Author: Peter Fabricius, Daily Maverick

But the reforms that the IMF would impose as conditions for the loan would save the economy, says Peter Leon.

South Africa will probably have to go back to the IMF for a much bigger loan than it has just got and this would come with conditions such as deep structural reforms to the economy.

These reforms would, however, be the “silver lining” on the immense fiscal crisis which the country now faces, exacerbated by the coronavirus pandemic, said Peter Leon, senior partner and co-chair of the African group at the law firm Herbert Smith Freehills.

He told a webinar in Johannesburg on Wednesday that SA was teetering on the edge of a fiscal cliff with the economy likely to shrink this year by 5,8% according to the IMF, 6,1 % according to the National Treasury and 7% according to the World Bank.

The fiscal deficit would exceed 13% this year and public debt to GDP ratio could reach 80% 2021, Leon said.

The recent IMF loan for US$4,2 billion under the IMF’s Rapid Finance Instrument which the government was granted to help it fight the economic fallout of the Covid-19 pandemic, came with few conditions attached, he said.

“Analysts, however, suggest that this is only a precursor to a full IMF programme and SA may find itself, in the next five years, with little choice but to approach the IMF for long-term assistance in the form of an extended credit facility (ECF) or standby arrangement (SBA),” he said at a webinar on Wednesday.

“These facilities, which could give SA access to up to US$18 billion, are typically conditional on the implementation of extensive structural reforms aimed at addressing microeconomic challenges and raising the country’s long-term growth trajectory.

“The IMF’s last Article IV report on SA in January 2020 suggests that SA would be required to implement major microeconomic reforms, especially for SOEs and product and labour markets.”

The IMF had predicted that the implementation of its proposed structural reforms would have great benefits. These would include; increase per capita income; boosting economic growth through 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; reduce inflation over the medium term as the impact of higher competition and exchange rate appreciation counterbalanced the inflationary impact of robust domestic demand; allow fiscal consolidation and create greater room for monetary policy easing, thus reducing broader financing costs.

Although the IMF’s “upside scenario” was based on a pre-Covid-19 assessment, the structural weaknesses in SA’s economy remained the same, Leon said.

“The silver lining of the current malaise is thus that it may prompt and hasten the kind of structural reforms that have been thus far resisted by the government – in particular the ruling ANC’s alliance partners (COSATU and the SACP).

These microeconomic reforms – in particular, liberalising the labour and product markets, and at least partly privatising electricity, rail and port networks – held the key to SA overcoming the legacy of Zuma’s “lost decade”.

But it might be difficult to achieve these goals as this would clash with the ANC’s Post-Covid-19 Economic Reconstruction, Growth and Transformation Plan. “

However Leon said to prevent further severe economic decline, South Africa needed to rethink its economy and identify measures to resuscitate it post Covid-19.

An absolute imperative was to entice more local and global businesses to invest in SA, including urgent mechanisms to attract more foreign direct investment.

Leon noted that from 1994 when the ANC came to power until 2009 South Africa had signed 49 bilateral investment treaties (BITs) with other countries and ratified 22.

These BITs gave investors classic protections such as no expropriation without due process and prompt, adequate and effective compensation at full market value; unrestricted repatriation of funds; and recourse to international arbitration.

But then it lost an international arbitration dispute with a Swiss company for failing to protect his game farm from vandalism after a land invasion and had to settle with an Italian/Luxembourg granite company which claimed that the black empowerment requirements imposed on it amounted to uncompensated expropriation. In response, the SA government started unilaterally terminating SA’s BITs, but only those with EU members and Switzerland, in September 2013. It did so without any prior consultation with SA’s Parliament; the affected states; major investors into SA from those states; major SA investors into those states; or the SA public at large.

In 2015 the SA government signed into law the Protection of Investment Act, to replace the BITs though it only came into effect in July 2018.

The act substituted fair and equitable treatment with the right to administrative justice, access to information and access to courts, which all investors already enjoy under the Constitution.

And the act entirely ruled out investor-state arbitration though it gave foreign investors the special right to request SA’s department of trade and investment to facilitate mediation of a dispute with the state.

Meanwhile, South Africa also persuaded the other member states of the Southern African Development Community (SADC) to amend the SADC investment protocol- which had given foreign investors similar rights to SA’s BITS- by aligning the protocol with SA’s much more restricted foreign investor protection under the Protection of Investment Act.

Leon said the combined effect of these Zuma administration’s measures had been to dilute foreign investment; from US$8,3 billion in 2013 when the BITS were scrapped, to US$1,7 billion in 2015, before rising to US$5,34 billion when President Cyril Ramaphosa took office and launched a campaign to attract US$100 billion in investment over the next five years.

Meanwhile, GDP growth also dropped, from 2,5% in 2013 to 0,4% in 2016..

Leon noted that in its 2019 investment climate statement, the US State Department had said SA was still fighting its way back after the “lost decade” of Zuma’s presidency.

The report added that Ramaphosa’s early steps to remedy the economy were encouraging but he would have to go further, by strengthening economic growth, stabilising public finances to reverse credit rating agency downgrades, creating policy certainty, reinforcing regulatory oversight; making state-owned enterprises (SOEs) profitable rather than recipients of government bail-outs; weeding out widespread corruption; reducing violent crime; tackling labour unrest; improving basic infrastructure and government service delivery; creating more jobs while reducing the size of the state ; and increasing the supply of appropriately-skilled labour.

“Given SA’s economic fragility, the government is rapidly running out of fiscal headroom,” Leon said.

“If SA is to emerge from the economic devastation of the Covid-19 pandemic, it will need more than investment-friendly rhetoric from the President and his envoys.”

It would have to go beyond even the structural reforms proposed by the IMF and show concrete commitment to the protection of foreign investors, by:

*amending the Protection of Investment Act to provide for proper investment protection;

*joining the World Bank’s International Centre for the Settlement of Investment Disputes or at least negotiating new BITs with important trading partners, especially in the EU, or with the EU as a bloc;

*submitting itself to investor-state international arbitration.

These steps would go a long way towards restoring confidence in SA as a safe destination for long term job-creating investment.

Leon also proposed that Ramaphosa go even further by withdrawing SA’s termination of the original BITs.

And he suggested South Africa and the rest of Africa should introduce similar strong investment protection into the investment protocol of the African Continental Free Trade Agreement which was still being negotiated. . DM 

 

This article was first published on Daily Maverick, 11 June 2020


For more information, please contact Peter Leon or your usual Herbert Smith Freehills contact:

Peter Leon
Peter Leon
Partner & Co-Chair of Africa Practice Group, Johannesburg
+27 10 500 2620