The South African economic environment has remained challenging during the past quarter with the economy lagging our global peers by up to 6 months. The strengthening of the Rand has exacerbated the problem with the mining and manufacturing related sectors bearing the brunt of this. This comes through in the PMI data where South Africa has remained in negative territory for the past 4 months while some of the major developed nations have turned positive. Above inflationary wage increases and the 31 % increase in electricity costs points towards pressure on profitability for South African corporates in the short term. The response by South African corporates to the current environment has been fairly decisive with a focus on cashflow generation and strengthening of balance sheets. The past quarter has seen working capital being driven down substantially with a key focus on inventory. Despite the challenging environment in the short term, signs of stabilization and recovery are emerging with expectations that the South African economy should bottom early next year. Interest rates have been cut by 500bps over the past year with the impact of this expected to come through in the year ahead. Inflation has continued its downward spiral with the August (PI of 6.2% being very close to the South African Reserve Bank target range of 3-6%. With lower inflation, lower finance service costs and improving access to credit, consumers face a substantially improved environment with rising disposable income in the near future.

The South African central bank has lagged in the monetary easing curve when compared with its global peers and the recovery in economic growth, consumer demand and any potential upward pressure in inflation is expected to lag during 2010. Interest rates are therefore expected to remain low over the short term. Our income fund remains focussed on the fundamental characteristics of the instruments and underlying issuers and we are well positioned to take advantage of the current opportunities while maintaining our philosophy of investing with highly rated institutions and not to sacrifice quality.

The macro environment indicates that the global economy continues to face serious headwinds in the form of banks and households de-leveraging, so demand for consumer durables amongst individuals will remain subdued for some time. In addition, the industrial capacity built up over the past few years to service an ever expanding demand now seems far too much, but government bailout efforts are preventing the closure of excess capacity, which means that competitors to the government-supported companies do not have pricing power. There also remains the problem of how to exit from the monetary and fiscal stimulus with a legacy of higher taxes, increased regulation and higher cost of capital the net result of the current survival efforts. The South African economy seems to be lagging the downturn in the rest of the world as the 2010 Soccer World Cup-related infrastructure spending had already started in 2008, so it was the export-orientated mining and manufacturing sectors that took the brunt of the downturn due to the global trade collapse and recent stronger rand. Higher union wage demands, alleged price collusion and administered prices pose an inflation threat, which is why the South African Reserve Bank kept interest rates steady in June. The monetary transmission mechanism seems broken with companies repaying a record R27.3bn in loans to banks in May, while households are not being extended credit due to their high debt to income ratio, so the interest rate cuts between December 2008 and May 2009 have not boosted consumer demand. Against the backdrop of a more significant slowdown in the domestic economy and the pressure from the strong rand on exporters the decision of the Reserve Bank to keep interest rates steady at its June Monetary Policy Committee (MPC) meeting was surprising. The next MPC meeting is only at the end of August. A comparison with other central banks in commodity exporting countries like Australia, Canada, Chile and New Zealand shows that the South African central bank is behind the monetary easing curve when compared with its peers. Our income portfolios remain focussed on the fundamental characteristics of the instruments and underlying issuers and we are well positioned to take advantage of the current opportunities while maintaining our philosophy of investing with highly rated institutions and not to sacrifice quality.

