Five years on from the onset of the pandemic, it is becoming clear the Government’s finances are suffering from long Covid – not just a Covid hangover.
Many Kiwis have taken their medicine – stomached high interest rates and faced job cuts, as the Reserve Bank has curbed inflation and the Government removed pandemic-era spending initiatives.
But still, the Government’s books are not back in shape.
In fact, its debt position is expected to continue deteriorating before it improves.
Treasury is warning the books are in a “structural” deficit.
Spending is at a fundamentally unsustainable level, even once you strip out the ups and downs associated with different parts of the economic cycle.
The Government’s finances aren’t just suffering from a hangover that will pass. The chills run deeper.
What’s more, they are becoming harder to cure because the population is ageing.
Barring something transformative, like energy prices plunging, it looks like strong economic growth won’t be enough to get the Government’s finances “back on track”.
New Zealand is not in trouble, but it does need to brace for deeper spending cuts and/or higher taxes.
Core Crown borrowings rose by 11% to $239 billion in the year to May – that’s 156% higher than in May 2019.
Net core Crown debt was worth nearly 42% of gross domestic product (GDP) by the end of May this year.
Pre-Covid, this figure sat at 19%. Last year, Finance Minister Nicola Willis promised to put it on a downward trajectory back below 40%.
But Treasury expects debt to peak at 46% of GDP in 2028 – a level slightly below the 50% limit it deems prudent for normal times.
Because the Government’s books are in the red, it’s not repaying its Covid-era debt. Rather, it’s refinancing this debt, while issuing new debt to pay for new commitments and mounting interest costs.
The Government isn’t getting on top of its fiscal deficit, because it isn’t cutting spending aggressively enough.
While high inflation pushing income earners into higher tax brackets has been a saviour for Governments for some time, the sluggish economy has weighed on the tax take.
GDP growth was weaker than expected through 2024, with the Reserve Bank downgrading its forecasts for growth through 2025.
While high global dairy prices are supporting the agricultural sector, the US tariffs have created uncertainty, which has hampered sentiment.
With the average interest rate paid on the country’s stock of mortgage debt falling to 5.66% in June, many borrowers are also yet to really feel the impacts of lower interest rates.
Meanwhile, they’re still grappling with high living costs.
Looking further down the track, healthcare and New Zealand Superannuation costs are expected to rise dramatically.
The annual cost of superannuation rose by 39% between 2020 and 2024 and is expected to rise by another 28% by 2028, to nearly $28b (in nominal terms).
Inland Revenue estimates that in 35 years’ time, a quarter of the country’s population will be over the age of 65 – up from about 16% today.
One might look at the situation, and say: “Well it isn’t great, but why should we cut our cloth when other countries are more indebted than us, and face similar demographic challenges?”
Treasury’s response would be that the New Zealand Government needs to maintain extra-large buffers, because the country is heavily reliant on trade, indebted to offshore investors, susceptible to natural disasters and has high levels of household debt.
The main thing is that the Government needs to be able to assure the domestic and foreign investors it borrows from that they will be repaid.
If it struggles to provide this assurance, investors will demand higher returns.
New Zealand Government Bonds are currently seen to be relatively low-risk.
In 2021, S&P Global Ratings upgraded New Zealand’s credit rating to AA+. It is now in the same tier as Australia, the US, Taiwan, Hong Kong, Finland and Austria.
While the outlook for New Zealand is “stable”, S&P is wary of the fact New Zealand’s deficit is among the deepest of its peers (as a percentage of GDP), so wants to see it shrink quickly.
“If it doesn’t narrow in the next few years, we may start looking at the AA+ rating,” S&P analyst Anthony Walker told the Herald.
If New Zealand’s credit rating was downgraded with its peers, which face similar headwinds, it wouldn’t be any less attractive, relatively speaking.
However, New Zealand’s geographic isolation means it’s already on the back foot.
The Government needs to offer investors higher returns than its counterparts in, for example, Europe that have weaker credit ratings, for investing offshore in a different currency.
Some will argue New Zealand shouldn’t be hamstrung by the threat of the so-called “bond vigilantes”.
However, they have proven to be quite successful recently, throwing tantrums when Governments in the US and UK have put unsustainable spending plans on the table.
Longer-term US Government bond yields are currently relatively high, as investors are wary of the US’s ability to repay its debt.
This dynamic has put upward pressure on other government bond yields, including New Zealand Government Bonds.
What’s the upshot? New Zealand pays more interest on its debt.
Core Crown finance costs are currently surpassing $8b a year, which is about 2.5 times the size of the country’s defence budget.
Parties from across the political spectrum agree the Government can’t pull back from investing in healthcare, education and infrastructure.
To varying degrees, they accept Governments can’t be so fixated on debt that they lose sight of the cost of under-investment.
Opposition parties argue the Government is cutting operational expenditure, like staffing costs and welfare, too much.
Nonetheless, ahead of the election the debate will likely turn to whether the big-ticket item – NZ Super – could be made more affordable.
There are also calls from the likes of ANZ senior economist Miles Workman for more means-testing and targeted spending to those who really need it.
His view is that there is still more fat that can be cut out of the system.
Inland Revenue is looking at ways of increasing the Government’s tax take, if expenses are insufficiently cut.
It is supportive of hiking the GST rate, if need be.
Calls for a capital gains tax continue to be made, including by those of the view the country’s tax base needs to be broadened.
Harbour Asset Management co-chief executive Andrew Bascand believes a small stamp duty on the sale of residential property could be an efficient way of generating more revenue.
While the coalition Government opposes the introduction of new property taxes, it is looking at effectively hiking taxes by applying more of a user-pays model to public services.
It wants to welcome private investment into public assets – a dynamic that could see the part-owners or operators of these assets charge for their use.
Think about more toll roads, charges for using busy roads during peak hours, targeted levies for those who buy property in new developments and fees for those whose properties increase in value thanks to major public investments in their neighbourhoods.
Ideally, New Zealand finds a way of boosting growth sustainably - becoming more productive, rather than inflating house prices and importing cheap labour, as has been done in the past.
Otherwise, higher interest costs to compensate investors for taking on more risk lending to New Zealand, or deeper spending cuts and higher taxes, are inevitable.
Some tough political choices will need to be made. “She’ll be right” is a good motto – until it isn’t.
Monday: NZ nears trillion-dollar debt burden
Wednesday: Consumer debt: What are Kiwis borrowing for?
Thursday: Student debt: How big? How bad?
Jenée Tibshraeny is the Herald’s Wellington business editor, based in the Parliamentary Press Gallery. She specialises in Government and Reserve Bank policymaking, economics and banking.