South Africa's current account deficit is among the highest in the world.
Our economics expert David Mayfield points out that what is not a major crisis today could well become one in the future.
Since the second quarter of 2004, South Africa's has consistently experienced a trade deficit and a corresponding deficit on its current account, which reached a record high of 7.8% of GDP in the fourth quarter of 2006. Large outflows from the net services, income and current transfer payments components have threatened to further widen the deficit on the current account. However, with a modest improvement in the terms of trade and a decline in consumer demand for imports due to tighter monetary policy, the international trade deficit narrowed significantly in the third quarter of 2007 resulting in a contraction of the deficit on the current account to 6.3% of GDP.
A recent report by the IMF noted that South Africa experiences an inherent private sector savings-investment imbalance, which manifests in a current account deficit. The increase in imports of capital goods has become an increasingly important driver of the deficit.
The basis for increasing investment is that while it may lead to capacity constraints in the short term, which in turn would lead to an increase import demand for basic inputs over the long term. Increased fixed capital investments enhance capacity and reduce the demand for imports, while at the same time increasing export competitiveness. Therefore, government seems tolerant of the county's high current account deficit as it anticipates that it is a short-to-medium-term phenomenon caused by increasing private and public domestic investment. To this end, South Africa's is experiencing its first ever synchronisation of public and private sector investment.
For the time being, South Africa's current account deficit remains comfortably offset by large capital inflows. Capital inflows are expected to remain high, particularly foreign portfolio investments in equities, on the back of robust economic growth, a stable currency and prudent macroeconomic management. However, South Africa's reliance on portfolio flows relative to other emerging market economies has increased its vulnerability to external shocks.
The current global credit market debacle has increased risk aversion from emerging markets towards safe haven assets, such as gold, which is trading at around USD710/oz from USD636/oz at the beginning of the year, with investors seeking greater returns on their investment in the current liquidity-strapped financial markets. The knock-on effect caused the rand to strengthen as it gained on the back of fortunes offered to commodity-based currencies.