Selection Process of Strategic Defence Packages; Stockholdings in Department of Defence: public hearings

Meeting report

STANDING COMMITTEE ON PUBLIC ACCOUNTS
11 October 2000
SELECTION PROCESS OF THE STRATEGIC DEFENCE PACKAGES; STOCKHOLDINGS IN DEPARTMENT OF DEFENCE: HEARINGS

Relevant documents:
Auditor General's Report: Selection Process of the Strategic Defence Packages
Auditor General's Report: Stockholdings in Department of Defence
(note: you will need the Adobe Acrobat Reader for these reports)

Present:
Gavin Woods, Chair
Laloo Chiba
Andrew Feinstein
Nomvula Hlangwana
Graham McIntosh
John Gogotsha
Ntsiki Mashimbye
Thandi Modise, Chair, Portfolio Committee on Defence
Chippy Shaik, Director of Acquisitions
Jayendra Naidoo, Chief Negotiator of the Countertrade Packages
Sipho Thomo, Chief Executive Officer, Armscor
Shauket Fakie, Auditor General
Secretary of Defence Masilala
Judge Willem Heath
Ron Haywood, Chairman, Armscor
Lew Swann, former CEO of Armscor
Du Plessis, Treasury
Representatives of the SA Army, SA Air Force and SA Navy
British High Commission representative

Selection Process of the Strategic Defence Packages by Department of Defence
Woods: The Auditor General stresses importance of adherence to procedures. His report provides stark examples of how policies and procedures were not adhered to during the acquisition process. He recommends a forensic audit. We will not be availing of the Department of Defence (DoD) presentation: we are here to question the DoD.

Chiba: I will focus on three aspects: the cost of the defence package, the National Industrialisation Programme of the Department of Trade and Industry and the inadequacy of offset performance guarantees.

Cost of the defence package: In December 1999 the package was given as being R29.8 billion. But when it was signed it amounted to R33 billion. What do the additional costs represent?

Shaik: VAT, duties and Export Credit premiums. The DoD had not originally incorporated the ECA premiums.

Chiba: Your response is not acceptable. The answer of statutory costs is not correct. A flight simulator was bought for R900 million instead of the R787 million allocated for marine helicopters. I want total calculations to be resubmitted to this committee within seven days. What will be the total cash outflow for years 8 and 12?

Shaik: The foreign exchange rate was calculated at R6.25:US$1, but by December 1999 when the contracts were signed, the commitments were in Euros. Total costs are difficult to say because of foreign exchange fluctuations. The Minister of Finance contracted the financial aspects in March 2000.

Chiba: The rand/dollar rate was stable during that period. What will be the total outlay -- R50, R60 or R70 billion? Without such calculations, how could you motivate such purchases?

Shaik: That is the responsibility of the Department of Finance. We now calculate the costs at R46,5 billion at the year 2011. Financing arrangements are a matter between the Department of Finance and overseas banks. The finance costs are not included.

Chiba: Can we then expect the package to cost R55 or R60 billion? Furnish this committee with complete package costs within seven days.

Industrial Participation: The R29.8 billion package estimated the offsets at R110 billion, but the offsets were in fact reduced to R104 billion. Why?

Naidoo: The National Industrial Packages are intangible. Nowhere in the world would you get a 4:1 multiplier. We got over 2:1 The procedures were complex.

Chiba: Who were the parties involved in drawing up the agreements?

Naidoo: The negotiating teams were: Department of Defence, the technical committee; Department of Trade and Industry, National Industrial Participation programme; National Treasury, banks and Export Credit Guarantee Department.

Chiba: Submit copies of the agreements to this committee within 3/4 days with the contracts and figure work. Why were the performance guarantees not set at 10 percent of the offsets rather than 10 percent of the defence package?

Naidoo: The NIP policy originally required only 5 percent. The negotiating team concluded that 5 percent was inadequate to ensure the industrial participations. We doubled the performance guarantees to 10 percent, but the tender documents had only required 5 percent. It is not common practice for such performance guarantees to be linked to the offsets, which would then have become a disincentive to the suppliers.

Chiba: Was it such a feat to increase the guarantees from R1.5 billion to R3 billion? Can you assure us that 10 percent is adequate to ensure 100 percent delivery of the offsets? Obviously the lower the guarantee the greater the likelihood that the supplier would walk away. The nation of South Africa is being defrauded. Who evaluated the NIP? Did all bidders sign performance guarantees. Furnish full agreements to this committee. Were there non-costed options?

Shaik: After the Cabinet decided on the package, the negotiating team dealt with the suppliers as preferred bidders.

Feinstein: We as a committee don't deal with policy, but value for money for public funds. Why don't we spend most of our budgets on arms in order to leverage economic development? It doesn't make sense to me as an economist. International literature suggests these offsets are subsequently diluted or disappear, or the suppliers factor the penalties into the costs. Why should South Africa be different from international experience?

