Standing Committee on Public Accounts Eskom Debt

1. Standing Committee on Public AccountsEskom Debt Presented by National Treasury: 11 May 2018

2. Content • Background : Reporting Framework • National Treasury engagements • Root causes of municipal failures • Resource allocations through DORA: LGES • Fact sheet - analysis of the 62 municipalities • Conclusion

3. Municipal Reporting Framework Section 71 of the Municipal Finance Management Act, 2003 (MFMA, Act No. 56 of 2003) • The s71 monthly reports provides for a list of creditors as well as the age analysis of the debt, the observation is that municipalities deliberately understate their creditors. • The formal benchmark engagements and the mid-year visit are other platforms in which this matter is raised and analytical support is provided to municipalities . • The annual publication of the State of Local Government Finances since 2009/10 has raised concern over the magnitude of debt showing that during the respective period debt far exceeded cash and investment for certain municipalities, with list of municipalities is financial distress growing Section 41 of the Municipal Finance Management Act, 2003 (MFMA, Act No. 56 of 2003) • Since 2012, reports indicated arrears to Eskom and Water Boards which continue to grow The 2015 position • Municipalities owed • Eskom in total R9 bn which consisted of R4.56 bn of current and R4.49 bn of arrear debt • Water boards in total R3.66 bn which consisted of R1.33 bn of current and R2.33 bn of arrear debt • Organs of state owed municipalities for rates and taxes and services rendered: • National Departments in total owed R1.51 bn of which R1.30 bn was for arrears • Provincial Departments in total owed R2.0 bn of which R1.85 bn was for arrears

4. National Treasury engagements • The equitable share allocation for 59 municipalities was delayed • National Treasury met affected municipalities on Eskom and Water Board • The objective was to understand why municipalities were not able to pay creditors on time and conform to the 30 day MFMA requirement - S65(2)(e) of the Municipal Finance Management Act, 2003 (MFMA, Act No. 56 of 2003) • To understand the root causes of municipalities failure to pay creditors and to assist them to deal with these problems so that they change their payment culture and do not find themselves in the same situation again • National Treasury was more concerned: • over the total creditors owed by the municipality which included the bulk suppliers (Eskom, DWS and water boards) which were observed to be the highest single creditors that municipalities owe • Of the impact on the financial health and sustainability of the bulk entities as a going concern at that stage e.g. BotsheloWater Board had to disestablished as the result of debt owed to it amongst other things • That non-payment to creditors which included SMME’s threatened the existence of these small businesses and contradicted the NDP goal to foster more job opportunities • To assist municipalities put in place in agreement with Eskom and water boards affordable payment plan, while taking measures to address systemic problems in the billing and collection of revenue

5. General observations from the engagements The following general observations relate to the municipalities’ failure to pay their creditors which have emerged from the engagements between these municipalities and National Treasury: • Poor leadership and weak financial management led to mismanagement of finances which in turn allowed the debt to escalate; • Poor financial and revenue management practices • Weak tariff setting ability - tariffs being set that are not fully cost reflective; • Payments due creditors far exceed revenue collected; • High levels of water and electricity losses which have reduced municipalities revenues dramatically; • High operating costs and in particular, above normal staff costs; • Past repayment arrangement were not affordable and realistic (not cash backed) and in many cases were signed merely for compliance; and • Municipalities are found to be over stating the debtors figures and under stating their creditors figures. This exercise also revealed that the creditors amounts far exceed the equitable tranche due. • Weak or absence of SLA’s between municipalities • and their bulk services providers (Eskom and Water boards); and • and district municipalities as well as weak institutional arrangements between them. • Municipalities not holding electricity distribution licenses in their service areas raised concerns about challenges to implement credit controls which has negative consequences for revenue collection.

