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The Role of the IDC in Small and Medium Enterprise Development

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1 The Role of the IDC in Small and Medium Enterprise Development
Jorge Maia Head: Economic Research and Information Department Industrial Development Corporation of South Africa Stellenbosch, 6 June 2006

2 SA economic performance
Average annual GDP growth rate of 3% over the period and 4.7% over the last two years A rapid increase in fixed investment to expand the country’s productive capacity South Africa’s general economic stability and sound macro- economic management widely acknowledged Prudent fiscal policy and continued improvements in tax collections resulted in a substantial decrease in the budget deficit in recent years Inflation is well under control and at levels last seen in the 1960s Interest rates are at a 24-year low Strong inflow of foreign capital into South Africa – reflecting increased investor confidence

3 Business confidence The SA business community remains very upbeat about the future of the domestic economy The positive business sentiment is echoed by the excellent performance of the Johannesburg Securities Exchange (JSE) The JSE’s All-share index increased by 43% during 2005 South Africa’s business community remains very upbeat about the future of the domestic economy, as reflected in a continued rise in business and consumer confidence indicators throughout the course of 2005. The business confidence index ended 2005 at a high, whilst the consumer confidence index for the fourth quarter of 2005 rose to a level only seen once before in the past 25 years. This positive view on the SA economy was further emphasised by various short-term indicators such as the sharp increase in motor vehicle sales, with new vehicle sales reaching an all time record of vehicles in 2005, an increase of 25.7% over 2004, making South Africa probably the best performing market internationally in that year, a rebound in the manufacturing sector, a sharp increase in the number of building plans passed and buildings completed, as well as the announcement of various large capital projects during 2005, all point towards strong economic growth and development in the short to medium-term.

4 Investment environment challenges
Recent Investment Climate Survey* : Survey revealed that overall conditions are conducive to investment activity However, certain obstacles remain … Exchange rate volatility (negative perceptions) Relatively high cost of skilled labour (shortage of specific skills) Crime (is factor, however, widely accepted that the crime rate is declining as a result of better policing) Lack of competition in specific sectors of economic activity where there are high levels of concentration and significant barriers to entry Commitment of SA government to engage business in improving any element of the investment climate * Survey conducted by Citizen Surveys, a private SA firm firms were surveyed between January and December % of sample were in manufacturing sector; 14% in the construction sector and the remaining 11% in wholesale and retail trade

5 Sector-specific drivers of growth
INDUSTRY FACTORS DRIVING SECTORAL GROWTH Agriculture, forestry and fishing Strong demand for agricultural products, including an increasing demand from neighbouring countries; reduction in agricultural subsidies in advanced economies; conducive and/or normal weather conditions; increase in real disposable income and subsequent consumer spending on fresh agricultural produce; high and sustained global demand for agricultural produce. Mining and quarrying International demand for commodities, especially from China and India; increased focus on environmentally friendly automotive components and related products (e.g. catalytic converters, fuel cells, etc.).

6 Sector-specific drivers of growth
INDUSTRY FACTORS DRIVING SECTORAL GROWTH Manufacturing Robust domestic consumer and investment demand. Consumer spending should benefit sectors such as food, beverages and tobacco, clothing, textiles and footwear, automobiles, furniture and household appliances. Rapid investment spending should impact upon sectors such as iron and steel, metal products, machinery and equipment, electrical equipment and machinery as well as transport equipment. Other drivers include strong and sustained global economic growth; sound fiscal and monetary policies; preferential market access and free trade agreements to allow ease of access into global markets; increased global competitiveness through improved productivity; and a stable but competitive currency.

7 Sector-specific drivers of growth
INDUSTRY FACTORS DRIVING SECTORAL GROWTH Electricity, gas and water Government spending on service provision for the poor; re-commissioning of mothballed power stations; new power plants and dams; increased urbanisation. Construction Government’s multi-billion infrastructure programme; SOE capex spending; Expanded Public Works Programme; Gautrain; 2010 Soccer World Cup; continuation of the residential property boom (based on a continuation of the low interest rate environment and the rising black middle class); increased demand for non-residential buildings. Wholesale and retail trade, hotels and restaurants Increased job creation; higher disposable income levels; rising foreign tourism; emerging black middle class; growth supportive fiscal and monetary policies; low interest rates and high levels of credit extension.

