ASSET SALES, THE GOVERNMENT ACCOUNTS, AND THE NEW ZEALAND ECONOMY

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1 Discussion Paper prepared for: ASSET SALES, THE GOVERNMENT ACCOUNTS, AND THE NEW ZEALAND ECONOMY Prepared by Dr Ganesh Nana Fiona Stokes Kelly Dustow Copyright BERL BERL ref #5260

2 Asset sales, the Government Accounts, and the NZ economy 1 Summary BERL assessment Other objectives or benefits Impacts on wider economy the external debt situation Introduction The rationale for selling assets The fiscal situation By the book The assumptions Baseline Selling investment assets to finance building other assets Summary An alternative option Borrowing from domestic private sector Comparing the options Other expected benefits and wider impacts Other expected benefits Impacts on wider economy Appendix alternative assumptions Reduced return on new assets Faster return on new assets Asset sales, the Government Accounts and the NZ economy

3 1 Summary The Government s financial situation cannot be used as justification for a programme of partial asset sales. Our assessment finds that a programme of asset sales to finance the construction of new assets leaves the Government accounts permanently worse off (compared to the baseline) in terms of Government debt, debt ratio, net worth and total assets. Another objective, or set of benefits, needs to be established and verified for this programme to be considered prudent fiscal policy, and robust economic policy. BERL has constructed a hypothetical, simplified set of accounts to assess the impact of a programme of partial asset sales on the Government s accounts. These accounts were stripped of technical details to allow us to focus on the impacts on core indicators, and the underlying position of the Government s fiscal situation. As part of this assessment we adopted a set of assumptions, and considered the rationale for asset sales from the perspective of prudent financial management. Our assumptions were: The funds from the programme of asset sales are used to build other assets and infrastructure, such as school buildings, roads and broadband. The interest rate paid on previous borrowing is less than the dividend yield on the investment assets being sold. The return on the new assets (equivalent to an increase in tax receipts arising from the improved economic activity resulting from the newly constructed and better assets) is equivalent to the dividend yield on the investment assets being sold. There is a length of time before these returns are realised. All other levels of spending and revenue are held unchanged. BERL also determined the impact of an increase in assets through a programme of increased borrowing from the domestic private sector. We compared the outcome of these assessments to a baseline, no change situation. Our assessment finds that a programme of asset sales to finance the construction of new assets leaves the Government accounts permanently worse off (compared to the baseline) in terms of debt, debt ratio, net worth and total assets. At best, the annual deficit remains 3 Asset sales, the Government Accounts and the NZ economy

4 unchanged on the baseline. This is because the interim loss of earnings resulting from reduced dividends and the period of time before the new assets reap benefits is never recouped. Subsequently, the option of asset sales can only significantly improve the Government s accounts if a set of assumptions are adopted that are at the extreme ends of plausibility. Any long-term improvement in the Government s borrowing position (or debt ratio) can only be achieved through permanently lowering the level of the Government s deficit, not a programme of partial asset sales. 1.1 BERL assessment Programme of partial asset sales In the short term the option of selling investment assets to fund the construction of new assets leaves the Government s accounts in a worse situation compared to the baseline. The annual deficit increases as a result of the loss of dividend revenue, with no compensating decrease in spending. Assuming that the increased deficit is funded out of cash reserves, total assets decline. This leads to a deterioration in net worth. Debt remains the same, but the debt ratio increases as a result of the decline in total assets. Figure 1 Government fiscal surplus (+) or deficit (-) $ baseline asset sale option domestic borrowing option year 1 year 6 year 10 year 15 In the long term the annual deficit returns to baseline, but net worth, total assets and debt ratio are worse than baseline. The short-term impact on the financial surplus is not recouped in subsequent periods, leaving this permanent impact on net worth and total assets. 4 Asset sales, the Government Accounts and the NZ economy

5 This is based on a critical assumption that the new assets begin to reap benefits in terms of an increase in government tax revenue. However, if we assume that the new assets will rapidly increase the size of the economy and tax revenue, and that this return will be at a higher rate than the yield on dividends, then the impact on the Government s fiscal situation would be positive. Undoubtedly, if sufficient evidence was available to support this assumption, then it would be clearly prudent fiscal and sound economic policy to replace lower yielding assets with higher yielding assets Borrow from the domestic private sector In the short term the option of borrowing from the domestic private sector to fund the construction of new assets results in a mixed outcome. The annual deficit is better here than under the option of partial asset sales, but worse than the baseline. This is because the cost of interest on the new borrowing is less than the yield from dividend holdings. Total assets are higher under this option; but, the increase in debt leads to lower net worth compared to the baseline. Net worth is better under this option than the partial asset sale option. Over the long term the annual deficit is permanently improved under this option compared to the baseline and the partial asset sale options. Total assets are permanently higher under this option compared to the baseline and the partial asset sales options. Debt is higher under this option compared to the baseline and the asset sale option. But, the permanent improvement in the annual deficit, coupled with higher total assets, means the net worth and debt ratio will both eventually be better under this option compared to the partial asset sales option. 5 Asset sales, the Government Accounts and the NZ economy

