GDP growth will
rise from 4.1 percent per year in 2002-06 to 4.9 percent per
year in 2007-12. In 2006 alone, parastatals raised their
real level of investment by 19 percent. Note: The SAG is
more optimistic than the IMF about the outlook for capital
formation, employment and productivity. It projects
potential annual growth rising to above 5 percent in coming
years. The SAG's official goal is to achieve growth of 6
percent per year in 2010-14. End Note.

-----------------------------------------
The Bad News: The System Is Under Stress
-----------------------------------------

7. (U) The IMF views near-term prospects as broadly
favorable, with GDP growth of 4.7 percent projected for 2007.
However, the continued growth of domestic demand in
combination with capacity constraints -- as evidenced by
record-setting capacity utilization rates and emerging
scarcities of electricity, cement and steel -- is
intensifying price pressures and could widen the
already-large current account deficit. The IMF expects
inflation to remain above 6 percent in the near term. It
projects that the current account deficit will exceed 6
percent of GDP in 2007 and 2008.

PRETORIA 00003092 002 OF 003

8. (U) According to the IMF, the main downside risk lies in
South Africa's large current account deficit, which was 6.5
percent of GDP in 2006. The deficit is the result of rising
investment and low national savings, and is financed largely
by portfolio inflows, not foreign direct investment. The IMF
warns that a drying up of global appetite for emerging
markets or a substantial rise in global interest rates could
prompt a sharp depreciation of the rand, followed by equally
sharp interest rate hikes by the Reserve Bank to keep
inflation at acceptable levels. However, the Fund believes
that South Africa's strong fundamentals -- including low
external debt and a sound financial sector -- would limit the
impact of external shocks. Note: The current account
deficit exceeded 7 percent of GDP in the second quarter of
2007. End Note.

9. (U) The IMF projects that average growth in 2007-12 will
be slightly lower than the potential growth rate (4.8 percent
versus 4.9 percent, respectively). This should cause the
current account deficit to narrow to about 4.5 percent of GDP
by 2012.

---------------
Competitiveness
---------------

10. (U) The IMF noted that the rand has fluctuated without a
definite trend since mid-2006, when it depreciated markedly
after a period of turbulence in global markets. The IMF
could find no strong evidence of serious exchange rate
misalignment, though it did acknowledge that estimates of the
equilibrium exchange rate are difficult to make. The IMF
endorsed the Reserve Bank policy of allowing the exchange
rate to float while building up reserves in order to bring
South Africa's reserve balance in line with other emerging
markets.

11. (U) The Fund recommended that competitiveness concerns
be addressed by measures to raise productivity and reduce
costs, not by manipulating the exchange rate. The IMF noted
that surveys of competitiveness usually rank South Africa
slightly above large Latin American economies such as Brazil
or Mexico. According to these surveys, South Africa ranks
well on business and government efficiency. It ranks poorly
on infrastructure, broadly defined to include human capital.

-------------------
Bones of Contention
-------------------

12. (U) While praising South Africa's sound macroeconomic
policies, the IMF noted areas of disagreement with the SAG:

-- The IMF is concerned that the SAG's new industrial policy
could introduce economic distortions. It recommended that
industrial policy interventions be of short duration and
limited to cases of clear market failure.

-- The IMF suggested that the SAG resume the process of trade
liberalization and tariff simplification, which has stalled
in recent years. In reply, the SAG argued that reforms in
this area should reflect the outcome of multilateral
negotiations and be considered in the context of the new
industrial policy.

-- The IMF advised the SAG to consider revisions of labor
market laws that inhibit job creation.

-- The IMF believes that privatization would enhance the
efficiency of state-owned companies. However, the SAG
prefers to restructure parastatals and sell off non-core
assets rather than pursue wholesale privatization. Comment:
The SAG is actually creating new parastatals, such as
Infraco, a new state-owned broadband network. End Comment

-------
Comment
-------

13. (SBU) South Africa is in the enviable position of having
to manage the consequences of growth. Developments since the
Article IV report was published have only reinforced the
Fund's principal conclusions: inflation has mounted, the

PRETORIA 00003092 003 OF 003


current account deficit has widened, and the battering taken
by the Johannesburg Stock Exchange in August underscored the
economy's vulnerability to global mood shifts. The SAG has a
long-term strategy (plus the cash) to invest in
infrastructure and boost the growth potential of the economy.
With the economy growing above capacity right now, however,
authorities must decide whether to raise interest rates
further, or wait to see whether a series of interest rates
hikes after mid-2006 will finally kick in and cool growth
without further action.
Teitelbaum

© Scoop Media

 
 
 
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