On October 10 the IMF released its latest Fiscal Monitor. Titled Managing Public Wealth, the paper highlights the important role of the balance sheet in the management of government finances. It is loaded with quotable quotes on why effective public financial management relies on the information reported in a government balance sheet. It also makes clear that focusing on the balance sheet benefits not only fiscal policy and management at an aggregate level, but also asset and liability management. The paper gives compelling reasons in support of the propositions that governments should use accrual based measures of fiscal performance and position, and that this information is essential for fiscal management and decision-making, not just for transparency and accountability.
As if to pave the way for the Fiscal Monitor, on the previous day the New Zealand government released its financial statements for the year ended 30 June 2018. In a number of ways these financial statements provide a case study of what it means to use the balance sheet in fiscal management, as well as the results this can produce. These financial statements demonstrate clearly that accrual-based information, when used as the basis for the whole public financial management system (including fiscal objectives and policy making, budgeting, appropriations, in-year monitoring and operational management, and end of year reporting), can generate outstanding fiscal results.
So, what does the Fiscal Monitor say? The major parts of the paper outline a conceptual framework for the balance sheet, describe the evolution of public wealth, describe how the balance sheet can be used to identify fiscal risks, how to use it to evaluate fiscal policies, examine balance sheet analysis in practice and finally, present some conclusions. The topic has been approached through a number of country-based case studies. Encouragingly, this report is described as “a first step of an ongoing research agenda”.
The first paragraph of the introduction warrants quoting in full: “Public sector balance sheets (PSBS) provide the most comprehensive view of public wealth, yet they are little understood, poorly measured, and only partly managed. Standard fiscal analysis focuses on flows – revenues, expenditures, and deficits – with assessment of stocks largely limited to gross debt. The focus on debt misses large swaths of government activity and can fall victim to illusory fiscal practices.”
The report goes on to note that “empirical analysis finds that financial markets consider governments’ asset positions, in addition to debt levels in determining borrowing costs” and that “countries with stronger balance sheets pay lower interest on their debt”. And, further, that “empirical evidence also shows that countries with strong balance sheets experience shallower and shorter recessions compared with those with weaker balance sheets”. There are good reasons for focusing on the balance sheet.
The New Zealand government’s financial statements for the year ended 30 June 2018 also show the benefits of using the balance sheet in fiscal management. These statements are the latest in a series that started in 1992. For two decades before this, the New Zealand government had run persistent deficits. In the period since, its net worth, the most comprehensive measure of fiscal position, has increased virtually every year except 2009-2012, when it declined as a result of the global financial crisis and the two major earthquakes in Canterbury. The financial statements include, in the commentary, a discussion and analysis of the net worth of the New Zealand government, including showing the breakdown of assets, liabilities and net worth into social, commercial and financial holdings.
For the year just reported, the operating balance was $8,908m, equivalent to just over 3% of Gross Domestic Product. Total net worth was reported as $135,637m (47% of GDP), which was an increase of $19,165m over the previous year, continuing the upward track of net worth that resumed in 2013.
The financial statements include historical financial information which show a ten-year track of key numbers from the statements of financial performance and financial position, as well as on the cash and debt positions. This information shows clearly the trend in net worth, the impact of the financial crisis and earthquakes, and the speed with which net worth resumed its upward track, relative to other comparable countries. And, of course, that net worth is significantly positive, where the national governments of other countries such as Australia, Canada, the UK and the US all have significantly negative net worth, in some cases at levels equivalent to or greater than their annual GDP.
However, there are important differences between the position of the IMF in the Fiscal Monitor and the New Zealand government’s financial statements – specifically the underlying set of rules that govern the content and presentation of the balance sheet, and the “reporting entity” whose performance and position are being reported. The general rationale for using the accrual basis for reporting and analysis was articulated clearly by the IMF in 2001 when the Government Finance Statistics Manual first moved to adopt the accrual basis, which gives us a balance sheet, from the cash basis, which does not. While there has certainly been progress since, it has been slow, partial and “cherry-picked”, which has had a significant opportunity cost. Perhaps the most widespread example of the cherry-picking is seen in the fact that about 50% of OECD countries still budget and appropriate on a cash basis and yet report on an accrual basis. Stating the problem in a different way, accrual information has not been deeply embedded into the whole public financial management system. Leaving the budget on a cash basis is a signal that the balance sheet is not important. Conversely, if the balance sheet is important, why would a government not build it into the budget process, as part of its fiscal planning?