6 Figure 2 Government net worth $ 66,000 baseline asset sale option domestic borrowing option 62,000 58,000 54,000 50,000 year 1 year 6 year 10 year 15 Figure 3 Government total assets $ 154,000 baseline asset sale option domestic borrowing option 148, , , ,000 year 1 year 6 year 10 year 15 Figure 4 Government debt ratio (as % of total assets) 40 % baseline asset sale option domestic borrowing option year 1 year 6 year 10 year 15 6 Asset sales, the Government Accounts and the NZ economy

7 1.2 Other objectives or benefits As the Government s financial situation cannot be used as justification for a programme of partial asset sales, other objectives need to be considered. Consequently we examined other benefits or objectives that have been sought for the partial asset sale programme: to improve the pool of investments available to New Zealand investors, thereby deepening the capital markets. to allow mixed ownership companies to grow and access capital without total dependence on the Government. to allow for external oversight to place sharper discipline and more transparency on a company s performance. Each of these objectives has merit, but does not rely on the adoption of a mixed ownership model. Further, while a reduction in the state-owned equity share may contribute to these objectives, they could also be achieved through alternative means Improvement in the pool of investments available to New Zealand investors This objective is consistent with the option to finance new assets through borrowing from the domestic private sector. Households (colloquially termed mom and pop investors ) can be attracted to direct investment opportunities in government bonds. These investment vehicles could be in the guise of infrastructure or national development bonds directly targeted at the retail investor Allowing mixed ownership companies access to capital to grow The objective of allowing mixed ownership companies access to capital to grow without depending entirely on the Government need not require a partial sale of equity. To access capital, mixed ownership companies need to attract funds from the private sector. This can be done, subject to the maintenance of a prudent debt-to-equity ratio, without the reduction in an existing owner s equity stake. Accessing funds to finance growth, through the use of debt instruments, is standard practice in the business sector Allowing for the external oversight of companies This objective could be achieved through alternative means such as the appointment of independent directors, directors/boards reporting to a Parliamentary committee (as opposed 1 As noted in the Supplement to the 2010 Investment Statement, as at December 2009 around $100 billion was held by domestic retail investors in term deposits and other short-term accounts. 7 Asset sales, the Government Accounts and the NZ economy

8 to Ministers), or the setting of clearer, transparent directions from shareholder Ministers as to market-related objectives. We note, in passing, that the need for this objective does seem in contradiction to the stated expectation of a gain on sale of these assets (as forecast in the 2012 Budget Policy Statement). Were these companies performances below par and in need of sharper discipline, such a gain on sale would seem unlikely. 1.3 Impacts on wider economy the external debt situation As noted in the 2010 Budget, New Zealand s largest single vulnerability is now its large and growing net external liabilities. New Zealand now owes the world $168bn, or around 90% of (annual) GDP. Since then the level (and ratio) of external debt has been reduced to a degree but it remains at an uncomfortably high level. BERL would stress the difference between the Government s debt and the external debt in any discussion in regards to the Government s financial situation being used as justification for a programme of partial asset sales. The partial asset sale programme does not aim to pay off some of our external debt. While there could well be no direct impacts, the indirect effects on the external debt are important to note. A level of external debt can only be permanently reduced through a reduction in the annual external deficit (or increase in external surplus). As a result, the impact of the asset sale programme on external receipts and payments needs to be assessed. While the Government has stated that New Zealanders will be at the front of the queue to purchase the investment assets being sold, some assets may be sold to overseas investors. Consequently, the portion of company earnings (dividends and profits) that relate to overseas investors will be an outflow (or payment) on the external accounts. This would ultimately represent, and assuming all else unchanged, a permanent deterioration in the external deficit and the level of external debt. Further, while the initial offering may be directed towards domestic purchasers, future private share transactions could increase the portion of shares (and earnings) in overseas investors hands. Such an outcome would lead to a further deterioration in the external deficit and external debt position. As a counter, the Government has suggested measures to ensure widespread and substantial New Zealand participation in the asset sales programme. Those noted in the Supplement to the 2010 Investment Statement include: 8 Asset sales, the Government Accounts and the NZ economy

9 a priority allocation, pre-registration and instalment receipts financial incentives, such as price discounts and loyalty shares hard ownership restrictions, such as individual or total ownership caps, or separate domestic shares. Consequently, until decisions are made as to how these are to be implemented, BERL can make no conclusion as to the magnitude, or significance, of the negative impact of these sales on the external deficit or external debt. However, it should be noted that there may be an impact on external receipts. If the asset sales programme lifts the competitiveness and performance of businesses that earn external receipts (i.e. exporters) then the external deficit could be reduced with a beneficial flow-on effect to the external debt. This would also be an indirect effect. The precise manner of this influence remains unclear and the subject of considerable conjecture. To estimate the magnitude of this influence would need further careful investigation. At the very least, though, we advise that it would be unwise from an economic perspective to embark on a policy that risked increasing external payment obligations, without at first verifying and confirming a counter-balancing positive impact on external (i.e. export) revenues. This advice is even more pointed given the context of ongoing global financial market instability arising from uncertainty as to the future of the Euro. 9 Asset sales, the Government Accounts and the NZ economy

