SAA Unallocatable Debt Bill: hearings

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Finance Standing Committee

10 February 2000
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Meeting report

FINANCE PORTFOLIO COMMITTEE

FINANCE PORTFOLIO COMMITTEE
11 February 2000
SOUTH AFRICAN AIRWAYS UNALLOCATABLE DEBT BILL: HEARINGS

Documents Handed Out:
COSATU Submission on the South African Airways Unallocatable Debt Bill (attached to end of these minutes)
Report on Non-Profit Organisations (email info@pmg.org.za for this document)

SUMMARY
The committee unanimously passed the Report on Non-Profit Organisations, with the agreed upon amendments. Discussion centered on the role of the South African Revenue Services (SARS) in relation to Non-Profit Organisations (NPOs).

COSATU made a submission to the committee on the South African Airways Unallocatable Debt Bill. They stressed concerns over the questionable use of public resources, the further privatisation of SAA, an increased debt load, and the lack of a clear economic basis for the proposal.

Questions were then put to COSATU over the validity of their claims. It became evident that the committee required more information on the fiscal issues of the Bill. It was agreed that discussions would be postponed until the Department of Finance could submit to the committee the cost-benefit analysis report for review.

MINUTES
Report on Non-Profit Organisations
The committee finalised amendments to the draft report. Some of the more notable amendments include the following:
Defining Characteristics of Tax-exempt Organisations
6.1.3(i) This proposal was generally supported however, the Department of Finance was not in favour of the Minister being granted the power to determine further benefit categories.

The committee believed it was necessary to limit the Minister's scope in prescribing further categories of exempt public-benefit organisations.

6.1.3(vi) This matter should best be dealt with as a governance issue in terms of the Non-Profit Organisations Act, without removing the right of the Revenue Services to take action where they believe tax evasion or other related tax irregularity has taken place.

Estate Duty:
6.3 The Portfolio Committee endorses the principle of this approach, but is concerned about additional categories of Non Profit Organisation's over and above those already identified.

It was unanimously agreed to adopt the Report with the proposed amendments.

Discussion:
Regarding 6.1.3(vi), a member asked for clarity on the term 'governance issue.'
Ms Hogan stated that it was necessary to use this as it encompasses all general policy issues relating to the NGO sector. Secondly, the Chair felt that it was inconceivable for SARS to police NGOs, as they lacked the expertise and insight to understand the finances of NGOs. Ms Hogan concluded that whatever was not included in this report would more than likely be covered in the Non-Profit Organisation Act.

Dr Woods (IFP) asked if the obligation for NGOs to spend a minimum of 75% of their net revenue that accrued in the previous tax year was too generous? The Chair felt that the committee had to consider the need for NGOs to be self-sustaining. Ms Hogan argued that NGOs deal in the Medium Term Expenditure Framework (MTEF) in terms of funding, and expecting them to deal on a per year budget would be problematic. Dr Davies (ANC) added that 75% was not generous as NGOs require leeway since they need to retain a pool of money.

COSATU submission on South African Airways Unallocatable Debt Bill
COSATU raised concerns over the implications of the South African Airways Unallocatable Debt Bill. Some of the major issues included the following:
1.That this Bill is a pilot project, and will expand to other Transnet subsidiaries with even higher debt burdens.
2. That the Government's intention to further privatise SAA is illogical in that it will allow foreign companies to benefit from future profits, instead of retaining public ownership and using the profits to cross-subsidise mass forms of transport and other basic needs.
3. The money allocated to this Bill could be better spent on social services ensuring that basic needs are met.
4. That this is another example of Government rapidly pursuing economic policies at the expense of achieving higher levels of delivery and employment creation.
5. That the future revenue gains arising from further privatisation of SAA would not recover the massive outlay proposed in the Bill.
6. That this is a venture which primarily serves business and the wealthy.

Among others options, COSATU called for a review of the revenue-sharing formula between government and Transnet for the proceeds of privatisation, and that there be a review of Transnet's financial situation.

Discussion:
Dr Woods (IFP) stated that COSATU neglected to consider fundamental issues. First, the monies received from the sale of any part of SAA by the State will be heavily influenced by the debt-burden of the entity. Second, the State has100% ownership of Transnet, and so the R4.057 billion debt has always existed within the State, and thirdly, that the State would get either cash or assets from any of SAA's present profits. This includes approximately R500 million in assets, and R610 million as part of the burden-sharing arrangement, which will on receipt be paid into the National Revenue Fund.

