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Functions, Powers and Operation of the Australian Loan Council - Senate Select Committee - Reports - 3rd, December 1993


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Parliament of the Commonwealth of Australia

SENATE SELECT COMMITTEE ON THE FUNCTIONS, POWERS AND OPERATION OF THE AUSTRALIAN LOAN COUNCIL

THIRD REPORT

December 1993

© Commonwealth of Australia 1993

ISBN 0 642 19902 7

This document was produced from camera-ready copy prepared by the Secretariat of the Senate Select Committee on the Functions, Powers and Operation of the Australian Loan Council, and printed by the Senate Printing Unit, Parliament House, Canberra.

THE COMMITTEE

Members:

Senator J R Coulter (AD, SA), Chairman

Senator N Sherry (ALP, TAS), Deputy Chairman

Senator B Bishop (LP, NSW)

Senator B Burns (ALP, OLD)

Senator K Carr (ALP, VIC)

Senator B Gibson (LP, TAS)

Senator J R Short (LP, VIC)

Former Members:

Senator R Alston (LP, VIC)

Senator R Crowley (ALP, SA)

Senator J Faulkner (ALP, NSW)

Secretary:

Peter C. Grundy The Senate Parliament House

Canberra

Telephone: (06) 277 3552

iii

Transparency and Accountability: 1992-1993 69

. Prerequisites for Accountability 70

. The Role of the Parliaments 76

. The Role of the Markets 80

. Conclusion 88

Recent Reforms - Assessment 89

. Reform Proposals: December 1992 89

. Endorsement of the 1992 Proposals 92

. Reform in 1993 93

. Assessment of the 1992 and 1993 Reforms 101

Prospective Reform 115

. The Financial Agreement 115

. The Operation of the Council 118

. The Limits to Reform 122

. Prescriptions for Reform 124

. Conclusion 129

Summary and Recommendations 131

Dissent to Third Report - Government Senators 137

Minority Report - Liberal Senators 143

Interim Report 143

Chapters 5 to 7 143

Appendixes

appendix A Minute by Dr D Sams, General Manager, Finance Division, Treasury of Victoria, 21 December 1992 147

appendix B Letter from Hon Nick Greiner to Hon John Dawkins, 22 April 1992 157

appendix C Undated Draft Letter from Hon Tony Sheehan to Hon John Dawkins 161

Appendix D Draft Letter from Hon Tony Sheehan to Hon John Dawkins, 24 June 1992

167

Appendix E Executive Minute from Mr J Wright to Hon John Dawkins, 23 July 1992

173

Appendix F The Treasury - Supplementary Submission dated 7 September 1993 183

Appendix G Submissions 189

Appendix H Public Hearings and Witnesses 193

Appendix 1 Invitees Who Declined to Attend 201

\ppendix J Chronology 205

Appendix K Interim Report - Conclusions to Chapter 2: Victoria's Breach of Global Limits 213

Appendix L Interim Report - Dissent by Government Senators 221

vii

PREFACE

On 1 March 1993 the Senate Select Committee on the Functions, Powers and Operation of the Australian Loan Council presented an Interim Report. The Senate on 12 May 1993 reappointed the Committee to inquire into and report upon the same matters on or before the first sitting day in September

1993:

(a) the functions, powers and operation of the Australian Loan Council in co-ordinating all financial transactions by all Commonwealth and State bodies, including Government business enterprises, instrumentalities and other authorities, which involve a call on the private sector;

(b) the role of all Governments in the Loan Council process, including the provision of information to the council and the advising of other council members on the activities of members;

(c) the administration of global borrowing limits set by the council, in particular, the administration of breaches and possible breaches of those limits;

(d) the appropriate responsibility and powers of the federal Treasurer, as Chairman of the Loan Council, in dealing with breaches or possible breaches of the global borrowing limits, particularly as they affect the national economy; and

(e) the powers (and limits of power) of State Premiers and Treasurers to administer borrowing agreements approved by the council and the responsibilities of State Premiers and Treasurers to notify the council about the borrowing activities

of their Governments.

The Senate passed a motion on 18 August 1993 to extend the time for the presentation of the report to 16 November 1993. The Committee tabled a second report on 30 September 1993.

On 16 November 1993 the Senate passed a motion extending the time for presentation of the report to 25 November 1993. A further motion was passed on 24 November 1993 providing an extension of time to report until 9 December 1993. On 9 December 1993 another extension, until

15 December 1993, was agreed by the Senate.

ix

ACKNOWLEDGMENTS

The success of this inquiry depended in large part on many contributors who provided

documentation and submissions. Many participants also gave evidence at public

hearings.

The submissions received by the Committee are listed at Appendix G, and the

witnesses who appeared are listed at Appendix H. (A number of people invited to

provide evidence to this inquiry declined to do so. A list of those is at Appendix I.)

The Committee is most grateful for the interest shown and advice provided. While

some of the submissions are not mentioned in this report, they were carefully

considered and taken into account during the inquiry.

Further, in the thirty-seventh parliament this inquiry was considerably assisted by the

professional officers of the Senate who staffed the secretariat at various times under

the direction of the Committee Secretary. The Committee expresses its appreciation

to: Ms P Corrigan, Mrs R Barter and Ms S Sabihi (Executive Assistants),

Mr D Drinkwater, Mr W Hooper and Ms M Lindsay (Research Officers).

ACRONYMS AND ABBREVIATIONS

ABS Australian Bureau of Statistics

ACIR Advisory Council for Inter-government Relations

ALC Australian Loan Council

ANAO Australian National Audit Office

BOO Build, Own and Operate

BOOT Build, Own, Operate and Transfer

CBA Central Borrowing Authority

CWA Capital Works Authority

QBE Government Business Enterprise

GFS Government Finance Statistics

GTE Government Trading Enterprise

LCA Loan Council Allocation

NFO National Fiscal Outlook

NRG National Rail Corporation

PFE Public Finance Enterprise

PSBR Public Sector Borrowing Requirement

PSUT Portland Smelter Unit Trust

PTE Public Trading Enterprise

S & P Standard and Poor's

SECV State Electricity Commission of Victoria

SMA Statutory Marketing Authority

TCV Treasury Corporation of Victoria

xi

VC A Victorian Commission of Audit

VDF

VET

VicFin

VTBA

Victorian Development Fund

Victorian Equity Trust

Victorian Public Authorities Finance Agency

Victorian Transport Borrowing Authority

xii

GLOSSARY*

Accrual accounting: an accounting system in which revenues and expenses are recognised as they are earned and incurred, respectively, rather than as cash is received or disbursed. Accrual accounting is used almost universally in the private sector, by local governments and by government business enterprises. However, Commonwealth and State government departments, and the budget sector of most governments, operate on cash accounting systems.

‘ Central borrowing authorities: agencies established by the States to undertake borrowing on behalf of State semi-governmental and local authorities. In recent years, the State governments have also tended to borrow from their central borrowing authorities. The NSW Treasury Corporation is an example of a central borrowing

authority. The amount of borrowing by CBAs is regulated under the Global Borrowing Limits. (D. James, Intergovernmental Financial Relations in Australia, Australian Tax Research Foundation, Sydney, 1992, p. 108.)

Commonwealth Grants Commission: an independent authority originally established by the Commonwealth Government in 1933 to make recommendations to the Commonwealth concerning special grants to the less populous States. In recent years its principal role has been to make recommendations for the distribution of financial assistance grants among the States.

Consolidated Fund: the account into which the Victorian Government's revenue is paid (unless specifically provided otherwise) and from which money is appropriated by Parliament for government purposes.

Contingent liabilities: obligations which become payable only under certain circumstances. The most common form of contingent liability is a guarantee given by the Government or by legislation to secure borrowings made by a third party. For example, the borrowings of non-budget sector entities are guaranteed by the Treasurer; they are thus a contingent liability of the budget sector. The Treasurer also

provides guarantees for borrowings by private schools, hospitals, local government bodies, and (in certain circumstances) companies and co-operative housing societies. These guarantees become liabilities only if the borrowing party defaults on the debt.

‘ Deficit/Surplus: as defined by the Australian Bureau of Statistics, the difference between government outlays on the one hand and revenue and grants received less increases in provisions on the other. It measures the extent to which each government is increasing or decreasing its financial position (i.e. net financial assets and liabilities) in respect of entities outside that government. (Based on Future Arrangements for Loan Council Monitoring and Reporting, 1993, p. 5.)

Except for those marked with an asterisk, all of the definitions in this glossary are reproduced from, or based on, the Report of the Victorian Commission of Audit (2vols), 1992, vol I, pp. 269-283.

xiii

Finance lease: a leasing arrangement in which substantially all the risks and benefits incidental to the ownership of the leased property effectively pass from the lessor (i.e., the provider of finance) to the lessee (i.e., the user of the property). Finance leases are in substance borrowings. Under current accounting standards, the interest component of rental payments under finance leases must be accounted for as a finance charge; while the capitalised value of outstanding lease components is

reported as a liability. Finance leases by State and Territory governments and their authorities are also regarded as borrowings for global limit purposes. Australian Accounting Standard 17 provides a more precise definition of the criteria used to

determine whether a lease is a finance lease or an operating lease.

* Financial Agreement: an agreement made by the Commonwealth and the six States on 12 December 1927. It formalised existing Federal and State public sector borrowing arrangements and provided for the creation of the Australian Loan Council to regulate borrowing by the Commonwealth and the States. It is presently the subject of extensive redrafting.

Financial assistance grants: grants made by the Commonwealth to State and Territory governments for expenditure by the latter in accordance with their own priorities. Financial assistance grants are sometimes referred to as general revenue or general purpose grants. The distribution of financial assistance grants among the States and Territories is based, for the most part, on the recommendations of the Commonwealth Grants Commission. These are in turn based on horizontal fiscal equalisation principles, so that Victoria and NSW typically receive lower financial assistance grants per head of population than the less populous States.

•Gentlemen's Agreement: an agreement entered into by the Commonwealth and the six States in 1936. It extended Loan Council control to encompass borrowings by local government authorities and autonomous semi-government instrumentalities in relation to aggregate borrowings and the terms and conditions of loans. It was based on Loan Council resolutions outside the Financial Agreement, and endured until 1984.

Global limits: annual limits on new money borrowings by State and Territory governments and their authorities (other than government-owned financial institutions and statutory marketing authorities). The limits for each State and Territory are determined each year by the Loan Council. New money borrowings to which the limits apply include 'conventional' domestic and overseas loan raisings, deferred payment arrangements, overseas trade credits, finance leases, sale and lease-back arrangements, instalment purchases by government departments, the net change in temporary purpose borrowings over a financial year, and 'any other form of raising

new capital funds (including equity raisings)'. New money borrowings have excluded temporary borrowings within the financial year and operating leases, although the latter will be included from 1993-94. Compliance with the global limits is voluntary.

Government business enterprise (GBE): a publicly-owned entity providing goods or services on commercial terms with the objective of recovering its costs of production and, in most cases, of providing some financial return to its owner government. GBEs

xiv

are often referred to as public trading enterprises (PTEs) or, more recently, as State- owned enterprises.

Government Finance Statistics: a short-hand term for the framework developed by the Australian Bureau of Statistics for presentation of data on public sector outlays, revenue, and financing transactions in a national accounting format - that is, in accordance with the concepts and definitions used by the ABS to present estimates

of national income and expenditure. Victoria began presenting budget information in this format in 1990-91, and was the first State to do so.

* Infrastructure Borrowing Program: a term used to describe special additions to the borrowing programs of larger government authorities for infrastructure purposes, which were introduced in June 1978. To be eligible for such funding, the proponents of projects had to demonstrate that they could not be financed under the existing

Loan Council programs; that they related to public utility operations; and that they had particular significance for development. (D. James, Intergovernmental Financial Relations in Australia, Australian Tax Research Foundation, Sydney, 1992, p. 50.)

*Loan Council Allocation (LCA): the borrowing allocation to be nominated to Loan Council by the Commonwealth, States and Territories. It is based on the deficit/surplus plus some memo items. Final negotiation and endorsement of each LCA is the responsibility of Loan Council. (Future Arrangements for Loan Council

Monitoring and Reporting, 1993, p. 2 and p. 7.)

*Niemeyer Statement: monthly statements of government financial transactions showing movements in government accounts. They are produced by the Federal and State governments and are named after Sir Otto Niemeyer (1883-1971), a Director of the Bank of England, 1938-1952, who headed a Financial Mission to Australia and

New Zealand in 1930. (Edna Carew, The Language of Money, Allen and Unwin, Sydney, 1988, p. 168.)

Operating lease: a leasing arrangement in which substantially all the risks and benefits incidental to the ownership of the leased property effectively remain with the lessor rather than passing to the lessee (which would make it a finance lease). Australian Accounting Standard 17 provides a more precise definition of the criteria used to distinguish between the two types of leases. Under presently applicable accounting standards, commitments under operating leases do not have to be reported as liabilities. In addition, operating leases by State governments and their authorities have not been regarded as borrowings for global limit purposes (though it is currently intended that they will come within the global limits from 1993-94 onwards).

Public Account: the principal bank account of the Government of Victoria. It holds the balances of the Consolidated Fund and the Trust Fund.

‘ Public sector borrowing requirement (PSBR): the net PSBR is a calculation which measures the public sector's direct call on the financial markets. It is equivalent to the Australian Bureau of Statistics concept of a "net financing requirement". The PSBR is

xv

arrived at by subtracting total revenue from total outlays, less increases in provisions (including depreciation and superannuation). In the case of the public trading enterprise and state/local sectors, it excludes net advances received from general government and from the Commonwealth. (State Finance Victoria (Nicholls Report),

1992, "Glossary of Terms", p. G10.)

Public trading enterprises (PTE) : government-owned entities which provide goods and services for sale in the market with the aim of recovering all, or at least a significant proportion of, their operating costs. Examples are the SECV, GFCV, Melbourne Water and the port authorities. PTEs generally fall within the non-budget sector in the Victorian Treasury's classification of public sector entities. PTEs are also widely referred to as government business enterprises (GBEs) or as State-owned enterprises (SOEs).

Specific purpose grants: grants made by the Commonwealth to State and Territory governments on terms and conditions laid down by the Commonwealth, generally with a view to ensuring that Commonwealth policy objectives (or national objectives agreed between the Commonwealth and the States) are met. In practice the terms and conditions may simply require that the grants be spent in accordance with broad agreements covering principles and program delivery mechanisms; or may be more detailed, and include requirements for Commonwealth approval of individual projects or the commitment of matching funds by the State.

Transparency: the extent to which financial statements fully disclose all revenue, expenses, assets and liabilities.

Trust Fund: it comprises various accounts created for particular purposes, such as the receipt and disbursement of specific purpose grants from the Commonwealth; the receipt of Commonwealth grants for on-passing to third parties; and working or suspense accounts used for accounting purposes. The Trust Fund also includes the Works and Services Account, the Cash Management Account and the State

Development Account. The latter two accounts comprise the Victorian Development Fund.

♦Vertical fiscal imbalance: an imbalance between the expenditure responsibilities of each tier of government and the own-source revenue resources available to that tier. Australia is characterised by significant vertical fiscal imbalance since the Commonwealth raises around 75 per cent of all government revenues but is only responsible for around 50 per cent of all government outlays. (D. James,

Intergovernmental Financial Relations in Australia, Australian Tax Research Foundation, Sydney, 1992, p. 111.)

xvi

Chapter 1

Introduction

1.1 The Australian Loan Council is one of the major institutions of Australian

public finance and it is also a political entity. It originated some seventy years ago

from the perceived need for the Commonwealth and the States to agree on the

management of public debt. From the earliest meetings of the national leadership of

Australia to consider government borrowings the process was highly political. Over

the years, as an important institution in the organisation of federated states under the

Constitution, this has come to be accepted as inevitable.

1.2 When the formal process commenced in 1927, it should also have been

clear that the Loan Council would need to resolve or accommodate differing agendas

held by the Commonwealth and particular States. The range of factors bearing on the

participants made this inevitable. Even in the period ending with the Second World

War, when the States imposed taxation on incomes, Commonwealth governments

enjoyed wide responsibility for national economic decisionmaking. Clearly, this interest

on the part of the Commonwealth was a potential source of conflict with the various

financial and political programs of State governments.

1.3 Nevertheless, over the years the Commonwealth and the States have

reached pragmatic accommodations through the Loan Council. For example, voluntary

arrangements were followed for annual borrowing programs of semi-government and

local authorities. This 'Gentlemen's Agreement1 between the Commonwealth and the

States provided the framework for Loan Council oversight of borrowings by

Commonwealth and State authorities for almost half a century (1936 to 1984).

Throughout the history of the Loan Council it seems that the States and the

Commonwealth have cooperated in order to ensure that individual interests were

managed if not satisfied.

2 Chapter 1

1.4 While there were highly dissatisfied Loan Council members from time to

time, this significant institution continued through almost seventy years as a

consequence of its pragmatic outlook and progressive readjustments. However, it has

never been very clear to external observers how the Loan Council has actually

operated and what its processes have been. This is despite the publication of some

interesting books and academic articles: the most revealing information about Loan

Council processes has emanated from parliamentary inquiries at both Federal and

State level. By 1992, these processes were at risk as a result of a set of circumstances

that this report will articulate. And the Senate Select Committee was appointed on 3

November 1992 to inquire into the functions, powers and operation of the Loan

Council.

1.5 Reactions by a broad range of individuals and institutions to the Senate

inquiry have confirmed that the Loan Council is a highly political entity. The day

following the original appointment of the Committee, Prime Minister Keating advised

the House of Representatives that whether the Treasurer, Mr Dawkins, wished to

attend the Senate inquiry or not, Mr Keating would forbid him going to the Senate to

account to this unrepresentative swill over there'.1 The Treasurer's reaction to requests

for his participation in the Senate inquiry has been consistent with this direction from

the Prime Minister. While Mr Dawkins has allowed his department to participate, he

has not responded to the Committee's requests for his personal appearance. The

Committee considers that the attitude of Mr Keating and Mr Dawkins to this inquiry

indicates a view about the Senate and the legitimacy of its Committee inquiries.The

Prime Minister and Treasurer may also have been seeking to protect the reputation

of a former State Labor government in Victoria. It is regrettable that this approach

entailed keeping elements of the operations of the Australian Loan Council from the

knowledge of the Federal Parliament and the Australian people.

1

House of Representatives, Weekly Hansard, No 15, 4 November 1992, p. 2549.

Introduction 3

1.6 The inference here is clear. Given that governments normally cooperate

as a matter of course with Senate inquiries, either the Loan Council process was in

considerable disarray or there were specific breaches of Loan Council guidelines, or

both. And if there were specific breaches, it was in the interests of the Labor Party that

the Federal government should not divulge details in the latter half of 1992.

1.7 The Senate inquiry into the Australian Loan Council, initiated through a

motion from Senator Coulter on 3 November 1992, has proceeded on the twin

assumptions that the Loan Council process was in disarray and that it was in the

national interest for the facts to be revealed. The Loan Council itself has vindicated

the Committee's approach. In a paper adopted at the Loan Council meeting on

7 December 1992, increased transparency of government finances was advocated.

And the Loan Council's document released on 5 July 1993 entitled Future

Arrangements for Loan Council Monitoring and Reporting admitted for the first time

that by the end of 1992 Loan Council arrangements were at the point o f breakdown.

1.8 Despite strong resistance to this inquiry from the Prime Minister and

Treasurer through to a State Premier, former Premiers and Treasurers, the inquiry has

pursued and acquired significant documentary evidence and obtained advice and

comment through public and in camera hearings.2 This sustained resistance has only

served to confirm the necessity of divulging what was the parlous state of one of

Australia's significant national institutions.

1.9 In order to fully consider ways in which the Loan Council was in need of

reform, the inquiry drew on the circumstances of the Victorian breach with the intention

2 Prime Minister

Commonwealth Treasurer State Premier Former Premiers

State Treasurer Former Treasurer Former State Minister

- Hon Paul Keating - Hon John Dawkins - Hon John Fahey - Hon John Bannon

Hon Robin Gray Hon Joan Kirner - Hon Tony Rundle - Hon Tony Sheehan - Hon David White

4 Chapter 1

of making the Loan Council more open and more accountable so as to better serve

the national interest.

1.10 The Committee is not suggesting that the task has been completed to

full satisfaction. However, the apparent effect of the instigation of the inquiry was to

galvanise significant reform for the processes of the Loan Council. The Committee has

assessed the reforms that the Loan Council has endorsed to date and has considered

reform that should be adopted for the future.

Chapter 2

The Australian Loan Council: 1923-1984

2.1 The Australian Loan Council is a unique body. No other Western

democratic federation possesses such an institution to regulate the borrowings of its

member States and to direct the management of public sector debt. The central

government of the United States of America, for example, exercises no coordinated

control over the borrowings of its States. Nor does Canada attempt to coordinate the

borrowings of its Provinces.

2.2 The structure and operations of the Loan Council have been subjected

to scrutiny in 1992-93, largely as a result of the State of Victoria breaching its 1991 -92

global borrowing limit from 1 May 1992. The actions of the Victorian Government, and

the events to which they gave rise, were followed by some reform of Loan Council

operations in December 1992 and further significant changes in Council arrangements

in July 1993. However, if the Loan Council is to play an optimal role in the complex

area of Commonwealth-State financial relationships and public sector financial

management in the future, further reform could be necessary.

2.3 The formulation of reform proposals rests in large part on an

understanding of the historical role of the Loan Council in coordinating public sector

borrowing in Australia. Professor Cheryl Saunders, a witness before this inquiry, has

pointed out:

Government borrowing occupies a special place in the story of Australian federalism. The co-ordination and control of borrowing has been a recurring theme, predating federation itself. The reasons it has attracted the interest of successive governments have varied with

prevailing economic and political circumstances but a connection of some kind between borrowing and that other perennial problem, revenue redistribution, has usually been present.1

1 C. Saunders, "Government Borrowing in Australia", Melbourne University Law Review, (17), 2, December 1989, pp. 187-218, p. 187.

6 Chapter 2

Changing Commonwealth and State financial requirements and differing perceptions

about the purposes of the Loan Council have greatly affected the structure and

functions of the Council since it was established in the 1920s.

2.4 For convenience, the history of the Loan Council can be divided into six

periods, each of which marks a distinctive change in the Council's structure, or

functions, or both. The six phases of Loan Council development are:

(i) The Voluntary Loan Council: 1923-1927;

(ii) Borrowing under the Financial Agreement: 1927-1936;

(iii) The Gentlemen's Agreement: 1936-1984;

(iv) The Global Borrowing Limits: 1984-1992;

(v) Transparency and the Public Sector Borrowing Requirement

(PSBR): 1992-1993; and

(vi) The Deficit/Surplus Measure and Loan Council Allocations (LCAs):

from July 1993.

The Voluntary Loan Council: 1923-1927

2.5 Government borrowing was a major subject of discussion at the

Australian Constitutional Conventions of the 1890s. It remained at the forefront of

public sector concerns over revenue redistribution after federation. Immediately

following the First World War, the Commonwealth and the States were borrowing

heavily; the former to redeem or convert war debt, and the latter to finance public

works development projects. Commonwealth-State competition for funds on the

domestic market was intense and damaging to the economy.2 Prevailing economic

and financial conditions, particularly the pressure on already high interest rates, which

derived from strong private and public sector demands for capital, were major reasons

behind the creation of a voluntary Loan Council at the Premiers Conference of June

2

ibid., p. 190.

The Australian Loan Council: 1923- 1984 7

1923.3 The formation of the Council was the first systematic attempt to coordinate

Commonwealth-State government borrowing in Australia. Its primary emphasis was

on borrowing rather than general revenue redistribution. The Council was established

to facilitate agreement on the timing of loan issues, the equalisation of interest rates

and other conditions governing loans. However, Commonwealth control over

borrowing was limited; the States could still raise their own loans in the capital market,

no agreement having been reached on centralising the issuing of loans nor on the

amounts which each State could borrow.

2.6 The aims of the voluntary Council were largely realised but, as the

Advisory Council for Inter-government Relations has argued, it remained very much

'subsidiary to the existing system of financial relationships1 .4 Difficulties emerged in

the mid-1920s between the Commonwealth and the States over a number of central

financial issues - revenue redistribution, debt, future borrowings and transferred

properties5 - and it was in response to these problems that a decision was made by

the Commonwealth and the States to establish the Loan Council on a permanent,

statutory basis.

Borrowing under the Financial Agreement: 1927-1936

2.7 During the early 1920s the tension between the Commonwealth and the

States over revenue redistribution was not seriously addressed by the voluntary Loan

Council, whose main emphasis was on borrowing. Nevertheless, as Professor

Saunders has made clear, the voluntary body did provide 'both a precedent and a

useful model when revenue redistribution and borrowing became linked again, in

R. S. Gilbert, The Australian Loan Council in Federal Fiscal Adjustments, 1890-1965, ANU Press, Canberra, 1973, p. 49.

Advisory Council for Inter-government Relations (ACIR), The Australian Loan Council and Intergovernmental Relations, AGPS, Canberra, 1982, p. 7.

Saunders, op. cit., p. 191.

8 Chapter 2

1926'.6 In June 1927 the Commonwealth submitted a draft Financial Agreement to

the voluntary Loan Council, proposing the establishment of a statutory Council to

regulate Commonwealth and State public sector borrowing. Under section 105 of the

Constitution the Commonwealth would assume responsibility for all State debts as well

as contributing the amount it had formerly paid in per capita grants towards the

interest due on those debts until 1985 when, it was assumed, they would be

discharged. The Commonwealth also consented to meet all liabilities on a volume of

debt which represented the value of the transferred properties. The Agreement made

it possible for the States to redeem their public debts by contributing to the National

Debt Sinking Fund. In general terms the Agreement also provided for the

Commonwealth to make grants to the States to assist them in discharging their

interest and sinking fund obligations. Representatives of the Commonwealth and the

States signed the Financial Agreement in 1927 and it was approved by the various

Australian Parliaments the following year. The reform proposal was passed at a

referendum in 1928, a new section (105A) governing the operation of the Agreement

being inserted in the Commonwealth Constitution. The Agreement was validated with

the passing of the Financial Agreement Validation Act 19297

2.8 Under the terms of the Financial Agreement legislation a Loan Council

representing all governments was established:

...to make decisions about terms and levels of borrowing. Most decisions would be by majority, with the Commonwealth having two votes and a casting vote, and the States one vote each. With a few exceptions all borrowing would be carried out by the Commonwealth. The States would be liable to the Commonwealth for interest on the loans and the Commonwealth would be liable to the bond holders...Both the Commonwealth and the States would make fixed contributions to a sinking fund in respect of both existing and new debt for periods of up to 58 years.8

ibid.

ACIR, op. cit., pp. 10-11 and Saunders, op. cit., p.191.

Saunders, op. cit., pp. 191-192.