10 2 Introduction This document has been prepared by BERL for the. The Green Party requested BERL to assess the impact of the sale (or part-sale) of stateowned assets on the Government accounts and the wider New Zealand economy. In the 2011 budget, the Government announced the introduction of a mixed-ownership model for the four state-owned energy companies of Meridian, Genesis, Mighty River Power, and Solid Energy, and the sale of government shares in Air New Zealand over the next two to three years. The sale of these assets will see the Government retain a 51 percent share in these state owned enterprises. This document provides a high-level assessment of how a partial sale of state assets would affect the Government accounts. This assessment considers the impact on the annual performance on the Government accounts, as well as the impact on deficit and government debt. Overall, BERL considered the rationale for asset sales from the perspective of prudent financial management. At this point we would note our concern about various discussions on the partial asset sales. Considerable confusion has arisen in regards to the potential impact on the government accounts particularly around the distinction between the government deficit and the government debt. Further, the distinction between the government deficit and the external deficit is also blurred in commentary and discussions, as is the distinction between the government debt and the external debt. Some of this confusion is not helped by the unclear, and sometimes conflicting, messages on the objectives of an asset sales programme. 10 Asset sales, the Government Accounts and the NZ economy

11 3 The rationale for selling assets For any organisation the rationale for selling assets depends on their objectives and the context in which their business is operating. The objectives for such a decision could include: A desire to access cash in order to pursue other investment options. Access to cash to repay past borrowing, and reduce the debt-to-equity ratio to a more desirable/prudent level. A change in strategic direction that makes the existing asset holding inappropriate. A need to take an under-performing asset off the balance sheet. The liquidation of the value of an asset to return gains to shareholders/owners. Without doubt, the context for a government s decision to sell assets is different to those of a private business enterprise or organisation. However, the principles of prudent financial management remain similar. The intention of the current asset sales programme revolves around four stated reasons, or expected benefits. These benefits, as listed in the Budget Policy Statement 2012, are: Freeing up capital for the Government to invest in other public assets, without having to borrow to do so. Improving the pool of investments available to New Zealand investors and deepening the capital markets. Allowing mixed ownership companies to access capital and grow without depending entirely on the Government. Allowing for greater external oversight, which places sharper discipline and more transparency on a company s performance. We note that some commentary focuses solely on the goal of asset sales as enabling a reduction in borrowing. However, the four stated benefits do not include the reduction of borrowing as a primary objective. Rather, there is a statement that further borrowing is not a desired option. The first stated benefit is not driven by the need to reduce borrowing (or debt), but the desire (or need) to increase investment in other assets. The remaining stated benefits are related to encouraging behaviour that would be conducive to generating wider economic benefits. 11 Asset sales, the Government Accounts and the NZ economy

12 4 The fiscal situation This section of our report discusses the hypothetical, simplified model that BERL constructed of the Government s accounts. This model was used to demonstrate the effects of asset sales to fund other investment opportunities and the reduction in borrowing. It was also used to assess the impact of alternative options that could be used to fund investment opportunities. 4.1 By the book The simplified model represents a depiction of the Government s financial statements including the statement of financial performance and statement of financial position. It assesses the interaction between financial performance and position over the short and long term. Our highly simplified accounts comprised a statement of financial performance (i.e. income earned and expenditure incurred) for a year; and a statement of financial position (i.e. holdings of assets and liabilities) as at a point in time. In the financial performance account we simplified income to comprise tax and other revenue, as well as dividends (or earnings) from investment assets held by government. Expenditure consists of general spending across the range of government activities, as well as interest payments on previous borrowings. The financial performance account begins with a deficit on the annual accounts (i.e. total current income is less than total current expenditure of the order of four percent of income). On the balance sheet or statement of financial position, the asset side comprises a small holding of non-income earning assets ( cash ), a holding of investment assets (which yields a flow of dividends), and a stock of fixed assets. This stock of fixed assets represents the value of infrastructure constructed by the Government such as broadband, roads, schools and hospital buildings. Liabilities are broken down into short-term creditors, arising from the ongoing activities of the Government, and the amount of previous borrowing or debt. The difference between total assets and liabilities is equivalent to equity, or the Government s net worth. Here, government debt, representing earlier borrowings, is about 30 percent of total assets with a net worth at about 40 percent. 4.2 The assumptions Our assumptions include: 12 Asset sales, the Government Accounts and the NZ economy

