2014 Parliamentary Budget Hearings Fiscal Framework and Revenue

2014 Parliamentary Budget Hearings Fiscal Framework and Revenue Proposals Presentation to the Standing and Select Committees of Finance Parliament of the Republic of South Africa 4 March 2014

The Manufacturing Circle has a Plan in the Making

PROMOTING MANUFACTURING FOR HIGHER JOB-RICH GROWTH FACT: Manufacturing output accounts for 11% of GDP FACT: Manufacturing is among the top three sectors in terms of value addition, job creation, export earnings and revenue generation for every R 1 invested. FACT: Manufacturing provides the base load and scale for key national infrastructure such as electricity generation and municipal services Fact: Manufacturing provides the only viable means of beneficiating natural resources in SA FACT: More than 300 000 South African manufacturing jobs have been lost or exported to other countries since the beginning of 2008, with the majority going to China FACT: More than 440 000 small business owners have closed up shop in 5 years between 2006 and 2011 FACT: In September 2012, South Africa’s Purchasing Management Index registered a three-year low gesturing at bad business conditions and contraction in Manufacturing Source: Manufacturing’s Moment: Four Goals for Higher Job-Rich Growth

PROMOTING MANUFACTURING FOR HIGHER JOB-RICH GROWTH FACT: Electricity costs have rocketed by over 170% in South Africa over the past 5 years while administered prices in other BRICS countries have decreased by over 36% in the last decade FACT: The SA domestic market is under-protected against unfairly incentivised imports, while China, India, Brazil and other countries offer much higher incentives and protection to their manufacturers FACT: The imbalance in our trade situation is evidenced by our negative trade balance with China, which rapidly outstripped the negative trade balance with all other trading partners FACT: There will be further decline over the next two years unless key domestic policy issues and the unfair trade situation are addressed immediately. More companies will close down, more jobs will be lost, the Manufacturing contribution to GDP will contract further and the balance of payments situation will weaken FACT: Manufacturing output is supported by a more stable and competitive rand exchange rate, but this requires more focused policy determination FACT: Post-2009, South Africa’s manufacturing sector has not recovered to the extent its peers has, as our domestic policies do not foster manufacturing competitiveness Source: Manufacturing’s Moment: Four Goals for Higher Job-Rich Growth

THE MANUFACTURING CIRCLE’s FOUR-GOAL PLAN that will put South Africa on a higher, job -rich growth path and enable us to compete and succeed as a manufacturing destination Goal 1: South Africa will offer a business environment that attracts investment in manufacturing Goal 2: South Africa will be the gateway manufacturing destination for exports to Sub. Saharan Africa and South African manufacturers will compete domestically on an equal footing with imports Goal 3: South Africa will be a competitive beneficiator of its own resources Goal 4: South African manufactured products will be preferred by South Africans and have an excellent reputation around the world Source: Manufacturing’s Moment: Four Goals for Higher Job-Rich Growth

Current Situation in Manufacturing

Current situation in Manufacturing in South Africa Currency vulnerability to external and domestic factors 11, 5 11, 0 10, 5 10, 0 9, 5 9, 0 8, 5 3 -1 нв я -13 в фе 3 р-1 а м Source: i-Net Bridge and Pairs -13 й-13 н-13 л-13 вг-13 н-13 кт-13 -14 -13 к я в р е а о се ян ап д но ма ию ию

Current crisis for Manufacturing in South Africa Cost of production expected to rise faster despite a slowdown in 2014 Q 4 Source: Stats. SA and Pairs

Cost pushes and Rand strength The Rand is currently at 2003 levels, and has strengthened by 24% in the last 10 years. Costs (PPI, Electricity and wages) have increased by between 74% - 181% over the same period

Current situation in Manufacturing in South Africa Manufacturers and Currency: Volatility a Big Factor • 95% of companies either sensitive (40%) or very sensitive (55%) to currency risk • Risk mostly because of dependence on imports/exports (around 70%) and because currency moves cannot be passed on to customers (nearly 50%) • Just over 50% of all companies either selectively or comprehensively hedge against currency risk • While 40%-50% of companies believe hedging is simple enough and management capable enough to use it, around 70% of companies are either indifferent or positive re the viability thereof • More than 50% of companies have a system for evaluating currency exposure and the majority believe currency exposure is relatively easy to estimate NB Conclusion: Currency volatility impacts investment decisions more than trade NB Conclusion: Exporters selling majority of their output domestically give currency volatility and competitiveness issues as reason for not exporting more Source: WEF & Frontier Advisory

Export Competitiveness: Economic Outlook 11

Real GDP is projected to grow by 2. 7% in 2014 and 3. 4% in 2015…

…driven by the recovery in high income countries.

South Africa’s current account exposes it to shifts in global markets

If China weakens, commodity price declines could extend further

Export Competitiveness: 5 Stylised Facts about South Africa’s Export Competitiveness 16

Fact #1: All main export sectors are underperforming Minerals rode the boom in prices but did not rise much in volumes Non-mineral exports grew much slower than in peers

Fact # 2: 93% of exports from 5% of exporters

Fact #3: Super exporters are losing competitiveness

Fact #4: Exports are capital and knowledge intensive

Fact #5: Africa is now the main market for non-mineral exports

Export Competitiveness: 3 Opportunities to Help Ignite Exports and Create Jobs 22

#1: Competition will spur innovation improve incentives to export More competition at home encourages firms to Innovate Cuts costs Go abroad More Exports

