Bills Digest no. 157 2008–09
Guarantee of State and Territory Borrowing Appropriation
Bill 2009
WARNING:
This Digest was prepared for debate. It reflects the legislation as
introduced and does not canvass subsequent amendments. This Digest
does not have any official legal status. Other sources should be
consulted to determine the subsequent official status of the
Bill.
CONTENTS
Passage history
Purpose
Background
Financial implications
Main provisions
Concluding comments
Contact officer & copyright details
Passage history
Date
introduced: 27 May
2009
House: House of Representatives
Portfolio: Treasury
Commencement:
On Royal
Assent
Links: The
relevant links to the Bill, Explanatory Memorandum and second
reading speech can be accessed via BillsNet, which is at http://www.aph.gov.au/bills/.
When Bills have been passed they can be found at ComLaw, which is
at http://www.comlaw.gov.au/.
The Guarantee of State and
Territory Borrowing Appropriation Bill 2009 (the Bill) has two main
purposes. The first is to provide an appropriation enabling the
Commonwealth to pay any claim made under the Commonwealth s
Guarantee of State and Territory Borrowing (see below). The second
purpose is to enable the Commonwealth to borrow funds to meet a
Guarantee should there be inadequate funds in the Consolidated
Revenue Fund.
As a consequence of the recession, state and territory
governments are incurring budget deficits. In addition to incurring
operating deficits, the states and territories (hereafter referred
to as the states ) are expanding infrastructure investment to help
counter the recession.[1] The states are therefore embarking on substantial
borrowing programs.
Much of this investment will be undertaken by government trading
enterprises such as water, electricity and port authorities,
railways, etc. The states (except the Australian Capital Territory)
have established central financing authorities, which are
responsible for raising funds for all sectors of government
including government trading enterprises.[2]
Associated with the recession has been increased caution of the
part of lenders generally. They are demanding greater certainty
that they will be repaid because the risk of loan default has
risen. This increased caution has, amongst other things, put upward
pressure on interest rates. For their part, the states wish to
maintain their credit ratings because a fall in those ratings would
mean having to pay higher interest rates on borrowed funds. The
states are therefore trying to balance their desire to increase
infrastructure investment, on the one hand, and limit borrowing to
avoid jeopardising their credit ratings, on the other hand.
On 25 March 2009, the Rudd Government announced that it would
provide to the states and territories a time-limited guarantee over
state borrowing:
The Rudd Government will take further action to
support jobs and protect vital infrastructure plans from the global
recession by providing a time-limited, voluntary guarantee over
state government borrowing.
This important measure recognises that pulling
back on critical nation-building infrastructure investment now
would mean ever slower growth and higher unemployment into the
future.
Like bond markets around the world, state
government bond markets have been hit hard by the global
recession.
This has threatened the capacity of state and
territory governments to deliver critical infrastructure projects
that will support jobs in the face of the global recession, as well
as boost productivity and improve living standards in the medium
and long-term.
That's why the Rudd Government in consultation
with the state and territory governments has taken this decisive
action to support jobs and protect vital nation-building plans.
Details of the scheme
The guarantee will be available for both
existing and new issuances of securities, but will not extend to
issuances denominated in foreign currencies.
The guarantee will be available over a range of
maturities. This will allow states to more readily structure their
finance requirements to meet their longer-term infrastructure plans
and prevent the potential crowding which would occur if the
maturity of eligible securities was limited to shorter term
issuances. States will have the option to determine whether any
eligible issuance is subject to the guarantee. The guarantee also
extends to the existing stock, should states choose to take up the
guarantee for those securities. The option to guarantee existing
stock is open to states for 28 days.
The Commonwealth will charge a fee for the use
of the guarantee. The fee has been set according to historical
experience of borrowing spreads, and at a level that provides an
incentive for states to cease utilising the guarantee when market
conditions normalise (see below).
|
Credit Rating
|
Fee (existing stock)
|
Fee (new issuance)
|
|
AAA
|
15 basis points
|
30 basis points
|
|
AA+
|
20 basis points
|
35 basis points
|
This approach will provide an appropriate set
of incentives for those states which choose to use the guarantee.
