REPORT ON THE ANALYSIS OF MUNICIPAL BUDGETS FOR THE 2004/2005 FINANCIAL YEAR

QUALIFICATIONS

In reading this document please take note of the following important information:

 

1. INTRODUCTION

1.1 Background to the Local Government Budget Week Concept

The budget week is intended to be an annual policy statement that focuses on challenges, realities and complexities within the Local Government sphere. It seeks to bring together fiscal elements of developmental local government. In this regard, SALGA started during the 2003/2004 financial year to analyse and comment on budget trends based on information obtained from sample Municipalities. For the 2003/2004 financial year the report focussed only on operational budgets whilst this report is extended to also include capital expenditure and the effect of tariff increases on household consumers.

1.2 Purpose of the Report

The purpose of this report is to present comments and provides some trends based on a review of operational and capital budgets submitted by a sample of Municipalities for the 2004/2005 financial year.

The report is focussed on the following:

1.3 Methodology

In total the budgets of 31 Municipalities for the 2004/2005 financial year have been evaluated. The current sample is a significant increase from the 17 Municipalities evaluated in 2003/2004 and allows for a more comprehensive evaluation. Comparisons of the budgets of the sample Municipalities were performed, by stratifying them as set out below:

2. OUTCOMES OF THE ANALYSIS

The outcomes of the analysis is presented under the following headings:

    1. General Growth in Municipal Budgets.
    2. Operating Expenditure per Category.
    3. Operating Income per Category.
    4. Impact on Monthly Consumer Accounts.
    5. Capital Expenditure.
    6. Sources of Funding for Capital Projects.
    7. Surplus Generating Potential of Services.
    8. Indigent Support.
    9. Bad Debt Provision.
    10. Influence of Equitable Share Allocations.

2.1 General Growth in Municipal Budgets

National Treasury, on an annual basis, provides guideline growth parameters to Municipalities in respect of the growth allowed for municipal budgets. These parameters serve as a guideline only and can be exceeded if motivated by a particular Municipality.

Growth rates in terms of Guideline Growth Parameters contained in the National Treasury Budget Circular 1 for the 2004/2005 financial year, dated 16 March 2004, are set out below:

 

Budget Year

Growth Rate

2003-2004

9%

2004-2005

7%

2005-2006

6.5%

2006-2007

6%

The general growth in Income from 2002/2003 to 2004/2005 is set out below:

Municipal Group

Growth Rate

2002/03 to 2003/04

Growth Rate

2003/04 to 2004/05

Group One Municipalities

14%

12%

Group Two Municipalities

18%

11%

Group Three Municipalities

16%

23%

Metropolitan Municipalities

15%

9%

The excessive growth, measured against the Guideline Growth Parameters can mainly be attributed to the increases in the Equitable Share Allocations for all Municipalities in both years. In addition, a number of Municipalities for the first time included all their grant allocations as required by the Budget Circular, which previously were not recognised as revenue but rather as a capital receipt.

The general growth in Expenditure from 2002/2003 to 2004/2005 is set out below.

 

Municipal Group

Growth Rate

2002/03 to 2003/04

Growth Rate

2003/04 to 2004/05

Group One Municipalities

14%

12%

Group Two Municipalities

20%

11%

Group Three Municipalities

22%

18%

Metropolitan Municipalities

14%

9%

Again the excessive growth, measured against the Guideline Growth Parameters can mainly be attributed to the increases in the Equitable Share Allocations for all Municipalities, which in return were utilised for the provision of free basic services as well as the expenditure portion of all grants received. In addition, salary increases for all Municipalities, in terms of the National Bargaining Council agreement, were higher than the Guideline Growth Parameters.

The average growth rate indicated above does not necessarily mean that tariffs have been increased by the same margin. If the correct inclusion of all grants as well as the significant increase in Equitable Share Allocations to allow for the implementation of free basic services is deducted, municipal operational budgets will only increase by approximately 8% to 10%.

The increase in growth will also not necessarily mean that Municipalities will have additional income to provide services, as the Equitable Share Allocation will only substitute income usually received directly from consumers. However, the increase in Equitable Share Allocation should definitely improve the cashflow position of especially small to medium Municipalities, as it will ensure a stable and predictable income base for free/subsidised services rendered to indigents.

 

2.2 Operating Expenditure per Category

2.2.1 General Observations

Set out below, is a summary of general observations made in respect of expenditure per category for the different categories.

Salaries, Wages and Allowances

The main characteristics of expenditure patterns are that salaries have in general remained constant as a percentage of total expenditure. However, it is important to note that the Rand value of expenditure has increased between 8% in Metropolitan Municipalities to as high as 15% to 18% in Group One and District Municipalities. This increase can mainly be ascribed to the following important factors:

Apart from bulk purchases, salary costs are the second biggest cost factor in the provision of services such as electricity and water. In general, tariffs have again been increased below the salary increase rate resulting in other expenditure such as general expenses or repairs and maintenance being decreased to maintain operating margins.

It should also be noted that the cost related to Section 57 appointments still have a significant effect on smaller Municipalities. In these Municipalities the cost of contract personnel represents approximately 10% of the total salary budget. In addition, the amalgamation of former local councils resulted in duplication of certain organisational structures, as the distances between the various service delivery units (towns) does not allow for a roving service.

The norm for Salaries, Wages and Allowances is approximately 30% of the total expenditure budget. As indicated in our previous review, this situation will result in these Municipalities most probably not being able to contain their salary cost below 35% as a percentage of total expenditure in the long-term. The question arises whether new benchmarks should be developed for different categories of Municipalities, i.e. salary cost in the case of Metropolitan Municipalities should not be more than 30% whilst in the case of Group Three Municipalities it should not be more than 40%.

General Expenses

General Expenses constitute the administrative cost and supplies and material needed to render services. As a result of cashflow problems over the past few years general expenses have gradually been scaled down in accordance with actual cash received. General Expenses, excluding the cost of bulk services, have again increased below the inflation rate.

Budgeted expenditure in future years has therefore in general again been restricted to actual expenditure plus some insignificant increase. It therefore remains necessary to identify methods that will ensure cost effective measures of operating to avoid the lowering of service level standards, as these expenses cannot be scaled down much further. In this regard there is still a significant number of Municipalities where controllable cost such as telephone expenses, stationary, subsistence and travel, etc. reflect a need for good financial management.

