PROPOSED ALUMINIUM PECHINEY SMELTER WITHIN THE COEGA IDZ CHAPTER 15: IMPACT ASSESSMENT AND MITIGATION: MACRO-ECONOMICS

Transcription

1 CHAPTER 15: IMPACT ASSESSMENT AND MITIGATION: MACRO-ECONOMICS

2 Contents 15. IMPACT ASSESSMENT AND MITIGATION: MACRO-ECONOMICS Introduction Macro-economic aggregates and indicators Gross Domestic Product (GDP) Gross Geographic Product (GGP) Gross National Disposable Income (GNDI) Balance of Payments Approach to the study Scope and methodology Economic assumptions Other key economic terms used Externality costs Economic inputs and outputs for the proposed project Construction Operations Project financing Impact assessment and mitigation Impacts on South Africa s balance of payments Impacts on income generation and employment Impacts on government revenue Impacts on GDP and GNDI Local economic impact during the operations phase Other important issues to be considered Recommendations Summary List of Figures Figure 15.1: Potential South African and foreign sources of equity and debt 15-9 List of Tables Table 15.1: Value of direct and indirect investment costs during construction 15-6 Table 15.2: Estimated financial flows during operations (2006 prices) 15-7 Table 15.3: Financing plan for the Aluminium Pechiney smelter 15-8 Table 15.4: Economy-wide impact for the construction phase ( ) Table 15.5: Economy-wide impact for the operational phase (2006 to 2046) Table 15.6: Government revenues generated during operation of the smelter Table 15.7: Summary assessment of predicted macro-economic impacts from the proposed aluminium smelter 15-21

3 15. IMPACT ASSESSMENT AND MITIGATION: MACRO-ECONOMICS IMPORTANT CAUTIONARY NOTE: At the time of preparing the macro-economic specialist study and this chapter of the draft EIR, the financing and budgeting for the Aluminium Pechiney smelter project was still being finalised. Budgets and financial assumptions are currently still being adjusted and refined. The figures provided in this chapter must therefore be interpreted as indicative of the positive and negative macro-economic impacts. The purpose of providing these figures is largely to explain macro-economic concepts and scenarios for South Africa, and not to provide absolute quantification of impacts Introduction The chapter is based on the specialist study on the Macro-economic impacts undertaken Blignaut and Schoeman (2002) for the Aluminium Pechiney smelter EIA, together with inputs and analysis from the reviewers, Tony Leiman and Trudy Hartzenberg (University of Cape Town) and Dr Martin de Wit (CSIR). This study needs to be considered in the context of the macro-economic policy for South Africa, which is currently based on the Growth, Employment and Redistribution (GEAR) strategy. Within a local context, industrial development zones are being developed to implement this macro-economic strategy. Section 4.4 contains an overview of the objectives of GEAR. The macro-economics analysis provided inputs on predicted employment numbers and economic growth for the socio-economics specialist study, the results of which are presented in Chapter Macro-economic aggregates and indicators The aggregates (i.e. measures) and indicators used to analyse and communicate the macro-economic impacts of the proposed smelter project on the South African economy are presented below: Gross Domestic Product (GDP) Economic growth is usually expressed in terms of the percentage change in the Gross Domestic Product (GDP). The GDP refers to the total production (value) of goods and services produced within the borders of a country during a page 15-1

4 particular time period, usually one year. The important (conventional) determinants of the long-term growth path of a country are: Employment (labour) Ordinarily, fluctuations in employment closely follow the fluctuations in real GDP. As an economy s production grows (i.e. GDP increases), employment tends to grow. A concern recently is that due to the capital intensity of investments and the high degree of competitiveness and efficiency, one does tend to observe GDP growth without the concomitant growth in employment. Investment (capital formation) The net increase in capital stock (eg. equipment, structures and other facilities needed for production) in a given time period. Capital is the main determinant of the number of labourers who can be employed. An economy s rate of progress is proportional to its rate of investment. Technology - the knowledge about how to use labour and capital to produce goods and services. Technology is perhaps the most abstract of the three determinants of growth, and is more difficult to measure than labour and capital. The GDP of South Africa was estimated to be R million ($ million) in 2001 of which R million ($ million) (15%) was capital formation or gross fixed investment; and R million ($3 560 million) (4%) net exports (exports less imports). In real terms, the GDP grew by 2,2% in Gross Geographic Product (GGP) The GGP is the value of all final goods and services produced in a specific local geographic area of the country within a given time period Gross National Disposable Income (GNDI) The GNDI is the value of all final goods and services produced by citizens of the country within a given time period. This indicator is used in addition to GDP in order to account for remittances out of the country associated with a project with large foreign ownership. The GNDI of South Africa was estimated at R million ($ million) in 2001, or R million (4%) lower than the GDP reflecting transfer payments to the rest of the world in the form of remittances. The GNDI grew by 1,2% in real terms in page 15-2

