Cablegate: South Africa: Finance Minister Spells Out

This record is a partial extract of the original cable. The full text of the original cable is not available.





E.O. 12958: N/A



Sensitive But Unclassified; Protect Accordingly

1. (U) Summary. Finance Minister Trevor Manuel addressed
Parliament on October 26 to table the Medium Term Policy
Statement, an appropriations adjustment bill, and a tax
amendment. He presented a detailed overview of the
government's development priorities over the next three years
and economic outlook. Manuel said that sound fiscal
management and successful inflation targeting meant that the
government could now focus more on growing the economy "to
create employment, and to generate resources to plow into
education, health care, social security, fighting crime, and
reducing poverty." He predicted growth would average 4% over
the next three years and flatly declared that the
government's goal was to increase the rate of gross fixed
capital formation from 16% of GDP to 25% by 2014. While
acknowledging that private sector investment would be
responsible for most of this increase, he focused most of his
discussion on what the public sector needed to do. Manuel
warned that public sector borrowing would rise as state-owned
enterprises borrowed from capital markets to fund a large
proportion of their infrastructure investment.

2. (U) Manuel departed from political convention on several
occasions. He commented that the ownership criteria in some
draft Black Economic Empowerment (BEE) charters were self
defeating, leading to unnecessarily complex and risky
financing structures. Just as critical, he thought, was
building the economy, increasing production, creating jobs,
developing young black managers, and investing in social
development. Manuel conceded that immigrant skills could be
critical to growth, since it would take time before education
and training programs yielded substantial returns to the
economy. Manuel admitted that the social security net was
under severe strain, and should be removed from the provinces
and consolidated under a new national social welfare agency
that would be able to stem the flow of grants to people who
did not warrant them. Finally, he said that the Cabinet
wanted to introduce an index to monitor government
administered prices in electricity, water, transport,
education, and health sectors -- all of which seemed to be
growing faster than inflation. End Summary.

3. (U) Finance Minister Trevor Manuel addressed Parliament on
October 26 to table the Cabinet's Medium Term Policy
Statement, the Adjustments Appropriations Bill, and the
Revenue Laws Amendment Bill. Manuel's speech reflected the
government's growing confidence in its ability to manage the
economy. Manuel made the point that sound fiscal policy and
inflation targeting had contributed to lower interest rates
and buoyant consumer demand. This, in concert with high
commodity prices and a strong international economy, had
fomented greater local business confidence. He said that
trade reforms of the 1990s had caused South African business
to become internationally competitive and more able to
penetrate new markets. The result was that domestic
investment was evident across a wide range of sectors --
particularly construction, services, and manufacturing -- and
more balanced growth. Moreover, strong capital inflows meant
that the country could finance a higher current account
deficit and use that deficit to grow faster. Manuel
concluded that the reforms of the last ten years were now
bearing fruit.

State of the Economy

4. (U) While the South African economy grew just under 3% per
year since 1994, Manuel said that government projections
suggested that the economy would now grow faster. Manuel
confirmed the government's forecast at least 2.9% growth in
2004. However, continued fiscal stimulus, firm commodity
prices, and a more competitive real exchange rate (assumed in
the future) along with low interest rates and rising income
would support an average of 4% growth over the next three
years. At this point, Manuel broke from his prepared text to
say that he, personally, felt 4% was a conservative estimate;
actual growth might be closer to 5%.

5. (U) Manuel reaffirmed his commitment to inflation
targeting, predicting that CPIX (consumer inflation less
mortgage costs) would remain firmly within the 3-6% target
range over next three years. He pointed out that sticking to
the target thus far had successfully lowered inflation
expectations. While high oil prices posed risks to both
global growth and domestic inflation, projected inflation for
2004, at 4.4%, would still fall within the target range.
Administered prices, on the other hand, had become a subject
of Cabinet attention. Manuel noted that the Cabinet wanted
to introduce an index to monitor administered prices in
electricity, water, transport, education, and health sectors
-- all of which seemed to be growing faster than inflation.
While administered prices still needed to balance price
stability, capital requirements, and service delivery
objectives, the Cabinet also felt that there was room to
improve the price setting process.