From this writer’s perspective, the Fiscal Monitor is an encouraging sign of official recognition that fiscal position is very poorly reflected in the current, widely used, measures of cash flows and debt. The implication is that fiscal policy decisions and fiscal management suffer as a result of this inadequate measurement, with serious consequences for fiscal stability, strength and resilience. But there are some problems with the IMF’s position as reflected in the Fiscal Monitor. Key amongst them is that they give insufficient weight to the role of government accounting standards and systems as tools of fiscal policy and management. There is some acknowledgment of the role of accounting: “Because balance sheet estimates can involve various data quality issues, with challenges in measuring and valuing many assets and liabilities, improving public sector accounting standards is important”. But this seriously understates the role of accounting in ensuring that government balance sheets present accurate and reliable information on assets and liabilities in a manner that reflects economic reality.
Neither does the Fiscal Monitor address the importance of the balance sheet being embedded in the whole public financial management system. The New Zealand experience is that better fiscal performance is associated with a public financial management system in which high quality accounting information, based on independently set standards, is at the heart of the system. The numbers in the New Zealand government’s financial statements are not statistical estimates[1], they are audited numbers produced by an integrated financial management system. This system ties together fiscal objectives, budget development (including forecast financial statements), appropriations, budget monitoring and operational management, and results in the production of monthly financial statements for monitoring and management purposes, as well as end of year financial statements which report results against previous year and budget comparatives. The balance sheet is not an ad hoc exercise in statistical estimation, it is at the heart of managing the government’s finances prior to and during a fiscal year. Managers throughout the government, from the minister of finance to the individual managers in government departments and agencies, use the numbers that go into producing the balance sheet in managing their operations. Unless all of these managers are making decisions off consistent numbers the quality of financial control will be significantly weakened, and the fiscal results less robust.
Allied to the point above is the problem of the reporting entity. The financial statements of the New Zealand government are just that. They are not the statements of the whole public sector, as are the numbers cited in the Fiscal Monitor. The financial statements reflect those activities under the control of the government, consistent with the accounting standards it applies. Local government in New Zealand is not controlled by the central government, so its activities are not consolidated into the government’s financial statements. Local authorities produce their own financial statements. If statistical agencies wish to have an aggregate picture of the public sector, they have a far stronger basis if their input data is drawn from audited financial statements. It is important to recognise that statistical information is more reliable when it is underpinned by a reliable accounting system which operates in accordance with independently set accounting standards.
A further omission is the failure to make any reference to International Public Sector Accounting Standards (IPSAS) which have been adopted (as in the New Zealand case) or adapted by many of the countries that have made progress in adopting accrual accounting, and thus producing balance sheets. The program to set these standards was commenced in 1996, and they have become the international benchmark for accrual based financial reporting by governments. They have been highly influential in extending the reach of accrual reporting by governments, and thus giving a more solid basis for the estimates of public sector assets and liabilities used by the IMF. This omission is the more surprising given the support for the IPSAS program from the World Bank, and indeed the IMF itself. The IMF is a co-chair of the Public Interest Committee which provides oversight of the IPSAS standard setting process. It is further worth noting that the International Public Sector Accounting Standards Board, has, from the inception of the IPSAS program, sought to harmonise the IPSAS with government finance statistics, and has to this end worked with the IMF for many years.
We should all be concerned to ensure that public financial management systems are supportive of good fiscal outcomes. The IMF has taken a significant step by stating so clearly the role of the balance sheet in fiscal policy analysis and discussion. Hopefully this will lead to very much richer discussions of fiscal policy, based on a more comprehensive view of fiscal performance and position. Getting governments to act on this important insight will be assisted if the central role of accounting in generating the necessary information is also recognised and promoted by the IMF. And finally, the ability of governments to achieve their desired fiscal outcomes will be greater if the same accrual concepts which produce the balance sheet are embedded in all stages of the public financial management system.
[1] Though of course all valuations are based on estimates, including when the valuations are prepared by professional valuers.
