UPDATE 2-South African economy to grow slowly in 2016, risks remain

* Policy makers’ remarks follow unexpectedly strong Q2 data

* Finance minister says recession not part of 2016 forecast

* Central bank says growth remains “inadequate” (Recasts with additional quotes, background)

CAPE TOWN/PORT ELIZABETH, Sept 7 (Reuters) - South Africa’s economy is likely to grow more than initially forecast this year but the pace remains slow and subject to risks including drought-induced food inflation, the finance minister and central bank governor said on Wednesday.

Governor Lesetja Kganyago said the South African Reserve Bank is likely to revise its 2016 growth estimate upwards after figures this week showed the strongest expansion in six quarters between April and June. That erased fears the economy might slip into recession after shrinking in the first quarter although Kganyago said growth would remain slow.

“Even if we sustain growth at 3 percent it will still result in below 1 percent average growth,” Kganyago said in a public lecture in Port Elizabeth, adding that initial indications were for growth in the third quarter but it was “too early to tell.”

Finance Minister Pravin Gordhan meanwhile said the government was working hard to avert threatened credit rating cuts that would lift the cost of borrowing and further damage already fragile investor confidence.

Fitch and Standard & Poor’s, which both assign South Africa their lowest investment-grade ratings, have warned that policy uncertainty and political instability could prompt a downgrade that would take the ratings into “junk” territory.

South African markets have recently been rocked by police investigation into the activities of a surveillance unit set up within the revenue service when it was headed by Gordhan, a respected figure in his second stint as finance minister.

Answering questions in parliament in Cape Town, Gordhan dismissed “nonsense” swirling around himself and the Treasury: a clear reference to public spats between the Treasury and state-run firms and the police probe into Gordhan.

“The nonsense that is going on in respect of the Treasury or myself is not, I think, to the benefit of this country,” said Gordhan, known as a blunt-talking technocrat.

For the year as a whole, Gordhan said, “a recession is not (the Treasury’s) baseline forecast, however we should understand that there are risks both outside of the country and within the country we need to recognise.”

After data on Tuesday showed the economy grew 3.3 percent in the second quarter -- a full percentage point more than forecast by a Reuters poll -- Kganyago said the central bank is likely to revise its 2016 growth estimate higher in September.

The bank’s previous forecast of zero growth was made in July and followed a 1.2 percent contraction in the first quarter.

Kganyago said higher food prices, which he called “a classic supply shock,” remained the immediate problem for inflation after a searing drought hit production of key staple crops such as maize.

“We expect food prices to come down quite slowly, even if we do get enough rain this year,” he said.

South Africa’s headline consumer inflation slowed to 6 percent year-on-year in July from 6.3 percent in June but price pressures remain and annual producer inflation accelerated to 7.4 percent in July from 6.8 percent.

Economists have said lower inflation could prompt the Reserve Bank to cut lending rates after keeping them on hold at its last two policy meetings. (Writing by Stella Mapenzauswa and Ed Stoddard; Editing by James Macharia and Catherine Evans)