South Africa: Relationship With Western Financial Institutions

Published by the Government Accountability Office on 1990-06-07.

Below is a raw (and likely hideous) rendition of the original report. (PDF)



                              United        States   General   Accounting   Office
                              Report to Congressional Requesters
GAO                                             ,.

June 1990
                              SOUTH AFRI,
                              Relationship With
                              Western Financial

                       RESTRICTED--      Not to be released outside the
                       General Accounting OfIke unless specifically
                       apprwed by the Office of Congressional

                   I                   340&-k--(               m
National !Security and
International Affairs Division


June 7,199O

The Honorable Paul Simon
Chairman, Subcommittee on
  African Affairs
Committee on Foreign Relations
United States Senate

The Honorable Edward M. Kennedy
United States Senate

This report responds to your November 2, 1989, request that we provide a profile of South
Africa’s debt, an analysis of trade credits to South Africa and the economic impact on South
Africa of denying trade credits, and an analysis of the implications of excluding South Africa
from the American Depositary Receipt system. On February 16, 1990, we issued a report
entitled South Africa: Debt Rescheduling and Potential for Financial Sanctions
(GAo/NsIADso-109BR),which contained information on South Africa’s debt and the implications
of excluding it from international payments systems.

Unless you announce its contents earlier, we plan no further distribution of this report until
30 days after its issue date. At that time, we will send copies to the Secretaries of State and
Treasury, Director of the Office of Management and Budget, congressional committees
responsible for overseeing implementation of the Comprehensive Anti-Apartheid Act, and to
other interested parties. Copies will also be made available to others upon request.

This report was prepared under the direction of Allan I. Mendelowitz, Director, Trade,
Energy, and Finance Issues. He can be reached on (202) 2754312, if you or your staff have
any questions. Other major contributors are listed in appendix I.

Frank C. Conahan
Assistant Comptroller General
Executive Summaxy

                   In 1986, in an effort to change South Africa’s policy of racial segrega-
Purpose            tion, the Congress passed the Comprehensive Anti-Apartheid iZct that
                   prohibited certain transactions and trade in selected items with that

                   At the request of Senator Paul Simon, Chairman, Subcommittee on
                   African Affairs, Senate Committee on Foreign Relations, and Senator
                   Edward M. Kennedy, GAO analyzed South Africa’s financial situation,
                   trade credits being provided to that country and the economic impact on
                   South Africa of denying such credits, and the implications of excluding
                   South Africa from the American Depositary Receipt system.

                   The Comprehensive Anti-Apartheid Act of 1986 bans new investment
Background         that includes new loans; however, the ban excludes short-term credits
                   associated with trade, which allow importers to pay for goods over a
                   period of time. Before recent steps toward negotiation in South Africa,
                   some advocates of sanctions had proposed imposing additional mea-
                   sures. Among these were banning all credits associated with trade and
                   excluding South Africa from the American Depositary Receipt system.
                   An American Depositary Receipt is a negotiable certificate issued by an
                   American bank, representing ownership of the stock of a foreign com-
                   pany, that simplifies and aids the purchase of such stock by US.

                   South Africa faced a financial crisis beginning in 1985, when American
                   banks refused to extend existing short-term credit lines because of polit-
                   ical pressure, and other international banks followed suit. Because
                   short-term credit then became unavailable, South Africa did not have
                   the resources to pay off its debt when it came due. As a result, South
                   Africa continued to pay interest on this debt but unilaterally froze
                   repayment of much of the principal. Since 1985, South Africa has
                   announced, after limited negotiation with its creditors, a series of three
                   loan rescheduling arrangements to gradually pay off part of the frozen

                   Although South Africa has managed to significantly reduce its large
Results in Brief   debt repayments that fall due in 1990, its most critical barrier to sus-
                   tained long-term economic growth is still a shortage of capital. This
                   shortage is due to capital outflow and the unwillingness of international
                   banks to make new, long-term loans. South Africa is able to get credits
                   associated with trade to partially compensate for the lack of new bank

                   page2                                             GAO/‘NSIADB@   189 South .A.frica
                           Executive   Summary

                           lending, but the inflow of credits is small compared to the large outflows
                           of total debt repayment and capital flight by cautious investors.

                           If the Western nations decide that additional economic sanctions are
                           needed, a multilateral ban on credits associated with trade would prob-
                           ably have a significant economic effect by compelling the cash-short
                           South African economy to pay cash for imports or resort to barter
                           trading. South Africa would likely have to further restrict imports and
                           increase exports in order to generate hard currency to make up for the
                           reduced credits. However, a unilateral U.S. ban would have a limited
                           effect, because many U.S. banks have already voluntarily stopped
                           giving credits associated with trade.

                           Excluding South Africa from the American Depositary Receipt system
                           would have a small impact on South Africa’s economy because under the
                           Comprehensive Anti-Apartheid Act, the receipts cannot be used to make
                           new U.S. investments in South Africa. Furthermore, U.S. investors could
                           still purchase underlying shares of South African companies issued
                           before the statute’s enactment and might take advantage of new off-
                           shore markets that would give them the same advantages as the Xmer-
                           ican Depositary Receipt. But forcing U.S. investors to divest themselves
                           of South African American Depositary Receipts might have some nega-
                           tive effect on South Africa’s business climate and make it slightly more
                           difficult to raise capital.

GAO's Analysis

South Africa’s Financial   South Africa has the resources to pay the interest costs on its intema-
                           tional debt, but because it is virtually frozen out of world capital mar-
Situation                  kets, it is unable to get new medium- and long-term loans to repay the
                           principal on existing loans as it comes due. The problem is exacerbated
                           by capital flight linked to its unstable political climate.

