Cablegate: South Africa Economic News Weekly Newsletter June 20, 2008

DE RUEHSA #1352/01 1721459
R 201459Z JUN 08




E.O. 12958: N/A

PRETORIA 00001352 001.2 OF 007

1. (U) Summary. This is Volume 8, issue 25 of U.S. Embassy
Pretoria's South Africa Economic News Weekly Newsletter.

Topics of this week's newsletter are:
- Fitch Downgrades Outlook for SA to 'Stable'
- Rising Interest Rates and Inflation Add to
Manufacturers' Woes
- SA Trade Policy 'Hurting the Poor'
- Retail Sales Drop Over Two Months
- Commodity Boom Drives SA Exports in 2007
- U.S. Displaces Japan as Largest Export Market,
While China Closes in on Germany as the Largest
Source of Imports
- Airport Expansion Costs Rise
- Solar-Powered Cars to Race in SA
- Volkswagen SA Wins Big Export Contract
- Infrastructure Bottlenecks Threaten Security of Fuel
- NERSA Approves Limited Tariff Hike
- Anglo Slips to Fifth Place
- Mining Production Down
- ICT Costs Set to Drop Drastically
- Vodacom Explores Expansion in Africa
- IDC to Inject Funds Ahead of West Coast Cable
Project Roll-Out
- Outsourcing Industry to Receive Boost from
Improved ICT Infrastructure
End Summary.

Fitch Downgrades Outlook for SA to 'Stable'

2. (U) Global rating agency Fitch has downgraded the outlook on its
credit rating for SA from positive to stable, citing rising
inflation, political uncertainties, and a widening current account
deficit. The downgrade means that while economic fundamentals are
still seen as sound, the country is no longer in line for a possible
upgrade to its BBB+ investment grade rating, which would have
encouraged foreign investment. Foreigners have sold a net R9.2
billion ($1.2 billion) of local shares so far this year, fuelling
concern about the funding of the current account deficit, which
widened to about 9% of gross domestic product in the first quarter
of this year. The widening shortfall will put more pressure on the
weaker rand, which is stoking inflation, and might boost borrowing
by private and public sector corporations, forcing the country's
external debt ratios to deteriorate. (Business Day, June 18, 2008)

Rising Interest Rates and Inflation Add to
Manufacturers' Woes

3. (U) The Bureau for Economic Research (BER) reported that the
outlook for SA's manufacturing sector was "grim", with soaring
inflation, rising interest rates, waning demand and business
confidence sliding to a seven-and-a-half-year low in the second
quarter of 2008. Furthermore, rising input costs, which reached a
historic peak in the second quarter, are putting the profitability
of producers under pressure as they are unable to pass on the full
extent of input cost increases via higher selling prices. The BER
survey showed manufacturing exports decreased despite the stimulus
of a weaker rand. The rand has weakened by 16% against the dollar
and 18% versus a trade-weighted basket of currencies this year, in a
trend which would normally make local exports more competitive.
However, the BER pointed out that manufacturing exports have now
fallen for five years in a row, dashing hopes of a recovery spurred
by the currency's steady decline. Furthermore, the manufacturing
Qby the currency's steady decline. Furthermore, the manufacturing
sector, which accounts for 14% of employment, reported job losses
for the second quarter in a row, with that measure rising to a
seven-year peak. Manufacturing output, which accounts for 16% of
gross domestic product (GDP), fell by an annualized 1% in the first
quarter of this year, helping to curb the economy's growth rate to
2.1%, its slowest pace for six-and-a-half years. (Business Day,
June 18, 2008)

SA Trade Policy 'Hurting the Poor'

