By Bernard Hickey
John Key finally got religion today.
After a couple of years of being in denial about the seriousness of the government's finances and the nation's foreign debt situation, Key finally fessed up about the precariousness of our books.
Key spoke at length in his State of the Nation address and in a 20 minute news conference afterwards about the need to reduce foreign debt.
"We recognise that New Zealand’s high level of foreign debt is our biggest vulnerability," Key said.
He even (rightly) compared our foreign debt levels of around 85% of GDP to those of the notorious PIGS (Portugal, Ireland, Greece and Spain).
This is quite a turnaround.
As recently as the second week of December John Key was downplaying the warning about New Zealand's credit rating from Standard and Poor's and saying the government's net debt levels weren't really that bad.
"The truth of it is government debt at the moment is sitting at around about 18% of GDP and is likely to top out at, in all the numbers we have, at 28.5% of GDP. Now relatively speaking how does that put us? The answer is in very good shape (relative) to a lot of other countries. So the UK is on its way to 100% of GDP, the US is on its way to 100% of GDP, Japan is at 200% of GDP," he told Andrew Patterson of Radio Live back in mid December.
"The ratings agencies tell us ‘look if your debt is under 30%, you’re of no concern to them, if it’s between 30-60% they think it might hold back growth a little bit, but again of no major concern, anywhere near 100% then you really get their attention," he said then.
So why the big shift?
Key is even now using the shield of fiscal responsibility and the bogeyman of foreign debt to attack Phil Goff's plans for a broad tax cut without an obvious way to pay for it. He accused Goff of living in fairyland and of threatening the fiscal situation so much as to push interest rates. See more on Goff's tax cut plan here.
It's as if the boss of Standard and Poor's got in his ear over Christmas and told Key that New Zealand had to buck up its act if it wanted to keep its credit rating. I suspect though that behind the scenes Treasury and Finance Minister Bill English have been arguing hard that a tougher stance is necessary.
However, the rhetoric from Key is much tougher than the action.
He may have got religion, but he isn't doing much worshipping yet.
Rhetoric tougher than action
Key detailed in his state of the nation address how the government was cracking down on unnecessary spending by reducing the new spending allowance by around NZ$200-300 million to NZ$800-900 million.
That is a tiny cut and it's actually only a cut in the growth in spending, not a cut in total spending. That's worth about 1 week's foreign borrowing. Core crown spending in the current 2010/11 year is forecast to be NZ$70.65 billion. Key is proposing a reduction in spending growth (let alone spending itself) of just 0.4%.
Key made clear in the news conference afterwards at the Waitakere Trusts stadium that the government had no plans to touch Education, Health or the other big entitlement areas of Social Welfare (Pensions, DPB, Dole, Sickness benefits) or the bottomless pit of Health. I asked him if the government would consider cuts in the middle class welfare areas of Working for Families or Student Loans and he said these were areas he had ruled out to voters in the past and he wasn't about to go back on his promises. He also had no regrets about cutting the top personal income tax rate last year.
I've always found it curious how Key won't break promises on pensions, benefits, health and education, but was more than happy to break his promise about not increasing GST.
Moving on, Key was also unwilling to revisit the area of last year's tax cuts for the wealthy. He said Treasury had forecast they would be fiscally positive for the government.
I'd be interested to see whether that fiscal positivity is the case by the end of the year, given the lack of consumer spending growth after the GST increase and the lack of income growth. Much of the tax cut is being saved in the form of early mortgage repayment. That's not a bad thing for the economy and ultimately foreign debt, but it's not going to help the government's finances in the short term.
An investment decision
Key said Treasury would now go away and analyse whether it was a good idea to sell up to 50% of the three power generators (Meridian, Genesis and Mighty River Power) and Solid Energy through stock market floats to New Zealand investors..
The theory is that for the sale to make immediate sense then the dividends given up would have to be less than the interest costs of the debt not incurred by selling the asset.
A quick tally of the dividends received and the equity invested suggests it's a line ball call about whether selling the asset is better than borrowing.
Meridian Energy returned NZ$353.5 million in dividends to the government in the year to June 2010 and shareholder equity was valued at NZ$5.07 billion, which suggests a raw dividend yield of 7%. It reports its return on average equity at 3.9% and its underlying return on equity of 19.8%. Here's the annual report.
Mighty River Power reported an average return on equity in the year to June 2010 of 9.7%. It paid dividends of NZ$286 million and shareholder equity was valued at NZ$2.688 billion, which suggests a raw yield of 10.6%. Here is its annual report.
Genesis Energy paid dividends in the 2010 financial year of NZ$39 million and shareholder equity was valued at NZ$1.448 billion, giving a raw dividend yield of 2.7%. It says it achieved return on equity for the year of 4.9%. Here is its annual report.
Solid Energy paid dividends of NZ$54 million in the 2010 financial year on shareholder equity of NZ$436.8 million, delivering a raw dividend yield of 12.4%. Solid Energy and reported profit as a percentage of shareholder funds at 15.4%. Here is its annual report.
In total, the four SOEs potentially up for sale generated total dividends last financial year of NZ$732.5 million and shareholder (government) equity stood at NZ$9.642 billion. This implies a combined (and very raw) dividend yield of 7.6% last year.
Does this compute?
Yet the government is currently having to pay around 5.5% for the new debt it is selling, mostly offshore.
So on the face of it the government is a net loser by selling half of these state assets and avoiding having to raise new debt.
The Treasury will no doubt do a much more sophisticated analysis, but this is a question the government and voters will have to ask in a very hard way before deciding to go ahead with asset sales.
Simply stating that asset sales are a good idea for making these companies more efficient and giving investors on the NZX more options will not be enough.
Lots of hurdles would have to be jumped. For it to make financial sense, the government would have to sell the assets to the public (in theory the New Zealand public) for book value or better and be expecting long term interest rates to be much higher than they are now.
Meanwhile what's the best way to avoid more foreign debt?
The most obvious, and least politically acceptable, way for any government of whatever shade to reduce new debt is to run much smaller government deficits.
That means cutting into entitlements or core spending, including health, education and social welfare.
That means attacking the elephants in the room of Working for Families, free student loans, social welfare benefits and health spending. Or it means increasing taxes, particularly income taxes.
Another way might be to introduce new taxes, such as a capital gains tax or a land tax.
Yet neither side seems willing to pick up those hot potatoes, let alone throw them at each other.
John Key might have gotten a little bit of religion over the holidays, but he's far from a fundamentalist yet.
The high priests of international finance (Moody's, S&P, the international bond markets and the IMF) may yet force us to pay a penance for our sins in the same way that Greece and Ireland have had to pay in the last year.
But it hasn't happened yet and John Key is hopeful yet more rhetoric and a strong economic recovery will bail him and the country out.
Battle lines drawn
The two states of the nation addresses this week have certainly marked out the battle lines for the election campaign later this year and given voters a clear choice.
Labour wants to tax the rich and keep borrowing. National wants to keep taxing the poor, borrow a little bit less and partly sell off some state assets.
So far our opinion poll (look to your right) is saying the voters are against asset sales.
Your views? Comments below please.