SUBMISSION TO STANDING COMMITTEE ON PUBLIC ACCOUNTS REGARDING THE "ARMS DEAL", PAUL HOLDEN, January 4 2009

Private and Confidential

INTRODUCTION

I am a freelance researcher, writer and historian with a particular interest in the Arms Deal. I have recently written a book, published through Jonathan Ball, entitled "The Arms Deal In Your Pocket", which details the history of the Arms Deal and its various associated scandals. In conducting research for this book, it is clear that cognizance of certain issues has not yet been taken by appropriate bodies such as the Standing Committee on Public Accounts, amongst other portfolio committees. This submission outlines these issues in order to highlight the necessity for SCOPA to fully address the issue. It is verily believed that SCOPA should, in its capacity as a "watchdog" empowered to ensure that taxpayer funds are used appropriately, wisely and efficiently (as outlined in the Constitution), recommend an independent judicial Commission of Inquiry into the Arms Deal.

The following submission is made in my personal capacity.

UNMANDATED EXPENDITURE

It is common knowledge that the South African government and the Cabinet in particular had no specific mandate to conduct the Arms Deal purchases in the form that was presented to the public in December 1999. The formal review of Defence Policy, completed in 1997 and referred to as the Defence Review, was clear as to the major threats facing South Africa at the time, most of which were non-military in nature: "The greatest threats to the security of the South African people are socio-economic problems like poverty and unemployment, and high levels of crime and violence." The SANDF was not viewed as competent to address these concerns: "The government has adopted a narrow, conventional approach to defence. The primary function of the SANDF is defence against external aggression. The other functions are secondary."[1]

As such, arguments that were made (dealt with below) that Arms Deal expenditure would lead to employment and investment ignores the reality that the SANDF was never conceived of as the appropriate means to facilitate investment and economic growth, nor was it considered competent to tackle socio-economic problems that consisted the key threats to the South African public. With good reason: it is an established fact, internationally, that the use of the military for resolution of socio-economic and non-Defence concerns is economically irrational, as deploying military resources in this regard often constitutes a much larger cost to the tax-payer than other appropriate civilian avenues.

In addition, the Defence Review clearly outlined the manner in which civilian oversight was to be exercised with regards to Defence expenditure. In short, the Defence Review argued that any major equipment purchase undertaken by the South African government would require parliamentary approval:

"The approval of a force design by the parliamentary defence committee, Cabinet or Parliament does not constitute blanket approval for all implied capital projects or an immutable contract in terms of the exact numbers and types of equipment. At best, it constitutes approval in principal for the maintenance of the specified capabilities at an approximate level...[2]

This parliamentary approval was never sought. As such, Cabinet, in effect, violated the terms of the Parliamentary approved Defence Review and conducted the Arms Deal without the necessary mandate from Parliament.

In addition, the "package" nature of the Arms Deal (in which various equipment types were bought at the same time) was never envisaged by the Defence Review. In fact, it was acknowledged that the priorities of socio-economic reconstruction were such that Defence expenditure should remain minimal and equipment purchases undertaken in a phased manner appropriate for a country undertaking post-Apartheid reconstruction. This was clearly acknowledged in the Defence Review:

"It has become apparent that national priorities and budgetary restrictions place constraints on defence expenditure. This means that the achievement of a sustainable force design of the magnitude envisaged in the Defence Review will not be possible in the short-to medium-term."[3]

The "package" nature of the Arms Deal was thus unmandated and, as will be shown below, a major reason for the consistent burden that the Arms Deal has exercised on the South African fiscus.

THE ARMS DEAL: ECONOMICALLY IRRATIONAL

The Arms Deal was presented to the public as economically rational, inasmuch as offsets would lead to investment in excess of R100bn and the creation of 65000 jobs. Notwithstanding concerns about non-delivery of offsets (discussed below), such statements ignored the basic fact that expenditure on the Arms Deal exercised an opportunity cost: money spent on the Arms Deal, in other words, could not be directed to other socio-economic expenditure, which, as was pointed out above, constituted the actual measures needed to be undertaken in order achieve security in post-apartheid South Africa.

