CHAPTER 6
BACKGROUND
The Government has acknowledged the existence of a debt problem.
A feature of the Victorian Government's economic and financial policies has been the greater reliance on borrowings than in other States, except Tasmania. The appropriateness of this has come under increasing questioning, particularly since the down-grading in June 1990 by Moody's of the rating assigned to $A denominated debt guaranteed by the Victorian Government. (1) This was the first such down-grading of $A denominated debt of an Australian State since World War II and, while the rating (Aa1) remained at a high level, the basis of the down-grading -- the high proportion of revenue going to meet debt servicing costs and the Government's "diminished capacity to address its economic and financial problems" -- highlighted the potential for high borrowing policies to result in political and economic instability. Further emphasis has been given to this potential by the announcement in March-April 1991 by both Moody's and Australian Ratings that they were considering a possible further down-rating. On that occasion Moody's identified a number of areas of concern, viz, continuing national economic slowdown, growing infrastructure needs, continually high budget deficits, political inertia, high level of contingent liabilities and potential for further weakening of Commonwealth assistance.
In his 1990-91 Budget Speech the Victorian Treasurer acknowledged that Victoria has a high level of debt and that the cost of servicing debt "has now reached a point where the policies of the past need fundamental change". He also stated that in future the Government intended to make a stronger contribution to capital works from recurrent revenue. The Treasurer attributed Victoria's high debt level to two main factors. First, certain services, notably gas supply, provided from within Victoria's public sector, are a private sector responsibility in other States. Second, Victoria has "always" operated on the basis of high borrowings and high debt because successive governments believed "it was fair that the cost of State infrastructures should be borne by future generations that derived the benefit".
A central feature of the Government's 1990-91 Budget was the implementation of a debt management strategy which envisaged a small estimated reduction in budget sector debt through an increase in the sale of government "business" assets (2) sufficient to more than meet the estimated (lower) budget deficit and the increase in debt resulting from the take-over of additional debts of Tricontinental. The Treasurer also indicated that Victorian semi-government authorities would sharply reduce their net borrowings in 1990-91 and that Victoria would accordingly borrow less than the global borrowing limit set for its authorities by Loan Council. For the Victorian public sector as a whole the budget estimates for 1990-91 suggested that, while there would be an increase in net debt (from $26.6 billion at June 1990 to $27.2 billion at June 1991), that would involve a reduction (of 0.7% points) in the proportion of debt to Victorian non-farm GDP, taking it down to just over 25% at June 1991.
The Budget also provided for a sharp cut back in estimated capital expenditure by the public sector in 1990-91 -- expenditure on fixed assets was estimated to fall by 16.4%. This also appears to be a "fundamental change" compared with the previous policy of making the rate of capital investment responsive to the state of the economy and the economic cycle. (3)
But the acknowledgement leaves a question mark.
Apart from accepting that economic and financial circumstances had changed, the acknowledgement by the Victorian Treasurer that "the policies of the past need fundamental change" was not accompanied by any explanation of why such a change had suddenly become necessary, or what particular level of debt servicing charges should be targeted. The apparent continued support in the Budget Speech for the notion that it is "fair" for future generations to bear the cost of State infrastructure, and persistent assertions by The Age's chief economic writer that "borrowings by Victorians from Victorians" are no cause for concern, suggest that the underlying rationale for a policy of high public sector borrowings has not necessarily been discarded and that it may have some residual support.
This Chapter examines the issues against the background of trends in debt and debt servicing costs of Victoria and other States, and the purposes for which debt has been employed. The examination covers the debt and other financial commitments of both the budget and non-budget sectors as both sectors are the ultimate responsibility of the State Government and each sector contributes to Victoria's overall debt problem.
What constitutes a debt problem?
There are no precise criteria or even rules of thumb which can be used to determine whether a State or even a country has a debt problem. Much depends on economic and political circumstances and the purposes for which borrowings have been used. (4) Further, as indicated by the considerable range of ratings by credit rating agencies, there are degrees of debt problems. The rating currently given to Victorian debt -- the second highest -- indicates that the State still has capacity to increase the burden of debt should it be judged appropriate to do so. At the same time, the initial down-grading, and the recently emerged prospect of a further down-rating, are warning signals that the State's policies have become significantly more risky. Moreover, it is important to note that major down-gradings sometimes come after a financial crisis has occurred.
What constitutes a "debt problem"? At one end of the spectrum the most obvious answer is that a debt problem exists when there is an incapacity to service and/or repay outstanding borrowings; a "problem" of that order would, however, be not a problem, but a crisis. In the case of a State Government it is most unlikely that such a situation would ever arise in any absolute sense, given the assets held and the power to tax. (5) However, there is potential for serious economic and financial problems to emerge well before any possible question arises of suspension of payments. Essentially, these problems arise from two main sources.
