Symposium: The 2003–04 Federal Budget

Public debt: Another perspective

Ian McAuley, University of Canberra

‘Beer up, cigs up’ was the clichéd post-budget headline of the 1960s. Forty years later the headlines have moved on to a different simplification, namely the budgetary cash balance. The prevailing wisdom of the major political parties, the finance sector and the popular press is that the cash surplus should be kept positive. Apart from a minor transgression in 2001–02 (explicable, perhaps, by an election and the response to terrorism), the Commonwealth’s budgets under the Coalition government have been models of fiscal rectitude, with Keynesian excursions into deep deficits fading into history.

Through cash surpluses and the sale of financial assets, the Commonwealth has reduced government debt, from a peak of nineteen per cent of GDP in 1995–96 to a budgeted four per cent of GDP in 2003–04. Budget projections suggest net Commonwealth debt will be eliminated by 2006–07. This performance is impressive: it compares with a current OECD average of 50 to 60 per cent of GDP.

The Treasury points out that this low debt places Australia in a strong position to respond to external shocks. It has been responsible for a strong (AAA) foreign exchange credit rating from international agencies, which in turn has cushioned Australia from the severe falls experienced in overseas stock markets, and allowed world financiers to overlook (at least for the time being) Australia’s chronic current account deficit.

But is eliminating debt necessarily a desirable policy objective? There are at least two policy issues. The first, which has been the concern of the financial media, is the technical problem of the loss of the bond market. The deeper problem is that an obsession with debt may blind us to considering the other side of the government balance sheet, the value and condition of our public assets. It is the technical issue of the future of the bond market which has captured the most attention.

A world without debt

The prospect of a debt-free Commonwealth raises the possibility of closing the Commonwealth bond market. It is hard to imagine how the government or central bank could sustain the mechanisms of monetary policy without this market. In a speech to Australian Business Economists a week after the Budget, Treasury Secretary Ken Henry assured the financial community that the Commonwealth would maintain a stock of Commonwealth Government securities to support the Treasury bond futures market. In explaining this decision, he stated:

Initially, there were some eight potential roles identified for the CGS market. As the arguments were examined and tested in consultations, the number of core issues was reduced to three—managing interest rate risk, financial sector stability during times of uncertainty and, to a lesser extent, the pricing of other financial products (Henry 2003).

There is no risk to the bond market in the foreseeable future.

The financial community can take this assurance in good faith. While the Commonwealth has indeed reduced debt heavily, it has taken a fairly restricted view of what constitutes debt. There will still be plenty of government liabilities for the foreseeable future, even if the full sale of Telstra goes through.

Table 1, drawn from the Commonwealth’s Budget statements, provides two presentations of the Commonwealth’s balance sheet and resulting debt projections. There will be no shortage of debt. In italics are the figures which the Commonwealth uses to calculate ‘net debt’. In plain type are elements the Commonwealth leaves out of its calculations. In this presentation, the Commonwealth’s ‘equity’ remains at a deficit of around $45 billion over the period of budgetary projections. That is still low: if economic growth averages three per cent a year, even a $45 billion debt in 2006–07 would still be only five per cent of GDP.

Table 1: Commonwealth Government’s construction of debt vs. complete accounting, $b
  02–03 03–04 04–05 05–06 06–07
Financial assets counted in net debt calculations 39.8 31.8 33.3 33.8 34.6
Financial liabilities counted in net debt calculations 72.2 61.6 60.9 47.9 32.8
Net debt as reported in budget statements 32.4 29.8 27.6 14.1 –1.8
Other financial assets 63.9 65.8 65.3 54.7 44.6
Other non-financial assets 36.1 35.5 35.1 34.9 34.6
Total other assets 100.0 101.3 100.5 89.7 79.2
Other liabilities 113.9 116.3 119.2 121.8 124.9
Total assets 139.8 133.1 133.8 123.5 113.8
Total liabilities 186.1 177.9 180.1 169.8 157.8
Equity –46.3 –44.9 –46.3 –46.3 –44.0

(Source: Budget Paper No. 1 2003–04, Statement 9, Table 2)

The category ‘other financial assets’ is dominated by the Commonwealth’s share of Telstra. This treatment of Telstra as merely a financial asset is revealing, for it suggests that the Commonwealth sees its majority share in Telstra as simply a portfolio investment, akin to the Reserve Bank’s holdings of foreign currency. If it saw itself as the substantial owner, with policy responsibilities, it would surely count Telstra under ‘non-financial’ assets—in the same way a home owner might consider equity in a house to have more significance than a BHP-Billiton shareholding.

The liabilities not counted are mainly superannuation and other employee entitlements ($99 billion of a total of $116 billion in 2003–04). The reasons for their exclusion are obscure. Superannuation and employee liabilities cannot be measured with the same numerical precision as some other liabilities, but that, of itself, does not justify their exclusion. All liabilities have some degree of contingency.

In any event, there is an air of spurious precision about the whole exercise. Projections of budget balances, be they on a cash or accrual basis, are projections of the difference between two very uncertain quantities. In round figures, each one per cent variation in revenue or expenses produces a two billion dollar variation in the budget balance. This sensitivity, shown in Table 2 below, dwarfs any variations from uncertainties such as the valuation of Telstra.

