Mining investment will lead the charge
Overall investment levels are low
“In our mining division, we will have to turn work away if it continues at this pace”— MARIUS HEYNS
A nation’s physical infrastructure is one of the best indicators of its likely prosperity. Infrastructure is a requirement for economic growth and prosperity. Investment in infrastructure creates jobs and stimulates economic growth.
The erratic nature of recent government spending on infrastructure development in SA, however, has caused investment to drop.
Large government projects the size of the Gautrain and the 2010 soccer World Cup infrastructure, such as stadiums, have petered out. The recession and resultant squeeze in financial markets have made sourcing capital harder than before. Skills shortages at municipal and provincial level have compounded the problem, causing bottlenecks.
In this environment, a lot has changed for industry players, particularly for the construction sector, which was the largest beneficiary of these high levels of investment.
But in spite of the gloom, some industry players are optimistic. “In our mining division, we will have to turn work away if it continues at this pace,” says Basil Read CEO Marius Heyns.
He insists that there is available work in the sector. But competition has forced margins sharply lower than they were four years ago.
A more competitive construction industry has made strategy and good management critical, to the benefit of firms like Basil Read and Stefanutti Stocks.
But even then, Heyns says infrastructure spending has dropped dramatically, taking the entire sector’s profits with it.
However, lower margins benefit government, which, according to public enterprises minister Malusi Gigaba, has an estimated R1,5trillion infrastructure investment backlog. Between 2005 and 2007, the SA National Roads Agency (Sanral) was forced to accept tenders at extremely high margins. Fierce competition has changed that.
There is far more competition for road construction today, a benefit government should take advantage of.
Government still hopes to spend R808bn on its infrastructure investment programme over the next three years. The largest portion of this falls within Gigaba’s portfolio. State-owned enterprises have been the biggest spenders in recent years, overtaking private-sector investment, which slumped during the recession. It has also soared above general government spending.
But despite its spending ambitions, few large projects have been announced by government recently, slowing its overall contribution to real fixed investment – or gross fixed capital formation (GFCF).
Overall GFCF, which includes general government, public enterprises and the private sector, rose to 15% in 2008, only for it to drop thereafter. On an annual basis, real GFCF contracted by 3,7% in 2010, and its prospects for 2011 are mixed.
Though private-sector spending has increased slightly, bottlenecks are still holding up government infrastructure projects.
GDP growth in the first quarter of 2011 increased above expectations, but growth in the construction sector was completely flat, indicating that investment levels in the economy are very low.
Employment in the construction sector is also a direct beneficiary of higher investment. Construction is one of the sectors identified by government for its contribution to job creation. But its employment levels have dipped.
Despite the drop in actual investment, there is no shortage of plans. Stateowned enterprises, in particular Eskom and Transnet, have extensive spending programmes. Projects in the telecommunications and water sectors have also received attention.
But funding has been one of government’s biggest hurdles.
Investec economist Annabel Bishop says government will source its funding from three main areas: internally generated resources (42%); government funding (5%); and long- and short-term borrowing in domestic (28%) and foreign (25%) markets.
Consumers are already paying significantly higher tariffs (such as the 25%/annum increase in the electricity price and expected increases in other tariffs like toll roads) to finance the construction of infrastructure.
Electricity tariff hikes will reflect the costs of electricity provision, giving Eskom a consistent revenue stream. Consumers are now paying for the Medupi and Kusile power stations.
Gigaba has recently said public enterprises such as Transnet would tap into new sources of funding in a bid to increase the capacity on key commodity export corridors.
Before the recession, government investment rose dramatically, resulting in a general improvement in the state of infrastructure. The soccer World Cup, in particular, forced local and national government to improve the condition of large national assets such as airports, roads and ports.
A recent assessment by the SA Institution of Civil Engineering shows that national assets have benefited from considerable investment.
Airport infrastructure, for example, is in excellent condition, after a R17bn investment injection from the Airports Company of SA. OR Tambo International was recently named the best airport in Africa at a global awards ceremony.
The condition of rail infrastructure for heavy-haul freight lines has also improved. Good maintenance and capital investment have enhanced the network. Unfortunately other rail infrastructure has been neglected, causing the movement of goods to move from rail to road.
Transnet’s investment programme, however, is designed to reverse this trend, by returning freight to rail.
Rapid-rail projects are also firmly on the agenda. A proposed high-speed railway project between Johannesburg and Durban has been mooted by the department of transport, at an estimated cost of R560bn.
The Passenger Rail Agency of SA will also embark on an 18-year programme to replace its coach and locomotive fleet, at an estimated cost of R86bn.
