GDP UPDATE

March 2006

INDUSTRY ANALYSIS

1. WORLD

World growth will be about 4 percent for the third consecutive year. World trade growth will be slightly higher, at 6.5 to 7.0 percent, as import tariffs and quotas continue to give way to freer trade. Inflation will be well contained in all of the key consuming countries. As a result, credit costs will rise only modestly, remaining relatively low and imposing very little constraint on borrowing. Exchange rate changes should be minimal. Now that China has embarked on a carefully controlled currency appreciation, no major currencies are at risk for abrupt changes in value.

However, there will be significant shifts in the country/product mix of world GDP. In the NAFTA region, economic growth will be 0.5 percent higher in 2006 in Canada and Mexico. Both countries get a boost from higher energy prices and faster growth in U.S. manufacturing. The U.S. economic growth rate in 2006 will begin at well over 4 percent, with a rebound from the depressed post-hurricane period, but will ebb to near 3 percent by the end of the year.

Economic growth will accelerate markedly in the Euro-currency countries. Italy and the Netherlands will continue emerging from recent recessions, and GDP growth will nearly double in France and Germany, once they enact major labor reforms.

Economic growth will slow in China, from the pressure of rising credit costs and other restraints on investment spending. The more modest slowdown in India will be in the farm sector, following several favorable monsoon seasons, but there will be no slowing in the industrial sector. Japanese economic growth will be marginally higher, but 2 percent annual growth is now about the maximum sustainable expansion rate. The smaller Asian/Pacific countries will expand 4.8 percent, up from 4.4 percent in 2005. This pickup is already under way, after a long period of inventory disinvestment. Economic growth in the rest of the world will be in the 4 to 6 percent range but will average slightly less than in 2004-05, when commodity export volume and prices were unusually high to supply a rebound in industrial countries.

If you're following each country's business cycle in 2006, expect no unusual changes in them. The United States, China and Eastern Europe will be in the mature end of their cycles, in which growth is slowing although still high. In the U.S., this will tilt the spending mix toward capital goods and away from consumer goods. Within consumption, the mix will tilt toward services and away from goods, limiting growth in consumer purchases of electronics products. However, in China, the heavy use of non-market economic management means that capital spending will experience most of the slowdown in spending growth. Western Europe, Japan and the smaller Asia/Pacific countries will move to the phase of their cycles in 2006 when capital spending begins to expand measurably after a long stagnant period. But the acceleration in consumer spending — heavily weighted for goods relative to services — will be even larger. This result is from a resumption of hiring, higher wage gains and improved confidence in economic prospects.

Worldwide, inflation will be marginally higher but not enough to spur advance buying to beat price increases. Just as important, inflation will be more pervasive, encompassing most products and services. The commodities inflation surge early in 2004 and the surge in energy prices in 2005 both stopped after a few months, so that very little inflation pressure crept permanently into the prices of other items. Long-term interest rates, which depend on inflation expectations, did not increase in 2004-05, but in 2006 three years of strong world growth will have absorbed enough unused labor and factory capacity that most prices will be rising.

The consequence for credit costs is a rise of 50 to 100 basis points in long-term interest rates for capital investment loans. This will be a very marginal restraint on investment in 2006, but it will become more significant over the year and may be a serious restraint in 2007. Short-term interest rates for operating loans will be affected differently: They will be markedly higher in the U.S. and China, probably rising more than 100 basis points during the year, but will be steady or even decline slightly elsewhere, as central banks act to stimulate consumer demand.

The hot markets will be the major suppliers of four items now in short supply, with rapidly rising prices and little prospect of significant new supply in 2006: oil, petrochemical feed stocks and products, cement and copper. These include Canada, Chile, Egypt, Mexico, Norway, the OPEC countries, Peru and Russia. All told, however, the prognosis is for steady growth all the way around.

WHERE GDP IS RISING:

GDP (annual percentage change)

2. AMERICAS

    U.S.

