ECONOMIC POLICY: SENDING THE WRONG SIGNALS,

C O N F I D E N T I A L SECTION 01 OF 03 PRETORIA 003308 SIPDIS USDOC FOR 4510/ITA/MAC/AME/OA/DIEMOND TREASURY FOR OAISA/JEWELL DEPT PASS USTR FOR PCOLEMAN E.O. 12958: DECL: 07/19/2014 TAGS: EINV ETRD EFIN ECON SF SUBJECT: ECONOMIC POLICY: SENDING THE WRONG SIGNALS, LIMITING GROWTH REF: A. PRETORIA 2875 ¶B. PRETORIA 3113 ¶C. PRETORIA 3052 ¶D. PRETORIA 2381 ¶E. PRETORIA 2936 Classified By: Ambassador Cameron R. Hume; Reasons: 1.5 (b/d) ¶1. (C) Summary/Conclusion. Recent policy statements by senior government officials and moves to intervene in the economy send the wrong signals to the business community and undermine investor confidence. Still, despite the counterproductive rhetoric and ill-conceived policy interventions, the economy remains fundamentally sound. Government's key economic policy makers are unlikely to make any substantial shift to the left in policy that would roll back the success of the last decade. The price of pandering to the left, however, is that the recent rhetoric and policy initiatives limit South Africa's ability to achieve sustained higher growth, necessary to create jobs and reduce poverty. In the short term, South Africa will muddle through with moderate but positive growth and little progress on its most pressing economic issues. End Summary/Conclusion. Policy Fundamentally Sound -------------- ¶2. (U) South Africa's economic fundamentals are sound. The economy grew 3 percent in first quarter of 2004, its eighteenth consecutive quarter of positive growth. Forecasters expect the economy to grow at 3 percent throughout the year. Based on higher than forecast revenue growth, the budget deficit for fiscal 2004/5 is likely to be smaller than the Finance Minister's estimate of 3.1 percent of GDP. Inflation (CPI minus mortgage costs) remains stable and low at 4.4 percent, in the mid-range of the Reserve Bank's 3-6 percent target. While export volumes declined slightly in the first quarter, export values grew, supported by high commodity prices. The current account deficit, 1.8 percent and 1.6 percent of GDP over the last two quarters respectively, is easily financed by strong capital inflows. Jobs creation, however, remains the weak point: unemployment is 30-plus percent and the economy lost 113,000 formal sector jobs in the first quarter. ¶3. (SBU) The first quarter's performance is characteristic of the economy's performance over the last decade: steady, moderate growth based on sound fiscal and monetary policy management. The country's economic performance has, however, been insufficient to address the fundamental problem in the economy: poverty and unemployment. Addressing this issue is key economic challenge of President Mbeki's second term. But Sending the Wrong Signals -------------- ¶4. (C) Since early this year, and particularly since April's election, government economic policy statements and initiatives have become more interventionist, reflecting a sense of urgency and frustration with the economy's failure to create formal sector jobs. In a June 23 address to Parliament, Mbeki cited leftist British author Will Hutton in justifying an important role for the state in establishing a just society (reftel A). The President's remarks, and similar ones by leading ministers, plus several ill-handled policy initiatives, outlined below, have sparked a lively debate on the direction of economic policy. Parliamentary opposition and Democratic Alliance (DA) leader Tony Leon has accused Mbeki of moving "economic policy from the free market and towards state control." SAG spokespersons countered that the DA favors "unbridled market dominance" while ignoring the role of government in any economy. The press has reported the debate in detail, and "Business Day," the leading business daily, has published numerous opinion pieces by prominent commentators in its series "Towards an Economy of Our Own." Control Drug Prices -------------- ¶5. (C) Early this year, the government announced draft regulations that would have required pharmaceutical companies to set ex-factory prices for regulated drugs at no more than 50 percent of their current listed price to help reduce the cost of medical care. Following months of negotiations between the government and the pharmaceutical industry, the two sides agreed on a pricing method that should lower consumer costs without jeopardizing the industry's operations. While the multinational pharmaceutical companies reached an acceptable agreement, the fight dampened companies' inclination to expand operations in South Africa. For example, a major U.S. pharmaceutical firm dropped plans to introduce five new products in the market due to uncertainty about the regulatory environment. Slow Down Restructuring of State-Owned