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Aug 16, 2013

Africa and localisation offer some hope for ailing manufacturers, but constraints linger

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Deloitte South Africa|Education|Africa|Asia|Europe|Brazil|China|Germany|India|Russia|South Africa|Automotive Manufacturing Standards|Electrical Machinery|Energy|Energy Infrastructure|Gross Domestic Product|Manufacturing|Manufacturing Industry|Manufacturing Production Capacity|Manufacturing Sector|Manufacturing Subsectors|Manufacturing Support Programmes|Manufacturing Tech|Non-electrical Machinery Subsectors|Public Infrastructure|Sector Products|Steel|Transport|Transportation|Coenraad Bezuidenhout|Henk Langenhoven|Izak Swart|Karthi Pillay|South Africa
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Constrained investment in manufacturing production capacity and a slower-than-expected rise in State investment into public infrastructure, including transportation and energy infrastructure, have weighed heavily on South African manufacturers over the past few years.

However, growing export demand from the rest of Africa, higher costs of imports and the bolstering of local demand through infrastructure development programmes may eventually provide something of a spark to stimulate the country’s ailing industrial sector.

Value added by the manufacturing sector as a ratio of gross domestic product peaked at about 24% in 1981, before declining steadily to 14% in 2010 and 12% in 2012, according to the South African Reserve Bank’s 2013 Annual Economic Report.

Steel and engineering sector products feed into other facets of the economy, making them useful indicators of the prospects of the general manufacturing sector, says industry body Steel and Engineering Industries Federation of South Africa (Seifsa) chief economist Henk Langenhoven.

“It is important to note that the global economic crisis has stunted investment in these industries due to low demand and low capacity utilisation. The value of capital stock has declined and in some cases capabilities have been lost. Investment has not recovered.”

This is true for the basic ferrous metals, fabricated metals, electrical machinery and non-electrical machinery subsectors.

Further, about 60% of the steel and engineering industries’ production is exported, making the industries price takers that were negatively influenced by the 2008 global economic downturn and have lost global market share since 2002, says Langenhoven.

“Industries will not invest when they are losing market share. Rising domestic costs are eroding competitiveness. Between 12% and 15% of the industries’ costs are influenced by administered prices, which, coupled with the lack of growth drivers, are placing increasing pressure on profit margins, which are currently about 4.5%. This means that increases in administered prices can wipe out profitability in these sectors.”

Prices are expected to increase during the current year and industry perceptions of political constraints have risen significantly, he says.

“South Africa is a small, open economy, which implies that the manufacturing industry is facing increasing competitive pressure, regardless of whether firms are exporting their products or competing with imported goods. For South African manufactured goods to be competitive in internationals markets, pro-ducers should limit input-cost increases where possible,” says Bureau for Economic Research (BER) economist Lisette IJssel de Schepper.

“However, labour costs, in particular, are already significantly higher than those in other developing economies. The ‘Doing Business’ report, published by the World Bank 2013, indicates that South African wages are well above those of Brazil, Russia, India and China,” she adds.

South Africa should also focus on public infrastructure investment to develop transport and ensure the availability of affordable energy. Relatively cheap energy used to be a main competitive advantage for manufacturers, but that advantage has waned in recent years, she says.

“Skills development through education and training will be vital in future. Both elements will ensure that South African products can compete internationally from a longer-term perspective,” highlights IJssel de Schepper.

Manufacturing Support
The margin squeeze that many manufacturers experienced as a result of weak local demand and export demand, coupled with the effects of a strong rand in the past few years, has reduced investment in manufacturing tech- nologies, processes and expansions that could help to improve the competitiveness of manufacturers, says industry body Manu-facturing Circle executive director Coenraad Bezuidenhout.

However, there are significant differences in the various manufacturing subsectors and there is a chance to localise competitiveness support in different subsectors through manufacturing support programmes, such as the Department of Trade and Industry’s Manufacturing Competitiveness Enhancement Programme, says advisory firm Deloitte South Africa risk advisory director Karthi Pillay.

“Supporting manufacturing through local- isation thresholds can also present South Africa with the opportunity to implement varied support initiatives and incentives to bolster different subsectors of the manu- facturing industry.

“From a quality perspective, South Africa is getting it right. However, we may want to focus our support on the subsectors or industries where we have a competitive advantage and then develop skilled people to support these competitive industries,” adds Pillay.

Bezuidenhout agrees, adding that South Africa is inherently competitive in certain products. He advocates the support of these competitive sectors, which typically beneficiate local resources, to build on the strength that the country has, but warns that incentives must be transparent to be effectively used by manufacturers.