                           South Africa faced particularly large payments due in 1990 but has
                           managed to reduce these by “smoothing” its payments and pushing
                           them into the future. This smoothing was achieved through a new,
                           favorable debt rescheduling arrangement for the largely short-term
                           credit frozen in 1985 and by extending repayment periods for the
                           largely longer-term loans and bonds not affected by or removed from

                           Page 3                                            GAO/NSLADW-133   South .Afrka
                            Executive   Su~nary

                            the arrangement. Yet, even with the improved climate for political nego-
                            tiations, most international creditors are still unwilling to make new,
                            medium- and long-term loans because of the uncertain political situation
                            and because South Africa is a problem debtor. This situation, combined
                            with the debt repayment and capital flight problem, results in a substan-
                            tial capital outflow for the South African economy. Such an outflow
                            slows economic growth and remains South Africa’s most critical eco-
                            nomic problem.

Credits Associated With     South Africa is able to get some medium- and long-term credits associ-
                            ated with trade to partially make up for international banks’ reluctance
Trade                       to offer new, conventional loans. Thus, a South African company that is
                            closed off from international lending for general purposes or for a spe-
                            cific development project may buy capital equipment for the project and
                            receive credits associated with the purchase. South Africa’s debt owed
                            to foreign banks declined $2.8 billion from June 1986 to June 1989,
                            while its medium- and long-term credit associated with trade increased
                            by a maximum of $1.1 billion. However, such inflows are small com-
                            pared to South Africa’s overall capital outflow of at least $6.5 billion
                            during that same period.

                            A multilateral ban on credit associated with trade to South Africa could
                            significantly impede South Africa’s trade by compelling that country to
                            pay cash for its imports. To make up for the reduced credit, South
                            Africa would be required to decrease imports and increase exports. The
                            alternative to paying cash would be to barter its exports for imports.

                            In contrast to the significant effect of a multilateral ban, a unilateral
                            U.S. ban on such credit to South Africa would have a limited effect;
                            indeed, many U.S. banks already are voluntarily refraining from pro-
                            viding credits to South Africa because of the economic and political risks
                            of doing so. The ban would mainly affect American companies that are
                            still selling to South Africa and extending credit of up to 1 year on the
                            sales. Such companies might then be at a competitive disadvantage rela-
                            tive to international competitors who could continue to provide such

Excluding South Africa      Most financial analysts GAO interviewed stated that South African com-
                            panies were more or less indifferent to participation in the American
From the American           Depositary Receipt system and would feel minimal effect if excluded. If
Depositary Receipt System   South Africa were excluded from the American Depositary Receipt

                            Page 4                                           GAO/‘NSIAIM@l89   South Africa
                  Executive   Summary

                  system, there would be little effect on South Africa’s economy; Ameri-
                  cans cannot currently use the receipts to buy new South African shares.
                  American Depositary Receipts can only be used as surrogates for shares
                  issued prior to passage of the Comprehensive Anti-Apartheid Act. Thus,
                  Americans who hold the receipts cannot provide new capital to South
                  Africa. Requiring Americans to divest their South African receipts
                  would only result in a transfer of ownership between investors. As
                  American investors divest, they may have to sell at reduced prices; thus,
                  the price of the underlying shares may fall in the short-term. Divestiture
                  also could cause a marginal downturn in the business climate in South
                  Africa, thus slightly impairing South Africa’s ability to raise capital in
                  the future.


                  As requested,         GAO   did not obtain agency comments on the report.
Agency Comments

                   Page 6                                                  GAO/NSIAMO-189   South .Ah-ica

Executive Summary                                                                                     2

Chapter 1                                                                                             8
Introduction            Objectives, Scope, and Methodology                                            8

Chapter 2                                                                                           10
South Africa’s          South Africa’s Debt Rescheduling
                        Prospects for New Capital Infusions Into South Africa
Financial Situation
Chapter 3                                                                                           13
Prohibiting Credits     Background
                        The Nature of Credits Going to South Africa
Associated With Trade   Western Credit Policies Toward South Africa                                 16
                        Impact of Ban on Credits Associated With Trade                              19

Chapter 4                                                                                           21
Excluding South         Background
                        Impact of Excluding South Africa From the ADR System
Africa From the
American Depositary
Receipt System
Appendix                Appendix I: Major Contributors to This Report                               26

Tables                  Table 2.1: South Africa’s Overall Debt Repayment                             10
                        Table 3.1: Net Flow of Total Bank Lending and                                14
                            Guaranteed Trade-Related Credits
                        Table 4.1: Percent of Foreign Holdings in South African                      22
                             Mining Shares


                        ADR       American Depositary Receipt
                        GAO       General Accounting Office
                        OECD      Organization for Economic Cooperation and Developmtwt

                        Page 6                                           GAO/NSIADS@IUS   kuuth   Utica
         GAO/NSLAIHJ@   I 66 %U I h \ I ma
Page 7
Chapter 1


                            In response to South Africa’s policy of apartheid, the United States has
                            imposed economic sanctions on selected products and transactions. In
                            1985, the President issued Executive Orders 12532 and 12535, which,
                            among other things, administratively banned imports of South African
                            Krugerrands (gold coins); exports of computers to apartheid-enforcing
                            agencies; exports of nuclear goods and technology; and new loans to the
                            South African government. Subsequently, the Comprehensive Anti-
                            Apartheid Act of 1986 legislatively banned selected transactions and
                            trade in selected products, including

                        . imports into the United States of South African coal, textiles, uranium,
                          agricultural products, iron and steel, and products from South African
                          government-owned or -controlled entities;
                        . exports of oil, arms, nuclear goods and technology, and computers to
                          apartheidenforcing    agencies; and
                        l new U.S. loans and investment in South Africa.

                            Since 1986, debate in Congress has focused on the effectiveness of these
                            existing sanctions and whether more should be imposed.

