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Understanding balance sheet sustainability

Crown solvency - a minimum requirement

A sovereign is solvent if it can meet its obligations or liabilities when they fall due. This requires it to be able to raise finance when needed, refinance debts as they mature, and meet any associated finance costs.

There are a number of important factors that impact on solvency that are not captured by the balance sheet. These include future tax revenues, discretionary social expenses and the possible triggering of implicit or contingent liabilities. These issues were outlined in Box 2.1.

Sustainability - the heart of fiscal strategy

Fiscal sustainability is a stricter form of solvency. It requires that a sovereign be able to meet its obligations as they fall due without significantly changing existing tax and spending policies.

Sustainable fiscal policy provides confidence that allows for better planning across the economy. This improves labour productivity, investment and innovation leading to better economic performance. A stronger economy in turn helps to support fiscal sustainability.

The importance of sustainable fiscal policies has been demonstrated following the global financial crisis, where countries with fiscal positions that have not been perceived as sustainable have faced significant fiscal adjustments to avoid further destabilising interest rate increases. This has frustrated efforts to improve economic growth.

To maintain fiscal sustainability, it is important that governments keep debt at prudent levels. Achieving this over the long run requires governments running a balanced budget or operating surpluses on average over the economic cycle.[54] This means that over the long run the primary use of debt is to finance capital expenditure.[55] These requirements are a key feature of the fiscal responsibility provisions in the PFA.

Benefits of debt

Debt creates a financial obligation that needs to be serviced through future revenues, but its sustainable use provides many benefits. Along with financing capital expenditure that would otherwise be delayed if funded through current revenues, debt can be used to finance short term fiscal deficits. This helps support stability in tax policies and government services.

Crown debt also supports capital markets in New Zealand by enhancing their liquidity and depth, providing a useful benchmark for the pricing of credit, and giving investors access to instruments that better meet their needs.

For these reasons debt should not necessarily be seen as something to be avoided, as long as it is used prudently.

Notes

  • [54]See http://www.treasury.govt.nz/publications/research-policy/wp/2013/13-20 for more discussion.
  • [55]Another benefit of this approach to fiscal policy is that it helps spread the financing costs of long-lived assets over the generations that benefit from them. It does this by transferring financing payment obligations to current and subsequent generations.
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