The health of the U.S. economy was a bit better than originally thought during the fourth quarter of last year, according to new numbers from the government. The U.S. Bureau of Economic Analysis released its second of three reads on the fourth quarter of 2005, indicating that the overall economy had grown at a 1.6 percent annual pace from October to December. This is significantly better than the original read of 1.1 percent and outpaces consensus estimates of 1.5 percent.

Even with the upward revision, Q4 2005 saw the worst performance for overall economic growth in three years. A final assessment of the quarter will be released on March 30, 2006.

There are three major components to the upward revision: increasing business inventories, increased business spending on equipment and construction, and stronger government spending. These three numbers moved up as new and revised data were fed into the government's economic model.

Economists looking at the most recent economic data say that these tepid numbers will likely be short-lived. There will likely be a small upward revision in the final read of GDP next month, and Q1 2006 will likely show strong growth according to economists.

Real GDP increased 3.5 percent in 2005 (that is, from the 2004 annual level to the 2005 annual level).  In 2004, real GDP increased 4.2 percent.

During 2005 (that is, measured from the fourth quarter of 2004 to the fourth quarter of 2005), real GDP increased 3.2 percent, 0.1 percentage point more than in the advance estimate.  Real GDP increased 3.8 percent during 2004. 

The price index for gross domestic purchases increased 3.5 percent during 2005, 0.1 percentage point more than in the advance estimate.  During 2004, this index increased 3.4 percent.

Economists said that strong January spending boded well for a strong rebound in economic growth in the first quarter, after America’s GDP rose at an annualized rate of just 1.6 percent in the final three months of last year.

Cary Leahey, of Decision Economics, in New York, said: “The first quarter is off to a very strong start. This will dominate some of the disappointing numbers we got earlier this week, at least in terms of forecasting GDP. It’s hard not to have a GDP forecast now that’s not around 5 percent or higher.”

Current momentum seemed to be sufficient, analysts said, for the Federal Reserve to continue raising interest rates at least over the next few months. Inflation was also running at levels consistent with further monetary tightening.

    CANADA

The value of goods and services produced by the Canadian economy crossed the US$1-trillion mark for the first time in history in 2005, as the global commodity boom swelled the country's coffers. David Wolf, Canadian economist at Merrill Lynch, calculated gross domestic product averaged US$1.13-trillion in 2005, up from US$991-billion in 2004.

"Canadian GDP in U.S. dollar terms is up 70 percent over the past four years, which is just an extraordinary number and has gone, over that period, from being a 10 percent smaller economy than New York state to 20 percent bigger," Mr. Wolf said.

"[We're] still about 20 percent smaller than California or Italy, but ... Canada's weight in the world economy is on the way up."

The increase has been driven by surging prices for oil, natural gas, gold and other commodities and the Canadian dollar, the “loonie”, which yesterday reached a new 14-year high of US88.09 cents bringing its gains for the past four years to nearly 40 percent.

Mr. Wolf made his calculations after the release of data yesterday showing real gross domestic product grew at an annual rate of 2.5 percent in the fourth quarter. That was slightly weaker than the market expected and down from 3.5 percent in the third quarter but it ended strongly with a 0.4 percent burst of growth in December.

For 2005 as a whole, the economy expanded 2.9 percent, unchanged from 2004. The numbers are a far cry from 5 percent-plus growth rates of the late-1990s, but they mask the massive injection of income Canada is getting from the commodities boom and the stronger dollar, which is now trickling down into the economy.

Among the highlights of this trickle-down effect in the 2005 report from Statistics Canada:

• The Canadian dollar's appreciation over the past three years has helped drive import prices down a whopping 10 percent.
• Corporate profits rose 10.7 percent in 2005, off from 18.7 percent in 2004 but continuing the rebound that started in 2003.
• Wages, salaries and supplementary labor income rose 5.4 percent, the strongest since 2000.
• Investment in machinery and equipment rose 10.7 percent, its best annual performance since 1997.
• Consumer spending rose 4.0 percent, the largest annual increase since 2000.Government income rose 7.1 percent, thanks to an 11.7 percent rise in corporate income tax, a 10.6 percent jump in investment income (mainly due to increasing oil and gas royalties) and a 10.4 percent increase in personal income taxes.

