South Africa has struggled to attract foreign direct investment since it emerged from its apartheid era isolation in the early 1990s. The country’s macroeconomic policies are sound, its financial institutions are solid and markets sophisticated. It has investment grade ratings and it possesses an infrastructure that is often compared to that of an advanced industrialised country. Yet foreign investment has dribbled in, for the last two years amounting to around half a percent of its GDP. This is well below what the country requires to make up for its low savings rate and low rate of capital investment.

Investment banks and management consultants rushed in to grab new business following the political transition of the country in 1994, but South Africa was not virgin territory for the larger manufacturing multinationals. That may well account for much of the reason why there was no surge in FDI with the end of apartheid. The winning bid to host the 2010 World Cup has elevated hopes of a catalyst to FDI. Hosting the event will raise the country’s profile, but sustained high growth will be needed to act as the real magnet for investment.

FDI hurdles

The reasons for the country’s difficulty in attracting FDI are largely related to its low rate of growth, the small market size, distance from the world’s large markets, and the government’s hesitant privatisation programme.

The average annual growth rate since 1994 of 2.7% is up on the previous decade, but well short of the 6% required to absorb new labour market entrants. Last year growth was 1.9% and the National Treasury expects 2.9% this year, and 4% in 2006, largely on the back of an expected rise in investment. But per capita income growth continues to be low – from 1995-2002 it was only 0.7%. While the trend is better than in the 1980s and 1990s up until 1994 when there was a drop in per capita incomes, South Africa has yet to demonstrate it can achieve a sustained growth rate of above even 5%.

Small but strong

The country is widely regarded as the entry point for the sub continent, but the region is small. South Africa’s economy amounts to over 85% of the combined economy of the 14-member Southern African Development Community.

Much as higher growth would push aside other concerns for investors, the South African cost base for manufacturers is not helped by the relatively small size of the domestic market, the transportation cost to world markets, the import parity pricing practiced by many raw material manufacturers, and the high cost of ICT services.

The government has been, at best, hesitant about privatisation and the only sell off of any significant size has been that of the state telco, Telkom. There are no heavy fiscal pressures from losses at state owned enterprises to accelerate privatisation and the signal from government now is that the transport parastatal, Transnet, and the electricity supply body, Eskom, are viewed as means for investment to promote growth.

New perceptions

Without growth, which in itself is a compelling reason to consider investment whatever the other challenges, negative perceptions persist. The country’s high violent crime rate – which is at about the level of a US inner city such as Washington, DC; the HIV/AIDS epidemic; rigid labour laws; and currency volatility are revealed in surveys to be the overriding impression of the country.

Luke Mills, who heads Calling-the-Cape, a provincial government body which seeks to bring call centres to the Western Cape province says the hardest part of his job is encouraging US and UK executives to come to South Africa to have a look. “They are unduly influenced by the bad press South Africa gets overseas, notably from former South Africans,” he says. “When they actually move here, they love it,” he adds.

Reg Rumney, executive director of Business Map, a research group that monitors foreign investment, says there are also political concerns mainly about events in Zimbabwe and “Afro-pessimism”.

In practice, labour market legislation is not a paramount concern to investors, says Mr Rumney, mainly because firms can retrench, become more capital intensive, and outsource. Equally, once on the ground, investors are finding black economic empowerment requirements – working with previously disadvantaged black South Africans – not to be overly onerous. Many foreign firms regard this as another form of tax and not a severe deterrent, says Mr Rumney.

South Africa’s empowerment “charters” which set out the different industry goals for achieving a set level of black ownership and management in industries vary and in some cases it is possible to comply without giving up ownership.

One issue that is not of concern is the repatriation of dividends by foreign subsidiaries. Some foreign subsidiaries say permission tends to be given far faster in China than it is by the South African central bank but, if all documents are in order, permission is never denied.

Spreading the word

There is an evident sense of frustration in government that macroeconomic and political stability have not resulted in a flood of FDI. To present its story to potential foreign investors the government has sent high level delegations to attend the World Economic Forum meetings in Davos for the past decade. It has also created an International Marketing Council to sell the South African story of political and economic stability, and its viability as an investment destination. In addition, President Thabo Mbeki, meets about twice a year with the great and the good including investors and speculators – George Soros and Daimler Chrysler chairman Jurgen Schremp are just two members of his International Investment Advisory Council.

