Notes from Durban Roundtable: State Capture and State Owned Enterprises

 

The Helen Suzman Foundation held its Durban Roundtable on Tuesday, 24 October 2017 at the Lion Match Factory Park hosted by Jonsson Workwear. The theme for this Roundtable was ‘State Capture and State-Owned Enterprises’. Our keynote speaker was Dr Iraj Abedian, chairman and Chief Executive of Pan African Investment and Research Services, joined by the HSF’s Head of Research, Charles Simkins, and the HSF’s Legal Counsellor, Anton van Dalsen. 

Charles Simkins on the infrastructure challenge


Charles Simkins started off the discussion with preliminary comments on “the infrastructure challenge”. He set out the following five themes within which we can assess the extent of this challenge:


1. Economic and demographic

South Africa is in a period of low growth which is likely to continue for the next few years.  The average growth rate was 1.3% over the five years between 2013 and 2017 and is projected by the IMF to be 1.8% between 2018 and 2022.  The need for capacity expansion is modest, except where there are bottlenecks and backlogs. Simkins stressed the importance of not overbuilding capacity, so that every public provider of infrastructure should work with realistic growth projections.

He argued that we have an opportunity to deal with bottlenecks as technical capacity grows, provided that financing problems can be dealt with.  The SA Institute of Civil Engineers report on infrastructure [1] indicates quite rapid growth of young engineers, though there is a capacity constraint at the more senior level where importing of capacity is both possible and necessary. 

The population is projected by the United Nations to grow from 55.3 million in 2015 to 58.7 million in 2020 and 61.8 million in 2025, implying an annual average population growth rate of 1.1% per annum over the ten year period.  The urban population as a percentage of the whole is projected to rise from 64.7% in 2015 to 67.2% in 2020 and 69.4% in 2025, implying an urban population growth rate of 1.8% per annum.  This is good news.  Concentration in urban areas makes infrastructure easier to provide, while cities and towns are not going to be overwhelmed by inmigration.  Over the long haul more efficient cities which contain urban sprawl will have positive effects on the need for infrastructure, but the co-ordination requirements are complex and gains here will be very modest over the next decade.

2. Re-orientation of plans by all three levels of government and state owned enterprise.

The SAICE report points out that neglect of maintenance is the most serious problem identified in its three infrastructure reports of 2006, 2011 and 2017.  It goes on to say:

Political leadership, planning capability and technical capacity are inconsistent, and frequently deficient, across departments and different spheres of government. Engineering capacity shortages are chronic at the municipal level, which is often where infrastructure is operated and maintained. There are also institutional problems, such as insufficient data to properly schedule maintenance, and a lack of accountability for mismanagement of infrastructure. Often institutional failures and skills shortages allow corruption to thrive and thus create resistance to improving maintenance systems.

Better management of maintenance should move up the agenda and can do so if there is modest new capacity required.  Preventative maintenance is invariably cheaper than reactive maintenance and it extends asset life more, but it requires more in the way of systematic information collecting for use in maintenance programmes.  Moreover, maintenance can be put through income and expenditure accounts with recovery through tariffs, unlike capital expenditure which requires debt financing.

3. Poor capital expenditure and financing decisions will have a large adverse impact on  increasingly fragile public finance and hence on the economy

The IMF debt sustainability analysis prepared for the 2017 Article IV consultation with South Africa suggests that South Africa’s government debt-to-GDP ratio is sustainable in the baseline scenario, but is highly sensitive to shocks. Persistent low growth or a shock to contingent liabilities could push both South Africa’s gross financing needs and debt level above the high-risk benchmarks of 15 and 70 percent of GDP, respectively.  There is an urgent need for reforms to increase economic growth and reduce contingent liabilities, especially from state-owned enterprises, to increase the resilience to shocks. 

Recent developments have been adverse and their effect magnified by a growing gap between government revenue and expenditure.  There seems to be a general view among public providers of infrastructure that the principal risk in their business is that the Treasury will not bail them out.  It needs to change, and fast.

4. Infrastructural development cannot beat the rents being extracted from it at the moment.

Rents, which are payments over and above those required to get the job done take the following forms:


i. The difference between the most competent available appointment and the appointment which is actually made.


ii. Political patrimonialism, which in addition to the costs of incompetence disrupt the chain of accountability.  Cadre deployment is simply cancerous.


iii. Procurement policy when it departs from the principle of lowest price among tenderers capable of doing the job.  The most recent tendency in procurement policy is for agencies each to make up their own with ever greater departures from price competition


iv. Fruitless and wasteful expenditure and outright theft, fraud, embezzlement, tender manipulation, acceptance of bribes for lax enforcement of contracts and the like.


A radical reduction in rent is needed.  Otherwise, the development of new infrastructure and maintenance will be hopelessly compromised at the same time as actual, never mind contingent, liabilities will expand in a chaotic fashion.  Substantial political change will be needed if rents are be reduced.  If we don’t get it, an economic crisis will force structural adjustment down the line.

5. The provision and maintenance of infrastructure is about the efficient management of engineering and finance. 

Simkins advised that information and proposals should flow up an organisation to senior management and the Board and decisions should flow downwards, with capacity for learning from experience and error correction.  However, what we too often see is chaotic management in which information flows are disrupted, coherent frameworks not achieved, with the consequence that policies lack an adequate foundation.  Illegality and patrimonialism, on the other hand, encourage secrecy and a divergence between stated policy for public consumption and the actual basis on which decisions are made.