5 Balance of Payments The Balance of Payments (BoP) is an accounting record of a country s involvement in: international trade, indicated on the current account of the BoP, which is the external account of the country with the rest of the world with respect to the imports and exports of goods and services; and international capital flows, indicated on the capital account, which is the external account of the country with the rest of the world with respect to financial assets. An increase in exports, for example, would therefore lead to a surplus on the current account of the BoP. The consequences of a surplus (or deficit) in the current account on the economy of a country can be assessed in terms of the impact on three key economic variables: the foreign reserves; the money supply (monetary liquidity); and the exchange rate. Increased exports (surplus on current account) cause the amount of foreign reserves in the country to increase. Foreign reserves are critically important since they are essential in paying for imports. This trade account surplus may have a counterbalancing outflow on the capital account. If not the currency will appreciate in value, making imports progressively cheaper and the country s exports less competitive until eventually balance is restored. A country cannot sustain a BoP deficit for an indefinite period. Eventually there will be insufficient foreign reserves to pay for imports - especially essential imports such as oil. Furthermore, when foreign reserves reach relatively low levels one can expect interest rates to increase. A BoP surplus influences the money supply positively in the sense that it is a monetary injection into the economy, which will be enlarged by the normal monetary multiplier process. A BoP surplus (due to increased exports) implies an excessive demand for Rands. If exports increase, the demand for the Rand increases and the Rand (exchange rate) will strengthen. Should prolonged pressure be exerted on the BoP, the reverse is obviously true. International experience shows that there is a positive link between export performance and economic growth rates. In 2001, the balance of payments was estimated to yield a net inflow of R5 182 million. Relative to the GDP and GNDI, the balance of payments totals are page 15-3

6 small. Nonetheless, any major changes in either the current or capital accounts are likely to impact on foreign reserves, the exchange rate and domestic interest rates Approach to the study Scope and methodology The approach to the specialist study by Blignaut and Schoeman (2002) was designed to address the macro-economic issues identified through scoping. These included: Quantification of the macro-economic impact of the proposed Aluminium Pechiney smelter project (using macro-economic variables such as GDP, GNDI, GGP, income generation, employment, balance of payments, government revenue); and Evaluation of upstream and downstream opportunities associated with the project (i.e. multiplier effects). Information on the project economics and financing was provided by Aluminium Pechiney. Together with information from existing sources, this was fed into an economic input-output table for South Africa for An input-output table provides a breakdown of inter- and intra-industry flows by disaggregating the inputs and the respective outputs. For example, inputs to an aluminium smelting process include labour, capital and raw material that can either be imported (eg. alumina) or produced locally (eg. electricity). Outputs refer to the final product that could be consumed either locally or exported. The tables were used to assess the impacts of the proposed development on the national economy, in terms of the variables listed above. These economy-wide effects were also interpreted within a provincial context, as well as a local (Nelson Mandela Metropole) context where possible. Excluded, however, is an elaborate actuarial analysis of the financial flows as well as an evaluation of the possible negative externality costs as a result of the project Economic assumptions The analysis presented in this chapter is based on the following economic assumptions: Rand:US$ exchange rate for 2002 of R10,50:US$ 1 Corporate tax paid at 30% (it is estimated by Aluminium Pechiney that this will be paid from 2013, after depreciation allowances) Secondary Tax on Companies (STC) of 12,5%, which is to be paid from 2006, when the project is operational page 15-4

