Governance in the Mining Sector -Mozambique and Botswana

Governance, Shmuverance

Last week the EU and US ambassadors in South Africa were reported to have  at the Ernst and Young  Strategic Growth Forum Africa 2014, saying that their private sector was really looking for places to invest but was highly concerned about good governance. The  EU ambassador to South Africa Roeland van de Geer was reported to have said last week “Governance, the political will and the political climate is incredibly important, and there is an increased interest in investing outside the EU in countries that are transparent and open. Money will go where it’s welcome,” he noted during a panel discussion at the EY Strategic Growth Forum Africa 2014. US ambassador to South Africa Patrick Gaspard was reported to have added that a combination of good governance and effective regulation in any State culminated in the “perfect storm” for attracting investment.

Responding politely and with all due respect to their excellencies, their conclusions  regarding the importance of corruption in determining investment seem to be at variance with the facts on the ground.  There is no doubt that the appetite for corruption varies from country to country and firm to firm and US and EU firms are under strict national laws such as the Foreign Corrupt Practices Act in the US not to offer bribes or involve themselves in corrupt practices when operating abroad. There is no way that large mining companies want to do business in the eastern Congo but there are people who will help. That is precisely why in every capital or every country in Africa and throughout large parts of the world you will find ‘brown bag men’ who are paid ‘commissions or finder fees’ to act as ‘agents’ for large transnationals and pay the bribes to corrupt officials, something that could not be done directly. In this way the good and the virtuous Americans and Europeans do not have to do precisely what businesses from Latin America and Asia have no compunctions or even national legal restraints in doing. Thus the commissions paid to the brown bag men are efficient ways  to operate in environments where their governments and share holders do not wish to dirty their hands with the reality of daily business.

Of Botswana and Mozambique

Perhaps no contrast is sharper than that between Botswana and Mozambique. On the Transparency International Index Botswana ranks as the least corrupt country in Africa with a position of 30^th in the Transparency International Index but  Mozambique on the other hand ranks as 119^th out of 177. It has minimal budget openness and while it is a  beautiful country, with fine food  and wonderful people  it is just not a country that has  developed a  reputation for the probity of its officials and ministers.

Corruption exists everywhere and Batswana complain bitterly about corruption in the country but they are simply not used to the sort of grand malfeasance found in Mozambique. It is simply on another plain, another dimension altogether from the corruption found in Botswana. Perhaps the best example from Mozambique of the nature of that country’s  corruption problem is the murder of Mr Orlando José, who was Director of Audit, Intelligence and Investigation of Mozambique. His responsibility had included the internal investigation of customs services. He was killed on 26 April 2010, only three hours after announcing on national television that three imported luxury cars had been impounded in Maputo for various illegalities. Regrettably the death of Mr Jose is not the only case in Mozambique’s struggle against corruption. The violence and level of corruption in Mozambique is simply off Botswana’s scale.

 Location, Location, Location!

If one believes their excellencies, and you have to be very young to do so, then all the good governance loving resource firms of the  developed world would be investing in Botswana and not touching Mozambique with a proverbial barge pole.  Yet the opposite is of course the case. Mozambique is experiencing a massive boom in foreign direct investment and it is expected that Mozambique will have a growth rate of 8.3% this year, up from 7.1% the previous year Why, one asks in  Botswana  which is not only highly placed by Transparency International but also by  Canada’s  Fraser Institute  which ranks it very highly as a place to do be involved in mining activities. So why is Botswana getting very little FDI and Mozambique is booming?

Botswana has Africa’s biggest deposits of coal,  with an estimated resource of some 212 billion tonnes though the known reserves are much smaller. Yet it is the smaller coal fields in Mozambique that are being developed by the Brazilian giant Vale and exports are expected to reach 50 million tonnes per annum within a decade. The answer is location, it will cost Botswana USD10 billion to build a heavy duty railway from the Eastern Kalahari coal fields to the Indian Ocean and then if we are lucky we will have to pay USD20 per tonne to get Botswana’s coal to Mozambique. Being landlocked is a real drain on the development of Botswana.  For that sort of money you can put up with a whole lot of corrupt officials and so the choice is obvious, the rich deposits of the eastern Kalahari are still in the ground while Mozambique’s coal is already on the market. On top of the coal Mozambique has huge off-shore gas fields which being developed by, you guessed it, European firms like ENI and American firms like Anadarko. 

To give primacy to the role of corruption in dissuading investors from exploring and developing highly profitable natural resources is simply disingenuous. But equally underestimating the potential longer term effects of severe corruption is commercial folly. Companies enter many countries expecting to deal with corrupt officials. But sometimes they find the level of corruption is such that it is simply not worth the effort of staying and they leave, no matter how rich the resource or the market. This departure of foreign investors happens frequently and often quite publicly in countries like Nigeria.

These are the views of the author and not necessarily those of any institution with which he may be affiliated.

 

 

 

 

 

 

 

A Tale of Two Breweries- The Limits of Sovereign Industrial Policy in a Globalized Market

(This story is from 2012/2013 and illustrates the, at times, predatory nature of industrial policy in Southern Africa)

 

It is with great sadness I found that Botswana has a structural deficit in the trade of beer. Year in, year out Botswana  imports much more beer than we export and the deficit is growing exponentially. In fact in 2011, according to CSO statistics, we imported Pula 124 million of beer up from a mere Pula 3.6 million in 2007. Exports on the other hand were a mere Pula 30 million, up from  Pula 0.5 million in 2007. Now the interesting question is why on earth Botswana imports that much beer? Is it because the local brewer Kalagadi Breweries Limited (KBL) which is a subsidiary of the global giant SAB-Miller  can’t keep up with demand for its chief brand  St Louis. Hardly! The reason is because its only real competitor ie Heineken Diageo which is in a strategic alliance with Namibian Breweries (NBL) has been making serious inroads into the local market. If you listen to KBL the only reason has been because of the way in which the alcohol levy was applied which gave the biggest import- Windhoek of which many Batswana are very fond. The alcohol levy used to be imposed on the import price of beer and on the retail price which gave NBL a massive price advantage over KBL. The other alternative explanation is that for years KBL has basically become a lazy monopoly in the market and could get away with one local brand St Louis* and really had to do nothing else until NBL and the alcohol levy shook the market.   

