South Africa - Seventh Transport and Third Electricity Supply Commission (ESCOM) Power Projects

L4V- 304 5f3 R E S T R I C T E D Report No. P-269 FILE COPY This report was prepared for use within the Bank. It may not be published nor may it be quoted as representing the Bank's views. The Bank accepts no responsibility for the accuracy or completeness of the contents of the report. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON TWO PROPOSED LOANS, ONE TO THE REPUBLIC OF SOUTH AFRICA AND THE OTHER TO THE SOUTH AFRICAN ELECTRICITY SUPPLY COMMISSION November 21, 1961  REPORT AND RECO=ENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON TtIO PROPOSED LOANS, ONE TO THE REPUBLIC OF SOUTH AFRICA AiND THE OTHER TO THE SOUTH AFRICAN ELECTRICITY SUPPLY C014ISSION 1. I submit the following report and recommendations on two proposed loans for a total amount in various currencies equivalent to $25 million* One loan of $11 million would be made to the Republic of South Africa to finance part of the improvement and expansion program of the South African Railways. Another loan of $14 million to the Electricity Supply Commission would help to expand its generating capacity and transmission system. PART I - HISTDRICAL 2. The Bank has made eight loans to South Africa aggregating the equiva- lent of $,1;i96.8 million. The status of the loans as of October 31, 1961 was as follows: Year Borrower Purnose Amount (equivalen in $ million) 1951 Union of South Africa Transport 20.0 1951 Electricity Supply Commission Electric power 30.0 1953 Union of South Africa Transport 30 0 1953 Electricity Supply Commission Electric power 30,0 1955 Union of South Africa Transport 25.2 1957 Union of South Africa Railway improvements 25.0 1958 Union of South Africa Railway improvements 25DO 1959 Union of South Africa Railway improvements 11.6 Total 196.8 of which has been repaid 78.3 Total now outstanding 118.5 Amount sold 82.8 of twhich has been repaid 59.2 23.6 Net amount now held by Bank 94.9 3. In the spring of 1958 I informed the South African Government that I would be willing to recommend to the Executive Directors loans up to a total amount of (Y50 million for projects in South Africa, to be matched by an equal sum raised by the Government in the financial markets of the world. Pursuant to this arrangement the Bank made two loans totalling $36.6 million in 1958 and 1959, matched by a $25 million Government bond issue in the New York market and an $11.6 million issue by ESCOM in Switzerland. Toward the end of last year, the South African Government informed me that since they no longer found it possible to raise money in the private markets, they hoped that the Bank would consider additional lending in the amount of around 5;i25 million to complete the $100 million program which had originally been contemplated. The two loans which are presented herewith would meet this request.  - 2 - 4, The Government requested the Bank to consider loans for the railways and the electric power system. A mission visited South Africa in March and April of this year to appraise these projects and the economic situation. PART II - DESCRIPTION OF THE PROPOSED LOANS A., Railwav Loan Borrower: The Republic of South Africa, Amount: The equivalent in various currencies of $11 million. Amorti7atior: In 17 semi-annual installments beginning December 1, 1963 and ending December 1, 1971. Interest Rate: 5-3/4%, inclutding 1% commission. Commitment Charge. 3/4 of 1%. Purnose_ To finance part of the development program of the South African Railway (ShKH) B. ESCOM Loan Borrower: The Electricity Supply Commission (ESCOM). Guarantor: The Republic of South Africa. Amount: The equivalent in various currencies of ,1P14 million, Amortization: In 17 semi-annual installments beginning December 1, 1963 and ending December 1, 1971. Interest Rate: 5-3/4%, including 1% commission, Commitment Charge: 3/4 of 1%. Purpose. To finance part of ESCOMts power expansion program. PART III THE RAILWAY LOAII 5. An appraisal report on the project for the improvement of South African Railways - No. TO-297b - is attached (No.1 ).  - 3 - 6. The South African Railways and Harbours Administration is a govern- ment department under the Ministrv of Transport. It operates the railway system, the harbours and the airways together with ancillary services such as road transport. To keep pace with the economic development of the country the railways have been engaged in a large program of expansion and mcderni- zation since 194p7. This program has included the construction of new lines, the increase of line capacity bv double-tracking, tbe expansion of rolling stock including motive power, the electrification or dieselization of certain lines and other associated improvements. Between 1950 and 1960 about 1,1.45 billion equivalent was invested in this program and the Bank participated with six loans amounting to (136S million equivalent or nearly 10% of the program, 7. The program for 1960-65 has the same basic elements as the previous programs, with emphasis on increasing capacity to meet traffic demands, on improving efficien,zy and on decreasing costs. Th3 whole program will cost about $340 million equivalent, of which about two-thirds will be provided in the form of governm.ent loans and the remainder from the railwayst owin resources. The proposed prolect covers the 1961/62 and 1962/63 part of the railway program and the 3ank's loan will provide part of the foreign exchange requirei-nents for this period. Orders for imported equipment will be or have been, placed after international cormpetitive bidding. 