Table 2: Sensitivity of Budget cash balances, $b
  As presented
in Budget
Receipts up 1%
outlays down 1%
Receipts down 1%
outlays up 1%
02–03 3.9 7.9 –0.1
03–04 2.2 6.3 –1.9
04–05 1.3 5.6 –3.0
05–06 1.2 5.8 –3.3
06–07 4.7 9.4 0.0

(Derived from Budget Paper No. 1 2003–04, Statement 9, Table 2)

It would take a great deal of misestimation, however, to wipe out $45 billion of debt. There is no risk to the bond market in the foreseeable future.

But to look at the bond market only as an instrument of monetary policy is to overlook a much more basic aspect of public policy. This is the Commonwealth’s responsibility for sustaining the nation’s assets of productive infrastructure.

The asset side of the balance sheet

Imagine a slight re-framing of the presentation of the debt statement in Budget Paper No. 1, perhaps along these lines:

Over the last twenty years the state of the nation’s infrastructure assets has deteriorated seriously. Debt reduction, by Commonwealth and State Governments, has been achieved primarily through cutbacks in public sector investment. Australia can afford to invest another $260 billion in public infrastructure, while keeping our debt below 40 per cent of GDP. We have come to be seriously out of step with other OECD countries.

The first sentence is supported by research by the Institution of Engineers, in its 1999 Report Card on Australia’s infrastructure. This identified severe deficits, particularly in roads, railroads, water supply and sewerage. It did not produce an aggregate estimate of the deficit, and indeed was critical of the lack of government accounting for infrastructure needs. It identified deficits in well-studied areas, such as seventeen billion dollars to bring non-urban national highways to an adequate standard, and estimated the cost of urban road congestion at thirteen billion dollars a year. However its strongest warnings related to ageing water and sewerage infrastructure, for which figures are not readily available.

Some public investments may yield higher returns than private markets.

The Institution acknowledged that in some cases private sources could fund infrastructure, but also identified severe deficits in forms of infrastructure with public good characteristics which will not be funded by private investors. Thanks to organisations such as the Institution of Engineers, we have some rough estimates of our funding needs for transport infrastructure. However we have not begun to account for deficits in other public goods where measurement is more difficult, notably environmental resources and human capital.

Australian governments are locked into a ‘crowding out’ notion of capital markets: that public investment may lock out desirable private investment. This notion, and the simplified presentation of budgetary data focusing on cash balances, has been used to justify heavy cuts in all forms of government capital investment. Figure 1 shows how general government capital investment, as a share of GDP, has halved over the last thirty years. (Declining investment by government-owned corporations may be explained by privatisations.)

Governments have failed to acknowledge the alternative to ‘crowding out’ theory—the strong possibility that certain public investments may yield much higher returns than are achieved in private markets. While many public investments yield low or even zero financial returns, their social returns, in terms of benefits not captured in financial flows, are often very high. This is the case for assets for which it is impossible or impractical to apply direct user charges, such as rural roads and investments in environmental restoration.

The experience of the last decade, which has seen much of our national savings dissipated in asset price inflation, first in the stock market and more recently the real-estate market, should cause governments to re-examine their ‘crowding out’ assumption. In many private ventures, recent high returns have been no more than passing illusions. It is strange that the Budget papers and Treasury statements see the bond market in such narrow terms, without even considering its traditional function—a mechanism to fund productive public assets.


Technically, the budget statements are no more than a set of financial statements prepared in accordance with the conventions of financial accounting. These conventions confine such documents largely to historical statements, with provision only for recording liabilities which have been incurred as a result of past decisions. To the public and politicians, however, budget statements are vested with more meaning. Technical statements about cash balances and debt take on the authority of statements about the nation’s economic health.

If budget statements are to be used in this way—as is entrenched in political tradition—they should perhaps include a more comprehensive national balance sheet, bound not by the conventions of financial accounting, but instead by the requirements of economic accountability. Such a balance sheet would report on the state of the nation’s public assets, and record accumulating liabilities in areas such as repair of physical assets, necessary restoration of environmental damage and perhaps, in time, required investments in human capital.

This would force some maturity on a political debate which, for the last few elections, has been impoverished by a narrow focus on budgetary cash balances. It would clarify the distinctions between the recurrent and capital components of public budgets (which, despite the move to accrual accounting, is still obscure in budget statements) and between governments’ responsibilities for financial and economic management.

Moreover, it would give political permission for linking the bond market to the financing of productive public assets. Because many people and institutions have had their fingers burnt by over-exposure to high-risk equity and real-estate markets, they may be seeking low-risk moderate-yield investment instruments to balance their portfolios. And they would be given an opportunity to direct their savings to rebuilding the common wealth.


Budget paper No. 1, Budget Strategy and Outlook 2003–04.

Henry, K. 2003, ‘Economic prospects and challenges’, Speech to Australian Business Economists, Sydney.

The Institution of Engineers Australia and GHD Pty Ltd. 1999, A Report Card on the Nation’s Infrastructure (Institution of Engineers, Australia).

Ian McAuley is Lecturer in Public Sector Finance at the University of Canberra.

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