Dialogue: Caught between a fiscal rock and a hard place

By DAVID CARTER

In the leadup to the release of the December Economic and Fiscal Update, market economists are taking a hard look at the Government's accounts - and they don't like what they are finding.

Finance Minister Michael Cullen's borrowing programme is finally receiving the scrutiny it deserves as the fiscal situation continues to deteriorate.

National warned Dr Cullen at the time of his first Budget that he was buying himself some major political and fiscal management problems down the track. He frontloaded his expenditure, his growth forecasts were too optimistic and everyone knew he would face inevitable spending pressure in election year.

In the May Budget, Dr Cullen wiped $2.7 billion off forecast operating balances and flagged a financing requirement of $7.6 billion for 2001-2005 - $4.8 billion of which was to be met by rising debt.

The December Economic and Fiscal Update is likely to wipe another $1.8 billion off operating surpluses because of lower growth, and money is also required for Air New Zealand and the Auckland rail corridor. These factors could increase the financing requirement for the five-year period to more than $10 billion.

In the Budget, Dr Cullen took the debt position to the very edge of what was prudent. Any deterioration in the debt outlook will now have debt rising as a percentage of GDP - the first time we will have been in that situation for more than 10 years.

Rising debt implications of the increasing cash shortfall are causing some economists to call for the Government to cut its contributions to the super fund - arguing the fund adds nothing to the economy anyway. I totally agree.

The market is becoming increasingly concerned about its capacity to absorb the extra debt. Some argue this is leading to a permanent rise in risk premium on New Zealand interest rates.

That means businesses looking to invest and households paying off a mortgage will face higher interest rates.

The result will be lower growth.

Dr Cullen is caught between a rock and a hard place. He's given himself only $815 million new money for his election-year Budget, and that was only after blowing his spending cap in last year's Budget.

That spending room needs to cover rising pressure in health, to which he has already allocated half of this money, and election year giveaways to an increasingly fractious coalition.

The pressure is even greater because he knows that, politically, there are two things he can't do.

On election, the super fund must have looked like an easy ask when faced with rising structural surpluses.

But it's all much harder than it looks - especially when you wipe a cumulative $4.5 billion off those surpluses in just a few months.

An average $2 billion dollars a year for a savings fund is looking tougher with every downward revision of the numbers.

He can't cut the super fund contributions, because then his 100-year plan is effectively dead.

Nor can he blow his spending cap again, particularly under the heightened scrutiny of the Government's fiscal position.

They are already trying to take the pressure off via health deficits, placating teachers with small pay increases and better conditions and raiding the balance sheets of CRIs.

So Dr Cullen has a problem. The Coalition's left want to spend more, but he wants to save for the future and he knows the markets will not like rising debt. But it's getting harder to make it all add up.

* David Carter MP is the National Party's associate finance spokesman.