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The Liquidity of the Crown's Balance Sheet

Sovereign liquidity management has received strong attention in recent years…

Despite the recent global financial crisis, the creditworthiness of the Crown remains strong and as such the need for liquidity is relatively small. However, the Crown is mindful of the importance of sovereign liquidity management, an importance which has been highlighted by recent events. Internationally, a strong reliance on credit markets has seen many governments face significant funding pressures when heightened solvency concerns, both perceived and real, resulted in a reluctance of these markets to lend. Domestically, the recent Canterbury earthquakes have also illustrated the possibility of funding requirements arising from extreme and unexpected natural events.

Strong liquidity buffers are unlikely to have entirely eased the funding pressures on governments, nor would their use necessarily be preferred to borrowing to meet the costs of natural disasters. However, asset liquidity provides the Crown with flexibility to reallocate resources if required and as such having an understanding of this ability can help reduce its market reliance when such events occur.

…but Crown liquidity should have a broader focus than financial marketability alone

Understanding liquidity is also an important component of the New Zealand Crown's risk management. Broadly speaking, liquidity is an organisation's ability to meet obligations as they fall due without incurring unacceptable costs. Typically, the main factors which influence this ability are the access to debt markets and the financial marketability of assets - that is, the ability of different assets to be sold within a specified period without requiring a heavy discount.

When assessing the Crown's liquidity, two other factors should also supplement this:

  • Legal accessibility - many assets on the Crown's balance sheet, such as the assets held by the CFIs, have their use restricted by legislation. Legislative changes are complex, will take time and thus reduce the ability of the Crown to use these assets for meeting short-term obligations.
  • Social costs - for the Crown, “unacceptable costs” should include both financial and social costs; for example, the possible detrimental effects to social services. Some judgements regarding which assets can be sold with fewer practical implications than others are possible.

Governments also have unusual capabilities to meet liquidity requirements from sources off the balance sheet. A government's power to tax, the potential existence of strong international credit lines and its control of the money supply provide, at least in principle, an extensive ability to meet obligations without drawing on assets. Although these are valid options for the Government, they do not lend themselves to balance sheet-based liquidity analysis and so their consideration is not included in this Supplement.

The Crown's assets can be roughly divided into three liquidity classifications...

The Crown's balance sheet assets can be loosely grouped into three liquidity classifications:

  • Liquid assets: assets which are realisable within three months at full market value, face no legal restrictions and where liquidation would have limited short-term social costs. These consist of NZDMO's marketable assets which are held primarily for day-to-day fiscal purposes, along with tax and student loan receivables due within a three-month period.
  • Fairly liquid assets: assets which can be realised at or near market value, but where disposal could require legislative changes and/or involve moderate social costs. For example, assets held by the CFIs are legally ring-fenced for specific uses, and drawing on them would expose the Crown to significant future fiscal obligations.
  • Illiquid assets: assets which are unmarketable within a three-month period,[16] or where disposal would involve significant social costs. This includes: all social assets, owing to the undesirability of affecting social services and the difficulty in identifying saleable assets in the short term; and SOEs, owing to their largely publicly-untraded nature and the subsequent difficulty in selling any entity within the timeframe.

A summary of each classification and a portfolio breakdown is shown below.

Table 3.1 - Liquidity classification as determined by financial marketability, legal accessibility and practical costs
Liquidity classification Assets included In liquidity classification $million[17]
Liquid assets
  • NZDMO marketable assets
  • Tax receivables (incl. repayments currently due on student loans and social benefits)
13,531
Fairly liquid assets
  • CFIs' marketable assets
  • RBNZ's marketable assets
  • Shares in listed companies (eg, Air NZ)
59,305[18]
Illiquid assets
  • Social assets (all assets held by agencies and CEs, incl. student loans where repayments not yet due but excl. tax receivables)
  • SOEs' assets
  • All financially unmarketable assets
150,327
Figure 3.2 - Asset portfolio breakdown by liquidity classification
Figure 3.2 - Asset portfolio breakdown by liquidity classification.
Source: The Treasury

...to provide an indication of the liquidity of the Crown's balance sheet

The above figures show that a third of the Crown's balance sheet is held in either “Liquid” or “Fairly liquid” form. The large proportion of illiquid assets is appropriate given the dominance of social assets and PPE on the Crown's balance sheet. Of the approximately $73 billion of assets potentially suitable for short-term liquidity purposes, the majority ($63 billion) is held in the financial portfolio.

Notes

  • [16]A conservative approach has been taken to financial marketability in this analysis. All assets excluding cash and equivalents, receivables, marketable securities and deposits due within 12 months are deemed “unmarketable” for the three-month timeframe considered here.
  • [17]All figures are based on February 2011 data, which are the most recent available at the time of publication.
  • [18]Based on the book value of Air NZ.
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