The municipal credit market in South Africa

Thesis (M.Com. (Economics))--North-West University, Potchefstroom Campus, 2004.South African municipalities today face enormous challenges. They are faced with severe infrastructure backlogs, increased service provision and deteriorating municipal finance. These services, which include water, sanitation, electricity and waste disposal are essential to the basic needs of all citizens in South Africa, and contribute greatly to local economic development. Municipalities lack the necessary revenue to supply these essential services, or the necessary infrastructure to support these services. Because of this, and in order not to cause further deterioration of municipal service provision, additional infrastructure investment for municipalities in South Africa is needed, and fast. Additional investment can come from various sources, but government's ultimate goal is to see private finance or private capital, flow to the municipal sector. This can be achieved either through issuing municipal bonds, or by providing bank loans to municipalities. Previously (before 1994), South Africa still had a municipal bond market, and both of these instruments traded, but currently the composition of debt is changing. Securities debt remains to decrease, while loan debt increases continuously - a principle, which is inconsistent with that which government wishes to achieve at this stage. The residual credit market in South Africa is largely an intermediate one, with banks and other financial intermediaries holding most loans. Government wishes to see this market supplemented by the development and expansion of a securities market, or a "bond model" that lowers the cost of capital to the municipal sector. This market will imply that municipalities (usually the larger ones) issue debt in the form of bonds, which will then trade in the secondary market. To encourage this, government in South Africa designed the main elements of a municipal debt market necessary to support such a framework. This framework supports the direct access of municipalities to the municipal bond market, rather than the indirect access by intermediaries, which is currently the case. The two intermediaries currently operating in South Africa is INCA - a private sector intermediary, and the DBSA - a public sector intermediary. Together these two market players hold more than half of all municipal debt in South Africa. In supporting a market where direct capital market access is achievable, or where municipalities issue municipal bonds, a few essential things have to be in place first. This becomes obvious when one considers the underlying strengths of the United States municipal bond market, which makes use of the direct access method or municipal bond issuance. One of the most important market strengths of the United States is the fact that U.S. municipalities,. unlike most municipalities in South Africa, are creditworthy. This creditworthiness can mainly be ascribed to three things, (i) adequate revenue that supports borrowing, (ii) reliable financial information, which is necessary for public disclosure, and (iii) proper credit ratings. All three these elements are important to ensure municipal creditworthiness. South Africa faces enormous constraints on all three these elements. Firstly, South African municipalities do not have adequate revenue to support borrowing, mainly due to debt outstanding, and revenue collection problems. Secondly, the financial information of most municipalities in South Africa - which is imperative for public disclosure - is usually absent, late or unreliable, and thirdly, only five municipalities in South Africa currently reported having credit. The creditworthiness of most municipalities in South Africa seems to be the greatest obstacle in the way of municipal bond market development. If South Africa wishes to achieve successful and efficient ways to aid the re-emergence of the municipal bond market, it would have to reduce the credit risk of most municipalities. Municipalities can reduce credit risk by making use of certain credit enhancement mechanisms that will also provide additional investment. There are various forms of credit enhancement mechanisms available, which include government lending, government grants, government subsidies, and government guarantees, interception of intergovernmental transfers, municipal bond insurance, bank letters of credit, and making use of special purpose intermediaries. Many special purpose intermediaries do exist in the world today, which include anything from municipal development banks to bond banks. The United States successfully uses bond banks that give access to smaller, poorly rated municipalities via a process known as ''bond pooling." Bond pooling involves a concept where a number of small municipalities pool their issues together to create one large bond pool with numerous advantageous. Although larger municipalities in South Africa would have no problem accessing the municipal bond market directly via bond issuance, smaller un-creditworthy municipalities would find it much more difficult to access the municipal bond market via bond issuance. One solution to the problem could be if the smaller poorly rated municipalities, makes use of a municipal bond bank similar to the municipal bond banks in the United States. The proposed bond bank, besides providing access assistance to smaller municipalities could also provide certain technical assistance and training concerning the municipal bond market, bond issuance, the role of municipalities in this market, all the requirements necessary for municipalities to access this market effectively, and municipal creditworthiness. Since the majority of municipalities in South Africa do not have the necessary requirements to access the capital market directly, and secondly, since this direct access method would solve the problem of only a few exceptional municipalities in South Africa, the government proposed framework seems ineffective. One solution could be if the South African government instead of making use of municipal bond issuance uses an intermediary like the bond bank to access additional finance. Although this would be indirect contrast with that, which government wishes to achieve it could be the only solution in reactivating or stimulating the municipal bond market.Master