The Arms Deal has absorbed a large portion of the South African budget available for social expenditure. As is clear from the 2008 budget, the Arms Deal has cost South Africa R43.097bn, with a further R4bn to be spent by 2011. This is larger than the expenditure on key social services, such as the provision of low cost housing, the provision of anti-retrovirals or bursary schemes for tertiary students. The following table provides a clear sense of this:

Fig 1. Expenditure on the Arms Deal compared against other social expenditure[4]

The manner in which the Arms Deal was conducted, inasmuch as it consisted a package deal, was economically irrational on a number of levels. First, it was conducted at the same time as the government had adopted the Growth, Employment and Redistribution (GEAR) macro-economic framework. It is common cause that this framework was adopted in order to reduce South Africa's debt burden and place the economy on an appropriate macro-economic footing. This was to be achieved through a programme of fiscal austerity, which included reducing government expenditure to reduce the current account deficit to roughly 3%. As has been frequently noted, this programme was adopted without the "buy-in" of key components of civil society and in direct contravention of the mandate provided to the government-elect articulated in the Reconstruction and Development Programme document. However, the Arms Deal, which was conducted largely in foreign currency and facilitated by large international loans, violated this principle of fiscal austerity. That a constricted national budget was forced to include expenditure on this scale, which exceeded other social expenditure that was more appropriate for the security needs of the country, is both irrational and evidence that Cabinet was acting in bad faith.

Second, the Arms Deal consisted of large capital expenditure on foreign acquisition. This was facilitated by the leveraging of considerable foreign exchange loans, much of which was either Euro or Dollar denominated. This, in turn, opened the government to a substantial inflation in terms of cost. The size of the Arms Deal precluded "hedging" the loans, allowing for massive costs to be incurred through foreign exchange fluctuations. That such fluctuations were expected is uncontested: the 1998 Asian Crisis, for example, had clearly outlined international investor aversion to developing economies and illustrated the manner in which the currencies of developing nations could be subject to adverse fluctuation. Similarly, the forward rate projection of the South African Reserve Bank, at the time, indicated that the Rand would devalue to roughly R12 to the Dollar by 2010.

In reality, the period from 1999 to date has been one that has been marked by the consistent decline in the value of the rand versus major currencies. The cost of the Arms Deal was calculated at a rate of R6.25 to the dollar. It is clear that this was unrealistic, as evidenced by the fact that the Rand has fluctuated at a relatively consistent rate of between R8 and R11 to the Dollar. This explains the major inflation in the cost of the Arms Deal, rising from R29.9bn in 1999 to R47bn in 2008. That this was not clearly explained by the Cabinet to the South African public at the time that the Arms Deal was conducted can only be construed as acting in bad faith. Similarly, undertaking such a large expenditure at the time when foreign exchange fluctuations were clearly anticipated, consisted of an unwise and inefficient model of expenditure at a time of national budgetary contraction.

Third, it can only be construed that, at the time of the Arms Deal, the South African government was unconcerned about its potential cost, despite its major budgetary implications. This is clear inasmuch as key contracts were initialed by then Defence Minister, Joe Modise, in March 1999 prior to his leaving office. [5] That this was done is scandalous and evinced a disregard for the financial implications of the Arms Deal is made clear by the fact that Cabinet was only presented with the Affordability Study, which outlined the cost of the Arms Deal and its impact on the national economy, in August 1999. Thus, the South African government had committed itself to key weapons purchases before its economic impact was fully appreciated.

Fourth, the financing costs of the Arms Deal have never been properly disclosed to the South African public. These were the costs associated with making interest payments on the loans undertaken to finance the Arms Deal. That these were not factored into public statements regarding its cost should be viewed in a serious light, as they consisted a major expenditure in their own right. According to the Joint Investigation Report, it was commonly acknowledged that the cost of financing would account for roughly 49% of the capital cost[6]. At 1999 rates, this would have equaled roughly R14.847bn (49% of R30.3bn); in 2008 terms, factoring in the inflation of the Arms Deal cost, the financing could be estimated to cost R23.03bn (49% of R47bn). This would increase the cost of the Arms Deal, by 2011, to R70.03bn. It should be noted that this consists nearly R29bn more than has been spent on the provision of low-cost housing.

