Thursday, November 5, 2009

Public Debt (for Nerds)

Public debt is going to be a big issue in the coming years and the following is a summary of an excellent article from 3 economists at the Treasury, with some additions and updating with some recent statistics from the 2009-10 Budget and 2009-10 MYEFO.

From Treasury A History of Public Debt in Australia by Katrina Di Marco, Mitchell Pirie and Wilson Au-Yeung

The International Monetary Fund (IMF) Government Finance Statistics (GFS) manual defines gross debt as:

All liabilities that require payment or payments of interest and/or principal by the debtor to the creditor at a date or dates in the future. Thus, all liabilities in the GFS system are debt except for shares and other equity and financial derivatives [paragraph 7.142].

The main component of gross debt on the Australian Government’s balance sheet is Commonwealth Government Securities (Treasury Bonds) outstanding.

Gross debt does not incorporate amounts that are owed to government by other parties. Also governments, like an individuals or businesses, hold assets which can be sold to meet their financial obligations. To capture the asset side of equation, net debt needs to be considered.

Broadly speaking, net debt is equal to gross debt less a related pool of financial assets.2 Table 1 gives a simple representation of the main components that are included and excluded from the Australian Government’s net debt calculation.

Table 1: Components of net debt

Source: The Australian Treasury

Compared with gross debt, net debt is a better measure of a government’s overall indebtedness as it also captures the amount of debt owed to the government. Still, like gross debt, net debt is only a partial indicator of the government’s financial strength, as not all government assets or liabilities are included. As an example, unfunded superannuation is not included in the calculation of net debt. On the other side of the ledger, the equity holdings of the Future Fund are also not included as an asset in the calculation of net debt.

Australia has had historically low levels of net debt over the past two decades compared with the G-7 economies (Chart 2). In the early 1990s, Australia, along with the major economies, experienced an increase in net debt largely because of the global downturn. But in contrast to other economies, after 1995, Australia experienced a significant fall in its net debt.

Other measures of financial position

Over time, the demand for greater public accountability has led governments to publish more comprehensive sets of fiscal data. This has resulted in a trend towards using accrual accounting measures. By introducing a balance sheet into the primary Budget documents from 1999-2000, the Australian Government has been able to measure net financial worth and net worth.

• Net financial worth is defined as total financial assets less total liabilities.

• Net worth is defined as total assets less total liabilities.

Both measures are conceptually better than gross debt and net debt at capturing the Australian Government’s financial strength, as they are more comprehensive.

From MYEFO 2009

Definitions from the 2009-10 Budget

Measurement of the Government's financial position

Net debt is the most commonly quoted and well known measure of a government's financial strength. One of the reasons is that it is part of everyday life for business and households. Another reason is that, historically, it was the only available stock measure for governments that were recording financial information in a cash based accounting system. Net debt provides a useful measure for international comparisons, given most OECD countries report on it.

Net worth provides a more comprehensive picture of the Government's overall financial position than net debt. However, the valuation of physical assets can be problematic as they are typically valued without consideration of their potential use. Also, the Government may not be in a position to sell certain non financial assets, and therefore these assets would not be available to meet the Government's financing requirements.

Net financial worth is used by the Government as the primary indicator of balance sheet sustainability, because it provides a more effective and intuitive indicator of the sustainability of the Government's finances. It is a broader measure than net debt as it includes government borrowing, superannuation and all financial assets, but is narrower than net worth since it excludes non financial assets. There are advantages to excluding non financial assets since they are often illiquid and cannot easily be drawn upon to meet the Government's financing needs.

The projected deterioration in net financial worth is largely driven by the sharp downward revisions to tax receipts over the forward estimates resulting from the deterioration in the global economic outlook.

From Treasury A History of Public Debt in Australia by Katrina Di Marco, Mitchell Pirie and Wilson Au-Yeung

The difference between the two measures is the inclusion of non-financial assets in net worth. Given concerns surrounding the valuation of non-financial assets and their liquidity in the face of adverse shocks, the Australian Government has decided to use net financial worth as its primary indicator of balance sheet sustainability.

