Presentation by Robin Marshall, Managing Director,

Economic Research,& Taryn Rebeck, SA Economist

JP Morgan

November, 2002

South African Economic Outlook

and the MTBPS

2

Key Points

JPMorgan expects weaker growth in 2003 than official budget forecasts given recent monetary tightening & a likely slowdown in consumption

A tight budget suggests 1.6% deficit is easily achievable but disappointing that govt. has not taken opportunity to reduce tax burden further

Further inflation overshooting of official forecasts likely but suspending inflation targeting more damaging

SARB policy regime close to best practice, but more frequent meetings, employment stabilization clause & more statistical data on transmission mechanism needed

3

Key Macro Forecasts

CPIX inflation, %oya, avgJPMorganReuters consensusMTBPSReal GDP growth, %oyaJPMorganReuters consensusMTBPSCurrent account balance, %of GDPJPMorganReuters consensusMTBPSPrime lending rate, %, eopJPMorganReuters consensusPrime lending rate, %, eopJPMorganReuters consensus

2002 2003

10.0%9.7%9.6%

2.5%2.5%2.6%

0.0%0.1%0.1%

18.0%17.0%

10.8010.80

8.7%7.4%7.2%

2.5%2.8%3.5%

-0.2%-0.2%-0.3%

17.0%15.3%

11.5011.50

Source: JPMorgan, Reuters, MTBPS

4

2001 2002 2003 2004 2001 2002 2003 20042005

Real growth in demandFinal household consumption 2.7% 2.5% 2.8% 3.1% 2.8% 3.1% 2.9% 3.3%

3.6%Final government consumption 1.4% 2.3% 2.6% 2.7% 1.4% 2.5% 3.6% 3.6%

3.8%Gross fixed capital formation 3.2% 4.5% 5.5% 7.1% 3.3% 6.0% 5.7% 6.2%

6.8%Gross domestic expenditure 1.4% 2.2% 3.0% 3.4% 1.8% 3.1% 3.2% 3.5%

3.8%Exports 2.1% 2.6% 6.6% 6.7% 2.4% 3.2% 6.4% 6.6%

6.7%Imports -1.2% 2.4% 6.1% 6.3% 0.4% 5.6% 6.1% 6.5%

6.9%Real GDP growth 2.2% 2.3% 3.3% 3.6% 2.2% 2.6% 3.5% 3.7%

3.9%GDP inflation 6.9% 6.6% 5.7% 4.6% 7.5% 9.2% 7.4% 5.3%

4.5%Gross domestic product atcurrent prices (Rbillion) 969.1 1,057.0 1,153.9 1,250.5 975.0 1,093.0 1,214.2 1,325.0

1,439.0CPI inflation

CPIX (Metropolitan and urban areas) 6.6% 6.9% 5.8% 4.7% 6.6% 9.6% 7.2% 5.5%4.9%

Balance of payments

Current account balance (% of GDP) 0.0% -0.5% -0.5% -0.7% -0.2% 0.1% -0.3% -0.6% -1.1%

Government macroeconomic forecasts

2002 Budget 2002 Medium Term Budget Statement

Source: SARB

5

Main uncertainties about growth forecasts

2003 Growth forecast looks optimistic given likely slowdown in household consumption in response to recent monetary tightening, lower income growth and higher inflation

Overall increase projected in domestic demand for 2003 looks odd given 400 bp of tightening to date in 2002 & 12-15 month lag in monetary policy impact – demand indicators are already showing signs of slowdown (retail & auto sales)

Official forecast of 6.4% export growth in 2003 looks difficult to achieve during subdued global growth recovery

Other traditional lead indicators of GDP growth – like inverted yield curve – suggest growth will slow modestly in 2003

JPM believes that a larger fiscal stimulus could have been made in budget statement

