Cablegate: South Africa Economic News Weekly Newsletter May 16, 2008

DE RUEHSA #1056/01 1401320
R 191320Z MAY 08





E.O. 12958: N/A

1. (U) Summary. This is Volume 8, issue 20 of U.S. Embassy
Pretoria's South Africa Economic News Weekly Newsletter.

Topics of this week's newsletter are:
- Mboweni Favors Further Rate Hike
- International Groups Believes SA Cannot Grow Faster Than 3.5%
- Commodity Prices to Drive Growth
- House Prices to fall in Real Terms
- Net Reserves Down on Lower Gold Price
- SAA Restructuring Program on Track, but Profit-Margins Shrink as
Fuel Prices Rise
- SAA to Realign Its Fleet to Include More Fuel-efficient
- SAG Unveils New Power Pricing Policy
- Eskom Price Hike Unlikely to Go Through
- Eskom Takes Steps to Finalize Nuclear Power Supplier Selection
- Treasury Concedes on Mining Royalties
- Interest Grows in MTN Acquisition
- HP Acquires SA IT Services Company
- Durban Hosts Africa's Largest Travel Trade Show
End Summary.

Mboweni Favors Further Rate Hike
2. (U) South African Reserve Bank (SARB) Governor Tito Mboweni sent
a clear message that interest rates will rise again at the next
Monetary Policy Committee (MPC) meeting in June, stating that price
pressures have spread well beyond food and fuel and must be
contained. "We can't say that the inflation problem we are facing
is just because of food and energy, it's more generalized," he
announced after the SARB published a twice-yearly monetary policy
review. When the MPC started raising interest rates in June 2006,
the main concern was the effect of high domestic demand on
inflation, the SARB report said. But now the inflation landscape
was dominated by "a succession of supply-side shocks", which include
a weaker rand and the likelihood of steep electricity price hikes,
which the SARB now sees as South Africa's main inflation threat.
Mboweni emphasized the importance of anchoring inflation
expectations, which have deteriorated significantly this year.
Interest rates have already increased by a cumulative 4.5 percentage
points since June 2006, taking prime lending rates up to 15% and
curbing consumer demand, the economy's main engine of growth.
Mboweni dismissed suggestions that South Africa's inflation
targeting policy was not working, although the annual rise in the
CPIX price gauge has exceeded its 3%-6% official target for a full
year, rising by a five-year peak of 10.1% last month. "Any central
bank worth its salt will want to contain inflation at lower levels
... I promise you we are going to do our job, come hell or high
water", he said. Mboweni said that monetary policy had become
"particularly challenging" for all inflation targeting countries
with many exceeding targets due to the effect of soaring global food
and fuel prices. At its policy meeting last month, the MPC said
inflation was expected to peak at an average 9.3% in the first
quarter of this year and return to its target only by the end of
next year. (Business Day, May 15, 2008)

--------------------------------------------- ------
International Groups Believes SA Cannot Grow Faster Than 3.5%
--------------------------------------------- ------
3. (U) A Harvard-led group of international experts said, in final
recommendations released by the National Treasury, South Africa's
rapid pace of economic growth over the past three years was well
Qrapid pace of economic growth over the past three years was well
above a sustainable "potential" growth level of about 3.5%. This is
well below the South African Reserve Bank (SARB)'s sustainable
growth estimate of 4.5%. The Harvard group said South Africa's pace
of growth, which amounted to about 5% during each of the past three
years, was unsustainable as it was driven by domestic demand. To
achieve an official goal of boosting growth to a sustainable annual
rate of 6% by the start of the next decade, South Africa should
focus on creating jobs that boosted exports. The group said the
biggest constraint to growth was that only 42.6% of South Africa's
working-age population was employed, compared with 65% in comparable
countries. The group urged the SAG to stick to its conservative
fiscal policies and inflation targeting, which has come under fire
as soaring food and fuel prices force the SARB to continue raising
interest rates. The group also suggested that the SARB control
currency volatility, which has been cited as a big impediment to

