Debt for dummies: How the Government borrows money

When Finance Minister Grant Robertson released his third Budget on Thursday, it came as a surprise to no one to include a hefty amount of borrowing.

Facing the biggest economic challenge since the 1930s, Robertson looked to one of the decade's most influential economists - John Maynard Keynes - and made the call to massively increase spending, well beyond what the Government can afford right now.

But not even the Government has $50 billion hidden under the mattress or sitting in the piggy bank - so where does the money come from? And how does it get paid back?

To find out, Newshub went directly to the woman in charge of it all, Kim Martin - acting director capital markets and head of funding strategy and engagement at the New Zealand Debt Management Office, deep in the bowels of Treasury. 

It's her team's job to source the money the Government needs that it doesn't already have - kind of like how you or I would go to the bank. Except very, very different.

Who decides how much to borrow?

The process starts after the Government has decided how much it wants to spend, which usually happens twice a year - once at the Budget in May, and again at the Half-Year Economic and Fiscal Update in December. This might be more than they have collected in taxes and other revenue, producing a deficit.

"They could decide to reduce some of that expenditure - so spend less; or they could decide to increase the revenue side, so they could increase taxes, for example," said Martin.

"But if they're happy with their tax decisions and they're happy with the amount they want to spend, then... you've got to borrow to fund that difference."

The Finance Minister then tells Treasury what they plan to spend, but leaves it up to Treasury to figure out how to pay for it.

"They don't say to us, 'you need to borrow X billions of dollars' - we just get some information that shows us the difference between the revenue and expenditure, and it's left to us to figure out what we need to do from there."

While not constitutionally independent like the Reserve Bank, Treasury is politically neutral and does what the Finance Minister asks. Once they've worked out how much they need to borrow - which may or may not exactly match the deficit the Government is expecting - they go back to the Finance Minister to have their borrowing plans approved. 

Martin said it would be "highly unusual" for the Finance Minister and Cabinet to reject whatever amount of borrowing the Treasury comes up with.

"This won't be a shock to them - they would have a sense during the conversations about what they want to spend money on, they would have a sense of whether they've got enough revenue to cover that. It won't suddenly sideswipe them, so we're really just getting approval on the exact number. We have a bit of flexibility on that because we're managing a few things behind the scenes."

This year, that number is $60 billion, about three times bigger than the previous largest amount ever borrowed in a single financial year - which was almost $20 billion in 2011 in the wake of the global financial crisis, when National's Bill English held the reins. But even in good years we borrow, Martin said - the smallest amount in the past 20 years was about $2 billion. 

Grant Robertson.
Grant Robertson. Photo credit: Getty

Martin said each Budget comes with five years of forecast deficits or surpluses, so Treasury can plan some of its borrowing ahead. 

"The programme... is never going to exactly match the amount of money we need in that particular year, as we don't particularly want to have them bouncing all over the place. So we do smooth it out a wee bit - by the end of the five-year period you've got as much money as you need, but maybe in one particular year you get a bit more than you actually need, and the next year it smooths out."

This year's borrowing is particularly large because they've worked in a much bigger buffer than normal, with no one - not even economists - really knowing how the pandemic is going to play out over the next few months, let alone years.

"We're borrowing a bit more than we absolutely think we need on the forecast, just to account for that greater uncertainty." 

It also helps that interest rates are at record lows, making paying back the borrowing a bit easier than it would have been in other years.

Where does it come from?

So where does the money come from? The answer might surprise you - it might even be you, particularly if you have a KiwiSaver account. 

Almost all of the Government's borrowing comes in the form of bonds. At present, there are about $80 billion worth of these out there.

"They're kind of like when you put your money in the bank - you choose how long you want to lock it away for - that's called the maturity - and then there's an interest rate that's associated with that," said Martin.

"We have bonds that have different maturity dates - the shortest one is in 2021 and the longest one is right out to 2037, 17 years long."

Bond owners get paid what's called a coupon - it's a bit like the interest you'd get on a term investment, but paid out a couple of times a year over the life of the bond. When it matures, you get back what you initially put in.

"If people have got KiwiSaver funds, what's called the conservative part of that is often held in Government bonds," said Martin. "It's considered to be a low-risk investment."

It's a very safe - if not particularly lucrative - investment to make because the New Zealand Government in its history has never once defaulted on paying up. For that reason they're popular with insurance companies, pension funds and fund managers, like the people who look after your KiwiSaver. 

The Government issues new bonds every Thursday afternoon in a kind of compressed Trade Me auction that takes only half-an-hour. But unlike Trade Me, you can't just sign up and start bidding. Firstly, because bidding starts at $1 million, and secondly there are only eight institutions at present allowed to take part in the tenders. Most of them are banks.

Before the pandemic, between $150 million and $250 million worth of bonds would usually be issued every week.

Once they're sold to the banks, they're onsold on the secondary market - think of it like the electricity market, where the Government is the wholesaler and the banks the retailers.  

"That's when if you as a person want to buy those, you can buy them - you can go to your bank or a broker, or a wealth manager-type person, and then you can get them in parcels of $10,000."

At the moment about half of the Government's debt is held by New Zealand residents and institutions, and half overseas. But this doesn't mean we're beholden to foreign interests - quite the opposite, Martin says. 

"It's not really a risk - it's a really beneficial thing to have a really diverse investor base. That's a positive thing, as opposed to thinking you're beholden to overseas investors - it's something we actively pursue."

Ex-Finance Minister Sir Michael Cullen.
Ex-Finance Minister Sir Michael Cullen. Photo credit: Getty

How do we pay it off?

Robertson has said he had previous Finance Ministers Sir Michael Cullen and Sir Bill English to thank for paying down New Zealand's debts, leaving us in a good position to weather this storm. But if the bonds are paid out over several years - some spanning nearly two decades - and not in lump sums, how is this possible? 

By not taking out new debts, it turns out. Think of it this way - if you finish paying off a car loan, and don't have to buy another car right away, you've freed up more cash to spend on other things. That might tip what was a deficit into a surplus.

The difference is with bonds, the Government's only been paying off the interest - when it matures, they've got to pay back the principal. If they don't have the money to do that, they've got to put their hand out again.

"Let's say we've got $10 billion maturing next year - in order to pay that back, you'd have to have enough money from your revenue again not to issue an equivalent bond. You'd have to have enough money in your pocket."

Ex-Finance Minister Bill English.
Ex-Finance Minister Sir Bill English. Photo credit: Getty

What other options are there for borrowing? 

There are other ways the Government can borrow. One of those is Treasury bills, which are similar to Government bonds but for much shorter periods of time, or bonds in other countries' currencies, which Treasury currently doesn't do. 

A borrower New Zealand luckily doesn't have a need for is the International Monetary Fund, which has loans currently with nations such as Afghanistan, Rwanda, Yemen, Haiti, Congo and the Solomon Islands.

"If you're a high-quality sovereign issuer like New Zealand and you're in a good, strong financial position - which is what New Zealand is - [bonds are] the way to do it," said Martin.

"For example, borrowing through the IMF is really for countries that don't have access to this kind of market because they may be considered uncreditworthy or their borrowing task is too great. New Zelaand doesn't need to resort to borrowing through the IMF."

New Zealand's debt is expected to rise to nearly 50 percent of GDP thanks to COVID-19 - the highest it's been since the early 1990s, but still fairly low by international standards.

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