Structure is business-friendly, but new laws are not
The government continues to pursue legislation that is not friendly towards investors
On Friday, 17 March 2017, President Jacob Zuma launched Invest SA, a one-stop shop service for foreign investors. An initiative of the Department of Trade and Industry, Invest SA is tasked with promoting investment in SA.
It was mentioned in the state of the nation address as part of an attempt to characterise SA as an investment-friendly destination. Zuma said it would focus on investment promotion and facilitation, reducing “undue delays” and “unnecessary red tape”. However, local and foreign investors are likely to remain cautious about the president’s promises.
SA has suffered an alarming decline in foreign direct investment (FDI). According to research by the UN Conference on Trade and Development, SA’s annual FDI inflow dropped 74% in 2015 to $1.5bn from $5.7bn in 2014 and is at its lowest level in 10 years.
BMI Research expects this trend to have continued in 2016 and to continue into 2017. It indicates that business confidence in SA as an investment destination has severely deteriorated.
This is a setback for the South African economy, which relies heavily on FDI. Based on research by BMI, FDI amounted to 40% of GDP in 2015. SA remains a net exporter of capital (as its total capital outflows exceed its total capital inflows). Thus, it relies on sizeable inflows of foreign capital to finance the deficit on the current account of its balance of payments.
FDI is needed to stimulate economic growth. The Industrial Policy Action Plan seeks to harness foreign investment to boost industrial infrastructure. However, the government continues to pursue legislation that is not friendly towards investors and does not create an enabling environment for foreign investment.
In the early 1990s, SA entered into bilateral investment treaties with many foreign countries, which governed the investment regime for foreign investors. In particular, these treaties protected foreign investors from government interference in their businesses and the right to enforce these protections through international arbitration.
In an effort to protect domestic industries and further the country’s socioeconomic plans, the government has since 2013 cancelled at least 13 of these treaties or expressed that they would not be renewed (including those with important investor countries such as the UK, Germany and France).
In their place, under the Protection of Investment Act of 2015, the Department of Trade and Industry published draft regulations that significantly alter the protections for foreign investors in the settling of legal disputes between foreign investors and the government.
As currently drafted, the regulations provide that mediation will be available only if the foreign investor and the government have agreed to submit their dispute to mediation — effectively giving the government a veto to any referral to mediation. These regulations are inconsistent with the act, which clearly articulates recourse to mediation as a right afforded to foreign investors.
Another concern for foreign investors is that the Protection of Investment Act of 2015 has altered the way in which foreign investors will receive compensation if their property is expropriated.
Under the old bilateral investment treaties, foreign investors were guaranteed compensation at “fair market value” if their property was expropriated. Under the new legislation, foreign investors are due to be compensated at a value that is considered “fair and equitable” by the government, creating a risk that the compensation will be disproportionate to the actual market value of the property.
A second piece of legislation that is expected to have a negative impact on SA’s openness to foreign investment is the proposed new Mining Charter, which is expected to increase legal and policy uncertainty for the sector — largely because the government and industry stakeholders are at odds over the interpretation of the “once empowered, always empowered” principle.
The government maintains that mining companies operating in SA must be 26% owned at all times by broad-based black economic empowerment (BBBEE) stakeholders. If the stakeholders decide to sell their shares to a non-BBBEE stakeholder, the company must divest more of its shares to maintain the 26% BBBEE ownership requirements.
The mining sector views this interpretation as impractical and one that will further damage the already embattled sector by impeding investment.
Another piece of harmful legislation is the Regulation of Land Holdings Bill. As it stands, the passing of this legislation will mean foreigners are not allowed to own agricultural land and would only be able to lease it. This would be highly detrimental to foreign investment in the agricultural sector.
Should it pass constitutional muster, it will significantly raise business costs, given that leasing land over a long
period of time is more expensive than ownership.
Despite SA’s economic and legislative woes and plummeting FDI inflows, the country remains a regional outperformer in terms of investment openness.
SA has the largest FDI inward stocks in the wider sub-Saharan region and has been one of the more amenable investment environments.
The World Bank’s Doing Business report states that, on average, it takes 19 days to open a business in SA and two years to close one, while property registration takes 23 days — sixth in sub-Saharan Africa.
SA outperforms regional averages in both the number of bureaucratic procedures and the cost of the process for opening a business.
Registering a company requires six procedures in SA, relative to an average of eight procedures in sub-Saharan countries and 4.7 procedures in Organisation for Economic Co-operation and Development (OECD) countries.
But the costs are considerably lower than in sub-Saharan Africa and the OECD. Registering a business costs 0.3% of income per capita in SA, compared with 5.2% and 3.2% in the rest of sub-Saharan Africa and the OECD.
SA also outperforms the rest of sub-Saharan Africa and the OECD on the time it takes to acquire a construction permit at an average of 141 days, compared with 162 days for the rest of sub-Saharan Africa and 152 days for OECD countries.
Investors and business benefit from strong legislative protections set up for intellectual property rights and limited corruption in the judiciary. Businesses also benefit from SA’s legal system, which is effective at enforcing contracts and impartially enforcing regulations.
For example, it takes 600 days to enforce a contract in SA, outperforming the sub-Saharan Africa average of 650 days, though falling considerably behind the OECD average of 540 days. SA also performs well by regional standards for the cost to enforce a contract, estimated at 33.2% of a claim, relative to the regional average of 45% of a claim.
Comparatively speaking, the coherence of much of the regulatory environment and the lack of red tape still makes SA an attractive investment destination. Notable advantages include the lack of restrictions on foreign property and business ownership, although this could change for agricultural land.
Legislation on key commerce and labour issues is well developed and laws relating to competition policy, copyright, patents, trademarks and disputes conform to international norms and conventions.
SA’s tax environment is highly favourable to foreign investors by regional standards, owing in part to its efficient tax bureaucracy and its competitive corporate tax rates.
Although the recent trends in FDI flows suggest foreign investors are taking their money elsewhere, SA remains a regional outperformer in terms of investment attractiveness.
However, whether it will be able to reverse the decline in foreign investment will depend on which path the country chooses to follow: pursuing unfriendly investor legislation, or investment openness and multilateral engagement.
*This article originally appeared in Business Day.
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