SERVICE DELIVERY

The growing demand

Eyal Shevel, Head of Corporate Sector Ratings at Global Credit Ratings (GCR)
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Considerable progress has been made in the municipal sector over the past decade in terms of the rollout of basic services, with key measures of service delivery and living standards having improved across all of South Africa’s geographies, particularly in larger urban areas.

This is according to Eyal Shevel, head of Corporate and Local Authority Ratings at Global Credit Ratings (GCR), who says that in some ways this success has fuelled the recent spate of service delivery protests.“Ongoing urbanisation has seen growing indigent populations migrating to major city centres, driving the demand for basic services. This has placed increasing pressure on ageing infrastructure assets (requiring upgrade, rehabilitation or replacement).”

Despite the general improvement, Shevel says local authorities have not utilised resources in an efficient manner. “The level of fruitless and wasteful expenditure, though declining, remains unacceptably high, and employees often lack the skills to implement large and complex projects.”

As such, he says the infrastructure backlogs remain significant. “While this is true across the country, performance by smaller municipalities in terms of operational efficiencies and infrastructure developments has been worse, as they are more acutely affected by funding constraints and the lack of skilled personal.”Shevel told Service that further compounding this situation is the sluggish economic growth over the past two years.

“Unemployment levels remain high and even within the employed sector of the economy, an increased level of financial distress is being reported.”While the social welfare grants are distributed by national government, Shevel says most of the burden of providing everyday services such as water, sewerage and electricity to indigent populations falls on the municipalities.

“The national government does provide grants to cover much of this expenditure, but municipalities also need to rely on internally generated revenue through the provision of services.”Shevel says municipalities have become increasingly proactive in respect of their debtors’ administration, but affordability issues are likely to affect both the debtors’ performance and the demand for indigent services.

“Having improved in the three years to FYE2012, debtors’ performance has begun to deteriorate for local authorities as a whole, with substantial provisions having to be made for non-collection.“With fiscal indebtedness now approaching the levels last seen in the mid-1990s, capacity of government for further borrowing is constrained and could limit capital grant funding to municipalities beyond the medium term (to which central government is already committed).”

According to Shevel, municipalities are increasingly expected to be self-sustaining in terms of servicing other residents and the rollout of new income-generating fixed assets/infrastructure. “Municipalities are also being forced to seek alternative sources of funding and borrow off their own balance sheets. The diversity of funding available to them has been bolstered by strong appetite from capital markets investors for different fixed income instruments, as well as from commercial banks seeking to lend to lower risk clients.

“To date, bond issuances have only been undertaken by four metros, but at least two more Metros are looking to inaugural bond issuances during 2014,” explains Shevel.

Apart from the other benefits, accessing bank or capital market funding has exposed municipalities to the more rigorous reporting standards required in the private sector.

“There has been vast improvement in terms of municipal reporting and transparency, which in turn has bolstered the financial strength and sustainability of the municipalities. Nevertheless, there is a clear trend of improving service delivery from the municipal sector, if somewhat slower than can be achieved. This is very much in line with central government’s mandate to create a self-sustaining municipal sector that is increasingly corporatised and efficiently operated.”

Responding to the question of how the current economic climate is affecting consumers and municipalities – and what impact this is having on municipal debtors’ books – Shevel told Service that in some ways municipalities are affected by the economic environment to a greater extent than businesses. Firstly, the amount they bill residents and business for services such as electricity and water declines, as will the number of businesses paying rates.

However, the greater impact is with regard to debtors, with non-payment of municipal accounts (particularly rates) rising during difficult economic times, as there is little immediate impact for the consumer of non-payment, unlike with other service providers (cellphones, Telkom, electricity, DStv) where they can just discontinue one’s service.

“On the expenditure side there is an impact too because, as jobless numbers start to increase, so does the number of indigent residents.Municipalities are obligated to provide a certain amount of free services to indigent residents, increasing the amount of non-billable expenditure at a time when cash flows are also coming under pressure,” he says.

Regarding funding challenges, and which alternatives municipalities have been looking into, Shevel reminds us that funding for a municipality comes from three main sources: internally from the provision of services and collection of rates, from the national government through grants, and through access to debt funding.

“Aside from the challenges to internal funding listed above, there has been some margin pressure emanating from the provision of electricity and water (traditionally accounting for around 50% of revenue). In this regard, National Energy Regulator of South Africa (NERSA) has permitted Eskom to increase tariffs by a greater percentage than the increases allowed to the municipalities. Thus, while the real amount of income from electricity and water provision has been growing, the net margin earned has been decreasing.

“National Treasury has also been battling declining income and growing expenditure on social services. Thus there is less money available to provide to municipalities to cover their operating and infrastructure investment needs. As a result, National Treasury has indicated that municipalities cannot rely entirely on grants form infrastructure projects and has prompted them to seek ways to self-fund projects.

“Self-funding is really only available to the metros, and a few of the larger municipalities where there is a fairly diverse economic base from which to generate income. Smaller municipalities remain almost entirely dependent on grant funding. Traditionally, municipalities have relied on facilities from development agencies for the majority of debt funding. While this remains a critical component for larger municipalities with diverse sources of income, private sector sources have become available.

All the major banks have sought to lend to stable municipalities. “From the banks’ perspective, a municipality provides a relatively low risk client, especially as they have cut back in lending to the private sector.”He says strong demand from the capital market investors has made bond issuances a viable option for larger municipalities.

The major benefit to municipalities is that these loans often have long dated maturities, and bonds need only be settled on the maturity date, as opposed to amortising loans typical of bank funding. In addition, competition by asset managers for bonds has maintained interest yields at relatively low levels.

According to Shevel, to date only three metros have issued bonds, but more are expected to do so.

DID YOU KNOW?

The biggest challenge is the scale. The need for services is so widespread and continues to grow at a faster rate than infrastructure can be developed. In some way, success in infrastructure development has exacerbated the problem by enticing rural people to move into the large cities, placing great strain on the existing infrastructure, which has not been able to cope with the volumes. This divergence between expectation and the inability of infrastructure to maintain pace with the actual volume is often behind the service delivery protests.

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