‘Terribly scary’: Dysfunctional municipalities are a threat to South Africa’s economy

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Earlier this year, Clover announced its decision to close the country’s biggest cheese factory, located in Lichtenburg in the Ditsobotla local municipality. The factory employed about 380 permanent and 40 temporary workers. The reason for the company’s Lichtenburg exit: poor service delivery.

The Clover factory’s closure is one example of how South Africa’s ailing economy is being squeezed by its municipalities, only 38 of which are confirmed to be 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 — which will on 1 November see its local government elections unfold — 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 among the factors that impede local economic development, according to Helanya Fourie, a senior economist at the Bureau for Economic Research (BER).

“Aside from low levels of fixed investment, and other challenges that we face, I think the municipal problems are definitely a contributor to the fact that we’ve seen very low levels of growth,” she said. 

“And it also has a sort of reinforced impact. So if you see municipalities performing poorly, it dis-incentivises further investment in the area, which prevents new jobs from being created.”

Knock-on effect

The hit to local economies has a knock-on effect for the country as a whole, Fourie added, especially 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.”

It points out that only 199 out of 257 municipalities submitted their audits in time to be included in the auditor general’s consolidated report for the 2019-20 financial year. Of these, only 38 were deemed to be in good financial health.

A total of 53 municipalities expressed doubt that they would be able to continue their operations as a going concern. This means they rely on the equitable share grant provided by the national government 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 a little bit more self-sustaining from a financial perspective,” Fourie said.

“But smaller municipalities — where there are perhaps more indigent households, where people are further away from each other and where people are potentially less able to  pay property taxes, or to pay 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.”

Risk

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 — the City of Johannesburg and the City of Ekurhuleni in Gauteng, the City of Cape Town, the Nelson Mandela metropolitan municipality in the Eastern Cape, and the City of 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 very 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.”

‘Terribly scary’

Skenjana described municipal dependence on the fiscus as “terribly scary”. 

“Because how is government funded? Through borrowings and through 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 are continuing to need more, because they are not using their finances efficiently,” he said.

“So you’ve got a constraint on the one side and then you have an existing developmental constraint on the other. Because 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 medium and long term picture is actually quite 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’s intergovernmental relationship structure is based on the assumption that local governments can raise their own money, Cawe said. “But the reality of that is that that capacity in a society like ours is deeply unequal … Now what that suggests is we have to re-entrench the progressivity of our allocation mechanisms.

“But 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, massive investments in capacity, that would ensure that the money is spent properly. 

“You don’t want to end up punishing somebody for having been born in a poor district and then say, because you have got poor leaders in that part of the world, you are now locked into a path of declining allocation 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 for development “is quite clear”, he added. “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. But we’re also seeing this disinvestment and flight industry,” Cawe said, citing Clover’s Lichtenburg exit.

“So, in a sense, the failure of those municipalities has massive impact, not just on those communities, but 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. And I think for me that is one of the massive existential risks to our democratic society.”

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