7 The smelter will become operational in 2006 and have an initial lifespan of 40 years Depreciation of capital will take place over the first six years of smelter operation (i.e from 2006 to 2012) International debt will be re-paid over a 14 year period (i.e to 2020) South African discount rate of 11% used to discount future Rand values back to present value in Various other assumptions were applied (eg. employment numbers, volumes of raw materials, volume of aluminium production etc). These are consistent with the information contained in Chapter 2. The project financing has not been finalised and therefore the exact split between local and foreign sources of finance and the financing institutions involved, are indicative only and still subject to change Other key economic terms used TERM Direct impact Indirect impact Induced impact EXPLANATION Within the context of input-output modelling, it refers to the immediate (first round) effects of a project. Within an input-output context, it refers to the direct as well as the knockon (downstream) economic impact (income is treated exogenously, i.e. externally). This takes into account the linkages of the project to other sectors in the economy Within an input-output context, it refers to the direct as well as knock-on (downstream) and upstream economic impact (income is treated endogenously, i.e. internally). This brings in effects on spending as a result of changing household incomes engendered in both the project and sectors linked to it. The reader is referred to the glossary at the front of the EIR for other terms used Externality costs It was beyond the scope of the macro-economic specialist study to investigate the costs caused by the potential negative environmental externalities of the project, especially the externalities caused through the generation of electricity. The electricity sector is the domestic sector that will benefit most from this investment, but, inevitably, this will also lead to a higher level of air pollution. By committing Eskom to a significant production of additional electricity, the country's already stressed carbon balance will be put under further pressure. The issue of electricity generation is discussed in more detail in Chapter 16. page 15-5

8 15.4 Economic inputs and outputs for the proposed project Inputs to the proposed Aluminium Pechiney smelter include raw materials, labour and capital. These constitute the investment costs associated with the project. The output is the final product (aluminium ingots) produced by the smelter, which is to be sold on the foreign market (95%) or domestically (5%). Inputs and outputs are described for construction and operations in the following sections. The data are based on information received from Aluminium Pechiney as of 14 August Construction The total investment cost of construction is approximately $2 094 million. Of this $1 042 million constitutes the direct investment (capital cost) into South Africa. A breakdown of direct and indirect investment costs for the construction phase is provided in Table Table 15.1: Value of direct and indirect investment costs during construction: US $ MILLION FOREIGN LOCAL TOTAL Roofing & cladding Piping & vessels Steel Civil works Aluminium conductors Mechanical equipment Miscellaneous Transport Salaries Sub-total: direct investment Temporary facilities 30 Construction services, project management, direction and promotion 250 Licence and technical assistance during construction 151 Start-up costs and insurance 84 Contingencies 90 Escalation of the above 65 Less grants -55 Sub-total: indirect investment 615 Direct and indirect investment cost (approximate) 1654 Working capital 137 page 15-6

9 Reserve account 91 Debt financing cost 211 Total investment (approximate) 2094 Source: Pechiney (2002). From the above table it can be seen that South African capital is expected to constitute approximately 47% of the direct investment costs, to a value of $493 million. To minimise negative impacts of large capital intensive projects on South Africa s balance of payments, local funds should be used to cover the cost of local factors (materials and labour); while foreign capital is used to finance investment costs incurred abroad, as well as the imported materials required for the construction of the smelter. As described in Table 2.9 (Section ), approximately employees would be employed during the 12-month peak construction period. The majority of these jobs will be unskilled or semi-skilled. The average number of jobs for the 26-month construction period will be approximately Operations The inputs and outputs during operation of the smelter are shown in Table Table 15.2: Estimated financial flows during operations (2006 prices) US$ MILLIONS ANNUAL INPUT/OUTPUT ONWARDS Aluminium sales (output) IMPORTED COMPONENT (%) Alumina, Coke, Pitch Logistics costs Other raw materials 8 8 Electricity Personnel Operating costs Administration costs 8 8 Local taxes 1 1 Corporate taxes 0 87 STC Depreciation (books) 94 0 Financial cost Net income Source: Pechiney (2002) Details of the electricity supply contract with Eskom are still to be finalized and the cost of electricity is therefore an estimate only. Various price options are page 15-7

10 currently being considered, including linking the electricity price to the international price of aluminium on the London Mercantile Exchange (LME). Eskom will, however, be responsible for the establishment and cost of additional powerlines required by the smelter. Due to a high depreciation rate, no corporate tax other than the $20 million in secondary tax on companies (STC) will be payable until From 2013 onwards, the project would be subject to normal corporate income tax at 30% and STC of 12.5%. It is estimated by Aluminium Pechiney that $87 million will be paid annually in corporate tax from However, calculations from the macroeconomic study indicate this value to be in the order to $31 million. This is one of the issues that should be clarified in a comprehensive actuarial study that needs to be undertaken at a point when investment costs and financing arrangements are confirmed (refer to recommendations in Section 15.7). Indirect local taxes include property rates, environmental rates, Regional Services Council (RSC) establishment levy and a RSC services levy. During operation, the smelter would directly employ 750 permanent staff. These include 550 positions for semi-skilled and skilled shift operators and 200 highly skilled technical and management positions. A further sub-contractors would be employed permanently at the smelter, bringing the total employment number to approximately 1000 permanent employees Project financing The project s total investment cost of $2 094 million is to be financed by an equity:debt ratio of approximately 40:60 as shown in Table Table 15.3: Financing plan for the Aluminium Pechiney smelter US $ MILLIONS (%) Source Foreign Local Total Equity 518 (65%) 279 (35%) 797 (38%) Debt 719 (61%) 465 (39%) (57%) Commissioning cash-flow (5%) Total (59%) 744 (36%) Commissioning cash flow refers to the operating profit generated during the first 8 months of operation, which will be used to finance approximately 5% of the total investment cost. Approximately $744 million (36%) of the total investment cost will be sourced locally in South Africa, with $279 million being financed with local equity and $465 million provided on loan by South African lending institutions such as the Industrial Development Corporation (IDC), the Development Bank of Southern page 15-8