To thinking beer drinker ( i.e those before the third glass) the immediate response to this should be,  who on earth cares? Well it should matter but not to beer drinkers as long as we are allowed to choose where our beer comes from. But the trade statistics hide a genuinely fascinating story about business and government policy in SACU. The brewery game is dominated by two players in Southern Africa – SAB-Miller and Heineken Diageo which operates with NBL. Basically despite the variety of brands available on the SACU market to suit everyone from your day laborer to the CEO there are really only two commercial choices of breweries available and SAB-Miller remains by far the biggest player in the SACU market.  

But the really interesting beer story is not the Goliath of the industry ie SAB Miller but the David ie Namibian Breweries Limited (NBL). Unlike KBL, NBL is a local Namibian owned company which over many years has had considerable assistance from the Namibian government and has done  what almost no other brewery in Africa has managed to do,  which is to create a recognizable African brand across three continents. It now exports to over 20 countries. The Namibian government helped first by keeping SAB Miller from either buying NBL or establishing a brewery in Namibia in the mid-1990’s. The Namibian government then helped with a range of export promotion activities knowing full well the benefits to the country as a whole of having a globally recognized brand. But most breweries hate exports- they normally considered these junk volume sales because the profit margins are usually low due to  the transport costs of such a low value to weight items. This eats into the slim margins available in an industry that is so heavily taxed by government. But the real difference between KBL and NBL  was that the Namibian brewer had a tiny market of 2 million people in Namibia and it was either grow by export or die.

In Botswana KBL was never under such commercial pressure.  NBL, according to the company’s mangers derives some 60% of sales from exports  and its two biggest export markets are South Africa and Botswana. In 2010 Namibia exported Rand 1.3 billion in beer and it is one of the most important examples of the country's export diversification.

Why has NBL’s Windhoek brand been so successful? In part it has been what the beer marketing people call ‘premiumisation’. NBL took the German colonial origins of Namibia and turned it onto an advantage. The Rheinheitsgebot   which is the 16^th century German beer making standard is used for making Windhoek which assures that only water, hops and barley are used  which assures purity.  This has been a major selling point for Windhoek at the premium end of the market. In Botswana, KBL has, twenty years too late, discovered  that it might be losing the market not just because of price and taxes and has recently introduced a new premium St Louis Export which has started winning awards.   

           The economics of trucking huge volumes of beer across the Namib and the Kalahari from Windhoek to Gauteng and Gaborone is really poor. Because beer is a low value to weight item you simply destroy your profit margins. It is one of the reasons that SAB Miller’s business model in Southern Africa is based on  breweries in each of the countries in which it operates and then those breweries will produce not only the local brand but also the whole stable of SAB Miller products. This model is not unique to SAB Miller and almost all breweries look for local firms to produce their products under license. Guinness, the world famous Irish black beer is produced under license in a score of countries with no access to Liffy water as the basic ingredient for all Guinness purists.

In 2008 NBL saw the enormous advantage of trying to produce its products in South Africa rather than reducing its margins and shipping beer to Gauteng. So when its partners Heineken Diageo decided to establish a Rand 7.7 billion brewery in Sedibeng in Gauteng in the run up to the World Cup, NBL decided to shift a part of its production to Gauteng. The decision over where to establish the brewery was not purely a commercial one. The government of South Africa, according to NBL as well as DTI reports, provided considerable tax concessions to set up in such a high unemployment area. Since 2008, if the Namibian trade statistics are to be believed, both the value and volume of beer exports from Namibia have been flat. NBL says the figures are inaccurate but refused to provide its own. The bigger bottles are now being produced in Sedibeng and for the moment the smaller bottles are still coming  across the Kalahari. But eventually the transport economics dictates that exports from Namibia should diminish greatly.

Since the move to Sedibeng in 2008 there has been a perceptible shift in policy towards competition to NBL in Namibia. In 2010 the government of Namibia authorized the building of a brewery in the country by SAB Miller which it had previously blocked in the 1990’s. The SAB Miller brewery has not yet started construction.

There are at least two lessons from the SACU beer saga. The first is that South African tax concessions only strengthen the natural commercial forces that drive business to areas of high economic density like Gauteng. The government of South Africa might wish to stop aiding the loss of diversification from one of its neighbors. For all the smaller SACU partners all this is part of century long process of Pretoria behaving in a commercially predatory manner and is nothing new. It should also be an object lesson to those in Gaborone designing the current Economic Diversification Drive that foresees the establishment of local firms first that produce for the local market and then is a second and later stage move into exports. The experience of KBL and the whole SABmiller business model simply means that this will never happen because more exports mean less profits for the group as a whole. There is no avoiding the lesson of Namibia that a lean and hungry business helped by government to export can do much better in terms of export diversification than any inward looking approach to diversification. NBL exports ZAR 1.3 billion from Namibia and KBL exports P 30 million  from Botswana – the  numbers speak volumes.