6

Growth – Stable with relatively subdued domestic demand

-8

-6

-4

-2

0

2

4

6

8

90 91 92 93 94 95 96 97 98 99 00 01 02 03

%q/q, saar

Source: SARB, JPMorgan estimates

Forecast

GDP Growth

HCE Growth

SA GDP vs HCE Growth

7

Main uncertainties about inflation forecast

• Inflation forecasts for 2002/3 look optimistic, given evidence of 2nd round effects in wages and broad-based increase in 2002

• Combination of declining inflation and stronger GDP growth next year is possible but unlikely

• Given scale of inflation overshoot in 2002, and to prevent deterioration in inflation expectations, SARB is likely to tighten a further 100 bp in November

8

BER survey of CPIX inflation expectations

Finance

Business

Labour

Average

2002

Source: Bureau for Economic Research, University of Stellenbosch

2003

9.2 (8.5)

8.3 (8.4)

7.9 (7.6)

8.5 (8.2)

7.1 (7.0)

7.9 (8.2)

7.9 (7.4)

7.6 (7.5)

2004

6.2 (6.0)

7.5 (7.9)

7.3 (7.4)

7.0 (7.1)

Percent

3rd Quarter 2002 (2nd Quarter in parentheses)

9

23456789

10111213

1998 1999 2000 2001 2002 2003

%oya%oya

Forecast

Targetrange

Source: StatsSA, JPMorgan estimates

Inflation - Close To Peaking But Underlying Picture Less Favourable

CPIX forecast 2002 y/e : 12.1% (10.0% ave) 2003 y/e : 6.6% (8.7% ave)

(Metropolitan & other urban areas)

Peak of 12.2%oyain November

SA CPIX Inflation

10

Food price inflation remains the major cause for concern

0

5

10

15

20

25

2000 2001 2002

0

6

12

18

24

30

%oya%oya

CPIX Food Inflation

PPI Food Inflation

SA CPIX vs PPI Food Inflation

Source: StatsSA

%oya%oya

Food price inflation has been increasing steadily at both the producer and consumer level in the past year – JPMorgan does not expect it to unwind just yet

11

Also Note Current inflation is broad-based

4

5

6

7

8

9

10

11

12

13

2000 2001 2002Source: StatsSA

Goods

Services

%oya

CPIX goods vs services inflation

Although inflation was initially driven by exogenous shocks, it has become very widespread

12

Further petrol price increases remain a major risk

-60

-30

0

30

60

90

120

150

180

98 99 00 01 02

-12

-6

0

6

12

18

24

30

36%oya%oya

Source: Bloomberg, I-Net, StatsSA

Gauteng Petrol PriceRand Oil Price

%oya

CPIX Transport

JPMorgan forecasts Brent to average $25.7/bbl in 2002 and $26.6/bbl in 2003 – but risks are on the upside

13

A further key risk is more pass-through from rand depreciation

-3

0

3

6

9

12

15

18

90 91 92 93 94 95 96 97 98 99 00 01 02 03

2.0

3.5

5.0

6.5

8.0

9.5

11.0

12.5

CPIX

Overall PPI

%oya

Source: StatsSA, Bloomberg, JPMorgan estimates

R/$

Rand/US$

Forecast

PPI and CPIX Inflation vs Rand/$

Both directly (although behavior of corporate margins makes the extent difficult to predict) & through second-round effects via deterioration in inflation expectations and wage settlements.

14

-9

-6

-3

0

3

6

9

12

15

1996 1997 1998 1999 2000 2001 2002

3

4

5

6

7

8

9

10

11

12

13

R billion

Both bond and equity portfolio flows turned negative in 02H2.

Total Portfolio Flows vs Rand/US$:Rate

Source: I-Net

Rand/US$(inverted scale)

R/$

Portfolio Flows

Much of the strength earlier this year was propped up by portfolio flows, which have turned

15

And outflows have picked up as expected

-56

-48

-40

-32

-24

-16

-8

0

8

92 93 94 95 96 97 98 99 00 01 02

Services Account

Net Dividend Outflows

R billion

After falling in 02Q1, outflows have picked up again now that the Myburgh Commission is out of the way

SA Services Account vs Net Dividend Payments

Source: SARB

16

Strong trade performance has supported the rand, but fading with subdued global growth

-4

-2

0

2

4

6

8

10

1998 1999 2000 2001 2002Source: SARS

SA Trade Balance

R billion

South Africa has posted trade surpluses of R2.9 billion on average in the ten months year to date thanks to a weak currency, but export performance is starting to come off due to an uncertain global outlook.