                            We were asked by the Chairman, Subcommittee on African Affairs,
Objectives, Scope,and       Senate Committee on Foreign Relations, and Senator Edward M. Ken-
Methodology                 nedy to provide a profile of South Africa’s financial situation, to analyze
                            the level and type of trade credits currently believed to be provided to
                            South Africa, and to assess the economic impact on South Africa of
                            denying trade credits. We were also asked to provide an analysis of the
                            implications of excluding South Africa from the American Depositary
                            Receipt (ADR) system and from international electronic systems used to
                            facilitate trade. On February 16,1990, we issued an interim report con-
                            taining information on South Africa’s debt and the implications of
                            excluding it from international payments systems.’

                            In developing a profile and analysis of South Africa’s debt and debt
                            rescheduling, we interviewed and obtained documentation from repre-
                            sentatives of the major banks in New York, London, and Frankfurt
                            involved in lending to South Africa and from independent researchers
                            and other knowledgeable private sector sources.

                            ‘South Africa: Debt Rescheduling and Potential   for Financial Sanctions (GAO/NSIAD!M-    109BR.
                            Feb. 16, 1990).

                            Page 6                                                             GAO/NSIAIHO-189       South Africa
We interviewed officials from South African banks, securities firma,
insurance companies, the Department of Finance, the South African
Reserve Bank, and private economists to obtain information about the
country’s financial situation.

We obtained information and documentation on credits associated with
trade to South Africa from officials at the U.S. Export-Import Bank, the
Treasury Department’s Office of Foreign Assets Control, the Japanese
and Taiwanese governments, and independent researchers. We also used
information derived from the Beme Union, an association of interna-
tional credit and investment insurers. We also interviewed representa-
tives of seven major U.S. companies that trade with South Africa and
one Japanese trading company to obtain information about trade
financing arrangements.

We obtained information and documentation on the American Deposi-
tary Receipt system from international securities firms, a major gold
mutual fund with large investments in South Africa, and Treasury’s
Office of Foreign Assets Control. In addition, the above sources provided
their views on the potential impact of excluding South African shares
from the ADR system and banning credits associated with trade to South

We also retained the services of an expert consultant to provide us with
technical assistance on all issues.

We conducted our work from November 1989 to April 1990, in accor-
dance with generally accepted government auditing standards. As
requested, we did not obtain agency comments on this report.

Page 9                                           GAO/NSLADSOlW   +m~lh Africa
Chapter 2

South Africa's Financial Situation

                                        According to international bankers we interviewed, South Africa’s
                                        financial difficulties are different from those of other nations with
                                        heavy debt burdens. Unlike these other nations, whose economies
                                        cannot support the large amount of debt owed, South Africa has a
                                        liquidity problem. South Africa has the resources to pay the interest on
                                        its international debt, but cannot repay all principal obligations as they
                                        come due because most are short term, and it cannot obtain new loans.
                                        South Africa’s special situation is illustrated by the fact that its debt is
                                        sold for a much higher price on the secondary market than the debt of
                                        most countries with heavy debt burdens.

                                        South Africa gets few new loans because other countries perceive
                                        lending risks associated with the country’s political situation, a potential
                                        for turmoil, and a problem with loan repayment. South Africa has also
                                        been excluded from access to loans from international organizations
                                        such as the International Monetary F’und. Therefore, it must repay
                                        existing debt by running a current account surplus.’ South Africa’s eco-
                                        nomic policy is driven primarily by the need to generate these funds for
                                        debt repayment to improve its standing with the international financial
                                        community; South Africa eventually hopes to get new loans from inter-
                                        national bankers.

                                        Our review indicated that South Africa’s third and latest debt payment
South Africa’s Debt                     arrangement, which will take effect in 1990, was particularly favorable
Rescheduling                            for the country. It allowed a smoothing out of the debt service burden
                                        by increasing repayments of the frozen short-term debt only as sched-
                                        uled payments on other debt decrease. South Africa’s overall payment
                                        schedule for frozen debt and other debt is shown in table 2.1.

Table 2.1: South Africa’s OverallDebt
Repayment Schedule                      Dollars in millions
                                        Type of Payment                                         1990          1991          1992 - -.__ 1993
                                               . oavments
                                                  .~      on frozen debt                        $2W           $427          $440        $513
                                        Principal payments on other debt                        1,400          .700          700         600
                                        Total payments                                        $1,646        $1,127        $1,140      $1,113
                                        %cludes   last payment of the second arrangement   on June 15, 1990.

                                        ‘The current account is defined as exports of goods and services, including dividends   and Interest
                                        (earned from overseas investments and lending) minus imports of goods and se~ces.        uwludmp. dw-
                                        dends and interest (paid to overseas entities).

                                        Page10                                                              GAO/NSIAD9@H39        South   Africa
                         chapter 2
                         soah Mrlca’r   -   sltlutioll

                         The third and latest arrangement requires a lower payment for frozen
                         debt in 1990, a year in which payments on unfrozen debt are the
                         highest. South Africa has about $1 billion in unfrozen debt maturing in
                         1990, most of it held by institutions and individuals in European coun-
                         tries. According to an economic officer in the U.S. embassy in South
                         Africa, about one-fourth to one-third of the $1 billion are bonds issued
                         by ESCOM, the South African state-owned electric utility. Originally, the
                         country had about $2 billion of repayments on unfrozen debt due in
                         1990, which made it important to minimize repayment of principal on
                         frozen debt during that year. Indications are, however, that South
                         Africa has been able to renew about half of this unfrozen debt, thereby
                         extending repayment, and thus significantly reducing the payment
                         squeeze in the critical year 1990.

