Options for budget repair for the new NSW government

Fiscal repair will be a priority for the new government given still-large deficits will propel already substantial debt even higher.
Kieran Davies

Coolabah Capital

On Saturday, the ALP won the New South Wales election, returning to power for the first time since 2011, with a large swing probably securing a majority government.

As the new treasurer, Daniel Moohkey will receive an incoming briefing from the state treasury, which will cover the economic and fiscal outlook.  

The challenge for the new treasurer will be to achieve fiscal repair while simultaneously providing the public services required by the public.  

The case for fiscal repair is clear from the latest budget update, which showed still-large budget deficits adding to an already-substantial state public debt.  

For example, gross borrowings of the non-financial public sector are forecast to increase from $119bn in June 2021 to $226bn - which is approaching a quarter of a trillion dollars - by June 2026.

Higher debt goes hand-in-hand with an increased cost of servicing that debt, where interest payments will rise as the state's debt is refinanced at higher interest rates over the coming years. 

Given this significant challenge, CCI offers the following four options for fiscal repair:

1. Use the NSW Generations Fund's (NGF) Debt Retirement Fund (DRF) to repay debt.

Established in 2018 to reduce NSW's fiscal pressures, the NGF is a state investment vehicle funded by the privatisation of WestConnex and diversion of revenue.  The NGF is almost entirely made up of the Debt Retirement Fund (DRF), where the NGF was valued at $14.7bn in June 2022.

When the NGF and DRF were set up in 2018, NSW's total non-financial public sector debt was about $58bn. Today that debt is forecast by the latest budget update to almost triple to $160bn by June 2023.

According to the NSW Generations Funds Act 2018, the purpose of the DRF is to "provide funding for reducing the debt of the State in accordance with the principles of sound financial management set out in section 7 of the Fiscal Responsibility Act 2012".  

The objective of the latter Act is to "maintain the AAA credit rating of the State of NSW", which was lost in late 2021, for the purpose "limit[ing] the cost of government borrowing".

As a spread over Commonwealth bonds, NSW pays about 80 basis points to borrow 10-year money today, which is materially higher than the average spread over the last decade of about 33 basis points. This means that the total interest rate that NSW pays on its 10-year borrowing is about 4% annually at the current time. That's $6.4 billion in annual interest on debt assuming all NSW current debt outstanding was refinanced at a 4% interest rate. (Some of the debt has been issued at much lower rates, but will need to be refinanced over time.)

Incoming NSW Treasurer Daniel Mookhey has himself argued that rather than expose the state's balance sheet to the more volatile earnings of riskier financial assets, the prudent approach would be to use the DRF to pay back debt now, thereby avoiding adding to the interest burden for taxpayers:

"Embracing debt to buy stocks, and billing taxpayers, is controversial in ordinary times. But right now, the state cannot afford to bankroll Perrottet’s huge bet. He might have a big risk appetite. NSW taxpayers do not." 

While it might be argued that S&P deducts some of the NGF's more liquid assets from the state's debt when determining the state's credit rating, S&P is similarly wary of the riskiness of the fund's investments.  

As a result, the offset against state debt is incomplete because S&P rightly applies "haircuts to the NGF's non-cash assets reflecting their market price and liquidity risks".    

2. Use either part or all of the NSW Infrastructure Future Fund  (NIFF) to repay debt.

The NIFF is another state sovereign wealth fund that invests the proceeds of asset sales to finance future infrastructure projects under the Restart NSW and Rebuilding NSW programmes.  

The NIFF was valued at $8.9bn in June 2022.

For the same reasons outlined for the NGF, we think a better approach would be to use either part or all of the NIFF to repay state debt now.    

3. Defer state infrastructure investment.

The New South Wales government is undertaking a massive infrastructure programme, worth about $117bn over four years to 2025-26.  

Most of the money is earmarked for transport (c$80bn), with less spent on health (c$11bn) and education (c$10bn).

This massive increase in spending is coming at a time when other states are making similarly large investments in infrastructure.

