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Research Note no. 43 2001-02
The Australian Loan Council
Richard Webb
Economics, Commerce and Industrial Relations
18 June 2002
Australia is unique among federations in that it has a mechanism-the
Australian Loan Council-to coordinate borrowing by Federal and State governments.
The exercise of this function has, however, changed considerably over
time. The purpose of this Research Note is to describe how the Loan Council
has evolved and to explain its current role.(1)
Origins
The Loan Council's origins lie in the 1920s when the Commonwealth and
States competed for funds on capital markets. The Commonwealth wanted
to refinance war debt while the States wanted to fund infrastructure programs.
To resolve this and other conflicts, the May 1923 Premiers' Conference
agreed to form a voluntary Loan Council. Its prime function was to coordinate
the timing of debt issues and deal with other matters such as interest
rates on issues of securities.
In 1927, the Commonwealth submitted a draft Financial Agreement to the
Loan Council. The draft proposed, among other things, that the Loan Council
be made a statutory Commonwealth body and that existing arrangements be
formalised. The Loan Council formally came into being in 1927, and the
ratified Financial Agreement was incorporated into the Financial Agreement
Act 1928. This Act, provided among other things for:
- the Loan Council to regulate borrowing by the Commonwealth and States
- the Commonwealth to borrow on the States' behalf
- limits on the States' borrowing powers
- the Commonwealth and the States to contribute to the National Debt
Sinking Fund to redeem debt, and
- the Commonwealth to provide grants to the States to help them meet
interest payments and Sinking Fund contributions.
The 1928 Financial Agreement has been altered on a number of occasions
to take account of new developments.
Gentlemen's Agreement
The 1928 Financial Agreement did not encompass borrowing by Commonwealth
and State semi-governmental and local authorities. In 1936, it was resolved
under the so-called 'Gentlemen's Agreement' to bring these authorities'
borrowings into the Loan Council's ambit to prevent them from circumventing
the Council's borrowing limits. This Agreement remained in effect until
1984-85 when the so-called Global Borrowing limits were introduced.
Policy Shift
A major change to the role of the Loan Council took place in the 1950s
when the Commonwealth increasingly saw it as an instrument of macroeconomic
policy. Early in the 1950s, Australia faced strong inflationary pressures,
and the Commonwealth Treasurer advocated reducing Council-approved borrowing
to ease these pressures. The Commonwealth's influence over the Loan Council
was strengthened by the fact that the Commonwealth undertook to provide
funds to the States if the States were unable to raise, through the issue
of securities, any borrowing that the Loan Council had approved. In effect,
the Commonwealth agreed to underwrite State borrowing.
From a State perspective, this was a mixed blessing. On the one hand,
the States were under pressure to acquiesce to the Commonwealth's demands
and its increased influence over their fiscal affairs. On the other hand,
the Commonwealth's undertaking to underwrite State borrowing gave the
States access to guaranteed levels of funding at reasonable interest rates.
Global Borrowing Limits
The Gentlemen's Agreement unravelled when some States used 'unconventional'
financing techniques-such as financial leases-to circumvent its restrictions.
The States also established borrowing authorities-such as the New South
Wales Treasury Corporation-which they used to circumvent Loan Council
borrowing limits. In 1984, the Loan Council suspended the Gentlemen's
Agreement and replaced it with Global Borrowing Limits. This 'global approach',
among other things, limited the level of all new borrowings-conventional
and unconventional-by Commonwealth and State authorities.
1993-94 Arrangements
However, the global approach also broke down. A major reason was the
increasing use of sophisticated financing techniques that eroded the Loan
Council's effectiveness. The 7 December 1992 Loan Council meeting
therefore adopted new arrangements for monitoring and reporting. Under
these arrangements which came into effect in 1993-94, each jurisdiction
nominated a Loan Council Allocation, which was based on its net borrowings
as indicated by its deficit/surplus.(2) The arrangements also
changed the way in which borrowings were allocated among the States. Previously,
the global limit was allocated by a formula based on State population.
But this formula did not take account of a State's particular fiscal circumstances.
The Loan Council therefore considered the nominations having regard to
each jurisdiction's fiscal position and 'reasonable' infrastructure needs
as well as the macroeconomic implications of the total nominations.
The Loan Council Today
The Loan Council is formally a Commonwealth-State Ministerial Council
comprising the Commonwealth Treasurer as chairman, and State and Territory
Treasurers. It operates under the Financial Agreement between the Commonwealth,
States and Territories-which is incorporated as a schedule to the
Financial Agreement Act 1994-and came into effect on 1 July 1995.
The Financial Agreement includes changes agreed at the June 1992
Loan Council meeting. The changes:
- removed the requirement for Commonwealth and State borrowings to be
approved under the Agreement
- removed the Commonwealth's explicit power to borrow on the States'
behalf
- abolished the restriction on State's borrowing through the issue of
securities in their own names, and
- included the Australian Capital Territory and Northern Territory as
members (they previously had observer status).
It can be seen that these changes-especially the removal of the requirement
that borrowings do not have to be approved-constitute a major restructuring
of Loan Council powers. Current arrangements seek to emphasise transparency
of public sector finances, through financial market scrutiny of proposed
borrowing to restrict borrowing to prudent levels.
The mechanism for determining a jurisdiction's allocation is that each
jurisdiction nominates a Loan Council Allocation for the forthcoming year.
The Loan Council meets once a year to consider the nominations having
regard to each jurisdiction's fiscal position.
- For a fuller description of arrangements until mid-1992, see Denis
James, 'The Australian Loan Council (Second Edition)', Background
Paper, no. 29, Department of the Parliamentary Library, 1993-94.
Subsequent developments can be found in Budget Paper No. 3 for various
years.
- Loan Council Allocations comprised the estimated general government
deficit/surplus, the public trading enterprise sector net financing
requirement, and certain other items. Net borrowings are a more meaningful
indicator of a jurisdiction's exposure to financial markets than gross
new borrowings used under global limits
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