First, and most obvious, investors start to demand a higher rate of return for lending to a high debt State. In Victoria's case, this has already occurred and the Auditor General has estimated that this is probably adding around $5 million per annum cumulatively to the cost of Victorian borrowings. (6)
Second, and more important, there is likely to be an increasing reluctance by the "present generation" to bear the burden of increasing servicing costs either through higher taxes or through a lower level of ordinary services. This increased reluctance becomes the more evident if past borrowings have been used for non-revenue earning purposes or for investments in enterprises which are earning poor returns and requiring increasing subsidies from general revenue.
Moreover, if comparisons with other States indicate that those States have used their borrowings more productively, this will likely add to dissatisfaction. Thus, far from regarding it as "fair" to bear the cost of past borrowings, the present generation is likely increasingly to resent having to pay the costs of decisions in which they played no part, and the benefits of which they may well dispute. This is likely in turn, to be reflected in increased political resistance to higher taxes or cuts in ordinary services, thereby making it more and more difficult for the Government to service the existing debt without taking decisions that would lead to its political overthrow. The South American "solution" -- to expand the money supply and reduce the real cost of debt servicing by impoverishing its citizens in a different manner -- is not available to a State Government.
It is this potential for political instability, leading to an incapacity to make decisions needed to restore a State's finances, that goes to the heart of what constitutes a debt problem. Once that political incapacity emerges there are inevitable flow through effects to the State economy as businesses and individuals also become more reluctant to take decisive action, particularly as regards longer term investment. The emergence of such a situation can, in turn, increase the difficulty of servicing State debt as the growth in the State's economy and revenues slows.
The change in economic circumstances after the 1960's and 1970's made particularly inappropriate the pursuit by the State Government of high borrowing policies. The shift from negative real interest rates in the 1960's and 1970's to high positive real rates in the 1980's not only raised the costs of borrowing but required greater attention to improving the return on capital expenditure.
Now, with the Australian economy in recession and the prospect of slower growth in the 1990's, the State is in a classic over-geared situation in which high debt servicing costs are accompanied by slower growth and, hence, a reduced capacity to meet them.
THE EXTENT OF DEBT AND ITS SERVICING
Victoria has the second highest per capita debt after Tasmania.
ABS figures of net debt for State public sectors, compiled on a basis comparable between States, are set out in Table 6.1 (7) which also includes our estimates for 1990-91. ABS figures show that, at 30 June 1990, net public debt was $27.7 billion, which constituted over $6,400 per head. At this level the Victorian public sector's net debt is the largest in Australia and only Tasmania has a higher per capita debt and a higher debt relative to State product. Part of the reason for Victoria's high net debt is the fact that Victoria has a relatively low level of financial assets. Thus at 30 June 1988 Victoria's gross financial assets were less than those of NSW, Queensland or South Australia.
It should be noted that the ABS estimate of net debt at 30 June 1990 is $1.1 billion higher than the estimate published in the Victorian Budget papers. This appears to be due in part to the inclusion as debt by the ABS of operating leases which the State Government refuses to count as debt, presumably because it would mean acknowledging that they effectively involve avoidance of Loan Council global limits on borrowing.
TABLE 6.1:
NET DEBT
| 1983-84 | 1986-87 | 1989-90 | 1990-91(e) | |||||
| $bn | % GSP | $bn | % GSP | $bn | % GSP | $bn | % GSP | |
| NSW | 15.6 | 23.1 | 20.1 | 21.7 | 20.8 | 15.8 | 22.0 | 16.2 |
| VIC | 16.0 | 28.3 | 21.5 | 29.4 | 27.7 | 27.1 | 27.9 | 26.7 |
| QLD | 4.8 | 17.0 | 5.7 | 14.8 | 3.4 | 6.2 | 3.5 | 6.2 |
| WA | 5.1 | 29.5 | 6.4 | 25.0 | 7.8 | 21.3 | 8.5 | 22.5 |
| SA | 3.3 | 21.9 | 4.1 | 19.6 | 4.7 | 16.7 | 5.3 | 18.1 |
| TAS | 2.1 | 49.2 | 2.6 | 42.9 | 3.0 | 36.8 | 3.4 | 40.4 |
| All States | 46.0 | 24.8 | 60.4 | 23.5 | 67.4 | 18.7 | 70.6 | 19.0 |
| All States excl Vic | 31.0 | 23.3 | 38.9 | 21.2 | 39.8 | 15.3 | 42.7 | 15.9 |
Notes:
(i) Net debt figures for 1983-84 and 1990-91 (est) are derived by adjusting net debt figures published in ABS 5501.0, 28 March 1991 on the same basis as on page 5 of that publication.