Grants and incentives have proven effective in bolstering the automotive industry in South Africa to meet world automotive manufacturing standards and costs, says Deloitte South Africa tax director Izak Swart.

“Placing more burdens on industry will be inhibitive. For example, a carbon tax would reduce industrial beneficiation and energy- intensive manufacturing, reducing the potential to beneficiate minerals. An alter- native could be to provide incentives to reduce carbon intensity, allow for industry to implement the necessary changes within a certain period and then punish companies that are not complying,” he says.

Incentive schemes may not be large enough to provide sufficient incentives for large manufacturers, while smaller companies find it difficult to navigate the approval regimes pertaining to incentives and often are not aware of incentives and support programmes, notes Swart.

To make localisation effective, municipalities and State infrastructure projects must have information on locally manufactured goods so that authorities can decide whether to use locally manufactured goods that meet specifi- cations, says Bezuidenhout.

The sustainability of local industries is important for job creation and competing with subsidised imports. This can be achieved through better information on the local market to support demand volumes in local industries.

Local industry is working closely with the South African Customs Office to identify goods at ports of entry to implement the price referencing system that is aimed at preventing below-price goods coming into South Africa, adds Bezuidenhout.

“Many municipalities and government projects do not have information on local products. We must improve information to enable project managers to decide whether to choose South African products, where avail-able and competitively priced,” he says.

Productivity Competitiveness
Skilled people, innovation to drive improved competitiveness and next-generation manu-facturing, which often uses automation to improve efficiencies or quality, are needed to ensure South African manufacturing remains competitive internationally, explains Bezuidenhout.

“Germany is a good example of innovation in manufacturing, which is a result of innovative and creative people opting to work in manufacturing. Universities with close ties to the manufacturing industry produce skilled graduates needed for future manufacturing demands; syllabi are also informed by exposure to and input from the sector,” notes Pillay.

Manufacturing provides skilled, high-quality jobs that support the development of infrastructure and the economy in South Africa, he says.

The cost of labour is a concern, but must not viewed in isolation, and it is critical that a commensurate value of productivity from South African workers is aligned with salary demands. Productivity in South Africa has stalled and this is partly due to socioeconomic conditions, in which solitary income earners support multiple dependants, which drives wage-demands increases. A lack of public infrastructure and transport results in most factory workers having to rise three hours before starting work, says Pillay.

This means that investment in developing effective public infrastructure, specifically transport infrastructure, can help improve manufacturing competitiveness and labour productivity. However, this is an example of only one of several structural constraints on the manufacturing sector, he notes.

The manufacturing sector continues to face a challenging environment and muted demand. The sector will likely make a positive contribution to economic growth in the second quarter of 2013. The BER Quarterly Manufacturing Survey shows manufacturers expect fairly strong domestic demand during the third quarter of this year, says IJssel de Schepper.

Given the weaker rand exchange rate, imported goods have become more expensive and manufacturers could expect a shift towards cheaper locally produced goods. Hence, import substitution might provide some respite for local manufacturers, she notes.

The promise of local infrastructure development to support manufacturing demand and volumes locally is viewed with some doubt by the manufacturing industry in South Africa.

Seifsa highlights that manufacturers’ perceptions of policy implementation of infrastructure plans and development plans are negative despite several national development and incentive initiatives.

Growth in the demand for fabricated metal products and electrical machinery does indicate higher demand emanating from these projects. These trends and supplier development programs, which take time, could allay some of the uncertainties.

“The rating of the political climate as a constraint on business and investment is critical. The high rating reflects a persisting sense of uncertainty in the sector, especially as the survey indicates that the political climate constrains not only general business con- ditions but also the ability to invest over 12 months’ time,” argues IJssel de Schepper.

African Hope?
“There has been an increase in exports and trade with African countries at the expense of traditional trade markets, such as the European Union, where demand is low,” says Langenhoven.

Manufacturing exports to Africa have increased to 22.6% of total exports in 2012, up from 15.4% in 2005. Traditional markets, such as Europe and Asia, have slipped to 23.5% and 22.9% respectively in 2012, down from 28.5% and 27.1% respectively in 2005, says IJssel de Schepper.

“Manufacturers could be more positive about exporting to Africa. Data show that Africa’s share of South Africa’s total manufacturing exports has increased quite significantly over recent years.”

A report by industry body the National Association of Automobile Manufacturers of South Africa shows that Africa is South Africa’s biggest export market for new-vehicle sales, relegating Europe to second place. The International Monetary Fund estimates growth in the sub-Saharan Africa region to be 5.1% in 2013, which could increase to 5.9% in 2014.

This stronger-than-expected growth could boost demand for our exports, concludes IJssel de Schepper.

Edited by: Martin Zhuwakinyu
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