Repairs and Maintenance

The norm for Repairs and Maintenance is approximately 10% of the total expenditure budget. For 2004/2005 expenditure on repairs and maintenance are still well below the norm of 10% with little movement to improve the current allocation. It is important to note that if not addressed, this situation may result in lower service level standards or Municipalities having to incur excessive cost to replace/upgrade infrastructure and equipment.

There are examples of Municipalities where essential services have been interrupted for a period of time due to the breakdown of expensive vehicles/equipment because such Municipalities could not afford the expenditure needed to undertake maintenance as a result of poor cashflow positions. In addition, old infrastructure such as electricity networks break down often, especially during winter months, when these networks cannot deal with the increased demand during peak hours. Interruption of services creates unnecessary friction between Municipalities and consumers and is resulting in an increased resistance from consumers to pay for poor quality services.

An attempt should be made to decrease the Salaries, Wages and Allowances portion of budgets in future in order to redirect funds for Repairs and Maintenance. The importance of preventative maintenance of infrastructure cannot be over emphasised, as failure in this regard can result in Municipalities incurring significant expenditure in future to replace assets not well maintained.

With the developments in accounting standards, Municipalities will soon have to recognise reductions in the value of infrastructure resulting from the lack of maintenance as an expense. As development occurs, this expense category should gradually be increasing or as a minimum remain at 10% of operating expenditure.

Capital Costs

Capital Costs constitutes the external interest and redemption cost to service external loans as well as the interest and redemption cost to service loans financed internally from the Capital Development and other Statutory Funds of a Municipality. The norm for Capital Charges is approximately 10% to 12% of the total expenditure budget.

Capital Costs, especially in the smaller Municipalities, are still decreasing as Municipalities are becoming more reliant on grants/ donations to fund capital programmes as a result of inter alia poor payment levels. Although capital programmes are initiated from internal funding it is most likely that a large number of these projects will not be executed as a result of a lack of funding. In some cases capital projects are budgeted for, to be financed from internal resources, although it is indicated in advance that the Capital Development Fund is not represented by cash.

Smaller Municipalities also find it increasingly difficult to raise external loans, as the cashflow position of these Municipalities does not allow for the timeous and continued servicing of the debt. In this regard smaller Municipalities are to a large extend becoming more dependent on District Municipalities and Provincial and National Government to address infrastructure backlogs. In the case of the Metropolitan Municipalities there is a significant increase in external loans raised and in this regard the cost of servicing these loans will only have an effect in future operational budgets.

Infrastructure development also brings along the burden of future maintenance and increased operating expenses. There is still an increasing need from Local Municipalities to have District Municipalities assist Local Municipalities in respect of Repairs and Maintenance and not only to fund the capital cost of new infrastructure. In this regard it is becoming more and more important that Local Municipalities are consulted in advance when future projects are planned to ensure that such Municipalities can in fact afford future maintenance costs.

Contribution to Funds

Contributions to Funds constitute statutory and voluntarily contributions made by a Municipality to leave, working capital, bad debt reserve and the capital development and other statutory funds. The norm for Contribution to Funds is approximately 3% of the total expenditure budget.

The guidelines from National Treasury require that Municipalities provide for bad debt/ working capital in line with their current payment levels. Current provisions for reserves are a matter for concern, as it again appears that some Municipalities are not providing sufficiently for bad debt/ working capital. This situation will only lead to budgets having to be reviewed within the first quarter of the financial year after approval to ensure satisfactory cashflow positions.

It is also a matter of concern that some smaller Municipalities utilise a significant portion of their Equitable Share contribution to provide for bad debt/ working capital. Effective credit control measures could ensure that these funds are rather applied towards the provision for free services or subsidisation of tariffs.

In terms of the recent agreement between the National Bargaining Council and labour unions, a new policy in respect of leave came into effect from 1 January 2004. In this regard, leave accumulated by all municipal officials up to 31 December 2004 becomes payable within a period of time. Officials will have the option to take this leave or to encash it or a combination thereof depending on the financial situation of the Municipality. However, due to affordability restrictions a number of Municipalities over time annually contributed less than the amount required to their leave provision fund. In other cases the annual provision equals the liability but is not backed by cash. This situation now resulted in a number of Municipalities having to make provision for significant increases in respect of their contribution to leave provision funds to ensure that they are in a position to meet their obligations.

2.2.2 Expenditure per Category – Group One Local Municipalities

Salaries, Wages and Allowances

Budgeted Salaries, Wages and Allowances reveal a significant increase from 30% in 2002/2003 to 32% as a percentage of the total expenditure budget. It is also important to note that this item on average increased by 15% in Rand value from 2003/2004 to 2004/2005. This can be attributed to a general salary increase of 7.85% across the board and the implementation of newly approved organisational structures. A number of Municipalities also only finalised appointment of Section 57 staff during 2003/2004 resulting in salary costs only being borne for a full financial year for the first time during 2004/2005.

General Expenses

General Expenses (excluding bulk purchases) remain stable at 29% as a percentage of the total expenditure budget although the Rand value increased by approximately 11%. Bulk purchases decreased marginally from 31% to 30% as a percentage of the total expenditure budget whilst the Rand value only increased by 6%. This can mainly be attributed to the low increase in the cost for the purchase of bulk electricity.

Repairs and Maintenance

Repairs and Maintenance decreased further from 7% to 6% as a percentage of the total expenditure budget whilst the Rand value only increased by approximately 5%. The current negative trend remains a matter for concern and the importance of preventative maintenance of infrastructure cannot be over emphasized, as failure in this regard can result in Municipalities incurring significant expenditure in future to replace assets earlier than intended as they are not well maintained.

Capital Charges

Capital Charges remained stable at 11% as a percentage of the total expenditure budget whilst the Rand value only increased by approximately 7%.

Current problems faced in general by Municipalities is that low payment figures over a period of time resulted in Capital Development Funds not to be backed sufficiently by cash, but merely be represented by outstanding debtors. Although capital projects are budgeted for on an annual basis these proposed projects are sometimes not implemented or completed due to a lack of funding. In addition, some Municipalities are reluctant to secure external funding, as the cash burden of servicing these loans cannot be maintained. This may have come about as a result of insufficient payment levels. In this environment, Municipalities are compelled to restrict their actual capital expenditure largely to projects funded from grants and donations.

