The Economic Environment of South Africa

INVESTING IN SOUTH AFRICA

The economic environment, Prof. André Roux | Danny Jansen, EMBA10

Table of content
Perception or reality? .............................................................................................................................. 2 the Broad-Based Black Economic Empowerment Act............................................................................. 4 Other legal boundaries ............................................................................................................................ 5 Uncertainties of the future...................................................................................................................... 6 Strains on resources ................................................................................................................................ 7 Come one come all? ................................................................................................................................ 8 Finance for International Business .......................................................................................................... 8 Should my company invest in South Africa? ........................................................................................... 9 Should other companies invest in South Africa? .................................................................................. 10 References ............................................................................................................................................. 11 Other references read ........................................................................................................................... 11

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Perception or reality?
When any person would be asked on his opinion of Africa in general or South Africa specifically, this opinion would by large be formed by what the media have been showing; corruption, riots, bad infrastructure with dirt roads and the believe that most people still live in clay huts or self-built constructions made out of cardboard, plywood and corrugated sheets. Although my own opinion was formed by these images as well, seeing South Africa in person changed a lot of my perceptions of the country. Definitely on what the country looks like in real life, the mentality of the people and on the potential it has. When having to attract foreign investors into the country this misperception of the country is one of the strongest forces South Africans need to battle against. The stereo typing of items like corruption though are real and need to be battled internally. Besides that there is also the fact that South Africa is seen as being part of Africa. Geographically that is absolutely correct, however, there are large differences within the continent when it comes to division of resources, (industrial) developments and heritage. The globalization of the world and the development of technology should enable South Africa to influence the perception of others. Africa as a whole is already improving, but South Africa should be able to distinguish itself between the rest of its fellow African countries. A survey performed by Ernst & Young in 2012 already shows an improvement of the situation.

Figure 1 Source: Ernst & Young’s 2012 Africa attractiveness survey. Total respondents: 505

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Figure 2 Source: Ernst & Young’s 2012 Africa attractiveness survey. Total respondents: 505

When looking at the real number of investments one can tell that the situation as such is improving.

Figure 3 Foreign Direct Investments in African countries since 2003, Source: fDi Intelligence, data as of 3 February 2012; Ernst & Young

These figures show that there is a lot of trust in South Africa by foreign investors. However, when drilling down further, one could argue this as well.
Table 1 Source: fDi Intelligence, data as of 3 February 2012; Ernst & Young

Sector Services Manufacturing Extraction Infrastructure related Other

Percentage of total projects 50.9% 24.6%5 9.9% 13.0% 1.5%

Percentage of total capital invested 4.0% 29.9% 27.6% 38.3% 0.2%

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Most of the investment projects were service related projects, demanding very few investments in capital.

the Broad-Based Black Economic Empowerment Act
In the decades before South Africa achieved democracy in 1994, the apartheid government systematically excluded African, Indian and colored people from meaningful participation in the country 's economy. With the Broad Based Black Economic Empowerment Act of 2003 the South African government wanted to bring the black community (the majority of the South African population) into the economic mainstream. Although there was an improvement of the situation for black and colored people after the ban of apartheid in 1994 and Nelson Mandela and his ANC now reigning the land the division between rich and poor remained linked to the racial differences. To avoid taking the wealth from the rich white population and giving it to the poor black population the government tried to implement a growth strategy where this inequality was tackled automatically. The government’s Black Economic Empowerment (BEE) policy the government aims to stimulate more black people to get involved in the economic development of the country by applying a number of benefits for them. The objectives of the BEE policy were: - The empowerment of more black people owning and managing enterprises. An enterprise is seen as being black-owned if 51% of it is owned by black people. - Realization of a substantial change in the racial composition of ownership and management structures. - Promotion of accessibility to finance for BEE - Empowerment of rural and local communities by enabling the access to economic activities, land, infrastructure, ownership and skills. - Promotion of the development of black people through, internships, learnerships and mentorships. - Ensure that black-owned enterprises benefit from the government 's preferential procurement policies. - Aid in developing the operational and financial development of BEE enterprises, especially SMME’s and enterprises that are black-owned. - Increasing the share of black women owning or managing existing and new enterprises. In 2007 this led to the Broad-based Black Economic Empowerment (B-BBEE) Codes of Good Practice, which should give guidance to measurement of BEE across multiple sectors. In the first phase all entities, both public and private,

