South Africa - Fourth Transport Project (Vol. 1 of 2) : Main report

R E S T R I C T E D 114F1 tCOPY Report No. P-140 This report was prepared for use within the Bank. In making it available to others, the Bank assumes no responsibility to them for the accuracy or completeness of the information contained herein. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS of the PRESIDENT to the EXECUTIVE DIRECTORS on a PROPOSED LOAN TO THE UNION OF SOUTH AFRICA September 4, 1957  2ITMFATIONIAL BAMK FOR RECONSTRhCTION Ai)D LEVELOPMENT REPORT AID RECO&IMLNDATIONTS OF THE PRESIDEINT TO THE EXECUTIVE DIRECTORS ON A PROPOS10 LOANJ TO THE UNIOIN1 OF SOUTH AFRICA 1. I submit the following report and recommendations with regard to an application from the Union of South Africa for a loan in various currencies equivalent to $25 million. PiART I - HISTORICAL 2. The prospect of further borrowing by the Union in 1957 was first raised at the Bank's Annual Mleeting in September, 1956. In subsequent discussions with the Union and with Dillon, Read & Co. Inc. (the Unionts Net.y York bankers) the possibility of borrowing a total of 050 million was explored. Half of this would be borrowed from the Bank and half would be borrowed in the market, X15 million of it in the form of a public issue of the Union's bonds and 0'$O mil1ion in the forn of a credit from commercial banks. 3. A mission from the Banlc visited the Union in May, 1957 to examine the economy and a pronosed railway project and to open discussions regarding a loan. Anart from agreement about interest rate and amortization and similar matters, which are to be settled nearer the time of the public issue, negoti- ations have been concluded. 4. The Banik has already made loans aggregating 3135.2 million to the Union or bearing the Union's guarantee. The status of the individual loans is as follows (in millions of dollars): Outstanding at July 311 1957 Held by Held by Other Year Borrower Amount Repayments Bank Investors 1951 Union of South Africa 20 3.0 17.0 - 1951 Electricity Supply Comm. 30 4.6 23.2 2.2 1953 Union of South Africa 30 7.0 14.7 8.3 1953 Electricity Supply Comm. 30 6.1 13e9 10.0 1955 Union of South Africa 25.2 _ 25.2 _ 135.2 20.7 9h.0 20.5  - 2 - 5. 'The first two loans were for termts of 15 and 20 years, respectively; all subsequent loans have been for 10 years. The last loan wTas made simul- taneously with a :25 million issue of Union of South Africa bonds in 1Tew York. All loans have been fully disbursed except the last one, iThich is expected to be drawn down soon. PFRT II - FUNDS TO BE RAISE.D IhT TINT ih--AR1ET 6. Dillon, Read &o Co. Inc. are arranging the borrowing of ,;25 million in the market. Megotiations betwfeen them and the Union of -outh Africa were carried on by their representatives who were in the Union at the same time as the Bank's mission and again in August. These negotiations are now being concluded in Hew York. The funds being raised in the market will be used to meet a part of the costs of the TJnion's current transportation development program. They are being obtained partly from a public issue of bonds and partly from private borrowing. The public issue is to consist of 1J5 nillion of ten-year sinking-fund bonds and would be subject to a pur- chase fund. Sinking-fund payments wTould beaflin in the third year and would be sufficient to retire the issue by maturity. This issue is to be regis- tered with the Securities and Exchange Comm,ission. 7. Ten million dollars would be raised from certain corm-mercial banks. In 1951 Dillon, Read & Co. arranged a ~10 million revolving credit for the Union froin a group of commercial banks and this credit has been regularly renewed. It is now proposed that wnen this credit falls due in January 1958 it lie renewed and increased to "P"20 million. PART III - DESCRIPTION OF THE FRCPOSET) LOAPI FROi TIFE BA-K 8. The proposed loan would help to finance the foreign exchange costs whic'h will be incurred by the Union in its current programo for the develop- ment of the transportation system owned by the Union and operated by the South African Railways and Harbours Administration, consisting principally of improvement and expansion of railroad facilities. 9. The loan would have the following characteristics: Borrower: Union of South Africa. Amount: Tne equivalent in various currencies of ,$25 million. Amortization: The loan would be repaid by 1967. Its amor- tization (which has yet to be determined) wouild, as far as possible, be fitted into the retirement of the bonds so that repayment of both together would involve approximately equal se.mi-annual payments by the Union. Interest Rate: To be determined.  -3 - Cormnitment Charge: 3/4 of 1%. Use of the Proceeds of the Loan: The proceeds of the loan would be spent outside the Union for purchase of equipment and material for the project. All orders will be placed under the Administration's normal procedures calling for competitive bidding by prospective domestic and foreign suppliers. 10. The Ban; has already lent ""75.2 million for the general developiment program of the South African Railways and Harbours Administration, and followi-up investigations by Banlk staff have sho-wn that the previous loans have been effectively used. PART IV - LEGAL INSTRUPENTS AND AUTHIORITY 11. A draft Loan Agreenent between the Union of South Africa and the Banlk, incorporating Loan Regulations NIo. 3 dated June 15, 1956 is attached ("\1o. 1). The draft Loan Agreement is substantially similar to the Loan Agreement between the Union and the Bank dated NSovember 28, 1955, and follows the normal pattern. It would not become effective until the Borrower had delivered and received payment for the bonds issued under the public bond issue (Section 7.01). PART V - APPRAISAL OF THE PR0POSRD LOAN 12. An appraisal of the project is contained in the technical report dated August 26, 1957 attached (I,o. 2). The South African Railways and Harbours Administration 13. Established some 47 years ago, the 3outh African Railways and Harbours Administration is a government department under the ?4inister of Transport who exercises policy control. It is run by competent management assisted by a large and well organized staff. The Administration operates the entire railroad network, cartage services in thae main cities, road transport ser- vices, all the main ocean ports, domestic and international airlines and some coastal shipping. These properties represent a total investment at original cost of approximately 91.14 billion equivalent, of which railway properties account for more than nine-tenths. 