What are the expectations of foreign and domestic investors for a welcoming investment climate in the SADC community?

Comments by Peter Leon, Partner and Co-Chair: Africa Practice, Herbert Smith Freehills, at the 1^st Annual Southern African International Arbitration Conference, University of Pretoria

12 December 2016

KEY POINTS

A welcoming investment climate for both domestic and foreign investors requires clear and consistent policies, as well as the robust protection of property rights.  Essential to these are independent institutions which promote as much as protect good governance, staffed by suitably qualified personnel who uphold the rule of law.

The nexus between the rule of law, property rights and prosperity is well explained by economists Daron Acemoğlu (of MIT) and James A. Robinson (of Harvard), authors of the celebrated book Why Nations Fail: The Origins of Power, Prosperity and Poverty (2012):

Inclusive economic institutions foster economic activity, productivity, growth, and economic prosperity.  Secure private property rights are central, since only those with such rights will be willing to invest and increase productivity.  A businessman who expects his output to be stolen, expropriated, or entirely taxed away will have little incentive to work, let alone any incentive to undertake investments and innovations.  But such rights must exist for the majority of people in society.

In a much earlier work, An African Success Story: Botswana (2001), they argued as follows:

The success of Botswana is most plausibly due to its adoption of good policies… [T]hese policies resulted from an underlying set of institutions - institutions of private property - that encouraged investment and economic development…

Institutions of private property … require effective property rights for a large segment of the society, both against state expropriation and predation by private agents, relative political stability to ensure continuity in these property rights, and effective constraints on rulers and political elites to limit arbitrary and extractive behavior.

Botswana was able to grow rapidly because it possessed the right institutions and got good policies in place.  Despite being a small, agriculturally marginal, predominantly tropical, landlocked nation, in a very precarious geo-political situation, Botswana experienced rapid development.  We think this shows what can be done with the right institutions.

Various useful indices have been devised to define the expectations (or hopes) of foreign and domestic investors, and to measure different states against them (see attached table):

- The Global Competitiveness Index, assessed annually by the World Economic Forum, measures 114 indicators that matter for productivity and long-term prosperity, grouped into twelve pillars: institutions, infrastructure, macroeconomic environment (regarded as basic requirements), health and primary education, higher education and training, goods market efficiency, labour market efficiency, financial market development, technological readiness, market size (regarded as efficiency enhancers), business sophistication, and innovation.

- The Ease of Doing Business ranking, assessed annually by the World Bank, measures aspects of regulation that enable or prevent private sector businesses from starting, operating and expanding, using eleven indicators: starting a business; dealing with construction permits; getting electricity; registering property; getting credit; protecting minority investors; paying taxes; trading across borders; enforcing contracts; resolving insolvency; and labour market regulation.

- The Economic Freedom of the World index, assessed annually by the Fraser Institute in Canada, measures the degree to which a state’s policies and institutions are supportive of economic freedom, in five broad areas: size of government (expenditures, taxes and enterprises); legal system and security of property rights; access to sound money; freedom to trade internationally; and regulation of credit, labour and business.

In 2006, the SADC member states adopted a Protocol on Finance and Investment, which entered into force in 2010.  Annex 1 to the Protocol requires that all SADC States must–

- harmonise their investment regimes, including policies, laws and practices, in accordance with international best practice;

- establish predictability, confidence, trust and integrity by adhering to and enforcing open and transparentinvestment policies, practices, regulations and procedures;

- create favourable conditions to attract investments in its territory through suitable administrative measures and expeditious clearance of authorisations;

- not expropriate or nationalise property without a public purpose, a non-discriminatory basis, due process of law and prompt, adequate and effective compensation;

- afford foreign investors fair and equitable treatment, no less favourable than that granted to investors from any other state;

- facilitate the repatriation of investments and returns and encourage the free movement of capital;

- ensure that investors have access to the courts, as well as recourse to international arbitration, after the exhaustion of local remedies.

The Preamble to Annex 1 records the rationale for making these binding undertakings:

RECOGNISING the increasing importance of the role played by investment to advance productive capacity and increase economic growth and sustainable development and the importance of the link between investment and trade; 

CONCERNED with the low levels of investment into the SADC, even though a number of measures have been taken to improve the investment environment; …

CONSCIOUS that without effective policies on investment protection and promotion, the Region will continue to be marginalised in terms of investment inflows and sustainable economic development; …

After the adoption of the SADC Protocol, Mauritius took an immediate lead in improving its investment climate:

- Since 2007, Mauritius has concluded at least twelve new BITs (at least six of which have entered into force).

- In 2008, Mauritius enacted an International Arbitration Act, adopting the UNCITRAL Model Law, the global gold standard for the resolution of commercial disputes.

- In 2009, Mauritius effectively replaced South Africa as the Hague-based Permanent Court of Arbitration’s Regional Facility for Africa.

- In 2011, the government announced a “new economic diplomacy initiative to position Mauritius as the preferred gateway for investment into Africa”.