11 Africa (DBSA) and commercial banks. Loan finance agreements are currently being negotiated and therefore details of interest rates and loan repayment periods are unavailable. International loan finance is being sourced from a number of export credit agencies (ECAs), bilateral agreements and international banks. Pechiney is expected to provide 40% of the total equity component of the project. Possible South African equity partners include Eskom, the IDC, Imbali and a black economic empowerment partner (BEE). Although financing arrangements are still being negotiated, other possible equity partners include foreign companies with defence offset commitments in South Africa (such as Thyssen Krupp and Ferrostaal) and companies with interests in the aluminium industry. A breakdown of the likely sources of equity and debt is shown in Figure Final investment amounts may still vary as equity and loan agreements are still being finalized. Sources of equity Sources of debt ECAs & bilaterals 30% 5% 13% 13% 39% Pechiney IDC Eskom BEE groups Other 19% 4% 16% 5% 56% International banks IDC DBSA Local SA banks Figure 15.1: Potential South African and foreign sources of equity and debt 15.6 Impact assessment and mitigation Four main macro-economic impacts are identified: Impact on South Africa s balance of payments Impacts on income generation and employment Impacts on government revenue Impacts on GDP and GNDI. Values presented in this section reflect the annual averages over the 40 year life of the plant in 2002 prices. The impact of the construction phase is summarised in Table page 15-9

12 Table 15.4: Economy-wide impact for the construction phase ( ): 2002 Prices, $ millions (Employment: Numbers) DIRECT INDIRECT INDUCED TOTAL IMPACT IMPACT IMPACT IMPACT Imports (current account) Capital inflow (financial account) Impact on balance of payments (capital inflow less imports) Income (Salaries and wages) Employment (Created and sustained) Net indirect taxes Contribution to GDP Source: Pechiney input data; Blignaut and Schoeman, The impact of operations is summarised in Table Table 15.5: Economy-wide impact for the operational phase (2006 to 2046): 2002 prices, $ millions (Employment: Numbers) DIRECT INDIRECT INDUCED TOTAL IMPACT IMPACT IMPACT IMPACT Total sales Sales' contribution to exports and GDP Domestic demand (118) Imports (current account) GDP (sales + domestic demand imports) Factor remittances Total GNDI Debt repayment Depreciation investment Total capital outflow (Remittances + debt repayment + depreciation investment) Balance of payments (exports - imports - total capital outflow): 2006 to Balance of payment (exports - imports - remittances - debt repayment): 2013 to Balance of payments (exports - imports - remittances): 2021 to Net indirect taxes Corporate tax: from 2013 onwards Income Employment Note: The number in brackets is not included in the GDP calcul ation since it will lead to double counting. Source: Pechiney input data; Blignaut and Schoeman, page 15-10