Contribution to Funds

Contribution to Funds increased from 6% to 7% as a percentage of the total expenditure budget, whilst the Rand value increased by approximately 32%. Current contributions are significantly above the norm of 3% but merely came as a result of Municipalities increasingly trying to account for low payment levels through sufficient provision to bad debt reserves.

2.2.3 Expenditure per Category – Group Two Local Municipalities

Salaries, Wages and Allowances

Budgeted Salaries, Wages and Allowances decreased marginally from 33% to 32% as a percentage of the total expenditure budget. However, it is again important to note that this item on average increased by 10% in Rand value from 2003/2004 to 2004/2005.

This can be attributed to a general salary increase of 7.85% across the board and the implementation of newly approved organisational structures. A number of Municipalities also only finalised appointment of Section 57 staff during 2003/2004 resulting in salary costs only being borne for a full financial year for the first time during 2004/2005.

General Expenses

General Expenses (excluding bulk purchases) increased significantly from 26% in 2002/2003 to 35% in 2004/2005 as a percentage of the total expenditure budget, whilst the Rand value increased by approximately 27% from 2003/2004 to 2004/2005. The increase can mainly be attributed to the increases in the Equitable Share Allocations for all Municipalities, which in return were utilised for the provision of free/ subsidised basic services. Bulk purchases remained stable at 22% as a percentage of the total expenditure budget whilst the Rand value increased by 13%. This can mainly be attributed to the low increase in the cost for the purchase of bulk electricity.

Repairs and Maintenance

Repairs and Maintenance remained constant at 8% as a percentage of the total expenditure budget whilst the Rand value increased by approximately 12%. The current under spending remains a matter for concern and again the importance of preventative maintenance of infrastructure cannot be over emphasized, as failure in this regard can result in Municipalities incurring significant expenditure in future to replace assets earlier than intended as they are not well maintained.

Capital Charges

Capital Charges decreased marginally from 8% to 7% as a percentage of the total expenditure budget whilst the Rand value only increased by approximately 3%. The current situation again underlines general financial constraints experienced by Municipalities as a result of low payment figures, which in turn resulted in Capital Development and other Statutory Funds not being backed sufficiently by cash. Although capital projects are budgeted for on an annual basis, these projects are sometimes not implemented or completed due to a lack of cash resulting in relatively low infrastructure spending. However, there is a significant increase in external loans to be raised. Although it is not certain how many of these loans will actually be raised, the cost of servicing these loans will only have an effect in future operational budgets.

Contribution to Funds

Contribution to Funds remained constant at 8% as a percentage of the total expenditure budget. Current contributions are still above the norm of approximately 3% but merely came as a result of Municipalities increasingly trying to account for low payment levels through sufficient provision to bad debt reserves. This will result in a more realistic cash funded budget.

2.2.4 Expenditure per Category – Group Three Local Municipalities

Salaries, Wages and Allowances

Budgeted Salaries, Wages and Allowances for smaller Municipalities decreased marginally from 44% to 43% as a percentage of the total expenditure budget. The decrease can mainly be attributed to the significant increases in equitable share allocations for this category of Municipalities resulting in the broadening of their income base. However, it is again important to note that this item on average increased with 14% in Rand value from 2003/2004 to 2004/2005. This can be attributed to a general salary increase of 7.85% across the board and the implementation of newly approved organisational structures.

A number of Municipalities also only finalised appointment of Section 57 staff during 2003/2004 resulting in salary costs only being borne for a full financial year for the first time during 2004/2005. These appointments have a much larger impact on the Municipalities’ salary account than in the case of larger Municipalities. Councils determine the remuneration packages individually and in the majority of smaller Municipalities the total cost of these Managers may represent as much as 10% of the total salary budget.

In the case of smaller Municipalities salary cost represents the biggest single expenditure and it is not foreseen that small Municipalities will be in a position in the immediate future to restrict salary cost to less than 35%. As discussed above, the question arises whether new benchmarks should be developed for different categories of Municipalities.

General Expenses

General Expenses (excluding bulk purchases) increased significantly from 16% in 2002/2003 to 30% in 2004/2005 as a percentage of the total expenditure budget, whilst the Rand value increased by approximately 26% from 2003/2004 to 2004/2005.

The increase can mainly be attributed to the increases in the Equitable Share Allocations for all Municipalities, which in return were utilised for the provision of free/ subsidised basic services. Bulk purchases decreased marginally from 16% to 14% as a percentage of the total expenditure budget whilst the Rand value only increased by 6%. This can mainly be attributed to the low increase in the cost of purchasing of bulk electricity.

Repairs and Maintenance

Repairs and Maintenance increased marginally from 5% to 6% as a percentage of the total expenditure budget whilst the Rand value increased by approximately 36%. Although there is a slight improvement against the norm of 10% of the total expenditure budget, the current situation remains a matter for concern. Again the importance of preventative maintenance of infrastructure cannot be over emphasized, as failure in this regard can result in Municipalities incurring significant expenditure in future to replace assets earlier than intended as they are not well maintained.

Capital Charges

Capital Charges decreased significantly from 9% in 2002/2003 to 4% in 2004/2005 as a percentage of the total expenditure budget whilst the Rand value increased only slightly by approximately 3% from 2003/2004 to 2004/2005. This negative trend again underlines current problems faced in general by especially small Municipalities in that low payment figures resulted in Capital Development and other Statutory Funds not being backed sufficiently by cash. Against the norm of 10% to 12% of total expenditure the current trend is a matter for concern.

Although capital projects are budgeted on an annual basis these projects are seldom undertaken due to a lack of cash. In addition, Municipalities are reluctant and even unable to secure external funding, as the cash burden of servicing these loans cannot be maintained due to insufficient payment levels. This situation resulted in Municipalities restricting their actual capital expenditure to a large extend only to projects funded from grants and donations. This is clearly illustrated by the fact that none of the sample Municipalities in this category indicated that any external loans will be raised in the 2004/2005 financial year.

