SINK OR SWIM

State-owned enterprises are the key to the developmental state

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South Africa is staring a sovereign downgrade in the face. Global credit rating agencies are mulling over whether or not to reduce our credit rating to junk status. If that happens, there will be a lot of unnecessary pain. State-owned enterprises (SOEs) play an important role in this scenario—especially the transport and energy behemoths, Transnet and Eskom which, because of their size, significantly influence the rest of the economy. Consequently, if they are managed badly, the credit rating agencies are unlikely to be impressed.

There are many examples of how state-owned enterprises have helped countries develop. When the state takes an active role in guiding and participating in the economy, working hand-in-hand with the private sector, the results can be spectacular. Successful examples include those of Japan, China, or Malaysia, whose fast-tracked developmental programme is the inspiration behind South Africa’s own Operation Phakisa. Consequently, there is no reason that South Africa’s SOEs should not emulate their Asian counterparts in driving the country’s bid to become a flourishing developmental state – provided that operations are underpinned by sound policies and practices.

Therein lies the rub. South African SOEs have been making the news recently for all the wrong reasons. The problem is that SOEs are uniquely vulnerable to abuse by politicians for whom sound policy is far from sacrosanct. South African Airways, Eskom, Transnet and Denel have all come under the spotlight recently, with allegations of good business practice being trumped by political interests. The allegations have all been vehemently denied, of course, and concrete facts are not in the public domain. However, it is worth examining the risk posed to the public good when SOEs are treated as cash cows for the connected.

The first thing to bear in mind is that SOEs are funded by taxpayers’ money. As recently pointed out by Mark Ellyne, Adjunct Professor at the University of Cape Town, “when private companies make big mistakes the public doesn’t fret because the private shareholders pay the price. But when state-owned enterprises make losses taxpayers have to pay for their mistakes.”

The stakes are higher when “the government has higher than average public ownership of the means of production and worse than average public sector governance. An OECD study of 53 countries placed South Africa as having the 11th largest public sector, and rated it the 15th lowest on quality of governance of state-owned enterprises.”

According to Nicola de Jager, Senior Lecturer in Political Science at Stellenbosch University, “Instead of being the mandated sites of development and profitability, they are costing the country and the public purse billions. In the 2014/2015 financial year, they made a combined loss of R15,5 billion.

“Some of South Africa’s state-owned enterprises are being used for personal ends by individuals within the ruling African National Congress. The root of the problem is that the principle of impartiality has been transgressed. Instead, the state is being used as a partisan role player, notably in the distribution of patronage.”

South African Airways is a case in point. “The national airline incurred a R2,5 billion loss in the 2013/14 financial year. It has failed to submit financial statements for the past two years and is technically insolvent. Although several of its board members laid complaints against its chairperson Dudu Myeni, no action has been taken against her. Instead, they were summarily removed from their positions. And Myeni has been reappointed chairperson,” De Jager comments.

“Myeni is close to Zuma and serves as chairperson of his charity, the Jacob Zuma Foundation.”

Investors are taking a dim view of these developments. For example, international credit rating agency Moody’s has put Eskom’s BA1 rating on review for downgrade because the rising cost of buying power from independent producers and Eskom’s spending to refurbish and build new power stations, including the now notorious Medupi power station, several years behind the original project delivery date, have created a situation in which Eskom’s funding needs have become exaggeratedly large.

Moody’s is also reviewing the credit ratings of the Development Bank of Southern Africa (DBSA), the Industrial Development Corporation (IDC), the South African National Roads Agency (Sanral) and Land Bank.

This lack of confidence is reflected in the decision by asset managers Futuregrowth and Abax Investments to reduce or halt lending to several SOEs, citing political uncertainty and governance issues as the cause.

Futuregrowth and the broader asset management industry substantially fund Eskom, Transnet, Sanral, Landbank, the IDC and the DBSA through direct loans in addition to capital and money market investments. Futuregrowth alone has suspended negotiations on more than R1.8bn of SOE debt finance.

