South Africa has done well attracting foreign investment in its automotive, mining and now banking sectors but southern Africa’s most powerful economy must shift into high gear if it is to emerge as a top global FDI destination.

The South African government and its Department of Trade and Industry (DTI) have won plaudits for adopting a broadly pro-market economic stance since the country’s move to democracy in 1994. Foreign investors have responded – most notably in UK bank Barclays’ blockbuster $5.5bn purchase of local bank Absa in May.

In recent months, General Motors, the world’s largest car maker, has ploughed $100m into South African production of a new global version of its Hummer sport utility vehicle. And the Coega Industrial Development Zone (IDZ) outside Port Elizabeth has secured its first tenant in a $31m deal with Belgian-owned Sander International Textiles.

Foreign capital has piled into South Africa in recent months as local bonds, equities and the rand offer overseas funds attractive returns in a well-regulated, sophisticated and legally protected market. Rating agencies have also given the country an investment grade rating.

Yet capital inflows still dwarf FDI and key challenges remain if South Africa is to build on its positive if modest FDI performance.

Investment hurdles

FDI’s failure to take off has been tied to various challenges: restrictive labour laws, hefty business regulation, complex black economic empowerment requirements, an HIV-AIDS epidemic, currency volatility, skills shortages and the country’s chilling crime rate. In addition, perceived political risk has also risen due to the growing dominance of the ruling African National Congress (ANC), the marginalisation of opposition politics, the uncertain future of broadly market-friendly economic policies after President Thabo Mbeki steps down in 2009 and the potential fall-out from unrest in neighbouring Zimbabwe.

Tensions over the slow pace of land reform and a spike in union activity in recent months have also clouded optimism about South Africa, which together with Nigeria is pitching for a seat on a reformed UN Security Council.

But Mr Mbeki is making key moves on economic reform aimed at stimulating the economy beyond its traditional growth mechanisms and has made a decisive strike against the number-one scourge of Africa: corruption. His decision to sack his deputy and presumed successor Jacob Zuma after a Durban court ruled that a corrupt relationship had existed between Mr Zuma and his adviser won Mr Mbeki favour in business circles.

South Africa’s solid legal system and democratic constitution provide some comfort despite ongoing tensions in the judiciary and with the government over the pace of racial transformation on the bench. Foreign mining companies have also used the court system successfully to overturn decisions by the Ministry of Mines and Energy and to reserve their rights to sue the government if their mineral rights were threatened with expropriation.

South Africa’s infrastructure is world-class, even though it is under strain from growing electricity and transport demands on a system dating back to white-minority rule.

Prospects for major FDI inflows, however, have been diminished by the government’s decision to effectively quash its privatisation programme. It has opted for public-private partnership rather than the initial plan of the wholesale sale of state assets, such as transport giant Transnet.

Labour law policy, which has been blamed for stifling jobs growth and FDI, remains an issue of debate in government and any changes are expected to be bitterly resisted by the ANC’s union alliance partners. Government recommendations this month to attract overseas skilled workers have already been blasted by the labour movement and the ANC’s Communist Party allies.

Business barriers

Doing business in the Rainbow Nation has never been terribly easy. Foreign executives have complained of not obtaining work permits from the Department of Home Affairs, which until recently was a political battleground between Mr Mbeki and his rival cabinet minister Mengistsu Buthelezi of the Inkatha Freedom Party. That spat is now over and new immigration laws came into effect in July that removed some of the more controversial conditions.

Targeted incentives for potential foreign investors, such as tax relief, wage subsidies and help in getting through the hurdles of bureaucracy, have also been slow in coming. So has the dismantling of remaining currency restrictions, which limit foreign-owned firms’ ability to raise capital in the local market.

HR crisis

The biggest crisis faced by the country, though, is the prevalence of HIV/AIDS, which directly affects more than five million South Africans. The crisis compels companies to have workplace AIDS strategies in place, including the provision of life prolonging antiretroviral drugs.

Apart from mining and financial services companies, very few companies have conducted research to assess the impact of HIV/AIDS on their labour force, production costs and consumer base, according to a survey by the South African Business Coalition on HIV & AIDS. More than 60% of the mines and roughly 50% of the manufacturers surveyed indicated that HIV/AIDS has already reduced labour productivity or increased absenteeism among employees and has led to higher employee benefit costs.

Auto success

South Africa’s biggest FDI successes have been in the automotive sector. The world’s leading car manufacturers have been boosting their investments in the country. There are also promising early signs that the DTI’s push on industrial developments zones will have the desired effect.

The motor industry has been an FDI success for South Africa for almost a decade. Major car makers Volkswagen, General Motors, Ford, DaimlerChrysler and Toyota are among those with production facilities in the country. This has made the automotive industry the largest manufacturing sector in South Africa and the country’s biggest manufacturing exporter.

A big factor behind the sector’s FDI success has been the DTI’s Motor Industry Development Plan (MIDP). “The MIDP is undoubtedly the key driver behind the automotive industry’s success since its implementation in September 1995,” says Dave Coffey, president of the National Association of Automotive Component and Allied Manufacturers (NAACAM). “Even though the MIDP will be reviewed in 2005, the government remains committed to ensure that the achievements and positive developments experienced by the automotive sector to date continue until and beyond 2012.”

