A preliminary investigation into the relationship between municipal debt and the financial viability of waterboards in South Africa

The water sector in South Africa is made up of many role-players, which, among others, include the Department of Water and Sanitation (DWS), waterboards, municipalities, and catchment management agencies. Each of these role-players plays a critical role in the water and sanitation value chain following what can be described as a systems management theory. Enquist & Ziervogel (2019) reported that the DWS is responsible for regulation, the waterboards are bulk water providers, and municipalities are responsible for water service provision. In recent times, the fortitude of the water and sanitation value chain has been put to the test as high municipal debt threatens to weaken the financial viability of the waterboards in South Africa (Tony 2021; DWS 2022). In the 2021 fiscal year, the municipal debt was estimated to be R14 billion (DWS 2022). The precarity imposed on waterboards by municipalities in South Africa, if unabated, may lead to the collapse of the entire water and sanitation value chain. It is mind-boggling to establish what attributed to such a staggering municipal debt figure of R14 billion, especially when one considers the catalytic nature of water to socioeconomic development in a developing country like South Africa. Municipalities accumulated this debt over time, despite their vulnerabilities being monitored regularly for more than 10 years using the Municipal Strategic Self-Assessment (MuSSA) programme. The MuSSA tool is used to monitor the vulnerability of municipalities using a composite vulnerability index (VI) computed from 16 business health attributes related to the provision of water and sanitation services. Of the 16 key attributes used in the composition of the VI, revenue collection, financial management, and financial asset management are directly linked to the going concern status of any municipality. There are remedial actions stipulated in the MuSSA report that municipalities are expected to implement as part of municipal priority action plans (MPAP). Kleynhans & Coetzee (2019) reported that most municipalities do not appear to have taken all necessary corrective procedures; furthermore, financially perturbed municipalities frequently fail to meet their financial commitments of paying waterboards for bulk water supplied. For instance, Sedibeng Water, which supplied bulk water to mostly financially vulnerable municipalities, was disestablished by the DWS for going bankrupt (DWS 2022).

It is not established as to how the MuSSA status of municipalities relates to the financial health (FH) or performance of waterboards. There are currently no published studies that investigated the relationship between the vulnerability of municipalities in South Africa and the financial viability of waterboards. A study conducted by Mulenga (2017) pointed out that the failure of municipalities to collect revenue is a high risk to service delivery in the local government sphere. According to Kleynhans & Coetzee (2019), the high proportion of unemployed individuals in relation to the overall population contributed to the poor financial status of municipalities in KwaZulu Natal. High unemployment and social grant dependency juxtaposed with financial mismanagement in the Sundays River Valley municipality in the Eastern Cape caused the failure of the municipality to provide water and sanitation services (Holmes et al. 2015). Shava (2020) argues that when households fail to pay municipal rates, the municipalities' capacity to provide reliable water and sanitation services is weakened. These studies provide anecdotes on how municipalities' capacity is negatively impacted due to non-payment of services by households. However, the studies are silent on how the non-payment by communities has ramifications on waterboards' financial viability. Benchmarking with other developing countries such as Brazil and India, which are members of the Brazil, Russia, India, China, and South Africa grouping, there is convergence from these countries on the fact that it is difficult to collect revenue from rural households (Gomes et al. 2013; Machado et al. 2019).

According to the World Bank (2017), countries that perform well in revenue management at the local level are those with a flexible approach that takes the different economic classes of households into account. This approach results in a differentiation regarding communities' contribution to payments of water and sanitation services and further assists in reducing the backlog on the provision of water and sanitation services to rural communities while ensuring that urban communities do not feel the brunt of paying exorbitant rates and taxes. Several authors in the literature have previously reported on the subject over the years. For example, Gomes et al. (2013) reported that larger municipalities in Brazil are likely to manage revenue better than small municipalities. This can be attributed to the former being able to collect sufficient revenue, resulting in better profit margins that can be used to attract the best talents that bolster the capacity of their human capital. Machado et al. (2019) reported that the establishment of adequate tariff schemes in Brazil is one of the essential aspects required to ensure the sustainability of rural water supply services. Loubser et al. (2021) argued that dispersed settlements in rural areas in South Africa are one of the reasons why assurance of water supply in rural communities is less than in urban communities.

