The project would be implemented by the Zululand District Municipality and would aim to help 165,000 people in rural areas, the department said in a statement.
The "Dutch Orio grant" was intended for the improvement of infrastructure in the most needy communities.
The agreement comes at the start of Africa Water Week.
Water Minister Buyelwa Sonjica said African countries would not meet targets for water and sanitation set out in the Millennium Development Goals (MDG) if trends continued.
The MDG set goals for sanitation and water to be met by 2015. At current rates of development, goals for the water target would be met only by 2036 and sanitation by 2109, said the department.
"Africa's sanitation and water is making slow progress and is stifling economic growth," said Sonjica.
"Sustainable financing to upscale infrastructure and service delivery in Africa remains a key focus."
She said a key problem was in financing water and sanitation infrastructure.
Sapa
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