PRETORIA 00001056 002 OF 005

growth. The panel did not recommend a specific level for the rand,
which has depreciated by 13% against major currencies this year.
Growth is expected to slow to well below 4% this year. (Business
Day, May 9, 2008)
Commodity Prices to Drive Growth
4. (U) Finance Minister Trevor Manuel stated that the prices of
commodities such as gold and platinum will remain at near record
levels, fueling overall economic growth in Africa. "There is
nothing to suggest that they [prices] will come off in the short to
medium-term," Manuel said during an interview in Maputo, Mozambique,
where he was attending the annual meeting of the African Development
Bank. "The demand for metals and mineral commodities will remain
strong." Manuel also said that investment into countries such as
South Africa, Zambia, and other metals producers has picked up as
metal prices have climbed to new heights, driven by demand from
China and India. (Business Day, May 14, 2008)
House Prices to fall in Real Terms
5. (U) According to the latest ABSA house price index, house price
growth slowed to 6.8% y/y in nominal terms in April, the lowest in
eight and a half years. ABSA Home Loans Senior Property Analyst
Jacques du Toit said that further price drops were expected in real
terms and while some price growth in nominal terms was still
expected this year, this would be at much lower levels towards the
end of the year. "Currently we are looking at an overall drop in
real terms of just over 4% in 2008. In nominal terms, growth of
between 5% and 6% is expected for this year," said Du Toit. He said
higher interest rates were driving real prices down, and that
households were also coming under increasing pressure from sharply
rising food and fuel prices. Du Toit expects the property cycle to
bottom out in 2009 after which there will be a gradual recovery when
interest rates start to drop. (Business Day, May 11, 2008)
Net Reserves Down on Lower Gold Price

6. (U) The South African Reserve Bank announced that net gold and
foreign exchange reserves fell from $33.1 billion in March to $33.0
billion in April, the first decline in almost two years. The
decline was mainly a result of a lower gold revaluation, which
subtracted $261 million from the reserves as the gold revaluation
price fell from $937 per ounce in March to $872 per ounce in April.
The SARB has said it will continue to build reserves to help cushion
the country against external shocks, particularly with the current
account deficit at 7.3% of GDP in 2007. The SARB brought a
long-standing negative position in reserves into balance early in
2004 with the elimination of its loss-making forward foreign
exchange book, historically the Achilles' heel of the currency.
However, South Africa's foreign exchange still lags holdings in
other emerging economies. (Business Day, May 11, 2008)

SAA Restructuring Program on Track, but Profit-Margins Shrink
as Fuel Prices Rise
7. (U) South African Airways (SAA) CEO Khaya Ngqula, announced that
Q7. (U) South African Airways (SAA) CEO Khaya Ngqula, announced that
the airline is still on track to meet the objectives set out in its
restructuring plan initiated in 2007, but it was possible that a
projected 7.5% profit margin would not be reached by the end of
2009, due to soaring oil prices. The upward movement of oil prices
during its 2007/8 financial year wiped R950 million ($125 million)
off the airline's bottom-line. However, Ngqula stressed that SAA's
financial position had improved through fleet downsizing. SAA has
also implemented aggressive oil and currency hedging programs to
mitigate the risk for 2008/9. CFO Kaushik Patel indicated that it
was now working on a 3% to 6% margin range, which would be heavily
dependent on fluctuations in the rand/dollar exchange rate as well
as the oil price. Initial planning had been done at an oil price of
$84 per barrel for 2008/9, but SAA was now working with scenarios
between $84 and $150 per barrel. SAA is considering the use of fuel
surcharges to offset rising oil prices, but Ngqula indicated that it
would not be in a position to pass through the full costs of rising
fuel prices. A R6 million ($800,000) incentive scheme, designed to
retain highly skilled staff, had also received board approval.
During the past year, 963 SAA employees took voluntary retrenchment
packages and a further 869 resigned, making forced retrenchments