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were encouraged to implement proper BEE initiatives. This was done through the issuing of licences, concessions, sale of assets and preferential procurement In the second phase the seven components of the B-BBEE scorecard came into place: Element Points Ownership 20 Management control 10 Employment equity 15 Skills development 15 Preferential procurement 20 Enterprise development 15 Socio-economic development 5 TOTAL 100 All state bodies and public companies are bound by the B-BBEE to apply this scorecard when making decisions of tendering for business. The government is required to apply them when making economic decisions on procurement, licensing and concessions, public-private partnerships and the sale of stateowned assets or businesses. In these same fields private companies need to apply the codes. Companies in South Africa are also encouraged to use these codes when interacting with each other. The codes of the B-BBEE can be considered a threshold for international companies to start activities within South Africa. Although there is some flexibility towards these companies, there remain measurements that could be considered as ‘not preferable’ by foreign companies on the verge of making the decision whether or not to invest in starting up a new business in South Africa. One of the rules in the B-BBEE on the part of ownership requires that a company is owned for a minimum of 51% by black people and black people have a substantial management control of the business. With the application of the flexibility, companies are allowed to contribute in lieu of a direct sale of equity. These contributions are known as equity equivalent contributions and may be an equivalent of 25% of the value of the multinational’s South African operations or 4% of the total revenue of its yearly South African operations over the period of continued measurement.

Other legal boundaries
One of the biggest bottle necks that South Africa is suffering from is the lack of skilled people. In a survey performed by Adcorp (SA’s economy desperately needs high-skilled workers) it shows that there were as many as 829,800 unfilled positions for high-skilled workers in South Africa. One of the reasons that is mentioned for this situation is the Immigrations Act of 2002. This Immigrations Act makes it exceedingly difficult for foreigners to find work in South Africa. The most recent amendments to the Immigrations Act, of

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April 2011, prohibit the use of immigration agents and quota work permits, which both have historically been widely used by South African companies seeking foreign skills. This shortage entails that foreign investors that would require skilled personnel for their business run a large risk that they will not be able to fulfill these positions, as such making the feasibility of reaching their targets rather small. Research reveals that the highly-skilled categories suffering the greatest skilled shortages are: •senior management •the professions – medicine, engineering, accounting and the law •technical occupations – specialized technicians and artisans •agriculture The other downside for companies needing the scarce resources that are available in South Africa is that these resources follow the market principle of supply and demand, having the wages for these people increase in a fast pace. As a result, Adcorp finds, South African citizens’ wages in highly-skilled occupations have been unduly escalated, in inflation-adjusted terms, by a mammoth 286,4% since 2000. Besides the uncertainty of being able to find the employees needed to deliver the proper services, there is also the cost aspect of these employees that need to be calculated into the selling price of the product or service. Another complication is that in a market that is under this tension other companies would be willing to ‘buy away’ employees of others to fulfill their own needs.

Uncertainties of the future
When talking with people in South Africa their outlook for the future of their country was a mixed one. One of the most actual situations is the health of former president Mandela. Some people fear what will happen if he would pass away. The present political situation where more and more people become dissatisfied with the policy of the ANC together with the uncertainty of mister Mandela’s health create some restlessness among the population. The reactions of the people vary from ‘awaiting what will happen’ to ‘fear violent reactions of black people towards white people’. These signals could spread outside the borders of South Africa and reach potential investors. All hopes should be focused on Cyril Ramaphosa. Being the preferred successor of president Mandela in the eyes of Madiba himself, he was surpassed by the ANC and Mbeki was put forward to fulfill this role. After this he built up an empire that is presently estimated to be worth more than usd 650 million, benefiting of the Black Empowerment Act to its fullest. At the last congress he was elected to be the perceived vice president of South Africa. The success of Ramaphosa as a business man, his history within the ANC and his visions of the future has led to the situation in which he is restructuring the policy of the ANC and therefore indirectly the political course of the ANC in the