The Australian Loan Council: 1923- 1984 9

The principal reasons for the creation of a statutory Loan Council were the perceived

need to reduce competition between the public sector and private enterprises in

approaching the market, and the need for greater efficiency, economy and prudence

in raising loans:

These ends were to be achieved by co-ordinating and centralising the borrowings of the Commonwealth and the States, and by establishing a system for the redemption of public debt through regular sinking fund charges against government recurrent revenue.9

The Financial Agreement was important for Federal-State financial relationships and:

...represented a watershed in the development of Australian fiscal federalism, marking as it did a transition from the philosophy of co­ ordinate federalism which had permeated the Constitution, with its emphasis on a clear division of powers, to one of co-operative federalism based on policy co-ordination and the acceptance of joint decision-making responsibility.10

2.9 The Financial Agreement has been formally amended four times (in 1934,

1944, 1966 and 1976), but none of these amendments resulted in significant reform

of Loan Council arrangements. (Other variations occurred in 1928, and twice in 1931.)

The formal amendments dealt with Loan Council membership (1934), the

Chairmanship of the Council (1944), Commonwealth refinancing of State debt maturing

abroad (1966) and Commonwealth assumption of responsibility for servicing of State

debt (1976). The Financial Agreement legislation empowered the Commonwealth to

regulate State Government debt and to ensure that the States adhered to the

provisions of the Agreement.

ACIR, op.cit., p. 11.

R. Mathews, The Australian Loan Council·. Co-ordination of Public Debt Policies in a Federation, AND, Centre for Research on Federal Financial Relations, Canberra, 1984, p. 5.

10 Chapter 2

2.10 As could be expected, economic conditions had a significant effect on

Commonwealth and State perceptions about the purposes and uses of the Financial

Agreement. The 1920s preoccupation with eliminating competition for loan funds

evolved to one of managing total borrowings and expenditure during the depression

years of the early 1930s.11 Commonwealth influence on Loan Council operations

rose considerably during the Great Depression, with the Commonwealth assuming the

leading role on the Council in negotiations with prospective lenders whose funds were

necessary in addressing Australia's worsening economic situation. Professor

Saunders has argued:

The divergence between the interests of governments on the Loan Council began early but initially took place more slowly. The seeds of Commonwealth domination were always there, in the Commonwealth's weighted vote which, although eminently justifiable by reference to

Commonwealth responsibilities under the Agreement, offered a path to total control with the support of only two States. Such support may have been expected from the outset, with at least two States, Western Australia and Tasmania, in regular receipt of special grants even at this stage.12

As the Depression deepened, and some States received what they considered

inadequate amounts of funding, they developed ways of by-passing the Loan Council

in their efforts to obtain the requisite funds. Out of this developed a new Loan Council

borrowing arrangement known as the 'Gentlemen's Agreement'.

The Gentiemeris Agreement: 1936-1984

2.11 Under the terms of the Financial Agreement, borrowings by local

government and autonomous semi-government instrumentalities were not subject to

Loan Council control. Such entities could borrow independently and, as economic

R. H. Scott, The Australian Loan Council and Public Investment, Occasional Paper No. 31, 1983, pp. n.21, 18; quoted in Saunders, op. cit., p. 200.

12 Saunders, op.cit., p. 201.

The Australian Loan Council: 1923- 1984 11

conditions deteriorated during the 1930s, some States, notably New South Wales,

created more and more semi-government bodies as a vehicle for increasing their

borrowings. As the Commonwealth Treasury has pointed out:

This posed potential difficulties, such as adverse implications for interest rates arising from competition for funds, and the possibility of parties to Loan Council effectively circumventing its control of public borrowing by channelling borrowings through authorities.13

By the mid-1930s most Loan Council members acknowledged that such large-scale

independent borrowing threatened the overall stability of Loan Council arrangements.

The Commonwealth and the States accordingly reached the Gentlemen's Agreement,

whereby Loan Council control was extended to encompass borrowings by local

government authorities and semi-government bodies, in relation to aggregate

borrowings and the terms and conditions of loans.

2.12 The Gentlemen's Agreement, which covered Loan Council resolutions

outside the Financial Agreement, had no legal force. Nevertheless it proved enduring

and experienced varying degrees of success and compliance until 1984. Professor

Saunders has described the new arrangements introduced as part of the Gentlemen's

Agreement in 1936:

The mechanism of the Gentlemen's Agreement was to regulate the terms and timing, and to restrain the amount, of the borrowing of semi­ government and local government authorities. Within those limits, each authority borrowed on its own behalf. While the details varied over time, the general scheme was to categorise authorities as larger or smaller,

by reference to the amount they sought to b orrow ... After 1962-63, there was no limit on aggregate borrowings of smaller authorities as long as each one kept within the ceiling. A total program for larger authorities

was approved by the Loan Council each year and allocated between States in proportions which, again, resisted alteration over time. Each State allocated its own share between its authorities. Except in special cases, where additional amounts were approved, the Loan Council did

13

Commonwealth Treasury, Committee Hansard, 15 December 1992, p. 14.

12 Chapter 2

not concern itself with the purposes for which governments or their authorities sought the borrowed funds. All authorities were subject to Loan Council direction in the timing and terms of their loans.14

2.13 The Gentlemen's Agreement was a positive reform, with the Loan Council

functioning in a collegiate way (largely as its founders had intended) until the early

years of the Second World War. Professor Russell Mathews has characterised this

period as one of 'co-operative federalism' in which 'a relatively high degree of vertical

fiscal balance' existed.15 During these years the Loan Council provided an

institutional framework within which the Commonwealth and State governments were

able to share responsibility for fiscal and monetary policy decisions.16

2.14 However, with Australia's increasing involvement in the Second World

War, Commonwealth economic dominance over the States generally and within the

Loan Council in particular, grew considerably:

The tenuous separation of Commonwealth and State finances achieved by the Financial Agreement was destroyed indefinitely by the Commonwealth assumption of sole responsibility for income taxation in 1942. One result was to virtually eliminate Commonwealth reliance on Loan Council decisions for borrowing for its own purposes.17

Commonwealth domination of the national economy and the Loan Council expanded

greatly between the 1940s and the 1980s, a period described by Professor Mathews

as one of 'chronic fiscal imbalance', in which governments dealt with each other in a

climate of 'coercive federalism'.18

14

15

16

17

Saunders, op. cit., p. 204.

Mathews, op. cit., p. 10.

ibid.

18

Saunders, op. cit., p. 201.

Mathews, op. cit., p. 10.

The Australian Loan Council: 1923- 1984 13

2.15 An examination of broader financial developments in the economy which

have influenced Loan Council operations since the Second World War is beyond the

scope of this inquiry. However, the move in the direction of Federal dominance in

Loan Council is clear. The immediate post-war years were marked by large

Commonwealth revenue surpluses and by continuing State dependence on

Commonwealth grants, the level, growth, form and distribution of which were

determined unilaterally by the Commonwealth.19 During the 1950s the

Commonwealth sought for the first time to use the Loan Council to control the level

of national interest rates. This further strengthened the Commonwealth's

preparedness to utilise the Loan Council as an instrument of macroeconomic

policy.20

2.16 Developments in the early 1950s tended to establish the Commonwealth

as a potential creditor of the States.21 In 1951, unable to secure the necessary funds

to finance expenditure, the States outvoted the Commonwealth in the Council,

approving a larger loan program than that proposed by the Commonwealth.

However, the States could not raise the required funds in the capital markets to

finance their programs and they were forced to agree to an arrangement under which

the Commonwealth would underwrite State loan proposals each year up to a figure

which it would determine. This was also to be the amount approved by the Loan

Council. The loan program proposals were underwritten and reduced by 25 per cent

in 1951. In 1952 the same procedure was followed, in the face of opposition from all

six States. In Professor Saunders' view:

The underwriting agreement enabled the Commonwealth to stipulate the terms on which it would underwrite the State program and, if necessary, make special loans to the States. It also entrenched the existing proportionate shares of the States in the total, in the absence of any

19 ibid., p. 13.

D. James, Intergovernmental Financial Relations in Australia, Australian Tax Research Foundation, Sydney, 1992, p. 47.

21

Saunders, op. cit., p. 201.

14 Chapter 2

realistic process by which a different allocation might be made.22

2.17 Mr Don Nicholls, Independent Reviewer for the report State Finance

Victoria, has commented on the regrettable implications of such a static arrangement,

especially for Victoria.23 For more than thirty years up to 1986-87 no State share

varied by more than 2 per cent: in most cases the variation was far less and in the last

three years of that period there was no movement at all.24 This underwriting

arrangement lasted until the late 1980s, facilitating a steady rise in Commonwealth

dominance in the Loan Council, and resulting in an increasingly unsatisfactory situation

for the States.

2.18 In the early 1970s, Commonwealth control over State borrowing

programs expanded considerably. While retaining its income taxation powers, the

Commonwealth empowered the States to impose payroll tax, raised the level of

financial assistance grants and undertook to provide about one third of the States'

Loan Council borrowings as non-interest bearing, non-repayable grants. At this time

one fifth of all State debt was owing to the Commonwealth.25 In 1976:

The Commonwealth took over a further $1000 million in State debt and the practice began whereby a proportion of between one-third and one- half of the State Loan Council program was made up by the

Commonwealth as an interest free capital grant.26

Professor Saunders has pointed out that the combination of the longstanding

underwriting procedure and this new capital grant system greatly strengthened

22 ibid.

D. Nicholls, Committee Hansard, 21 June 1993, p. 541.

Scott, op. cit„ p. n.21 and pp. 32-33, quoted in Saunders, op. cit., p. 201.

James, op. cit., p. 48; ACIR, op. cit., pp. 15-16.

Saunders, op. cit., p. 202. 26

The Australian Loan Council: 1923- 1984 15

Commonwealth control over the Loan Council.27 Clearly the Commonwealth had

learned to employ its inherent powers to become the primary influence on the

operations of the Loan Council28

2.19 During the 1960s and 1970s, there was a steady decline in the amounts

the States obtained through traditional Loan Council borrowing programs. In

circumstances similar in some respects to those of the mid-1980s, the States

increasingly resorted to borrowing outside the Council for certain types of project. To

counter this development, and gain greater direction over borrowing, the Council

adopted new guidelines relating to infrastructure borrowing in 1978. This reform,

known as the Infrastructure Borrowing Program, was largely an extension of the

Gentlemen's Agreement. For large Commonwealth and State public authorities it

made possible special additions to their borrowing programs for specific expenditure

on public utility development projects which could not be funded by normal Loan

Council borrowing. However, the Commonwealth's retention of a right of veto over

which projects were to be financed, and the stipulation that increased funding under

the Program would be matched by a decline in funds for other projects, confirmed

Commonwealth power over the Council.29

2.20 The 1977 Premiers Conference asked the Advisory Council for Inter­

government Relations (ACIR) to investigate relationships between Commonwealth,

State and Local government in Australia. In its report, published in 1982, the ACIR

concluded that:

... as an institution, the Loan Council is under strain. This is due in part to current economic circumstances. It is also due to the differences of approach between the Commonwealth government which perceives the Loan Council as an instrument of fiscal and economic management, and

State governments that view the Loan Council as a device for obtaining

28

29

ACIR, op. cit., p. 22.

Mathews, op. cit., p.16.

16 Chapter 2

a subsidised supply, but inadequate volume, of capital funds for works and services.30

The ACIR went on to point out that, when the Financial Agreement was first

implemented in 1927, it encompassed practically all Commonwealth payments to the

States. However, payments outside the Agreement increased to the point where, by

1982, Commonwealth loans to the States, including loans provided through the Loan

Council but excluding capital grants, constituted only 8 per cent of Commonwealth

payments to the States.31 Public sector borrowing programs approved by the Loan

Council, as a proportion of total capital payments to the States, fell from 71 per cent

in 1966-67 to approximately 47 per cent in 1981-82. Approved borrowings, as a

proportion of total Commonwealth payments to the States, declined from 34 per cent

to 10 per cent during the same period. As a proportion of total funds available to

State authorities, borrowings fell during these years from around 20 per cent to some

6 per cent.32 The ineffectiveness of the Loan Council arrangements in providing

the States with adequate revenue to finance their public works programs had resulted

in the States resorting increasingly to other means of obtaining funds outside the

ambit of the Council.

The Breakdown o f the Gerttiemerts Agreement

2.21 During the 1970s the Commonwealth budget began to record large

deficits for the first time since the Second World War. As a consequence the

Commonwealth began to reduce the funds it provided to the States through the Loan

Council. And by the end of that decade, it was clear that the Gentlemen's Agreement

was impotent with regard to borrowing programs for State semi-government and local

government authorities. The States devised a range of techniques designed to

circumvent the most onerous restrictions of the Gentlemen's Agreement as they

30

31

32

ACIR, op. cit., p. iii.

ibid., p. 37.

ibid., p. 2.

The Australian Loan Council: 1923- 1984 17

related to borrowing for infrastructure projects.

2.22 From 1982 the States were assisted in this by the establishment of

central borrowing authorities. These were seen by the Commonwealth as vehicles for

coordinating and consolidating the borrowings of individual States. In fact, the States

used them to circumvent borrowing limits. Techniques included leasing arrangements,

deferred payments, instalment purchases, export credits and a requirement for private

companies involved in resource development to contribute to the finances of public

sector infrastructure. In general the private sector was prepared to cooperate with

these arrangements since risks were generally guaranteed by State (and sometimes

Federal) governments.

2.23 In his submission to the Committee, Mr Graham Rogers provided an

analysis of a pioneering example of this type of financial arrangement. He outlined

how, in the late 1970s and early 1980s, the State Electricity Commission of Western

Australia, with the guarantee of the State Government, entered into a Take-or-Pay'

contract to underwrite the full market risk of the North West Shelf Domestic Gas

Phase 1 Project:

This large contingent liability appears to have fallen outside the then current interpretations of Loan Council guidelines, (on the grounds it did not give use [sic] to current year borrowings) even though it potentially locked the State into having to borrow to make up for any shortfall in its own gas sales should these prove inadequate in generating sufficient revenue to pay for the gas it was obligated to take (which was about three times the then Western Australian domestic gas consumption).

Hence contingent obligations entered into by the State appeared to be acceptable to those administering the Loan Council rules at that time, given a project perceived by parties at both State and Federal levels as

of national significance.33

The State's [sic] were to learn quickly from these developments, and the financial innovations which followed have transformed the role of the

33

G. Rogers, Committee Hansard, 21 June 1993, p. 568.

18 Chapter 2

States in economic and social development, away from

direct investment, towards that of a contingent risk-bearing supporter for private sector investment.34

2.24 The financing techniques which the States used to evade the borrowing

limits imposed by the Commonwealth, combined with the Loan Council's June 1982

decision to exclude the borrowings of State electricity authorities from its purview for

a trial period of three years, substantially eroded the Loan Council's ability to control

the borrowing activities of State authorities. The Loan Council control arrangements

had been based on the assumptions of conventional financing - straight borrowings;

they simply could not cope with the sophisticated financial structures deliberately

engineered to circumvent them. As one Treasury official said in evidence to the

Committee:

The ... gentlemen's agreement was patently not working. It was in disrepute both here and overseas. 35

2.25 In essence, then, while in the early 1980s Loan Council functions36

were:

to determine the volume of public sector borrowing;

to distribute public sector borrowing limits between States and between types of authority;

to determine the terms and conditions of loans;

to determine priorities for different types of loans (e.g. infrastructure program);

to develop orderly marketing systems for government

securities; and

34

35

36

ibid., p. 569.

J. Fraser, Committee Hansard, 15 December 1992, p. 92.

ACIR, op. cit., p. 93.

The Australian Loan Council: 1923- 1984 19

. to co-ordinate the approach of governments to overseas

capital markets,

the period 1978 to 1983 was characterised by a significant decline in Loan Council

control over the borrowing of Commonwealth and State semi-governmental and local

authorities:

Borrowings by this sector burgeoned. In fact, many commentators would characterise the period as one of profligacy, where authorities, unused to their new-found financial freedom, borrowed excessively and, in many instances, unwisely. Not only were many Loan Council controls relaxed but authorities resorted more and more to unconventional financing techniques which were designed to circumvent Loan Council guidelines. Such techniques included complicated financial leases, sale and lease-back arrangements, security deposits and the like.37

In fact by 1983 the Loan Council really only had control over the amount, terms and

conditions applying to the overseas borrowings of Commonwealth and State

authorities, along with the magnitude of the domestic borrowing programs of non­

electricity authorities.38 On 4 November 1992 Prime Minister Keating advised the

House of Representatives that at the time he became Treasurer (1983) only 25 per

cent of State authorities borrowings were under the control of the Loan Council.

2.26 The system of large and small authority borrowing, increasingly being

undertaken beyond Loan Council control, reached crisis levels at this time, and these

arrangements, in Professor Saunders' opinion, ultimately distorted the whole pattern

of government borrowing.39 The Commonwealth Treasury has confirmed that the

proportion of State and local authority borrowings subject to Loan Council approval

fell from about 95 per cent in 1979-80 to around 25 per cent in 1983-84.40 The

James, op. cit., p. 51.

38 ibid.

39 Saunders, op. cit., p. 204.

40 Commonwealth Treasury, Committee Hansard, 15 December 1992, p. 17.

2 0 Chapter 2

Gentlemen's Agreement clearly no longer provided a satisfactory framework for Loan

Council operations in the context of changing State financial needs.

2.27 In response to this situation the Loan Council in 1984 introduced the

Global Approach to borrowing limits.

Chapter 3

The Global Borrowing Limits: 1984-1992

3.1 The volume of 'off-program' borrowings, the establishment of central

borrowing agencies in all States during the 1980s - largely in response to a call by the

Campbell Committee of Inquiry into the Australian Financial System (1981) for greater

coordination of authorities' borrowings - and the worsening national economic

situation, resulted in the replacement of the Gentlemen's Agreement by a system of

'Global Borrowing Limits' in 1984-85.1 The so-called Global Approach remained in

place until 1993, although it was refined significantly between 1990 and 1992.

The Global Approach to Borrowing Limits

3.2 On 21 June 1984 the Loan Council suspended the Gentlemen's

Agreement and resolved to adopt in its place the Global Approach to authority

borrowings on a trial basis for 1984-85. In May 1985 it was agreed to continue with

the new approach which aimed to broaden the scope of Loan Council oversight of

authority borrowings. This was to be done by bringing within voluntarily agreed limits

all forms of borrowings by Commonwealth and State semi-government and local

authorities, government-owned companies and trusts.2

3.3 Commonwealth Treasury officials in evidence to the Committee outlined

three objectives for the global limits. The first, a macroeconomic policy objective, was

to ensure that public sector borrowings did not outstrip the capacity of the economy

to fund them. The microeconomic level objectives were explained as follows:

It is a fact that a government authority's borrowing capacity is limited by the credit worthiness of its owner, rather than the profitability or

C. Saunders, "Government Borrowing in Australia", Melbourne University Law Review, (17), 2, December 1989, pp. 187-218, p. 206 and p. 208.

Commonwealth Treasury, Committee Hansard, 15 December 1992, p. 17.

2 2 Chapter 3

otherwise of the particular project for which the lending is undertaken. Therefore, it is reasonable to impose some limits on government borrowing otherwise they [sic] can crowd out other borrowers and there is an efficiency in the allocation of resources that is put at risk. I think another micro element of it is really the affordability of a debt level for a particular jurisdiction. They are two micro reasons. So there is one macro and two micro reasons why.3

Representatives from Schraders Australia Ltd suggested additional objectives for the

Global Approach, which they described as follows:

...firstly, to protect the citizens of a State from the financial

mismanagement of its State government by exercising a degree of control at a higher level of government.

Secondly, to enable the Commonwealth government to coordinate fiscal policy at a national level so that it is consistent with monetary policy; and thirdly, a putative objective could be to keep pressure on the States, either to encourage them to run down their holding of liquid assets - that is, to empty their hollow logs - or to seek greater returns from their State owned authorities, or to sell them, to privatise them.4 S .

3.4 During the period of the Global Approach, the overall global limit was

nominated by the Commonwealth and accepted, with varying degrees of reluctance,

by the States. General borrowings were then allocated between the States on the

basis of their relative needs as established in 1951. Between 1952 and 1987 there

was never more than a 2 per cent change in the proportion of funds allocated to

particular States (and often no change at all) despite the very significant changes in

the relative sizes of their populations and economies during this period. State

government dissatisfaction with the inflexibility and increasing inappropriateness of the

allocation between States, as well as with the apparently arbitrary nature of the global

limit set by the Commonwealth, undermined support for the global limits from their

inception.

T. Cole, Committee Hansard, 15 December 1992, p. 62.

S. Morris, Committee Hansard, 19 January 1993, p. 226.

The Global Borrowing Limits: 1984-1992 23

3.5 In appearances before the Committee, representatives of the

Commonwealth Treasury maintained that decisions about the total global allocation

and about allocations between States were mutually agreed between the

Commonwealth and the States. They also argued that the Commonwealth was not in

a position to override the views of the States since it had no legal sanction through

which it could enforce an unpopular decision:

The whole of the global borrowing arrangements, in fact most of the Loan Council arrangements, depend on cooperation and depend on a good relationship between the various levels of government. For example, the global borrowing limits do not have any force of law, they replace what was called the gentlemen's agreement...

They are a voluntary system rather than a system that has any legislative force or that carries any fines or other clear penalties. That sort of system is an appropriate system when you are talking about different sovereign governments trying to come to an agreement that is to their

mutual benefit ...5

3.6 This kind of view, however, has been disputed by a number of

commentators. Professor Saunders for example has suggested that, irrespective of

the semblance of joint Commonwealth-State agreement and its voluntary nature, the

Commonwealth retained sufficient bargaining power (in the form of capacity to reduce

or withhold general revenue grants) to force decisions upon the States:

The most important decision made at these meetings, [of the Loan Council] over which the States retain any shadow of discretion, is the global limit for authority borrowings. Agreement to the global limits was made a condition of underwriting in 1988-89 although, when Queensland refused to comply, the sanction actually threatened was reduction of the

revenue redistribution payments.6

Commonwealth authority was formally acknowledged in legislation following

T. Cole, Committee Hansard, 15 December 1992, p. 61.

6

Saunders, op. cit., p. 202.

24 Chapter 3

Queensland's attempt to borrow in excess of its global limit. Mr Des Moore from the

Institute of Public Affairs advised the Committee that in 1988 the Commonwealth

threatened to reduce Queensland's general revenue grant if its authorities borrowed

in excess of the State's global limit. The Federal Treasurer then included in the

Commonwealth legislation authorising payment of those grants a provision allowing

a State's payments of general revenue grants to be reduced by the amount of any

unauthorised borrowing. Thus, the Commonwealth recognized that its principal

remaining weapon for controlling State authority borrowings was its control over

general revenue grants, then amounting to around $12 billion per annum.7

3.7 While the Commonwealth had this form of control over Loan Council

decisions, the States had difficulty in identifying exactly which borrowings were subject

to their global limits and which fell outside those limits. (Chapter 4 refers to the

attempt by Victoria in 1992 to exploit such difficulties.) In attempting to increase Loan

Council control of borrowings the Global Approach both broadened the range of

borrowings and specified the forms of borrowing which were to fall within the global

limits. These are nominated in the Treasury Submission to the Committee as all forms

of borrowings by Commonwealth and State semi-government and local authorities,

government-owned companies and trusts within voluntarily agreed limits.8

3.8 Despite this categorisation, doubts remained about whether Loan Council

constraints should apply to commercial authorities, however defined, to equity

financing and to private sector bodies with State government support. Subsequent

attempts to clarify areas of particular obscurity, for example through the Coverage of

the Global Approach of 1991 or the Guide to the Global Limits of May 1991, which

explained the application of the global limits to new types of financing arrangements,

did not resolve these difficulties.

D. Moore, Committee Hansard, 19 January 1993, p. 259.

8

Commonwealth Treasury, Committee Hansard, 15 December 1992, p. 17.

The Global Borrowing Limits: 1984-1992 25

3.9 The Commonwealth attempted, through imposition of the global limits,

to control the total value of State authority domestic borrowings (but not the terms and

conditions attaching to these borrowings) and to retain control over overseas

borrowings. However, the Loan Council limits were determined by an arbitrary

formula. And in the view of some States, unacceptably low borrowing limits

encouraged circumvention of the global limits.

Failure of the Global Approach

3.10 Varying opinions were presented to the Committee on the effectiveness

of the global limits. Representatives from the Commonwealth Treasury maintained

that, at least initially, the global limits were successful in controlling public sector

borrowing; they also suggested that their effectiveness declined in the late 1980s. By

the time that the Commonwealth Treasury began to investigate the possible breach

by Victoria of its 1991-92 limit in 1992, Treasury had reached the conclusion that the

global limits were not a particularly accurate or useful tool.9 Treasury stated that:

The global limits did work quite well for a couple of years, at least, but certainly in the second half of the 1980s there was a general view, not just with us but with other treasuries around Australia, that they were becoming less effective, partly because of the access to alternative

sources of financing, financing that was basically very sophisticated.

We went from a situation where we were monitoring globals with the States, as part of the Loan Council on a purely voluntary basis in a world that was changing rapidly, through deregulation and the international financial markets developing products right, left and centre. With that situation clearly recognised by all, we put a lot of resources, as

did a number of the State treasuries, into responding to that situation.

One of the things we did to respond was to prepare a very

comprehensive guide to the global limits, to try to clarify these issues. As anybody who has been involved with tax law or any other regulatory law will know, once you start defining it, you encourage an industry to work out ways to get around it, and that was certainly the case. As the

9

J. Fraser, Committee Hansard, 15 December 1992, pp. 127-128.

26 Chapter 3

Secretary said, the globals went from being something that was born of a gentlemen's agreement, into something that it was never meant to be - a very legalistic approach.10

3.11 The Committee heard other views on the failure of the global limits. The

following was put succinctly by Mr Brett Allender of Schraders Australia Ltd:

... we have now had the global approach to Loan Council in place for some eight years, going on nine years. In that time the

Commonwealth's foreign debt rating has been downgraded twice. Victoria has fallen from AAA State to an A1 State. There are two AAA States left on domestic debt ratings at the moment; that is, New South Wales and Queensland. To the extent that the Loan Council was supposed to protect Australia from these sorts of problems, it has failed.11

3.12 There appeared to be general agreement among those presenting

evidence to the Committee that by the late 1980s the Global Approach was at risk of

breakdown. Of the reasons for the failure of the Global Approach, the most important

were State dissatisfaction with the arbitrary way in which the global limit was

determined by the Commonwealth and allocated between the States, and the difficulty

of establishing just what borrowings fell inside the limits and what fell outside. Mr Des

Moore has suggested a number of other basic flaws in the Global Approach. He has

concluded that the Global Approach has not been an effective policy instrument:

Firstly, the global limits were initially set at too high a level to exercise any constraint so far as borrowings by the State public sector as a whole were concerned - although this was not so in the case of Victoria.

Second, given the "generosity" of the global limits, the States as a whole were able to build up not inconsiderable reserves of cash and financial assets. In effect, some States borrowed more than they needed (but within the global limits) at the long end of the market and, taking advantage of higher short term interest rates, re-invested these

ibid., pp. 92-93.