Contribution to Funds

Contribution to Funds decreased significantly from 12% in 2002/2003 to 6% in 2004/2005 as a percentage of the total expenditure budget whilst the Rand value also only increased by approximately 8% from 2003/2004 to 2004/2005. This situation mainly is a result of Municipalities not making sufficient provision for bad debts. Sufficient provision will relieve the burden on other expenditure such as Repairs and Maintenance and the timeous filling of vacant positions and prevent an immediate review of the budget shortly after approval to try and ensure a cash funded budget.

2.2.5 Expenditure per Category – District Municipalities

Salaries, Wages and Allowances

Budgeted Salaries, Wages and Allowances for District Municipalities increased slightly from 22% to 23% as a percentage of the total expenditure budget. However, it is important to note that this item on average increased with 18% in Rand value. This can be attributed to a general salary increase of 7.85% across the board and the implementation of newly approved organisational structures. A number of Municipalities also only finalised appointment of Section 57 staff during 2003/2004 resulting in salary costs only being borne for a full financial year for the first time during 2004/2005.

General Expenses

General Expenses (excluding bulk purchases) remain stable at 22% as a percentage of the total expenditure budget, whilst the Rand value increased by approximately 15%. Bulk purchases decreased marginally from 8% to 6% as a percentage of the total expenditure budget whilst the Rand value decreased by 12%. This can mainly be attributed to the transfer of functions to Local Municipalities.

Repairs and Maintenance

Repairs and Maintenance decreased marginally from 2% to 1% as a percentage of the total expenditure budget whilst the Rand value decreased by approximately 19%. Most District Municipalities do not own significant infrastructure or other assets. Therefore this amount shall be low in value.

Capital Charges

Capital Charges increased marginally from 2% to 3% as a percentage of the total expenditure budget whilst the Rand value increased significantly by approximately 60%. Again, most District Municipalities do not finance significant assets and therefore this amount shall be low in value.

Contribution to Funds

Contribution to Funds decreased marginally from 8% to 6% as a percentage of the total expenditure budget whilst the Rand value decreased by approximately 6%.

2.2.6 Expenditure per Category – Metropolitan Municipalities

Salaries, Wages and Allowances

Budgeted Salaries, Wages and Allowances for Metropolitan Municipalities remained constant at 28% as a percentage of the total expenditure budget, whilst the Rand value only increased by 8%. This can merely be attributed to a general salary increase of 7.85% across the board.

General Expenses

General Expenses (excluding bulk purchases) increased slightly from 36% to 37% as a percentage of the total expenditure budget, whilst the Rand value increased by approximately 14%. Bulk purchases remained stable at 24% as a percentage of the total expenditure budget whilst the Rand value increased by approximately 10%. This can mainly be attributed to the low increase in the cost of purchasing of bulk electricity.

Repairs and Maintenance

Repairs and Maintenance remained stable at 7% as a percentage of the total expenditure budget whilst the Rand value increased by approximately 13%. Against the norm of 10% of the total expenditure budget, the current trend remains a matter for concern. Again the importance of preventative maintenance of infrastructure cannot be over emphasized, as failure in this regard can result in Municipalities incurring significant expenditure in future to replace assets earlier than intended as they are not well maintained.

Capital Charges

Capital Charges decreased slightly from 10% to 9% as a percentage of the total expenditure budget whilst the Rand value also decreased by approximately 9%. As in the case with Local Municipalities the Metropolitan Municipalities also experience low payment figures resulting in Capital Development and other Statutory Funds not being backed sufficiently by cash. Although capital projects are budgeted on an annual basis these projects are sometimes not implemented or completed due to a lack of cash. However, Metropolitan Municipalities are able to secure external funding to maintain reasonable levels of capital expenditure. Although it is not certain how many of these loans will be raised during 2004/2005, the cost of servicing these loans will only have an effect in future operational budgets.

Contribution to Funds

Contribution to Funds decreased slightly from 6% to 5% as a percentage of the total expenditure budget whilst the Rand value increased with 4%. Again current contributions are above the norm of approximately 3% but also came as a result of Metropolitan Municipalities trying to account for low payment levels through making sufficient provision to bad debt reserves.

2.3 Operating Income per Category

2.3.1 General Observations

Set out below is a summary of general observations made in respect of income per category for the different categories.

Tariff Increases and Free Basic Services

Tariff increases in general were kept in line with the inflation rate. However, there are still a number of Municipalities that had to increase their tariffs above the inflation rate to ensure financial stability and sustainability. This situation mainly stems from historic tariff increases that were insufficient. If bulk purchases and salary cost for a service increases by 10% it is likely to expect tariffs to increase by the same margin. However, a number of Municipalities increase tariffs only by approximately 5% to 8% resulting in an under recovery of cost. Such practise needs to be managed as it may result in community dissatisfaction with future proposed tariff increases that are significantly greater than inflation.

Tariff increases are ultimately determined politically and is to a large extend dominated by political events such as national or local government elections. Insufficient tariff increases, for example shortly before elections, will only result in the situation discussed above occurring and will leave the newly elected Council with the task of introducing abnormal tariff increases shortly after elections.

The introduction/expanding of free basic services resulted in the majority of household consumers benefiting from lower tariff increases. Although the information cannot be verified at this stage, it can be expected that the majority of Municipalities, in terms of the guidelines, introduced at least free basic electricity and water to household consumers. It is significant to note that smaller Municipalities, who are dependant on household consumers for the majority of their income, do not recover these free services through higher tariffs from bigger consumers but utilised the Equitable Share Allocation to fund the total cost.

In anticipation of the implementation of the Property Rates Act, where the first R15 000 of household property value will be exempted from assessment rates, a number of Municipalities have already implemented some form of rebate on current assessment rate tariffs to benefit poorer communities.

In addition to the above, Municipalities also introduced efforts to implement free sewerage and refuse removal to at least indigent households. With the exception of the minority of Municipalities that introduced tariff increases above the inflation rate, tariffs in general were kept close to/ under the inflation rate. This trend will assist the efforts of National Government in respect of inflation targets. However, it must be noted that services tariffs are largely influenced by bulk purchases and as such Municipalities do not have an influence on annual tariff increases announced by the respective bulk service providers. In this regard the limited increase by Eskom has had a positive impact.

Electricity

Electricity remains the largest source of income for the majority of Municipalities and represents approximately 28% to 33% of total operational income. The introduction of prepayment systems allows for a very stable income base in respect of this service. As this service is normally operated at a surplus of 12% to 15% the outcome of the envisaged restructuring of the electricity distribution industry will have a major impact on all Municipalities. Distribution losses still remain the greatest threat to income potential. The effect thereof will be discussed in more detail under profitability of services.

