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Strategic Defence Procurement ]
Background notes: Press statement on the Strategic Defence
Procurement Package
Press statement
issued by the Ministers of Defence, Finance, Public Enterprises and Trade and Industry
12 January 2001
Introduction
The Strategic Defence Procurement
authorised for contracting in December 1999 was a major expenditure decision and marked
the end of a complex four stage process of policy formulation, management and evaluation
of proposals, negotiation and decision making. Between February 1996 and April 1998 a
comprehensive process was carried out to determine the kind of Defence force we needed and
how it should be equipped. The Defence Review was tabled and approved in Parliament in
April 1998. This had the support of all Parties.
The Government understood that this would be a difficult
and, for some, a contentious decision. We respect the fact that there are many who are
opposed to defence purchases and have accordingly lobbied very actively against the deal.
Such debate is in the nature of our new democracy.
This was a carefully considered and thoroughly researched
and analysed decision. The decision was made in the interests of maintaining an effective
and modern defence capability. This policy decision was taken in the full cognisance of
the competing needs of our funds and every effort was made to balance the competing claims
on our funds, including the necessity of building an effective defence capacity over the
next decade. It is the duty and prerogative of government to make such policy decisions.
It is also fundamental to our democracy that the Standing
Committee on Public Accounts (SCOPA) and the Auditor General took it upon themselves to
look into allegations of impropriety and what, if proven would amount to criminal
activity. Accordingly, the Government and the relevant departments have cooperated fully
with these enquiries. We thank both the Auditor General and SCOPA for acknowledging this
cooperation. There have been occasions where departments have sought clarity from SCOPA as
to how commercially or military sensitive information would be dealt with and we would
regard it as irresponsible to have done otherwise. Since government has legislative and
contractual obligations to meet we will need the cooperation of all parties to comply with
these obligations and allow transparency. Government cannot be expected to violate
standard procedures.
The Government does have clear reservations on certain
procedural matters and on the published outcome of both the Auditor General’s Special
Review and the Fourteenth Report of SCOPA. A brief outline of these reservations is
provided in the body of this statement. However, at no time have these reservations
constituted refusal to work with Constitutional structures or to hinder the process of
transparency. It is in the national interest that any form of delict be uncovered. It is
equally imperative that due process is adhered to and that the integrity of our
institutions is not needlessly called into question. Subsequent to both reports
representatives of the offices of Judge Heath, the Auditor General, the National
Directorate of Public Prosecutions and the Public Protector have had controlled access to
all relevant documents. The documents have, however, remained in the custody of the
Department of Defence.
Government is prepared to make very detailed
representations to SCOPA in the ongoing work envisaged for that committee. This would
allow us to correct basic misperceptions. The government is quite confident of the
integrity of the Departments, Ministers and the Cabinet. We are also confident that the
deal is sound and that the process was conducted correctly. Accordingly, the Cabinet has
made it quite clear that the relevant Ministers must personally make representations. We
reiterate our support for processes to uncover any criminal conduct or to highlight and
address inappropriate expenditure on programs and administrative inadequacies in
government.
In the light of continued ill informed and unfounded
speculation and assertion in the public domain that is clearly prejudicial to the
perceived integrity of this government we are choosing to deal with certain matters at
this stage. In doing this we are in no way pre-empting further enquiry or our own right to
provide detailed information to any such enquiry. However, it is our view that unjustified
attacks on the integrity of government must be defended and that the processes of redress
and the issues to be dealt with must be accurately defined.
Accordingly, we wish to provide essential background
information as to the nature of the Strategic Defence Procurement Packages and then to
comment on certain findings which we believe are misleading in the absence of the more
detailed context of this very large and complex set of contracts. Our purpose is to
redress what has become an unwarranted set of speculations based on very preliminary and
not necessarily correct or accurate assessments.
The decision to undertake a Strategic Defence Procurement
Much preparation went into the decision to procure a wide
range of equipment for the South African National Defence Force (SANDF). The equipment
needs were detailed in the Defence Review as approved by Parliament in 1998. The Defence
Review pointed to the need to provide strategic equipment for a number of arms of service
of the SANDF if we wanted to retain an effective defence capability. Without this
replenishment of the main arms of service of our SANDF, its operational capabilities would
have been structurally impaired. Whilst there maybe those who are opposed to the idea of
South Africa having a defence capacity this is not supported by the Defence Review or by
government policy. Such capacity is a Constitutional matter.
In the light of the developmental challenges facing us, the
Government is acutely conscious of the various competing calls on our limited resources.
This is why we have undertaken massive fiscal and budgetary reform to ensure prudent
expenditure of limited resources. All departments have to prepare three-year medium-term
expenditure programs. A procurement of this nature with expenditures spread over more than
a decade meant a specific budgeting process and Cabinet adopted a three phased decision
making process for the Strategic Procurement.