(ii) Gross State Product figures are the author's estimates based on GDP figures in ABS No.5206.0, Dec Q 1990
Table 6.1 shows that, while the burden of Victorian debt (measured relative to GSP) has been falling since the recent peak reached in 1986-87, the reduction has been much less than in Queensland and NSW and significantly less than the average for all States excluding Victoria. Moreover, reflecting the much slower than expected growth in even nominal GSP, the burden of debt is now likely to drop by no more than 0.4% points of GSP in 1990-91. Since 1983-84, the Victorian public sector's net debt has increased by 8.3% per annum, the highest of any State and well above the average of 4.7% per annum for all States excluding Victoria.
Thus, while the annual increase in indebtedness has declined as a proportion of GDP since 1986-87, it has remained above the average for the States up to the current financial year. Indeed, in three out of the last five years Victoria's increase in net debt has been greater than that for any other State, relative to GSP. The very small increase in net indebtedness estimated for 1990-91 is primarily a reflection of the large provision for asset sales, which the ABS estimates put at around $2,000m but which appears to be an under-estimate (see below).
Victoria has easily the highest debt servicing burden.
As to the debt servicing burden (measured by taking the proportion of interest to total revenue), Table 6.2 shows that this has actually increased since 1986-87 and is significantly higher than in 1983-84.
The servicing of Victoria's net public sector debt now takes over 21 cents of every dollar received in revenue, more than double the average for all other States of over 10 cents per revenue dollar. In fact, Victoria has easily the highest debt servicing burden, with even Tasmania having to pay "only" 19 cents per revenue dollar. The net interest bill faced by the total Victorian public sector in 1990-91 is estimated at $3.4 billion, more than the total estimated outlays on health, social security and welfare combined, more than any other State and nearly $800 million more than for the much larger State of NSW. If Victoria could reduce to NSW levels the proportion of revenue going on net interest, there would be a saving of about $1.4 billion.
These official figures do not tell the full story, however. The debt management strategy announced in the Budget includes provision for "managed increases in the rate of growth of debt charges through the use of interest rate swaps and other instruments, effectively spreading interest costs over the next 5 or 6 years".
Moreover, the increased resort to "operating" leases (see below) has to an extent substituted lease payments for interest payments. In short, even allowing for the reduction in interest rates, the estimated slight fall in the debt servicing burden in 1990-91 is almost certainly misleading.
Also relevant is the decision by the June 1990 Loan Council meeting for the States to take back the primary responsibility for debt raised by the Commonwealth on behalf of the States under the Financial Agreement. This means that the volume of public debt issued in the name of Victoria will increase progressively and the cost of servicing that debt will be higher than otherwise.
From a longer term historical perspective, estimates of net public sector debt published by the Victorian Government suggest that there has been little change in the burden of net debt since the mid 1970's and that the present burden is much lower than in 1960. (8) While from one point of view that may be comforting, what it also suggests is that the strengthening of Victoria's net debt position between 1960 and the mid 70s (chiefly as a result of inflation reducing the real burden of the State's debt) has not been consolidated, and in recent years has been partly lost. Moreover, estimates published of debt servicing costs (9) suggest that net interest payments now represent a higher proportion of non-farm GDP than in 1960 (about 3.0 compared with 2.5%) and almost double the proportion in the mid 1970's. These estimates show that, as a proportion of public sector revenue, (10) there has also been a doubling in the burden of debt servicing costs since the mid 1970's. The fact that the burden of net debt has hardly changed since the mid 1970's, while the burden of debt servicing costs has about doubled, primarily reflects the much higher interest rates experienced in the 1980's.
TABLE 6.2:
DEBT SERVICING COSTS (Net Interest Paid As % of Revenue)
| 1983-84 | 1986-87 | 1989-90 | 1990-91(e) | |
| NSW | 11.5 | 12.1 | 12.3 | 12.4 |
| VIC | 17.4 | 20.0 | 21.6 | 21.4 |
| QLD | 7.9 | 5.6 | 5.4 | 6.2 |
| WA | 12.2 | 13.6 | 13.0 | 12.7 |
| SA | 11.1 | 11.3 | 12.8 | 12.6 |
| TAS | 15.7 | 17.1 | 17.2 | 18.6 |
| All States | 12.6 | 13.4 | 13.4 | 13.2 |
| All States excl Vic | 11.0 | 11.0 | 11.1 | 10.4 |
Source: ABS 5501.0, 28 March, 1991.