National roads managed by Sanral are also highly rated infrastructure. Government has also broadened the agency’s mandate. The network of roads that it is responsible for has increased to include some provincial roads. This was done in a bid to counter slow investment at provincial government level.
However, the Institution of Civil Engineering’s assessment raises concerns about the state of disrepair of social infrastructure, which serves the majority of people. Basic infrastructure such as sanitation, waste-management, water, health and public education facilities are in a state of decline.
For example, some sanitation infrastructure and gravel roads outside urban areas have deteriorated to such an extent that they are unfit for their intended purpose, or are on the verge of failure. Gravel roads constitute 75% of SA’s road network.
The evaluation also points out that greater investment has not been matched with an equal commitment to maintenance.
Endemic underspending is part of the problem. In the 2009/2010 financial year, municipal government authorities failed to spend 17c out of every rand budgeted for capital expenditure, according to national treasury. With this trend also visible at national and provincial government level, the problem has become critical.
Government has adopted steps to address the problem. Treasury is developing a strategy to appraise public-sector projects. National departments are also building capacity in provinces to ensure that projects are run effectively.
And for municipalities, the department of co-operative governance is establishing a specialist support unit to help plan and contract large capital projects.
Government has emphasised that building new and maintaining existing infrastructure is a key element of its aim to create 5m jobs over the next 10 years.
As public awareness of deteriorating or dysfunctional infrastructure has risen, the added pressure has forced government to respond more positively.
In this environment, private funding of infrastructure may become more important. Government has voiced support for public-private partnerships (PPP), but delays have prompted a number of firms, such as Stefanutti Stocks, to scale back their PPP units.
PPPs for hospitals and prisons are still awaiting announcement by government. Government’s flagship project, the R4bn upgrade of Chris Hani Baragwanath Hospital in Soweto, for example, has been five years in the making.
The Wild Coast toll road and the N1N2 Winelands road both faced delays because of environmental and social concerns, though tenders for the Winelands project were finally issued at the end of last year.
Innovative funding models are also important at the level of smaller projects. In the Free State province, for example, authorities have asked construction companies to design, finance and construct roads in the province in an attempt to stem its rising backlog.
The initiative has helped the province to start addressing the condition of its roads. The Free State government is responsible for 6370km of tarred and 22179km of gravel road, and most of it is in a poor state and requires urgent rehabilitation. It also has to grapple with damages claims worth millions of rand from commuters affected by bad roads.
With this strategy, the province has begun to deal with its budget shortfalls, work around its critical shortage of skilled professionals as well as reduce the road repair backlog.
About R3,9bn in tenders for 23 projects has already been awarded, and construction is in progress.
Municipalities, despite their constraints, are faced with the most urgent construction and maintenance work. Though private intervention such as the one in the Free State could be a solution, it has not been used effectively.
The private sector, which is traditionally the biggest contributor to fixed investment in SA, has also been a slow spender. Nedbank’s most recent capital projects listing shows that just 53 new projects worth over R20m were announced in 2010, valued at R52,9bn. This is down from 55 projects pursued in 2009, valued at R76,7bn, a 31% decline in investment.
This is a drop from a peak of 80 projects announced in the six months to June 2008, at a cumulative value of R336,1bn. When the recession hit, firms responded by scrapping or postponing their capex plans.
Since then, large new projects have dropped, causing overall investment activity to plunge.
Investec’s Bishop says factors that could negatively affect private-sector investment include further escalations in living costs, which would reduce disposable incomes and hence the need for companies to expand capacity (and increase employment).
But there are signs of activity, and local and international mining houses appear to be leading the charge.
Rising commodity prices have caused a flood of new mining investments, and more are expected, particularly in other African countries. They will need mine infrastructure, as well as basic supporting infrastructure.
An iron ore mine in Sierra Leone for example, requires the construction of a railway line, supporting roads, and even housing. Many of the contracts have been snatched by local construction firms like Basil Read and WBHO.
Subcontinental projects are also on the agenda. Government intends to champion an infrastructure development corridor, to improve the regional transport network. A new railway link between Gauteng and the Namibian port of Walvis Bay is one project that has been supported under this initiative.
A public-private partnership network was also launched recently under the Southern African Development Community to enhance public-sector capacity to integrate private-sector investment in infrastructure in the region.
The launch of new equity funds, backed mostly by foreign investors who want to invest in infrastructure in Africa, could become a resource for African governments. Infrastructure funds provide technical and commercial skills to a project and are able to energise and structure projects at an early stage.
Ultimately, the urgency for investment will increase the pressure to spend. That failing infrastructure in SA is most evident at municipalities crippled by skills shortages, won’t make it any easier. But with better intervention by national government authorities, the critical decline can be halted.