It is important to point out that the decision to
consolidate all the systems into a single Strategic Procurement package was in itself a
major step in creating transparency in the whole process. The procurement process has been
explicitly set out and was not merged into annual budgets of the Defence department or
opaque funds as was the case in the past. The acquisition process is also dealt with in
Chapter 13 of the Defence Review.
The magnitude of the expenditure would have macroeconomic
effects and also budgetary allocation effects for all departments. The Cabinet therefore
decided to move forward in a particular way that allowed us to establish the implications
of the deal in all its aspects as accurately as it is possible to do with long term
contractual expenditure.
The agreement on the need for the purchase of strategic
equipment on the basis of the Defence Review and Government’s policy of maintaining a
defence capability at an effective level was subject to certain constraints in regard to
the affordability of the packages. This immediately led to downscaling of the full
acquisition proposals in and around the Defence Review.
The process was unique for South African defence
procurement for a number of reasons. The process was conducted in an open and transparent
manner unlike decades of previous purchases. The deal represented a strategic package
rather than piecemeal procurement and a systematic process of Industrial Participation
obligations was developed in line with the National Industrial Participation Program
(NIPP) adopted by Cabinet in April 1997. The latter is applied to all public sector
procurements where the imported content will exceed $10 million.
The NIPP for this procurement had a direct component
relating to defence equipment, where the objective was to assist the South African defence
industry, and a non-defence component where the objective was to facilitate investment and
technology and skill transfer into South Africa’s manufacturing sector. In both these
programs black economic empowerment is an objective as it is in all government economic
policy.
This approach meant that in all decisions there would be
four national government departments involved. Finance (National Treasury) dealt with
budgetary implications, financial affordability and macro fiscal and economic
implications. Trade and Industry dealt with the non-defence (and in part defence
industrial participation) and assisted with certain economic implications. The Department
of Public Enterprises dealt with aspects relating to state owned corporations. The
Department of Defence dealt with the technical defence requirements, defence industrial
participation and the specific budget of the Defence vote. There were also four
independant evaluation groups, each with a mandate and scoring system comprised of unique
value systems for assessment.
A committee of the Ministers of these departments was
chaired by the Deputy President (and later as President) and it decided on and prepared
the final recommendations to Cabinet. It is important to note that this critical level of
decision making was not able to input into either the Auditor General’s Special
Review or make representation to SCOPA and it is why Cabinet is insistent that it have the
right to deal with many inaccurate assessments.
It is apparent from the unique nature of this process that
any corruption in the awarding of the prime contractors and many major subsystems would
have to have infiltrated central departments and Ministers of the South African
government. The deal was structured in this manner precisely to reduce the prospects or
even incentive for corruption as they would have no prospect of influencing the deal. We
will return to this matter in commenting on the Review and the Report of SCOPA.
The next milestone decision made by Cabinet was to conduct
further negotiations with the short listed bidders. The decision was based on a
recommendation made by the Committee of Ministers set out above. Again the relevance of
this will be addressed in the specific comments that follow. Once again the negotiators
had a mandate to address affordability questions. It was also decided to appoint a Chief
Negotiator to coordinate the negotiations and report to the President and the Ministers.
The appointment of Jayendra Naidoo into this position was a further step in ensuring that
the Government objectives would be met. This was a unique and quite conscious aspect of
the process. In the light of endless unsubstantiated and outlandish accusations being made
by unknown sources we were wise to take these precautions.
After extensive negotiations involving the technical
structure of the equipment, industrial obligation requirements and the financing of the
deal a final report was prepared. The report dealt with a wide range of matters. Of
decisive importance was a report on an assessment of the economic, fiscal and financial
impacts of the packages. In particular it assessed the risk across a number of dimensions
and the final affordability of the deal in the light of the intense negotiations
conducted. This was done by the Department of Finance with the assistance of other
government departments, external economists and a local university. This report and the
various options available was presented to the Ministerial Committee and circulation was
tightly controlled. It is unlikely that any previous expenditure by government has been so
thoroughly analysed.
It is important to explain this decision in the light of
some of the comments of SCOPA. The Committee of Ministers sitting with the President had
to weigh the need to meet the objective of retaining a defence capacity, which meant that
a critical mass of equipment was needed. Yet we could not destabilise the Medium-Term
Expenditure Program and existing allocations to other departments or the basic budget
framework. In particular risk was assessed over the critical early years of the contract.
To achieve this balance further adjustments were made to the final contracted
authorisations and a fail-safe option was developed to allow for tranches of equipment to
be purchased. This does make the final contracts complex.
