Country Report

South Africa at a glance: 2006-07

OVERVIEW The ruling African National Congress (ANC) is expected to maintain its overwhelming hegemony during the forecast period. However, the party and its leadership will be preoccupied with maintaining party unity and an orderly process of electing a successor to as ANC president at the party!s national congress in December 2007. Economic policy will continue to focus on increasing economic growth and investment in order to create employment. Assuming a sound mix of fiscal and monetary policy combined with public- sector wage moderation, weaker administered prices and lower private-sector unit labour costs (owing to productivity gains), inflation is expected to remain within the target range of 3-6% in 2006-07. The rand is forecast to average R6.85:US$1 in 2006, and to continue to depreciate gently in the medium term. A sharper fall is possible, however: risk factors continue to be the high price of crude oil, US interest-rate movements, South Africa!s widening current-account deficit and the role of short-term speculative inflows in the capital account. Further growth in construction and continued expansion in total domestic demand is expected to support real GDP growth of 4.7% in 2006 and 4.5% in 2007. Fairly strong global demand and high commodity prices will help to boost exports, but rising imports mean that the current account is forecast to remain in deficit, at 5% of GDP in 2006, although the deficit should narrow to 4.7% of GDP in 2007.

Key changes from last month Political outlook • The corruption trial of the former deputy president, , finally started on September 5th, an event that has served to intensify divisions within the ANC. Indeed, if the trial goes Mr Zuma!s way or the case is dismissed for technical reasons, he would be a firm favourite to succeed Mr Mbeki in 2009. The stage has thus been set for a period of increasing uncertainty that will last until the end of 2007, by which time the ANC will have chosen its candidate for the May 2009 presidential poll. Economic policy outlook • The economic policy outlook remains unchanged from last month. Economic forecast • The economic forecast remains essentially unchanged.

September 2006

The Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom

The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group.

London New York Hong Kong The Economist Intelligence Unit The Economist Intelligence Unit The Economist Intelligence Unit 26 Red Lion Square The Economist Building 60/F, Central Plaza London 111 West 57th Street 18 Harbour Road WC1R 4HQ New York Wanchai United Kingdom NY 10019, US Hong Kong Tel: (44.20) 7576 8000 Tel: (1.212) 554 0600 Tel: (852) 2585 3888 Fax: (44.20) 7576 8500 Fax: (1.212) 586 0248 Fax: (852) 2802 7638 E-mail: [email protected] E-mail: [email protected] E-mail: [email protected]

Website: www.eiu.com

Electronic delivery This publication can be viewed by subscribing online at www.store.eiu.com Reports are also available in various other electronic formats, such as CD-ROM, Lotus Notes, online databases and as direct feeds to corporate intranets. For further information, please contact your nearest Economist Intelligence Unit office

Copyright © 2006 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author's and the publisher's ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it.

ISSN 0269-6738

Symbols for tables "n/a" means not available; "–" means not applicable

Printed and distributed by Patersons Dartford, Questor Trade Park, 151 Avery Way, Dartford, Kent DA1 1JS, UK.

South Africa 1

Contents

South Africa

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2006-07 7 Political outlook 9 Economic policy outlook 10 Economic forecast

14 The political scene

18 Economic policy

24 The domestic economy 24 Economic trends 27 Mining 28 Energy 29 Telecommunications 30 Infrastructure

30 Foreign trade and payments

List of tables 10 International assumptions summary 11 Gross domestic product by expenditure 13 Forecast summary 23 Business environment 24 Real GDP growth by sector 26 Inflation as measured by CPIX 31 Balance of payments

List of figures

14 Gross domestic product 14 Consumer price inflation 20 Spending on key infrastructure sectors, 2006-09 26 Household debt as a percentage of disposable income

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006

South Africa 3

South Africa September 2006 Summary

Outlook for 2006-07 The ruling African National Congress (ANC) is expected to maintain its overwhelming hegemony during the forecast period. However, the party and its leadership will be preoccupied with maintaining party unity and an orderly process of electing a successor to Thabo Mbeki as ANC president at the party!s national congress in December 2007. Economic policy will continue to focus on increasing economic growth and investment in order to create employment. Growth in construction and continued expansion in domestic demand is expected to support real GDP growth of 4.7% in 2006 and 4.5% in 2007. Fairly strong global demand and high commodity prices will help to boost exports, but rising imports mean that the current account is forecast to remain in deficit, at 5% of GDP in 2006, although this will narrow to 4.7% of GDP in 2007.

The political scene The corruption trial of the former deputy president, Jacob Zuma, has finally started, an event that has served to intensify divisions within the ruling ANC. If the trial goes Mr Zuma!s way or the case is dismissed by the court, he will be a firm favourite to succeed Mr Mbeki in 2009. The government!s position on HIV/AIDS has been complicated after the health minister was effectively sidelined on the country!s most crucial health issue by a cabinet committee. Concerns about the rising level of have intensified as the government steps up its preparations to host the 2010 football World Cup.

Economic policy The SARB raised its interest rates in August, for the second time in three months, to take the repo rate to 8%. The SARB based its decision mainly on the increasing risk to inflation posed by high international oil prices and a weaker rand exchange rate. A recent World Bank survey has ranked South Africa among the top 30 easiest countries in which to do business, but the country lags behind its emerging-market peers in effecting regulatory reform.

The domestic economy Real GDP growth rose by 4.9% in the second quarter of 2006, making the cur- rent economic upswing the longest on record. Strong consumer spending has continued to be financed by new debt, with household debt at a record high. The first fixed-line SNO was launched, to rival the largely state-owned Telkom.

Foreign trade and payments South Africa!s overall current-account deficit breached 6% of GDP in the first half of 2006 as the visible and invisible trade deficits both deteriorated. A positive turnaround for the local textile industry is expected following the government!s announcement of textile quota restrictions from China.

Editors: Pratibha Thaker (editor); David Cowan (consulting editor) Editorial closing date: September 12th 2006 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 4 South Africa

Political structure

Official name Republic of South Africa

Form of state A federal state, consisting of a national government and nine provincial governments

Legal system Based on Roman-Dutch law and the 1996 constitution, in force since February 4th 1997

National legislature Bicameral parliament elected every five years, comprising the 400-seat National Assembly and the 90-seat National Council of Provinces

Electoral system List system of proportional representation based on universal adult suffrage

National elections April 14th 2004; the next election is to be held in 2009

Head of state President, elected by the National Assembly; currently Thabo Mbeki; under the constitution, the president is permitted to serve a maximum of two five-year terms; Mr Mbeki is serving his second term

National government African National Congress

Main political parties The African National Congress (ANC) is the governing party with the support, in a tripartite alliance, of the smaller South African Communist Party (SACP) and the Congress of South African Trade Unions (COSATU); other parties include the Democratic Alliance (DA), the (Inkatha or IFP), the (ID), the United Democratic Movement (UDM), the (FF+), the African Christian Democratic Party (ACDP), the Pan Africanist Congress (PAC) and the National Democratic Convention (Nadeco)

President Thabo Mbeki (ANC) Deputy president Phumzile Mlambo-Ngcuka (ANC)

Key ministers Agriculture & land affairs (ANC) Communications Ivy Matsepe-Casaburri (ANC) Defence (ANC) Education (ANC) Finance (ANC) Foreign affairs Nkosazana Dlamini-Zuma (ANC) Health Manto Tshabalala-Msimang (ANC) Home affairs Nosiviwe Mapisa-Nqakula (ANC) Housing (ANC) Justice & constitutional development (ANC) Labour (ANC) Minerals & energy (ANC) Provincial & local government (ANC) Public enterprises (ANC) Public works Thokozile Didiza (ANC) Safety & security (SACP) Trade & industry Mandisi Mpahlwa (ANC) Transport (ANC)

Central bank governor

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 5

Economic structure

Annual indicators 2001a 2002a 2003 a 2004 a 2005a GDP at market prices (R bn) 1,020.0 1,168.8 1,257.0 1,386.7 1,523.3 GDP (US$ bn) 118,254 111,113 166,342 215,052 239,510 Real GDP growth (%) 2.7 3.7 3.0 4.5 4.9 Consumer price inflation (av; %) 6.6 9.3 6.8 4.3 3.9 Population (m)b 42.6 42.7 42.8 42.7 42.6 Exports of goods fob (US$ m) 31,064 31,771 38,700 48,238 54,580 Imports of goods fob (US$ m) -25,809 -27,015 -35,270 -48,519 -56,458 Current-account balance (US$ m) 153.0 684.0 -2,324.0 -7,442.0 -10,079.0 Foreign-exchange reserves excl gold (US$ m) 6,045.0 5,904.0 6,496.0 13,141.0 18,579.0 Total external debt (US$ bn) 24.1 25.0 27.8 28.5 30.0c Debt-service ratio, paid (%) 11.3 12.1 8.6 6.3 6.6c Exchange rate (av) R:US$ 8.63 10.52 7.56 6.45 6.36 a Actual. b UN estimates. c Economist Intelligence Units estimate.

