Budget basics: debt #nlpoli

Board of trade president Sharon Horan wrote in her Telegram column last weekend that the unfunded pension liability will make up 85% of the provincial government’s debt not to long into the future.  That will be up from the 75% of the public debt it makes today.

There you have proof that even the president of the largest business organization in the province does not understand the first thing about the state of the provincial government’s finances.

Public debt is a really basic idea that you have to know if you want to understand public finance.  And you need to understand public finance if you want to have a useful say in how the government is running things.  That’s what the folks at the board of trade want to do, one would expect.

And yet Horan got it wrong. 

Not a mere technicality.

But dead wrong.

So if the board of trade can bugger up public debt, let’s see if we can walk everyone through the notion in a way that we can all understand.

The looming debt problem: update

Canadian household debt is at at record levels according to report by the Certified General Accountants Association.

The latest report adds a new twist to a discussion of the potential risks for consumer debt in this province discussed in a post last week.

Table 17 from the report shows provinces with  segments of the population considered to be highly vulnerable for debt growth and financial problems associated with heavy debt loads.

Another table (19 on page 74) shows levels of savings for Newfoundland and Labrador are relatively low.  At the same time, house prices increased at the highest average level of all provinces for the period 2007 to 2009. 

According to some thinking, the economic vulnerability represented by small savings could be offset by the relatively high level of equity that could be represented in the high house prices. That would theoretically make Newfoundland and Labrador no more risky than Alberta where the savings levels are the highest in the country while house prices have dropped lately.

Small problem.

House prices can shift dramatically while savings and investments tend to hold value over a long period of time.

The summary of that chapter’s conclusions also sounds a strong warning, even allowing that the conclusions are for the country as a whole, not just one province.  Incidentally, this is all one paragraph in the report.  The layout is changed here to make reading easier:

First, the positive signs of improving labour market conditions portrayed by the unemployment rate and the hiring intentions of firms may be deceptive. Labour market conditions continue to be fairly weak: the market’s ability to keep up with the increase in working age population recovers slowly (and even deteriorates in some of the provinces); the long-term unemployment rate continues to increase while the decline in the proportion of discouraged workers has not  yet materialized.   Weak labour market conditions may suppress the short-to-medium term growth in earnings while increased and more prolonged absence of employment may decrease individual’s life-long earnings.

Second, certain socio-economic groups (i.e. youth, workers with low educational attainment, lone parents, and self-employed) may be seen as vulnerable as they are faced with higher labour market stress due to elevated likelihood of longer-term unemployment and reduced employment options.

Third, individuals in vulnerable groups that reside in provinces having a weak labour market may be at a higher risk of elevated financial stress. 

Fourth, the recent recession and economic recovery brought only slight improvements to the conventional savings out of income; at the same time, accumulation of savings through wealth has been weakening in the past several years. Neither active savings from income, nor passive savings through equity are evenly distributed across provinces and households. The lack (or low levels) of active savings may jeopardize individual’s ability to pay and honour debt obligations in the future.

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Harris Centre economic forum: the media coverage

The Telegram’s James Macleod had a decent front page summary of the Harris Centre’s discussion of economic issues facing the province and the subsequent discussion.

The CBC has a super short version that is already bumped off the front page of its website in favour of stories like one on a baby bear in Terra Nova park, a batch of fake 20s making the rounds on the northeast Avalon and an earth-shattering story about two idiots who stole metal for scrap and found out it was worth more than they thought when they wound up in court for the theft.  Talk about if it bleeds, leads.

Anyway, for those in tune with evidently less important issues – how does an multi-billion dollar economic mess compare to two scrap metal dorks? -  Wade Locke’s presentation isn’t on line yet but here is the slide likely to be causing a few stomach’s to turn in knots. 

It’s Locke’s deficit forecast based on current trends and current government policy:

Within a decade the current account deficit will be running at record levels if the current administration carries on with its policies. We can expect more of the same from the incumbents since finance minister Tom Marshall is already trying to pretend that the mess doesn’t exist or that he has things under control. 

Unfortunately for the rest of us,  it does and he doesn’t.

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Oil prices continue fall

Crude oil hit US$114 a barrel Monday on the New York Mercantile Exchange down from the record high of $147 set only a month ago.

The Monday price was the lowest closing price for crude since May 1. It continued the fall in price from last week.

The folly of budgeting based on volatile energy prices would seem obvious. Crude oil prices have dropped 22% in four weeks.