13 The interest rate on government borrowing is four percent per annum. Return on government investments (non-fixed assets) (i.e. dividend yield) is eight percent per annum. When referred to, the short term is one year. Current spending by government is constant over the long term. Capital spending by government is constant over the long term, except when it relates specifically to the options under investigation. The government tax revenue over the short term is fixed. The government tax revenue over the long term is related to government investments in fixed assets Baseline We begin with a baseline situation, which is used for comparative purposes. Table 1 is presented as the starting point. Table 1 Baseline Statements Financial Position as at beginning of year 1 Liabilities Assets Creditors 35,000 Cash 10,000 Borrow ings 50,000 Investments 40,000 Net w orth 65,000 Fixed assets 100,000 Total 150,000 Total assets 150,000 Financial Performance: for Year 1 Expenses Revenue Spending 9,700 Tax & oth income 8,000 Interest 2,000 Dividends 3,200 Surplus -500 Total expenditure 11,200 Total revenue 11,200 2 Fixed assets in this context can be seen as a proxy for government investment in infrastructure, such as broadband, roads, school and hospital buildings and the like. 13 Asset sales, the Government Accounts and the NZ economy

14 In the baseline, the Government s debt ratio (borrowings) is 33.3 percent while the Government s net worth is 43.3 percent of total assets. The 40,000 of investments results in 3,200 of dividend income to the Government, while its 50,000 of previous borrowings incurs 2,000 in interest payments. The assumed tax, other income and current spending figures, as in the table, result in a negative surplus (i.e. a deficit of 500 during the year). Given the status quo the Government s financial position deteriorates, such that the 500 deficit throughout the year reduces cash reserves by this amount. This assumes that no further borrowing is undertaken. Consequently, total assets decline, along with the Government s net worth, and the debt ratio climbs to 33.4 percent. Table 2 Baseline Financial Position as at end of year 1 Liabilities Assets Creditors 35,000 Cash 9,500 Borrow ings 50,000 Investments 40,000 Net w orth 64,500 Fixed assets 100,000 Total 149,500 Total assets 149,500 Further, assuming that the annual financial performance continues unchanged, and with consequent deficits each year of 500, the Government s financial position statement at the end of year 10 would look like Table 3 below. Table 3 Baseline Financial Position as at end of year 10 Liabilities Assets Creditors 35,000 Cash 5,000 Borrow ings 50,000 Investments 40,000 Net w orth 60,000 Fixed assets 100,000 Total 145,000 Total assets 145,000 This situation is not sustainable; and without changes this can only continue for as long as there are cash reserves to access. Thereafter, the Government would be forced to explore increasing tax and other income revenue, reducing spending, or increasing borrowing. With this baseline situation, we can compare the outcome of alternative options. 14 Asset sales, the Government Accounts and the NZ economy

15 4.4 Selling investment assets to finance building other assets The option of selling assets to fund expansion in other assets is akin to reducing the Government s holdings of investment assets and expanding its holdings of fixed assets. Again, the term fixed assets is used as a proxy for infrastructure like broadband, roads, school and hospital buildings. This option will impact on both the government s financial performance and financial position Short term Under this example, the Government reduces its investment holdings in year 1 by 2,000 and increases its investments in fixed assets by the equivalent amount. This results in a set of statements as shown in Table 4. For simplicity we ignore timing issues and assume there are no other changes in tax, and other income and general spending. Here, dividends decline due to the sale of investments. This leads to a lower surplus, higher deficit compared to the baseline outcome (i.e. compared to Table 1). Table 4 Asset sale option Financial Performance for Year 1 Expenses Revenue Spending 9,700 Tax & oth income 8,000 Interest 2,000 Dividends 3,040 Surplus -660 Total expenditure 11,040 Total revenue 11,040 Financial Position as at end of Year 1 Liabilities Assets Creditors 35,000 Cash 9,340 Borrow ings 50,000 Investments 38,000 Net w orth 64,340 Fixed assets 102,000 Total 149,340 Total assets 149,340 As to its financial position, the interchange of assets, from investments to fixed assets, is noted but the higher deficit is by assumption funded from cash reserves. Consequently, total assets and net worth is lower than in the baseline, (i.e. compared with Table 2), while the debt ratio has increased from the 33.4 percent in the baseline to 33.5 percent under this 15 Asset sales, the Government Accounts and the NZ economy

