Unlike mermaids and unicorns, sovereign balance sheets are real, but very rare. They are also very valuable, for a range of reasons

There is no escaping the fact that the sovereign debt crisis has exposed the weak fiscal positions of many governments. From Greece to Portugal, to Italy, to Ireland, to Spain, with more to come, markets have reacted negatively to the fiscal positions of many sovereigns.

Much of what has been written about the relative fiscal strength of these countries has referred to 'sovereign balance sheets'— for example, the International Monetary Fund’s 'Guiding Principles for Managing Sovereign Risk and High Levels of Public Debt' (updated June 18, 2012) and various Financial Stability Board documents.

But the reality is that most sovereigns do not have balance sheets.  So for those countries sovereign balance sheets have some of the characteristics of mermaids and unicorns, existing only in fiction. However, it is a safe bet that the balance sheets of sovereigns that choose not to produce them would be by no means as attractive as these mythical creatures are reputed to be. After all, why would a government not disclose its true fiscal position, if such disclosure would be reassuring to markets?

Unlike mermaids and unicorns, sovereign balance sheets are real, if rare. And they are also very valuable, for at least two reasons.

First, a balance sheet ensures that a country’s fiscal position is much more accurately and reliably presented than is the case with conventional debt to GDP measures. It‘s an account of all the government’s assets and liabilities, and therefore provides a clearer snapshot of its financial strength and sustainability. It recognizes that sovereigns have significant liabilities other than debt (for example employee pension obligations) and different asset structures from which to meet those obligations.

As we know, in the past many governments have used cash-basis accounting, which does not produce a balance sheet, to obscure their weak financial positions. A balance sheet provides investors in sovereign debt—which is a huge market, for example on the New York Stock Exchange US Government debt represents over three-quarters of the value of trades—with a more complete and transparent picture of the quality of their investments. It gives investors the information necessary to analyze a sovereign’s fiscal position—an essential part of investment decision-making in a world where sovereign debt can no longer be viewed as risk-free.

Second, a balance sheet gives a sovereign a starting point for better managing its assets and liabilities. Better accounting helps a government use its assets more productively and efficiently, make more informed decisions and choices about the acquisition, management and disposal of capital assets, and redirect capital where it is most needed and produces most value.

It helps the government match the size and composition of its assets to its liabilities, so that it has sufficient liquidity and flexibility to meet current and future spending commitments. For example, a government may have a large portfolio of unused property; disposing of the surplus assets can help fund current needs, such as highway improvement, or future needs, such as pensions. And, perhaps most importantly given today’s circumstances, balance sheet management helps manage potential economic shocks — such as the sovereign debt crisis, ageing populations, earthquakes etc — whilst maintaining long-term fiscal sustainability and without burdening future taxpayers.

But note that I said the balance sheet is a 'starting point'. Producing a balance sheet is no guarantee that a government will use the information effectively.  It could be produced merely as a compliance activity.  That would be a lost opportunity. The accrual basis of accounting, which enables the production of a balance sheet, opens the door to the possibility of active management of the sovereign’s balance sheet.

Currently there are very, very few examples of governments that seek to manage their balance sheet in the way a corporation might. That is what makes the Investment Statement (IS) of the Government of New Zealand and its later Supplement, such interesting documents. They give a clear sense of what it means for a government to manage its balance sheet, and the benefits from doing this. It is certainly an innovative approach and is an object lesson for governments that do not yet have a balance sheet.

So, unlike mermaids and unicorns—which exist only in legends and folklore—sovereign balance sheets are real. They can be found in in Australia, Canada, Chile, Estonia, New Zealand, Switzerland, the United Kingdom and the United States, among other countries.

The essential point is that having a balance sheet is necessary for many reasons, but it is not sufficient. New Zealand’s Investment Statement provides a clear view of how the information in the balance sheet can be put to work.