A slowdown in China would cost $157 billion and cause the Government’s debt-to-GDP ratio to rise to 33 percent, but ratings agencies are unworried, Thomas Coughlan reports. 

Economic stress tests from Treasury paint a dark picture of the threats facing the Government’s finances. 

Treasury estimates that a downturn in China sparking a global panic similar to the 2007-8 financial crisis would cost the Government around $157 billion and cause core Crown debt to rise to 33 percent of GDP within five years of the slump. The current debt-to-GDP ratio is just 21.4 percent, according to financial statements released last week. 

This scenario is included as one of three stress tests in Treasury’s 2018 Investment Statement. The stress tests are topical going into Thursday’s Budget as the Government faces pressure from some quarters to take on more debt to fund infrastructure spending.

Finance Minister Grant Robertson has said the Government remains committed to its goal of reducing net core Crown debt to 20 percent of GDP by 2021-22, saying that keeping the ratio low placed New Zealand in a good position to weather shocks such as another Christchurch-sized earthquake or a Chinese-led financial crisis.

Debt-to-GDP is used as a gauge of the Government’s ability to service its debt and is watched by ratings agencies and bond investors who push interest rates around when the riskiness of a bond issuer changes.

The Opposition has piled into the fray as well. 

Opposition Finance Spokesperson Amy Adams attacked the Government’s plan to borrow an additional $10 billion by 2020 in the House last week. Former finance spokesperson Steven Joyce had planned to reduce the debt-to-GDP ratio to 20 percent by 2020, earlier than Labour. Just before last year’s election, he set a new target of reducing it to 10 to 15 percent by 2025.

At the time, Joyce cited the same concerns as Robertson.

“We have learnt from the global financial crisis and the Canterbury earthquakes that shocks can come along at any time, and sometimes they come in pairs,” Robertson said announcing the debt target. 

Treasury’s investment statement looks at the Government’s assets and liabilities and gives some insight into what those shocks might cost.

The severe scenario

The most severe scenario pictures a shock in China of a similar scale to the GFC, radiating outwards to engulf the world economy. Unemployment would nearly double to 7 percent and the the Reserve Bank would cut the Official Cash Rate to near zero.

The Government’s balance sheet would take a $30 billion hit as the value of equities held by the institutions like the Superannuation Fund and ACC plummet in value. Property assets owned by the Government will also lose value in an assumed downturn in the real estate market. 

Treasury also estimates indirect fiscal costs of $127 billion as nominal GDP falls short of pre-crisis expectations. Tax revenue would decline and expenditure increase as more people claimed welfare and benefits following the unemployment rate rising to nearly double its rate today. 

Treasury also forecast a scenario for a large earthquake hitting Wellington. This would cost around $65 billion. It projected the direct fiscal costs to the Government would be $22 billion, with indirect fiscal costs, including lower tax revenue, of $38 billion. 

Additional Government borrowing would push the debt-to-GDP ratio to 31 percent. 

The report says that one of the scenarios alone “is not likely to lead to debt becoming unsustainable in the short term”.

Sometimes they come in pairs 

But as the previous government knew well, catastrophes can strike in pairs. 

The combined cost of the Christchurch Earthquake and the GFC to the Government saw an increase in core Crown debt by about 20 percent. 

This led ratings agencies Fitch and S&P to downgrade New Zealand’s credit rating in 2011. A credit rating downgrade raises the cost of borrowing as lenders have less confidence the Government can repay its debt. 

Realistic projections

A Christchurch Starbucks branch was still derelict more than two years after the February 2011 quake. Photo: Lynn Grieveson.

Treasury’s projections were not uncontroversial, indicating just how contentious the debate over New Zealand’s debt profile has become.

Treasury officials appeared before the Finance and Expenditure Select Committee last week to discuss the Investment Statement. 

National MPs on the committee, including Adams, David Carter and Andrew Bayly questioned Treasury’s projections. 

They took particular issue with Treasury’s projection that the impact of a Wellington earthquake on the value of the Government’s equity and properties would be just $5 billion.

“I’m looking at those on face value and I could see $5 billion just out of equity and I would have thought that was conservative,” said Bayly. 

Carter disputed Treasury’s estimate of the cost of a foot-and-mouth outbreak, which it calculated would increase the debt-to-GDP ratio by just 5 percent. 

“It strikes me that you’ve underestimated that one completely,” he said. 

Adams later told Newsroom she was concerned Treasury’s models had failed to take into account the severity of the risks New Zealand was exposed to.

“None of these fiscal resilience tests measure an extreme fiscal reaction,” Adams said.

“Either they have picked too small a natural catastrophe or a global economic crisis or they haven’t measured it properly” she said. 

She said it would have been more useful to measure what the Government’s books could withstand, rather than looking at whether it could withstand shocks of a certain size.

Adams said it would be more useful to say, “this is the size of an economic shock before we’re in real trouble”, rather than, “we’ve modelled one and it’s not too bad”.

Ratings agencies not concerned

Ratings agencies do not seem overly concerned with New Zealand’s debt profile. 

Moody’s sovereign risk analyst for New Zealand, Matthew Circosta, told Newsroom that New Zealand looked like it could adjust to shocks with its current debt levels. 

“Moderate gross central Government debt … affords the Government higher fiscal room than many other similarly rated high-income sovereigns to counter shocks,” Circosta said. 

He said New Zealand’s fiscal position was strong compared with its peers, and continued fiscal and monetary discipline would give the economy “capacity to adjust to shocks and keep its credit metrics consistent with a Aaa rating even in the event of such shocks materialising”.

S&P’s New Zealand analyst Anthony Walker told interest.co.nz that its credit rating was unlikely to shift should the Government take on more debt.

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