This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 06 PRETORIA 005007 
 
SIPDIS 
 
SENSITIVE BUT UNCLASSIFIED 
 
DEPT FOR AF/S; AF/EPS; EB/IFD/OMA 
USDOC FOR 4510/ITA/MAC/AME/OA/DIEMOND 
TREASURY FOR OAISA/BARBER/WALKER/JEWELL 
USTR FOR COLEMAN 
LONDON FOR GURNEY; PARIS FOR NEARY 
 
E.O. 12958: N/A 
TAGS: ECON EINV EFIN ETRD SF
SUBJECT: SOUTH AFRICA: FINANCE MINISTER SPELLS OUT 
PRIORITIES 
 
REF: A. PRETORIA 4879 
 
     ¶B. PRETORIA 4809 
 
Sensitive But Unclassified; Protect Accordingly 
 
¶1. (U) Summary.  Finance Minister Trevor Manuel addressed 
Parliament on October 26 to table the Medium Term Policy 
Statement, an appropriations adjustment bill, and a tax 
amendment.  He presented a detailed overview of the 
government's development priorities over the next three years 
and economic outlook.  Manuel said that sound fiscal 
management and successful inflation targeting meant that the 
government could now focus more on growing the economy "to 
create employment, and to generate resources to plow into 
education, health care, social security, fighting crime, and 
reducing poverty."  He predicted growth would average 4% over 
the next three years and flatly declared that the 
government's goal was to increase the rate of gross fixed 
capital formation from 16% of GDP to 25% by 2014.  While 
acknowledging that private sector investment would be 
responsible for most of this increase, he focused most of his 
discussion on what the public sector needed to do.  Manuel 
warned that public sector borrowing would rise as state-owned 
enterprises borrowed from capital markets to fund a large 
proportion of their infrastructure investment. 
 
¶2. (U) Manuel departed from political convention on several 
occasions.  He commented that the ownership criteria in some 
draft Black Economic Empowerment (BEE) charters were self 
defeating, leading to unnecessarily complex and risky 
financing structures.  Just as critical, he thought, was 
building the economy, increasing production, creating jobs, 
developing young black managers, and investing in social 
development.  Manuel conceded that immigrant skills could be 
critical to growth, since it would take time before education 
and training programs yielded substantial returns to the 
economy.  Manuel admitted that the social security net was 
under severe strain, and should be removed from the provinces 
and consolidated under a new national social welfare agency 
that would be able to stem the flow of grants to people who 
did not warrant them.  Finally, he said that the Cabinet 
wanted to introduce an index to monitor government 
administered prices in electricity, water, transport, 
education, and health sectors -- all of which seemed to be 
growing faster than inflation.  End Summary. 
 
¶3. (U) Finance Minister Trevor Manuel addressed Parliament on 
October 26 to table the Cabinet's Medium Term Policy 
Statement, the Adjustments Appropriations Bill, and the 
Revenue Laws Amendment Bill.  Manuel's speech reflected the 
government's growing confidence in its ability to manage the 
economy.  Manuel made the point that sound fiscal policy and 
inflation targeting had contributed to lower interest rates 
and buoyant consumer demand.  This, in concert with high 
commodity prices and a strong international economy, had 
fomented greater local business confidence.  He said that 
trade reforms of the 1990s had caused South African business 
to become internationally competitive and more able to 
penetrate new markets.  The result was that domestic 
investment was evident across a wide range of sectors -- 
particularly construction, services, and manufacturing -- and 
more balanced growth.  Moreover, strong capital inflows meant 
that the country could finance a higher current account 
deficit and use that deficit to grow faster.  Manuel 
concluded that the reforms of the last ten years were now 
bearing fruit. 
 
State of the Economy 
-------------------- 
 
¶4. (U) While the South African economy grew just under 3% per 
year since 1994, Manuel said that government projections 
suggested that the economy would now grow faster.  Manuel 
confirmed the government's forecast at least 2.9% growth in 
¶2004.  However, continued fiscal stimulus, firm commodity 
prices, and a more competitive real exchange rate (assumed in 
the future) along with low interest rates and rising income 
would support an average of 4% growth over the next three 
years.  At this point, Manuel broke from his prepared text to 
say that he, personally, felt 4% was a conservative estimate; 
actual growth might be closer to 5%. 
 
