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Viewing cable 05PRETORIA2161, SOUTH AFRICA: PUBLIC SECTOR INVESTMENT, PART II OF II

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Reference ID Created Released Classification Origin
05PRETORIA2161 2005-06-02 10:05 2011-08-24 01:00 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Pretoria
This record is a partial extract of the original cable. The full text of the original cable is not available.
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