Shaik: Too much emphasis is being placed on suggestions that the DoD is acquiring equipment because of the countertrade.

Feinstein: The deal presented to Parliament is that R43.8 billion is being paid for armaments, a second fundamental factor being that we will receive massive economic benefits. We want surety that the economic benefits will be forthcoming.

Naidoo: It is a highly questionable proposition that offsets will generate economic development. Our exercise was to recoup some of the expenditure on the armaments approved by government. The acquisitions were not meant to generate a massive economic boom, but would be economically neutral. The defence industry works world-wide on the basis of offsets. If it failed to perform on its commitments, it would be unlikely to gain business elsewhere.

Feinstein: Of the R104 billion, only 10 percent of R30 billion(R3 billion) is guaranteeed. What monitoring programmes and enforcibility have been instituted? How can we legally bind a commitment? If the offsets are not going to be growth generating but economically neutral, what was the point of the offsets? We need the legally binding contracts, and we need to ask why the deal was not underplayed but instead emphasised that South Africa would gain R110 billion and create 65 000 jobs. Was Cabinet misled? On what basis was the Cabinet decision made?

Woods: We find the figures malleable and conditional, and that the agreements are fudged. How do you monitor the offsets?

Feinstein: The Auditor General has noted that the packages were negotiated before the Budget was provided. Did the tail wag the dog? What exit clauses apply between the prime and sub-contractors. The Auditor General indicates grey areas. The Department of Defence had very limited control over the selection processes. Is that so?

Shaik: The package was government to government with tenders provided by the respective embassies. There were government commitments to the pricing structures, and also government undertakings of responsibility to perform the offsets.

Feinstein: What controls were instituted by the DoD in terms of agreed procedures? What procedures were adopted in terms of potential conflicts of interest?

Shaik: We followed the Armscor precedent of the Pilatus acquisition programme. There was a Minister's committee, multi-departmental committee including Finance, the DoD, Department of Trade and Industry, Armscor and the branches of the SANDF. I admit that there was no formal declaration signed by individuals disclosing interests. This I concede was a weakness. There was just a verbal understanding regarding recussal in the event of conflicts of interest.

Feinstein: When did conflicts of interest occur? How many times did individuals admit conflicts of interest? Did the individuals have no further contact once they admitted conflicts of interest?

Shaik: I don't have the figures.

Feinstein: Was the Minister advised of the conflicts of interest?

Shaik: Yes. But the process doesn't permit individuals to influence the decisions. The rating system applies.

Woods: What influence did African Defence Systems have in the process?

Shaik: The German frigate consortium nominated ADS to handle the combat suites for the corvettes. Thomsons had to provide the guarantees and offsets. The Germans and ADS were given a list of prospective suppliers for sub-contracts. We know the capabilities of the sub-contractors. A risk evaluator was applied. The Germans then elected to use Thomson.

Woods: Did ADS receive money from the State?

Chiba: Thomson is the parent company of ADS. When did it become the parent?

Shaik: Altech sold 50 percent over a three year period.

Woods: What conflicts of interest applied with ADS directors.

Shaik: I have recused myself on the combat suites because my brother is a director of ADS.

Feinstein: What are the connections between Futuristic Business Systems and ADS?

Shaik: FBS is a supplier for R35 million in contracts for the helicopter package.

Feinstein: Did you declare your conflict of interest?

Shaik: The corvette programme is the only area in which I have a conflict of interest.

McIntosh: The Auditor General notes the Armscor tendering procedures. Did you comply with Armscor's procedures?

Shaik: Armscor makes provision to appoint individuals, but does not require advertisements in the Bulletin.

Thomo: At Armscor we have asked everyone to declare their interests in writing. I have no knowledge of anyone at Armscor who has a conflict of interest in the R30 billion acquisition process.

Woods: We want a list of people who signed the statement.

Howell: None of my naval people had a conflict of interest.

Naidoo: No one else declared any conflicts of interest, other than Chippy Shaik.

Swann: I had no conflicts of interest in the prime contractors, but since the acquisition decisions have become involved in BAe, the National Industrial Participation programme and the submarine consortium

Air Force rep.: No member of the Air Force has had conflicts of interest.

Kannemeyer: Paragraph 3.4 of the Auditor General's report regarding Ministry of Defence policy notes that a first-order value was not established.

Shaik: The first order value system was verbally communicated as part of risk management strategies. The inclination of package deals came from foreign governments which wished to link investment in South Africa with acquisition programmes. The proposals came from respective governments making unsolicited tenders.

Kannemeyer: The Alfa and LIFT projects had no staff requirements approved. Why that deviation?

Shaik: The DoD had planned for more expensive planes in a US$1 billion system. The staff requirement for the Upholder submarine project was transferred over to the German submarines. The corvette programme was started in 1980, but only approved in 1998. There were provisions made in the contracts that in the event of bribery, the contracts would be null and void.