[*According to senior officials from KBL the local Botswana  bee,r St Louis is named after city in the USA, not the French patron saint. Why one asks, would anyone in Botswana name the national beer after a big but relatively uninteresting American city? The response given to me by those officials was that this was done because Batswana like big American cities. This seems curious and if anyone has a better and  more credible explanation it would be appreciated]

Deflated Egos- the Place of South Africa in the African Economy

Deflated Egos- South Africa within the African Economy

And finally when Pretoria starts to think like Tswane it will also recognize the recalcitrant and ugly facts … it is now number two in Africa and it really needs its neighbours as partners to even stay second!

Some numbers actually do make people and countries change their whole way of thinking about their relations with other people as well as themselves. Take the GDP of China as compared to that of the world’s number one economy, the USA. Economists have spent the last few years speculating on when the day will come when China, with its fabulous rates of GDP growth, would finally resume its rightful place as the world’s biggest economy which it was for many centuries until European, Japanese and American colonialism systematically plundered the country in  the 19^th century. When that day comes and it will certainly come at some time between 2020 and 2030 the US will become  something that is not part of its national psyche, it will become number two!

In Africa we have had the same situation with South Africa and Nigeria.  For years, South African officials and politicians as well as the public, whether under apartheid or under democracy, could take for granted that their country was number one in Africa and that anyone north of the Limpopo was small stuff and could be taken for granted. It has resulted in an insufferable level of hubris and arrogance in Pretoria towards its neighbours that was painful to not only those in Botswana but throughout southern Africa. But suddenly in early April Nigeria recalculated its GDP and overnight its GDP  went from 42 billion naira to 80.2 billion Naira. The Nigerian economy had grown 90% overnight and South Africa was in a new position- number two in Africa!

Big doesn’t mean Rich

Unfortunately Nigeria has developed the reputation of being Africa’s home of ‘shonk’ and ‘dodgy deals’ and the sudden doubling of its GDP was initially seen by many who did not understand as something could be not possibly be accurate. However,  this recalculation was not a product of Nigerian fudging of numbers but the exact opposite, their statistics office finally got the numbers right. The old GDP estimates were based on weightings from a 1990 base. These weights should be recalculated every 5 years to reflect the change in the economy but statistics being what they are, i.e. a very low priority for every government, this was not done for almost quarter of a century. In 1990 Nigeria had no telecoms, no Nollywood to speak of and no booming and aggressive financial sector. This all changed in 20 years  with a new 2010 base,  lo and behold Nigeria was found to have a larger economy  than South Africa. This meant that the usual measure of how rich a nation’s citizens are, its GDP/capita went from USD1,500 to USD2,688 in 2013.  Of course it does not mean much because South Africa has some 53 million people and Nigeria 170 million and approximately 61% of those Nigerians are estimated to live on less than one dollar (9 pula) per day. This is up from 10 years ago when it was only 54%. The GDP per capita in South Africa  was US$ 5,920  and so we will have wait for  a very long time before the average South African worker would voluntarily swap places with his Nigerian counterpart no matter how big his economy may be.

Despite the brave face put on his country’s relative decline in economic importance in Africa by then South  African Finance Minister  Pravin Gorham you could almost hear the South African egos deflating  all the way from Pretoria. The sound will be much more audible from Washington when China overtakes them as the egos are much, much bigger.  But like his South African counterpart the average American worker is still a very long way from wanting to voluntarily swap places with his Chinese counterpart.

Hiding the Trade Numbers

Some statistics are just so embarrassing that its better to just hide them from the public. For years it has been impossible to get any reasonable estimate of South Africa’s exports and imports from its SACU neighbours, Botswana Lesotho Swaziland and Namibia i.e. the so-called BLNS. Like most commercial acts there was a good and a real reason for why these figures were not public. The good reason offered by South African officials is that all five SACU countries  are part of a customs union i.e basically one economy and officials in SARS could say that there was no need for SARS to separate these numbers. In 2009, before I was blacklisted by the South African Treasury and never again allowed to work on SACU issues, I was conducting an agriculture study for SACU and despite desperate attempts could not get access to South Africa’s agricultural exports to the BLNS. I was told first these did not exist, then I was told these were confidential. Then I was told that the data is completely inconsistent between one country and another, which is entirely true. Given that some ZAR 20-30 billion in SACU customs revenue is distributed to each of the 5 SACU members every year on the basis of the share of intra-SACU imports, the fact that the trade figures should not be public in countries that claim to be accountable for their finances seemed scandalous. But I suspect the real reason for the secrecy is that the import statistics of the all SACU members were so inconsistent between one country and another with SA and Namibia, for example,  never being able to agree that the actual distribution of the SACU customs pool was in effect not by any given formula but rather by agreement over which set of import statistics should use.

At the SACU centenary celebrations in Pretoria in 2010, the last SACU event to which I was ever invited, I publicly asked why such figures are not in the public domain in four countries that are democratic and respect the rule of law. My complaint and that of others was finally heeded by SACU which soon after started publishing some trade data and at the end of last year South Africa finally started to publish detailed trade data with and without the four BLNS.

Pretoria needs its Piddling Neighbours!

When you look at the South African trade figures you start to understand that there was yet another reason for keeping the figures out of public view. The trade figures show how important Africa in general is to South Africa and just how important the BLNS are to maintaining South Africa’s economic stability and a manageable trade deficit.  There are no full year figures yet available  on BLNS trade as they only started late last year. What the available figures say is that for the year from January to August 2014 South Africa’s trade deficit was a mere ZAR70 billion. But if you exclude the SACU partners the trade deficit  would have  been ZAR 137 billion. In other words South Africa on net has exported this year ZAR 67 billion to the BLNS more than it imported and that is one of the main reasons why they agree to pay the substantial transfers to the BLNS. South Africa’s trade deficit with every other region of the world is subsidized by its surplus with Africa and the BLNS countries. And that is why the South Africans fight so hard to maintain their rail monopolies and their dominant position in Africa in general and Southern Africa in particular. It is Africa and the BLNS and that trade surplus that allows Pretoria to maintain its trade deficits with all the other regions with which its trades.

