14 November 2006, Innovation Hub, City of Tshwane

In the context of the SACN's State of the Cities reporting processes, the findings of a report such as the Local Government Expenditure and Budgets Review 2006 published by National Treasury in October 2006 are of great interest. This meeting of the Well-governed Cities Reference Group of the SACN was convened in order to provide municipal managers in the finance, development planning and information sectors of municipalities with an opportunity to (a) consider the key findings as presented by the National Treasury; (b) respond to these findings; and (c) discuss the key municipal finance challenges that are shown up by the review and the experience of the cities.

In opening the meeting, Sithole Mbanga, CEO of the SACN, emphasized the need to build the relationship between National Treasury and local government. He also challenged the SACN member cities to strengthen their arguments and positions on strategic financial challenges.

By TV Pillay, Chief Director: Local Government, National Treasury
(Annexure: Presentation 1) [PDF, 539kb]

TV Pillay, Chief Director: Local Government at the National Treasury, set the scene by reminding cities that budgets are central to the achievement of service delivery and development targets set local government. The Local Government Expenditure and Budgets Review, launched in October 2006, has shown that aggregate municipal budgets have nearly doubled from R64 billion in 2002/03 to R119 billion in 2005/06. These increases are driven largely by capital expenditure (22% growth), and grants from Naitonal Government, which rise from R2.3 billion (19% of municipal budgets) to R6.4 billion (38% of municipal budgets) in 2005/06.

He pointed out that electricity sales make up the largest revenue contribution in municipal budgets: R24 billion in 2005/06. Followed by property rates (at R17 billion in 2005/06); grants and subsidies (R13,2 billion in 2005/06); water tariffs (R11,2 billion in 2005/06) and refuse, levies and fines (R28 billion in 2005/06). This raises the question of what municipal budgets will look like when the regional electricity distribution institutions (REDs) are introduced and municipalities no longer receive electricity revenue.

The review shows that municipal capital budgets are funded largely by grants and subsidies (R13,3 billion in 2005/06), internally generated funds (R5,9 billion in 2005/06) and borrowing (R4,4 billion in 2005/06). Although expenditure on capital projects has more than trebled from R2,5 billion in 2002/03 to its current levels, there is clearly room for municipalities to borrow more in order to step up capital infrastructure projects. Capital spending is currently being fueled by projects associated with hosting the 2010 Fifa Soccer World Cup, but this level of spending must be sustained over a longer period.

Operating expenditure has also almost doubled since 2002/03. Metropolitan municipalities spend 29,6% on salaries and wages, and when spending on electricity infrastructure is shifted to the REDs salary spending will make up an even higher percentage of municipal budgets. Of the 1,6 million people employed in the SA public sector in 2005/06, over 180 000 were employed by 283 municipalities across all three municipal categories.

Outstanding consumer accounts have increased from R12 billion in 2002/03 to R23 billion in 2004/05. This is clearly unsustainable growth in debt trends, and municipalities need to find better ways to manage the problem.

He raised the following as emerging issues shown up by the Local Government Budgets and Expenditure Review:

• How should municipalities deal with increasing dependence on national grants and subsidies for capital projects on the one hand; and the concept of developmental local government on the other?
• What can be done to improve the debt collection among municipalities, given the growing demand for services?
• Can municipalities with strong balance sheets exploit borrowing opportunities and expand or accelerate their capital spending programmes?
• How can municipalities increase the pace of capital spending to grow the economy?
• How can municipalities ensure better performance by officials to improve service delivery and eradicate backlogs?

Speaking about the implementation and impact of the Municipal Finance Management Act (MFMA), TV Pillay confirmed that while implementation plans are on the table, action is slow. Municipalities are becoming accustomed to the municipal finance reforms that include early budget tabling, monthly reports to mayors, annual reports that talk to performance against budgets, more active audit committees, independent credit rating, new municipal Public Private Partnership regulations, and website information standardisation. There are delays however in incorporating municipal entities into the municipal accounts, and the quality of published information can be improved.

For additiona information and support see www.treasury.gov.za/mfma

By Krish Kumar, CFO: eThekwini and past president of the Institute of Municipal Financial Officers (IMFO)
(Annexure: Presentation 2) [PDF, 685kb]

Krish Kumar, the CFO from eThekwini and immediate past president of IMFO, responded to the Treasury input. He began by reminding the reference group that the rationalisation of the number of municipalities in SA (from 843 in 1999 to 284 at present) was a very complex process; and still presents administrative and institutional challenges for many municipalities. For example, the rationalisation of different administrative systems and pay structures.

In addition to the administrative and institutional issues, cities were faced with the urban development legacy of Apartheid, including inequity in the provision of municipal services; and infrastructure maintenance and operating backlogs. The key challenge is that municipalities needed to improve services in neighbourhoods that cannot contribute to the tax base.

He pointed out that budget allocations need to be linked to an assessment of actual needs (and special consideration should be given to high capacity municipalities). While planning and budget alignment remains a challenge, longer time horizons for development plans (especially infrastructure plans) and additional funding through the Municipal Infrastructure Grant (MIG) should help. There may be other ways to extend the revenue raising abilities of municipalities, such as by introducing a petrol levy.

Municipalities are also faced with challenges and uncertainty when it comes to the alignment of functions and fiscal powers. The introduction of the REDs, housing accreditation, and the devolution of public transport functions will all have an impact on municipal budgets. There are also unfunded mandates, and National targets set by National and Provincial Government that depend on local government for their implementation.