Fifth, it can be questioned as to whether the government was ever in possession of the appropriate facts to consider the economic impact of the Arms Deal. The Joint Investigation Report, for example, noted that an assessment by independent economists of the Affordability Study found major flaws in its modeling assumptions: "the model did not include all relevant costs, such as price escalations, cost of negative foreign exchange movements etc."[7] As is clear from the discussion above, the cost of negative foreign exchange movements has accounted for the major increase of the cost of the Arms Deal from roughly R30.3bn to R47bn in 2008. That this was not included in the Affordability Study's modeling exercise thus illustrates that Cabinet was never fully appraised of the true economic impact of the Arms Deal.

Lastly, it is clear that the expenditure of the Arms Deal was unnecessary in terms of South Africa's defence needs. This has been made clear by the fact that key equipment has been under-utilized upon its receipt. As Scopa will be aware, Major-General Otto Schur responded to Scopa questioning by noting that the South African Airforce was scaling back the use of Gripen and Hawk aircraft as a consequence of the cost of maintenance and a lack of military need:

"The current need for combat aircraft and combat aircraft support for joint operations is very low because there is no real conventional threat.  For that reason, the air force is focusing mainly on transport capabilities (both helicopter and fixed wing) as well as the training of new pilots to feed into the squadrons to prepare for future operations ... Instead of 200 hours a year per aircraft, we may only achieve 100 hours per aircraft. We will not use them as often because there is no need in the short term. Until such time as the physical risk to national security escalates, where it requires a larger investment in combat systems, this is a wilful decision to reduce the investment in that environment."[8]

OFFSETS: NON-DELIVERY and MISLEADING INFORMATION

As has frequently been discussed, offsets (also known as counter-trade) was presented by Cabinet as a major reason behind the economic rationality of the Arms Deal. According to Cabinet pronouncements, winning Arms Deal contractors would facilitate business activity to the value of over R100bn, which, in turn, would create roughly 65000 jobs.

While sounding impressive, the reality is somewhat different. First, it should be noted that the cost per job created is excessive. According to 1999 figures, the Arms Deal would cost R30.3bn (excluding the roughly R15bn in financing charges). This, in turn, equates to R460 000 spent per job created. It is perhaps trite to point out that such a figure is far in excess of what it would have cost to create a single sustainable labour-intensive job through state expenditure. Indeed, in 1999 terms, the average salary of a member of the police or correctional services was R50 600; for the amount paid on the Arms Deal, the state could have employed, for a year, 590 909 member of the police or correctional services, which equals roughly triple the number of employees in this field at the time.[9]

Second, it has been admitted by members of the Department of Defence, especially Jayendra Naidoo and Chippy Shaik, that the possibility of Arms Deal offsets presenting economic benefits in excess of what could have been garnered through diverting Arms Deal expenditure to other social services and activities is incredibly slim. Naidoo, for example, admitted that "it is a highly questionable proposition that offsets will generate economic development. Our exercise was to recoup some of the expenditure on the armaments approved by government."[10] Naidoo, it should be noted, was placed particularly well to make such a statement as he had headed the Cabinet team that assessed the economic impact of the Arms Deal.

Third, it has become increasingly apparent that the job creating potential of offsets has been consistently overstated. In 2006, for example, Minister of Defence, Mosioua Lekota, acknowledged that only 13000 jobs had been created through the offset programme; roughly a fifth of what was initially promised in 1999.[11]

Fourth, it should be acknowledged that even figures such as those provided by ex-Minister Lekota are dubious and untestable. It is commonly acknowledged that civilian oversight of the offset projects have been refused by the Department of Trade and Industry on the grounds of "commercial confidentiality." For a programme with such huge political and economic implications, this attitude towards non-disclosure is egregious and outrageous. For the sake of brevity, only two examples will be provided, but it is certain that there exist other examples.