Hlangwana: The SA Navy preferred a local company's integrated management system for the combat suites for the corvettes. Why was the French Thomson product chosen?

Shaik: The French system was chosen because of prohibitive risk systems with the South African system which would have nullified the whole effectiveness of the corvette package.

Hlangwana: Why, when South Africa had already paid for the development of the system, was it not required in the tender?

Shaik: The integrated management system is the "spine" of the combat suite, and it was too great a risk to use unproven South African technology. As far as the Navy preferring the system, this is factually incorrect. The technology belongs to the SA Navy, but the Navy had to freeze the technology and then test it. The technology is the nervous system of ships and radar. The risk was considered too high on a R30 million contract within the R6 billion corvette programme. A Cabinet committee instructed the tender process not to take that risk. Would the company be around in 30 years' time? The Chief of the Navy did not want to take that risk. The CEO of the local company accepts that his tender is technology at this stage rather than product. ADS and the German consortium were not prepared to take such risks.

Feinstein: I have a letter here signed by Captain Cummerman of the SA Navy that the c2i2 technology was preferred. This seems to contradict Mr Shaik's reply.

Cummerman: That letter must be put into a time frame. The combat suite was not tendered for by the German consortium, which was not prepared to take the risk of the South African technology. The SA Navy preferred the technical potential of the c2i2 product, but it was potential rather than proven.

Modise: Why did South Africa put money into c2i2 into its integrated management system, and then not use it?

Committee member: What offsets have been established since the contracts were signed?

Van Dyk: On the military side, I don't have information on the civilian side:
BAe/Saab R118 million
BAe Hawks 92 million
Agusta 1.6 million
Thomson --------
German Frigate Consort. 36.5 million
German submarines --------
R 248.9 million since April 2000

Haywood: Denel's joint ventures with the suppliers mean that Denel will break even financially next year and will become a major supplier in international markets. The British government has a representative at the Department of Trade and Industry to make sure that the offsets work, and another representative from DEXA. The offsets must be considered over a seven year period.

Gogotsha: These benefits are "chickenfeed" relative to the total package.

Woods: The Committee will assess the submissions it has received from the public and the reports it has called for from the Department of Defence, and will meet again on Monday October 30 to report to and make recommendations to Parliament.

Auditor General's Report on Stockholdings in Department of Defence
Department of Defence panel: Rear Admiral Visser, Chief of Logistics; Brigadier General Jack Grundling, Chief of Finance; Secretary of Defence Masilala

In October 1998 the former Standing Committee on Public Accounts had expressed grave concern about the excessively high levels of stockholding by the SANDF, estimated at R70 billion for the 1996/997 financial year.

The Auditor General reported stockholdings at R57.5 billion at 31 March 1999, and the report is highly critical of the Department of Defence's inventory-keeping and reporting procedures, which are based on a 1930 Treasury approval for stock administration. Accordingly, stock is accounted for by quantity rather than monetary value, and there is no policy on how stock should be valued within the DoD. The current estimates for DoD stocks are R98 billion.

Heated exchanges occurred between the Committee and the DoD representatives, Brigadier Jack Grundling, the Chief of SANDF Finance and Rear Admiral Visser, Chief of Logistics.

Visser: One needs to consider peace support operations, and stocks are still being considered within strategic arms requirements.

Grundling: I appeal to the Committee to consider the survival of the DoD during these transformation circumstances.

Woods: Your reply is unacceptable. You expect the Committee to swallow that you don't know what you are doing and that you are awaiting other people to tell you what to do.

Grundling: It is policy that we should be able to go to the DRC for peace support operations.

Woods: It is unacceptable to hold such stocks when social expenditures are unavailable.

Grundling: A lot of the old equipment is being donated to neighbouring countries to assist their development of democracy. Old equipment can be very useful to other countries.

Modise: Aren't you, Grundling, misrepresenting facts? I recall the policy and a defensive posture by government. You should be spending according to that force design. It is absolutely wrong to say that the DoD is being neglected. You are saying that if we don't give you what you want, you won't undertake government instructions. That you are holding too much stock is an illustration.

Masilala: We know where the SANDF is going. Force levels and designs are clearly understood. The reality is a gap between force design and government policy. We are expecting the Minister to instruct us on revisiting the Defence Review. We are doing everything in our power to rectify shortcomings.

Woods: There is no reason why you can't keep good records to look after your stocks. Purchasing stocks without knowing what you are doing whilst writing it off and giving it away….Recommendations will have to be tough. You have been fobbing us off.

Feinstein: Issues which have been raised for years have still not been addressed. What financial requirements are now being adhered to in respect of the Special Defence Account? When will the front organisation accounts be made available to the Auditor General? It has taken more than eighteen months to undertake an asset register.

Grundling: Control arrangements have been installed, except for two of these projects started in 1995/96. The person responsible for the irregularities has been identified, and the monies recovered.