Origins of gross domestic product 2005a % of total Components of gross domestic product 2005 % of total Agriculture, forestry & fishing 2.5 Private consumption 63.5 Mining & quarrying 7.0 Public consumption 20.2 Manufacturing 18.6 Gross domestic fixed investment 16.8 Construction 2.5 Change in stocksa 1.1 Electricity, gas & water supplies 2.3 Exports of goods & services 27.1 Financial services 21.1 Imports of goods & services -28.6

Principal exports 1997 US$ bn Principal imports 1997 US$ bn Metals & metal products 6.3 Machinery & appliances 8.9 Gold 5.6 Mineral products 3.7 Diamonds 2.9 Chemicals 3.4 Machinery & transport equipment 2.6 Transport & equipment 1.7

Main destinations of exports 2005 % of total Main origins of imports 2005 % of total UK 12.4 Germany 14.8 US 10.6 US 6.9 Japan 9.7 UK 6.8 Germany 7.3 China 6.8 a Includes residual item.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 6 South Africa

Quarterly indicators 2004 2005 2006 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Central government finance (R m) Revenue & grants 82,498 91,234 99,969 88,581 103,288 106,877 118,000 101,625 Expenditure 93,841 82,836 104,416 101,319 107,452 94,520 114,989 106,623 Balance -11,343 8,398 -4,447 -12,738 4,164 12,357 3,011 -4,998 Output GDP at constant 2000 prices (R bn) 268.13 273.52 264.48 277.19 281.15 285.43 274.85 287.22 Manufacturing index (2000=100)a 111.2 111.3 110.5 113.8 115.5 115.2 116.4 118.2 Durable goods 113.1 113.3 112.5 114.3 115.0 119.4 120.2 n/a Non-durable goods 109.3 110.3 109.6 112.8 114.9 112.7 113.2 n/a Employment & pricesa Employment, private (2000=100) Mining 110.1 109.5 107.8 106.9 106.6 104.2 n/a n/a Manufacturing 98.9 90.9 90.7 91.2 91.7 92.5 n/a n/a Construction 125.7 168.5 168.7 194.1 196.6 203.1 n/a n/a Consumer prices (2000=100) 130.1 131.3 132.5 134.3 136.0 136.7 138.1 140.0 Consumer prices (% change, year on year) 3.9 4.4 3.4 3.7 4.6 4.1 4.2 4.2 Production prices (2000=100) 127.6 127.4 126.8 129.7 132.8 133.2 133.8 137.9 Production prices (% change, year on year) 1.1 2.1 1.5 2.2 4.1 4.6 5.5 6.3 Financial indicators Exchange rate R:US$ (av) 6.38 6.05 6.00 6.40 6.51 6.53 6.14 6.46 Exchange rate R:US$ (end-period) 6.48 5.65 6.22 6.67 6.35 6.33 6.15 7.17 M2 (end-period; R bn) 762.1 818.7 836.6 876.5 927.0 961.0 1,031.8 1,050.3 M2 (% change, year on year) 22.1 14.9 15.2 20.0 21.6 17.4 23.3 19.8 Deposit rate (av; %) 6.5 6.0 6.1 6.0 5.9 6.2 6.6 6.6 Lending rate (av; %) 11.2 11.0 11.0 10.5 10.5 10.7 10.5 10.7 Money market (av; %) 7.1 6.9 6.9 6.5 6.5 6.7 6.6 6.8 Long-term gov bond yield (av; %) 9.7 8.8 8.1 8.3 8.0 8.1 7.3 7.8 JSE, all items (Dec 1960=100) 11,761 12,657 13,299 14,155 16,876 18,097 20,352 21,238 JSE, all items (% change, year on year) 31.8 21.9 24.4 40.0 43.5 43.0 53.0 50.0 Gold mining share prices (2000=100) 195.4 206.7 177.9 173.9 199.1 243.9 299.5 301.7 Gold mining share prices (% change, year on year) -22.4 -19.8 -31.6 -14.1 1.9 18.0 68.3 73.5 Sectoral trends (2000=100)a Gold mining (volume of production) 78.8 74.1 73.1 67.9 65.5 67.4 65.4 63.5 Other mining (volume of production) 125.3 121.2 129.2 128.6 126.6 122.0 121.3 126.4 Retail sales, volume 122.6 125.7 123.4 126.9 129.5 134.9 135.9 n/a Foreign trade (US$ m) Exports fob 11,683 13,357 11,768 13,726 13,293 13,183 12,687 14,305 Net gold exportsb 1,010 1,264 1,038 1,012 998 1,199 1,192 n/a Imports fob -12,290 -13,862 -12,544 -13,870 -14,527 -13,886 15,047 -16,417 Trade balance -607 -505 -775 -144 -1,234 -703 -2,360 -2,112 Balance of payments (US$ m) Merchandise trade balance fob -173 -783 -418 -69 -900 -491 -1,284 n/a Services balance -459 -120 -78 -655 -648 -217 -289 n/a Income balance -1,243 -1,041 -1,027 -1,470 -1,002 -1,368 -1,490 n/a Net transfer payments -412 -367 -463 -387 -478 -409 -487 n/a Current-account balance -2,287 -2,311 -1,986 -2,581 -3,028 -2,485 -3,550 n/a Reserves excl gold (end-period) 10,669 13,141 14,149 16,917 17,627 18,579 20,607 21,512 a Seasonally adjusted. b Balance of payments basis. Sources: South African Reserve Bank, Quarterly Bulletin; Statistics South Africa; IMF, International Financial Statistics.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 7

Outlook for 2006-07

Political outlook

Domestic politics The ruling African National Congress (ANC) is expected to maintain its overwhelming hegemony during the forecast period. The final term of office for the president, Thabo Mbeki, expires in 2009, and the debate about his possible successor, who is due to be chosen at the ANC!s national congress in December 2007, has already begun. The start of the formal proceedings in the corruption trial of the former deputy president, Jacob Zuma, is beginning to shape politics within the government!s tripartite alliance with the Congress of South African Trade Unions (COSATU) and the South African Communist Party (SACP). Mr Zuma faced a decline in his popularity after being charged with rape, but following his acquittal support for the populist leader has been surging. Mr Zuma is strongly supported by the unions, the ANC Youth Movement and the small, but influential, SACP. His ethnic Zulu background also allows him to garner support from his home base in KwaZulu-, which is boosted by a perception within the ANC that the organisation is led by members of the Xhosa tribe. Yet this ethnic underpinning has not served to restrict his popularity among other groups in a rapidly urbanising country where ethnicity is an evident but fading force. Even if Mr Zuma himself is not a viable candidate"much will depend on the outcome of the trial, since it is highly likely that the case will either have been dismissed (owing to complex technical issues) or be ongoing when the ANC leadership election is held in 2007"he represents a potent symbol for an increasingly dissatisfied constituency within the ANC. If Mr Zuma!s case is dismissed and the prosecutors are unable to file another case against him, the former deputy president would be a firm favourite to succeed Mr Mbeki as president in 2009. The stage has thus been set for a period of increasing uncertainty that will last until the end of 2007, by which time the ANC will have chosen its candidate for the May 2009 presidential poll. Indeed, the Zuma camp has sufficient strength to influence the choice of Mr Mbeki!s successor in what is shaping up to be a battle between the left and the centre along economic policy lines. The Zuma camp is likely to support a candidate perceived to be sympathetic to the left and its policies of redistribution. It will not be easy to find a candidate who can make the technocratic approach to government adopted by Mr Mbeki and his supporters sound similarly charismatic, and the current deputy president, Phumzile Mlambo-Ngcuka, does not appear to have built up a particularly strong support base within the ANC. Investors might prefer one of the other potential candidates, such as Trevor Manuel, the well-respected finance minister, or , who left politics for the private sector after losing the leadership contest in 1999. Relations between the government and its two tripartite alliance partners" COSATU and the SACP"will remain somewhat strained. Although trade union membership has been falling, COSATU has managed to broaden its

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 8 South Africa

influence, thereby reducing its reliance on public-sector trade unions"its main support base"by taking up the cause of the poor and the unemployed on the one hand and those perceived to be threatened by the government!s pro- market policies on the other. Although it is unlikely that COSATU can force the government to change direction, industrial action is expected to increase in the medium term. The trade unions are adamantly opposed to privatisation, arguing that it leads to job losses. This is probably a major reason for the government having changed tack on privatisation in the last two years. Despite these tensions, the alliance is unlikely to fragment over the forecast period. The ANC is likely to pay more attention to service delivery and poverty alleviation in an attempt to contain this dissatisfaction. The opposition parties will remain weak and fragmented. Because the ruling party is such a broad church, it has been difficult for opposition parties to establish an identity that is both credible and distinct from the ANC. Opportunism and personality clashes have also played into the hands of the ANC, widening its electoral majority and leading increasingly to a virtual one- party state. The ANC will continue to ignore the opposition parties, thus emasculating the operation of multiparty democracy. Meanwhile, the playing- field will become increasingly uneven as black economic empowerment (BEE) takes hold among major companies. In addition, the ANC will continue to conflate state and party, and state-owned media and public funds will be used to boost its electoral image. Although there are insignificant policy differences between the major opposition parties, only a credible new black leader could broker the formation of a larger unified opposition party. This is unlikely to occur in the forecast period.

International relations South Africa!s foreign policy will continue to be shaped by the objectives of the New Partnership for Africa!s Development (Nepad), an ambitious pan-African development initiative championed by Mr Mbeki. It will maintain a high level of commitment to any new round of global trade talks, in which it will ostensibly seek to champion the interests of poor African countries. In addition, Mr Mbeki will seek to strengthen and expand South Africa!s ties with Asia and the Middle East, as shown by the leading role that the country took in setting up the New Asian-African Strategic Partnership in April 2005. The crisis in Zimbabwe will continue to be the major foreign policy issue for South Africa. Mr Mbeki has used up a considerable amount of time and personal credibility in trying to solve Zimbabwe!s political crisis via "quiet diplomacy""an approach that has proved to be a failure to date. Even if the mounting economic crisis in the country forces Zimbabwe!s president, Robert Mugabe, to accept some South African conditions in return for financial support, any prospect of rapid progress towards resolving the country!s political crisis is unlikely. In the meantime, Mr Mbeki seems to be increasingly keen to support other initiatives to resolve the issue, such as the recent effort by the UN secretary-general, Kofi Annan, although to date these have achieved little.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 9

Economic policy outlook

Policy trends Economic policy will continue to be shaped by the government!s medium- term programme, the Accelerated and Shared Growth Initiative for South Africa (ASGISA), which aims to raise the average growth rate to 4.5% in 2004-09 and at least 6% from 2001-14 in order to meet the government!s objectives of halving poverty and unemployment by 2014. The spotlight will remain in particular on the expansion of infrastructure, education, health, stronger economic growth, the reform of labour legislation and the promotion of BEE. The government will remain committed to the market economy, maintaining its disciplined fiscal approach of recent years. Although the government will continue to encourage public-private partnerships, privatisation is no longer a priority because parastatals in the transport and energy sectors, in particular, are seen as key to ASGISA!s focus on expanding public infrastructure and investment. However, the government!s aim will be to boost the efficiency of state-owned enterprises by restructuring their operations and selling off non-core assets in the medium term.