McArthur Baths (Port Elizabeth)

In 2001, SAAB (contracted to supply Gripen aircraft), spent roughly R15m upgrading the facilities of McArthur Baths in Port Elizabeth. This included installing salt pools and providing investment for a tourism marketing drive in Sweden.[12] As a result of this investment, SAAB has claimed considerable offset credits. An investigation by the Swedish media discovered that SAAB had claimed $218m in offset credits as a result of Swedish tourism up until 2005; it is unclear how much more might be claimed, although it is admitted that SAAB will receive offset credits for this transaction until 2011, despite the fact that this period includes a potential increase in Scandinavian visitors as a result of the 2010 World Cup.[13] In fact, it was established that, due to the difficult nature of monitoring the influx of Scandinavian tourists and measuring the impact of SAAB's marketing drive in this respect, SAAB had claimed offset credits for every Scandinavian (including Finland, Norway, Sweden and Denmark) landing at a South African airport, regardless of whether such a trip was made with attending McArthur Baths in mind, or whether the trip was strictly business.[14] This, in turn, was based on a figure of 50000 Scandinavian visitors, suggesting that SAAB had claimed 30 500 Swedish kronor per tourist; this equates to roughly $3830 per tourist, or nearly R20000 per tourist at current exchange rates. It would take only 750 Scandinavian visitors, in total, to accrue offset credits equal in amount to the original R15m invested. In Sweden, this matter is a public scandal, as many Swedes visiting South Africa feel that they are unwittingly supporting the offsets project, and, in turn, the arms trade, despite whatever moral objections they might hold in this regard.[15]

Global Forest Products

In November 2001, Defence Minister Mosioua Lekota addressed the media, extolling the virtues of a new project to rehabilitate a plywood plant and sawmill based in Sabie, Mpumalanga, previously owned by Mondi. The project was a joint initiative between the US-based company, the Global Environment Fund and the South African semi-parastal, the Industrial Development Corporation. According to his statement, British Aerospace and SAAB was central in facilitating the funding for the entire project, estimated to be worth close to R1bn: this was a claim that was repeated in SAAB/Gripen's own promotional material.[16] British Aerospace's contribution in this regard - facilitating the investment - allowed the firm to claim substantial offset credits for the project. Although the firm admitted to investing only $6m in the project[17], by 2002 the DTI had estimated that the company would earn offset credits in the region of $90m for "investment" (presumably as a result of "facilitating" the investment) and $81m for export sales: a total of $171m claimed for a $6m investment.[18] It is unclear how much has been claimed subsequent to this date: according to the DTI's annual NIPP report (2007) the Global Forest Products project was listed as "approved" rather than "completed", suggesting that BAe may still be claiming offset credits in this regard.[19]           

That BAe could claim such a large figure for a relatively minimal investment should be a cause for concern. Certainly, it is uncertain to what extent BAe "facilitated" any such investment in the first place. Indeed, in most of the promotional material provided by the Global Environmental Fund, no mention is made of BAe's contribution to the project. Similarly, when the project was first publicized in January 2001, BAe's name was not associated with the project, a fact confirmed by the BussinessMap foundation.[20] Indeed, according to the GEF's 2007-2008 review, it is stated, in a case-study of the project that "in 1998, GEF identified an opportunity to invest in an attractive but undervalued set of sustainably managed pine plantations owned by Mondi Ltd."[21] GEF, which consisted the second largest investor in the project (the IDC was the largest such investor), had therefore identified the project prior to the signing of the final Arms Deal contracts. BAe could thus only have facilitated such an investment in 1998 if they were extremely confident in the success of their bid to provide Gripen and Hawk aircraft.

It should also be noted that the figure of $90m investment credits to be awarded to BAe in this regard should be treated with additional caution. Indeed, according to a 2002 report by Jeff Leonard, a Board Member of the Global Environment Fund to the Forest Trends Group, it was estimated that a total of $60m would be invested in the Capital Expansion Project linked to Global Forest Products: $30m less than the total of $90m estimated as an investment credit for BAe in the DTI's 2002 report.[22]

OFFSETS: A POTENTIAL AVENUE FOR CORRUPTION?

