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

UNCLAS SECTION 01 OF 03 PRETORIA 003092 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
DEPARTMENT PASS USTR FOR PATRICK COLEMAN 
TREASURY FOR TRINA RAND 
USDOC FOR 4510/ITA/IEP/ANESA/OA/JDIEMOND 
AF/S FOR RMARBURG 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD SF
SUBJECT: HIGH MARKS FOR SOUTH AFRICA'S ECONOMY:  THE IMF'S 
2007 ARTICLE IV REPORT 
 
 
¶1.  (U) Summary:  The IMF's 2007 Article IV report for South 
Africa reports that the country is experiencing record levels 
of growth on account of strong domestic demand and favorable 
external conditions.  Planned investments in infrastructure 
should expand the growth potential even further in 2007-12. 
In the meantime, the strong performance is causing inflation 
and has led to a large current account deficit.  The current 
account deficit is financed by inflows of portfolio capital, 
leaving the country exposed to shifts in global investor 
sentiment.  The exchange rate is not seriously misaligned. 
Surveys of competitiveness rank South Africa slightly above 
large Latin American economies such as Brazil or Mexico. 
Trade liberalization has stalled as South Africa awaits the 
outcome of trade negotiations and implements a new industrial 
policy.  With the economy growing above capacity and 
inflation rising, the SAG must decide whether to raise 
interest rates further, or wait to see whether interest hikes 
after mid-2006 will cool growth without further action.  End 
Summary 
 
------------------------- 
The IMF Article IV Report 
------------------------- 
 
¶2.  (U) Experiencing record-high GDP growth, South Africa is 
reaping the benefits of sound macroeconomic management and 
favorable external conditions, according to the International 
Monetary Fund (IMF).  The IMF is concerned, however, that 
inflationary pressures are building up in the economy and 
that South Africa's large current account deficit leaves the 
country exposed to a "sudden stop" in capital inflows should 
investor sentiment toward emerging markets turn negative. 
 
¶3.  (U) The IMF's views can be found in the report of its 
2007 Article IV consultations with South Africa, available at 
www.imf.org/external/pubs/scr/2007.  Published in July, the 
report was based on consultations between IMF staff and SAG 
officials and private sector representatives in South Africa 
in May 2007. 
 
-------------------------------- 
The Good News:  Growth is Strong 
-------------------------------- 
 
¶4.  (U) Driven by strong domestic demand, South Africa's 
economy is undergoing its longest expansion on record, with 
GDP growing by 5 percent in 2006 for the third year in a row, 
the IMF reported.  Household consumption is being fueled by 
growing disposable income, low interest rates (until late 
2006), and wealth effects from rising asset prices.  Private 
and public sector investment is buoyant due to high levels of 
business confidence and SAG infrastructure spending. 
 
¶5.  (U) The sustained expansion lifted total employment by 
4.1 percent in the year ending September 2006.  However, the 
unemployment rate declined only modestly, to 25.5 percent, as 
labor force participation rose significantly. 
 
¶6.  (U) As a result of investments in electricity, ports and 
railways, the IMF projects that potential GDP growth will 
rise from 4.1 percent per year in 2002-06 to 4.9 percent per 
year in 2007-12.  In 2006 alone, parastatals raised their 
real level of investment by 19 percent.  Note:  The SAG is 
more optimistic than the IMF about the outlook for capital 
formation, employment and productivity.  It projects 
potential annual growth rising to above 5 percent in coming 
years.  The SAG's official goal is to achieve growth of 6 
percent per year in 2010-14.  End Note. 
 
----------------------------------------- 
The Bad News:  The System Is Under Stress 
----------------------------------------- 
 
¶7.  (U) The IMF views near-term prospects as broadly 
favorable, with GDP growth of 4.7 percent projected for 2007. 
 However, the continued growth of domestic demand in 
combination with capacity constraints -- as evidenced by 
record-setting capacity utilization rates and emerging 
scarcities of electricity, cement and steel -- is 
intensifying price pressures and could widen the 
already-large current account deficit.  The IMF expects 
inflation to remain above 6 percent in the near term.  It 
projects that the current account deficit will exceed 6 
percent of GDP in 2007 and 2008. 
 