3. ASIA

    AUSTRALIA

Sluggish growth figures are likely to ease pressure on Australia's central bank to lift official interest rates. Australia's gross domestic product grew by 0.5 percent in the December quarter, putting the annual rate at 2.7 percent.

Agriculture shows most growth with manufacturing a major negative influence.

The Australian Reserve Bank has signaled its next move on interest rates is more likely to be up than down. Chief economist for AMP Capital Investors in Australia, Shane Oliver, says the latest figures weaken the case for a rate rise.

Australia's economic growth is forecast to remain at or above 3.0 pct in 2006-2007, with business investment continuing to support growth while household spending remains subdued, ANZ Banking Group chief economist Saul Eslake said.

Addressing an industry forecasting conference in Sydney, the economist said wage and labor capacity constraints will continue pressuring costs, while further fiscal expenditure remains a significant risk to rate hikes ahead.

Eslake said his firm sees Australia's GDP growth rising to 3.0 percent annually by the December quarter of this year and 3.5 percent over 2007.

Eslake said Australian households have stopped borrowing against actual or expected rises in house prices as the nation's housing boom peaked in 2003-2004, resulting in a slowdown in consumer spending. He said running concurrent with this trend, business investment in Australia continues to surge.

Also speaking at the industry conference, Reserve Bank of Australia head of economic analysis Anthony Richards said the central bank continues to see GDP growth of three percent or slightly more over the next year or so. The central banker said Australia's economy continues to reap rewards from booming world commodity prices which have resulted in a record level of the nation's terms of trade through rising export prices and falling import prices.

But Richards said that Australian household spending is likely to remain subdued ahead as spending growth runs below income growth for a while longer.

ANZ's Eslake said Australia's previous policy mistakes of letting wages grow faster than productivity in a tight labor market may be reduced through the current government's policy of decentralized wage fixation. He said in prior times Australia has fallen into recession due in part to rising wages which led to rising interest rates. However, Eslake said, a significant risk to interest rates remain from the Federal government spending surging tax revenues.

    CHINA

Powered by strong growth in the agricultural, industrial and services sectors, the Chinese economy registered a robust growth of 9.9 percent in 2005, higher than the 9.5 percent achieved in 2004, the National Bureau of Statistics (NBS) of China said. According to the NBS' latest statistics on the national economy and social development in 2005, China's gross domestic product (GDP) totaled 18,232.1 billion yuan, or about $2,279 billion.

Agriculture accounted for 12.4 percent of the GDP, compared to 47.3 percent from industry and 40.3 percent from services sector.

Though China's arable land decreased by 8,94,502 acres, its grain production increased by 3.1 percent to 484.01 million tons. However, cotton output declined by 9.8 percent to 5.7 million tons.

In the industrial sector, state-owned companies saw their profit go up by 17.4 percent, compared to 47.3 percent for private enterprises. Overseas-invested companies recorded the lowest growth rate in profits, which stood at 6.9 percent.

China, already the world's biggest producer of many industrial products, saw another double-digital growth in many such products.

In 2005, it generated 2,474.7 billion kilowatt/hours of electricity, produced 2.19 billion tons of coal, 397 million tons of steel, 1.06 billion tons of cement and 5.7 million vehicles.

    INDIA

Indian GDP in 2004-05 registered a growth of 7.5 percent as against the growth rate of 8.5 percent the previous year.

The Indian economy has gained prominence as a preferred investment destination. This year, the economy is set to reflect an 8.1 percent GDP growth. That, combined with benign inflation, buoyant capital markets and contained fiscal finances, has renewed calls for 10 percent growth in India.

There are several infrastructure projects slated for modernization — these include roads, ports, airports and five proposed 4,000 MW power projects. They have large funding needs, but what is uncertain is how this funding gap will be bridged. Unless the issue of liquidity is addressed, interest rates may tighten further.

    JAPAN

Japanese GDP is seen rising 1.2 percent in October-December from the previous quarter, or an annualized 4.6 percent, according to median forecasts by the nine think tanks.