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government. The moment of truth will be during the elections of next year, when it remains to be seen if the ANC will remain the biggest political party of the country. Based on the present situation though the forecast of the economic growth is not enough to have South Africa grow the way it should to close the gap between rich and poor, educated and non or lower educated. For this purpose the growth should be 6%, where table 2 shows that the actuals of the last years have been too low and table 3 shows that the estimates for the years to come are not better either.
Table 2 Actual GDP growth per annum. Source: World bank

GDP growth

2008 3.6

2009 -1.5

2010 2.9

2011 3.1

Table 3 Outlook on GDP growth per annum. Source: Treasury Department of South Africa

GDP growth

2012 2.7

2013 3.6

2014 4.2

Price Waterhouse Cooper has estimated that between now and 2050 the average growth of the GDP per capita will be approximately 3%. When looking at it from a purchasing power parity (PPP) perspective, as shown in figure 1, it is an average of 4%; still not enough to create an environment that is needed to create the right circumstances.

Figure 4 Breakdown of components of average real growth in GDP at PPP (2011 – 2050), source: PWC

Strains on resources
Companies that do not supply services and have to rely on (natural) resources have to consider that there is a limit on resources to be used.

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Together with the growth of the economy the usage of electricity has been growing as well. The network and power stations of South Africa are not able to deliver the amounts of electricity that are needed, both for industrial and for individual use. Companies therefore run a risk of being without power or have to invest in an expensive backup system, like a generator. Solar power could be an excellent alternative, but requires a large investment at the start. A similar problem glooms for the usage of water. At this moment South Africa is already depending on other countries for their water supply. The water network is lacking maintenance which causes large amounts of water (28.8%), that are being put into the network, not reaching its final destination. At the same time solutions to save rain for use at a later stage are not a common item. Food producing companies should keep in mind that a shortage of local produced food is a dark shadow approaching South Africa slowly, but steadily. The growth of consumption, combined with the mentioned shortage of water could lead to a diminished supply of resources.

Come one come all?
The investor’s climate for South Africa will be determined by the behavior of larger companies, the multinationals of this era. Smaller investors will consider it to be a sign of trust if multinationals dare to invest money in a country that is considered to be questionable by themselves. Unilever sent out a press release (Unilever continues to invest in South Africa to increase capacity for growth, 2011) in 2011 about the company unveiling new manufacturing facilities in Durban. “This commitment is one of the largest private investments in South Africa since the 2010 World Cup. This new facility will enhance Unilever’s ambitious growth plans for South Africa, an important market in which we have strong category positions across our portfolio, as we do across the whole of Africa.” said Pier Luigi Sigismondi, Unilever’s Chief Supply Chain Officer “Unilever has made significant contributions to the advancement of South Africa and its people for over a century and government is encouraged by this large investment and its augmented environmental benefits. Future plans to expand local operations and Unilever’s pledge to create social benefits locally in a sustainable manner is laudable.”. The size of the investment, €70 million, was part of a €500 million, 5-year investment program of Unilever in South Africa. As such putting out a statement about its trust in the future of the country and its potential.

Finance for International Business
On the 15th of July 2012 the Dutch government introduced a subsidy regulation, called ‘Finance for International Business’ (FIB). With the FIB the government wants to stimulate small and medium enterprises (SME) to invest in a number of emerging markets: China, India, Vietnam, Colombia and South Africa.

