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PPPs key to achieving economic growth

PPPs key to achieving economic growth

It is well documented that one of the key constraints to economic growth in Africa is the lack of adequate and well-maintained infrastructure. The same holds true for South Africa.

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In the 2017 Budget Review, then Director-General of National Treasury, Lungisa Fuzile, in his Foreword , acknowledged that Government is constantly challenged by how to use its investments to promote economic growth, deepen transformation and revitalise private-sector investment and he affirmed that National Treasury would continue to partner with the private sector to build infrastructure, create jobs and develop skills.

Underscoring the importance of infrastructure to economic growth in South Africa, an entire chapter in the Budget Review is usually dedicated to Public Sector Infrastructure updates and, in 2017, the Budget Review also contained a chapter on Public-Private Partnerships (PPPs) in South Africa.

In the latter chapter, a PPP is defined as “a contract between a public-sector institution and a private party, where the private party performs a function that is usually provided by the public-sector and/or uses state property in terms of the PPP agreement. Most of the project risk (technical, financial and operational) is transferred to the private party. The public sector pays for a full set of services, including new infrastructure, maintenance and facilities management, through monthly or annual payments”.

According to the 2017 Budget Review, of the total number of major infrastructure projects under way, most of the projects are publicly funded, whilst a few like the Renewable Energy Independent Power Producer Procurement Programme, are funded by the private sector. The outlook for expenditure on PPPs, according to the 2017 Budget Review, is that they are expected to increase from R4.8 billion in 2016/17 to R5.9 billion in 2019/20.

The success of PPPs in South Africa is critical to achieving the GDP growth target set by National Treasury of 2 per cent by 2020 . In 2015, the World Bank commissioned a benchmarking study “The 2015 Infrascope” carried out by the Economist Intelligence Unit that evaluated the capacity of African countries to implement sustainable and efficient PPPs. South Africa scored highest overall in all but one category (which is touched on below). Factors favouring South Africa, versus its peers on the African continent, is that it has PPP-specific laws and policies, sufficient financial market depth to fully enable PPP financing and National Treasury as an established central unit coordinating and approving PPPs. However, the following in particular need to be addressed in order for PPPs to flourish and produce sustainable economic growth:

Policy certainty and commitment

In the 2015 Infrascope Report, South Africa was placed one before last out of 15 African countries in the category of Investment Climate. The Report noted that the South African Government, while broadly supportive of PPPs, especially in the renewable energy sector, has been less committed and coordinated in recent years. The overall score was therefore brought down by what is referred to in the Report as “political distortion”, which reflects challenges surrounding institutions, governance levels and transparency. It reminds us that although the private sector bears significant risk in a PPP infrastructure project, it is the public sector, ie Government and/or the public sector institution involved which must largely drive the process, identify the needs, set out the tender process and bidding requirements and identify the right private sector partner. Bidding for and developing PPP projects is an incredibly expensive exercise from a private sector perspective and therefore requires commitment. When South Africa’s commitment to the process and/or policy waivers, there are other eager countries on the African continent waiting in the wings ready to provide a more stable pipeline of infrastructure projects for investors. There are, however, encouraging political signals from the ruling party, the African National Congress (ANC) recently. The newly elected President of the ANC, Cyril Ramaphosa, was quoted , during the 2018 World Economic Forum held in Davos, as saying that policy certainty and clamping down on corruption are just some of his short-term priorities. Also, one of the outcomes from the new ANC National Executive Committee Lekgotla held in January 2018 includes a commitment to turn the South African economy around by, amongst other action items, implementing the Infrastructure Development Plan.

Local content

This requirement is gaining traction in the PPP space, more especially in developing countries. In the South African context, local content encompasses for example, black economic empowerment shareholding, job creation and the involvement of Small to Medium & Micro-sized Enterprises along the value chain. As it is a non-price factor in the bidding process, often the private sector sees local content requirements as a barrier to trade and investment because it often results in higher domestic production costs. On the other hand, Government must be seen to be protecting the interests of trade unions and reign in the privatisation of state assets by regularising local content. In balancing these interests, the mighty objectives of securing sustainable local job creation or boosting domestic innovation gets lost somewhere along the way and manipulation of the process may creep in.