Fiscal policy According to the government!s forecasts, the fiscal deficit is expected to remain well below 3% of GDP over the next three years, increasing to 1.5% of GDP in 2006/07 before easing to 1.2% of GDP in 2008/09. Fiscal revenue is forecast to rise to R446.4bn (US$64m) in 2006/07, R492bn in 2007/08 and R547.1bn in 2008/09 as real GDP growth boosts domestic revenue. Expenditure is also projected to increase rapidly, to R472.7bn in 2006/07, with provision being made to tackle the backlog in infrastructure investment; spending on infrastructure is set to increase by 14.2%, as against 11.4% in 2005/06. Higher social spending will include additional funding for new housing programmes, community infrastructure, education, health and welfare. The latest official data show that cumulative fiscal revenue for the first four months of 2006/07 (April to July) increased by 13.7%, reflecting continued strong revenue growth. Cumulative expenditure growth of 16.4% for the first four months was also ahead of the budget estimate of 13.4%. Overall, the Economist Intelligence Unit now expects the fiscal deficit to edge up to 1.5% of GDP in 2006 and to just under 2% of GDP in 2007 (calendar years). A budget deficit of this size will be funded easily through a mixture of foreign and domestic debt.

Monetary policy Monetary policy will remain focused on containing inflation, as measured by CPIX (consumer prices excluding mortgage costs), within the official target range of 3-6% per year, which is set by the Ministry of Finance and anchors the activities of an independent central bank, the South African Reserve Bank (SARB). As we expected, the SARB raised its interest rates for the second time in three months on August 4th, again instituting an increase of 50 basis points, to take the repurchase (repo) rate to 8%. The SARB based its decision mainly on the increasing risk to inflation posed by high international oil prices and a weaker rand exchange rate. These prompted the SARB to raise its forecast for CPIX inflation, to 6.2% in the first quarter of 2007"exceeding the 3-6% target range"before lowering it to 5.2% in the third quarter and to 4.8% by the end of

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 10 South Africa

2008. The recent tightening in monetary policy reverses the downward adjustment to rates that took place in April 2005. Increased volatility in emerging markets in May started a swift depreciation of the rand, while concerns about the current-account deficit, which rose to 6.1% of GDP in the first half of this year, have continued to increase pressure on the rand. There are growing signs that inflationary pressures are increasing across the economy and household debt levels are still rising despite the two rate increases. Looking ahead, it now seems certain that the SARB will raise rates again in October, taking the repo rate to 8.5%, and may opt for a further rate increase in December if the rand remains weak and consumer spending high. The SARB!s Monetary Policy Committee is expected to continue to pursue a tighter monetary policy and to increase interest rates in 2007.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2004 2005 2006 2007 Real GDP growth World 5.5 4.9 5.3 4.7 OECD 3.1 2.6 3.0 2.2 EU25 2.4 1.7 2.6 2.1 Exchange rates ¥:US$ 108.1 110.1 114.1 100.3 US$:€ 1.244 1.245 1.255 1.365 SDR:US$ 0.675 0.677 0.678 0.641 Financial indicators € 3-month interbank rate 2.13 2.15 3.06 3.86 US$ 3-month Libor 1.62 3.56 5.28 5.33 Commodity prices Oil (Brent; US$/b) 38.5 54.7 71.1 70.0 Gold (US$/troy oz) 409.5 445.0 639.5 700.0 Food, feedstuffs & beverages (% change in US$ terms) 8.5 -0.5 8.9 -4.5 Industrial raw materials (% change in US$ terms) 21.0 10.3 43.6 -3.2 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

Global economic growth (on a purchasing power parity basis) is forecast to accelerate to 5.3% in 2006, compared with growth of 4.9% in 2005. Growth is then forecast to slow slightly, to a still healthy 4.7%, in 2007, owing to policy tightening in a number of major economies. Modest growth in South Africa!s main trading partner, the EU25, of 2.6% in 2006 and 2.1% in 2007, will continue to support export volumes but make rapid growth difficult. Prices for the country!s key exports, gold and platinum, will remain high, particularly in 2006. Strong international oil prices, now forecast to average US$71.1/barrel in 2006, will keep the cost of energy imports high, although this will fall in 2007 as global supply improves and international oil prices decline to US$70/b.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 11

Economic growth Gross domestic product by expenditure (R m at constant 2000 prices where series are indicated; otherwise % change year on year) 2004a 2005 a 2006b 2007b Private consumption 683 730 758 787 6.5 6.9 3.8 3.9 Public consumption 206 217 232 252 6.9 5.6 7.0 8.5 Gross fixed investment 178 194 211 230 9.7 9.2 8.5 9.0 Final domestic demandc 1,067 1,142 1,201 1,269 7.1 7.0 5.2 5.7 Stockbuilding 15 8 2 2 0.5d -0.6 d -0.6d 0.0d Total domestic demand 1,081 1,150 1,203 1,271 7.6 6.4 4.6 5.7 Exports of goods & services 270 288 321 336 2.5 6.7 11.4 4.6 Imports of goods & services 300 331 359 389 14.1 10.1 8.6 8.4 Foreign balance -30 -42 -38 -53 -3.0d -1.2 d 0.4d -1.3d GDPe 1,057 1,108 1,161 1,213 4.5 4.9 4.7 4.5 a Actual. b Economist Intelligence Unit forecasts. c Statistical discrepancy included in total domestic demand, as recorded in South African Reserve Bank, Quarterly Bulletin. The sum of components may not equal real domestic demand for all years. d Contribution to real GDP growth (as a percentage of real GDP in previous year). e Statistical discrepancy included in total GDP, as recorded in South African Reserve Bank, Quarterly Bulletin. The sum of components may not equal real GDP.

Leading indicators suggest that real GDP growth increased by 4.9% in the second quarter of 2006, making the current economic upswing the longest on record, approaching seven years of expansion. The main driver of economic activity was finance, real estate and business services (the largest sector, with a 19.8% share), which grew by a healthy 8.6%. The other key service sectors, trade and hotels, and transport and communications, also continued to post solid growth, reflecting the rapid increases in private-sector credit following interest-rate cuts in 2004 and 2005 and from the expansion of South Africa!s black middle class. Manufacturing grew by 6.1%, owing to stronger output in several subsectors, including motor vehicle production, iron and steel, metals, machinery, petroleum and chemicals. The mining sector rebounded, growing by 3.1%, after contracting in the first quarter. However, the overall growth rate was dragged down by a recession in the agricultural sector after farmers reduced their planting of maize because of unfavourable weather. Excluding agriculture, overall real GDP growth for the second quarter reached 5.8%, up from 4.6% in the first quarter and the highest quarterly rate seen since the third quarter of 2004. For the year, average real GDP growth is forecast to remain firm, but the pace of activity is expected to moderate to 4.7%, from 4.9% in 2005. Further growth in construction and continued expansion in total domestic demand is expected to drive real GDP growth of 4.5% in 2007. In terms of domestic

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 12 South Africa

demand, private consumption is forecast to ease slightly as a substantial hike in transport costs, rising food prices and a steady rise in interest rates curb consumer demand. Real government consumption growth, which has until recently been held back by the authorities! tight budgetary controls, will remain positive during the forecast period. Public spending (mainly on infrastructure and social services), combined with ambitious infrastructure investment in core state assets, will provide the stimulus for investment and boost the construction industry. Foreign direct investment inflows will remain strong over the forecast period, but growth will be limited by the slow progress with the sale of state assets. Exports of goods and services are showing a rising trend, which is forecast to continue in 2006-07, underpinned by fairly firm global demand. Imports of goods and services are expected to continue to post positive growth as domestic demand achieves structurally higher levels.

Inflation South African inflation, as measured by CPIX, accelerated in July, to 4.9% year on year. Food prices"which hold the largest weighting in CPIX"rose by 6.7% year on year, to mark the fastest pace of price growth since July 2003. Transport costs, which are the second-largest category, continued to rise, reflecting a further petrol price increase in July, but year-on-year transport inflation eased slightly, from 8.9% in June to a still high 8.6% in July. Inflation is expected to continue to rise in the coming months, given the persistence of high oil prices, continued rapid growth in credit extension (despite a slight recent slowdown) and the weakening of the rand in recent months, which will add to imported inflation. Average annual inflation for 2006 is now likely to be at the upper end of the SARB!s official inflation target of 3-6%. Assuming a sound mix of fiscal and monetary policy combined with public-sector wage moderation, weaker administered prices and lower private-sector unit labour costs (owing to productivity gains), we expect inflation to remain within the central bank!s target range in 2007.