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As explained by the service desk for SME’s (Overheid steunt ondernemers die willen investeren in opkomende markten, 2012) The FIB entails that the government will cover 35% of the amount to be invested, as long as the maximum amount stays below €2.5 million per company. The remaining 65% will have to be covered by a professional financer, like a bank or an informal investor. However, there are a couple of conditions to meet:  The enterprise and the project must show enough profitability and continuity for the future.  The money needs to be used for new activities of the enterprise in China, India, Vietnam, Colombia or South Africa.  The money must be invested in capital goods, start up or expansion of production facilities and sales offices and/or working capital.  The money cannot be used to replace an earlier supplied finance. The duration of the loan is limited to five years. After this period the loan needs to be paid in full. Although the FIB is a loan and needs to be paid back, it is an opportunity for companies that want to invest in South Africa, but are not able to get funds from banks. Financial institutes still tend to consider South Africa as a country where investors and businesses run a higher risk.

Should my company invest in South Africa?
The company I work for is a small consultancy agency in the field of data quality management. What it is specialized in is the analyses of large sets of data within companies, matching it against the business rules of the company. After the analyses, we advise the company of the discrepancies we found, leaving the cleansing of the data to the company itself to avoid a conflict of interest. To avoid repeating of the errors we can screen the processes and the data architecture and advise on changes to be made in them. The work itself is very specialized, however due to the economic circumstances within the Netherlands companies take the risk they run by corrupt data as a given, calculating it to be lower than the amount needed for the data quality project. These risks consist not only of financial damage by not charging or mischarging customers for delivered services, but also damage of image. An example of the last is the municipality of Alphen aan den Rijn, which sent letters to 400 deceased people, creating a lot of negative publicity. Since the work is very specialized and businesses in South Africa are growing rapidly there could be a market for my company to deliver these services. However, as has been stipulated if these people can be found within South

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Africa their wages would be relatively high. Besides this fact they need to have someone to manage them to guide them through the process of how to perform a data quality analysis. This entails that at least one of the present employees would need to move to South Africa to build up this knowledge, bringing along the next challenge. If that person is allowed to work in South Africa under the Immigrations Act, the salary of that person would require compensation for working abroad, making that salary a lot higher when compared to people that are at a similar level of skills and experience. All in all this would put the price of the service to be delivered at such a level, that this would be considered to be too expensive to acquire. Based on this information my advice would be to not invest in South Africa. However, further in-depth research on actual wages of this specific labor force would be required together with a market research on the need for this service and the willingness to pay of the companies that do have a need for this.

Should other companies invest in South Africa?
Any company that is not relying on skilled employees or the transfer of own people from other countries could have a great opportunity within South Africa. If this company is not ‘black owned’ it should process goods that can either be sold directly to the end consumer or can be sold outside of South Africa. One of the most recent examples of a company that is able to sell directly to its end consumers is Walmart. As a supermarket it is not dependent of selling goods to other companies, as such ‘suffering’ from the Black Empowerment Act, but is selling to consumers directly. There are opportunities in the mentioned threats for companies settling in South Africa as well. Companies specialized in water management and alternative/new energy should be able to combine the best of both worlds; expanding or growing a new business, but at the same time helping out in a field where more expertise is highly needed. Educating and training South Africans and by such contributing to narrowing the gap between skilled and unskilled people, should be a core activity of any company wanting to build up a business.

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References
Black economic empowerment. (2013). SouthAfrica.info as found on http://www.southafrica.info/business/trends/empowerment/bee.htm Buitenlandse investeringen in Afrika verdubbeld. (2012). Emerging Africa as found on http://www.emergingafrica.nl/algemeen-nieuws/buitenlandse-investeringen-afrika/132buitenlandse-investeringen-in-afrika-verdubbeld Ernst & Young’s 2012 attractiveness survey. (2012). Ernst & Young as found on http://www.ey.com/ZA/en/Issues/Business-environment/2012-Africa-attractivenesssurvey SA’s economy desperately needs high-skilled workers. (2012). Adcorp as found on http://www.adcorp.co.za/NEws/Pages/SA%E2%80%99seconomydesperatelyneedshighskilledworkers.aspx Unilever continues to invest in South Africa to increase capacity for growth. (2011). Unilever press release as found on http://www.unilever.nl/nieuwsenmedia/persberichten/2011/UnileverblijftinvestereninZuid -Afrika.aspx Overheid steunt ondernemers die willen investeren in opkomende markten. (2012). MKB Servicedesk as found on http://www.mkbservicedesk.nl/6378/overheid-steunt-ondernemers-die.htm