8. The South African Railways have generally earned sufficient revenue to cover their operating costs, including adequate depreciation, and inter- est. In 1958/59 the railways incurred a small deficit, largely owing to a general fall in business activity. But in the two most recent years an improvement in traffic, some increase in tariffs and ilower operatirg expenses enabled the railways to produce net surpluses. In 1959/60 the interest paid on total capital (predominantly government loan capital) was 3,4% and it was earned abouti two times. There is every reason to believe that the railways will continue to be financially self-supporting. 9. Further investment in railways is essential for South Africa's economic growth. Eighty percent of the railway freight is bulk traffic between the industrial and mining areas of the Transvaal and the ports and agricultural areas. Virtually none of this traffic could be carried more economically by other means of transportation. The expansion pro- gram is justified by the expected increase in traffic and the operational economies arising from improved lines and yards, electrification and dieselization. PART IV - THE ESCOM LOAN 10. An appraisal report cn the power expansion program of the Elec- tricity Supply Commission (ESCOM), No. T0-295b is attached (No. 2). 11. ESCOM is a statutory authority established in 1922. Its principal function is to generate and supply electricity to all classes of consumers and it now provides about three-quarters of all the electricity used in  - 4 - the country. It has a competent staff and its various electric systems are well maintained and efficiently operated. 12. Over the last ten years, its sales of energy increased at an average annual rate of 8,8% and it is engaged in an extensive program for increasing its generating and transmission capacity. Its presen-t program is estimated to meet the existing and projected demrand, calculated on a conservative basis. This prograin, which covers the period 1960-64. inclusive consists of extending four existing power stations, building two new ones and construct- ing about 3,550 circuit miles of transmission lines. rne new power stations, like the old ones, will be thermal, taking advantage of local low-cost coal. The new generating capacity will add 1,395 megawatts to ESCOMts capacity, an increase of close to 40%, This program is estinated to cost about R 196 million (3274 million)O 13. ESCUMI1s operations are divided into a number of regional undertakings wrhich serve different parts of the countryv The proposed project, which forms part of the program described above, is concerned with the expansion of the Cape Northern-Rand and Orange Free State - Eastern Transvaal inter- connected system. The project consists of the completion of the first stage of the Komati power station in the Eastern Transvaal and the expansion of the Hg . ld power station in the Orange Free State together with ...>sociated transmission lines and substations, This will add 870 114 to the s-.stem. The total cost of this project is estimated at $?122.5 million equ-alent of which $34.35 million will be required in foreign exchange. The Bank's loan of ';14 million provides the foreign exchange required from July 1, 1961 to the end of 1962 or early 1963. Orders for the plant and equipment requlired for the project will be, or have already been, placed after international competitive bidding. Contracts for construction work are also placed after bids are received from a number cf contractors. 14. The Cape Ncrthern-Rand and Orange Free State -- Eastern Transvaal system is by far the largest of the ESCOM group and serves the principal industrial ard mining areas of South Africa. The Rand and Orange Free State area includes the heart of the goad mining industry as well as the largest center of manufacturing industry in the country. The Northern Cape includes the Kimberley diamond mining area and it also produces iron ore, asbestos, limestone and manganese, In the Eastern Transvaal new gold mines have recently been opened and large coal deposits have attracted newr industries. M1arket forecasts prepared by ESCOM in cooperation with representatives of the mines, industry and the railways indicate an average annual increase of the peak load on the system of about 7.5% over the next five years, The additional investlment represented by the project is thus amply justified. 15. ESCO1l's capitalization consists of debt equivalent to $'371 million due partly to its bondholders and partly to public agencies like the Bank, and of reserves, provided out of earnings, equivalent to $33 million, The Electricity Act, wihich governs ESCOM's operations, requires that each of its undertakings be operated so as to earn revenues sufficient to cover  - 5 - operating costs (excluding depreciation), interest on debt and contributions to a debt redemption fund and a reserve fund. In practice, contributions to the redemyption fund are calculated to retire loans at the end of 25 years. Since ESCOM's assets can be assumed to have a life of 30 to 35 years, the result has been the generation of substantial net earnings which have estab- lished ESCOM in a sound financial Dosition and have enabled it to raise successfully the large amounts of capital required for expansion. I am confident that ESCOM will be able to fulfill its obligations to the Bank. PART V - LEGAL INSTRUIIENTS AND AUTHORITY The Railwav Loan 16. A draft Loan Agreement between the Republic of South Africa and the Bank, to which Loan Regulations No. 3 dated February 15, 1961 would be applicable, is attached (No0 3), The draft Agreement follows the Bank's normal pattern and is similar to previous Loan agreements with South Afr4ca. The ESCOM Loan 17. AUtached are a draft Loan Agreement between the Electricity Supply Commission and the Barnc (No.4 ) and a draft Guarantee Agreement be;ween the Republic of South Africa and the Banl (No.5 ). Loan Regulations 1(o, 4 dated February 15, 1961 would apply to these Agreements, which follow the Bank's normal pattern and are similar to the Agreements relating to the Bank's previous loans to ESCOM. lS. As an additional condition to the effectiveness of the Loan, the Bank would receive legal opinions froom the Government and from ESCOM con- firming ESCOMIs statutory powers to increase rates to cover costs (Section 7.02, Loan Agreement). The Guarantor would undertake that ESCOMI will continue to have these powers during the life of the Loan (Section 3.07, Guarantee Agreement). The Guarantor would also undertake generally to do everything necessary to enable ESCOM to perform its obligations under the Loan Agreement and, in particular, 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 purpose (Section 3.06, Guarantee Agreement). 19. The report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Barik is attached (No. 6). This report covers both the loans.  - 6 - VI - THE ECONOjAIC SITUATION 20a A report on the current economic position and prospects of South Africa is attached (No. 7). 21, Since the last economic report was circulated to Executive Direc- tors in November 1958, the South African economy has had to face problems which have brought about a situation significantly different from that which had existed during most of the post-war period. Since 1955 or 1956 the rate of growth has been somewhat slower than it was in the early tfifties (when it was unusually high). This appears to have been due mainly to a leveling off in private investment arising from a number of causes including a reduced inflow of capital, a temporary exhaustion of investment opportunities and the completion of the opening up of the new gold fields in the Orange Free State. In recent budgets the Government has introduced a number of measures to stimulate private investment. However, in the last two years its efforts have been greatly handicapped by the general atmosphere of uncertainty both in the continent of Africa generally and within South Africa itself. This led to a substantial out- flow of capital in 1960 and the first half of 19610 22. Already in 1959 there had been some outward movement of pri.vate capital from South Africa but in 1960 the outflow increased great ;4r. The consecuent rapid decline in foreign e.x:change reserves presented tihz authorities with a difficult problem, since the restrictive monetary and credit policy which would have been appropriate to deal with the falling exchange reserves would have run counter to the Goverinent's desire to encourage private investment. In any event, the desirability of external borrow-ng was obvious, both from a foreign exchange and an investmnent point of view. 23. By June 1961 more severe direct controls o-rer the movement of private capital had to be introduced. The most important step taken was to require that the proceeds of sales of shares by non-residents to residents be credited to blocked accounts and used only for the purchase of other South African shares. The measures have proved quite effective and the Reserve Bank's foreign exchange holdings have risen by R 66 million to R 306 million by October. 24. The South African Government has an excellent debt record. Its external public debt is low, amounting at June 30, 1961 to W4O3 million equivalent. Annual service on this debt amounts to less than 4%, of present gross foreign exchange earnings, The annual value of gold production now amounts to twice the amount of the public external debt, Although South Africa faces nur1 problems with regard to capital supply and economic growth, the burden of indebtedness, including the loans here proposed, should be manageable.  - 7 - 25. In previous reports I have drawn attention to the possibility of interracial strife as one of the risks inherent in lending to South Africa. Recent events in Africa, and in South Africa itself, have centered attention on this possibilitry, Nonetheless I believe that the South African Governlment should be able to fulfill its obligations under the proposed agreements. PART VII - COIPLIAANCE WITH ARTICLES OF AGREEiENT 26. I am satisfied that the proposed loans comply w-ith the requirements of the Articles of Agreement of the Bank. PART VIII - REC01EINDATIONS 27. I recommend that the Bank at this time make a loan to the Republic of South Africa amnounting in various currencies to the equivalent of k11 million and a loan to the Electricity Supply Comnission amounting in various currencies to the equiva'ent of 4$14 mil.lion, each for a total term of about 10 years with interest (including commission) at 5-3/4% per ann-m, and on such other terms as are sDecified in the respective draft Loan and Guarantee Agreements attached hereto, and that '-he Executive Directors adopt resolutions to that effect in the forms attached (Ino. 8 and No. 9). Eugene R. Black President Attachments Washington, D. C. November 21, 1961