11 B. Allender, Committee Hansard, 19 January 1993, p. 242.

The Global Borrowing Limits: 1984-1992 27

borrowings on the short term money market at a handsome profit. South Australia was notorious for adopting such a strategy. The existence of these reserves, however, limited the potential for the global limits to constrain States' resort to finance.

Third, while the diminution in the State Government's own Loan Council borrowing program helped the Commonwealth in its attempts to control its own deficit, the reduced size of that program also reduced the Commonwealth's capacity to exercise control over State authorities' borrowings.12

3.13 Mr Greiner agreed that the global limits were set at too high a level - at

least in relation to New South Wales.13 Mr Don Nicholls suggested that Victoria's limit

was high, reflecting that State's high level of expenditure when the formula for

allocations was originally devised in 1951, while those of Queensland and New South

Wales were relatively low.14 It is clear that, irrespective of their views on their

individual allocations, States objected to the arbitrary way in which the total global limit

was arrived at by the Commonwealth and the inappropriate way in which it was

divided between States.

3.14 A representative of Schraders identified inefficiencies created by the

Global Approach. These can be summarised as follows:

. Limiting the borrowings of a State government does not necessarily improve

that government's efficiency in spending the reduced sums available.

. Excessively tight borrowing constraints may lead to underinvestment in public

sector infrastructure which can be as detrimental as the overinvestment which

the global limits were designed to prevent.

. There is an incentive in any system which seeks to limit borrowing capacity for

prospective borrowers to conceal or recategorise borrowings or to bypass the

D. Moore, Committee Hansard, 19 January 1993, pp. 258-259.

N. Greiner, Committee Hansard, 27 July 1993, p. 924.

D. Nicholls, Committee Hansard, 21 June 1993, p. 541.

28 Chapter 3

system entirely.15

Given its shortcomings, States acted to circumvent the intent, if not the letter, of the

Global Agreement.

Exploitation o f the Global Approach

3.15 Once set upon evasion, there were many ways in which the Global

Agreement could be exploited. Furthermore, deregulation of the Australian financial

system increased both the opportunities for borrowing outside the global limits and

the number of financial experts offering advice on how this could best be done. The

former Treasury Secretary, Mr Cole, explained how:

...when we made the wording of the voluntary agreement [the Global Agreement] public no end of bankers, merchant bankers, brokers and other financial advisers trooped around visiting the states, telling them how they could do things which would enable them to escape the apparent constraint imposed by the global limits system.16

3.16 The techniques for structuring financial arrangements to avoid the global

limits did not have to be invented. Private sector financial experts had already

developed the capacity to structure transactions in a way that assisted decisionmakers

to circumvent certain accounting, disclosure and other rules so as to permit the

pursuit of objectives and programs outside of the limits imposed by Loan Council.17

Mr Don Nicholls, in evidence to the Committee, suggested that all of the States, and

possibly even the Commonwealth, colluded in breaches of the borrowing limits:

In the past, ... the States were not interested in policing any of these arrangements. If they saw that one State had been able to successfully

15 S. Morris, Committee Hansard, 19 January 1993, p. 225.

16 T. Cole, Committee Hansard, 20 August 1993, p. 1096.

17 G. Rogers, Committee Hansard, 21 June 1993, p. 562.

The Global Borrowing Limits: 1984-1992 29

introduce a finance lease that was not caught there was no incentive for them to complain about it, because it gave them the opportunity to do the same in their State if they felt that the amounts that were being allocated by the Commonwealth were insufficient.

Remember this: when you talk about the States and possibly the Commonwealth authorities getting into these deals, you raise the question of whether the total amount that the Commonwealth was allocating in these borrowing allocations was realistic. Did the

Commonwealth realise to some extent that they were not realistic, and was it therefore prepared to be a little bit flexible in the way in which they looked at these particular deals?18

3.17 A range of ingenious and complex mechanisms was adopted by State

governments to enable the borrowing limits to be by-passed. Limits were intended

to apply to all forms of borrowing by Commonwealth and State semi-government and

local authorities, government-owned companies and trusts with voluntarily agreed

limits.19 The Guide to the Global Limits elaborated upon the intentions of the Global

Agreement as follows:

An entity or project may be controlled by a Government, and hence fall within the global limits, even if the Government does not hold majority equity in that entity or project. In such cases, the key test is usually that, to fall outside the global limits, the private sector participants, rather than

the Government, must be assuming the greater part of the financial risks associated with the entity or project.20

Hence the main technique used to avoid the global limits was to restructure existing

entities or to structure new projects in such a way that control was not directly by

government. Mr Graham Rogers said in evidence to the Committee that there were

strong financial incentives under Loan Council rules for States to restructure a wide

D. Nicholls, Committee Hansard, 21 June 1993, p. 540.

Commonwealth Treasury, Committee Hansard, 15 December 1992, p. 17.

Committee Hansard, 15 December 1992, p. 30.

The Global Borrowing Limits: 1984-1992 31

1989. Those types of arrangements escape parliamentary scrutiny, and a small part of the borrowings which were undertaken in order to fund those subsidies went through the budget, but the remainder of the borrowings were not reported to the Bureau of Statistics as part of

public sector debt and may well have escaped the Loan Council arrangements also.22

3.20 One refinement of this technique was to identify financial leases (which

fell within the limits) as operating leases (which did not). There were disagreements

between the Commonwealth and Victorian governments on this issue, as explained

by Mr Tony Cole:

Take the case of trams, for example. If the Victorian government owns a tram, then sells a tram and leases it back, all the way through it has got control of it; and the person who purchases that tram and leases it back to Victoria is not exposed to any risk whatsoever.

We defined that as a financial lease. They have a guaranteed revenue stream which they continue to receive, no matter what happens to the tram and no matter how much revenue the tram itself earns.

The Victorian government had got accountants to certify that it was an operating lease rather than a financing lease.23

3.21 A frequently adopted technique for the evasion of the global limits was

the use of lease-back arrangements, the advantages of which were explained by Mr

Saul Eslake of the VCA:

The major reason for entering into these types of arrangements is to increase the cash that is available to the government in any given period. For example, a State government ... may have assets worth $100 million and it may want to undertake some additional expenditure.

It then has the choice of borrowing $100 million and spending it on an alternative project or on current expenditure, or it could sell those assets for $100 million, lease them back at $10 million per annum, to pick a

S. Eslake, Committee Hansard, 23 June 1993, pp. 682-683 and p. 684.

T. Cole, Committee Hansard, 20 August 1993, p. 1100.

The Global Borrowing Limits: 1984-1992 33

Government involvement in raising funds or guaranteeing returns on the project." Ownership of the road passes to the NSW Government at the expiry of the lease, but "this is not in consideration for any public sector involvement."

The Loan Council decided the project would not be "controlled" by the NSW Government and therefore did not fall within the global limits.26

3.23 The evasion technique which has perhaps received the greatest attention

because of its recent and much publicised use in Victoria is the classification as short­

term borrowings (which fall outside the global limits) certain borrowings which in fact

extend beyond the end of the financial year and represent new borrowings on the part

of the public sector. The latter are generally subject to the global limits. The

circumstances of the Victorian situation were summarised in Committee hearings as

follows:

...public attention has focused on the so-called temporary purpose' borrowings of $1.3 billion which the State Government undertook in the period 1989-90 to 1991-92. It now appears that these involved borrowings by the State Government not from the private sector but from other Victorian authorities until they were converted on 1 May 1992

into a medium term borrowing from the private sector. This latter borrowing was regularised by the granting of a 'special addition' at the December 1992 Loan Council meeting, thus confirming that prior to the December 1992 approval Victoria had borrowed that amount in excess of its global limit for 1991-92.27

The Consequences o f Evasion of Global Limits

3.24 Witnesses before the Committee identified a number of significant

negative effects of the techniques used to avoid the global limits. The most important

were:

26

27

R. Walker, T h e sport in testing out global limits*, New Accountant, 14 May 1992, p. 22.

D. Moore, Committee Hansard, 19 January 1993, pp. 271-272.

34 Chapter 3

. they were usually not cost-effective;

. they distorted investment priorities;

. they led to more cumbersome and expensive tendering processes;

. they discouraged transparency of transactions and reporting and mitigated

against a well-informed market; and

. they could encourage high risk decisionmaking by commercial utility managers.

Cost-Effective Borrowing

3.25 One technique developed to circumvent the Global Approach to

borrowing limits was to transfer ownership and control (although not always a

commensurate degree of risk) from the government to the private sector, which was

not subject to borrowing limits. It resulted in higher financing costs. The nature of this

problem was put clearly by the Federal Treasurer on 12 October 1993 in announcing

new Loan Council guidelines to deal with infrastructure:

...the new guidelines address the concerns with the previous approach which has forced all projects to be classified as either totally within or totally outside Loan Council. In the past this has resulted in private sector involvement being encouraged simply to avoid Loan Council coverage and created the potential for a less than optimum use of resources and higher financing costs.28

3.26 Governments can almost always borrow more cheaply than private

enterprise because of the extent of their assets and their creditworthiness. Thus the

end result of these transactions was, contrary to the raison cfetre of the Loan Council,

to increase the cost of borrowing for public infrastructure. A representative of

Schraders stated that:

...it is generally cheaper for a State treasury to borrow money than to borrow money through project finance, simply because the treasury bonds have greater liquidity. Leaving aside the fact that they have got

28

Commonwealth Treasurer, Press Release, 12 October 1993.

The Global Borrowing Limits: 1984-1992 35

a State guarantee, they have greater liquidity. The liquidity of the lendings to a one-off project, however, even if it were virtually risk free, would still attract a premium because of its unique nature, the fact that nobody knows what the risks are and the fact that you have got to get

it through umpteen credit committees to assess it. All of that adds to the cost of borrowing but it does not contribute anything to the economic efficiency, it does not contribute anything to risk management by the private sector.29

The costs of structuring borrowing arrangements so as to evade the global limits were

also highlighted by Mr Eslake with respect to Victoria:

...we were advised, and the Auditor-General has observed in his written reports, that some of the arrangements which the Victorian Government and its instrumentalities entered into to avoid the strictures of the global

limits - some of the operating leases, off-balance financing arrangements and so forth - also resulted in significantly higher costs to taxpayers than if they had been funded through conventional borrowings.30

3.27 Responding to a question as to why the Victorian Government did not

resort to lease-back arrangements rather than converting its short-term borrowings to

medium-term borrowings, Mr Tony Cole, former head of the Commonwealth Treasury,

replied:

That is the way they could have done it. They chose not to for the simple reason that this was a more sensible option. Frankly, it was a straight option, a straight borrowing, and they would have ended up with better terms on this borrowing than they would through some of those other half-clever devices.31

3.28 Mr Rogers emphasised the financial advantages to governments of

publicly financed borrowings:

S. Morris, Committee Hansard, 19 January 1993, p. 236.

S. Eslake, Committee Hansard, 23 June 1993, p. 655.

T. Cole, Committee Hansard, 20 August 1993, p. 1097.

The Global Borrowing Limits: 1984-1992 37

...the global approach does nothing to ensure that we do not get overinvestment in some sectors and underinvestment in others. For instance, we can continue to get overinvestment in those sectors which can be pushed outside the global limits because of the nature of the project, making them easy to finance just outside that risk transfer limit and therefore just outside global borrowing limits.34

...I have heard anecdotal evidence from one State Treasury; its officers said that they had seen projects creep up the list of priorities because they were easy to get outside the global limits.35

...the global approach at the moment does not reward the State for allocating the money that is borrowed to the most efficient use. You can use it to build an excess of power stations and that does not effect [sic] your global limit next year, or you can use it in some more productive

use or you can use it to fund current expenditure. That is your global limit. You do not get a benefit under the global approach from using your money wisely.36

The same point was made by Mr Greiner:

The Water Board in Sydney used to put into its expressions of interest, This must be done in such a way as to fall outside Loan Council limits'. I think that is a recipe for getting nowhere. That is playing a game that is a side game from the real game. The question is: what is the best proposal for the government or, in that case, the Water Board?37

Tendering

3.30 Throughout its operation, the Global Approach to borrowing limits was

characterised by difficulties in defining borrowings that fell within the limits and those

that fell outside. Furthermore, interpretations of the guidelines varied over time.

Because of the benefits of borrowing outside the global limits, both governments and

34 B. Allender, Committee Hansard, 19 January 1993, p. 249.

S. Morris, Committee Hansard, 19 January 1993, p. 249.

36 ibid., p. 250.

N. Greiner, Committee Hansard, 27 July 1993, p. 928.

The Global Borrowing Limits: 1984-1992 39

was to avoid the global limits; accordingly, there was a strong disincentive to publicise

details of the ways in which they were structured. This concealment impeded both

monitoring and accountability, and the market was not as well-informed as it should

have been. The Schraders submission suggested that quantitative controls give

States an incentive to conceal borrowings or to bypass the system with 'private

infrastructure transactions'. Its representatives enlarged on this at public hearings:

So we live in a dark world of transactions which may be in or may be out [of the global limit]. It is a matter on which it is very difficult to get objective criteria. It is a matter in which there is no incentive on the part of anybody to disclose to the marketplace the terms of those transactions.42

Certainly, if anyone in our organisation was devising a structure which was at one and the same time not exposing a State or some of its public works to Federal income tax and was trying to get outside of the global

approach, we would have no incentive to spread that information more widely than we had to.43

High Risk Decisionmaking

3.32 A further undesirable consequence of the widespread evasion of the

borrowing limits was the encouragement it gave the private sector to engage in high

risk decisionmaking because of the general understanding that such risks would be

underwritten by governments, either Federal or State:

...State governments enjoy a degree of implicit support from the Commonwealth, because of perceptions that the Commonwealth stands behind the States - which allows them both to borrow more than they otherwise could and to borrow at lower interest rates than they might

otherwise have to pay. Therefore, with that guarantee behind them, it is quite likely that they would borrow more than would be optimal and more than perhaps the private sector, without that backing, would be

S. Morris, Committee Hansard, 19 January 1993, p. 246.

43

ibid., p. 247.

The Global Borrowing Limits: 1984-1992 41

...the actual purpose and functions of the borrowing arrangements have now departed so far from the originals that the formal structure is positively misleading.

The arrangements for government borrowing in Australia no longer serve the purpose for which they were originally devised. Partly because an old form has been so extensively adapted to new purposes, there are serious accountability problems and apparent inefficiencies in the current

system ... The existing arrangements require extensive change ... The binding quality of the existing arrangements has expired through effluxion of time.47

3.34 Some attempts were made between 1990 and 1992 to redress the

imbalances in Commonwealth-State borrowing relationships. In 1990, primarily to

ensure that the States assumed greater responsibility for their debts in the future, the

Commonwealth and the States agreed on the latter servicing all remaining loans

issued on their behalf by the Commonwealth under the terms of the Financial

Agreement. The Commonwealth undertook to reimburse the States for the revenue

foregone by them in taking over responsibility for existing debts. Another important

series of reforms was introduced at the June 1992 Loan Council meeting which

agreed on:

the inclusion of operating leases within the global limits from 1993-94; the exclusion from the global limits of overseas subsidiaries of entities within the Global Approach where

they operate solely outside Australia and at arm's length to the parent entity; and the abolition of the queuing arrangements relating to debt issues by the States in overseas markets.48

These changes gave the States and Territories greater scope under the global limits

to borrow within Australia to refinance debt. It was also agreed at the June 1992 Loan

Council meeting to amend the Financial Agreement to enable the States to borrow in

ibid., pp. 187-188.

Commonwealth Treasury, Committee Hansard, 15 December 1992, p. 21.

Chapter 4

Victoria’s Breach

of its Global Borrowing Limit: 1992

4.1 From 1 May 1992 the Victorian Government breached that State's 1991 -

92 global borrowing limit, an action which resulted in considerable controversy when

the breach was made public by the incoming Treasurer, Hon Alan Stockdale, on

26 October 1992. Not only was the decision itself widely debated, but the

effectiveness of existing Loan Council arrangements was seriously questioned . Any

examination of the reasons for the breach and its consequences requires an

understanding of the institutions and processes of government financial management

in Victoria at that time. The broad structure and operations of government financing

will be examined and then the reasons for, and events following, the breach will be

explored in some detail using the following time periods:

. May - December 1991;

. 1 January - 1 May 1992;

. 1 May - 17 June 1992;

. 17 June - 6 July 1992; and

. 6 July - 7 December 1992.

Government Borrowing Arrangements in Victoria

4.2 The Victorian Public Authorities Finance Agency (VicFin) was established

as Victoria's central borrowing agency in 1984 to borrow on behalf of public authorities

but not on behalf of government: Section 17 of the Victorian Public Authorities

Finance Act 1984 provided that VicFin could not 'represent the Crown for any purpose

whatsoever1 . VicFin could borrow both within Australia and overseas. The Capital

Works Authority (CWA) was created in 1985 to borrow on behalf of government funds

raised by VicFin. It was established by Order-in-Council and had no statutory basis:

Victoria's Breach of its Global Borrowing Limit: 1992 45

in the area of budget sector debt management, was expressed clearly in June 1990

and May 1991 when the rating agency Moody's downgraded Victoria's credit rating.

In May 1991, prompted by marketplace rumours about the Victorian economy after

Moody's second downgrading of Victoria's credit rating within a year, Commonwealth

Treasury officers expressed their concerns to the Victorian State Treasury. Oral

reassurances were given both then and some weeks later that there was no cause for

alarm. However, rumours persisted in the financial community and the Commonwealth

Treasury repeatedly raised the matter with its State counterpart in Victoria throughout

1991. No satisfactory oral or written responses were forthcoming.2 The

Commonwealth Treasury accordingly continued to monitor the economic situation in

Victoria, briefing the Federal Treasurer on Victoria's 1991-92 budget in September

1991.3

The Refinancing Proposal: 1 January - 1 May 1992

4.6 The Victorian Treasurer from 28 January 1992 to 6 October 1992 was

Hon Tony Sheehan. He was succeeded by Hon Alan Stockdale after the Labor

Government lost office at the 3 October 1992 election. Until 20 January 1992, Mr

Barry Nicholls served as Director-General of the Victorian Treasury. His successor

was Dr Robert (Bob) Smith who held the position between 29 January and 6 October

1992.

4.7 Late in 1991 Mr Barry Nicholls was aware month by month of an

increasing deficit problem with the Victorian budget. Deficit amounts were not being

repaid because of deficiencies in the government's financial strategy. However, VDF

short-term borrowings continued to be used to provide finance and no proposal for

T. Cole, Committee Hansard, 15 December 1992, p. 74.

3

J. Fraser, Committee Hansard, 15 December 1992, p. 75.

Victoria's Breach of its Global Borrowing Limit: 1992 47

actually refinance the $1,267 billion from the VDF to VicFin was taken within the

Treasury. (Following the Treasurer's direction to pursue the transaction VicFin entered

the market in May 1992 and commenced borrowing.9)

4.10 Importantly, the Victorian Government's budget sector problems had not

gone unremarked; some of its decisions came in for particular scrutiny. On 5 March

1992, the Premier of New South Wales, Hon Nick Greiner, expressed concern about

Victoria's proposed sale and lease-back arrangements in regard to certain buildings.

This prompted the Secretary of the Commonwealth Treasury, Mr Tony Cole, to write

to Dr Bob Smith on 6 March, requesting details of these projected transactions.10

He also sought clarification about the proposed construction and lease-back of police

stations and law courts.11 Dr Smith did not reply to this letter until 30 March. He has

claimed that, due to an oversight, he did not see Mr Cole's letter when it came in and

that this accounted for the delay in his response.12 Dr Smith has stated that he

believed, mainly because of advice from a number of Melbourne merchant banks, that

these leases were operating leases and therefore outside the Loan Council

guidelines.13 In evidence Dr Smith also claimed that he did not discuss Mr Cole's

letter of 6 March or his reply of 30 March with Mr Sheehan, but he did discuss it with

D. Sams, Minute to the Treasurer, 21 December 1992; Committee Hansard, 6 August 1993, pp. 1046 -1047. The minute by Dr Dennis Sams, General Manager of the Victorian Treasury's Finance Division, dated 21 December 1992, was released under Freedom of Information provisions early in 1993. It reviews the Victorian Treasury's advice to Treasurer Sheehan and sets out the sequence of the correspondence relating to the refinancing; it is reproduced at Appendix A.

T. Cole, Committee Hansard, 15 December 1992, p. 60.

Commonwealth-Victorian Treasury Correspondence and Related Loan Council Minutes and Memoranda, House of Representatives, Votes and Proceedings, No. 154, 3 November 1992, p. 1794, T. Cole to R. Smith, 6 March 1992. This correspondence is not reprinted in the Votes and Proceedings, but copies of it are held by the Committee. A Commonwealth Treasury report on the refinancing, dated 28 October

1992, has also provided valuable background for this chapter. It is reproduced in the Committee's Interim Report, pp. 65-73.

R. Smith, Committee Hansard, 6 August 1993, p. 966.

13

ibid., p. 967.

Victoria's Breach of its Global Borrowing Limit: 1992 49

attached to the memorandum be provided to VicFin when seeking the latter's advice

on managing the end-of-year funding requirements for the consolidated fund.21 Dr

Smith could not recall this memo.22 Nothing, apparently, was done about it by Dr

Smith. Dr Sams sent a minute to Mr Sheehan on 6 April which subsumed the draft

minute of 26 March.23 It recommended that the Treasurer instruct the Capital Works

Authority to finance the deficits on a medium-term basis. Dr Smith stated that he

would normally countersign such documents, and that he would be surprised if he

had not signed this one.24 The instruction was signed by the Treasurer and

forwarded to the chairman of the CWA.25

4.14 Dr Smith claimed that in 'March, April or May' he discussed with Mr

Sheehan for the first time the subject of rolling over temporary borrowings into

medium and long-term borrowings. But he could not be any more specific than

this.26 To establish personal contact with the newly-appointed Dr Smith and to

discuss with him the Victorian budgetary situation and Loan Council issues generally,

Mr John Fraser, then Deputy Secretary (Economic) of the Commonwealth Treasury,

called on Dr Smith on 2 April.

4.15 In April the Victorian Treasury instructed the Chairman of VicFin to

refinance past deficits estimated at $1.267 billion with medium-term funding, funding

intended partly to replace a portion of the then expected $2.7 billion required to be

financed by the VDF. The Treasury informed VicFin of its confidence that the position

on refinancing past deficits on a medium-term basis would be accepted by the Loan

Sams, Minute, op. cit., quoted in Committee Hansard, 6 August 1993, pp. 980-981.

R. Smith, Committee Hansard, 6 August 1993, pp. 980-981.

Sams, Minute, op. cit., quoted in Committee Hansard, 6 August 1993, p. 981 and p. 1048.

R. Smith, Committee Hansard, 6 August 1993, p. 981.

Sams, Minute, op. cit.

R. Smith, Committee Hansard, 6 August 1993, p. 990.

Victoria's Breach of its Global Borrowing Limit: 1992 51

17 June. Victoria's monthly report on its borrowings for May, which the

Commonwealth received on 17 June, contained no reference to this medium-term

borrowing, which was undoubtedly a breach of Victoria's 1991-92 global borrowing

limit.32 The breach consisted, not in the conversion of the $1,267 billion in

borrowings from short-term to medium-term, but in their conversion from borrowings

within the public account in Victoria, to borrowings from the general public that were

medium-term and would extend beyond the end of the financial year.33

4.18 On 10 May 1992 Mr Cole again wrote to Dr Smith, requesting a reply by

18 May. He sought information - as he had done before - about the infrastructure

borrowing proposals and the implications of these arrangements for the global limits.

Mr Cole asked for details of intended arrangements covering the sale and lease-back

of government buildings. He also pointed out that another Loan Council member had

formally requested that the Council examine these matters.34 Although he did not

specify the member, it was New South Wales. Dr Smith replied to Mr Cole's letter of

10 May on 25 May, but again failed to provide the information requested about the

sale and lease-back arrangements. He made it clear that these arrangements were

administered by the Ministry of Finance and concluded that:

I am not prepared to provide you with information of a general nature without being clear of what your concerns are.35

4.19 Commonwealth and Victorian Treasury officers met on 22 May and the

Victorians outlined an expected deterioration in the 1991 -92 Victorian budget outcome

and in the overall budgetary and financial outlook for 1992-93. Mr Dawkins was

briefed about this meeting, which prompted him to write to Mr Sheehan on 27 May.

D. Nicholls, Committee Hansard, 21 June 1993, pp. 545-546.

T. Cole, Committee Hansard, 15 December 1992, p. 64.

Commonweatth-Victorian Treasury Correspondence, op. cit., T. Cole to R. Smith, 10 May 1992.

ibid., R. Smith to T. Cole, 25 May 1992. 35

Victoria's Breach of its Global Borrowing Limit: 1992 53

Fraser met with Dr Smith to discuss Loan Council matters.38 While Mr Greiner had

drawn attention to the potential for a breach on 22 April, at this meeting on 17 June

the Commonwealth Treasury was told directly for the first time about the rollover of the

short-term financing of budget deficits for 1989-90 to 1991-92 into medium-term

borrowings of $1,267 billion. Victorian Treasury officers provided an unsigned and

undated draft letter from Hon Tony Sheehan to Hon John Dawkins stating that on

1 May 1992 the refinancing had taken place. (This draft letter is reproduced at

Appendix C.) Officers of the Commonwealth Treasury must have suspected earlier

than 17 June that a breach had occurred, but they had no proof.

4.23 The General Finance Division of the Victorian Treasury had forwarded a

briefing paper to Dr Smith on 7 May concerning the options surrounding the Treasury

Bill Program. A draft letter to the Commonwealth Treasurer as Chairman of the Loan

Council on the 1 May refinancing was prepared in early May but was not sent

immediately. This letter went through three more drafts: on 17, 22 and 24 June.39

Dr Sams did not know what had happened to these drafts after they were sent from

the General Finance Division on the third floor of the Treasury building to Dr Smith's

office on the fourth floor.40 The State Treasurer's office was adjacent to the Director-

General's at that time. Dr Smith has claimed that the drafts were deficient in several

respects, and that this accounted for the delay between the first draft (in early May)

and the last draft (on 24 June).41 While Dr Sams has claimed 42 that no significant

changes were made between drafts, the unsigned draft provided to the

Commonwealth Treasury on 17 June was considerably rewritten before being

provided again on 25 June. The General Finance Division was never informed that the

T. Cole, Committee Hansard, 15 December 1992, pp. 59-60.

Sams, Minute, op. cit; quoted in Committee Hansard, 6 August 1993, pp. 981 -982 and p. 1052.

D. Sams, Committee Hansard, 6 August 1993, p. 1051.

R. Smith, Committee Hansard, 6 August 1993, pp. 981-982.

D. Sams, Committee Hansard, 6 August 1993, pp. 1050-1051.

Victoria's Breach of its Global Borrowing Limit: 1992 55

matter was not mentioned. It is very difficult to accept Dr Smith's statement that one

of the reasons the matter was not raised with the Commonwealth before 17 June was

the difficulty of arranging a meeting.48 Other issues such as the Loy Yang B

proposal were discussed while the more important issue of the refinancing was never

mentioned.