In South Africa, households expect high-quality water services as water is a human right, which is enshrined by the constitution. However, Loubser et al. (2021) reported that most people in South Africa experience intermittent water supply. This is due to poor water services provision as a result of failing governance, financial mismanagement, and high municipal debt (Toxopeüs 2019). Ngobeni & Breitenbach (2020) further emphasised that waterboards in South Africa, which are established in terms of Section 28 of the Water Services Act, 1997, are at high risk because of the financially struggling municipalities. This precarious situation of high municipal debt, which threatens water security in the country, has prompted calls to re-configure waterboards with the view to improve efficiencies and increase economies of scale (Lubbe & Rossouw 2008; AG South Africa 2020; Enwereji & Uwizeyi 2020; DWS 2022; Odendaal 2022). It is envisaged that the results of this study will assist the DWS when reconfiguring the waterboards into regional water utilities. The study unlocks an opportunity to narrow the gaps between academic research, policy, and practice in the provision of basic services space for developing countries. To date, the relationship between MuSSA status and financial viability of waterboards has not been scientifically explored or published. The current study aims to investigate the extent of the relationship between the vulnerability state of municipalities and the impacts thereof on the FH of waterboards.

Regression analysis was used to measure causal relationships between municipal vulnerabilities and FH of waterboards. Gallo (2015) reported that regression analysis is used by most companies to make business decisions. However, regression analysis is not the be-all and end-all of decision-makers as it has pros and cons that the researcher must consider. Datasets for this current study were assessed before regression was performed to check for limitations such as outliers and underfitting. Assessment of datasets was also done to ascertain if there were variables other than the vulnerability of municipalities (X) that were not studied, although they do influence the FH of waterboards (Y). In a pragmatist philosophy manner, financial data from annual reports of waterboards were used to generate six key financial indicators, which were subsequently converted into FH check-up figures that can be placed on a scale of 1–10. Only five key financial indicators were used because not all waterboards participated in the bond markets to raise capital to drive their organic and acquisitive strategies, and therefore the debt service coverage ratio was removed as one of the six key financial indicators to allow a fair comparison between the waterboards (Appendix, Table 1.1, and Figure 1.1). For a waterboard to get a full score in a category of financial indicator, it must have met the target for a period of 5 years consecutively. The vulnerability indices of municipalities were obtained from MuSSA reports, which covered the period from the 2018 to 2022 financial years.

The collection of data from waterboards was mainly from the annual reports. The study involved six waterboards (i.e., Rand Water, Magalies Water, Umgeni Water, Lepelle Northern Water, Amatola Water, and Bloem Water) and 53 municipalities whose bulk water is supplied by the said six waterboards. Rand Water provides mostly urban-based municipalities with bulk potable water in Gauteng, parts of Mpumalanga, the Free State, and the North West provinces. Magalies Water serves mostly urban-based municipalities across the three provinces of North West, Limpopo, and Gauteng within the catchments of the Crocodile West and the Pienaars rivers. Umgeni Water provides mostly urban-based municipalities spread across approximately 39% of the KwaZulu Natal province's geographical area. Bloem Water's area of bulk potable water supply covers mostly the urban-based municipalities in the Free State province. Lepelle Northern Water and Amatola Water provide bulk potable water to mostly rural municipalities in the provinces of Limpopo and the Eastern Cape, respectively.

A total of nine key financial data points of waterboards were collected, namely: total operating revenues, total operating expenses, depreciation and amortisation expenses, debt principal payments, debt interest payments, current assets (excluding inventories, restricted cash, and prepaids), current liabilities (excluding deposits and bond anticipation), unrestricted cash and investments, total accumulated depreciation, and total depreciable capital assets. The vulnerability indices as stipulated in the MuSSA reports of 53 municipalities (Appendix, Table 1.2) whose bulk water supply was provided by the six waterboards were collected.

The six financial indicators were developed to examine how the waterboards performed financially (Environmental Finance Centre 2016) and those indicators were: operating ratio (including depreciation), operating ratio (not including depreciation), debt service coverage ratio, quick ratio, days cash on hand, and per cent of capital assets depreciated (Appendix, Figures 1.1 and 1.2). The FH check-up for each waterboard was assessed against the set target. The equity-to-assets and debt-to-equity ratios were computed in this study to assess how vulnerable the waterboards are to financial shocks (Appendix, Figures 2.1 and 2.2). An average VI for each municipality was computed over a period of 5 years to determine temporal vulnerability trends within and among municipalities.

The study analysed financial data from six waterboards that represented both rural- (Lepelle Northern Water and Amatole) and urban- (Randwater, Umgeni Water, Bloem Water, and Magalies Water) based state-owned enterprises and composite vulnerability indices derived from 16 business health attributes (Appendix, Table 1.3) related to the provision of water and sanitation services from 53 municipalities. The results in Table 1 show a FH check-up mean value of 7.36 for all waterboards and a VI mean value of 0.59 for all municipalities.

The magnitude and significance of the Pearson correlation between FH check-up of waterboards and VI of municipalities were examined and Table 2 shows a medium correlation of a negative value of 0.361 and a p-value of 0.003, which indicates high significance.

The collinearity tolerance value of 1.00 is above the minimum value of 0.40, which most researchers use as the lower limit beyond which multicollinearity levels become high enough to be considered a problem. The variance inflation factor (VIF) value of 1.000 shows that there are no issues with multicollinearity.