Official debt figures do not tell the whole story.
The foregoing relates to trends in and comparisons of official published statistics of debt and debt servicing costs. However, there is a range of other commitments given by the Victorian public sector which either constitute near debt or involve contingent liabilities. Thus, in his report on the budget for the year ended June 1990, the Auditor General included as part of debt unfunded superannuation liabilities of $16.0 billion and estimated that, on that basis, indebtedness of the budget sector alone was $32.6 billion compared with the figure of $14.5 billion published in Budget Paper No.2. The Auditor General also drew attention to additional financial commitments totalling $3.1 (11) billion and contingent liabilities amounting to $48.8 billion, of which some $25.1 billion were in respect of guarantees to financial institutions. Some of these guarantees (for example, those in respect of the Victorian Equity Trust) are almost certainly going to be called up.
It is a matter of concern that contingent liabilities in the form of guarantees about doubled in the three years to June 1990. Of course, with the sale of the State Bank since then, that will about halve these liabilities. Even so, guarantees other than in respect of the State Bank amounted to $23.3 billion at 30 June 1990, compared with only $8.1 billion at 30 June 1983. The resort to such guarantees creates the potential for "moral hazard" problems to arise -- as indeed occurred in the case of the State Bank -- and it seems particularly anomalous that every policy of insurance by the SIO should carry such a guarantee.
However, putting contingent liabilities on one side, the following picture can be compiled for public sector indebtedness, defined broadly, as at 30 June 1990. It should be noted that these estimates do not include anything for employee entitlements and other commitments that may have been entered into by the non-budget sector, (12) or for potential liabilities in respect of unfunded liabilities of the Workcare and Third Party Insurance schemes. It is not clear why the Auditor General has excluded these commitments, which would have added another $3-4 billion to the figures.
TABLE 6.3:
VICTORIAN PUBLIC SECTOR INDEBTEDNESS, 30 JUNE, 1990
| Budget Sector Net Borrowings Employee entitlements Creditors and accrued interest Other Financial Commitments (incl operating leases) Victorian Equity Trust | 15.0 16.9 0.7 3.1 0.7 36.4 |
| Non-Budget Sector Net Borrowings | 12.1 |
| Total | 48.5 |
| Per Capita | $11,175 |
The Victorian Treasurer has disputed the inclusion as debt of employee entitlements and has disagreed with the Auditor General's conclusion that operating leases are "simply another form of borrowing and should have been taken into account for Loan Council purposes and reported as borrowings in the Treasurer's statement". However, the Tasmanian Government has acknowledged that these leases are tantamount to borrowing. In its Budget Papers it is stated that "While the usage of leasing and similar arrangements has been less in Tasmania than other States, the financing costs involved are becoming a significant element in the State's overall indebtedness". (13) Indeed, Tasmania's annual leasing payments now take around 0.7% of public sector revenue and, while no comparable figures are published for Victoria, it would be surprising if annual leasing payments were not taking at least 1% of Victorian public sector revenue, that is, the servicing costs of all forms of borrowing by the Victorian public sector almost certainly account for more than 21.4% of revenue.
As to the indebtedness in regard to unfunded superannuation liabilities, while it is common practice amongst the States not to count these liabilities as debt per se, there is no doubt that they represent a liability that will have to be met out of future Victorian government revenue. Certainly, the substantial borrowings of the superannuation funds on behalf of the Government, in order to finance amounts the Government would otherwise have had to pay to superannuitants, ought to be included in the official debt figures. (14) Further, while it is true that most other States also have liabilities for unfunded superannuation schemes for Budget sector employees, (15) there is some evidence to suggest that the Victorian scheme may be more generous than in other States. In particular, at 30 June 1990 NSW had a significantly lower net unfunded liability of $14 billion, (16) or $2413 per head of population compared to Victoria's $16 billion or $3,665 per head of population. Grants Commission data on Victoria's superannuation payments from the budget shows that, over the five years to 1988-89, they increased by no less than 80%.
No information is available on Government physical assets.
In assessing Victoria's debt liability, account ought to be taken of the physical assets which have been created by the borrowings. While no data is available, the value of such assets would undoubtedly exceed net Victorian public sector debt. In this sense, therefore, the State Government itself can never be considered a candidate foi bankruptcy per se. But well before bankruptcy is reached debt problems can and do arise in the sense referred to earlier.
THE USE OF BORROWINGS
Borrowings have been used to finance capital exenditure.