6. (U) Manuel was mindful of the current strength of the
rand, particularly vis-a-vis the dollar. He acknowledged
that there were adjustment problems for industry at R6 to the
dollar and equally important problems at R10 to the dollar,
especially with oil prices at record highs. On the bright
side, he thought that business confidence in the face of a
strong rand revealed South African resiliency and improved
competitiveness, and also reflected the general perception
that doing business in South Africa now carried lower risk.


7. (U) Manuel reminded Parliament of President Mbeki's three
challenges: 1) to encourage the growth and development of the
First Economy to increase employment; 2) to address the
challenges of the Second Economy; and 3) to build a social
security net to alleviate poverty. With these in mind,
Manuel said that the government could now focus more on
growing the economy "to create employment, and to generate
resources to plow into education, health care, social
security, fighting crime, and reducing poverty." He said
that for the first time in ten years, there was evidence that
growth was resulting in employment gains. Between March 2003
and 2004, South Africa gained 400,000 new jobs, causing the
official unemployment rate to fall by 3.4%.

8. (U) Manuel outlined the government's short and long-term
approaches to growth. In the short-term, targeted incentives
and public works programs would accelerate investment and job
creation. In addition, the government would take measures to
make the distribution and pricing of water and energy
resources more efficient. Manuel conceded that immigrant
skills could be critical in the short-term, since it would
take time before education and training programs yielded
substantial returns to the economy. In the long-term, Manuel
said that the government had to pay attention to investment
in economic infrastructure (including electricity supply and
rail service), regional development policy reform, and more
effective competition policy.

9. (U) During this discussion, Manuel highlighted sequencing
and coordination issues in social policy. Housing programs
could be accelerated, he said, but needed to be aligned with
regional development plans, job creation, and community
services. Social health insurance was a long-term goal that
needed to be preceded by the modernization of public
hospitals. Land redistribution and BEE agricultural
development needed to move forward, but not until the
restitution program was completed and needed bureaucratic
resources freed.

The First Economy

10. (U) Manuel flatly declared that the Government's goal was
to increase the rate of gross fixed capital formation from
16% of GDP to 25% by 2014. To do this, the Government would
pursue a supportive investment environment which included
moderate inflation, low real interest rates, a stable and
competitive currency, and implementation of certain
microeconomic reforms. Manuel was encouraged by 7% private
sector investment growth in 2003 and 7.6% in the first half
of 2004. While acknowledging that most investment in the
economy would have to come from the private sector, he then
spent more time talking about what the public sector would
do. This included employing public-private partnerships to
overhaul the country's public transport systems, investing in
ports, and renewing the country's rolling stock. Other
public sector priorities included investment in health and
education infrastructure, roads, housing, as well as
expanding water and electricity services to the poor.
11. (U) In a departure from past ministerial statements,
Manuel admitted that the ownership criteria in some draft BEE
charters were not realistic, leading to unnecessarily complex
and risky financing structures. This was self-defeating, he
said. While increasing the level of ownership of black
people in corporate South Africa remained critical, just as
critical was building the economy, increasing production,
creating jobs, developing young black managers, and investing
in social development. At the same time, Manuel lauded the
Financial Services BEE Charter for providing the impetus
behind the launch of the low-cost Mzansi bank account that
was designed to attract millions to the formal banking system.

The Second Economy

12. (U) To foster development of the country's "Second
Economy," Manuel said that the government would have to
balance direct income support with investing in human
capital. This covered a wide spectrum of programs, including
expanded public works programs to create jobs and
infrastructure, housing and municipal grants,
micro-enterprise development, skills development, land
restitution, land reform, and agricultural support programs.
Manuel also promised that the 2005 budget would further raise
teacher salaries. He said that the renewal of the primary
school nutrition program under the education departments of
the provinces was already in progress. The provinces would
receive additional funding to cover increases in social
grants, higher personnel costs, greater infrastructure
spending, and the consolidation of spending programs in
education and health.