Water

The devolution of the water services function will pose major challenges to Local Municipalities involved. Although the service has a significant income potential, current derelict/ lack of infrastructure, especially in rural areas, also poses a major threat to Municipalities and to the provision of free basic water. The importance of sufficient subsidies to accompany the transfer of this function to Local Municipalities cannot be over emphasized. Municipalities will also have to introduce organised campaigns to register and educate consumers to start to pay for services rendered.

Similarly to the impact of electricity distribution losses, water distribution losses still remains a challenge to maximising income. The effect of distribution losses will be discussed in more detail under profitability of services.

Assessment Rates

The implementation of the Property Rates Act will allow a significant increase in the income base of all Municipalities.

A number of Municipalities, especially in the rural areas have already used the opportunities, created by the "wall to wall" boundaries, to broaden their income base through the inclusion of rural areas not previously valued for the payment of rates and taxes. Remaining Municipalities will most probably be valuating land during 2004/2005 to ensure implementation of a more comprehensive rating system in the 2005/2006 financial year.

The manner in which these taxes have been introduced has led to several challenges over the past few months. However, there are also examples of Municipalities following a process of community consultation, where all parties have co-operated in good faith to ensure a fair tariff for rural areas.

Refuse Removal and Sewerage

The majority of Municipalities are trying to ensure that basic services such as sewer and refuse removal are rendered at the lowest cost possible and tariff increases were in most cases limited to ensure only a breakeven position to ensure that tariffs are sufficient to meet the costs of rendering the service.

2.3.2 Income per Category – Group One Local Municipalities

Electricity

Electricity remains the largest source of income although the budgeted income decreased slightly from 35% to 34% as a percentage of the total income budget. The Rand value of income only increases by approximately 8%, which implies that Municipalities tried to limit tariff increases to those announced by Eskom.

Assessment Rates

Income from Assessment Rates is the second largest source of income and budgeted income and remains constant at 18% as a percentage of the total income budget although the Rand value of income increases by approximately 10%.

Water

Income from Water is the third largest source of income and budgeted income remains constant at 14% as a percentage of the total income budget whilst the Rand value of income only increases by approximately 8%.

Sewerage

Income from Sewerage decreased significantly from 11% in 2002/2003 to 5% in 2004/2005 as a percentage of the total income budget whilst the Rand value of income only increased by approximately 3%. This situation implies that Municipalities are attempting to ensure that this service remains affordable to all consumers, especially the poorer communities.

Refuse Removal

Income from Refuse Removal remained stable at 2% as a percentage of the total income budget whilst the Rand value of income decreases by approximately 1%. Again this situation implies that Municipalities are seriously trying to ensure that this service remains affordable to all consumers.

Sundry Income

Sundry Income remains constant at 26% as a percentage of the total income budget. Income from grants decreased slightly from 14% to 13% as a percentage of the total income budget, whilst the Rand value of income increases by 8%.

2.3.3 Income per Category – Group Two Local Municipalities

Electricity

Electricity again remains the largest source of income and the budgeted income remains constant at 34% as a percentage of the total income budget. The Rand value of income only increases by approximately 11%, which implies that Municipalities in general tried to only pass on the tariff increase announced by Eskom.

Assessment Rates

Income from Assessment Rates is the second largest source of income and budgeted income decreased slightly from 19% to 18% as a percentage of the total income budget, whilst the Rand value only increases by approximately 7%.

Water

Income from Water increased slightly from 11% to 12% as a percentage of total income. However, the Rand value of income also increases by approximately 24%. The increase in Rand value came as a result of the devolution of water services and the inclusion of water subsidies.

Sewerage

Income from Sewerage decreased slightly from 6% to 5% as a percentage of the total income budget whilst the Rand value of income only increases by approximately 7%. This again implies that Municipalities are trying to ensure that this service remains affordable to all consumers, resulting in tariff increases being restricted to below the inflation rate.

Refuse Removal

Income from Refuse Removal decreased slightly from 6% to 5% as a percentage of the total income budget whilst the Rand value of income only increased by 3%. Again this situation implies that Municipalities are trying to ensure that this service also remains affordable to all consumers, resulting in tariff increases being restricted to below the inflation rate.

Sundry Income

Sundry Income remains stable at 24% as a percentage of the total income budget. Income from grants increases from 9% to 11% of the total income budget, whilst the Rand value of income increases significantly by 30%. The growth can mainly be attributed to the increases in the Equitable Share Allocations to all Municipalities. In addition, a number of Municipalities for the first time included all their grant allocations as required by the Budget Circular.

2.3.4 Income per Category – Group Three Local Municipalities

Electricity

Electricity still remains the largest source of income although the budgeted income decreased significantly from 25% to 22% as a percentage of the total income budget. The Rand value of income only increases by 7%, which implies that Municipalities have limited tariff increases to those announced by Eskom.

Water

Income from Water is now only the third largest source of income and budgeted income decreased further from 19% in 2002/2003 to 9% in 2004/2005 as a percentage of the total income budget whilst the Rand value of income increases by approximately 12%.

Assessment Rates

Income from Assessment Rates is now the second largest source of income and budgeted income remains constant at 11% as a percentage of the total income budget whilst the Rand value of income increases significantly by approximately 26%. The increase in Rand value merely came as a result of Municipalities broadening their income base through the inclusion of rural areas not previously valuated.

Sewerage

Income from Sewerage decreased marginally from 8% to 6% as a percentage of the total income budget whilst the Rand value of income increases by approximately 2%. Municipalities are trying to ensure that this service also remains affordable to all consumers.

Refuse Removal

Income from Refuse Removal remains constant at 6% as a percentage of the total income budget whilst the Rand value of income increases by approximately 12%. Again this situation implies that Municipalities are trying to ensure that this service also remains affordable to all consumers, resulting in tariff increases that are below the inflation rate.

Sundry Income

Sundry Income increased significantly from 38% to 44% as a percentage of total income. Income from grants increases significantly from 28% to 35% of the total income budget, whilst the Rand value of sundry income increases by 56%. The growth can mainly be attributed to the significant increases in the Equitable Share Allocations for all Municipalities. In addition, a number of Municipalities for the first time included all their grant allocations as required by the Budget Circular.