Some comfort can be taken from the fact that net borrowings (17) by the Victorian public sector have been equivalent to only some 50-60% of expenditure on fixed assets by the Victorian public sector. In the current year, the Victorian Budget papers estimate that net borrowings will finance no more than around 30% of capital expenditure, reflecting the increased resort to proceeds of asset sales and the sharp reduction in estimated expenditure on fixed assets.
But more capital expenditure has been of a "social" kind.
But, while it is thus clear that borrowings have not been used to finance government consumption expenditure, that does not tell us anything about whether they have been productively employed. A very broad indication can be obtained of the use of borrowings from the fact that net debt of the non-Budget sector (that is of statutory authorities), which makes up a little under half of the total state public sector net debt, was growing up to 1989-90 at a significantly slower rate of around 8% per annum compared with the 11% per annum growth in the Budget sector debt. This doubtless partly reflects the reduction in major capital projects, primarily in the areas of electricity and gas, which together account for about three quarters of non-budget sector debt. In the electricity area, capital spending slowed markedly following the installation of excess capacity in the early to mid 1980's on the basis of expectations of a major resources boom. Moreover, although there now appears to be a need to increase spending, the SECV (which has been a major borrower) has recently announced its intention not to borrow for a period of several years in order to improve its debt/equity ratio and has proposed the partial privatisation of electricity generation. Borrowings by bodies such as the SECV and Gas and Fuel might have been even lower but for the Government's policy of deliberately holding down their charges and requiring such bodies to pay hefty "dividends" to the Budget, thereby limiting the internal funds available to finance capital works.
And total capital expenditure has been cut back.
The slower growth in non-Budget sector debt raises a question as to whether the real decline in gross fixed capital expenditure in that sector in recent years reflects a reduction in need for infrastructure or whether it is more a reflection of Government "rationing" of borrowings for such purposes because of other perceived priorities. More generally, the fact that Victoria is the only State in which the nominal level of capital outlays was lower in 1989-90 than in 1983-84, and the further very sharp cut in capital expenditure in the 1990-91 Budget, suggests that high debt levels are now constraining capital spending.
TABLE 6.4:
COMPOSITION OF VICTORIAN DEBT (NET)
| Budget Sector | Non-Budget Sector | |||
| $Bn | % GSP | $Bn | % GSP | |
| 1982-83 | 6.9 | 14.1 | 7.1 | 14.5 |
| 1983-84 | 7.6 | 13.6 | 8.0 | 14.3 |
| 1984-85 | 8.5 | 13.8 | 9.1 | 14.7 |
| 1985-86 | 9.7 | 14.2 | 10.1 | 14.8 |
| 1986-87 | 10.8 | 14.9 | 10.6 | 14.7 |
| 1987-88 | 11.6 | 14.0 | 10.7 | 12.8 |
| 1988-89 | 12.7 | 13.8 | 11.5 | 12.5 |
| 1989-90 | 14.5 | 14.4 | 12.3 | 12.2 |
Source: Victorian Budget Papers for debt figures. GSP figures are the author's estimates.
This also, of course, raises an important question about the sustainability of the reduction in estimated net borrowings in 1990-91 once additional infrastructure spending becomes unavoidable and once there is a diminution in the supply of non-business assets capable of being sold.
Debt servicing costs of the budget sector have risen sharply.
What is clear is that an increasing proportion of net borrowings has been used to finance projects in the Budget sector, rather than the non-Budget sector. This is of potential concern because the Budget sector comprises government activities that do not attract sufficient revenue to cover a significant proportion of costs and where there are few market tests as to the likely returns. (18) Thus, since 1986-87 the burden of net debt servicing costs of the budget sector have risen sharply from around 6% to 9% of revenue, about three times the NSW level. The Queensland budget sector, by contrast, is actually a net earner of interest, that is, a net lender to the rest of the public sector.
While debt servicing costs of trading enterprises remain high.
Moreover, while the debt servicing ratio for the non-Budget sector of Victoria has been coming down in recent years, it remains at a very high level. Almost 80 cents in every net revenue dollar of Victorian public trading enterprises is going to meet interest payments. This is much higher than for Queensland (37%), NSW (62%), or WA (54%) and considerably higher than the average for the five States excluding Victoria. Not surprisingly, this high debt servicing burden is reflected in the high losses of Victorian public trading enterprises, which are running at around $1 billion per annum or close to 1 % of Victoria's GSP.
THE OUTLOOK FOR DEBT
The Government budgeted for only a small debt increase in 1990-91.