8 Sector-specific drivers of growth
INDUSTRY FACTORS DRIVING SECTORAL GROWTH Transport, storage and communication Innovative products and services in telecommunication; under-serviced area licences; more efficient logistics system such as an improved rail and road network, harbour and port facilities. Finance, real estate and business services Sound consumption and business fundamentals; black economic empowerment; increased public sector activity; demand for residential buildings. Community, social and personal services Increased government spending on service provision for the poor; increased social responsibility focus by the private sector.

9 Manufacturing industry performance
Strong domestic demand East Asian crisis and High interest rates (Prime rate = 25.5% in Aug ’98) Substantial strengthening of the Rand Strong improvement in growth performance over past decade (2.9% p.a. vs 0.5% in previous ten years). Strong rand adversely impacted on the export-oriented sector of manufacturing, resulting in a 1.4% contraction in Manufacturing GDP in 2003. Domestic demand a key driver behind revival in 2004 and 2005 due to buoyant consumer spending.

10 Manufacturing: Production capacity utilisation
Longest upward phase in the business cycle Highest level of production capacity utilisation in the past 35 years. Strong growth of domestic economy resulted in many sectors operating near full capacity. Urgent investments in new productive capacity are essential to sustain higher economic growth momentum. Low levels of investment in manufacturing perhaps an indication that business did not anticipate that the strong growth in the SA economy in recent years would be sustained over a prolonged period.

11 Manufacturing: Production capacity utilisation
A number of manufacturing divisions are now operating at more than 85% of capacity, with 85% capacity utilisation being regarded as full capacity. At the sub-sectoral level, for example, the cement industry (part of non-metallic mineral products) is operating at almost full capacity, whilst new investment plans have been announced to meet increased demand in future.

12 SA sector performance: 2003 – 2005

13 Manufacturing: Business confidence
Business confidence in the manufacturing sector continued to improve in recent quarters. Nevertheless, the confidence level still remains well below that of other sectors of the economy. This is mainly due to a less favourable performance for exports on the back of a strong rand.

14 Manufacturing industry performance
Manufacturers switch production away from exports to the lucrative domestic market. Exporters become increasingly pessimistic about export prospects due to a strong rand reducing their export competitiveness. Import-competing manufacturers, on the other hand, also find it more and more difficult to face cheaper imports flooding some sectors in the domestic economy.

15 Investment opportunities
Identified via ... A number of initiatives…. Examples of the most viable opportunities... Infrastructure development New power stations, restructuring of ports and new cargo handling facilities, improvement of rail infrastructure, development of dams and water infrastructure projects & road projects - Sector investment strategies Business Process Outsourcing, tourism, agriculture and agro-processing, wood, pulp & paper, chemicals, bio-fuels, downstream minerals beneficiation, cutting- edge technologies (e.g. aerospace, fuel-cell technology, broad-band ICT infrastructure) Skills development - etc. Accelerated & Shared Growth Initiative The investment opportunities listed over the next few slides are associated with a number of initiatives currently underway in South Africa. Firstly, the Accelerated & Shared Growth Initiative is championed by South Africa’s Deputy President. The objective is to step up economic growth to a sustainable 6% average rate from 2010 onwards. This initiative will benefit infrastructure development, sectors such as business process outsourcing, agro-processing and downstream mineral beneficiation.

