A mixed ownership model for state assets
Speech to Victoria University Faculty of Commerce and Administration
A mixed ownership model for state assets
Wednesday 15 February 2012
It's just over a year since Prime Minister John Key first outlined the Government's plans to sell minority stakes in its four energy companies and Air New Zealand.
Since then, there has been plenty of noise - mainly from our political opponents. So today I'd like to go back over the reasons why the Government is proceeding with mixed ownership.
The rationale is fairly simple - mixed ownership is a win-win for New Zealand.
Firstly, the Government gets to free up $5 to $7 billion – less than 3 per cent of its total assets - to invest in other public assets like schools and hospitals, without having to borrow in volatile overseas markets.
Secondly, New Zealanders get an opportunity to invest in big Kiwi companies at a time when they are looking to diversify their growing savings away from property and finance companies.
Thirdly, it’s good for the companies themselves. Greater transparency and oversight from being listed on the stock exchange will improve their performance and the companies won't have to depend entirely on a cash-strapped government for new capital to grow.
We already have a living, breathing example of the mixed ownership model - Air New Zealand, which is 75 per cent owned by the Government and 25 per cent by private shareholders.
Air New Zealand has been a creative and innovative company, a model corporate citizen, and has twice won Airline of the Year awards.
Before I talk in more detail about the benefits of mixed ownership, I'd like to take a little time to explain the economic context in which the Government has taken its decisions.
Lifting national savings
For the last three years, the Government has been focused on lifting New Zealand's national savings.
That's because our biggest vulnerability remains our high foreign debt, a legacy of excessive household and government consumption and a debt-fuelled property boom through much of the 2000s.
Between 2000 and early 2009, New Zealand's combined Government, household and business debt to foreign lenders climbed from about $100 billion to about $160 billion.
Markets are increasingly looking at this measure when they decide whether to keep lending a country money.
The Government has made some progress reducing this liability, but most forecasters are picking it to widen again as confidence gradually improves.
This is a concern. You only have to look at Europe to see how markets treat countries with too much debt.
Their interest rates have climbed sharply, while they remain low for countries that are deemed a good risk.
The message from this is clear. The price for failing to get on top of debt is higher interest rates and lower growth.
When we break down what is happening with savings and debt flows in New Zealand, there are two notable trends.
The first is the Government's debt is still growing and will continue to grow until we get back to surplus in 2014/15.
At the same time, households seem to have got the message around debt and are borrowing less and saving more.
In the year to March 2011, net household saving became positive for the first time in 10 years. That's quite a turnaround from 2007 when households were spending about $1.11 for every dollar they earned.
Private savings rates are forecast to continue improving.
So we now face a situation where Crown debt is still growing and needs to be contained.
At the same time, household savings are improving, but savers need more choices of where to put their money.
The mixed ownership model addresses both of these problems – by helping to contain public debt, while providing new savings options for local investors.
Reducing Government debt through mixed ownership
On the Government side, we are addressing our debt in two ways.
We have laid out a clear plan to build a more competitive economy based on savings and exports, rather than the borrowing and consumption that characterised the last decade.
Over time this should lift growth and with it the Government's revenue.
Secondly, we have put in place measures to manage our finances more responsibly.
For example, over the last three Budgets we found $9 billion of operating savings that we either redirected into higher priority areas or used to reduce debt.
And we have committed to a faster return to surplus in 2014/15 after which we can start repaying debt. This is one of the most important contributions the Government can make to lifting national savings.
But operating spending is just one side of the Government's ledger. The Government also holds about $245 billion of assets on its balance sheet and spends about $6 billion a year maintaining these assets and buying new ones.
These assets are forecast to grow another $22 billion over the next four years. That's a very large commitment to public investment.
Over a third of these assets are either financial or commercial assets, which carry considerable risk.
The rest are social assets, including a large amount of property. This property is subject to all the same risks as privately held property, but there has been little incentive put on the state sector to manage this risk properly.
So, it's important we make the best use of this growing pool of capital and where possible reduce the Crown's exposure to risk.
The Government has taken several steps in this direction.
We have demanded better asset management practices from the
We've clearly set out the Crown's assets and liabilities and how we intend to manage them, in the Government Investment Statement.
And we have been more demanding about how we allocate capital through the Budget process.
Previous governments have sorely neglected these areas.
Another part of managing the Government's capital more efficiently has been taking a hard look at the mix of assets we own.
At the margin, there are two ways we can acquire new assets – either we can borrow more, or we can change the mix of assets we own.
Part of better managing the Government's balance sheet has been identifying where new assets are most needed and where we have more money invested than we need to.
The greatest scope to change the mix of assets lies with the Government's portfolio of commercial assets – and that is what we are doing with mixed ownership.
By selling minority stakes in some of these companies, the Crown reduces its exposure to commercial risk and frees up $5 to $7 billion to pay for new priority assets.
That's $5 to $7 billion less the Government needs to borrow on volatile overseas markets.
How mixed ownership impacts on the Crown accounts
Over the past year there has been a lot of conjecture about how mixed ownership will impact on the Government's books, so I'd like to take a moment to explain that.
Under mixed ownership, the Government is foregoing up to 49 per cent of the future income from the companies involved. But it’s getting a big lump sum of money in exchange – as I mentioned, somewhere between $5 and $7 billion.
That’s a fair exchange. To the extent that the mixed ownership companies are well run and profitable, the sale price will reflect that. So in effect, the Government is not missing out on any future earnings under mixed ownership, it simply gets these expected earnings up front and in a lump sum.