Exchange rates The rand fell sharply, from R6:US$1 in mid-May to R7.40:US$1 in June, as US monetary tightening sparked a turnaround in investor sentiment towards emerging markets. Although the rand settled back to a certain extent in July and August and the first half of September, global currency markets remain volatile, and further sell-offs are possible if inflationary pressures intensify or South Africa!s overall current-account deficit continues to deteriorate. Following the recent adjustments, we expect the rand to trade in the range of R7.55:US$1- R6.95:US$1 in the coming months, but tightening international liquidity and higher inflation are likely to contribute to a further fall, and we therefore expect the rand to average R6.85:US$1 in 2006 and R7.47:US$1 in 2007. However, a sharper fall is possible, the main risk factors being continuing high world oil prices, US interest-rate movements, a widening current-account deficit and the role of short-term speculative inflows in the capital account. Also, some pressure from increasing political uncertainty may fuel volatility in the currency, particularly in 2007.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 13

External sector Recent official data show that the cumulative trade deficit in the first six months of 2006 was a massive R37bn, far higher than the shortfall for the whole of 2005. We expect the trade deficit to widen further, to about US$2.4bn in 2006, driven by still strong growth in domestic demand and higher oil prices. In 2007 the trade deficit is forecast to be a lower US$1.4bn as international oil prices start to ease and a softer rand supports rising exports. Merchandise exports are expected to rise during the forecast period, supported by rising volumes and relatively strong commodity prices. Exports of mining products such as platinum, iron and coal will benefit from sustained strong demand in the Asian markets. Exports of high-value-added goods, such as vehicles, automobiles, chemicals and mining machinery, are also expected to rise. Imports in 2006-07 will continue to be boosted by the increased need for capital equipment by a number of parastatals. Although the growth in consumer demand for imports is slowing, demand remains robust and will help to sustain a high level of imports over the forecast period. The customary deficits on the services and income accounts will persist, the former being driven mainly by the increased need for imported services associated with the growth of merchandise trade and the latter by higher dividend payments abroad. The deficit on the net transfers account is expected to rise to just under US$2bn in 2007 as more revenue is transferred by South Africa to the other members of the Southern African Customs Union (SACU; , Namibia, Lesotho and Swaziland) in terms of SACU agreements. Overall, the current- account deficit is forecast to increase to 5% of GDP in 2006, before narrowing modestly, to 4.7% of GDP, in 2007.

Forecast summary (% unless otherwise indicated) 2004 a 2005 a 2006b 2007b Real GDP growth 4.5 4.9 4.7 4.5 Manufacturing production growthc 4.2 3.6 7.1 7.8 Gross agricultural production growth -1.7 5.4 5.0 4.5 Consumer price inflation (av) 4.3 3.9 5.0 4.7 Consumer price inflation (year-end) 4.3 4.0 5.3 5.0 Short-term interbank rated 11.3 10.7 11.0 12.0 Government balance (% of GDP)e -2.5 -0.6 -1.5 -1.8 Exports of goods fob (US$ bn) 48.2 54.6 59.5 62.4 Imports of goods fob (US$ bn) 48.5 56.5 61.9 63.8 Current-account balance (US$ bn) -7.4 -10.1 -12.7 -12.1 Current-account balance (% of GDP) -3.5 -4.2 -5.0 -4.7 External debt (year-end; US$ bn) 28.5 30.0 f 30.8 31.4 Exchange rate R:US$ (av) 6.45 6.36 6.85 7.47 Exchange rate R:¥100 (av) 5.96 5.78 6.00 7.45 Exchange rate R:€ (year-end) 7.64 7.47 9.45 10.28 Exchange rate R:SDR (year-end) 8.77 9.05 10.95 11.85 a Actual. b Economist Intelligence Unit forecasts. c Based on index of manufacturing production only. d End of period. e Government finance data are presented on a calendar year basis to allow comparisons with other macroeconomic data. The fiscal year in South Africa ends March 31st. f Economist Intelligence Unit estimate.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 14 South Africa

Gross domestic product Consumer price inflation (% change, year on year) (av; %)

South Africa Sub-Saharan Africa South Africa Sub-Saharan Africa 7.0 10.0

6.0 9.0

5.0 8.0

4.0 7.0

3.0 6.0

2.0 5.0

1.0 4.0

0.0 3.0 02 03 04 05 06 07 02 03 04 05 06 07 2001 2001

The political scene

Jacob Zuma's trial begins The corruption trial of the former deputy president, Jacob Zuma, finally started on September 5th, an event that has served to intensify divisions within the ruling African National Congress (ANC). Mr Zuma first appeared in connection with the corruption allegations in the Durban magistrate!s court in October last year, and prosecutors spent the intervening period collecting and examining evidence (December 2005, The political scene). Mr Zuma has cleverly depicted the charges against him as political manoeuvring designed to subdue his political ambitions. In the process, he has positioned himself as a touchstone for popular dissatisfaction within the party about everything from the government!s macroeconomic policy to the centralisation of power in the hands of the South African president, Thabo Mbeki. Mr Zuma!s populist campaign against Mr Mbeki has spread to the ANC-aligned Congress of South African Trade Unions (COSATU), which is preparing to elect national office leaders in September. Strained relations between Mr Mbeki and Mr Zuma, who were once close allies, have continued to dominate the domestic agenda and media. Mr Zuma was dismissed as deputy president in June 2005, after his former financial adviser, Schabir Shaik, was convicted of corruption, and in whose trial Mr Zuma featured prominently (June 2005, The political scene). Mr Zuma bounced back on a wave a popular support, most graphically demonstrated by his reinstatement as deputy president of the ANC by popular demand of ANC delegates. Mr Zuma!s comeback was only briefly impeded when a charge of rape was filed against him earlier this year. He was acquitted of the rape charge on the basis that sex with the 31-year-old daughter of a family friend had been consensual (June 2006, The political scene). The corruption case is likely to be dismissed, otherwise the trial will take months and is unlikely to be completed until 2007, the year in which Mr Zuma"unless convicted and imprisoned"is almost certain to challenge Mr Mbeki!s still to be chosen candidate to become South Africa!s third "post " president.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 15

The Zuma factor continues to Given the question marks over whether Mr Zuma will even be able to contest dominate the succession battle the post, the succession issue has continued to dominate domestic politics. The succession battle is already proving divisive, with Mr Zuma undoubtedly the wild card in the battle. The longer his trial persists, the harder it will be for Mr Zuma to throw his hat into the ring. Mr Zuma fears that the trial"being heard by Judge Herbert Msimang in the Pietermaritzburg High Court"will be stretched out in such a way that he will be unable to stand as party leader at a crucial ANC congress in December next year. In the ANC!s short history as a governing party, the party leader has automatically become the party!s presidential nominee and then, given the ANC!s almost total dominance of the country!s politics, the likely president. A constitutional bar prevents Mr Mbeki from standing for a third presidential term. Mr Zuma would be little more than a temporary difficulty for the ANC if there were an obvious and strong successor to Mr Mbeki waiting in the wings. However, because there is no clear heir apparent, and because Mr Mbeki has sought, with some success, to stifle debate over the succession"while stressing that he will step down once his two-term stint ends in May 2009"the Zuma factor will continue to dominate the political scene for at least the next year, if not longer. Politically, two elements of the Zuma factor are crucial. • Prior to his dismissal from office as deputy president because of his alleged corrupt involvement with the Durban businessman, Mr Shaik, Mr Zuma was the front-runner to succeed Mr Mbeki. There are many in the youth wings of the ANC, the South African Communist Party (SACP) and COSATU who are convinced that the rape and corruption accusations were designed to thwart Mr Zuma!s presidential aspirations. Mr Zuma!s acquittal on the rape charge has merely served to strengthen his position among his supporters. • Mr Zuma!s appeal is not just that he is a populist, in contrast to the academic persona of Mr Mbeki, but that he represents a powerful and important ethnic minority, the Zulus. Although it would be misleading to exaggerate the role of ethnicity among black South Africans, there is little doubt that many Zulus feel left out in the new South Africa dominated by Xhosas, a group that includes the former president, , and Mr Mbeki. Although the ethnic split matters less than the "haves/have nots" divide, it has helped to broaden Mr Zuma!s political base, and this could become increasingly important when it comes to the 2007 succession debate.

The health minister is The sheer intensity of this political drama has served to obscure a host of other

sidelined significant political developments. The already complex position of the government on HIV/AIDS has been compounded, with the health minister, Manto Tshabalala-Msimang, being effectively sidelined by a cabinet committee on the country!s most crucial health issue. The first crack became apparent at the 14th International AIDS Conference, held in Toronto, Canada, when the South African government in general, and Ms Tshabalala-Msimang in particular, was castigated by the UN special envoy for AIDS in Africa, Stephen Lewis, for being "obtuse, dilatory, and negligent about rolling out treatment". Mr Lewis was referring to the South African health minister!s stress on natural remedies (beetroot, garlic, lemons and African potatoes), and her previously expressed

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 16 South Africa

doubts about the effectiveness of anti-retroviral (ARV) drugs. This was followed by the decision of a group of 81 scientists and doctors to write a letter to Mr Mbeki saying that the minister!s health policies were ineffective and immoral. The emotional response of the signatories appears to have been backed by the government!s own statistical office, which announced that the death rate for women aged between 20 and 39 had more than tripled between 1997 and 2004, and had more than doubled for men aged between 30 and 44. In response, Ms Tshabalala-Msimang has continued to assert that South Africa has the largest ARV campaign in the world, and that about 140,000 citizens are currently provided with ARV drugs. However, that number is around half the government!s own target of 380,000 people set in 2003 and well below the estimated 500,000 who probably need them. The combination of events tipped the government!s hand, and it decided to enlarge its inter-ministerial committee on HIV/AIDS, with the deputy president, Phumzile Mlambo-Ngcuka, appointed as a spokesperson. The effective sidelining of Ms Tshabalala-Msimang constitutes an implicit retreat by Mr Mbeki, who has staunchly defended her in the past.