The South African economy experienced a substantial easing in economic growth during the second half of 2008 with slowing consumer spending and a sharp fall in the export driven mining and manufacturing sectors. The result was that the non-farm economy suffered two successive quarters of contraction on a quarter-on-quarter seasonally adjusted basis, but growth momentum was sufficiently strong so that the annual average was a still robust 3.1 % despite the sudden withdrawal of foreign capital from the South African equity and bond markets. Foreign capital returned in the first quarter of 2009, but concerns remain about its volatility. The slowdown in the domestic economy in the second half of 2008 is one of the reasons why the government enhanced its fiscal stimulus, while the South African Reserve Bank has cut interest rates three times in the past four months. Commodity prices declined rapidly from their mid-2008 highs as the global economy slowed. We therefore anticipate earnings for the mining and resources related companies to decline significantly during the first half 2009, on a year on year basis. Lower commodity prices will however provide some relief on the input costs side. Private sector capital expenditure growth slowed down in the second half of last year with the real value of building plans down 52% yearon-year in January 2009. With credit conditions tightening as shown in the sharp decline in the narrow M 1 money supply measure, as well as the slowing global and domestic economies, private sector capital expenditure growth will continue to decline in 2009. Government and parastatal related fixed investment remained robust with momentum expected to be maintained in the year ahead based on the current pipeline of projects as government acts in a counter-cyclical manner to support growth. After a stress-full 2008 which saw consumer spending decline, the South African consumer can look forward to a brighter 2009 on the back of lower inflation and interest rates. With inflation trending downward and the economy slowing, we anticipate aggressive interest rate cuts during the year. This expectation is reflected in the change of the frequency of the South African Reserve Bank's Monetary Policy Committee meetings from every two months to monthly except for July this year. Consumers' disposable income is expected to increase substantially; hence we anticipate further debt repayments as well as an increase in spending. Already the household debt to disposable income ratio has declined to 76.4% in the fourth quarter 2008 after peaking at 78.2% in the first quarter 2008. South African bonds are currently expensive with the current yields on government issues around 7.8%. Bonds rallied strongly during the last quarter of 2008 on the back of lower inflation expectations to reach a 7% yield in December 2008, but as the January and February 2009 consumer inflation data disappointed the market, so they gave back part of their gains. South African money market yields (3 month) are currently around 9% after starting the year at 11.4%. With policy interest rates set to decline more rapidly now that the South African Reserve Bank has increased the frequency of its Monetary Policy Committee meetings to monthly from bi-monthly, these yields should continue to trend lower over the next quarter. This is clearly evident in the current rates offered for one year deposits of 8.5%, having declined from their peak of 14% in June 2008.

The South African economy experienced a substantial decline in economic growth during the second half of 2008 with slowing consumer spending and a sharp fall in the export driven mining and manufacturing sectors being the major drivers. Commodity prices declined rapidly during the last quarter as the global economy slowed with prices expected to remain under pressure over the next few months. We therefore anticipate earnings for the mining and resources related companies to decline significantly during the first half 2009, on a year on year basis. Private sector capital expenditure growth has slowed down in the second half of last year, particularly on the mining front. With credit conditions tightening and the slowing global and domestic economies, private sector capital expenditure growth will continue to decline in 2009. Government and parastatal related fixed investment has remained robust with momentum expected to be maintained in the year ahead based on the current pipeline of projects committed to. However, credit conditions are unlikely to ease significantly over the short term highlighting a significant risk for the funding of this capital phase. In light of South Africa's budget deficit widening over the next 2 years, the funding of public sector fixed investment will need to be closely monitored. After a severe 2008 which saw consumer spending decline, the South African consumer can look forward to a brighter 2009 on the back of lower inflation and interest rates. The fuel price was cut by 134c in January 2009, which translated into a 20% decline in fuel costs, year on year. With a bumper harvest for maize and wheat, prices of soft commodities (food, etc) have declined in recent months and will contribute to lower inflation during 2009. The impact of lower food and fuel inflation together with the reweighting of the South African consumer inflation basket, effective 1 January 2009, could see inflation moving below the South African Reserve Bank target of 6% by the end of 2009. With inflation trending downward and the economy slowing, we anticipate aggressive interest rate cuts during the year.

South African bonds are currently expensive with the current yields on government issues around 7.2%. Bonds have rallied strongly during the last quarter on the back of lower inflation expectations. South African money market yields (3 month) are currently around 11.3% but still negative in real terms (3 month rates peaked at 12.5%). With inflation declining rapidly, these yields should continue to trend lower over the next quarter. This is clearly evident in the current rates offered for one year deposits of 9.7%, having declined from their peak of 14% in June last year.