The next step is to invest that $5 to $7 billion in other types of assets that will benefit New Zealand. For example, we are going to invest $1 billion of these proceeds in building new schools, and modernising existing schools, which the Government would otherwise have to borrow to pay for.
So it’s quite clear from this reinvestment that the Government’s assets will not decrease as a result of mixed ownership. The effect of mixed ownership is simply to change the mix of assets the Government owns, without affecting the overall amount.
After the mixed ownership changes, we’ll have a bit less invested in commercially-driven energy companies and a bit more invested in public assets like schools.
These won’t be huge changes – mixed ownership affects less than 3 per cent of the Crown’s total assets. But because we are able to change the mix of our assets, we won’t have to borrow to invest in new public assets over the next few years.
In other words, mixed ownership allows us to keep up our investment in much-needed capital projects, while at the same time reducing the amount the Government has to borrow quite considerably.
That is hugely important for New Zealand.
The alternative is a lot more debt, which would need to be borrowed from foreign lenders, at a time when markets are increasingly worried about lending to heavily indebted countries.
Because of mixed ownership, our net government debt will peak at just under 30 per cent of GDP, which maintains our fiscal credibility in a world that is more and more focused on government debt.
That credibility is helping keep interest rates in New Zealand at record lows. It’s also helping keep overseas lenders funding our banks and therefore ultimately our mortgages, business loans and so on.
In terms of the precise impact of mixed ownership on the Government’s books, that can’t be confirmed until the transactions have actually occurred. Until then we can only estimate the sale price we will receive for shares.
But the Budget Policy Statement, which is being released tomorrow, will contain more information on the impact of mixed ownership than was possible in previous updates.
Total proceeds from mixed ownership over the next four years are assumed to be $6 billion, which is the midpoint of the estimated range of $5 to $7 billion. Estimates of foregone profits and foregone dividends are based on a four-year average of the companies’ own forecasts.
So in the accounts, net government debt is reduced by a bit over $6 billion because of mixed ownership.
The operating balance before gains and losses decreases slightly because of mixed ownership, which simply reflects the difference in risk between owning a commercial business and reducing our debt requirement. As I’ve said, we are firmly focused on reducing our debt.
The overall operating balance, however, increases slightly because of mixed ownership, because it includes an $800 million gain on sale. That’s because the $6 billion proceeds that have been assumed are more than the current book value of the mixed ownership assets.
So I would summarise the effects of mixed ownership on the Governments books as a significant reduction in debt, together with a fairly neutral impact on the Government's cash flows and operating balances over the forecast period.
As well as reducing the Government's debt, the mixed ownership companies will also provide New Zealanders with another investment option for their large and growing pool of savings.
In fact, New Zealanders are telling us they're hungry for other options as they look to diversify their investments away from highly-leveraged property and finance companies.
Kiwi investors have about $100 billion sitting in term deposits. And there are tens of billions of dollars invested by other New Zealand investors from KiwiSaver providers to the NZ Super Fund, ACC, Government Superannuation Fund, and iwi.
As a result, we expect strong local demand for these shares and a high degree of New Zealand ownership. Ministers have made three clear promises to ensure this happens:
The Government will retain at least 51 per cent control.
Kiwi investors will be at the front of the queue for shares and ministers expect New Zealand ownership will be around 85-90 per cent.
No shareholder other than the Government will be able to own more than about 10 per cent.
We expect the high level of interest will also lift confidence and participation in our capital markets, which will benefit the economy overall.
Benefits for the companies
In addition to benefiting the balance sheets of Kiwi investors and the Government, the mixed ownership model will be good for the companies themselves.
The Government has already taken steps to improve the transparency and performance of these companies. However commercial discipline and oversight imposed by ministers fluctuates from election to election and government to government.
The Treasury's advice is that sharper commercial disciplines, more transparency and greater external oversight as a result of being listed on the stock exchange will over time improve the economic performance of these companies.
That's good for the companies and taxpayers.
Listing these companies will also give them access to additional capital from the market. Currently, if these companies need a capital injection, they generally come cap in hand to the Government, which can be fairly reluctant to take on additional commercial risk – particularly if it requires more borrowing.
Under the mixed ownership model, these companies will also be able to call on their private shareholders for additional capital, reducing the Government's contribution and sharing the risk.
Completing the mixed ownership programme is likely to take three to five years, depending on market conditions.
That process is already underway with the first sale – Mighty River Power – expected to take place in the third quarter of this year.
The exact timing of the initial public offering will be firmed up in the next three months, once Ministers have made more decisions around its design, including how shares will be allocated.
At the same time we are consulting Maori around the removal of Mighty River Power, Genesis, Meridian and Solid Energy from the State Owned Enterprises Act.
This consultation includes how the Crown's Treaty of Waitangi obligations should be reflected in legislation covering the companies. Among the issues is whether a general principles clause of the SOEs Act – Section 9 – should be carried over, made more specific or not included.
The Crown clearly recognises its Treaty obligations and will continue to meet those obligations irrespective of the final shape of the mixed ownership legislation.
And Section 9 will remain in the SOEs Act regardless of how the Crown's Treaty obligations are recorded in the mixed ownership legislation.
Decisions will be taken following consultation and new legislation covering these companies will then be introduced.
Let me finish by saying the mixed ownership programme will be good for Kiwi investors, the Government and the economy as a whole.
But let's remember, it is just one part of a broad programme to build a more competitive, faster-growing economy supported by higher savings and less debt.
Over the next three years, New Zealand has the opportunity to grow solidly, create more jobs and increase wages. The Government wants to take advantage of that opportunity.