¶5. (U) Manuel reaffirmed his commitment to inflation 
targeting, predicting that CPIX (consumer inflation less 
mortgage costs) would remain firmly within the 3-6% target 
range over next three years.  He pointed out that sticking to 
the target thus far had successfully lowered inflation 
expectations.  While high oil prices posed risks to both 
global growth and domestic inflation, projected inflation for 
2004, at 4.4%, would still fall within the target range. 
Administered prices, on the other hand, had become a subject 
of Cabinet attention.  Manuel noted that the Cabinet wanted 
to introduce an index to monitor administered prices in 
electricity, water, transport, education, and health sectors 
-- all of which seemed to be growing faster than inflation. 
While administered prices still needed to balance price 
stability, capital requirements, and service delivery 
objectives, the Cabinet also felt that there was room to 
improve the price setting process. 
 
¶6. (U) Manuel was mindful of the current strength of the 
rand, particularly vis-a-vis the dollar.  He acknowledged 
that there were adjustment problems for industry at R6 to the 
dollar and equally important problems at R10 to the dollar, 
especially with oil prices at record highs.  On the bright 
side, he thought that business confidence in the face of a 
strong rand revealed South African resiliency and improved 
competitiveness, and also reflected the general perception 
that doing business in South Africa now carried lower risk. 
 
Priorities 
---------- 
 
¶7. (U) Manuel reminded Parliament of President Mbeki's three 
challenges: 1) to encourage the growth and development of the 
First Economy to increase employment; 2) to address the 
challenges of the Second Economy; and 3) to build a social 
security net to alleviate poverty.  With these in mind, 
Manuel said that the government could now focus more on 
growing the economy "to create employment, and to generate 
resources to plow into education, health care, social 
security, fighting crime, and reducing poverty."  He said 
that for the first time in ten years, there was evidence that 
growth was resulting in employment gains.  Between March 2003 
and 2004, South Africa gained 400,000 new jobs, causing the 
official unemployment rate to fall by 3.4%. 
 
¶8. (U) Manuel outlined the government's short and long-term 
approaches to growth.  In the short-term, targeted incentives 
and public works programs would accelerate investment and job 
creation.  In addition, the government would take measures to 
make the distribution and pricing of water and energy 
resources more efficient.  Manuel conceded that immigrant 
skills could be critical in the short-term, since it would 
take time before education and training programs yielded 
substantial returns to the economy.  In the long-term, Manuel 
said that the government had to pay attention to investment 
in economic infrastructure (including electricity supply and 
rail service), regional development policy reform, and more 
effective competition policy. 
 
¶9. (U) During this discussion, Manuel highlighted sequencing 
and coordination issues in social policy.  Housing programs 
could be accelerated, he said, but needed to be aligned with 
regional development plans, job creation, and community 
services.  Social health insurance was a long-term goal that 
needed to be preceded by the modernization of public 
hospitals.  Land redistribution and BEE agricultural 
development needed to move forward, but not until the 
restitution program was completed and needed bureaucratic 
resources freed. 
 
The First Economy 
----------------- 
 
¶10. (U) Manuel flatly declared that the Government's goal was 
to increase the rate of gross fixed capital formation from 
16% of GDP to 25% by 2014.  To do this, the Government would 
pursue a supportive investment environment which included 
moderate inflation, low real interest rates, a stable and 
competitive currency, and implementation of certain 
microeconomic reforms.  Manuel was encouraged by 7% private 
sector investment growth in 2003 and 7.6% in the first half 
of 2004.  While acknowledging that most investment in the 
economy would have to come from the private sector, he then 
spent more time talking about what the public sector would 
do.  This included employing public-private partnerships to 
overhaul the country's public transport systems, investing in 
ports, and renewing the country's rolling stock.  Other 
public sector priorities included investment in health and 
education infrastructure, roads, housing, as well as 
expanding water and electricity services to the poor. 
¶11. (U) In a departure from past ministerial statements, 
Manuel admitted that the ownership criteria in some draft BEE 
charters were not realistic, leading to unnecessarily complex 
and risky financing structures.  This was self-defeating, he 
said.  While increasing the level of ownership of black 
people in corporate South Africa remained critical, just as 
critical was building the economy, increasing production, 
creating jobs, developing young black managers, and investing 
in social development.  At the same time, Manuel lauded the 
Financial Services BEE Charter for providing the impetus 
behind the launch of the low-cost Mzansi bank account that 
was designed to attract millions to the formal banking system. 
 
The Second Economy 
------------------ 
 
¶12. (U) To foster development of the country's "Second 
Economy," Manuel said that the government would have to 
balance direct income support with investing in human 
capital.  This covered a wide spectrum of programs, including 
expanded public works programs to create jobs and 
infrastructure, housing and municipal grants, 
micro-enterprise development, skills development, land 
restitution, land reform, and agricultural support programs. 
Manuel also promised that the 2005 budget would further raise 
teacher salaries.  He said that the renewal of the primary 
school nutrition program under the education departments of 
the provinces was already in progress.  The provinces would 
receive additional funding to cover increases in social 
grants, higher personnel costs, greater infrastructure 
spending, and the consolidation of spending programs in 
education and health. 
 