The success of implementing local content requirements, hinges on transparent engagement and on-going collaboration with all stakeholders (versus a top-down approach), realistic local content targets that can easily be adapted over time as the environment changes and more targeted policies such as government-sponsored financing (for instance, in the form of loan guarantees for local developers of alternative green energy) or skill development in selected sectors to complement local content requirements. It will be interesting to see how National Treasury and, indeed, other Government institutions approach this aspect.

Tax incentives

Whilst tax incentives are not the primary reason for a PPP investor when looking at investment options, the tax cost is certainly a key driver of any investment decision. If the Internal Rate of Return (IRR) of a project looks better after using tax incentives, it could very well end up being the deciding factor for investment in a particular country. Currently, there are a handful of tax incentives available in the South African Tax Act in the form of accelerated depreciation allowances (which are a form of tax incentive) that create large upfront tax losses that can be set-off against taxable income once the infrastructure projects become operational. There is also the Critical Infrastructure Programme grant from the Department of Trade and Industry and the fairly recent introduction of Special Economic Zones which provide a reduced corporate tax rate of 15% amongst other benefits. On the surface, the tax depreciation allowances, in particular, appear to be the sweetener needed to incentivise capital spend on infrastructure projects. However, experience has shown that if you delve into the devil that is the detail, anomalies show up. For instance, depending on the type of PPP model used, very often the State owns the land on which the private sector will construct the particular infrastructure asset. The accelerated depreciation allowances only apply if the taxpayer incurring the cost of the asset also owns the asset – hence a problem. There is a deemed ownership provision in the Tax Act in the case of improvements made by a lessee but this only applies if the taxpayer is the lessee which oftentimes is not the case, as the State leases the land.

In addition, when infrastructure projects are built in remote areas, there is usually a need to construct supporting infrastructure. However, investors are often surprised to find out that not all assets constructed would be tax depreciable if not built for the exact purpose envisaged in the tax legislation. National Treasury, for instance, was alerted to the fact that renewable energy projects needed to build roads and fences but the cost associated with these could not be tax depreciated under the accelerated depreciation allowance available for renewable energy assets because roads and fences, simply put, do not generate electricity. A change in legislation was made to allow for these specific supporting infrastructure costs to be tax depreciated. However, there are even more examples of supporting infrastructure that PPPs must build but that do not qualify for any tax allowance simply because the legislation is not fit for the PPP’s purpose in many respects. Thus, the tax legislation as it pertains to PPPs needs to be relooked at holistically to fix the anomalies and provide coherent, clear tax incentives and in so doing cheerleads the PPP into investing more into infrastructure.

If South Africa has a fighting chance of achieving its GDP growth target, the success of PPPs will be a key driver. Hopefully, amongst the many items fighting for Minister Gigaba’s attention, PPPs will be given the special attention they deserve in Budget 2018.

Preshnee Govender

Senior Manager
International Corporate Tax
Energy and Natural Resources
 

Source: http://www.treasury.gov.za/documents/national%20budget/2017/review/FullBR.pdf
Annexure E of the 2017 Budget Review
In the February 2017 Budget Speech, then Minister of Finance, Pravin Gordhan, optimistically set out the expectation that GDP growth for South Africa will increase from 0.5 per cent in 2016 to 1.3 per cent in 2017 (source). However, by the time new Minister Malusi Gigaba delivered his Medium Term Budget Speech in October 2017, GDP growth was revised to 0.7 per cent for 2017 with a projection of growth reaching 1.9 per cent in 2020 (source).
Source: http://infrascope.eiu.com/wp-content/uploads/2017/02/Africa_Infrascope_Report_2015_English-1.pdf

Source: http://ewn.co.za/2018/01/18/ramaphosa-keen-to-create-investor-confidence-in-sa-at-world-economic-forum
Source: http://www.anc.org.za/content/statement-african-national-congress-outcomes-national-executive-committee-lekgotla-held-20th
 

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