Further thoughts on Auckland Council’s emergency budget
Council is in the process of preparing an emergency budget.
Clearly Covid19 is having a dramatic effect on Council’s finances. I wrote earlier about the effect could be that Council loses hundreds of millions of dollars in revenue.
I also said this:
In working out how to respond there is always the fiscally disciplined approach, cut the expenditure back until fiscal equilibrium is reached. Unfortunately as shown by the great depression this is the wrong approach for a public entity to take, and all that it will do is make the recession worse.
Every Kensyan economist in the world will tell you that public institutions have to be counter cyclical, when economies crash public entities have to start spending. The neoclassical ideas proposed by the Chicago School of Economics in the 1980s that has dominated economic approaches through most of the world are in decline. We are all Keynesians now.
The problem though is that Auckland Council is nearing its debt ceiling of 270% of debt to income ratio.
This is a ratio set by rating agencies to measure the fiscal health of Auckland Council. The fear is that the rating agencies will downgrade Auckland Council’s credit rating if this cap is breached and borrowing will be more expensive. But at a time when even the strongest of corporations are having their balance sheets battered and public institutions are the only safe entities standing I think it is time to invite the rating agencies to review this.
Sure the debt will have to be repaid. But interest rates are at a historically low point and to get us through this is an option I think Council should be considering.”
Council’s fear is that there will be an interest rate increase if the borrowing cap is breached and the cost of borrowing ill increase. But its debt maturity profile suggests that less than a fifth of the debt is due to expire in the next couple of years so I can’t imagine the effect to be significant. The following graph provides a view of what Council’s debt profile looks like.
How big a problem is it? Total debt last September was $8.9 billion and total assets were $52.9 billion. And income was $4 billion.
It is impossible to say how much disruption Covid-19 will cause to Council’s finances. You would need a well functioning crystal ball to guess that. But lets say that it causes $250 million dip in income over a period of the next 12 months before things return to a relatively normal level. This represents about a 6% loss of income and is one of the scenarios that staff have suggested Council considers.
To put this into a household context it is comparable to owning a million dollar home with a $180,000 mortgage when the household earns $80 thousand a year. Covid19 caused problems cuts off $5,000 a year of income.
To respond you can obviously cut back on expenses, borrow more or sell stuff. Or put off the house extensions that you were planning to do.
Philosophically I am opposed to Council selling any strategic assets and by this I include land holdings in growth areas. Too often I have seen this end in tears. Like the property in the middle of Glen Eden which Council sold for $150,000 and then rented the land back from the landowner. Eventually it was paying in rent each year the same amount of money that it received from the sale. And the land is now worth millions. The interests of the ratepayer would be well served by Council taking a longer term view of the matter. It always seemed bizarre to me that Council would sell something to corporate interests and expect to do well from the transaction. Corporate interests are not known to do things out of the goodness of their collective hearts.
I am also opposed to cutting back on expenses unless they are for activities that are not needed in which case they should be reprioritised. Now is the time for Council to be active, to keep people in employment, and to ensure as far as possible that firms that provide goods and services to Council can continue to operate.
Should Council defer projects?
Again philosophically I am opposed to this as it will also have an adverse effect on the local economy. But it seems inevitable that Auckland’s population will grow much slower than previously anticipated. And the Government is ready to step in with projects of its own. Some deferrals particularly of growth projects would therefore help. Although any project that assists the mitigation of and adaption to climate change should not be delayed as we are running out of time to deal with this most pressing of challenges.
Which leaves borrowing and I think why not?
This is the sort of rainy day where the normal rule book should be thrown out. And at a time where the cost of borrowing is at historic lows. By law Council is meant to run a balanced budget unless it resolves not to do so because of special circumstances and these are special circumstances.
What is the cost? Recently I have seen first mortgage rates for home buyers at under 3%. In 2016 they were over 5%. Currently the Reserve Bank Official Cash Rate is 0.25%. In 2016 it was 2.5%.
In the financial year to June 2017 Council paid $422 million on debt of $8.3 billion. The figure to June 2018 it was $454 million. This suggests that it was paying in the vicinity of 5% interest for its borrowing.
Given Auckland’s asset base and overall income the cost in interest would not be high.
I think that the debt ceiling policy is hard to understand and somewhat irrational. Economist Shamubeel Eaqub thinks the same. From Dileepa Fonseka at Newsroom:
Sense Partners Economist Shamubeel Eaqub said there was a simple solution to averting a debt ceiling breach during the “mother of all recessions” – central government cash.
Council revenues would rise if they were given more money via a Government grant. They could then borrow more off the back of that and never breach their debt ceilings.
“I have no idea why that debt cap is where it is at anyway … it makes no sense to me. I think it’s idiotic.
“Essentially the current rules stop you from being able to invest in the future at a time when interest rates are very low [and] the private sector investment cycle is in a slump.””
To expand on my individual analogy it is as if Auckland Council is a landowner with a million dollar house, a mortgage of $180,000 and household income of $80,000. Because the household income has been hit by a $5,000 cut because of a reduction in working hours the household decides to run the debt up by that amount to keep the household budget in kilter. There will be some extra bank fees but on the scale of things they will not be high.
The figures are big but the proportions are manageable.
Now is not the time for major service cuts or selling council assets. Some short term borrowing to get through this difficult time and to make sure that the Auckland Region as a whole is not hit too dramatically is in my personal view the right thing to do.