1. Introduction

This submission is a response to a request forwarded by the Select Committee on Finance to facilitate its public hearings on the 2002 Division of Revenue Bill. The terms of reference for the Commission were to focus on:

• Assessment and performance of conditional grants during the previous year;
• Output of grants;
• The flow, timing and size of grants
• The capacity at national and provincial government departments to facilitate allocation, operation and running of grant programs, and;
• Other related matters.

The Commission notes that, in its previous submissions on the Division of Revenue Bill, it has not given detailed attention to the conditional grant system. The Commission intends to give more attention to the use of conditional grants in its future submissions on the Division of Revenue Bill.

1. The Financial and Fiscal Commission’s position on the use of conditional grants

Conditional grants are used in most decentralized systems of government to enable specified national objectives. The Constitution states that conditional grants must be provided from the national equitable share and that the division of revenue must recognize the role played by conditional grants within the national equitable share. This implies that there is a trade-off between increasing conditional grants to provinces and municipalities and the total amount available for equitable sharing between the 3 spheres of government.

The FFC noted in its recommendations for the 2001-2004 MTEF cycle (May 2000) that the use of conditional grants should be limited and should promote Constitutional intentions with respect to decentralization and the principles of good governance applicable to sub-national governments. Furthermore, the FFC noted the importance of conditional grants as an instrument for speeding up access to basic services given national norms and standards.

Accountability for conditional grants is shared between national government and the recipient government in the sense that they remain part of the national equitable share, for which national government is accountable. In this respect, the commission emphasized the need for government to develop norms and standards for basic service delivery. Conditional grants represent revenue for receiving governments and as such, the receiving sub-national governments are accountable for delivery on national priorities against norms and standards where the equitable share is not achieving such priorities.

2. Objectives of the conditional grant system

An important feature of the SA intergovernmental system is the existence of concurrent functions between national and sub-national government departments. Some national departments have not clearly defined norms and standards that would facilitate the efficient monitoring of how far provinces are delivering on national priorities. Without such norms and standards, there is a temptation to perceive conditional grants as the sole mechanism for translating national priorities into sub-national expenditure and delivery programs. Such behaviour has, in the past, led to a proliferation of conditional grants. For example, given the absence of clearly defined norms and standards for Early Childhood Development (ECD), the conditional grant mechanism has been used to fund this program where ideally, ECD would be funded through the Equitable Share mechanism. The Commission welcomes the fact that it is government’s intention to eventually phase the funding for ECD into the equitable share once the current pilot programs have run their course.

National Treasury identifies the following objectives:

• To ensure fulfillment of national policy objectives involving the provision of standard levels of access to government services;
• To compensate for inter-jurisdictional spillovers, e.g. tertiary hospital grants;
• To effect transition by supporting capacity building and structural adjustments at sub-national level;
• To address backlogs and regional disparities in economic and social infrastructure.

1. Relationship to the Budget Process

Conditional grant types can be classified in the following way:

1. Block grants: have limited conditionality, are used for recurrent spending within broad guidelines and are used for Constitutionally or legislatively assigned functions (to Health) that, due to spillover effects, can not be adequately funded through the Equitable Share.
2. Service delivery grants: support programs for implementing norms and standards and introducing new service delivery levels, such as infrastructure development, and early childhood development. The supplementary grant provides general supplementary funding and is not attached to any particular service but is meant to provide incentives for compliance with overall budgetary priorities.

• Infrastructure grants: These include a mix of sector specific grants and general infrastructure grants aimed at assisting provinces to deal with maintenance and construction backlogs particularly those supporting delivery in Health and Education as well as economic infrastructure such as roads. An example of a sector-specific grants is the hospital rehabilitation grant. The general infrastructure grant requires some degree of matching by provinces
• Recurrent grants: provide for funding of a recurrent nature, e.g. personnel and materials for operations. Such grants as those for Early Childhood Development may be appropriately phased out into the PES since they result in permanent resource commitments.