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4. (U) Harvard Group panelist and University of Cape Town Economics
Professor Lawrence Edwards strongly criticized SA's trade policy.
Edwards said import tariffs were to blame for maintaining high
consumer costs through high levels of protection for certain
sectors, while promoting an anti-export bias and thus inhibiting
growth. These findings are part of a study by the Harvard Group and
were presented to government, business and labor representatives at
the National Economic and Development and Labor Council (NEDLAC) on
June 17. Edwards said it was "astounding" that high tariffs, such
as a 40% tariff on beef, were maintained to protect local industries
while SA was considering reducing the Value-Added Tax (VAT) on basic
foodstuffs to protect the poor in the face of a global food crisis.
Calling SA trade policy a "dartboard" approach, Edwards said that
the average tariff on consumer goods was 20%. He said that while
tariffs protected jobs in sectors such as clothing, textiles and
cars, they constituted a tax on other sectors and consumers.
Finance Minister Trevor Manuel has called for a more proactive
approach towards trade liberalization to stimulate export-led growth
and wants SA to adopt a unilateral trade liberalization approach.
Meanwhile, Trade and Industry Minister Mandisi Mpahlwa supports an
industrial policy approach, where industrial policy dictates trade
policy and is geared towards protecting strategic sectors to drive
manufacturing and growth. The Harvard study showed that
protectionist trade policies had hampered export-led growth. It
recommended the adoption of a single or dual-band tariff structure,
abolishing tariffs on primary goods while capping tariffs on final
goods at 15% or, in the case of a dual structure, maintaining
tariffs on finished goods at 20% and 10%. (Business Day, June 18,

Retail Sales Drop Over Two Months

5. (U) Statistics SA (StatsSA) reported that retail sales decreased
for the second month in a row by 0.3% y/y in April, after a fall of
1.5% y/y in March. Economists said the retail sector, which
accounts for 14% of the economy, was set to remain under siege until
interest rates started to fall, which might not happen before 2010,
given the bleak outlook for inflation. Many analysts expect another
rise in lending rates at the SA Reserve Bank's next policy meeting
in August. Interest rates have climbed by five percentage points in
the past two years, taking prime lending rates up to 15.5%, a
five-year peak. This has pushed debt costs as a ratio of disposable
income for households up to more than 11% and curbed growth in
spending to 3.3% in the first quarter of 2008, down from a peak of
9.5% in the last quarter of 2006. More stringent credit rules
introduced a year ago have also eroded consumers' spending power and
moderately curbed credit demand, while the latest electricity tariff
increase will add to the burden on local consumers, already saddled
with soaring prices for food and fuel. (Business Day, June 19,

Commodity Boom Drives SA Exports in 2007
QCommodity Boom Drives SA Exports in 2007

6. (U) SA's merchandise trade totaled $149.5 billion in 2007, an
increase of 22.9% over 2006. Merchandise exports increased by 25%
in 2007, driven by strong global demand, higher commodity prices,
and a weaker rand. SA's 2007 export-basket was comprised of mining
products (52%), manufactured products (45%), and agricultural
products (3%). The top export product categories, accounting for
more than 75% of SA's total exports, were precious minerals, iron
and steel, machinery and mechanical appliances, mineral products,
vehicles and transport equipment, and aluminum. Strong global
demand for industrial commodities, metal, and mineral commodities,
fueled by rapid economic growth in China and India, contributed to
strong demand for SA's mining products. Precious minerals exports,
including platinum, gold, diamonds and silver, increased by 21.7% to
$18.9 billion, and constituted 27.1% of the total export basket in
2007. Merchandise imports increased by 21% in 2007, propelled by
the SAG's multibillion-rand capital expansion program, fixed
investment spending by the private sector, strong domestic consumer
demand, and high oil prices. (South African Revenue 2007 Data)

--------------------------------------------- --
U.S. Displaces Japan as Largest Export Market,

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While China Closes in on Germany as the Largest
Source of Imports
--------------------------------------------- --

7. (U) The U.S. was SA's largest export market in 2007, receiving
10.7% of exports and displacing Japan from the top spot. The value
of SA exports to the U.S. increased by 27.5% y/y in 2007.
Platinum-group metals, including platinum, palladium, rhodium and
iridium, were the biggest export item to the U.S. in 2007, followed
by vehicles and transport equipment. Much of the growth in vehicle
and transport equipment exports can be linked to the preferential
market access SA enjoys under AGOA. Germany was SA's biggest
supplier of imports during 2007, followed by China, the U.S. and
Japan. However, China is aggressively eating into Germany's
position, and is currently SA's largest supplier of machinery and
electrical equipment as well as textiles and apparel. China's share
of SA's import basket increased from 9% in 2005 to 10.7% in 2007,
while Germany's share decreased from 14% to 11.7% during the same
period. Given current trends, China is expected to surpass Germany
as SA's largest source of imports by 2010. (South African Revenue
Service 2007 Data)