South Africa's crime problem Concerns about South Africa!s rising level of crime have intensified as the

re-emerges government steps up its preparations to host the 2010 football World Cup. Although official data on crime for this year are not available, indications from the private sector suggest that crime across a number of areas has continued to rise. For instance, Mutual & Federal, the country!s second largest insurer, registered 1,683 claims for stolen vehicles, an increase of 25%, for the first six months of the year. The unexpected rise was also graphically demonstrated by a bloody shoot-out that took place in the Johannesburg suburb of Jeppestown, during which four policemen and eight suspected armed robbers were killed. The government!s decision to close all 503 specialised detective units in 2003 now seems poor. The decision was intended to help to concentrate and improve detective work at station level, and better-equipped crime-prevention units were intended to take over from the specialised units. Yet the initiative appears to have diffused the impact of detective work without spreading its reach. The problem may, however, appear to be worse than it actually is. The increase in the crime rate could partly have to do with a prolonged strike by workers at security companies earlier this year. The strike was protracted, lasting three months, and gained support from workers across the country. Over the past decade the sudden spurt in the crime rate and general public paranoia about crime has been a boon to private security companies, whose employees now outnumber the police by two to one. In any case, failure to tackle the country!s crime could dent the country!s tourism and investment prospects.

The Scorpions remain largely The South African cabinet has announced that the FBI-style crime unit, the an independent body Directorate of Special Operations (the Scorpions), will remain an independent body (March 2005, The political scene). The issue was ostensibly whether the Scorpions should remain a division within the National Prosecuting Authority, become a division of the justice ministry or come under police control. Yet the success of the Scorpions, notably their involvement in the Zuma case and the conviction of Mr Shaik for corruption, led to fear in some quarters that the

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 17

establishment of the commission was, in effect, an attempt to limit the ambit of the Scorpions! powers, particularly its investigation of politicians. However, Judge Sisi Kampepe affirmed the original structure of the body, with slight amendments: notably that the political oversight and responsibility for the law enforcement component of the Scorpions should rest with the minister of safety and security. The recommendation, which, in effect, means that both justice and police ministers share responsibility for the unit, was quickly approved by the cabinet.

Press freedom is under The South African press has come under some pressure from the government

pressure in recent times. The country!s three main freedom-of-expression organisations, the South Africa National Editors! Forum, the Media Institute of Southern Africa and the Freedom of Expression Institute, have lamented a proposed amendment to the Film and Publications Act, saying that the change would be detrimental to the daily functioning of the media. The film and publications amendment bill 2006 is currently under review by parliament, with a view to tightening up the anti-pornography provisions. However, the media organisations were concerned about the proposed deletion of a clause in the Act that exempts newspapers and broadcasters from the same type of pre- publication screening and scrutiny applied to films, computer games and magazines. Despite their objections, the cabinet approved the amendments, while at the same time arguing that it had no intention of muzzling the press. The cabinet has argued that the bill should be published in its current form to allow public discourse before promulgation. Media bodies regard this decision as a tactic in the negotiation process. Although it is unlikely that the exemption will be reinstated, the way that the issue has unfolded does suggest a slight hardening of attitudes by the authorities. Although a minor issue nationally, the amendments to the Act were raised in an otherwise modestly upbeat report on South Africa!s credit rating by Moody!s Investors Services, reflecting the extent to which the issue is being monitored internationally.

The Russian president visits The latest step in South Africa!s high-profile foreign policy was a state visit by

South Africa the Russian president, Vladimir Putin"the first Russian head of state to visit the country. For Mr Mbeki and Mr Putin the visit was something of a reunion, since both were in Moscow in the early 1970s, Mr Putin as a recent graduate and soon to become a KGB officer, while Mr Mbeki was receiving military training as part of the Soviet Union!s support for the ANC!s armed combat against apartheid. However, the recent meeting between the two leaders focused on developing stronger economic and business ties. With commodity prices at historic highs, both countries are keen to foster closer business links, particularly between resource companies, since both countries are major producers of key resources, including platinum group metals and diamonds. In recent times several Russian resource companies have invested in South Africa, notably the Renova group, whose chairman, Victor Vekselberg, was one of over 20 businessmen to accompany the Russian president. Mr Putin announced that Russia planned to make multibillion-dollar investments, and business co-operation agreements were signed. A deal was announced to extend

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 18 South Africa

the sales of nuclear fuel and technology to South Africa, forming part of South Africa!s plans to expand power generation from nuclear plants over the next decade.

Economic policy

Interest rates are increased by The South African Reserve Bank (SARB, the central bank) increased its base a further 50 basis points (repo) lending rate by 50 basis points in June and August, taking the repo rate to 8%. Even with these increases, in September the SARB!s governor, Tito Mboweni, said that there were further rises in prospect. "The only way to deal with conspicuous consumption is by raising interest rates", the governor commented. Credit demand remains very strong, increasing by nearly 25% in the 12 months to July, and Mr Mboweni believes that it will take time for the rate increases to affect consumer behaviour. Higher interest rates are designed to slow consumer borrowing/spending and bolster the country!s balance of payments at a time when inflation looks likely to move above the government!s 3-6% target range and the rand is under pressure (the currency depreciated by 14% by end-July). Economists say that the inflation rate may nudge above 6% early in 2007, but after that they expect it to moderate so that the SARB can resume cutting interest rates in the second half of next year. However, there are no grounds for complacency, since the inflation data show that "administered prices" set by the government are rising rapidly, increasing by 9.8% in the year to July. There is also concern over the balance of payments, with the current-account deficit in the first half of 2006 equivalent to 6.1% of GDP"the largest figure in more than 20 years. Officials are understandably worried that this should coincide with booming prices and demand for South African mining exports, although Mr Mboweni says that the weaker rand is beginning to boost exports and industrial output, which rose by 5.5% in the first half of the year, after falling towards the end of 2005. At the heart of the problem is a surge in imports, which reached a monthly record of nearly R43bn (US$6.8bn) in July. Only part of this can be ascribed to high oil prices, and now that the housing boom"which also fuelled imports"is slowing, the focus has switched to the import-intensive spending habits of South African consumers. This explains why Mr Mboweni is so determined to push interest rates up again in October, and probably also in December. The risk, of course, is that such rate rises will undermine economic growth. As it is, the latest Reuters poll of economists, based on a July survey, forecasts growth of 4.2% in 2006, down from 4.3% in the previous survey, and the August rise in the repo rate is likely to have depressed their projections further. In October the finance minister, Trevor Manuel, is expected to reveal revised economic growth estimates when he issues his medium-term budgetary policy statement.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 19

ASGISA continues to frame The government has continued to drive supply-side reforms under the banner

supply-side interventions of the Accelerated and Shared Growth Initiative for South Africa (ASGISA), the programme of action adopted by the cabinet in July 2005 (September 2005, Economic policy). The programme aims to raise South Africa!s average economic growth rate to 4.5% over the period 2004-09 and to at least 6% from 2010-14 by identifying the main constraints to growth and intervening to remove them. Public investment in infrastructure is one of the most important of these interventions, with plans for the government and parastatals to spend R372bn over the next three years. Higher rates of economic growth and urbanisation in recent years have strained the country!s transport, energy and communications infrastructure. Logistical bottlenecks and power outages have hampered growth and exports in sectors such as mining and manufacturing. The investment programme aims to tackle these bottlenecks, with the two largest parastatals, Transnet (rail, ports and pipelines) and Eskom (electricity), spearheading the public-sector effort. In addition, the government seeks to increase investment in public housing and infrastructure in areas such as roads and commuter rail, water and sanitation, schools, prisons and public hospitals. Improving the country!s infrastructure will itself provide the basis for higher rates of growth, as well as improving living conditions. However, higher rates of public-sector investment are also expected to "crowd in" private-sector investment, raising the overall rate of investment and economic growth in the coming years.

Higher spending is earmarked Both Transnet and Eskom have announced their investment programmes, with

for infrastructure Transnet set to spend R64.5bn and Eskom planning to spend R97bn over the next five years. A key issue is how much of that spending will benefit domestic suppliers. A study by the Industrial Development Corporation earlier this year found that up to 40% of the investment spending of the two parastatals would go on imported equipment and components if there were no change to existing procurement practices. The government is, therefore, working with the parastatals and the private sector to try to boost the local content of capital spending, although the minister of public enterprises, Alec Erwin, made it clear in a July briefing that local industry would not be given preference if that meant that prices would be significantly more expensive. The focus is therefore on upgrading local suppliers rather than protecting them, and work is being done to rebuild or expand private-sector firms in industries such as the foundry industry that have suffered from lack of investment. Details of the supplier development programme were put to the cabinet in July, and the government also has a project under way to examine how to target some of the public- sector capital spending to benefit small and medium-sized enterprises.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 20 South Africa

Spending on key infrastructure sectors, 2006-09 (share of total)

Education Other Water 4.1% 5.5% Roads 7.7% 25.1% Health 9.0%

Ports and Railways 12.8% Electricity Housing 23.0% 12.8%

Source: Department of Finance, Budget Review 2006.

Municipalities' failings are put South Africa!s 284 local authorities, which have the constitutional responsibility

under the spotlight to provide basic services such as water, sanitation and electricity and local roads, are also expected to play a key role in the government!s infrastructure spending drive for the medium term. Of the total planned capital spending of R372bn over the next three years, 22% is earmarked for the local authorities. However, many of the local authorities are poorly managed and very inadequately resourced, with severe skills shortages in areas such as project and financial management, and there is growing concern about the authorities! ability to deliver on the government!s commitments to upgrade and expand services. About half of the authorities have already been identified for "special care and attention" under the government!s Project Consolidate programme, but the cabinet recently approved further measures to assist ailing municipalities in sorting out their finances and combating corruption. Through the Development Bank of South Africa, it has also established a programme that recruits retired (usually white) professionals with suitable skills who can assist municipalities. At the same time, some larger metropolitan authorities"such as Johannesburg and "would like to have greater powers to plan for and invest in urban infrastructure. A recent report on the state of the cities by the South African Cities Network (which represents the city managers of the nine largest cities) has recommended that the cities need to take full control of housing and transport. In both of these areas responsibility is fragmented between national, provincial and local government and parastatals, hampering integrated urban planning and development. The SA Cities Network estimates that public spending on urban infrastructure will total R68bn over the next three years. This includes spending for the new rapid rail system, the Gautrain; investment in the stadiums; public transport upgrades for the 2010 football World Cup; and on housing and other services.

