Government is increasingly recognising the extent of the problem, so we hear statements that call on the private sector to invest in the upgrading of infrastructure and that public-private partnerships are now being favoured.
It is said that necessity is the mother of invention. It is also said that ingenuity happens on the cusp of chaos. Both are true. They are also applicable to the South African water sector, where systemic failure is ravaging the economy.
There is some good news, however, but first let us describe the problem. It is public knowledge that municipalities are under pressure. Almost all face severe service delivery constraints from which none are exempt. The small towns are hardest hit, but most of the reporting comes out of the large cities and metros, where the biggest population density occurs.
We can summarise the service delivery crisis in a few words as financial mismanagement arising from institutional failure resulting in underspending on infrastructure operations, maintenance and upgrades that cause systems to fail.
Root causes
I have often called for a root cause analysis, repeatedly saying that in the absence of such an exercise, inappropriate solutions are applied to inadequately diagnosed problems. This is just another way of saying that mismanagement arises from institutional failure resulting in the misallocation of resources, causing systemic failure.
I have also noted that the application of inappropriate solutions to poorly diagnosed problems results in large flows of cash that end up fuelling patronage networks.
The root cause of the problem is financial mismanagement. Unfortunately, the Public Finance Management Act (PFMA) does not require the ringfencing of finances. This means that revenues collected for water and sewerage services are not spent on the maintenance of those systems. It is quite legal to use that money to fund a vanity project driven by a powerful politician, and this is the root cause of the problem.
Another shortfall of the PFMA is that it differs fundamentally from the Companies Act by not holding executive decision-makers legally accountable for financial mismanagement. This simply allows powerful political appointees to mismanage one municipal structure and then be redeployed to another after it fails.
These two factors – the absence of ringfencing and the lack of fiduciary liability – are the root cause of the service delivery failures we are seeing in water supply and sewage processing across all municipalities.
If we continue applying the same inappropriate solutions to inadequately diagnosed problems, then we will certainly end up as a failed state. This is clearly not a desirable outcome for anyone, so we need to avoid it at all costs.
Private sector investment
Now the good news. The government is increasingly recognising the extent of the problem, so we hear statements that call on the private sector to invest in the upgrading of infrastructure. We even hear statements suggesting that public-private partnerships (PPP) are now being favoured.
While this is encouraging, we don’t see too much enthusiasm from the private sector at this stage. But why would we? After all, corporations are governed by the Companies Act, so executives carry fiduciary responsibilities from which their counterparts in municipal government are exempted. The board of directors of any registered company is obliged to protect shareholder value and is prohibited from agreeing to any investment into a PPP that places the capital at risk.
I predict that this will remain the status quo for as long as government keeps the notion of expropriation without compensation alive in the minds of the electorate, so we are unlikely to see a flood of cash into the recapitalisation of the water sector.
Yet it is precisely in this PPP space where some magic is starting to happen.
Water boards are major players that form part of the institutional investment landscape in South Africa. I recently reported on Rand Water bonds that remain the single largest sustainability-linked bond in Africa. Water boards are also pioneering the concept of a special purpose vehicle (SPV) with the full buy-in from Treasury, the DBSA and the Department of Water and Sanitation.
The truly interesting aspect of an SPV is the way it merges the Public Finance Management Act with the Companies Act, effectively closing the two gaps noted above.
Major benefits
There are six major benefits arising from the SPV model.
The first is the ringfencing of finances, because the SPV becomes a vertical silo within a municipality that protects the inner workings from the meddlesome interventions that redirect revenues to vanity projects at the expense of service delivery.
This means that revenues paid by the public for water and sewerage services are reinvested directly back into the maintenance and upgrading of infrastructure. This will eventually manifest as a massive benefit to the improvement of infrastructure and therefore an increase in the reliability of the services being delivered.
The second benefit is that the water boards will be paid for the bulk water they supply. At present, most municipalities simply refuse to pay the water boards, knowing that shutting down supply is a human rights infringement.
This means that all the water boards are slowly being forced into bankruptcy and will eventually require a government bailout that the fiscus can no longer afford. In short, the SPV model will guarantee financial sustainability of the water boards, thereby securing the hydraulic infrastructure on which the entire economy is based.
The third benefit is that the technical skills currently lacking in the failing municipalities will be strengthened as each SPV will effectively become a stable silo of competence around which other distressed departments can be rearranged. This means that institutional strengthening will be an automatic outcome of the SPV process.
The fourth benefit is that the SPV will logically attract private sector involvement. The current impediment to private sector investment in the water sector is the inherent risk associated with debt arising from the mismanagement of funds. The integration of the Companies Act with the PFMA means that fiduciary liability will apply to all executives, so any financial mismanagement will result in criminal sanction.
Gone are the days that a thieving cadre will be shielded from liability and simply redeployed elsewhere to repeat the same malfeasance. This means that some pushback can be anticipated by those with vested interests in maintaining access to the revenue flows, but the fight against corruption has begun.
The fifth benefit is that we will start to see the emergence of a new cohort of water service providers (WSPs) for potable water and sewage processing. The SPV model is rich with experiences in the international community, so we are likely to see the selection of the most appropriate solution. Many examples exist.
The ones I am most impressed with are the utility-scale desalination plants in water-constrained regions such as Australia and the Middle East. Many of these are run by contractors who are legally liable for the delivery of defined quality and quantities when needed.
The sixth benefit is that these SPVs will be easier to contract with because the procurement process will also be ringfenced. What is likely to happen as a result is the emergence of the next generation of sewage management that recovers water from waste while converting sludge into energy. This is already part of the water security toolbox in arid regions and will rapidly be rolled out in South Africa once the SPV model has been embedded.
All of this is reason for cautious optimism. DM