25 May 2015
Special Report
SA - Investing in a new era of rail

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Special Report

SA - Investing in a new era of rail

South Africa: investing in a new era of rail

11 May 2015 Eva Grey

The biggest railway deal in South Africa’s history is predicted to propel its economy to a new level of prosperity. Eva Grey explores the country’s infrastructure strategy and finds out more about a recent spate of record investment deals.

rail bridge

South Africa's railway system is set to flourish under a boost of record investment aimed at turning the country into a key player in the global freight industry. The development was first announced in 2012, when Transnet, South Africa's state-owned ports and rail company, launched the Market Development Strategy, a seven-year R300bn ($33.82bn) investment scheme with a clear strategy to rejuvenate the country's ports, rail and pipelines infrastructure.

A big portion of this investment is dedicated to rail. In March 2014, Transnet announced a R50bn ($4.26bn) contract with four manufacturers to build a 1,064-strong locomotive suite. The move marked the start of the biggest rail recapitalisation programme in the country's history. China's rolling stock manufacturers China North and South Rail won the lion's share of the contract, followed by Bombardier Transportation and General Electric as key tenders.

Much more than just a development scheme, the project is an initiator of growth: by boosting the national freight volumes to unprecedented levels, with a particular focus on the country's key industries of iron ore and coal, MDS is trusted to fuel a strong economy in South Africa.

Currently in its third year, the outlook of the plan is positive. The most recent development saw Transnet secure R13bn ($1.1bn) in funding to build its locomotive fleet. The financial backing announced on 2 March comes from a range of funders and financial institutions, including Barclays Africa, Investec, Standard Bank, Old Mutual and Export Development Canada. The money is funding locomotives from Bombardier and General Electric.

Most importantly, the deal marks the first tangible step towards South Africa's ambition to accommodate the fifth-largest railway system in the world by 2019.

South Africa's focus on freight: from road to rail

Despite a few ventures over the past five years which aimed to rebalance the transport sector, rail had been losing out in favour of road investment, especially when it came to freight transportation.

Whether by derailments, collisions or level crossing incidents, around 15,000 people die every year on India's creaking railways.

In 2013, about 734 million tons of freight was moved in South Africa, according to an Oxford Business Group (OBG) report, out of which nearly 71% was moved by road, despite the fact that railways make up 80% of Africa's infrastructure, according to a PWC report.

Now, over the next four years, South Africa will shift its freight from road to rail, cutting both enormous logistical costs and carbon emissions in the process. According to the Market Development Strategy overview, "rail volumes are projected to increase from approximately 200 million tons to 350 million tons" by the end of the programme.

Given this predicted growth in cargo volumes, the government has also launched the National Infrastructure Plan (NIP), a wide-ranging scheme planning to put 4.3 trillion rand ($407bn) towards new infrastructure and upgrading the existent networks across a vast array of sectors. In particular, the second of its 18 Strategic Integrated Projects looks at improving the rail corridor between Durban and Gauteng, South Africa's main industrial centres.

Operating in conjunction with the NIP, the National Transport Master Plan aims to invest R751.74bn ($71.2bn) in infrastructure projects until 2050, with 43% of this expected to be dedicated to the rail segment.

Increased tonnage by rail will improve the country's overall efficiency, explains Mike Asefovitz, senior media relations Manager at Transnet.

"Our aim is to lower the cost of doing business in South Africa. As we increase our efficiency and become a more reliable transporter, that will transpose into the rest of the economy," Asefovitz says.

"What we anticipate is that this capital investment will give us an additional 128 million tons of rail volume. So by the end of the seven-year period, we are looking at transporting some 344 million tons of commodities. And that's really what rail is: a bulk business."

"Our aim is to lower the cost of doing business in South Africa."

"Long distances and big volumes is what makes us more cost-effective. And this cost-efficiency gets passed onto the customers."

Transforming rail infrastructure will have a direct impact on the country's key industries, in particular mining. One of the initiatives already in place is upping capacity on the country's coal transport line, Asefovitz explains, by running 200 wagon trains instead of the former 100 wagon trains.

With the introduction of a further 1,300 diesel and electric locomotives by 2019, the general freight business is bound to expand and strengthen.

The locomotive acquisition deal should also prove to be a significant milestone in the country's ambition for financial autonomy. In keeping with its promise to become an original equipment manufacturer, all the locomotives, apart from the first 70, will be built in South Africa, using a majority of locally-sourced components and opening up the job market. By 2019, a total of R7,7bn ($631m) will be spent specifically on skills development and staff training as part of the market strategy.

"The intention is that, with time, we will become an exporter of locomotives," says Asefovitz. "We spent a lot of money on training staff to ensure we have the right staff for the future, and that is going to be our competitive advantage."

"We are looking at growing a business, we are looking at becoming the fifth-largest railway in the world, and we are on track to do that."