PRETORIA 00001056 003 OF 005

unnecessary. Ngqula admitted that many skilled employees had left
its employ, and the exodus had taken a particular toll on SAA
Technical (SAAT), its maintenance unit. SAAT is in the process of
appointing 100 replacements, including 23 technicians recruited from
bankrupt competitor Nationwide, and that it would continue to
recruit. He said SAA continued to 'unbundle' its business into its
seven distinct components, a process that should be finalized by
midyear. A recent FAA audit of SAAT that was leaked to the local
press expressed concern over SAAT's loss of technical personnel,
noting that if SAAT continued to lose personnel at the current pace,
it would not be able to adequately provide maintenance for SAA and
the other international airlines that it serves. (Business Report,
May 13, 2008)
SAA to Realign Its Fleet to Include More Fuel-efficient
8. (U) South African Airways (SAA) issued a request for information
(RFI) to Airbus and Boeing to form part of a new fleet plan. Fuel
efficiency would underpin the RFI for the "next-generation" fleet,
which would be introduced from 2014, as well as the "bridging
fleet", to be operated between 2010 and 2014. According to the
press announcement, a formal request for proposals (RFP) would be
compiled on information garnered from the RFIs. SAA is expected to
then outline the number of aircraft sought, as well as the purchase
and funding scenarios, which are likely to involve a mix of outright
aircraft purchases and leasing arrangements. SAA could seek to
initiate a competitive bidding process between Boeing and Airbus
later this year, probably built around Boeing's B-787 series and
Airbus' A350s. These planes are viewed as considerably more energy
efficient than the current operational fleet. According to press
reports, SAA might also consider the purchase of an Airbus A-380
super carrier. In the meantime, SAA issued a firm RFP to aircraft
manufacturers and leasing organizations for six aircraft to join its
current Airbus-dominated fleet during the course of 2008/9. Three
of these would need to be wide-bodied aircraft for international and
long-haul African routes, while the balance would comprise
narrow-bodied planes to service domestic and regional capacity. CEO
Khaya Ngqula said that SAA's restructuring plan had created the
financial platform for growth and that SAA was now poised to add
capacity to 11 existing routes and add a brand-new service to Maun,
Botswana, in the coming months. Business Development Head Jason
Krause explained the airline would add capacity to the Cape Town,
Luanda, Dar es Salaam, Entebbe, Victoria Falls, Mauritius, Mumbai,
Frankfurt, Munich, Perth and Sao Paulo routes in the immediate-term
and that the six leased aircraft would be crucial to achieving this
goal. Last year, SAA grounded its fleet of six Boeing 747-400s.
Three of these aircraft were returned to the leasing entities, one
had been sub-leased to TAAG of Angola, and the last two would also
be subleased. Krause said the RFP for the additional six aircraft
incorporated SAA's desire for fleet simplification in the
immediate-term, which implied that it would seek to add additional
Airbus capacity. (Engineering New, May 13, 2008)
QAirbus capacity. (Engineering New, May 13, 2008)
SAG Unveils New Power Pricing Policy
9. (U) A new electricity pricing policy was approved by Cabinet this
week, details of which were announced on May 16 at the national
stakeholder summit on electricity. The summit focused primarily on
Eskom's request for a 60% tariff hike for the 2008/9 determination
period, as well as South Africa's future pricing policy.
"Preliminary discussions between government and all the key
stakeholders were taking place to ensure that consensus is reached
at the summit," Government Spokesperson Themba Maseko said following
Cabinet's meeting. Cabinet endorsed a "smoothing mechanism" for
tariffs. It is now unlikely that the National Energy Regulator of
South Africa, which is scheduled to hold public hearings into
Eskom's application on May 23 and make a determination on June 6,
would approve the full 60% nominal increase requested. A Cabinet
statement said the policy sought to ensure that the electricity
value chain:
* contributed to economic growth;
* provided universal access to electricity;
* created an investor-friendly pricing structure, which promotes
efficient cost recovery measures and a reasonable return on
* guaranteed an environmentally friendly usage of resources;
* provided an open and nondiscriminatory access to the transmission
system; and

PRETORIA 00001056 004 OF 005

* created greater levels of transparency on electricity prices to
the users.
The Cabinet statement made no reference, however, to a possible
increase in the size of the shareholder injection that might be
required to sustain Eskom's financial ratios and its credit rating
in view of the lower-than-requested tariff increases. (Engineering
News, May 15, 2008)
Eskom Price Hike Unlikely to Go Through

10. (U) Business and labor groups called for the creation of a
multi-stakeholder group to debate the funding options for
State-owned power utility Eskom's R343 billion ($46 billion)
expansion projects. Speaking at the National Energy Summit on May
16, Congress of South Africa Trade Unions (COSATU) General Secretary
Zwelinzima Vavi said that a five-to-ten person committee should meet
to thrash out the "best possible solution" in the context of the
current emergency. The summit was called for after rolling power
cuts plagued the country and state power company Eskom requested a
60% nominal tariff increase. Eskom's request to augment the 14.2%
hike it had been granted in 2007 has unleashed a wave of opposition.
Vavi did not discount the need to raise prices to deal with the
funding challenge, but suggested that the state funding role should
be properly debated. Business Unity South Africa Chairperson Bobby
Godsell acknowledged that the crisis was primarily of government's
making, but said it would be unhelpful simply to seek scapegoats.
Instead, he said lessons should be learned from the failure of all
participants to deliver on the 1998 White Paper, which warned that
SA would run short of power in 2007. He called for both an
immediate-term focus, to overcome the upcoming winter, and a
medium-term focus, which dealt with the pricing architecture. Vavi
also rejected any notion that workers and the poor should bear the
brunt of the pain for "other people's mistakes". He also lambasted
the unilateral actions taken by Eskom to cut power to the mines and
factories, saying such unilateralism on the issue of rationing
should never be allowed to take place again. Minister of Minerals
and Energy, Buyelwa Sonjica attended the summit along with other
senior government officials. Eskom appears to have lost support
even from the government in its plea for an immediate and drastic
hike in electricity tariffs. Instead, the government has shifted
towards supporting a cash injection for the utility to permit five
years of smaller, incremental hikes. The emerging consensus between
the SAG, business, labor and the African National Congress and its
allies is that a sudden price shock would deliver irreparable harm
to the economy and add significantly to inflation and interest rate
concerns. (Engineering News, May 16, 2008 and Business Day, May 16,

