Warning on costs of Labour's student loan plan

The cost of Labour's interest-free student loans could blow out to nearly $1 billion - three times the Government's prediction - a leading bank economist has warned.

Westpac chief economist Brendan O'Donovan has released costings he concedes are extreme, but which predict the annual bill for Labour's election pledge will be far higher than the $300 million Education Minister Trevor Mallard says.

"Our position is not to comment on election issues; that's a strong preference," Mr O'Donovan told the Weekend Herald.

"This one, I think, carries just such large fiscal risks and potential long-term impact on the economy, I felt beholden as an economist ... to try and get sanity into the debate.

"In our view, this election lolly would result in a chronic case of tooth decay. We implore that the 'free interest' proposal is not made an election pledge."

Other economists spoken to yesterday also predicted that the policy would cost much more than Labour has suggested.

Mr Mallard said yesterday that Westpac's analysis was "extremist and scaremongering".

He said there were stringent controls on how much students could borrow, and they could not get large amounts of extra cash.

Labour's figure of $300 million a year is an estimate. The party's own briefing papers say a definite costing is not possible because it is hard to predict what students will do. Its figures assume little behavioural change.

Mr O'Donovan, working on the premise that all students have been handed an incentive to borrow as much as they are entitled to, and that every student will do that, says the cost could reach $1 billion a year.

He doubted the costs would blow out as badly as his worst-case predictions. "But it's always useful for any policy to have a look at what your maximum risk is, and it's a whole lot more than $300 million."

Internet blog sites are already awash with predictions that students will take the maximum $150 a week in living costs and invest it or spend it on boosting their lifestyles.

The Treasury has not costed the election pledge because Labour says it is party, not Government, policy.

For that reason it is not preparing costings for the pre-election opening of the books by the Government next month.

National's education spokesman, Bill English, said it defied common sense to suggest students would not try to get as much interest-free money as they could.

Mr Mallard said students still knew they would have to pay back any money borrowed, even without interest.

"It is highly unlikely that all students who have not got a loan will now borrow money, and even more unlikely that they will borrow the maximum."

Economists at others banks said they had not costed the policy, but said if there was no cost for borrowing, then the takeup of loans could be expected to rise.

ANZ-National Bank chief economist John McDermott said it would take a couple of years for the impact of the policy to be known.

"If you set the wrong incentives, if it gets overabused, it will get closed down and rightly so."

BNZ head of market economics Stephen Toplis said people should not get incentives to borrow more than they needed.

Victoria University professor Jonathan Boston, who helped develop the original loans scheme, said there was certainly a risk the policy would encourage borrowing - "the magnitude of which is extremely difficult to estimate".

Meanwhile, Labour has changed the notes on its student loans calculator following accusations that it was overstating the savings.

The website now says the calculator is there to give "an estimate" of the impact of Labour's policy on individuals, and explains more fully the factors the calculator takes into account. It also notes that the variables can differ from those of other student-loan calculators.

Loan rules

* Fulltime students can borrow the total amount of their tuition fees.

* They are not handed cash; the money is paid directly to their tertiary institution.

* Money can also be borrowed for living expenses, to a maximum of $150 a week - paid weekly, not as a lump sum.

* Students may also borrow $1000 for course-related expenses, but must provide proof of the costs.

- additional reporting: Claire Trevett