16 scenario. This outcome is due to the decision to replace income-yielding assets with assets that are, in the short term, not delivering any replacement income to the Government Long term Over the long term, the Government s overall tax and other income depends to a degree on investments in fixed assets such as broadband, roads, school and hospital buildings. Here we make a critical assumption in regards to the extent of this dependence. This assumption focuses on what is the long-term return to the Government, in terms of tax and other income, of these new fixed assets being available to the economy. In the case where the return is (eventually) at the same rate as the dividend yield on the investments that were sold, then the longer-term outcome in terms of financial performance is eventually equivalent to the baseline outcome. Here it is important to recognise the difference in terms of impact on annual performance and financial position. Annual performance considers the difference between income and spending, while financial position considers the balance between assets, liabilities, debt, and net worth. In particular, the long-term outcome in terms of the Government s financial position remains inferior. This is because of the loss of income and subsequent lower surplus or higher deficit over the intervening period. We assume a 10-year horizon and that the new fixed assets return income at eight percent per annum (i.e. equivalent to the dividend yield on the formerly held investments). But, we further assume that the return on new assets does not commence until the fifth year after construction 3. These assumptions result in financial statements in year 10 as per Table 5. Table 5 Asset sale option Financial Performance for year 10 Expenses Revenue Spending 9,700 Tax & oth income 8,160 Interest 2,000 Dividends 3,040 Surplus -500 Total expenditure 11,200 Total revenue 11,200 3 There will be timing issues here and the returns should be phased in. But we make the five-year assumption here purely for simplicity sake. The important principle to note is that there is a delay before these assets begin delivering a return. 16 Asset sales, the Government Accounts and the NZ economy

17 Financial Position at the end of year 10 Liabilities Assets Creditors 35,000 Cash 4,200 Borrow ings 50,000 Investments 38,000 Net w orth 59,200 Fixed assets 102,000 Total 144,200 Total assets 144,200 Under this situation it is worth noting that the annual financial performance has reverted back to the equivalent of the baseline situation. In particular, there is an annual deficit of 500. However, there is also a change on the income side that mirrors the restructure of the Government s asset holdings. There is an increase in income from tax and other revenue, but less income from dividends. However, the higher deficit over the first (assumed) five years of this period has a permanent negative effect on the Government s financial position. In particular, the lower cash reserves (compared to baseline Table 3) results in lower total assets, lower net worth, and the debt ratio climbing to 34.7 percent. Here, it is worth noting that the shorter the period over which the new assets are zero yielding, then the less damage there is to the financial position. If the eventual return on the new assets is higher than those on the investments being replaced, then there is an eventual positive impact on the annual financial performance. This means the deficit would be less over the long term. Under this assumption, the permanent effect on the financial position would also be positive. Such a situation is a clear example of the financial benefits of selling-off relatively under-performing assets. 4.5 Summary The short-term impact of replacing positive-yielding investments with assets with no immediate returns to revenue is negative on the Government s financial performance and position. The critical assumptions (or influential factors) determining the impact of this option includes: The expected return, through the impact on tax and other revenue, from the new assets. o the higher this expected return, then the lower the deficit over the longer term o the lower this expected return, then the higher the deficit over longer term The eventual rate of this return relative to the dividend yield on the formerly held investments. 17 Asset sales, the Government Accounts and the NZ economy

18 o where the rate of return is no higher than the dividend yield, then there is a permanent negative impact on the Government s financial position o if this rate is greater than the dividend yield, then there is a positive permanent effect on the financial position The period during which the new assets are not returning additional revenue or financial benefits. o the shorter this period, the less permanent effect on the financial position o the longer this period, the greater the permanent effect on the financial position. 18 Asset sales, the Government Accounts and the NZ economy

19 5 An alternative option 5.1 Borrowing from domestic private sector This option considers the impact on the Government s accounts if the Government were to borrow from the domestic private sector to finance investment in new assets Short term We begin with the same starting point and assumptions as in the previous section. This includes the example of building an extra 2,000 in fixed assets such as broadband, roads, school and hospital buildings. In this option we assume the extra assets are funded from increased borrowing. This leads to the Government s interest expense increasing from 2,000 to 2,080. In the short term this shows through in the statements in Table 6, and leads to an annual deficit of 580 (compared to 500 in the baseline). Table 6 Domestic borrowing option Financial Performance for year 1 Expenses Revenue Spending 9,700 Tax & oth income 8,000 Interest 2,080 Dividends 3,200 Surplus -580 Total expenditure 11,200 Total revenue 11,200 Financial Position at end of year 1 Liabilities Assets Creditors 35,000 Cash 9,420 Borrow ings 52,000 Investments 40,000 Net w orth 64,420 Fixed assets 102,000 Total 151,420 Total assets 151,420 The higher deficit compared to the baseline leads to a greater rundown in cash reserves. While an increase in fixed assets leads to an increase in total assets, the increase in borrowing leads to a reduction in net worth and an increase in the debt ratio to 34.3 percent. 19 Asset sales, the Government Accounts and the NZ economy