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In a nutshell

1. The finance minister admitted today in comments to reporters that the government had paid scant attention to the provincial debt thus far in its mandate. The government will apparently use the bulk of the 2007 budget windfall (estimated at more than $800 million) to reduce the public debt. Check the video when it comes available. Tom Marshall's comments show the hollowness of his previous claims about debt fighting.

2. Words to watch out for: "Once we account for the change in capital assets, the balance will reduce the province’s net debt." It's a question of assets and liabilities. Since the equity position contains both, let's see how the provincial government accounts for those in its upcoming budget. The windfall might actually go out the door with the debt only appearing to be reduced.

3. The only principle is cash. Not in the media reports by mid-day, but the provincial government is accepting the Harper Equalization deal, as amended by the agreement with Nova Scotia.

There's a gigantic surprise.

Not.

4. The finance minister still likes to pump out nonsense: "It is also important to acknowledge the Atlantic Accord 2005, which was successfully negotiated by Premier Williams, and its remarkable contribution to the overall improvement to the province’s fiscal position."

The improvement in the province's fiscal position is driven entirely by the results of the 1985 Atlantic Accord (the real one), three offshore development deals signed before 2003 and high mineral prices flowing from deals signed before 2003.

As the government statement said: "the change is due to much higher oil prices, increased production from the offshore projects, higher royalties for the White Rose project and higher than expected mineral prices."

Update:

5.  A portion of the finance minister's remarks are available from CBC [ram file].  Marshall refers to the cabinet decision to put $55 million of the last budget against the debt as being "not enough".    That isn't what Marshall said at the time of the budget.  In fact, his budget speech trumpeted the great strides in debt reduction he and his colleagues had made.  Rather than quote the Telegram editorial (even though the words are worth heeding), Marshall might well have pointed to those of us who have been drawing attention to the current administration's debt-reduction nakedness for some months now.

Turns out the Emperor and the entire court had no clothes and knew it all along.

6.  While you're listening try asking yourself a simple question:  who is Marshall trying to convince that paying down the debt is a good thing?  Is his audience inside cabinet or outside?

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Stop your more for me please rants

Danny Williams is using Loyola Sullivan's old debt boogeyman to try and frighten people away from demanding too much of a provincial government awash in petro-cash.

The problem for Williams is that while he uses the debt as a bogeyman, his own record of increased public spending and increased public debt make it clear his administration is willing to spend.

His spending and borrowing is fueled by rising oil prices that may deliver a $500 million dollar surplus to the province's treasury by the end of March.

"The people of the province also realize that we have the highest debt in the country, and still do, and will have for a long time," Williams said.

"Our debt is twice as high as the next worst province, which is Nova Scotia."

Of course, it will and of course the debt is the highest in the country.

That's because the provincial government doesn't have a debt reduction plan; it has a debt management policy of borrowing at lower interest rates and of rolling over debt to lower interest rates when it comes do.

And, if everything rolls out as the premier plans, the provincial government will increase the public debt through loan guarantees and borrowing on projects like the Lower Churchill.

Everything Danny Williams said is absolutely true.

The provincial government will have the highest debt in the country and "will have for a long time."

And in the meantime, Williams was basically warning people to stop asking for more and thereby interfering with his own spending and borrowing plans.

It's that line from the campaign song:

"Stop your more for me please rants."

People should expect they'll be hearing it a lot more from Danny Williams during his last couple of years in office.

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Budget 2007: a quick look at the numbers

The Government of Newfoundland and Labrador forecast record spending for 2007, at more than $5.5 billion.

Some quick observations based on a simple breakdown into the good, the bad and the ugly of the budget:

The Good

Tax cuts and increased program spending.

All good in an election year and make no mistake: this is an election budget.

People will be happy and the provincial government is certainly counting on people's immediate sense of contentment to see the current administration re-elected with an overwhelming majority.

No region of the province is untouched by extra cash. No person will be left out of the tax breaks or other benefits.

The source of the cash: all the supposedly bad deals signed before 2003 by previous administrations, Liberal and Conservative.

Windfalls from high oil prices produced the supposed miracle of deficit slaying. Everything in this budget, indeed every budget increase since 2003 has been based on high oil prices.

Thank you Brian Mulroney and Brian Peckford. Thanks to the administrations that developed Voisey's Bay and the offshore oil fields at Hibernia, Terra Nova and White Rose.

