US embassy cable - 04PRETORIA3308

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