Social Security Net

13. (U) Manuel admitted that the social security net was
under severe strain. Social welfare services were unable to
respond adequately to the range of needs and distress that
confronted them. In particular, the rapid growth in
disability and foster care grant applications indicated both
rising income support needs and deficiencies in
administrative systems. He added that the caseloads in
public hospitals and clinics reflected large numbers of
victims of crime, road accidents, and disease -- especially
HIV/AIDS and tuberculosis. Manuel stated that the government
believed that a single Social Security Agency would be better
able to target and deliver social welfare grant programs. A
national agency would to tighten procedures, develop clear
qualifications for the grants, and reduce the number of
welfare grants going to people who did not warrant them.

14. (U) Manuel explained that the administration of social
security grants would shift to the new national agency once
it was up and running. In the interim, the provinces would
continue to deliver social welfare grants under the
conditional funding category from the national budget instead
of equitable share funding as was now the case. The
provincial equitable share formula would be adjusted to take
this shift into account as well as 2001 census data. He said
that the restructured equitable share formula would have a
larger education and health components and no longer
contingent on social welfare payments taking priority over
other categories of expenditures. This change would allow
for a more stable budgeting process for education and health.
In addition, he said that the housing grant would receive a
substantial boost, and a new housing strategy, focusing more
on the creation of whole communities, would be phased in over
the next three years, together with the expanded provision of
basic household services.

Fiscal Policy

15. (U) Manuel said that after a concerted effort to reduce
the budget deficit between 1996-2001, the government was now
able to increase public expenditure in real terms through
borrowing at lower interest rates and managing a higher
budget deficit. He said that in 2003/4 the government
recorded a budget deficit of 2.4%, a bit higher than
predicted because revenue fell a bit below expectations.
Revenues should be above expectations in 2004, but greater
spending on social security grants and wages (government
workers successfully went on strike recently for an above
inflation wage increase) should result in a budget deficit of
3.2% of GDP as compared to the 3.1% expected. Manuel
predicted that for 2005, rising corporate profits, continued
strength in VAT and personal income tax receipts, and further
broadening of the tax base would result in a moderate
increase in overall revenue. He said that the budget deficit
was expected to widen to 3.5% of GDP next year, bringing net
borrowing to its highest level relative to GDP since 1997/8.
Nonetheless, he projected that the deficit in 2007/8 should
fall to 2.7% and that debt service costs should stabilize at
about 3.6% of GDP.

16. (U) Manuel added that R50 billion in extra spending would
be added to the budget estimates. Of this, about R21 billion
would finance growth in disability and foster care grants.
Over the next two years, the rest would go to fund recently
agreed salary increases for government workers, the land
restitution program, social welfare grants, and increased
salary payments from increased government hiring. In third
year, additional allocations would be required for
infrastructure, education and training, and municipal

17. (U) Manuel warned that public sector borrowing would rise
as state-owned enterprises borrowed from capital markets to
fund a large proportion of their investment in
infrastructure. New borrowing to finance provincial and
municipal government spending on infrastructure projects
would also contribute to the growth in public sector debt.
The Treasury expected public sector borrowing to reach 4.6%
of GDP in 2007. Since the debt would be directed toward
improving the country's economic infrastructure, it would be
supportive of growth.

18. (U) Manuel said that revenue was R5.1 billion short in
2003 mainly because of lower profits in resources sector.
However, he expected revenue to exceed its target for 2004.
In 2005, the contribution from the resources sector would
likely remain below target, but should be offset by a
recovery in VAT and personal income tax receipts.

Tax Policy

19. (U) Manuel said that tax relief would not be a prominent
feature in the 2005 budget. However, efforts to simplify the
income tax system and reduce the compliance burden on small
businesses would continue, as would consideration of easing
taxes related to health insurance.

