Costello makes Telstra more difficult to sell

When Federal Liberal Party President Shane Stone wrote his "mean, tricky and out-of-touch" memo it was Peter Costello he was blaming for the government’s problems. Part of his criticism was that Costello was a captive of his department and evidence of this was the cumbersome reporting system for the GST.

Costello simplified the GST forms, but is he still run by his department? In the light of the transcript of the Senate Economic Estimates Committee hearings of Thursday, June 6, the answer would appear to be "Yes".

Sometime around 9:10am, Victorian ALP Senator Stephen Conroy had the pleasure of grilling seven officers from the Australian Office of Financial Management (AOFM) - around 20 per cent of its total workforce.

Before reporting the exchange, it is important to understand the context. In the 1996 election campaign the Coalition alleged that Labor had sent public debt out of control. This was dramatically illustrated by the Debt Truck - a bill-board festooned lorry which was driven around the country bearing the exact number of the national debt to the last decimal place. Since the election, although national debt has continued to climb, Howard and Costello have pinned much of their economic competence on the fact that they have paid back almost half of the Commonwealth debt. Most recently Peter Costello boasted at a Press Club luncheon that the Commonwealth planned to completely retire all of its debt as a result of asset sales.

With the sale of Sydney airport, the only asset of any consequence left to be sold is Telstra, but that is problematic, with fewer than half the Senate, including a number of National Party members, agreeable to its sale. If Telstra is not sold, the government debt stays. It is in Costello’s interests in the way that he has framed the debate to put maximum pressure on the Senate. To date he has done this by painting opponents as spendthrifts standing between the Australian public and the final installment on our collective "over-draft".

So, what did Conroy find out? First, that in Treasury speak, paying off debt does not really mean paying off debt, it means reaching a position of zero "net debt". And how do you explain the concept of zero "net debt". I’ll hand over to Dr Parkinson, Executive Director of the Economic Group who told the committee: "Net debt can be zero with $50 billion of government securities on issue and $50 billion worth of assets." In other words, net debt free can also equal zero net worth! But wait, there’s an upside to this way of looking at the world. If you have an asset worth $50 Billion and debt of $50 Billion, then you have already paid back the government debt. And as Telstra is worth about $50 billion, and government debt on issue is also $50 billion, we’re already there. So there we have it – Peter Costello is a modest over-achiever and has been hiding the fact from us that we don’t need to sell Telstra because we don’t really have any government debt. At least that is the Treasury view of it, but surely Costello doesn’t go along with this?

Well, he does and he doesn’t. He wants to sell Telstra, but instead of using the money to pay back debt, he is apparently planning to reinvest it in other sharemarket assets. But he can’t say that because it raises the question: Why sell at all? So the budget papers and the public servants do their best to hide this intention.

The accounts don’t separate out assets and liabilities, just show a figure for net debt. The bureaucrats refused to reveal the assets and liabilities that made up that figure saying that everything was "hypothetical" and the government had yet to make a decision. How "hypothetical" can a government budget figure be? Not so hypothetical that it doesn’t earn interest, apparently. In this case about $2 billion income per year which does show in the budget papers, allowing Conroy to infer that the asset must be worth $40 billion at least! No wonder the Treasury was shy about it.

Logically, the Costello argument can no longer be the simple one that government should not be involved in running a business. It becomes an issue of what sort of business, involving questions of price earnings ratios, betas, portfolio theory, internal rates of return, growth prospects and so on and so on. He won’t hold the attention of the electorate with those. His department seems to know this, otherwise why hide the figures? But as the politician in charge, Costello should know better than to go along with the strategy.

While the decision is not politically smart, it is also economically and ideologically dumb. If you have followed things to this stage you might be wondering what the government is going to do with the sale proceeds of Telstra. They are going to invest it so they have an asset to borrow against so that they can continue to run the Commonwealth Government Securities market. Why have a Commonwealth Government Securities market when you don’t need to borrow? Apparently for three reasons: to maintain liquidity in the bond market itself; to provide pension funds with risk-free assets in which to invest; and to give the investment markets a risk-free rate to use to price other assets.

These are all dud reasons. The only people who benefit from a liquid market are the participants. After the sale of Telstra the government won’t need the market, so won’t need it to be liquid. Bond traders are another matter, but then they should have thought of that before they bought the bonds - the Government’s plans to pay off debt have been on the table for a while.

As for pension funds, well, there will be plenty of other debt markets to invest in - government, semi-government and corporate - the Commonwealth is not the only large creditworthy borrower in the universe issuing bonds. And pricing assets is a matter of finding a willing seller and a willing buyer, not reference rates. If they really need a reference rate then I’m sure they will be able to price just as well off the corporate or bank debt markets.

What appears to have happened is that Treasury officials have been ear-bashed by financial markets players who don’t want the inconvenience of finding a living some other way, and have acquiesced, possibly because some of these same Treasury officials also make their living from the bond markets. And the Treasurer has gone along with this.

What has happened to the dollar sweets Costello? This is a treasurer and a government that is driven by the economically rationalist theories that small government is good, and that individuals know how to invest their money best. The money that will come from the sale of Telstra is our money. Shouldn’t it be given back to us as tax cuts? Allowing for the loss of dividends from Telstra this could be as much as a billion dollars a year.

Alternatively, but still within the same theme, the savings could be redirected into schemes to get the unemployed back into the workforce leading to more taxpayers, fewer welfare payments and eventually to lower taxes.

From a more sophisticated view, there actually are some good reasons for keeping a CGS market running because there are a lot of advantages to debt. Borrowings can be used to fund schools, hospitals, roads, dams and other infrastructure, which increases standards of living over the long term. If the Commonwealth pays back all of its debt, it will lower the potential rate of growth of the country. By world standards our debt is low. There is no need to pay it back.

One option for the Treasurer would have been (and still is) to have an inquiry into what our debt levels should be and to look at investing the proceeds of Telstra into infrastructure in line with those debt levels. Costello would parlay away the good house-keeping arguments (but then he already has) to replace them with arguments perhaps even more compelling. Imagine the pressure that you could put on the Greens, Dems and the Nats over the Telstra issue if, instead of paying the debt back to zero, you promised to put the money into economically sound projects which would visibly make the lot of ordinary Australians better?

In fact, given the linkage between infrastructure and economic growth, it might be a good idea for the Commonwealth to explicitly link borrowings and assets and undertake to only borrow for capital expenditure. There are such things as natural monopolies and public goods, which the government ought to be in the business of supplying, and debt is a legitimate way of paying for a proportion of them.

If Peter Costello wants to become Prime Minister, he needs to pay attention to his portfolio. As this latest tricky and out-of-touch episode indicates, he is very much in thrall to his Mandarins. One of the reasons that John Howard is looking so relaxed is that, while he has an heir apparent, Costello has been unable to give any but a small coterie a compelling argument to push for change in leadership. As a result, there is no mood among the parliamentary party for Howard to move on. Perhaps just as well for the whole party.