South Africa - Second Electricity Supply Commission (ESCOM) Project

P-50 'FILE COPY RESTRICTED This report is restricted to use within the Bank. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON TWO PROPOSED LOANS one to THE UNION OF SOUTH AFRICA and the other to THE SOUTH AFRICAN ELECTRICITY SUPPLY COMMISSION August 20, 1953  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMNT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON TWO PROPOSED LOANS, ONE TO THE UNION OF SOUTH AFRICA AND THE OTHER TO THE SOUTH AFRICAN ELECTRICITY SUPPLY COMMISSION 1. I submit the following report and recommendations on the applications of the Union of South Africa and the South African Electricity Supply Com- mission, respectively, for loans totalling $60 million. The Union of South Africa has applied for $30 million to finance in part a program for expand- ing the capacity and improving the equipment of the South African Railways, and the E'lectricity Supply Commission has applied for $30 million to expand its generating capacity and transmission system. PART I - HISTORY OF NEGOTIATIONS 2. In January'1951, the Bank made two loans to South Africa, one of A20 million to the Government for the railways, and one of .30 million to the Electricity Supply Commission (ESCOM) guaranteed by the Government. At the same time, the Government obtained a short-term loan from New York banks of $10 million, also for the railways. These loans were to cover the estimated import requirements of the railways and ESCOIM during 1951 and 1952. 3. In February of 1952 Mr. Havenga, the South African Minister of Finance, wrote to the Bank stating his country's needs for external capital and asking whether the time was opportune to submit requests for further loans for power and transport development. As a consequence of this inquiry, it was agreed that the Bank should send a small mission to South Africa to examine the general position before entering into discussions of loan pro- posals. This mission, which was postponed for a time at the request of South Africa, arrived in the Union in October 1952. 4. After considering the report of this mission, I came to the con- clusion that if suitable projects were put forward, I would be prepared to recommend that the Bank lend further to South Africa to promote development. The South African Government were informed of this conclusion and after some Drelimina*y conversations between the Management and the South African Ambassador in Washington, a second mission was dispatched to the Union to examine projects and negotiate agreements for financing them.  -2- 5. Negotiations took place in South Africa during late July. The negotiators for the Government were Dr. D. H. Steyn, Secretary for Finance, and Mr. G.-X. G. Browne; and the negotiators for ESCOM were Mr. G. R. D. Harding, General Manager, and Mr. R. K. Gregor, Secretary. PART II - DESCRIPTION OF THE PROPOSED LOANS A. Transport Project Loan The Borrower 6. The Borrower would be the Union of South Africa, a member of the Bank. South Africa's existing direct and contingent obligations to the Bank on account of the loans made in 1951 amount to about $50 million. Purpose 7. The purpose of the loan would be to assist the South African Rail- ways in carrying out that part of its expansion and re-equipment program which is to be in progress during the three years between March 1953 and March 1956. The estimated cost of the program in these three years is about fSA 92.5 million (5260 million). Amount 8. The amount of the loan would be the equivalent in various currencies of $30 million. Terms 9. The loan would be amortized by seventeen equal semi-annual payments designed to retire the loan by its maturity. The first payment would be due on November 15, 1955, and the last on November 15, 1963. The sum of the interest and repayment due each half year would decrease from about $2.5 million in 1955 to about $1.8 million in 1963. 10. The loan would bear interest, including 1% commission, at the rate of 4-3/4% per annum. The first date for the payment of interest and other charges would be November 15, 1953. 11. There would be a commitment charge of 3/4% per annum. B. ESCOM Project Loan The Borrower 12. The Borrower would be the Electricity Supply Commission (ESCOM), an autonomous state corporation. ESCOM has an existing loan from the Bank which will amount to the equivalent of $30 million when it is fully with- drawn. ESCOM was established in 1922 for the purpose of producing and  - 3- supplying electricity cheaply and abundantly. Its present capital is about ISA 90 million ($250 million) and it provides about three-quarters of all the electric power produced in South Africa. Guarantor 13. The Guarantor would be the Union of South Africa. Purpose 14. The purpose of the loan would be to assist ESCOM in carrying out its program for increasing its generating capacity and transmission facili- ties. Amount 15. The amount of the loan would be the equivalent in various currencies of -730 million. Terms 16. The loan would be amortized by seventeen semi-annual payments designed to retire the loan by its maturity. The first payment would be due on September 15, 1955, and the last on September 15, 1963. The sum of the interest and repayment due each half year would be about 12.2 million. 17. The loan would bear interest, including 1% commission, at the rate of 4-3/4% per annum. The first date for the payment of interest and other charges would be March 15, 1954. 