Adopting appropriate service delivery instruments to fulfil local government development objectives
Barry M Jackson
CEng, MA(Oxon), MICE, MWISA
Principal Policy Analyst
Development Bank of Southern Africa
Most of today’s municipal councils are concerned with redressing the inequities of the past in terms of infrastructure services. This must be done through extensive infrastructure investment programmes, while at the same time ensuring the continued financial viability of the service to be funded. Common to all forms of service provision and finance, there is a need to undertake realistic long term planning and to carry out both investment and ongoing operations as efficiently as possible. There are many ways in which the private sector can contribute toward funding and operating services. The Municipal Infrastructure Investment Unit has been set up to provide partial grants for advisory services to enable municipalities to adopt the most appropriate service delivery option for each of its municipal services.
3rd Annual Local Government Symposium
23-24 June 1998
Throughout South Africa municipal councils are committed to redressing the inequities of the past, which are frequently characterised by glaring discrepancies in the levels of service provided for different segments of the same community. Using water supply and sanitation as an example, estimates vary, but if we assume that about 50% of South Africa’s population is urban, then 18% of them (4 million) have only a minimal water supply, or none at all. The equivalent figure for lack of urban sanitation is 22%. In rural areas, it is estimated that 40 - 60% of the population (8 - 12 million) do not have an adequate water supply service (in South Africa, this is defined as a reliable 25 litres/capita/day within 200 metres walking distance).
It is estimated that between 50 and 80 billion Rands are needed over the next ten years to eliminate the backlogs in services in the urban areas, depending on the level of service provided. The combining of "black" and "white" local authorities means that operating surpluses no longer exist, that cash reserves are being swiftly gobbled up and that capital expenditure must be externally financed. This will be through a mix of government grants (sufficient to achieve a basic level of service), concessionary finance from the DBSA and loans from the local capital market.
Government is currently looking at ways of enhancing credit arrangements in order to enlarge the flows of private sector finance to municipal infrastructure (see White Paper on Local Government). However, to borrow funds on the open market a service supplier will need to demonstrate its capacity to use scarce resources efficiently, and to repay the loan, which is not easy under present circumstances. This will probably require many local authorities to review their current ways of operating, and to explore alternative arrangements for providing public services. Government (Departments of Finance and Constitutional Development) and the DBSA have co-operated in setting up the Municipal Infrastructure Investment Unit Company with the aim of assisting municipalities to access the various ways in which the private sector can get involved through the provision of advice, expertise and finance.
LOCAL GOVERNMENT DEVELOPMENT OBJECTIVES
The extension of municipal services to the under-served parts of the population is understandably a number one priority, but the political imperative to do this must not push aside other equally important objectives such as the encouragement of economic opportunities and the support of economic growth.
The extension of services, and the proper operation and maintenance of those services, consume considerable resources and must be carried out in a financially sustainable manner. Grants may be available for some capital expenditure but loans will need to be raised for the rest. However the capital is raised, there must be sufficient recurrent income to cover operations and maintenance, otherwise services will deteriorate or fail, and investments may be wasted. Municipalities should be judged not only on the construction of new facilities, but particularly on their ability to continuously provide a good service with those facilities.
PLANNING FOR SUSTAINABLE SERVICE PROVISION
By now it should be clear to decision-makers that service provision is not just a matter of building engineering-type infrastructure, but is also about operating and maintaining it. In other words, service provision should be a sustainable process. This is recognised in the latest proposals from DCD that municipalities should prepare Integrated Development Plans as part of their budgeting process. This is not solely about physical development plans, indeed they should avoid undue detail in land-use matters, but about checking the long term financial implications of proposals to ensure that they are affordable to individual consumers and the entire municipal tax base.
The DBSA has developed tools to assist with long term infrastructure investment planning and, with the Department of Constitutional Development, is preparing a guideline on how to include this in the IDP process. A common feature of good infrastructure investment planning is the use of some form of financial modelling using computer spreadsheets of varying complexity. One such tool is the Combined Services Model: a computer-based financial model which allows users to make ten-year projections of their investment needs and to test the ongoing financial viability of the municipality in terms of borrowing needs and the tariff increases required to service those loans and to operate and maintain the resulting infrastructure. The CSM can be used inter-actively by engineers, treasurers and councillors, working together, in order to test various scenarios (adjusting many variables, but the most important being levels of service and tariff increases) and arrive at a realistic, sustainable investment programme, which is also politically "sellable". If the municipality is committed to stay within the parameters that are indicated by such a modelling exercise, it will be much easier to raise finance from whatever source.