2.3.5 Income per Category – District Municipalities

Services and Establishment Levies

Services and Establishment Levies remains the largest source of income and increased from 45% to 46% as a percentage of the total income budget whilst the Rand value of income increased by approximately 15%.

Grants and Subsidies

Income from Grants and Subsidies is the second largest source of income and increased significantly from 16% to 26% as a percentage of the total income budget whilst the Rand value of income increased by approximately 86%. The significance of grants and subsidies to assist Districts in exercising their responsibilities in terms of legislation is clearly illustrated.

2.3.6 Income per Category – Metropolitan Municipalities

Electricity

Electricity remains the largest source of income although it decreased from 29% to 28% as a percentage of the total income budget whilst the Rand value of income only increases by approximately 5%. Tariff increases were limited to below the inflation rate.

Assessment Rates

Income from Assessment Rates is the second largest source of income and budgeted income remains constant at 21% as a percentage of the total income budget whilst the Rand value of income increases by approximately 9%.

Regional Services Levies

Income from Regional Services Levies remains constant at 7% as a percentage of the total income budget whilst the Rand value of income increases by approximately 9%.

Water

Income from Water is still the third largest source of income and budgeted income remain stable at 13% as a percentage of the total income budget whilst the Rand value of income only increases by approximately 9%.

Sewerage

Income from Sewerage decreased slightly from 3% to 2% as a percentage of the total income budget whilst the Rand value of income decreases by approximately 1%. This situation indicates that Metros, like other Municipalities in general, are trying to ensure that this service remains affordable to all consumers.

Refuse Removal

Income from Refuse Removal remained constant at 3% as a percentage of the total income budget whilst the Rand value of income only increases by approximately 5%. Again this situation implies that Municipalities are trying to ensure that this service remains affordable to all consumers, resulting in tariff increases to be restricted within the inflation rate.

Sundry Income

Sundry Income increased slightly from 23% to 25% as a percentage of the total income. Income from Grants and Subsidies increased from 5% to 7% as a percentage of the total income budget whilst the Rand value of income increased by approximately 35%.

2.4 Impact on Monthly Consumer Accounts

National Treasury determines definitions of large and small households as set out below.

Item

Large Household

Small Household

Size of Stand

1 000m˛

300m˛

Improvements

150m˛

48m˛

Units of Electricity

1 000

498

Kilolitres of Water

30

25

Average tariff increases are slightly higher than the inflation targets. However, salary increases, which form a significant part of total operating expenditure, were 7.85% and contributed the most to tariff increases exceeding inflation targets. The fact that Group Three Municipalities hardly had any increase merely came as a result of free basic services to be implemented in full and as such benefiting consumers in these particular categories the most. In this regard, it should be noted that consumers with high consumption experienced tariff increases of approximately 6% to 8%.

 

It should be noted that the Tariffs for George Local Municipality has not been included in the average for Group 2 as these tariffs are significantly higher than the tariffs of this group.

 

 

From the above it is quite clear that there is a significant difference in tariffs between the various categories of Municipalities. In this regard, the tariffs for small households for Group Two Municipalities are a reason for concern as these tariffs are much higher than the average. In the case of large consumers the total account of these consumers are influenced by the value of their properties and as such assessment rates are the main difference when evaluating the tariffs of the various Municipalities. One Municipality in particular influences this average and that is George Local Municipality.

2.5 Capital Expenditure

An extract from the Division of Revenue Act, Act No 5 of 2004, reads as follow:

"National transfers to municipalities supplement own revenue to enable them to fulfil their developmental roles. The key local government priorities are the expansion and provision of free basic services; acceleration of delivery of water, electricity and sanitation infrastructure to poor households, extension of services……….."

2.5.1 Capital as a Percentage of Operating Expenditure

The fact that budgeted capital, as a percentage of operational expenditure in general is remaining constant/ declining, as indicated in the chart below, is mostly the result of over budgeting during the 2003/2004 financial year as well as the guidelines from National Treasury for 2004/2005 indicating that only projects for which funds have already been secured may be included in the capital budget.

 

2.5.2 Breakdown of Capital Budget

From the chart above it is quite clear that the emphasis throughout all Municipalities is to eradicate the backlog in respect of infrastructure. In respect of infrastructure projects the main emphasis is on roads, electricity, water and sewer. This does not leave much room for other types of projects and as such District Municipalities are concentrating more on community projects and other assets.

2.5.3 Breakdown of Infrastructure Expenditure – Group One Local Municipalities

In respect of infrastructure projects, the main expenditure is on roads, electricity, water and sewer.

2.5.4 Breakdown of Infrastructure Expenditure – Group Two Local Municipalities

 

In respect of infrastructure projects, the main expenditure is again on roads, electricity, water and sewer.

2.5.5 Breakdown of Infrastructure Expenditure – Group Three Local Municipalities

In respect of infrastructure projects, the main expenditure is also on roads, electricity, water and sewer.

2.5.6 Breakdown of Infrastructure Expenditure – District Municipalities

 

In respect of infrastructure projects main expenditure is roads, water, sewer and community projects.

2.5.7 Breakdown of Infrastructure Expenditure – Metropolitan Municipalities

In respect of infrastructure, the main expenditure is on roads, electricity, water and housing.

    1. Sources of Funding for Capital Projects

 

The above chart clearly indicates that Municipalities are largely becoming more reliant on external funding (loans/grants/donations) to address capital projects. The chart also indicates that smaller Municipalities (Group 3) are more reliant on external funding in the form of grants than bigger Municipalities (Group 1). At the end of the financial year the above chart will indicate an even bigger portion funded externally as a large portion of internal funding will not take place due to poor cashflow situations.

As discussed above more and more Municipalities experience cashflow problems as a result of low payment levels. This situation results in Capital Development and other Statutory not being backed by cash. With the implementation of GAMAP all funds and reserves not represented by cash will have to be written back. Municipalities with no cash will remain reliant on external funding.

2.7 Surplus Generating Potential of Services

The general norms in respect of surpluses on services are 10% for water and 12% to 15% for electricity, which are regarded as trading services whilst refuse removal and sewerage as economical services are supposed to at least break even. Municipalities in general are operating their services at a surplus except for Refuse Removal Services, which are operated at a loss.

