The trouble with municipalities

Just 28% of municipalities submitted quality financials for audit purposes – and only 11% received clean audits.
The extent of the rot is alarming, says the author. Image: Moneyweb

The extensive infrastructure needs of South African municipalities provide an opportunity for long-term bond investors – such as retirement funds – to help finance these important, long-term assets. However, many municipalities have failed to meet the basic needs of their constituents, including providing adequate access to water, sanitation, housing and electricity.

Consequently, faith in the system has been eroded, as reflected by the very low voter turnout in the November local government elections.

The municipal sector needs a reboot for the overwhelmingly negative trend to be arrested, and this requires capable and honest leadership.

The Auditor-General of South Africa minced no words in its latest (2019/2020) report on local government audit outcomes, which have deteriorated markedly over the years.

Read: Read the AG’s report before you invest in a municipality, says Sapoa CEO

Although the downward trend in municipal health has been well documented in the press, the sheer extent of the rot is still alarming: Uncondoned irregular, unauthorised, fruitless and wasteful expenditure amounted to a whopping R189 billion.

Only 28% of municipalities submitted quality financials for audit purposes and just 11% received clean audits, as shown in Graph 1.

The Free State and North West provinces did not have a single clean audit between them.

Source: Auditor-General of South Africa

The Auditor-General’s report describes a death spiral: Rampant corruption and mismanagement at many municipalities result in a lack of funds and increasingly poor service delivery, the latter of which reinforces a culture of non-payment of municipal rates and service fees which, in turn, exacerbates the financial deterioration of the municipalities and further affects service delivery.

Graph 2 reflects the concerning financial health of the sector.

Source: Auditor-General of South Africa

Discouragingly, many of the issues plaguing municipalities have been raised by the Auditor-General in prior years, but the respective mayors and councils have not addressed these. The lack of consequences further reinforces bad behaviour and malfeasance. Ethical and accountable leadership is needed to turn these municipalities around.

Deteriorating credit ratings

On July 16, 2021, Moody’s downgraded five municipalities, including the large metros of Cape Town, Johannesburg, Ekurhuleni and Nelson Mandela Bay. Tshwane had already been downgraded to junk in June. In November, Nelson Mandela Bay and Ekurhuleni were downgraded again, with the latter falling to sub-investment grade. The rating agency cited material revenue shortfalls and liquidity concerns, which are expected to persist, given the weak economy. The agency has also indicated that further downgrades may be forthcoming.

While the ability of households and businesses to pay their municipal rates and service fees has undoubtedly been impacted by the Covid-19 pandemic, this only partly explains the deterioration in the creditworthiness of local governments.

Graph 3 shows various municipal ratings’ distance from the investment grade threshold, being the last notch before junk status (Baa3 or BBB-), which is 0 on the graph. In the case of Mangaung, Rustenburg and Ekurhuleni, credit rating downgrades had already started in 2019.

Sources: Moody’s, Allan Gray

According to the National Treasury, total municipal borrowings were R68 billion in March 2021, of which some 28% consisted of bonds. Lower credit ratings result in higher funding costs and may lead to some municipalities becoming uninvestable for conservative funds, such as retirement funds, whose mandates prohibit junk-rated investments. The end result is less funding being accessible for municipalities to spend on much-needed infrastructure for service delivery.

Knock-on effect on state-owned enterprises

The fallout from failing municipalities does not only affect residents of that locale; municipal financial distress also has an impact on creditors such as Eskom, the water boards and smaller suppliers.

The bearing on small businesses – which rely on prompt payment for their very survival and have been touted as a crucial source of jobs – is particularly egregious.

The amount of municipal debt owed to Eskom, and the debtor days outstanding of two of the large water utilities, are shown in Graph 4.

Municipalities make up 42% of Eskom’s revenue, and municipal arrears have ballooned to R35 billion. This non-payment affects the regular taxpayer directly: Bailouts from the fiscus to Eskom will have amounted to R136.7 billion between 2020 and 2022.

Source: Annual reports of the respective state-owned enterprises

The water utilities derive almost all of their income from municipalities.

Although the amount of overdue municipal debt to these (R377 million to Umgeni Water and R1.9 billion to Rand Water) pales in comparison to that due to Eskom, the upward trend in debtor days is not promising, and these entities may eventually need bailouts too.

A vote of no confidence

The basic services that municipalities are meant to provide are foundational to improving living standards, yet hardly a day goes by without a headline about municipal fraud, corruption, wastage and infrastructure degradation.

Read: Emfuleni and Midvaal enter the record books, but for very different reasons (Oct 2020)

Municipalities also often underspend on infrastructure due to poor project management, impacting service delivery.

In his letter to the nation ahead of the 2021 local government elections, President Cyril Ramaphosa wrote that public trust is easily lost and difficult to regain without accountability from public officials. It is therefore unsurprising that many municipalities have lost the trust of their communities.

The lack of public belief in municipal officials arguably shows up in poor collection rates, with the Auditor-General estimating that around 60% of municipal debt is irrecoverable.

The recent local government elections also saw the lowest voter turnout in the democratic era, at an effective 30% of the voting age population.

Read:
Local government will never be the same again
Now that the elections are over, the brutal reality sinks in for metros

A low voter turnout points to a loss of public belief in the electoral system, which has profound implications for social cohesion, as evidenced by the escalating number of protests and riots, shown in Graph 5.

If a population loses faith in the electoral system, people will make their voices heard in other, more destructive ways.

Source: Armed Conflict Location & Event Data Project

The way forward

Leadership sets the tone at the top of any organisation. If leaders are unethical, have a disregard for sound governance and lack accountability, it filters through to the rest of the organisation and results in a culture of poor performance and impunity.

Many residents do not pay their fair share, while paying residents understandably become disillusioned when their hard-earned money is being wasted or stolen, and are tempted to stop paying their municipal bills.

This inevitably results in municipal collapse. Indeed, a number of municipalities are already deemed to be dysfunctional.

Read: Court victory for Mpumalanga residents facing 14-hours-a-day power cuts

Turning the situation around will require a delicate dance between two groups: leaders, who must drive the change, and residents, who must pay their bills.

One cannot happen without the other, but the former clearly leads the latter.

Londa Nxumalo is a portfolio manager at Allan Gray.

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It’s ‘Trouble with ANC municipalities’ and therefore the trouble lies with the ANC.

Although it is supposed to protect human rights, our constitution basically guarantees the implosion of service delivery. At its most basic level, a municipality is a “mutual organization” that structures the way in which citizens and members provide services to themselves. It is impossible to take a group of individuals who cannot provide those services to themselves, in their personal capacity, to be successful as a group. When a group consists of individual failures, the group will be one big failure. Consider the stark differences between Bafana Bafana and the Springboks.

When the majority of voters in a municipality don’t have the mental capacity, and mindset to provide the individual services to themselves, they will also fail to do so as a group. A person who does not have the capacity to provide his own running water and to build his personal pit latrine, won’t be able to make any contribution to a group of people who need sanitation. Such a person can only be a drag on any system that does provide these services.

The mere fact that a piece of paper, call it the Municipal Systems Act, groups people together and calls them a municipality, does not imply that the outcome should resemble an actual municipality.

This explains the reality that the quality of service delivery is merely a manifestation of the mindset of the average voter. Collectivist voters who are morally bankrupt will cause the bankruptcy of any municipality. The implosion of service delivery merely describes the slave mentality of voters in that municipality. Given enough time, people with a victim complex will create, and be responsible for, their own victimhood.

This is a very logical, natural, and ultimately fair process.

End of comments.

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