Michael Coote: On the Money - Can perpetual bonds avert COVID-19 tax increases in New Zealand?

The 52^nd New Zealand Parliament, which opened on 7 November 2017, finds its terminal countdown months in 2020 blighted by the COVID-19 pandemic.  This Parliament is finally extinct as of Saturday 19 September 2020, the date nominated by the prime minister for a general election.  

The Ardern tripartite coalition government’s Great Lockdown emergency measures are causing huge and mounting national compensatory expenditure blowouts that will have to be funded somehow.  In the short run ramped up national debt and expedient money printing will fill the breach, but afterwards the resultant liabilities must be addressed. 

While many uncertainties linger about how the COVID-19 threat will play out in New Zealand, one thing is certain.  The 52^nd Parliament has racked up massive debts, but the 53^rd Parliament to follow will have to work out how to pay for them.  Media reports indicate increased taxation will be imposed to pick up the Ardern lockdown tab.  But the political composition of the yet-to-be-elected 53^rd Parliament cannot be predicted at this stage given the vagaries of MMP, and so it is unclear how debt reduction strategies, including any changes to the tax system, might arise.  It can be taken for granted that competing proposals to pay for the Ardern lockdown will be centre stage in the upcoming Parliamentary election campaign.  That debate should start now.

Similar problems have arisen elsewhere, including in the European Union (EU).  George Soros has proposed a solution to the EU’s massive trillion euro COVID-19 economic recovery stimulus cost by suggesting issuance of perpetual bonds to fund it.  Such bonds have historically been deployed by both Great Britain and the United States of America.  These bonds entail the issuer paying interest on principal received, but being under no obligation to repay the principal.  Whilst this may seem to be a strange sort of deal to buy into, for the purchaser these bonds promise an indefinite income stream that might stretch out decades or longer into the future.  According to Mr Soros’s website, Spain is promoting issuance of perpetual bonds in the EU.

Mr Soros sees three main advantages to the EU issuing perpetual bonds under COVID-19 fiscal emergency circumstances:

• The issuer does not have to repay the principal raised, but only needs to fund the interest costs.  This means that massive sums of money could be obtained at minimal fiscal cost given current depressed interest rates.  A sovereign issuer of good standing like the EU should be able to pull this trick off.
• A perpetual bond can be drip-fed in instalments as part of a single issue, rather than issuing multiple tranches of finite bonds at potentially different interest rates and with the eventual burden of principal repayment or refinanced rollover.
• The European Central Bank (ECB) could buy the EU perpetual bonds as part of its COVID-19 bond purchase programme without needing to rebalance a portfolio of bonds that have no expiry date.

Missing from Mr Soros’s list of advantages is the argument that purchasers apart from central banks conducting extraordinary monetary policy might be interested in buying perpetual bonds as assets.  These acquirers could include funds confronted with long-term liability matching requirements, such as sovereign wealth funds, pension funds, and life insurance funds.  A perpetual bond issue would provide such funds with an income stream of prospectively unlimited duration, subject to the risk of the issuer electing to redeem it.

Within the New Zealand context, perpetual bonds could represent an option for the government arising from the 53^rd Parliament, if not the 52^nd Parliament, to explore as a way to finance COVID-19-related fiscal obligations.  New Zealand has good sovereign credit ratings, which is a basic precondition.  There are two pre-existing potential government-linked purchasers in the Reserve Bank of New Zealand (RBNZ)and the New Zealand Superannuation Fund.  Outside of these obvious candidates, there are domestic and foreign funds - both retail and wholesale - with long-term liability matching requirements who are likely to trust the full faith and credit of the New Zealand government, including KiwiSaver schemes.  This idea needs to be explored seriously in the run up to the mid-September Parliamentary general election.

Perpetual bonds are not without potential hitches.  Don Brash, former Governor of the RBNZ, comments upon the Soros proposal of perpetual bonds, if applied to New Zealand, as follows:

“[A]s Soros notes, perpetual bonds have been issued in the past.  At an interest rate of, say, 1%, they would certainly be a more attractive investment than 100-year Argentine bonds which were issued, from memory, at a pretty low coupon not so long ago.  Personally, I would not be keen to buy perpetual bonds given that I have no confidence that politicians would allow central banks to keep inflation under control forever!”

As usual, the sagacious Dr Brash hits the nail on the head.  The primary weakness of perpetual bonds is inflation. For the foreseeable future, the risk with inflation surely lies on the downside, with disinflation and perhaps even deflation lying ahead as the global economy slumps into deep recession of uncertain duration.  It might be years before strong inflationary pressures return to many economies, including New Zealand’s.  But once these pressures are back, low interest rate perpetual bonds would likely tank in value, producing significant capital losses.  Indeed, if governments wished to evade their perpetual bond liabilities, then encouraging inflation would work to that end.  But given that successive New Zealand governments of different political stripes have placed great value upon retaining high sovereign debt credit ratings and strong investor confidence, perhaps this risk is not so critical in the case of our country.

Michael Coote is a freelance writer and financial journalist based in Auckland.