13 Impacts on South Africa s balance of payments Construction phase Based on the data provided, total direct investment in South Africa, domestic as well as the imported component, is estimated to be $773 million in 2002 prices. This is derived from discounting the direct investment of $1 042 million (Table 15.1) over the construction period to the 2002 present value. Fifty seven percent of the total investment, or $443 million (2002 price), is spent on imported goods and $331 million (2002 price) comprises domestic demand. As a result of this investment, the current account of the BoP will enjoy a surplus during the construction phase, since the total of the direct import component ($ 443 million) and the import component of the downstream domestic requirement of $215 million (indirect and induced impacts) is offset by an inflow of $1237 million (Table 15.4). A net inflow of $579 million is therefore predicted. The total import requirement during construction ($658 million) is approximately 2,5% of total national imports. Regarding the financial account of the BoP, the surplus capital inflow during construction will support the Rand. Operations phase Total annual aluminium sales of $775 million (2006 prices) are predicted, with 95% ($736 million) to be exported. The direct contribution to the GDP and exports (and thus the current account of the balance of payments) is $ 736 million (2006 prices). Imports imply a negative entry on the current account. During operations, annual imports for the smelter amount to $172 million, with alumina, petroleum coke and liquid pitch accounting for by far the bulk of the import costs. These imports are intermediate goods that are treated as current expenditure with no impact on the financial account of the balance of payments. As a result of the expected increase in domestic demand, additional imports (over and above the direct import requirement of $172 million) of between $32 million and $46 million can be expected. This would mean an increase in imports to $219 million. The financing of the debt sourced from abroad and debt redemption imply a capital outflow. This capital outflow amounts to $272 million per year in 2002 prices (also refer to Section ). page 15-11

14 For the period 2006 to 2012, the net impact on the balance of payments (exports less imports and capital outflow) is a negative $6 million per year. Once the capital investment has been written off through depreciation, a positive of contribution of $53 million per year will be made to the balance of payments. This value is applicable for the period 2013 to Once the international debt is redeemed, the positive contribution to the balance of payments grows to $196 million per year. This applies to the period 2021 to Impacts on income generation and employment Construction phase Due to the technical requirements of the project, the construction of the smelter is highly capital-intensive and based on a large volume of imported goods and services. The input-output analysis reveals that only $78 million of the total of $ 410 million additional domestic demand (or 19%) will be used for employment. Over the construction period, the aluminium smelter will result in additional income of between $184 million (direct and indirect effect) and $267 million (direct, indirect and induced effect due to an increase in consumer expenditure)(table 10.4). The total effect is equal to 0,4% of total remuneration in South Africa. As a result of this investment and the downstream economic activity, between (direct and indirect effect) and jobs (direct, indirect and induced) will be affected, either in the form of existing jobs that are sustained or as new jobs created (Table 10.4). These jobs will mainly occur in the construction, iron and metal sectors of the country. Operations phase At a national scale, the input-output model shows that as a result of the Pechiney investment, indirect jobs will be created. Including the jobs created through the induced effects of the development, a total of direct, indirect and induced jobs will be created or existing jobs sustained indirectly. Additional income will amount to between $55 million and $80 million depending on how strong the spill-over effect will be between the direct and indirect effects and the induced effect. Being an extremely capital intensive plant, the cost per job created is high. The estimate of domestic finance (equity and debt) to be used is $744m (Table 15.3). If one assumes roughly 1000 permanent jobs are created directly, the domestic cost per job is $0,74 million (R7,8 million). Another way of looking at this that the approximate total investment is $2094 million, with a direct investment in South page 15-12

15 Africa of $1042 million (Table 15.1). Assuming the creation of 1000 new jobs at the smelter, every job requires an investment of $2 million or $1 million (when compared to the total or direct investment of the project respectively). This highlights the high level of capital intensity of the project. The input-output analysis shows that the main indirect and induced benefits for South Africa are in the electricity sector. The annual electricity input to the smelter is estimated to cost $62 million. The sectoral analysis in the specialist study found that electricity is by far the largest single domestic input, contributing 53% to direct domestic demand and 58% to total domestic demand, inclusive of indirect and induced effects. It is also this sector that sustains the most jobs, namely between and out of the total number of jobs affected (approximately 44% of the total). Other sectors that will benefit significantly are glass and bricks and other manufacturing. Electricity is not generated in the Nelson Mandela Metro area, but elsewhere in the country. Since Eskom has some surplus capacity, it is possible that, at least in the short term, Eskom would utilise this capacity. This would lead to a lower level of employment and income than what is presented above Impacts on government revenue In order to encourage foreign direct investment in South Africa, the Coega IDZ has been established as a customs free zone and Aluminium Pechiney would therefore be exempt from import duties. The contribution of the project to government revenues during both construction and operations is discussed below. Constructions Phase During the 26 month construction period, no company tax is payable. Increased domestic demand for goods and services, downstream economic activity and the employment of a relatively large workforce would, however, contribute $49 million in indirect taxes such as Value Added Tax (VAT). This translates into approximately 0.4% of total national VAT earnings. Operations Phase It is expected that Aluminium Pechiney will contribute to local government taxes (property taxes, environmental taxes, RSC levies etc) and STC from the start of operations in This will generate approximately $14 million in direct government revenues in 2002 prices. Indirect taxes through downstream activities will contribute approximately $6 million. From 2013, Aluminium Pechiney will start paying 30% corporate tax. It is estimated that corporate tax page 15-13