Airport Expansion Costs Rise

8. (U) Airports Company of South Africa (ACSA) CEO Monhla Hlahla
announced that escalating construction costs would significantly
impact ACSA's infrastructure upgrades. ACSA's estimated budget for
infrastructure improvements between 2008 and 2012 was R19.3 billion
($2.4 billion) and has already risen by almost 14% to around R22
billion ($2.8 billion), owing largely to unprecedented inflation in
building materials costs. ACSA's planned infrastructure spending
for 2008 was R3.8 billion ($475 million) for its nine airports, but
the actual spending will be closer to R4.4 billion ($550 million)
for the year. Airport-by-airport, the long-term capital injection
was split into R11.4 billion ($1.4 billion) for OR Tambo
International Airport, R2.5 billion ($310 million) for Cape Town
International Airport, R6.7 billion ($840) million) for the
Durban/La Mercy Airport, and the remaining R1.3 billion ($160
million) for the other national airports. The huge capital
expenditure is to cater for the steadily increasing passenger
numbers at the airports. Hlahla indicated that passenger numbers at
the company's airports had increased yearly by 8.5% y/y and that
domestic traffic had grown by 11%. This dramatic increase in
capital costs has also been experienced by other public entities,
such as state-owned power company Eskom. (Engineering News, June
19, 2008)

Solar-Powered Cars to Race in SA

9. (U) The Advanced Energy Foundation (AEF) is organizing an
international solar-powered car race in SA in September 2008. Teams
planning to participate in "The Solar Challenge" are already in the
process of designing and building solar-powered vehicles. The
vehicles are expected to have the capability to reach between 80km
and 100km per hour without any external assistance. AEF head
Winston Jordaan said the event would be an opportunity to showcase
QWinston Jordaan said the event would be an opportunity to showcase
cutting-edge solar technology innovations from around the world.
Jordaan also noted that to win the contest, racers needed advanced
technological prowess combined with exceptional strategy and
tactics. Participants would set out on a 4,175km long distance race
around the country, starting and finishing in Pretoria at the
Innovation Hub. Two entrants will represent SA while other
participants are expected to come from Australia, Holland, and the
U.S. (Financial Mail, June 6, 2008)

Volkswagen SA Wins Big Export Contract

10. (U) Volkswagen SA (VWSA) has won a R12 billion ($1.5 billion)
contract to supply its parent-company, the Volkswagen Group, with
diesel particulate filters (DPFs) for the next five years. VWSA
will complete the contract in partnership with local catalytic
converter and exhaust systems manufacturer Eberspdcher SA, which

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will share the production volume. A DPF is designed to remove
diesel particulate matter or soot from the exhaust gas of a diesel
engine, and is rapidly gaining popularity as global emission
standards are becoming stricter. VWSA Managing Director David
Powels said the deal was one of the biggest export contracts for a
single part ever awarded to the SA company. "Furthermore, it is a
coup for the SA automotive component manufacturing industry."
Collectively, VWSA and Eberspdcher SA will invest about R55 million
($6.9 million) in tooling and equipment to manufacture the DPFs. In
addition, investment in the broader national supplier base will
reach about R26 million ($3.3 million). Eighty percent of these
suppliers are based in the Nelson Mandela Bay region, in the Eastern
Cape. VWSA estimated that the new contract will secure more than
100 new jobs in the region. It will use the most modern DPF
manufacturing method, known as calibrated stuffing, which
encompasses new laser measuring and sizing technologies. "This is
the benchmark in the Volkswagen group and will benefit the SA
catalytic converter industry as a whole," said Powels. "The
decision to award the contract to VWSA proves emphatically that SA
can be globally competitive in terms of pricing and technology, even
when measured against the best global players in the DPF industry,"
said VWSA Purchasing Division Director Karlheinz Hell. Catalytic
converters are SA's biggest single automotive component export and
SA has a 14% market share in the global catalytic converter
manufacturing industry. Export sales of catalytic converters
reached R18.3 billion ($2.3 billion) last year, compared to R15.8
billion ($1.9 billion) in 2006. The SA catalytic converter industry
is based in SA because SA produces 80% of the world's platinum and
because the SAG Motor Industry Development Plan (MIDP) program
encourages value-added exports. (Engineering News, June 17, 2008)