It is time for South Africa to conclude that it needs its neighbours, not just as markets but as partners to its own economic development in which all must share- not just South Africans. This is a position that has long been recognized by countries like Kenya which have moved to a deep integration with its east African neighbours in the East African Community but not by South Africa in the context of SADC. And finally when Pretoria starts to think like Tswane it will also recognize the recalcitrant and ugly facts … it is now number two in Africa and it really needs its neighbours as partners to even stay second!

These are the views of the author and not necessarily those of any institution with which he may be affiliated.

Is Julius Malema right? The increasing role of government ownership in Botswana's Mining Sector?

Botswana’s Increasing State Ownership in the Mining Sector

I woke up sweating at what the Europeans know as the ‘devil’s hour’- 3AM. The previous evening I had just finished reading a taxation report. The report was important and as I calmed myself I thought …how pathetic, only an economist can wake up sweating at 3 am over the results of a mining taxation report. But the report has enormous implications for Botswana and all of Africa. It was completed by the reputable  International Centre for Taxation and Development (ICTD) in 2013 came to really significant conclusions. Basically it said that only in Botswana in Africa and Chile in South America, which both have significant government ownership of mining  companies (Debsawana in Botswana and Codelco in copper rich Chile),  have  governments  ever earned  a significant proportion of the revenues from mining. In those jurisdiction where governments rely solely on taxation systems to extract returns from mineral assets, they have gained precious little.

Mining, when it works, is a high rent (profit) business e.g. Debswana. But unless you are on the inside your will never know whether what you are being told by the mining company is exported is in fact accurate. Most countries in Africa, which have limited technical capacity to check, simply take the mining company’s export figures, valuations  and profits for granted.

This is not just a theoretical question for tax economists as it has been the very basis of Julius Malema’s argument for the nationalization of the South African mines when he was still leader of the ANC Youth League. It is a position that Malema continues to support in the South African parliament today as leader of the Economic Freedom Fighters The debate Malema unleashed four years ago terrified South African mining investors but while the debate over how countries benefit from their mineral assets changes its form, it will simply not go away easily anywhere in Africa or for that matter in any resource rich country in the world whether it is Indonesia or Kazakhstan or Venezuela.

The unavoidable fact is that most resource rich countries that followed the dominant advice given to them by the World Bank since the 1980’s that governments should not own mines and should only tax them have proven not to be bid winners. Equally, those that take no risk have not proven to be big losers. The report by the ICTD authored by Olav Lundstøl, makes it very clear that state ownership only really works to bring  economic benefits to a society when  the mines are ‘managed in a strictly commercial manner’.  This is no small caveat because as we know governments are very reluctant to just leave business alone to get on with the business of making a profit.

…. Yes, but what about Zambia?

If state ownership can do such wonders for resource rich countries then why was the Zambian nationalization of its copper mines by President Kenneth Kaunda at independence such a commercial disaster? By the end of the period of nationalization in 1998 the Zambian state mining company  Zambian Consolidated Copper Mines  (ZCCM)  was losing about US$1 million per day. The reason is that copper prices which peaked in the early 1970’s fell dramatically over the next 20 years but just as importantly Lundstol’s caveat was not applied. The mines were not run in a commercial manner. The government mismanaged the commercial side of the business and so it proved to be a monstrous failure that brought Zambian government to the point of bankruptcy in the 1990’s. Zambia was  eventually forced by the World Bank and the IMF to privatize its copper mines as a condition for a financial bailout.

This fire sale of Zambian assets occurred just before the current commodity ‘super-cycle’ which began in 2004 and saw copper and other metal prices sky-rocket under demand pressure from China and developing Asia. In retrospect it could not have a been a worse time to sell. The Zambian government was forced to give ‘away the crown jewels for almost nothing’ and then agree to a taxation regime on the newly privatized companies that meant that government earned very little taxes. This was all done with the technical help of the World Bank and the Commonwealth Secretariat and it was definitely not seen as one of the high points of their policy assistance to developing countries.  

 State ownership of mining and resource companies has gained a new lease of life over the last decade, especially in the BRIC countries where it was the largely state owned enterprises have lead the growth and development of the mineral sector. Vale, the giant Brazilian miner is owned by largely the government of Brazil but has been allowed to operate in a largely commercial manner.  These BRIC largely state owned or controlled companies, from Gasprom in Russian to Vale in Brazil to Sinopec in China have been the driving force behind minerals policies in these countries.

Vale or BMC?

Over the last while the government of Botswana has moved quietly to increase government ownership in the mining sector. Unlike some other policies that are written up in policy statements but are never implemented, this increasing state ownership was not written in a policy document but appears to be happening nonetheless. There has been a  take-over of the last remaining private shares in BCL owned by Norilsk after Anglo American and AMEX sold out. Normally well informed sources in the mining industry suggest that the government, perhaps through BCL, will very soon announce the takeover of the remaining interests in the Tati Nickel mine that is currently owned by the Russian nickel company Norilsk. The government has  established a fully government owned diamond trading company Okavango Diamonds, has established the Botswana Oil Company and is going to establish a  state owned mining company which is likely to be what BCL will eventually become.  

Those who care for Botswana should view these developments in the mining sector as both a real opportunity for the economic future of the country as well as a possible threat. It is an opportunity because for once the role of mining may go beyond just digging holes in the ground and extracting maximum short term profit.  But it will be only a threat to the future of Botswana if we do not apply Lundstøl’s caveat as we did with Debswana. It is possible for government to own a very large share of a mining asset and greatly profit from it but only so long as we allow business to get on with the business of making profits. That often involves truly ugly decisions that no politician likes- dismissing redundant workers and squeezing costs where necessary.