Decades of underinvestment

Until recently, South Africa's rail suffered from 30 years of underinvestment. In OBG's 2013 overview of South Africa's economy, Tsepho Lucky Montana, group CEO at Passenger Rail Agency of South Africa, deplored the current state of the country's railways, saying: "South Africa had the capacity to design, manufacture and maintain trains back in the 1960s and 1970s, but that capacity has been lost over three decades of underinvestment in passenger and freight rails."

Despite the EU’s efforts to establish a fairer set of rights for rail passengers, extensive exemptions allow easy loopholes.

The undermining of the rail freight industry was the result of an aggressive road de-regulation initiative that first started with the Road Transport Act in 1977. The Act increased the maximum road payload capacity to 22 tons per vehicle, surpassing the payload limit of 20 tons per train wagon. Later on, legislation further increased the limits up to 45 tons per vehicle. A clear preference for road transportation was formed, much at the expense of rail.

In his opening address at a 2011 Railways & Harbours Conference, Jeremy Cronin, South Africa's Transport Deputy Minister noted that, by 1986, "about 60% of the rail network was being used at less than half of its practical capacity".

Over the following 20 years, operational and logistical costs of heavy road tonnage soared, putting a major strain on the economy.

A not-so-smooth ride: challenges lie ahead

In May 2010, Transnet was hit by a series of prolonged strikes sparked by over 54,000 of its employees demanding higher pay. Inability to settle a deal quicker led to an almost complete stall in exports as both passenger and freight rail came to a standstill. Faced with the inability to export their resources, the country's coal, iron ore and fruit industries were hit the hardest.

Now, South Africa is rushing to strengthen the relationship between its mining industry and railway system. Transnet's market strategy specifically highlights its ambition to transport 98 million tons of coal per year by 2019, a total 44% increase arching over seven years, with a further 57% increase in iron ore over the same period.

But OBG's analysis warned that "the plan is something of a gamble" and noted that "Transnet will need to grow its volumes substantially to meet further growth targets. Quoted in OBG's 2013 report, Jackie Walters, the head professor at the Department of Transport and Supply Chain Management at the University of Johannesburg, said: "Transnet is investing R300bn but I'm not convinced that they will get enough traffic to justify the investment."

Mike Asefovitz admits the investment is a huge leap of faith when it comes to predicting the demand market for all the transported goods.

"One of the big mental leaps that we took in implementing the MDS is that we are putting capacity ahead of demand."

"One of the big mental leaps that we took in implementing the MDS is that we are putting capacity ahead of demand," he says. "A lot of people asked how we can do this when we don't even know the markets are there. "

"But we believe that when the absolute comes, we will then be ready to deal with those increased volumes. If you look at our main exports like coal and iron ore, their prices on international markets have halved, yet our volumes have gone up."

However, this year, a series of power blackouts since February put South Africa's future economic growth at risk. A faulty and under-maintained power grid is to blame for a severe country-wide electricity crisis. The longest blackout reached its seventh consecutive day at the time of writing, according to Reuters. With experts predicting that power shortages could last for years, this poses a serious threat to the country's overall productivity, including rail activity and export volumes.

To tackle the crisis, Transnet's long-standing chief executive Brian Molefe left his position on 17 April to join power utility firm Eksom, where he was appointed acting CEO. His leadership is expected to find a rapid solution to the country's crumbling power supply.

Furthermore, Bombardier Transportation, one of Transnet's main partners in the current R6.99bn ($596.67m) locomotive deal, is at the centre of a corruption scandal regarding a past South African train contract.

Bombardier was previously involved in the construction process of Gautrain, the country's first metro connecting Johannesburg to Pretoria.

The manufacturer is currently under investigation by South Africa's corruption watchdog for allegations of bribery and questionable fees paid as part of the $3bn Gautrain deal between 2006 and 2012. Bombardier denies all allegations.

It remains to be seen what impact these challenges will have on the plan's delivery. But if we were to believe Transnet's announcement during the economic crisis that "slow economic growth will not hamper investment", it would seem that we can soon expect a new generation of railway infrastructure across South Africa.

The curse of cars going cheap

Roman Grynberg

Africans are snapping up cheap, second-hand cars but the Southern African region pays dearly for this.

Japan sells Africa its second-hand cars rather than recycling them. (AFP)


Batswana love their cars and, regardless of the size of their pay packet, they will proudly drive their cars to work on the ever-more congested roads – even if they have not had enough money to service them since the late Jurassic period.

There is perhaps no other country where the private sector so completely dominates transport. In most cities, national or local government provides some form of public transport, but not in Gaborone. The last form of public transport was the Botswana Railways commuter train system, but it could not make a profit and closed many years ago.

The options now are either shared private transport such as the use of minibus taxis or, increasingly, privately owned second-hand cars, commonly derogatorily referred to as Fong Kongs. They are imported from Japan, the United States and the European Union, and can be cheap, sometimes selling for as little as $1 000.

That, of course, is the price in Japan, and you have to add to that the cost of transport to Gaborone, high import duties (up to 28%) and 12% to 16% value added tax (VAT), depending on the Southern African Customs Union (Sacu) country.

