Imbalances threaten macroeconomic stability in the domestic economy

The South African economy faces several worrying imbalances despite inflationary pressures appearing to be in check, says Absa senior economist Ridle Markus.

"The South African economy is reaching that transition point where the monetary authorities must decide whether or not the current level of monetary tightening is sufficient to contain inflationary pressures.

"On the face of it, inflationary pressures appear to be contained and the outlook much more upbeat than was the case at the end of 2006.

He points out factors impacting positively on the domestic economy such as the volatile, but currently lower oil prices, declining food inflation, and the decrease in private sector credit extension due to higher interest rates.

According to Markus, the imbalances plaguing the domestic economy include:

* The large current account deficit of over 5 percent of Gross Domestic Product, which is attributed to factors such as strong consumer demand for imported goods, the strong rand, an increase in fixed capital formation, and persistent structural problems in the manufacturing industry.
* High and rising household debt levels.
* Excessive private sector credit extension.
 
Markus says the threat is aggravated by the severe imbalances in the international economic environment.

"The global economy is also suffering from severe imbalances, which is one of the key policy challenges today. This poses a real threat to economic and financial stability worldwide."

According to Markus, the global economic imbalances were driven by:

* The huge surpluses of oil-producing countries accruing from a surge in oil prices.
* The savings glut in major Asian economies.
* The US's current account deficit - which has exceeded 6% of GDP and is approaching the US$1 trillion mark.

Markus says there is no certainty regarding the period and manner of adjustment within the domestic economy.

"It is therefore important that both fiscal and monetary policies be used to limit the level of overshooting of the current account deficit taking place, or attempt to smooth the adjustment.

"In addition, fiscal incentives could be used to rise private and public saving and create an environment conducive for investment in manufacturing capacity. On the other hand, monetary policy should attempt to curb excessive credit demand and consumer demand because this is not only inflationary, but is also pushing the deficit deeper into the red."