We have sufficient examples in Botswana. In the case of the Botswana Meat Commission (BMC), for example, following  Lundstøl’s  caveat  means shutting abattoirs that don’t make profits such as Francistown, laying off hundreds of workers who are redundant rather than keeping them for years. In the case of BCL, it means shutting mine shafts that are sub-economic or in the case of Tati closing mining operations where there are no more profits because ore grades are too low. It also means not even beginning iron ore operations when world prices hit rock bottom. All this means politically unpalatable job losses.

Is Malema Right…..No, but Seretse Khama  probably was?

Sir Seretse Khama came across an excellent formula for Debswana which is now the envy of all resource rich African countries. The government gets 50% of the profits but Sir Seretse Khama was wise enough to leave De Beers with the business of running the mine and running the diamond cartel and making money. If BCL or Okavango or the Botswana Oil Company turn out to be managed like BMC has been over the years then this will threaten the economic stability of the nation. There are two or three pretty basic ways to avoid this threat. First, is to put any management out to tender on a commercial basis and second is to sell a chunk of the shares to   Botswana citizens and float them on the Botswana stock exchange as quickly as possible. Because the stock market will tell the government and the public right away if the company is being mismanaged. But there is no substitute to government which understands that its strengths do no lie in managing businesses.  

Malema’s road of mine nationalization will lead South Africa and any African country that follows to where Zambia was in 1998. This is because the amount of economic power that governments  possess with ownership of mines make its exercise irresistible of political power ‘in the public interest’ and that is exactly where much of the troubles begins. Seretse Khama’s model of a 50/50 joint venture with Debswana where government does not manage business is one of the main reasons the nation is as relatively prosperous as it is today. The formula precluded unilateral action without De Beers agreement. It is a first class model that Botswana should not forget as we  go ahead with the policy of increased state ownership in the mining sector. The way Botswana proceeds will determine whether we develop strong and healthy state owned companies like the Brazilian miner Vale, or we just produce more loss making BMCs.

These are the views of the author and not necessarily those of any institution with which he may be affiliated.

What will Happen to Botswana as the Diamonds Run Out?

What will Happen to Botswana as the Diamonds Run Out?

On 25^th September BOCCIM (Chamber of Commerce)  and BIDPA (Botswana Institute for Development Policy Analysis)  under the auspices of the Ministry of Finance and Development Planning will hold a one day meeting to present the results of three studies undertaken over two years of work on what will happen to Botswana once the diamonds run out. The studies also look at what needs to be done in the coming years. Some of the predictions regarding the decline in mining revenues and resultant decline in living standards need to be confronted for the nation to advance.

There is increasing concern about what will become of Botswana as the diamonds are depleted. Unfortunately there has been much hype about the fact that diamond mining  is almost certainly likely to continue in the country until 2050. Botswana has been blessed by the discovery of diamonds slightly after independence. At first the Orapa mine was discovered and developed after 1966 which produced extremely large volumes of diamonds that has not been seen since the main discoveries in Russia and even as far back as the discoveries in the Kimberly a century before. Orapa remains prolific as it is a very low cost mine. The only problem was that the mine produced a very high concentration of industrial diamonds which are relatively low value. Approximately half of Orapa’s output was industrial diamonds.  

The discovery of Jwaneng and its development by 1982 produced the richest mine on earth. The Kimberlite produced not only very high volumes of diamonds confirming Botswana as the world’s most important diamond producer, but high quality diamonds with the vast majority being gem quality rather than industrial diamonds. We have now been mining diamonds for over 40 years and will, even based on the current deposits continue to mine substantial quantities for the next 35 years. It is said that at Jwaneng it takes 10 thebe of operating cost to produce one pula of diamonds. There is no such mine on earth-it is rightly called the richest piece of real estate on earth! 

The second blessing that has come with diamonds is that those who managed this massive wealth in the past did not plunder it. One need only look at the record of some, but by no means all of our neighbours and one sees a political elite that has enriched itself massively through corruption and malfeasance. In Botswana the mineral resources have been used to fund education and health programs and huge improvements in the nation’s infrastructure. The results are plain to see- a country that has moved from one of the world’s poorest at independence to a middle income country now. 

While there has been prudent macroeconomic management in the past, some of the wealth has been accumulated in the nation’s so-called sovereign wealth fund the Pula Fund. But as the diamonds become depleted we shall probably conclude that we did not save enough for a rainy day… and the rain will certainly come.

What will happen over the next fifteen years

 The great wisdom of those who ruled in the past was they did not listen to the prevailing advice that was offered to them by international institutions. Throughout the 1980’s and 1990’s the World Bank was consistently advising countries that they should not own shares in their mines and  helped many like Zambia to privatize their mines, often on terms that were not to the country’s advantage.

In Botswana a different path was taken. Debswana, unlike the copper mining interests in Zambia was never fully nationalized. The agreement was that the company would be owned 50%/50% by De Beers and the government. This would mean that decisions had to be made by consensus. But more importantly the private sector was left to run the business as a business, there was no attempt to politicize business decisions as was the case with other enterprises such as BMC or in the mining sector in Zambia in the early 1990’s. It is this that has been the great secret of Botswana – joint profits but business was allowed to get on with the business of business i.e. making a profit. Not only did Botswana own 50% of Debswana it became a significant partner in De Beers itself holding currently 15% of the value. The vast bulk  of the revenue that the government receives from mining is not from taxation but from dividends and royalties which in 2013 made up P9 billion while taxes from minerals were P4.2 billion.