The main thrust of the MIDP was the development of an internationally competitive and growing automotive industry in South Africa, according to the DTI. The major lever to be used in pursuing this was the encouragement of higher volumes by allowing exporting firms to earn rebates that can be used to offset automotive import duties while exposing the industry to greater global competition through tariff reductions.

The Import Rebate Credit Certificates are issued to exporters of qualifying built-up vehicles and automotive components based on the value of the exports less foreign content of those particular exports. The face value of the certificate entitles the holder to a full rebate on duties on qualifying imported goods of the same value.

The investments are paying dividends. Local vehicle sales and exports are hitting new records, led by a series of South African interest rate cuts, stable new vehicle prices, attractive incentives offered by manufacturers and a positive economic environment.

Car sales soar

Vehicle exports should receive a substantial boost from two new car lines from the middle of this year: the export of Toyota multipurpose vehicles as well as exports by Ford Motor Company of cars and light commercial vehicles. Vehicle exports are expected to hit 145,500 units this year, up just over 111,000 on last year, climbing to 180,500 units in 2006 and 205,500 units a year later, according to projections by the National Association of Automobile Manufacturers of South Africa.

Domestic vehicle production is expected to reach 549,500 units this year from 455,052 last year, and grow to 605,500 in 2006 and to 646,500 in 2007. This contrasts with 1995, when a mere 11,500 vehicles were exported.

The components sector has also enjoyed the upturn in the vehicle manufacturing sector as companies like General Motors South Africa increase production. Over the next three to four years, General Motors will be able to produce 10,000 Hummers a year.

“The recent announcement from General Motors of its R18bn contract to manufacture the Hummer H3 for export was welcomed as a vote of confidence in the South African motor industry,” says NAACAM’s Clive Williams. “Like General Motors, other overseas engine manufacturers are increasingly focused on South Africa as a production base. For example, South Africa is positioned as one of the global production bases in Toyota’s world strategy, and others such as DaimlerChrysler and BMW are increasing their local production.”

Cost advantages

NAACAM estimates that South Africa has a cost advantage on short runs for car exporters, such as model run-outs or for lower volume vehicles. Tooling costs are also competitive: for tooling under a foot (30cm), South African costs are typically half of European costs for the same quality, NAACAM says.

A further boost to the region’s automotive industry has been provided by the Africa Growth and Opportunity Act (AGOA), which allows preferential access to the US market.

Minister of Trade and Industry Mandisi Mpahlwa has told the foreign-led car industry that the government will be flexible in how the industry meets its black economic empowerment (BEE) obligations.

“Government regards it as more advantageous to allow multinationals in certain parts of this industry to commit to their own BEE initiatives rather than to force them into a single approach via a BEE charter,” says Mr Mpahlwa. “We are open to negotiation with global companies that might elect to extend BEE ownership upstream or downstream, rather than ownership in the company itself; although clearly we would prefer BEE equity participation.”

Development zones

The DTI’s IDZ programme is a key plank in its efforts to attract FDI by encouraging international competitiveness in South Africa’s manufacturing sector. An IDZ is a purpose-built industrial estate linked to an international airport or port, which contains a controlled Customs Secured Area (CSA). A CSA is exempt from duties, VAT and import duty on machinery and assets.

Coega is part of the Nelson Mandela Metro (comprised of Port Elizabeth, Uitenhage and Despatch), which is the home of one of the most diverse auto clusters in the world. It includes original equipment manufacturers General Motors and Volkswagen, as well as more than 150 suppliers, including Goodyear, Bridgestone, Corning, Visteon, Hella, Faurecia, LUK and Johnson Controls. More than 90% of the automotive component manufacturers and vehicle assemblers that export from South Africa can be found in the industrial areas around Coega.

But the Coega IDZ is now aiming to break the region’s dependency on the auto trade and become an industrialised manufacturing hub through a deal with Canadian aluminium firm Alcan. Interest in Coega has come from sectors as diverse as steel, ferrous metals, textiles, energy, agri-processing, warehousing and office park developments. Major investments in a chlorine plant, aluminium smelter and liquid natural gas power station are in negotiations, according to the Coega Development Corporation (CDC).

Negotiations with Alcan to build a $2bn, 660,000-tonnes-per-year aluminium plant at Coega is seen as critical to the future success of the zone. France’s Pechiney had developed the project before being taken over by Alcan last year, and the Canadian firm has been reviewing the scheme, particularly which technology to use.

Delays over the aluminium plant have not stopped the South African cabinet from approving a tariff supply agreement between state power supplier Eskom and Alcan. Alcan’s board is also expected to make a decision on the scheme in October.

Interest in Coega

Other metal producers have also shown interest in developing processing facilities at Coega, including an integrated one-million-tonnes-a-year stainless steel plant.

Of the 80 companies that the CDC is talking to on the subject of investing in Coega, more than 20 are involved in the metals industry. Coega includes a customs-controlled area, which is exempt from import duties. Certain goods and services are also VAT-zero. This means that investors will be able to warehouse, pack, unpack and assemble their equipment in a custom secure zone.

Coega got off the starting blocks in May when it signed its first investor, Belgian-owned, high-end niche textile company Sander International Textiles. The company signed a 20-year lease agreement with Coega for an investment to the tune of R200m.