NIP a swindle

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The internal-compliance investigation by international law firm Debevoise & Plimpton (D&P) of German firm Ferrostaal shows up starkly what a swindle NIP is – a view I have long held.

The Mail & Guardian last week republished aspects of the report, concentrating on irregularities in the 1999 Strategic Defence Package (SDP, Agents paid millions in submarine deal). More interesting was D&P’s views on NIP (National Industrial Participation), also known as offsets.

The D&P report notes that South African government documents show that the Ferrostaal consortium won the bid because of its offset offer. The consortium agreed to deliver offset spending worth almost €3-billion. “But, of course, this was funny money,” the M&G adds. The D&P report explains: “It should be noted that this did not require investment actually worth €3 billion, rather, offset investments are granted multipliers by South Africa’s Department of Trade and Industry (DTI). This is where the fraud occurs.
“The offset provider would thus invest a figure that was unknown at the start of the project, but in any event significantly less than €3 billion. In its initial calculations, Ferrostaal expected that it would need to provide investment of only approximately 1.5% to 2% of that amount and indeed, ultimately it spent €62 million, approximately 2%.” The report says most of the projects “failed or performed poorly”, but this did not seem to interest or concern Ferrostaal very much. “What evidently mattered to Ferrostaal … was not the business case for the investment or the likelihood of good returns, but its prediction of how much the DTI would like the project … and what multiplier it would receive.”

NIP, or National Industrial Participation, came into effect in South Africa on September 1, 1996. The programme applies to all government acquisitions from foreign suppliers greater than US$10 million and can be discharged in various ways, including investment, export promotion, research or collaborative business activity.

In September 1999 the government advertised that the SDP would cost R29.992 billion in “real” 1999 Rand. A government media release noted the imported content of the equipment (about 85%) will be financed through ECA loans (Export Credit Agency loans guaranteed by the governments of the supplier countries). “During the negotiations the Finance Negotiating Team, led by the Department of Finance, was able to secure terms which are highly attractive to the SA government and which are much better than it could achieve on the commercial markets. In fact, as a whole, these terms are much better than is typical of defence deals internationally,” the September 1999 statement avered.

The statement continued that an economic impact analysis had been conducted as part of the overall affordability assessment. “This analysis indicated that the net effect of the total procurement on the SA economy is broadly neutral. Over the medium and long term the benefits deriving from the Defence Industrial Participation (DIP) and … NIP programmes will fully offset the economic and fiscal costs of the military equipment. Government is naturally aware that the risk of the NIP and DIP benefits not materialising fully is intrinsic to the procurement. During the negotiations, specific measures were taken to ensure these risks are minimised. Moreover, special steps will be taken by the DTI to ensure that the NIP and DIP commitments of the supplier companies are monitored and enforced.”

Government continued that the “industrial participation projects linked to the purchase deals will yield significant economic benefits for South Africa. The total contracted commitments amount to R104 billion. The actual economic benefit deriving from these commitments will amount to R70 billion over a period of 11 years.” The benefits will come in three forms:
— defence related offsets (about 20% of the total, or R14.5 billion). Local defence firms will earn over R4 billion via direct participation in the production of the aircraft and ships being procured. In addition, the suppliers will transfer technology worth about R3 billion in royalties and license agreements to South African firms, and will direct other export orders to South African firms for more than R7 billion worth of production of defence contracts with third parties.
— counter-purchase by the defence equipment suppliers of South African goods (about 45%, or R31 billion). The goods to be procured include automotive components, furniture, fabricated metal goods including railway wagons, and electronic goods.
— foreign investment in South Africa by companies associated with the equipment suppliers (the remaining 35% or R24 billion).
“Offset benefits of this kind have become a standard feature of defence industry deals during the past 20 years, with more than 130 countries now making use of them. An investigation of international experience suggests that the ratio between benefits and costs which South Africa has achieved is probably unprecedented.”

On the jobs front, the state noted the industrial participation projects “will create significant numbers of jobs in sectors where the new investments are to take place. This emerges from a comparison of the direct employment impact of the NIP investments with expected trends in South Africa’s employed workforce. Although the industrial participation projects represent foreign investment, the vast majority of the jobs created will be for South Africans rather than for nationals of the companies’ home countries. In addition to the jobs created directly, the programme will also have an indirect impact in the labour market. The demand for raw materials, the spending of incomes earned by employees and the spending by Government of its tax revenues obtained from the companies will all contribute to economic growth and job creation. Just how big this ‘job multiplier’ is, is a matter of debate amongst economists.
“But estimates of the multiplier range upwards from a ratio of four to one for indirect jobs — that is, a total of five jobs per direct job created by the programme. This would suggest that the industrial participation programme would exceed 65 000 jobs through its lifetime,” the government said in its September 1999 missive.