As a result, the nation-wide surge in state capex has seen costs blow out given already sharply higher input costs.

This can be seen in the drivers of NSW's state and local capex over the past year, where higher costs account for nearly all of the 11% increase in investment over the past twelve months, with inflation accelerating to 9%.

State capital expenditure matters for the budget because it is driving still-large deficits over the next four years, with the latest budget update forecasting a sustained return to cash operating surpluses for the non-financial public sector from this financial year onwards.

The new government already intends to rein in spending on capex by deferring/cancelling some projects, but given both the sheer scale of the infrastructure programme and rapidly-rising costs it makes sense to take stock of the programme and explore the scope for a broader pause in spending.

4. Investigate whether some general state financial investments can be used to reduce state debt. 

TCorp, which is the state's central borrowing authority, has become a substantial asset manager over recent years with about $101bn of funds under management as at June 2022, placing it in the top ten of institutional investors in Australia.  

TCorp's assets under management comprise c$68bn in money managed on behalf of its public-sector clients and c$33bn in specific fund mandates, such as the NGF, NIFF and other funds relating to the state' government's insurance risk and social housing.

The money parked with TCorp by public-sector bodies is substantial and it seems very worthwhile for the new government to investigate whether some of it can be used to pay down state debt, particularly if some of the money is not expected to spent in the short term.   

Investment Disclaimer Past performance does not assure future returns. All investments carry risks, including that the value of investments may vary, future returns may differ from past returns, and that your capital is not guaranteed. This information has been prepared by Coolabah Capital Investments Pty Ltd (ACN 153 327 872). It is general information only and is not intended to provide you with financial advice. You should not rely on any information herein in making any investment decisions. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. The Product Disclosure Statement (PDS) for the funds should be considered before deciding whether to acquire or hold units in it. A PDS for these products can be obtained by visiting www.coolabahcapital.com. Neither Coolabah Capital Investments Pty Ltd, Equity Trustees Ltd (ACN 004 031 298) nor their respective shareholders, directors and associated businesses assume any liability to investors in connection with any investment in the funds, or guarantees the performance of any obligations to investors, the performance of the funds or any particular rate of return. The repayment of capital is not guaranteed. Investments in the funds are not deposits or liabilities of any of the above-mentioned parties, nor of any Authorised Deposit-taking Institution. The funds are subject to investment risks, which could include delays in repayment and/or loss of income and capital invested. Past performance is not an indicator of nor assures any future returns or risks. Coolabah Capital Investments (Retail) Pty Limited (CCIR) (ACN 153 555 867) is an authorised representative (#000414337) of Coolabah Capital Institutional Investments Pty Ltd (CCII) (AFSL 482238). Both CCIR and CCII are wholly owned subsidiaries of Coolabah Capital Investments Pty Ltd. Equity Trustees Ltd (AFSL 240975) is the Responsible Entity for these funds. Equity Trustees Ltd is a subsidiary of EQT Holdings Limited (ACN 607 797 615), a publicly listed company on the Australian Securities Exchange (ASX: EQT). Forward-Looking Disclaimer This presentation contains some forward-looking information. These statements are not guarantees of future performance and undue reliance should not be placed on them. Such forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual performance and financial results in future periods to differ materially from any projections of future performance or result expressed or implied by such forward-looking statements. Although forward-looking statements contained in this presentation are based upon what Coolabah Capital Investments Pty Ltd believes are reasonable assumptions, there can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. Coolabah Capital Investments Pty Ltd undertakes no obligation to update forward-looking statements if circumstances or management’s estimates or opinions should change except as required by applicable securities laws. The reader is cautioned not to place undue reliance on forward-looking statements.

Kieran Davies
Chief Macro Strategist
Coolabah Capital

Based in Sydney, Kieran Davies joined Coolabah Capital in 2020, an asset manager than runs over $7 billion in fixed-income strategies, and is responsible for macroeconomic research and investment strategy, contributing to the investment decisions...

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