4.26 In fact, Dr Smith has confirmed that a decision was made by the

Victorian Treasury not to raise the issue of the refinancing at the 12 June Loan Council

meeting.49 Dr Sams has stated that he prepared a briefing paper dated 11 June for

the 12 June meeting which proposed that the subject not be raised at this meeting but

instead that it should be discussed with the Commonwealth Treasurer as Chairman

of the Loan Council as soon as possible. (In retrospect Dr Sams believed that the

matter ought to have been raised prior to the 12 June meeting.50) Dr Smith could

not recall countersigning this briefing paper but agreed that he must have done so.51

Disclosure of the Refinancing: 17 June - 6 July 1992

4.27 At the 17 June meeting Dr Smith raised the question of Victoria

requesting Loan Council approval for a special addition to its 1991-92 global

borrowing limit. The Commonwealth Treasury responded by stating that this

depended very much on Victoria undertaking drastic budgetary reform. Dr Smith also

told the Commonwealth Treasury officers of the imminent announcement concerning

the appointment of an independent commission to inquire into Victoria's budgetary

situation to be chaired by a former senior New South Wales Treasury official, Mr Don

Nicholls.

ibid., p. 987.

ibid., pp. 986-987.

D. Sams, Committee Hansard, 6 August 1993, pp. 1056-1057.

R. Smith, Committee Hansard, 6 August 1993, pp. 986-987. 51

Victoria's Breach of its Global Borrowing Limit: 1992 57

being entered into. Nor is Victoria prepared to respond to generalised requests for information which are in the nature of fishing expeditions.55

He went on to say:

Financial arrangements are not entered into by Victoria until it has appropriate professional advice which confirms their appropriate agreement under the globals arrangements. Having obtained this advice and made decisions whether or not to proceed with the arrangements, we are then quite prepared to provide the information to

Loan Council and to provide any additional specific information which Loan Council may subsequently consider it requires.56

Dr Smith concluded by expressing a willingness for Victorian Treasury officers to brief

their Commonwealth counterparts on budgetary and Loan Council-related matters.

4.30 This briefing took place on 25 June. The information previously

requested in correspondence relating to Victoria's budgetary position, sale and lease­

back arrangements and the Loy Yang B power station proposal was provided to the

Commonwealth. The meeting also dispelled any doubt on the part of the

Commonwealth Treasury officials. It was clear then that Victoria had breached its

global limit on 1 May. Mr Cole stated in evidence to the Committee on 15 December

1992 that:

It is only in recent weeks that we have been able to establish quite clearly that the borrowings were from authorities within the ambit of the global limits and therefore that they were not in breach prior to 1 May. It was only after 25 June that we were confident ourselves that the Smith

argument about not being in breach of globals could only be accurate with respect to the short term transactions rather than the medium term transactions.57

Commonwealth-Victorian Treasury Correspondence, op. cit., R. Smith to T. Cole, 19 June 1992.

56 ibid.

T. Cole, Committee Hansard, 15 December 1992, p. 121.

Victoria's Breach of its Global Borrowing Limit: 1992 59

4.33 On 26 June Victoria's Niemeyer statement for May was published.

However, it:

.... gave no indication that any borrowing in excess of Victoria's global limit was involved or indeed that the borrowing was other than an internal accounting shuffle. The statement described it as a refinancing "which does not represent any new or unplanned borrowings".64

Early in July, Mr Don Nicholls, then recently appointed to review Victoria's State

finances, raised questions about the refinancing based on his examination of written

records within the Victorian Treasury. The Treasury official to whom he spoke stated

that there was no cause for concern, since the matter had been cleared with the

Commonwealth Treasury. Mr Nicholls remembered this officer as being possibly Dr

Dennis Sams. However, Dr Sams has stated that he was not the officer

concerned.65

4.34 The Federal Treasurer, Mr Dawkins, was briefed on 6 July about the

meetings between Commonwealth and Victorian Treasury officers which had taken

place on 17 and 25 June. At this briefing Mr Dawkins was told by the Commonwealth

Treasury that Victoria had breached its 1991-92 global borrowing limit.66 No

adequate explanation was forthcoming to account for the delay in informing the

Treasurer.

Institute of Public Affairs, Submission No. 2, p. 7; Committee Hansard, 19 January 1993, p. 262. The Niemeyer Statements are named after Sir Otto Niemeyer (1883-1971), a Director of the Bank of England, 1938-1952, who headed a Financial Mission to Australia and New Zealand in 1930.

D. Nicholls, Committee Hansard, 21 June 1993, p. 552 and D. Sams, Committee Hansard, 6 August 1993, pp. 1063-1064.

Commonwealth Treasurer, Press Release, 12 February 1993.

Victoria's Breach of its Global Borrowing Limit: 1992 61

4.38 Mr Dawkins wrote to Mr Sheehan on 27 July expressing his concerns

about the 1 May refinancing and emphasising the need for Victoria to formulate a

strategy to deal with its budgetary situation. He pointed out that such a strategy

would have to be acceptable to other Loan Council members before special

arrangements could be put in place to assist Victoria. In response to Mr Sheehan's

request at their 2 June meeting that the Loy Yang B proposal be exempted from Loan

Council global limits, Mr Dawkins stated that he was still considering this proposal.

On the matter of Mr Sheehan's call for an 'e x p o s t special addition to ratify global limits

of medium-term borrowings of $1267 m, the amount borrowed by Victoria on 1 May

1992',71 he stated that:

...I am sure that you appreciate that Victoria's actions and your proposal are not consistent with either the spirit or the letter of the Loan Council arrangements.72

4.39 On 29 July Mr Dawkins met with Mr Sheehan and Mr White. He re­

iterated his call for a medium-term budget strategy for Victoria and expressed

reservations about the Loy Yang B proposal. However, it was agreed that the Nicholls

Report would contain information to assist in the formulation of a long-term Victorian

budget strategy.

4.40 A week later, on 7 August, the Federal Treasurer wrote to Mr Sheehan

enlarging on the issues discussed at their 29 July meeting. He made it clear that the

medium-term borrowings should not have been undertaken by Victoria without Loan

Council approval, and urged Mr Sheehan to submit a formal proposal as soon as

possible:

Loan Council arrangements clearly require prior approval. I do not accept that the requirement to conduct the transaction in a discreet

Commonwealth-Victorian Treasury Correspondence, op. cit., Hon J. Dawkins to Hon A. Sheehan, 27 July 1992.

72

ibid.

Victoria's Breach of its Global Borrowing Limit: 1992 63

encountered considerable difficulties in its attempts to obtain information from the

Victorian Treasury about the budgetary situation in Victoria. The most serious

difficulties occurred between May 1991 and June 1992. They included unsatisfactory

oral reassurances about the state of the Victorian economy; repeated failures on Dr

Smith's part to provide the information requested by Mr Dawkins and Mr Cole; an

apparently inadequate understanding by Dr Smith of the Loan Council's role in

oversighting the global limits arrangements; and a reluctance by Victoria to

acknowledge and work within the existing Global Approach in close consultation with

the Commonwealth.

4.45 Clearly, the system then in existence (and to a degree the present

system) whereby a small group of Commonwealth Treasury officers monitored events

in Victoria, proved less than satisfactory. Mr John Fraser, then Deputy Secretary of

the Commonwealth Treasury, may be correct in his view that Commonwealth - State

Treasury working relationships have improved in recent years. However, it is difficult

to accept his argument that this closer contact with the Victorian Treasury was largely

responsible for resolving the issues resulting from Victoria's refinancing.75 Further,

it is clear that Mr Dawkins has not always encouraged better relations between the

Commonwealth and the States. On 24 August 1993 The Australian reported that Mr

Dawkins had forbidden senior Commonwealth officials from meeting with the NSW

Public Accounts Committee. That Committee had visited Canberra as part of its

investigation into complaints that the Loan Council was blocking multi-million dollar

infrastructure projects. While being unable to consult senior officials, the NSW

Committee met with the Loan Council Committee on 20 August and outlined members'

concerns about not having access to Commonwealth Treasury officials.

75

J. Fraser, Committee Hansard, 21 June 1993, pp. 609-610.

Victoria's Breach of its Global Borrowing Limit: 1992 65

Commonwealth Treasury received on 17 June, made no reference to the $1.267 billion

of temporary purpose borrowings', even though they had been undertaken from

1 May. However, the Victorian report on that State's June global borrowings and on

its total borrowings for 1991-92, received by the Commonwealth Treasury on 24 July,

contained a footnote listing a borrowing of $1,267 billion as temporary purpose

borrowings'. Why this figure was not in the May borrowings report is difficult to

understand. Dr Smith's indication that Victoria did not inform the Commonwealth

before or soon after 1 May about the refinancing because he did not see it as

presenting an urgent problem is difficult to accept, given the amount of money

involved and in view of his statement that Victoria believed it may eventually have

recourse to global borrowing arrangements to secure the necessary funds.

4.49 Both Dr Smith and Dr Sams have stated that the Victorian Treasury

decided not to raise the subject of the refinancing at the Loan Council meeting on 12

June 1992. Dr Smith's explanation that the matter was not raised with the

Commonwealth before 17 June because of the difficulty of arranging a meeting is very

hard to accept. At none of the meetings between the Commonwealth and Victorian

Treasurers or their officials between 1 May and 17 June and in none of the available

correspondence between them during this period, did the Victorians make any

reference to the refinancing. A possible explanation for this reluctance to inform the

Commonwealth may have been a desire to conceal what the Victorian Treasury knew

to be, or thought might be, questionable decisions and practices. This might have

been done ultimately to reach a better financial accommodation for Victoria in

addressing these problems. Dr Smith's reluctance on several occasions to provide

the information requested about the Victorian Government's sale and lease-back

arrangements also supports the view that the Victorian Treasury was at the very least

uncertain about some of its financial policies and hesitant about having them exposed

to outside scrutiny. The absence of correspondence from the Commonwealth in the

Victorian Treasury's files for the period from late June to 9 October makes it difficult

to reach conclusions grounded in known fact about the Victorian Treasurer's role in

this process during that time.

Victoria's Breach of its Global Borrowing Limit: 1992 67

. Given that he was advised of the Victorian breach on 6

July 1992, why did Mr Dawkins not make the Victorian

borrowing explicit in the 1992-93 Budget papers, indicating

that a breach of Loan Council limits had taken place?

At paragraph 2.73 of the Interim Report, this Committee expressed the belief that the

Treasurer's actions had the effect of concealing from the public a major breach of

financial discipline. The further evidence reviewed by the Committee since the Interim

Report has done nothing to modify that belief.

Chapter 5

Transparency and Accountability: 1992-1993

5.1 In view of the fact that States felt increasingly ill-served by the Loan

Council system, it is not surprising that they sought ways to circumvent it and that as

a result its effectiveness declined. States were being less and less constrained by the

Global Approach and Victoria's breach of its 1991-92 global borrowing limit from 1

May 1992, which became public in October 1992, brought the need for Loan Council

reform into sharper focus.

5.2 An examination of Loan Council operations proceeded under the

auspices of the Commonwealth Treasury. In December 1992, the Council endorsed

a Heads of Treasury paper entitled Loan Council Options which, in order to increase

transparency', recommended the introduction of uniform quarterly and annual

reporting for each jurisdiction in compliance with definitions by the Australian Bureau

of Statistics. It also proposed a borrowing approach based on the net public sector

borrowing requirement (PSBR).1 Significantly, Loan Council Options proposed that

any new arrangements should involve greater disclosure and accountability.2

5.3 However, the December 1992 reforms were only a partial solution to

Loan Council problems. Further reforms were proposed in July 1993 in the document

Future Arrangements for Loan Council Monitoring and Reporting.3 In the

Commonwealth Treasurer's view they represented a major overhaul of the way Loan

Council operated as well as a significant step in the evolution of public sector finances

in Australia to a more rational and cooperative basis.4 He stated that the new

These proposals are set out in the Heads of Treasury paper, Loan Council Options: Reporting and Monitoring 1992.

Committee Hansard, 15 December 1992, p. 4.

Future Arrangements for Loan Council Monitoring and Reporting (Future Arrangem ent, 1993.

Commonwealth Treasurer, Press Release, “Premiers' Conference/Loan Council Outcome for 1993-94", 5 July 1993, p. 5.

4

Transparency & Accountability: 1992-1993 71

fundamental prerequisite for adequate accountability. To assist in this process the

establishment of effective monitoring and reporting mechanisms is also essential.

Availability and Accessibility of Information

5.6 One State even went so far as to refuse to supply information to the

Loan Council when it was available:

The Queensland Government had, in fact, consistently refused to provide information to Loan Council on the amount of its authorities' borrowings under the Global Approach.7

In such a situation the Loan Council has very limited ability to compel a sovereign

government to comply. The threat by the Commonwealth to reduce a State's grant

is probably the Loan Council's only lever, and one it would be reluctant to use in

response to what might be considered a relatively minor misdemeanour, especially

in view of its potentially damaging effect upon the financial market.

5.7 Further, details of Loan Council operations have never been well known.

Even Commonwealth and State Cabinets have not fully understood its operations, a

fact which Loan Council members have used to their advantage, as Mr Greiner

explained:

Very few people understood or understand how Loan Council worked. What it does have is a sort of mythology about it, which is frankly useful. I used to use it to beat up Ministers who wanted to borrow things and do things. If you said, 'You could never do this; it would never get past

Loan Council' it was an effective lever, if you like.8

7

8

D. Moore, Committee Hansard, 19 January 1993, p. 259.

N. Greiner, Committee Hansard, 27 July 1993, pp. 930-931.

Transparency & Accountability: 1992-1993 73

The Loan Council itself gets very little information about the overall position of the States. What the Loan Council gets is information about States' borrowings.

Even the information available on a yearly basis published by the Bureau of Statistics was rather inadequate, but particularly the information published on a monthly and quarterly basis was very inadequate. There have been very considerable improvements in that information since then although there is still a fair way to go. As I said, the latest

published information on State debt on a comparable basis as between States by the Bureau of Statistics is some two years out of date. I think that is a very poor show and it needs to be remedied.11

And Mr Graham Rogers from the University of Canberra stated that:

My suspicion is that the information that is currently collected does not detect what might be a quite massive scale of contingent claim writing and innovative financial structures. It certainly does not appear to collect the qualitative information about the kinds of structures that are being

put in place.12

Further, the need for better information was confirmed by Standard and Poor's:

...our call is for more comprehensive and more timely financial information on the States. From our perspective, we are getting much of that information that we require but we can appreciate that, from other

perspectives, some of that information is not being made public. From some perspectives, some of that information is not being subjected to the scrutiny it perhaps deserves, which then obviously feeds back into how much weight we can give to that information. The extent to which

we can see Loan Council playing a positive role in this process depends on the extent to which it can influence this process of making more transparent the States finances.13

11

12

13

D. Moore, Committee Hansard, 19 January 1993, p. 303.

G. Rogers, Committee Hansard, 21 June 1993, pp. 589-590.

A. Tregilgas, Committee Hansard, 6 August 1993, p. 1014.

Transparency & Accountability: 1992-1993 75

Annual Report on Loan Council borrowings. Mr Nicholls suggested that accountability

could be improved if an independent body were established to monitor, interpret and

report to the Loan Council upon comparative State debt levels. The Loan Council

secretariat, he believed, was too closely tied to the Council to undertake this role and

the ANAO's function was to check the figures provided to it rather than to interpret

them, as would be necessary if optimum information were to be available to the Loan

Council.16

5.14 Further, as a consequence of widespread dissatisfaction with the

timeliness, accuracy, frequency and uniformity of information available to the Loan

Council, some participants advocated an enhanced role for the Australian Bureau of

Statistics in collecting, monitoring and reporting:

It would be preferable for the Australian Bureau of Statistics, rather than the Loan Council Secretariat situated within the Commonwealth Treasury, to be given the responsibility for publishing more comprehensive, regular and timely figures on financial transactions of

individual States and their authorities. The ABS is independent and has no involvement with policy issues. It already has a statistical framework for undertaking such a task.17

5.15 In its first submission to the Committee the ABS expressed its interest

in being involved with the development and implementation of new reporting

arrangements. First, the ABS has recognised statistical competence. Second, there

may be an ongoing role for the ABS in preparing statistics using the information to be

provided for Loan Council monitoring purposes. Third, the ABS can coordinate its

collection of data from public sector authorities with the collection of data for Loan

Council purposes.18

16

17

18

D. Nicholls, Committee Hansard, 21 June 1993, pp. 556-557.

D. Moore, Committee Hansard, 19 January 1993, p. 266.

Committee Hansard, 21 June 1993, p. 446.

Transparency & Accountability: 1992-1993 77

My assumption is that, if there was an obligation in an Act to obtain regular authorisation of borrowings from the parliament to which you are responsible, that would constrain in some way what you thought you could do by way of borrowing during the year.20

5.19 Although acknowledging a legitimate Commonwealth interest in State

government borrowings in so far as they contribute to national economic performance,

Professor Saunders considers that State governments should be responsible for their

borrowings to State parliaments and not to the Commonwealth. She suggests that

Commonwealth attempts to make the States accountable to the Commonwealth have

contributed to the current breakdown in accountability at the State level:

I think that to a degree we have led ourselves into difficulties by assuming that the Commonwealth can exercise a directing role over economic policy decisions of the States, and that may have simply encouraged the States to play up. If they are not responsible for themselves, their main focus has been: 'How can we get around the

impositions that have been placed on us from above?' Surely it is far better to have the States accountable for their own actions at their own level within the traditional framework that we all know. If we can superimpose upon that a genuinely cooperative coordinating approach to government policy so much the better I imagine.21

The inter-governmental borrowing arrangements are arrangements that involve all governments to the extent that the overall national economic performance is the Commonwealth's responsibility. I am sure that the Commonwealth Parliament is interested in the way in which those arrangements are working. But I do not think we should exaggerate the exclusivity of the role that the Commonwealth Parliament has in this. We tend to assume, partly because of the way in which our ministerial councils have operated in the past, that they are Commonwealth bodies with the States attending, and I think that we have suffered in the way

in which our own arrangements work because of that. If we treat them as cooperative bodies and it is everybody's business to make them work, then it is not just the Commonwealth's responsibility, it is the States' responsibility as well, and I think they will work better.22

C. Saunders, Committee Hansard, 20 January 1993, pp. 316-317.

ibid., pp. 322-323.

22

ibid., pp. 324-325.

Transparency & Accountability: 1992-1993 79

In this context it is considered that the Agreement needs to be amended to require the Loan Council to table in the Commonwealth Parliament an annual report including details of approved global borrowing limits and

performance against them. These details should be produced in a form so as to permit an independent audit report to be given on them and included in the annual report.25

5.22 The ANAO provided a further view following the release on 5 July 1993

of the Future Arrangements document. The Auditor-General recognised the

significance for accountability of the proposed quarterly reporting and annual Loan

Council Financial Statements:

The new reporting arrangements should provide improved accountability for each participating government.

Under the proposed arrangements there would appear to be less need for reports of each jurisdiction to be aggregated (or summarised) by the Loan Council for presentation to the Commonwealth Parliament.

However, there is still a requirement for the Loan Council to oversight the operations of the participating governments. In this context it would seem that financial statements audited by the relevant Auditor-General would be the most appropriate base for such a review rather than the

unaudited returns as presently used.26

5.23 The Australian Loan Council is an intergovernmental body whose

accountability has not been formally expressed. At present its members are seven

separate sovereign governments and they have used their sovereignty when it has

been to their advantage to do so, for example, by withholding information requested

by Council members. Although effectively controlled by the Commonwealth, the Loan

Council does not report to the Commonwealth Parliament. Furthermore, the

Commonwealth Parliament, like the State Parliaments, has been inhibited by Loan

Council secrecy in its attempts to comprehend Loan Council operations. This should

no longer be possible to the same extent following the proposals in

25

26

ANAO, Committee Hansard, 21 June 1993, p. 500.

ANAO, Submission 7(a), paras. 6 and 7.

Transparency & Accountability: 1992-1993 81

5.26 Agencies rate a range of organisations and instrumentalities. When

assessing the creditworthiness of particular Australian States, agencies are influenced

by their perceptions of: the amount of vertical fiscal imbalance between the

Commonwealth and the States; the extent to which the Commonwealth is prepared

to guarantee State government debts; the degree to which economic developments

in one State or in the Commonwealth can be expected to affect other States; the

strength and potential of the State economy; the political climate, and the State's

financial structures, including its debt profile and debt management.

5.27 Representatives from Standard and Poor's explained that in assessing

a State's credit rating, they had access to information that was not generally available

to the public. However, their published assessments did not include information which

had been provided in confidence:

...we get this information by going directly to treasuries and asking for it. We are in the fortunate position where, by and large, we can obtain information that is not necessarily public.28

Our only communication with federal Treasury with regard to the States is via what we publish, and that is available to those people who subscribe to our service or who actually ring up and inquire about it. We do meet annually with federal Treasury for the purpose of reviewing the Commonwealth of Australia's credit rating and in that process there is exchange on the States as they impact upon the broad public sector borrowing requirement. But those discussions rarely get down to specifics and if we had information that had been provided to us in confidence we would not necessarily share that with the Treasury.29

5.28 A number of inquiry participants agreed that information on the situation

in Victoria, including its borrowing beyond the global limit, was generally known to the

rating agencies and included in their assessments. Mr Des Moore of the Institute of

Public Affairs advised the Committee that, regardless of whether or not Victoria's

A. Tregilgas, Committee Hansard, 6 August 1993, p. 1011.

29

ibid., pp. 1017-1018.

Transparency & Accountability: 1992-1993 83

borrowing. Under this proposal decisions about the quantum of public sector

borrowings would be based upon rating agencies' assessments of the

creditworthiness of the Commonwealth and the various States. Representatives from

Schroders Australia Ltd put the strongest case for regulation through the market. They

argued for 'an exemption from the global limits for those States which have

maintained, and continued to maintain, their credit rating at an agreed level and that

might either be AAA or it might be the foreign debt rating of the Commonwealth,

AA2'.33 They explained the benefits of this approach as follows:

We see the credit rating system as providing an incentive for them to maintain their high credit rating, that is, to borrow as much as is reasonable and to spend it as efficiently as possible so that they can maintain that credit rating by rewarding them, if they do maintain their credit rating, with the flexibility to borrow without global limits and, secondly, by penalising them for the poor forecasting of their borrowing requirements in any year.34

5.30 However, on the question of disciplining borrowing by State and Territory

governments, the Commonwealth Auditor-General confirmed his conviction that it may

be inappropriate to rely entirely on the market:

Where there continues to exist a residual Commonwealth responsibility for the financial obligations of State or Territory Governments, either real or perceived, then it would seem to be inappropriate to leave the responsibility for monitoring financial performance entirely to the market.

In the event that a State or Territory Government was unable to meet its commitments the market may not readily accept this responsibility without looking to the Commonwealth for redress.

Any relaxation of Commonwealth control and oversight of State and Territory government borrowings would need to be developed in the context of this perception and any obligations which may result.35

S. Morris, Committee Hansard, 19 January 1993, p. 227.

ibid., p. 228.

ANAO, letter to Committee, 29 October 1993.

Transparency & Accountability: 1992-1993 85

Firstly, it is the credit ratings that to a large extent impose the discipline on the borrowings of governments and their authorities. Secondly, credit ratings provide another source of information to Loan Council and directly back to governments, so that if you can see that there is some sort of differential between the rates at which one jurisdiction can borrow

and the rates at which other jurisdictions can borrow, that is telling you something. That information could be relevant to Loan Council when thinking how much it was going to, say, acquiesce in a particular jurisdiction wishing to borrow more.38

... I do not think that we would use the ratings as a guideline as such. It would just be an information input into the thing and we would try and add something to those ratings and our own considerations.39

5.33 Importantly, a number of witnesses spoke forcefully about the limitations

of relying on the market to set borrowing limits. Mr Des Moore argued that:

The main problem with such a "market solution" is that governments do not necessarily respond to market signals, or at least not in a timely way. Further, markets and credit rating agencies are susceptible to allowing governments to borrow excessively because they know that, in the end, governments can and do generally fall back on their taxing powers to service their debts.40

And the former General Manager of VicFin, Mrs Barbara Yeoh, warned against relying

too strongly on the markets to protect against non-disclosure:

Dilution replacement of Loan Council controls of the public sector borrowing requirement with a more market driven mechanism for the rationing of credit needs to take into account some of the following aspects. Firstly, there is the potential moral hazard at the

Commonwealth and State government level. The extent to which the market operates on the basis of an implicit government guarantee can act to counterbalance market efficiencies in the rationing of credit.

38

39

40

R. Shogren, Committee Hansard, 27 July 1993, p. 801.

J. Wright, Committee Hansard, 27 July 1993, p. 801.

D. Moore, Committee Hansard, 19 January 1993, pp. 264-265.

86 Chapter 5

Secondly, an entirely market driven system of credit rationing with heavy reliance placed upon credit agency assessments of public sector entities and governments would not necessarily encourage cooperation between the States and the Commonwealth in the development of macro­ economic policy.

Thirdly, an entirely market driven system to ration public sector calls upon the capital markets would, in practice, primarily reflect market assessment of reported or rumoured information and not in itself be a panacea for prevention of non-disclosure.41

Some political commentators have also questioned the high profile accorded to rating

agencies in this country:

...today's credit rating agencies ... have insidiously crept behind the guarantee of the national government to impose rather absurd and meaningless ratings which have become far too powerful a comparative factor in our political system. Government by Moodys is not something we ought to tolerate.

5.34 Significantly, even Standard and Poor's representatives themselves

cautioned against too great a reliance on the market:

Given that there is a continuing information vacuum regarding many aspects of State finances, it is valid to ask whether the monitoring of individual States can be left to international rating agencies like Standard and Poor's. Our short answer is no.

...a credit rating is not a general purpose evaluation of an issuer as it is influenced as much by factors outside the control of individual State governments as by that government's own financial policies. All I will say at this point is that, to achieve public policy objectives, State finances must be subject to a range of scrutiny covering a wide spectrum of interest. As well as the lender perspective, which we represent, clearly monitoring needs to involve the perspective of consumers of public

41

42

B. Yeoh, Committee Hansard, 23 June 1993, p. 717.

K. Wiltshire, T h e Tragedy of the Loan Council", Directions in Government, February 1993, p. 6.

88 Chapter 5

5.35 This is an important issue. Although the financial market can play a role

to discipline public sector borrowing, it cannot assist public policy decision-making

about the use to which such finance is put. In Australia it is likely only ever to

influence decisionmaking in that it affects the cost of debt. Probably it will continue

to be the case that even the smallest Australian States would have access to all the

finance that they require; this is so for two reasons:

. Australian State governments historically have been among the single largest

borrowers in the world; and

. even the worst performances of Australian State governments compare well on

a world scale, and in the past the interrelationship between the Commonwealth

and the States has pushed the ratings of all States into the higher investment

category.

So the discipline of the market is likely to continue to affect decisionmaking about

government borrowing only to the extent that the cost of debt is a determining factor.