The guarantee fee needs to provide a balance between facilitating
access to the market whilst also providing a disincentive to use
the guarantee once market conditions have normalised.
The volatility and significant uncertainty that
is evident in the current market environment means that it will be
necessary for the guarantee fee arrangements to be reviewed on an
ongoing basis and revised if necessary.
A website will be established to transparently
display information on guaranteed securities and related scheme
details.
The Loan Council will provide an additional
level of transparency and rigour to the operation of the guarantee,
as state borrowing requirements will continue to be considered by
the Loan Council through the Loan Council Nomination process. In
particular, scrutiny via the Loan Council will ensure that the
states have to account for their infrastructure spending
The provision of a guarantee will increase the
Commonwealth's contingent liabilities, and this will be reflected
in the Commonwealth's financial statements. This change in the
Commonwealth's circumstances will also be reflected in the
disclosure documents which allow banks and states to access foreign
debt markets. The existing disclosure documents have been withdrawn
and will be replaced as soon as possible with updated versions
reflecting the details of the guarantee of state borrowing.
The Commonwealth views the likelihood of state
default as remote and unquantifiable. Nevertheless, should any
payment be required under the guarantee it will be handled in a
timely fashion.[3]
The Bill has been referred to the Senate Economics Legislation
Committee for inquiry and report by 16 June 2009. Details of the
inquiry are not yet available.
The following is a small sample of reactions to the guarantee.
In general, reactions were favourable although questions remain
about aspects of the proposal.
Infrastructure Partnerships Australia, the peak body
representing private sector infrastructure providers, welcomed the
guarantee, saying that it will help state governments to undertake
more infrastructure investment.[4]
David Crowe (the Australian Financial Review) noted that the
general response to the guarantee was positive and that the
announcement of the guarantee resulted in a fall in the cost of
state borrowing.[5]
However, he also noted questions over the extent of the
guarantee.
Laura Tingle (the Australian Financial Review) observed that
while most market commentators had argued for a temporary
guarantee, the duration of the guarantee is indefinite.[6] The shadow Treasurer, the
Hon Joe Hockey, is reportedly critical, among other things, of the
absence of a cap on the Commonwealth s potential liability.
Lenore Taylor (the Australian) quoted the director of Access
Economics, Chris Richardson, as saying that the problem with the
guarantee is that it puts more pressure on borrowers who do not
have the guarantee: The trouble is we can t guarantee everybody the
more people we include under the guarantee, the more pressure it
puts on everybody outside the guarantee .[7]
An alternative to guaranteeing state borrowings would be for the
Commonwealth to borrow on the states behalf. Historically, the
Commonwealth did this on the grounds that its greater borrowing
power and perceived financial stability would enable it to borrow
on more favourable terms than if state governments sought to raise
funds on their own behalf.[8] However, by 1998-99, the Commonwealth ceased borrowing
on the states behalf as the states increasingly assumed
responsibility for fund raising.
As noted, the states have established centralised borrowing
authorities. These authorities raise funds for the entire state
government sector including government trading enterprises.
Arguably the Commonwealth s decision to cease borrowing on the
states behalf has forced the states to be more financially
responsible because they now have to raise funds. Having to do so,
this argument holds, forces the states to be cautious in their
borrowing and use of funds. This is particularly the case given
that, historically, some states sought to bypass limits that the
Loan Council placed on state borrowings.[9]
A feature of the legislation is that it is open-ended in time
and amount. The Minister s media release refers to the guarantee as
being time-limited . But there is nothing in the legislation which
refers to any such limit. Further, the legislation does not place a
limit on the Commonwealth s potential financial liability. Potentially, the Commonwealth government could be
called on to pay claims under a Deed of Guarantee or to repay state
borrowings. For the moment, the likelihood of this happening seems
low given that the states are, so far, limiting borrowing and
taking other measures to preserve their credit ratings. The states
know that a loan default would be especially damaging for
them.
