Mercury: Expropriation sends a negative signal

http://www.themercury.co.za/index.php?fArticleId=4580755

Expropriation sends a negative signal

August 28, 2008 Edition 1

Jeff McCarthy

A 30-YEAR-OLD friend who works for a global investment bank in its London office and earns the equivalent of millions of rands per annum can’t raise a bond for a house in London today. Property is seen by banks there as an asset which is in value decline; and being a hot-shot investment banker is a job that is seen as very risky.

What does this mean for us in South Africa? That foreign investment is desirable has been a point largely beyond dispute among South African political parties. But to get more of it, we need to realistically understand why individuals and institutions invest in foreign countries.

Most of the time foreign investment has to do with expected returns on investment, interpreted within a perspective on comparative risks. For short-term investors there is of course possible currency risk (e.g. rand devaluation), but if such an investor is alert and can react early, that shouldn’t matter too much. The issue of comparative risk arises more when investments are fixed, or semi-permanent, as in property, pipelines, factories, or mines.

It is the latter that governments of developing countries (including South Africa) are usually most interested in. This investment often results in new jobs, taxes, economic innovation, and other good things, all of which may not be possible by simply relying on domestic resources or borrowings.

From the point of view of foreign investors, though, when money is tight, they look more closely at value and price in relation to risk. It’s not very different from ordinary citizens’ private behaviour. When banks are literally throwing cheap money at you (as they did in South Africa say two years ago), people are less likely to scrutinise price, value and reliability when waltzing down the shopping aisle. When one’s wallet is empty, shoppers tend to take longer in surveying their options, and become more sharp-eyed about price.

That’s also the view from the London or New York investment banker’s office window today. The two darlings of foreign investors in the past couple of years – China and India – got only about half the private equity investment in the last year than they did a year before that. The average value of shares on the Shanghai stock exchange is also less than half what they were a year ago, partly because there’s just less foreign investment money around.

Although interest in foreign investment is just picking up again, in the meantime, concerns are growing about the valuation of fixed foreign investments. In New York and London, the global financial crisis is widely understood to be the result of banks having been too lenient in assessing the underlying asset values of those to whom they lent, and too optimistic in relation to their anticipated income streams (the so-called subprime mortgage crisis in the US is one – admittedly very serious – symptom of this). To use an old-fashioned word, the bankers were imprudent.

Well, prudence is now back in fashion. And apart from looking hard at whether there really are income streams to be expected, and whether the asset is priced correctly, prudence now also means a strong interest in risks associated with more permanent foreign investments. In the words of a leading London investment lawyer cited in the Financial Times in late August, “Expropriation of foreign assets is on the rise (and now a major concern).”

Nothing quite focuses the prudent investor’s conservative sensitivities than the prospect of losing one’s investment altogether.

While London and New York bankers are now worried mainly about Russia and South America, where expropriations are on the rise, it is the generic nature of threat that counts, rather than the country. Thus for example while innovative British farm entrepreneurs are still happily investing in growing wheat on leased land in Russia, the recent BP experience in Russia is making investors much more wary about long-term, fixed investments there.

The differentiating issue in these two cases, really, is the security of property rights.

And here South Africa is unfortunately beginning to look suspicious on the global stage. Whether fairly or not, much of the foreign press perceive President Thabo Mbeki as having consistently protected Robert Mugabe, who in turn is internationally synonymous with land expropriation. The more carefully observant investors have also watched the South African government’s recent moratorium on the sale of land to foreigners, and the introduction of new, harsher expropriation laws.

Those who read the fine print notice something else: the South African constitution does not guarantee that those whose property is expropriated will be compensated at market value. Market value is just one of many (non-market) criteria that the constitution identifies. Moreover, a consistent theme in government pronouncements over the past two years is that (willing or unwilling) sellers are overvaluing their properties.

So why buy something today at price x if it could be expropriated at price x-y in years to come?

Now, for the first time in my recollection, we are also witnessing major municipalities using the threat of expropriation as an apparently legitimate tool in “negotiating” with private landowners on how to use their land (e.g. at Cornubia near Umhlanga).

It is not just expropriation terms which are shifting targets, but also interpretations of terms of sale. Recently there were reports of differences between Transnet and British and Dubai investors over the terms of sale of the V&A Waterfront in Cape Town. Allegedly, the foreign investors believed they were sold the coast and near shore waters (as is apparently possible in Dubai) as part of their plans to develop marinas there.

But, as is now plain from South Africa’s forthcoming Integrated Coastal Management Act, giving effect to such “ownership” may be improbable, despite a R7 billion price tag. Consequently, the press is now replete with accusations and counter-accusations about possible liabilities running into billions.

Needless to say, this type of public conflict over asset definitions and asset values, and municipal threats of expropriation of thousands of hectares over minor planning differences as in Cornubia/Umhlanga, tend to increase the size of the South African “blip” on global radar screens of perceived investment risk. In a context of much reduced overall global investment capital, this is an unwelcome trend.

South Africa’s current saving grace in the international investment context, however, is its as yet successful public infrastructural efforts, as in the Gautrain project, the s occer World Cup stadia, the new Durban airport, and so on. Here, foreign investment in the fixed asset itself is not the issue. The assets will be locally owned. Rather, foreign experience is often used to build and operate, and prices for the buildings and divisions of income spoils for operating are agreed upfront. This may be the most viable model for further attractions of foreign investment.

Why entice foreign people to own South African fixed assets when the sensitivities of global investment radar systems, combined with local political trends, are flashing red for such investment types?

Every sunset brings with it the prospect of a sunrise. The evidence suggests that the way forward for South Africa, in attracting foreign investment in 2008 and 2009, will need to be different. It may be wiser in this environment to rather offer leased land options together with financial contributions to both infrastructure and superstructure development on that land, as a way to attract foreign expertise and capital and expand local jobs and taxes.

This is not very different from the model Mozambique has adopted or for that matter China. But then we will also need to demonstrate – scientifically, and with hard evidence, rather than with nationalistic bravado – that the expected returns on investment will be there for investors. This means South Africans being honest and realistic about our asset values and in our projections of future income streams.

# Prof Jeff McCarthy is a development specialist.