NZ’s fiscal position better than you think
New Zealand should pay more attention to the balance sheet and net worth when assessing our government’s fiscal position, and give less emphasis to debt, writes Victoria University of Wellington's Ian Ball
On October 10, the International Monetary Fund (IMF) released its latest Fiscal Monitor. Titled Managing Public Wealth, it explains the role of balance sheets in assessing a government’s fiscal position. The introduction starts with the sentences: “Public sector balance sheets (PSBS) provide the most comprehensive view of public wealth, yet they are little understood, poorly measured, and only partly managed. Standard fiscal analysis focuses on flows – revenues, expenditures, and deficits – with assessments of stocks largely limited to gross debt. The focus on debt misses large swathes of government activity and can fall victim to illusory fiscal practices.” This is a fair description of the situation internationally, but is not the case in New Zealand.
The day before the IMF released the Fiscal Monitor, the New Zealand Government released its Financial Statements for the Year Ended June 30, 2018. Those statements do have a balance sheet, and reveal a fiscal position that is unusually strong. More on that later. For the first time the financial statements explain, in the commentary, the nature and significance of net worth as a fiscal indicator: “Net worth measures the difference between the Crown’s total assets (what the Government owns) and its liabilities (what the Government owes).” Net worth is the 'bottom line' in the balance sheet – it shows how strong the Government’s finances are. “A positive level of net worth indicates that the Crown broadly has sufficient assets to meet its liabilities. Prudent net worth should provide a sufficient buffer, given the Crown’s expected future fiscal outcomes and risks to those outcomes, to ensure the Crown is resilient to fiscal shocks (such as natural disasters or significant deterioration in the global economy).”
While this focus on net worth is welcome, the concept is not new within New Zealand’s public financial management system. Indeed, one of the principles of fiscal responsibility in the Public Finance Act relates to net worth, requiring the Government to pursue its policy objectives in accordance with “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”.
New Zealand governments over the past two and a half decades have operated in a manner consistent with this principle, and it is reflected in the results. Our net worth is significantly positive, it has been growing for most of the past two and a half decades, and it has recovered more rapidly from the financial crisis than many other comparable countries.
The total net worth of the Government is $135,637 million, equivalent to 46.9 percent of gross domestic product. By comparison, the national governments of Australia, Canada, the United Kingdom and the United States all have negative net worth – their liabilities total more than their assets – and in some of those cases negative net worth is close to or greater than their GDP.
Since the current system in New Zealand was implemented in 1994, the Government’s net worth has increased virtually every year bar the four years following the global financial crisis and the Canterbury earthquakes. This was after two decades in which the government had a deficit every year.
And it has now been on a upward track for five years, whereas the same group of comparative governments show their net worth still on a downward trend (other, perhaps, than Australia, where net worth increased in 2017 for the first time since 2008). Using 2017 numbers – the latest available from the other governments – we can see how seriously their fiscal positions have deteriorated since the financial crisis.
But does a strong balance sheet really matter? The IMF thinks so. It cites evidence that shows (1) “financial markets consider governments’ asset positions in addition to debt levels in determining borrowing costs”, (2) “countries with stronger balance sheets pay lower interest on their debt”, and (3) “countries with strong balance sheets experience shallower and shorter recessions compared with those with weaker balance sheets”.
The lesson for New Zealand is we should pay more attention to the balance sheet and net worth when assessing our government’s fiscal position, and give less emphasis to debt. The Budget Responsibility Rules adopted by the present Government include debt but not net worth, notwithstanding it is one of the principles of fiscal responsibility. Yet we all know from our personal finances that borrowing for investment purposes (buying a house, for example) leaves our net worth largely unchanged as both assets and liabilities increase. This is very different to borrowing to meet current expenditure, which reduces net worth – because the debt remains but we have no assets to show for it.
Early in its paper, the IMF says “the balance sheet approach to fiscal policy is long overdue”. It concludes by giving one further, fundamental reason why balance sheets and net worth matter: “balance sheet analysis enriches the policy debate, by increasing transparency and asking how public wealth can be better used to meet society’s economic and social goals”.