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Australia’s government debt and its ‘lazy balance sheet’

The Federal Budget and the level of government debt are hot topics in the media once again, so an update on the facts will provide some context for the debate.

Government debt levels and interest burden

This first chart shows the level of Commonwealth (CW) Government debt measured in three ways:

  • debt relative to national income (GDP) - pink bars on the lower section of the chart
  • government interest burden relative to national income – black line
  • government interest burden relative to government income (mainly tax receipts) – red line

Where we are now?

The current position (mid February 2015) is that Commonwealth Government debt securities outstanding total $356 billion, or around 22% of national income (GDP). (Source: Australian Office of Financial Management)

But this excludes many other types of debts, including unfunded ‘defined benefit’ pension liabilities, other financial liabilities and commitments and derivative exposures. It also excludes assets held to fund those other liabilities, for example, the Future Fund’s assets to fund future government pension liabilities.

Interest being paid on debt securities is $16 billion per year or $44 million per day. This equates to 4.5% of Commonwealth Government revenues and about 1.1% of national income.

The above chart shows that on these measures the level of debt and the level of interest paid on that debt are very low, and on a par with the low levels of the 1950s to the 1970s.

Australia’s debt-to-GDP ratio first increased dramatically to fund the war-time spending during WW1 and then rose again in the 1930s depression. The main reason for the increase in the ratio in the 1930s was the dramatic collapse in national income, not an increase in debt. In fact between 1929 and 1932 the level of debt actually reduced by 15% but nominal GDP contracted by 31%.

Australia did not go on a Keynesian deficit spending spree in the 1930s depression like the US because we simply were not able to borrow. The Commonwealth and state governments had run out of credit availability in foreign debt markets by 1929, and the Commonwealth’s then wholly-owned Commonwealth Bank refused to lend it more money. So the only option was to stick to the savage and deflationary austerity of the 1931 ‘Premier’s Plan’ and force all holders of domestic government debt into a haircut restructure deal not unlike the recent Greek debt restructure.

The chart shows that after WW2 the debt to GDP ratio reduced in the 1950s but it was not because the government paid off debt. The level of debt kept growing steadily, but the national income grew even faster, so the debt to GDP ratio declined although the level of debt rose. The rising level of debt was mostly put to good use being invested in productive purposes, mainly infrastructure to support the rapidly growing population, driven by the post-war ‘baby boom’ and the aggressive ‘populate or perish’ immigration program.

Interest burden

The black line on the above chart shows that interest payments on government debt consumed 30-40% of all government revenues in the 1920s (on a par with the PIIGS and Japan today) and it was still consuming more than 10% of revenues in the 1930s and 1940s (on a par with the US today). The interest burden was then brought down in the post-war boom in the 1950s and 1960s, as national income rose at a much quicker rate than the rise in interest rates.

In recent years the interest burden of government debt was at its lowest level ever in 2007-2008 when the level of debt was also at its lowest level.

However, the current interest burden (at around 1% of GDP and around 4% of tax receipts) is no higher now than it was in the 1950s to the 1970s. This is due to the relatively low level of debt and the relatively low interest rates today.

Lazy balance sheet’

If Australia was a company its national debt would be labelled a very ‘lazy balance sheet’ and the CEO and Chairman would be thrown out by shareholders for not borrowing enough to invest for future growth!

Australia has always been a country in which the opportunities for growth and investment have far exceeded the local savings pool available to fund its development, and so it has always had to import people and capital, in the form of equity and debt.

Many people liken a country to a household, where it is prudent to have no debt, or at least to pay off debts as quickly as possible. However a country is more like a company than a household. In a household, the breadwinner(s) stop generating income and have to draw down their accumulated savings during decades of retirement. Companies and countries can exist forever (in theory anyway) and they can (and probably should) carry debt as long as the cost of debt (interest) is lower than the additional income generated from the investments funded by that debt.

In truth, the reality for most countries is probably somewhere between these two views. Australia has an aging population and rising welfare and health costs, but it is still the best placed among its ‘developed’ country peers (in the OECD for example) thanks to its relatively favourable demographics. It is far better placed than Japan and northern European countries that have declining populations, declining workforces and declining tax-payer bases. Those countries are indeed more like households, where the breadwinners in aggregate are reducing their income-generating ability and are literally dying off.