The countdown to the 2010 An economic debate on how big a direct impact the 2010 football World Cup

soccer World Cup has started will have on the country!s overall growth and job creation has started. According to a recent University of study, the event would add only 0.28% to overall GDP growth and create about 20,000 jobs, but other forecasts are higher"the indirect benefits, in terms of attracting tourism and investment,

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 21

could be significant. The longer-term legacy of the event is likely to be greatest if the host cities can use the opportunity to develop the public transport and public spaces that their citizens need. A weekly magazine, the Financial Mail, has estimated the cost to the host cities at more than R22bn-R7.2bn on the ten stadiums, plus training facilities and infrastructure. Also linked to the event are the R15bn Gautrain rapid-rail project; plans to invest R7.7bn by the Airports Company of South Africa (ACSA) to upgrade the airports; and R600m (US$86m) to be spent on broadcasting infrastructure. The government has, so far, allocated about R12.5bn in funding, although much more is likely to be needed. Parliament has recently approved a Special Measures Bill that creates a legal framework for South Africa to fulfil its contractual obligations to the Fédération Internationale de Football Association (FIFA). The Development Bank of South Africa has been brought in to help host cities with project management and funding projections. Crime will be a key issue, and the Ministry of Safety and Security is preparing to brief FIFA on its 2010 security plans (see The political scene). Executive brain drain accelerates

One of the weakest aspects of"and greatest threats to"South Africa!s recent strong economic performance is the accelerating rate of skills emigration, especially at executive level. A recent survey by Deloitte!s Consultancy found that 39% of respondents in the sales and marketing sector had lost senior staff through emigration in the 12 months to July 2006, up from 24% the previous year. Manufacturing firms, meanwhile, lost 16% of senior executive staff to emigration (although there is no comparable figure for 2004/05). In financial services 11% of respondents reported that senior executives had left the country over the past year. According to Louise Marx, human capital manager at Deloitte!s South Africa, "We are now seeing the effects of a skills shortage in the executive market""despite the fact that executive pay has been rising much faster than inflation. In fact, Deloitte!s estimates that executive salaries increased twice as fast as inflation in the 12 months to July. According to the survey, for which more than 500 firms were polled, the main reason for the accelerated outflow is better jobs and salaries abroad. It found that 55% of respondents"up from 39% a year ago"implemented "executive retention" strategies to mitigate managerial turnover, although clearly these are having only limited success. The report also shows that one-fifth of participating firms had difficulty in recruiting management personnel, especially in sales and marketing. "The talent shortage in this field is becoming manifest", Ms Marx says. Economists are already warning that South Africa!s attempt to achieve average annual GDP growth of 6% is being threatened by the skills bottleneck. Government officials have admitted that it may be necessary to re-hire experienced white staff, displaced as part of the country!s affirmative-action and black economic empowerment programmes, and last month the deputy president, Phumzile Mlambo-Ngcuka, called for "a skills revolution to extricate us from the crisis we face", adding that "the most fatal constraint to shared growth is skills".

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 22 South Africa

Government plans "sector Concern over the supply of skills and the country!s capacity to achieve

strategies" sustained growth of 6% annually lies at the heart of the increasingly fractious debate about the role of state assistance. South African policymakers appear to be divided over the issue, amid growing signs that the Department of Trade and Industry (DTI) is gearing up for an interventionist strategy, in conflict with the broadly free-market approach adopted by the Ministry of Finance, the South African Reserve Bank and some of the top officials in the economic advisory unit of the president, Thabo Mbeki. The dispute resurfaced in August, at a trade strategy workshop in Johannesburg. At the workshop, Peter Draper, a research fellow at the South African Institute of International Affairs, warned against the DTI!s proposed sectoral strategies, saying that they were likely to raise production costs, reduce competitiveness and harm exports. In particular, he criticised the government!s much-praised Motor Industry Development Programme (MIDP), saying that its impact on both jobs and exports had been "rather muted". The MIDP, currently being revamped by the DTI, is a controversial political issue now that one of the country!s major motor manufacturers, DaimlerChrysler, has threatened to pack up and leave if the programme is discontinued. However, Frank Flatters of Queen!s University, Ontario, Canada, supports Mr Draper, saying that the South African government should forget targeted interventions in specific sectors and instead concentrate on other factors that are undermining competitiveness. Mr Flatters calculates that more than 70% of the R550bn MIDP went to just four major automakers, adding that renewing the MIDP would be "tantamount to injecting more steroids into those groups." Meanwhile, a draft strategy for the clothing and textile sector that has been circulated for discussion proposes state intervention, although the document concedes that this could contravene World Trade Organisation regulations. Proposed measures include government grants to finance industry "re-tooling", tax rebates and preferential lending (interest) rates. As the industry!s problems deepen, owing largely to Chinese and other Asian competition at home and abroad, so industry pressure for more state support will mount (see Foreign trade and payments). Once this is agreed in clothing and textiles, as well as the vehicle industry, economists fear that such sectoral strategies could become the norm in South Africa, especially ahead of parliamentary and presidential elections in 2009, at which the economy, poverty and unemployment will be the main battleground.

Red tape is hampering A recent survey by the Bureau for Economic Research at Stellenbosch

business activity University found that labour regulations and official red tape were the most debilitating constraints to business activity. The survey, which asked business people about the economic growth constraints identified in the ASGISA programme, also found that state leadership and capacity, infrastructure deficiencies and costs, and labour skills were the key issues hampering business activity and, by extension, economic growth. The four factors at the top of the list were labour regulations (which 45% rated as a serious or debilitating constraint), electricity supply problems, official red tape and government policy support. The government was on the right track by

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 23

addressing these constraint areas in terms of its ASGISA strategy. However, the survey results suggest that the problem most in need of urgent action is the government!s interface with business"regulations and red tape, and poor services and infrastructure were all factors holding back South Africa!s economic growth and employment potential.

South Africa ranks favourably Another survey that identified "red tape" as a constraint to economic growth

in Africa for doing business and development was the annual edition of the World Bank report, Doing Business in 2007, which measures countries on factors such as the ease of hiring and firing labour, starting or closing a business, complying with tax laws and securing credit. The attractiveness of the World Bank measures is that the indicators are objective (rather than reflecting perceptions)"based on the number of procedures, costs relative to income and time spent on various administrative tasks. The data are relatively easy to collect and are comparable across countries. Another attractive feature is that many of the aspects covered are seemingly easy to implement"in some cases all that is required is the stroke of a minister!s pen. These indicators do not, however, amount to a measure of the overall business environment. They do not account for a country!s market potential, infrastructure, the security of property or macroeconomic and political stability. From a global perspective, the survey found that South Africa was still among the top 30 easiest countries in which to do business (though it ranks near the bottom of the top 30), and was the only African country on the list. However, South Africa lagged behind its emerging market peers in effecting regulatory reform. South Africa has done little to make it easier to do business over the past year, while many other emerging markets, including several African countries, have started to reform more rapidly.

Business environment Mauritius South Africa Namibia Thailand Malaysia Starting a business No. of procedures 6 9 10 8 9 Time (days) 46 35 95 33 30 Dealing with licences No. of procedures 21 17 11 9 25 Time (days) 145 174 105 127 281 Registering property Time (days) 210 23 23 2 144 Protecting investors Investor protection index (0–10) 7.7 8.0 5.3 6.0 8.7 Paying taxes Taxation of gross profits (%) 24.8 38.3 25.6 40.2 35.2 Trading across borders Time for export (days) 16 31 32 24 20 Time for import (days) 16 34 25 22 22 Overall rank Worldwide (out of 175) 32 29 42 18 25

Source: World Bank, Doing Business in 2007.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 24 South Africa

The domestic economy

Economic trends

The economic upswing Real GDP growth remained robust in the second quarter of this year, at 4.9%,

continues in second quarter bringing the length of the current upswing to the 31st consecutive quarter, and suggests that the upward phase of South Africa!s longest "business cycle" since 1945 is still under way. The previous economic upswing, in 1993-96, lasted only about half as long as the current one. The second-quarter figure exceeded market expectations and was in line with a growth rate of nearly 5% for the whole of 2005. A pick-up in the manufacturing sector, to 6.1% in the second quarter from 4.3% in the first quarter, helped to drive output growth. Manufacturing remained the economy!s second-largest sector, accounting for about 16% of GDP, but it had underperformed late in 2005 and early in 2006 as the strong rand curbed export competitiveness and exposed manufacturers to intense competition from imported goods (particularly from Asia). The financial and business services sector, the economy!s largest, at nearly 20% of GDP, continued to provide the strongest impetus to growth, sustaining quarterly growth rates of more than 8%. Retail and wholesale trade also continued to be significant growth drivers. However, it is construction, one of the economy!s smallest sectors, at about 2%, that has been growing the fastest, reflecting a building boom in the residential market but also, increasingly, a step-up in infrastructure spending by the public sector, in particular the parastatals. After contracting for three successive quarters, the mining sector expanded by 3.1% in the second quarter, owing mainly to a weaker rand and strong commodity prices. Although gold output continued to suffer as a result of the mature nature of the industry, production of other metals, led by platinum, posted an increase. For the second half of the year the Economist Intelligence Unit expects economic growth to subside, reflecting the impact of higher inflation and interest-rate increases. We continue to forecast average growth of 4.7% for the year"GDP data are subject to upward revisions in November and are likely to post close to the official growth target of 4.5% for the whole of 2006.