18. There would be a commitment charge of 3/4% per annum. PART III - DESCRIPTION OF THE PROJECTS 19. Full descriptions of the South African Railways and ESCOM and of their development programs will be found in technical reports on "The South African Railways' Development Program" and on "The Electricity Supply Com- mission Project" dated August 17, 1953, which are attached hereto. South African Railways and Harbours Administration 20. The South African Railways and Harbours Administration is a govern- ment department charged w7ith operating the country's railways, harbors, air transport, and ancillary services such as road motor transport. It employs about 200,000 persons and operates about 13,000 miles of railway, six major ports, a fleet of twenty-six aircraft, and a fleet of about two thousand motor vehicles. Its capital stands at almost ESA 400 million (about 1,100 million).  21. Since the end of the war, the South African Railways and Harbours Administration has been engaged in a program of expansion which would enable the railways to meet the increased demand for transport caused by the rapid economic development of the past ten years. This program has now reached its peak and, as mentioned above, will cost about fSA 93 million during the three years ending in March 1956. About a third of this expenditure will be for rolling stock and locomotives, another third will be for new struc- tures (mainly workshops) and their equipment, and most of the remainder will be for new and improved lines and ancillary works such as marshalling yards. 22. It is planned that, as in the past, most of the finance required for this development program will be provided by borrowing, but perhaps as much as 10% of the requirements will be found from revenues. As a government department, the Railways and Harbours Administration does not itself borrow, but is provided with- capital from the proceeds of government borrowings and it assumes the interest charges applicble to these borrowings. The proceeds of the Bank's loan to the Government would be allotted to the Administration on this basis. The loan would finance in part the Administration's whole program for the three years specified. The particular goods which would be paid for out of the loan would be imports required for the program. It is contemplated that most of these imports would come from the United Kingdom. Electricity Supply Commission 23. ESCON is a statutory state corporation engaged in the supply of electricity to all classes of consumers. Its operations are split up into a number of regional "undertakings" each of which ESCOIM is obliged to run on a business basis but without making either a profit or a loss. To ensure that costs (including loan charges and redemption) are met, ESCOIVl has the power to place surcharges on the rates of an undertalcing at any time. 24. Faced with heavy demands for power from expanding mining and secondary industry, ESCOM since the war has been engaged in an extensive program for increasing its generating and transmission capacity. This involves extend- ing existing stations and lines and building new ones. Despite strenuous efforts, it has not been able to keep up with demand and still has to resort to frequent "load shedding" (or "power cuts") in some areas. Its present construction program (which is scheduled to be completed by 1958) is estimated to meet the existing and projected demand calculated on a con- servative basis. This program consists of building eight newi power stations, extending six existing stations, and constructing about 900 miles of trans- mission lines. The new generating capacity will add about 1400 megawatts to ESCOM's present capacity, an increase of over 80%. This program will cost about ESA 74 million (about S207 million). 25. Until 1951 ESCOM obtained all its capital by borrowing on the South African market and it still counts on this market for the greater part of its requirements. In the last two years, however, it has twice borrowed abroad - once from the Bank and once from the Extort-Import Bank of  -5 - Washington, and like these borrowings, the proposed borrowing from the Bank is intended to supplement rather than replace recourse to the local market. 26. The Bankts loan would finance in part ESCOM's whole development program as now authorized and the proceeds of the loan would be spent for imports, most of which are expected to come from the United Kingdom. PART IV - APPRAISAL OF THE PROPOSED LOANS 27. A Report on the Economy of South Africa dated August 17, 1953, is attached hereto. It describes and appraises the present economic situation in South Africa and provides the basis for a judgment of South Africa's need for the loans and of her ability to service them. The Need for the Loans 28. In the years since the war, South Africa has witnessed a sustained investment boom arising from a rapid growth of secondary industry and the establishment of a new gold mining area in the Orange Free State. All this activity has strained the public services, particularly the railway system and the power supply. Between 1950 and 1952 railway traffic increased by 13% and power production by 17%, yet neither the Railways nor ESCOM were able to keep up with the increasing demand. Iloreover, the demand for power has recently been further increased by the establishment of uranium recovery plants operated in conjunction with the gold mines. 29. The programs of the Railways and Harbours Administration and ESCOM are designed to meet these needs and are soundly conceived. I am satisfied that both organizations are technically and administratively competent to carry out their programs effectively. 30. South Africa's internal savings are not yet sufficient to maintain the rate of investment at the level of the last few years and the country must still look abroad for capital. The United Kingdom, to which the South African Government has traditionally looked for additional funds, is not now in a position to take care of the Union's needs and as a matter of policy the South African Government has not pressed its claims in London. As an alternative, therefore, it has applied to the Bank for assistance. 