- Since 2011, Mauritius has annually updated its Investment Promotion Act of 2000, establishing a dedicated Board of Investment, to improve the investment environment and promote Mauritius as an attractive base for investments.

- In July 2011, the government concluded an agreement with the London Court of International Arbitration for the establishment of the LCIA-MIAC Arbitration Centre, which won the Global Arbitration Review award for an up-and-coming regional arbitral institution in 2015, and hosted the prestigious International Council for Commercial Arbitration Congress earlier this year.

At the regional level, the harmonised implementation of the SADC Protocol on Finance and Investment entailed two streams of work: the development of a SADC Model BIT; and the development of an SADC Investment Policy Framework.

In June 2012, the drafting committee completed the SADC Model BIT Template, to be used by SADC States “as a basis for developing their own specific Model Investment Treaty or as a guide through any given investment treaty negotiation”.

Also in 2012, SADC engaged the assistance of the OECD in developing a SADC Investment Policy Framework.  Workshops over the next three years yielded the following basic norms: 

- strengthening security and protection of investors’ property rights;

- providing well-defined rights for land access and use;

- reducing and refining restrictions on foreign investment;

- facilitating private participation in infrastructure investments and promoting good governance of state-owned enterprises;

- building a coherent and transparent investment environment;

- ensuring responsible and inclusive investment for development.

Both streams of work have, however, been undermined by the South African government, which has unilaterally undertaken measures that are irreconcilable with the SADC Protocol:

- Despite the SADC Model BIT being completed in June 2012, for the very purpose of negotiating and renegotiating more balanced BITs, South Africa instead, only two months later (in August 2012), commenced a campaign of unilaterally terminating all of its BITs with EU Member States, as well as Switzerland.

- And, despite the SADC Investment Policy Framework being due for completion in November 2015, South Africa inexplicably rushed the Protection of Investment Bill through Parliament in September and October 2015.  The Bill, which became an Act after signature by the President in December 2015 (but has not yet entered into force), is in conflict with key provisions of the SADC Protocol (notably, fair and equitable treatment, prompt market value compensation for expropriation, and investor-state international arbitration). 

- The government admitted this and asserted that the Protocol would thus be amended to accord with South Africa’s domestic law.  As a result, the SADC Investment Policy Framework apparently no longer has any foreseeable date for completion, and the project of harmonising the region’s investment regimes has been halted indefinitely.

In the ten years since the SADC Protocol was adopted, South Africa has been left far behind by Mauritius as the top African economy on each of the three indices identified earlier:

- On the World Economic Forum’s Global Competitiveness Index, while South Africa fell from 35th place in 2006 to 50th in 2011 and 47th in 2016, Mauritius climbed from 55th place in 2006 to 54th in 2011 and 45th in 2016.

- On the World Bank’s Ease of Doing Business ranking, while South Africa fell from 29th place in 2006 to 35th in 2011 and 74th in 2016, Mauritius climbed from 32nd place in 2006 to 23rd in 2011 but fell to 49th in 2016 (still the top African economy).

- On the Fraser Institute’s Economic Freedom of the World index, while South Africa fell from 71st place in 2005 to 105th in 2014 (the year under review in the 2016 report), Mauritius climbed from 31st place in 2005 to 5th place in 2014.

EXTRACTS FROM SELECTED SOURCES

Daron Acemoğlu & James A. Robinson, An African Success Story: Botswana, 11 July 2001

Botswana has had the highest rate of per-capita growth of any country in the world in the last 35 years. This occurred despite adverse initial conditions, including minimal investment during the colonial period and high inequality. Botswana achieved this rapid development by following orthodox economic policies. How Botswana sustained these policies is a puzzle because typically in Africa, “good economics” has proved not to be politically feasible. In this paper we suggest that good policies were chosen in Botswana because good institutions, which we refer to as institutions of private property, were in place. 

Why has Botswana been so successful? Botswana did not start out with favourable initial conditions at independence. When the British left, there were 12 kilometers of paved road, 22 Batswana who had graduated from University and 100 from secondary school.  Botswana is a predominantly tropical, landlocked country (which many economists see as a disadvantage, e.g., Bloom and Sachs, 1998). It is true that diamonds have been important for growth in Botswana, and currently account for around 40 percent of the country's output. Yet, in many other countries, natural resource abundance appears to be a curse rather than a blessing (e.g., Sachs and Warner, 1995). So how did Botswana do it? 

There is almost complete agreement that Botswana achieved this spectacular growth performance because it managed to adopt good policies. The basic system of law and contract worked reasonably well. State and private predation have been quite limited. Despite the large revenues from diamonds, this has not induced domestic political instability or conflict for control of this resource. The government sustained the minimal public service structure that it inherited from the British and developed it into a meritocratic, relatively non-corrupt and efficient bureaucracy. The parastatal sector has never been large and to the extent it has existed, it has faced hard budget constraints.

