South Africa is encouraging investment through its National Industrial Participation programme. Stuart Theobald looks at the latest success story involving the supply of fighter jets.

The South African government has taken to a new tactic for attracting FDI: force it through procurement offset programmes. So far it has tied up $14bn-worth of economic activity, including the biggest offset package anywhere: a $8.7bn commitment from aircraft supplier BAE Systems and Saab. BAE is now one of South Africa’s biggest investors, with holdings in a long list of companies, including lumber mills, tyre factories, swimming pools and jewellery manufacturers.

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New reality

The two companies, which jointly produce Gripen aircraft, realised a new reality of business in South Africa. To do more than $10m-worth of business with the government or the companies it owns requires a commitment to the government’s National Industrial Participation Programme, which is an offset scheme that requires suppliers to facilitate general industrial development in the country. BAA Systems and Saab committed to the $8.7bn offset package so that they could supply $2.2bn-worth of fighter jets to the South African military.

Offsets are nothing new. They have been successful in developed countries, like Canada, and developing countries, like India and South Korea. But South Africa has taken them to new levels, broadening the type of economic participation and the quantum. Globally, offsets are most often a part of defence procurement packages. But offsets have been generated in South Africa through supplies to the national airline and telephone company. And the reciprocal economic activity is not just related to the domestic defence industry, as is the norm elsewhere, but to broader industrial activity. The BAE Systems/ Saab deal makes for the lion’s share of the $14bn in offset commitments that the South African government has secured to date.

“The purpose is to generate sustainable economic activity,” says Lionel October, a deputy director general of South Africa’s Department of Trade and Industry, who heads up the programme. “It’s using procurement to achieve other social and economic goals.”

Huge offset

Although the typical offset is 30% of the value of the deal with government, the defence contract was negotiated with a 400% offset. That was driven by the need to placate criticism of the government’s defence spending. Lobby groups still decry the need for South Africa to spend so aggressively on military equipment and some have strongly criticised the real economic value of the offset programme. But, so far, real tangible benefits have been delivered to the economy.

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Commitments

Of the $8.7bn commitment, $1.5bn is part of a defence participation programme, that requires BAE Systems to deliver $1.5bn-worth of activity to the South African defence industry. That is being achieved through a range of supply contracts that BAE/Saab has formed with South African producers. High-tech helmets developed in South Africa that allow jet pilots to direct missiles by looking at the target are now standard equipment with BAE/Saab’s Gripen fighter aircraft. The rear fuselage of the jets is also built in South Africa.

The second component is $7.2bn of commitments to broad industrial activity. On that score, BAE/Saab is involved in 27 projects, with another 30 on stream, says Bernard Collier, head of the National Industrial Participation (NIP) office of BAE Systems and Saab in Johannesburg. “We draw up a concept paper and fire it into the DTI asking: ‘Is this what you want us to do?’ They would come back and say yes. If government approves the concept paper, the offset office gets to work. Then a five-page business plan is submitted for analysis and final approval,” he says.

Mr Collier will not disclose the total value of projects so far but says they are on track to making the first $2.3bn benchmark by April 2004. The full $8.7bn has to be delivered by April 2011.

Offset points

The numbers look huge but the financial commitment by BAE/Saab need not be. The dollar value of the package is measured in offset points, which can be earned in more ways than just FDI. To earn points, a project has to satisfy three criteria: that the programme has caused the activity, that it adds to the industrial base of the country and that it is sustainable. For example, the NIP office recently invested R169m ($20.9m) with Citibank in a tyre manufacturing plant. The NIP’s commitment was a fraction of the total but without it the investment would never have happened. So the NIP earns points for the full R169m. In addition, any tyre sales made that are directly attributable to the investment earn additional points for the NIP.

Investment projects

In another project, the NIP invested R15m in a public swimming pool facility in the coastal city of Port Elizabeth. At the same time, using Saab in Sweden as a prime mover, it launched a tourism promotion campaign in Scandinavia. Now it can claim points for every Scandinavian tourist going through the province, using data collected by contracted Scandinavian tour operators. The swimming facilities are still owned by the city authorities.

Mr Collier estimates that the project has so far generated $6m-worth of activity in Port Elizabeth.

Another investment is a $3m-dollar grant to a university medical school to research an Aids treatment technique. Although highly experimental, if the research pans out, it could deliver a significant amount of economic activity.

The government has no problem with that type of leverage. “They would never spend on a project like that [Aids research] unless there was the prospect of big returns,” says Mr October. The defence offsets, though, are measured in direct revenue points without any multiplier.

Schemes like the swimming pool project are loss leaders for the NIP. But Mr Collier says they are not there to pay away an economic cost of doing business with government. “I have been given a budget and at the end of the process I have to give it back,” he says.

So most projects are real income earning investments, particularly in gold beneficiation, a strategic priority for the DTI. Also, using the rest of BAE/Saab’s infrastructure to procure goods from South Africa, from electricity generators to office furniture, contributes to the offset targets without any economic cost to the group.

The DTI closely monitors the NIP office. Each project submits six-monthly audited statements and only then are offset points accrued. Although it would be difficult for the government to stop BAE/Saab from walking away from the commitment,

Mr October says there is little risk of that happening. The government holds a $200m deposit from BAE/ Saab as security for its commitment. There is also major reputational risk of walking away from a project, he says: if BAE/Saab did so, they would never get business from South Africa again.

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