Defence Industry in South Africa status and challenges: DOD, Armscor & South African Defence Industry briefing

Meeting report

ARMSCOR status and challenges

Mr Malusi Motimele, Deputy Chairperson: ARMSCOR Board, introduced the presentation by saying that the entity was on a path to self-sustainability which would require support though legislative guidelines from the Portfolio Committee, and that economic empowerment charters had been drafted to empower communities. 

Mr Sipho Mkwanazi, Group Executive: Acquisition and Supply Chain Management, ARMSCOR, said that the challenges faced by the corporation could be categorised into three sections.

Firstly, the reduction of the defence budget had led to an under-utilisation and loss of development expertise in the defence industry. There had been a loss of competitive edge by the industry due to a lack of new products in the market. There had been an increase in global competitiveness, but the reduced budget had disadvantaged the local industry from competing on a global scale. The impact of the budget reduction had affected the country’s sovereign strategic capabilities, which were facing unsustainability risks. Some smaller companies were facing insolvency due to the risk of unsustainability. Exports were suffering because requirements had to be sourced from foreign suppliers, which was costly. The cost of operating and maintaining imported systems was high. This had led to a decline in the local defence industry.

Mr Mkwanazi urged the Committee to be aware of the need for intervention to resolve the issues. He pointed out the difference in the operating and capital funding budget from the years 2015/16 to 2021/22, which had declined. In addition, the number of ARMSCOR projects had declined due to the budget cuts. 

Secondly, there were challenges in the tendering process due to a lack of understanding, mainly by the newly-appointed Defence Industry personnel, and a change in the legislation. ARMSCOR had been able to resolve internally some of the challenges which had resulted in an increase of no-bids and delays in contracting. He suggested that the Department of Defence’s allocated funds should be committed, to avoid roll-overs, and the money be redirected into other ventures. However, ARMSCOR had been working with the Defence Industry to improve the commitment of funds.

Lastly, there was the under-performance of the Defence Industry, which ARMSCOR attributed to the manufacturing phase, as many companies were beginners and were still improving their performance. This improvement process had caused delays in delivering goods and services, and cash flow disruptions within the Industry. 

Mr Mkwanazi classified the industry’s requirements into three categories, and named the key role players in each category:

• Research and Development -- ARMSCOR and the Council for Scientific and Industrial Research (CSIR);
• Manufacturing -- Denel, which had most of the order book in the industry; and
• Maintenance and Support -- Denel Group and the Defence Industry.

He described the impact that Denel, which was the main contractor, had on the Defence Industry. The current challenges it was facing affected the industry and was causing financial distress among small local companies. The DENEL group’s cash flow problems were the result of a lack of performance against capital projects, and a loss of technical capability and capacity. This had decreased its ability to meet the requirements of the South African National Defence Force (SANDF), and resulted in sub-contractors not being paid.

The delays in contracting by ARMSCOR were a result of failed bids by the Defence Industry. Spending should be increased to avoid left over money. Industry workshops had been implemented to address the challenges of delayed contracting, where small companies were trained on the tendering process, supplier days were organised to encourage engagements with suppliers, especially in designated areas, and complying requirements of the Department of Trade and Industry (DTI) were communicated.

Mr Mkwanazi said that ARMSCOR contracted late in the year because of the reduced Department of Defence expenditure and requirements. Local industries were penalized for exporting because there was a delay in contracting. The newly appointed Defence Industry had underestimated the Department’s requirements, which had led to an underestimation of the cost and time to carry out contracted requirements, contracting delays and financial challenges.

He described the sovereign and strategic companies and their ability to self-sustain, and the funding that should be allocated to the companies.

Mr Mkwanazi asked the Committee to consider the impact of the budget reduction on the loss of skills, the reduction of competitiveness of the local industry and the challenges faced by the SANDF --which included antique technology -- and the inability to maintain critical systems.

He suggested that DOD funding should be optimised to provide financial support. Government intervention should be obtained for funding companies and developing departmental initiatives. Alternative funding should be supported. Lastly, possible strategic initiatives should be considered, such as partnering with other industry players.     

Aerospace, Maritime and Defence Industries Association (AMD) on the Defence Industry

Mr Simphiwe Hamilton, AMD Executive Director, began by giving a brief background on the AMD and the scope of the organisation as a government industry. An analysis had been conducted to view the difference in the South African Defence Industry profile from 1989/1990 to 2017, which included a decrease in Defence Industry employees, and the jobs needed to be sustained because they were high- technological jobs. The defence industry had a multiplier effect, which resulted in the jobs creating more job opportunities. However, there had been a decline in the Defence Force’s acquisitions due to the budget cuts, and the number of companies in the Defence Industry had increased.

Mr Hamilton emphasized that South Africa had a capable Defense Industry, and that it was a necessity in the country. The exports from South Africa had increased compared to the expenditure. The Defence Industry was a beneficiary to some state-owned entities, therefore capitalising on the need for a stronger, well-maintained Defence Industry through the Defence Industry Council.