The fact that the taxes are so high provides a considerable incentive for importers to undervalue the vehicle. Getting a false receipt is easy – you just ask for it.

In theory, the customs union could use an international reference, such as the Blue Book, which gives you a list of prices and values of cars. But customs officials know that the cars being imported are being undervalued.

It is difficult to know exactly how many second-hand cars Botswana is importing and what their value is because the statistics do not readily differentiate between the import of new and used vehicles.

Moreover, you cannot tell accurately from the export figures from source countries because so many of the vehicles entering Botswana go to the bond in Durban first and are bought there.

The bond is a strange place and you have to have a foreign passport to enter it because South Africa long ago banned the import of second-hand cars, knowing the damage it would do to its highly protected and subsidised automobile sector.

But, based on Japanese statistics, the number of vehicles exported to Botswana is growing exponentially, from 3 000 a year in 2007 to more than 8 000 a year in 2012.

Of course, much of the Japanese data does not include vehicles under about $2 000 and much of the data excludes what Africa is buying.

In 2014, Japan exported more than one million used vehicles and about 15% to 20% went to Africa.

If one is young enough to believe the trade statistics, the unit export value of the cars entering the bond in Durban, and then into Botswana, are becoming lower each year.

This could be because the exporters and importers are evading import duties and VAT, or it could be because the market for these vehicles is becoming more closely targeted at low-income groups. The export values might also be declining as the global second-hand market becomes saturated with more developed countries either subsidising the sale, or increasing the export, of old cars.

For Japan, the US and the EU, the second-hand market, although not significant, is an important way of disposing of older vehicles. Their governments have, since the 2008 financial crisis, provided economic incentives for people to get rid of their used cars to stimulate domestic production.

The US under President Barack Obama had the “cash for clunkers” programme but this is only the tip of the iceberg in terms of incentives that governments have given to get rid of used cars and to stimulate consumption of new cars. Developed countries are developing their electric car markets, which is providing a huge incentive to their domestic producers.

So what do you do with the junk? Export it.

Japan has the most sophisticated incentive system to get its citizens out of their motor vehicles that are three to six years old. After three years, every car has to pass a roadworthy test, which, in some cases, costs up to $1 000 – and that is without the repairs that are needed. This creates a considerable incentive for the Japanese to get rid of their ageing cars.

But the Japanese have another problem. In other countries, the biggest second-hand market is usually local buyers. But the Japanese have a cultural aversion to buying anything second-hand. So the Japanese government has organised a first-rate export certification system, which has led to the development of a multibillion-dollar used vehicle trade.

The biggest markets are Russia, Chile and the United Arab Emir­ates. The fourth biggest is South Africa – that is, Durban – from where the vehicles are distributed to Africans other than South Africans.

The South African ban is to protect local manufacturers but, ironically, those who pay the price for this protection are the citizens of the Sacu countries that import used cars.

The South African industry receives tariff rebates from the customs pool, which would other­wise go to the four other small Sacu states – Botswana Lesotho, Namibia and Swaziland. The main countries subsidising the South African industry are Botswana and Namibia, which each lose about R5-billion annually from customs revenue.

But the growth of these second-hand cars are an economic disaster for much of Southern Africa. Because the use of roads is free and second-hand cars are cheap, the growth of the market is distorting the development of infrastructure. Small cities such as Gaborone now have four-lane roads to accommodate the flood of second-hand cars, which is taking up the scarce funding that should be used for rural roads and infrastructure.

Africa is accepting scrap cars, and those importing them should pay for the environmental costs. A substantial scrapping tax should be levied on all imported vehicles, which would rise from, say, 1% for new cars to 40% for the oldest, biggest engined used cars. This should be based on book values because undervaluation is so pervasive in the market.

The levy could be used to subsidise the VAT and import duties on minibuses in the short term and to reintroduce low-cost commuter railway services in Gaborone and other cities.

This sort of cross-subsidisation would also have a dramatic effect on the galloping land prices in Southern African capitals. Gaborone and its increasing congestion is proof that the free market cannot solve all the nation’s problems and that an effective public transport system is needed.

But there is much bigger policy issue at stake in the Fong Kong trade. The importation of second-hand vehicles, like that of second-hand clothing, is emblematic of Africa’s place in the global value chains.

West Africans once produced some of the world’s finest cloth but now Europe dumps its discarded clothes in Africa and Japan sells us their second-hand cars rather than recycling them.

This the Europeans and Japanese do in the name of energy efficiency, but they are exporting their energy inefficiency to the developing world. In the long run, the used vehicles will produce even more pollution because Africans, often with unsafe, poor or no public transport, will keep them for much longer than the Europeans and Japanese.

Africa will continue to produce nothing more than holes in the ground – it will sell ever more minerals to Asia and the EU to pay for ever more cheap cars, which, in turn, will be made from African minerals.

Is this ever to be Africa’s place in the global value chain?

Published in M&G. These are the views of Professor Roman Grynberg and not necessarily those of any institution with which he is affiliated

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