As succinctly stated in a Futuregrowth announcement, “We have observed recent reports which strongly hint of conflict between branches of South Africa’s government, the possible machinations of patronage networks, and a seeming challenge to the independence of the National Treasury. This follows many months of such information flow, and stories of evidently patronage-driven contracts/potential contracts by SOEs to what appear to be politically connected persons.

“Into this already unsettling environment, we note the recent and sudden announcement that the Presidency would chair a ‘council’ to directly oversee the SOEs. The meaning, timing and intent of this announcement, particularly at this juncture, is entirely unclear – and, lacking clarity and context, we feel compelled to view this announcement with concern. As rational and fiduciary investors we must adapt our views and investment strategies when circumstances change,” read a Futuregrowth statement, highlighting the fact that the President’s decision to effectively place all SOEs under his own review (coming on the heels of the well publicised debacle following the removal of former Finance Minister Hlanhla Nene, not to mention the ongoing and public spats between current Finance Minister Pravin Gordhan and certain influential individuals within the ruling ANC) has made a lot of people extremely nervous.

Ellyne observes that “Zuma has justified the move on the grounds that it will ensure that state-owned enterprises are properly governed. But how will he achieve this when his policies and relationships with certain individuals are being called into question?

“This doesn’t mean the state-owned enterprises are in imminent danger. But it does appear that their future financial viability is in question. This is because of government interference in their management in form of cronyism is weakening them.”

Allegations of cronyism aside, South Africa’s developmental state policy appears to be ambiguous. There are two prevalent economic models for developmental states. The labour-intensive Asian strategy is based on high investment and export-led growth, with low wages initially assuring competitiveness. Big business is subsidised and protected in return for investment. The Scandinavian model is that of a capital-intensive welfare state with high wages, productivity and state social transfers.

“The South African government appears to want the impossible solution of living like a Scandinavian welfare state and growing like an Asian developmental state,” says Ellyne. “This is the unique ANC Developmental Welfare State—but it can’t work now. We want to keep the social welfare net, but the government has to grow the economy, create jobs, and create more wealth. This requires more encouragement and flexibility for the private sector. Why not partially privatise the commercially oriented state-owned enterprises and make them more efficient and competitive?”

There is nothing intrinsically wrong with state-owned enterprises. Indeed, they can deliver the developmental state of our dreams. However, it is necessary for political interference to be removed and for sound policies to be set. This demands leadership of the highest order. Nobody can predict who will emerge as our next leaders from the present climate of political uncertainty. One thing is certain, though—that they will have to turn around our too-big-to-fail SOEs… and decisively so.

The national airline incurred a R2,5 billion loss in the 2013/14 financial year. It has failed to submit financial statements for the past two years and is technically insolvent

What is a State-Owned Enterprise?

  • A state-owned enterprise (SOE) is a legal entity that is created by the government in order to partake in commercial activities on the government's behalf. It can be either wholly or partially owned by a government and is typically earmarked to participate in commercial activities.
  • SOEs are common across the globe, including in the United States, where mortgage companies Freddie Mac and Fannie Mae are considered government-sponsored enterprises (GSEs).
  • Also known as government-owned corporations (GOC), state-owned entities should not be confused with companies with stocks that are owned, in part, by a government body, as these companies are truly public corporations which happen to have a government entity as one of their shareholders.
  • The state-owned enterprise (SOE) is a global phenomenon, and such organisations exist in the United States, China, South Africa and New Zealand. Legally, most SOEs qualify as business entities, providing them with all the rights and responsibilities associated with them. This means that they are normally required to follow any laws and regulations governing the operation of their business type, and they can also be held liable for their actions. (www.investopedia.com)

“When private companies make big mistakes the public doesn’t fret because the private shareholders pay the price. But when state-owned enterprises make losses taxpayers have to pay for their mistakes.”— Mark Ellyne

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