The NIPP can never be used to justify the decision to
purchase. It arises only when that decision has been taken. A study of the publicly
available program makes this apparent. Accordingly, the NIPP was not and could not be
decisive in the final procurement decision. The NIPP played two roles. The first was that
it has been an effective investment promotion device and therefore will assist with job
creation. Secondly it was used in a number of the exercises to assess economic risks such
as balance of payments effects and the growth impact. Government accepts that there were
many proponents of the deal, and others, who sought to justify the deal on the basis of
the so-called NIPP offsets. There was continuous media comment around the potential
investment and job creation aspects of the deal. However, when accounting to SCOPA or the
Auditor General the Ministers who made the decision to recommend a particular course to
Cabinet must be judged on what they decided on rather than on public perceptions of what
their decision was.
The purpose of providing this background is that it allows
us to deal with what we regard as inaccurate assessments in the two reports and it is
these assessments that are fuelling further reckless and unsubstantiated speculation and
accusation.
The special review by the Auditor-General
A review is by its nature a preliminary and less than
complete audit. Accordingly, both findings and assessment should be expressed with
caution. The Government believes that on a matter such as this it would not be correct for
the review to be left in its present form as it does not do justice to a very complex
process and in so doing calls into question certain processes without being able to fully
justify this. We wish to illustrate this be a few brief comments. We refer here to the Key
Findings as numbered in the Review.
3.1. It is not clear to Government what is meant by the
overall independence of the role players. We raise this since it would appear as if the
review ignored the complexity of the process and the different levels of decision making.
In particular the role of the Committee of Ministers is not taken into account. It is very
hard for us to see how we could have put in more safeguards and we look forward to the
further contact with the Auditor-General to clarify this matter.
3.2. The matter of the LIFT program and the so - called
uncosted option attracts a great deal of attention. The mistaken inference is made that
the Armaments Acquisition Council made the decision on this matter. This is not correct.
On the basis of their deliberations a number of options and considerations were placed
before the committee of Ministers. In effect the bids had thrown up two groups of
possibilities in regard to the links between trainers, advanced trainers and advanced
fighters. This meant a number of permutations were possible and were presented to the
Committee of Ministers. This is not an uncommon situation. The Committee of Ministers
considered the permutations and all four Ministers expressed views that emanated from
their areas of responsibility. After considerable consideration and taking many factors
into account and respecting the bidding parameters the decision was to go for the
Hawk-Gripen option. The Cabinet is clear that this is a correct process and that no undue
influence could have been exercised given that very different considerations influenced
different Ministers in their views and that the decision was reached after detailed
consultation. It should also be pointed out that the unsuccessful bidders themselves have
not invoked any action to question the decision. If the conduct had been improper it is
within their rights to do so.
It is our view that the Auditor-General may not have been
adequately exposed to the high-level decision-making process and is dealing with various
aspects of the evaluation mechanisms. Accordingly, the inferences are based on incomplete
information.
3.3. The Auditor-General is entitled to his opinion as to
the adequacy of the performance guarantees. However, we would wish to make four points and
then express our own opinion. The first is that the standard performance guarantee is set
at 5% in the NIPP and we were able to negotiate above this in certain cases. Secondly, the
level is in-line with or exceeds international norms. Thirdly, a higher performance bond
may have the effect of providing a greater incentive to build it into the price, and
fourthly the prime contractor has to assume the liability for the guarantee but it is a
consortium that provides the NIP obligations. The performance guarantee should not be
measured against the size of the NIP but against the loss the prime contractor may take if
the NIP is not fulfilled. When this is done it is clear that there is a very powerful
incentive for the main contractor to work with us to achieve success. We believe that we
are entirely within international practice and as indicated above the Auditor-General is
incorrect when he sees the counter-trade aspects of the deal as a major objective of the
deal. This is not correct, rather than counter-trade aspects are an important achievable
consequence of the Strategic Procurement.
3.4. The Auditor General has not correctly dealt with the
matter of a first order value system as this policy was not adopted and he will need to
hold further discussions with the Ministry of Defence to clarify this matter.
3.5. It is our contention that the Auditor General has not
understood the intricacies of the acquisition process and that further discussion is
needed. This relates to the matters of staff target and staff requirement approvals. The
differences in past and present procurements have to be taken into account.
3.6. It is quite clear that in a major equipment purchase
where reliability of performance is mission-critical that the Department of Defence must
be able to hold one contractor liable for performance and delivery. Accordingly, it is
clear policy not to become involved in negotiations with individual subcontractors. This
matter is clearly set out in the documentation. This is standard procedure in all major
contracts. We can only assume that the Auditor-General’s Office did not spend enough
time on the particular case cited. This is not a matter for government but is a matter for
the contractors and they are quite certain that the company concerned was not going to be
their supplier.