Social Security Net 
------------------- 
 
¶13. (U) Manuel admitted that the social security net was 
under severe strain.  Social welfare services were unable to 
respond adequately to the range of needs and distress that 
confronted them.  In particular, the rapid growth in 
disability and foster care grant applications indicated both 
rising income support needs and deficiencies in 
administrative systems.  He added that the caseloads in 
public hospitals and clinics reflected large numbers of 
victims of crime, road accidents, and disease -- especially 
HIV/AIDS and tuberculosis.  Manuel stated that the government 
believed that a single Social Security Agency would be better 
able to target and deliver social welfare grant programs.  A 
national agency would to tighten procedures, develop clear 
qualifications for the grants, and reduce the number of 
welfare grants going to people who did not warrant them. 
 
¶14. (U) Manuel explained that the administration of social 
security grants would shift to the new national agency once 
it was up and running.  In the interim, the provinces would 
continue to deliver social welfare grants under the 
conditional funding category from the national budget instead 
of equitable share funding as was now the case.  The 
provincial equitable share formula would be adjusted to take 
this shift into account as well as 2001 census data.  He said 
that the restructured equitable share formula would have a 
larger education and health components and no longer 
contingent on social welfare payments taking priority over 
other categories of expenditures.  This change would allow 
for a more stable budgeting process for education and health. 
 In addition, he said that the housing grant would receive a 
substantial boost, and a new housing strategy, focusing more 
on the creation of whole communities, would be phased in over 
the next three years, together with the expanded provision of 
basic household services. 
 
Fiscal Policy 
------------- 
 
¶15. (U) Manuel said that after a concerted effort to reduce 
the budget deficit between 1996-2001, the government was now 
able to increase public expenditure in real terms through 
borrowing at lower interest rates and managing a higher 
budget deficit.  He said that in 2003/4 the government 
recorded a budget deficit of 2.4%, a bit higher than 
predicted because revenue fell a bit below expectations. 
Revenues should be above expectations in 2004, but greater 
spending on social security grants and wages (government 
workers successfully went on strike recently for an above 
inflation wage increase) should result in a budget deficit of 
3.2% of GDP as compared to the 3.1% expected.  Manuel 
predicted that for 2005, rising corporate profits, continued 
strength in VAT and personal income tax receipts, and further 
broadening of the tax base would result in a moderate 
increase in overall revenue.  He said that the budget deficit 
was expected to widen to 3.5% of GDP next year, bringing net 
borrowing to its highest level relative to GDP since 1997/8. 
Nonetheless, he projected that the deficit in 2007/8 should 
fall to 2.7% and that debt service costs should stabilize at 
about 3.6% of GDP. 
 
¶16. (U) Manuel added that R50 billion in extra spending would 
be added to the budget estimates.  Of this, about R21 billion 
would finance growth in disability and foster care grants. 
Over the next two years, the rest would go to fund recently 
agreed salary increases for government workers, the land 
restitution program, social welfare grants, and increased 
salary payments from increased government hiring.  In third 
year, additional allocations would be required for 
infrastructure, education and training, and municipal 
services. 
 
¶17. (U) Manuel warned that public sector borrowing would rise 
as state-owned enterprises borrowed from capital markets to 
fund a large proportion of their investment in 
infrastructure.  New borrowing to finance provincial and 
municipal government spending on infrastructure projects 
would also contribute to the growth in public sector debt. 
The Treasury expected public sector borrowing to reach 4.6% 
of GDP in 2007.  Since the debt would be directed toward 
improving the country's economic infrastructure, it would be 
supportive of growth. 
 
¶18. (U) Manuel said that revenue was R5.1 billion short in 
2003 mainly because of lower profits in resources sector. 
However, he expected revenue to exceed its target for 2004. 
In 2005, the contribution from the resources sector would 
likely remain below target, but should be offset by a 
recovery in VAT and personal income tax receipts. 
 
Tax Policy 
---------- 
 
¶19. (U) Manuel said that tax relief would not be a prominent 
feature in the 2005 budget.  However, efforts to simplify the 
income tax system and reduce the compliance burden on small 
businesses would continue, as would consideration of easing 
taxes related to health insurance. 
 
¶20. (U) One of the purposes of Manuel's presentation to 
Parliament was to introduce the 2004 Revenue Laws Amendment 
Bill.  He explained that the amendment contained measures to 
encourage foreign investment and improve South Africa's 
position as a regional economic center.  These included the 
elimination of the existing tax on interest-bearing 
investments by residents from Swaziland, Namibia, and 
Lesotho, changes to the VAT to support South Africa's 
position as a freight distribution hub, and allowing 
companies to distribute shares valued up to R9000 to 
employees over a three-year period without any tax 
consequences under certain conditions.  On the other hand, 
Manuel said that tax benefits from share options for 
high-income earners would be subject to more stringent 
limitations. 
 