17

Interest rates – globally rates appear to be on hold for now

United States

Euro area

Japan

United Kingdom

Canada

Current Mar 03Dec 02

Source: JPMorgan

Jun 03

1.75

3.25

0.00

4.00

2.75

1.25

2.75

0.00

4.00

2.75

1.50

2.75

0.00

4.00

2.75

1.75

2.75

0.00

4.25

3.00

Dec 03

2.00

3.25

0.00

4.75

3.50

Percent of total

18

In South Africa, one more 100bp rate hike forecast for November

2

5

8

11

14

17

20

23

26

95 96 97 98 99 00 01 02 03

Nominal

Real (using CPIX Inflation)

Forecast

And Morgan looks for a 100bp rate cut in 03H2 once inflation is clearly falling towards the target range.

Source: SARB, JPMorgan estimates

%%

Prime Lending Rate

19

GDP Growth (%oya)

HCE Growth (%oya)

GCE Growth (%oya)

GDFI Growth (%oya)

Current Account (R billion)

Current Account (% of GDP)

CPIX Inflation (average, %oya)

CPIX Inflation (eop, %oya)

Prime Lending Rate (eop, %)

R153 Yield (eop, %)

Rand/$ Exchange Rate (eop)

2003(f)2002(f)

2.5

2.4

2.6

4.5

-2.0

-0.2

8.7

6.6

17.0

11.10

11.50

2.5

3.0

2.8

5.5

0.0

0.0

10.0

12.1

18.0

12.20

10.80

JPMorgan AnnualSA Economic Forecasts

Source: JPMorgan estimates

20

Budget deficit target FY2002/03 and 2003/04 unnecessarily tight at 1.6% and 2.2% of GDP, given infrastructure spending and tax reform needs

Statement suggests a modest fiscal tightening…

…given government caution on revenue assumptions, which makes another undershoot likely

Very low debt/GDP ratio and debt service costs gives government more scope to ease fiscal policy further

South Africa: Medium-term budget policy statement: Main Points

21

Government cautious again on revenue projections

Government revenue collection assumptions are very conservative for 2002/03; growth in government revenue is forecast to be 10.1% for the year

Revenue growth so far this fiscal year is 17.5%– Very strong growth in corporate tax revenue (especially

mining )

– Strong retail sales have helped VAT collection

– Continuing improvement in efficiency of tax collection

JPMorgan expects revenue growth close to 13% for full fiscal year 2002/3

22

Government expenditure control remains tight…perhaps unnecessarily so

Year to date government expenditures up 12%…

…. expenditure over-runs modest and due to impact of higher inflation especially on public sector wages

Overall Government target for FY2002/03 looks excessively prudent

JPM’s weaker growth forecast for 2003 suggests govt. has more scope to increase public expenditure

23

International comparison of fiscal positions

Yield - 10-year govt bond

CPI, avg 2002

Budget deficit, % of GDP, ESA meth.

Public debt, % of GDP

Czech

Source: JPMorgan

Poland

4.2

2.1

6.4

20.0

6.0

1.9

4.4

48.0

Hungary

7.1

5.3

8.7

53.0

24

SA official budget projections

2002 Budget 2002 Medium Term Budget Statement

R million 2002/03 2003/04 2004/05 2002/03 2003/04 2004/052005/06

National Revenue Fund (main budget)