Enterprises -------------- -------------- ¶6. (C) Newly appointed Minister of Public Enterprises Alex Erwin told Parliament June 14 that while the SAG had not abandoned its policy on restructuring state-owned enterprises (SOE's),"it is not our intention to do so now" (reftel B). In addition, the minister said that no state-owned enterprises would be sold this year. Instead the government would focus on improving the efficiency and capital structure of SOE's to support higher economic growth rates. Erwin elaborated that "in the case of Eskom, Transnet and Denel we will move to implement concessions, joint ventures and PPPs" over the next five years. The minister indicated, however, that this administration's top priority was to create jobs. Although Erwin's statement refuted trade union assertions that restructuring was dead, the announcement was also a move in the trade unions' direction: maintaining jobs will take priority over efficiency in the parastatal sector. Discourage FDI with BEE Equity Requirements -------------- ¶7. (C) For foreign investors, the lack of flexibility in Black Economic Empowerment (BEE) equity requirements is a growing disincentive. In the financial services charter negotiations, foreign banks won a last minute exemption from prescribed equity requirements in return for a commitment to finance local business development. In the ongoing ICT charter negotiations, BEE equity requirements for multinational corporations are the central issue (reftel C). So far, representatives of local ICT businesses have refused to offer foreign ICT companies any flexibility on equity, such as higher performance standards in human resource development. While a compromise may be reached, as in the financial sector charter negotiations, U.S. ICT companies are not confident: several are already preparing contingency plans to divest. As a U.S. business advisor in the ICT sector noted, the damage to investor perceptions is already done. The controversy over the ICT charter is also creating nervousness in other sectors. Foreign banks express concern that the financial services charter will be reopened and their equity exemption lost. In addition, several U.S. firms in the pharmaceutical and freight sectors are in discussion with their headquarters about their continued presence in the South African market. Stifle Minerals Exploration -------------- ¶8. (C) As part of its drive to push ahead BEE in the mining sector, the SAG tried to implement in June a requirement that firms must be 51 percent Black South African-owned to obtain a minerals exploration license on state-owned land. Following objections from the mining sector, led by foreign investors, the SAG agreed to review the requirement in light of the fact that the BEE Mining Charter calls for 15 percent and 26 percent Black equity ownership in five and tens years, respectively. Industry is concerned that the 51-percent requirement could bring minerals exploration to a halt and seriously hinder the development of new mines and employment. In July, the government backed down, stating that the 51 percent BEE requirement would only apply during a one-year transition period and then fall away. Keep Telecom Monopoly -------------- ¶9. (C) In telecommunications, the SAG is publicly committed to bringing competition to the sector; yet after two years of delay, the Communications Minister refuses to authorize the ownership structure for the Second National Operator, despite a recommendation by the independent regulator (reftel D). As a result, telecom charges in South Africa remain among the highest in the world. Restrict Land Ownership -------------- ¶10. (C) The SAG's June announcement that it would open a dialogue on restricting foreign ownership of land was poorly handled (reftel E). The SAG presented no evidence to support its claim that foreign demand was driving up land values. In fact, the limited research publicly available indicates that from 0.5 percent to eight percent of property transactions involved foreigners. Not Serious About Investment -------------- ¶11. (C) Among other things (e.g., more flexible labor markets),South Africa needs higher levels of investment if it is to reach the growth rates needed to reduce poverty and increase employment. The government's recent policy statements and its poorly managed interventions in the economy, however, underscore that the SAG is not serious about promoting private sector investment, and particularly attracting foreign direct investment. Private sector investment last year was 12.6 percent of GDP, markedly below the 20 percent of GDP of high-growth emerging markets. South Africa has also failed to attract significant levels of FDI: it receives about one third the level of FDI as similar emerging markets. HUME