16 Investment opportunities
A number of initiatives…. Examples of the most viable opportunities... - Building materials - Construction services - Electrification - Water reticulation - Telecommunications - Transportation - etc. Expanded Public Works Programme (EPWP) The Expanded Public Works Programme is a nation-wide initiative covering all spheres of government and state-owned enterprises that aims to draw significant numbers of unemployed into productive work accompanied by training so that they increase their capacity to earn an income. Activities benefiting from: Locating in industrial development zones Current investment incentives (tax holiday, IDC schemes) Promotion of small scale industries - Offset programme Industrial Policy

17 Investment opportunities
A number of initiatives…. Examples of the most viable opportunities... - Mineral sectors benefiting Aluminium, magnesium and titanium light metals, coating technology, incl. paints and thin films, platinum beneficiation, high performance magnesium alloys, production of titanium sponge, jewellery manufacturing, etc - Industry and enterprise competitiveness including technology enhancement, work reorganisation and research and development Minerals Beneficiation Strategy Historically, South Africa has been seen as a mining country, focusing on the production of raw materials. These raw materials were then exported, for beneficiation abroad and the final product often imported thereafter. This deprived the country of value addition, much-needed foreign exchange and opportunities of creating jobs. However, this business model is about to change as government is pursuing a Minerals Beneficiation Strategy. The move is part of government’s drive to boost the capacity of the local economy and to create jobs in sectors that are linked to mining, such as aluminium, magnesium and titanium, light metals, jewellery manufacturing and platinum beneficiation - Transnet - South African Airways - Alexkor - Denel ACSA etc. Privatisation Programme

18 Investment opportunities
A number of initiatives…. Examples of the most viable opportunities... Revival or resuscitation of previously viable industries: Forging and casting, boilers, tooling, several sub-component manufacturers, railway lines Expansion and/or improved competitiveness: Locomotives (refurbishment/upgrading), wagons & coaches, railway sleepers, alloys, transformers, pumps, valves, taps, cables, overhead transmission lines, conductors Partnerships with global suppliers so as to set-up local subsidiaries to: Produce components of turbines Assemble turbines Produce components of engines (electrical as well as diesel) Produce components of switchgears Build locomotives, wagons & coaches Capex Programmes of State-owned Enterprises The capital expenditure programme of State Owned Enterprises mainly involves Eskom and Transnet. A capital expenditure totalling R134 billion has announced by these two parastatals for the next five years. This will translate it numerous opportunities. Some of these are listed on the slide.

19 Investment opportunities
A number of initiatives…. Examples of the most viable opportunities... Soccer World Cup 2010 Infrastructure upgrades in meeting the objectives of the 2010 Soccer World Cup, including: Stadium upgrades and new stadiums, Airport upgrades, Road upgrades Accommodation etc.

20 Investment opportunities
A number of initiatives…. Examples of the most viable opportunities... Transport Services & Logistics Road freight, commuter bus service, port services, ship maintenance Chemicals Industries Bio-fuels, man-made fibres, tubes and pipes, composites, soaps and other cleaning products, plastics for automotive industry Wholesale & Retail Trade Shopping centre development in townships and rural areas, convenience stores, franchising investments, warehousing facilities High Growth Potential Industries Research compiled by the IDC (Research and Information Department) identified sectors with high growth potential in terms of GDP, export growth and employment growth. According to this research, investment opportunities exist in sectors such as road freight, commuter bus services, bio-fuels and shopping centre development in townships and rural areas, to name but a few. Other investment opportunities are mentioned as per sector group.

21 Investment opportunities
A number of initiatives…. Examples of the most viable opportunities... Construction Construction project development (Soccer World Cup 2010, Eskom & Transnet capital expenditure programmes, Power generation projects, Gautrain Project, etc), building materials (cement plants, concrete making, concrete recycling); mobile brick plants; construction services Mining and Mineral Beneficiation Platinum group metals, iron ore, coal, diamond cutting and polishing, jewellery manufacturing Waste Management waste treatment, waste recycling (paper and board, plastics, metal & glass) High Growth Potential Industries South Africa's construction sector, with a contribution of approximately 3% to national GDP in 2005, is one of the fastest growing sectors in the economy with an average annual growth rate of 7.7% p.a. over the past five years, outstripping real economic growth of 3.8% p.a. for the economy at large. The sector is closely linked to the investment cycle, with both government and private sector capital spending impacting directly on this sector’s performance. This sector can be broken up into two broad categories namely: building construction industry with a market size (turnover) of R75 billion in 2004; and the civil engineering or infrastructure industry with a total market value of R48 billion for the same year. Construction project development opportunities include, amongst others, those associated with the Soccer World Cup 2010, the SOE capex programme and the Gautrain project.

