04 April 2013

Well on the way to Debt Freedom #nlpoli

According to economist-consultant Wade Locke, the provincial government’s “Sustainability” Plan includes a debt commitment:
The long-run target is to bring the province’s net per capita debt gradually down to the all-province level within ten years.
Locke made it clear in another part of his March 25 memo to finance minister Jerome Kennedy that the purpose of any surpluses the provincial government achieves within the next decade will be to fund Muskrat Falls.

For those who haven’t figured it out yet, the Locke-Conservative plan isn’t actually to reduce public debt.  They want to book the Muskrat Falls asset and – since that’s what net debt is -  make it appear they have lowered public debt when they likely haven’t moved it down very much at all.

By contrast, the SIDI model shows that the provincial government could have reduced direct public debt by $3.675 billion.  The net debt would currently stand at $4.6 billion with a downward trend.  According to Budget 2013, the net debt is is forecast to be about $8.5 billion, continuing an upward trend.

Big difference.

As detailed on Tuesday,  the SIDI model held current account spending since 2007 to a four percent annual increase funded by the Stabilisation Fund.  That’s one of four new funds described in the SIDI model and used in this series of posts to illustrate an alternative public financial policy than the one that will produce continuing government financial problems over the next decade at least.

The funds contained equal amounts of the non-renewable resource revenues collected by the provincial government each year.  Another fund for Infrastructure supported $500 million of capital spending annually.  As it worked out, the Stabilisation Fund was able to balance the books annually and cover the $500 million in capital works until 2011 when the model needed to draw money from the Infrastructure Fund.  In the simulation used for these posts, the Infrastructure Fund held $2.67 billion by 2012.

Two other pots of money – Debt Reduction and Investment – were designed to reduce the public debt and produce new revenue.  By 2012, the Investment Fund held a total of $3.675 billion in oil revenues.

Real Debt Reduction

In the simulation, SRBP used the Debt Reduction Fund reduce the total public debt as described in the Estimates.  The total debt consists of accumulated deficits and the debt of Crown corporations such as Nalcor.  It peaked at $8.6385 billion in the 2008 Estimates.  That figure includes sinking funds.

The DRF in the simulation accumulated $3.675 billion from 2007 to 2012 leave a total public debt of $4.961 billion.

Net debt is a calculation of assets minus liabilities.  To figure out the total provincial government liabilities, SRBP relied on the current estimate of the unfunded public sector pension liability of $5.6 billion and added that to the SIDI public sector debt in 2012 of $4.961 billion.  The total is $10.561 billion.

To figure out the net debt, approximately, SRBP subtracted the cash assets in the Investment Fund and the Infrastructure Fund.  That left a net debt in 2012 in the SIDI simulation of at most $4.216 billion.  (10,561 minus 6,345)  The actual net debt would be lower if we included any other cash on hand at the end of the fiscal year as well as non-financial assets normally used to calculate net debt.

It’s the reduction in actual debt, not net debt that would have made a difference to the annual budget if the provincial government had followed a different financial policy.  A rough calculation using available provincial budget figures suggests that the debt reduction would have produced an annual saving in debt servicing costs of about $200 million by 2012.  That money would be available for program spending, infrastructure, debt reduction of investment.

New Cash from Investments

The Investment Fund is modeled on the Alberta Heritage Fund and other, similar investment funds around the globe.  In practice, such a fund would be managed by a non-political investment manager according to rules set by government or by the House of Assembly through legislation.  Typically, the money would be for investments outside Newfoundland and Labrador that would guarantee an average return each year.

For simulation purposes, we can use an annualized rate of return of four percent. That’s below the current target for the Alberta Heritage Fund.  The government’s pension fund has made nine percent annualised since the fund was established in 1981.

Compound interest at a rate of four percent annually delivered a total of $526.518 million in interest in the simulation.  That assumes that the fund retained the interest from year to year and invested it.  Contrast that with the estimated half million dollar deficit in the real-world 2013 budget forecast.

Eliminating Public Debt

One of the most significant uses of oil and mining royalties would be making money for the people who own the resources, the people of Newfoundland and Labrador.  In the SIDI model,  the debt fund and the investment fund achieved that goal by freeing up money from debt servicing and by bringing new income to the provincial government from outside.

The average income to the debt reduction fund over the six years of the simulation was $612 million.  At that rate, the total public debt would be paid off completely within a decade. Newfoundland and Labrador and Alberta would have been the only provinces in the country with no public debt in 2023 in this scenario.

The unfunded pension liability would remain in that scenario, but the investment fund would make cash annually to offset that.  Any government using oil and mining to pay down debt,  for overseas investments, or both would make new money for the provincial government in the process.

Think about that for a moment. 

Then watch any given cabinet minister trying to justify the cuts and the ongoing financial problems the current government has created by its own mismanagement.