The Government has lowered its target for the debt to GDP ratio, effectively shifting one of the anchors of its economic policy. Bernard Hickey looks at why the Government made the change and how it might restrict its choices over the long run around tax cuts, infrastructure spending and social spending.
What just happened?
Finance Minister Steven Joyce used his Budget preview speech to the Wellington Chamber of Commerce on Thursday to announce the Government had reset its target for reducing net debt to GDP to between 10 and 15 percent by 2025. Previously, the Government had set a target of getting net debt down to 20 percent of GDP by 2020. It set this original target in 2012, having aimed before that to get net debt down to 20 percent of GDP by the early 2020s. Up until 2009 the target was for gross debt to be below 20 percent of GDP.
The target of getting debt below 20 percent of GDP by 2020 has been an anchor for the Government’s economic and fiscal policy over the last four years and was used in tandem initially with ‘zero’ budgets in 2011 and 2012, whereby the Government held operating allowances in those budgets at zero. They have since been increased to $1.5 billion a year, but have been restricted at these levels to ensure net debt is reduced from the current forecast of 24.3 percent of GDP in the current financial year to June 30.
The idea of a debt target has been around since the mid-1990s and was largely a result of the 1989 Public Finance Act’s unspecified focus on managing public debt at “prudent levels.”
Victoria University Pro Vice Chancellor Bob Buckle and Treasury analyst Amy Cruickshank wrote a paper in 2012 for the New Zealand Association of Economists conference on ‘Long Run Fiscal Sustainability’ which looked at the history of Government debt targets (as detailed in this chart below)
Why make the change?
Joyce argued in the speech the Government did the right thing by allowing net debt to rise from nearly zero to a peak of 26 percent of GDP between 2008 and 2014 as it borrowed to cushion the blows of the Global Financial Crisis and the Canterbury earthquakes.
But now was the time to reduce debt and make sure future Governments had the capacity to respond to future shocks.
“We are a geologically young country, and we are also a small country in an often turbulent world, so there are plenty of a bumps ahead in the road ahead of us, whether they are natural disasters or from international events,” Joyce said.
“It’s important to save now for our next rainy day,” he said.
“At 10 to 15 percent, New Zealand will have the capacity to absorb not just one but a couple of big shocks at once if we need to, as we had to last time.”
How might this restrict the Government?
The new lower debt target will make it harder for the Government to use the fruits of higher tax revenues from economic growth to significantly reduce tax rates, increase social spending or ramp up investment in infrastructure.
Despite stronger-than-forecast budget surpluses this year, the Government is holding back from reducing income tax rates, and is only talking about increasing income tax thresholds. That would produce only small reductions in income taxes. Joyce also shied away from the prospect of any reduction in the 28 percent corporate tax rate, despite proposals by President Donald Trump to slash America’s corporate tax rate to 15 percent from 35 percent, which some think might lead to competing reductions in corporate tax rates globally.
Joyce also held back from a massive increase in infrastructure spending. He announced the Budget on May 25 would contain a $1.2 billion increase in infrastructure spending over the next four years, compared to the December Half Yearly Economic and Fiscal Update (HYEFU).
The headline of his announcement was for an extra $11 billion of infrastructure spending, but the Government had already announced in December it planned to spend $9 billion over four years and it committed to spend $812 million on rebuilding the Picton to Christchurch road — which it had also previously said it would do.
Joyce said the extra infrastructure spending announced on Thursday would include spending on transport, schools and hospitals, but he was not specific on the details, saying they would come in the Budget. He has previously said the extra capital spending would be partly to fund the Government’s contribution to the multi-billion City Rail Link.
Compared to the December HYEFU announcement, Joyce said there was no extra capital spending allowance in Budget 2018.
Is it actually a tightening?
The lower debt target implies the Government is looking to further tighten its fiscal outlook, but the 10 to 15 percent target is actually above the latest Treasury projections that saw net debt at 8.8 percent of GDP by 2024/25.
Treasury’s Fiscal Strategy Model for forecasting the Government’s finances over the medium was published in December and forecast net debt would eventually fall to zero by 2027/28. It actually forecast net debt would be negative 13.5 percent of GDP by 2030/31, which would imply the Government was storing up net assets.
Is this what New Zealand’s creditors want?
Global bond markets and credit ratings agencies are not agitating for New Zealand to borrow less in either the short or long terms.
Demand for Government bonds remains very strong as ageing populations in developed and developing countries look to put their savings into less volatile assets with strong credit ratings. Standard and Poor’s and Moody’s have recently reaffirmed their AA and Aaa ratings respectively and have pointed to the Government’s already ample ability to respond to shocks.
“The government’s efforts over many years to preserve strong public finances provides it ample room to pursue expansionary fiscal policy to buffer the economy from any potential future shocks, which could stem from another natural disaster, a housing market correction or a sharp fall in global trade,” Moody’s said on March 24.
“Moderate (gross) government debt levels around 30 percent of GDP give the government the capacity to implement stimulus policies, if required, to shore up economic growth,” it wrote in a report affirming New Zealand’s credit rating.
“Overall, we expect increasing budget surpluses to help reduce gross government debt toward 28 percent of GDP in coming years — significantly lower than the median for Aaa-rated sovereigns. With government debt at moderate levels, New Zealand has higher fiscal flexibility than in many other high-income economies.”
The average gross debt for OECD countries in calendar 2015 was 86 percent, almost triple New Zealand’s gross debt in that year of around 35 percent. New Zealand’s 10 year Government bond yield is currently at just over three percent and up from a record low of 2.17 percent in August last year, but down from a post-Trump high of 3.4 percent in late December last year.
Joyce argued after the speech that interest rates are likely to rise, but Government bond markets are not forecasting any rapid rise in Government bond yields over the next ten years.
What might a future Government do?
Labour Finance Spokesman Grant Robertson said he was still committed to reducing net debt to 20 percent of GDP by 2022, which both Labour and the Green parties committed to in their fiscal pact announced last month.
He was dismissive of the Government’s announcement of an extra $300 million a year over four years, with no extra spending in 2018/19.
“The new spending announced today is only enough to buy 650 metres of the Auckland Central Rail Loop each year,” he said.
ACT Leader and Epsom MP David Seymour said the Government should prioritise tax cuts over further reductions in the debt to GDP ratio.
“When private debt is more than four times worse, the emphasis needs to be on returning government surpluses to households and businesses,” he said.