Infrastructure Bottlenecks Threaten Security
Of Fuel Transport

11. (U) SA faces the possibility of fuel shortages when it hosts the
2010 FIFA World Cup. "In the third quarter of 2009 we are expecting
that SA won't be able to supply our inland (fuel) needs unless
something drastic is done," said Department of Minerals and Energy
Deputy Director-General Nhlanhla Gumede. A re-engineering exercise
to manage the transport of fuel from Durban to the industrial
heartland in Gauteng is under way to ensure that there is no
breakdown in supply over the next two critical years. The drive is
geared towards improving the efficiency of rail transport of fuel
ahead of the completion of Transnet's new R11.2 billion ($1.4
billion) multi-product pipeline between Durban and Gauteng. The
pipeline is expected to be operational in the third quarter of 2010
and will reduce reliance on poor and inefficient road and rail
transport infrastructure used to ferry fuel inland from the coast.
According to Gumede, the Durban-Gauteng corridor is responsible for
68% of SA's total liquid fuels consumption. Growth in demand has
created supply problems and if something is not done, inland
Qcreated supply problems and if something is not done, inland
shortages would be experienced. Gumede said about 25% of
non-pipeline product was transported inland by rail, but road
transport would have to be used unless rail transport was increased
dramatically. This would mean more than 10 road tankers an hour
would have to leave Durban in 2010, creating a continuous "train" of
tankers on the highway. He said the only solution was to increase
the efficiency of rail transport, slashing the Durban-Gauteng return
journey from 10-14 days to not more than four days. He noted that
"22.2% of GDP is linked to the availability of liquid fuel" and the
economy would lose R1 billion ($125 million) per day without liquid
fuels. Gumede noted that SA, Africa's largest economy, was a net
importer of crude oil and was struggling to store enough fuel
reserves to last beyond 10 days. A new Energy Bill before
parliament proposes the creation of strategic fuel stocks, which
would last at least 60 days. (Business Day and Engineering News,
June 19, 2008)

NERSA Approves Limited Tariff Hike

12. (U) The National Energy Regulator of SA (NERSA) granted Eskom an
additional 13.3% average increase in electricity tariffs in addition
to the 14.2% already approved in December 2007. NERSA chairman
Collin Matjila said NERSA decided to allow Eskom to recover
additional primary energy costs of R2.8 billion ($353 million)

PRETORIA 00001352 005.2 OF 007

through its electricity tariff. The increase is well below the 53%
(real) or 60% (nominal) increase that Eskom had asked for. Two
weeks ago Business Report reported that NERSA hearings showed
households would face a 76% increase in their municipal bills, and
many industrial and commercial customers would be ruined, if the
full 53% was granted. Municipalities had also expressed concern
that the high prices would cause payment levels to drop and cases of
illegal connections and tampering to escalate. However, NERSA's
decision to not approve a higher rate could cause international
credit rating agencies to downgrade Eskom's credit rating,
increasing the future cost of Eskom's massive capital expenditure
program. Another key factor in this decision will be whether the
SAG decides to increase or bring forward its capital support for
Eskom. (Engineering News and Business Day, June 18, 2008)