The fact that such a large proportion of the revenues from mining come from dividends and royalties should give some indication of what will happen as we have to dig further and deeper to extract diamonds. Profits which have been extraordinarily high at the nation’s mines will start to fall as the cost of extraction rises. This is a typical end of mine life scenario and should not be surprising to anyone in the industry. There will be no immediate ‘cliff’  but revenues from diamonds will probably start to fall off slightly  from the end of the current decade and then sharply as diamonds production is expected to fall in the period post 2026/27. At that time, if not well in advance, severe economies will have to be made and considerable  economic pain will be felt. 

What the numbers say….

Dr Fichani and Mr Freeman, two eminent mining specialists were hired by BIDPA to help develop models of what would happen to the mining sector over the next fifteen years. In their most likely or ‘base case’ none of the propitious mines in coal, copper uranium, coal bed methane would be developed in time to arrest the decline in diamond revenue. But most startling is that even in the best case, even if all the propitious deposits were developed by 2026/27 this would not generate enough revenue to compensate for the fall off of government revenue from diamonds when the decline in output really begins. In other words the main conclusion of the report is that even if everything went really well with new mining project we are still likely to face a major fiscal crisis post- 2026/27 and we need to prepare ourselves.

The next article will look at the implications of the fall off of government revenues on living standards in Botswana.  These are the views of the author and not necessarily those of any institution with which he may be affiliated.

 

 

 

The International Diamond Trade - A very rough business

The International Diamond Trade - A very rough business

It is said in the diamond business that each rough diamond crosses at least three borders before anyone even tries to cut and polish it. In 2012 total world diamond production of mined diamonds stood at some 128 million carats of diamonds at a value  US14.5 billion. But the total imports of diamonds as recorded by all countries in the Kimberly process which exists to regulate ‘conflict diamonds’ was three times this figure at 393 million carats valued at some $50 billion. So without cutting a diamond their value had risen from $98 to about $125/carat.

The first time a rough diamond crosses a border it is from the country of production in Africa, Canada or Russia to where it is aggregated which was until very recently in London at De Beers office at Charterhouse. Under the 2011 marketing agreement between Botswana and  De Beers aggregation of diamonds  is now returning to its geological home in Africa ie Botswana so diamonds produced by De Beers in Canada, Namibia and South Africa will go to Botswana rather than to Charterhouse in London, the former capital of diamond aggregation.

The second time a rough diamond  crosses a border it is often traded for ‘cleaning purposes’ i.e. either to clear it of any possibility that the owner will ever pay  a penny in income  taxes in another jurisdiction, to gain other commercial benefits  or just simply to launder money from other businesses  and increasingly to fund criminal activities. The beauty of diamonds lies not just in their appearance but their high value to weight. This has always made them easy to smuggle and because of their natural scarcity as well as the De Beers cartel they were, in the 20^th century, a good hedge against inflation  and economic and political crises. But increasingly organizations like the OECD are taking a keen interest in diamonds and their  use for money laundering and funding of terrorism. A major publication by the OECD on diamonds and money laundering is expected in the coming months.

The third time a rough diamond crosses a border it is to be cut and that normally is in India which despite the pretensions of the Southern African countries like Botswana, South Africa and Namibia  is basically where 80-90% of the world’s diamonds were cut in 2012. India regularly boasts that 14 out of every 15 diamonds set as jewellery in the world were  processed in India. For India diamonds are amongst its biggest export sectors responsible for exports US$ 43 billion (14% of total exports) in the financial year 2011-12. Diamond production is one of the leading growth sectors of India’s economy with an estimated 1 million jobs.

Dubai  and Switzerland – laundries of choice?

The equivalent of about half of the world’s production of rough diamonds passed through the Dubai Diamond Exchange in 2012. In the 21^st century it is rapidly replacing Antwerp and Tel Aviv as the trading centre of choice. In 2012 Dubai imported some 60 million carats of rough and exported virtually the same volume. So what were the diamonds doing in Dubai? -  The short answer is they were increasing in value. The average price of the 60 million carats of rough entering Dubai in 2012 was $78/ carat and when the same volume of rough left it was worth $112, an increase of almost 45% which is what you would expect from trade with a country that offers businesses a 50 year tax holiday.  Make your profits in the tax haven and there are no issues with those very few countries that are still taxing ‘diamantaire’ on what they say their income and profits are. Because diamond traders are notoriously  economical with the truth when it comes to the real price of diamonds most diamond jurisdictions like Belgium and Israel  have long ago dispensed with  the nicety of even asking ‘diamantaire’ what their incomes are and have moved to presumptive taxes based largely on turnover.

But evading income tax in the diamond industry where there are potentially thousands of different grades of diamond which can make the appearance of low or zero profits almost pro forma certainly predates the ease and simplicity of evasion that tax havens like Dubai and Switzerland created.  One the most important commercial benefits of these havens lies in the secrecy they permit when it comes to the corrupt trade in diamonds. Let us say you are a corrupt official of a diamond exporting country. Assume that you have a shipment of USD 100 million of diamonds that you value it at $50 million. This allows the trader to avoid the payment of export taxes or royalties and to split the benefits with the corrupt official. This is amongst the more profitable of rough diamond transactions but you need a place where secrecy is respected and where you can realize the full $100 million value of the transaction by trading with a related company.

