Brian Fallow: Prudent Cullen reins in debt

COMMENT

This Budget does nothing to undermine the reputation of fiscal prudence enjoyed by Michael Cullen or for that matter by New Zealand as a country.

Few Governments could credibly combine such a major increase in social spending with the announcement of a more stringent target for Government debt.

The aim has been to keep gross debt under 30 per cent of gross domestic product on average over the cycle. Currently it is about 25 per cent.

Yesterday Cullen said the target was now to slowly reduce the gross debt to GDP ratio over the longer term, passing through 20 per cent of GDP before 2015.

This is a very low ratio by international standards. In Europe for example Governments are struggling to stay or get below a ceiling of 60 per cent.

Even with the spending package announced yesterday, Treasury is forecasting operating surpluses (excluding revaluations and accounting changes) of 3.9 per cent of GDP this year and 3.2 or 3.3 per cent for subsequent years.

True, out of those surpluses have to come contributions to the Superannuation Fund, to the tune of 1.5 per cent of GDP a year.

But that still leaves a large buffer.

The gross debt target is the one which matters because it captures all Government spending, capital as well as operating.

Over the next five years the Government expects $22 billion in positive operating cash flows.

But out of that it will put $11.1 billion into the Cullen fund, $1.9 billion in new capital into state-owned enterprises, another $6.2 billion in capital expenditure, $1.9 billion for the purchase of foreign reserves and $5.7 billion for student loans, leaving it having to borrow an extra $4.9 billion ($800 million of it in the year ahead).

But even though Government debt will grow in dollar terms, the economy will grow even faster, reducing the debt to GDP ratio.

All this may seem arcane, but it is worth real money to borrowers.

Research by the Reserve Bank indicates that the reduction in Government debt over the past 20 years has shaved about 1 percentage point off New Zealand interest rates.

If that reputation for fiscal virtue, as the financial markets define it, were lost we would all pay a price in terms of a higher cost of capital.

Since Labour took office in 1999 gross debt (relative to GDP) has fallen from 33.7 per cent to 25 per cent. The decline from here will be slower, but it will bite, Cullen warned yesterday.

In other words major tax cuts would require one of three things - equally major spending cuts, a retreat from the debt target (risking adverse market reaction and higher interest rates) or scrapping the Superannuation Fund.

On this last option the National Party seems equivocal.