Monday, 20 May 2013

Debt higher than budget figures show - AFR 17/5/2013

 AFR -17th May 2013

Debt higher than budget figures show

Christopher Joye

I hate to be the bearer of bad news, but you’ve been misled about two key things on Australia’s financial situation.

First, the debt figures touted by the government, its lobbyists and certain sections of the media suffering Stockholm syndrome after the usual press gallery conditioning and a six-hour budget lock-up are totally bogus. The real numbers are much worse.

Second, this budget is not the austere, responsible plan that shores up the Treasurer’s credibility and validates Australia’s commitment to balancing its books through the cycle.

Let’s deal with debt first. Actual or gross debt is a much more transparent measure of how much Australia owes other people than the “net” figures bandied around. For example, the government uses a big chunk of the $85 billion Future Fund, which Treasury says “was established … to accumulate financial assets and … address the Government’s unfunded superannuation liability”, to lower its net debt figure.

This might be reasonable if the government added the “unfunded super liability” to its debts to begin with. But Treasury discloses that “net debt does not include superannuation-related liabilities”.

The government also doesn’t recognise liabilities associated with the free taxpayer guarantee of about $700 billion of bank deposits (they are all “contingent”). If the deposit guarantee was priced, this would not be an issue – but the Treasurer has ignored advice from the Council of Financial Regulators to do so.

All up, the government reduces its gross debt by about $70 billion through an “other investments” line item, including Future Fund assets. If we remove this influence, the low net debt figure of 10.6 per cent of GDP in 2012-13 jumps to about 16 per cent.

Here’s the next debt scam. In contrast to many other nations, Australia has a federated structure where government is divided among Commonwealth, state and local layers.

But when talking about Australia’s government debt, politicians and the media mostly like to assume state and local government does not exist. This is despite the Commonwealth explicitly guaranteeing state government debts during the GFC.

Remarkably, the most commonly cited net debt calculations also exclude the debts of the wholly government-owned companies, like the various state financing entities, Australia Post and the NBN, which are all guaranteed by government.

The latest budget papers do have a table that breaks out net debt by the Commonwealth, state, and government-owned concerns.

And here’s the shock: Australia’s net debt figure is almost twice the 10.6 per cent estimate you’ve been told is so comforting – the real number was around 20 per cent in 2012-13. Importantly, this has exploded off a sub-zero base in 2007 when we had allegedly no net debt.

Excising the influence of the Future Fund and “other investments”, total government net debt rises to roughly 25 per cent (see first chart).

When financial markets consider a company’s riskiness, they focus on the gross level of borrowings relative to assets. We can do the same.

In 2007, the Commonwealth and states owed about $150 billion. These were just the bonds on issue and ignore other borrowings. By December 2012 Commonwealth and state government debt on issue had more than tripled to $500 billion. That’s nearly 35 per cent of GDP and excludes government-guaranteed companies. The true gross debt-to-GDP ratio is probably circa 40 per cent. While that is still relatively low, it is not the ultra-benign image that has been projected.

The second chart shows how Australia’s actual debt-to-GDP ratio has changed since 1990. You can see there’s been a big increase in leverage across the country, back towards levels after the searing 1991 recession. The difference, of course, is that in 1991 the jobless rate hit 11 per cent, in contrast to the 5.9 per cent GFC peak. And whereas the RBA floored its cash rate to 3 per cent in 2009, it averaged 8.5 per cent over 1991 and 1992.

This brings me to the final scam: this budget and its predecessors have significantly elevated Australia’s financial risks and are not the prudent policy settings of prescient seers. The decline in the $A is one sign of this.

The main reason we avoided the worst of the GFC is that we were in the biggest investment and export price boom in 150 years, and most of our trade is with countries – China, Japan, South Korea and India – not directly involved in the crisis.

Unfortunately, the folks running the show have expended Eamon Sullivan-like fiscal and monetary energy on policy that should have been pacing itself like Kieren Perkins.

A related concern is that the supposed commitment to balancing the books through the cycle is not backed by history. Taking government forecasts at face value, Australia will have produced surpluses just 40 per cent of the time since 1980. Even if we look at its performance since 1990, Australia will have delivered surpluses in only 11 of the 25 years to 2014-15.

The big sleeping problem is there is not much ammo left. While our jobless rate has been effectively unchanged for two years and the economy has bumped along close to its trend rate, the government has racked up cumulative budget deficits of about $200 billion. And now the RBA has pre-emptively slashed its cash rate to the lowest level in history.

If Australia suffers a big external shock in the next few years – not my base case – we could be in for a nasty surprise. And while nobody wants to talk about it, you might have to kiss goodbye to the AAA credit rating that keeps our borrowing costs so low.

Talking down Australia’s credit rating is taboo in market economist land because the big banks all rely on it for their own ratings. If the nation gets downgraded, so will they, which will drive up funding costs and undermine their profitability.

Here are two ideas to help lower the risk the budget books are cooked again. First, why not force Treasury to follow the RBA’s lead and publish 70 and 90 per cent upside and downside “confidence intervals” in their GDP forecasts? This would give people a real sense of what could go wrong.
Second, why not have Treasury simply use the RBA’s inflation, GDP, and unemployment rate forecasts, which would give the projections some bona fide independence?

Christopher Joye is an economist and director of YBR Management.