Dubai’s imports of rough in 2012 came from several very conflict prone producing countries in Africa including Congo (DRC), Zimbabwe and Angola. Not one of these countries has had a happy history with diamonds and Zimbabwe and Congo have had their share of problems with the Kimberly process itself. If the Kimberly statistics are to be believed then three quarters of Zimbabwe’s 12 million carats of diamond exports in 2012 went straight to Dubai. The importance of Zimbabwe to Dubai is such that permanent secretary of Mines and Mineral Development in Zimbabwe is, as a regular matter appointed to the board of the Dubai Diamond exchange. Almost one half of Angola’s production and one queater of DRC’s production was exported to Dubai and one quarter of DRC total production of 21 million carats went there as well. But this is by no means where the bulk of Dubai’s trade is coming from. Of course it would be easy to blame the three weakest African  producers but the real magnitude of the Dubai’s trade with Africa is small stuff when compared to the two biggest users of tax free trading environment. – the EU and India. India imported roughly a quarter of its rough diamonds through Dubai and the rest from Europe. For Dubai exports to India in 2012 were approximately half of its total exports of rough. Thus it remains an entrepot for African rough going into India for processing.  The other main trading partner with Dubai was the EU which has been one of the main destinations for exports. It is by no means simply Africans and Indians using Dubai as a laundry service of choice.

Round tripping –scamming the Indian export incentives 

Dubai also has a thriving polished diamond market where its tax free environment has lead to massive growth and the country becoming one of the truly great diamond centres of the world. But there is another reason for this burgeoning trade in rough and polished diamonds. Until early this year India allowed the import of polished diamonds duty free while simultaneously providing financing subsidies to stimulate the exports of  the country’s largest export. The ever industrious Indian diamantaire, developed a new technique of ripping off their national diamond trading system called ‘round tripping’. The Indian government has long provided subsidized export credits at subsidized rates for the diamond sector and these subsidies were very lucrative but dependent on the export of cut diamonds. So some of the Indian traders would ship the same consignment of cut and polished diamonds five or six times across the Indian ocean to Dubai claiming export credits each time. But this illicit trade went full circle because the Indian authorities also required the Indian cutters to show that they had processed the rough and so they would have to ‘round trip’ rough diamonds as well as cut and polished and so volumes in this very rough trade also increased massively until the Indian government finally imposed a 2% import duty earlier this year on imported cut diamonds. With gold prices tumbling, import duties on gold in India rising the Indian government is set to increase the import duty on cut diamonds yet again to 5% in the coming weeks. As there remain several commercial reasons for round tripping, not just skimming for export credits, this may decrease the trade significantly across the Indian Ocean.   

Dubai is by no means the only country that plays the role of entreport for the free wheeling trade in rough diamonds but it is now by far the biggest. Its importance is a reflection of the shift in international trade patterns that  increasingly excludes Europe and  brings Africa and Asia closer together. For many years Switzerland has performed a similar function. Now Dubai as well as several provinces in China are starting to swamp the traditional tax havens and are gaining an important place in the global diamond market. And in the meantime the world’s diamantaire will continue to claim that they make no profits from diamonds in the middle of the pipeline and schools and hospitals will not be built in Africa and India.

These are the views of Professor Roman Grynberg and not necessarily  of any institution with which he may be affiliated.

Synthetic Diamonds and the Reform of the Kimberly Process

Synthetic Diamonds and the  Reform of the Kimberly Process

‘The moment the average divorcee finally becomes aware that diamonds are no longer rare, and can be made, as Karl Marx once famously said ,  ‘as cheap as bricks’, then the diamond ring she has in the jewellery box from her last failed marriage, which she believes is appreciating in value every year will suddenly hit the market and then we will all discover that diamonds are not forever.’   

For a decade now the world has been engaged in what has been seen as a battle against blood diamonds i.e. diamonds that have been used to fund wars in countries like Sierra Leone, DRC and Angola. The Kimberly process, has been a unique but flawed example of an attempt at global co-operation by producers and consumers to stamp out blood diamonds. That the Kimberly process even succeeded in being established is because it was in just about everyone’s interest for it to do so. No-one in the diamond business needed these stones which are sold as symbols of love being associated with war and bloodshed. Moreover, the blessing of the World Trade Organization and the UN to restrict the trade of blood diamond did much to help do what the De Beers cartel could no longer do in the 1990’s. Unfortunately not all went to plan as the Kimberly process did not come with a system of traceability.

The Kimberly Makeover

The Kimberly process is named after the town in South Africa where in the 1860’s Cecil Rhodes, who owned De Beers and was the first of the great African war lords, made his millions in diamonds and went on to use those funds for the pillage of Zimbabwe. Kimberly,  a name that should go down in infamy as the first source of blood diamonds in Africa,  has with a rare marketing brilliance, rebranded itself and has become synonymous with the good governance in the diamond industry. Given its history it is a truly spectacular marketing makeover, almost as big a marketing coup by De Beers  when in 1948 it introduced the marketing slogan that ‘diamonds are forever’ which convinced every poor consumer in the western world that if he wanted to really demonstrate love for his fiancée he would need to part company with at least two months salary to buy his beloved a diamond engagement ring. Diamonds, like his love and despite the high divorce statistics,  were supposed to be forever and if the love was not going to last forever then the diamonds were supposed to stay forever off the market. As long as the diamond rings stayed off the market supply could readily be controlled which it was at least up to the end of great De Beers cartel, the Central Selling Organization (CSO) in 2000.  As long as De Beers could assure buyers that in the longer term that their diamond rings would be a real store of value rising by at least the rate of interest after taking into account inflation then diamonds were indeed forever.

But now it is Zimbabwe and the De Beers success in the marketing of diamonds that is requiring a fundamental change in the decade old global consensus around the Kimberly process. For NGOs like Global Witness, which were amongst the original drivers of the war on blood diamonds,  the multiple sins of the diamond industry went well beyond the funding of Africa’s wars.  The abuses of human rights at the alluvial Marange diamond fields as well as the use of child labour in cutting in India were all human rights issues that needed to be addressed. But many of the participants in the Kimberly process want no part of an expansion of its mandate beyond the narrow confines of what are conflict diamonds. Like all international organizations the Kimberly Process is made up of 54 countries and works on consensus and many of the participants who profit from a system without real traceability want no part of the extension of its mandate to human rights or to polished diamonds.

