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Adding fuel to the fire

Apr 12 2017 14:08
Mariam Isa

The ominous question of whether the government will forge ahead with an expensive nuclear build programme regardless of its affordability has become the focus of concern that South Africa’s track record of sound financial management will be undermined by the policies decided by President Jacob Zuma’s new Cabinet. 

Fitch Ratings Agency highlighted the threat when it cut SA’s credit rating to junk status on 7 April, warning that under the newly appointed finance and energy ministers the programme was likely to move ahead more quickly, requiring further financial guarantees which would weigh on the government’s balance sheet. 

In Fitch’s view political differences over implementation of plans to expand nuclear power in the country preceded the abrupt dismissal of former finance minister Nhlanhla Nene in December 2015 and may also have contributed to the sweeping reshuffle which resulted in the removal of former finance minister Pravin Gordhan. 

Fitch’s comments tapped right into the mounting anger and helplessness felt by many South Africans over the way in which corruption and state capture appear to be gathering momentum, and the apparent inability of the ANC to rein in Zuma’s reckless agenda for the country’s fragile economy. 

Nuclear deal speculation ‘overdone’

Real though the threat may be, since the shock Cabinet reshuffle there has been a spate of misleading media reports presenting the existing schedule for the nuclear programme as completely new and suggesting that a shady deal over the estimated R1tr project is already done and dusted. 

Energy experts believe that the speculation has been overdone and power utility Eskom, which was given control over nuclear procurement plans late last year, issued a statement on 10 April denying that a deal had already been signed.  

“In my opinion, there are too many people involved in the deal for it to be done behind closed doors,” said Chris Yelland, investigative editor at EE Publishers. “If things are done incorrectly, it’s bound to get out. A lot of people are watching very closely – NGOs, the media and civil society. Government leaks like a sieve and it’s just too big to be done secretly.” 

Almost immediately after the Cabinet reshuffle was announced on 31 March, a story surfaced that the new finance minister, Malusi Gigaba, had signed papers for the nuclear deal on his first day in office. On the weekend of 9 April, two leading newspapers carried reports detailing the timeline for the programme, citing internal Eskom documents dated just a few days before Gordhan and his deputy, Mcebisi Jonas, were axed. 

In fact, the information was released by Eskom weeks ago, and reported by other publications. The utility issued a request for information from nuclear vendors in December, saying that a request for proposals would be issued by the middle of 2017 and that by early 2018 the preferred bidder should be selected, with a contract in place between the end of 2018 or early in 2019.

What was new in the weekend stories was that most of the nuclear contracts would be implemented through “turnkey procurement”, which means that a single company would be appointed to manage and deliver an entire project. That means the management company would be responsible for appointing all contractors and service providers – a policy that makes corruption easy to conceal. 

Another rumour that appeared just before Zuma recalled Gordhan from London was equally alarming – former ANC MP Vytjie Mentor was quoted as saying that a Russian participant in one of the minister’s investor presentations left the room when Gordhan said the government would “never” develop nuclear energy, and then called another Russian who immediately called Zuma. This was the real reason for which Gordhan was fired, the reports alleged. 

Apart from obvious question marks raised by the purported events, the main discrepancy is that Gordhan had never said the nuclear project would not go ahead – he repeatedly pointed out that it was part of the state’s planned energy mix but would not be implemented at a pace or scale which the country could not afford. This is exactly what Gigaba said at his first press conference. 

No faith fiscal policy will be retained

The problem is that few have any faith in Gigaba’s insistence that SA’s fiscal framework will be adhered to, least of all Standard & Poor’s and Fitch, which both cited the policy uncertainty generated by the Cabinet reshuffle as one of the main reasons for their decision to downgrade SA’s sovereign credit rating to junk status. 

Comments by Enoch Godongwana, the ANC’s head of economic transformation, were also taken with a large pinch of salt. He said that the government’s expenditure plans – including for the nuclear programme – would have to be revised in light of the country’s junk status, which raises the cost of its borrowing. 

“The issue now is the separation between the ANC and government,” said Nomura emerging market analyst Peter Attard Montalto. 

“The whole point at the moment is that the ANC is far less important than Zuma’s own policy agenda. Oversight will be reduced and if Treasury stops asking for information (on the nuclear deal) which can be shared, he will get away with whatever (sic).” 

The fact that three top ANC officials – secretary general Gwede Mantashe, deputy president Cyril Ramaphosa, and treasurer general Zweli Mkhize – backed down from initial public objections that Zuma carried out his reshuffle without proper consultation, reinforces the view that he is increasingly wielding his power. 

Track record of transparent budgets

For the past decade, Treasury’s Budget has been recognised globally for its complete transparency and willingness to highlight the risks to its spending and revenue targets. In its Budget for the coming year in February, it said that guarantees on the debt of state-owned enterprises like Eskom remained a major risk to the fiscus. 

These guarantees amounted to R477.7bn at the end of February while exposure totalled R308.3bn. Eskom accounts for three-quarters of the guarantees and about two-thirds of the exposure. 

Yields on government bonds have climbed about 60 basis points since the Cabinet reshuffle and are likely to rise more as Fitch’s downgrade of local currency means that they will fall out of some bond indexes used by passive investors. 

Standard & Poor’s (S&P) only downgraded the country’s foreign debt, but has put a negative outlook on local currency debt.   

J.P. Morgan said on 7 April SA would depart from its investment grade government bond index starting in late April, and noted that about $49bn worth of South African bonds are benchmarked against its investment grade-only emerging-market bond indexes, while $10bn is linked to its global bond index for emerging markets. 

It will be even worse if both S&P and Moody’s downgrade SA’s domestic debt to junk status, as that means it will also fall out of Citigroup’s World Government Bond index.  

Downgrade impact contained so far

So far the impact of the two downgrades on the rand and government bonds has been relatively contained, partly because it was expected by markets and also because global factors are benign – US interest rates are rising at a modest pace and commodity prices have stabilised. 

The issues going forward will be net portfolio flows – which are foreign purchases of domestic bonds and equities – and how the current account deficit would be funded, said Colin Coleman, MD of Goldman Sachs International in South Africa. 

Coleman said that the choice of a replacement for Treasury director-general Lungisa Fuzile, who resigned beginning of April, would be seen as an important indication of whether fiscal discipline will be maintained. The appointment of one of the current incumbents in Treasury would help to instil confidence. 

Business is “extremely concerned” about the long-term direction the country is taking and would be watching closely to see whether “state capture” would spill over into the private sector through regulatory and other pressures, he added. 

Gigaba’s first medium term budget policy statement in October will have to give some indication of how government intends to fund its nuclear build programme and will be closely scrutinised for signs that fiscal discipline is slipping. 

Investors are also waiting for more details on what the government means by “radical economic transformation”, which is likely to be clarified at the ANC policy conference in June. 

Mariam Isa  is a freelance journalist who came to SA in 2000 as chief financial correspondent for Reuters news agency after working in the Middle East, the UK and Sweden, covering topics ranging from war to oil, as well as politics and economics. She joined Business Day as economics editor in 2007 and left in 2014 to write on a wider range of subjects for several publications in SA and in the UK. 

This article originally appeared in the 20 April edition of finweek. Buy and download the magazine here