                         South Africa’s payments also have been smoothed out and delayed
                         because some creditors have opted to take lo-year exit loans under the
                         second debt rescheduling arrangement. Creditors who take exit loans
                         obtain higher priority repayment by converting frozen debt to longer-
                         term loans that are not frozen, but payments on principal do not begin
                         until 5 years after the conversion. Payment in full by installments is
                         received in the subsequent 5-year period. Over $4 billion, or a little less
                         than one-third of the original $14 billion caught in the payment freeze,
                         has already been converted from frozen debt to exit loans. In the latest
                         rescheduling arrangement, South Africa tightened provisions for taking
                          lo-year exit loans, making them less attractive for creditors than did the
                         provisions of the second arrangement. According to a South African
                         Reserve Bank official and independent financial analysts from South
                         African securities firms, the Reserve Bank is actively managing the
                         granting of exit loans to smooth payments so that a payment bulge sim-
                         ilar to that in 1990 does not recur in later years.

                         According to financial experts we interviewed in South Africa (including
Prospects for New        a senior South African Reserve Bank official, financial analysts in
Capital Infusions Into   banks, and representatives from securities firms), international banks
South Africa             and investors are reluctant to make medium- and long-term loans to and
                         investments in South Africa, even with the improved political climate
                         there. They are waiting to see what, if any, changes are made in the
                         political system and what effect they wilI have on the business climate.
                         Even if there were a rapid change to a post-apartheid government, the
                         holders of international capital would wait to assess the political sta-
                         bility of the new government and its economic policy.

                          Page 11
chapter 2
soatll Aflicn’6   PinAlla   sitnation

In addition, because of past problem loans to Third World countries,
increased opportunities for lending to emerging democracies elsewhere
in the world, and new requirements for higher levels of capital, interna-
tional banks may have less capital to lend to South Africa.

Because little new capital is flowing into South Africa, and its debt
repayments are substantial, the net capital outflows it has experienced
since 1985 will probably continue. From January 1985 to June 1989, at
least $10.8 billion has flowed out of South Africa. Of this, $3.7 billion
has been loan repayment to banks; $7.1 billion has been other debt
repayments and capital flight by cautious investors. These figures prob-
ably understate capital outflow because some capital flight is unre-
corded by the official statistics. Such capital outflow has contributed to
the low level of investment by South Africans in their own economy.

Net capital outflows are South Africa’s most critical economic problem
because they slow economic growth over the long term. At its stage of
development, South Africa should be running a current account deficit
to import capital goods and technology needed for development and
should finance it by inflows of capital. Instead, a current account sur-
plus is needed to finance capital outflows. Nevertheless, despite the cap-
ital outflow, the South African economy has been able to grow at an
average of 1.5 percent per year since 1985. This growth rate, however,
does not keep pace with the rate of population growth.

 P&g@ 12                                          GAo/NsIADso18.9   !5cnlLh Africa
Chapter 3

Prohibiting Credits AssociatedWith Trade

               South Africa is able to get credits associated with trade to partially com-
               pensate for the lack of new bank lending, but the inflow of credits is
               small compared to the large outflows of total debt repayment and cap-
               ital flight by cautious investors. If political negotiations fail and the
               Western nations find that additional economic sanctions are needed, a
               multilateral ban on credits associated with trade would probably have a
               significant economic effect by compelling the cash-short South African
               economy to pay cash for imports or resort to barter trading. South
               Africa would likely have to further restrict imports and increase exports
               in order to generate hard currency to make up for the reduced credits.
               However, a unilateral U.S. ban would have a limited effect, because
               many U.S. banks have already voluntarily stopped giving credits associ-
               ated with trade.

Background     allowing firms to import goods and services while paying for them over
               a period of time. Short-term credits, extended for 30 to 180 days, are
               given for commodities and consumer and manufactured goods. Medium-
               term credits of l-5 years are generally employed to finance the supply
               of industrial and agricultural capital equipment. Long-term credit
               arrangements, lasting up to 10 years, apply to major engineering or con-
               struction projects.

               The most common credits associated with trade are export credits,
               which are extended to the importer by the exporter, on behalf of the
               exporter by commercial banks, or by government export credit institu-
               tions in the exporting country. These credits help an exporter to sell its
               goods more competitively by providing reasonable financing for the
               importer. If an importing company did not have access to credits, it
               would have to pay cash for the imported goods or resort to the barter
               system. Longer-term credits associated with trade can provide a limited
               substitute for the hard currency normally obtained through conven-
               tional loans. Such hard currency is needed by South Africa to meet
               existing debt repayment obligations.

               The Comprehensive Anti-Apartheid Act prohibits new lending to South
               Africa but does not prohibit short-term credits associated with trade.’
               The regulations define short-term credits as those lasting 1 year or less.
               Proponents of further sanctions believe that restricting credits would
               impair trade with South Africa and decrease capital flow to that

               ‘The prohibition   also does not apply to firms owned by black South Africans.

               Page 13                                                              GAO/IWAD9@189   South Ah-h
                                     chapter 3
                                     Prohibiting   Crdita   Aseociated   With Tide

                                     country at a time when it already has a capital shortage. Such a sanction
                                     would impose substantial economic pressure on South Africa.

                                     The United States provides only short-term credits associated with
The Nature of Credits                trade to South Africa. The situation in other countries is different, how-
Going to South Africa                ever. According to both foreign official statistics and statements by the
                                     Governor of the South African Reserve Bank, longer-term credits associ-
                                     ated with trade may occasionally be made available to South African
                                     clients by credit agencies outside the United States.

                                     Worldwide data on credits associated with trade are extremely limited,
                                     and there is little information about both the level and the origin of
                                     credits to South Africa. In addition, the South African government does
                                     not publish figures specifically on the amounts of trade credit its compa-
                                     nies raise on international markets. However, some information on
                                     credits can be derived indirectly.