16 will contribute $ 31 million to government revenues, based on calculations by Blignaut and Schoeman (2002). The total contribution of local taxes, indirect taxes and corporate taxes would then generate approximately $ 51 million in government revenues per year (Table 15.6). This would contribute 0.2% of total government revenue per year in 2002 prices from 2013 onwards. Table 15.6: Government revenues generated during operation of the smelter (2002 prices) US $ MILLIONS Sou rce of revenue onward Local government tax and STC Indirect tax 6 6 Corporate tax (30%) - 31 Total The amount of revenue generated will be reduced if Aluminium Pechiney is eligible for tax incentives under the s kills support programme and the strategic industrial projects schemes. However, the long-term benefits to the government in supporting these capacity building programmes is in fa cilitating the development of skills and earning potential of more South Africans. Ultimately this would have a positive impact on government revenues through the taxes received from higher income earners trained through these incentive schemes Impacts on GDP and GNDI Construction Direct domestic investment is $331 million in 2002 prices, if the investment value of $493 million is discounted to present value. The results of the specialist study show that this direct domestic investment will contribute approximately $438 million directly and indirectly (through the increase in demand for downstream products) to GDP over the construction period. Including induced effects (i.e. the increase in consumption due to an increase in compensation or income), the total contribution of the project to South Africa s GDP increases to $657 million. This is approximately 1,2% of gross fixed investment and would contribute approximately 0,25% to the GDP. The South African economic sector that will benefit most from the construction of the smelter is the iron and metals sector. Since the largest proportion of these materials will be sourced outside of the boundary of the Nelson Mandela Metropole, the majority of the upstream benefits (such as job creation and local revenue generation) will not accrue locally. page 15-14

17 Operations Phase The project s net impact (direct, indirect and induced impacts included) on GDP is calculated as being $282 million per year in 2002 prices. This is approximately 0.3 % of the national GDP. Given the fact that the project is largely foreign funded, approximately $70 million would be remitted from South Africa per year in the form of foreign dividends and profits. The total contribution of the project to the Gross National Disposal Income (GNDI) is therefore $212 million (i.e. the amount that will accrue to South African citizens annually). This is approximately 0.2% of the national total. It should be noted that the contribution to the GNDI is less than the annual total capital outflow of $ 272 million for the period 2006 to Local economic impact during the operations phase Conningarth Consulting (2001) calculated the distribution of the economic impact of the operational phase of the smelter between the local area (i.e. Nelson Mandela Metropole) and the rest of South Africa. Their analysis shows that 36% of the increase in domestic demand (caused by the operation of the smelter) will be experienced by the Metro, with the remaining 64% experienced by the rest of the country. The increase in local demand is estimated to be $81 million; or 1% of the GGP of the Eastern Cape; or 5% of the Port Elizabeth GGP (estimated at $1.7 billion). This picture is mirrored in terms of income. The local benefit of an increase in income is 36% or $29 million/year (0,6% of the province's remuneration) and hence the local benefit in terms of sustained jobs amounts to (0,08% of the Eastern Cape population). Every one Rand increase in direct domestic demand will lead to an injection of R0,68 into the GDP of the local Nelson Mandela Metro, and R1,22 to the economy of the rest of the country. That is a total injection of R1,90. This tendency also prevails in the case of employment, with one direct job opportunity having a direct effect on 7,8 others in the Metro and 13,7 jobs elsewhere in the country Other important issues to be considered Contracts and financing agreements are in the process of being negotiated. Therefore, certain information was not available to fully assess the macroeconomic implications of a number of issues of importance when evaluating the costs and benefits of the project for South Africa. These issues should be taken into consideration in the decision-making process and, where appropriate, in the negotiation of agreements. page 15-15

