SOUTH AFRICA: PUBLIC SECTOR INVESTMENT, PART II OF II

UNCLAS SECTION 01 OF 04 PRETORIA 002161

SIPDIS

SENSITIVE

E.O. 12958: N/A
TAGS: EINV ECON EFIN ETRD SF
SUBJECT: SOUTH AFRICA: PUBLIC SECTOR INVESTMENT, PART II OF II

REF: A. PRETORIA 01998

B. 2004 PRETORIA 03113

C. CAPE TOWN 00114

(U) This cable is Sensitive But Unclassified. Not for
Internet distribution.


1. (U) Summary. Faced with the dilemma of having so much
capability vested in often-troubled SOEs and the slow decline
of the nation's economic infrastructure, President Mbeki has
set a new strategic course. The central element is to raise
the level of public investment to improve the nation's
infrastructure and achieve faster economic growth. In
particular, Mbeki wants state owned enterprises (SOEs, i.e.,
public corporations with the state as the sole shareholder)
and public-private partnerships at all levels of government
to lead the way. Two giant SOEs, Eskom and Transnet, will be
responsible for about half of R267 billion ($45 billion) in
planned public sector investment over the next five years.
The strategy represents a marked departure from the past, and
effectively puts the government's privatization program of
major SOEs on hold. The Department of Public Enterprises,
which represents the government's shareholder interest in
large SOEs, and the National Treasury, which must approve all
PPP projects (ref A),will have to play leading and sometimes
intersecting roles. End Summary.

Expanding the Role of the Public Sector
--------------


2. (U) South Africa has embarked on a public sector
investment campaign driven by state owned enterprises (SOEs)
and public-private partnerships (PPPs) to upgrade the
nation's infrastructure and drive economic growth. In his
February 2005 State of the Nation address, President Mbeki
made it clear that SOEs and PPPs would lead public sector
investment, especially to improve the nation's aging
infrastructure, attract greater foreign investment, and to
finally propel South Africa into a period of high, employment
generating growth. In October 2004, Finance Minister Trevor
Manuel announced plans to spend R267 billion ($45 billion) on
public sector investment over the next five years. The
government also wants public sector investment to create new
opportunities for "Black Economic Empowerment" (BEE)
companies.


3. (U) The change in policy has been accompanied by a fair
amount of introspection. In an article entitled "A Failed
Consensus" published in the New Agenda economic journal and
the Financial Mail (May 27, 2005),Manuel questions the
relevance of the Washington Consensus to African countries.
"One of the most important drawbacks of the Washington
Consensus" he writes, "was that, though it provide a good
mixture of reforms to both stabilize the economy and
encourage private sector activity, it did little to help
resolve structural and institutional constraints on growth."
He later concludes, "most African states need to expand, not
contract, their public sector and dramatically improve
(their) efficiency in delivering quality public services."

The Problem is Now the Solution
--------------


4. (U) Mbeki's new strategy represents a marked departure
from the 1990s, effectively putting privatization on hold and
breathing new life into large, monopolistic SOEs. South
Africa's SOEs were originally formed to pursue the industrial
policies of an economically isolated apartheid regime. In
the mid 1990s, an ANC-led government embraced privatization
as a way of dislodging SOE control of the economy, attracting
foreign direct investment, driving economic growth, and
ultimately merging the white and black economies. Government
began unloading state assets and preparing parastatals for
eventual privatization by converting them into public
corporations and establishing industry regulators. While
plans to restructure various industry sectors were drawn,
most stalled for political, bureaucratic, and sometimes
market reasons.


5. (U) Slow implementation gave SOEs the opportunity to prove
to government that they could serve new political purposes --
such as rolling out ambitious social service programs to
deliver electricity, water, transportation, and telephone
services to the poor. Left-of-center politicians agreed,
pushing for an expanded role for SOEs to redress the
inequities of the past. The problem was that many government
social service programs were essentially unprofitable, and
came sometimes at the expense of maintaining or investing in
new infrastructure. The sad fact has been that, since 1994,
SOEs have consumed far more fixed investment than they have
contributed to the South African economy. This partly
explains the serious bottlenecks in electricity supply and
transportation services today. Now, the government's plan is
to use the balance sheets and market dominance of these SOEs
to invest in large infrastructure projects to overcome these
bottlenecks and entice private sector investment through an
assortment of PPPs.