Anton van Dalsen on Eskom

Anton van Dalsen, legal counsellor of the Helen Suzman Foundation, encouraged the audience to look beyond the issues of corruption and corporate governance at SOEs to other issues that are just as worrisome.  These further concerns include the financial situation of SOEs and their inability to develop and implement a long term strategy.  It is fair to assume that these problems may well stem from issues of corruption or bad corporate governance practices – if not directly then indirectly.

To illustrate his point, Van Dalsen used Eskom as a case study – providing some staggering figures to place Eskom’s situation in context.  He noted that the demand for electricity has been stagnant for five years, attributed in part to the lack of economic growth and an increase in consumer choices, while the cost of generating electricity and surplus generating capacity continues to increase.  This has resulted in Eskom’s application to the National Energy Regulator (NERSA) for an increase in the standard electricity tariff of 19.9% and 27.5% for municipalities.[2] Further calculations based on Eskom’s financial statements show an annual cash flow shortfall of R32 billion

Even more concerning is the total government guarantees available to SOEs, amounting to R550 billion (R335 billion of which has already been used), which effectively equates to 12% of the GDP or 25% of current Government debt.  The ever-growing electricity generating capacity is compounded by the completion of Kusile and Medupi power stations which will further increase the surplus generating capacity by 25% if demand remains stagnant.  The costs relating to the Independent Power Producers are also becoming increasingly cheaper while Eskom is failing to provide the full story to the public.  In view of this surplus, South Africa does not need nuclear energy for many years and cannot afford it anyway.

Against this background, there is no sign that Eskom realises that its current model is unsustainable or that it knows how to deal with this changing scenario.  Van Dalsen emphasised that the audience needs to be mindful that the problem does not concern a narrow focus on corruption and corporate governance  -  but also includes planning, strategy and the ability to analyse what is needed in a changing environment.

The issue, therefore, goes much wider than corruption.

Dr Iraj Abedian on the role of ethical behaviour in the relationship between the public and private sectors

Dr Iraj Abedian posited a thought experiment to the audience: to conceptualise society as a system. Within this system there is no difference between the private and public sector. The reason for this lack of distinction is because of the nature of “interrelationships”. Essentially, it means that a corrupt government cannot succeed without professional help in the form of bankers, lawyers, auditors, etc. The same is true for corporations where professionals collaborate to support corruption.

The human is the common denominator in both systems.

The state becomes the principal and the private sector becomes the client. This statist developmental project relegates the private sector not as a discussant, but instead to the position of a contracting party which must comply with certain “terms and conditions” should it wish to benefit from this project.

The crux of Dr Abedian’s address was to interrogate this specific relationship and emphasise the role (or lack thereof) of morals, ethics and values within such a system. The developmental project has noble ambitions in the form of redress policies such as BEE and affirmative action. These are necessary remedies, although such policies have been abused for individual gain. Empirically, this can be seen from poverty statistics which indicate that 54% of employed South Africans, and in particular, 89% of domestic workers, live below the poverty line. The cognitive dissonance is most pronounced where private actors such as Cash Paymaster Services (CPS) can report high dividends or individual employers are aware of the low wage rate in South Africa yet there are no questions asked. At this juncture, Dr Abedian turned the spotlight to audience to begin asking these questions. He encouraged more open discussions about such contradictions, especially where our own inertia or inaction is present.

As concerns key players, such as banks, asset managers, prominent law and accounting firms, he expresses the belief that they have lost their “moral authority”. In failing to be compliant themselves with the appropriate codes of corporate governance they have made their organisations “ready for purchase” with the state as the main spender.

South Africa has avoided complete junk status through our split grade with junk status not being accorded by all ratings agencies to local and foreign currency exposure. This amounts to effective but not official junk status. Dr Abedian pointed out that effectively we are already there. He sets out the two major constraints on the fiscus as being zero growth and increased borrowing (while the cost of borrowing also increases). This amidst the rise of what he deems a “predatory government”, where the governance regime which is deeply corrupted, sits above the next tier of technical, competent people who through direct or indirect action find themselves complicit in the corrupt behaviour. This is compounded by the culture where those who would speak up are quickly silenced either through intimidation or removal.

He stresses that we must start empowering people to be people in the face of state capture facilitated by a complex, trans-national machinery. In a situation where the state is looted to a standstill, the private sector becomes the only engine left. The imperative then is for the private sector to be pushed for more explicit “codes of engagement”. A criteria where the application of the fit and proper standard must be implemented in order to achieve proper corporate governance.

Conclusion

The discussion was well received by the audience. One pertinent question from the audience focused on the question of how do we achieve these outcomes; of a corporate culture that supports ethical behaviour and decision making. In response, the panel stressed the importance of civic engagement, and participation in ensuring accountability and good corporate governance. The society plays an intrinsic role in bettering the relationship between state actors and the private sector.

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[1] The report can be accessed here: http://saice.org.za/wp-content/uploads/2017/09/SAICE-IRC-2017.pdf

[2]  See the comments submitted to NERSA by the Helen Suzman Foundation on Eskom’s tariff application at http://hsf.org.za/resource-centre/hsf-briefs/comments-on-eskom2019s-2018-19-revenue-application.