                                     The only published data on trade credit flows into South Africa are for
                                     credits guaranteed or insured by governments of countries that are
                                     members of the Organization for Economic Cooperation and Develop-
                                     ment (OECD). The OECD is a group of 24 major industrialized countries
                                     that promotes the economic growth of its members. The figures for
                                     guaranteed trade credits to South Africa do not include any U.S. credits
                                     because the U.S. Export-Import Bank does not guarantee credits to
                                     South Africa either directly or through banks.

                                     As table 3.1 shows, the level of bank-provided loans declined between
                                     June 1986 and June 1989, while government-guaranteed trade-related
                                     credits increased during the period.

TaMe 3.1: Net Flow of Total Bank
Lending and Guaranteed TmdaRelated   Dollars in millions
CrOdik                                                                                     Total bank       Total guaranteed trade-related
                                                                                              lending                               credits
                                     June 1986 throuah      June 1989                           - $2.787’                          + $1 0666

                                     %oes not include government-guaranteed          bank credits

                                     qncludes government-guaranteed  bank credits.
                                     Source: GAO analysis of OECD’s Statistics on External Indebtedness.

                                      These guaranteed trade credits, however, represent only a portion of the
                                      total trade credits going into South Africa because there may be many
                                      credits that are not guaranteed.

                                      Page 14                                                                GAO/NSLUM&It39     South Africa
Chapter 3
Prohibiting   cndita   AwodaM   with   Thde

Nevertheless, we believe that guaranteed credits are an important mea-
sure of the medium- and long-term credits entering South Africa because
governments guarantee the preponderance of medium-and longer-term
credits associated with trade with South Africa. The $1.1 billion repre-
sents a maximum for increases in medium- and long-term credits associ-
ated with trade and may include some government-guaranteed short-
term credits and conventional loans.

Total bank lending has declined over time as South Africa has repaid its
existing debt and has been able to get few new loans from international
banks. It does appear from the guaranteed trade-related credits portion
of table 3.1, though, that South Africa may be having some success in
attracting medium- and long-term credits associated with trade. These
credits are mainly provided by large corporations or trading companies
doing business with South Africa. This financing may be permitting
South Africa to substitute medium- and long-term credits associated
with trade for the lack of medium- and long-term conventional lending.
For example, a South African business entity might get a credit associ-
ated with a purchase of capital equipment for a construction or engi-
neering project because it could not receive a conventional loan covering
the entire project. In this regard, the current Governor of the South
African Reserve Bank has alluded in public statements to the potential
use of trade fiiancing as a source of new credit for South Africa. The
Governor has also encouraged South African companies to take advan-
tage of lines of trade-related credits that are currently not being used.

The substitution of medium- and long-term trade credit for conventional
lending may offer South Africa some relief from its balance of payments
problem, but it does not fully compensate for the scarcity of conven-
tional bank lending. These relatively small inflows have not made up for
the drain in South Africa’s capital stock of at least $6.5 billion from
June 1986 to June 1989. This capital outflow is due to the repayment of
international debt owed to creditors other than commercial banks (such
as the International Monetary Fund), redemptions by foreign private
bond holders, repayment of foreign government-guaranteed loans, and
to capital flight that has continued unabated over this same 3-year
period. The figure may understate capital outflow because some capital
flight is unrecorded by official statistics.

Pye    16
                              Chapter 3
                              ProhlbitixqCredta    Associated   With Trade

                              It is unclear which companies in which countries are providing most of
Western Credit                the medium- to long-term credits to South Africa. The stated policies of
Policies Toward South         government export agencies and private banks in selected OECD coun-
Africa                        tries on the issue of trade finance for South African clients can, how-
                              ever, provide some insight into likely sources of credits.

U.S. Policies and Practices   The US. Export-Import Bank is prohibited from supporting exports to
                              the South African government or its agencies.” The bank’s export credits
                              for other purchasers in South Africa are restricted to South African
                              companies that are majority-owned by blacks and nonwhites and to any
                              South African companies that adhere to certain principles of equal
                              opportunity.3 Also, the U.S. Export-Import Bank, except for the cases
                              noted above, has placed South Africa “off cover,” meaning that no offi-
                              cial government guarantees for trade credits are given to South Africa.
                              Exporters from the United States either have to assume the risk them-
                              selves or arrange for trade credit insurance in the private sector.

                              Short-term private sector trade credits to South Africa are specifically
                              exempted from the Comprehensive Anti-Apartheid Act. The private
                              sector can also provide trade financing guarantees. However, according
                              to international bankers, including many in the United States, U.S.
                              banks are reluctant to provide credits associated with trade to South
                              Africa. A U.S. Export-Import Bank official stated that there has been a
                              decrease in the number of U.S. banks that are confirming letters of
                              credit (one form of credit associated with trade) for South Africa. This
                              official lmew of one specific bank that was still providing credit as of
                              September 1989, but believes there are not many others. This view was
                              corroborated by the Office of Foreign Assets Control in the Treasury
                              Department, which conducted a survey in 1987 and found very low
                              levels of bank credits for exports to South Africa.

                              ‘The prohibition does not apply if the President determines that significant progress towanI the elim-
                              ination of apartheid has been made and transmits to the Congress a statement descnbmg and
                              explaining that determination. To date, no such determination has been made.

                              3These principles are nonsegn@xtion of races in all work facilities; equal and fair empioymmc 11br all
                              employees; equal pay for equal work for all employees; initiation and development of Crarnlnp pm
                              grams to prepare nonwhite !h.~t.h AIricans for supervisory, administrative,   clerical. and [pr hmxl
                              jobs; an increase in the number of nonwhites in management and supervisory positlom. d u II~~DWS
                              to engage in collective bargain@ with labor unions; and improvement in the quality of h fr ft K
                              employees in such areaa as housing, transportation,  schooling, recreation, and health facM-

                              Page 10                                                             GAO,‘NSuDsOlw9        sati   Urlca
                                Chapter 3
                                ProhibitingClpdita   Asmochted   WithTrde

                                According to private and governmental financial experts we inter-
                                viewed, factors deterring U.S. banks from providing short-term trade
                                credits include

                            . the absence of Export-Import Bank guarantees,
                            l the combined economic and political risks in South Africa,
                            . the increase in laws at the state and local level in the United States
                              directing government business and pension plan investments away from
                              companies and banks dealing with South Africa, and
                            . the growth in public sensitivity on the apartheid issue.