6. What are the root causes Municipalities are autonomous and Councils are the ultimately responsible and accountable Weak political leadership and accountability • This led to weakmunicipal leadership, including ineffective councils and governance structures that contributed to weak fiscal discipline (tabling unfunded budgets); and no consequences of financial mismanagement, political/ administrative instability and conflicting relationships, bloated organizational structures“not fit for purpose” • Notably accountability is weaker at municipalities where there is an “acting” incumbent as an municipal manager is less inclined to take decisions • The abscence of suitably competent CFOs – is a risk to sound financial management, non-compliance to the legal framework and general mismanagement of public funds The impact of this contributed to poor financial management • These span from poor implementation of financial management principles to weak budgeting capabilities, unacceptably low collection levels, ineffective budget planning and implementation, inadequate allocation for repairs and maintenance and asset management, weak internal controls and risk management and supply chain management challenges This was confirmed by the 2015/16 AG’s findings • Calls for leadership accountability in management of municipal affairs, starting with appropriate planning focused on the needs of citizens • Respect for the law in the running of municipalities, monitoring by all political and administrative leadership • And that there must be consequences for mismanagement and non-performance • In 2015/16, vacancies in the positions of MM, CFO and head of the SCM unit increased – of which CFO vacancies are most notably (vacancies at 27% of municipalities)

7. Municipalities complained of being under funded through the LGES: • The Local Government Fiscal Framework is premised on the understanding that there are economic inequalities across the country - certain municipalities have less own revenue raising potential • The local government equitable share is designed to fill the fiscal gap, enabling the local government sphere “to provide basic services and perform the functions allocated to it” in terms of section 227(1)(a) of the Constitution, taking into account “the fiscal capacity” and “developmental and other needs” of municipalities • LG share of DOR increased from 3% in 2000/01 to the current 9% • Municipalities are expected to fund basic services and functions like the provision of water, electricity, refuse removal, fire-fighting and emergency services from their own revenue taken together with the equitable share and related allocations • The LGES formula allocates additional funding to municipalities with limited revenue raising capacity to subsidise administration costs, community services, and also receive allocation for special support for councillors salaries and ward committees. • Municipalities are expected to use the equitable share to subsidise or fund the provision of municipal services to poor households: The equitable share: • cannot fund municipalities for lack of revenue raising efforts • does not accommodate operational inefficiencies and financial mismanagement

8. Redistribution to poorer resourced municipalities achieved through the Division of Revenue • The DOR achieves a substantial redistribution of revenues raised through taxes in relatively wealthy (mainly urban) areas to areas where the demand for subsidised public services are the highest • As a result, the most rural municipalities receive twice the allocation per household than metros (although 70% of tax revenue is raised in metros) Per household allocations to municipalities

9. Impact of the new equitable share formula New formula - Allocation per poor household Old formula - Allocation per poor household • Lack of strategic prioritisation of additional resources by rural and small municipalities has nullified the impact of the new redistributive new LGES formula implemented in 2012/13 • There is a direct trade-off between personnel spending and other expenditures related to the delivery of services • In 2011/12, employee costs as a percentage of total operating expenditure was 27.8 per cent for local municipalities. This has increased to 33 per cent by the end of 2015/16 • The increase in allocations to rural municipalities has increased employee costs and did not result in higher service delivery expenditure • This trend should be reversed

10. How the local government equitable share formula allocates funds How the local government equitable share formula works • Allocated through a formula to ensure fairness for all 257 municipalities • The formula is updated annually • The formula is fully funded to account for House Hold growth and bulk cost increases over the MTEF • Unconditional transfer means that municipalities are accountable for ensuring free basic services are provided to their residents Free basic services R45.1 billion R383 per month for a package of free basic services for the 59% of SA households with an income of less than 2 old age pensions per month These funds are only allocated to poorer municipalities Institutional R4.7 billion to assist with administration costs Community Services R7 billion to fund community services