While the risk to the Commonwealth s coffers may seem low now,
much will depend on developments in the world and Australian
economies. Should the recession get worse and the states seek to
borrow more, the greater the likelihood that the Commonwealth will
be called on to meet its undertakings, that is, assume greater risk
of having to meet its undertakings.
Much will also depend on how contracts are written between state
governments and infrastructure providers, particularly as to which
party assumes various risks in the event that projects fail.
Providers will be keen to ensure that state governments assume as
many financial and other risks as possible. The Commonwealth will
therefore have a strong interest in ensuring that state governments
do not unnecessarily assume risks and thereby be in a position to
pass the buck to the Commonwealth. This will require careful
oversight of state activities. Arguably, given that the
Commonwealth is assuming risk under the guarantee, the Commonwealth
should have some oversight of how contracts are written and, more
generally, how the states spend funds. In short, the guarantee
could lead to greater centralisation of economic policy making.
A question that arises is the future of the Loan Council in
limiting state borrowing.[10] In particular, the Commonwealth may have to be more
forceful in the Loan Council to restrict state borrowing in order
to limit its own potential exposure under the guarantee.
The passage of the Bill may encourage some additional lending or
lending on more favourable terms to the state central financing
authorities. However, it is impossible to quantify these potential
effects.
The Bill provides a standing appropriation to enable the
Commonwealth to pay claims to under a guarantee, and repay
borrowings (including interest), if required.
Clause 3 contains two definitions. The
definition of a Deed of Guarantee has two
elements:
- it must be executed on behalf of the Commonwealth in 2009
[paragraph 3(a)],
- it must be entitled Deed of Guarantee in respect of the
Australian Government Guarantee of State and Territory Borrowing
[paragraph 3(b)],
as that deed is in force from time to time.
The second definition is of Scheme
Rules. They are those identified in the Deed of
Guarantee as those Rules are in force from time to time.
Clause 4
Application within and outside Australia
states that the proposed Guarantee of State and Territory
Borrowing Appropriation Act 2009 applies within and outside
Australia. Presumably this allows the Commonwealth to issue
guarantees to overseas lenders. It also allows the Commonwealth to
borrow overseas, should it be required to borrow money under
clause 6 (see below).
Clause 5
Appropriation is a standing appropriation, and
provides that the Consolidated Revenue Fund is appropriated to:
- pay claims under the Deed of Guarantee in accordance with the
Scheme Rules [paragraph 5(a)]
- repay a borrowing, and interest on a borrowing, made under
section 6 [paragraph 5(b)]
Clause 6
Borrowing provides that the Minister may
borrow money for the purposes of paying claims under the Deed of
Guarantee [subclause 6(1)]. However, the period of
the borrowing must not be for a period longer than 24 months
[subclause 6(2)]. Subclause 6(3)
defines borrow, for the purpose of clause
6, as including raising money or obtaining credit, whether by
dealing in securities or otherwise, but specifically does not
include obtaining credit in a transaction forming part of the
day‑to‑day operations of the Commonwealth. This
definition ensures that money borrowed under this clause will be
quarantined from being used to finance day-to-day government
operations.
From the Commonwealth s perspective, the nature of the guarantee
is that it assumes a contingent liability. This liability is
unquantifiable. It may be the case that the Commonwealth will never
have to meet its undertakings under the guarantee but that is not
certain. A more immediate test of the success or otherwise of the
guarantee is the extent to which the guarantee succeeds in freeing
up funds for borrowing by the states that might not otherwise have
been available.
The Commonwealth may receive some revenue if the states pay
fees. At this stage, the amount, if any, is unquantifiable because
the states have to determine what course of action they will
pursue.
Members, Senators and Parliamentary staff can obtain further
information from the Parliamentary Library on (02) 6277
2464.
Richard Webb
3 June 2009
Bills Digest Service
Parliamentary Library
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