Real GDP growth by sectora (% real change, unless otherwise indicated) 2005 2006 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Finance, real estate & business services 10.6 4.2 4.5 3.7 8.8 8.6 Manufacturing -2.3 7.9 5.6 -0.3 4.3 6.1 Trade & hotels 5.8 6.9 6.3 9.0 5.1 6.1 Transport & communications 5.1 6.3 6.1 6.5 4.9 5.6 Mining 9.6 2.1 -3.4 -5.4 -4.4 3.1 Agriculture 6.4 2.9 10.2 3.9 -18.8 -33.0 Construction 11.2 12.7 9.5 12.4 13.7 14.0

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 25

Real GDP growth by sectora (% real change, unless otherwise indicated) 2005 2006 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Power & water 0.3 0.3 -1.7 3.5 3.6 4.0 Government services 1.9 1.2 0.9 1.9 1.2 1.5 GDP (incl others) 4.6 5.3 4.1 3.2 4.0 4.9 a Annualised change from the previous quarter, seasonally adjusted. Source: Statistics South Africa.

Expenditure continues to post This year real gross domestic expenditure also increased, by 14.5% in the first

strong growth quarter, driven mainly by faster growth in fixed investment and inventory accumulation. Buoyant household spending and fixed investment both helped to drive overall expenditure growth, although government consumption spending slowed in the first half. Consumer spending, which accounts for nearly two-thirds of overall GDP, increased by a high 7.5% in the first half of this year, compared with 7% for 2005. Much of the spending has been on durable goods such as new cars and appliances, reflecting high levels of consumer confidence and increases in disposable income, as well as the low interest-rate environment and falling prices of imported goods because of the stronger rand.

Spending is financed by debt Much of the spending spree has, however, been financed by new debt, with household debt as a percentage of disposable income rising to a record high of nearly 67% in the first half of the year. Although the overall debt burden level is high (by South Africa!s historical standards), it remains affordable, with debt- service costs at about 7% of household disposable income. In addition, a high proportion of the debt is in mortgages, and therefore represents household investment rather than consumption; vehicle finance is also a significant contributory factor. The expansion of the black middle class, many of whose members have become suburban homeowners for the first time, has been a major factor driving the increase in the overall household debt level. Therefore, although some of the expansion in consumer credit (and consumer spending) in recent years has been cyclical in nature, it also reflects important structural changes in the economy and in South African society. There is concern, however, that many of the consumers who have taken on debt in the current cycle are first-time borrowers, a proportion of whom took out mortgages at the bottom of the interest-rate cycle, and it is not yet clear how vulnerable these households are to the interest-rate rises.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 26 South Africa

Household debt as a percentage of disposable income

80 70 60 50 40 30 20 10 0 1995 96 97 98 99 2000 01 02 03 04 05 Jan-Jun 06

Source: South African Reserve Bank, Quarterly Bulletin, June 2006.

Consumer inflation is South Africa!s inflation, as measured by CPIX (the consumer price index

edging up excluding mortgage interest payments) rose to 4.9% in July, from 4.8% in June, taking it to its highest level since June 2004, when it reached 5%. Higher food and fuel prices were the main drivers of the July figure, although increases in homeowners! costs and rents, which are surveyed once a year, were also contributing factors. Although the July increase was slightly above market expectations, it was still well within the official target band of 3-6% and there are still only minimal signs of second-round effects from this year!s steep increases in fuel prices, with core inflation (excluding food and petrol) below the bottom end of the target range, at 2.6% in July, up from 2.2% in June. As a further sign of underlying pressure, producer price inflation increased by a substantial 8.1% in July"the highest year-on-year rate of increase since January 2003"largely because of an 18.3% increase in the price of agricultural goods, higher fuel prices and the weaker rand. Cuts in fuel prices are expected in September and October, and these should help to stabilise consumer inflation in the coming months, before it climbs later this year and early next year, peaking in the first quarter. Although forecasts from the South African Reserve Bank (SARB, the central bank) show it breaching the 6% top of the target range in the first quarter of 2007, there is little risk that inflation will breach targets for the remainder of 2006, and we continue to forecast that CPIX will average 5% for the year.

Inflation as measured by CPIXa 2005 2006 Year Jan Feb Mar Apr May Jun Jul Index (2000=100) 134.9 137.7 138.0 138.6 139.2 140.7 140.7 142.2 % change, year on year 3.9 4.3 4.5 3.8 3.7 4.1 4.8 4.9 a CPIX is the consumer price index excluding mortgage interest. Source: Statistics South Africa.

The rand has weakened The rand, which had depreciated sharply from mid-May as a result of

signficantly heightened emerging-market volatility, began to appreciate again in June and July, but was then hit by concerns about South Africa!s increasing current- account deficit in the subsequent months. The rand has depreciated sharply, from R7.07:US$1 in July to R7.50:US$1 in mid-September (losing around 12% of

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 27

its value). Although the SARB!s current non-intervention policy has helped to boost the confidence of the financial markets, there is an ongoing debate about the appropriate level for the rand. The Accelerated and Shared Growth Initiative for South Africa (ASGISA; the programme of action adopted by the cabinet in July 2005) identifies the level and volatility of the exchange rate as one of the "binding constraints" to economic growth, although the IMF says in its recent report on South Africa that it can find no compelling evidence for this assertion. Those who would like to see a weaker rand argue that it would help to boost non-commodity exports (manufactured goods and services), curb imports and narrow the current-account deficit. Against this, it is argued that manufacturers have adapted to a stronger rand by improving productivity, and that a weaker rand is damaging for inflation, particularly at a time of high oil prices. As a result, we foresee little risk of a major rand crash in the coming months, despite the current volatility. Moreover, foreign-exchange reserves (excluding gold) have remained strong, climbing from US$18.6m at the end of 2005 to a new peak of US$21.5m at the end of June 2006, representing an estimated 3.8 months of import cover. Also, higher inflows of foreign direct investment" Russia!s Renova group is expected to invest US$1bn in the local ferro-alloy industry over the next three years"and other short-term capital inflows, such as those through the domestic bond and equity markets, will remain supportive of the rand. We expect the rand to continue to weaken gently for the remainder of the year, partly as a result of the rising deficit on the overall current account.

Mining

Ultradeep-level mining sets a Surging international metal prices have revived some new investment interest

new world record in South Africa!s mining sector, but such expansion projects are taking place only where gold grades are considered high enough to offset the substantial cost of operating deep mines. In July TauTona mine, part of the AngloGold Ashanti group, "celebrated" a new record mining depth, a fact that it said it intended registering with the Guinness Book of Records. The mine reached 3,778 m below ground level and the achievement was marked by the installation in the shaft of a plaque inscribed, "The deepest man-made hole in the world". AngloGold plans to expand the mine to 3,902 m below ground level in March 2007. In addition, Gold Fields has announced plans to dig deeper at the Driefontein mine, thus extending the mine!s lifespan by 13 years, to 2035, and produce additional gold reserves of 8.8m troy oz. Nonetheless, major players such as AngloGold Ashanti, Gold Fields and Harmony are keeping their options open owing to the increasing difficulties and costs of mining at unprecedented depths. For instance, a new mine in South Africa as deep as 4 km costs upwards of US$1bn and could take 10-12 years to bring into production. Owing to this consideration, together with the overall downturn in the country!s gold production in recent years"due to closures of unprofitable shafts, a decline in high-quality reserves and a rise in unit labour costs"mining companies have been increasing their investments in other African and global mines. For example, AngloGold Ashanti has signed two joint-venture agreements, one with a leading Chilean copper

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 28 South Africa

producer, Antofagasta, and one with a Toronto-listed company, Bemba Gold, to explore gold and copper in Colombia. AngloGold is also updating a feasibility study for the US$1bn Quellavaco copper project in Peru, which was shelved during the copper price recession in 2000. Whatever the short-term trends in gold prices, it seems likely that there will be further examples of mining companies broadening their focus in terms of minerals targeted as well as operational locations.

Energy

New energy regulator accuses On July 28th the new National Energy Regulator of South Africa (Nersa)

Eskom of negligence released the findings of the task team that was commissioned to investigate the causes of a series of power outages in the between November and February (March 2006, The domestic economy: Energy). It found that there had been negligence on the part of South Africa!s state-owned electricity utility, Eskom. This reflected the fact that maintenance procedures and policies for substations and transmission lines were inadequate in certain cases, and that there were flaws in the configuration management system and commissioning procedures. Nersa found that Eskom had breached its licensing conditions in the Western Cape and was negligent, and is considering various sanctions. Nersa did, however, commend Eskom for developing a detailed and comprehensive Western Cape Recovery Plan, and said that there had already been improvements that had helped to avoid frequent power outages during the winter months. It is significant that the new regulator has been so critical of Eskom, demonstrating its willingness to challenge the utility. Eskom has said that it does not accept the Nersa findings, which it fears could expose it to legal action by companies or individuals that suffered losses as a result of the power outages. Nersa did not probe an accident that took place in December at the Western Cape!s nuclear power station, Koeberg, because at the time it was under investigation by the police and the National Intelligence Agency for suspected sabotage. However, the public enterprises minister, Alec Erwin, announced in August that no evidence of sabotage had been found. The accident was a major factor in the power outages because it put one of Koeberg!s two units out of action at a time when the other unit had been shut down for maintenance, but the affected unit is now back in operation.

An investigation into fuel An investigating team headed by an advocate, Marumo Moerane, which was shortages is launched commissioned by the minister of minerals and energy to establish the causes of the fuel shortages experienced during December throughout South Africa, said that the shortages exposed underlying structural and regulatory weaknesses in the sector. There had been talk that the industry was breaching agreements with the government and should be held liable for the shortages in stock in December. However, the investigation concluded that the shortages had been the result of a "convergence of a number of events". Among these were the approach taken to introducing new fuel specifications with a January deadline, refinery shutdown troubles, low stock levels and inadequate logistical infrastructure. The investigation warned that if the weaknesses in the sector

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 29

were not addressed, petroleum product supply shortages could become a more frequent problem. A plan to prevent another supply crisis emerging in the second half of this year because of scheduled refinery shutdowns has also been recommended.

