3  Measuring the Crown’s exposure to risk

In this section, we take up the challenge of measuring the Crown's exposure to risk.

3.1  The Crown’s comprehensive balance sheet

The government publishes financial statements according to GAAP that include a balance sheet made up of the Crown’s financial and physical assets and its debts and other binding liabilities. Other resources and obligations that do not meet accounting recognition criteria are nonetheless important for risk analysis—in particular, the power to tax and the implicit obligation to provide social services. Incorporating the values of these rights and obligations is the essence of an approach to fiscal analysis known as comprehensive accounting (Buiter, 1984; Bradbury, Brumby and Skilling, 1999; Irwin, 2009). The approach has received recent attention from the rating agency Moody’s as a way to think about the riskiness of sovereign balance sheets (Moody’s, 2009).

The ideal measure of fiscal sustainability is comprehensive net worth, defined as the present value of the government's future net cash flows. Unfortunately, it is difficult to measure with any precision. Among other things, any measurement relies on assumptions about the policy choices of future governments. The measurements underlying GAAP net worth are more reliable, and useful for many purposes, but GAAP net worth does not provide a good indication of fiscal sustainability because it represents only a subset of the cash flows that the Crown will pay or receive. And GAAP net worth is not without its measurement issues. For example, the book values of many assets do not reflect their market value. Many SOEs in particular would probably sell for more than their book value.

A further measurement issue is that some of the Crown's GAAP assets are unlikely to generate future cash flows. For example, national parks and social infrastructure such as schools are unlikely either to be sold or to be used to generate revenues and therefore cannot be used to repay debt. The relevance of the volatility of these assets to fiscal analysis is therefore questionable. Yet these assets still deliver a stream of benefits to the Crown, and if the Crown did not own them, it would presumably have to lease them to meet its implicit obligations. If so, holding the assets reduces future cash outflows.

Because each measure of net worth has advantages and disadvantages, we look at four measures of the Crown's net worth: GAAP net worth; net worth excluding social assets; and two measures of comprehensive net worth. One starts with GAAP net worth and adds the present value of future primary revenue and subtracts the present value of future primary spending flows.[9] The other excludes social assets. These measures are defined more precisely in Table 2.

To quantify future primary revenue and spending we use the projections contained in Treasury's Long-term Fiscal Statement published in October 2009. The Statement contains two scenarios of future spending—one based on historic trends and the other on the Government's stated fiscal strategy. Both are relevant as interpretations of the Government's spending commitments. Table 3 reports estimates of the comprehensive balance sheets constructed from each of these scenarios. The projection of historic trends leads to an unsustainable increase in debt, whereas the government’s stated fiscal strategy is sustainable. The projection of historic trends helps understand the implicit liabilities the government faces under current policy from population ageing and the growth in the cost of government services such as healthcare. But it is inconsistent with the Government’s risk-management objectives. So we base our analysis on the projections contained in the sustainable debt scenario.

Note: A nominal discount rate of 10% has been used to calculate the present values of primary revenue and expenditure. The long-term fiscal projections extend to 2050. An infinite discount horizon is used by assuming primary revenue and expenditure in subsequent years each grow at a constant rate, determined by the final-year rate of growth.

Sources: New Zealand Government, the Treasury, authors' calculations.

In Table 4 we report our calculation of net worth excluding social assets. At −$3 billion, it is about $100 billion lower than GAAP net worth. The difference is the estimated value of social assets.

Sources: New Zealand Government, authors' calculations