The Government is legislatively required to maintain a financial buffer in case of crises like the current one. To maintain that advantage, this Budget has to give a clear timeframe over which that buffer will be restored.
Going into the global financial crisis in 2007-2008, the New Zealand government had a very strong balance sheet. Its net worth was equivalent to approximately 55 percent of gross domestic produce (GDP). Following the crisis, and then the Canterbury earthquakes, net worth dropped substantially, to under 30 percent of GDP.
The Public Finance Act 1989 (PFA) requires the Government to “pursue its policy objectives in accordance with the … principles of responsible fiscal management”. One of the principles is “achieving and maintaining levels of total net worth that provide a buffer against factors that may impact adversely on total net worth in the future”.
Net worth, the difference between total assets and total liabilities, is a more comprehensive and realistic measure of fiscal position than debt, because debt takes no account of either non-debt liabilities, such as those of ACC, or of assets – debt ignores the asset side of the Government’s balance sheet altogether. In fact, debt represents only 20 percent of the total assets and liabilities the Government must manage.
Since 2008, governments clearly complied with this legislative requirement to build a net worth buffer. After only four years of decline, a very short period by international standards, the Government’s net worth resumed its upward path, reaching just under 50 percent of GDP by 2019.
And then Covid-19 struck. Finance Minister Grant Robertson attributed the Government’s ability to “go early, go hard” to, among other things, the Government’s strong balance sheet. Prior to this week’s Budget, the Government has already committed very large sums both to fighting the virus and to providing economic support to individuals and companies adversely affected. It is likely there will be more measures in the Budget.
At the time of writing, it appears Covid-19 has been eliminated and the buffer has served its purpose. But the economic pain is not over for citizens, for businesses and for the Government’s balance sheet.
So what am I looking for in the Budget?
Clearly, measures to continue containing the pandemic and restore the economy will need to be financed. But, even though the impact of Covid-19 will take some years to dissipate, I will still be looking for evidence the Government plans to restore the buffer net worth provides.
There are a number of reasons for this.
First, and most obviously, this will not be the last serious economic shock the country will face, and we will be better placed to deal with future shocks if the Government’s balance sheet is strong. In both the current crisis and the global financial crisis, the value of the buffer has been demonstrated. So, with a number of crises just waiting in the wings, we need to rebuild that buffer.
Second, if we care about intergenerational equity, as the current Government explicitly does, then restoring net worth reduces the burden being passed to future generations. The Treasury’s estimates of the net worth impact of an ageing population already tell us maintaining the buffer will be a huge challenge, so we should not make that situation worse.
Third, recent work by the International Monetary Fund (IMF) points to a number of advantages that accrue to governments with strong net worth positions – they have lower interest expenses, lower yields on their debt and greater fiscal flexibility. The IMF also finds these countries are more resilient to economic downturns and grow, on average, three times faster following a recession. This is a good place to be.
Finally, in its own Budget Responsibility Rules, the Government does not mention this legislatively required buffer, which calls into question its commitment to maintaining a strong balance sheet.
Very few governments globally have balance sheets as strong as New Zealand’s. In the current crisis, that strength is a real advantage. So where will I look to see if the Government plans to maintain that advantage?
The Budget contains a section on the Government’s fiscal strategy, which outlines long-term intentions (a minimum of 10 years) for total net worth, as well as for a number of other factors. Also included in the Budget papers is the Budget Economic and Fiscal Update, which includes forecast financial statements through until the 2024 financial year.
Between the long-term projections and the forecast financial statements, we should get a clear view of the timeframe over which the buffer will be restored. As a reference point, last year’s Budget projected net worth would stabilise around 47 percent of GDP by 2026.
With the significant uncertainties of the present situation, there are real difficulties in producing forecast financial statements and long-term projections. We know things will not turn out exactly as forecast. Nevertheless, these documents provide us with the clearest picture of how quickly the net worth buffer will be restored, the shock of future crises mitigated, and the wellbeing of future generations protected.