The Defence Industry impacted on national security, and ensured that there was strategic independence, a security of supply as well as cost saving through the sustainability of equipment. A good Defence Industry may possibly be useful for foreign policy by creating positive relations with other countries through the support and assistance of the armed and security forces. It may support government departments with equipment and services such as intelligence services, correctional services and home affairs.

The impact on the economy by the Defence Industry had resulted in quality jobs and the support of indirect jobs. Money had been retained within the country by importing less, there had been an increase in skills development in scarce skills areas, andtechnology development through innovation.

Mr Hamilton highlighted the challenges of the Defence Industry in relation to the policy frameworks. These were the National Conventional Arms Control Act (NCACA), the Non- Proliferation Act, the Firearms Control Act and the Explosives Act. The policy frameworks include the irregularity and unpredictability of Cabinet Committee meetings, as well the processing of applications and the issuance of permits.

The Portfolio Committee should consider inviting the National Defence Industry Council (NDIC) to motivate the progress and significance of the Council. A strategy was drafted with the NDIC, but the Defence Review did not have a budget allocated by the DOD. Furthermore, the challenges faced by Denel had affected the course of the completion of the implementation. A public strategy would be issued by the NDIC in a month.

Mr Hamilton said that a Defence Industry Fund had been registered, in collaboration with ARMSCOR, that would be funded through private investments at R1.5 bn in the following year. Funds would be allocated to small, medium and micro enterprises (SMMEs). The industry had attempted to resolve some of the challenges faced. The black economic empowerment (BEE) charter was a third attempt, which was concerning, because the previous attempts had failed.

A resource-based alternative funding model had been submitted to the National Treasury by the NDIC for consideration. The first programme for the model would include Zambia purchasing equipment from South Africa, which would retain resources within the African continent.

Designations and localisations had been approved by the NDIC for small arms ammunition and weapons, but additional designations would be requested. Other initiatives include a drive for exports which would impact on South Africa’s revenues, and promoting women in the defence sector to increase their involvement in the industry. The Defence Industry had also participated in a public-private growth initiative, which placed the industry in a top position, along with other industries.

The Defence Industry would be participating in the Fourth Industrial Revolution Commission. Short-term projects had been planned by the industry.

Possible designations for consideration by the industry would include command and control, communication, cyber intelligence, optical radar and electronic surveillance systems, personal protective equipment, unmanned vehicles and patrol vehicles in rural areas. There was no need to import everything.

Mr Hamilton queried the extent to which the research conducted in the defence environment had been successfully industrialised, and stressed the importance of research and development.

He concluded by asking the Committee to encourage the Department of Defence to review the Arms Control Act so that improvements were enforced, and for the Chairperson to engage with other committees about the revision of the act.

Discussion

Mr J Maake (ANC) thanked the presenters for being honest and providing solutions to the challenges that had been mentioned, and asked whether the purpose of the presentations had been to prove the incompetence of the Committee. The problems were quite evident in the Department, and there should be a will to resolve the issues. He had an issue with the industry portraying the Committee as not doing anything about the challenges it faced, but added that the lack of support for local products and services was an issue.

Mr S Marais (DA) said that the presentations had been informative for the Committee, and acknowledged the issues that had been raised. He asked what the economic impact of the government’s funding restrictions had been, and whether an exercise had been done by the industry on what the government would have gained or lost. He said there should not be an expectation to withdraw money from other departments to assist the Defence Industry, but there should rather be better alternatives for funding.

He asked whether the Defence Industry had been involved in the investment summit that took place recently, and requested feedback from the Treasury about the resource-based alternative funding Model. He wanted to know how the Committee could assist in liaising for the funding.

With regard to the ARMSCOR presentation, he said that there was never an opportunity to interact with Denel, considering the massive role the organisation plays. The interaction between Denel and the Defence Industry was emphasized. There should be rationalisation and reprioritisation in order to sustain small companies. He asked for the real reasons of the failed bids by the Defence Industry, and how they could possibly have been prevented.

Mr Marais asked how public funding institutions such as the Development Bank of Southern Africa (DBSA) had been involved and utilised by the Defence Industry for alternative funding, and how the Committee could assist with liaising. Hr agreed that the issue with End-User Certificate (EUC) permits was a real challenge for the Defence Industry, and was often misunderstood. There had to be negotiations or compromise.

Ms. A Beukes (ANC) asked when the ARMSCOR industry workshops had started, and the tool used to measure the effectiveness of the workshops. She said the impact of the declining budget should not be ignored, but rather analysed, monitored and evaluated. The Committee should look into promoting cooperative governance amongst the government departments. 

Mr T Mmutle (ANC) applauded the presentations for being honest and truly reflecting the challenges faced by the Defence Industry. He referred to the budget constraints, and emphasised that the Department wanted to grow the economy, and questioned whether the regulations prevented growth and investments. There should be a will to engage with decision makers to solve challenges, instead of moving forward without feasible solutions.

Mr Mmutle commented that the employment figures in the AMD presentation were not a good representation because there had been a sharp decline in jobs, and he asked for clarification on the status of employment. The figures giving the number of increased exports and decreased jobs were contradictory -- increased exports should result in increased job creation. He asked for feedback on the role of transformation played by the 72 companies, and whether new companies involved in the industry were involved in the transformation. He stressed that redressing historical imbalances affected youth and gender should be a priority, and would assist the Committee to determine whether the country was moving in the right direction.