At the time of the 1990-91 Budget the Government estimated that the net addition to Victoria's public sector debt in 1990-91 would be $574 million, which is broadly consistent with the estimate of $220m based on ABS estimates shown in Table 6.1 above. The Victorian Government estimate assumed that, in addition to above-the-line asset sales of $711 million, there would be sales of "business" assets amounting to $2.6 billion and that the proceeds would be used to retire debt (including $1,700 million of bad debts of Tricontinental not taken over by the Government in 1989-90) and to help offset the estimated "deficit" (19) of $845 million. Estimated proceeds from business asset sales included the $2.0 billion from the sale of the State Bank and (potentially) from the State Insurance Office, pine plantations and the State's interest in the Portland Smelter.
But the increase may be quite a bit larger.
However, there are serious doubts about whether the increase in public sector debt can be held to the Budget estimate. Certainly, the projected "deficit" for 1990-91 seems likely to be significantly higher than $845 million and sales of "business" assets are unlikely to achieve the target of $2.6 billion.
It would not be surprising, in these circumstances, if the increase in net public sector debt were to reach say, $1,500 million or 1.4% of GSP. While there are indications that the Government has been exploring "innovative" methods of borrowing, this would imply that the Government's target of borrowing "at least" $118 million less than its global borrowing limit of $1,137 million is unlikely to be fulfilled. Indeed, the Government may need to seek a "special" increase in Victoria's global borrowing limit from the Commonwealth.
Beyond 1990-91 there mil be pressure to increase borrowings -- but the Commonwealth will seek to hold them down.
Beyond 1990-91 there is a question as to the sustainability of such lesser increase in net debt as may be achieved in 1990-91. Thus neither the existing high reliance on asset sales nor the very low level of capital expenditure in 1990-91 can be sustained; the effects of the spreading of interest costs to future years will wear off; and the possibility of an extended recession and/or a slow recovery from it will make for slow growth in State revenues and upward pressure on the public sector deficit. Of course, the Commonwealth Government will be anxious to hold down the level of State authorities' borrowings in order to increase domestic saving and reduce the current account deficit. Further, the move to allocating States' basic shares of Loan Council borrowing limits on an equal per capita basis will mean a reduction in Victoria's share of whatever overall global limit is set.
Victoria faces a serious debt problem.
All this adds up to the conclusion that, in the absence of measures to reduce recurrent spending and/or to privatise some statutory authorities, it will be difficult to repeat the (likely) reduction in 1990-91 in the ratio of net debt to GSP. The reality is that the Victorian Government faces a serious debt problem. Thus:-
- While the burden of debt has fallen in recent years the reduction has been less than for other States and the relative burden remains high by interstate comparison. Further, the published debt figures do not tell the full story, as other means have been found of financing capital spending which constitute quasi-borrowings;
- The debt servicing burden is the highest among the States and has actually increased significantly since 1986-87. Further, the published figure does not reveal the full extent of the burden, which probably involves the taking of over 22% of public sector revenue to meet interest or quasi-interest payments. The re-assumption of responsibility for Financial Agreement debt, and the widening of interest margins from this and the credit rating down-grading, will add to servicing costs, although lower interest rates will provide some relief. (However, real interest rates seem likely to remain high);
- In addition to the official figures for public-sector debt, the Victorian Government has very considerably increased commitments of the public sector that constitute quasi-debt or contingent liabilities. The extent of unfunded superannuation liabilities suggests a more generous superannuation scheme for Victorian public sector employees than for their NSW counterparts. Even allowing for the reduction that will occur in contingent liabilities as a result of the sale of the State Bank, the increase in guarantees is of concern;
- While borrowings have not been used to finance government consumption expenditure, there has been an increase in recent years in the proportion of borrowings used to finance Budget sector capital expenditure, which generally has much lower revenue earning potential. Moreover, borrowings used to fund capital expenditure in the non-Budget sector have produced inadequate returns, reflected in the fact that interest payments continue to take 80% of every net revenue dollar and that losses are running at around $1 billion per annum;
- While the 1990-91 Budget projects only a small increase in public sector debt and a fall in the relative burden, the much greater than expected deterioration in the Victorian economy and the likelihood of a higher public sector "deficit" means that any reduction in the relative debt burden is likely to be small in the current year.
- Although the 1990-91 Budget is the first official acknowledgement that Victoria needs to effect a fundamental change in its high borrowing policies, the reliance on asset sales as the major vehicle for reducing the burden of debt fails to go to the heart of the problem and will be difficult to sustain. The possibility of an extended period of slower growth in Victorian revenues will also make it difficult to sustain lower deficits (let alone reduce them further) and, hence, difficult to reduce borrowings for that purpose. In addition, the current relatively low level of public fixed capital expenditure will not be sustainable and there will be mounting pressure either to increase borrowings for this purpose or to privatise. Pressure to privatise is likely to be enhanced by the Commonwealth macro-economic policy objective of increasing domestic savings and, hence, maintaining a tight control on Loan Council global borrowing limits.