20 However, compared to the option that involves the partial sale of assets (Table 4), the deficit is smaller under this option while total assets, net worth and the debt ratio are higher. This results from the assumption that the interest cost on debt borrowings is less than the dividend yield on investments Long term Retaining the same assumptions in regards to relative yields or financial returns as the previous option, the long-term financial performance is permanently improved compared to the baseline and the asset sale option. This is as result of: permanently increased revenue from tax and other income no reduction in dividend income higher interest costs that are less than the increase in income. The combination of these effects results in a permanently lower deficit of 420, compared to the baseline situation of 500. Table 7 Domestic borrowing option Financial Performance for year 10 Expenses Revenue Spending 9,700 Tax & oth income 8,160 Interest 2,080 Dividends 3,200 Surplus -420 Total expenditure 11,360 Total revenue 11,360 Financial Position as at end of year 10 Liabilities Assets Creditors 35,000 Cash 5,000 Borrow ings 52,000 Investments 40,000 Net w orth 60,000 Fixed assets 102,000 Total 147,000 Total assets 147,000 Consequently, and again assuming a five-year delay before the new assets begin returning revenue, the impact on the long-term financial position is positive. The total assets are higher under this option than both the baseline and the asset sale option. Further, net worth 20 Asset sales, the Government Accounts and the NZ economy

21 is the same as the baseline but greater than the asset sale outcome, and borrowings and the debt ratio are higher. Again, the critical assumption under this option is in regards to the relative yields or returns on the assets, and the length of the period during which the new assets do not yield revenue. 21 Asset sales, the Government Accounts and the NZ economy

22 6 Comparing the options Under an equivalent set of assumptions, namely: interest rates are less than dividend yield return on new assets, in terms of additional revenue, is equivalent to dividend yield five-year lag occurs before the new assets begin to deliver additional revenue. The comparative outcomes of the key parameters are listed in Table 8 and depicted in the following charts. $ 0 Figure 5 Government fiscal surplus (+) or deficit (-) baseline asset sale option domestic borrowing option year 1 year 6 year 10 year 15 Figure 6 Government net worth $ 66,000 baseline asset sale option domestic borrowing option 62,000 58,000 54,000 50,000 year 1 year 6 year 10 year Asset sales, the Government Accounts and the NZ economy

23 Figure 7 Government total assets $ 154,000 baseline asset sale option domestic borrowing option 148, , , ,000 year 1 year 6 year 10 year 15 Figure 8 Government debt as % of total assets 40 % baseline asset sale option domestic borrowing option year 1 year 6 year 10 year 15 Given these assumptions, only in the domestic borrowing case is there a permanent impact on the deficit. This impact is positive and results in a lower deficit. However, in this case debt (borrowing) is higher as is the debt ratio out to year In contrast though, the asset sale case results in a permanent deterioration in the financial position (net worth and debt ratio worse) compared to the baseline, although the annual financial performance (eventually) returns to the baseline situation. 4 If we were to extend the horizon then the debt ratio in the domestic borrowing case would eventually fall below the baseline and the asset sale case due to the permanently lower deficit leading to higher total assets. 23 Asset sales, the Government Accounts and the NZ economy

24 Table 8 Comparison of outcomes Baseline Sell assets to fund the build of new assets Borrow domestically to fund the build of new assets Short term Govt surplus(+) or deficit(-) Government net worth 64,500 64,340 64,420 Govt debt (borrowing) 50,000 50,000 52,000 Govt total assets 149, , ,420 Govt debt ratio (%) Long term (year 10) Govt surplus(+) or deficit(-) Government net worth 60,000 59,200 60,000 Govt debt (borrowing) 50,000 50,000 52,000 Govt total assets 145, , ,000 Govt debt ratio (%) Long term (year 15) Govt surplus(+) or deficit(-) Government net worth 57,500 56,700 57,900 Govt debt (borrowing) 50,000 50,000 52,000 Govt total assets 142, , ,900 Govt debt ratio (%) Asset sales, the Government Accounts and the NZ economy

25 7 Other expected benefits and wider impacts 7.1 Other expected benefits The Government s financial position cannot be used as a basis for arguing a sale of investment assets is required to fund the construction of new assets. Consequently, we look to alternative motivations underpinning the proposed programme of partial asset sales namely: improving the pool of investments available to New Zealand investors and deepening capital markets allowing the mixed ownership companies to access capital and grow without depending entirely on the Government allowing for external oversight, which places sharper discipline and more transparency on a company s performance. We note that while each of these objectives has merit, they do not rely on the adoption of the mixed ownership model. For example, the objective of improving the pool of investments available to New Zealand investors is entirely consistent with the option of the Government financing new assets through borrowing from the domestic private sector. Households (colloquially termed mom and pop investors) could be attracted to direct investment opportunities in government bonds. Perhaps in the guise of infrastructure or national development bonds or similar, such investments vehicles could be targeted directly at the retail investor 5. The objective of allowing mixed ownership companies access to capital to grow without depending entirely on the Government need not require a partial sale of equity. To access capital, mixed ownership companies need to attract funds from the private sector. They can do so, subject to the maintenance of a prudent debt-to-equity ratio, without the need to reduce an existing owner s equity stake. Of course, accessing funds through the use of debt instruments to finance growth is standard practice in the business sector. The objective of improving external oversight, could also be achieved through alternative means the appointment of independent directors, directors/boards reporting to a Parliamentary committee (in addition to shareholding Ministers), or the setting of clearer, transparent directions from shareholder Ministers as to market-related objectives. We note, 5 As noted in the Supplement to the 2010 Investment Statement, as at December 2009 around $100 billion was held by domestic retail investors in term deposits and other short-term accounts. 25 Asset sales, the Government Accounts and the NZ economy

