SA’S ‘terribly scary’ municipal debt risk
Mismanagement of local governments is locking them in a vicious cycle of underdevelopment
Earlier this year, Clover announced its decision to close the country’s biggest cheese factory, in Lichtenburg in the Ditsobotla local municipality. The factory employed 380 permanent and 40 temporary workers. The reason for the company’s exit: poor service delivery. The Clover closure is just one example of how South Africa’s ailing economy is being squeezed by its municipalities, only 38 of which are in good financial health.
Well-performing municipalities encourage local investment, drive employment and don’t depend on the fiscus to survive. But in South Africa, financially sound municipalities with strong records of service delivery are few and far between.
The country’s dysfunctional municipalities are a drag on investment, a strain on the fiscus and pose a critical sovereign risk, analysts say.
The country’s municipal woes are factors that impede local economic development, says Helanya Fourie, a senior economist at the Bureau for Economic Research (BER).
“Aside from low levels of fixed investment, and other challenges, the municipal problems are a contributor to the fact that we’ve seen very low levels of growth,” she said. “It also has a reinforced impact. So if you see municipalities performing poorly, it disincentivises further investment in the area, which prevents new jobs from being created.”
The hit to local economies has a knock-on effect for the whole country, Fourie added, as municipalities on the edge of disaster rely on the national fiscus to survive.
Earlier this month, the BER published a research note outlining the effect financially unsound municipalities have on the local economy. The note cited the Clover example.
“Municipalities need to provide the infrastructure and basic services that support a favourable investment climate, without which disinvestment, deepening unemployment and poverty may follow,” it said.
“This has the further effect of eroding the local tax base, increasing municipal dependence on fiscal transfers and worsening South Africa’s already constrained fiscal environment.”
Only 199 out of 257 municipalities submitted their audits in time to be included in the auditor general’s consolidated report for the 201920 financial year. Of these, only 38 were in good financial health, and 53 municipalities expressed doubt that they would be able to continue their operations as a going concern. This means they rely on government’s equitable share grant for survival.
“Some of the specifically larger municipalities are, just by virtue of the citizens that live within their jurisdiction, better able to get revenue … so they are more self-sustaining financially,” Fourie said.
“But smaller municipalities — with more indigent households, people further away from each other and potentially less able to pay property taxes or for services — need to rely on grants from the national government for survival.”
The reliance of some municipalities on the government for support “speaks to the fiscal challenges that South Africa faces”, Fourie said, adding that although municipalities are a drag on economic growth, they are also a victim of the country’s low growth rate.
“And, of course, this situation is made more complex by Covid and the fact that there are now more households that depend on support from the state for survival, because that also threatens the financial viability of the municipalities.”
Sifiso Skenjana, the chief economist at Iqbusiness, noted that municipalities with weak financial management threaten to drive up the cost of debt.
“Municipalities also borrow money and so the weaker their financial reality, the higher the borrowing costs. So you’re spending money paying higher interests but they are cannibalising service delivery,” he said.
“So there are many ways that problems in municipalities trickle down to create a fiscal risk for the country.”
Municipalities pose a critical sovereign risk, Skenjana pointed out. “They create a tail risk on your borrowing costs … So the financial health of municipalities has a direct correlation to how the pricing gets done on a sovereign risk rating.”
In July, ratings agency Moody’s downgraded five municipalities — Johannesburg and Ekurhuleni in Gauteng, Cape Town, the Nelson Mandela metropolitan municipality in the Eastern Cape, and umhlathuze (Richard’s Bay) in Kwazulu-natal .
The rating downgrades reflected rising liquidity pressure as a result of material shortfalls in revenue collection. Moody’s said it expects these revenue shortfalls to last in the context of South Africa’s weak growth.
“South African regional and local governments [RGLS] are likely to draw down on cash buffers, with different starting positions, eroding their capacity to absorb future shocks. In this environment, the reviews for further downgrade reflect high uncertainty about the RLGS capacity to secure financing well in advance of debt and other payments being due.”
He described municipal dependence on the fiscus as “terribly scary”.
“How is government funded? Through borrowings and tax collection … Not only at a national level are we spending more to try and finance our borrowings, now you’ve got these institutions that continue to need more, because they are not using their finances efficiently.”
“So you’ve got a constraint on the one side and an existing developmental constraint on the other. If you don’t fund the municipalities you dull the development process.”
The situation threatens to drive down South Africa’s development indices, Skenjana said. “The mediumand long-term picture is bleak if those indices don’t turn around.”
Development economist Ayabonga Cawe said the dependence of some municipalities on the fiscus is “the biggest existential challenge we have”. South Africa is structured on the assumption that local governments can raise their own money, Cawe said. “But that capacity in a society like ours is deeply unequal. We have to re-entrench the progressivity of our allocation mechanisms.
“It is not only about saying that those who have less of an industrial base to tax have to get more money. That money also has to be followed by massive investments in personnel, in capacity, that would ensure that the money is spent properly.
“You don’t want to punish somebody for having been born in a poor district and then say, because you have poor leaders, you are locked into declining allocations for critical infrastructure.”
If government does not resolve the funding quandary, it stands to widen the gap between urban and rural South Africa, Cawe said.
The consequence is clear: “The failure of the function of municipalities doesn’t only lead to the social reproductive crisis which we see in what we problematically call service delivery protests. We’re also seeing disinvestment and [the] flight [of] industry,” Cawe said, citing Clover’s Lichtenburg exit.
“The failure of those municipalities has massive impact on the ability to build, industrialise and to facilitate the catch-up of those areas.
“The moment municipalities are so dysfunctional,” Cawe added, “you then have a logjam in your economic development process. That is one of the massive existential risks to our democratic society.”