                                The decrease in export credit financing is also partially a result of the
                                adverse effect of the world debt crisis on banks. Banks are now more
                                cautious about becoming exposed to highly indebted countries, partly
                                because of the costs of setting aside loan loss reserves for loans with a
                                reduced likelihood of repayment. South Africa’s foreign debt as a pro-
                                portion of gross domestic product and in comparison with the debt of
                                other countries is low, but South Africa has frozen payments on the
                                short-term bank lending portion of its external debt. This action has
                                made South Africa an unattractive borrower for international banks.

                                According to officials from the Export-Import Bank, companies trading
                                with South Africa must be extending trade credits on their own because
                                these credits are not provided or guaranteed by the U.S. government or
                                by the U.S. commercial banking sector. Most of the U.S. companies we
                                spoke to either traded on open accounts or had turned to credits from
                                their European subsidiaries.

Policies and Practices of       The government export finance agencies of Canada, Australia, and Sew
                                Zealand have kept South Africa off cover for short-term trade insur-
Other Countries                 ance. The following members of the Berne Union continue to guarantee
                                export credits to South Africa: Austria, Belgium, France, Germany,
                                Italy, Japan, Spain, Switzerland, the United Kingdom, and Zimbabwe.
                                Some of these countries have short-term financing available without
                                restriction, but most financing is available on a case-by-case basis with
                                some limits on total commitments and on individual transactions.
                                 Medium- and long-term financing, while still officially on cover, is sub-
                                ject to greater restrictions.

                                 The Beme Union reported the following as of September 1989:

                                 P8ge 17
l   The German export-import bank Hermes has the largest total commit-
    ments outstanding to South Africa. Hermes has $281.3 million in short-
    term commitments and $2.73 billion in medium- and long-term commit-
    ments. Hermes offers maximum terms of 5 years for credit, with limits
    of $28.8 million per transaction; anything over $11.3 million is approved
    only in exceptional cases.
l   The United Kingdom’s Export Credit Guarantee Department has out-
    standing short-term credit commitments for exports to South Africa of
    $197.7 million and medium- and long-term commitments of $2 billion.
    Short-term trade credits are open without restrictions. Medium- to long-
    term trade credits are also open, but subject to a total commitment
    ceiling and limited to $16.8 million per transaction.
l   France’s export credit agency, COFACE, has %178.8 million in short-term
    commitments and $1.2 billion in medium- and long-term commitments.
    All credits are open on a caseby-case basis, with no total or individual
l   Japan’s Ministry of International Trade and Industry has $69.1 million
    in short-term credit commitments for exports to South Africa and
    $251.9 million in medium- and long-term credit commitments. Higher
    levels of Japanese government guarantees would be expected because of
    its large amount of trade with South Africa. The Japanese government
    seems to limit credits to South Africa because of its sensitivity to U.S.
    legislative restrictions toward South Africa. As a result, it is possible
    that the bulk of credit to support Japan’s trade with South Africa is
    provided from internal sources by the Japanese trading companies

    According to a report by the Commonwealth Committee of Foreign Min-
    isters on Southern Africa, Hong Kong provides trade fmancing for
    exports to South Africa from Hong Kong, Japan, and Taiwan, mainly
    through endorsing letters of credit or taking over notes with terms of up
    to 18 months. Hong Kong may also be documenting and financing
    exports from other countries; these exports do not pass through the

    Taiwan is South Africa’s second most important Asian trading partner
    after Japan, and South Africa is actively trying to expand its relation-
    ship with that country. According to an economic officer from the Coor-
    dinating Council of North American Affairs, Taiwan’s representative in
    Washington, D.C., Taiwan practices normal banking relations with South
    Africa. The Export-Import Bank of China (Taiwan) has financial pre
    grams for suppliers and buyers of exports to South Africa just as it does
    for those of other countries. South Africa is one of the few countries

    Page 18
                     Chapter 3
                     Prohibiting   Credits   Asaociati   With Trade

                     that has a diplomatic mission in Taiwan, a reflection of the open trading
                     relationship that exists between the two countries.

                     Both economic and political considerations influence the provision of
                     trade credit to foreign customers. Most exporters who have dealt with
                     South Africa say the country is a reasonably good credit risk. In some
                     countries, however, political pressure and/or perceived political risks
                     have resulted in prohibitions on medium- and long-term trade credits,
                     even though South Africa may still officially be on cover. Thus, Euro-
                     pean Community member countries voluntarily agreed in 1986 not to
                     provide new investment funds to South Africa, including credits associ-
                     ated with trade of longer than 5 years’ duration. Britain recently lifted
                     this voluntary moratorium on new investment, but it remains in force
                     throughout the rest of the European Community. The previously men-
                     tioned outstanding medium- and long-term credits associated with trade
                     from European countries were either of less than 5 years’ duration or
                     came before the 1986 ban.

                     In October 1989, the CommonweaIth of Nations adopted a proposal that
                     limited credits associated with trade to South Africa to 90 days and took
                     them off cover from official government export credit agencies. This
                     action has the effect of transferring the risks of providing trade credits
                     from the taxpayers to the market. The United Kingdom, however, has
                     rejected this proposal. The United States has already taken South Africa
                     off cover.