26 in passing, that the need for this objective does seem in contradiction to the stated expectation of a gain on sale of these assets (as forecast in the 2012 Budget Policy Statement). Were these companies performances below par and in need of sharper discipline, such a gain on sale would seem unlikely. Consequently, while a reduction in the state-owned equity share may contribute to each of these other objectives, such objectives could also be achieved through alternative means. 7.2 Impacts on wider economy External debt situation As was rightly noted in the 2010 Budget, NZ s largest single vulnerability is now its large and growing net external liabilities. NZ now owes the world $168bn, or around 90% of (annual) GDP. While the level (and ratio) of external debt has since been reduced a degree, it remains at an uncomfortably high level. We urge that the difference between the government s debt and the external debt be stressed. We note that the (partial) asset sale programme, contrary to what some in the public may be being led to believe, is not aimed at paying off some of this external debt. We further argue that the impact of the asset sale programme should be of paramount importance when assessing its economic benefits. This is a logical consequence of the statement that New Zealand s external debt is its largest single vulnerability. While there could well be no direct impacts, the indirect effects on the external debt are important to note. Parallel to the underpinnings of a government s accounts, a level of external debt can only be permanently reduced through a reduction in the annual external deficit (or an increase in the external surplus). As a result, the impact of the asset sale programme on external receipts and payments needs to be assessed. While the Government has stated that New Zealanders will be at the front of the queue for purchase of the investment assets being sold, some may well be sold to overseas investors. Consequently, the portion of mixed ownership company earnings (dividends and profits) that relate to overseas investors will be an outflow (or payment) on the external accounts. This would represent, (ultimately, and assuming all else unchanged) a permanent deterioration in the external deficit and so the level of external debt. Further, while the initial offering may be directed towards domestic purchasers, future private share transactions could well increase the portion of shares (and so of earnings) in overseas hands. Such an outcome would lead to a further deterioration in the external deficit and external debt position. 26 Asset sales, the Government Accounts and the NZ economy

27 As a counter, the Government has suggested there may be measures to ensure widespread and substantial New Zealand participation in the asset sale programme. Those noted in the Supplement to the 2010 Investment Statement include: a priority allocation, pre-registration and instalment receipts financial incentives, such as price discounts and loyalty shares hard ownership restrictions, such as individual or total ownership caps, or separate domestic shares. Consequently, until decisions are made as to how these are to be implemented, we can make no conclusion as to the magnitude or significance of the negative impact on the external deficit or external debt. On the other hand, it should also be noted that there could be a potential impact on external receipts. That is, the asset sale programme could lift the competitiveness and performance of businesses earning external receipts (i.e. exporters). If so, the external deficit could be reduced with a beneficial flow on effect on the external debt. Again, this would be an indirect effect and the precise manner of this influence remains unclear and the subject of considerable conjecture. To estimate the magnitude of this influence would need further careful investigation. At the very least, though, we advise that it would be unwise from an economic perspective to embark on a policy that risked increasing external payment obligations, without at first verifying and confirming a counter-balancing positive impact on external (i.e. export) revenues. This advice is even more pronounced given the context of global financial market instability arising from the uncertainty as to the future of the Euro Ensuring a competitive market The other primary factor to assess from the perspective of the wider economy would be the degree of competitiveness in the market(s) in which the mixed ownership companies were operating. The presence of competitive markets is central to ensuring the efficient use of resources and cost structures that do not undermine the productivity and profitability of business enterprise. This is particularly important for business operating in externally traded sectors. The implied increase in commercial disciplines as a result of asset sales would, in the textbook course of events, be balanced by the presence (or threat) of a sufficient number of 27 Asset sales, the Government Accounts and the NZ economy

28 competing players in the same market. However, this may not be the case in the actual market, particularly where elements of a natural monopoly could be present. In such cases the importance of market regulation, or other such oversight, should be reinforced where a mixed ownership model is being considered. 28 Asset sales, the Government Accounts and the NZ economy

29 8 Appendix alternative assumptions 8.1 Reduced return on new assets The results discussed in the earlier sections assume that the new assets successfully grow economy. We further assume that the new assets eventually deliver a return to government, in the form of increased tax receipts, equivalent to the dividend yield on the formerly held investment assets (i.e. an assumed 8% per annum). Figure 9, Figure 10 and Table 9 below, note the impact if this assumption is changed to the return on new assets being only 4% per annum (i.e. equivalent to the cost of borrowed funds). We continue to assume that the delay before reaping this return is five years. The outcome under this alternative assumption is worse for both options. In addition to a permanently worse net worth position, the Government deficit is now also permanently worse under the asset sale option. For the domestic borrowing option, the Government deficit only returns to baseline, noting that the earlier assumption resulted in a permanently lower deficit for this option. Figure 9 Govt fiscal surplus (+) or deficit (-) assuming reduced return on new assets $ baseline asset sale option domestic borrowing option year 1 year 6 year 10 year Asset sales, the Government Accounts and the NZ economy