    LAOS

The Lao government recently discussed measures to ensure the success of major domestic events, and the development of local tourism and education sectors. At the two-day meeting, cabinet members touched upon the preparation for Laos' 6th General Election, measures to ensure security for the coming 8th Congress of the Lao People's Revolutionary Party, and anti-bird flu activities.

The meeting chaired by Lao Deputy Prime Minister Bouasone Bouphavan also discussed a draft 2006-2020 tourism development strategy, and a draft plan on education improvement between 2006 and 2015.

Laos has recorded an annual average gross domestic product (GDP) increase of 6 percent since its application of the renovation policy in 1986. The country's per capita GDP increased to estimated US$438 in 2005 from $76 in 1975.

    PHILIPPINES

The Bangko Sentral ng Pilipinas will conduct its first-ever business process outsourcing (BPO) survey this year to properly account for the contribution of the industry, particularly the call centers, to the total economic output.

Diwa C. Guinigundo, central bank deputy governor, said that the survey, which is expected to be accomplished in one year, will cover all 800 BPO firms nationwide. Finance Undersecretary Gil Beltran earlier said that the output of call centers has "not been properly accounted" and may even be understated.

Government statisticians are still figuring out how to compute the industry's value-added, or output less inputs, which is taken into account in measuring gross domestic product (GDP). This was previously the case of the electronics sector, and at one time GDP estimates for previous years had to be revised, he said.

Mr. Beltran said there has been a spike in the growth of call centers that vacancy in top grade office spaces has been reduced to 5 percent, the lowest in 15 years. Call center seats are expected to increase by 50 percent to 60 percent this year, he added, as the country continues to compete with India.

Economic analysts have said that the GDP could be higher if only the BPO sector is properly accounted for. GDP - the total value of goods and services produced by the country - grew by 5.1 percent last year, buoyed mainly by a recovery in agricultural output and a positive performance for the services and industry sectors in the fourth quarter.

    THAILAND

The drawn-out political crisis has prompted the University of the Thai Chamber of Commerce (UTCC) to lower its growth projection for the Thai economy this year. From an original 4.8 percent, the university’s growth projection has been reduced to a range of between 3.5 and 4.5 percent in 2006, said Saovanee Thairungroj, dean of UTCC’s economics faculty.

The revised forecast is based on three scenarios. The worst-case scenario assumes violence will erupt and an election will not be held, resulting in an economic growth of only 3.5 percent. This takes into account an annual export expansion of 11 percent and a 10.9-percent rise in imports. The current account deficit will balloon to US$5.09 billion, or 2.7 percent of gross domestic product (GDP), said Saovanee.

UTCC’s best-case scenario assumes that the Election Commission will be able to organize the snap election within 60 days and the new government will be able to carry out the megaprojects this year. Based on this scenario, the economy is expected to expand 4.4 percent this year. GDP growth will hit 4.1 percent in the second quarter this year, 4.3 percent in the third quarter and gain momentum at five percent in the last quarter, said Saovanee. Imports and exports will both expand about 13.3 percent year on year, said Saovanee, adding Thailand will have a current account deficit of $4.3 billion, or 2.2 percent of GDP.

Another scenario assumes that an interim government will be appointed by His Majesty the King, resulting in economic growth of four percent. Exports will grow 13.3 percent over 2004, while imports will rise 12.6 percent. Thailand will record a current account deficit of $4.04 billion, or 2.1 percent of GDP.

4. EUROPE / AFRICA / MIDDLE EAST

    FINLAND

Finland's Handelsbanken said that it saw the Finnish economy growing by 3.7 percent this year (2006) and 2.7 percent in 2007, up from previous projections of 3.5 percent and 2.6 percent, respectively.

Finland's gross domestic product in 2005 was up 2.1 percent from the previous year, official preliminary data show. GDP, or the combined value added of the goods and services produced, amounted to €155 billion last year, said Statistics Finland.

The volume of exports rose by 7 percent, while import volumes increased by around 10 percent. During the last quarter, the volume of GDP rose by 0.9 percent year-on-year, primarily on the back of increased household consumption and investments.