20. (U) One of the purposes of Manuel's presentation to
Parliament was to introduce the 2004 Revenue Laws Amendment
Bill. He explained that the amendment contained measures to
encourage foreign investment and improve South Africa's
position as a regional economic center. These included the
elimination of the existing tax on interest-bearing
investments by residents from Swaziland, Namibia, and
Lesotho, changes to the VAT to support South Africa's
position as a freight distribution hub, and allowing
companies to distribute shares valued up to R9000 to
employees over a three-year period without any tax
consequences under certain conditions. On the other hand,
Manuel said that tax benefits from share options for
high-income earners would be subject to more stringent

21. (U) Manuel also said that the Treasury was undertaking
reviews of the South African pension fund industry from both
a regulatory and a tax perspective to derive a regulatory
framework that had more transparent disclosure rules
regarding costs and benefits, encouraged the preservation of
built-up reserves and discourage early withdrawals, and
improved competition in the industry by providing incentives
for portability. Manuel said that a discussion paper on the
regulatory aspects of pension funds would be released for
comment later this year. It would be followed by a tax
policy discussion paper that dealt with existing shortcomings
of the pension fund tax regime and proposing changes that
would align South Africa's taxes in this area with
international best practices. He explained that the central
aim was to protect and promote individual savings for

22. (U) With respect to the mining industry, Manuel stated
that the 2003 Mineral and Petroleum Royalty Bill would have
to be revised to address outstanding issues such as the
differentiation of royalty rates, marginal mine treatment,
the elimination of the double royalty risk, and transitional
matters. He said that Treasury would undertake a holistic
review of the mining sector that would include the low
effective tax rates that mining companies paid,
recommendations relating to the gold mining tax formula, the
appropriateness and international comparability of the
current mining investment allowances, and the consideration
of special allowances for exploration and mining
rehabilitation programs. Possible tax measures to assist the
small-scale mining sector would also be considered.

23. (U) Manuel recalled the exchange control amnesty
announced in 2003. He reported that the government had
adjudicated 16,033 of 43,000 applications received --
yielding a total of R826 million in tax revenue from newly
declared income on foreign assets. The Treasury estimated
that the value of declared foreign assets would reach about
R65 billion, yielding a total of R2.2 billion in additional
annual tax revenue.

Foreign Exchange Liberalization

24. (U) Manuel announced that, following discussions with
SARB Governor Mboweni, the Treasury was proposing abolishing
exchange control limits on new outward foreign direct
investment by South African corporations. He added that
demonstrated benefit to South Africa would still be a
criterion for SARB Exchange Control Department approval. In
addition, Manuel said that South African corporations would
now be allowed to retain foreign dividends offshore, and
transfer any dividends repatriated to South Africa at any
time for any reason. To position South Africa as a financial
center for the rest of Africa, Manuel restated the
government's February announcement that foreign companies,
governments, and institutions would be able to list on South
Africa's bond and securities exchanges. Manuel said that in
November, Aquarius Platinum (an Australian mining company)
would be the first company to take a secondary listing in
South Africa. Manuel stated that all investment restrictions
in such companies would be eliminated for South Africans.
Explaining that the sequencing of reforms was critical to
liberalizing exchange controls, Manuel added that the
government's end goal was to abolish exchange controls
altogether and put in place a set of prudent financial
benchmarks that protected the institutional savings of
working people.


25. (SBU) Manuel's presentation covered all major issues of
concern with clarity and purpose. His recurring message was
that since the economic fundamentals were good, job-creating
growth could now be the central aim of economic policy. The
government's growth plan grants a new lease on life to South
Africa's huge parastatals, as their role now will be to raise
and manage the lion's share of public sector investment.
Manuel is convinced that the impact on the national budget
will be limited because considerable funding will be sourced
from the country's deepening bond market at relatively low
domestic interest rates (i.e., when compared to recent
years). Moreover, parastatals will be expected to contract
or enter into joint ventures with private sector firms to
accomplish their dual objectives of turning around their
operations and building the nation's infrastructure. The
result will be greater public sector debt, but Manuel clearly
believes that the markets can supply it. He also believes
that the resulting increase in government expenditures,
especially on economic infrastructure, will kick start faster
growth for the rest of the economy. The onus, of course,
will be on the parastatals, provinces, and municipalities to
manage public sector investments well. This may be the
Achilles heel of the grand scheme as their record on this has
been mixed. Manuel's warnings about social welfare grants,
recognition of the value to an economy that skilled
immigrants bring, and criticism of BEE ownership requirements
reflect his concern that strict adherence to achieving
certain social goals as originally set out can be self
defeating and perhaps hinder growth.

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