Anglo Slips to Fifth Place

13. (U) Anglo American has slipped from third to fifth spot in the
ranks of global mining giants measured by market capitalization.
Anglo has given way to Brazil's Vale and China's Shenhua.
Similarly, the "big four" mining countries Canada, U.S., Australia
and SA have lost ground to the "BRIC four" of Brazil, Russia, India
and China. Vale, formerly Companhia Vale do Rio Doce, has shot up
the global ranks since the company's state-owned iron ore monopoly
was privatized in 1997. Vale has averaged a 79% market
capitalization growth rate over the past five years, much of it
through acquisitions such as the purchase of Canada's Inco nickel
miner. Anglo's slide can be attributed to its sell-off of
non-mining and gold assets and its failure to bring major new
production on stream, while rivals went on an acquisition spree.
The annual Price Waterhouse Coopers survey of the global mining
industry trends shows that the Top 40 companies grew their revenues
by 32% in 2007, but their costs increased by 38%. The survey cites
the growing pains of the industry as the three "ps", namely people,
power and procurement. Skills and electricity shortages are the
basic hindrances for SA, but procurement problems and rising costs
are the result of global economic growth and demand for plant and
equipment. (The Times, June 18, 2008)

Mining Production Down

14. (U) Statistics SA reported that mining production volumes for
the three months to April 2008 fell by 4.1% when compared with the
previous three months. The decrease was a result of a 5.5% drop in
the production of gold and a 3.9% reduction in the output of
non-gold minerals. The major contributors to the slump were
platinum group metals, diamonds, and gold. However, coal production
increased by 1.3%, softening the drop. On an annual basis, mining
output for the first quarter decreased by 9% compared with the same
period in 2007. Mining production for April fell by 2% compared
with the same month a year ago. Gold production decreased by 10.1%
in April compared with April 2007. Country-wide power cuts in
January forced the mining sector to shut its large mines for five
QJanuary forced the mining sector to shut its large mines for five
days which curbed output. At present, mines are receiving only a
90-95% supply of power. Mining represents around 5.4% of the
country's gross domestic product. (Business Report, June 19, 2008)

ICT Costs Set to Drop Drastically

15. (U) Financial Mail Analyst Duncan Mcleod said that mega-deals,
triggered by state-controlled Telkom's review of its mobile
strategy, are set to reshape the ICT sector and usher in a more
competitive era in which SA communications costs will plummet.
According to Mcleoad, doing business in SA will become cheaper and
the economy, which for years has been hostage to Telkom's high
prices, is set to reap the rewards. The Electronic Communications
Act (ECA), introduced in 2006, gives licensed infrastructure
operators a chance to build any type of network. Duncan said the
legislation opened the way for a second fixed-line operator Neotel
and mobile players MTN and Vodacom to compete directly with Telkom
for the first time. Neotel recently unveiled its first retail
consumer offerings, which significantly undercut Telkom's fixed-line

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prices. Telkom is expected to respond on June 20, when it files its
annual tariffs for approval by ICASA, the industry regulator.
Analysts predict that if Neotel continues with is its policies, it
may capture 10% to 15% of market share. Telkom, Neotel, Vodacom,
and MTN are all also laying high-capacity, fiber-optic cables in
metropolitan areas in the expectation of an explosion in demand for
broadband. Three new undersea, fiber-optic cable projects, which
will ultimately deliver 50 times the bandwidth capacity of the
current Telkom-controlled Sat-3 system, will drive down
international bandwidth costs between 70% and 90%. Analysts predict
that monthly broadband prices will fall to below $20 for
all-inclusive packages. (Financial Mail, June 13, 2008)