The Chairperson welcomed the responses to the questions asked by committee members. And asked if the Denel Chief Operations Officer, Mr William Hlakoane, would like to answer some of the questions on behalf of Denel. 

Responses

AMD: Defence Industry

Mr Hamilton acknowledged that the poor decisions made by the Defence Industry had impacted on other areas of the economy. He insisted the need for funds to be taken from other departments was vital for the functioning of all government departments. There were international deployments which were funded through the operational budget, and this had had an impact on the overall budget of the Defence Industry. The Committee had to find a way to prevent the Special Defence Account (SDA) from collapsing as a tool for financial management.

The Chairperson responded that the SDA was affected by the declining budget. The Committee was aware of the impact this had, because the issue had been discussed.

Mr Hamilton accepted the Chairperson’s response.

Mr Hamilton said that the EUC had issued one verification, and one country had been inspected throughout the export period. The Defence Industry wanted to save money on an inspection that may not happen.

Regarding the economic impact on SARS, the R2.3 bn had been a contribution into the fiscus by the Defence Industry. An analysis had not been done by the industry, and other tax categories were not included in the R2.3 bn.

Mr Marais requested that the industry provide feedback on the analysis once it had been done.

Mr Hamilton said that the Defence Industry had not beeninvolved in the investment summit, which was a deliberate decision by the Defence Industry. With regard to rationalisation and reprioritisation to promote sustainability, some events would occur naturally, and some would occur with guidance from the political structures, because the Defence Industry had no view of the Department’s planning.

He commented on the contradiction of increased exports and decreased jobs, and explained that the Defence Industry sector was not labour intensive. Increases in exports were based on the nature of the sector, not labour productivity.

He admitted that the Defence Industry was the least transformed sector in the South African economy, and that transformation could be driven through the BEE charter once it was overseen by the DOD. Feedback and figures would be provided to the Committee at a later stage.

Denel 

Mr William Hlakoane, Chief Operating Officer (COO): Denel, commented on the exit of Denel from the Airbus A400M work. He said it was because of the budget cuts and predicted losses that the company had decided to exit, in order to remain liquid. This had been done by cutting jobs and redeploying workers within the organisation.  

ARMSCOR

Adv Solomzi Mbada, Acting Chief Executive Officer (CEO): ARMSCOR, said that there was a delay in a contract to deliver services mainly because of the budget decline. He asked the Committee whether organisation should continue with delivering the services, because there was a 24-month delay. or if there should be an alternative. The decision should not be delayed, but should be made as soon as possible. The failed bids issue had been about non-compliance with clearance certificates. The lack of support from the industry, as well as poor performing ARMSCOR staff, may have contributed to the issue of non-compliance. He also mentioned that the industry workshops had not been implemented, but there were plans to implement them soon. The workshops would allow the industry to support companies in resolving prevalent issues.  

Mr Mkhwanazi said there were ten SOEs operating in the industry, mainly operating under Denel, and the two examples of the force multiplier technologies included border control radar and an Unmanned Aerial Vehicle (UAV) to monitor areas. There was an industry day held once a year, which involved engagements with small companies and veterans, creating networking spaces between small and large companies. There had been improvements over previous industry days, with the participation of small companies increasing as a result of the workshops. Companies were getting recurring orders instead of once-off orders.     

Mr Marais asked which enterprises were in crisis, as they should have been highlighted in the presentation so that the Committee could assist where necessary.

The Chairperson said that the presentations should have included one by the NDIC, because it was a critical body in decision-making. Some of the solutions to the challenges should have been presented to the NDIC, and there would have been progress in resolving the issues. He would request a presentation from the NDIC. The National Arms Control Commission (NACC) was also a critical administrative body in acquiring an EUC. The acquisition plan of the DOD was affected when the Defence Industry also failed to submit the acquisition plan. Denel should present a turnaround strategy for resolving the issues. Denel, the NACC and the NDIC should present to the Committee as soon as possible.

Mr Maake requested that a list of expected events be provided to the Committee. There had been no mention of local conferences and investments in the presentations. He also asked why the End User Certificate (EUC) was provided at the end of the project, instead of the beginning.  

Mr Trevor Mketi, Director: Industry Support and NDIC Secretariat, DOD, said the NDIC had done its best to resolve the issues. The EUC was not a UN requirement, but was how the requirement was drafted by South Africa. There would be a NDIC meeting to endorse the DOD strategy to resolve the challenges.   

Mr Mmutle suggested that Denel should be relocated from operating under ARMSCOR, back to the DOD. He enquired about Denel’s progress in resolving its challenges and how effective it was while operating under ARMSCOR. Where would Denel be more effective?

Mr Mketi said that Denel would not be facing the challenges it was facing currently if it reported to the DOD. He said the company was becoming expensive to maintain.

The Chairperson said ARMSCOR’s requests would be discussed with the NDIC, and engagement with other critical bodies regarding the performance of the sector would be scheduled.

The meeting was adjourned.