During the First World War, gross Australian Government debt increased from around 2.2 per cent of GDP to around 50 per cent of GDP (Chart 5), with around one-third of this increase met through loans issued in London (AOFM 2003-04). By comparison with the First World War, the financing requirements of the Second World War were met largely through domestic borrowing. Gross Australian Government debt increased from around 40 per cent of GDP in 1939 to around 120 per cent of GDP in 1945. During both wars, War Savings Certificates, targeted at retail investors, were the primary instruments used to raise funds.

Australian Government debt was progressively reduced after the Second World War and largely eliminated by the beginning of the 1970s. In the decade following the Second World War, relatively tight fiscal policy halted the growth in gross debt, while high inflation underpinned the sharp reduction in gross debt as a share of GDP. By 1974, gross debt had declined to around 8 per cent of GDP from a peak of around 120 per cent of GDP in 1946.

There were two further episodes of debt accumulation, and subsequent reduction, during the 1980s and early 1990s driven by periods of weak economic growth and associated budget deficits. From the mid-1990s, as the Australian Government’s fiscal position improved, gross debt declined steadily as a share of GDP.

The Australian Government historically had a significant proportion of its debt denominated in foreign currencies, but foreign-denominated debt is now negligible (Chart A).

For the first 30 years after Federation, foreign currency debt made up around 35 per cent of total debt on issue. A large portion of this debt was financed from London. Between 1940 and 1950 the amount of foreign currency debt fell as domestic markets grew in size. After the Second World War, the value of foreign currency loans began to rise to finance balance of payment deficits (AOFM 2002-03).

The share of foreign currency borrowings of the Commonwealth Government Securities (CGS) portfolio remained around 30 per cent from 1970 until 1988. In 1988, the Government decided to concentrate debt issuance in domestic markets to maintain liquidity and efficiency.

Capital account liberalisation has underpinned an increase in foreign holdings of Australian dollar-denominated CGS since the early 1980s (Chart B).

Chart 6 shows that the Australian Government has historically had a positive net debt position — that is, the value of debt liabilities has exceeded the value of debt assets. Since 1970-71, net debt has averaged 5.7 per cent of GDP, reaching a peak of 18.5 per cent in 1995-96, and a low of -3.8 per cent of GDP in 2007-08. Changes in net debt have largely been driven by changes in the government’s budget position.7 Especially in the 1990s, asset sales have also been a significant contributing factor (Box 2).
During the early 1970s net debt was mainly negative and reached lows of -3.1 per cent of GDP. During the first half of the 1970s budget surpluses averaged 1.7 per cent of GDP, while in the second half, there were budget deficits averaging around — 1.6 per cent of GDP. By 1979-80, net debt was around 4.7 per cent of GDP.

During this same period, the current account deficit was on the rise and reducing the Government’s call on foreign capital was an important driver of fiscal policy (Kennedy, Luu, Morling and Yeaman 2004). As a result, in 1988, the government decided to concentrate its debt issuance in Australian dollars (Box 1). In 1987, 30 per cent of total borrowings were in foreign currencies. By 1990-91 it was around 21 per cent.

In the early 1990s recessions in many advanced economies caused a marked slowing in the world economy. The government implemented a more expansionary fiscal policy that was funded by borrowing. Net debt reached a peak of 18.5 per cent of GDP in 1995-96.

From 1995-96 onwards, the government undertook a program of fiscal consolidation (Kennedy, Luu, Morling and Yeaman 2004). The government also undertook significant sales of Public Trading Enterprises around this period (Box 2).

The combination of successive budget surpluses and asset sales led to the elimination of net debt. Net debt as a proportion of GDP gradually declined to its historical low of -3.8 per cent of GDP in 2007-08.


A government’s balance sheet comprises both assets and liabilities. This article has demonstrated that only considering gross debt can result in an incomplete picture of public finances. By taking into account assets the public sector owns, a more accurate view of a government’s ability to respond to economic conditions can be determined.

This article has shown that Australia has undergone several periods of debt accumulation, followed by periods of fiscal consolidation. Periods of strong economic growth following episodes of debt accumulation have helped support relatively quick improvements in the public sector’s net debt position. Australia has a low level of net debt both historically and when compared with G-7 economies.


  1. I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.


  2. Hi Lucy,
    Thanks for that. I've been a little slack on the blog lately because I'm trying to finish a grant application on industry policy in Australia.


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