A matter of concern is that Municipalities are faced with challenges regarding water and electricity distribution losses as a result of theft, meter tampering or infrastructure that is not properly maintained. In this regard, the actual surpluses are below the norms, resulting in Municipalities forfeiting much needed income from these services.

Electricity distribution losses of 10% to 25% are common. In the case of a larger Municipality with an electricity income of approximately R80 million a 15% distribution loss will result in an income loss of approximately R12 million per annum.

Water distribution losses are even more worrying and distribution losses of 10% to 40% are common. In the case of a larger Municipality with a water income of approximately R20 million a 15% distribution loss will result in an income loss of R3 million per annum.

A matter of concern is that these Municipalities usually indicate a lack of funds as the main reason for not addressing distribution losses. However, if funding is made available to curb this problem, the cost could be recovered within a reasonable time from the savings. In addition, lower distribution losses will result in lower tariff increases or additional income.

Some Municipalities obtain water from natural resources and only have to spend small amounts on the purification thereof. A matter of concern is that some of these Municipalities lack determination to address distribution losses as the cost factor thereof are not as high as in the case where water are bought from a service provider such as a Water Board.

2.8 Indigent Support

In order to implement effective credit control measures it is of utmost importance that Municipalities at all times are aware of the status of individual consumers in respect of their indigent policy. In this regard it is disturbing to note how many Municipalities have not yet completed/ regularly updated their indigent register.

This situation results in outstanding debtors growing at an alarming rate whereas the correct and effective implementation of the indigent policy will result in indigent debtors being subsidised and able to access basic services without interruption through unnecessary cut offs. Subsidisation of indigent consumers through the Equitable Share Allocation will also result in Municipalities having to provide for reduced bad debt contributions.

Municipalities also have different methods to determine the monetary value of indigent support. In some cases subsidies are paid according to income levels on a sliding scale formula whilst in other cases the monthly amount paid to a state pensioner is used as a benchmark. Payments according to a sliding scale formula are normally used where the Municipality is not in a financial position to pay a full subsidy to all registered indigents.

    1. Bad Debt Provision
    2. It is common that some Municipalities average payment levels of 90% and more. These payment levels are normally achievable in Municipalities where the income base from industries and large businesses are greater than households. However, smaller Municipalities that do not have major industries or businesses are normally reliant on household consumers for 50% or more for their income. The payment levels in these Municipalities are on average 70% to 85%. Guidelines from National Treasury also requires Municipalities to provide at least an amount equal to their current payment levels for working capital.

      In analysing the above table it is a matter of concern that Group 3 Municipalities are not adequately providing for bad debt but rely on the Equitable Share Allocation to support their cashflow position. Although there is an attempt from Group 2 and 3 Municipalities to improve their current provisions, unfortunately these are insufficient and need to be doubled to compensate for current national payment levels.

       

      Outstanding debtors balances as a percentage of the operating budget remains constant for the majority of Municipalities. This is an indication that credit control has been effective to a certain extent or that indigent consumers have been registered and subsidies implemented. However, there are a number of Municipalities where the outstanding debtors are a matter for serious concern and where outstanding debtors balances is almost equal to one year’s operating income.

      The Equitable Share Allocation aims to assist Municipalities to provide free basic services to the poor. However, in order to optimise this grant it is essential that Municipalities register all possible indigents in terms of the Municipality’s Indigent Policy. This process still needs serious attention as too many Municipalities have not completed this process or updated their database on a regular basis. The result in certain cases is that Municipalities are utilising the Equitable Share Allocation to stabilise their cashflow position whilst outstanding debtors increase significantly on an annual basis.

      The lack of adequate provision for working capital/ bad debt results in some Municipalities having to review their approved budgets within the first quarter after approval to ensure that the budget is cash funded. This situation normally results in vacant positions not being filled, repairs and maintenance being scaled down or deferred and general expenses cut back significantly. As a result, the standard of service delivery is reduced and productivity of municipal employees declines.

      Poor cashflow in any Municipality results in fixed commitments such as debt servicing, lease agreements and payment of Council contributions falling into arrears. Capital projects become restricted to grants/ donations, as the Municipality is not in a position to fund projects internally through the Capital Development or other Statutory Funds that are not cash backed or by means of external loans. In addition, Municipalities should formalise their indigent registers and ensure that Credit Control Policies are strictly implemented to ensure financial stability.

    3. Influence of Equitable Share Allocations

The need to increase Equitable Share Allocations to assist Municipalities in the implementation of free basic services as well as to subsidise poor consumers cannot be over emphasised. The increase in Rand value for Group 1, 2 and 3 Local Municipalities from 2003/2004 to 2004/2005 amounts to 9%, 19% and 21% respectively. In small Municipalities the Equitable Share Allocation can represent as much as 50% of the total income budget. It is also important to note that the Equitable Share allocation will increase significantly over the next few financial years. This will result in all Municipalities being in a position to provide free/ subsidised basic services.

A matter of concern is that the Equitable Share Allocation in a number of Municipalities is still not fully utilised to provide free basic services but merely to provide for working capital or fund the bad debt reserve. It is therefore necessary that measures be implemented to ensure that this grant is utilised in accordance with the Division of Revenue Act.

3. CONCLUSION

Implementation of the Municipal Finance Management Act as well as the Budget Reforms (National Treasury) will necessitate a change in the way that Municipalities manage their current budget processes. Although Municipalities were exempted from the provisions of the Act for the 2004/2005 financial year a number of provisions must be implemented during the 2005/2006 financial year (see Annexure A for detail implementation dates).

The Act will be implemented over a period of time, taking into account the capacity of Municipalities to comply with the various sections. In this regard, Municipalities have been classified as high, medium or low level capacity. Implementation dates for the various sections according to capacity are attached to this report. Given the current constraints of a large number of Municipalities to comply with current timeframes, it is recommended that an analysis of Municipal capacity constraints be undertaken, to ensure their readiness to be able to comply with the Act.