Conclusion

5.36 The balance of evidence presented to the Committee suggests that,

while the rating agencies have played a role by informing and influencing Loan Council

decisions on borrowing limits, it is important for the Loan Council to continue for the

foreseeable future. Decisions can be taken by Loan Council for significant public

policy reasons. The financial markets have a limited role to play in that respect,

affecting the government policy process, although being outside it. Nevertheless, it

is important for the Loan Council to be able to take those considerations into account.

And, the Loan Council needs to continue to be the final arbiter of the quantum of

public sector borrowing. The Loan Council also needs to be accountable: it must

report comprehensively to parliaments. The extent to which recent reforms could

facilitate the 'discipline' of the Loan Council by the financial market is one of the issues

reviewed in the next Chapter's assessment of Loan Council reform processes.

90 Chapter 6

Financial Market Discipline

. Heads of Treasury acknowledged that the Commonwealth and all States are

subject to rating by international agencies. Any new arrangements would be

more subject to what was described as the discipline of the financial markets'.

Macroeconomic and Microeconomic Objectives

. Loan Council Options identified the need, at the macroeconomic level, to

ensure that net borrowing by the public sector as a whole is consistent with

national economic management objectives. It was also considered that

microeconomic considerations encompass the need for debt limits within each

jurisdiction to be kept within affordable limits, and the recognition that

government business enterprises operate in a less commercial environment

than private sector firms.

Net Borrowings

. Proposed new arrangements in the December 1992 paper were to focus more

on the net borrowings of the Australian public sector.

Solutions

6.3 In addressing these issues, Loan Council Options advocated that any new

arrangements should invoke greater accountability and disclosure of each

government's financial performance rather than further centralisation of Loan Council

controls. It suggested that increased transparency of government finances would

permit financial markets, media and the public to make judgements about each

government's financial responsibility.2 The two major issues for reform in December

1992, then, were:

2

Committee Hansard, 15 December 1992, p. 4.

92 Chapter 6

statements. It was recommended that a Working Party of Heads of Treasuries

be convened to resolve the detailed implementation of the new arrangements

for report at the next meeting of Loan Council.

Endorsement o f the 1992 Proposals

6.5 The Senate Select Committee to inquire into the Loan Council was

appointed on 3 November 1992 and the Loan Council meeting on 7 December 1992

endorsed the proposed reforms. Indeed, the reforms were widely considered by Loan

Council participants to have rendered the Senate inquiry irrelevant. In declining

requests for undertakings to appear before the Committee, the following State

parliamentarians referred to the proposed new Loan Council arrangements:

Hon John Bannon

Hon John Fahey

Hon Wayne Goss

Hon Ray Groom

Hon Joan Kirner

Hon Carmen Lawrence

Hon David White

6.6 While it is possible that these responses utilised the December 1992 reform

proposals as an excuse for not appearing before the Committee, it is likely that current

and former Loan Council participants were under the impression that these reforms

were substantial and covered the necessary changes then required to overcome the

difficulties facing the Loan Council. In the Heads of Treasury paper endorsed on 7

December 1992, however, not only were several matters noted as unresolved but the

proposals made represented only a partial solution to the five areas of necessary

reform identified in the paper. Work proceeded on further steps towards reform: they

were drafted as another Heads of Treasury paper dated 17 June 1993 and published

94 Chapter 6

Loan Council Limits

. Measurements of the Financing Requirement

6.9 The December 1992 proposal to reform the establishment of the public sector

borrowings advocated agreement on net PSBRs. That document, Loan Council

Options proposed that:

Agreement on the total PSBR and its split between jurisdictions ... would proceed on the basis of nominations by each jurisdiction of its borrowing requirements.3

This document also contained the following recommendation:

Loan Council arrangements be directed to the total PSBR for Australia and to each jurisdiction's PSBR (rather than to gross new money borrowings), covering both the general government sector and PTEs.4

6.10 By July 1993, however, this proposal was acknowledged5 to be

inappropriate. According to Future Arrangements, a PSBR-based aggregate can be

highly volatile due to the adjustment required to exclude the repayment by the

States/Territories of debt previously borrowed by the Commonwealth on their behalf.

For this reason the Future Arrangements document proposed a change in focus from

global limits to an aggregate based on the deficit/surplus as a measure of the

financing requirement; it would apply from 1993-94:

Under the new arrangements the Commonwealth and each State and Territory will be responsible for nominating to Loan Council its intended

3

4

5

Committee Hansard, 15 December 1992, p. 5.

Committee Hansard, 15 December 1992, p. 8.

Future Arrangements for Loan Council Monitoring and Reporting {Future Arrangements), p. 2.

96 Chapter 6

6.13 For the 1993 Premiers Conference, the 1992 Conference commissioned a

Heads of Treasury report entitled National Fiscal Outlook (NFO). On the basis of

current policy and against alternative economic growth scenarios, the NFO analyses

the fiscal outlook for the States, the Commonwealth and the Australian general

government sector in aggregate to 1997-9S.9

Monitoring and Reporting

6.14 Loan Council Options noted that Loan Council members are responsible

for administering and reporting the application of the global borrowing limits in their

own jurisdictions.10 While this reporting requirement had been on a monthly basis,

the June 1992 Loan Council meeting agreed on quarterly reporting. And the 1991

Premiers Conference agreed on the publication by each jurisdiction of annual financial

statements. Accordingly, in 1992 Loan Council Options proposed the following public

reporting arrangements for the medium term:

(a) Quarterly Financial Statements - showing:

. outlays, revenue and financing transactions for the general government sector on a uniform basis; and . net debt for the entire public sector but split between general government and PTEs.

(b) Annual Financial Statements:

. Financial Assets and Liability Statements supplemented with explanatory notes disclosing the total values of contingent liabilities and guarantees as well as asset sales. This would be included in government budget papers or published separately as soon as possible after the budget is brought down; and

Borrowings and Net Debt Statement showing the level of, and changes in, net debt at current capital value during the preceding year to be published on the same basis.11

ibid.

Committee Hansard, 15 December 1992, p. 6.

Committee Hansard, 15 December 1992, p. 7.

98 Chapter 6

. The annual Financial Statements should show Financial Assets and Liability Statements for the general government and PTE sectors on a basis consistent with the uniform budgetary reporting standards which the ABS is currently developing (and all jurisdictions have previously committed themselves to).

- These will be supplemented by explanatory notes disclosing the total values of the memorandum items plus contingent liabilities and guarantees.

- Jurisdictions will be permitted to vary their presentations from the ABS standards but, if they do so, are obliged to present a reconciliation between their preferred basis and the ABS basis.

. It was also considered that the comprehensiveness of the annual Financial Statement made redundant the need for additional monitoring of an annual borrowing and net debt statement as suggested by Loan Council in December.13

6.17 It is important to note that both the December 1992 Loan Council Options

and July 1993 Future Arrangements documents perceived that improved monitoring

and reporting could assist the financial market in its role. Loan Council Options

expressed confidence that better presentation of data by each jurisdiction would

greatly assist financial markets to monitor budgetary outcomes and borrowings.14

And Future Arrangements reported that it was recognised that Loan Council

arrangements needed to be designed so as to facilitate financial market scrutiny:

...judgements by those markets would be the main form of discipline on individual jurisdictions.15

13

14

15

ibid., p. 11.

Committee Hansard, 15 December 1992, p. 7.

Future Arrangements, op. cit., p.4.

100 Chapter 6

Northern Territory) presented the full statement in their 1993-94 budget documents and the remainder generally presented sufficient information to meet the minimum requirement. It is too early to know whether jurisdictions that did not present the full statement in their budget

documents will present it in some later document.17

. Risk Assessment

6.20 Further, with regard to the difficult question of private sector involvement in

public sector infrastructure, Future Arrangements confirmed that a working party of

Heads of Treasury would be tasked to develop a detailed framework based on risk­

sharing for classifying private sector involvement in public infrastructure projects. The

working party was expected to report by September 1993.18

6.21 In September 1993 an Officers Report on this matter was finalised; its

conclusions were endorsed by Loan Council and the report was released by the

Commonwealth Treasurer on 12 October 1993. The report advocated a 'risk

weighting1 for each project; methodologies for risk weighting assessment would be

developed with the aim of implementation by 1 July 1994. As an interim measure it

was proposed that jurisdictions would record the full capital value of all projects having

private sector involvement against their Loan Council Allocation.

6.22 Chapter 3 of this Committee report noted the ways in which the exploitation

of private sector involvement in public sector infrastructure was used to circumvent

Loan Council global limits; this resulted in a significant corruption of the Global

Approach. Unless a credible methodology can be established to deal with this issue

under the present Loan Council Allocation process, it will continue to have a

corrupting effect on Loan Council procedures. That said, the Committee considers

that a risk weighting method is certainly worthy of trial implementation in attempting

to deal with this problem.

17

18

Australian Bureau of Statistics, Submission No. 12(a), para. 6.

Future Arrangements, op. cit., p. 6.

102 Chapter 6

sector borrowing requirement' (PSBR) and "deficit/surplud. Both measures represent the revenue shortfall less funds available from internal sources. "Deficit/surplus" is the revenue shortfall less "provisions", or amounts set aside to cover depreciation and contingencies such as bad debts. The PSBR is defined as "deficit/surplus" less "net advances", which is money borrowed from other Australian governments less repayments of those borrowings.21

The ABS confirmed that 'deficit/surplus' was the measure finally selected because of

unusual circumstances affecting intergovernment financing in this decade. The States

are progressively taking over responsibility for debt issued by the Commonwealth on

their behalf under the Financial Agreement. Through these arrangements, the States

make additional payments to the Commonwealth sufficient to permit redemption at

their maturity of all Commonwealth Government securities issued on their behalf.

These additional payments are financed by State borrowing from the private sector.

The corresponding repayments of the maturing loans made by the States to the

Commonwealth result in 'net advances' becoming a large negative amount, thereby

increasing each State's PSBR even though its overall debt position is not affected.

Accordingly, 'deficit/surplus' was preferred to PSBR because it is not affected by these

intermittent repayments (which are often large and render the PSBR a volatile measure

likely to be misunderstood by financial markets). The ABS has confirmed that for an

individual government 'deficit/surplus' is wider than that government's funding from

private sector sources since it includes funds provided by other governments, but as

a consolidated total for all governments it represents the public sector's call on private

sector funds because in that total all intergovernment funding cancels out.22

6.27 The Committee concurs with the judgement that measures of public sector

debt should be capable of representing the most consistent picture and not be

subject to avoidable fluctuation in their presentation. On this criterion, deficit/surplus

clearly is preferable to net public sector borrowing requirement.

Australian Bureau of Statistics, letter to Committee, 20 July 1993.

22

ibid.

104 Chapter 6

Arrangements commented that the evolution in Loan Council arrangements broadly

reflects the evolution of financial markets and their interaction with the public sector:

It was recognised that Loan Council arrangements needed to be designed so as to facilitate financial market scrutiny, and judgements by those markets would be the main form of discipline on individual jurisdictions.24

Future Arrangements confirmed that the increase in the transparency of government

finances that will result from reporting of the LCA, first after the Loan Council meeting,

secondly in each jurisdiction's Budget and then throughout the year at quarterly

intervals, will permit financial markets, the media and the public generally to make their

own judgements about each government's financial performance 25

6.31 The clearest expression of the role for financial markets comes from the

Overview summary in Future Arrangements. The first point noted there is that the new

Loan Council arrangements are intended to:

...facilitate financial market scrutiny of public sector finances via better reporting and so make jurisdictions more accountable to the markets.26

And the strongest expression of the role of the markets in Future Arrangements 27

is that the judgement of the market "would be the main form of discipline on individual

jurisdictions'. While the Loan Council's new arrangements clearly express reliance on

a much more significant role for the financial markets in disciplining public sector

borrowing programs, the Loan Council has not been articulate about what it expects

financial market scrutiny to achieve. Broadly, market 'discipline' can be exercised by:

Future Arrangements, op. cit., p. 4.

ibid., p. 12.

ibid., p. 3.

ibid., p. 4.

106 Chapter 6

arrangements make only a limited contribution to enhancing debt market scrutiny of

the finances of individual State governments. In fact, Standard and Poor's noted that:

Much more important is the accelerated development of uniform and more comprehensive and timely government financial reporting.29

6.34 Importantly, Standard and Poor's informed the Committee that a

government's financial condition is influenced fundamentally by the nature of the

activities it finances by the issue of debt, and so by the purpose of its borrowings.30

Accordingly, for the financial market to be better able to perform its assessment

function and so further contribute to the 'discipline' of public sector borrowing activity,

the Loan Council would need to provide more comprehensive information of this kind

than has been available:

...assessing a State government's financial condition also requires an appreciation of its policy intentions and expectations over the coming three to five years. This requires a better articulation of a government's policy framework and objectives than is typically the case at the moment, and the publication of multi-year financial estimates.31

6.35 On this point, it should be noted that the rating agencies have enjoyed

access to confidential information relevant to their assessment function for some time.

Standard and Poor's informed the Committee that they have access to much of the

information that they require, but some of that information is not made public. 32

Even were the Loan Council's new reporting arrangements to result in this confidential

information becoming publicly available, it would not be an additional benefit to the

financial market (including Standard and Poor's) that already has access to it unless

even more extensive confidential information was made available.

29 ibid.

30 ibid., p. 1004.

31 ibid.

32

ibid., p. 1014.

110 Chapter 6

The Victorian Auditor-General presented a similar view. He confirmed that currently

departments in Victoria only account on a cash basis:

The use of this basis for Loan Council monitoring purposes has limitations, in that surpluses and deficits can be manipulated by shifting cash transactions around balance dates and not accounting for debt assumptions from financial institutions. I think, in the last couple of years, the Victorian State Government has assumed debt totalling $2.2 billion from the State Bank and Tricontinental. The use of accrual accounting would provide more comprehensive information to enable better monitoring of government financial performance. In addition, this basis of accounting which is adopted by all statutory authorities within Victoria - approximately 500 - is universally accepted in the business community, including financial markets.39

6.44 The Committee is aware of the difficulties of accrual accounting for the

public sector. However, the momentum towards accrual accounting is such that it is

reasonable to expect the Loan Council to report on an accrual basis in the foreseeable

future. The Commonwealth Department of Finance has announced in a circular letter

that it is anticipated that all departments would report on an accrual basis for the

financial year ending 30 June 1995. And in a media release on 4 November 1992, the

Minister for Finance announced that the Department of Finance had published

supplementary Financial Statements for the 1991 -92 financial year on an accrual basis

alongside its annual report.

Macroeconomic and Microeconomic Objectives

6.45 Loan Council Options stated that:

In devising new arrangements, all governments also need to be mindful of the macroeconomic and microeconomic objectives that continue to underlie market and community scrutiny of their operations. At the macroeconomic level, this involves ensuring that the net borrowing of the

39

C. Baragwanath, Committee Hansard, 6 August 1993, pp. 1020-1021.

112 Chapter 6

States were not greatly constrained by the global limits.43 The extent to which such

techniques were exploited by the States was very wide. Mr Don Nicholls, former

Deputy Secretary of the NSW Treasury, advised the Committee that in the past the

States were not interested in policing the Loan Council arrangements:

If they saw that one State had been able to successfully introduce a finance lease that was not caught there was no incentive for them to complain about it, because it gave them the opportunity to do the same in their State if they felt that the amounts that were being allocated by the Commonwealth were insufficient.44

6.47 The former Premier of New South Wales, Hon Nick Greiner, informed the

Committee that under the Global Approach the global limit for Australia was decided

and then divided between the States on what he described as an 'arbitrary basis'. Mr

Greiner identified the reform in abandoning global limits as a combination of a

macroeconomic (or top-down') approach, and a microeconomic (or 'bottom-up')

approach. Mr Greiner has suggested that unlike previously, the new arrangements

allow for microeconomic considerations.45 Mr Greiner's view is correct in so far as

it concerns decisionmaking under the Global Approach: the States were not then fully

involved in microeconomic decisionmaking. Nevertheless, the effect of Loan Council

limits under the Global Approach extended to the microeconomic level, State

authorities being constrained in their borrowing activities.

6.48 By contrast, Future Arrangements provides for significant microeconomic

decisionmaking by the States concerning public sector borrowing. Under the new

arrangements the Commonwealth and each State and Territory will be responsible for

nominating to Loan Council its intended allocation (LCA). Microeconomic adjustments

would then occur:

43 ibid.

44 D. Nicholls, Committee Hansard, 21 June 1993, p. 540.

45 N. Greiner, Committee Hansard, 27 July 1993, p. 924.

116 Chapter 7

. the Commonwealth was able to take over State debts and Sinking Fund

arrangements were established to reduce outstanding debt.

However, the Financial Agreement did not control or even influence the borrowings

of semi-government and local authorities. The need for influence over authorities'

borrowings was reflected in the Gentlemen's Agreement of 1936, which was

succeeded by the Global Approach Resolution of 1984.2

7.3 While on seven occasions3 the Financial Agreement has been amended,

or has otherwise been varied through agreement, it is now the subject of significant

if not radical redrafting proposals following decisions of Loan Council on 12 June

1992. In its preliminary submission to the Committee, the Commonwealth Treasury

advised that the proposed changes would permit the States to issue securities in their

own names and would make other changes to simplify the administration of the

Agreement:

The effect of these changes would essentially leave the Financial Agreement Act with little substance.4

Even by June 1992, prior to the uncovering of Victoria's breach and recent reform

proposals, many of the provisions of the Financial Agreement were obsolete.

7.4 The Committee sought further advice about the redrafting of the

Agreement, particularly in the context of the changes to Loan Council arrangements

proposed at the meetings on 7 December 1992 and 5 July 1993. The Treasury

responded with a supplementary submission on 7 September 1993; it is reproduced

at Appendix F.

2

3

4

Commonwealth Treasury, Committee Hansard, 15 December 1992, p. 14.

1928, 1931 (twice), 1934, 1944, 1966 and 1976.

Commonwealth Treasury, Committee Hansard, 15 December 1992, p. 15.

118 Chapter 7

The Operation o f the Council

7.7 Of the two major reasons for a Loan Council - decisions concerning

levels and terms of borrowing - that relating to terms of borrowing ceased to be a

factor by the late 1980s. No new money borrowings have been undertaken by the

Commonwealth on behalf of the States since 1987-88.®

7.8 Nevertheless, and despite the fact that by the end of 1992 Loan Council

arrangements were at the point of breakdown, the Commonwealth and

States/Territories have not canvassed between them the dissolution of the Loan

Council. So far as is known, no jurisdiction has put such a proposition. Whatever the

shortcomings of the Loan Council, its members convey the impression that its

operation will continue to be supported. More than that, there has been strong

endorsement by members of the reforms proposed since December 1992. There

have been expressions of confidence that they will overcome the difficulties under

which the Loan Council has operated for many years.

7.9 This situation is satisfactory to the Commonwealth in that the continuation

of the Loan Council provides an additional macroeconomic 'lever': in December 1992

the Loan Council Options paper expressed the macroeconomic objective for Loan

Council of ensuring that the net borrowing of the public sector as a whole is consistent

with national economic management objectives.9 The States continue to support the

Loan Council largely, perhaps, because it provides a supplementary source of finance

to the General Revenue Grants.

7.10 To what point, then, has reform brought the Australian Loan Council?

The Loan Council no longer:

Commonwealth Treasury, Committee Hansard, 15 December 1992, p. 24.

Committee Hansard, 15 December 1992, p. 4.

120 Chapter 7

'memo items' as they call them, so you will effectively have a catch-all situation.12

Mr Greiner approved of this development provided that it was accompanied by

'significant disclosure transparency'. He had earlier confirmed his confidence in the

financial market exercising discipline as a control on public sector borrowing.13

7.12 Mr Greiner's confidence in the discipline of the market is not a view

shared by the Committee. Importantly, even were confidence in the discipline of the

market warranted, is it appropriate to impose 'discipline' on activities that could be

described, as Mr Greiner has, as being in a 'catch-all situation'? It was argued in

Chapter 5 that the discipline of the market, operating as envisaged by Loan Council,

was likely to affect public policy decisionmaking only to the extent that the cost of debt

was a determining factor. That is, it is unlikely to affect significantly the amount of

finance available to the States. For controls on that, Loan Council limits would

continue to be required. And if that is desirable, then future Loan Council

arrangements must provide for effective decisionmaking; any tantamount dissolution

of this institution should be resisted.

7.13 Effective decisionmaking requires careful consideration of the relevant

issues. In the past, Loan Council meetings have not been characterised by such an

approach. Mr Greiner advised the Committee that:

On the question of the past, suffice it to say that I will always remember the present Prime Minister saying at a Loan Council meeting - 1 think the first one I attended in 1988 - that this was a beautiful but blunt instrument. It is a beautiful but blunt instrument from the point of view of Federal Treasury in the sense that it did enable you to determine to a significant extent the borrowing programs in one fell swoop and in a very short period of time.

ibid., p. 926.

13

ibid., p. 925.

122 Chapter 7

whole issue led, I think, to the impetus for the changes that are now suggested.15

7.14 Reforming the disclosure arrangements of the Loan Council, as is

proposed in Future Arrangements, would have limited effect unless a proper

decisionmaking process is employed. States must comprehensively review their LCA

proposals and determine precisely their borrowing requirement to be expressed as

an LCA. This would contribute to a more precise and articulate Loan Council process.

The Limits to Reform

7.15 Recognising the reforms that have already been achieved, could the

Loan Council expand its function into regulating infrastructure development?

Professor Wiltshire has identified this option as a lost opportunity on the part of the

Loan Council:

As the only nation with one body having an oversight of our infrastructure needs, and being still a growing frontier society, we could have shaped the whole future of our economy and the patterns of our settlement and growth through the Loan Council. If the funding it allocates were done on economic criteria ranking projects according to whether they would benefit the nation as a whole rather than just handing out parcels of money on a political basis to each government, this would be the greatest chance we could have of improving our standard of living.16

While this may be an option in theory, it is very difficult to envisage that, in practice,

sovereign State governments would submit their proposed infrastructure projects to

scrutiny by the Loan Council.

15

16

ibid., pp. 924-925.

Wiltshire, op. cit., p. 6.

128 Chapter 7

they had done in terms of forming an opinion on their particular State's activities, and then provide an opinion to the Commonwealth Parliament on the overall activities of the Loan Council.

That sort of process obviously would require cooperation between the members of the Loan Council and the various State governments and the willingness by the State governments to have their auditors-general audit their element of the activities. So in terms of mandate, we could provide an opinion on the Commonwealth element, in my view, under existing arrangements if it was the wish of the Executive and the Parliament to require the Loan Council, as it related to the

Commonwealth, to have a report.31

However, Mr Taylor revised this view in evidence on 8 October 1993. In responding

to a question from the Chairman concerning the concept of a comprehensive Loan

Council report audited by each Auditor-General and tabled in each parliament, he

stated:

I believe that there is a role for the auditors-general as a whole in commenting or in coming to some agreement on the overall figures. I would think that we are the appropriate people to start that off. I would also feel that, given we are all equals-no auditor-general is above another auditor-general; we are equal in our fields-it would be wrong of me to attempt to oversight what somebody else was doing in his or her field. But when it comes together as a 'Commonwealth' thing, maybe it changes its nature. I am not quite sure of that but I would be very loathe to come out ex cathedra without having talked to my colleagues.

Again, as I have said, we are continuing to liaise and talk about things and it is quite possible that we could have a meeting around the table ourselves. I do not think it is legally possible for them to come to an opinion about the lot, but if it were it is conceivable that we could all sign it. I would like to work cooperatively with my colleagues.32

31

32

G. Williams, Committee Hansard, 21 June 1993, p. 514.

J. Taylor, Committee Hansard, 8 October 1993, pp. 1129-1130.

130 Chapter 7

. annual reports by jurisdictions to their parliaments concerning all activity that

falls under Loan Council scrutiny: such annual reports would include the audit

reports of the relevant Auditors-General;

The Committee concludes that in order to fulfil the Loan Council's own goal of greater

disclosure and accountability, each of these elements, particularly that concerning

annual reports to parliaments, needs to be articulated in the redrafted Financial

Agreement and complementary legislation. The Committee also considers that, in

order to ensure uniformity of auditing practices, Auditors-General should review their

Loan Council auditing practices annually at meetings of Auditors-General.

132 Chapter 8

institute monitoring arrangements for non-standard

transactions in order to ensure that the global limit

guidelines be consistently and correctly applied.

Mr Dawkins did not respond to this letter.

In April 1992 the Victorian Treasury, at the direction of the

Victorian Treasurer (Hon Tony Sheehan) instructed VicFin

to refinance past deficits estimated at $1.267 billion with

medium-term funding.

From 1 May 1992 Victoria undertook a medium-term

borrowing of $1.267 billion to rollover short-term financing

of Budget deficits for the years 1989-90 to 1991-92. This

action resulted in a breach of Victoria's Loan Council

global limit.

On 12 June 1992 the Loan Council met. Mr Dawkins, as

Chairman of the Loan Council, did not raise the issue of

Victorian sale and lease-back arrangements specified in

Mr Greiner's letter of 22 April.

On 17 June 1992 at a meeting of Commonwealth and

Victorian Treasury officials, the Commonwealth was

informed for the first time of the Victorian breach of its

global limit. An unsigned and undated draft letter from the

Victorian Treasurer, Hon Tony Sheehan, to Mr Dawkins as

Chairman of the Loan Council was provided by the

Victorian officials.

On 25 June 1992 the Victorian Treasury briefed

Commonwealth Treasury officers on the Victorian

134 Chapter 8

raisings (under any definition of 'memo item') must know what is to be reported to

their governments for reporting on to Loan Council. Adequate reporting also entails

the uniform disclosure of 'memo' items by each jurisdiction.

8.8 The employment of 'deficit/surplus' as a measure of public sector debt

is preferable to 'net public sector borrowing requirement'; nevertheless, the

presentation of 'deficit/surplus' statistics needs to be enhanced by the use of accrual

accounting.

8.9 Accordingly, the Committee recommends:

Recommendation One

. That the Loan Council continue for the foreseeable future.

Recommendation Two

. That State and Federal governments adopt accrual accounting as a matter of

priority for the purpose of reporting all government financial transactions

including Loan Council disclosures.

Recommendation Three

. That the uniform reporting requirements established by Loan Council include

auditors reports.

Recommendation Four

. That all authorities which could generate public sector debt that is subject to

Loan Council review be advised of the reporting requirements with

which they must comply.

Recommendation Five

. That each jurisdiction under the Loan Council present annually to its parliament

an annual report of activity subject to Loan Council control; that the Loan

138 Chapter 9

by the Commonwealth Treasury. And in December 1992 the Loan Council regularised

the Victorian refinancing that had been beyond its 1991 -92 global limit.

9.5 Second, important steps were underway from June 1992 to significantly

reform Loan Council processes and overcome the problems evidenced by Victoria's

actions and those of several other States. In declining invitations to appear before the

Committee a range of State parliamentarians, both Liberal and Labor, made the point

that recent reforms to the Loan Council, particularly those proposed at the December

1992 meeting, satisfied their concerns about difficulties that had been experienced in

recent years. The further reforms developed by Loan Council and announced in July

1993 owe little to the existence of the Select Committee - the Loan Council itself had

been well aware of the need for reform and has devised new ways of operating to

overcome the kind of problems experienced over several years.

