5.7  Risk summary for each scenario

In all three scenarios, the final level of risk will depend firstly, on how risk averse markets are at the time and secondly, on how the government responds. Almost anything is "survivable” in the sense that governments cannot become insolvent and the decision to default is, first and foremost, a political decision. The question is, would the government prioritise debt repayments, and what impact would the required consolidation have on the nation as a whole? A sharp consolidation in a crisis situation will have welfare effects. At some point populations may prefer the delayed cost of a debt default (higher borrowing costs or lack of access to markets) over the immediate pain of a fiscal contraction.

Table 8 summarises the results of our three scenarios. In our average OECD scenario the shock creates limited liquidity risk, as the size of consolidation is manageable. Debt would also stabilise without any action, although at 54% of GDP debt would place a heavy toll on future resilience. It would be preferable to reduce debt, although the government would have a range of options around how this is phased.

In the Spanish scenario, debt continues to grow and reaches 117% of GDP within 15 years. Markets may give the New Zealand Government limited leeway, but, given the continued growth in debt at the end of the projection period, some degree of policy change would likely be necessary at some point. Moves to stabilise debt over five years would require zero additional spending and cuts of $1.1 billion per year for five years. This equates to a change of 5.5% in the operating balance - a change that is large, but not historically unprecendented. Cuts of this size would create adjustment costs if enacted in a crisis environment. However, to the extent that markets are willing to extend some leeway, the government may still be able to delay some adjustment until the private sector starts recovering.

The Irish scenario, our most severe, would likely require immediate adjustments to stabilise debt. Debt reaches 248% of GDP and is still growing exponentially after 15 years. Under this scenario, policy is clearly no longer sustainable and the government would have to act quickly to retain the faith of markets. This paper investigates a scenario with zero additional spending and spending cuts of $3.2 billion per annum to stabilise debt at 73% of GDP after five years. It is conceivable that a one-off cost, such as a banking crisis, could, increase this figure to nearly 90% of GDP (the point at which the IMF suggest that debt dynamics could become unsustainable). Markets may question the size of consolidation needed or the level at which debt stabilises. Thus, under this scenario, depending on how markets react, New Zealand may still need to seek emergency funding until credibility could be reestablished.