But some participants in the Kimberly process like the US as well as NGOs like Global Witness which withdrew from the Kimberly process in 2011 want to see fundamental reform. The Kimberly certificates, which allow trade in parcels of rough diamonds  are issued by governments and are in some, but not all cases are simply not credible. Because there is no system of traceability of  rough and polished diamonds some certificates cannot be trusted. Conversations between diamond traders will inevitably turn to the cost of the bribe one has to pay to launder one’s diamonds in one or other jurisdiction. It was also in the interests of the major diamond mining companies to control the value chain for diamonds and to get the international community to do voluntarily what De Beers had so effectively done as a cartel for 80 years. But without traceability it was simply not far enough.  

Synthetics – real diamonds but not real value

The De Beers marketing campaign has not yet run out of steam and as more and more people enter the urban upper middle classes in China and India, the more diamonds are becoming part of Asian engagement ceremonies. As a result, diamond demand  is rising in Asia but diamonds, at least in nature, remain rare and supply is not keeping pace with the success of diamonds. Enter synthetics!

In the  early 1950’s synthetic, as opposed to imitation diamonds, were first developed. At first the synthetics were only used for the production of industrial diamonds. Up until the late 1990’s the technology to create these synthetics was dominated by three companies, De Beers in Europe (Element 6), General Electric in the US and then Sumitomo in Japan. The three flooded the industrial diamond market with millions of carats and the price in the US and EU collapsed over a period of three decades. But suddenly now the technology for making these near perfect copies of mined diamonds, which are virtually undetectable to the naked eye, is no longer dominated by the traditional producers. The big boy on the diamond block is no longer Botswana or Russia and certainly not South Africa but China, which with no diamond mines to speak of, has entered the market and is now the world’s biggest producer of diamonds selling what the US Geological Survey estimates to be between 6-10 billion carats of diamonds for largely but not exclusively for industrial uses. Total world production of mined diamonds in 2012 was only about 128 million carats.

In most countries gem diamond traders and retailers are supposed to inform buyers whether the goods they are buying are mined or synthetic. However, despite the best efforts of De Beers to brand some of its own diamonds, develop machines that can, at a price, detect synthetics and work with agencies such as the Gemmological Institute of America to issue certificates to differentiate mined from synthetic diamonds more and more of these synthetics are entering the gem market without being detected. But with the smallest of diamonds below 0.2 carats called melees the cost of detection of an individual synthetic diamond is so high relative to their price that significant penetration of synthetics into the mined diamond value chain has already occurred. Unless the whole diamond value chain can be controlled from ‘mine to mistress’, and this can only be done with a system of traceability, then diamonds almost certainly have no future as a store of value. The moment the average divorcee finally becomes aware that diamonds are no longer rare, and can be made, as Karl Marx once famously said ,  ‘as cheap as bricks’, then the diamond ring she has in the jewellery box from her last failed marriage, which she believes is appreciating in value every year will suddenly hit the market and then we will all discover that diamonds are not forever. 

The biggest threat to diamonds is no longer blood diamonds or the effect of Marange or child labour exploitation in Surat but synthetics.  One large diamond trader in South Africa said to me that he knew that the synthetics that he sells in increasing volumes would kick the bottom out of the lower end of the mined diamond market. But he assured me this was only the bottom end. Unfortunately most mined diamonds are very small – about 80-90% of stones are under half a carat. If this market collapses the profits from the entire mined diamond sector will collapse with it as well as the stock market funds for further diamond exploration.

There is at least a partial confluence of interests once again. It is in virtually everyone’s interest in the diamond industry, even the synthetic producers, not to allow the value of gem quality diamonds to follow the experience of industrial diamonds. But markets are markets and they are driven by human greed and what is true of China as a whole is certainly not true of each individual synthetic producer in China. To control the supply of diamonds, both rough and polished can,  be done by extending  the mandate of the Kimberly Process beyond its current mandate of rough diamonds. This was recommended in a draft report late last year on the Kimberly process by Harvard University and the so-called Multi-Stakeholder initiative integrity. Extending the Kimberly process to polished diamonds will require a system of traceability which those in the low profit middle of the diamond value chain will find difficult to afford. Moreover, those who profit from issuing of Kimberly certificates for laundered diamonds would also lose and would certainly oppose such an extension.

Consensus will not be possible

Much to the chagrin of the South African government the Americans are using the developed world’s proxy of choice, the Organization for Economic Co-operation and Development, as they did in the past over tax havens a decade ago, to impose a new trading regime on the developing countries without any real consultation. It is a fundamentally undemocratic process and yet it is in the interests of virtually all participants that the Kimberly process be extended from rough to polished diamonds. It will then make the Kimberly a truly global standards body. But the South Africans are mistakenly leading the charge because they believe that all countries need to be consulted. While it is also in Zimbabwe’s and DRC’s interests that the value of diamonds not collapse, they will not voluntarily agree to a global trade regime which imposes higher human rights standards on them.

The mined diamond industry is living on borrowed time and unless it is able to show developed country consumers that the products they are buying are both ethical and mined and hence rare, then the industry’s demise seems only a matter of time, just as happened with industrial diamonds two decades ago. Only a truly global process that offers traceability of rough and polished diamonds ‘from mine to mistress’ will give the NGO’s and the US the instrument of control of human rights in mining that they seek. By extension this same system, will also give the industry the instrument it needs for diamond to survive as a store of value. Seeking global consensus from individuals that profit from illegal trade and laundering and with countries that will not agree to heightened standards will only delay the process of establishing a global diamond standards body and time is not on the industry’s side.

These are the views of Professor Roman Grynberg and not necessarily those of any institution with which he may be affiliated.