After a lost decade, now it’s time to focus on the post-Covid rebuilding process

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After a lost decade, now it’s time to focus on the post-Covid rebuilding process

• 13 June 2020
• Accounting
• South African Accounting Academy

Finance minster Tito Mboweni last week hinted that “zero-based” budgeting is the way of the future. This is a radical departure from past budgeting practice, and means each year National Treasury will no longer start with the previous year’s spending budget as the baseline. Proper zero-based budgeting assumes you start with a blank piece of paper and ignore what was spent last year.

Government has no choice. In May 2020, SA Revenue Services (Sars) Commissioner Edward Kieswetter said tax receipts were expected to come in R285 billion below budget due to the Covid-19 lockdown, and the fiscal year was likely to see tax collections down 15-20%.

Given a 10-16% economic contraction for the year, and possibly four million jobs lost, there is no easy fix.

Peter Leon, partner at law firm Herbert Smith  Freehills, says this latest crisis comes on top of the “lost decade” when former President Jacob Zuma sat astride the wholesale looting of state and public assets.

Just because the country lost the last decade, this does not mean the next decade has to follow the same script.

“The South African economy currently finds itself on the edge of a fiscal cliff,” says Leon. “The Covid-19 pandemic has caused a massive and rapid shock to the economy. While the effects of the pandemic were initially localised to Asia, Europe and the US, the virus transmitted rapidly to South Africa and the rest of the continent with a dual impact on the demand and supply-side of the affected economies. “

How to attract foreign investment

How to fix it? Well, Leon has some solutions, and the cost is miniscule. All it takes is some political will and some regulatory shifts.

What’s most needed in the country is foreign direct investment (FDI), which has fizzled out over the “lost decade.” FDI peaked under former President Thabo Mbeki in 2009 when it exceeded $9 billion. Under Zuma, it dwindled to around $2 billion a year, with one or two exceptional years.

One quick solution is to reinstate the 49 bilateral investment treaties (BITs) that were revoked in 2012 under then Trade and Industry minister Rob Davies. These treaties protected investors from expropriation and allowed unrestricted repatriation of funds, with recourse to international arbitration in the event of disputes.

The reason for cancelling the BITs has never been adequately explained, but a clue may be the 2007 case of Foresti et al v South Africa, where investors from Italy and Luxembourg took SA to the International Centre for Settlement of Investment Disputes (ICSID), as allowed under the BIT treaties. The foreign investors contended that the black empowerment requirements imposed on mining companies from 2004 amounted to uncompensated expropriation, discrimination, as well as derogation from fair and equitable treatment. The matter was settled before the merits were argued, but it’s safe to assume the government saw potential for a huge wave of similar cases inspired by its BEE regulations.

An own goal

Hence, withdrawing from the BIT treaties avoided this type of claim being referred to ICSID.

The problem is, it also crashed FDI. A total and predictable own goal.

In 2006 and 2008 respectively, SA signed and ratified the Southern African Development Community Protocol on Finance and Investment, which came into force in 2010. This provided investors from anywhere in the world the kind of protections typical of BITs, such as no expropriation, fair and equitable treatment, due process of law, free repatriation of investments and returns, and recourse to investor-state arbitration, after exhausting domestic remedies.

Protection of Investment Act

Having cancelled the BITs and watered down investor protections, SA introduced the Protection of Investment Act in 2015, which gave foreign investors no greater legal protection than that enjoyed by domestic investors, and substituted “fair and equitable” treatment with rights to administrative justice, access to information and access to courts, which all investors already enjoy under the Constitution. The only special ‘right’ the Act affords to foreign investors is the right to request the DTI to facilitate mediation of a dispute with the state. This amounts to “an impotent palliative for investor-state arbitration, which the Act rules out entirely,” says Leon.

Meanwhile, SA then lobbied the SADC to amend its investment protocol to exclude foreign investors from outside the region. The Amendment also narrows the definition of “investment”, by excluding government bonds, portfolio investments and claims to money that arise solely from commercial contracts.