22 Investment opportunities
A number of initiatives…. Examples of the most viable opportunities... - Wood and Paper Industries forestry products, furniture, packaging, paper recycling - Services Sectors Tourism (eco, accommodation, conference facilities), health and educational services, information technology, business process outsourcing High Growth Potential Industries

23 Investment opportunities
A number of initiatives…. Examples of the most viable opportunities... - Free State: logistics, biofuels, knowledge-based industries - Gauteng: logistics, commuter passenger transport - KwaZulu-Natal: ethanol, agriculture, water, sanitation, energy - Mpumalanga: rail infrastructure - Limpopo: infrastructure development, cultural and recreational facilities, logistics - North West: logistics, bio-diesel, livestock, infrastructure development, warehousing facilities - Eastern Cape: forestry, agriculture, livestock, infrastructure development - Northern Cape: diamond cutting & polishing, jewellery manufacturing, iron ore and manganese mining, logistics, infrastructure, radio telescope project - Western Cape: oil & gas hub, steel beneficiation cluster, infrastructure development Provincially-led Projects Provincial Governments identified projects for their respective Growth and Development Strategies. These identified projects are at different stages of development ranging from conceptual to business plan phase. High priority projects (that is, those projects that would make a significant contribution to the goals and objectives of the “Accelerated and Shared Growth Initiative”), include infrastructure development, logistics, a massive radio telescope project, jewellery manufacturing, agriculture and livestock projects, as well as bio-fuels/ethanol.

24 The IDC: Corporate profile
Established in 1940, the IDC is a self- financing, state-owned development finance institution Provides financing to entrepreneurs engaged in competitive industries Follows normal company policy and procedures in its operations Pays income tax at corporate rates and dividends to the shareholder Independent Board of Directors Reports on a fully consolidated basis, with its Annual Report freely available to the public IDC Head Office in Sandton, South Africa

25 “To be the primary driving force of commercially sustainable industrial development and innovation to the benefit of South and the rest of Africa” Contribute to the generation of balanced, sustainable economic growth in South Africa and Africa Economically empower the South African and African population Promote entrepreneurship through the building of competitive industries and enterprises based on sound business principles Vision and mission

26 The IDC’s core strategies
Job creation Promote entrepreneurship Facilitate BEE Regional development Small and medium enterprise development Africa’s development Encourage social transformation IDC needs to maintain its balance sheet integrity to ensure that it can deliver the above on a sustainable basis.

27 New sectoral involvement
Now Agriculture Mining Manufacturing Services - related energy tourism IT telecoms motion pictures healthcare & education transport & storage venture capital government / corporate tenders franchising financial services Other public private partnerships development agencies 1997 Agriculture Mining Manufacturing Property

28 IDC’s financial instruments
IDC offers a wide array of financial instruments, including : Equity Quasi-equity Commercial debt Wholesale & bridging finance Share warehousing Guarantees Export/import finance Short-term trade finance Wholesale venture capital These may be provided singly or in combination Flexible Deal Structuring

29 Financing criteria Project/business must exhibit economic merit in terms of profitability & sustainability Fixed assets & working capital for new start-up ventures or expansion of existing businesses R1 million minimum Owners/shareholders contribution 40% of funding is normally a requirement Equity participation: Considered as an alternative if loan finance inappropriate; minority investments; IDC exit within reasonable period Some developmental impact such as: value addition; job creation; export earnings; expanding industrial base; poverty reduction; empowerment Environmental compliance IDC may require security, the form and nature relating to clients circumstance Seek no shareholding control or management participation

30 Appraisal process Feasibility Completed
Basic Assessment Due Diligence Feasibility Study Decision-making (Investment Committee) Legal Agreements Disbursement Post-investment Management Initial Screening Term Sheet MOU/Co-operation Agreement Feasibility Completed Feasibility not fully investigated

