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Budget 2010 Home Page 2010 Investment Statement of the Government of New Zealand

Objectives for Crown balance sheet management

Recent events in New Zealand and other countries illustrate that there are a number of overall objectives for the effective management of the Crown's assets and liabilities. These are summarised in the box below.

Objectives for Crown balance sheet management

  • Provide a buffer against adverse future events, such as economic shocks and risks, and against the fiscal pressures of an ageing population.
  • Manage and reduce material risks to the Crown’s financial position.
  • Maintain a satisfactory credit rating and a low overall cost of capital for the Government and domestic borrowers.
  • Assist in addressing domestic economic imbalances (ie, low national savings, high net international investment position).
  • Ensure that scarce domestic resources are most effectively employed.
  • Ensure that long-term value is created and maintained for taxpayers – by maximising the benefits and performance of current assets.
  • Achieve a fair and equitable distribution of benefits, costs and risks between current and future taxpayers.

There are ongoing finance and opportunity costs associated with the Crown's existing assets and obligations - as set out in the box below - that are borne by taxpayers and that reduce the amount of capital available to the Government to invest in higher priorities or pay down debt.

These costs need to be fully recognised in decisions about the best use of Crown capital and the mix of assets the Government should own (in full or in part), in light of alternative ways to achieve the Government's policy objectives.

The cost of holding assets - the Crown's “cost of capital”

The assets on the Crown's balance sheet have a cost associated with them which is the cost of capital. If the Crown did not own as many assets, for example, debt would be lower than it would otherwise be, annual interest payments would be lower and the risks associated with ownership would be reduced.

Measuring the Crown's cost of capital is not straightforward. The Crown faces a direct and obvious cost of borrowing when it raises debt. This cost is almost always lower than that faced by the private sector because sovereign borrowers normally have a higher credit rating than private companies. The Crown's cost of borrowing (for the benchmark 10-year bond rate) is around 6% in nominal terms (ie, not adjusted for inflation) or around 4% in real or inflation-adjusted terms.

The fact that the Crown has a lower cost of borrowing than the private sector leads some to conclude that the Crown is necessarily best placed to finance investment. But the direct cost of borrowing is not the whole picture. Investments come with risks borne by taxpayers when Crown projects fail to meet expectations. For example, a newly constructed road may fail to support assumed traffic forecasts, or a poorly designed school building might lead to higher than expected maintenance costs over the course of its useful life.

The Crown's cost of capital therefore reflects both the direct cost of borrowing and the risks associated with each of the Crown's investments.

As a general rule, the best estimate of the Crown's cost of capital is given by the public sector discount rate of 8% in real terms. This rate reflects the level of Crown debt and the risks associated with the Crown's activities. If the Crown was to borrow more, or take on activities with greater risk, then its cost of capital would be expected to rise. Conversely, lower debt or reduced risk would be expected to reduce the rate.

There were $223 billion of assets on the Crown's balance sheet as at 30 June 2010. The interest expense on the Crown's debt for the 2009/10 year was $2.8 billion. But the full annual cost of capital associated with the assets is 8% of $223 billion, or $18 billion. To put this in perspective, the size of the Government's health budget is approximately $13 billion per annum.

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