WHAT NEEDS TO BE DONE
Major changes in policies are needed.
The foregoing conclusions are based on there being little or no change in existing policies. However, if policies along the lines proposed elsewhere in this Report were to be introduced to reduce recurrent outlays, improve the returns on public capital and/or to privatise substantial sections of that capital, there is no doubt that the debt problem could be brought under control.
The difficulty that now exists is that the implementation of such policies takes time and, because they will inevitably impinge on entrenched pressure groups, are likely to be subject to considerable opposition. In our view, however, the problem is serious enough to warrant major changes in policies in the near term. It will be argued, of course, that a recession is not the time to be cutting government spending and employment. Arguments along such lines need to be balanced against the difficulties of reviving private sector activity in a sustained way without action along the lines indicated. Moreover, the time to implement reforms is when the community most readily perceives that serious problems exist and can most readily identify their causes.
However in terms of possible objectives for bringing the debt problem under control, it is difficult to be specific either as to timing or as to ultimate objectives. Certainly, the top priority should be to stop the further growth of public sector debt, which involves bringing public sector receipts and expenditures into balance. The aim should be to do that without relying on proceeds of asset sales, that is, any such proceeds should be used to retire debt, and without increasing taxes. The next step would then be to move into surplus so that, for a time, the public sector is contributing, in an on-going sense, to the reduction of debt. The aim should be to gradually reduce budget sector debt, that is, the debt that largely represents "social" expenditure of a non-revenue earning nature.
We recognised, however, that, in view of generous redundancy provisions incorporated in wage awards, it may be difficult to bring the public sector into balance in the initial stages of any "reconstruction" program. Accordingly, it may be necessary to borrow in order to pay off those who are made redundant in addition to voluntary redundancies through normal "wastage". Such borrowings would, of course, be a good "investment" for the Victorian community and, provided they are limited to such purposes, would be well justified.
There also needs to be a change in the role of public sector borrowings and in the capacity of State Governments to undertake such borrowings.
More generally, there is a need to change the role of borrowing in financing State expenditure. As a matter of policy, the Queensland Government has for some time financed non-revenue earning capital expenditure from budget revenues and the NSW Government has started to move in the same direction. There have been similar indications from the Western Australian and Tasmanian Governments that they intend to adopt similar policies and, as noted, the Victorian Treasurer indicated in his Budget Speech that the Government intends to make a stronger contribution to capital works from recurrent revenue.
In our view, however, more needs to be done to prevent politicians succumbing to the strong temptation to resort to borrowings to finance expenditure that will result in short term electoral support, particularly from powerful interest groups in the community that are pursuing their own narrow interests.
The United States experience and practice is relevant.
The electorate of the States of the United States (US) has since the early 19th century adopted a wide variety of institutional restraints on the fiscal behaviour of their politicians.
The most widely used fiscal disciplinary tool (which all but one state employs in one form or another) is the requirement of a balanced budget. In seven States, the requirement is solely statutory; in 29, solely constitutional; and in 13 States, the requirement is both constitutional and statutory. In three States, the requirement stipulates only that the governor must submit a balanced budget but, in 25 States it requires that the State may not carry over a deficit into the next fiscal year.
There is also a wide variation in the stringency of these rcquirements across States. By way of example, Art XVI Sec I of the California Constitution requires that the legislature shall not, in any manner, create a debt in excess of $300,000 without a vote of the people.
US balanced budget requirements have in Australia been generally perceived as restrictive but in reality to have little or no effect. The experience of States of the US does not bear this out. Indeed a recent major study of this experience found. (20)
"the presence of relatively stringent balanced budget requirements seems to be consistently and significantly associated with lower levels of deficits, lower levels of spending, debt and taxes".
and
"that it is safe to conclude on the basis of the findings reported here that balanced budget requirements generally have substantial effect. It is not the case that these devices are only associated with tiny or trivial differences in state fiscal outcomes".
The Victorian Constitution should be amended to provide for a balanced budget.
It would be inappropriate to simply assume that what works in the US will work in Australia for there are significant institutional and political differences. However, the success of the balanced budget requirements in the States of the US, as well as the poor fiscal performance of the Victorian and other Australian State Governments over the last decade and the weakness of other fiscal disciplines, strongly suggest the desirability of examining an amendment to the Victorian Constitution to require a balanced budget. The precise form of such an amendment would require detailed examination and community debate.
