Publication: Business Report Issued: Date: 2004-07-25 Reporter: Helmoed Heitman

Highs and Lows of Arms Deal … in Rands and Sense



Business Report

Date 2004-07-25


Helmoed-Römer Heitman

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There was much noise made about how disastrously the cost of the strategic defence package had escalated with the collapse of the rand, with some self-defined experts putting forward figures that were nearly stratospheric.

Those experts have been strangely quiet when it comes to the effect of the strengthening rand.

There was, for instance, no audible sound of rejoicing when the department of defence returned R1 billion to the treasury in the last financial year as a result, mainly, of the effect of a stronger rand on the packages.

This financial year will also see the department spend about R1 billion less on the packages than was expected last year, which has also been met with studios silence.

To be fair, trying to come to an accurate current figure is difficult, because multiple factors are involved : the amounts that have already been paid at previous exchange rates; and the percentage of the earlier amounts that have been paid in cash or been financed.

Those difficulties notwithstanding, it is possible to develop a good idea of the trend by setting out the actual contract prices at the relevant exchange rates and by looking at the estimates in the budget each year.

The first step must, however, be to remove from the equation the deliberate mistakes made by commentators.

Specifically, they tend to take the published cost to the department, assume that it is all in the currency that is strongest against the rand on the day they write, assume that the government will finance everything at the highest likely rate of interest, add that up and wind up in the stratosphere.

The reality is, firstly, that the original cost to the department of R29.4 billion included about R4 billion in VAT, customs and excise duties, sundry fees, and initial financing costs.

The actual cost of the equipment to the state was R25.33 billion at the exchange rates ruling when the contracts were signed. That figure must be the basis for any calculations seeking to predict the overall cost.

Secondly, the cost of the packages includes an amount in rands, and that the foreign currency amount is made up of four different currencies, which have not all moved in unison against the local unit.

A breakdown by currency, with the 2004 and 1999 equivalent rand amounts, is set out in table 1.

That gives a total of R29.67 billion at the current exchange rate, except, of course, that some amounts have already been paid, making this an essential artificial figure.

Nevertheless, it is a useful figure for comparisons, setting it against the initial total cost of R25.33 billion and the total calculated at the exchange rates of this year, amounting to R29.67 billion.

Alternatively, one can take the predicted figures presented in the estimates of national expenditure for last year and this year. The 2003 budget estimated that the total cost of the packages, including financing costs, would come to R52.94 billion. The 2004 budget estimate is R48.74 billion.

That brings us to the third point : it is not the department that decides whether to pay cash or take up credit. That is a decision taken by the treasury.

Financing charges should, therefore, not really be taken into account when considering the packages in isolation, but only when considering government activity as a whole.

That said, the credit terms negotiated as a part of the packages are probably more attractive than can be obtained elsewhere, making it likely that the government will take up credit here and spend its cash elsewhere.

But that is not a cost that should be charged to the defence department.

Having said that, the credit terms are probably very favourable. There is one example in the public domain, the $3 billion (R18 billion) package negotiated with Barclays in respect of the Gripen and Hawk acquisition.

Key elements of this package include : a 20-year spread, with the option of repayment when currency moves suggest that; the option to select from a basket of currencies or gold at each payment due; the option to take floating, commercial fixed rates, or those supported by the export credit guarantee department; the option to access capital market funding by securitising a proportion of the borrowings; no inflation indexing over the full 20-year period; and a default penalty of only a 1 percent rate increase, rather that 2 percent.

A final area to consider is the effect of exchange rate fluctuations on the offsets, the defence and national industrial participation committee linked to the packages.

These commitments are denominated entirely in dollars ($1.68 billion and 10.69 billion respectively) and euros (e634 million and e2.85 billion), and their rand value will therefore fluctuate with the value of the local unit against the currencies.

While the actual value to South Africa of investments and technology transfers will not really be affected, the export facilitation elements will.

That is one of the downsides of the strengthening rand.

With acknowledgements to Helmoed-Römer Heitman and the Business Report.