30 Figure 10 Govt net worth assuming reduced return on new assets $ 66,000 baseline asset sale option domestic borrowing option 62,000 58,000 54,000 50,000 year 1 year 6 year 10 year 15 The consequential impact on net worth and total assets is permanently worse for both the asset sale and the domestic borrowing options (compared to baseline). As previously, the domestic borrowing option fares better in comparison to the asset sale option in terms of total assets and net worth, resulting from the relatively more favourable outcome for the Government fiscal deficit. The conclusion here is that the assumed return on new assets is important in determining the outcome of each option compared to the baseline. However, altering this assumption does not change the relative comparison between the asset sale option and the domestic borrowing option. That is, the domestic borrowing option remains more favourable than the asset sale option in terms of Government deficit, total assets and net worth. The outcome for the debt ratio remains higher in the domestic borrowing option. Although, as noted earlier, the more favourable outcome for the Government deficit and total assets means that the impact on the debt ratio will be also be eventually lower in the domestic borrowing option. 30 Asset sales, the Government Accounts and the NZ economy

31 Table 9 Comparison of outcomes assuming reduced return on new assets Baseline Sell assets to fund the build of new assets Borrow domestically to fund the build of new assets Short term Govt surplus(+) or deficit(-) Government net worth 64,500 64,340 64,420 Govt debt (borrowing) 50,000 50,000 52,000 Govt total assets 149, , ,420 Govt debt ratio (%) Long term (year 10) Govt surplus(+) or deficit(-) Government net worth 60,000 58,800 59,600 Govt debt (borrowing) 50,000 50,000 52,000 Govt total assets 145, , ,600 Govt debt ratio (%) Long term (year 15) Govt surplus(+) or deficit(-) Government net worth 57,500 55,900 57,100 Govt debt (borrowing) 50,000 50,000 52,000 Govt total assets 142, , ,100 Govt debt ratio (%) Asset sales, the Government Accounts and the NZ economy

32 8.2 Faster return on new assets In this sub-section, we explore the impact of each option assuming that the delay before returns are reaped from the new assets is shorter (i.e. two years, compared to the five years in the earlier sections). For comparability, we return to the original assumption that the return on new assets is equivalent to 8% per annum. Figure 11 and Table 10 summarise the outcomes. Figure 11 Government net worth assuming faster return on new assets $ 66,000 baseline asset sale option domestic borrowing option 62,000 58,000 54,000 50,000 year 1 year 6 year 10 year 15 Assuming a faster return on new assets reduces the loss of income in the asset sale case and so reduces the long-term damage to the Government s financial situation. However, there remains a permanent reduction in net worth arising from the two years delay in reaping returns, although this reduction in net worth is less than that with the assumptions adopted in the earlier sections. Note, though, that the faster return from new assets assumption also improves the outcome in the case of the domestic borrowing option. This also arises from the reduced delay between the building of new assets and the reaping of returns. Again, the conclusion is that while this assumption is important when the outcome of each option is compared to the baseline, the relative comparisons between the asset sale option and the domestic borrowing option are not altered. That is, the domestic borrowing option remains more favourable than the asset sale option in terms of Government deficit, total assets and net worth. 32 Asset sales, the Government Accounts and the NZ economy

33 Table 10 Comparison of outcomes assuming faster return on new assets Baseline Sell assets to fund the build of new assets Borrow domestically to fund the build of new assets Short term Govt surplus(+) or deficit(-) Government net worth 64,500 64,340 64,420 Govt debt (borrowing) 50,000 50,000 52,000 Govt total assets 149, , ,420 Govt debt ratio (%) Long term (year 10) Govt surplus(+) or deficit(-) Government net worth 60,000 59,680 60,480 Govt debt (borrowing) 50,000 50,000 52,000 Govt total assets 145, , ,480 Govt debt ratio (%) Long term (year 15) Govt surplus(+) or deficit(-) Government net worth 57,500 57,180 58,380 Govt debt (borrowing) 50,000 50,000 52,000 Govt total assets 142, , ,380 Govt debt ratio (%) Asset sales, the Government Accounts and the NZ economy

34 All work is done, and services rendered at the request of, and for the purposes of the client only. Neither BERL nor any of its employees accepts any responsibility on any grounds whatsoever, including negligence, to any other person. While every effort is made by BERL to ensure that the information, opinions and forecasts provided to the client are accurate and reliable, BERL shall not be liable for any adverse consequences of the client s decisions made in reliance of any report provided by BERL, nor shall BERL be held to have given or implied any warranty as to whether any report provided by BERL will assist in the performance of the client s functions. 34 Asset sales, the Government Accounts and the NZ economy