Revenue 265,217 288,708 313,211 273,281 302,102 330,338358,323

Expenditure

Interest on debt 47,503 49,845 52,434 47,236 51,463 54,59957,853

Percentage of GDP 4.4% 4.2% 4.1% 4.2% 4.1% 4.0%3.9%

Contingency reserve 3,300 5,000 9,000 – 2,000 4,0008,000

Allocated expenditure1 237,106 256,386 273,128 244,517 275,955 299,825322,247

Total 287,909 311,231 334,561 291,753 329,418 358,424388,100

Percentage increase 9.6% 8.1% 7.5% 11.1% 12.9% 8.8%8.3%

Surplus (+) / Deficit (-) -22,692 -22,523 -21,350 -18,472 -27,316 -28,085-29,777

Percentage of GDP -2.1% -1.9% -1.7% -1.6% -2.2% -2.1%-2.0%

1. Includes transfers to provinces and local government, the National Skills Fund and sectoral skills development funds.Source: JPMorgan.

25

Official SA budget projections

Budget Revised Medium Term estimates

R billion 2001/02 2001/02 2002/03 2003/04 2004/05

2005/06

Main budget deficit 14.4 22.7 18.5 27.3 28.1

29.8

Extraordinary payments 2.1 1.6 8.6 7.0 7.07.0

Extraordinary receipts -4.7 -12.0 -12.0 -5.0 -5.0-3.0

Main budget borrowing 11.8 12.3 15.1 29.3 30.1

33.8

Other government borrowing1 -5.3 3.1 3.1 1.5 2.02.5

General government borrowing 6.5 15.3 18.1 30.8 32.1

36.3

percentage of GDP 0.7% 1.4% 1.6% 2.5% 2.4%

2.5%

Plus:

Non-financial public enterprises -2.3 -0.5 -0.5 0.3 1.11.2

Public sector borrowing requirement 4.2 14.9 17.7 31.1 33.2

37.5

percentage of GDP 0.4% 1.3% 1.6% 2.5% 2.5%

2.6%

1. Social security funds, provinces, extra-budgetary institutions and local government.Source: JPMorgan.

Outcome

26

International experience with inflation targeting

International experience suggests -

– monetary policy should be carried out by independent central bank, even if choice of inflation target rests with govt./Finance

– credibility gains from announcing and implementing inflation targeting (lower borrowing costs, reduced inflation expectations)

– implementation of targeting should be stable & predictable, but policy responses also involve judgment

– optimum central bank implementation depends on structure of economy, nature of shocks and welfare judgments

– successful inflation-targeting regimes generally employment-friendly, enhancing political credibility by minimizing output losses in achieving inflation target

– open economies, subject to international capital flows and shocks, can still benefit from successful inflation targeting (UK)

–

27

Inflation targeting means inflation forecast targeting due to lags in impact of policy (SARB estimates lags at 12-15 months)

Inflation forecasting must be accurate, reflecting stable structural relationships

Thus for a Taylor rule, or variation, to work, where interest rates are set to minimize deviations of inflation from target and output from trend, these relationships should be stable

Smaller, open economies may be subject to de-stabilizing shocks from international capital flows & exchange rate moves, with uncertain inflation consequences

Difficulties with inflation targeting for an emerging economy

28

South Africa’s evolving monetary policy framework

Years Monetary policy framework

1960-1981 Liquid asset ratio-based system with quantitative controls over interest rates and credit

1981-1985 Mixed system during transition

1986-1998 Cost of cash reserves-based system with pre-announced monetary targets (M3)

1998-1999 Daily tenders of liquidity through repurchase transactions (repo system), plus pre-announced M3 targets and informal targets for

core inflation

2000 Formal inflation targeting

Source: JPMorgan, SARB

29

South African experience with inflation-targeting

Much of South African policy regime conforms with industry best practice, but 2002 experience suggests -

– more frequent meetings desirable to reduce risk of “ getting behind inflation curve “ (inflation data monthly)

– uncertainty over inflation forecasting due to structural change in economy

– more information required on transmission mechanism & inflation pass-through from rand to improve accuracy

– a secondary objective for stabilizing employment; current escape clauses deal only with shocks

– missing targets in 2002/3 not a mortal blow to regime.. only repeated target misses & evidence of unstable inflation expectations would justify suspension

– difficult to specify longer term path for target until SARB becomes more confident about transmission mechanism