2014 Parliamentary Budget Hearings

Fiscal Framework and Revenue Proposals

Presentation to the Standing and Select Committees of Finance Parliament of the Republic of South Africa4 March 2014

The Manufacturing Circle has a Plan in the Making

PROMOTING MANUFACTURING FOR HIGHER JOB-RICH GROWTH

Source: Manufacturing’s Moment: Four Goals for Higher Job-Rich Growth

PROMOTING MANUFACTURING FOR HIGHER JOB-RICH GROWTH

Source: Manufacturing’s Moment: Four Goals 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 decadeFACT: 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 manufacturersFACT: 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 partnersFACT: 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 weakenFACT: Manufacturing output is supported by a more stable and competitive rand exchange rate, but this requires more focused policy determinationFACT: 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

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

Source: Manufacturing’s Moment: Four Goals for Higher Job-Rich Growth

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

Current Situation in Manufacturing

Current situation in ManufacturingManufacturing in South Africa

Currency vulnerability to external and domestic factors

Source: i-Net Bridge and Pairs

Current crisis for Manufacturing in South Africa

Cost of production expected to rise faster despite a slowdown in 2014 Q4

Source: StatsSA 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

PPI Electricity Wage Costs Rand: USD% (strengthen) /

Weakening in Rand2002 13.4% -1.1% 7.3% 10.502003 2.2% -1.5% 7.0% 7.54 -28.2%2004 2.4% 2.4% 0.0% 6.40 -15.1%2005 3.6% 4.9% 6.5% 6.34 -0.9%2006 7.7% 4.6% 6.5% 6.75 6.5%2007 10.9% 6.7% 6.4% 7.04 4.2%2008 14.3% 21.4% 8.0% 8.25 17.3%2009 0.0% 26.2% 0.0% 8.40 1.8%2010 6.0% 24.0% 7.5% 7.31 -13.1%2011 8.4% 25.3% 8.0% 7.26 -0.7%2012 6.6% 7.0% 7.97 9.8%Average increase 6.9% 11.3% 5.8% 7.61Total increase since 2002 81.4% 181.1% 74.0% -24%

Current situation in ManufacturingManufacturing in South Africa

Manufacturers and Currency: Volatility a Big Factor

Source: WEF & Frontier Advisory

• 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

Export Competitiveness: Economic Outlook

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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

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Fact #1: All main export sectors are underperforming

Minerals rode the boom in prices but did not rise much in volumes

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2001

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Decomposition of mineral export growth

Volume

Volumes virtually flat

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

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#1: Competition will spur innovation improve incentives to export

More competition at home encourages firms to

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

#3: Deepening regional integration in goods and services

Location Of Production

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• 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.

Trends in the Location of Production

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• While global manufacturing companies were keen to exploit emerging markets growing on the back of rising incomes, more than a third of US-operators 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.

Trends in the Location of Production

Employment & Outlook

Employment & Outlook

Manufacturing Employment Shrank in 2013 Q4

Source: StatsSA and Pairs

-49,000Q4 ’13 vs. Q4 ‘12

-13,000Q4 ’13 vs. Q3 ‘13

Employment & Outlook

Subdued manufacturing activity in US, China and SA, but not Germany

Source: BER, Markit, NBS, ISM and PAIRS

Current situation in ManufacturingManufacturing in South Africa

Factors that affected demand conditions in 2013 Q4

Source: WEF & Frontier Advisory

1. Seasonality of certain manufacturing activities2. Sluggish domestic spending3. Elevated competition

Factors that affected production processes in 2013 Q41. Disruptions in Telkom landline and internet connectivity2. Congestion and delays at the Durban port3. Water and electricity supply disruptions (esp. in Ekurhuleni)4. Shortage of steel as well as high quality grade coal5. Poor road infrastructure (affecting regional deliveries)

Factors that negatively affected manufacturing employment in 2013 Q4

1. Weak domestic demand2. Seasonal factors3. Increased competition4. Elevated labour costs

Current crisis for Manufacturing in South Africa

Surveyed firms source significant inputs locally, but did not benefit from govt’s local procurement programme

Source: PAIRS

What percentage of your total purchase is locally sourced products?

Does your manufacturing concern currently benefit from the government’s local procurement programme?

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 EkurhuleniFACT: Energy (electricity and gas prices) have rocketed in South Africa over the last decade while they have declined in competitor economiesFACT: Our port charges are three times higher than the global averageFACT: Local government, the vanguard of service delivery, allocated only 9% of budgetFACT: 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 R25.5bn 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

THANK YOU