Eskom Takes Steps to Finalize Nuclear Power Supplier Selection

11. (U) State electricity utility Eskom requested Best and Final
Offers from Westinghouse and Areva. The two companies have bid to
build a fleet of power plants in South Africa supplying up to 20,000
megawatts of power. The Westinghouse N-Powerment Team submitted a
Qmegawatts of power. The Westinghouse N-Powerment Team submitted a
proposal in response to the Eskom request. Eskom is expected to
review the Westinghouse and Areva offers over the next few weeks,
and make a recommendation to its Board in June to select to a single
supplier. The next steps include the development of an Early Works
contract so the successful supplier can begin ordering materials.

Treasury Concedes on Mining Royalties

12. (U) National Treasury has made major concessions on mining
royalties to accommodate the mining industry's fear of being
overtaxed under a new royalty regime. Cabinet-approved amendments
to the Mineral and Petroleum Resources Royalty Bill will introduce a
distinction between the royalties imposed on refined minerals (such
as gold) and unrefined minerals (including diamonds, gas and oil),
which will have their own formulas. The amendments also lower the
base for calculating the tax. Chamber of Mines Chief Economist
Roger Baxter said that National Treasury had not yet discussed the
amendments with the Chamber, so he could not give a definitive
comment, but the Chamber appreciated the Treasury's willingness to

PRETORIA 00001056 005 OF 005

engage on the issues. (Business Day, May 14, 2008.)

Interest Grows in MTN Acquisition

13. (U) India's leading mobile operator Bharti Airtel has contacted
Middle Eastern sovereign wealth funds in a search for additional
cash to back a bid for a majority stake in South Africa's MTN Group,
according to press reports. Bharti, which said it was in talks with
MTN but had not made any bid yet, was reported to be considering
offering R160-165 ($21-22) a share for a 51% stake in MTN that would
cost $19 billion. A combination of Bharti and MTN would create the
world's sixth-biggest mobile firm with around 130 million
subscribers. Singapore Telecommunications, Bharti's largest
shareholder with more than a 30% stake, is actively involved in the
talks between Bharti and MTN. Emirates Telecommunications
(Etisalat) said it was also looking at MTN as a possible acquisition
target as part of Africa expansion plans. (Engineering News, May
13, 2008)

HP Acquires SA IT Services Company

14. (U) Hewlett-Packard's (HP) imminent $13.9 billion takeover of
Electronic Data Systems (EDS) is expected to strengthen both
companies' operations in the South African technology services
market, which is dominated by local entities such as arivia.kom,
Business Connexion and Gijima Ast. HP recently entered the South
African IT services market. EDS generated an estimated revenue of
more than R400 million ($53 million) in 2007. Frost & Sullivan
Technology Analyst Lindsey McDonald said EDS had seen steady growth
and was "very well respected" within the industry for its expertise
in storage techniques. (Business Report, May 15, 2008)

--------------------------------------------- --
Durban Hosts Africa's Largest Travel Trade Show
--------------------------------------------- --

15. (U) Thousands of visitors traveled to KwaZulu-Natal (KZN) for
the 2008 Tourism Indaba, Africa's biggest travel trade show. The
Indaba took place at the Durban International Convention Center May
10-13. Deputy Minister of the Department of Environmental Affairs
and Tourism Rejoice Mabudafhasi announced at the opening session
that South Africa was on track to receive 10 million tourists per
year by 2010. The 2008 Tourism Indaba attracted 1,850 exhibiting
companies and over 15,000 delegates from more than 80 countries.
This marked a 14 percent growth in the number of delegates from
2007. The growth in the number of delegates this year provided a
boost for the regional economy as delegates participated in city
tours and add-on events throughout the province. The Indaba focused
on leveraging tourism growth opportunities presented by the 2010
FIFA World Cup. (Tourism Indaba Daily News, May 10-13, 2008)


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