Africa Weekly Review: The Eskom dilemma for the South African government; fiscal deterioration in Ghana.

South Africa: Power and funding shortfalls at Eskom

The negative consequences of the electricity shortages this year have been numerous. They have included the introduction of a new word (load-shedding) to South Africans’ vocabulary. In our Weekly Review we want to comment briefly on three other consequences: the impact on growth, inflation and fiscal policy.

Electricity shortages, along with an easing of private consumption, have contributed to a slowdown in growth. The Bureau for Economic Research at the University of Stellenbosch currently sees growth at 3.2 per cent this year and 3.0 per cent in 2009, compared with average annual growth of 5.0 per cent in the period 2004-07.

Meanwhile Eskom’s reserve capacity remains modest. The company set a target of a 10 per cent decline in consumption this year; to date only a 4 per cent reduction has been achieved. This does not inspire confidence that the outages suffered by industry and mining in January 2008 will not be repeated in the near future. According to Eskom’s timetable, it will be 2012 before supply concerns will be fully addressed thanks to additional capacity from its planned coal-fired power plants, two of which are already under construction.

Inflation targets further off course

The consequences of power shortages for inflation have also been severe. The industry regulator Nersa ruled in June that Eskom could raise its tariff for municipalities by 27.5 per cent from 1 July. (The municipalities then add a margin to their bills for customers; large electricity consumers negotiate separate long-term contracts with Eskom.) Nersa has also approved tariff increases in excess of 20 per cent each year for the period 2009-2011. This decision prompted the strikes called earlier this week by Cosatu, the trades union umbrella group. One of the specific demands of the strikers was for a halving of the tariff increase authorised for this year.

The monetary policy committee (MPC) said after its last meeting on 12 June that consumer price inflation would not return to the target range (between 3 and 6 per cent) until the third quarter of 2010. Yet this central forecast did not assume any tariff increases from Eskom. It will be interesting to see what the MPC says about inflation expectations following its next meeting on 13-14 August.

Eskom’s need for more state support

The consequences of Eskom’s difficult situation for fiscal policy are less clear. The National Treasury said on 18 July that it would compress loan disbursements to Eskom totalling ZAR60 billion (US $8 billion), previously intended to be spread over five years, into a three-year period, the first of which is the current fiscal year ending in March 2009. It also said it would consider providing financial guarantees for the company. Eskom’s five-year investment programme amounts to ZAR343 billion (US $46 billion) excluding nuclear projects.

There is some flexibility in terms of funding this programme between tariff increases (including contract reviews) and borrowing. If Nersa had granted in full Eskom’s request for a 61 per cent tariff increase for 2008, the company’s projected balance sheets would have looked healthy, and funding would not now be contentious. The government will be pleased that this did not happen, and it may even have influenced events, leading to questions about the regulator’s autonomy. Nersa’s decision to grant only part of this tariff increase spared the government a hefty boost to inflation and more protests orchestrated by Cosatu.

Instead the government has a fiscal problem. Investors are reluctant to increase their exposure to Eskom. There are perceived to be weaknesses with its credit situation, and, at least in the rand-denominated domestic bond market, there are capacity restraints on how much new issuance can be absorbed from any source. This helps to explain why Eskom went on an extended European roadshow in the final week of July. A sizeable funding shortfall for Eskom (after its approved tariff increases) could be covered by external lenders if the Treasury provides financial guarantees.

Our conversations at the Treasury have shown a strong aversion to guaranteeing loans or bonds. But at the same time the Treasury is aware that a failure by Eskom to cover its funding shortfall will lead to the company having to scale down its programme and live with worse credit ratings. A scaled-down programme could well extend electricity supply shortages beyond 2012 and therefore extend the constraint on growth. Given this circumstance, the Treasury would be likely to increase its loans through the budget and/or guarantee new Eskom loans in the market. This would be a step taken reluctantly since the Treasury is particularly anxious to maintain its reputation for fiscal rectitude ahead of a political change seen in some quarters to be a harbinger of a likely deterioration of its reputation.