1. Transitional grants: address capacity building and institutional restructuring issues (e.g. financial management, function-specific issues, etc) associated with new jurisdictions since 1994 for provinces and since the successive re-demarcations for local government. Once their objectives have been achieved, they can either be phased into an Equitable Share or redirected elsewhere depending on whether or not permanent obligations resulted from implementation.
2. Special allocation grants: Since 1999/00 these grants have been used to address national priority areas such as poverty and HIV/AIDS. Initial allocations were decided outside of the Budget Process with the results that funds were disbursed late resulting in under-spending. This destabilizes the budget planning process. Because poverty and HIV/AIDS are long-term problems, these grants could be allocated through the budget process, and phased into the Equitable Shares as the intergovernmental system matures.

1. The Current Conditional Grants Framework

The fact that both, provincial and national government are accountable for the use of conditional grants has been cited as the major cause of the inefficiency of the conditional grant system. Reforms that have been put in place at National Treasury coupled with the advent of the Public Finance Management Act are expected to deal with accountability and performance issues. This section summarizes the government’s policy framework for conditional grants.

As already noted in situations where provinces are not meeting national norms and standards, conditional grants provide a useful intervention tool for national departments with concurrent functions. Such intervention requires strategic planning by the intervening department. Such strategic planning requires the identification of objectives to be achieved and performance monitoring. Accountability arrangements also need to be clarified upfront.

National departments are required to meet certain key requirements in their MTEF submissions. These defined the Conditional Grant Framework and are set out below.

• Purpose and conditions of the grant
• Measurable outputs and delivery indicators
• Why the objective can not be met through the Equitable Share mechanism
• Projected lifespan of the grant
• Allocation criteria that must comply with Section 214 (a-j) of the Constitution.
• Proposed payment schedule (grants above R400 million should be paid in two to four installments and those below in two installments). Payment schedule should indicate

• The amount of each installment of an equitable share of the grant or allocation for the financial year
• The installment payment date
• To whom and to which accredited bank account the installment is paid
• Identification of a code by provinces for the grant to ensure adequate monitoring of spending.

This is the broad framework for conditional grants that has been put in place to ensure the smooth functioning of the system. It is important to note that within this broad framework guidelines now exist (since December 2001) that provide more detailed requirements for specific grant types. The FFC notes that the very fact that conditional grants are now part of the broader budget process is a significant step forward towards streamlining the conditional grant system. The onus is now on the national departments to ensure that any conditional grant is effectively monitored and under-spending can be sanctioned by payment delays. A further benefit deriving directly from the framework is that national departments are encouraged to develop the necessary norms and standards that should accompany conditional grant transfers. From provincial departments’ standpoint, planning for conditional grants is also now part of the overall budget process. Unplanned programs that tend towards under-spending can now be minimized.

1. The Size of Provincial Conditional Grants

Table 2 in Appendix 2 indicates the nominal values of Provincial Conditional Grants.

Conditional grants constitute between 15% (in 1998 / 99) and 13% (in 2001 / 02) of transfers from national to sub-national governments. Approximately 85% of conditional grants attach to the provincial sphere.

Conditional grants constituted 13% of provincial expenditure in 1999 / 00 and just below 12% this year. Whilst the relative importance of conditional grants to provincial budgets is declining, it is rising for municipalities.

The relative importance of conditional grants varies between functions. Conditional grants finance relatively small proportions of Education and Welfare budgets. By contrast, over 20% of the Health budget is funded through conditional grants. The Housing function is almost entirely funded through conditional grants.

2. Composition of Provincial Conditional Grants

For the financial year 2000/01, 43% of the total value of Provincial Conditional Grants was generated by the Health sector. The second highest allocation was for the housing fund at 23.9% to the total. This was followed by the National Treasury’s Supplementary grants allocation of about 17.6 %.

In 2001/2002 the allocation to HIV/AIDS under Education, Health and Welfare amounted to 0.9 % of conditional grants to provinces (up from 0.4% in 2000 / 01). Further detail on the performance of these grants (important with respect to relative value or policy impact) is provided in Appendix 1.