31. M4ost of the imports required for the two projects will be purchased in the United Kingdom and hence the loans will be disbursed mainly in sterling. It is proposed to buy this sterling with other currencies, primarily dollars; South Africa's obligation to the Bank would then be in the currencies used in buying this sterling. This procedure is in keeping with the Bank's present policy of conserving its non-dollar currencies, such as sterling, for those borrowers who would find it arduous to service dollar debt. South Africa is in the fortunate position of being able to service debt in dollars as readily as debt in any other currency. The procedure proposed is identical to that followed by the Bank under its earlier two South African loans.  - 6 - Prospect of Fulfillment of Obligations by ESCOM 32. ESCOM is required by law to carry on its operations in such a way as to cover its costs, including debt service, out of its revenues. Where costs rise, it has the power to increase rates proportionately. It is a well managed enterprise with a pound reputation and long experience and its needs have always received quick and sympathetic attention from the Government. I am satisfied that ESCOM will be able to fulfill its obliga- tions to the Bank. Prospect of Fulfillment of Obligations by South Africa 33. South Africa is well placed to undertake the additional indebtedness proposed. The country's public external debt amounts to about fSA 85 million (0240 million). About two-thirds of it is repayable in dollars, Swiss francs, or gold. Debt service is not a large item in the Union's balance of payments. Even at their heaviest (in 1954) debt charges will be less than 5% of estimated annual earrings of foreign exchange over the next year or two. Yoreover, these earnings are likely to increase significantly as the new gold mines in the Orange Free State and the new uranium extraction plants come into full production. 34. In recent years large amounts of foreign capital have flowed into South Africa. This flow has made rapid development possible but has also brought the strains of inflation. Now, however, South Africa's internal savings are increasing and to a significant extent they may be able to replace this capital inflow. It is, of course, possible that the sum of imnorted capital and local savings will not be enough to permit expansion to continue on the same scale as for the last fewf years, but this need not be unhealthy and there is no reason to believe that South Africa's ability to meet her obligations would be affected by a slower rate of development. 35. South Africa's prosperity depends on there being viable working relationships between the European, Asian, and native African inhabitants. One of the risks inherent in any lending in South Africa is that inter- racial tensions might emerge which would seriously disrupt these relation- ships and would impair the economic stability of the country. How relations between the races will evolve in the next decade is impossible to say. Much depends on the way the problem is handled. I believe, however,-that South Africa is not likely to be so disturbed by racial tensions as to make her unable to fulfill her obligations in respect of the proposed loans. PART V - LEGAL DOCUMENTS AND AUTHORITY A. Electricity Supply Commission 36. A draft Loan Agreement between the Electricity Supply Commission and the Bank is attached. This draft agreement incorporates Loan Regula- tions No.4 dated October 15, 1952, and follows the normal pattern. Before  - 7 - the Loan Agreement can become effective, ESCOM is required to submit to the Bank, in addition to the usual legal opinions as to the validity of the loan, a government legal opinion confirming ESCOM's statutory powers to increase rates to cover costs. 37. A draft Guarantee Agreement between the Union of South Africa and the Bank is also attached. It follows the usual pattern except that it contains a clause under which the Government undertakes to permit ESCOM to borrow in the local market amounts needed by it to carry out the project and to sell foreign exchange to ESCOM as required for that pur- pose (Section 3.06). 38. Under the Electricity Act, 1922, as amended, ESCOM is empowered to borrow from the Bank and the Government is specifically empowered to guarantee such loans. The Act is, however, to be slightly amended to overcome an inadvertent omission in the existing wording. B. The Transport Project 39. A draft Loan Agreement between the Union of South Africa and the Bank is attached. This draft agreement incorporates Loan Regulations No.3 dated October 15, 1952. The agreement follows the normal pattern. 4o. Legislation enabling the Govermnent of the Union of South Africa to borrow from the Bank has been enacted by the South African Parliament. PART VI - COiPLIANCE IITH ARTICLES OF AGREEMENT h1. The report of the CoiTnittee provided for in Article III, Section 4(iii) of the Articles of Agreement of the Bank is attached. 42. I am satisfied that the proposed loans comply with the Articles of Agreement of the Bank. PART VII - RECOMIvENDATIONS 43. I recommend that the Bank at this time make a loan to the Union of South Africa amounting in various currencies to the equivalent of $30,000,000, and a loan to the Electricity Supply Commission amounting in various cur- rencies to the equivalent of $30,000,000, each for a total term of about 10 years, with interest (including commission) aty:f3/% per annum, and on such other terms as are specified in the respective fd6ms of Loan Agreements and Guarantee Agreement attached hereto. Eugene R. Black August 20, 1953