Brian Easton on why Government borrowing is limited

This is a re-post of an article originally published on pundit.co.nz. It is here with permission.

This column started out to explain how the proposed structural outsourcing of public surgery was partly a consequence of the peculiarities of our fiscal borrowing practices. In summary, the restriction on the government’s debt level means seeking indirect ways to provide the required capital. One way of doing this is ‘leasing’ the capital from the private sector. Next week I’ll explain how that is done in the healthcare sector; this week is to explain where the debt constraint comes from.

The consequence is that we either make some hard decisions or we undermine the future of the New Zealand economy by having too much debt and not enough capital. Wilkins Micawber reminds us it is not much fun being a debtor.

New Zealand’s Debt Strategy

The asymmetry between borrower and lender is well illustrated by Keynes telling the New Zealand Minister of Finance, William Downie Stewart, that New Zealand should borrow as much as it could to offset the Great Depression, but if he (Keynes) were a lender he would probably not be prepared to advance New Zealand any more.

Each lender has to make an assessment of the borrower’s ability to service and repay the loan in the future. The lender is likely to be more cautious about that prospect than the borrower. Arguably, the financial cost to the lender of failure is greater than the cost to the borrower. (However, the human cost may be less, although this is not usually a major consideration in such financial decisions.)

This superior position of lenders frames New Zealand’s debt policy. The government judges that its net-debt-to-annual-GDP ratio should not exceed 50 percent (based on its chosen debt measure). Because there is a need for a margin for emergencies – like the Great Depression – the government targets 30 percent. Currently the ratio is about 40 percent as a result of measures taken during the Covid pandemic.

In my view a 20 percent margin for emergencies is reasonable, so I focus on the 50 percent ratio. It largely comes from discussions with credit rating agencies (CRAs) and larger lenders. A credit rating saves every potential lender going through the same process of assessing the risk of default. The awarded grade help sets an industrywide benchmark – the higher the grade, the lower the risk and the lower the interest rate charged, not only for the government but for private borrowers too. As Keynes indicated, their judgement is decisive even if it is irrational (which it need not be).

I have never been at an assessment meeting with representatives of a CRA but I have had discussions with a number of those that have. I was told that the raters are sophisticated and knowledgeable; their questioning can put the New Zealand team under considerable pressure (which, those who have told me to their chagrin, is usually justified). CRAs do not just look at the government-defined debt ratio (which has varied under different regimes) and they include the NZ Super Fund assets in their assessments. They also look at private foreign debt, especially the offshore debt of the private banking system, because it can affect the ability of the government to service its debt.

This was well illustrated during the GFC, because a deterioration in the liquidity of foreign exchange markets meant the banks might not have been able to roll over their maturing offshore debt and could have turned to the Reserve Bank, forcing it to do the international borrowing instead.

I am certain that the CRAs are tetchy about borrowing for consumption. I’d like to think they accept that such borrowing can be temporarily justified during an emergency, as occurred with the GFC and the Covid pandemic, just as you would do during a household crisis. But, as I reported in an earlier column, the government’s relative net worth is projected to decline from about 40 percent of GDP this year to under 36 percent in 2029. That suggests we are borrowing for consumption and running down the public assets.

Borrowing for Development

Credit rating agencies are more benign towards funding investment for development (providing politicians are not syphoning off funds for personal use). Even so, there are caveats which mean that there will still be limits to how much lenders are willing to advance. Vogel’s publicity, aimed at lenders to fund his ‘think big’ development, insisted that New Zealand’s total debt was not high. Attitudes have not changed much since.

Consider the Ardern-Hipkins Government’s three-waters proposal which involved $10b and more of funding for future investment on fresh, waste and storm water systems. It would have made no sense to load onto this generation the cost of the infrastructure which provides for four and more generations. It seems that the Treasury was keen to keep the debt off their books and potential lenders were asked to advise which of the various funding options was most acceptable to them. This was one of the sources of the contorted policy; politics was another. The lesson is that funding arrangements affect the ability of New Zealand to develop.

Can we do better? First, because it is generally considered last, the private sector has a role. The more it borrows overseas, the more it compromises our credit rating, making it more expensive for the government to borrow. The more we save, the less we borrow overseas. There are some fine-tuning options. For instance, foreign direct investment in businesses is considered less compromising than bank borrowing. (Since the GFC, the Reserve Bank has reduced the exposure of the banking system to short-term international crises.)

Second, the CRAs probably think the government accounts remained exposed. (The government goes on and on about reducing borrowing but it is the debt and net worth levels which really matter; perhaps they don’t want the public to notice that net worth is deteriorating.)

Third, it seems likely that lenders would be more willing to make advances where it is transparent that the funds are being invested competently in real infrastructure. That suggests that separate entities may be relevant. I illustrate this in regard to hospitals next column.

The measures outlined require sacrifices to implement. But there is no easy alternative unless compromising the future of New Zealand is easy.

Footnote: I would not expect my readers to make this mistake, but they may have to remind friends that the government issuing cash is borrowing. In effect a banknote is an anonymous deposit in the Reserve Bank. (Issue too much cash and people try to dispose of it for goods which can contribute to inflationary pressures.)

*Brian Easton, an independent scholar, is an economist, social statistician, public policy analyst and historian. He was the Listener economic columnist from 1978 to 2014. This is a re-post of an article originally published on pundit.co.nz. It is here with permission.