Three waterboards, namely, Rand Water, Magalies Water, and Umgeni Water, financially performed well above the average FH index value of 7.36. The three waterboards were able to generate enough revenue from sales of bulk potable water to municipalities to cover the cost of operations and depreciation for the past 5 years from 2018 to 2022 as reflected in their audited financial statements. It was also possible to establish that Rand Water had sufficient financial resources to pay off operating and maintenance costs and service existing debt. These three waterboards were also in a better position to weather a significant temporary reduction in revenue due to municipal debt. Their equity-to-asset ratios reflect businesses with high equity to assets and less reliance on debt financing, meaning these enterprises are not highly financially leveraged. One may argue that the waterboards might be missing out on opportunities to expand business both organically and acquisitively using borrowed money especially when the cost of debt is much lower than the rate of profits. However, there are pros and cons that should be considered before financial leverage is considered the best option. According to Paeleman et al. (2023), it is very important for companies to strike the balance between financing business operations by debt and equity. Piper & Weinhold (1982) warned of an overstated tax advantage for debt financing, which often leads to long waits for investors to get returns from their invested capital.

The other three waterboards, namely, Amatola Water, Bloem Water, and Lepelle Northern Water, did not have sufficient financial resources to withstand any future prolonged financial storm on their revenue streams. For these three waterboards to make a turnaround, the first port of call should be to ensure that their financial reporting is standardised to show the gaps clearly. The issues of not reporting in a standardised format in line with generally accepted accounting principles were also highlighted by the auditor's report for the 2020/21 fiscal year. It does seem that the current financial model is not suitable for these three waterboards, as it assumes that municipalities take accountability when it comes to servicing of debt, which does not seem to be the norm, especially in rural municipalities.

The VI of most municipalities seems to be higher in rural areas than in urban areas, as shown in Appendix, Table 1.2. However, the situation is complex because all these rural areas supply skilled labour to the urban areas (Ramuhulu 2021) and the same rural areas serve as retirement homes for most of South Africa's urban dwellers. This is a unique situation for South Africa as most professionals have both rural and urban homes, and this becomes more apparent in Gauteng province during the festive season. The question is why urban dwellers only pay municipal tax and rates for their urban homes and not rural homes as the rural municipalities need revenue to maintain infrastructure.

South Africa has challenges regarding the provision of water and sanitation services (Asoba et al. 2020), and the provision of these services is a mandate of local government because it is closer to where the services are required by citizens. However, there are historical issues that need to be resolved. After the end of Apartheid, South Africa's newly elected government inherited huge service backlogs with respect to access to water and sanitation services (Bazaanah & Mothapo 2023). Since 1994, South Africa is reported to have reached universal access to an improved water supply in urban areas, while in rural areas, access increased to slightly above 60% (StatsSA 2011). However, the progress made had some associated complexities to deal with in all three spheres of government. There are problems associated with the technical and financial sustainability of infrastructure, because of insufficient or no asset management practices, including financial planning, maintenance, refurbishment, and ineffective operation of infrastructure. According to Selala et al. (2019), these problems can be addressed by developing a tariff collection system for rural municipalities to be able to fulfil the operations and maintenance requirements.

The current study was successful in showing the dire situation that most waterboards in South Africa are experiencing due to high municipal debt on waterboards' balance sheets. The study's unravelling of a causal relationship between the financial viability of waterboards and the vulnerability of municipalities is one step in the right direction of addressing the underlying problems of water and sanitation services in South Africa. There are more factors whose contributions to the vulnerability and financial viability of municipalities and waterboards must be factored into the equation to ensure that the root cause of the water and sanitation service problems is well defined. This will ensure that a well-thought-out solution is sought, and that solution is tailored to deal with the uniqueness of every situation on the ground. There are several issues such as non-payment of municipal services by households, lack of technical capacity at local government, corruption, and mismanagement of funds by officials that must be resolved for municipalities not to be vulnerable. It was also possible to show the weakness of the water and sanitation value chain regarding the implementation of remedial actions stipulated in the municipal priority action plans. More work must be done to deal with the systemic problem, which threatens the country's priorities, and the achievement of goals and targets set in the National Development Plan of the country and the United Nations' Sustainable Development Goal 6. The results of the current study justify why a systems theory approach is required to deal with the problems that plague the water and sanitation service landscape in South Africa. The authors recommend that the allocation of grants to municipalities should be linked to their MuSSA scores and how the municipalities have implemented their respective MPAP. If municipalities fail to implement the MPAP, their water service provider status must be revoked. All waterboards must perform a compulsory FH check-up and use the outcome of the assessment to set new targets that lead to the attainment of FH check-up values of more than 8.5. All waterboards that fail to attain the FH check-up value of more than 8.5 for more than 2 years in a row must be put under administration.

All relevant data are included in the paper or its Supplementary Information.

The authors declare there is no conflict.