                     A ban on U.S. credits associated with trade would primarily affect
Impact of Ban on     short-term credits provided by US. suppliers still trading legally with
Credits Associated   South Africa because most U.S. banks are already voluntarily with-
With Trade           holding such credit from South African clients. As a result, the effect on
                     South Africa of a unilateral U.S. ban would be limited, though it might
                     reduce the volume and value of U.S. exports to South Africa. Such a
                     unilateral ban might marginaIIy decrease imports into South Africa for a
                     period, while alternative sources of supply are sought. U.S. exporters
                     may be able to offset some of the effects of a U.S. ban. For example, the
                     exporters could get credits through foreign banks and overseas subsidi-
                     aries, enter into joint ventures with other foreign manufacturers, or use
                     open account trading, as they have in the past. However, they may lose
                     some business to exporters from countries that are stiII allowed to
                     arrange credits.

                     Pw     19                                        GAO/NSUlM@l89   Soat.b Atrka
According to Treasury’s Office of Foreign Assets Control, the historic
levels of compliance with current U.S. restrictions on financial transac-
tions with South Africa show that the compliance with any new ban on
trade financing to South Africa would probably be substantial.Extensive
monitoring of bank and company compliance with current restrictions
has led agency officials to conclude that there have been no violations.
These officials believe US. companies know it is in their best interest to

Only a multilateral agreement to ban export credit finance for South
Africa could be effective. Without such an agreement, South Africa
might shift its trade to the significant number of countries still willing to
provide credit. With restricted access to such credit worldwide, the
South African economy could be severely injured by the necessity to pay
cash or to barter for its imports. To generate the cash, South Africa
would be required to reduce imports and increase exports. Reducing
imports could reduce economic growth.

Page 20                                            GAO/NSIADSO-   189 SW t h Africa
Excluding South Africa From the American
Depositary ReceiptSystem

               Exclusion of South African shares from the ADR mechanism would have
               minimal direct impact on South African companies because they do not
               use the United States as a source of new capital. Divestiture of ADRS
               would result in a change of ownership of existing shares on the sec-
               ondary market; U.S. investors might have to sell their interests at lower
               prices while permitting other investors, many of whom might be South
               African, to purchase South African shares at a reduced price. A ban on
               South African ADRS,moreover, might be circumvented. Larger investors
               could still buy the underlying shares, and a system similar to the ADR
               could be created offshore. Consequently, effectively prohibiting U.S.
               ownership in South African businesses would require banning the
               purchase and holding of the underlying shares as well as the ADRS.

               Although a forced divestiture would have few direct economic effects on
               the South African economy, it might have a psychological impact, con-
               tributing to a slight lowering of South African business confidence, thus
               having some negative effect on South Africa’s ability to raise new

Background     by American investors. An ADR is the negotiable certificate for a share in
               a foreign company that gives the owner the right to dividends and to
               changes in the capital value of the company’s stock. The underlying
               South African stock for an ADR is held by a U.S. American depositary
               bank through an account in a South African bank. The U.S. bank issuing
               the ADRfor the shares collects all dividends from them and makes pay-
               ments to the ADRholders for a fee.

               ADM are bought and sold in the market and offer a number of conve-
               niences to the investor. The ADR system simplifies the process of owning
               a foreign share, thereby allowing more investors to own foreign shares.
               An ADR translates various foreign methods of issuing shares and regis-
               tering their ownership into a standardized, American format. Unlike
               dividends on the foreign shares, dividends on ADRSare paid in U.S. dol-
               lars. In addition, ADRScan also be separated by the depositary bank into
               parcels at more convenient prices if the original share price is either
               very high or very low; one ADR may represent as little as one-tenth of an
               actual share or as much as 5 or 10 shares. It may be less convenient to
               hold the actual share than an ADR because of the efficiency of the US.
               clearing and settlement system and the ease of trading ALXB.Although
               ADRZJ  may be a more convenient method of investing in foreign shares,
               particularly for the smaller investor, these shares are less liquid than

               Page 21                                          GAO/NSIAD@&lS9   South .Urica
                                            Chapter 4
                                            Excluding South Africa From the Americln
                                            Depositary Receipt System

                                            ordinary shares, however. They may also cost more because the deposi-
                                            tary bank charges a fee for handling ADR transactions.

                                            Euromoney magazine lists 66 South African ADRs that were active as of
                                            mid-May 1989. Anyone may own ADRS, but most financial analysts we
                                            interviewed believe that American investors are the main holders.
                                            According to a major South African brokerage house, the majority of
                                            U.S. investments in South Africa is in American Depositary Receipt
                                            form. Foreign equity in South Africa is heavily concentrated in mining
                                            shares, and South African ADRS reflect this concentration, because the
                                            receipts have been issued mainly in the gold mining sector.

                                            According to table 4.1, ADRs are the dominant form of nonresident stock
                                            holdings in the South African mining industry, accounting for 48 percent
                                            of all foreign ownership in 1987 and 1988.

Table 4.1: Percent of Foreign Holdlngr in
South African Mining Shares                 Percent of Shares on Issue
                                                                                As of December 31,1667             As of December 31,1988
                                                                                 Percent of                         Percent of   Number of
                                                                                   holdings   NU%z;:~                 holdings       shares
                                            American Depositary Recerpt
                                              holdings                                    48.4    313546,666                47 9       292601.598
                                            ASA, Ltd. holdings” (American
                                              owned)                                       1.4      9,120,ooo                15          9 120.000
                                            London registered holdingsb                   33.4    216,254,434               333        203531,139
                                            Other European registered
                                              holdings                                     8.8     56,869,279               105         64 118.390
                                            Other foreign registered
                                              haldingsC (Cape registered
                                              holdings)                                    8.0      52,052,617               68         41 237019
                                            Total foreign holdings                      100.0    647,642,6%               100.0       610,606,146
                                            aASA, Ltd., is a South African, closed-end, nondiversified investment company tnvestlng in Soulh
                                            African compames, 50 percent of which are gold mines, and is listed on the New York Stock Exchange.

