Govt debt - it's the trend that's the worry

For 15 straight years until the recession of 2008-09, the New Zealand Government ran surpluses and paid down debt.

Now it is hellbent on returning to surplus as soon as possible. The OECD is the latest to urge it to do so.

As elsewhere, keeping domestic demand afloat by means of fiscal deficits may have been necessary, says the organisation, but now financial markets have shifted their focus from banking troubles to sovereign debt burdens.

"The New Zealand Government thankfully has no worrying sovereign debt burden, both because of its low debt going into the crisis and its lack of any need for bank bailouts afterwards."

But with two ratings agencies having put New Zealand's sovereign rating on negative outlook because of the country's high external debt, even economic recovery poses a risk: the prospect of widening current account deficits caused by growing demand for imports and rising profits at foreign owned companies.

"The main protection New Zealand has against such risks is its strong reputation for fiscal probity, which must at all costs be preserved," the OECD says.

The strategy the Government outlined last December - before the February earthquake intervened - envisaged a return to surplus in the 2014-15 fiscal year and a surplus of 2 per cent of GDP (about $4 billion in today's dollars) four years later, which would enable contributions to the Cullen Fund to be resumed.

"With the economy in a delicate state the Government might be rightly concerned about imposing fiscal pain on it too rapidly for fear of jeopardising the recovery," the OECD says. "Yet 2018 seems late to be getting back to 'minimum' surpluses, especially when monetary policy has headroom for action."

The concern about government debt is not so much about its level, but the pace at which it is increasing. In June 2008 net government debt was $10 billion, or 5.6 per cent of GDP, and gross debt $31 billon, or 17.2 per cent of GDP.

By next month net debt is projected to be $42 billion, or 21 per cent of GDP, and gross debt $67 billion or 33.3 per cent.

And those projections were made before the February earthquake, the fiscal costs of which have to be recognised as soon as they can be quantified.

Even before the quake, the cash deficit in the current fiscal year was projected to be $15.6 billion - the famous $300 million a week.

Hence the mantra: The Government cannot keep borrowing at that rate.

But then again, there is no reason to expect that it would need to.

Only some of the deterioration in the fiscal bottom line, and the rise in debt, results from policy choices to increase spending and cut taxes.

Much of it is the result of "automatic stabilisers". The recession cut tax revenue and boosted spending on things like the unemployment benefit. But when the economy recovers those effects will reverse, just as automatically though with a lag, and the fiscal bottom line will improve again.

The International Monetary Fund attributes about 40 per cent of last year's and this year's deficits to cyclical effects.

In addition, the debt market shows no sign of wariness of New Zealand government debt.

Quite the reverse. The most recent bond tender was oversubscribed nine times for one maturity and seven times for the other, and yields remain low by historical standards.

Indeed, the Debt Management Office has just announced it is stepping up its borrowing programme to take advantage of "favourable market conditions" and reduce its borrowing in future years.

About 63 per cent of government bonds are held by overseas investors.

"The New Zealand name sells well overseas" says Bank of New Zealand chief economist Tony Alexander.

"Partly that reflects the government having run surpluses for 15 years. But it is also confidence in the banking system, because if you have confidence in the banks, you are confident they are doing some decent lending on the other side and you will get your money back."

New Zealand Institute of Economic Research director Jean Pierre de Raad sees government debt more as a chronic than an acute problem.

"It is not so much where we are today that is a worry but looking out 10 to 20 years' time, with the pressures of an ageing population not only on the fiscal side but on a household savings rate which is already weak," he says.

"There has been a lot of focus on getting back to surplus soon. That's all fine and we probably need to do that, but what is really important is the longer-term picture, which we are really not tackling - super and health care."

Net govt debt

June 2008: $10 billion, 5.6 per cent of GDP

June 2011 (projected): $42 billion, 21 per cent of GDP