Categories ofMunicipalities,FY 2003/04

Local Government Organization and Finance: South Africa 81

TABLE 2.8 Distribution ofNational Direct Transfers to Categories of Municipalities, FY 2003/04

Percentage distribution by capital Percentage Percentage grants Percentage distribution distribution (including distribution ofequitable ofrecurrent water Category oftotal transfers share grants capital)

A (metro) 16.9 20.0 1 16.1 B (local) 43.5 63.4 87 15.5 C (district) 39.7 16.6 12 68.4 Total 100.0 100.0 100 100.0

Source: Division ofRevenue Act 2003; Whelan 2003b. Note: Totals may not add to 100 because ofrounding.

is not hierarchically subject to national and provincial government.More specifically,the constitution allows municipalities to borrow,within a regulatory environment provided by the national government.The MFMA forms the core ofthis regulatory environment.However,sparked by its intentions with the MFMA,the government amended the constitution in 2003 to allow municipal councils to bind themselves and future councils in pledging security for debt and to enable government to intervene—through provincial executives at first,but ifthat approach fails,then directly—ifa municipality fails to meet its obligation.The MFMA also allows for the establishment of an agency that governs recovery plans for such municipalities.

In reality,private sector lending to municipalities has remained subdued and has focused on short-term lending.Very little investment occurs in the long-term debt market—the pivotal area from which funding for infrastructure investment is supposed to be forthcoming.Almost halfofthe short- and long-term lending since 1997 has been provided by the Infrastructure Finance Corporation (INCA),a specialized municipal lending agency attached to one ofthe major commercial banks.The other halfhas come mainly from the Development Bank ofSouthern Africa (DBSA),a public sector financial intermediary supposedly targeted to the more risky market but in reality doing a substantial portion ofits long-term lending in the more overtly commercially viable market.This scenario indicates the lackluster interest on the part offinancial institutions at large to become involved in a market affected by considerable fiscal stress.Nonetheless,by 2004 private sector credit stood at R 12 billion,or 60 percent ofmunicipal borrowing.

82 Chris Heymans

Commercial banks and INCA accounted for 79 percent ofthe private sector market.Insurance and pension funds,which used to account for 35.3 percent ofprivate sector lending to municipalities in 1997,now account for a mere 2.5 percent ofprivate sector lending.The absence oftradable municipal securities poses a challenge to the development ofa municipal bond market, although Johannesburg’s issue in 2004 ofa 12-year bond (supported by a partial guarantee from the International Finance Corporation) was a remarkable success,and the issue was significantly oversubscribed.

In principle,the government’s policy stance is that all municipalities should have equal borrowing powers,because formal differentiation would be too complex and overregulated.The government would prefer that potential lenders decide whether to venture into lending.In practice,however,all municipalities are not equally attractive to lenders;the government has therefore tailored its capacity-building support around a conceptual differentiation between three risk categories ofmunicipalities with different levels ofreadiness to borrow.

The first risk category does not require external assistance to achieve access to the bond market or to obtain commercial loans.This category is still relatively small.The second risk category is unlikely to attract private capital investment now or in the near future.These municipalities’constraints are structural;therefore,they will likely continue to depend to a great degree on intergovernmental transfers.The third risk category is perhaps ofgreatest interest from a reform point ofview:local governments that could—with some adjustment—be made ready to access the bond market or at least obtain loans.In theory,this category typically forms the clientele ofthe Development Bank ofSouthern Africa (DBSA) (as the primary concessionary institution supporting municipal investments in infrastructure).However,the DBSA has not been lending extensively in this market, and the fact that it had not been receiving any new fiscal support since the mid-1990s has led it to adopt a risk profile perhaps lower than that assumed by its ostensibly facilitative role.Recently,the National Treasury has indicated that it wants the DBSA and other development finance institutions to adopt higher-risk profiles,and the DBSA is believed to be doing some modeling to scope its leeway in municipallending to this end.

The relevance ofsuch differentiation is demonstrated by the findings ofa National Treasury survey in 2002/03 ofmunicipalities participating in the FMG pilots.It found that more than 70 percent oftotal municipal borrowing occurred in 39 municipalities.This aggregate disguises the fact that the bulk ofthat borrowing has actually been made by the six metros,which have accounted for 93.4 percent ofall borrowing.Category B municipalities have