Turning Frogs into Princes
--------------


6. (U) Faced with the dilemma of having so much capability
vested in often-troubled SOEs and the slow decline of the
nation's economic infrastructure, President Mbeki set a new
strategic course for his second term. Essentially, he wants
to turn SOE "frogs" into investment leading "princes." The
"edge of the spear" may have been the late 2003 appointment
of National Treasury Director General Maria Ramos as CEO of
Transnet (the SOE parent of the national railroad, port,
airline, and pipeline companies). Her instructions were to
revitalize the transport sector, even if it means massive
reorganization. Another key appointment was the reassignment
of Minister of Trade and Industry Alec Erwin, the architect
of Mbeki's public sector investment strategy, to Public
Enterprises soon after the 2004 elections. His instructions
were to press large SOEs into undertaking major investment
programs, thus morphing them into drivers of economic
efficiency and growth.


7. (U) Erwin has a lot of material to work with in the seven
SOEs that he supervises. They include Eskom (electric
utility),Transnet (transportation),Denel (defense),Alexkor
(diamond mining),SAFCOL (forestry),Arivia.kom (information
technology),and Aventura (vacation resorts -- in the process
of being sold to a BEE company). Together, these SOEs employ
136,000 people, procure R13 billion ($2.2 billion) annually
in goods and services, own combined assets of R176 billion
($29 billion),and generate R84 billion ($14 billion) in
annual revenue, roughly equal to 6% of South Africa's GDP.


8. (U) Since his arrival at the Department of Public
Enterprises (DPE),Erwin has thrown himself into overhauling
the seven large SOEs that report to him, as well as
re-engineering DPE itself (ref B). On April 15, during his
budget presentation to Parliament, Erwin dismissed DPE
Director General Eugene Mokeyane and Denel (defense SOE) CEO
Victor Moche. He also declared that from now on SOEs would
focus on their core businesses and sell off non-core assets.
In fact, Denel, Eskom (electric utility SOE),and Transnet
plan to sell assets totaling R8.6 billion ($1.4 billion). In
addition, Denel's focus, in expectation of a large Airbus
offset contract, will shift to aerospace instead of
conventional arms. The other, smaller SOEs are still subject
to sale.


9. (U) Erwin also wasted little time in making major changes
at DPE, which he has already reorganized into four
streamlined divisions: corporate finance and transactions,
corporate structure and strategy, governance and policy, and
analysis and risk management. In addition, Erwin has
launched a major recruiting effort to find the skills his
department needs to implement Mbeki's strategy, and to grow
his staff well beyond its current 150 employees.


10. (U) Similarly, Ramos has wasted little time in making
major changes at Transnet, including cleaning house of
unwanted executives and reorganizing the state enterprise.
Transnet's companies include Spoornet (railroad),National
Ports Authority (port ownership),South African Port
Operations (port operations),South African Airways
(airline),and Petronet (oil and gas pipelines). In June
2004, Ramos replaced Transnet's Treasurer with a former
General Manager from the National Ports Authority. In August
2004, she engineered the replacement of all members of the
Transnet and South African Airways Board of Directors. In
January 2005, she replaced Spoornet's CEO. Nicknamed "South
Africa's Iron Lady," Ramos has earned a reputation for
"no-nonsense" as she pulls out the stops to turn around her
unwieldy state enterprise.


11. (U) Ramos quickly unfurled a four-part strategy to turn
around Transnet that can be encapsulated as follows: (1)
focus on core businesses; (2) restructure Transnet debt; (3)
improve corporate governance; and (4) invest in human
capital. In an effort to streamline a top heavy parent
corporation, Ramos is in the midst of slashing Transnet staff
from 700 to around 50. For focus on core businesses, Ramos
plans to sell 14 non-core assets within the next 24 months,
including Transnet's lucrative 26% stake in the Cape Town's
Victoria and Albert Waterfront (ref C). Ramos will also cut
scandal-ridden South African Airways loose, converting it
into its own state enterprise that will report directly to
Erwin at DPE.

Spotlight on Eskom and Transnet
--------------


12. (U) Under the government's public sector investment
program, two giant SOEs, Eskom and Transnet, will assume
responsibility for about half of all planned investment, or
R136 billion ($23 billion),over a five year period. Of
considerable note is that Eskom and Transnet will not/not
receive any budget support from government. They will have
only their own cash flows, joint venture partners, and debt
markets on which to draw.