14. Most of the capital needed by the Administration for new investment is obtained from the Government in the form of perpetual interest bearing loans. The Administration pays interest at the rate which the Government pays on funds specifically borrowed by it for the Administration during the life of the loan to the Government - thereafter the interest rate is adjus- ted to conform with the current cost of internal Government borrowing.  15. The A-iinistration finances all its renewals and some new investment from its own revenue which was the ecuivalent of some " 70 million in the last fiscal year. Earnings after depreciation, taking one year with another, are enough to pay the interest on the perpetual loan capital invested by the Union. The Project 16. The project is the part of the development program of the Administra- tion relating to its railway, harbor and road transport facilities (but excluding airlines and coastal shipping). The project covers the three-year period ending Ilarch 31, 1960 for which detailed plans have been made. It also covers the completion of parts of the three-year program which will be in progress on -Iarch 31, 1961. 17. It is estimnated that over this three-year period gross capital expenditures on the project will total the equivalent of about 4$h0 million of which about ;j280 million equivalent will be spent abroad. Capital expenditures for the railways -ill amount to `h90 million, the balance going to other transportation services and to working capital. 18. The most important item in the program is a further increase in line and. yard capacity; some 160 miles of line rill be double tracked, 140 miles regraded, 450 miles electrified and five marshalling yards enlarged or constructed. 5ome 80 miles of new suburban or branch lines lTill be built, Further electrification will call for the procurement of about 200 electric locomotives, 155 motor coaches and 375 trailers. Diesel traction will be introduced and 135 diesel locomotives will be bought. In addition, 70 steam locomotives, 1100 coaches and 19,000 freight cars will be bought. 19. The project will substantially increase the carrying capacity of the railways and thus provide the basis for further economic development. ;ith its large areas, lack of navigable rivers, abundance of cheap coal and sub- stantial trade in bulk commodities, the Union depends heavily on rail trans- port. Since the end of the war the ton-mileage of freight traffic has increased by almost two-tlhirds, but the railways have not succeeded in keeping up with the requirements of the rapidly expanding economy and in providing for all export traffic offered, in particular of coal and other minerals. The Need for the Loan 20. An appraisal of economic developments is contained in the economic report attached dated August 27, 1957 (IJo. 3). 21. This shows that despite a substantial past increase in savings in the Union a return to the more rapid growthl which resources would permit would require an inflow of foreign capital. This would be especially the case if, as seems likely, there would be no irniediate increase in the rate of domestic savings.  - 5 - 22. It would probably not be possible for the Government to meet its capital needs from the domestic markcet alone without diverting funds from the private sector or neglecting Liportant capital needs in the public sector. The Government has allowed private industry free access to the capital market, has limited its own local borrowings as far as possible and has borrowed abroad from time to time to meet part of the needs of the public sector. This policy, while it has meant sometimes that public invest- ment has lagged behind private, has had the advantage that economic develop- ment - particularly in the private sector - has gone ahead. 23. The proposed loan would facilitate the public bond issue and the bank credit and thus help the Union obtain as much foreign capital as pos- sible from private sources. 24. The proceeds of the loan would be well directed in helping to relieve the shortage of transport facilities and thus remove an imiportant barrier to further economic expansion. Prospects of Fulfilllment of Obligations 25. South Africa should be able to service the loan without difficulty. Service payments in the peak year are about 3% of current foreign exchange receipts. The total of external public debt as of June 30, 1957 is esti- mated at p315 million, of which about 55' is in dollars and Swiss francs; almost all the remainder is in sterling. The Union's annual gold production is almost twrice the total of its external public debt. Since its inception the Union has borrowed abroad and has never failed to meet its obligations. 26. The continuance of 3outh Africa's prosperity depends on whether tolerable working relationships among the European, Asian and African inhabitants of the country can be maintained. One of the risks inherent in any lending in South Africa is that inter-racial tensions might disrupt the economy or through their impact on investment or on Government policies result in an inhibition of further economic grotrtlh. It is not possible to predict the trend of race relations in the Union during the next decade. Piluch depends upon the TATay the problem is handled by the European population and on the extent to which non-uropeans share in South Africa's growing prosperity. There seems to be an increasing awareness in the European community of the economic implications of racial policy. I believe 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 loan.  - 6 - PART VI - _CEC C_ !T-.TK 27. Before filing a registration statement Dillon, Read & Co. Inc. wish to be assured that in the absence of some major adverse development there is no reason to believe that the loan would not be approved by the xcecutive Directors in time for the public issue, and if you concur I would give them this assurance. 28. In this event I propose to submit to you at a meeting before the public issue (wErhich at present is planned for October 2, 1957) a supplement to this report setting forth the rate of interest and amortization schedule of the loan agreement and containing my recommendation regarding the loan. To this would be attached the Report of the Committee provided for in Article II, Section 4 (iii) of the Articles of Agreement and draft form of resolution. Eucene Rq. Blaclc Washington, D.C. September 4, 1957