Government deficits

Governments borrow money when they run a budget deficit – where their outlays exceed their revenues. The second chart shows government surpluses or deficits for Australia (upper section of the chart) together with the Debt to GDP ratio (lower section) for reference.

This chart shows that the Abbott government deficit performance (relative to national income) is similar to those under Rudd/Gillard, Keating, Hawke, Fraser and Menzies, but far lower than the deficits in both World Wars and in the 1930s depression.

‘Good’ or ‘bad’ debt?

When a household, company or country borrows money, the debt ideally should be used to generate future revenues that will repay the interest on the debt and also repay the principal due at maturity.

In the case of a household there is said to be ‘good debt’ (debt that is used to buy an asset or activity that generates enough income or capital growth to more than cover the principal and interest on the debt), and ‘bad debt’ (debt that is used to fund lifestyle expenses). The argument goes that it is the same with a country, and debt used to pay pensions, welfare and healthcare costs fall into the category of ‘bad debt’ that must be avoided because it doesn’t generate revenue to cover the interest on the debt. Whether it is good or bad debt, rising pensions, welfare and healthcare costs in a country with an aging population must either be kept in check or met with rising tax revenues. If not it will require larger deficits and debts in the future.

Focus on income instead of debt

This brief story has shown that most of the big changes in Australia’s Debt to GDP ratios over time were due to changes in the national income (ie the output from the economy) more than changes in the level of debt. While most of the shrill media debate is focused on the absolute level of debt, what is more important is a debate about what the debt is spent on, and whether it will maximise the productive capacity of the economy in the future.

Australia still has a relatively ‘lazy balance sheet’ (ie a relatively low level of debt) and is still a country with far more opportunities and development potential than the savings pool available locally to fund it, together with a growing and relatively young population relative to our ‘developed’ country peers.

With record low interest rates and global investors clamouring to lend us money, this is the time to borrow at ultra-low rates locked in for long periods and use the money wisely to fund long term projects to maximise Australia’s long term economic growth. But that requires long term vision and that is sadly lacking in our leaders from all sides of politics in Australia.

 

Ashley Owen is Joint CEO of Philo Capital Advisers and a director and adviser to the Third Link Growth Fund.

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13 Comments

Jim Noonan

March 09, 2015

Debt for productivity growth is not a burden to future generations as they have the productivity benefit to use and enjoy.
Debt for consumption is not generally considered good for future generations but this should be balanced against the productivity growth that the future generation has the benefit of, without any production from the future generation, made by the group incurring the debt.
For example, people who have worked for 50 or more years and have built an Australia that has much more for all people, than was available to the public when these people started their employment, is not toxic debt.

Frank Camilleri

March 09, 2015

Successive Governments have focussed on the size of debt as it wins votes. The actual benefit delivered by taking on debt is disregarded to simply get votes. Governments are great a demonising issues to their own detriment. Take the GST and tax on earnings on assets backing retirement income streams; sensible reform here could go a long way towards rectifying the budget deficit and yet neither party seriously considers it due to the negative polling impact.

Alex Dunnin

March 09, 2015

The obsession is both ideological (political) and structural, ie business tax revenues have fallen while we are committing to increased expenditures that don't seem to have the funding underneath them we thought they had. Our headline debt levels is of course trivial but it's recurrent deficit that is the bigger worry, fuelled by the political classes being unable to articulate a workable framework to deal with it. We should however be wary of comparing our debt to OECD benchmarks given some of the basket case economies in that grouping. Having said that, borrowing to fund some grand infra projects makes sense. But borrowing to avoid resolving our recurrent problems is not a good idea. The idea that we just whack up taxes is thus vague waffle because it doesn't resolve much.

Donald Macmillan

March 09, 2015

The author of the article does not address a fundamental issue of debt be it good, bad or indifferent debt. It has to be repaid.

second I am hard pressed to think of a single style of 'development project' that would not be subject to screaming by the greens that it would ruin the environment . Be it railways thru the outback, to dam building to provide water for food production, let alone nuclear waste reprocessing or storage to control the nuclear cycle from mining to final disposal.

Ramani

March 09, 2015

David is right to focus on the end usage of money ( be it debt or one's own). If it creates contra assets which would enhance future income or quality of life, then debt would be acceptable.

Like in a household, this should be stress-tested for future shocks on income, expense and unknown unknowns, before being taken on.

