Basket

Latest News

INSTITUTIONAL DECAY THREATENS SOUTH AFRICA’S MARCH TO PROSPERITY

By 9th Mar 2015Sep 20th, 2019No Comments

The existence of cul-de-sacs in old medieval towns is a well-documented phenomenon in architecture. They existed due to the organic and haphazard expansion of towns and the need for walls and other fortifications against enemies. It would appear that South Africa has recently met more than one of these obstacles, with important implications for economic policy in general and for the metals and engineering sector in particular.

In his Medium-Term Budget Policy Speech in October, Finance Minister Nhlanhla Nene announced that “fiscal consolidation can no longer be postponed”. This came after several warnings that fiscal expansion could not continue, lest deficit expanded out of control.

The previous Governor of the Reserve Bank, Gill Marcus, described the twin deficits of Government debt and the balance of payments as deeply uncomfortable as she watched the growing apprehension from ratings agencies, the fear of rising debt servicing costs, compounded by the potential damage from US monetary policy action on the rand exchange rate and capital outflows. Last week’s budget speech had as its theme fiscal credibility, and most commentators argue that the Minister succeeded in accomplishing that goal.

A second obstacle (a “binding constraint” in industrial policy parlance), electricity, is now a significant factor. It is not immediately obvious how this has been reflected in the budget. The National Development Plan (NDP) did not get much attention in the budget speech, but the Budget Review document handed out contained much more detail and showed blatant contradictions and ambivalence. The Budget Review says that the economy should shift over the long term to the tradable sectors through more investment in manufactured exports and should move beyond the core minerals base. It says that investment should be in dynamic sectors that transfer ownership and economic structure.

However, the self-same Budget Review document says that, given the electricity constraint, in the medium term (over the next 7 years) a less energy-intensive growth path should be pursued. This means support for tourism, agriculture, agro-processing, light engineering and services.

The electricity crisis is of two makings: the country did not invest enough in expanding its power generation capacity and recklessly neglected maintenance. South Africa had a 40% surplus power generation capacity in 1984/5, with a generation capacity of 45 000 megawatts. Today the economy is estimated to be 100% larger (manufacturing is 70% larger) and, speculatively, available generation capacity is 44 000 megawatts.

It is estimated that at one time in December 2014, when maintenance took place, we had 40% of that capacity unserviceable. The reserve margin of 31% in 1994 went down to 7% in 2007 and is non-existent now. The benchmark result for maintenance is to have only 1% unplanned production losses, which was more or less the state of affairs in 2005. Deferred maintenance days have risen from 1500 in 2006 to 7000 days in 2013/14. Therefore, average unplanned production losses have risen from 1% in 2005 to 15% today.
 
These two issues, fiscal credibility and the electricity constraint, have serious consequences for how the Minister mixed the medicine that he decided to administer to the economy. The other symptoms presented by the patient, the SA economy, are low growth, the balance of payments deficit, persistent high inflation, industrial uncertainty and the need for policy certainty. At least in the short term, the prerequisite to contain Government spending, the necessity to conserve energy and the need to alleviate the balance of payments are clearly conflicting objectives.

How did Minister Nene do it? The budget documents argue that spending cuts will not damage growth – capital expenditure continues, the Manufacturing Competiveness Enhancement Programme gets more resources, Special Economic Zone construction continues, the Jobs Fund is strengthened, small business gets a boost and there is relief on unemployment insurance fund contributions – while tax increases are marginal and, therefore, too small to damage growth.

The success of the Government’s plans for its finances is completely dependent on the assumption of economic growth resuming, with the latter largely pinned on export growth accelerating and the electricity constraint being resolved. In the short term, the probability of export volume growth pulling the economy out of its doldrums, thus alleviating the balance of payments challenge, is not high. It would appear that there is dependence on a depreciating exchange rate, resulting in higher rand export earnings and simultaneously lowering import demand due to the higher rand prices of imports. Very soft international demand and exports to hard-hit, commodity-dependent countries in Africa will not do the trick.

Electricity supply and the country’s ability to export and earn foreign exchange are inextricably linked. The highest electricity users/sectors in the economy are also the foreign exchange earners, namely non-ferrous metals (aluminium, copper, zinc), basic iron and steel, non-metallic minerals (gold, diamonds, etc), mining, paper and paper products and chemicals. As these users install their own generation capacity, powerful diesel generators are needed. According to the latest foreign trade statistics, this already has an impact on diesel imports, thus harming the balance of payments even further.

The statement that only low-import and electricity-light sectors would be supported over the medium term is backed up by a table in the budget review document, with sectors ordered from low- to high-energy intensive. It seems that this is a serious point of departure for policy in the foreseeable future, and this can only spell doom for re-industrialisation and beneficiation.

Furthermore, the measures announced to increase taxes may also set in motion dynamics that could have unintended consequences. The clear method used is indirect taxes, but not called VAT. The great concern is that virtually all measures will tax the income-producing and productive side of the economy. Although company taxes are not going up, virtually all the increases will hit the productive sector directly: the fuel levy (30 cents/l), the electricity levy (from 3,5 to 5,5cents/kwh) and the energy efficiency levy (from 45 to 95 cents per kwh), with the diesel rebates to farmers and others curtailed. Most of the indirect tax increases to companies will be passed on to consumers, so consumption expenditure in the economy will not be supported by any of these measures.

At the best of times, domestic economic growth is pedestrian, and so far the large investment projects have not had the anticipated stimulatory impact. The State could experience its own industrial relations instability during 2015, further jeopardizing fiscal credibility. Inflation remains a problem and both the electricity tariff and the fuel levy increases may cause inflation to accelerate on top of widely-expected food-price increases due to the drought.

Budget documents distributed by the Treasury state several times that all measures, including the bailouts to struggling State-owned enterprises, will be “deficit neutral”. That means that taxpayers are asked to fill the gaps. The South African financial system was not in doubt when the US and EU crises occurred. Even the fiscal remedies applied in SA since the crisis could not be faulted.

If anything, this budget highlights the extent to which institutional decay can throw the country’s path to prosperity off track. Most of the adjustments are needed to prop up institutions or functions that are failing. The planning for and provision of electricity has failed, local authorities use resale electricity tariff income to make up for their failed ability to keep their local authorities functioning and the Road Accident Fund is in a mess. Allowing surpluses to build up in the Unemployment Insurance Fund and not adjusting in time also represents sunk costs for companies. The same can be said of the surpluses building up in the SETAs.

The support for Eskom is a case in point: it needs R23 billion immediately (more than the total tax deficit). Electricity tariffs will increase, State assets will be sold and consideration will be given to converting the Government’s subordinated loan to equity. We should not be in the unenviable Ksituation in which we now find ourselves. South Africa deserves much, much better.

Henk Langenhoven is the Chief Economist of the Steel and Engineering Industries Federation of Southern Africa (SEIFSA).

Leave a Reply