David Ross
The economy is headed for stagflation. The rand/dollar exchange rate is at R8.67. This relative weakness is technically an indication that exports should flourish – a less expensive rand makes the importation of our products that much more attractive.
This should result in an influx of foreign exchange, keeping our current account in rude health. Unfortunately, the picture is complicated and the outlook bleaker.
The cost of electricity is effectively killing South Africa’s mining and manufacturing capacity, causing us to forfeit the export opportunities a weak currency offers.
Another issue is that investors are withdrawing their money. We have seen a 43.6 percent decline in foreign direct investment over the last two years while Chile has seen an uptick of 82 percent over the same period. This lack of confidence is a further blow to mining and manufacturing.
The contributing variables are adequately captured by the recent credit ratings downgrades. Political risk is among the strongest explanatory factors for the downgrades, vehemently denied by Finance Minister Pravin Gordhan. A weak rand also fuels import-driven inflation, which will likely lead to higher interest rates, further militating against investment in productive manufacturing capacity. The cumulative effect is that our economy is likely to grow by only 2.2 percent this year, while comparable emerging economies are growing at rates of 6 percent to 8 percent.
If economic stagflation is to be diverted, the negative impact of administered pricing must be understood and reversed.
The economic theory of administered prices hypothesises that, in comparison with competitive or market-determined prices, administered prices are relatively inflexible and set at the discretion of sellers according to some rule or judgement, mostly on a cost plus mark-up basis. Inefficient consequences result because these costs are artificially inflationary.
Administered prices tend to continue to rise well after market prices may have stopped rising altogether. How true this rings of Eskom’s monopolistic behaviour over the last 18 years, especially. Electricity prices remained relatively affordable between 1994 and 2003. The average price increased from 10.26c a kilowatt hour (kWh) in 1994 to 16c/kWh in 2003. During that time, however, the government wilfully stopped investing in new generating capacity, which kept prices artificially low.
To catch up on the deficit, Eskom has hammered producers and consumers for the last three years. Its latest submission to the National Energy Regulator of South Africa (Nersa) requests a further 16 percent electricity tariff hike each year for the next five years; this in a bid to raise R1 trillion, which only covers capital expenditure to the end of Kusile. The current average selling price is 50.3c/kWh (at a cost of production of 41.3c/kWh). By the end of multi-year price determination (MYPD) 3 in 2018, that price will have increased to R2.91/kWh. Independent wind power currently costs only 89c/kWh to produce, according to estimates.
Eskom chief financial officer Paul O’Flaherty, thinks South Africa is at least 15 years away from inflation-linked pricing. He seems not to grasp how cost reflectivity at all costs will be so inflationary as to kill the very economy that underpins future electricity demand. Even prior to the latest MYPD-3 submission, economist Roula Inglesi demonstrated that Eskom’s search for funding would lead to a substantial drop in energy demand due to the price policies.
Eskom has lobbied for a 16 percent increase, it expects to receive less but is still likely to receive more than enough to continue operating inefficiently.
Perpetual government funding and guarantees simply serve to further entrench the problem, crowding out market competition or allowing it exclusively on Eskom’s terms. The impact on mining and manufacturing is likely to be devastating.
A submission by the Manufacturing Circle to Parliament last week revealed that manufacturers have faced an average electricity price increase of 181.1 percent in the decade since 2002, in addition to producer price inflation of 81.4 percent and wage cost inflation of 74 percent. These domestic inefficiencies have the direct effect of raising the baseline cost structure for local manufacturers, undermining their global competitiveness. These costs would be unbearable in ordinary circumstances, but their impact is amplified through a reversal of these costs in the nations with which we are trying to compete.
Mining and manufacturing productivity data to be released tomorrow is expected to be dismal. These sectors account for roughly 20 percent of economic output. Standard Bank predicts that mining output shrank by 7 percent in September compared with last year, and 11.3 percent compared with August. The impact of administered prices was demonstrated by a survey of 42 foundries that showed that electricity constituted 14 percent of total operational costs of 25 percent of added value. With the past decade’s increases and future planned increases, the incentive to keep producing and employing is severely curtailed. The above analysis does not even take into consideration the wildly oscillating pricing structures employed by municipalities. Tshwane charged users 692 percent more than the Eskom Megaflex rate.
Eskom’s pricing application does not pay sufficient attention to affordability, efficiency or sustainability. The most urgent action is for the Independent System and Market Operator Bill to be passed. This will wrest control away from Eskom by placing the transmission grid in independent hands.
MP David Ross is the DA deputy spokesman for energy.