World Economic Forum, Global Competitiveness Report 2016–2017, 28 September 2016

Mauritius (ranking 45th) and South Africa (47th) remain the region’s most competitive economies, climbing two places and one place, respectively. South Africa maintains its regional leadership in terms of financial markets, competition, infrastructure, and education, despite recent challenges from exchange rate volatility, governance concerns, and policy uncertainty, as reflected in the institutions pillar.

Botswana also gains five places thanks to a better performance in infrastructure, higher education, and goods market efficiency.

Zambia’s decline [22 places to 118^th] is driven by difficulties in public finance and a lower performance in institutions, infrastructure, and goods market efficiency. The country has been affected this year by power shortages, low copper prices, and political uncertainty ahead of August’s elections.

UNCTAD, World Investment Report 2016, 22 June 2016

FDI flows to Africa fell to $54 billion in 2015, a decrease of 7 per cent over the previous year. … Lacklustre economic performance pushed FDI to a low level in South Africa, traditionally one of the top recipients in the region. Despite the depressed global economic environment, FDI inflows to Africa are expected to rise in 2016, due to liberalization measures in the region and some privatization of State-owned enterprises.

Weak commodity prices weighed on FDI to Sub-Saharan Africa. In the Democratic Republic of the Congo, flows declined by 9 per cent to $1.7 billion, and large investors such as Glencore (Switzerland) suspended their operations.

After several years of negative flows, [Angola] attracted a record $8.7 billion of FDI in 2015, becoming the largest recipient in Africa. This jump was largely due to loans provided to local affiliates by their foreign parents. Declining oil prices – oil accounts for roughly 52 per cent of government revenues and 95 per cent of export earnings – as well as the depreciating national currency and rising inflation have severely affected Angola’s economy. Consequently, foreign affiliates in the country increased their borrowing from their parent companies to strengthen their balance sheets. Nevertheless, expansion in energy-related infrastructure continued to occur: Puma Energy (Singapore) opened one of the world’s largest conventional buoy mooring systems in Luanda Bay.

FDI into South Africa, by contrast, decreased markedly by 69 per cent to $1.8 billion – the lowest level in 10 years – owing to factors such as lacklustre economic performance, lower commodity prices and higher electricity costs. Divestments during the first quarter from noncore assets in manufacturing, mining, consulting services and telecommunications contributed to the decline in FDI. Even excluding divestments, however, inflows were considerably lower than in 2014, owing to the economy’s continued reliance on mineral-based exports.

After years of record inflows, FDI to Mozambique declined in 2015. Yet the country attracted a still considerable $3.7 billion, which – though 24 per cent lower than 2014 inflows – still made it the third largest FDI recipient in Africa. The decline was due primarily to uncertainty related to the 2015 elections and low gas prices. In addition, the mining giant Anglo-American (United Kingdom) closed its office in Mozambique in 2015, 18 months after cancelling the $380 million purchase of a majority stake in a coal asset in the country. Intra-African FDI, however, helped support investment to the country: for example, Sasol (South Africa) announced it would build a second loop line to move gas from Mozambique to industrial customers in South Africa. 

FDI flows in Zambia declined by 48 per cent to $1.7 billion, as electricity shortages and uncertainties related to the mining tax regime continued to constrain FDI into the mining sector. Lower prices for copper (which accounts for over 80 per cent of Zambia’s exports), the collapse of the national currency and surging inflation all affected reinvested earnings.

FDI flows to Mauritius contracted by 50 per cent to $208 million, although this is likely to be only a hiatus. For instance, a record high investment of $1.9 billion (for the next five years) was recently approved. In addition to weaker investment flows to hotels and restaurants, a slowdown in the construction industry suggests reduced foreign investments in high-end real-estate projects, where more than 40 per cent of FDI flows had been generated. Seychelles also registered negative FDI growth (down 15 per cent to $195 million).

Reflecting recent global trends of rising FDI flows from emerging markets observed in developing countries, half of the top 10 investors in Africa were from developing economies, including three BRICS countries: China, South Africa and India. China’s FDI stock increased more than threefold from 2009 to 2014, as China overtook South Africa as the largest investor from a developing country in the region. Developed economies, led by the United Kingdom, the United States and France, remain the largest investors in the continent.

FDI outflows from Africa fell by 25 per cent to $11.3 billion. Investors from South Africa, Nigeria and Angola reduced their investment abroad largely because of lower commodity prices, weaker demand from main trading partners and depreciating national currencies. South Africa, which continues to be the continent’s largest investor, reduced its FDI outflows by 30 per cent to $5.3 billion. Similarly, investors from Angola reduced their investment abroad by 56 per cent to $1.9 billion, down from $4.3 billion in 2014. In both countries, there was a marked decline in intracompany loans, as parent firms withdrew funds or their foreign affiliates paid back loans to strengthen corporate balance sheets at home.

Issued by Peter Leon, Partner and Co-Chair: Africa Practice, Herbert Smith Freehills, 12 December 2016