9.6 Third, one of the major characteristics of this inquiry is that non­

Government Senators do not appear to have appreciated that breaches of Loan

Council borrowing agreements have characterised the Loan Council for decades. Mr

Don Nicholls, the author of the report State Finance Victoria which first publicly

referred to the Victorian breach in September 1992, gave evidence to the Committee

explaining that the following were examples of projects that involved technical

breaches of Loan Council limits: the Eraring project, the Sydney Harbour Tunnel, the

Sydney Entertainment Centre and the finance lease arrangements for $300 million of

NSW railway rolling stock in 1981-82. Not only was Mr Nicholls the author of State

Finance Victoria, but he is a former Deputy Secretary of the Treasury of NSW and an

authority on these matters.

9.7 Fourth, even in their unbalanced concentration on the 1992 Victorian

situation the Liberal Senators do not seem to understand the nature of the Victorian

refinancing transaction that took place from 1 May 1992. One could be forgiven for

concluding that the Liberal members of the Committee believe that Victoria acted

illegally. Nothing could be further from the truth. In evidence to the Committee Mr

140 Chapter 9

9.10 The Committee report further suggests that Mr Dawkins ought to have

raised the issue of Victorian sale and lease-back arrangements at the June 1992 Loan

Council meeting and that he should have made the Victorian refinancing explicit in the

1992-93 Budget papers. Mr Dawkins, however, has nothing to answer for here. He

dealt with Victoria on the sale and lease-back issue quite properly by correspondence

requesting details. It should be noted that such information passing between the

Commonwealth and the States was maintained confidentially as befits a voluntary

arrangement. And Mr Dawkins and his officers acted conscientiously to resolve this

issue in the interests both of Victoria and the Commonwealth. The correspondence

between Victoria and the Commonwealth that Mr Dawkins released on 3 November

1992 bears this out. And with regard to publishing details in the Budget papers,

Mr Dawkins was advised by Treasury that any such publication could have adverse

market consequences in respect of Victoria's debt (see Appendix E, page 6). It was

not unreasonable for Mr Dawkins to accept the advice of his department.

9.11 Although these facts indicate that the inquiry was not justified as a Select

Committee of the Senate, there were some positive outcomes. The Loan Council itself

since December 1992 has advocated greater transparency of its processes; despite

the unbalanced concentration on Victoria, the Select Committee inquiry has

contributed towards making the Loan Council and its activities better known and

understood.

9.12 Further, the inquiry has confirmed the necessity of having a financial

institution such as the Loan Council in order to control the quantum of public sector

debt. Without such an institution States would be largely unconstrained in their

borrowing activity except for the cost of such borrowing and the opprobrium of the

electorate. The Loan Council provides an effective forum to prevent States from

experiencing such difficulties periodically. In addition, it is a useful macroeconomic

'lever' for the Commonwealth.

Chapter 10

Minority Report - Liberal Senators

10.1 The Opposition Senators on the Committee concur with the major

findings and recommendations of the Committee's final report, subject to the following

qualifications and comments.

Interim Report

10.2 A major omission from the body of the final report is the lack of any

detailed mention, or evaluation, of the findings contained in the interim report of the

Committee handed down in March this year.

10.3 Since that report in March, no evidence has been presented to the

Committee to alter, annul or repudiate those findings. They are as pertinent today, in

this final report, as they were then.

10.4 That report's key findings on the Victorian breach are included in

Appendix K.

10.5 The Coalition members reaffirm these findings as important findings and

conclusions of the final report of the Committee.

Chapters 5 to 7

10.6 The Opposition members of the Committee do not accept that Chapters

5 to 7 represent a fair and balanced summation of the evidence presented to the

Committee.

10.7 Those chapters, as presented, detract from the quality and clarity of the

final report. The relevant testimony of all the witnesses appearing before the

Minority Report - Liberal Senators 145

or add to its findings. Furthermore evidence suggested that Premier Fahey had

nothing to conceal or deny from the Committee, unlike some other non-attendants.

10.13 The recent reforms to the Loan Council guidelines have been beneficial

and are, at least, a step in the right direction. The important principles of greater

disclosure and improved accountability are very welcome.

10.14 However, any reforms will only work so far as participants in the process

display honesty, openness and integrity in fulfilling their obligations. The participants

in the Victorian situation in 1992 showed a lack of these key characteristics, amongst

other things.

Chapter 7 - "Prospective Reform/'

10.15 The key elements to enhance financial responsibilities are greater and

more timely disclosure and consistent and improved accountability.

10.16 An important item in achieving this is the introduction of accrual

accounting. This introduction should be a matter of priority for all governments.

10.17 Reporting requirements should entail:

1) timely quarterly and annual financial statements to Loan Council and the public;

2) accrual accounting methods;

3) full auditing by Auditors-General;

4) at least annual formal audited reports to relevant parliaments of all borrowings

(incorporating information under Loan Council requirements); and

Appendix A 147

Minute by Dr D Sams,

General Manager, Finance Division,

Treasury of Victoria,

21 December 1992

M in u te to the Treasurer

F ro m : Dermis Sams

General Manager, Finance

S ubject: The $1,267 Billion Medium Term Borrowing - Advice Provided by Treasury and Correspondence

D ate: 21 December 1992

The Treasurer

Purpose

1. The purpose o f this Minute is to provide a review o f the advice by the Department to the former Treasurer and the correspondence relating to the refinancing o f the accumulated deficits as medium term borrowings on 1 M ay 1992

Background

2. You have asked for a review o f correspondence entered into by the Department cither

internally or externally and the procedures followed and recommendations made to the- former Treasurer prior to and during negotiations with M r Dawkins on Loan Council implications associated with the transaction.

3. In an associated Minute, advice has been provided on VicFin's role in relation to the transaction. In summary, VicFin raised concerns in January 1992 about the V D F s

Treasury Bill program and proposed some mechanisms for refinancing it through VicFin which maintained the borrowings as non-global. The latter were not

implemented and VicFin had little role in developing the proposal for the medium term

borrowing. In the end, VicFin was simply the agency which borrowed the funds for the Capital Works Authority.

4. The following is a chronology o f advice and correspondence relating to the transaction:

(a) On 24 March, a draft M inute from the General Manager, Finance, was circulated which proposed several options including the refinancing o f the deficits as temporary borrowings for Loan Council purposes.

A revised draft Minute was prepared on 26 March 1992, including a letter to the Chairman o f VicFin, and an attached detailed briefing (incorporating most o f the 24 March draft)

The proposed position (paragraph 7 o f the Minute) was,

[(i)] TCV to maintain the existing Treasury Program a: its current :v-c (about SI 5 billion) for 1991-92,

thus removing the current risks involved in the use o f short term

funding

It is my intention to hove discussions with the Commonwealth

Treasurer on this matter.

I request the advice o f the Corporation on the level o f funding it can

provide for the Budget from the V D F s non-global sources at 30 June

1992 and the level o f funding it could provide through a VicFin

program for the funding o f the accumulated deficits which currently arc projected to be just under S 1 5 billion at 30 June 1992 "

Although prepared and discussed within Treasury, the draft was never signed

or forwarded formally to the Treasurer. However, it does indicate the advice prepared by Finance Group within the Treasury.

(b) On 1 April, a Memorandum based substantially on the draft Minute and related material was forwarded to the Director General from the General Manager, Finance, with a recommendation that a paper (attached to the Memorandum)

be provided to VicFin as the basis for seeking the latter's advice on managing the end o f year funding requirements for the Consolidated Fund.

(c) On 6 April, a Minute was put to the Treasurer by the General Manager,

Finance, suggesting the following approach;

(i) the Treasury Bill program to be maintained at its current level (about

$1.5 billion) until June 1992, but to be wound down, with a target date o f 30 September 1992, during 1992-93 as "netting o lF arrangements are put in place; '

(ii) the CW A to authorise T C V to raise long term funds on a floating rate

basis to replace the existing Section 21 advances, which must be repaid together with interest no later than 30 June 1992, and

(iii) the T C V to manage the end o f year funding requirement to ensure that

sufficient funds are available from the Treasury Bill program and VDF deposits to meet the outstanding State Development Account ("SDA")

loans, Flexible Tariff Management Trust ("F T M U T ") loan and the

funding o f V D F assets.

Paragraph 6 o f the Minute stated;

''Treasury's preference is to argue that the funding o f the accumulated Budget deficits is a temporary borrowing for Loan Council purposes, as the cebt management strategy announcement indicates that the ceficits will be repaid from future recurrent surpluses over a five year period."

The M.r.ute recommended that the Treasurer sign an instruction to the CWA to finance :ne ueficit on a mec.'-m term basis

The Dirccior-Gcncral responded on 19 June This correspondence was processed principally by the Director General and Deputy Director General Again no reference is included in this correspondence to the medium term

borrowing

(i) The Deputy Director General w rote to the Loan Council on 28 May about the

use o f the 1991-92 Special Addition to finance redundancies The lettei did

not mention the medium term funding issue.

(j) A briefing paper to the Treasurer from the General Manager, Finance, dated 1 June was prepared on the "End o f Y ear Outcome of Global Limits" An

attachment to the Minute on “End o f Y ear Deficit Refinancing" stated,

"In early April 1992, you agreed to instruct the Capital Works Authority to

authorise the Victorian Public Authorities Finance Agency to raise medium

term funds on a floating rate basis to replace the Section 21 Advances, which

were to be repaid, plus interest, prior to 30 June 1992.

This refinancing occurred on 1 M a y 1992 and meant that non-global

borrowings may now need to be reported as global borrowings for Loan Council purposes.

A case will need to be presented to the Commonwealth and the other members o f Loan Council, which argues that, in accordance with the June 1991

Victorian Premier's Economic Statement, these borrowings for funding the deficits are

- temporary borrowings in accordance with the Loan Council guidelines;

- these temporary borrowings will be repaid from the surplus from future budgets over a predetermined period; and

- as a consequence are self-liquidating and do not require to be reported for Loan Council purposes;

I f the above argument is not accepted, Victoria will need to obtain a special addition to this year's global program for $1,267 2 million and further special additions for the expected budget deficit for the following years until a surplus is achieved;

Victoria would need to agree that these special additions would be repaid from the surplus from future years' budgets and would not be reborrowed, once repaid "

(k) On 25 June, Commonwealth Treasury officers visited Treasury and obtained, inter alia, a briefing from Treasury officers on the financing of the budge: deficit A copy o f the draft letter o f 24 June was provided to the Commonwealth officers

Victoria would wish to borrow and on the arrangements for those borrowings to be repaid He also sought confirmation that the Nicholls repon woulo be available by mid-September."

S Draft letters dated 17 and 24 June to the Chairman o f the Loan Council wcic provided

to the Commonwealth Treasurer, or Treasury. These letters were unsigned It is

presumed that the first was provided at the meeting of the Treasurers on 17 June and

the second when the Commonwealth Officers visited Treasury on 25 June.

9 A note to the Statement o f Budget Sector Transactions for May 1992, released on 26

June 1992 stated;

"Note on Supplementary Consolidated Fund presentation fo r May

In the Supplementary Consolidated Fund presentation o f this May statement, an item "CW A Borrowings" appears with an amount totalling $1,267 2 million for May These are borrowings through the Capital Works Authority

associated with the refinancing o f existing debt, in particular, past short term

borrowings through the Cash Management Account fC M A ) of $276.6 million and $204 5 million undertaken in 1989-90 and 1990-91, and a further planned

drawdown o f $786.1 million provided for in the 1991-92 Budget estimates.

This refinancing does not represent any new or unplanned borrowings. Rather,

it is part o f an approved strategy for repayment o f previous C M A temporary borrowings involving a repayment profile of staged annual repayments over

five years from 1994-95, when a current account surplus is planned.

The debit and credit entries involved in these refinancing procedures balance each other in the GFS format and thus have no net effect on financing transactions The presentation reflects the provision o f the Public Account Act 1958 that such transactions create a receipt of the Consolidated Fund."

10. A meeting of Loan Council was held on 12 June 1992. The issue o f medium term

borrowings was not on the Agenda and was apparently not raised at that meeting. A

briefing paper (dated 11 June) was provided to the Treasurer for the meeting, as pan of a suite of briefing papers. The recommended position for Victoria was, inter alia;

"...that the issue not be raised at Loan Council, but that discussion be

commenced with the Commonwealth Government and Loan Council next week "

11 On 24 July 1992, a report on global borrowings for the year to June 1992 was

forwarded to the Secretary of Loan Council. The report indicated full utilisation o f the global borrowing allocation from 1991-92 or $1,394.3 million but included the following footnote;

" U Excludes $1,267.2 million o f Temporary Purpose Borrowings Treatment o f the Victorian Equity Trust still under consideration "

Appendix B 157

Letter from Hon Nick Greiner

to Hon John Dawkins, 22 April 1992

1 .j-'^urer o f New South Wales Australia

Mr J Dawkins T r e a s u r e r and C hairm an, A u str a lia n " L o a n C o u n c il P a rk es P la c e

PARKES ACT 2600

R Goodyer 4590

176711

2 2 APR 1992

Dear Mr Dawkins

R ecen t m ed ia r e p o r t s have r e f e r r e d t o lo n g term s a le and l e a s e

back a r r a n g e m e n ts t h a t t h e V i c t o r i a n G overnm ent has e n te r e d

"into in r e s p e c t o f Government b u i l d i n g s su ch a s p o lic e

■ s t a t i o n s .

I n q u i r i e s we h ave made i n d i c a t e t h a t i t s arrangem ents are o f a

lo n g term n a t u r e , w ith g u a r a n te e d r e n t a l r e v ie w s . On th e

'b a s is o f t h i s in fo r m a tio n i t w ou ld a p p e a r t h a t th e y sh o u ld be

t r e a t e d a s f in a n c i n g under t h e g l o b a l b o rro w in g l i m i t s .

I w ould rem ind you t h a t New S o u th W ales i n 1 990-91 f u l l y

c o n s u l t e d w it h th e Commonwealth T r e a s u r y on a b u ild in g l e a s e

a rra n g em en t and d eterm in ed i n t h e end t h a t th e arrangem ent

s h o u ld b e in c lu d e d in i t s g l o b a l b o r r o w in g l i m i t .

I t i s e s s e n t i a l t h a t t h e r e i s a c o n s i s t e n t approach a p p lie d

a c r o s s G overnm ents t o th e g l o b a l b o r r o w in g l i m i t , w ith

G overnm ents l i a i s i n g w ith t h e Loan C o u n c il S e c r e t a r ia t on any

n o n -s ta n d a r d arran gem en ts w h ose s t a t u s c o u ld r e q u ir e

c l a r i f i c a t i o n i n r e s p e c t o f t r e a t m e n t u n d er t h e g lo b a l

b o r r o w in g l i m i t .

A c c o r d in g ly I r e q u e s t f i r s t t h a t t h e Loan C o u n c il review th e

V i c t o r i a n s a l e and l e a s e back a r r a n g e m e n t s . S econdly I

r e q u e s t t h a t Loan C o u n c il i n s t i t u t e m o n ito r in g arrangem ents

f o r n o n -s ta n d a r d t r a n s a c t io n s i n o r d e r t o e n su re th a t th e

g l o b a l l i m i t g u i d e l i n e s can be c o n s i s t e n t l y and c o r r e c t ly

a p p l i e d .

Yours s i n c e r e l y

/

8th floor. Stale Office Block. Macauane Street. Sydney 2000. Telephone: (02) 228 <426. Facsimile: (02) 221 7029.

Appendix C 161

Undated Draft Letter from

Hon Tony Sheehan to Hon John Dawkins

T he Treasury

C anb erra A C T 2600

Telephone (06) 263 2111 Overseas 61-6-263 2111 Fax (06) 263 3007

17 February 1993

Mr R J King Secretary Senate Select Committee on the Functions, Powers and Operation of the Australian Loan Council 20.3 Parliament House CANBERRA ACT 2600

Dear Mr King

In response to your telephone request to Mr Cassidy this morning, I attach a copy of a draft letter headed 'Victoria's 1991-92 Global Borrowing Limit - Financing o f Budget Deficit1. The draft letter, from the then Treasurer of Victoria to the Commonwealth Treasurer, was provided to us by Victorian Treasury officials on 17 June 1992. It was released publicly by the Commonwealth Treasurer, we understand in November last year.

Yours sincerely

J S Wright V J

Assistant Secretary State and Local Government Finances Branch

2

V i c t o r i a would r e p o r t su ch b o r r o w in g s t o t h e Loan C o u n c il,

i n c l u d i n g th e p r o g r e s s i v e rep aym en t o f t h e s e b o r r o w in g · from

f u t u r e s u r p lu s e s on an a n n u a l b a s i s u n t i l su ch t im e a s t h e

t e m p o r a r y p u rp o ses b o r r o w in g s a r e r e p a id . The b o r r o w in g s f o r th e

1 9 8 9 - 9 0 and 1 990-91 d e f i c i t s h a v e a lr e a d y b een r e p o r t e d as p a r t

o f t h e S t a t e d e b t and w i l l c o n t in u e t o be s o r e p o r t e d u n t i l

r e p a i d .

A l t h o u g h th e Government has in tr o d u c e d s i g n i f i c a n t a d ju s tm e n ts t o

i t s o u t l a y s and c a p i t a l e x p e n d it u r e su b se q u e n t t o t h e B u d g e t, th e

p r o j e c t e d r e c u r r e n t d e f i c i t f o r 1 9 9 1 -9 2 o f $786 m i l l i o n in c lu d e d

i n t h e June 1991 P la n n in g P r o j e c t i o n s w i l l be e x c e e d e d and i t i s

n o t n o w l i k e l y we w i l l be a b le t o a c h ie v e t h e p u b li s h e d b u d g et

p l a n n i n g t a r g e t s f o r f in a n c i n g t r a n s a c t i o n s i n 1 9 9 2 -9 3 and

1 9 9 3 - 9 4 . N e v e r t h e le s s , t h e G overnm ent rem ain s c o m m itte d t o a

p l a n n i n g s t r a t e g y o f r e s t r a i n i n g t h e s i z e o f i t s d e f i c i t and

r e t u r n i n g t o Budget s u r p lu s e s w h ich can b e u se d t o rep a y t h e

a c c u m u la t e d d e f i c i t s .

L o a n C o u n c il would b e k e p t f u l l y in fo rm ed by V i c t o r i a i n term s o f

i t s p r o g r e s s in r e d u c in g t h e s e a n n u a l d e f i c i t s . I t may w e l l be

n e c e s s a r y t o c o n s id e r s i m i l a r a rra n g em en ts f o r o t h e r S t a t e s .

T h e p r o p o s a l t o t r e a t t h e b o r r o w in g s as tem p o ra ry f o r g lo b a l

r e p o r t i n g p u rp oses i s c o n s id e r e d b o th a p p r o p r ia te and c o n s i s t e n t

w i t h t h e i r purpose and th e G overn m en t's c o m m itm en ts. H owever, as

a n a l t e r n a t i v e , V i c t o r i a c o u ld arg u e a c a s e f o r a s p e c i a l

a d d i t i o n t o th e g lo b a l program t o accommodate t h i s r e f i n a n c i n g .

T h i s w o u ld p r o v id e a r e f i n a n c i n g e n t it le m e n t su c h t h a t V i c t o r i a

w o u ld n o t n e c e s s a r i l y have t o r e p a y th e a c c u m u la te d d e f i c i t s . I t

i s c o n s i d e r e d more a p p r o p r ia te t o t r e a t t h e b o r r o w in g s a s

t e m p o r a r y b o rrow in gs i n a c c o r d a n c e w ith t h e P r e m ie r 's commitments i n t h e June 1991 Econom ic S ta te m e n t.

V i c t o r i a r e q u e s ts y o u r c o n f ir m a tio n o f t h e p r o p o s e d arra n g em en ts.

Y o u r s s i n c e r e l y

TONY SHEEHAN Treasurer

T r e e s R e f: F9108191R

( J P .2 3 7 )

Appendix D 167

Draft Letter from Hon Tony Sheehan

to Hon John Dawkins, 24 June 1992

S econ d , the accumulated deficits represent a mc«Aem * rw r o n w * ig re|uir Lremeqit in th a t the deficits are scheduled to tie repaid over the five years from i $93-94. In

V ic to r ia 's June 1991 Economic Statement, the Government Indicated that the Victorian B u d g e t d eficits to be incurred from 1989-90 to 1993-9* would be repaid from M u re re c u rre n t surpluses o f the Budget o ver the succeeding fiv e years.

A fte r considering the above factors. I agreed to VicFin borrowing 51,2 6 7 millions An 1 M a y 1 9 9 2 on behalf o f the Capital W orks Authority to refinance the accumulated d efic its on a medium term basis. These borrowings mature in 1995 and it is proposed th a t they be refinanced so that they can be repaid uniform ly over the five years gom

1 9 9 3 -9 4 .

A lth o u g h die refinancing program still leaves a significant funding requirement for the re m a in in g V D F program, the action relieves the V D F o f the need to fund the deficit c o m p o n e n t and reduces the Treasury B ill program to acceptable levels. The remaining p ro g ra m o f the V D F is currently being examined with the aim o f reducing the demand on this p ro gram in 1992-93.

T h e borrow ings by VicFin to fund the deficit were raised in the general capital miticets and not from sources tapped by V D F . Although, this reduces the funding, risk associated with the borrowing program , it raises a question o f their treatment forjLoan C o u n c il purposes.

V ic to ria proposes to manage these borrowings as medium term temporary borrowings since th e accumulated deficits are a consequence o f the current downturn fp the V ic to ria n economy and the Government remains firm ly committed to repaying them fro m fu tu re projected Budget surpluses as presented in the Premier's June-<1991 E c o n o m ic Statement and reiterated in the 1991-92 Budget papers. Victoria is ilbt the o n ly G overnm ent to run Budget deficits in the current economic environment byt was

the first to address these in the context o f 3 year Budget planning projections.

U is intended that these borrowings w ill be reported to Loan Council, including their p ro gressive repayment As w ell, the borrowings fo r the 1989-90 and 1990-91 deficits h ave a lread y been reported as part o f the State debt and the accumulating deficits will co ntin u e to b e so reported until repaid. „

V ic to ria has developed a strategy fo r the repayment o f the deficits consisting vf two legs. T h e first leg consists o f dedicating the proceeds o f business asset sales i s thev occur to repayments of debt. It is expected chat the process w ill commence p rio r to 30 June 1 9 9 2 . T he second leg involves moving towards Budgets which are structurally sound a n d achieve a return to current surpluses. T o this end. the Government has in trod u ced significant adjustments to its outlays and capital expenditure subsequent to the B ud g et. Nevertheless, the projected recurrent deficit for 1991-92 o f S786 million in c lu d in g the Budget Planning Projections w ill be exceeded and it is not now likely we w ill be ab le to achieve the published targets for 1992-93 and 1993-94. H ow ever, the G o v e rn m e n t remains committed to its strategy o f restraining the size o f the deficits and re tu rn in g the Budget to recurrent surpluses which can be used to repay the accumulated deficits.

In a separate letter to you. I have explained the steps being taken by Victoria td.concrol the level o f outlays and to increase revenue. As you are aware, Victoria has been p a rtic u la rly affected by the current recession and suffers significant losses lio m the a p p lica tio n o f the Fiscal Equalisation principles.

In a d d itio n , the Government is commissioning a review o f the performance o f the p u b lic sector with toe ourpose o f obtaining mcependen: sc vise on a .number o f issues a s s o c i a t e s w it h me cuafity. cu a r.v.rv a r c erfectiven.ess o f service c e iiv e r y o u tc o m e s a rc

• m a r . c ia . m a n a g e r ·:· .:. it .5 e x r e c t e a m at me : e · .ie .v . a - c - : : : c in e : m atters l „ . assist m a n a g e r · :'.:. ·. - Λ

- 3 -

the Government in addressing options for delivering lines o f service delivery In AiAjre years.

V ic to ria believes that the refinancing of its accumulated deficits provides for the prudent management o f its borrowings and is consistent w ith the Government's commitment to the conversion o f its current Budget deficits into future surpluses >nd the use o f these to repay the accumulated deficits.

W ith regard to Loan Council reporting requirements, I have agreed that the borrowings fo r the deficits arc temporary purpose borrowings. H ow ever. I would be please# to receive your views on alternative arrangements for the reporting o f the borrowing} to Loan Council and on the arrangements Victoria should enter into to obtain .the

necessary agreement from the relevant bodies. . -

Yours sincerely

TONY SHEEHAN Treasurer

Treasury Reference: F9108191R (F G 010001)

Appendix E 173

Executive Minute from

Mr J Wright to Hon John Dawkins,

23 July 1992

C O N F ID E N T IA L

TREASURY EXECUTIVE MINUTE

File:

Date: 23 July 1992

The Treasurer

V IC T O R IA N L O A N C O U N C IL - O P T IO N S

You asked for options regarding possible Commonwealth responses to the two major Loan Council issues raised by Victoria:

• exemption of Loy Yang B from the global limits; and

• approval o f a special temporary addition to accommodate borrowings of $1.3 billion in respect of accumulated Victorian budget deficits over the period 1989-90 to 1991-92.

Loy Yang B

2. This proposal has been developed over a long period of negotiation between ourselves and the Victorians. We have been trying to use possible exemption from the Loan Council global limits to encourage Victoria to introduce greater private participation and commerciality into the project Some significant concessions from

Victoria have been extracted but the proposal as it currently stands falls short of the requirements for exemption.

• The most significant difficulties relate to the Victorian government guarantee to stand behind the SECV's obligations in respect of the 30 year take or pay contract for Loy Yang B; and the constraints on selling direct to other purchasers than the SECV.

3. The options are:

a). To approve exemption o f Loy Y an g B

Given that the proposal does not meet the requirements for exemption, the Commonwealth would be unwise to formally recommend exemption to the other States without first taking some soundings o f likely attitudes.

• If major States such as NSW or Queensland objected, the Commonwealth would need to reconsider its position. Approval for special additions

r n X P T D F X T i S f

2

is normally sought on a consensus basis but there are no explicit requirements set out for approval. To force approval of a proposal of such dubious merit in the face of significant opposition would raise severe doubts about the credibility and durability of the Loan Council arrangements.

• If there was general support the Commonwealth could go ahead and formally endorse the Victorian proposal.

- However, such endorsement would need to be couched in terms that underlined the marginal nature of the case.

b ) Reject exemption w h ile the guarantee form ed p a rt o f the proposal

The desirable Victorian reaction to rejection would be to renegotiate the private participation to make the deal conform with Loan Council guidelines.

• However we would not regard this as likely.

• Given that the project is under construction and contracts have been entered into, there appears to be no alternative to Loy Yang B going ahead with or without private participation.

- Rejection would therefore force Victoria to proceed either in defiance of Loan Council or with a special addition under the global limits.

c) G ra n t a special a d d itio n fo r Loy Y ang B

There are no fundamental reasons why Loy Yang B would not qualify for a special addition.

