Government ignored arms-deal warning

The government brushed aside the advice of its own financial experts when it embarked on the ill-fated R30-billion arms deal — as well as their warnings about the serious economic risks involved.

This emerges from two documents obtained by the Mail & Guardian relating to the affordability of the arms package.

The first was apparently given to decision-makers in November 1998, before the announcement of preferred bidders and the second in August 1999, before final contracts were signed.

Neither document has been made public, although the M&G reported on the executive summary of the 1999 study seven years ago.

Government was forced to make limited disclosure of the documents during a failed high court attempt by activist Terry Crawford-Browne to have the deal cancelled. But, as the M&G reported last week, they have since been kept under wraps.

The first report, prepared by the finance department, warned that paying for the packages could only be achieved by shifting spending from other departments or expanding government borrowing.

It noted: ‘The scope and magnitude of these risks suggest that it is important that government adopt a more, rather than a less, prudent approach to the proposed procurements.”

It recommended one of two options: budgeting a slight expansion in the defence budget and allowing the department of defence to choose what to buy: ‘This would entail the department of defence cutting back substantially the strategic packages and ensuring that it enters into negotiations only for packages that it can afford …”

The other proposal was to delay a purchase decision slightly to allow for a ‘comprehensive review” in which the conflict between defence needs and budgetary imperatives could be properly reconciled.

Instead, Cabinet chose the option that was expressly discouraged: announcing the preferred bidders without addressing affordability.

The finance study pointed out: ‘A Cabinet decision to approve a list of preferred tenderers and to allow negotiations to begin would, in effect, signal that it is committed to defence expenditures in the region of the aggregate amount of the proposed procurements. ‘Once negotiations have begun it will become increasingly difficult for government to back out of the negotiation and procurement process without losing credibility with international governments and the industry.”

After preferred bidders were announced in November 1998, the Cabinet did appoint a full affordability team. Their report, the second document obtained by the M&G, was presented in August 1999. It was equally pessimistic about the risks involved.

The team noted: ‘Armament procurements are distinguished from other government procurement … First they are very large … Expenditures of this order will inevitably involve both a move away from government’s existing fiscal targets and a significant restructuring of the national budget towards defence expenditure.”

The report pointed out that the possible costs — put at between R16,5-billion and R25-billion, depending on the packages — were significant in relation to spending in other areas.

‘Under the R25-billion scenario, for instance, the additional arms spending is about the same as the current budget of the department of housing, about 50% more than the current investment in municipal infrastructure; and is roughly a third to half the budget of the department of education.”

More importantly, the affordability study presented a detailed modelling exercise on the acquisition’s possible impact on the country’s macro-economic health, including growth, employment, interest rates, the current account deficit and foreign debt.

This showed that even with low interest rates and the full realisation of national industrial participation (NIP) promises, the impact on economic growth would be slightly negative.

This was a far cry from the public justification of the deal, which suggested the R30-billion expenditure would produce a R110-billion injection to kick-start the economy.

This, it was claimed, would be realised from ‘offset” obligations attached to the deal involving new local investments by the bidding companies and expanded domestic sales and foreign exports.

But, crucially, the study warns of major economic risks if interest rates increased significantly or the NIPs fell far short of what was promised.

The study warned: ‘The materialisation of either one of the two risks — is likely to lead to the macro­economic impact of the programme being significantly negative in comparison with the baseline scenario — the higher the expenditure level the higher the risk of negative economic impacts.”

To those could be added ‘extrinsic” risks, including rand-dollar depreciation and worsening economic conditions. The study said these ‘could create conditions that are significantly worse than those described in scenarios as modelled”.

‘The most fundamental point that emerges from the risk analysis is that as expenditure increases the risks of the procurements escalate significantly.

‘Even the R16,5-billion expenditure scenario involves significant risk — to the extent that conditions do develop adversely, government will be confronted by mounting difficulties. These difficulties grow as the expenditure level rises.”

The study noted it was ‘for ministers to choose which level is appropriate”.

While the upper figure modelled by the affordability team was R25-billion, Cabinet opted for a R30-billion package.

The main risk scenarios have not materialised, thanks to sound fiscal management and better than forecast economic growth and tax collection. But some risks have materialised.

The 1998 finance study warned that normal defence expenditure would come under pressure from the arms-deal costs coming out of the defence budget, especially if proposed personnel reductions could not be achieved.

It also predicted: ‘There is the risk that [the new] operating costs will be greater than expected, leading to further pressure on the defence budget”.

The defence force has complained of a loss of other much-needed capital and operational expenditure. And there have been persistent rumours that the cash and skills to operate and maintain much of the new equipment are lacking.

The studies highlight the risk of very large foreign procurement exercises, in a context where Eskom plans to spend R343-billion by 2013 and more than a trillion rand by 2025 — amounts that dwarf the arms deal.