Nicola Willis faces the tough task of reducing government debt while addressing long-standing infrastructure deficit. Photo / Richard Dale
In our annual Nation of Debt series, we tally all the nation’s debt statistics, from across the private and public sectors to give a big picture of how much New Zealand owes as a country.
ANALYSIS
The Government’s debt pile has risen by 11% over the past year, and by 130% from pre-Covid, to $215 billion.
While it’s downsizing the public sector to pay for tax cuts, the sluggish economy is seeing it receive less tax revenue than expected.
This is pushing out a return to surplus. Until the books are out of the red, the Government has to keep renewing its debt, rather than pay it down.
It’s spending more than $8b a year on interest, and $5b a year to unwind the Reserve Bank’s Covid-era money printing endeavour - the Large-Scale Asset Purchase programme.
It can’t shake the Covid hangover overnight and needs to balance prudence with investment to future-proof the country.
If the Government slashes spending too much, it risks unnecessarily cutting the quality of public services, only to defer necessary investment.
But if it doesn’t tighten its belt, the Reserve Bank could be forced to keep interest rates higher for longer. The Government would also be in a weaker position when it inevitably faces the next crisis.
Is Finance Minister Nicola Willis striking the right balance?
S&P Global Ratings continues to be comfortable with the AAA credit rating it upgraded New Zealand to in 2021.
“New Zealand is doing pretty well in a global context if you’re just talking about levels of credit ratings,” S&P director of sovereign and international public finance ratings Martin Foo told the Herald.
“But there is no doubt, the response to the pandemic was costly. It did result in a big expansion in the size of government. That’s going to mitigate any upward pressure on the credit rating.”
Foo said S&P continued to keep an eye on New Zealand’s current account deficit – the amount we owe to other countries, relative to what we receive – and was mindful of the country’s vulnerabilities.
New Zealand is a small trading nation, susceptible to natural disasters. High house prices mean individuals also have a lot of debt.
Nonetheless, Foo noted that while New Zealand’s credit rating was recently upgraded, the average sovereign rating has been downgraded by two notches since before the 2008 Global Financial Crisis.
Core Crown borrowings hit $215b on May 31 – up $121b from May 2019, before the pandemic.
Net core Crown debt (the measure commonly used by politicians) rose to 43% of gross domestic product (GDP).
Former Finance Minister Grant Robertson got it down to 19% of GDP by May 2019.
The Treasury expects net core Crown debt to peak next year at nearly 44% of GDP, before dropping back.
It doesn’t see it falling below 40% – Willis’ target – within its five-year forecast period.
How is debt still rising, when the Covid response is over, and the new government is branding itself as a responsible fiscal manager?
Because the books are in deficit, the Government is servicing the interest on its debt, not chipping into the debt itself. It’s doing so in a relatively high interest rate environment.
Core Crown finance costs are expected to rise to $11b in 2028 – having bottomed out at $2b in 2021 when interest rates were at record lows.
To put $11b in perspective, this is worth more than what will be spent on law and order this year, and is a pinch less than half of what will be spent on NZ Superannuation.
The Treasury has also agreed to help the Reserve Bank normalise the size of its balance sheet by buying back a bunch of the $55b of bonds (debt) the Reserve Bank created money to buy in 2020 and 2021 to suppress interest rates.
The Treasury is borrowing money to fund the buybacks, which it’s doing over several years.
The obvious downside of the Covid response, boosting economic demand at a time supply was constrained, was that it caused inflation.
On the one hand, this cost the Government more. On the other, higher prices boosted the amount of goods and services tax (GST) it received and pushed people into higher tax brackets.
Willis has adjusted tax brackets to account for some of the bracket creep, but changing income tax brackets so that people pay the same percentage of tax on their incomes as they did say 10 years ago, would be too costly.
Most commentators believe the brackets needed to be updated. But it’s debatable whether now is the right time given the state of the books.
S&P’s Foo was unconcerned because the Government is cutting spending elsewhere.
However, independent economist Cameron Bagrie was adamant that any additional spending at this time should go towards building new infrastructure and better maintaining existing assets.
“What we are seeing more and more of is the impact of short-termism,” Bagrie said.
“It almost feels like it’s come to a head. The glossiness of lower debt levels… ignores a fundamental reality – you’ve got this huge amount of deferred liabilities.”
Bagrie was concerned about the cost New Zealand would incur as the population ages, and more needs to be spent on healthcare and superannuation.
He thought it was inevitable kiwis would have to pay more tax to fund the infrastructure deficit. He believed the average person wouldn’t mind if they saw results.
Bagrie also saw asset sales on the horizons, saying the Government needed to redeploy the cash tied up in some of these investments.
The Government is currently working with the Treasury to write “purpose statements” to sharpen its thinking on the merits of owning various entities like Kiwibank.
As for the resizing of the public sector, Bagrie believed this was appropriate, but said the reality was, “We are going to end up cutting into some muscle.”
Victoria University adjunct professor and former Reserve Bank acting governor Grant Spencer similarly believed the state sector had become “too big and cumbersome”.
He acknowledged it was a tough time to adjust income tax brackets and believed there was a case to be made for changes to be automatic in line with inflation.
What about the cost of doing so, on top of addressing the longer-term needs Bagrie was concerned about?
Spencer didn’t believe tax hikes were inevitable.
“You have to wait for the dust to settle a bit,” he said, confident the economy would eventually bounce back, as the Reserve Bank starts cutting the official cash rate.
Indeed, with other countries also expecting interest rate cuts, demand for New Zealand exports should pick up.
New Zealand really needs to become more productive to grow. While this is easier said than done, it’s the least painful way of reducing government debt.
The Treasury, in the May Budget, noted how sensitive the Government’s finances were to even small variations in economic growth.
The agency pushed out its forecast return to surplus by a year to 2027-28, mostly due to the economy being more sluggish than it expected five months prior, but also thanks to the Government’s tax cut package.
It said the Government wouldn’t be able to maintain existing services while sticking to the spending allowances it set itself.
So, it would need to reprioritise spending and/or increases taxes.
“This will involve difficult choices and trade-offs for the Government which are likely to become harder over time,” the Treasury warned.
Flipping the debate around, Bagrie questioned what was the cost of underinvestment, or not borrowing enough.
“We keep kicking the can down the road and we can’t keep kicking the can down the road,” Bagrie said.
“It’s a difficult balancing act,” Spencer concluded.
Jenée Tibshraeny is the Herald’s Wellington business editor, based in the Parliamentary Press Gallery. She specialises in government and Reserve Bank policymaking, economics and banking.
Demand for bonds may well stay strong, but there's a catch.