State governments are in unprecedented debt. Who do they owe the money to?

State budgets are on the horizon around Australia and we’re nearly all in the red. But if we were to default on our loan repayments, who would come calling?

As state and territory governments around Australia prepare to hand down their annual budgets in May and June, the political heat around public debt and deficit is set to rise.

The COVID-19 pandemic and accompanying economic crisis has seen public debt in Australia soar to unprecedented levels as money is borrowed and spent on the biggest economic stimulus effort the nation has seen.

The borrow-to-spend approach has the approval, and the financial backing, of the Reserve Bank of Australia but as the economy rebuilds, the question of the mountain of debt that is being accrued – and how to pay it back – will become more pressing.

How did the states get into all this debt? How much do they owe? And who do the states owe all this money to?

Credit:Illustration: Jamie Brown

How did we get into all this debt?

Government revenue streams simply cannot cover the $327 billion worth of state and federal COVID-19 response and recovery money expected to be spent by 2024.

Nationally, borrowing to pay for all this spending and cover shortfalls in revenue is due to blow out to $1.3 trillion in the next three years with most of it – $927 billion – owed by the Commonwealth.

But all over Australia, premiers and their treasurers are thinking big with their strategies for dragging their states out of the COVID-19 economic crisis, pumping unprecedented amounts of borrowed money into their local economies.

The states and territories, according to an analysis by the Parliamentary Budget Office, will owe $371 billion within three years.

If everything goes according to plan, the states’ share of all Australian government debt will be 29 per cent by 2024 – more than double the long-term average of 13 per cent.

Victoria, which has the economy hit hardest by COVID shutdowns, is leading the debt charge. Premier Daniel Andrews and his money man, Treasurer Tim Pallas, are planning to drive the state’s net borrowings up to about $155 billion by the middle of 2024 in an attempt create 200,000 jobs by next year and 400,000 by 2025.

The state’s huge stimulus effort, typical of the approach being used by governments around the country, deploys tax breaks for business, wage subsidies for women and young workers and a record “big build” of transport housing infrastructure, housing and schools.

Victoria’s net debt is expected to hit $87 billion this financial year on its way to $155 billion by 2024. Its nearest rival in the borrowing stakes, New South Wales, is forecasting net debt of $53.2 billion this year rising to $104 billion in three years. Next in line is Western Australia with $39 billion, rising to $43 billion in 2024 with Queensland set to owe $25.5 billion rising to $51 billion.

South Australia is set to be $15 billion in hock this year, rising to $25.5 billion, and the Northern Territory is forecast to owe $8.6 billion, rising to $12 billion, the ACT’s net debt of $4.6 billion this year is set to be nearly $8 billion in 2024 and Tasmania is set for net debt of $1.9 billion this year rising to $4.4 billion.

But all that state and territory debt is dwarfed by the federal government’s borrowing in response to the pandemic with Commonwealth net debt this year tipped to be $703 billion, growing to $966 billion by 2024.

What’s the difference between debt and deficit?

Victoria recorded its first budget deficit in nearly 30 years in July 2020, with the state $7.5 billion in the red, as the coronavirus hit state economies hard, and by November the deficit figure had ballooned to a gob-smacking $23 billion.

A deficit is the difference between what the government expects to receive in tax, grants and other revenue by the end of the financial year in June – in this case, about $67 billion – and what it believes it will spend; in this case, nearly $90 billion.

All the other states and territories, except Western Australia which is keeping its budget’s head above water with the help of a boom in resource prices and a GST revenue windfall, will run budget deficits this financial year, but none as large as Victoria’s.

There are three ways governments finance their deficits.

They either slash spending and government services, bringing down their expenses; or they hike up taxes, increasing their income.

Raising new taxes and charges or jacking up the rate of existing ones is not much of an option in state economies staring at the abyss so that leaves only the third way. Governments fill those budget shortfalls; they borrow.

When a government borrows to fund a deficit, it reports those funds as “net debt”; the sum the state owes to its creditors, minus the value of its financial assets.

So who do we owe all this money to?

In Victoria, the Andrews Labor government’s controversial Belt and Road deal with China has its political opponents and many in the community wondering if the Premier and Treasurer have approached Beijing for a bailout – and, if so, what the People’s Republic might want in return.