The temptation with country debt (as distinguished from individuals) is that countries wrongly presume immortality and their perpetual existence; selectively invoke their sovereignty to do their own thing (did not think of it when they borrowed); put the shutters down (by expropriating foreign payables or imposing exchange barriers). In short, pass the burden to unborn generations. Easy to do as those who decide are looking to the next election, not generation.

GFC saw that countries can go bankrupt as easily individuals. Messier to resolve than personal crises, as the ire of Ireland, the pain of Spain and the fall from grace of Greece showed. Look at France or Detroit when they tried to reduce pension obligations.

We do not want to go there.

David Orford

March 09, 2015

What happens in other countries may have good or bad lessons for Australia. The fact that other countries are less well managed is not a reason for us to increase our debt.
Debt to invest is good but debt to pay expenses means that we are increasing our living standards and expecting future generations to pay for it.
We need to pay off this bad debt soon as our country will need greater funding in 15 or so years' time - see InterGenerational Report - which could give you nightmares

Charles Sondergaard

March 02, 2015

Borrowing to fund deficits is like borrowing to go on a holiday. Borrowing to fund infrastructure can be good but wasteful infrastructure is a problem we have with government spending. EG National Broadband Network - Under Labour costs blew out exponentially and delivery never happened. We could quite easily have spent $100billion on a Rolls Royce infrastructure investment with square wheels. Best way forward is to be very cautious with debt when it comes to government.

Warren Bird

March 02, 2015

Funny you should mention those bonds, Ecosh. Although there has been a small amount of UK bonds on issue that have no maturity date, they are callable. That is, the investor can't demand face value to be repaid, but the government can decide it will do so.

The UK Government has decided to do so and issued call notices in December. The reason is basically that interest rates now are lower than the rates they're paying on these old bonds, some of which were first issued in the mid-1800's.

The following article has some information on this:

http://www.businessinsider.com.au/the-uk-government-redeems-war-loans-2014-10

Warren Bird

March 10, 2015

Here's a Youtube about the war bond that was repaid yesterday: worth a look

https://www.youtube.com/watch?v=jWMRaZz4GVA

Don MacMillan

February 28, 2015

Mr Owen does not attempt to address the fundamental aspect of debt -be it good, bad or indifferent. It has to be repaid.

Second does any one REALLY think Canberra is actually capable of 'borrowing' 20 or 50 Billion for say new highways or railways or water collection & usage etc thru the outback without diverting any of the cash to consumption spending on the cities' voters? Of course you can imagine the greenies crying over cashing on ALL of the stupid development projects listed above.

Ecosh

February 28, 2015

Why does it ever have to be repaid? My understanding is that Britain still has debt from WWII, some of which may go on forever. Many companies also always carry debt. Like the author said, if the borrowing is spent productively, it pays for itself, especially when you're locking in very cheap loans for a long period. How can that be bad? And if not now, when? When rates have gone back up and our infrastructure is even more lacking?
(The issue of "our leaders" actually doing this should be kept separate if we're to have a mature debate).

Steve

February 27, 2015

Comparing the current economic climate to the Great Depression is an interesting analysis but I'm not sure how really relevant that is to today's position. If our combined Federal and State debt is $600billion then I am very worried. If you try to pay if off in 10 years there as a capital repayment of $60billion a year plus interest at say 4% is $24billion making it an initial $84billion per annum to pay down the debt. Given we now have 4 the tiers of government in Australia, the Senate will not pass any savings, then this looks like mission impossible. You add to that significant reductions in income, ageing of the population, welfare exploding into the fastest growing business in Australia and we are in some considerable trouble. And for what, a huge debt spent on handouts, excessive and inannropriate expenditure that have little if any longer term benefit. Have wealready mortgaged our children's future?

Bruce

February 27, 2015

Ashley

The historical perspective is interesting - thanks for all the hard work. However the present outlook is still a bit worrying to me; Adding in current State governments debt gives a total of $600 billion gross debt (RBA stats Dec 2014) and I estimate Commonwealth defined benefit super liabilities (net of Future Fund assets) currently to be about $100 billion. On this basis total government debt and liability would be about 45% of GDP. I think this might get us closer to some of those past dark ages on your charts (although probably not exactly comparable). But in those days we did at least have a federal Loan Council which limited the states profligacy. Your last sentence re current governments applying borrowings "with long term vision" is very telling!

Bruce


 

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