11. Fact sheet – Finances for the 62 defaulting municipalities (17/18) • 60 of 62 municipalities adopted unfunded budgets suggesting that cash and cash equivalents does not cover all the commitments for that year • Most of the municipalities presented operating deficits suggesting that operating expenditure (incl dep. and debt imp) is more than the operating revenue • A major part of the operating expenditure is employee related costs (bloated structures largely with general workers), in some municipalities this cost is more than the revenue that they generate • Creditor amounts are much more than the cash available and in many cases municipalities did not budget for payment arrangements • The amounts owed by organs of state is minor compared to the amounts owed by municipalities to creditors (R1 bn owed by organs of state compared to R14 bn owed to creditors), however, the principle of the matter is that this money should not be outstanding • Many of these municipalities are being subsidised for the poor through the LGES much more than the indigent registers that these municipalities present eg. Naledi (NW) is subsidised for 12 783 HH through the LGES and caters for 5 900 HH through the budget • Water and electricity loses are extremely high and in some cases half of the purchased quantity are lost • (Total) Unauthorised (R13 bn), Irregular (R28 bn) Fruitless and Wasteful (R1.5 bn) exp is extremely high • 6 municipalities of this list invested with VBS (Dr Ruth Segomotsi Mompati DM, Madibeng LM, Mafikeng LM, Merafong LM, Vhembe DM and Westrand DM) • Collections rates for almost all municipalities were overstated when compiling their budgets • 36 municipalities have employee related costs more than 40% of the own revenue with 9 above 80% and 6 above 90% (Edumbe LM, Phumelela LM, Renosterberg LM, Tokologo, Tswaing L;M and Zululand DM)

12. What else have we done to address the challenges in Local Government ….. • Developed and implemented • a budgeting system for LG - including institutionalising the budget benchmark and mid-year performance engagements for municipalities • During the benchmark municipalities with unfunded budget are required to revise their budgets, but often council adopts the budget knowing its unfunded • a LG reporting system – including the establishment of the LG Database which provides for an ‘early warning system’ S71 reports • Routine publication of municipal performance in terms of the legal framework • Introduced province specific strategies in 2015 led by Provincial Treasuries to address LG finance performance failures with more given to revenue management supported by MFIP advisors – a key ingredient for funded budgets • Coordination sessions with Provinces, DCOG, SALGA to engage on follow up actions. • Municipal Financial Recovery Service which support municipalities to prepare financial recovery plans – only effective where council is committed to implementing corrective measures

13. Conclusions • Many distressed or dysfunctional municipalities are often those that have adopted unfunded budgets and lack effective internal controls, have poor cash flow management and struggle with operational inefficiencies • Institutions must be permitted to implement their credit control initiatives as this is sound business practice and the only leverage that they have at their disposal to collect outstanding revenue • A concerted effort must be made by municipalities to reduce losses on water and electricity and improve inefficiencies is their systems to maximise revenue • Delays in implementation of the Financial Recovery Plan often lead to further weaknesses in Governance, Service Delivery and crisis in financial management in municipalities. • To enhance oversight, regular reports to Mayors, Councils, Provincial Executives, Provincial Legislatures, National Executives and National Legislature. • Such feedback is also provided by Mayors of affected municipalities to National Assembly Committees - (Finance, Cooperative Governance, SCOPA)

14. Thank you

15. Annexure

16. Analysis of the 62 municipalities for the IMTT in 2017 (detail in the Annexure “Critical Indicators” attached) • Collections rates for almost all municipalities were overstated when compiling their budgets • Most municipalities present an operational deficit (expenditure exceeded revenue) • 37 municipalities present a cash deficit after commitments are considered • All these municipalities adopted unfunded budgets • 21 municipalities are not honouring their payment arrangement – Eskom • 10 municipalities are honouring their payment arrangement • 6 are partially honouring • Most of these municipalities contribute to capital programme even though they projected cash deficits • 19 municipalities present a surplus after commitments are considered • All these municipalities adopted unfunded budgets accept two • 8 municipalities are not honouring their payment arrangement – Eskom • 8 municipalities are honouring their payment arrangement • 3 are partially honouring • some of these municipalities contribute to capital programme • The analysis could not be undertaken in 6 municipalities due to incomplete documents • Total creditors is R14 billion and R1 billion (s71 Q4 prelim) is owed to these municipalities by organs of state • 17 of these municipalities reported no debt by organs of state • None of these municipalities are owed by organs of state more than what they owe creditors • 36 municipalities have employee related costs more than 40% of the own revenue with 9 above 80% and 6 above 90% (Edumbe LM, Phumelela LM, Renosterberg LM, Tokologo, Tswaing L;M and Zululand DM).