By Lullu Krugel is Chief Economist for PwC Africa

Context

In his “New Deal” for reigniting job creation and economic growth, President Cyril Ramaphosa identifies the need to restore State-Owned Enterprises

(SOEs) as drivers of economic growth and social development.[1] President Ramaphosa admitted in his State of the Nation Address (SONA) 2018 that SOEs “are experiencing severe financial operation and governance challenges”.[2] Finance Minister Malusi Gigaba is scheduled to deliver his 2018 Budget Speech on 21 February, and is expected to make particular reference to the financial health of SOEs.

Background

SOEs have a crucial role in maintaining the basic infrastructure of South Africa. Some of the main sectors where SOEs are dominant include electricity, transport, mining, water, and telecommunications. In the 2015/16 financial year, the overall financial position of SOEs improved, compared to the previous year. This was mostly due to capital investment and positive earnings.[3] However, at present, numerous SOEs are facing financial difficulties, which has led to credit rating downgrades and, in turn, increased financial deficits.

Table 1: Increasing rates of exposure on government guarantees

	2015/16			2016/17
	Guarantee (Rbn)	Exposure[4] (Rbn)	Exposure %	Guarantee (Rbn)	Exposure (Rbn)	Exposure %
Public Institutions	469.9	255.8	54%	477.7	308.3	65%
Eskom	350.0	174.6	50%	350.0	218.2	62%
SANRAL	38.9	27.2	70%	38.9	30.1	77%
Trans-Caledon Tunnel Authority	25.8	21.2	82%	25.7	20.7	81%
South African Airways (SAA)	14.4	14.4	100%	19.1	17.9	94%
Land Bank SA	6.6	5.3	80%	11.1	5.4	49%
Development Bank of Southern Africa (DBSA)	13.9	4.4	32%	12.7	4.2	33%
SA Post Office	4.4	1.3	30%	4.4	3.9	89%
Transnet	3.5	3.8	109%	3.5	3.8	109%
Denel	1.9	1.9	100%	1.9	1.9	100%
South African Express	1.1	0.5	45%	1.1	1.0	91%
Industrial Development Corporation (IDC)	2.0	0.2	10%	1.9	0.2	11%
South African Reserve Bank (SARB)	3.0	0.0	0%	3.0	0.0	0%

Source: National Treasury Budget Review 2017

The guarantees and exposure to SOEs pose a significant risk to South Africa’s fiscal position. The exposure increased from R174.6bn in 2015/16 to R218.2bn in 2016/17. In the past three years, the percentage exposure to guarantees increased from 47% in 2014/15 to 65% in 2016/17.[5] The two SOEs with the largest exposure currently have sub-investment credit ratings: Moody’s Investors Service adjusted Eskom’s long-term credit rating to B1 (highly speculative) and SANRAL’s rating to Ba1 (non-investment grade – speculative) in November 2017.

Some of the reasons stated for the most recent downgrades are the preceding sovereign credit rating downgrades, governance challenges and the SOEs’ deteriorating liquidity levels. The downgrades limit SOEs funding options, since it deters risk adverse investors and investors with specific limitations to investing funds in sub-investment rated entities. The poor credit rating also influences the cost of lending money.

Recent developments

There were recent outcries from the Public Servants Association (PSA) after the Public Investment Corporation (PIC) provided Eskom with R5bn in financing, which consists mostly of government employees’ pension funds. The main concerns from the PSA are that this transaction contradicts previous assurances from the Government Employees Pension Fund (GEPF) that pension fund money will not be used to finance struggling SOEs.

In turn, the PIC argued that they were “encouraged that the new Eskom Board and the new management team have moved with the necessary speed to restore good corporate governance at Eskom”[6]. The PIC indicated that it provided the money at a favourable rate of interest and that the loan is due in 30 days. Elsewhere, Eskom reported that three commercial banks have indicated that they were willing to extend their credit facilities, pending the outcome of their respective due diligence processes.

Figure 1: Increasing fiscal exposure to fragile SOEs

Source: National Treasury Budget Review 2017

Looking ahead

Finance Minister Malusi Gigaba explained in 2017 that there will be more stringent procedures in place going forward regarding future SOE funding. He mentioned that the executives of the SOEs should take responsibility for the management of the SOEs, since they are paid “competitive salaries” and that “the public and government are correct to expect a great deal from them”. He further emphasised that the SOEs reliance on bailouts must end. “As the shareholder, we [the National Treasury] are tired of being dragged into crises by those we employ to govern and manage state-owned companies. This must end.” [7]

President Ramaphosa promised in SONA 2018 that the government would “intervene decisively to stabilise and revitalise SOEs”. He acknowledged that some of these entities “do not have a sufficient revenue stream to fund their operational costs”, and that they “cannot borrow their way out of their financial difficulties”

SOEs have a crucial role to play in long-term economic development and transformation and should add to economic growth and stability. SOEs are a key source of jobs in South Africa, employing more than 300 000 people.

The finance minister must navigate an intricate balancing act between bailing out SOEs and dealing with credit rating agencies threatening more rating downgrade.[8] Ideally, SOEs should not require recurring cash injections from the state. While the government is the main shareholder in these entities, shareholders of other big companies are seldom asked to make annual contributions to the financial wellness of these corporations.

The 2018 Budget needs to set in motion tangible plans to achieve Mr Ramaphosa’s ideal of restoring SOEs as drivers of economic growth and social development. Proper accountability structures will improve the quality of governance at these companies which, in turn, would aid the financial health of SOEs. Improved financial management would eventually translate into improved credit ratings which, in turn, will encourage a greater volume of financiers to invest in SOEs. The result will be a decline in fiscal exposure to the performance of SOEs. Looking beyond Budget 2018, President Ramaphosa is looking to undertake a process of consultation with a variety of stakeholders to comprehensively review the funding models of SOEs.

[1] BizNews, 2017. Ramaphosa: My New Deal for SA – and 10-point action plan for jobs, growth, transformation.
https://www.biznews.com/thought-leaders/2017/11/14/ramaphosa-new-deal-for-sa/

[2] http://www.thepresidency.gov.za/speeches/state-nation-address-president-republic-south-africa%2C-mr-cyril-ramaphosa

[3] National Treasury, 2017, Budget Review. http://www.treasury.gov.za/documents/national%20budget/2017/review/Chapter%208.pdf

[4] Exposure is defined as the total amount of borrowing and accrued interest for the period made against the guarantee.

[5] National Treasury, 2017, Budget review. http://www.treasury.gov.za/documents/national%20budget/2017/review/FullBR.pdf

[6] Business Report, 2018, PIC will bail out Eskom with a R5 billion loan.
https://www.iol.co.za/business-report/energy/pic-will-bail-out-eskom-with-a-r5-billion-loan-13113950

[7] Fin24, 2017, Gigaba: Transnet, Eskom, SAA critical for transformation.
https://www.fin24.com/Budget/gigaba-transnet-eskom-saa-critical-for-transformation-20171025

[8] Mail & Guardian, 2018, Steven Friedman: State-owned enterprises shouldn’t be used as pawns in South African politics. https://mg.co.za/article/2017-09-19-state-owned-enterprises-shouldnt-be-used-as-pawns-in-south-african-politics