Implementation Dates of the Municipal Finance Management Act

(Applicable to all Municipalities)

Section of the MFMA

Description

Implementation Date

62 (1) (f) (iv)

General Financial Management Functions

01/12/2004

71

Monthly Budget statements

01/12/2004

110

Application of Supply Chain Management (SCM)

01/12/2004

116

Contracts and Contract management (SCM)

01/12/2004

120

Conditions & process for public-private partnership

01/12/2004

9

Bank account details to be submitted to provincial treasuries and Auditor General

01/04/2005

38

Stopping of funds to municipalities

01/04/2005

39

Stopping of equitable share allocations to municipalities

01/04/2005

40

Stopping of other allocations to municipalities

01/04/2005

41

Monitoring of prices and payments for bulk resources

01/04/2005

42

Price increases of bulk resources for provision of municipal services

01/04/2005

5 (3), (4) and (8)

General Functions of National Treasury and provincial treasuries

01/07/2005

28

Municipal adjustment budget

01/07/2005

34 (3)

Capacity Building

01/07/2005

73

Reports on failure to adopt or implement budget-related and other policies

01/07/2005

91

Financial year of municipal entities

01/07/2005

123

Disclosure on intergovernmental and other allocations

01/07/2005

126

Submission and auditing of annual financial statements

01/07/2005

127

Submission and tabling of annual reports

01/07/2005

128

Compliance to be monitored

01/07/2005

129

Oversight reports on annual reports

01/07/2005

130

Council meeting open to public and certain public officials

01/07/2005

131

Issues raised by Auditor General in audit reports

01/07/2005

132

Submission to provincial legislatures

01/07/2005

133

Consequences of non-compliance with certain provisions

01/07/2005

134

Annual report to Parliament

01/07/2005

Chapter 13

Resolution of financial problems

01/07/2005

179

Repeal and amendment of legislation

01/07/2005

83

Competency levels of professional financial officials

01/07/2006

107

Competency levels of professional financial officials (Municipal entities)

01/07/2006

119

Competency levels of officials involved in municipal supply chain management

01/07/2006

45 (4) (a)

Short term debt

01/07/2008

Implementation Dates of the Municipal Finance Management Act

(Implementation dates vary according to capacity classification)

Section of MFMA

Description

High Capacity

Medium Capacity

Low Capacity

15 (b)

Appropriation of funds for expenditure

01/07/05

01/07/05

01/07/05

16 (2)

Tabling of Annual Budget by Mayor

01/07/05

01/07/05

01/07/05

17 (1) (a), (b) and (d) (i), (2) and (3) (a) and (c) to (m)

Contents of annual budgets and supporting documents

01/07/05

01/07/05

01/07/05

18

Funding of expenditure

01/07/05

01/07/05

01/07/05

21

Budget preparation process

01/07/05

01/07/05

01/07/05

22

Publication of annual budgets

01/07/05

01/07/05

01/07/05

23

Consultations on tabled budgets

01/07/05

01/07/05

01/07/05

24 (1), (2) (a), (b), (c) (i), (ii), (iv) and (v)

Approval of Annual Budgets

01/07/05

01/07/05

01/07/05

25 (1) and (2)

Failure to approve budget before start of budget year

01/07/05

01/07/05

01/07/05

31

Shifting of funds between multi-year appropriations

01/07/05

01/07/05

01/07/05

37 (2)

Promotion of co-operative government by municipalities

01/07/05

01/07/05

01/07/05

53 (1) (a), (b) and (c) (ii) and (2)

Budget Process and related matters (Mayor)

01/07/05

01/07/05

01/07/05

54 (1) (b), (c) and (d) (i) and (3)

Budgetary control and early identification of financial problems (Mayor)

01/07/05

01/07/06

01/07/07

62 (1) (c) and (f) (i) (ii) and (iii)

Gen. financial management func.

01/07/05

01/07/06

01/07/07

63 (2)

Asset & liability management

01/07/05

01/07/06

01/07/07

65 (2) (j)

Expenditure management

01/07/05

01/07/06

01/07/07

71 (1) (c), (d), (g) (i) (ii)

Monthly budget statements

01/07/05

01/07/06

01/07/07

72 (1) (a) (ii)

Mid-year budget and performance assessment

01/07/05

01/07/06

01/07/07

75

Information to be placed on websites of municipalities

01/07/05

01/07/06

01/07/07

80

Establishment of budget & treasury office

01/07/05

01/07/05

01/07/06

165

Internal audit unit

01/07/05

01/07/06

01/07/07

166

Audit committees

01/07/05

01/07/06

01/07/07

122 (3)

Preparation of financial statements (GRAP)

01/07/06

01/07/07

01/07/08

17 (1) (c) and (d) (ii) and (3) (b)

Contents of annual budgets and supporting documents

01/07/05

01/07/05

01/07/06

 

Section of MFMA

Description

High Capacity

Medium Capacity

Low Capacity

19

Capital Projects

 

01/07/05

01/07/06

24 (2) (c) (iii)

Approval of annual budgets

01/07/05

01/07/05

01/07/06

71 (1) (a), (b), (g) (iii), (2), (3) and (4)

Monthly budget statements

 

01/07/05

01/07/06

72 (1) (a) (i), (iii) and (iv) and (b), (2) and (3)

Mid-year budget and performance assessment

 

01/07/05

01/07/06

122 (2)

Preparation of financial statements

 

01/07/05

01/07/06

53 (1) (c) (ii) and (ii) and (3)

Budget processes & related matters

01/07/05

 

01/07/07

69 (3)

Budget implementation

01/07/05

 

01/07/07

111

Supply chain management policy (SCMP)

 

01/07/06

01/07/07

112

SCMP to comply with prescribed framework

 

01/07/06

01/07/07

115 (1) (a)

Implementation of system (SCMP)

 

01/07/06

01/07/07

116 (2) (c)

Contracts & contract management (SCMP)

 

01/07/06

01/07/07

121

Preparation & adoption of annual reports

 

01/07/06

01/07/07

After 30 June 2005 medium capacity municipalities are exempted from or in respect of section 17 (1) (c) and (d) (ii), 17 (3) (b), 19 and 24 (2) (c) (iii) insofar as those sections are applicable to their annual budgets for the 2005/2006 budget year.

After 30 June 2006 low capacity municipalities are exempted from or in respect of section 17 (1) (c) and (d) (ii), 17 (3) (b), 19 and 24 (2) (c) (iii) insofar as those sections are applicable to their annual budgets for the 2006/2007 budget year.

*********************************