    HUNGARY

Hungary's GDP rose by 4.1 percent year-on-year in volume terms in 2005, according to unadjusted figures the Central Statistics Office (KSH) released in its first estimate for 2005 GDP growth. GDP rose by 4.3 percent year-on-year in volume terms in the fourth quarter last year. The fourth-quarter growth is slightly above a 4.1 percent forecast by KSH's research institute Ecostat.

Hungary's economy grew by 4.3 percent in the fourth quarter of 2005, down from 4.5 percent in Q3, the Central Statistics Office (KSH) announced on Wednesday. The KSH data compares with the flash estimate of Ecostat for a growth of 4.1 percent.

“The market impact of the figure is likely to remain limited; we expect momentum to carry through into 2006, supported by faster European growth and stronger household consumption. FY 2006 GDP growth is likely to come out at around 4.3 - 4.5 percent."

“The announced figure remained basically in line with our estimate, and slightly above the former flash estimate from ECOSAT, as we were expecting output growth to keep up its pace in the final quarter of 2005 in line with the continued strength in construction and industrial sectors as well as the slight recovery observed in the retail sales."

    ITALY

Official statistics show Italy experienced zero growth in 2005 underlining the dire state of the country’s economy and dealing a blow to Prime Minister Silvio Berlusconi’s election campaign. The zero growth in gross domestic product was a drop from an already-sluggish 1.1 percent growth in 2004. The country’s public deficit grew to 4.1 percent from 3.4 percent in 2004, in breach of eurozone guidelines but slightly lower than expected.

The poor state of the economy is a preoccupation with Italian voters ahead of the elections on April 9, 2006. Giulio Tremonti, Italy’s finance minister, however pointed to the lower-than-expected deficit, saying it showed that “the cure is working”.

“The data are not surprising as they confirm previous forecasts,” said an official at the Union of Christian Democrats, part of Mr. Berlusconi’s ruling coalition.

Istat, the official statistics institute, said that the weak data contrasted with the US’s 3.5 percent, the UK’s 1.8 percent, the 0.9 percent of Germany and Spain’s 3.4 percent.

However there were encouraging signs in separate manufacturing production figures released recently, which suggested there may be a marked growth in GDP in the first quarter of this year. The Italian manufacturing purchasing managers’ index hit its highest level for five-and-a-half years in February according to data from NTC Economics, an independent research company.

Alessandro Mitrovich, the Italy country head for Royal Bank of Scotland, said the latest data pointed to an acceleration in the growth rate for Italian manufacturing output.

    RUSSIA

Russia's GDP will grow 5.7 percent in 2007 and 5.9 percent in 2008, the Finance Ministry's press service said recently. The forecast is set out in the adjusted financial plan for 2006-2008 approved by the government's budget drafting commission.

"The financial plan suggests that the exchange rate of the dollar will be 27.9 rubles per dollar in 2007, and 28 rubles in 2008," the ministry said.

The oil price on which the 2007 and 2008 budgets are based is $46 per barrel, with the cut-off price for the Stabilization Fund, set up to accrue windfall profits from high world oil prices, at $27 per barrel.

Budget revenues in 2006 are estimated at 5.6062 trillion rubles ($200 billion), which is 660.1 billion rubles ($23.56 billion) less than the figure in the federal law on the 2006 budget. Budget revenues in 2007 and 2008 are expected to be 5.8285 trillion rubles ($208.01 billion) and 6.5874 trillion rubles ($235.1 billion) respectively. Budget expenditure will rise 243.8 billion rubles ($8.7 billion) in 2007, and 181.2 billion rubles ($6.47 billion) in 2008.

Spending on priority national projects will increase by 36.6 billion rubles ($1.31 billion) in 2007 and 38.3 billion rubles ($1.37 billion) in 2008. Investment spending will increase by 193.9 billion rubles ($6.92 billion) in 2007 and 133.9 billion rubles ($4.78 billion) in 2008.