3. Variations and Fluctuations in the Value of Conditional Grants

Variations in the amounts allocated to Conditional Grants can be attributed to (a) the entry and exit of specific grants (the rules of which are being currently defined) and (b) budgetary responses to under-spending and rollovers.

An example of the former is an over R 2 billion allocation in 2001 / 02 to Social Development to compensate beneficiaries for prior under-payments (Budget Review 2002). It appears that accommodation of future commitments in this regard has been covered by Equitable Share allocations to welfare.

The impact of persistent under-spending and roll-overs (if not spent) is usually lower than average growth of budgetary allocations.

4. Financial Performance Issues – Under- and Over-spending on Provincial Conditional Grants

Tables 3a & 3b in the Appendix indicate over and under-spending on different conditional grants. Between 1999/00 and 2001/02, compliance with PFMA reporting and disclosure requirements has improved with respect to Provincial Conditional Grants. With the data sources available for analysis on under- and over-spending, it is estimated that the proportion of conditional grant value accounted for has increased from 63% to 98% during this period.

Over the past 2 years, reported under-spending on Provincial Conditional Grants has increased from 5% to 16%. This may reflect management or systems inefficiencies. Alternatively, improved compliance during this period may be revealing the extent of under-spending.

The Provincial average hides important differences between government departments and types of conditional grant:

• The rates of under-spending on Education conditional grants have declined over this period (1999/00 to 2001/02). National Treasury’s "Early Warning System" (EWS) predicts over-spending on the Early Childhood Development Program this year.
• After finding it difficult to spend allocated conditional grant funds, the rate of spending on Health and Welfare sector conditional grants has increased significantly this year – to the extent that the Early Warning System suggests a shift to over-spending. The exceptions are the HIV-AIDs grants for which small under-spending is expected this year.
• In general, rates of under-spending remain high on conditional capital grants (primarily intended for infrastructure provision). However, the rate of under-spending declined this year, primarily due to increased utilization of housing subsidies.
• Under-spending rates are highest on Transitional and Special Allocation grants. This may reflect hesitation to make long-term expenditure commitments. Older, and more established grant (e.g. the Housing, Hospital Revitalization and Integrated Nutrition) programs appear to have eliminated under-spending. This may be attributed to experience.

1. Financial Performance Issues – Provincial Conditional Grant Flows & Timing

Table 4 in the Appendix indicates disbursement and reporting schedules of different conditional grants.

The quarterly disbursement of provincial conditional grant allocations tends to be the current norm. This is an appropriate mechanism for infrastructure projects and larger grants where expenditure is more "lumpy" and is also consistent with the criteria specified in the payment schedule for conditional grants. There may be a disjuncture between monthly payment schedules for personnel and less frequent disbursements if recipient governments do not manage their cash flow.

Late or infrequent disbursements by national departments may cause delays and disrupt the budgetary planning process. The delay in disbursements contributed significantly to under-spending especially on some of the newer conditional grants that were still in start-up phase last year (2000/01). The guidelines from December 2001 require that conditional grant proposals should be finalized 4 months prior to the tabling of the Budget and be indicated in Strategic Plans (due prior to the start of the financial year.)

Disbursement schedules for most of the Poverty Relief grants do not yet appear to have been specified. This is due to the fact that initial allocations for these and the HIV-AIDs grants were made outside the Budget Process and its consultative forums. Hence, provincial capacity to spend was not adequately addressed when these grants were introduced.

Compliance with the PFMA requirements of monthly financial reporting, quarterly performance reporting leading to an Annual Report is not immediately apparent from information submitted to compile the Provincial Conditional Grant Framework. Most grant programs are anticipated to yield quarterly reports only. Some of this year’s new grant programs have not yet specified reporting schedules, nor, it appears to the FFC, the Integrated Child Nutrition and Housing programs.

Inadequate reporting compromises effective budgetary planning and this may be reflected in lower than average growth in budgetary allocations.

