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Given the time needed to unbundle Eskom, the state will have to recapitalise it, writes Duma Gqubule.
Two decades ago, China’s four state-owned banks, which then accounted for almost 90% of the country’s banking assets and loans, were on the verge of collapse after years of policy lending or political instructions to support the government’s economic development priorities. They had nonperforming loans that accounted for about 40% of total loans. Indecision would have derailed the country’s economic miracle.
During the restructuring that followed over the next few years, the People’s Bank of China, which is the country’s central bank, and the finance ministry contributed 85% of a $500 billion bailout of the four banks. This was equivalent to 22% of gross domestic product (GDP), according to a paper by economist Guonan Ma.
The central bank also used $60 billion of its foreign exchange reserves to create a company called Central Huijin, which bought majority shares in the banks. The banks were later listed on the Shanghai and Hong Kong stock exchanges.
Last week, Eskom was on the verge of collapse after a R7 billion drawdown on a R36 billion loan from the China Development Bank – the world’s largest development finance institution, with assets of more than $2 trillion – failed to come through on time.
National Treasury released emergency funding of R5 billion to enable Eskom to meet its obligations, which included the repayment of a R3 billion loan from Absa Capital. Had payment not been made, there could have been a call on other existing guarantees of R350 billion.
South Africa is now at a critical moment, where failure to resolve Eskom’s R420 billion debt – which is equivalent to 8.6% of GDP – could derail a fragile economy and tip it into another recession. Already, Eskom has been a major contributor towards a 26% plunge in investment by public corporations between 2015 and 2018.
Like China, South Africa must look at its whole balance sheet to develop a solution.
At the end of December 2018, South Africa had net loan debt of R2.3 trillion, which was equivalent to 46.5% of GDP. This is not high by international standards. However, the country also had foreign exchange reserves of R742.3 billion. The Public Investment Corporation (PIC) had assets of R2.1 trillion. Eskom needs a R200 billion bailout – about 4.1% of GDP – to cut its debt by half and put it on a more sustainable financial path.
Firstly, the government can take over some of its debt. A Nedbank report says: “Using the Moody’s debt-to-GDP ratio of 60% as a threshold, the government has the capacity to support Eskom to the tune of R212 billion.”
Secondly, the PIC, the asset manager of the Government Employees Pension Fund (GEPF), could write off R90 billion of Eskom bonds.
The GEPF is a defined benefit fund. This means that its assets belong to the government and not the workers. The workers do not benefit or make losses if the value of the assets in the PIC increase or decrease. The GEPF says benefits are guaranteed – based on years of service and final salary – and are not dependent on investment returns or the level of member and employer contributions. Therefore, the GEPF is the government’s means of financing its obligations to public sector employees.
The decisions on whether to fund this obligation – by accumulating a fund to cover all future pension obligations for 1.2 million public servants – and the level of funding, are political. It has been argued that there is no need to accumulate such assets since a government cannot go bust the way a private company can.
As a result, the majority of government employee pension funds in developed countries are either unfunded – they operate on a pay-as-you-go basis – or partially funded. However, even if one accepts the need for funding, the GEPF has excess funding of R300 billion above the minimum level of 90% that was set by its trustees.
Finally, there is no reason why the SA Reserve Bank cannot step in and also contribute towards the bailout of Eskom.
So, how did Eskom get into this mess? It has very little to do with the midnight contract that a previous board gave to the Gupta family. Eskom awarded the contract to Tegeta during 2015. The hijacked contract was worth only 2% of the power utility’s revenues in 2016.
By February 2018, eight Gupta companies had filed for business rescue. But the Eskom crisis predates this episode of state capture.
Eskom was reasonably well run during the immediate post-apartheid period. Reuel Khoza, its chair from 1997 to 2005, recalls that the utility won the Financial Times Global Power Company of the Year award in 2001 for providing the world’s lowest-cost electricity.
By 2005, when he left, the company was debt free. It made a profit of R7.4 billion on revenues of R43 billion. However, the profits were artificial and partly because of low levels of investment. The board had told the government that it needed to build new power stations.
But the government instructed Eskom to wait as the plan was to privatise parts of the company. Nobody was interested, partly because of the low cost of electricity. In 2007, Eskom announced a huge investment programme a few months before rolling blackouts in October. But there was no plan on how to finance it.
Former Eskom chair Bobby Godsell warned: “It is not possible to fund the first major expansion of our electricity grid for several decades through revenue generated from tariffs alone. The growth of a business is normally funded by a sensible balance between owner’s equity, accumulated reserves and debt. We need to mobilise greater equity resources to fund the build programme.”
During the decade from 2009 to 2018, Eskom’s revenues increased by 230% on the back of a similar increase in electricity prices. But the company spent R537.5 billion on its capital investment programme.
Read: Eskom awaits Nersa ruling to assess bailout
This was equivalent to an average of 43% of the company’s revenues of R1.2 trillion over the same period. Primary energy costs accounted for an average of 48% of revenues during this period. Finance and depreciation costs increased to 26% of revenues in 2018 from 9% in 2009. Therefore, the company had no reserves. It made huge losses and accumulated debt, despite government bailouts of R83 billion until 2015. If the investment had started much earlier and had not been rushed, there would have been no crisis.
The government now wants to unbundle Eskom into four companies – generation, transmission, distribution and a holding company. But this does not address any of Eskom’s immediate financial and operational issues.
As chief financial officer Calib Cassim said recently, it would take time to split a complex company such as Eskom. Also, the Kusile and Medupi power stations cannot be sold until they have been finished.
In a speech at the Free Market Foundation, economist Dawie Roodt said other parts of generation, the older power stations, were not suitable for privatisation because they needed so much funding. Transmission was doing fine as a natural monopoly. Selling distribution would be difficult because municipalities would want to keep a grip on this lucrative business.
Instead of again waiting for privatisation events that cannot happen in the near future, even should Maria Ramos take charge of Eskom, the government has to recapitalise it. The company is simply too big to fail.
Gqubule is director at the Centre for Economic Development and Transformation