In response to these criticisms, COSATU representatives stressed that the calculations stated by Dr Woods were not exact. They argued that even with the R610 million from the sale of 20% of SAA, for the proposed burden-sharing arrangement to make financial sense, the government would need to receive a premium price on the future sale of a 20% share which would be unrealistic.

Dr Davies (ANC) dismissed COSATU's claim that privatisation of SAA is a cash-cow. He stated that to make SAA attractive, investments will be needed, and the debt must be taken care of, but that no one knew if there would be future sales of SAA assets. He also added that the committee needed expert input to better understand the validity of this transfer as an economic business proposal.

COSATU representatives replied there needed to be a regulated structure for state-debt restructuring, a framework to deal with the restructuring of assets, and guidelines and procedures for consultation to be established for the Government to follow.

Ms Hogan asked Mr Mafele from the Department of Defence to explain the "debt swap".

Mr Mafele stated that SAA had debts of R4.057 billion. Of this R1.33 billion had been allocated, leaving approximately R3 billion which was taken over by Transnet. The proposal is that Transnet should be alleviated of the debt by R1.33 billion. The Government will then take over the R1.33 billion debt, and Transnet will receive a liquid government bond for the same amount. He stated that the debt is already funded in Transnet's books so there is not a need to secure a loan. He further added that a cost benefit analysis had been done prior to the arrangements being agreed to. He concluded that there is no obligation placed on SAA to repay the debt.

Several members raised concern that they did not have enough information pertaining to the financial aspects of the Bill. It was agreed that discussions would be postponed until the Department of Finance could submit to the committee the cost-benefit analysis for review. It was expected the report would be available 14 February 2000.

Appendix 1:
COSATU SUBMISSION ON THE SOUTH AFRICAN AIRWAYS UNALLOCATABLE DEBT BILL [B1-2000]

1. Introduction

COSATU appreciates the opportunity to address the Portfolio Committee on Finance ("the Committee") on the South African Airways Unallocatable Debt Bill ("the Bill"). The strategic significance of this Bill goes beyond its stated content. Its importance for us relates also to its links to the state asset restructuring principles and process, to the question of optimising the use of public funds, and in terms of the consistency of government economic policy. COSATU believes that the Bill draws attention to tensions within government policy which we would like to raise with the Committee. It also raises concerns around precedent for future transactions.

The Bill essentially empowers government to borrow R1.333 billion (+ debt servicing costs) to absorb part of SAA's debt, apparently in anticipation of further privatisation of SAA. This amounts to a use of public funds in subsidising an entity which will subsequently be (at least partially) sold off into private hands. This throws up several major concerns for COSATU, including the questionable use of public resources, the anomaly of subsidising SAA while it is apparently enjoying unprecedented financial success, and the contradiction of government borrowing money in a way that contradicts stated policy. Our objections to the Bill, both principled and pragmatic, will be spelt out in the course of this submission.

We approach this issue within the context of a stated intention from the Ministry of Public Enterprises that the major restructuring focus this year will be on Transnet. The Minister has also indicated that a ground-breaking announcement will be made within the next few weeks around the restructuring of Transnet's debt. As COSATU we are concerned that the Bill under discussion today may be a "pilot" for similar burden sharing of other Transnet subsidiaries, which in fact have even higher debt burdens than does SAA. We call on the Committee, together with the Portfolio Committee on Public Enterprises, to ensure that there is adequate public debate and input into transactions which involve such huge amounts of public resources. Should similar arrangements be contemplated for Transnet and its other subsidiaries, many of the concerns which we are raising today will also apply.

The sharing of Transnet's debt is a complex and technical issue. It is related to various other matters, including pensions, macroeconomic parameters, and privatisation. COSATU recognises that the debt burden of Transnet attributable to its various subsidiaries is indeed a serious problem which needs to be addressed. It also needs to be acknowledged that at least some of SAA's debt burden is a historical legacy of mismanagement and imprudence, which unfortunately now has to be dealt with. Like the Committee, we do not have all the facts and background on SAA's "unallocatable debt" or about the feasibility of alternatives at our disposal. The explanations contained in the Bill and in the Department of Finance's briefing to this Committee however leave a number of unanswered questions around the necessity and advisability of government taking on this R1.333 billion burden.

