A Standard and Poor Budget

We may never know what passed between Standard and Poor’s and our Finance Minister on the eve of the budget. And only time will tell whether the “primary focus” of the budget was – as the Prime Minister claimed – the avoidance of a credit rating downgrade and whether, in the long run, that goal was achieved. But the episode does raise a number of interesting questions.

Eyebrows were understandably raised at the explicit acknowledgment that the government’s budget strategy has been shaped by the need to please an overseas credit rating agency. How did we, as a sovereign country, become so powerless to decide our own destiny?

We don’t have to look far for the answers. After decades of poor economic performance and – as a consequence – of living beyond our means, we are now one of the world’s most indebted countries. On some measures, only Iceland had a greater overseas debt in proportionate terms than we have – and we know what has happened to Iceland.

The size of our debt means that we are dangerously dependent on the willingness of others to lend to us. In times of plentiful and relatively cheap credit, borrowing (at a price) was not a problem. But the global crisis has changed all that. Credit is now in short supply and countries like New Zealand, with substantial deficits to finance, will have to pay an interest rate premium to borrow – if they are able to borrow at all.

The level of interest we must pay will depend crucially on our credit rating – and that is why the government is so concerned about the view taken of us by Standard and Poor’s. According to the Treasury, a downgrade would cost the country $600 million and interest rates could rise across the board by 1.5%.

But is this all as stark as it seems? Are the threats of a credit downgrade and its consequences as serious as they sound, and – even if they were – would they be a price worth paying for gains that are even more important?

We should note, first, that the Treasury and others have been very relaxed over a long period about interest rates that have been much higher and more damaging to our economy than anything currently contemplated. And we should also note that many of the more frightening Treasury forecasts of the likely level of government debt seem to be simple extrapolations of the short-term and recession-induced deterioration in the government’s financial position, and to pay little attention to the beneficial impact of an effective counter-recessionary strategy. And no one – least of all Standard and Poor’s – could overlook the fact that our government’s financial position is, by both our own historical standards and in terms of international comparisons, reassuringly strong.

Let us assume, in other words, that the credit rating agencies are not lacking in intelligence and know their own business. The government may be obsessed by the projected level of government debt but Standard and Poor’s know that the government’s relatively healthy debt position is only a small part of the real problem – the huge amounts that we as a country (and that includes all of us, banks, businesses, individuals as well as the government) have to borrow overseas if we are to keep our heads above water.

That is the real issue of credit-worthiness – not the government’s debt but the country’s indebtedness. That can be corrected only if we reverse the long-term failure of economic policy and performance and it will only get worse if we fail to use the spending power of government to rescue us from recession. That, surely, is what a credit rating agency should be focusing on.

The best and quickest way, after all, of bringing both the government’s debt and the country’s borrowing requirement down to manageable levels is to make the recession as short and as shallow as possible. The buoyant tax revenues produced by a recovering economy will quickly bring the deficit down, and repay the $600 million supposed cost of a credit downgrade (if it should happen) several times over. Just how rapidly that can happen can be seen from how fast the government’s finances travelled in the opposite direction once the recession struck.

No one would welcome a credit downgrade. No one can cavil at the government’s insistence on value for money in public spending. But our over-riding goal should surely be recovery from recession. In giving priority to a temporary increase in government debt as we face the worst recession in generations, we may be taking our eye off the ball. There is a bigger game in town, and that is the health of the economy as a whole.

Bryan Gould

28 May 2009

This revised version of an earlier piece was published in the New Zealand Herald on 1 June.