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South Africa must rapidly implement measures to attract FDI − Leon

Herbert Smith Freehills partner and Africa co-chair Peter Leon discusses the fiscal cliff edge that the South African economy finds itself on, and highlights some potential measures that can attract FDI into the country. Video: Creamer Media's Kutlwano Matlala. Editing: Creamer Media's Nicholas Boyd.

10th June 2020

By: Simone Liedtke

Creamer Media Social Media Editor & Senior Writer

     

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The South African economy finds itself on the edge of a fiscal cliff, especially as the Covid-19 pandemic has caused a “massive and rapid shock”, says law firm Herbert Smith Freehills partner and Africa co-chair Peter Leon.

While the effects of the pandemic were initially localised to Asia, Europe and the US, the virus has transmitted rapidly in South Africa and the rest of the continent, with a dual impact on the demand and supply side of the affected economies.

Considering that the virus will have a “very significant” effect on South Africa’s economic growth prospects, Leon notes that the International Monetary Fund (IMF) has forecast that the country’s economy may contract by 5.8% this year, while the National Treasury forecasts a contraction of 6.1%.

The IMF also forecast a fiscal deficit of 13%, adding that the public debt to gross domestic product (GDP) ratio could exceed 80% by 2021.

It is for these reasons that Leon stresses that enticing more local and global businesses to invest in South Africa “is an absolute imperative”, as it will help to prevent a severe economic decline from materialising.

“South Africa needs to rethink our economy and identify measures to resuscitate it post Covid-19, and to do so, the country must rapidly [start] implementing mechanisms to attract more foreign direct investment (FDI),” he says.

To determine which measures ought to be implemented, he highlights that South Africa’s share of regional inward FDI stock declined dramatically between 2010 and 2018, with Southern Africa's share having fallen from 76% to 55%; sub-Saharan Africa's share from 43% to 21% and Africa's share from 29% to 14%.

“While FDI in the region has been forthcoming, South Africa has been left behind,” he laments.

Yearly FDI inflows into South Africa followed “a steep downward trajectory from 2009”, Leon adds, noting that yearly FDI inflows were around $9-billion in 2008, prior to the global financial crisis.

This has declined to just over $5.3-billion following President Cyril Ramaphosa’s instatement as President, and subsequently lowered to $5-billion amid the Covid-19 pandemic.

During this 12-year period, South Africa’s GDP growth rate followed a similar trajectory, from 5.4% in 2007, to 0.2% in 2019 and now to -5.8% in 2020 amid the global health crisis.

However, Leon notes that, during the same period, South African investments abroad have continued to grow, which has made South Africa “unusually a net exporter of capital, despite being a developing country”.

In terms of measures that can be taken to secure post-Covid-19 FDI, Leon says a structural adjustment from the IMF is a potential option. Given South Africa’s economic fragility, “the government is rapidly running out of fiscal headroom”.

The South African government has reportedly approached the IMF for a $4.2-billion loan under the fund’s Rapid Financing Instrument, and Leon says analysts suggest that “this is only a precursor to a full IMF programme and that South Africa 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 or standby arrangement”.

These facilities, which could give South Africa access to up to $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.

Leon cites the IMF’s last Article IV report on South Africa, published in January, in which it suggests that South Africa will be required to implement major microeconomic reforms, especially for State-owned enterprises and labour markets.

The IMF predicts that the implementation of its proposed structural reforms would increase per capita income; see growth boosted by the effects of an improving business environment and lower costs of key inputs in network industries; meaningfully reduce unemployment and poverty; while also causing public debt to start declining in 2022 while bank lending would rise, creating “virtuous macro-financial feedback loops and further financial deepening”.

Additionally, implementation of the IMF’s proposed reforms will reduce inflation over the medium term as the impact of higher competition and exchange rate appreciation counterbalances the inflationary impact of robust domestic demand; and allow for fiscal consolidation and create greater room for monetary policy easing, thereby reducing broader financing costs.

However, Leon warns that although the IMF’s “upside scenario” was based on a pre-Covid-19 assessment, “structural weaknesses in South Africa’s economy remain the same”.

He adds, though, that the “silver lining” of the current malaise is that it may prompt and hasten the kind of structural reforms that have been resisted by the South African government so far.

These microeconomic reforms (in particular, liberalising the labour and product markets, and at least partly privatising electricity, rail and port networks) “hold the key to South Africa overcoming the legacy of the ‘lost decade’ since the end of [former President] Thabo Mbeki’s administration in 2008”.

However, Leon laments that it “may be difficult” to reach agreement on the terms of any programme, as the conditions which would accompany it conflict with the African Nation Congress’s post-Covid-19 Economic Reconstruction, Growth and Transformation Plan. 

However, in terms of improved investment protection, Leon said that if South Africa is to emerge from the “economic devastation” of the Covid-19 pandemic, “it will need more than an investment-friendly rhetoric” from government.

Even beyond implementing the structural reforms proposed by the IMF, Leon says the South African government will need to show a concrete commitment to the protection of foreign investors by amending the Protection of Investment Act to provide for proper investment protection; and submitting itself to investor-State international arbitration.

Additionally, he suggested that government would also need to enter into new bilateral investment treaties (BITs) with important trading partners, especially in the European Union.

“These steps would go a long way towards restoring confidence in South Africa as a safe destination for long-term job-creating investment,” Leon says.

Another measure that can be taken to secure post-Covid-19 FDI is the African Continental Free Trade Area (AfCFTA) agreement, which entered into force on May 30, 2019. The operational phase of the AfCFTA agreement was launched on July 7 that same year at the twelfth Extraordinary Session of the Assembly of the African Union.

While trading under the AfCFTA agreement was expected to begin on July 1 this year, it has since been postponed owing to the global outbreak of the Covid-19 pandemic.

While Phase 1 of the negotiations on liberalisation of trade in goods and services is at an advanced stage, Leon says Phase 2 negotiations on intellectual property rights, investment and competition policy are only expected to be completed by December.

“The anticipated conclusion of Phase 2 of the negotiations and the finalisation of the forthcoming Protocol on Investment (Investment Protocol), provides South Africa (and Africa) with a unique opportunity to develop an Afrocentric model based on best practice,” he noted.

Among other things, the Investment Protocol ought to create a single, continental rule book for trade and investment, and include predictable and comprehensive commitments on both investment protection and investor obligations.

“This may include, for example, provisions aimed at reducing barriers to foreign investment entry or undertakings from governments regarding protection against expropriation and non-discrimination,” Leon elaborates.

The AfCFTA agreement could also facilitate investment-building in respect of various initiatives and developments in the State Parties and in Regional Economic Communities; provide measures that impose obligations on investors and States to create favourable conditions for responsible investment that contribute to sustainable economic development; and prescribe a dedicated dispute settlement mechanism.

Edited by Chanel de Bruyn
Creamer Media Senior Deputy Editor Online

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