Other references read
Everyone’s guide to the South African economy. (2010). A. Roux Internet pages: http://visieopvastgoed.wordpress.com/2012/12/30/de-toekomst-van-zuid-afrika-ligt-bijeen-mcdonalds-man/ http://www.oavm.eu/OAVM-Consultancy/Ondernemen-in-Zuid-Afrika.html http://financieel.infonu.nl/beleggen/9639-beleggen-in-zuid-afrika.html http://www.lieshout-partners.nl/investeren_in_afrika.htm http://www.vooraltijdafrika.nl/?module=investeren http://www.unilever.nl/nieuwsenmedia/persberichten/2011/UnileverblijftinvestereninZuid -Afrika.aspx http://www.waterforum.net/Nieuws/2310-nederlandse-ondernemers-investeren-inspringplank-zuid-afrika http://africainmotion.nl/gateway-naar-afrika/ http://www.emergingafrica.nl/algemeen-nieuws/economie/103-zuid-afrika-investeertmeer-in-industrie http://www.mkbservicedesk.nl/6378/overheid-steunt-ondernemers-die.htm http://icco.nl/nl/participeer/co-financiering/?gclid=CMDjlPi3jbYCFcLHtAodZQkAOw

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References: Black economic empowerment. (2013). SouthAfrica.info as found on http://www.southafrica.info/business/trends/empowerment/bee.htm Buitenlandse investeringen in Afrika verdubbeld. (2012). Emerging Africa as found on http://www.emergingafrica.nl/algemeen-nieuws/buitenlandse-investeringen-afrika/132buitenlandse-investeringen-in-afrika-verdubbeld Ernst & Young’s 2012 attractiveness survey. (2012). Ernst & Young as found on http://www.ey.com/ZA/en/Issues/Business-environment/2012-Africa-attractivenesssurvey SA’s economy desperately needs high-skilled workers. (2012). Adcorp as found on http://www.adcorp.co.za/NEws/Pages/SA%E2%80%99seconomydesperatelyneedshighskilledworkers.aspx Unilever continues to invest in South Africa to increase capacity for growth. (2011). Unilever press release as found on http://www.unilever.nl/nieuwsenmedia/persberichten/2011/UnileverblijftinvestereninZuid -Afrika.aspx Overheid steunt ondernemers die willen investeren in opkomende markten. (2012). MKB Servicedesk as found on http://www.mkbservicedesk.nl/6378/overheid-steunt-ondernemers-die.htm Other references read Everyone’s guide to the South African economy. (2010). A. Roux Internet pages: http://visieopvastgoed.wordpress.com/2012/12/30/de-toekomst-van-zuid-afrika-ligt-bijeen-mcdonalds-man/ http://www.oavm.eu/OAVM-Consultancy/Ondernemen-in-Zuid-Afrika.html http://financieel.infonu.nl/beleggen/9639-beleggen-in-zuid-afrika.html http://www.lieshout-partners.nl/investeren_in_afrika.htm http://www.vooraltijdafrika.nl/?module=investeren http://www.unilever.nl/nieuwsenmedia/persberichten/2011/UnileverblijftinvestereninZuid -Afrika.aspx http://www.waterforum.net/Nieuws/2310-nederlandse-ondernemers-investeren-inspringplank-zuid-afrika http://africainmotion.nl/gateway-naar-afrika/ http://www.emergingafrica.nl/algemeen-nieuws/economie/103-zuid-afrika-investeertmeer-in-industrie http://www.mkbservicedesk.nl/6378/overheid-steunt-ondernemers-die.htm http://icco.nl/nl/participeer/co-financiering/?gclid=CMDjlPi3jbYCFcLHtAodZQkAOw 1 1