In other words, the SADC protocol was amended at SA’s insistence to narrow the rights affored to investors in terms of expropriation, non-discrimination and repatriation of investment and returns.

The message was clear to foreign investors: we don’t care about your money

The cumulative impact of the Zuma Administration’s measures – the termination of BITs, the Protection of Investment Act, and the SADC Protocol Amendment – was to dilute the legal protection afforded to foreign investors, especially those from EU Member States and Switzerland, as well as to send them a discouraging message about SA’s investment hospitality.

This was despite the EU being by far SA’s largest source of FDI (at 75%, accounting for at least half a million direct jobs).

The impact of these measures on FDI were severe:

SA’s share of regional inward FDI stock declined dramatically between 2010 and 2018:

• Southern Africa – fell from 76% to 55%;
• Sub-Saharan Africa – halved from 43% to 21%;
• Africa – also halved from 29% to 14%.

While FDI into the region has been forthcoming, SA has been left behind, says Leon.

Approaching the IMF for funding

Given the covid-induced economic crash, SA has approached the International Monetary Fund (IMF) for $4.2 billion under a short-term lending programme, which comes with few conditionalities. But Leon believes the government will have to seek an additional $18 billion in longer-term funding which means the country will be subjected to a structural adjustment programme (SAP).

Should SA submit to a SAP, the IMF sees the following potential upside for the country:

• increase per capita income;
• growth boosted by the effects of an improving business environment and lower costs of key inputs in network industries;
• meaningfully reduce unemployment and poverty;
• cause public debt to start declining in 2022 while bank lending would rise, creating virtuous macro-financial feedback loops and further financial deepening;
• reduce inflation over the medium term as the impact of higher competition and exchange rate appreciation counterbalances the inflationary impact of robust domestic demand;
• allow fiscal consolidation and create greater room for monetary policy easing, thus reducing broader financing costs.

The silver lining

The silver lining in all this is that the government may be forced to take radical reform measures that were simply inconceivable a few months ago. The IMF will not lend money without a reduction in public the liberalizing of the labour and product markets, and at least partially privatising the electricity, rail and port networks.

Leon suggests some other steps to encourage FDI

• amending the Protection of Investment Act to provide for proper investment protection;
• if not joining ICSID (by signing the Washington Convention), then entering into new BITs with important trading partners, especially in the EU, or with the EU as a bloc (these could be based on the 2012 SADC Model BIT, which the DTI has ignored to date); and
• submitting itself to investor-state international arbitration.

“A novel alternative to the negotiation of new BITs with EU Member States would be for President Ramaphosa to withdraw the notices of termination sent by the Zuma Administration,” says Leon.

“There is strong judicial precedent suggesting that the President is in fact constitutionally obliged to do this, as it is unconstitutional for the Executive to terminate any international agreement without a prior resolution by Parliament (as happened with all of these BITs).”

The Agreement establishing the African Continental Free Trade Area (AfCFTA Agreement) entered into force on 30 May 2019.

While Phase I of the negotiations on liberalisation of trade in goods and services are at an advanced stage, Phase II negotiations on intellectual property rights, investment and competition policy are only expected to be completed by December 2020.              

The anticipated conclusion of Phase II of the negotiations and the finalisation of the forthcoming Protocol on Investment, provides SA and Africa with a unique opportunity to develop an Afrocentric model based on best practice. For one thing, it will create a single, continental rule book for socially responsible trade and investment, and proper protections for foreign investors. Crucially – and this is a deal-breaker for many foreign investors – it create a dedicated dispute settlement mechanism.

Singing on to a programme such as this will cost SA very little. But it will require sacrificing some of the ruling party’s sacred cows, such as social and public sector spending, and labour laws will have to be revisited and relaxed to make it easier to for small businesses to hire.

This time, it seems Tito has no choice but to go for it.

 

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