31 The IDC’s approach to SME development

32 The role of SMEs in the SA economy
SME development: a national priority The National Small Business Act was promulgated in 1996 Numerous policies were adopted and programmes to implement these policies were introduced SMEs play a vital role in stimulating economic development Higher degree of labour intensiveness Lower average capital cost than large-sized enterprises Often use local recycled resources Provide opportunities for aspiring entrepreneurs ( especially the unemployed) Vital role in technical and other innovations SMEs are viewed as bridging gap between the first and the second economy

33 The role of SMEs in the SA economy
Contribution to GDP Contribution to employment

34 The role of SMEs in the SA economy
Challenges Access to finance Little or no entrepreneurial experience Lack of technical and financial skills Low survival rate of new businesses

35 IDC financing of SMEs Definition
IDC’s focus of the definition is on small to medium enterprises (excluding the micro enterprise segment) A business is classified as small medium enterprise (SME) if it fits any two of the following criteria: Less than 100 employees Less than R50 million annual turnover Less than R30 million total assets value

36 IDC financing of SMEs Various approaches geared towards developing SMEs: Franchising (providing finance to franchisor and franchisee) Agency Development and Support (serves as a support and resource facility to fulfill IDC’s developmental role through the establishment of agencies -particularly in rural areas) Risk Capital Facility (targets private SME sector through BEE) Special development financing schemes (Pro-SME Jobs Scheme)

37 IDC financing of SMEs Pro SME Jobs Scheme …
Capital allocation: R600 million. Key objectives: To promote employment creation and SME development by encouraging businesses to embark on labour intensive start-ups / expansions. Pricing and individual loan limits: Interest rate of prime less 5% applicable for the full period of the loan (max. 7 years). This period includes any grace period for capital repayments. The low interest rate finance will be limited to R25 million per project.

38 IDC financing of SMEs Pro SME Jobs Scheme (cont) … Criteria:
The financing is available for SMEs in all sectors within the IDC’s development mandate. Applicants must be independent companies or groups complying with at least 2 of the following 3 parameters: less than 200 employees; or less than R35 million turnover; or less than R40 million in total assets at application date or after the 1st year of full production in the case of start-ups. The business must have economic merit, i.e. have prospects of acceptable profitability, and must comply with the IDC’s normal funding criteria.

39 IDC financing of SMEs Pro SME Jobs Scheme (cont) … Criteria (cont.):
At least 10, direct, permanent new jobs must be created. The total capital cost of the new or additional assets (buildings, machinery and working capital) must not exceed R150 000 per job opportunity (calculated at peak funding requirement). The new or additional assets are the total assets involved in the start-up or expansion – not only the portion to be financed by IDC.

40 Development Financing Schemes (cont.)
Generic issues All schemes are effective as from 10 November 2005, and will be on offer until 1 December 2006 or earlier if the R1 billion capital allocation is depleted. In cases where the results of the financing provided under the schemes are not in line with the set objectives, IDC has the right to increase the interest rate to a “prime based risk adjusted rate”. All the normal IDC fees (including the breakage/cancellation fee) will be applicable except for the Pro Franchising and Pro Orchards schemes. The minimum IDC facility is R1 million (except for franchising). Only direct, permanent new jobs will be taken into account for the purposes of qualifying for finance, with the cost per job calculated at peak.

41 IDC financing of SMEs Since 1995, the IDC has funded over 3600 SMEs with a total value of R13.5 billion In 2004/05 financial year (9 months), over 70% of the number approvals pertained to SMEs.

42 IDC financing of SMEs Most of the SMEs funded by the IDC are in the agriculture, hunting, forestry and fishing sectors.

43 IDC business support in SME sector
Entrepreneur development assistance will include: Providing greater pre-investment support for high potential / high impact investments Closer monitoring of clients Providing technical support post investment Focused training to meet needs of specific entrepreneurs Providing generic training and systems to support new entrepreneurs Encouraging the development of women entrepreneurs Encouraging the development of disabled entrepreneurs

44 Concluding remarks Job creation is overarching objective of IDC financing Increase focus on the development of entrepreneurs Intensify balanced development and spread job creation across regions (including rural areas, various provinces, townships) Emphasis on expansionary BEE projects Continue to focus on Government’s policy objectives

45 Thank You

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