The background process to the proposed arrangement has been less than desirable, and the Department's explanations of the delay are frankly unconvincing. Parliament is now put in the awkward position of being asked to assent to what is basically a "done deal" of the Inter-Ministerial Cabinet Committee and involving the government, SAA and Transnet. While Transnet is holding government's agreed portion of the debt, the debt burden has to all intents and purposes already been shared and this Bill is merely to ratify the arrangement. It would have been desirable for parliament to have been meaningfully involved at an earlier stage; and we hope that this is not a precedent-setting process for future transactions.

We feel that it is necessary for us to state upfront the historical involvement of one of our affiliates in the issue of Transnet's debt burden. Shortly before the democratic transition, the management of what was then SATS put pressure on what was then the South African Railways and Harbours Workers' Union (SARHWU) to support an arrangement whereby the government would assume responsibility for SATS's debt burden. This debt burden was presented by management as being the cause of retrenchments of workers and the obstacle to wage increases. SARHWU thus took a defensive position and supported the taking over of SATS's debt by government. Notwithstanding this, COSATU as a Federation has taken a principled opposition to the arrangement proposed in the Bill as we will elaborate in the course of this submission.

2. COSATU's concerns with the Bill
2.1 The privatisation of SAA
The absorption of part of SAA's debt burden by government cannot be looked at in isolation of the privatisation process. In its briefing to this Committee, the Department of Finance explicitly motivated the proposed burden-sharing arrangement in terms of enhancing the attractiveness of SAA to future buyers. If there was no intention to further privatise SAA, the arguments of the Department of Finance suggest that the debt burden would still be a problem but its resolution would certainly not be as urgent and would arguably have been a different one.

A characterisation of SAA is important in informing an approach to its privatisation. Unlike most public enterprises, it does not primarily meet the "basic needs" of the population. The client base served by SAA consists mainly of the corporate sector (particularly established and reasonably successful businesses) and upper-class individuals. In fact, only a minority of South Africans will ever set foot on an aircraft. Notwithstanding this, we are also cognisant of the fact that an efficient and cost-effective national airline is important for the country's economic growth and for an enabling business environment (particularly in a geographically dispersed country such as South Africa), as well as for promoting the tourism and hospitality industry.

Given the client base of an airline, considerations such as affordability can be somewhat less paramount than in the case of an entity geared towards the meeting of basic needs, such as roads and railways, electricity, or basic telecommunications. In a situation where an airline is able to turn in profits, these profits can be used to boost the fiscus and to cross-subsidise the provision of other services by the state. Whilst an airline may thus not fall into a narrow definition of the "core business" of the state, it is still in the broader sense a strategic sector and a rational case can still be made for retaining state ownership. It is from this perspective that COSATU is concerned around a suggestion of further privatisation of SAA.

2.2 Privatisation and debt
One of the central rationales presented by government for privatisation as a whole has been the reduction of South Africa's debt. In this context it is strange that further borrowing is now required to improve the position of a public enterprise in anticipation of further privatisation. It can be noted that the government's receipts from the privatisation of SAA thusfar (R610 million from the Swissair sale) is less than half the amount which it is being required to contribute through this Bill.

Furthermore, if SAA is realising substantial profits as well as having its debt burden alleviated through the proposed arrangement, what is the rationale for further privatisation? Even if a case could be made for restructuring of a consistently loss-making entity where such an entity is not responsible for the meeting of basic needs, in a situation where an entity is in an apparently healthy financial situation it seems illogical to sell it off and allow the private sector, particularly foreign companies, to benefit from future profit flows. The fact that the private sector is willing to pay substantial amounts (R1.4 billion in the case of Swissair's 20% equity stake in SAA) is indicative of their confidence in its future profits, even at the stage when SAA was running at a loss. Why not retain public ownership of SAA and use these profits to cross-subsidise mass forms of transport and other basic needs?

A further issue related to privatisation initiatives of SAA is the division of the revenue flows generated from such transactions. The receipt and apportionment of income from SAA's privatisation and the sharing of SAA's debt burden are two separate transactions. There is no necessary reason why the income and debt burden should be apportioned in the same ratios. An optimal situation would be where the minimum sufficient income for SAA's viability is ploughed back into it with the state gaining the remainder for social and capital spending.