13. (U) Eskom, one of the top ten electric utilities in the
world in terms of generating capacity, is slated to spend R95
billion ($16 billion) to meet South Africa's growing demand
for power over the next five years. The company plans to
spend half of this amount, R48 billion ($8 billion),adding
to its current capacity of 35,000 Megawatts (MW). This
includes investing R12 billion ($2 billion) to bring back on
line its Camden, Grootvlei, and Komati coal fired power
plants, with a combined capacity of 3000 MW. In addition,
Eskom will partner with the private sector to build two new
1000 MW power plants by 2009, together worth R23 billion
($3.8 billion). These investments should raise Eskom's
overall generating capacity to more than 40,000 MW within
five years.


14. (U) Meanwhile, Transnet is poised to invest R41 billion
($7 billion) in rail, port, and pipeline projects in an
effort to create a seamless inter-modal freight transport
service for the nation. Ramos recently told an investment
conference that she was focused first on improving the
nation's railways, as industry had constantly criticized
Spoornet for poor quality service, inefficiency, and high
prices. Her plan to restructure Spoornet includes investing
R14 billion ($2.3 billion) on upgrading locomotives and
improving the railways. In particular, the OREX line from
the Sishen iron mine to Saldanha Bay will be upgraded to
carry an additional 10-15 million metric tons of iron ore per
year for export. Similarly, the Coallink line to Richards
Bay will be upgraded to carry an additional 10 million metric
tons of coal for export. Transnet will spend R7 billion
($1.2 billion) to redesign the ports of Durban, Cape Town,
and Ngqura (Coega). Transnet will also spend R3 billion
($500 million) to build another multipurpose pipeline from
Gauteng to Durban.


15. (U) As Ramos explained to the investment conference,
Transnet must undertake such an ambitious plan to recover
from its failure to invest in infrastructure over the past 30
years. Though she claimed that the private sector was
"knocking on her door" at all hours to propose PPP projects,
Ramos cautioned investors that Transnet would still take its
time to evaluate proposals and to sequence rail, pipeline,
and port projects in a logical manner.

Who's in Charge?
--------------


16. (SBU) Since much SOE investment should take the form of a
public-private partnership (PPP),SOE investment plans would
appear necessarily to intersect with the National Treasury's
PPP program, begging the question: "Which department will
lead?" According to National Treasury, the PPP Unit must
approve all PPP project feasibility studies, requests for
proposal, contracts, "value for money" reports, and
management plans -- including those involving the SOEs (ref
A). Therefore, National Treasury will lead. According to
DPE, however, SOEs are not legally bound to obtain Treasury
approval before investing. Therefore, DPE will lead when it
comes to Eskom and Transnet investment.


17. (SBU) The PPP Unit official that we spoke to admitted
that the government was entering uncharted territory, but
pointed out that the Public Finance Management Act 1 of 1999
required Treasury to monitor the progress of all PPPs. He
believed that all SOEs would likely have to obtain the
Finance Minister's blessing before proceeding with PPPs, even
though the investments did not draw directly from public
coffers. However, it was not clear to him whether the
National Treasury would scrutinize the implementation of all
SOE PPPs. He speculated that maybe the DPE and/or the
Auditor General (who reports to Parliament) would perform
this function. He added that Treasury and DPE were not alone
in administering the government's public sector investment
strategy. Coordination was important. Other departments,
such as the Department of Transportation and the Department
of Minerals and Energy, would continue to play important
roles as regulators and policy makers who supervised industry
activity and devised sector development strategies.

Comment
--------------


18. (SBU) Mbeki has made it clear that he intends to use
public sector investment to overcome growing deficiencies in
national infrastructure and kick start faster economic growth
for the country. To accomplish these goals, he has enlisted
the support of all government agencies -- national,
provincial, and municipal. He has clearly given marching
orders to National Treasury and DPE, and expects them to
lead. How these two departments relate to one another and
how they coordinate with other government entities, many of
which are classified by National Treasury as "under
performing," may define the success of Mbeki's strategy, if
not his second term. Beyond that, each department has its
own implementation challenges. Will the PPP Unit at National
Treasury be overwhelmed with projects just as the large SOEs
role out their major PPPs? Can DPE turn around failing SOEs
fast enough so that they can successfully perform the
investment roles that have been identified for them? Mbeki
is counting on DPE and National Treasury leadership to
achieve high economic growth, reduce unemployment, and set
the country on a solid economic footing for the next ten
years. For this tender democracy with over 40% unemployment
(broadly measured),the political stakes are considerable.

HARTLEY