The fundamental flaw in SA’s water financing model

The state of municipal water and sanitation services has become a central issue in South Africa. 

Driven by a steady decline in service delivery and reliability, the growing outcry from citizens underscores the severity of the ongoing crisis. In response to this deepening emergency, President Cyril Ramaphosa has declared a national crisis and established the National Water Crisis Committee.

The Green and Blue Drop assessment reports issued over the past few years by the Department of Water and Sanitation indicate that municipal water and sanitation services are in a critical or poor state of performance in 107 out of 144 municipal water services authorities, equivalent to 74%. 

A major root cause of this crisis, among others, is a fundamental flaw in the financial model for the water sector in South Africa: the model does not ensure that the resources intended for water services are used for that purpose. The absence of a statutory framework for ring-fencing water revenues results in the chronic underfunding of municipal water services.

The post-apartheid government adopted a financial model for the water sector that consisted of a combination of user-charges and a fiscal subsidy for providing a basic level of water services to the poor. The local government fiscal framework does not include conditional grants from the fiscus to municipalities to fund operational expenditure (such as maintenance, staff, electricity for pumping and water treatment chemicals) for water services. 

Water user charges

Municipalities are therefore expected to fund these operational costs from revenue generated through water user charges. The Norms and Standards for Water Tariffs issued by the Department of Water and Sanitation in terms of the Water Services Act guide municipalities to calculate their water tariffs based on detailed assessments of the efficient cost of supplying the service to the required norms and standards.

The fiscal subsidy was formally established under the Free Basic Services policy, which was adopted by the government in 2001. Section 227 of the Constitution states that local government is entitled to an equitable share of revenue raised nationally to enable it to provide basic services and perform the functions allocated to it. 

The cost of implementing the Free Basic Services policy per municipality is included in the calculations used by the National Treasury to determine the Local Government Equitable Share formula. However, while the formula takes account of the cost of providing free basic services, it does not identify a legally earmarked amount for this purpose. 

During the 2000’s several conditional infrastructure grants from the national government to municipalities were introduced, with the aim of helping municipalities eradicate historical infrastructure backlogs of a capital nature, and to subsidise capital project funding gaps for poor households. 

However, these grants do not replace the need for municipalities to use their own water revenue to invest in new infrastructure and to invest in the ongoing rehabilitation and renewal of their existing infrastructure. The grants only cover a fraction of the capital investment required. The fact that the grants are conditional means that they are fully ring-fenced for municipal water and sanitation infrastructure. 

Flaw

The financial model for the water sector has a defensible rationale, but the legal arrangements that have been put in place do not ensure that it works as intended. Firstly, the financial model assumes that revenues collected from user charges will be used to fund the cost of providing water and sanitation services. However, the Municipal Finance Management Act of 2003 did not legally require municipalities to ring-fence water revenues for water services. Municipal councils therefore can, and often do, vote for revenues from the sale of water to be allocated to other municipal functions.

This flaw undermines the purpose of calculating a cost-reflective water tariff. If revenue raised through such a tariff is allocated to other municipal functions, the water service will not be receiving the funding required to cover the efficient cost of providing it. 

An argument could be made that revenue from the sale of water is one of the few sources of revenue for municipalities, and that ring-fencing of this revenue for the water function would result in under-funding of other municipal functions. 

The counter-argument to this is that, if a municipality wishes to use water billing to raise additional revenue for other functions, it should do so through a transparent surcharge over and above the cost-reflective water tariff. 

If the water tariff reflects the full cost of efficiently providing the service to the required standard, as it should, then diverting any of that revenue to other functions would result in a deterioration of the water service. It is simply not possible for the government to meet its constitutional obligation to ensure that everyone has access to safe drinking water and an environment free of sewage pollution and simultaneously allow part of the revenue collected from cost-reflective water tariffs to be used to fund functions other than water services. 

Unconditional allocation

Secondly, the equitable share is an unconditional allocation to municipalities. Although the cost of providing free basic services is included when determining equitable share allocations per municipality, there is no legal requirement for those resources to be spent on water services. Municipalities can therefore allocate these resources to other functions. 

Municipalities with a high proportion of indigent residents rely heavily on the equitable share to fund their water services. Consequently, diverting these funds to other expenditures results in the severe underfunding of water services in such municipalities.

Inadequate maintenance funding has placed municipal water services in a downward spiral in most municipalities. Insufficient maintenance leads to more leaks and higher levels of non-revenue water, reducing the revenue available for maintenance and investment in water infrastructure. 

Furthermore, the lack of ring-fenced water revenues deters private capital, such as pension funds and commercial banks, from investing in municipal water services. Institutional investors inherently favour projects that offer secure, ring-fenced streams of income.

Increasing non-revenue water, combined with the lack of ring-fencing at municipal level, threatens the financial viability of the water sector. Municipal debt to the water boards is escalating – currently at R24-billion, excluding current invoices. The water boards do not receive any funding from the fiscus and non-payment by municipalities has already resulted in one water board going bankrupt and having to be closed. 

Some of the other water boards are under severe financial stress, are no longer able to borrow to invest in their infrastructure, and are unable to meet their payment obligations to the Department of Water and Sanitation for raw water. This in turn reduces the ability of the department to operate and maintain dams and other national water resource infrastructure. 

Direct threat to national water security

It also undermines the investability of new national water resource infrastructure projects, posing a direct threat to national water security.

In summary, there is a fundamental contradiction between the financial model of the water sector and the financial architecture of local government established in the Constitution and the Municipal Finance Management Act. The current legal framework does not ensure that the revenues and fiscal subsidies intended to fund water services are used for that purpose, with dire consequences for water service delivery. 

Two legislative reforms are urgently required: firstly, to mandate the ring-fencing of water service revenues for the water function; and secondly, to ensure that fiscal allocations intended for free basic water services are utilised for their intended purpose. DM