Business

Tough times for local authorities

Lynley Donnelly

Credit rating companies have revealed that relative debt levels have soared to historic heights and the outlook for SA's local government is gloomy.

Projects such as the construction have placed additional strain on cash-strapped metropolitan municipalities. (David Harrison, M&G)

The outlook for South Africa’s local government sector is gloomy. Even in large metropolitan municipalities where service delivery is better and the economic picture is more positive, local authorities face the threat of shrinking revenues as residents and businesses are hit by tariff increases and petrol price hikes.

It is happening as auditor general Terence Nombembe warned this week that not enough was being done to address the chronic financial and management problems experienced at local government level.

The poor financial state of local authorities has, in part, scuppered plans for a proposed bond pooling mechanism that would have allowed secondary municipalities to raise funds from private capital markets, according to Business Day.

The mechanism was proposed in last year’s local government budgets and expenditure review. It would have allowed smaller cities to pool their financial requirements into a single bond that could be issued to the market.

But a study by the treasury concluded that the sector was not “ready for the introduction of bond pooling”, thanks largely to the low investment grades granted by credit rating agencies to secondary cities. Only four – Msunduzi (Pietermaritzburg), George, Rustenberg and Mbombela (Nelspruit) – of about 19 secondary cities have investment-grade ratings.

Higher yields
In addition, investors are likely to ask for higher yields to compensate for the increased risk of default by a municipality, which will increase the cost of borrowing for all municipalities in the pool.

The country’s large metropolitan municipalities are among a handful of the 283 countrywide that received credit ratings. The metros, however, account for about 65% of all the income received across the local government sector, according to Marc Joffe, head of local authority ratings at Global Credit Ratings, which rated four of the large metros.

Local government ratings varied widely, but the outlook for all the municipalities was challenging, said Joffe. First, most were still living with the legacy of the Fifa World Cup in 2010.

“Leading up to the World Cup, there was immense pressure on the metros to upgrade their infrastructure extensively,” said Joffe.

This was partly funded through grants from the government, their own cash reserves or borrowing – either from commercial banks, development finance institutions or in the bond market.

Increased debt levels
Three metros – Johannesburg, the City of Cape Town and Ekurhuleni (East Rand) – were the only ones to issue bonds. “As a result, local government’s relative debt levels have increased to historic heights,” said Joffe. The use of cash reserves for infrastructure spending combined with increased debt placed strain on liquidity for many metros, said Joffe.

They have also had to contend with the effects of the global recession and a raft of tariff increases, particularly electricity, which have knocked their ability to collect revenue.

All these factors prompted Global Credit Ratings to reduce the sector’s ceiling in late 2010 to AA-. Star performers were the City of Cape Town and eThekwini (Durban), both rated at AA-. The City of Tshwane (Pretoria) and Buffalo City (East London) were rated two notches lower at A and Mangaung (Bloemfontein) received a BBB+ rating.

All the metros examined by Moody’s were penalised by South Africa’s sovereign rating downgrade and the outlook on all six metros it rated was adjusted to negative last year.

Despite the overall unfavourable position, cities such as Cape Town notched up an AA2.za rating (See “How the ratings work”) because of its strong financial position, prudent financial management and moderate debt-to-budget volumes. Nelson Mandela Bay (Port Elizabeth), Johannesburg and Tshwane were in the mid-level tier with ratings of AA3.za on their long-term debt.

A financial perspective
Increasing tariffs, said Joffe, were likely to remain among the chief challenges for most municipalities because rising electricity and fuel costs affected all local industries, businesses and citizens. “From a financial perspective, this is the most challenging for the sector, exacerbating the strains on liquidity.”

In addition there are a number of other problems, including pressure on municipalities to cope with and provide services to an ever-urbanising population and the operational capacity of most of South Africa’s local authorities.

There was also a well-documented dearth of technical and financial skills at municipal levels, said Joffe, resulting in poor service delivery and difficulty in complying with the Municipal Financial Management Act.

But the picture across the metros and larger municipalities was more nuanced, said Kevin Allan of Municipal IQ, an intelligence services firm that focuses on municipal government.

Despite the tougher climate because of the recession, tighter revenue streams and the aftermath of infrastructure building, the larger municipalities have increased their spend on citizens and Municipal IQ’s municipal productivity index showed big gains last year. It was the result of increased spending on indigent support as well as budget growth.

Performance capacity
The index measures the ability of individuals and economic agents to operate productively in their municipalities.

Johanesburg and eThekwini topped the list, scoring 78 and 74.5 respectively. Cape Town came third with a score of 73.8, followed by Tshwane (72.7), Ekurhuleni (72.1) and Nelson Mandela Bay (Port Elizabeth) (71.8).

The amount of money each municipality spent on its citizens was a good measure of its performance and service delivery capacity, said Allan.
 
According to Municipal IQ, municipalities in the Western Cape spent the most per resident (R4721) in the 2010-2011 financial year, followed by Gauteng (R4412) and the Free State (R2954).

On average, municipal authorities in the Eastern Cape, Northern Cape and Western Cape spent R100 less than the previous year.  Municipalities in Limpopo, the Eastern Cape and KwaZulu-Natal all spent less than R2000 per resident.

How the ratings work
Ratings agencies rate municipalities’ long- and short-term debt.

Moody’s provide these ratings on what is known as a national scale rating. These differ from global scale ratings, such as those given to South Africa under its sovereign rating. They are intended to rank the debt of national entities and their local peers. 
The rating most commonly referred to is that for long-term debt, or what is known as the national scale long-term rating.

Moody’s national scale ratings for South Africa range from AAA.za, when issuers or instruments issued are deemed to have the “strongest creditworthiness relative to other domestic issuers” to C.za, which are deemed “extremely speculative and ­demonstrate the weakest creditworthiness relative to other domestic issuers”.

Included in the Moody’s ratings is a numerical modifier from one to three. A modifier of one places the debt in the upper end of the rating category and three is the lowest.

Global Credit Ratings’ methodology and ratings vary slightly, but a triple A ranking (AAA) is the best possible rating.

For local government, however, it instituted an industry ceiling of AA- to account for the relatively constrained conditions the entire sector is experiencing. – Lynley Donnelly

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