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