#2: Lower costs of transport & ICT, address infrastructure bottlenecks

#3: Deepening regional integration in goods and services

Location Of Production 26

Trends in the Location of Production • An important expected effect of the rise of advanced manufacturing policies was that the costs of low-skilled labour may become less important, thus making off-shoring to low labour costs economies less attractive • Developed economies may benefit in terms of the location of production, but the direct employment benefits were still unclear and any benefits would likely accrue mostly to highly skilled workers only. The impacton emerging countries was of concern. • Explanations for this move to “on-shoring” or “backshoring” starts with the changing cost structure of production in emerging countries resulting in market size rather than labour costs once again coming to the for as the central concern for the location of production. • The trend seemed to be a two-step one of mechanisation in offshore facilities in developing countries, followed by back shoring to developedlocations. • The declining cost of energy in the United States due to shale gas usage exacerbates this trend. 27

Trends in the Location of Production • While global manufacturing companies were keen to exploit emerging markets growing on the back of rising incomes, more than a third of USoperators have underestimated the cost of entering markets like India, China and Brazil. • In turn, the trend towards global value chains may continue, but risk dispersion is now also prioritised post natural disasters like the March 2011 Tohoku earthquake and the flooding in Thailand in the same year, which cut off parts supply globally. • On-shoring have generally become a way to build larger operational flexibility into manufacturing companies, allowing them to adjust production process to market signals with shorter turn-around times. • Off-shoring to developing countries will remain an important strategy, but more so to benefit from market growth due to higher wages, rather than from low labour costs. 28

Employment & Outlook

Employment & Outlook 2, 00 Manufacturing Employment Shrank in 2013 Q 4 1, 95 Thousands 1, 90 -49, 000 Q 4 ’ 13 vs. Q 4 ‘ 12 1, 85 1, 80 1, 75 -13, 000 Q 4 ’ 13 vs. Q 3 ‘ 13 1, 70 1, 65 I II IV 2008 Source: Stats. SA and Pairs I II IV 2009 I II IV 2010 I II IV 2011 I II IV 2012 I II IV 2013

Employment & Outlook Subdued manufacturing activity in US, China and SA, but not Germany 60 55 50 45 40 J F M A M J J A S O N D J F M 2012 China Source: BER, Markit, NBS, ISM and PAIRS A M J J A S 2013 US Germany South Africa

Current situation in Manufacturing in South Africa 1. 2. 3. 4. 5. 1. 2. 3. 4. Factors that affected demand conditions in 2013 Q 4 Seasonality of certain manufacturing activities Sluggish domestic spending Elevated competition Factors that affected production processes in 2013 Q 4 Disruptions in Telkom landline and internet connectivity Congestion and delays at the Durban port Water and electricity supply disruptions (esp. in Ekurhuleni) Shortage of steel as well as high quality grade coal Poor road infrastructure (affecting regional deliveries) Factors that negatively affected manufacturing employment in 2013 Q 4 Weak domestic demand Seasonal factors Increased competition Elevated labour costs Source: WEF & Frontier Advisory

Current crisis for Manufacturing in South Africa Surveyed firms source significant inputs locally, but did not benefit from govt’s local procurement programme What percentage of your total purchase is locally sourced products? 25 20 24 16 12 Yes No Source: PAIRS 0% 10 81 %- 80 % %61 % 60 41 %- % 40 21 %- 1 - 20 % 0 0% Share of respondents 27 Does your manufacturing concern currently benefit from the government’s local procurement programme? 76

Budget Reaction

Budget Reaction: Cutting Costs Municipalities, Competitiveness Benchmarking and Infrastructure the Biggest Issues FACT: Service interruptions to municipal electricity and water customers are becoming so severe that numerous manufacturers have started to quantify this for their annual reporting, e. g 30 workdays lost per annum common in Ekurhuleni FACT: Energy (electricity and gas prices) have rocketed in South Africa over the last decade while they have declined in competitor economies FACT: Our port charges are three times higher than the global average FACT: Local government, the vanguard of service delivery, allocated only 9% of budget FACT: High administered costs leave manufacturers even more vulnerable to global vagaries PROPOSALS: National Treasury should conduct a full fiscal review and benchmarking effort to ensure that: - Infrastructure maintenance and provisioning is funded, financed and the costs recouped in the most efficient manner that is in sync with what is being done in competitor economies; - Price setting regulations and discount options for energy and other utility services are on par with competitor economies insofar as South African realities allow; and, - Act on research already completed by NEDLAC FRIDGE Fund and the dti on administered prices

Budget Reaction: Nurturing the Base IPAP Endorsement Great, Infrastructure Great, Implementation Crucial • • REACTION: Manufacturers derive great confidence from the strong endorsement provided to the Industrial Policy Action Plan in the Budget – IPAP best in government at promoting policy coherence and coordination and R 25. 5 bn over the MTEF for manufacturing investment and competitiveness allocations welcome SEZs: Manufacturing Circle does not support the exclusive design of this programme – should be extended to all compliant manufacturers to avoid market distortion and to enhance overall economic competitiveness Growth imperatives (5% of GDP) and debt (stabilising at 45% of GDP in 2016/17) will be manageable only if confirmed additions to generation capacity and shale gas exploration can be expedited. Minister rightly emphasised: Infrastructure investments and the promotion of capital expenditure to the quickest growing expenditure category will support competitiveness, provided government improves its implementation record significantly

Budget Reaction: Growing the Market IPAP Endorsement Great, Infrastructure Great, Implementation Crucial • • REACTION: The budget rightly affirmed the need to leverage local procurement, especially in light of depressed global conditions Growing the local market also means growing the regional market Technological infrastructure and management improvements at SARS Customs, and better industry co-operation through the SARS Customs Key Industry Forum have already resulted in significant improvements As a small open economy, we should use international finance and trade organisations to adopt definitions of currency manipulators, so that they may be isolated and sanctioned as currency manipulation by other nations frustrate the intended impact of legitimate trade remedies and encourage predatory trading

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