We propose that the Government issue a Green Paper on the matter in the first instance.
ENDNOTES
1. The down-grading by Moody's was followed by a down-grading to AA1 by Australian Ratings.
2. In 1990-91 proceeds of $2,600 million from the sale of business assets are estimated to more than offset the deficit of $660 million (on the basis set out in Victorian Budget papers) plus Trico debts of $1,700 million on top of the $576 million already taken over by the State in 1989-90. Proceeds of sales of "business" assets are distinguished in the Victorian Budget from proceeds of sales of "surplus" property and sales and leasebacks of property. Proceeds from such latter sales are deducted from capital outlays above the line in the Victorian Budget whereas proceeds of sales of business assets are treated as available to help meet or offset the deficit but are not actually brought into the Budget per se.
3. In "Victorian Public Sector Debt", Information Paper No.2, Department of Management and Budget, December 1986, it was stated that "The present Government believes that the rate of capital investment or asset creation should also be responsive to the state of the economy and hence should vary over the economic cycle".
4. For further discussion of the debt issue, see Debt: What Should Be Done, by Richard J. Wood, October 1990
5. There is also the likelihood that, in extremis, the Commonwealth Government would assist in some way. Under the 1927 Financial Agreement, the Commonwealth assumed primary responsibility for all outstanding State debts and agreed to contribute towards the interest and sinking fund costs, which the States continued to pay to the Commonwealth. However, it is questionable whether the Commonwealth would provide such extensive assistance in the event that only one State ran into debt problems.
6. That is, $5 million in the first year, $10 million in the second year, and so on.
7. To obtain an estimate of net debt, the ABS only deducts financial assets, which cover the financial claims of the non-financial public sector on other organisations and households and include shares and other forms of equity in companies listed on the stock exchange. Other (fixed) assets are not offset against gross debt. The ABS uses a "face value" definition of liabilities, i.e. the value to be repaid, or, in the case of securities, the nominal value shown on the security. In the case of securities issued at a discount, this type of valuation is a little misleading because the face value includes a component of deferred interest payments. For example, zero coupon bonds are normally sold at a deeply discounted rate. Holders of these bonds are willing to hold them because of the lump sum they will receive at the maturity date. Effectively, a proportion of this lump sum includes interest forgone over the life of the bond, thus not all of the face value of the bond represents debt outstanding. (Equally, financing by this method means that true debt servicing costs are understated, because the interest accumulating is only scheduled to be paid when the debt matures.) Excluded from the debt estimates are: all liabilities of the financial public sector (i.e. State Banks, State Treasury Corporations etc); equity; contingent liabilities; employee related liabilities such as superannuation and long service leave; and, because of information shortages, short term trade credits.
8. Chart 1.6, 1990-91 Budget Paper No.2. This shows net debt at 60 percent of NFGDP in 1961-62, falling to around 27 percent in 1975-76.
9. Media Release by Mr Roper of 18 May 1990, "Treasurer's Response to Moody's Statement".
10. The definition of public sector revenue in Mr Roper's statement differs from that used in Table 5.
11. Comprising $2.2 billion in respect of Trico and State Bank debts, $0.25 billion for guarantees of deposits with the Farrow group and $0.63 billion for operating lease arrangements.
12. However, Victoria's statutory authorities mostly operate funded superannuation schemes.
13. Tasmanian Budget Paper No.1, 1990-91, p 138.
14. According to superannuation consultant, Mr Daryl Dixon, the Victorian Government had borrowed $1.3 billion as at 30 June 1990 from superannuation funds in order to fund lump-sum superannuation pay-outs. Moreover, the Government pays a 6 percent real interest rate on such borrowings (Sunday Herald, 24 March 1991).
15. Queensland operates a fully funded scheme for such employees, Tasmania has started to implement such a scheme and NSW is investigating it.
16. Budget Paper No.2 1990-91 p.490. Part of the reason for a lower per head liability in NSW would be relatively fewer Budget sector employees
17. Net borrowings in this context includes net drawing on financial assets.
18. A recent study published by EPAC suggested, for example, an excessive cost of capital works in Melbourne's outer suburbs to develop and service new blocks. (See Infrastructure Costs On The Urban Fringe by Dr Robert Birrell).
19. Defined for this purpose as Total Financing Transactions, less Increase in Provisions, for the public sector as a whole.
20. Fiscal Discipline in the Federal System: National Reform and the Experience of the States, ACIR, A-107, July 1987.
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