Covid-era spending and urgent infrastructure investments may force future governments to carry more debt than previous ones

Finance Minister Grant Robertson has promised to focus on fiscal sustainability in Budget 2023, and beyond, but this doesn’t mean paying down debt. 

New Zealand’s net debt was sitting at $72.8 billion, or 19.1% of gross domestic product, by the end of March. This is up dramatically from 9.3% in 2019, but still relatively low globally. 

In Budget 2023, the government has to cover the cost of the cyclone rebuild while contending with a falling tax take. 

Treasury’s financial statements showed tax revenue was $2.3 billion short of forecast in the nine months ended March, with less economic activity meaning less GST and corporate tax.

Inflation helps to prop up tax revenue in nominal terms, but doesn’t significantly increase Government spending power as it comes with  higher costs on the other side of the ledger. 

Economists have forecast the Government will not return to a budget surplus this year and that debt levels are likely to rise further. 

Net debt is still comfortably below the 30% ceiling, which was set in 2022 and allowed for about an extra $100 billion of borrowing, but there isn’t much room to respond to another crisis. 

Yet, neither of the two major parties are putting much emphasis on paying down debt. This may be because New Zealand faces an enormous bill for overdue infrastructure. 

Bridging billions in gaps

Hundreds of billions needs to be spent on functional water pipes, public transit networks, and enough clean electricity production to be able to decarbonise the economy.

In the short-term, some $5 billion to $7 billion is required just to repair the government assets damaged by Cyclone Gabrielle and the Auckland Anniversary floods.

And so, neither Robertson or opposition leader Christopher Luxon had much to say about bringing down debt in their pre-budget speeches. 

Luxon focused his criticism on the wastefulness of Government spending, rather than the nominal value of it. Fiscal discipline was not just about spending less money, he said. 

“Governments do have a responsibility to control their spending. But they also need to be laser-focused on whether that spending is delivering value for money.”

“And—putting aside the sheer increase in spending—that’s where I believe the Government has truly failed”.

Robertson said, in his own pre-budget speech, that a Labour government would continue to use its balance sheet (meaning: borrow money) to fund infrastructure.  

The attitude toward public debt in NZ had gone beyond “a sensible level of caution” in the past, and had led to low debt being prioritised over other important considerations.

While the Labour finance minister has committed to bring annual spending back down to near 30% of GDP, there has been no promise to bring down debt. 

National plans to cut spending, but likely to fund tax cuts. It has promised to adjust tax brackets to account for inflation as a minimum, with more when fiscal conditions allow. 

Navigating the Bermuda Triangle

The difficulty for National is that tax cuts and spending are effectively the same thing from a government accounting perspective. 

At a very basic level, a government budget is made up of just three things—revenue, services, and debt—with each of those things in tension with one another.

Cutting revenue or adding services increases debt, which will likely only be brought down by increasing revenue or reducing services. 

Robertson took a jab at National’s unspecified fiscal policy in his speech, saying they were promising that public services will go up, public debt will go down, and taxes will be cut.

“That fiscal Bermuda Triangle is the domain of the Opposition, and I don’t believe it is either realistic or credible,” he said. 

But Labour has its own logical contradictions. Policies pitched at fighting inflation, such as cost of living payments, may actually be fanning its flames. 

Economics is a social science and shouldn’t be considered synonymous with ‘objectivity’, but it provides a useful lens with which to look at government decisions.  

It may surprise some readers that the preferred budget settings, from an economics perspective, might actually be for higher taxes. 

For example, many economists were disappointed the government ruled out using a cyclone levy to rebuild damage in the Hawke's Bay. 

Miles Workman and David Croy, economists at ANZ, said it was problematic to be running fiscal deficits and adding economic stimulus to an already out-of-balance economy.

“New Zealand’s record-wide current account deficit, a near record-low unemployment rate, and CPI inflation near a multi-decade high are all good reasons to consolidate the fiscal position faster than otherwise, but it’s not clear that Budget 2023 will deliver that”.

Lifting taxes would be one way to take some heat out of the economy, while also creating more room on the balance sheet to respond to future crises or build infrastructure. 

It’s politically unpopular, however, and could put pressure on households already struggling to make ends meet. But economists and market traders do want the government to rein in spending as much as possible.

Wrath of ratings

Ross Weston, a senior treasury portfolio manager at Kiwibank, said while the budget may not be inflationary, fiscal constraint wouldn’t be enough to stop increased borrowing.

“On Budget Day, keep an eye on [credit] rating agency responses if any, we have been warned about our huge current account deficit,” he said. 

NZ has a record trade deficit, a massive infrastructure programme, and a high chance of recession; all of which could spook credit rating agencies and lead to higher interest costs. 

Hamish Wilkinson, a senior dealer in Kiwibank’s financial markets team, said any hint of a declining credit outlook could see the kiwi dollar fall below US60.80 cents. 

“The balancing act of fiscal restraint in the eyes of credit agencies within an environment of a cyclone rebuild, a slowing economy and an election year tax plan will be closely watched”.

The Reserve Bank will also be watching closely, as it prepares its Monetary Policy Statement to be released on May 24. The central bank has warned any extra spending may need to be offset with higher interest rates.

Craig Ebert, an economist at BNZ, said this was likely to be one of the tightest election-year Budgets for a long time. 

“This will be framed by accounting limitations, and the significant costs arising from the recent vicious storms, rather than being an outcome of great choice for the government.”