The plan also includes adjusted expenditure on wages for public sector workers in view of the indexation slated to be held in two stages in 2006. For this purpose, the government has earmarked an additional 13.2 billion rubles ($471.09 million) for 2007, and 8.9 billion rubles for 2008.

    SPAIN

Basque GDP is up 3.7 percent in 2005. The major factor in sustaining this growth was home or domestic consumption, with growing expenditure throughout 2005, at an annual rate of 3.3 percent for the year, while public consumption rose by 2.4 percent. With 3.7 percent growth in the regional economy in 2005, the Basque GDP for the year was up four-tenths on the 2004 figure of 3.3 percent. Last year activity in the Basque economy not only exceeded the figure for the Spanish economy as a whole by three-tenths (3.4 percent), but also outreached the EU by 2.1 points (1.6 percent) and the eurozone by 2.4 points (1.3 percent).

A fine performance in anyone's book, and one that was made possible by growth of 4.2 percent in the GDP in Q4 and the renewed vigor in the construction industry, which registered 6 percent growth last year and was the most dynamic sector of all, with an increase of 6.5 percent in Q4. After years in the doldrums, the primary sector also provided a pleasant surprise for economic pundits by clocking up 5.8 percent growth.

Despite the major effort made in Q4, with 4.1 percent growth, industry ended the year with overall growth of 2.7 percent, leaving it a whole percentage point below the general GDP (3.7 percent), although it did improve over the previous year's figure of 2.5 percent.

With 3.7 percent growth, the same result as the regional GDP, internal demand was behind the growth in GDP in 2005 as a whole. Gross capital formation was the most dynamic factor in internal demand, at l 5.3 percent, much higher than the figure for end consumption, which came in at 3.1 percent.

The major factor in sustaining this growth was home or domestic consumption, with growing expenditure throughout 2005, at an annual rate of 3.3 percent for the year, while public consumption rose by 2.4 percent.

    SWITZERLAND

The Swiss economy grew by 0.5 percent in the final quarter of 2005, slowing down from 0.9 percent in the third quarter, but still confirming the economic upturn. The State Secretariat for Economic Affairs (Seco) said that preliminary figures showed the economy grew by 1.9 percent as a whole during the year.

 "The... trend upwards of the Swiss economy is proving to be increasingly anchored," Seco said in a statement. It added that the upswing, which started in 2004, had been confirmed and was now more broadly based.

"Growth should continue in 2006, with an increase of GDP of 1.8 percent," commented Seco's Bruno Parnisari. He said oil prices "almost miraculously" had not had a great impact, with inflation remaining moderate. Parnisari explained that competition among companies and the globalization of the economy had resulted in price cuts that had compensated for higher oil prices.

The economy was boosted by healthy exports. The sale of goods and services abroad rose by 4.5 percent in 2005, with an increase of 1.2 percent in the final quarter. Imports showed the same kind of dynamism, increasing by 5.3 percent for the years as a whole and by 2.9 percent for the final quarter.

Economists said the data confirmed the picture of a solid Swiss economy, which was likely to prompt the Swiss National Bank to raise interest rates again in March. Deutsche Bank economist Klaus Papenbrock said the fourth-quarter figure was largely in line with expectations.

"We had expected a number of 0.7 percent [quarter on quarter] but one has to note that the second quarter, for instance, was revised upwards and that compared to its neighboring countries, especially Germany, growth in Switzerland is certainly good." He added that economic indicators were pointing to "further robust growth" in the first half of the year.

"While there is no need for urgency or aggressive rate steps, the Swiss economy is growing well, above potential, and the SNB should increase rates [in March].

Switzerland's largest bank, UBS, reported on Tuesday that its consumption indicator rose in January for the third month running, signaling that private consumption was set to support the upturn led so far by exports.

The monthly indicator rose to 1.46 in January from 1.33 in December. UBS said in a statement that the latest jump had been fuelled by the "marked rise in the consumer sentiment index in the first quarter, coupled with the enhanced business outlook in the retail sector".