3.7. It is correct that the additional support and analysis
used in this deal is not standard procedure for procurement. We added further processes of
assessment and analysis and had to make special provisions to procure these services. The
Committee of Ministers considered the methods used and considered them to be fair and
reasonable in achieving even greater clarity on the deal. Nothing improper was being
carried out in this process.
3.8. The unusual nature of this deal has been explained and
the steps taken by Cabinet to budget for it and arrive at the afford ability of the deal
have been set out above. We would therefore take the view that the process has not been
fully understood by the Auditor-General’s Office.
It is apparent from the above remarks that the government
would take issue with the conclusion drawn by the Auditor-General as we believe that the
Review has not been able to do full justice to the issues at hand.
The Standing Committee on Public Accounts
Many of the points of concern in this report echo those
dealt with by the Auditor General. It is the government view that the SCOPA was not able
to go beyond the Auditor General in their work. It is also government’s view that the
Committee would have benefited from a more comprehensive presentation of this very
complex deal. A prime responsibility of SCOPA is to ensure that once government has taken
a decision that that decision results in value for money in the expenditure of state
resources. To establish this requires an immense amount of work in a deal as complex as
this. It is also a matter of regret that the Committee did not use the offer of Ministers
to appear or even to have called them in the first place.
Accordingly, it seems to us that they had no first hand
account of how the actual decisions were taken. They were exposed instead to a major
component of the process, which was the making of recommendations to the Ministers, rather
than the actual decisions the Ministers took. This consequently resulted in a number of
misunderstandings.
A major point raised by SCOPA is the assertion that the
Cabinet had information on the possible cost escalation of the deal and did not disclose
this fact. This is exceedingly misleading. SCOPA commends the National Treasury for the
work done on affordability of the packages. As is apparent from that work the immensely
complex range of risks was fully investigated and analysed, and taken into account by the
Committee of Ministers. These risks included the risk of Rand depreciation over the life
of the contract, the risk of interest rate increases for economic measures unrelated to
the contract and the risk of non-performance of contractors in relation to their NIP
commitments.
The lower figure of 30.3 billion Rand is in real 1999
prices ie. it is adjusted for expected inflation over the life of the contract and
includes also the cost escalations built into the contract. Since the contracts are
denominated in foreign currency this figure is the real Rand value of the package at the
time of signing, based also on the prevailing Rand exchange rate at the time. Government
was naturally aware that the Rand will fluctuate against foreign currencies during the
life of the contract and this issue was fully addressed in its risk analysis of the
October 1999 Cabinet decision. In the risk analysis various scenarios of the Rand’s
trajectory were used and their cost impact examined. It would have been totally arbitrary
to have identified any one of these scenarios as reflecting the Rand cost of the package,
as opposed to the cost of R30,3 billion, calculated at the then prevailing exchange rate.
The figure of R43, 8 billion is calculated on the basis of
a different trajectory for the Rand than the R30,3 billion, and thus the two amounts
don’t represent the same basis for measuring the package and cannot be directly
compared. It should also be noted that similar considerations regarding exchange rate
fluctuation affect all Government and private financial commitments denominated in foreign
currencies including foreign debt and imports of goods and services. The risks here are
indeed unusual because of the length of the contract, and this was taken full account of
in the decision by cabinet. Government has in place mechanisms to monitor exchange rate
changes and other economic movements, which might pose risks to the defense package and
all other government financial commitments, and to address problems should they arise.
The Committee is correct in needing to examine the cost
build up of the aircraft as this is clearly their function. This is a very onerous task
and government will continue to help and supply the necessary information.
The NIP issues have been canvassed in response to the
Auditor-General’s Review. Clearly the estimates of jobs are projections. The NIP
program will spread out over a number of years and regular reports will be given to allow
us to assess the success of this program.
Statements are made that are difficult to respond to in
regard to the quality of the contracts. The Committee will have to be more specific in
this regard. In the absence of specifics the point seems unwarranted.
Government wishes to express its very strong reservations
on the statement made on prime contractors. In the light of how decisions were made in
this matter the only inference that can be made is that the improper influence could only
be decisive if it held sway where the Ministers made the decision. Government rejects this
and in the light of the massive amount of information available regards this as a careless
statement that government must be allowed to dispel entirely.
Another matter raised is that of subcontractors. It should
be pointed out that the Procurement does not deal with subcontractors. This has to be the
contractual obligation of the prime contractor as it is they who must deliver reliable
equipment and undertake the performance and delivery obligations. This is standard
practice in major contracts. To insist that Government must be held to account for minor
subcontracts is to misunderstand procurement. The prime contractors are major
international corporations and we are confident that they would ensure the quality of the
subcontractors and this is their responsibility.
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Last modified: 16 November 2004 14:13:45.
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