¶21. (U) Manuel also said that the Treasury was undertaking 
reviews of the South African pension fund industry from both 
a regulatory and a tax perspective to derive a regulatory 
framework that had more transparent disclosure rules 
regarding costs and benefits, encouraged the preservation of 
built-up reserves and discourage early withdrawals, and 
improved competition in the industry by providing incentives 
for portability.  Manuel said that a discussion paper on the 
regulatory aspects of pension funds would be released for 
comment later this year.  It would be followed by a tax 
policy discussion paper that dealt with existing shortcomings 
of the pension fund tax regime and proposing changes that 
would align South Africa's taxes in this area with 
international best practices.  He explained that the central 
aim was to protect and promote individual savings for 
retirement. 
 
¶22. (U) With respect to the mining industry, Manuel stated 
that the 2003 Mineral and Petroleum Royalty Bill would have 
to be revised to address outstanding issues such as the 
differentiation of royalty rates, marginal mine treatment, 
the elimination of the double royalty risk, and transitional 
matters.  He said that Treasury would undertake a holistic 
review of the mining sector that would include the low 
effective tax rates that mining companies paid, 
recommendations relating to the gold mining tax formula, the 
appropriateness and international comparability of the 
current mining investment allowances, and the consideration 
of special allowances for exploration and mining 
rehabilitation programs.  Possible tax measures to assist the 
small-scale mining sector would also be considered. 
 
¶23. (U) Manuel recalled the exchange control amnesty 
announced in 2003.  He reported that the government had 
adjudicated 16,033 of 43,000 applications received -- 
yielding a total of R826 million in tax revenue from newly 
declared income on foreign assets.  The Treasury estimated 
that the value of declared foreign assets would reach about 
R65 billion, yielding a total of R2.2 billion in additional 
annual tax revenue. 
 
Foreign Exchange Liberalization 
------------------------------- 
 
¶24. (U) Manuel announced that, following discussions with 
SARB Governor Mboweni, the Treasury was proposing abolishing 
exchange control limits on new outward foreign direct 
investment by South African corporations.  He added that 
demonstrated benefit to South Africa would still be a 
criterion for SARB Exchange Control Department approval.  In 
addition, Manuel said that South African corporations would 
now be allowed to retain foreign dividends offshore, and 
transfer any dividends repatriated to South Africa at any 
time for any reason.  To position South Africa as a financial 
center for the rest of Africa, Manuel restated the 
government's February announcement that foreign companies, 
governments, and institutions would be able to list on South 
Africa's bond and securities exchanges.  Manuel said that in 
November, Aquarius Platinum (an Australian mining company) 
would be the first company to take a secondary listing in 
South Africa.  Manuel stated that all investment restrictions 
in such companies would be eliminated for South Africans. 
Explaining that the sequencing of reforms was critical to 
liberalizing exchange controls, Manuel added that the 
government's end goal was to abolish exchange controls 
altogether and put in place a set of prudent financial 
benchmarks that protected the institutional savings of 
working people. 
 
Comment 
------- 
 
¶25. (SBU) Manuel's presentation covered all major issues of 
concern with clarity and purpose.  His recurring message was 
that since the economic fundamentals were good, job-creating 
growth could now be the central aim of economic policy.  The 
government's growth plan grants a new lease on life to South 
Africa's huge parastatals, as their role now will be to raise 
and manage the lion's share of public sector investment. 
Manuel is convinced that the impact on the national budget 
will be limited because considerable funding will be sourced 
from the country's deepening bond market at relatively low 
domestic interest rates (i.e., when compared to recent 
years).  Moreover, parastatals will be expected to contract 
or enter into joint ventures with private sector firms to 
accomplish their dual objectives of turning around their 
operations and building the nation's infrastructure.  The 
result will be greater public sector debt, but Manuel clearly 
believes that the markets can supply it.  He also believes 
that the resulting increase in government expenditures, 
especially on economic infrastructure, will kick start faster 
growth for the rest of the economy.  The onus, of course, 
will be on the parastatals, provinces, and municipalities to 
manage public sector investments well.  This may be the 
Achilles heel of the grand scheme as their record on this has 
been mixed.  Manuel's warnings about social welfare grants, 
recognition of the value to an economy that skilled 
immigrants bring, and criticism of BEE ownership requirements 
reflect his concern that strict adherence to achieving 
certain social goals as originally set out can be self 
defeating and perhaps hinder growth. 
FRAZER