4 New Zealand's fiscal framework

4.1  Public Finance Act 1989 requirements

The Public Finance Act (PFA) 1989 requires the government to manage total debt at prudent levels. The PFA also requires regular reporting to promote fiscal transparency through the disclosure of relevant fiscal information in a timely and systematic way.

Gross government debt in New Zealand briefly surpassed 70% of GDP in the 1980s. New Zealand's sovereign credit rating was downgraded from AAA to AA+ in 1983 and again to AA in 1986 and AA- in 1991 (NZDMO, 2012a). Since the early 1990s, reducing and maintaining prudent levels of government debt has been a goal pursued by successive New Zealand governments. This has been due to a greater acknowledgement of the importance of fiscal sustainability with this being formalised in the PFA as well as governments wanting to reduce the high costs of debt servicing. Wells (1987, 1996), Janssen (2001), Wilkinson (2004), Mears et al. (2010) and Brook (2013) discuss fiscal policy reform in New Zealand in more detail.

In terms of the government's IBC, the focus in the past was on ways to reduce debt servicing costs due to high debt and high interest costs (ie, high (1+r)^h+1d_n-1 in expression (4)), whereas the current debate around fiscal sustainability has tended to have a longer-term focus on potential future paths of government taxation and expenditure (ie, t_s-g_s). This is perhaps due to lower government debt levels and lower interest rates in the recent past and greater awareness of the potential effects of an ageing population. However, if the government's fiscal position is not well-managed, then debt servicing costs could again become a more acute issue.

The government's fiscal position generally improved after the 1980s until 2008. The level of government debt has risen in recent years as the result of fiscal policy decisions, New Zealand's domestic recession beginning in early 2008, the effects of the Global Financial Crisis (GFC), and the Canterbury earthquakes all impacting on tax revenue growth and government expenditure. The government's current fiscal position is less favourable now than it was when the first Long-Term Fiscal Statement was published in 2006.

Figure 2 shows government debt ratios as well as some of the targets that governments have set for debt from 1986 to 2012. The current National-led government has a target to bring net debt down to no higher than 20% of GDP by 2020 (Fiscal Strategy Report, 2013).

The government debt target was changed from a gross to net debt target in 2009. The reasons for the switch from a gross to a net debt target in 2009 and the new gross and net debt definitions are explained in more detail in the Fiscal Strategy Report (2009). Gross government debt is currently defined as debt issued by the government, less settlement cash and bills issued by the Reserve Bank. Net debt is defined as gross debt less government financial assets (excluding New Zealand Superannuation Fund assets and advances).New Zealand Superannuation Fund assets are not included as financial assets for the purpose of this measure because NZSF assets are held for specific policy reasons.[17] Advances, which include student loans, are also not included as financial assets because they are substantially less liquid than other government financial assets and are not held for purposes associated with government finances (Fiscal Strategy Report, 2009).

Figure 2: Government debt ratios and debt objectives, 1986-2012

Notes: (1) The life of each debt objective is approximate as objectives sometimes changed in Budget Policy Statements. (2) GSID = Gross sovereign issued debt; SC = Reserve Bank settlement cash; RB = Reserve Bank bills. (3) The net debt indicator excludes advances, such as student loans as well as NZ Superannuation Fund (NZSF) assets; advances were excluded from the net debt measure from Budget 2009 onwards. (4) The net debt indicator is not available prior to 1992 because data about advances is not available.

Of interest when examining the evolution of government debt is the relationship between the nominal interest rate and growth rate of output. Expression (4) shows that if the nominal interest rate exceeds the growth rate of output (i>y), then to stabilise the debt ratio the government must be running a primary surplus; if i<y in the future then to stabilise the debt ratio the government debt can run a small primary deficit; and if i=y in the future then to stabilise the debt ratio the government accounts must be in primary balance.

Figure 3 shows how the government's cost of borrowing has compared to the economic growth rate in New Zealand since the mid-1980s. The government's cost of borrowing is approximated by the average annual five year government bond yield. A more comprehensive measure would take into account the composition of the government's borrowing portfolio and the yields on its different components.

The government's nominal cost of borrowing has generally been above the economic growth rate since the mid-1980s, although less so during the 2000s. This is broadly consistent with recent experience of most developed countries (Escolano, 2010). The difference between the cost of borrowing and the economic growth rate has decreased on average since the 1990s. This could be at least in part due to the reduction in government debt as a proportion of GDP over this period (shown in Figure 3) as well as the reduction of general price inflation.[18]

Figure 3: Government cost of borrowing and economic growth, 1986-2010 (%)

Source: Statistics New Zealand, Infoshare; Reserve Bank of New Zealand

Notes: The 5 year bond yield is defined as the average annual 5 year bond yield. The nominal GDP growth rate is the annual average change in the production GDP measure, in current prices, seasonally adjusted; data are for March years.

To reduce debt (as New Zealand governments have tended to do since the mid-1980s) the government would have had to run larger primary surpluses than would have been necessary to stabilise debt. If this trend of i>y continues into the future then this would tend to suggest that governments will have to be running primary surpluses to reduce and stabilise debt. Moreover, if in the future public debt rises due to the effect of population ageing and rising health costs, for instance, this gap could increase again. If higher debt reduces economic growth, and if higher debt leads to higher interest rates, then the gap between interest rates and economic growth rates would increase again, thereby accentuating the challenge of achieving fiscal sustainability.