PRETORIA 00003092  002 OF 003 
 
 
 
¶8.  (U) According to the IMF, the main downside risk lies in 
South Africa's large current account deficit, which was 6.5 
percent of GDP in 2006.   The deficit is the result of rising 
investment and low national savings, and is financed largely 
by portfolio inflows, not foreign direct investment.  The IMF 
warns that a drying up of global appetite for emerging 
markets or a substantial rise in global interest rates could 
prompt a sharp depreciation of the rand, followed by equally 
sharp interest rate hikes by the Reserve Bank to keep 
inflation at acceptable levels.  However, the Fund believes 
that South Africa's strong fundamentals -- including low 
external debt and a sound financial sector -- would limit the 
impact of external shocks.  Note:  The current account 
deficit exceeded 7 percent of GDP in the second quarter of 
¶2007.  End Note. 
 
¶9.  (U) The IMF projects that average growth in 2007-12 will 
be slightly lower than the potential growth rate (4.8 percent 
versus 4.9 percent, respectively).  This should cause the 
current account deficit to narrow to about 4.5 percent of GDP 
by 2012. 
 
--------------- 
Competitiveness 
--------------- 
 
¶10.  (U) The IMF noted that the rand has fluctuated without a 
definite trend since mid-2006, when it depreciated markedly 
after a period of turbulence in global markets.  The IMF 
could find no strong evidence of serious exchange rate 
misalignment, though it did acknowledge that estimates of the 
equilibrium exchange rate are difficult to make.  The IMF 
endorsed the Reserve Bank policy of allowing the exchange 
rate to float while building up reserves in order to bring 
South Africa's reserve balance in line with other emerging 
markets. 
 
¶11.  (U) The Fund recommended that competitiveness concerns 
be addressed by measures to raise productivity and reduce 
costs, not by manipulating the exchange rate.  The IMF noted 
that surveys of competitiveness usually rank South Africa 
slightly above large Latin American economies such as Brazil 
or Mexico.  According to these surveys, South Africa ranks 
well on business and government efficiency.  It ranks poorly 
on infrastructure, broadly defined to include human capital. 
 
------------------- 
Bones of Contention 
------------------- 
 
¶12.  (U) While praising South Africa's sound macroeconomic 
policies, the IMF noted areas of disagreement with the SAG: 
 
-- The IMF is concerned that the SAG's new industrial policy 
could introduce economic distortions.  It recommended that 
industrial policy interventions be of short duration and 
limited to cases of clear market failure. 
 
-- The IMF suggested that the SAG resume the process of trade 
liberalization and tariff simplification, which has stalled 
in recent years.  In reply, the SAG argued that reforms in 
this area should reflect the outcome of multilateral 
negotiations and be considered in the context of the new 
industrial policy. 
 
-- The IMF advised the SAG to consider revisions of labor 
market laws that inhibit job creation. 
 
-- The IMF believes that privatization would enhance the 
efficiency of state-owned companies.  However, the SAG 
prefers to restructure parastatals and sell off non-core 
assets rather than pursue wholesale privatization.  Comment: 
The SAG is actually creating new parastatals, such as 
Infraco, a new state-owned broadband network.  End Comment 
 
------- 
Comment 
------- 
 
¶13.  (SBU) South Africa is in the enviable position of having 
to manage the consequences of growth.  Developments since the 
Article IV report was published have only reinforced the 
Fund's principal conclusions:  inflation has mounted, the 
 
PRETORIA 00003092  003 OF 003 
 
 
current account deficit has widened, and the battering taken 
by the Johannesburg Stock Exchange in August underscored the 
economy's vulnerability to global mood shifts.  The SAG has a 
long-term strategy (plus the cash) to invest in 
infrastructure and boost the growth potential of the economy. 
 With the economy growing above capacity right now, however, 
authorities must decide whether to raise interest rates 
further, or wait to see whether a series of interest rates 
hikes after mid-2006 will finally kick in and cool growth 
without further action. 
Teitelbaum