Nimrod Zalk
Nimrod Zalk

The curious incident of the ratings agency and the developmental state

Something strange happened last week. An international credit ratings agency told us we should act more like a developmental state.

Standard & Poors — which does credit ratings of countries and large companies — warned that South Africa’s power utility Eskom needed a financial injection from the government in order to cover the costs of its capital expenditure programme. The power-build programme is currently estimated at about R720-billion in total, of which R300-billion will be spent over the next five years. As all South Africans became painfully aware this week, in the face of rolling blackouts, this build programme is critical for a country where electricity demand is outstripping supply.

S&P threatened that if this funding was not forthcoming it could downgrade Eskom’s local and foreign currency ratings. This would in turn make it more costly — and indeed difficult — for Eskom to raise capital on international and local financial markets. Of course S&P’s concern in issuing such a warning is not whether South Africa is more or less developmental, but rather the perceived credit risk to its clients in the capital markets. However, inadvertently it was pointing out some major contradictions in our “developmental state” agenda.

Although we are at present in the midst of the largest electricity and transport capital expenditure programme the country has seen in four decades, the funding of these programmes is currently predicated on two key state-owned enterprises (SOEs): Eskom and Transnet are financing this expenditure entirely off their own balance sheets. This entails a mix of funding from tariffs and borrowing on credit markets coupled with whatever cost-reducing efficiencies these entities can introduce.

This is happening within the context of two critical, economy-wide developments. First, the country is under a set of severe inflationary pressures relative to our 3% to 6% inflation target. The official inflation measure, CPIX, is currently running close to 8%. Second, there is a broad consensus that in order to tackle South Africa’s unemployment problem we urgently need to grow the “tradable” sectors of the economy: manufacturing, agriculture and mining, which are relatively intensive in low-intermediate skilled jobs relative to the more skill-intensive “non-tradable” services sectors.

The implicit decision that the capital expenditure programme should be self-financed by the SOEs contradicts both the objectives of lower inflation and growing the tradable sectors of the economy.

Our currently high level of inflation — relative to our inflation target range — is being driven predominantly by events external to the economy: record high oil prices and high global food prices. This has in turn led to a series of seven hawkish interest-rate hikes since August 2006: a total rise of 3%. Leaving aside whether this is an appropriate response to external shocks to the economy, self-financing means that both the SOEs will necessarily have to institute tariff increases well above the inflation target. Our energy regulator, Nersa, approved Eskom tariff increases of 14,2% for 2008, while Transnet this week announced hikes of between 16,5% and 22% effective from April 2008. This will have an inflationary knock-on effect for the whole economy, placing further upward pressure on interest rates..

The tradable sectors of the economy face a range of constraints, including a volatile and often over-valued currency, rising costs of capital as well as various monopolistically priced inputs which they must either absorb or pass on. The latter include electricity and transport tariffs. High transport tariffs and an unreliable logistics network are particularly damaging to exports of manufactured goods and agricultural and mining products — which are needed to narrow the current-account deficit.

Surely a more rational approach would be to take cognisance of the net economic benefits of a judicious injection of state funding into the capital expenditure programme with strong conditionalities and governance? As suggested by some of our eminent Harvard economic advisers, we are currently running a persistent “counter-cyclical” fiscal surplus on the grounds that further public expenditure would fuel inflation. But it is common sense that inflationary pressures would, in fact, be abated if the state contributed substantially to the cost of the public goods that are electricity and transport infrastructure.

Much ink has been spilt on the meaning of South Africa’s latter-day “developmental state”. But when a hard-nosed international credit ratings agency warns us that we need to behave more like one, then perhaps the lights should come on.