AFRICA

Africa's GDP is estimated to have grown by 5.1 percent in 2005 and is expected to sustain at 5.5 percent in 2006, according to a UN report.

    SOUTH AFRICA

Gross domestic product (GDP) data for the fourth quarter of 2005 came in slightly lower than many economists had predicted. The economy grew at an annualized rate of 3.3 percent in that quarter, following real annualized GDP growth rates of 4.6 percent, 5.4 percent and 4.2 percent during the first, second and third quarters, respectively.

First preliminary annual GDP estimates for 2005 are derived from the sum of the quarterly GDP data for the year. On this calculation, the annual growth rate in real GDP at market prices for 2005 is 4.9 percent.

The impact of an industry on the change in real GDP depends on two factors: the increase or decrease in the real value added of the industry and its relative size.

The main contributors to the 4.9 percent growth in 2005 were: finance, real estate and business services (1.5 percentage points); wholesale trade, retail trade, hotels and restaurants (0.8 percentage points); manufacturing (0.7 percentage points); and transport, storage and communications (0.6 percentage points).

The 3.3 percent annualized increase in the seasonally adjusted real GDP for the fourth quarter was mainly due to increases in the value added by: wholesale trade, retail trade, hotels and restaurants (1.2 percentage points); finance, real estate and business services (0.7 percentage points); transport, storage and communications (0.6 percentage points); and construction (0.3 percentage points).

The slowdown in growth between the third and fourth quarter - from 4.2 percent to 3.3 percent - was mainly the result of declines in mining and quarrying, which contributed -0.3 percentage points to fourth-quarter growth, and in manufacturing, whose contribution fell from 0.9 percentage points in the third quarter to nil in the fourth.

The latest GDP data release indicates that real annual GDP increased by 4.9 percent in 2005, up from the 2004 growth rate of 4.5 percent. This is despite the market's lower-than-expected increase for the fourth quarter of 2005 (3.3 percent), compared with the increase of 4.2 percent in the third quarter of 2005.

    SWAZILAND

Economic growth in Swaziland has weakened over the past decade. More recently, real GDP growth decelerated to 2.1 percent in 2004 and an estimated 1.8 percent in 2005.

A prolonged drought affected agricultural output, particularly maize, the main staple crop, and cotton. The real effective appreciation of the exchange rate of 24 percent in 2002-04 and high oil import prices hurt Swaziland’s main exports (sugar, wood pulp, and garments) and manufacturing activities.

In addition, the removal of textile quotas in industrialized countries in January 2005 has led to factory closures and significant job losses in the garment sector, further worsening the unemployment rate (estimated at 30 percent).The fiscal deficit has increased in the last two fiscal years.

In 2004/05, despite a large one-time windfall in South African Customs Union revenues and efforts to increase domestic revenue by removing some tax exemptions, the wage bill and other current expenditures were sharply increased, resulting in a deficit (including grants) of 4.3 percent of GDP, significantly higher than the original budget of 2.8 percent of GDP. Spending pressures have continued to rise in 2005/06, because of the full-year effect of the civil service wage increase granted in 2004, and further wage increases through a supplementary budget in the third quarter of the fiscal year, further widening the budget deficit.

The deficits have been financed by external and domestic borrowing, drawing down of government financial assets, including the Capital Investment Fund (CIF), and an accumulation of domestic arrears. As the budgeted obligations exceed inflows of revenues and available financing, the government is facing a serious cash flow problem.

Monetary developments have reflected those in South Africa. In line with interest rate reductions in South Africa, the Central Bank of Swaziland reduced its discount rate to 7 percent in April 2005. Market yields on treasury bills have moved downward and interest rate spreads relative to South Africa have remained small, as new issues of treasury bills have been contained to avoid incurring higher short-term borrowing costs, notwithstanding the government’s large financing needs. Available data indicate that the banking system, which is dominated by South African banks, remains strong.

McIlvaine Company,
 Northfield, IL 60093-2743
 Tel:  847-784-0012; Fax:  847-784-0061;
 E-mail:  editor@mcilvainecompany.com;
 Web site:  www.mcilvainecompany.com