But it doesn’t work like that. Australian governments do not take loans the way households and businesses do. Instead, they issue bonds.

A government bond, also known as “debt security”, guarantees its buyer regular interest payments from the government for the life of the bond, which could be five, 10, 20 years or even longer. There is no collateral offered, with the value of the bond vested in long-term flow of interest payments from the state.

Government bonds are a low-risk, low-return investment option, very attractive for banks and other institutions who need to show regulators a certain amount of safer-than-house assets – known as tier 1 capital – as a safeguard against going broke if some of their more hazardous holdings go bad.

Once the bond is issued, by a state’s treasury corporation via an auction process, it can then be traded again and again on a global “secondary market”, meaning it is impossible for a state government to control who owns the state’s public debt. And although corporations keep tabs on who is buying and selling, its registry of bondholders is not available to the public.

Treasury Corporation of Victoria’s Chief Executive Bill Whitford did provide some clues to the state Parliament’s Public Accounts and Estimates Committee in November. “The overseas investors are probably between 10 and 15 per cent of the overall holding,” Whitford told the MPs on the panel.

“The biggest single group of holdings of investors are the Australian banks. So the big four banks [Commonwealth, Westpac, ANZ and NAB] will hold about 40 per cent.

“The smaller Australian deposit-taking institutions [banks] will hold about 9 per cent.”

Victoria’s creditor profile is typical of all the other states, meaning that most of their debt is owed to Australian commercial banks and other financial institutions.

Other purchasers of Australian government bonds are overseas sovereign wealth funds and China has several of those. So while it’s quite possible that Victoria, any other state, or even the federal government, might owe money to interests associated with the Chinese government, it’s not like we’ve mortgaged the country to Beijing.

There’s a new player in town, too: the Reserve Bank of Australia, which has bought up about $100 billion in both federal and state government bonds and has embarked on another purchasing program looking to take its holdings to $200 billion, split 80-20 between federal and state securities.

The spending spree, known as quantitative easing, has a twin purpose. First, it helps the states and Commonwealth pump money into the economy – in an effort that has been likened to printing money without actually producing new banknotes – and it keeps down interest rates on all this government debt by increasing demand for bonds.

The latest figures show NSW owed the Reserve Bank just under $4.7 billion by the end of January, Victoria was in debt to the RBA to the tune of about $5.2 billion, Queensland owed $6.4 billion, WA had borrowed $3.75 billion and the federal government owed nearly $130 billion.

The interest rate is fixed for the life of the bond and right now, the rates are very low, with the states borrowing their money at about 0.1 per cent for a three-year bond and 1.15 per cent for a 10-year bond.

So those low rates mean that while Australian states’ total net debt increases more than tenfold – from $35 billion to $371 billion between 2019 and 2024 – the interest bill for those governments is only expected to go from $7 billion to $11 billion in the same period.

The rates are locked in for the life of the security, too. So state treasurers do not need to worry that interest bills on the money they have already borrowed will suddenly shoot up. The concern for states such as Victoria, NSW and Queensland, which plan to do a lot of fresh borrowing in the coming years, is where interest rates on its future borrowings go.

What happens if we don’t pay it back?

It’s a remote prospect. The enabling legislation of state treasury corporations gives watertight guarantees that investors in government bonds will be paid.

Just to be sure, credit rating agency Moody’s Investor Services, while downgrading its advice on Victoria’s creditworthiness in February, told clients that the federal government would almost certainly step in if a state found itself in real strife with “a high likelihood of extraordinary support from the Government of Australia in times of need”.

But would the big banks and international investors who have lent us money have any potential claim on a state’s public assets in the event of a default? No. States do not provide assets as security for borrowings.

The takeout is that we shouldn’t be worried about all this debt, says the Reserve Bank Governor, Philip Lowe – and he’s putting $200 billion of his bank’s money where his mouth is by lending it to the states and the Commonwealth.

The governor told the national Parliament’s Standing Committee on Economics in December that record state debt levels were manageable at record-low borrowing costs and that he was more concerned that governments keep spending to keep their citizens in jobs than he was about the views of the ratings agencies.

“What I want to see is strong public finances in Australia, and I think we have that and we are going to continue to have that,” Lowe told the MPs.

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