• Some Sates may question certain elements of the proposal but nearly all have benefitted from "flexible" special additions and are unlikely to upset the cart

• The volume o f the necessary borrowings - of the order of $3.3 billion - may raise some questions. Given that substantial work has been completed on Loy Yang B, Victoria has presumably borrowed some of this money already. These borrowings should have been offset against the global borrowing limits in the years in which they were incurred.

- However, it is possible that Victoria anticipated approval of exemption o f Loy Yang B and any existing borrowings are in excess of Loan C ouncil limits. We have no evidence that this is the case but it would be in line with some of Victoria's other actions.

• If we assume that none of the S3.3 billion has been borrowed within existing global lim its but the 40% private participation is retained, then a special addition o f around S2 billion would be required.

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• If the failure to obtain exemption led to the private participation being unwound then a special addition o f $3.3 billion would be required.

- This compares with Victoria's global limit of $ 1.1 billion for this year.

Accumulated Budget Deficit

4. Over the period 1989-90 to 1991-92 the Victorian Government has built up short term borrowings o f $1.3 billion to assist in funding its budget deficits. The Victorian Treasury have indicated that a further $1.1 billion is expected to be required to fund deficits over the next two years. In the light o f budget projections supplied to us, this

expectation would seem to err on the optimistic side.

The accumulated deficits have been funded through accessing funds of Victorian statutory authorities via the issue of 30 to 60 day Treasury Bills. These rrangements are described by the Victorian Treasury as "becoming unstable". Consequently on 1 May 1992, VicFin borrowed $1.3 billion, maturing in 1995.

• Victoria intends that these borrowings be repaid from recurrent budget surpluses over the five years from 1993-94.

- We have a draft of a letter from the Victorian Treasurer to you requesting a special addition to Victoria's global borrowing limits to cover the $ 1.3 billion already borrowed. While it is not mentioned in the draft letter, Victorian officials have made it clear that special

additions for budget deficits in 1993-94 and possibly 1994-95 would also be sought

5. The options are:

a) Agree to the Victorian request

As in the case of Loy Yang B, it would be unwise for the Commonwealth to formally adopt a position without taking some soundings on the attitudes of other States.

• As noted, special additions have been granted on a very flexible basis. Nonetheless, special additions for financing of budget deficits would raise questions about the very purpose o f the global limits and, at the very least other States may seek similar treatment

- Hence, any endorsement of the proposal should be couched in suitably stentorian tones.

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b) Agree w ith conditions

While recognising the limited short term options available to Victoria, this approach would articulate clear measures aimed at returning its budgetary situation to a sound structural basis.

• The conditions would also be aimed at making recourse to such borrowings unattractive to other States, because of the loss of budgetary flexibility and the odium of being seen to be subject to intrusive conditions and. perhaps, monitoring by outside bodies. Possible conditions include:

(i) a requirement that any special addition be clawed back from Victoria's global limits from 1994-95.

• The claw back could be spread over 3 years. This would still require a reduction in available limits from $1.1 billion this year to about $0.6 billion and similar reductions in the following two years. These reductions could only finally be decided after an assessment as to

what was feasible in the light of practical improvements in Victoria's budget d eficit

(ii) a requirement that Victoria provide far more comprehensive reporting of government transactions to the Commonwealth Treasury for the duration of the arrangements.

• This would have some resource requirements on our side if this information were to be effectively used.

Options (i) and (ii) obviously have little short term bite apart from the adverse publicity which would inevitably arise even in the absence o f any public announcement All members of Loan Council would have to know of the arrangements and a condition could be imposed that they have to be announced in the forthcoming Victorian budget on 12 August

(ifi) a requirement that Victoria allow an independent committee to inquire into its financial arrangements and budgetary position with a view to providing an urgent report to the Commonwealth and/or Loan Council.

• Such an inquiry would require at least 3 months to work and could comprise ourselves, Finance and a representative from the Victorian private sector as well as an independent chairman.

Option (iii) would have a slightly greater short term focus although once again its main impact would be presentational.

(iv) a requirement that Victoria com m it itself to a detailed budget strategy commencing in 1992-93 and aimed at generating reductions in deficits over 3 years sufficient to offset the borrowings.

5

• The baseline budget projections would obviously be crucial in determining this option.

The Victorians are aiming for a recurrent surplus in 1994-95. Baseline projections for the period 1992-93 to 1995-96 could be developed on the basis of a zero recurrent deficit in 1994-95 and steady structural improvement in the budget from 1992-93 to 1995-96. The projections would need to aim for additional savings against the baseline of

1992- 93 $300m 1993- 94 $500m 1994- 95 $800m 1995- 96 $800m

to reduce the budget deficits by the projected $2.4 billion borrowing requirement.

• Conditions could be imposed to ensure that these budgetary gains arise mainly from improved returns from GBEs through more efficient management and/or privatisation, rationalisation of service levels and improved efficiencies in service delivery. Increases on the revenue side o f the budget would need to be limited.

Option (iv) would have significant short term impact given that it would affect 1992-93 budget decisions. It would also be broadly in line with the professed intentions of the Victorian Treasurer, although presumably significantly more rigorous than he has in mind.

(v) approval o f the special addition could be limited to 3 or 6 months with Victoria required to unwind the arrangements at the end of that time.

• It would obviously not be possible for Victoria to achieve any substantive change in its fiscal position within that time. Even a privatisation of a significant GBE would take longer than 6 months.

• Victoria's only alternative would be to fall back on the previous short term financing arrangements. However, we are inclined to believe that Victoria would not have made this request, with the consequent risk o f having to expose its dirty laundry, unless those arrangements

were becoming genuinely unworkable.

Option (v) would force Victoria into a comer without allowing the time for the underlying problems to be sensibly addressed.

Refuse the Victorian request

Refusal of the Victorian request would leave them with the option of unwinding the arrangement w ith the problems outlined in B(v) or of defying Loan Council. In the latter case, the Commonwealth has two opuons:

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• The Commonwealth could withhold payments of financial assistance grants (FAGs) to Victoria to the amount o f $ 1.3 billion, or a lesser amount if so desired.

- In the absence o f legislation, these payments can only be delayed and would have to be paid by 30 June 1993. If the payment were to be permanendy withheld, authority would have to be incorporated in this years States Grants (General Purpose) Bill. A similar clause was inserted in the 1988 Bill against the possibility of Queensland breaching Loan Council guidelines. Of course, such a provision may face opposition in the Senate. In any event, there would be potentially very serious financial market and other consequences in the Commonwealth withholding payments from Victoria.

• The Treasurer could make a public announcement regarding Victoria's breach of the Loan Council arrangements and distancing the Commonwealth from Victorian borrowing arrangements. However, this could have (unpredictable) adverse market consequences in respect o f

Victoria's debt.

- Either of these options would force Victoria into a comer without addressing the fundamental problems.

Recommended Strategy

6. A major concern must be to protect the credibility of the Loan Council . arrangements. While Victoria has clearly not com plied with the spirit or the letter of those arrangements, they may have been a restraining influence and, indeed, have been the catalyst for finally revealing their difficulties. The authority flowing from those arrangements can now provide us with some extra leverage in dealing with these current problems.

7. The accumulated budget deficits are the major problem and it would be desirable to put Loy Yang B on hold until we have som e progress on the deficits.

• This would also increase the pressure on the Victorian government to be cooperative.

8. A first step could be for you, or the Prime Minister, to write to the Victorian government setting out our serious concerns about the proposal in respect o f the budget deficits and suggesting that urgent consultation at the officials level should be initiated with a view’ to developing some options to address the issue.

• This would allow us to gain more inform ation and to encourage the Victorians to participate in developing a package which addresses their problems while protecting, as far as possible, the credibility of the Loan Council arrangements.

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9. For your consideration. I have not copied this minute to other Ministers. However a copy has been passed to the Secretary of the Department o f Prime Minister and Cabinet

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Jim Wright Assistant Secretary State and Local Government Finances Branch

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Appendix F 183

The Treasury - Supplementary Submission

Dated 7 September 1993

- ------ I - - .. ■ . . . .

J

TELEPHONE: <0ί) M3 373* FA CSIM ILE

O FFICE O F THE SECRETARY CANBERRA ACT MM

THE TREASURY

Mr P. C. Grundy Committee Secretary Senate Select Committee on the Functions, Powers and Operation of the Australian Loan Council

20.3 Parliament House - CANBERRA ACT 2600

Dear Mr Grundy

F IN A N C IA L A G R E E M E N T B E T W E E N T H E C O M M O N W E A L T H A N D T H E

S TA TES

I refer to your letter of 30 July 1993 requesting a supplementary Treasury submission on the proposed amendments to the Financial Agreement that were agreed in principle by Loan Council in June 1992.

A brief submission on the issue is attached. It should be read in conjunction with the relevant paragraphs of Treasury's submission of 24 November 1992 to the Committee.

Yours sincerely

/ E.A. Evans

Secretary to the Treasury

S U B M IS S IO N T O T H E S E N A T E S E L E C T C O M M IT T E E O N T H E F U N C T IO N S , P O W E R S A N D O P E R A T IO N O F T H & A U S T R A L IA N L O A N C O U N C IL

F IN A N C IA L A G R E E M E N T B E T W E E N T H E C O M M O N W E A L T H A N D T H E

S T A T E S

This submission indicates the state of play with respect to proposed amendments to the Financial Agreement It supplements, and should be read in conjunction with. Treasury's submission to the Committee of 24 November 1992.

2. In June 1992 Loan Council resolved, in principle, to amend the Financial Agreement to remove its obsolete provisions and simplify its administration. The resolution was the consequence of changes that had taken place in the previous decade in the arrangements for public sector borrowings in Australia.

• These changes included the adoption by Loan Council of a voluntary system of oversight of borrowings, the advent of State central borrowing authorities so that the States no longer needed the Commonwealth to borrow on their behalf under the terms of the Financial Agreement, and decisions in the late 1980s to give individual States and Territories responsibility for managing their own debt and to be accountable to financial markets for their actions.

3. The proposed amendments to the Financial Agreement are also consistent with the philosophy of the new Loan Council arrangements agreed in December 1992, details of which were endorsed by Loan Council at its 5 July meeting. These voluntary arrangements are designed to enhance the role of financial market scrutiny as a discipline on the net borrowings of the public sector and build on the move to greater responsibility and accountability of States for their own finances.

4. As announced by the Treasurer following the June 1992 Loan Council meeting. Loan Council has agreed in principle to amend the Financial Agreement to:

• abolish the restriction on States' borrowing by the issue of securities in their own names in domestic and overseas markets;

• remove the Commonwealth's explicit power to borrow on behalf of the States;

• remove the requirement for future Commonwealth and State borrowings to be approved under the provisions of the Financial Agreement;

• remove references to the National Debt Sinking Fund; and

• include the Northern Territory and the Australian Capital Territory as members of Loan Council and as parties to the Financial Agreement

5. The amendments would be given effect by the passage of complementary Commonwealth, State and Territory legislation.

2

6. Draft amendments have been prepared by the Attorney-General's Department and were circulated to State and Territory officials in May 1993 for comment Most jurisdictions have now provided comments on the draft and these arc currently being reviewed by the Attorney-General's Department Once this process is complete, a

revised draft will be circulated for final comment at the officials' level before being submitted to Loan Council for approval via correspondence. The legislative process in each jurisdiction would follow.

7 At this stage it is proposed that Commonwealth legislation to approve the revised Financial Agreement would be introduced late in the Budget Sittings. The revised Financial Agreement would not become effective until all jurisdictions had enacted complementary legislation. It is not expected that this process would be completed in

less than six months from the time of Loan Council approval.

8. The amendments proposed are as set out in paragraph 4 above (and announced by the Treasurer on 12 June 1992). The specific legislative drafting gives effect to these amendments and includes some additional technical detail in respect of implementation

(eg, on arrangements to handle future repayments by the States of Financial Agreement debt issued by the Commonwealth on their behalf).

• Details of the proposed amendments have not yet been settled at the officials' level between the Commonwealth and States/Territories and have not yet been put to Ministers.

9. Treasury's earlier submission to the Committee noted that the proposed amendments to the Financial Agreement would leave it "with little substance". This is because the amendments would simply recognise the reality that the Financial Agreement has for many years played no role in controlling State borrowings and a purely formal role in relation to Commonwealth budget sector borrowings.

• The amended Financial Agreement would provide for the existence of a Loan Council with broadly specified role and powers but no binding legal powers over future borrowings, and specify certain obligations in relation to past borrowings (eg, interest payments on old debt).

• Borrowings by the Commonwealth, States and Territories would be subject to Loan Council control under the new voluntary monitoring and reporting arrangements agreed by Loan Council in December 1992 and July 1993.

10. At its December 1992 meeting Loan Council noted that the then Loan Council arrangements were established by voluntary agreement between the Commonwealth and the States and that Loan Council should continue to operate on the basis of collective decision-making. Loan Council considered that the new arrangements should involve

greater disclosure and accountability of each government's financial performance rather than further centralisation of Loan Council controls.

11. As noted, the key amendments would simply bring the formal terms of the Financial Agreement into line with the way Loan Council has operated for many years.

3

• Apart from borrowings under the Commonwealth’s so-called 'Hunting Licence', borrowings by all jurisdictions have been coordinated for many years under the voluntary global approach resolution and not under the Financial Agreement.

- This has reflected the use by the States of central borrowing authorities, outside the Financial Agreement, to undertake their budget sector borrowings (and the fact that semi-government and local authority borrowings have never been covered by the Financial Agreement).

- The Financial Agreement requires the Commonwealth to seek Loan Council approval (the 'Hunting Licence') for borrowings other than for refinancing, temporary purposes and defence expenditure.

: This requirement now overlaps with the requirement that the Commonwealth nominate a Loan Council Allocation each year under the new Loan Council monitoring and reporting arrangements.

: It is proposed to remove the Hunting Licence requirement so that Commonwealth borrowings are treated on the same basis as those of the States and Territories.

12. In short, new Loan Council arrangements provide for better co-ordination of Commonwealth, State and Territory borrowings, but the Financial Agreement - beyond providing for the existence of the Loan Council - has no specific role.

13. The other amendments - the removal of references to the National Debt Sinking Fund, the removal of the Commonwealth's explicit power to borrow on behalf of the States (not utilised since 1987-88 - see paragraphs 57-60 o f Treasury's earlier submission), and the inclusion o f the Territories as members o f Loan Council - are all designed to either delete obsolete provisions of the Agreement or otherwise bring it up to date and improve its administration.

The Treasury Canberra ACT 7 September 1993

Appendix G 189

Submissions

I

SUBMISSIONS

The Treasury, Canberra ACT The Treasury, Canberra ACT The Treasury, Canberra ACT Institute of Public Affairs Ltd, Jolimont VIC

Mr M Gawan-Taylor, Red Hill ACT Mr R G Webster, Blackburn NSW City of Werribee, Werribee VIC

Mr John P McAuley, Turramurra NSW Mr John P McAuley, Turramurra NSW Mr John P McAuley, Turramurra NSW Australian National Audit Office, Canberra ACT Australian National Audit Office, Canberra ACT Local Government Association of South Australia, Adelaide SA Municipal Association of Victoria, Melbourne VIC Schraders Australia Ltd, Sydney NSW Professor Cheryl Saunders, Melbourne VIC Australian Bureau of Statistics, Canberra ACT Australian Bureau of Statistics, Canberra ACT Business Council of Australia, Melbourne VIC Transfield Projects Pty Ltd, North Sydney NSW (In Confidence) Mrs G H Hammond, Port Noarlunga South SA Victorian Employers' Chamber of Commerce and Industry, Hawthorn VIC Australian Citizens Action Network, Footscray VIC Treasury Corporation of Victoria, Melbourne VIC (In Confidence) Australian Securitisation Forum, Sydney NSW Mr Graham Rogers, University of Canberra, Canberra ACT Hon Alan Hunt AM, Melbourne VIC Professor R R Officer and Mr Saul Eslake, Melbourne VIC City of Berwick, Malvern VIC S H Allen, Malvern SA Mr Peter Lock, Largs Bay SA KPMG Peat Marwick, Melbourne VIC (In Confidence) Mr Paul T Haylen, Randwick NSW Victorian Auditor-General's Office, Melbourne VIC County NatWest Australia Ltd, Sydney NSW

.

.

Appendix Η 193

Public Hearings and Witnesses

PUBLIC HEARINGS AND WITNESSES

Tuesday 15 December 1992 Committee Room 1S3 Parliament House CANBERRA ACT 2600

Cassidy, Mr Brian David, First Assistant Secretary, Fiscal Policy Division, Department of the Treasury, ACT

Cole, Mr Anthony Stuart, Secretary, Department of the Treasury, ACT

Fraser, Mr John Arthur, Deputy Secretary (Economic), Department of the Treasury, ACT

Wright, Mr James Stanley, Assistant Secretary, State and Local Government Finances Branch, Department of the Treasury, ACT

Tuesday 19 January 1993 Committee Room 2S1 Parliament House CANBERRA ACT 2600

Allender, Mr Brett Samuel, Chief Economist, Schraders Australia Ltd, NSW

Lucas, Mr Neil Bedford, Chief Executive and Town Clerk, City of Berwick, Municipal Association of Victoria, VIC

Moore, Mr John Desmond Cuthbertson Carty, Senior Fellow, Institute of Public Affairs, VIC

Morris, Mr Stephen John, Associate Director, Schraders Australia Ltd, NSW

Murphy, Councillor Anne, Chairman, Finance and Legal Standing Committee, Municipal Association of Victoria, VIC

Pensabene, Mr Tony, Senior Economist, Municipal Association of Victoria, VIC

Wednesday 20 January 1993 Committee Room 2S1 Parliament House CANBERRA ACT 2600

Gawan-Taylor, Mr Michael, ACT

Gibbons, Councillor John Ernest, City of Werribee, VIC

Kerr, Mr John Thomas, Town Clerk, City of Werribee, VIC

McAuley, Mr John Patrick, NSW

Russell, Mr Christopher John, Manager, Economic and Community Development, Local Government Association of South Australia, SA

Saunders, Professor Cheryl Anne, Director, Centre for Comparative Constitutional Studies, University of Melbourne, VIC

Monday 21 June 1993 Committee Room 1S3 Parliament House CANBERRA ACT 2600

Castles, Mr Ian, Australian Statistician, Australian Bureau of Statistics, ACT

Cochrane, Mr Warren John, Executive Director, Special Projects Branch, Australian National Audit Office, ACT

Edwards, Mr Robert William, First Assistant Statistician, Economic Accounts Division, Australian Bureau of Statistics, ACT

Efford, Mr Don, Assistant Statistician, Public and Private Finance Branch, Australian Bureau of Statistics, ACT

Fraser, Mr John Arthur, Deputy Secretary (Economic), Department of the Treasury, ACT

Lennie, Mr Douglas Stuart, Executive Director, Industry, Commerce and Finance Group, Australian National Audit Office, ACT

Nicholls, Mr Donald Frederick, NSW

Rogers, Mr Graham Charles, University of Canberra, ACT

Taylor, Mr John Casey, Auditor-General, Australian National Audit Office, ACT

Williams, Mr Gregory Malcolm, Group Director, Industry, Commerce and Finance Group, Australian National Audit Office, ACT

Wright, Mr James Stanley, Assistant Secretary, State and Local Government Finances Branch, Department of the Treasury, ACT

Wednesday 23 June 1993 Legislative Council Committee Room Parliament House MELBOURNE VIC 3002

Eslake, Mr Saul Richard, National Mutual Funds Management, VIC

Hunt, Hon Alan John, VIC

Nicholls, Mr Barry Newton, Secretary, Department of Planning and Development, VIC

Officer, Professor Robert Rupert, University of Melbourne, VIC

Yeoh, Mrs Barbara May, Executive Director, Oxley Corporate Finance Ltd, VIC

Tuesday 27 July 1993 Committee Room 2S3 Parliament House CANBERRA ACT 2600

Greiner, Hon Nicholas Frank, NSW

Shogren, Mr Rodney Francis, First Assistant Secretary, Fiscal Policy Division, Department of the Treasury, ACT

Walker, Professor Robert Graham, University of NSW, NSW

Wright, Mr James Stanley, Assistant Secretary, State and Local Government Financial Relations, Department of the Treasury, ACT

Friday 6 August 1993 Legislative Council Committee Room Parliament House MELBOURNE VIC 3002

Baragwanath, Mr Ches, Auditor-General, Victorian Auditor-General's Office, VIC

Coughlin, Mr Paul Antony, Director, Standard and Poor's Ratings Group, VIC

Elzink, Mr Frederik Jan Hendrik Rudolph, Director, Financial Operations, Department of the Treasury, VIC

Jarman, Mr Wayne Arthur, Managing Director, Treasury Corporation of Victoria, VIC

Mitsas, Mr Steven, Director of Audit, Victorian Auditor-General's Office, VIC

Sams, Dr Dennis Charles, General Manager, Finance, Department of the Treasury, VIC

Smith, Dr Robert, VIC

Stockdale, Hon Alan Robert, Treasurer, Government of Victoria, VIC

Tregilgas, Mr Alan Jeffrey, Director, Standard and Poor's Ratings Group, VIC

Walker, Mr Russell Alistair, Chief Director of Audit, Victorian Auditor-General's Office, VIC

Friday 20 August 1993 Committee Room 2S2 Parliament House CANBERRA ACT 2600

Cole, Mr Anthony Stuart, Secretary, Department of Health, Housing, Local Government and Community Services, ACT

Friday 8 October 1993 Legislative Council Committee Room Parliament House MELBOURNE VIC 3002

Dodd, Dr Peter Raymond, Fay, Richwhite Australia, VIC

Emery, Mr Peter John, Under Treasurer, Treasury Department of South Australia, SA

Fraser, Mr Bernard William, Governor of the Reserve Bank, NSW

Lennie, Mr Douglas Stuart, Executive Director, Statutory Authority Financial Statement Group, Australian National Audit Office, ACT

Nelson, Mr William George, Acting National Business Director, Financial Audit, Australian National Audit Office, ACT

Taylor, Mr John Casey, Auditor-General, Australian National Audit Office, ACT

Vertigan, Dr Michael John, Secretary, Department of the Treasury, VIC

Wright, Mr John Robert, Under Treasurer, Treasury Department of South Australia, SA

Appendix I 201

Invitees Who Declined to Attend

INVITEES WHO DECLINED TO ATTEND

Allan, Mr Percy, Secretary to Treasury of NSW

Bannon, Hon John, MLA

Dawkins, Hon John, MP

Fahey, Hon John, MLA

Fowler, Mr Stuart, County Natwest

Gray, Hon Robin, MHA

Kirner, Hon Joan, AM, MLA

Marshella, Mr Tom, Moody's Investors Service

Bundle, Hon Tony, MHA

Sheehan, Hon Tony, MLA

Walsh, Professor Cliff, University of Adelaide

White, Hon David, MLC

Appendix J 205

Chronology

CHRONOLOGY

1890s

1901 -

1923

1927

1928

1929

1936

1942

1951

1978

Part I: Government Borrowing in Australia 1890s - 1993

Borrowings by the colonial governments are a major subject of discussion at the Australian Constitutional Conventions.

23 Government borrowings remain a central issue in the

financial relationships between the newly-created Commonwealth and State governments.

The Voluntary Loan Council is formed.

The Financial Agreement is made.

The Australian Loan Council is established on a permanent, statutory basis.

The Financial Agreement Validation Act is passed.

The Gentlemen's Agreement is implemented.

The Commonwealth Government assumes uniform taxation powers.

The States agree to an arrangement under which the Commonwealth would underwrite State loan proposals up to a figure that it would determine.

The Loan Council adopts the Infrastructure Borrowing Program; this is largely an extension of the Gentlemen's Agreement.

1984

1992

1993

1982 A decision is made by the Loan Council to exclude from its

purview for a trial period of three years the borrowings of State electricity authorities.

The Global Borrowing Limits are introduced.

The Public Sector Borrowing Requirement arrangements are implemented.

The Deficit/Surplus and Loan Council Allocation reforms are introduced.

Part II: Victoria's Breach of its 1991 - 92 Global Borrowing Limit

June 1990 The rating group, Moody's Investors Service Pty Ltd,

downgrades Victoria's credit rating.

May 1991 Moody's Investors Service downgrades Victoria's credit

rating for the second time.

May - December 1991 Commonwealth Treasury officers express their concerns about Victoria's economy to the Victorian State Treasury.

Early 1992 The Victorian Treasury informs VicFin that the temporary financial accommodation needed by 30 June 1992 would require a total Victorian Development Fund balance sheet of at least $3.2 billion.

12 February 1992 The VicFin board advises the Victorian Treasurer that the non-global funding requirement is not achievable and that the government should approach Loan Council to have the shortfall funded within global limit requirements.

22 April 1992 The Premier of New South Wales, Hon Nick Greiner, writes to Hon John Dawkins as Chairman of the Loan Council requesting a Loan Council review of recent Victorian sale and lease-back arrangements. He also requests that the

Loan Council institute arrangements to monitor non­ standard transactions to ensure that the global limit guidelines can be applied both correctly and consistently. Mr Dawkins does not respond to this letter.

Late April 1992 The Victorian Treasury, at the direction of the Victorian Treasurer, instructs VicFin to refinance past deficits estimated at $1,267 billion with medium-term funding.

From 1 May 1992 Victoria undertakes a medium-term borrowing of $1.267 billion to rollover short-term financing of Budget deficits for the years 1989-90 to 1991-92. This action is a breach of Victoria's Loan Council global borrowing limit.

12 June 1992 The Loan Council meets. Mr Dawkins, as Chairman of the Loan Council, does not raise the issue of Victoria's sale and lease-back arrangements specified in Mr Greiner's letter of 22 April.

17 June 1992 At a meeting of Commonwealth and Victorian Treasury officials, the Commonwealth is informed for the first time that Victoria has breached its global borrowing limit. A copy of an undated and unsigned draft letter from the Victorian Treasurer, Hon Tony Sheehan, to Mr Dawkins as

Chairman of the Loan Council is provided to

Commonwealth Treasury officers.

25 June 1992 The Victorian Treasury briefs Commonwealth Treasury officers on the refinancing and provides a copy of an unsigned draft letter dated 24 June 1992 from the Victorian Treasurer, Hon Tony Sheehan, to Mr Dawkins. This draft is an expanded version of the unsigned letter provided on

17 June.

6 July 1992 Commonwealth Treasury officials brief the Federal

Treasurer, Mr Dawkins, about the Victorian refinancing.

Late July 1992 Upon advice from the Treasury, Mr Dawkins decides not to make public Victoria's breach of Loan Council arrangements.

3 October 1992 The Victorian Labor Government is defeated at a State election.

26 October 1992 The Treasurer in Victoria's newly-elected Liberal-National Party Coalition Government, Hon Alan Stockdale, makes public that Victoria has exceeded its Loan Council global borrowing limit.

3 November 1992 The Senate appoints a select committee to inquire into and report upon the functions, powers and operation of the Australian Loan Council.

