Leading up to the Budget South Africa’s government finances were in an unsustainable position, requiring fiscal consolidation. Ideally, the required adjustment should occur through total expenditure cuts, but not of infrastructure expenditure. Also, revenue should be raised through increased efficiency. But, given an unemployment rate of 25% and palpably weak GDP growth it is difficult to implement the ideal solution. To start, growth is simply too weak to rely on increases in tax collection efficiency alone (for example, by protecting the corporate income tax base).

In the end, the Minister went for tax increases upfront in 2016/17 (amounting to an additional R18bn relative to baseline) followed by further tax increases amounting to R15bn in both 2017/18 and 2018/19. Main Budget revenue increases to 26.9% of GDP by 2018/19, from 25.1% of GDP in 2014/15, which is a material increase. The comparison with 2014/15 is more relevant than a comparison with 2015/16 when the revenue take, which amounted to 26.4% of GDP, was boosted by the sale of assets.

Meanwhile, the expenditure ceiling for 2016/17, set out in the Budget Review of 2015, was maintained, while “new” expenditure cuts were back-ended to 2017/18 (-R10bn) and 2018/19 (-R15bn). The “new” expenditure cuts emphasise restraint on government compensation through, amongst other measures, restraints in hiring. The focus on constraining compensation, the largest government consumption expenditure item, is important, but the jury is out.

Consolidated non-interest spending growth is budgeted to increase by 5.1% in 2016/17 in current prices. This is less than expected inflation, but the base of 2015/16 is inflated by extraordinary payments (to Eskom and the Development Bank). This is followed by commendable, constrained increases in non-interest spending in 2017/18 and 2018/19 of close to 1% and 1.5% respectively.

Also, total Main Budget expenditure remains high, declining only slightly to 29.8% of GDP by 2018/19, from 30.6% of GDP in 2015/16. This is important considering the additional potential expenditure projected for National Health Insurance over the longer term.

The interest bill continues to climb, almost matching total social protection spending

The importance of stabilising the debt ratio is underlined by the size of debt service cost on government debt, which is budgeted to amount to R147.7 billion in 2016/17. This is not too far off the R167.5 billion budgeted for total social protection (which includes the old age grant, child support grant, disability grant, provincial social development, policy oversight and grant administration and other grants). Accordingly, debt servicing cost is expected to climb to 11.6% of GDP by 2018/19, from 10.4% of GDP in 2015/16. This illustrates the importance of stabilising the debt ratio.

NHI – the elephant in the room

The elephant in the room is National Health Insurance (NHI). In its current form, according to the NHI White Paper, published in December 2015, the funding plan is to use a mandatory prepayment system and to raise general taxes, although Minister Gordhan indicated the funding plan is still being considered.

For illustration, the NHI White Paper includes a projection showing total NHI spending at R256 billion (2010 prices) so that spending on healthcare by the public sector increases from around 4% of GDP currently to 6.2% of GDP in 2025/26, but only if the economy grows at 3.5% in real terms. This reflects a funding shortfall of R72 billion (2010 prices).

The Reserve Bank, however, argues that potential growth is currently below 2%. Of course, potential growth may lift, but should this not be the case the NHI White Paper includes projection, which indicates a R108 billion funding shortfall in 2025/26 (2010 prices) if the economy grows at just 2%. That would leave public sector spending on health at closer to 7% of GDP. That would be an especially onerous gap to fill. Clarity is needed on this issue.

Ultimately, the debt stabilisation trajectory shown is a welcome development. As is, it should reduce the downgrade risk. But, that said, the risk of a further downgrade is not nil. Ultimately, the likely outcome of the ratings agencies’ decisions on this is unknowable. Only time will tell.

But at least financial markets have, to a significant extent, already priced in the possibility of a downgrade to sub-investment grade. Another mitigating factor is that most of the South African government’s debt is denominated in domestic currency, which carries a higher rating than for its foreign currency denominated debt, which amounts to a relatively low 10% of total government dept.