An analogous situation at an individual level would be if I owned a shop which is doing badly and is heavily in debt to mashonisas. I borrow money on more favourable terms to repay the shop's debt, as well as repainting and refurbishing the shop, upgrading my employees' training, advertising the shop and improving its image amongst my customers, and buying new shop equipment and stocks. The shop becomes a local success story, relieved of its debt and turning in healthy monthly profits. At this point I sell the shop to someone else, getting only a once-off payment and leaving the buyer to enjoy the shop's future profits while I remain with the debt to repay.

Finally, it is needs to be borne in mind that SAA has been built up over the years with the investment of huge state subsidies. SAA is a national asset and privatising it in its time of apparent success is truly a case of "selling off the family silver".

2.3 An inappropriate use of public resources
The Committee is obviously familiar with the scarcity of available public resources to meet basic needs, and the many demands on the fiscus which are not being met. In many areas of social spending allocated expenditure is inadequate to deal with the constantly growing needs let alone to eliminate the massive backlogs. In this context the opportunity cost of such substantial state expenditure as proposed in the Bill - where such expenditure is debt-financed - needs to be rigorously interrogated.

COSATU would like to pose a question as to who the beneficiaries of the proposed burden-sharing arrangement will be. Will it be SAA clients, government, future purchasers of a stake in SAA? As pointed out by one of the Committee members in the briefing session on the Bill, were a part of SAA's debt burden not being absorbed by the state, one of the alternatives would presumably be for this burden to be absorbed by SAA operationally, for example by increasing its tariff fares. This needs to be considered in the context of SAA's affluent client base as characterised above.

It seems particularly anomalous for public funds to be used in this way in the context of the crisis in ground transport in South Africa - the high costs borne by commuters (which contributes heavily to the cost of living and working for the poorest South Africans in particular), the abysmal safety record, and so on. The proposed arrangement could be interpreted as cross-subsidisation - but in the wrong direction. Whereas SAA should be generating profits to subsidise mass public transport, in fact the reverse is happening. The fact that Transnet as a whole has taken over some of the debt suggests some cross-subsidisation from the less profitable mass transport subsidiaries to SAA.

As announced this week, SAA expects to realise an operating profit of R573 million for the year ending 31 March. We also note that an announcement is due within the next day or two on SAA's purchase of between 20 and 25 new aircraft worth about R4.3 billion. The profitable state of SAA only heightens the incongruity of using public funds to alleviate its debt burden. Why pour public funds into "bailing out" a profit-yielding enterprise? It is not clear whether the option of using current and future profit flows to repay SAA's debt has been sufficiently explored. In saying this we remain cognisant of the need for investment in improved SAA capacity, recapitalisation, and so on.

2.4 Tensions in government economic policy
One of the central thrusts of government's economic policy has been rapid debt and deficit reduction. Government has relentlessly pursued these targets at the expense of achieving higher levels of delivery and employment creation. As we have argued before this committee in the past, this pursuit of abstract fiscal targets over and above the pursuit of social objectives has come at significant costs in foregone social and capital spending. We thus find it surprising that government chooses to borrow R1.333 billion for the purposes proposed in the Bill. This amount, together with the money spent on the arms procurement deal, will obviously have an effect on debt ratios. The message that this sends out, rightly or wrongly, is that where there is a political will to borrow money this is indeed possible.

A few comparisons are indicative of the magnitude of the amount which the Bill mandates the Minister of Finance to borrow. The amount of R1.333 billion is in the region of the Department of Foreign Affairs's entire annual budget and is in the region of half of the entire budget of departments such as Justice, Trade and Industry or Public Works, or of the equitable share of the Northern Cape province. It exceeds the R1 billion allocation for poverty relief and job creation and is almost triple the amount in contention in the ongoing public sector dispute. As will be demonstrated below, if debt servicing costs of the R1.333 billion are added on, the amount in question obviously becomes substantially larger. Given our experience of government's past fiscal choices, we have reason to be concerned that this expenditure will "squeeze out" other items.

2.5 Economic rationale
The concerns raised in points 2.1 to 2.4 above are on issues on principle, where COSATU differs with the choices made by government. We also have concerns with the proposed arrangement on grounds of pure "economic logic". As pointed out by Committee members during the Department's briefing, there is no guarantee that future revenue gains arising from further privatisation of SAA would recover the massive outlay being proposed in the Bill, let alone generating positive net revenue for government.