The latter field is expected to hit payout in FY 2007. As a result, royalties will jump to 30% on the price of each barrel.

The Bad

This budget forecasts a spending increase 5.6% from Fiscal Year (FY) 2006. It also projects increased spending of 4.7% and 4.2% over the subsequent two fiscal years.

That's bad since it exceeds the rate of inflation by more than double in FY 2007. The Bank of Canada forecasts inflation to run at 2.2% in 2007 and at 2.7% for each of the two years after.

Prudent fiscal management would hold spending to at most the projected inflation rate. That doesn't mean program spending would need to be curtailed in important areas, nor does it mean the provincial couldn't afford tax cuts to bring provincial rates in line with Atlantic Canada. Rather it would simply require the provincial government to make some clear choices in what it considers important, rather than fix every problem by more spending.

Even in FY 2004 when the current administration proclaimed the province to be in a financial mess, it still introduced a budget that increased spending from the previous year. Spending has increased every year since. That's not going to be sustainable given the absence of a major new development at Hebron, which would have achieved first oil as production from at least two of the other fields slackened.

As it stands currently - and unless there are supersecret talks on Hebron no one is talking about - Hebron won't be producing oil for another decade or more. In the interim, the impact of demographic changes throughout the province will increase pressure on the provincial treasury at a time when the province's coffers will not be seeing significant new cash flowing in.

The current and forecast spending increases are based on optimistic projections for the price of oil in the medium term. Any downward trend in commodity prices (oil, minerals etc) will quickly make the consistent spending increases since 2003 unsustainable. Fiscal reality in those circumstances - taking less money in than is flowing out - would require program cuts, job losses and/or tax increases to correct.

Our plan is to continue this responsible approach in the years that follow to ensure we are increasingly strong, less reliant on the whims of others and more reliant on
ourselves.

The whims referred to are likely those supposed whims of the Government of Canada. This budget - like all recent budgets - builds itself on the whims of international commodities markets. Which one is less reliable?

More bad. Per capita spending will be $10, 871 per person in the province, assuming a population of 512, 000. It will jump to $11, 878 per person in FY 2008 putting Newfoundland and Labrador on par with Alberta for per capita provincial government spending. Drop the population below 500,000 and Newfoundland and Labrador will be outspending Alberta, the richest province in the country.

The difference is that Alberta isn't carrying around the per capita debt Newfoundland and Labrador shoulders, which, as noted below using the finance minister's own words, limits the provincial government's options in dealing with any financial setbacks.

That level of per capita spending is unsustainable in the long run. As a recent Atlantic Institute for Market Studies assessment concluded:

If the province fails to reign in its whopping per capita government spending (about $8800/person [in FY 2006]) and super-size me civil service (96 provincial government employees /1000 people) it will quickly erode any gains from increased energy revenues.

The Ugly

As much as the provincial government talks about the large public sector debt, so far it hasn't done anything to deal with it.

Finance minister Tom Marshall described the issue accurately in the budget speech, saying:

The most significant fiscal challenge facing Newfoundland and Labrador is the burden of debt we inherited, the highest per capita net debt in Canada, more than double the national average. High debt loads mean high interest payments, whether for a family or for a government. Reducing debt frees up money to spend on programs and other priorities.

All government has done is produce a net reduction in the debt by a mere $70 million in FY 2006 and forecast a further reduction of $66 million in FY 2007. At that rate - i.e. $70 million per year - the province will be debt free in 2178.

If there is a budget surplus in FY 2007, as currently forecast, most if not all should be committed to reducing the public debt. Anything else is whistling past the graveyard.

Government's reported success in reducing the debt to GDP ratio has come not from strong fiscal management by government but in growth in GDP driven primarily by commodity prices. Lower the GDP - as in a drop in commodity prices - and those apparent gains will vanish.

There's another ugly element in the budget reporting and that is in the misleading presentation of revenue from the 2005 agreement with the Government of Canada. It will not produce additional cash for the treasury in FY 2007 despite the claim by the finance minister that "[w]ithout the 2005 Accord negotiated by our Premier, we would be receiving $305.7 million less than we are getting this year."

In reality, that cash has already been received and spent on shoring up the teachers' pension plan. That was sound financial decision, but the provincial finance minister cannot claim double credit for the money.

Statement I in the FY 2007 Estimates shows the reality. A modest $49 million surplus on current and capital account forecast for FY 2007 becomes a $255 million shortfall once the $305 million from the 2005 cash advance is deducted.

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