18 Opportunity costs The benefits of the project should be assessed against the opportunity cost to South Africa if $465 million (R 4.9 billion) of local finance is invested into a project with low job creation potential during operations. If the financing institutions (eg. DBSA and IDC) face a shortage of investment opportunities and no shortage of liquidity, then the opportunity cost would diminish. If, on the other hand, they are rationing loanable funds between competing development projects, then the investment of local finance into the smelter may result in a shortage of available funds for other financially viable projects that may have greater economic and social development benefits. IDC has indicated that, while their funding emphasis has shifted towards secondary and tertiary industry in recent years, development of primary industry is still of strategic importance. IDC is currently researching projects beyond the boundaries of South Africa in order to find sufficient suitable economically viable projects in which to invest. IDC also raises funds from international sources for investment in local projects. This indicates that the funding of the smelter project should not restrict the amount of loanable capital available from IDC to other economically sustainable local industrial projects. (Etienne Roux, IDC, pers comm). Offset investments An unspecified proportion of the equity finance is expected to be provided by foreign companies that have offset commitments linked to the sale of defence equipment and aircraft to South Africa. Offset commitments are counter-trade obligations, made by companies who were successfully awarded large government procurement contracts, to invest in South Africa. The objective is to leverage economic benefits from the state s procurement of goods and services. Offset obligations can be worked off by accumulating credits either through direct investments in South Africa, or through showing evidence of having facilitated export promotion. Recent experience has brought into question the benefits of these offset investments to South Africa, and the effectiveness of the rules governing how offset credits are awarded. A number of projects have recently been exposed in which offsetters have claimed the full value of the project as credit, though they contributed only a part of the total cost. The implication is that South Africa will not fully realize the economic benefits promised as justification for massive expenditure on foreign defense and other equipment. Of concern is that offsetters will make a small investment in the smelter while claiming the full value of the investment, and possibly also the full value of the page 15-16

19 aluminium export. South Africa would therefore gain very little additional value from these offset obligations. It is recommended that, if defense offset investments are included in the financing of the smelter project, the value of credits claimed must be stated publically and not exceed the actual value of the offset investment. Potential subsidies Eskom will need to increase power generation to meet the medium to long-term electricity requirements for the smelter (see Chapter 16). An issue for consideration is whether increased costs of generation have been factored into the unit price at which electricity is sold to Aluminium Pechiney. If not, a concern would be that domestic users could cross-subsidise the electricity requirements of the smelter. Externality costs An assessment of the economic costs associated with negative environmental externalities was beyond the scope of this study, however, these potential costs which may be associated with the aluminium smelter should be borne in mind in the decision-makingeneration arising from impacts of air emissions from power stations on soils, process. In particular, the externality costs of electricity water supplies, agriculture and human health should be considered. The costs presented in this chapter therefore should be considered an underestimate of the total economic costs of the project Recommendations Recommendations are provided for the proponent (Aluminium Pechiney); as well as the authorities and other decision-makers (such as local financing institutions). The recommendations for the authorities raise issues that should be taken into consideration when evaluating the overall ecological, social, and economic sustainability of the proposed project. Recommendations for Aluminium Pechiney: Large projects have the potential to distort foreign exchange markets. In this regard South Africa is less exposed than say Mozambique was by the Mozal smelter, Nevertheless, unless large foreign exchange inflows are anticipated early in the operational phase, the South African contribution to project finance should not exceed the expenditure on local factors of production, i.e. there should not be a net outflow of funds. page 15-17

20 If defense offset investments are included in the financing of the smelter project, the value of credits claimed must be stated publically and not exceed the actual value of the offset investment. Recommendations for the authorities and decision-makers: A comprehensive actuarial study and financial analysis is required to fully understand the impact of the financial flows on the South African economy. This should be undertaken at a point when there is adequate knowledge of the proposed debt repayment structures, equity holdings and company structures. The study should provide recommendations for the most appropriate financing structure that would deliver optimal benefits to South Africa, and reduce the financial risks currently associated with the investment. A comprehensive environmental economics study is required, based on a lifecycle (cradle to grave) approach, to estimate the total externality costs and benefits of the smelter project within South Africa. Despite the relatively large net inflow during construction, implications for the exchange rate are uncertain. The South African Reserve Bank should be able to use its forward book to neutralise the immediate effects of large short-term inflows Summary It is envisaged that the proposed aluminium smelter will result in a total expenditure of $2 094 million over the 26 month construction period from 2003 to This expenditure consists of $1 042 million direct investment (eg. equipment, construction and salary costs), of which approximately 53% will consist of imported goods. The remaining costs consist of $615 million indirect investment (eg. construction servicing, licences, insurance and various start-up costs), and $439 million for other financial reserves and debt financing costs. The most significant quantifiable macro-economic impacts of the project are: Impact on South Africa s balance of payments The sale of ingots is estimated to generate $510 million/year (at 2002 prices) and will contribute positively to South Africa s balance of payments. However, this will be reduced by imports (estimated at $219 million/year) and capital outflow as a result of repayment of international debt and remittances such as dividends (estimated at $272 million/year). A negative contribution to South Africa s balance of payments could result in weakening of the exchange rate of the Rand and increased interest rates. Therefore, the structuring of international and local page 15-18