Vodacom Explores Expansion in Africa

16. (U) SA's Vodacom Group said it was exploring opportunities in
Africa, but declined to say if it would take advantage of
Mozambique's plan to license new fixed-line operators. Vodacom,
SA's biggest mobile phone operator and jointly owned by the nation's
largest fixed-line operator Telkom and Britain's Vodafone, launched
its Mozambique mobile phone operation in December 2003. In the year
to end-March, Vodacom Mozambique increased its customer base by
29.8% to 1.3 million, pushing its market share to about 40%.
"Vodacom is always investigating opportunities to grow and expand
its business," Vodacom Chief Operating Officer Pieter Uys told
Reuters. "This process is ongoing and a variety of opportunities
are being explored," he said when asked if Vodacom wanted to acquire
a license to become Mozambique's second fixed-line operator.
Vodacom has mobile phone operations in SA, Lesotho, the Democratic
Republic of Congo, and Tanzania. Its growth beyond these countries
has been hampered by a shareholder agreement between Vodafone and
Telkom. Telkom is planning to sell its 50% stake in Vodacom to
Vodafone and this will remove the agreement that prevents Vodacom
from seeking expansion opportunities on the continent. The disposal
of Vodacom stake would also enable Telkom to re-enter the mobile
phone market. (Engineering News, June 18, 2008)

IDC to Inject Funds Ahead of West Coast
Cable Project Roll-Out

17. (U) The Industrial Development Corporation (IDC) has approved an
equity investment of R500 million ($63 million) into the
state-owned, ICT infrastructure company Broadband Infraco. Infraco
is planning to build a $510-million "super cable" from Cape Town to
London, which it hopes will be operational ahead of the 2010 FIFA
World Cup. The African West Coast Cable (AWCC) project has been
endorsed as a Presidential lead initiative for SAG. It involves the
deployment of a 3,840 giga-bits-per-second, undersea, fiber-optic
cable terminating in London, but incorporating branching units to at
least ten countries along the West Coast of the African continent.
The transaction is in its final stages and the IDC is reportedly
ready to disburse the funds. Infraco is intent on facilitating the
Qready to disburse the funds. Infraco is intent on facilitating the
entry of as many as ten SA participants in the cable project, which
will receive a capacity entitlement at a cost that is directly
proportional to the size of the stake they buy. The open-access
model would safeguard against monopolistic pricing. It would also
mean that traffic to SA and London will terminate at "telecoms
hotels" or "vendor-neutral zones", from where unrestricted onward
connectivity rights will be guaranteed. According to press reports,
the AWCC is advancing steadily towards financial negotiations with
companies such as Telkom, Neotel, Equator Telecom Nigeria, British
Telecom, Tenet, Tata Communications, Multichoice, Vox Telecom,
Internet Solutions and Gateway Communications. Negotiations with
equipment suppliers are also said to be at an advanced stage.
Nevertheless, a decision will need to be made soon if the cable is
to be completed in time for the 2010 FIFA World Cup. (Engineering
News, June 20, 2008)

Outsourcing Industry to Receive Boost from
Improved ICT Infrastructure

18. (U) SA's outsourcing industry is set to benefit from increasing
ICT competition and infrastructure investment. Last week, Neotel

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announced that it would launch a "point of presence" (network entry
point) in Johannesburg that would link with the global network of
its parent-company Tata Communications. Neotel Product and Services
Division Head Rajeev Sinha said the point of presence would benefit
all companies with multiple offices across the world. "Instead of
linking through London to seek another service provider, a client
can now access the country directly via Tata's undersea fiber-optic
cable network," he said. The Johannesburg point of presence will
connect through Tata's global network to 600 cities and to customers
in 200 countries. Tata Communications Senior VP Genius Wong noted
that SA was quickly becoming a favored location for business process
outsourcing (BPO) and call centers. "By expanding our connectivity
to SA, and our investment in the SEACOM (East Coast of Africa)
cable, we're showing our commitment to support our customers as they
expand into this burgeoning region", said Wong. He predicted that
SA would become the third-largest BPO center in the world by the end
of 2008. Frost and Sullivan Telecoms Analyst Lindsey McDonald said
"astronomical" growth was possible for the SA BPO industry. Thus
far, investment in training and the development of call centers in
SA has been held back by high ICT costs. The South Africa
Foundation said international leased-line prices in SA are three
times as high as the next most expensive country and 31 times more
expensive than the cheapest country. With the implementation of the
SEACOM network in mid-2009, ICT costs are expected to fall by as
much as 90%. Analysts predict that up to 10,000 jobs are expected
to be created by the outsourcing industry within the next five
years, though high labor costs could restrict growth. (Business
Times, June 17, 2008)


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