Indicative projections of the likely interest payments on the R1.333 borrowing illustrate their possible magnitude. Were government to issue a 10 year bond for the R1.333 billion amount, the total interest paid over this period would be in the order of R1.103 billion. Were a 15 year bond to be issued the equivalent figure would be R1.782 billion, and R2.530 billion in the case of a 20 year bond. These projections make the assumption of a 13.5% interest rate. The inclusion of interest costs would clearly hugely inflate the real cost of the proposed arrangement.

Some simple hypothetical calculations call into question the financial prudence of the proposed transaction. Given the R610 million received by government for the first 20% sale of SAA, one could make a conservative projection (not taking into account the improved profitability since then) of receipt by government of at least this in the event of a further 20% sale. For the proposed burden-sharing arrangement to make financial sense, government would need to anticipate a premium on such a sale of a further R1.333 billion to recover the proposed outlay. This translates into a price tag of at least R2 billion for the next part of SAA to be sold. Has the work been done to provide the Committee with an indication that this is a realistic expectation?

The lack of a clear economic basis for the proposed arrangement suggests that its basis is ideological rather than economic logic. There appears to be a growing desire to corporatise and privatise for the sake of it irrespective of whether such policies make sense and of what their likely consequences may be. To attract investors at all costs, regardless of the impact on public policy, public resources, or the tax payer.

3. Conclusion and Recommendations
COSATU's objections to the proposed burden-sharing arrangement are both principled and pragmatic. We object to the use of scarce public funds for an entity which serves primarily business and the wealthy, and which is for that matter currently turning in
large profits. We object furthermore to the use of public funds being guided by a seemingly ideological commitment to privatisation. Instead of privatisation reducing government debt, government is borrowing in order to prime public enterprises for sale. This amounts to taxpayers subsidising privatisation and the future profit flows for private investors. Over and above these principled objections, COSATU finds the proposed arrangement irrational from a purely economic point of view. Under the proposed arrangement, government would be laying out a huge amount of borrowed capital with uncertain returns. The state will end up without SAA's assets, carrying a huge debt burden, and with an uncertain amount of privatisation revenue. It is ironic that the Department of Finance is promoting and rewarding fiscal indiscipline amongst public enterprises.

For the above reasons, COSATU objects to the burden-sharing proposals contained in the Bill. Our proposal is that the Minister of Finance not be mandated to borrow R1.333 billion for the proposed purposes, and that alternatives be found to deal with Transnet's debt which do not involve the transfer of public funds.

Should the Committee feel that outright rejection of the proposed arrangement is not feasible within current conditions, an alternative option would be for government to provide the amount requested as a long-term loan to Transnet rather than as a straight transfer. This could enable SAA to get out of the difficulties it is apparently currently experiencing, without an absolute drain on the fiscus. Such an arrangement would also take advantage of the relative affordability of the finance available to government as compared to Transnet and SAA. If necessary such a loan could be on very favourable terms such as being low-interest or even interest-free. Such an option could be accompanied by explicit conditionalities relating to the division of future revenue flows, the business and labour practices of SAA and so on - using loan financing to incentivise desirable behaviour from SAA.

Over and above these options, COSATU calls for a review of the revenue-sharing formula between government and Transnet for the proceeds of privatisation. As discussed above, there is no necessary reason as to why the ratios of the division of privatisation revenue and the burden-sharing formula need to be the same. Rather than an arbitrary division of revenue, there needs to be an independent assessment of the minimum injections needed for SAA to remain viable and the remainder of privatisation revenue should go to the state coffers to fund improved delivery.

A further proposal which COSATU would like to table here is for an independent review of Transnet's financial situation. There appears to be a lack of clarity as to the exact problems, their causes and possible solutions. Our affiliates which are directly engaged with Transnet have also complained about the opaqueness of Transnet's financial affairs. Both the process and content of this very Bill could be seen as symptomatic of these problems. We would thus like to see a process involving the Portfolio Committees on Finance, Transport and Public Enterprises aimed at unravelling this complex state of affairs and at avoiding problematic and ad hoc requests for money as is contained in the Bill. Such an enquiry could pay special attention to the debt-sharing arrangement proposed in the Bill in terms of its justifiability, implications and so on, as well as formulating pro-active proposals for the restructuring of the rest of Transnet's debt.



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