Plans for another synthetic The Moerane investigation also raised the question of whether South Africa

fuels plant are mooted needed more refineries, but did not probe this in detail. However, Sasol, the oil- from-coal producer that meets just under 30% of South Africa!s fuel requirements, put the new refinery issue firmly on the agenda in its submissions on a proposed windfall tax on synthetic fuels. The finance minister, Trevor Manuel, said in his February budget speech that the government was considering imposing a windfall tax on synthetic fuels and had appointed a task team to study this. The task team held public hearings, at which Sasol warned that the country would need a new, 150,000-barrels/day (b/d) refinery by 2011 because of the demand created by high rates of economic growth. It argued that a synthetic fuels plant would create many more jobs than a crude oil refinery, as well as protecting the balance of payments. It has now been confirmed that Sasol and the government are in talks on a greenfield coal- to-fuel refinery with capacity of at least 80,000 b/d.

Telecommunications

A second national operator South Africa finally launched its first fixed-line, second national operator (SNO), has finally been launched Neotel, as a rival to the largely state-owned fixed-line telecoms operator, Telkom. The launch has been delayed for a number of years by a complicated bidding process and the partial listing of Telkom on the Johannesburg Stock Exchange. Neotel has announced plans to invest US$1.53bn over the next decade and will begin operating for large corporate customers from December. It will initially focus its operations in the key cities"Johannesburg, Cape Town, Durban and Tshwane (Pretoria)"and its largest shareholder, VSNL, an Indian operator that is a subsidiary of the Tata Group, will provide access to international networks. According to local analysts, the SNO is estimated to capture 20% of the market and, importantly, put downward pressure on prices. Comparative research produced in 2004 found that South Africa!s telecommunications charges "were generally more expensive and price increases in recent years were also generally higher than in most countries". A research company, Efficient Research, found that "in some cases telecommunication costs in South Africa are extraordinarily high". The long run-up has provided Telkom with ample opportunity to extend its dominance, and as a result the new provider is likely to capture around 20% of the market. Neotel has set itself only modest goals and has declared itself against "entering into a price war" with its much larger rival. Still, the advent of a new player constitutes a step forward and will probably tend to mute future price increases.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 30 South Africa

MTN is to launch Irancell South Africa!s MTN is to launch its Irancell mobile-phone service for Iran towards the end of September and envisages a rapid build-up of subscribers, to some 2.5-3m, by May 2007, the company!s chief executive, Puthuma Nhleko, announced in Johannesburg on August 30th. Mr Nhleko described the Iran operation as the firm!s "fastest roll-out" to date, although South African financial analysts noted that MTN!s end-2006 target for Iranian subscribers had been trimmed to 1m, from an earlier 1.5m. MTN secured the Iranian licence in late 2005 after Turkcell, which had been placed first in the original tender, objected to the change in commercial conditions whereby the foreign operator would not be allowed a majority stake. MTN, which was placed second in the tender, has a 49% equity holding in Irancell. The 15-year licence is based on an upfront fee of #300m (US$375m) plus a revenue-sharing formula. Iran has one of the lowest levels of mobile-phone penetration in the Middle East.

Infrastructure

The construction of the The construction of the Gautrain Rapid Rail Link commenced in early

Gautrain begins September, after the High Court in Tshwane (Pretoria) ruled against property owners who sought to stop the train running through their areas. The Gautrain is a public-private partnership that is intended to provide an alternative to the increasingly congested roads connecting Tshwane, Johannesburg and Johannesburg International Airport (which has just been renamed Tambo International Airport), and is scheduled to begin operating in 2010. The total development cost to the government of the Gautrain project is R20bn (US$3.14bn), with a further R2.4bn investment to be made by the private-sector concessionaire, the Bombela consortium, that will build and run the Gautrain. Although it had originally been hoped that the project would be completed in time for the 2010 soccer World Cup, it now seems that only the first phase, involving the routes between Sandton and the airport, will be ready in time for the World Cup. The rest will be completed only nine months later.

Foreign trade and payments

The current-account deficit Recent data from Statistics South Africa indicate that the deficit on the current

breaches the 6% of GDP mark account jumped from 4.2% of GDP for the whole of 2005 to 6.4% of GDP in the first quarter of 2006"the highest ratio since 1982"and narrowed only slightly in the second quarter, to 6% of GDP, as the visible and invisible trade deficits continued to deteriorate. The substantial widening of the current-account deficit has raised concerns about a growing macroeconomic imbalance in the country. After increasing strongly in 2005, the value of exports rose only marginally (due to a 3.5% drop in the volume of gold exports and a further decline in manufactured exports), while imports rose faster (boosted by rising consumer demand and high oil prices), causing the trade deficit to widen to R7.9bn (US$1.3bn) in the first quarter of 2006. It is clear that South Africa!s trade structure has undergone significant changes over the past decade, reflecting the increased openness of the economy. Crude oil has steadily increased as a share of total imports, to 12%, from 8% in 1995,

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 South Africa 31

while capital equipment imports have declined from about 45% of all imports in 1995 to 36% in 2005. Vehicle components have risen as a share of imports, from 2% to 9%, as a result of the expansion of the motor industry under the Motor Industry Development Plan, which has enabled vehicle exports to rise from only 2.5% of total exports in 1995 to 8% in 2005. However, while vehicle exports have risen, so have vehicle imports, which have doubled their share of total imports to 10%, with passenger cars driving most of the increase. The deficits on both the services and income accounts also continued to widen in the first quarter of this year, owing to increased dividends and interest payments to non-resident investors. For the remainder of the year the Economist Intelligence Unit expects further improvements in commodity prices to partly offset the impact of falling export volumes but the continuing high oil prices and strong domestic demand to lead to a widening of the trade deficit, with the current account forecast to remain in deficit in 2006.

Balance of payments (R m) 2005 2006 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Merchandise exports 68,699 82,890 85,018 84,043 78,666 Net gold exports 6,226 6,474 6,495 7,828 7,333 Merchandise imports -77,422 -89,808 -97,363 -95,085 -93,883 Net services -468 -4,202 -4,213 -1,417 -1,778 Net income -6,135 -9,434 -6,520 -8,945 -9,155 Net current transfers -2,763 -2,486 -3,114 -2,672 -2,997 Current-account balance -11,863 -16,566 -19,697 -16,248 -21,814 Capital & financial account 26,756 26,602 10,109 6,352 46,592 Net direct investment 736 4,532 30,475 4,413 10,234 Net portfolio investment 10,072 23,740 4,071 -7,509 49,822 Overall balance of payments (incl others) 4,490 18,575 4,586 6,612 11,596

Source: South African Reserve Bank.

Strong capital inflows To date, the deficit on the current account has been more than comfortably

continue to finance the deficit financed by large capital inflows. In the first half of this year the surplus on the capital account of the balance of payments grew to R62.1bn, compared with the record surplus of R70bn for the whole of 2005. The capital account surplus was equivalent to 7.7% of GDP in the first half of 2006, up from 6.5% of GDP in 2005. Net portfolio investment remained highly significant, and mainly involved the purchase of shares, rising to a record level of R88.7bn, while net direct investment inflows amounted to R12.1bn. Overall, a strong balance-of-payments surplus was recorded in the first half of 2006, and the net positive position was reflected in the steady build-up of foreign-exchange reserves. These reached US$20.2bn at the end of June, equivalent to about 3.8 months! import cover. However, capital inflows eased slightly from May, with net foreign purchases of South African equities turning negative. Although the current-account deficit is expected to continue to be financed easily by inflows on the financial account of the balance of payments, risk aversion to emerging markets needs to be monitored carefully, since it may encourage investors to switch their equity portfolios to developed economies in the coming months.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 32 South Africa

A turnaround is possible for South Africa!s textile producers could face a turnaround in the struggle against textile producers the strong rand and more competitive foreign producers. Cheap Chinese imports have continued to make rapid inroads into the local market. At present, 40% of fabric, 60% of textile and 86% of clothing imports are from China. However, the negative impact of these imports on both employment and output of the domestic industry has prompted the government to implement quota restrictions on clothing and textile imports from China, effective from January 1st 2007 for a period of two years"the deadline has been extended from its initial recommendation of end-September following a meeting between the Department of Trade and Industry, manufacturers, retailers and union representatives from the clothing and textile industry. It is estimated that total employment in the sector has halved, with 67,000 jobs having been lost in the clothing, textile and footwear sector over the past four years. The purported aim of the quotas is to give the domestic industry the opportunity to restructure to levels of greater efficiency and competitiveness. The quotas are implemented in terms of a Memorandum of Understanding signed between the governments of South Africa and China, and will be administered through import permits issued on the basis of past imports from China. The tariff headings subject to the permit control have been specified, and include woven and knitted fabrics, and clothing. Clothing and textile manufacturers and the trade unions have urged the government to implement the country-of-origin labelling system and to increase tariffs on imported clothing from 40% and to promote brand recognition, which will continue to play a major role in influencing South African consumers. Most retailers, like Truworths and Woolworth!s, have signed up to support the Proudly South African campaign, under which they agree to obtain at least 75% of their products from local manufacturers. Asset managers and institutions in the financial sector have also signed a deal agreeing to buy all their clothing and textile products locally, to encourage retailers to support the Proudly South African campaign and to review their investments in retailers who do not support the campaign. The hefty 25% import duty on long, fine fibres, which constitute a vital input in many textile products, will remain a constraint on the industry.

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006