South Africa is ready for a sovereign wealth fund

IN HIS 2020 State of the Nation address, President Cyril Ramaphosa announced government’s intention to establish a sovereign wealth fund (SWF).

SWF’s are state investment vehicles, which are based on a number of funding sources.

The sources include foreign exchange reserves accumulated on the basis of balance of payment and government budget surpluses, official central bank interventions to stabilise the currency, natural resource revenues, proceeds from privatisation and pension fund reserves.

There are two types of SWFs: commodity and non-commodity based funds.

Two factors seem to have fuelled the rise of SWFs at least since 1999. The first factor has been the well-documented massive accumulation of foreign exchange reserves by central banks in export-led economies, especially in South East Asian economies.

There are costs associated with holding forex reserves, measured by the return differential between foreign and domestic financial assets. Since in these economies central banks are state owned and, therefore, the government determines the structure of the central bank’s balance sheet, governments decided to re-allocate a portion of these reserves to SWFs.

The second factor has been the significant increase in commodity prices from the early 2000s up until the onset of the global financial crisis. An example is the increase in the oil price from $10 per barrel in 1998 to $148 per barrel in 2008.

In oil-rich countries, the state owns a significant share in resource extraction, the massive foreign exchange earnings from this significant increase in the oil price prompted governments in oil-rich countries to establish commodity-based SWFs in search of high returns.

In the case of Nigeria, for example, the government appropriates 60 percent of revenues from hydrocarbon based joint ventures with multinational corporations. This allows the government access to oil-based foreign exchange earnings, which it then allocates to the Nigerian Sovereign Investment Authority (the SWF).

The idea of the SWF in South Africa arose from the debate about the nationalisation of the mines, because minerals constitute an important part of the basic sovereign wealth of South Africans.

South Africa leads in a number of minerals and our argument was that revenues from these resources should be invested in a developmental way. For example globally, in 2016 South Africa produced 56 percent of platinum group metals, 48 percent of chromite ore, 35 percent of manganese ore.

Revenue from these resources should naturally be used to establish, and continuously inject capital into, the proposed SWF to diversify the economy, because these are exhaustible resources.

Establishing a non-commodity based SWF in a country that is so rich in minerals would be a travesty to the idea of the SWF. It is, therefore, necessary for the government to give clarity about state participation in the South African minerals sector, if the proposed SWF is to be given content.

The Government Employee Pension Fund (GEPF) plays a similar role to the SWF. Through the PIC, the GEPF invests in almost all the sectors of the economy.

The GEPF also has investments abroad, like most SWFs. All these investments support government’s financing of its future pension fund obligations, while they could also ease fiscal expenditure pressures. The characteristics of the GEPF are similar to that of the SWF.

It would, therefore, appear strange why the ANC adopted the resolution on the establishment of the SWF, when already a non-commodity based fund and investment manager which plays the same role as the SWF already exist.

However, once we recall that the basic wealth of all South Africans lies in the minerals (and the land broadly) and in the resource-based monopolies, then it becomes clear that the idea of the SWF cannot be taken forward seriously without some degree of state participation in existing natural resource-based operations.

As a starting point, the government should consolidate state ownership of mineral resources in the African Exploration Mining and Finance Corporation (AEMFC), which is the designated stateowned mining company.

The AEMFC should have shares in all the minerals and natural resources operations in South Africa, through joint ventures with existing mining houses or through its own operations. The ministers of finance and mineral resources and energy should indicate the percentage that the state should have in existing operations.

The minister of finance should derive a formula that will guide the AEMFC in allocating resources to the SWF, determine the SWF’s investment mandate and define its governance structure.

Unfortunately, the idea of state participation in the minerals sector did not feature in the Sona.

South Africa has chronic current account and budget deficits, ballooning public debt. An allocation to the SWF from the existing revenue sources, such as royalties, which are about R8 billion, would be sorely inadequate, and would widen the budget deficit and further increase public debt.

Royalties are capped at 7 percent of gross mineral sales of unprocessed minerals and they are around R8 billion. They are already a line item in the revenue of the current government budget.

A bold and correct approach would be to implement section 86A of the Mineral and Petroleum Resources Development Act (MPRDA) allowing the AEMFC acquire the 20 percent free carried interest in all new natural resource-based operations. In addition, the government should devise ways through which the state can participate in existing operations.

The deficit on the current account makes the allocation of a portion of the SA Reserve Bank’s forex reserves to the SWF a tenuous idea. The government’s Contingency Reserve Account stands at R285 billion, far less than its Contingent Liabilities, which are R483bn. There is therefore very limited space to raise capital using the Contingency Reserve Account at the Sarb.

In any case, using the contingency reserve to set up the SWF invites questions. This portion could be used to address pressing contingent liabilities which government has guaranteed, such as Eskom debt, as they are meant to do exactly that.

The Sarb is already managing the Contingency Reserve Account on behalf of the government; the SWF’s role would not be significant in this regard.

An unfortunate possibility is to raise capital through privatisation: Eskom power stations and dams, concessions on Transnet lines, selling off spectrum, partial privatisation through strategic equity partnerships, joint ventures in the form of private public partnerships in potentially profitable infrastructure projects, etc.

The SWF will then, like the PIC, invest across the economy and abroad as a minority shareholder.

However, this would constitute rolling back efforts to build a developmental state, further dilution of state control of the economy and it would weaken its capacity to drive social and economic development. Such a path would be very unjust, in a country that is so rich in minerals.