The fact that the NIPP related to the Arms Deal is not subject to civilian oversight in any meaningful way raises concerns about whether or not these deals have been subject to corruption. Two instances should be noted in this regard.

First, it is public knowledge that the Scorpions raided the properties of Fana Hlongwane, Johan Bredenkamp and BAe Systems South Africa in late 2008. According to the search warrant issued in November 2008, the Scorpions were empowered to seize documents relating to a wide range of criminal activities in relation to the Arms Deal, including the decision to award the Hawk and Gripen contracts to BAe in December 1999. What has not been acknowledged in the media to date is that the search warrants also provide the right to seize documents relating to the NIP and DIP obligations of BAe in South Africa. To quote, in full, from the search and seizure warrants, the Scorpions were allowed to collect all material in which:

"Fana Hlongwane and his associates and/or their secretaries, assistants or colleagues would have compiled and/or received and/or kept, relating to or connected with any meeting(s), or other contacts with BAe and its associates relating to or connected with any influence or attempted influence or attempted influence on the course or outcome of the Armaments Acquisition Deal and/or the National Industrial Participation Programme (NIP)/Defence Industrial Participation Programme (DIP) related to the Armaments acquisition deal...

"[any documentation] relating to or connected with any gift, payment, loan, other benefit or gratification, assistance of whatever nature, direct or indirect, monetary or otherwise, which BAe and its associates and/or Fana Hlongwane and his associates directly or indirectly gave, intended to give or agreed to give to any person involved in or connected with the Armaments Acquisition Deal and/or the NIP/DIP related to the Armaments Acquisition Deal, or who, by reason of his or her employment or political office, might be in a position to influence the course or outcome of the same, or who might have been perceived to be in a position so to influence the course or outcome of the Armaments Acquisition Deal, whether or not he or she was in fact in such a position."[23]

That the NIP/DIP projects may have been an avenue for corruption has been substantiated - to a degree - by a recent article in the investigative magazine Noseweek. According to the article, a NIP project involving BAe Systems was established for the "beneficiation" of gold: the adding of value to a raw material for export purposes. According to the project, BAe invested $5m in the project, in conjunction with IDC (investing R10m), and facilitated an arrangement in which Harmony Gold would supply raw gold to the South African company (South African Royal Manufacturers) and receive payment once the raw gold had been turned into gold necklaces and moneys received through export sales.[24] It should be noted that the gold beneficiation project was a centerpiece of BAe's NIP project: in 2002 the DTI estimated that BAe would earn $637m in offset credits for all its downstream gold projects (it is uncertain what proportion the production of gold rope chain was accorded in this figure).[25]

In 2004, however, US citizens Luiz Perez and Valentino Diaz were arrested by the Scorpions in relation to the SARM project[26]. Perez and Diaz were the US chiefs of a company by the name of Mega Gold, the company that had been enlisted to market the gold chain rope in the US. At the time of their arrest, it was reported that they were charged with defrauding SARM and Harmony to the amount of roughly R100m. They were alleged to have received the metal chains on credit and subsequent failing to make any of the requisite payments to either SARM or Harmony Gold: SARM was said, by 2004, to owe Harmony Gold R68m for the raw gold received.[27] Perez and Diaz were subsequently released on bail and the charges eventually dropped as the State was not ready to proceed with the prosecution.

According to Noseweek, however, international auditing firm KPMG was in possession of an alleged list showing the beneficiaries of the scam alleged to have been perpetrated by Diaz and Perez. The list, according to Noseweek, included a number of beneficiaries who formed part of South Africa's cabinet and government.[28]

If the latter claim is true, it suggests that the NIP projects related to the Arms Deal could, indeed, be an avenue through which potential corrupt relationships were established. Unfortunately, the veracity of such claims cannot be fully interrogated in the vacuum created by the continued lack of civilian oversight of the NIP projects related to the Arms Deal.