21 financing for the project is critical. Based on information provided, the project will make a positive contribution to South Africa s balance of payments during construction (2003 to 2005) and during the operations period from 2013 to The most critical time is the operational period from 2006 to 2013, when capital outflows include depreciation as well as debt repayments. For this period, the contribution to balance of payments is marginally negative (-$6 million/year at 2002 prices). Impact on employment and income The project will provide an average of 4500 jobs during construction and approximately 1000 jobs (750 permanent and 250 direct subcontractors) during operation. During construction, an additional to jobs will be created or sustained in the South African economy; and during operation an additional to jobs. Of these jobs, some 36% will be created in the Nelson Mandela Metro and the remainder elsewhere in South Africa, mostly in the electricity sector. The increase in income for the Port Elizabeth area is predicted to be $29 million/year (R302 million/year), which is 0,6% of the province's remuneration. Impact on Gross Domestic Product (GDP) The project is expected to contribute approximately 0,25% to GDP over the construction period. During operations, the contribution to GDP is 0,3%. Impact on government revenue During construction, increased domestic demand caused by downstream business will contribute $49 million/year (R513 million/year) in indirect taxes, mostly VAT. During operation, the smelter will contribute local government taxes and secondary tax on companies (STC) of $14 million/year (R145 million/year). Down-stream activity as a result of the smelter will generate additional indirect taxes of approximately $5.7 million/year (R60 million/year). In addition, corporate tax of approximately $31 million/year (R322 million/year) is due from In total, it is estimated that this project will generate approximately $50 million/year (R527 million/year) in taxes, or 0,2% of total government revenue per annum in 2002 prices, once levied (i.e. from 2013). page 15-19

22 There are also other important but less quantifiable macro-economic impacts: Anchor tenant and catalyst for further investment The Aluminium Pechiney investment may be seen as a vote of confidence in the country and induce further inflows and economic growth. The smelter would also be an important long-term anchor tenant for the Coega IDZ. From the perspective of South African investors in the IDZ, this means that the project would be appraised in terms of its implications for the viability of the IDZ and Port of Ngqura, as well as the financial merits of the loan itself. Sales of defence procurement offsets In the financing of the smelter, international companies may be allowed to purchase defence procurement offsets. The offset obligations of these companies can be worked off by accumulating credits either through direct investments in South Africa, or through showing evidence of having facilitated export promotion. A concern is that companies seeking offsets will make a small investment in the smelter while claiming the full value of the investment, and possibly also the full value of the aluminium export. South Africa would therefore gain very little additional value from these offset obligations. Recommendations for the authorities and other decision-makers 1. A complete actuarial study and financial analysis should be done to determine the net financial impact that the project may have on the balance of payments and monetary system in South Africa. 2. A comprehensive environmental economics study should be undertaken, based on a life-cycle (cradle to grave) approach to quantify the externality costs and benefits of the smelter project within South Africa. Recommendation for Aluminium Pechiney 1. If defense offset investments are included in the financing of the smelter project, the value of credits claimed must be stated publically and not exceed the actual value of the offset investment. page 15-20

23 Table 15.7: Summary assessment of predicted macro-economic impacts from the proposed aluminium smelter Nature of impact Status Extent Duration 1 Balance of payments 3 Positive Construction phase Pressure on institutional framework/ economic system 1 (intensity) Probability of occurrence Confidence National Short-term Medium Definite High 2 Income & employment Positive 3 Government revenue Positive Local & Short-term Low Definite High National National Short-term Low Definite High 4 GDP and GNDI Positive Local & National Short-term Low Definite High Operational phase 1 Balance of payments to to 2046 Negative Positive National National 2006 to to 2046 Medium (Low) Medium Definite Definite High High 2 Income & employment Positive Local & Long-term Low Definite High National 3 Government revenue Positive Local & Long-term Low Definite High National 4 GDP and GNDI Positive Local & National Long-term Low Definite High The ratings in brackets are with mitigation, where this has changed from the without mitigation assessment. No high/medium/low significance rating has been ascribed as project financing is still being finalised and no appropriate benchmarks were identified in the specialist study. Notes: 1: Low implies it will not require additional management or changes to existing institutional structures and economic systems. 2: A comprehensive actuarial study is required to determine the optimal financing plan for South Africa. page 15-21

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