Such was the controversy surrounding the “arms deal”, that the government on January 12, 2001, released “background notes” on the project. This told the public NIP “can never be used to justify the decision to purchase. It arises only when that decision has been taken. A study of the publicly available program makes this apparent. Accordingly, the NIP was not and could not be decisive in the final procurement decision. The NIP played two roles. The first was that it has been an effective investment promotion device and therefore will assist with job creation. Secondly it was used in a number of the exercises to assess economic risks such as balance of payments effects and the growth impact. Government accepts that there were many proponents of the deal, and others, who sought to justify the deal on the basis of the so-called NIP offsets. There was continuous media comment around the potential investment and job creation aspects of the deal. However, when accounting to SCOPA or the Auditor General the Ministers who made the decision to recommend a particular course to Cabinet must be judged on what they decided on rather than on public perceptions of what their decision was. The purpose of providing this background is that it allows us to deal with what we regard as inaccurate assessments in the two reports and it is these assessments that are fuelling further reckless and unsubstantiated speculation and accusation.” But the perception endures…

How did this work out in practice? Frankly, I don’t know. The DTI publishes an annual NIP Programme report – the last posted on its website being that of 2008 – but this is not very helpful. Indeed, it is remarkably bland, superficial and vacuous. With all the multipliers and credits and voodoo formulae, there is no doubt much to be bland, superficial and vacuous about. Tim Harris, the opposition Democratic Alliance party’s shadow minister of Trade and Industry last year September avered “it is close to impossible to assess the status of the NIP because the DTI continues to obfuscate in its reporting… Each year, the NIP reports fail to provide specific detail on the sales and investment targets of each international contractors – and the milestone periods applicable to them. One can expect the 2010 report to be no better. As it is, Minister of Trade and Industry Rob Davies last November alleged the “arms deal” has created 73 000 jobs and had exceeded government’s expectations. I would love to believe him but where’s the proof?

Unfortunately much the same can be said for DIP offsets, but that is a complaint for another day. Commenting on Davies’ statement, “arms deal” gadfly Dr Richard Young said “one thing is for sure is that the South African Defence Related Industries (SADRI)sector is in dire straits.” Reason for this included government giving all the SDP prime contracts and most of the workshare to overseas companies, the “government through Armscor and DTI gave the SADRI so little real support in the DIP that whatever turnover there might have been hardly related in any profit or sustainability. These were simply not good deals because the overseas suppliers had the local suppliers over a barrel… and one ‘arms deal’ does not an industry make. The DIP offset period was about seven years and that ended three years ago. The SADRI needs ongoing business to be sustainable. It needs daily and yearly bread and not the feast and famine that the ‘arms deal’ created.”

Anyway, according to the 2009 NIP report, Ferrostaal had by March 2009 accrued credits worth €1.7 billion against an obligated value of €2.9 billion. The M&G highlighted three NIP projects highlighted by the D&P probe. In the case of the Magwa tea plantation in the Eastern Cape, the company invested R23.5 million in 2005 as a “non-refundable loan”. Ferrostaal received nothing in return. Ferrostaal also loaned R42.2 million to Sames – a printed circuit maker – between 2005 and 2007, of which the majority has not been repaid. Thirdly, Ferrostaal invested more than R26 million in Atlantis Development Trust, an educational body, between 2003 and 2006. According to the report: “The body failed and there were allegations of fraud. Before that, however, the head of Ferrostaal’s South African operation had informed Atlantis … that it would never have to repay the money provided to it.”

The D&P report concluded: “The examples above illustrate that Ferrostaal was prepared to support and invest in projects … that it seemed to have had little interest in succeeding. One former manager responsible for offsets said that this just confirmed the questionable nature of the offset business, in which DTI credits were the only real factor driving Ferrostaal’s investment decisions.”

If there is a “next time”, it would be prudent to put in place DIP with real consequence – which might pre-suppose a proper SADRI policy and strategy – and skip the NIP. It simply adds to the cost of acquisition, delivers nothing of great value and reflects the industry in a poor light.