JON STANHOPE and KHALID AHMED say the ACT government’s accumulated debt is increasing by more than $1 billion every year and will be $13.2 billion by 2025. If it can’t stop the debt spiral, a credit rating downgrade is inevitable.
WE have previously highlighted the risk of the ACT budget experiencing a debt spiral. We have also speculated, if the current trends continue, whether the ACT government will remain solvent.
We acknowledge, of course, that any mention of “solvency” in respect of a subnational (state or territory) government in Australia would to many people seem fanciful.
To be clear, by “solvency”, we mean an entity’s ability to repay its long-term financial obligations.
A standard measure of debt sustainability is called the Primary Balance, which is defined as revenue less expenditure, including capital but excluding interest costs on borrowings.
The cash balance, excluding the interest costs, indicates an entity’s capacity to pay both the interest on its accumulated debt and to repay the debt.
A negative Primary Balance means, obviously, that the entity needs to borrow in order to pay the interest on its previous borrowings. A surplus Primary Balance where the surplus is equal to interest costs means that the debt is stabilised, while a surplus greater than the interest means there is capacity to repay the accumulated debt.
By way of example, in 2018-19, the ACT had a negative Primary Balance with a deficit of $887 million in the General Government Sector. In that year, interest costs were $178 million. Therefore, the ACT government needed to borrow money in order to service (that is pay) the interest on its debt.
The debt was $3.4 billion at the start of that year, a part of which matured during the year, and hence also had to be repaid.
However, because the ACT government did not have the cash to pay the outstanding amount, it was forced to refinance the loan. That is, it had to borrow more money in order to honour the repayment of that loan. At the end of 2018-19, the debt had increased to $4.5 billion to cover the Primary Deficit and interest costs. This was before the pandemic.
A responsible government would normally consider trends over the medium to long term. The table details the trends on key debt metrics as well as revenue and expenditure growth rates in the ACT budget over the past two decades from 2001-02 to 2010-11, and 2011-12 to 2020-21. It also includes a medium-term outlook on those metrics as reflected in the 2021-22 Budget Review.
|Operating Budget Measures|
|Revenue Growth (Average Annual)||Per cent||7.0%||4.6%||3.2%|
|Expenditure Growth (Average Annual)||Per cent||6.3%||5.7%||3.5%|
|Net Operating Balance (End of Period)||$ million||28||-490||-636|
|Debt Measures – End of Period|
|Gross Debt||$ million||1,443||8,015||13,175|
|Interest Cost||$ million||81||185||359|
|Interest Cost to Operating Income Ratio||Per cent||1.9%||2.9%||5.2%|
|Debt Sustainability Measures|
|Average Primary Balance||$ million||254||-188||-715|
|Average Cash from Operating Activities||$ million||3,065||5,139||6,883|
|Primary Balance to Operating Income Ratio||Per cent||8.3%||-3.7%||-10.4%|
- 2001-02 to 2020-21 results are from Government Finance Statistics (ABS Cat. 5512.0).
- Data for 2021-22 to 2024-25 is sourced from 2021-22 Budget Review.
Over the decade (2001-02 to 2010-11), the Primary Balance was a surplus of $254 million annually on average. The then government not only had the financial capacity to pay interest which was 1.9 per cent of the operating income on average, but also to repay its debt.
In 2011 the ACT had a gross debt of $1.443 billion, and a negative net debt of $736 million, that is cash reserves were larger than the accumulated debt, and provided ample capacity to repay maturing debt.
Over the next decade (2011-12 to 2020-21), the average Primary Balance was a deficit of $188 million annually, a reversal of more than $400 million per annum on average or 12 per cent on the Primary Balance to Operating Income ratio.
The ACT government was accordingly forced to borrow additional funds in order to pay interest on its accumulated and growing debt.
Such a severe erosion in debt sustainability between the first and second decades is clearly attributable to: (a) a mismatch between the trajectories of revenue and expenses; and (b) a change in fiscal strategy.
“If the ACT government was to generate a continual $250 million annual cash surplus, it will take more than 50 years to repay the existing debt.
Over the first decade, operating expenditure (excluding capital) growth tracked 0.7 per cent below revenue growth on average annually, while over the next decade expenditure was 1.1 per cent above revenue growth. As we have noted previously, the mismatch between revenue and expenses was entrenched before the pandemic with expenditure growth tracking 1 per cent per annum on average above the revenue growth rate from 2011-12 to 2018-19.
With persistent deficits in the operating budget, the current ACT government passively adopted a fiscal policy of funding the General Government Sector capital expenditure through debt. Consequently, gross debt has escalated from $1.4 billion in 2011 to $8 billion in 2021.
The medium-term outlook, contained in the 2021-22 Budget Review, presents an alarming picture. The average Primary Balance is a deficit of $715 million across the forward years. This amount needs, therefore, to be borrowed every year.
The additional debt results in interest costs increasing to $359 million in 2024-25, and averaging $294 million per annum. This amount also, of course, will need to be borrowed. Accordingly, the ACT government’s accumulated debt is increasing by more than $1 billion every year and will be $13.2 billion by the end of the forward estimates, in 2024-25.
In our opinion, if the government is unable to stop further debt accumulation, a rating downgrade is inevitable.
While a turnaround of about $700 million in the Primary Balance would obviate the need for further borrowings to cover expenditure, debt will continue to increase in order to meet existing interest costs.
In that scenario, if the interest rate, whether real or nominal, is larger than the economic growth rate (correspondingly, real or nominal), this ratio will continue to rise. A turnaround of about $1 billion would stabilise the debt with no additional borrowings required, ie, all the expenditure including capital and interest costs could be met from the budget. This debt would still, of course, need to be repaid as it matures.
Technically, for an entity to be solvent, the net present value of its Primary Balance across the years should equal the accumulated debt. Accordingly, a cash surplus is required in order to repay the debt. To provide some insight into the magnitude of the challenge facing the ACT government and we the residents of Canberra, even if for example the ACT government was to adopt a fiscal strategy designed to generate a mere $250 million annual cash surplus, it will take more than 50 years to repay the existing debt and that forecast to be accrued by 2025. To achieve a $250 million cash surplus would require a $1¼ billion turnaround in the budget burden on the economy.
While this does not need to be achieved in a single year if steps are not taken to achieve that goal the consequences could be very severe.
Jon Stanhope is a former chief minister of the ACT and Dr Khalid Ahmed a former senior ACT Treasury official.
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