Infrastructure drive or dive?

After South Africa’s government debt was dramatically downgraded by global credit rating agencies Standard & Poor’s (S&P) and Fitch, finance minister Malusi Gigaba put on a brave face, moving fast to reassure wary investors that the country will maintain its fiscal discipline following President Jacob Zuma’s major Cabinet reshuffle at the end of March.

Gigaba’s words and deeds will determine the outcome of government’s massive infrastructure drive, which has struggled even during the fat years to produce the coveted “inclusive growth”.

In the last week of April, Gigaba was in the US to try and quell fears that the downgrades will increase borrowing costs and compromise the state’s ability to deliver infrastructure in an economy that is plagued by stagnant growth, high inflation, and rising unemployment.

The fears are not baseless.

The downgrades have already dragged down the credit ratings of Eskom and Transnet, both state-owned enterprises (SOEs) which are at the forefront of government’s plans to spend R947.2bn on infrastructure development over the next three years.

Roughly 77% of the spending is earmarked to go towards upgrading economic infrastructure, predominantly in energy, transport and logistics, water and sanitation. The bulk of it (R432.8bn) will be spent by the SOEs.

Other key SOEs in the infrastructure programme, the SA National Roads Agency (Sanral) and the Passenger Rail Agency of SA (Prasa), have not yet been downgraded, but they are being closely watched by the rating agencies as they are dependent on government guarantees to raise funds from the capital markets.

In spite of the credit downgrades setback, the financial executives at Eskom and Transnet have mimicked Gigaba by keeping their chins up, issuing statements that hinted that the companies will forge ahead with their infrastructure roll-out plans and will shrug off an increase in interest repayments stemming from the downgrades.

“We are confident that we will successfully execute Eskom’s funding plan over the next five years backed by the availability of the government guarantees; the only challenge that Eskom will have to contend with will be the higher cost of debt,” said Anoj Singh, Eskom’s chief financial officer, in a statement.

The statement was released on 7 April after the company’s long-term corporate credit rating was lowered to B+, two notches below investment grade, from BB- by S&P. The downgrade was immediately followed by Fitch, which lowered of the parastatal’s long-term local currency issuer default rating (IDR) and its senior unsecured local currency rating to BB+, one notch below investment grade, from BBB-. Moody’s warned the SOE that it too was on the verge of downgrading it.

On the other hand, Transnet said it had taken steps to mitigate the downgrades.

Prior to the downgrade of its credit rating by S&P to BB+, one notch below investment grade, the SOE had “proactively and successfully negotiated” with its lenders to lower and relax the credit rating default triggers to sub-investment grade on 26% of its debt portfolio.

“The company has strong liquidity and has secured more than R16bn in unused short-term credit facilities that are available within 24 hours, as well as long-term specific committed funding in excess of R15bn.

“Furthermore, the company has access to the domestic and global capital markets through the Domestic Medium-Term Note and Global Medium-Term Note programmes amounting to R93bn to meet its funding commitments,” said Garry Pita, Transnet group chief financial officer.

However, some companies participating in the infrastructure programme are concerned that the credit downgrades and the depreciation in the value of the rand may lead to government delaying or cancelling projects as they become too expensive to roll out due to high financing costs.

“The cost of foreign debt for infrastructure projects will rise, increasing overall project costs. However, the increase in project costs will not be offset by an increase in operating income and therefore returns from such projects will drop,” said Siyabonga Mbanjwa, managing director of SENER Southern Africa, a contractor that provides concentrated solar power to Eskom.

Mbanjwa also predicts that the fall in the rand triggered by the Cabinet reshuffle and the downgrades will increase the cost of imported materials and equipment used in the infrastructure projects.

“This will increase overall project costs and reduce returns. Marginal projects could be stopped or delayed as a result,” he pointed out.

While Eskom and Transnet sound more resilient, Sanral is deeply fearful of a potential downgrade of its credit rating, which will increase its borrowing costs and undermine its ability to raise funding.

In November last year, Moody’s placed Sanral on review for a possible downgrade due to continuing deterioration in cash flows from the Gauteng Freeway Improvement Project (GFIP) and rising funding challenges at a time when the roads infrastructure provider faced large debt maturities.

“For the toll portfolio – which includes GFIP, N1 North, N1 South, N3 Mariannhill, Tsitsikamma, Huguenot tunnel, N2 North and South Coast – this will have dire consequences for existing projects, which maintains the routes and ensure a level of service to the customer that is required for a toll road. It also means that future projects for strengthening or rehabilitation of these existing routes will be postponed,” said Sanral spokesman Vusi Mona.

About 85% of Sanral’s 21 490km-long road network is funded through direct transfers from National Treasury, while the remaining 15% of the portfolio is funded through toll fees levied on motorists. The controversial GFIP has been met with resistance from Gauteng motorists, many of whom are refusing to pay their e-toll bills, putting pressure on the revenue from the project, which is needed by Sanral to repay a R20bn debt linked to the project.

Because Sanral’s credit rating is inherently linked to the national government’s debt, analysts say the lowering of government’s credit rating will eventually affect the 85% of Sanral’s roads portfolio funded from Treasury.

This eventuality may slow down the issuance of tenders by Sanral to build and maintain roads.

“If a downgrade occurs, Sanral might be forced to reallocate funding internally within its portfolio, which might reduce its ability to deliver its full roads programme and therefore affect the total pool of roads coming into the market,” argues Jean-Pierre Labuschagne, Africa Infrastructure and Capital Projects Leader at Deloitte.

According to the Budget Review published by Treasury in February this year, Sanral was allocated R36.8bn to upgrade and maintain 85.5% of the national non-toll and coal-haulage road network over the next three years.

Eskom will spend R203.8bn of the R947.2bn public sector infrastructure budget to expand power generation and distribution, while Transnet is expected to spend R118.4bn to acquire modern locomotives and wagons and to upgrade railway routes and ports.

Prasa, which is plagued by leadership infighting and mismanagement, was allocated R45.3bn by Treasury to procure new trains for Metrorail (commuter service); acquire new locomotives for Shosholoza Meyl (its mainline passenger service); and to modernise its signalling, train stations and rail infrastructure.

Water and sanitation also has a big slice of the budget and is expected to spend R125.3bn. The money will be used to develop and rehabilitate water infrastructure, including dams, canals, water treatment works, reservoirs and pipelines, which are aimed at connecting households, mines and factories to water services.

Since the late 1990s, the SA government has invested heavily in infrastructure development. The public sector spent more than R2.5tr on infrastructure between 1998/99 and 2015/16. SOEs were the biggest contributors to the expenditure over this period, contributing R1.1tr in total.?Those figures are impressive, but they have done little to ameliorate the infrastructure backlog. Not to mention that much of the infrastructure arrears accumulated during periods of record growth.

These days growth barely registers a blip on the radar, while the freshly installed finance minister is confronted with obstacles that require far more than a charm offensive to overcome.

Andile Ntingi is CEO and co-founder of GetBiz, an e-procurement and tender notification service.

This article originally appeared in the 11 May edition of finweek. Buy and download the magazine here.