These initiatives may help raise South Africa’s profile among potential investors but it is the business case alone upon which investors have to focus.

Through its labour laws and relatively low skills base, the country cannot compete with China. Taiwanese investors in the clothing industry choose to invest in Lesotho, a small mountain kingdom surrounded by South Africa, because wages are lower and labour rules more flexible. They have been induced to invest in Lesotho because like South Africa it has duty-free access to the US market through the Africa Growth and Opportunities Act. Even with this access, China can land the clothes it makes at around 15% lower prices after duties than those produced in Lesotho.

The big foreign investment deals since 1994 have been overwhelmingly in the area of M&As, rather than in any new mega industrial projects. Dow Chemical bought Sentrachem for $504m, Malaysian state owned oil company, Petronas, bought Engen for $666m, Malaysia Telekom and SBC Communications from the US took a 30% stake in what was the then state controlled telephone monopoly, Telkom, for $772m. Canadian miner Placer-Dome took a 50% stake in Western Areas, and more recently Russian miner Norilsk has bought the Anglo American stake in Goldfields for $1.2bn. Saudi conglomerate Saudi Oger invested nearly $390m to acquire the third cellular license and establish Cell C.

In 1999 the foreign investment figures were pushed up by IT entrepreneur Mark Shuttleworth’s sale of his web site security software development company, Thawte, to US-based Verisign for $575m. This was somewhat of a distortion to the figures as Verisign bought the technology rather than invested in a South African entity. The figures were also distorted by the transaction under which De Beers was taken private by the Oppenheimer family, Botswana government, and Anglo American buyout – what flowed in flowed out again.

The country’s largest company Anglo American, now London-listed, is a foreign investor under the accounting definition. Last year, Anglo invested $1.7bn into an expansion of its platinum operations and this was reflected in the foreign investment figures, although prior to its London listing in 1998 this would not have been the case.

Hidden trends

The large amounts involved in these big deals overshadow the steadier flows of FDI into other areas which may actually point to far more significant trends. Investment into the vehicle assembly industry has enjoyed a steady rise. The country’s exports of cars has grown nine-fold since 1994 and more is to come. Capital expenditure more than doubled in 1996, grew steadily in the late 1990s, and is projected to rise by more than one-third this year. Over the next five years the National Association of Automobile Manufacturers of South Africa expects around $2.3bn in new investment.

The incentive behind the investment in the car industry has been the government’s Motor Industry Development Plan (MIDP) which links assemblers duty free imports to the amounts they export. This has encouraged larger economies of scale and forced concentration on fewer models.

The incentives have helped, but production in South Africa is not without its cost pressures. Car assemblers have a special deal with the country’s largest steel producer Iscor, but the parts manufacturers are only about to implement such an arrangement. Aluminum and plastics are still sold to the industry on an import parity basis.

As the government has yet to say what will replace the MIDP when it expires in 2012 there is a degree of uncertainty over the long-term future of the industry. In addition, China and India are increasingly attracting parts suppliers and assemblers.

Down to work

Another sector where there are positive prospects for investment is mining. The Foreign Investors Mining Association is bullish about changes in the law which vests mineral rights in the state. The Association believes that could free up ground for exploration and ultimately mining, that some companies may have been sitting on for decade.

Nevertheless they do have their worries about the degree of ministerial discretion in granting exploration and mining permission. And the association is seeking clarity on the issue of empowerment requirement in exploration ventures. For new ventures they do not believe the requirements for black participation present a problem as the levels of financing are not near those needed to enter into established ventures.

Investment calling

Call centres are another potential area for rising offshore investment. Lufthansa, Budget Insurance, Computer Science Corporation, and Dialogue Group have recently made investments in call centres and others are in the offing.

South Africans are far more culturally aligned with the US or UK than many other nationalities tend to be and have a better command of English. But there is the problem of cost of telephone calls. Calls centres pay a lower rate than normal business users, but it is still 10 times as expensive as India, for example, because the lower cost voice over IP is not permitted in South Africa.

South Africa has yet to enter a phase of self-sustaining enthusiasm among investors which creates a rush much like China is experiencing. The country needs far faster growth, but it also needs to reduce input costs for key materials like steel and communications and show at least some progress in fighting crime.

And above all investors have to see that the country is a base for a large growing and untapped market. That may all take time.