EU key to investment in SA

17 January 2006

The European Union is a key source of new foreign investment for South Africa, although the benefits of the EU-SA Free Trade Agreement require better marketing.

And while the outlook for investing in South Africa is broadly positive, a stable currency is vital for attracting more foreign direct investment (FDI) into South Africa.

These are just some of the findings of research conducted by the BusinessMap Foundation, in association with the London-based Centre for Research into Economics and Finance in Southern Africa, on the effect of the EU-SA Free Trade Agreement – more accurately called the Trade, Development and Cooperation Agreement – on investment in SA.

The research also stressed the need for the possible benefits of the agreement to be better marketed to EU and South African firms, and offered a possible explanation of why FDI flows to SA are low compared to similar countries.

Go to the BusinessMap Foundation website The full report, Foreign Direct Investment in South Africa: The initial impact of the Trade, Development and Cooperation Agreement between South Africa and the European Union, was released on Tuesday and is available on the BusinessMap Foundation website.

The project used BusinessMap’s unique database of FDI, as well as the results of interviews BusinessMap conducted with top executives of 25 foreign-owned firms in a wide range of sectors and of various sizes.

Since the sample is small, despite the high quality of the interviewees, the results should be considered as initial expectations of important factors influencing investment, rather than being conclusive. Nonetheless, the results seem to bear out previous surveys of foreign investors in the country.

Broadly positive outlook
For the companies sampled, the volatility of the exchange rate stood out as having the strongest negative effect on investment, along with the level of crime and corruption, the spread of HIV/Aids, the quality of the rail service, and the existence of exchange controls.

Those factors having the strongest positive affect on investment included the stability of the local business environment, the economic policy framework and rate of growth, political stability and the quality of infrastructure and services (excluding, however, rail and ports).

The responses received in the interviews regarding the performances of the firms relative to their initial expectations, together with the number of firms having expanded their local operations in recent years, presented a broadly positive outlook for investing in South Africa.

FDI and the domestic economy
The interviewed investors commonly employ a workforce that is almost entirely local, and most of the interviewed firms use mainly local inputs, thus supporting the view that an associated benefit of FDI is the creation and maintenance of linkages in the domestic economy.

Data gathered on the markets served by the companies showed a strong focus on the domestic market, reflecting market-seeking objectives of foreign investors. Notable exceptions to this include companies in the automobile and resource sectors.

While many firms were active in the rest of Africa, the percentage of products sold there was low, indicating that the main focus remains the larger and more important South African market.

Fewer firms sold products to the EU and the rest of the world; however, if a company entered these markets the percentage of products sold was generally higher than into the rest of Africa.

Developed capital market blunts FDI
Crucially, the report finds that FDI into South Africa may be low because South Africa is unlike other developing countries in having a developed corporate sector and capital markets.

The report argues that the developed corporate sector and large domestic capital market facilitates greater interaction between local and foreign investors, which can be seen by the relatively high proportion of acquisitions as a mode of entry.

One outcome of this may be that the country receives less foreign capital than countries with underdeveloped capital markets, as much of the necessary capital is available domestically.

However, the report differentiates between the level of foreign investor activity and the level of investment flows, suggesting that while the flows have been low compared to other middle-income countries, the level of activity is more significant than the official figures suggest.

Sources of foreign investment
EU companies are a key source of new foreign investment for South Africa. The level of EU investment has risen since the late 1990s, partly due to new investment by former South African multinationals now domiciled in the UK.

The UK has been the main source of EU investment, followed by Germany, which has also been a consistently significant partner. For other member states, shares of investment have been heavily influenced by periodic large transactions.

The US, Japan and Malaysia have also been important sources of investment in the past decade. Moreover, there is evidence that a broadening of investment partners has taken place since 2000.

Effect of the TDCA on investment
In terms of the effect of the Trade, Development and Cooperation Agreement (TDCA) on FDI, the results of the research are inconclusive. The limitations of available data mean it is difficult to identify individual instances of export-oriented FDI or the creation of new linkages supported by the TDCA.

Furthermore, an important aspect of the agreement is the signalling effect in terms of the commitment to liberalisation and increasing competitiveness in South Africa; here, the foreign investment response would not necessarily be linked to new trade opportunities.

Finally, only a short time has elapsed since the start of the implementation of the TDCA, and the foreign investment response seems likely to evolve over time.

Investment climate indicators
The report also assessed a variety of indicators of the investment climate, comparing South Africa to a selection of 10 competitor economies in Asia, Latin America and Eastern Europe. The analysis is supported by the findings from the aforementioned interviews.

Growth rates have increased in recent years, but there is still some way to go before South Africa experiences the rates of growth observed in parts of Asia. Interview evidence confirms the positive impact of current growth rates on the climate for foreign investment in South Africa.

The value of trade in South Africa has increased since the mid-1990s and is now more in line with the average performance of middle-income economies. Nevertheless, interview evidence suggests that trade policy, including the TDCA, currently plays a limited role in the climate for foreign investment.

In part, this reflects the continued importance of investments targeted at the domestic market. Cooperation to inform firms of the potential benefits of the agreement may be useful, especially for smaller firms who lack resources to monitor new opportunities regularly.

Exchange rate volatility is greater in South Africa than many of the competitors, and interview evidence confirms that this is an important weakness in the investment environment. Attracting longer-term forms of foreign investment and increasing export capacity should help to strengthen the resilience of the currency to shocks.

Furthermore, recent policy actions, including the strengthening of foreign reserves, should provide the basis for increased stability in the future. This should, in turn, help to reduce the uncertainty facing investors, both foreign and domestic.

Institutional framework
South Africa compares reasonably well on several institutional aspects of the investment climate. Firm interviews generally support the view that the broad institutional framework is favourable, but there are concerns with respect to efficiency of government, crime and corruption.

Regarding black economic empowerment (BEE), the main concerns from the interviews were related to the issue of transferring equity and the issue of clarity, with firms unsure about the exact requirements of compliance.

Labour market regulation in South Africa is less flexible than in several competitor economies and may be interpreted as an institutional weakness.

However, there is an important trade-off between flexibility to promote investment and growth, on the one hand, and an adequate level of protection for employees and the promotion of broader BEE objectives, on the other. Interview evidence shows legislation, productivity and skills to be of greatest concern, while costs are viewed more favourably.

Telecoms, transport infrastructure
The reach of telecommunications and transport infrastructure in South Africa appears to be broadly in line with middle-income competitors, but costs and reliability must also be taken into account. Interview evidence reveals concerns about the availability and reliability of rail services and inefficiencies and congestion at ports.

The quality of IT and telecommunications infrastructure is viewed positively, but dissatisfaction is expressed with high costs.

Other aspects of infrastructure and financial and professional services provide a generally positive contribution to the investment climate, but there is some concern regarding future electricity supply.

Firms interviewed from the motor industry are reliant on the Motor Industry Development Programme and are concerned about the future of the initiative, which is under review.

      Reg Rumney is the executive director of the

BusinessMap Foundation

      . The

Foreign Direct Investment in South Africa

    research project was funded by the British Department for International Development and the European Commission.