The programme, as we have already noted, excludes nuclear projects. A figure for Eskom’s capital spending over ten years and including the nuclear element could be close to ZAR1,000 billion (US $135 billion).

Ghana: Fiscal restraint overdue

In order to benefit fully from its newly found oil reserves, Ghana is seeking to draw on international experience. The government is working on a Master Plan intended to minimize any emerging negative effects and to ensure that oil revenue will be used for economic diversification. We commented on this issue in February (Ghana: oil and some fiscal implications).

However, any Master Plan is doomed if core policies derail. Some important variables have deteriorated. Even a well-designed framework for the use of oil money would fail without appropriate fiscal and other central policies.

Pre-election spending

The fiscal deficit (including grants) increased to 9.1 per cent of GDP in 2007; the IMF’s projection for 2008 is 10.3 per cent. Energy-related expenditure (including investments of about 2.5 per cent of GDP to address bottlenecks), subsidies of utility prices and public wages together bear a large responsibility for the deficit.

Politically driven expenditure is common in all countries and the ruling New Patriotic Party (NPP) faces a presidential election in December. Once in place, public expenditure is hard to reverse. Under the current policies, public debt is projected to increase to 56.3 per cent of GDP by 2009, up from 49.8 percent in 2007. It is fair to say that both the public debt and the deficit are now above prudent levels. Grants are expected to decline by an expected 1 per cent of GDP both this year and in 2009. Over time this gap will be filled by oil revenues, which are forecast by the IMF to amount to 3 per cent of non-oil GDP in 2011, the first year of significant production, rising to 5 per cent in 2013.

All these projections hinge naturally on oil production and price levels. Tullow Oil, the operator of the offshore Jubilee field, plans to start production at 60,000 barrels per day (bbl/d) and deploy its income stream for additional investment to push output to 250,000 bbl/d. Whether the IMF’s estimates are based on the stated plans of Tullow, and what underlying price assumptions are used, we cannot say.

Towards fiscal responsibility

The government intends to introduce a fiscal responsibility law. This would increase disclosure, enhance controls and introduce some enforcement mechanisms. More importantly, it could include a fiscal rule setting a debt ceiling within the government’s medium-term fiscal framework.

According to the IMF (see table), a rule stipulating improvements of 1 per cent of GDP per year in the primary balance when public debt is above 45 per cent of GDP would not be sufficient to bring public debt below a 60 per cent level by 2013; bringing it back to a prudent level (45 per cent) by that date would require an adjustment of 2 per cent of GDP per year in the primary balance. These calculations do not allow for the possibility that the authorities succumb to new short-term temptations (notably subsidies and wages) in this election year.

Public debt projections (in per cent of GDP)

Post-election pain

Whether the winner is the NPP or the National Democratic Congress, a tighter fiscal stance will be required in 2009. A 2 per cent adjustment (relative to GDP) in the primary balance would involve unpopular reductions in energy subsidies along with serious restrictions on public hiring and wage increases.

The alternative view, which we do not share, is that the government might choose to underestimate the required adjustment in anticipation of the revenue from oil and gas. The recent fall in crude oil prices, which are now down almost 20 per cent to a three-month low, is a reminder of the importance of an adequate regulatory framework. A much sharper fall could even call into question the political decisions to increase current expenditure. The market, at least measured by the dollar-denominated Eurobond issued by the government in September 2007, does not buy into this negative analysis of the fiscal stance. The bond was launched to yield 8.50 per cent, and the closing yield yesterday was 8.44 per cent. Admittedly the market in the issue is thin.

Recent research reports:

African property: Magnet for remittances
Real estate attracts diaspora and regional institutional investor interest as a play on economic recovery

South African mining: Opportunities in a changing regulatory environment
Government negotiations are not one-sided

Ivory Coast: Electoral risk ahead
A strong economic rebound would likely follow a successful election outcome

With best regards,

Gregory Kronsten
Director, Africa Research
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