Municipal service and infrastructure backlogs are driven by the combination of migration, population growth and shrinking household sizes; and the need to integrate and equalize service standards. Municipalities find it difficult to calculate these ever-changing backlogs and as a result the municipal IDPs are less credible than they should be.

Municipal finance reforms such as the requirement that municipalities produce asset management plans has affected the target level of municipal service standards and improved the sustainability of municipal infrastructure by encouraging municipalities to consider the life-cycle costs of this infrastructure.

Looking ahead, Municipalities are faced with the following key financial challenges:

• The Property Rating Act will challenge the administrative capacity of municipalities. For example the cost of preparing a valuation roll is daunting, and the impact of shifting incidence (as a result of dynamic market value and variations across neighbourhoods) is difficult to anticipate. Krish Kumar made the point that the implementation of this Act should be managed in a practical way.
• Preparations for hosting the 2010 Fifa Soccer World Cup are constrained by limited capital funding. In his view, cities should not borrow to deliver infrastructure for the World Cup, and yet the grants from National Government are not adequate. In the context of the scrapping of the RSC levy, a new business tax may provide suitable revenue for capital loan repayments in future.
• The change in the electricity revenue as a result of the introduction of REDs will impact on the credit rating of cities, and it is not clear what implication this will have. Many municipal CFOs believe that all of the utility revenue
• (i.e. water and sanitation revenue) should have been treated in the same way and removed from municipal accounts at the same time as the electricity revenue.

The immediate priorities for municipalities were identified as being:

• Strengthening integrated planning and budgeting
• Addressing funding gaps
• Building capacity and developing scarce skills

Priorities for National Government action include:

• Analysing municipalities in terms of effectiveness and recognising different capacities to spend
• Monitoring and responding to the impact of the introduction of REDs.
• Introduction of a replacement revenue flow for business levies in Metros and Category B municipalities.
• Carefully consider the implications of a single public sector for municipalities before finalizing the recommendations.

By Sharon Lewis, SACN Knowledge Manager, and Roland Hunter, Municipal Finance Consultant
(Annexure: Presentation 3 and Presentation 4) [PDF, 1.5Mb and 70kb]

With a view to producing the next State of the Cities Report in 2010 or 2011, the SACN intends to focus on preparing a series of sector reports in the next few years on subjects such as city finances, the state of readiness to host the Soccer World cup, and the state of sustainability in the cities.

Given the synergy between research objectives on financial management in the cities, the SACN and the Institute of Municipal Financial Officers (IMFO) have planned to produce a State of City Finances Report in 2007.

This report is primarily intended for a dual audience of (a) managers and leaders (non-financial) in the municipal sphere of government who are interested in and affected by municipal financial management policies and procedures; and (b) public finance managers (across the three spheres of government) who would benefit from a more detailed analysis of municipal finance trends and concerns. There is a supplementary audience of interested academics and private sector analysts who may find this report useful, but this is of secondary importance to the scope and tone of the report.

The report should therefore provide a technically credible but accessible presentation of the issues. It is anticipated that the report will take the form of an A4 full colour publication (approx 120 pages) with a substantial database of financial statistics.

The State of City Finances Report 2007 intends to review and analyse the financial statements of the SACN member cities for the period 2003/04 - 2006/07, and their budgets for the period 2007/08 - 2009/10 with a view to gaining a better understanding of:

• Spending incidence and patterns;
• The extent of alignment between strategic and development planning, budgeting and spending;
• Revenue sources and patterns;
• Borrowing incidence and lessons learnt; and
• The financial management challenges faced by cities.

It is also intended to strengthen municipal financial management by stimulating debate about city finances; and providing technical data and analysis to inform the agendas of a range of financial management forums including the Chief Financial Officers' Forums convened by IMFO and the technical committees convened by National and Provincial Treasuries.

Roland Hunter presented the process by which the report will be drafted, and highlighted some of the key themes that it will cover, including:

• Financial overview: To compare and contrast the financial characteristics of the SA cities
• Resource envelopes and growth: To understand differing poverty, growth and service levels, operating and capital resources envelopes, and revenue side tax bases, collection rates, and growth rates.
• Financial administration and accountability: To understand the ability to spend effectively, and to account for spending, financial capacity and how municipalities work at the organizational level
• Implications of restructuring of city finances: To understand the financial implications of the REDs, changes to property tax regimes, replacement of RSC levies, growing dependence on national grants, and the single public service.

Three key strategic concerns were raised: the introduction of REDs, the scrapping of RSC levies, and plans for a single public service. With the loss of two key elements of municipal revenue suddenly municipalities are no longer self-financing. These concerns were reinforced when the question of whether cities have accepted this new environment was raised. The general view is that the REDs issue needs to managed to limit revenue impact and municipalities need to retain control of the electricity revenue collection tool.

There were many recommendations for the State of City Finances Report. The participants pointed out that the report should: Tell the truth and dig beyond city financial statements to get to truth about revenue risks and expenditure capacity. Play an advocacy role by communicating clear implications of issues such as unfunded mandates. Provide examples of global leading practice on issues such as retaining skills, resource envelopes and economic growth, and theoretical public finance issues (such as how big should government be? What is sustainability? What are the benchmarks for value-for-money?)

Sithole Mbanga concluded the meeting by reinforcing the view that the report should be more than just figures. He defined the purposes of the report as being: (1 ) To promote learning and capacity building, (2) To have an impact on policy, (3) To advocate municipal positions, and (4) To analyse the existing financial trends to inform strategic thinking. He called for all SACN members to take ownership of the report and contribute to the drafting process through future Reference Group consultations.