2. Organizational Capacity Issues and Under-Spending

The emerging system of conditional grants has been in operation for a relatively short period. Grant programs that have been inherited (and are thus well-established) tend to receive more regular disbursements, report more frequently and indicate lower rates of under-spending and rollovers.

The growth rate of many of the newer conditional grant disbursements appears to be faster than the capacity to manage the grant by provincial governments. This is especially true when operationalizing new policy initiatives since these might require new personnel skills and management systems. In line with (i) of Section 214 (2) which establishes stability and predictability in funding flows as a Constitutional principle, disbursement schedules should be frequent, regular, consistent and certain.

A significant proportion of Provincial Conditional Grants (approximately 40%) is devoted to Capacity Building and Institutional Restructuring. These various initiatives are fragmented and may hinder the development of a co-ordinated financial and performance management system through government.

3. Output Performance Issues

Table 5 in the Appendix indicates output performance measures of different grants. Measurable outputs have been defined for most Provincial conditional grants. A small number of grants appear to have been designed with specific (i.e. quantifiable) objectives or targets. Grants aimed at institutional restructuring or systems development may be more difficult to attribute quantifiable outputs relative to other grant types.

Some grants (especially the newer Special Allocation grants) exhibit a wide range of measurable objectives. This tends to make reporting more onerous.

Measurement of outputs is expected of all public sector bodies in their Strategic Plans (due before the start of 2002 / 03). The generation of such data is essential if public expenditure is to be analyzed in terms of a progressive realization towards equal access to basic services. Expenditure growth in excess of budget allocations need not indicate greater effectiveness or efficiency in spending.

The intended long-term and developmental outcomes of most conditional grant programs have not been adequately specified in the past. This may complicate evaluation of the impact of policy initiatives.

Health constitutes the biggest share of conditional grants to provinces. The largest two are the Central Hospital (CHG) and Health Professional Training and Research grants (HPTR). A review of the tertiary and training grants was undertaken by DoH and a major reconfiguration (central hospitals; redistribution of specialized health services (RSS); and training and research grants) was proposed in the 2002 Budget.

The results of the review for the CHG were as follows:

• The CHG is imperfectly targeted,
• The existing grant system underpins inequities in the sector,
• Access to tertiary care is compromised in many provinces,
• Several provinces, particularly E. Cape, spend large amounts on tertiary care from their equitable share while other provinces receive large conditional grants which not only allow them a large tertiary infrastructure largely used by their citizens, but also to subsidise other non-tertiary services, and
• The current grant hinders nationally planned tertiary service restructuring.

Key Proposals

• The grant be reconfigured to fund all tertiary services throughout the country at the levels of expenditure shown through a costing study,
• The grant would be renamed the National Tertiary Services grant (NTSG),
• The Redistribution of Specialised Services grant be incorporated to fund this larger envelope, and
• Part of the Health Professional Training and Research Grant be incorporated to fund this larger envelope.

Results of the review for the HPTR

• The total cost of the tertiary services envelope exceeded the CHG and RSS grants, so the HPTR is seen as a potential source for the balance,
• There is double counting between certain elements of he CHG and HPTR grants which is difficult to disentangle,
• The HPTR grant is very problematic methodologically and needs revision.

The new framework for the three grants (CHG, RSS, HPTR) provides for rationalization of the three grants into two: a National Tertiary Service grant (NTSG) and a Health Professional Training and Development grant (HPTD grant). The aim of the restructuring is to improve equity.

The NTSG will now fund tertiary units in 27 hospitals compared to the 10 that the CHG funded. Effectively, this means funds will be redistributed from Western Cape and Gauteng to other provinces – to be phased-in over 5 years.

The HPTD grant consists of two components: The major portion is distributed to provinces based on the number of medical students. A new component also provides for phasing-in the increase in the number of medical specialists and registrars in under-served provinces. The objective is that 25% of post-graduate training capacity be developed in provinces that do not have the capacity.