Such planning is essential wherever a municipality is seeking substantial development finance. Recent experience has highlighted the need for a council to know the kind of investments and subsequent tariff increases that are indicated, and to make some of the difficult decisions beforehand. Many consumers may have got into the habit of demanding full services without understanding the costs involved, particularly the running costs, but with improved planning and good communication with consumers (or better still: with customers) realistic, sustainable service provision can be achieved.
There is growing evidence that over-investment in services which are generally not affordable can actually retard the economic growth that is so vital to the towns and cities of South Africa. Investment decisions may require certain compromises for the benefit of all. This could be a political balancing act which includes a basic level of service for some, and high tariffs for others. The basic level of service, with low running costs, should aim to reach all consumers as soon as possible, while encouraging further upgrading at a consumer’s expense. Other consumers should be required to pay cost-reflective tariffs to ensure that services are adequately maintained, and transparent cross-subsidies should be carefully explained to those most likely to bear them. Finally, it is imperative that all services are operated as efficiently as possible, using the best mix of public and private sector expertise. Such efficiency must include the optimal use of scarce resources (especially skilled manpower), the raising of capital (both grant and loan finance), matching the level and quality of services with customers’ affordability and willingness-to-pay, and effective cost recovery mechanisms. In all these issues, the private sector has something to offer.
EFFICIENT SERVICE PROVISION
The current pressures on local authorities demand a fresh look at how things are done. It can no longer be assumed that all activities will be handled by experienced, motivated municipal employees. Where competent capacity does exist, it should be well cared for, but it might also need some retraining to meet new challenges. In order to raise finance today it will be necessary to demonstrate that investment plans have been carefully thought through and that the agency responsible for the service is capable of running the service effectively, able to recover its costs and able to repay its debts. Municipalities, as a very least first step, should be looking to set up their "trading services" as self-accounting units (also known as ring-fencing) where management is responsible not only for expenditure but also for income - which should lead them to become more concerned with customer management: focussing on providing a service which customers are able and willing to pay for. A more comprehensive step may be to delegate increased autonomy to the management of the utility, enabling them to run the service as a semi-autonomous "corporation" (also know as corporatisation).
It is probable that much more of the local authority’s service provision may need to be "out-sourced." There are many examples of this, ranging from meter-reading and drain-cleaning through to long term investment-linked concessions for infrastructure provision such as water supplies and wastewater treatment. Each municipality will have its own set of needs and resources. But this is not static. All aspects of service provision should be regularly reviewed, perhaps annually, to see if a particular activity could be better and more efficiently performed by a private sector contractor. Another consideration is the potential for supporting emerging contractors and suppliers through small scale contracts for services. Such businesses commonly employ labour rather than machines, and they could contribute to lowering unemployment in the area. At all times, a municipal utility should aim to employ the best mix of public and private sector capacity in order to provide its customers with the best service at the right price, and to demonstrate a high degree of creditworthiness to potential financiers.
Where more comprehensive restructuring is indicated, in addition to the extensive use of out-sourcing work through service contracts, there is a range of options for involving the private sector. These include management contracts (lasting anything from 2 to 20 years, but typically about 5 years), renting or leasing of assets (also known by the French term "Affermage") (lasting between 10 and 20 years), and investment-linked contracts or concessions. There are many variants of concessions: BOT (Build, Operate, Transfer), BOO (Build, Own, Operate) and BOOT (Build, Own, Operate, Transfer). Each has its strengths and is appropriate in different circumstances. They may last from 15 to 30 years or more, depending on the amount of capital investment involved. Outright privatisation of some less central municipal activities may well be considered, but full privatisation (complete private ownership) of core services such as water supply and sanitation is not under serious consideration in South Africa at present.
LOOKING AT THE OPTIONS – the role of the MIIU
There is a need for good, reliable advice available to municipalities contemplating the different ways of raising finance and structuring service delivery. To this end Government has set up a grant / advance finance facility (the MIIU) to support the engagement of private sector advisers by municipalities. The MIIU is a section 21 company with an independent board representing central and local governments, and the private sector.