                                            bShares registered on the London International Stock Exchange

                                            ‘Shares registered on the Johannesburg Stock Exchange and the portion of ASA, Ltd      that ‘s ‘orelgn
                                            Source: GAO analysis of vanous financial sources.

                                            Excluding South Africa from the ADR system would require the liqrnda-
Impact of Excluding                         tion of all South African ADRSheld by American investors.
South Africa From the
ADR System

                                            Page 22                                                              GAO/NSLADSO-      189 Sou t h .Mrica
                           Excluding    South Africa Fkom the American
                           Dtpoaitary    Receipt System

Current Restrictions on    The Comprehensive Anti-Apartheid Act of 1986 prohibits new invest-
                           ment in South Africa. In practice, it prevents U.S. investors from buying
ADRs                       shares in South African companies issued after passage of the act, but
                           allows them to retain and trade shares issued prior to enactment. South
                           Africa issued distinct pre- and post-enactment shares so that ADR deposi-
                           tary banks could differentiate between the two issues and aid compli-
                           ance with the act.

                           As a result of the Comprehensive Anti-Apartheid Act, the ADR mecha-
                           nism cannot be used by South African companies to raise capital in the
                           United States through issuing new shares. ADRSare used only in the sec-
                           ondary market for the resale of pre-enactment stock.

Direct Effects of ADR      Because ADRScannot be issued for new South African shares, no new
                           capital is available from the U.S. market for business expansion and
Divestiture on the South   mining exploration in South Africa. Using ADRSto trade old shares on
African Economy            secondary markets merely alters the composition of the ownership of
                           South African mining companies. Because South African companies
                           raise no new capital through the ADRsystem, forced divestiture of ADRS
                           can only result in the transfer of stock ownership. Most financial ana-
                           lysts we interviewed stated that South African companies were more or
                           less indifferent to participation in the ADRsystem and would feel min-
                           imal effect if excluded.

                           Widespread forced selling of South African ADRS,however, could
                           depress the price of the underlying South African mining shares in the
                           short term. The U.S. investor might get lower prices for the shares when
                           selling them.’ Both South African and other foreign investors could then
                           be well positioned to purchase South African ADRSat a reduced price
                           during forced sales. In addition, the U.S. investor holding the ADR would
                           have to pay all fees associated with divesting, or selling, the ADR.

Potential for              A ban on South African ADRSwould not prevent American citizens from
                           buying and holding South African pre-enactment shares. Thus it would
Circumvention              still be possible, although somewhat less convenient, to own the actual
                           underlying share, known as the Cape share. While the ADR is the more
                           popular form of investment in South African mining stocks, some larger
                           investors do hold Cape shares. We found that larger investors, such as

                           ‘We did not examine whether this would trigger the requirement in the Constitution   that the L’ S
                           government compensate individuals for the taking of private property.

                           Page23                                                             GAO/NSIADW139         South Africa
Chapter 4
Jhluding South Mrita Prom the American
Dtpoedtary Rtctipt System

pension funds, are willing to hold the underlying Cape share to avoid
paying the dividend fee to the intermediary depositary bank and to
have voting rights. Because investors in South African mines tend to be
sophisticated, they may be better equipped and more willing to purchase
the actual share itself. The U.S. gold fund with the largest holdings of
South African gold mining shares has 61.4 percent of these shares in
ADRSand 38.6 percent of its shares in the underlying Cape share. Fund
managers told us they base their decision to purchase either the rn~ or
the Cape share on price alone.

According to security fund representatives, institutional investors are
beginning to favor holding the actual Cape share and, as restrictions on
pension funds are loosened, this trend is expected to accelerate. In addi-
tion, some larger investors are taking stock out of the ADR form because,
while it initially costs money to convert from ADR to share form, holding
the actual share brings bigger returns over time.

If additional restrictions are placed only on owning South African ADRS
and not on the share itself, U.S. investors could continue to hold South
African ordinary shares. Therefore, if South Africa were excluded from
the ADR system and investors were forced to divest, the sophisticated
investor would be able to convert the ADR to the underlying share and
continue to have access to South African stocks. Larger investors could
buy the underlying shares through a custodian bank in South Africa or
the London stock market. Thus, forced divestiture would primarily
affect small investors, who might be forced to sell their ADRSat lower
prices and be excluded from the market for South African shares.

Representatives of a gold mutual fund with the largest South African
gold share holdings mentioned another form of circumvention.
According to these representatives, if South African ADRSwere banned,
they could continue to purchase the pre-enactment Cape share and offer
it to their clients through their mutual fund. To avoid this method of
circumvention, any restrictions would have to ban the holding of South
African Cape shares as well as South African ADRS.

If ownership of South African ADRSwere banned, this action might not
prevent similar transactions from being conducted offshore. If divesti-
ture of ADRSwere required, a substitute market could easily be opened
outside the United States for U.S. investors to buy and hold the South
African shares in a form similar to that of the ADR. Alternatively, the
market for South African stocks registered and purchased in London

Page 24                                          GAO,N?IAD9@   189 .%a th Africa
clmpter 4
ExchdingSoath AfriaFromtk   Amdan
DepdUry    Receipt System

might expand. Such a shift of transactions overseas would take business
away from U.S. banks without necessarily hurting South Africa.

 P8gt 26
Appendix I

Major Contributors to This Report

                         Steven H. Sternlieb, Project Director
National  Security and   1va.n E1ar-d. Project Manager
International Affairs    Alison Pascale, Evaluator
                         Keith Ovenden, Financial Consultant
Division, Washington,

                                                                 GAO/NSIADBo   1I#!3 kmth   Africa
(486012)                  P8gt28

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