CONCLUSION: THE NEED FOR A JUDICIAL COMMISSION OF INQUIRY

As this submission has endeavoured to outline, there exist numerous avenues of investigation into the Arms Deal that have not been fully explored. That many of these coincide with allegations of corruption, fraud, racketeering and a litany of other criminal activities suggests a potentially complex, albeit rewarding, investigation. In order to ensure that such an investigation is carried out to its full extent, and considering the fact that many aspects of the Arms Deal are not made available for public scrutiny and civilian oversight due to numerous clauses, it is strongly felt by the author of this paper that an independent Judicial Commission of Inquiry, informed by the power of subpoena, be instituted without delay.

Unless this is done, it is verily believed that innumerable acts of corruption, and the substantial mismanagement of the public purse, will continue to be ignored. It is commonly understood that such a situation is of a dire consequence: a failure to address issues such as this in publicly mandated forums with the appropriate punishments attached produces a culture of acquiescence and acceptances regarding public mismanagement and corruption. As South Africa attempts to pursue its path as a "developmental state", such mismanagement and corruption could potentially derail this laudable task.

In making this presentation, I understand that this may result in an appearance before the Standing Committee on Public Accounts to verify many of these claims and to present further evidence. I hereby state that I am willing and able to do so.

PAUL HOLDEN
JOHANNESBURG
SOUTH AFRICA

http://paulholden.book.co.za/

FOOTNOTES:

[1] "South African Defence Review", 1997, Chapter One, para 28 - 29.

[2] Ibid, Chapters 8 and 15

[3] Ibid

[4] Holden, P. (2008). The Arms Deal In Your Pocket, Jonathan Ball: Jeppestown, p. 29

[5] ‘The litmus test has not yet been passed', Mail & Guardian, 23 November 2001; and ‘Strategic Defence Packages: Joint Report', 2001. Available at: www.info.gov.za.

[6] Ibid, para 9.3.1

[7] Ibid, para 9.3.4

[8] ‘SA's R13,7bn fighter jets turn into an expensive folly', Business Day, 12 March 2007.

[9] Holden, P. op Cit, p. 30 - 31

[10] Ibid, p. 24

[11] Ibid, p. 24 - 25

[12] "PE Set To Become Viking Mecca", Eastern Province Herald, 2001 and "Local Firms Line Up for Foreign Gain in Arms Deal", Business Report, 6 November 2002

[13] Jonson, Y. and Resare, N. "Tourists Pay for Jas/Gripen Fighter Jets", 6 February 2007. Kindly translated from the original Swedish by Fredrik Sperling.

[14] Ibid

[15] "Tourists Won Points for South African arms deal", The Local (Sweden), 6 February 2007, www.thelocal.se

[16] "Gripen News: Success Story: South Africa (Special Edition), September 2006, available for download from www.gripen.com

[17] Ibid, p. 7

[18] "Report on the National Industrial Participation Programme", March 2002, available for download from www.pmg.org.za

[19] "National Industrial Participation Programme: Report 2007", available for download from www.dti.gov.za

[20] See: "Doubts Vex South Africa's Offset Programme", BusinessMap Foundation, 25 August 2003, Ref No: 2003\012\INV\MP

[21] "Global Environment Fund: 2007 - 2008 Review", p. 31, available for download from www.gef.com

[22] Leonard, J. "Global Forest Products, South Africa", 13 March 2002, available for download from www.forest-trends.org

[23] "Search Warrant: Section 29(5) of the National Prosecuting Authority Act, No. 32 of 1998, Residence and/or Office Premises of Fana Hlongwane", November 2008, available for download from www.mg.co.za

[24] "Who Got Arms Deal Gold?", Noseweek, Issue 110, December 2008

[25] "Report on the National Industrial Participation Programme", March 2002, available for download from www.pmg.org.za

[26] "Harmony Gold in R100m Gold Scam", 16 February 2005, www.mineweb.com and "American Pair Held on Fraud Charges", 15 February 2005, SAPA/IOL

[27] Ibid

[28] "Who Got the Arms Deal Gold", op Cit

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