Robertson’s $50 billion debt buffer
The Minister of Finance was accused of imprudence when he suggested the Government's next debt target could be as high as 25 percent, but he actually undercut Treasury's suggestion by as much as $50 billion.
Grant Robertson has suggested he conservatively undercut Treasury’s advice on the correct level of Government debt. Robertson opted for a range which, at its lowest, sits 50 percent lower than Treasury’s recommendation.
That would equate to borrowings up to $50 billion less than Treasury’s suggestion, leaving a massive buffer between the Government’s debt level and Treasury’s suggestion.
Robertson’s remarks came after outgoing Treasury Secretary Gabriel Makhlouf gave a speech at Treasury on Friday on the optimum level of Government debt.
Last Month, Robertson announced the Government would move to targeting a debt envelope of net 15 to 25 percent of GDP when the current target of getting net debt to 20 percent of GDP expires in 2021/22. Makhlouf’s speech recommended a target of roughly 30 percent of GDP, based on a maximum debt level of 50 to 60 percent, and a buffer of 20 percent.
Even at the top end of Robertson’s window, his 25 percent target would still undercut Treasury’s debt limit by roughly $17.5 billion, using Treasury’s estimates of GDP for 2022 — the year the new rules come into force. At 15 percent of GDP, debt would be just $52.5 billion in 2022, far below the $105 billion Treasury would be comfortable with.
The specific advice Robertson received on his debt window has not yet been released, but he confirmed on Tuesday morning that Makhlouf’s speech was “broadly speaking” in line with the advice he had received.
“They said having a range would be a good idea and offered an idea about where that might sit — we’re not far away from it,” Robertson said.
He said that he was comfortable with the fact that he had added an additional buffer of 5 to 15 percent of GDP buffer between his own limits and Treasury’s suggestion.
“We just thought that represented a prudent range,” Robertson said.
“They’re not giving a hard and fast in that it should be 30, they just said a range would be a good idea,” he said.
How did we get here…
Makhlouf said that the maximum level of net government debt in New Zealand should be between 50 and 60 percent of GDP. This is based on an IMF calculation that the probability of debt distress increases if gross debt exceeds 85 percent of GDP (core crown worth — as it is calculated by Treasury deducts about 10 percent from the gross level of GPD to arrive at the net amount).
The Treasury secretary said this was the absolute upper limit using the wellbeing approach — any higher and the tax burden on future generations would introduce unbearable inequity to the system.
“[W]e should set the upper limit for public debt at the level where the material reductions in the welfare of New Zealanders, through the channels I have discussed, exceed the benefits of taking on more debt,” Makhlouf said.
Because debt at net 50 to 60 percent of GDP represents an absolute upper limit, Makhlouf recommended targeting a lower level, leaving a large buffer to absorb any shocks.
He said shocks in New Zealand tended to add at least 10 to 20 percent of GDP to our debt. Financial crises tend to cut the tax take and increase benefit expenses, leading to more borrowing, and natural disasters place a massive burden on public accounts.
“[F]ollowing post-war recessions, public debt in New Zealand has risen by an average of 10 percent of GDP in the five years after the recession,” Makhlouf told Treasury.
He said the suggestion for a 20 percent buffer came from the experience of the last 10 years, where debt increased by 20 percent of GDP following the Great Financial Crisis and the Canterbury earthquakes.
Using these numbers, Makhlouf suggested a “prudent” target of 30 percent, by subtracting the 20 percent buffer from the 50 percent “safe limit”.
"Taken together, they suggest a prudent net debt limit of around 30 percent of GDP – a 50 percent upper limit with at least a 20 percent buffer,” Makhlouf said.
“But this 30 percent is only an indicative limit to what a level of prudent debt might be, and an uncertain one at that,” he said.
Crying out for more
The speech, and Robertson’s response to it, were made at a time when the Government was caught between Opposition accusations of profligacy and calls from within the economic community for greater investment in capital projects that would improve New Zealand’s productivity.
As Makhlouf acknowledged, debt in New Zealand tends to follow the “golden rule” of not being spent on operational expenses like increases to pay and benefits, but on long-term capital projects like investment in roads, rail, hospitals, schools and other infrastructure.
Capital investment in New Zealand fell dramatically in the last decade. An ANZ report said capital spending for each 1000 additional people fell from $142 million in 2011/12 to just $37m in 2016/17.
There have also been concerns raised that the Government might not even have enough projects to green light, even if the money were available.