The long term aim of the MIIU is to develop a mature market for such financial, technical and legal advice by way of helping municipalities (giving them hands-on experience) to engage advisers, and by exercising oversight of the quality of advice given. (See Appendix 1.) This will be achieved through a fund for the provision of advice and maintaining a database of suitably qualified consultants. The fund would support, in whole or in part, the employment of consultants to assist a municipality in preparing and closing a "deal", be it a straightforward financing arrangement or a more complex delegation of a service to a private sector company.
The exact operating procedures for the MIIU are now being firmed up. One principle will be that a municipality will be expected to make a financial contribution towards the cost of advisory services. Indeed, as the likelihood of a firm deal emerges, arrangements can be made for including the full costs of project preparation in the deal. This is sometimes known as a "success fee". Another principle of MIIU support will be that it is demand-led. Municipalities must demonstrate their willingness to drive the necessary processes, which are both technical and political. Municipalities will be encouraged to undertake some form of in-house investigation of their own situation, along the lines proposed by the Department of Constitutional Development in their "Guidelines for Private Sector Participation in Municipal Service Delivery". (See Appendix 2.)
The MIIU will also expect a municipality to carry out an approximate "notional ring-fencing exercise" for whichever services are being considered for financial support and/or restructuring. Such an exercise is intended to present the financial situation of a utility service as if it were an entirely self-supporting, separate accounting unit or semi-autonomous corporation. (See Appendix 3.) This would be a pre-requisite for just about any organisation that might be asked to provide finance. Furthermore, the preparation of a set of notional accounts could be an immediate stimulus for both councillors and officials to look critically at their operations, with or without external assistance. With the results of such an exercise, the MIIU would be able to help a municipality to structure and finance a study into the potential options for private sector involvement.
It is worth noting here that an increasing number of municipalities seeking private sector finance are likely to find themselves in a similar position to the Greater Johannesburg Metropolitan Council - unable to borrow at reasonable rates because of a poor cash flow and uncertain future prospects. Municipalities with similar problems could well expect that future grants and loans could be conditional on some structural changes, in order to enhance the creditworthiness of the prospective borrower. In Johannesburg’s case the 12-point plan is set of reform steps that were deemed to be necessary to correct both present short term problems and to ensure a more stable future. (See Appendix 4.) The conditions of the recent DBSA loan were linked to the achievement of certain actions in the 12-point plan, thus providing an appropriate incentive to making the necessary changes. For some municipalities, the longer that changes are put off, the more painful they will be.
Despite numerous borrowings from the work of others, the views expressed here are the author’s and are not necessarily those of his employer.
South Africa has made a good start in moving towards more PSP in the water and sanitation sector. We need to continually learn from local and international experience in order to ensure that we are always doing the best for South African consumers.
Despite numerous borrowings from the work of others, the views expressed here are the author’s and are not necessarily those of his employer.
Investment Unit Company
To encourage and optimise private sector investment in core local authority services, on a basis that is sustainable for both local authorities and at a national level.
To assist the development of an established market containing informed local authority clients, private sector advisers, and private sector investors and service providers, so that the MIIU can be wound up no later than five years after the date of its original establishment.
MANDATE AND SCOPE OF ACTIVITIES
The MIIU is conceived as a five year intervention to develop a market for technical assistance for project preparation in the sphere of municipal infrastructure and services. Its scope of activities will include:
Provision of grant funding to local authorities to hire expertise for project preparation assistance from the private sector (up to the Request For Proposals, evaluation, negotiation, or initial implementation stages).
Assistance to local authorities in the process of hiring private sector consultants, where necessary.
Assistance to local authorities with the management of contracts with the private sector, where necessary.
Marketing and publicity of the MIIU’s services.
These activities will be undertaken with local authorities that are developing project proposals involving private sector investment. The investments can take any of a broad range of forms, including, but not exclusively:
Private sector financing of municipal debt.
Contracting out of the management of ongoing services.
Concessions to operate the local authority’s assets over a defined period.
Contracts requiring the private sector to Design, Build, Finance and Operate assets to deliver services for the local authority.
Privatisation of assets and services.