Central Hospital grants, which are directed towards funding recurrent costs of super-specialist services² not provided in all provinces, have had no under spending and were flowing to provinces according to the payment schedule. Generally expenditure within this grant exceeds the allocation.

There was some under-spending of this grant, mainly due to lack of a clear strategy for the restructuring of the health facilities. According to the Budget Review 2001, the grant has been used mainly for rehabilitation and maintenance of existing facilities rather than to support the restructuring of health facilities. For 2001/02, the Health sector decided to use the grant more flexibly to allow for spending on maintenance, whilst the national department is putting together a health revitalization plan and strategy.

Since 1998/99, there has been significant under-spending. In the fiscal year 2000/01, up to 68% had been reported as spent by provinces, implying possible under spending of the grant in that year.

The HIV/AIDS grant was initiated in 2000/01 to assist provinces in providing for life-skills in all primary and secondary schools; providing increased access to voluntary counselling and testing; and lastly for developing and piloting community based care models. Responsibility for achieving the objectives of this grant lies with the departments of Health, Social Development and Education, although Health plays the major role in co-ordination.

There have been problems of under-spending since inception, but the extent of such under-spending is narrowing. Problems that have been identified include:

• Lack of human and infrastructure capacity,
• Lack of appropriate skills (ie. project and management skills),
• NGOs still learning the process of submitting appropriate business plans,
• Lack of synergy between programme managers and finance persons,
• Transfer payments disbursed late;
• Inadequate administrative support for conditional grants workload, and
• In the case of VCT, most sites not ready for operational activities.

Most Social Development grants have been phased out. Only the HIV/AIDS grant remains up to 2003/04, which is the period covered in the Budget Review, 2002. The Financial Management and Social Security System grant will be phased out and 2002/03 is the last year that it is available.

The department of education manages three types of grants namely:

The aim is to improve the financial management of the education system and the quality of the education in schools. This grant was introduced in 1999/00 and was to be phased out in 2002/03, but is retained in order to consolidate gains achieved over the last three years in improving education outcomes.

Performance: reports from provinces show that spending is very low regardless of the improvement in the flow of this grant to province. Provincial reports reflect that more than 50 percent of the funds transferred to provinces were not spent.

This is aimed to continue with the pilot projects for the implementation of a compulsory reception year as part of the 10 years of compulsory education. Secondly to develop the capacity of the national and provincial education departments to ensure the expansion of a compulsory Reception year for learners turning six years old. This grant was introduced in 2001/02 and will be phased into the equitable share in 2003/04. The roll-out of the program, to be phased in over 10 years and will be mainly funded from provincial equitable shares.

The Housing grant, which is used for financing subsidies for the national housing programme, had an underspending of 48% in 2000/2001 of the allocated provincial grants allocation³. Spending for this grant is projected to reach 93% by the end of 2001/02 financial year.

The supplementary grant’s success is reflected by an increased alignment of provincial budgets to national priorities, e.g. social sector.

The HIV/AIDS grants are allocated to the three social sector services, i.e. Education, Health and welfare. From the Budget review 2001 it is reflected that under health the HIV/AIDS grant is aimed at developing an effective integrated response to the epidemic and was introduced in the 2000/01 fiscal year. However, the 2001/02 (EWS) data indicates that by January 2002, expenditure was at 48 % to the total allocated and anticipated to reach 99% before the end of the financial year. HIV/AIDS spending under education was at 45% in January 2002 and projected to reach 86% by the end of the financial year, whilst that for welfare or social development was at 50% in January and anticipated to reach 91% towards the end of the financial year.

Table 1: Role of the Provincial Conditional Grant System in the Division of Revenue Process

Table 2: Nominal Conditional Grant Values

Table 3a: Financial Performance – Under-spending on Provincial Conditional Grants

Table 3b: Financial Performance – Under-spending by Type of Provincial Conditional Grant

Table 4: Provincial Conditional Grant Flow and Timing Issues

Table 5: Provincial Conditional Grant Output Performance Measures