Data gathering and preliminary assessment
As a first step, municipalities in the process of determining how best to improve service provision and to meet their objectives should perform a preliminary assessment of current infrastructure service delivery. An internal task team should gather data on the full current costs of service delivery, determine the unit cost, and compare this to the current tariff(s). Complaints received from customers over the last six months to a year should be discussed and evaluated. The level of coverage should also be assessed, along with future service needs for rehabilitation, extensions, and the level of investment to achieve this.
The preliminary in-house analysis should stimulate discussion on improvements that could be made to the service to achieve efficiency gains and cost savings as well as improved levels and standards of service. The current state of the system should be compared to the municipality’s objectives. If it is determined that simple changes to the current system will not be sufficient to achieve these goals, and that restructuring the public provider or engaging the private sector is needed, the next step should be to create a Review Team.
(Source: "Guidelines for Private Sector Participation in Municipal Service Delivery" Department of Constitutional Development, 1997.)
OUTLINE OF A NOTIONAL RING-FENCING EXERCISE
This exercise is intended to inform decision-making at different stages of an investigation. It will therefore need different levels of accuracy depending on the decisions being made. In the first stage of an investigation it can be very approximate. Actual figures should be used where available, but intelligent estimates may be used to achieve, say a ten (or even twenty) per cent accuracy. The intention is to begin to understand the big picture and identify items which will need extra effort to obtain for the next phase of the investigation. Please include notes on available sources of information. The report on this exercise can be prepared using the headings below.
Present recurrent costs (for last financial year) to be included
All direct labour costs
All indirect labour costs (leave, medical aid, insurance, pension, etc)
All staff costs (and indirect)
Proportion of shared technical staff costs
Proportion of shared administration (including part of town clerk’s time) and accounts (part of treasurer’s time) staff costs
Overheads such as an estimate of rental for office space, heating, lighting and water (use local commercial figures)
Staff perks such as a subsidised canteen, transport, etc
Vehicle and plant costs
Fuel, chemicals, maintenance contracts, protective clothing, etc
Present capital costs
Cost of servicing existing loans for this service (even if part of a consolidated loan account - make an estimate)
Total costs & total income
From the costs above, it should be possible to calculate the average cost per customer or per unit output (for the previous financial year), in order to compare with income figures
Total amount billed in last financial year
Total amount actually collected in last financial year
Average income per customer or per unit
Present tariffs in force, and any expected changes
Demography and coverage
Total population and numbers of households
Population or households served at each level of service
Estimated income distribution of population
Future investment needs (over next five years)
Estimate future capital investment needs to redress current backlogs
Brief assessment of the condition of existing infrastructure and an estimate of possible rehabilitation costs
Estimate of the likely amount of grant finance which could reasonably be expected
Future capital grants and loans secured
Estimated borrowing requirements for capital expenditure and estimate of loan service charges (at commercial rates).
Is there any analysis of customer complaints or statistics to illustrate the current achievements or failures of the service?
Has the municipality set objectives for this service?
Summary of instructions to GJMC.
Set up a committee of councillors.
Appoint a four-person technical task team:
headed by an expert in municipal finance
with persons experienced in institutional, operating and capital budget restructuring.
Revise operating budgets to provide a working capital reserve sufficient to finance the anticipated shortfall in payment of rates and service charges in the current financial year.
Revise the current capital budgets to provide for already committed projects only.
Formulate credit control policies and practices to enable collection/recovery of outstanding debts within the operating budget cycle.
Determine which parts of capital programmes can be converted into long term loans.
Determine a financing plan for this year’s committed capital budgets.
Examine existing information systems for compatibility and make proposals on upgrading.
Introduce, within six months, cost reflective tariffs in accordance with prudent accounting practices.
Analyse all existing functions with a view to reducing operating costs.
Introduce mechanisms for an effective, economical and more efficient performance of functions.
Identify core functions that need to be performed by Local Government including those that will generate income/profit, and those that can be outsourced.
"In the event of the Committee failing to comply with any of the above instructions within the indicated time frames, I reserve the right to take such steps, or cause such steps to be taken, in terms of section 10G)2)(m)(iii) of the Local Government Transition Act, 1993, that I may deem necessary to restore the finances of the GJMC and the Substructures to a sound footing, irrespective of whether any instruction is still to be complied with within the time frame indicated in respect thereof."
MEC for Development Planning and Local Government.