7 December 1992 At a meeting of the Loan Council, a 'special addition' is granted to Victoria to regularise its 1 May refinancing of

$1.267 billion, confirming that Victoria's borrowing during 1991-92 has exceeded its global borrowing limit for that year by this amount.

1 March 1993 The Senate Committee presents an Interim Report.

12 May 1993 The Senate reappoints the Committee to again report on the functions, powers and operation of the Australian Loan Council on or before the first sitting day in September 1993.

18 August 1993 The Senate passes a motion to extend the time for the presentation of the Committee's report to 16 November 1993.

30 September 1993 The Senate Committee tables its second report.

16 November 1993 The Senate passes a motion to extend the time for the presentation of the Committee's report to 25 November 1993.

24 November 1993 The Senate passes a further motion providing an extension of time to report until 9 December 1993.

9 December 1993 Another motion is passed by the Senate extending the time to report to 15 December 1993.

V

Appendix K 213

Interim Report -

Conclusions to Chapter 2:

Victoria's Breach of Global Limits

Interim Report - Victoria's Breach of Global Limits 215

Interim Report - Chapter 2

Victoria’s Breach of Global Limits

CONCLUSIONS

2.56 It is not appropriate for the Committee to make conclusive findings

about the Victorian Loans Affair, given that key witnesses have not been heard.

However, interim conclusions can be drawn, as follows:

1 . Victoria's conversion of $1,267 billion of 'internal' debt to medium-term

borrowings from the private sector on 1 May 1992 was a clear breach

of its agreed borrowing limits.

2. No attempt was made by the Victorian Government to inform the

Commonwealth Treasurer as Chairman of the Loan Council, or to seek

his approval of an increased limit before the breach occurred.

3. The Commonwealth Treasurer and Treasury consistently expressed

concerns about Victoria's budgetary problems, with little apparent

impact.

2.57 The evidence given to the Committee by the Commonwealth Treasury

indicates that by the time the Victorian Under Treasurer met with the Secretary of the

Commonwealth Treasury on 17 June 1992, it should have been clear that the

conversion by Victoria on 1 May 1992 of short term borrowings into medium-term

borrowings could have constituted a breach of the State's global borrowing limit.

2.58 The question then arises: should more have been done by the

Commonwealth? On the evidence before the inquiry, there were two options available:

216 Appendix K

(a) publicise the breach; and (b) threaten to cut Commonwealth grants.

2.59 Cuts to grants have been counselled against because of their potential

to further degrade an already poor budgetary situation. As Mr J Wright, Assistant

Secretary (State and Local Government Finances), said in his minute of 23 July 1992:

there would be potentially very serious financial market and other consequences in

the Commonwealth withholding payments from Victoria1 .1 Mr Moore submitted that

the Commonwealth should use its power to withhold part or all of a State's general

revenue grant only in extremis where it was evident that a State's fiscal behaviour (or

potential behaviour) was damaging the national economy or threatening to do so.2

2.60 Publicising the breach appears to have been a more viable option, but

this was not adopted. The fact that the extra borrowings were not included in the

relevant table of Budget Paper No.4 has been justified in the following terms by the

Commonwealth Treasurer and Treasury officials:

(a) The Commonwealth is bound to accept the States' figures on new borrowings, and Victoria was not prepared to acknowledge the new borrowings as a breach.

2.61 This is contradicted by the Commonwealth's inclusion in the Budget

papers of estimates of Queensland's borrowings when Queensland refused to provide

those details. Given that the Commonwealth is the author of the Budget papers, it is

reasonable that the best information available to the Commonwealth be published.

(b) The exact status of the new borrowings, and in particular the extent to which they drew on private sector funds, was not clear at the time.

2.62 The Victorian Treasury, in its official advice to the Commonwealth on new

1 Tabled in the House of Representatives, 3 November 1992.

2 Mr Moore, Official Hansard Report, 19 January 1993, p.259.

Interim Report - Victoria's Breach of Global Limits 217

borrowings dated 24 July 1992, claimed that the $1,267 billion were temporary

purpose borrowings and therefore not covered by the global approach.

2.63 However, at the 17 June 1992 meeting between the Victorian Under

Treasurer, Dr Bob Smith, and the Secretary to the Commonwealth Treasury, Mr A S

Cole, the latter was given an undated draft letter from the Victorian Treasurer to the

Commonwealth Treasurer. The letter explained that Victoria's accumulated Budget

deficits for 1989/90 and 1990/91 and the Budget deficit for 1991/92 amounted to $1.3

billion. The accumulated deficits had been financed on a non-global basis by short

term loans by the Victorian Development Fund (VDF). However, it was no longer

prudent to finance the accumulated deficits by short term borrowings from the VDF.

As funding requirements were of a medium term nature, it had been considered

prudent to convert the short term borrowings to medium term. The letter stated: the

short term non-global borrowings for accumulated deficits amounting to $1,267 million

were refinanced on 1 May 1992 by the Victorian Public Authorities Finance Agency

(VicFin) on behalf of the Capital Works Authority'.

2.64 The letter suggested that, for Loan Council purposes, the accumulated

deficits be treated as temporary purpose borrowings outside the global limits, similar

to temporary purpose borrowings within the year, since they were a consequence of

the current downturn in the Victorian economy and were to be repaid from future

projected Budget surpluses. 'However', the draft letter went on, 'as an alternative,

Victoria could argue a case for a special addition to the global program to

accommodate this refinancing'.3

2.65 It is evident from this letter that the Victorian Treasurer realised that the

'refinancing' of the $1.267 billion accumulated deficits on 1 May 1992 constituted a

breach of global limits. The meeting on 17 June 1992 was the first occasion on which

the Victorian Treasury had acknowledged this to their Commonwealth counterparts.

3

Victoria Treasury reference F9108191R. The letter was released by Treasurer Dawkins' office on 8 November 1992.

218 Appendix K

However it provided Treasurer Dawkins with enough information to have included a

reference to the dubious status of this additional debt in Budget Paper No 4.

2.66 The fact that Victoria said one thing in official correspondence, and

another in informal communication - the Kirner Government made no formal request

for retrospective Loan Council approval before it lost power - appears to have been

an attempt to play for time to prevent the news from getting out in advance of the

Victorian election on 3 October 1992. On the evidence available, Victoria knowingly

misrepresented the facts in its 24 July advice to the Commonwealth. The

Commonwealth's unwillingness to set the record straight amounts to complicity.

Statements 1, 2 and 6 of Budget Paper No 1 (and in particular, Tables 1 and 2 of

Statement 6) provided information on public sector borrowings of the Commonwealth

and all the States, including Victoria's $1.267 billion. This amounted to an implicit

acknowledgment that a breach had taken place: the statement should have been

made explicit.

(c) Publicising the breach without a solution in place would have brought an adverse and costly market reaction.

2.67 There are several difficulties with this contention. First, it is contradicted

by the recent Loan Council agreement to improve routine reporting (which raises the

prospect of unwelcome figures being published without a solution in place) and by the

Treasury's assertion that greater accountability will impose a welcome discipline on

public sector borrowing. The longer a problem is kept secret, the greater the adverse

consequences will be, political as well as economic. The costs will be borne eventually.

2.68 Second, Victoria's well known scant regard for Loan Council controls

suggests that a solution (i.e. a 'structurally sustainable' budget) may not have been

possible without the embarrassment caused by adverse publicity. Repeated requests

for information and co-operation were rebuffed or delayed.

2.69 Third, it subjugates the principle of government accountability to the

Interim Report - Victoria's Breach of Global Limits 219

sensitivity of the market, a potentially dangerous precedent. Democratic principles

would suggest it was imperative that the Victorian public be told of this breach before

going to the polls, not after.

(d) The Loan Council controls are only voluntary and the emphasis has always been on co-operation.

2.70 This did not prevent Mr Keating as Treasurer from threatening to cut

grants to Queensland when that State threatened not to observe its allocated limits in

1988. In any case, it is plain from correspondence between Victoria and the

Commonwealth that Victoria's willingness to co-operate was extremely limited.

(e) The 1988 Queensland situation was different in that Mr Keating acted to head off a potential problem. The Victorian breach had already occurred and could not be reversed.

2.71 This misses the point that Victoria had on-going and major structural

budget problems requiring strong action to prevent an accelerating accumulation of

debt. In other words, there was a potential problem which required deterrent action.

Had the Commonwealth informed Victoria that it intended to publicise the breach in

the Budget papers, it would almost certainly have focussed the Victorian Government's

attention on its budgetary problems.

2.72 Evidence so far has not revealed that the Treasurer acted to protect the

Labor Government in Victoria against the advice of Treasury. However, it remains an

open question as to whether Treasury's advice was tailored to the understanding that

the Treasurer, Mr Dawkins, would not have compromised the Kirner Government in

an election year, if at all. There is ample evidence that the Loan Council has

traditionally operated as a cosy club, and that the actions taken in the Victorian case

were consistent with this culture. On the other hand, the evidence before the

Committee reveals no comparable breach of the limits.

220 Appendix K

2.73 Whatever the case, the Committee believes that the Treasurer's actions

had the effect of concealing a major breach of financial discipline from the public,

which had a right to know the truth. A legitimate alternative course was open to him.

2.74 It has been alleged that Victoria was forced into dubious borrowing

practices by cuts in Commonwealth grants.4 Indeed, it has been suggested that the

general slackness of the Loan Council controls allows a safety valve for States which

have been squeezed by grant cuts. This is a matter yet to be explored by the

Committee. Even if true, it does not excuse Victoria or the Commonwealth for

concealing a major symptom of the State's serious budget difficulties. It does suggest

directions for making the Loan Council a more effective instrument for

Commonwealth/State financial management.

4 Professor Russell Mathews, quoted in "Revamp Loan Council: Experts", The Age, 6 November 1992.

Appendix L 221

Interim Report -Dissent by Government Senators

Interim Report - Dissent by Government Senators 223

TABLE OF CONTENTS

CHAPTER 1

CHAPTER 2

CHAPTER 3

CHAPTER 4

CHAPTER 5

CHAPTER 6

APPENDIX 1

Introduction

Issues Arising under the Terms of Reference

Responses from State and Territory

Governments, and Former State Premiers

and Ministers, to the Committee

Role of the Loan Council

Local Government and the Loan Council

Conclusion and Recommendation

Minutes of Committee Meeting

held on 27 February 1993

224 Appendix L

Interim Report - Dissent by Government Senators 225

CHAPTER ONE

INTRODUCTION

1.1 An interim report, some 85 pages long, was circulated to Committee

members two to three days prior to the named date of a meeting on Saturday 27

February 1992.

1.2 Later less than 24 hours notice was given of a meeting for Saturday 27

February to be held in the Ansett Terminal, Melbourne Airport - a meeting called

without consultation.

1.3 A further set of amendments some sixteen pages long from the Liberal Party

members was circulated on the evening of Friday, 26 February. One member did not

secure a copy of these amendments.

1.4 At the meeting held on Saturday, 27 February, the majority of the Committee

(Deputy Chairman) Senator Sherry, Senator Faulkner and Senator Crowley) approved

a majority report.

1.5 The Chairman, Senator Coulter stayed for thirteen minutes. Senator Bishop

did not attend. Senator Alston's apologies were given, and the Committee was

informed that he was in hospital.

1.6 Following two hours of discussion, a majority report was prepared, moved

and carried.

1.7 In view of the obvious difficulty of meeting during the election period, the

meeting determined that the report be adopted as the final report of the Committee,

226 Appendix L

and that no further meetings be held prior to re-constitution of the Committee by the

full Senate in the next Parliament.

1.8 On Sunday afternoon, 28 February, with no consultation on date, time or

venue, a meeting was called for 4.15pm the next day, Monday, 1 March in yet another

airport lounge: the Australian Airlines Terminal, Sydney.

1.9 After fifteen minutes had elapsed, that meeting was abandoned for want of

a quorum. Senators Bishop and Alston failed to attend.

1.10 A further meeting was scheduled, giving ten minutes notice of time, but no

venue, by the Chairman, Senator Coulter.

1.11 This meeting was attended by Senators Coulter, Sherry, Short, Bishop,

Crowley and Faulkner.

1.12 The meeting was declared open with the Chairman, Senator Coulter,

refusing to accept any discussion on a motion of dissent, questioning the legality of

the meeting.

1.13 Whilst informal advice had been given by the Clerk of the Senate, via the

Chair that:

(a) Senator Alston would vote over the telephone;

(b) a motion passed at a duly constituted meeting was invalid;

the written advice on these issues had not been received nor tabled.

1.14 Senator Bishop moved a document entitled 'Interim Report, March 1993' be

adopted. It was not clear as to the content of this document.

1.15 Senator Faulkner moved dissent with the Chair's ruling accepting Senator

Bishop's motion.

Interim Report - Dissent by Government Senators 227

1.16 The dissent motion with Senator Sherry in the chair was carried on the

meeting on the casting vote of the Acting Chairman. The Acting Chairman did request

the mobile phone be handed to both himself and the Secretary to determine Senator

Alston's vote. Senator Short refused to relinquish the mobile phone.

1.17 Senator Bishop, in contravention of the dissent motion just moved, again

moved the motion that a document entitled 'Interim Report, March 1993' be adopted.

1.18 This motion was put without debate by Senator Coulter, despite a point of

order being offered about the resolution being contrary to Standing Orders.

1.19 The Chair closed the meeting with no further discussion.

1.20 Government members of the Committee express their total abhorrence and

disgust that:

. meetings have been called with little or no notice;

. inadequate opportunity has been given to debate lengthy documents;

. much evidence and many witnesses have not yet been heard;

. contrary to custom and practice, committee proceedings during an election

had not been put on hold.

1.21 Government members draw attention to the poor attendance record of

Senator Bishop and Chairman, Senator Coulter. Government members believe that the

Chairman, Senator Coulter, must carry much of the responsibility for the poor

proceedings of the Committee.

228 Appendix L

Interim Report - Dissent by Government Senators 229

CHAPTER TWO

ISSUES ARISING UNDER THE TERMS OF REFERENCE

2.1 On 3 November 1992, on a motion from Senator Coulter, the Senate agreed

to the appointment of a Select Committee to inquire into and report upon the

functions, powers and operation of the Australian Loan Council. The Committee was

to report by 1 March 1993 on the following matters.

(a) The functions, powers and operation of the Loan Council

2.2 The original purpose of the Loan Council under the terms of the Financial

Agreement of 1927, confirmed by the Financial Agreement Validation Act 1929, was

to regulate the impact of State government borrowing on Australian capital markets,

in particular, to co-ordinate the timing of loans issues and to equalise rates of interest

offered by competing States. By means of a referendum in 1928 to amend section

105A of the Constitution, the Commonwealth gained the power to regulate State

Government debt. The amendment also gave the Commonwealth the power to

enforce the States' adherence to the terms of the Agreement. The Loan Council

consisted of the Commonwealth and State Premiers or Treasurers, and thus had the

power to determine monetary policy at the highest executive levels. Its deliberations

were confidential and not subject to Parliamentary scrutiny.

2.3 By 1936, in response to States circumventing the terms of the Financial

Agreement by allowing statutory authorities and local councils to borrow directly on

capital markets, the voluntary so-called 'Gentlemen's Agreement' was initiated, by

which the Commonwealth regulated all public sector borrowing, including that by State

230 Appendix L

local and semi-government authorities. The Gentlemen's Agreement continued to apply

until 1984/85, when it was replaced by the global limits on aggregate borrowings.

2.4 In the early 1980s, control over borrowing programs was increasingly

devolved to State authorities, partly in recognition of the recommendations of the 1981

Report of the Committee on the Australian Financial System (chaired by Sir Keith

Campbell) on the deregulation of the Australian financial system. At the same time,

circumvention of Loan Council restrictions under the Gentlemen's Agreement by State

and local authorities led in many cases to the creation of reserves of funds.

2.5 By 1983/84, the proportion of State and local authority borrowings that had

been approved by Loan Council had fallen to 25 per cent,1 to cease altogether by

1989. The global limits were imposed in an attempt to re-assert Commonwealth control

over public sector borrowing. Linder the new arrangements, borrowing limits for each

State were agreed to by the Loan Council and States were individually responsible for

managing the terms and conditions of loans.2

2.6 Since the late 1980s, Commonwealth Government policy has been

concerned to decrease the size of the public sector borrowing requirement and the

global limits have been progressively tightened as a result. This has had the effect of

causing some States to run down the considerable reserves they had built up, and

others to apply for short term additional loans and to sell assets. In 1988, Queensland

gave notice that it intended to exceed the global borrowing limit, and the

Commonwealth was able to effectively enforce compliance by threatening to reduce

that State's general revenue grant by the extent of the projected excess borrowings.

This incident was an indication of the seriousness with which the Commonwealth

Government regarded potential breaches of the borrowing limits, and of the

effectiveness of the sanctions provided by the Commonwealth's economic power.

Budget Paper No 7, 1984/85, AGPS, Canberra, 1984, p.30.

Treasury, Official Hansard Report, 15 December 1992, p.16.

Interim Report - Dissent by Government Senators 231

2.7 In 1990 it was agreed that the States should directly service the remainder

of existing loans issued on their behalf by the Commonwealth under the Financial

Agreement, in order to encourage States to assume responsibility for their levels of

indebtedness. In return, the Commonwealth agreed to compensate the States for

revenue loss incurred by them in taking over existing debts. In 1992/93 such

compensation payments amounted to $123 million. In 1991/92, partly in recognition

of the States' increased responsibility for financial self-management, the

Commonwealth removed the queuing arrangements for overseas new money

borrowings by State authorities.3 In 1991 it was also decided to exempt from the

global limits certain categories of Government trading enterprises which could

'demonstrate an established record of meeting strict commerciality criteria', or which

had 'substantial private equity'.4 On 7 December 1992, it was agreed to put in place

uniform and effective quarterly reporting of all State borrowings, and to replace the

global limits with a borrowing strategy based on a consideration of each State's net

PSBR (public sector borrowing requirement).5

(b) The role of all governments in the loan council process

2.8 The Australian Loan Council consists of seven representatives: the Prime

Minister or his nominee (the Commonwealth Treasurer) and the six State Premiers or

their nominees (State Treasurers). Each member State has one vote except for the

Commonwealth, which has two votes and a casting vote. At the Loan Council meeting

Budget Paper No 4, 1991/92; p.61.

Such enterprises 'with substantial private equity (of the order of forty per cent or more) need to be constituted to operate in a commercial manner and have at least a demonstrated commitment to operating in a commercial manner, including the achievement of satisfactory performance. Continued exemption from the global limits would require that commitment to be realised in practice'. Budget Paper No 4, 1992/93, AGPS, Canberra 1992, p.59.

See Appendix 4, Loan Council Options: Reporting and Monitoring

232 Appendix L

on 12 June 1992 it was proposed to admit the Northern Territory and the Australian

Capital Territory to the Loan Council with one vote each.

2.9 Although State borrowing programs under the terms of the Financial

Agreement have ceased and have been replaced by the voluntary global limits

agreement, the fact that the Commonwealth raises approximately 75 per cent of total

general government funds and contributes about 55 per cent of State revenues in the

form of general and specific grants, means that the Commonwealth has the financial

power to enforce compliance with the global limits. While the Commonwealth has this

financial power, the State Governments are sovereign, answerable to their own

Parliaments, and while the Commonwealth has the ultimate financial sanction of

reducing a jurisdiction's financial assistance grant if it does not comply with Loan

Council requirements, this is a very blunt and difficult sanction to use in practice.

Under the terms of the Financial Agreement, the Commonwealth has responsibility for

the control of aggregate public sector debt. In line with this responsibility, the global

limits agreement, and the agreement reached at the Loan Council meeting on 7

December 1992, are essential tools of macro-economic policy. In fact, policy positions

developed within the Commonwealth Treasury determine most key Loan Council

decisions.

2.10 Commonwealth domination of the Loan Council has been entrenched

since the implementation of uniform taxation in 1942, when the Commonwealth gained

sole access to income tax revenues. The resulting vertical fiscal imbalance6 between

the Commonwealth and the States has led to appeals by the States for changes to

the relative levels of general and specific grants. At Premiers' Conferences held in

October 1990, May 1991, and May 1992, State Premiers called for a greater level of

consultation between governments on macro-economic issues, a winding back of the

Vertical fiscal imbalance' is a term used to describe an imbalance between the expenditure responsibilities between the Commonwealth and the States, and the financial resources to which each has access. The Commonwealth raises 75 per cent of all funds, while the States raise less than half of the funds needed for State programs.

Interim Report - Dissent by Government Senators 233

proportion of revenue assistance in the form of specific grants, and the maintenance

of general purpose capital grants at the same nominal level as for 1991/92.7

2.11 In response, the Keating Government remained firm in its refusal to

grant the States access to any fixed proportion of the income tax revenue base, but

agreed to the establishment of a Council of Australian Governments to consult on

Federal/State issues.

2.12 The Heads of Treasury Paper endorsed by the meeting of Loan

Council on 7 December 19928 states that the monitoring of global new money

borrowings will cease (Clause 33). Instead, the net Public Sector Borrowing

Requirement (PSBR) will become the basis for financial planning (Clause 19). More

rigorous reporting mechanisms will also be applied to facilitate scrutiny by capital

markets (Clause 9).

(c) The administration of global borrowing limits and breaches of the limits

2.13 Each member of the Loan Council is responsible for administering the

global limits in respect of its own central borrowing authorities and local government

within its jurisdiction. The Loan Council agreed on 7 December 1992 that, in the wake

of the breach of the global limits for 1991 /92 by the State of Victoria, the Loan Council

would continue to operate on the basis of 'collective decision making'. However, there

should be a greater degree of disclosure and more accountability for each

government's performance. Several submissions to the Committee recommended

ways of achieving this.9

7

8

9

Budget Paper No 4, 1992/93, AG PS, Canberra, p.8.

See Appendix 4, Loan Council Options: Reporting and Monitoring

See below, Chapter 3, Role of the Loan Council.

234 Appendix I

2.14 It was agreed at the Loan Council meeting of 7 December 1992 tc

base the global limits on the net PSBR, net PSBR being equivalent to the gross PSBF

minus debt re-financing requirements, which is a more accurate indication of the tota

debt of a jurisdiction and the likely focus of financial market assessments.10 The

meeting also agreed to institute uniform and timely reporting on a quarterly and annua

basis by the Australian Bureau of Statistics. These decisions are echoed ir

submissions made to the Committee by the Australian Bureau of Statistics on C

February 1993, and by the Australian National Audit Office on 11 December 1992.

(d) The appropriate responsibility and powers of the federal Treasurer in dealing witf

breaches of the global limits

2.15 The Loan Council is a co-operative body. In formal terms, the

Commonwealth has two votes and a casting vote on the Loan Council, while the

States (and in future the Territories) have one vote each.

2.16 Since the late 1980's, the Commonwealth Government's policy o

tightening its control over aggregate public sector borrowings has required Treasury

surveillance of State programs, a role undertaken by the Loan Council Secretariat

This, in the words of the Treasury submission to the Committee, 'provide;

administrative support for meetings of Loan Council and a 'clearing house' function foi

communications between Members/Treasurers. It is also a source of advice to the

States and Territories in interpreting and applying the global limits'.11

10 See Appendix 4, Loan Council Options: Reporting and Monitoring para. 18.

11 Treasury, Official Hansard Report, 15 December 1992, p.13.

Interim Report - Dissent by Government Senators 235

(e) The powers, and limits of power, of State Premiers to administer borrowing

agreements and their responsibilities to notify the Council about the borrowing

activities of their governments

2.17 Decisions of the Loan Council under the Financial Agreement are made

by simple majority vote. The global limits is a voluntary agreement which does not

specify formal voting procedures or any process other than consensus for making

decisions. The so-called consensus is, however, subject to the Commonwealth's ability

to enforce the States' compliance with the global limits by means of its power to

withhold general revenue assistance.

2.18 Since 1982, almost all State borrowing has been carried out by central

borrowing authorities set up by executive decision of State governments. Individual

State governments have the responsibility of monitoring all borrowing undertaken by

these authorities and of ensuring that they comply with the global limits. In a

submission to the Committee on 20 January 1993, Professor Cheryl Saunders, of

Melbourne University, said that it would be desirable to have continuous State

Parliamentary scrutiny of State Government borrowing.12

12 Professor Saunders, Official Hansard Report, 20 January 1993, p.313.

236 Appendix L

Interim Report - Dissent by Government Senators 237

CHAPTER THREE

RESPONSES FROM STATE AND TERRfTORY GOVERNMENTS,

AND FORMER STATE PREMIERS AND MINISTERS.

TO THE COMMRTEE

3.1 The Premier of Victoria, the Hon Jeff Kennett, responded on 20 January

1993 to the Committee's invitation to make a submission to its inquiry, saying that it

was being considered by the Victorian Government, but offering in the meantime to

co-operate in responding to specific requests from the Committee.

3.2 On 19 February 1993, Senator Coulter wrote to Mr Kennett requesting

documentation of the Victorian Government's awareness in early 1992 that it would

need to breach its global limit for 1991/92 to convert its short term borrowings for

accumulated Budget deficits to medium term borrowings. To date no response to this

request has been received from Mr Kennett.

3.3 The Hon Joan Kirner, Leader of the Opposition and former Premier of

Victoria, responded to the Committee's invitation on 11 December 1992, saying that

the Committee's terms of reference had been covered adequately by decisions taken

at the Premier's Conference/Loan Council meeting on 7 December 1992, and therefore

declined to make a submission. The Committee wrote again to Mrs Kirner on 20

January 1993, saying it believed that, as a result of her recent tenure of the office of

Premier, the information which she might be able to provide might be of great

importance for the success of its inquiry, and requesting her to appear before it at a

public hearing to give evidence.

3.4 To date the Committee has not received a response from Mrs Kirner to its

request to her to appear before it at a public hearing.

238 Appendix

3.5 The Committee has also requested the following to appear before it at

public hearing: former Victorian Treasurers, the Hon A J Sheehan, the Hon T W Rope

and the Hon Robert Jolly; former Victorian Minister for Manufacturing and Industr

Development and Minister Assisting the Treasurer, the Hon David White; former Sout

Australian Premier and Treasurer, the Hon John Bannon; and the Premier an

Treasurer of New South Wales, the Hon John Fahey.

3.6 The Committee has received no response from Mr Sheehan, Mr Roper c

Mr White. Mr White had declined to make a submission in a letter of 15 Decembe

1992, saying he believed the Committee's terms of reference had been covere

adequately by decisions made at the Premier's Conference/Loan Council meeting c

7 December 1992.

3.7 Mr Jolly advised the Committee that it was unnecessary for him to attend th

Committee, in view of the fact that he had not been Treasurer of Victoria for almos

three years, and he understood that the issues that had led to the establishment c

the Committee related to events in 1992, well after the time of his resignation a

Treasurer.

3.8 Senator Coulter wrote on 18 February to the Caucus Secretary of th

Victorian Labor Party, Dr Ken Coghill. Senator Coulter referred to press reports thi

the Labor Caucus had passed a resolution forbidding any of its members to appee

before the Senate Committee, and requested Dr Coghill to confirm whether or not an

such resolution had been passed, and if so, for a copy of the resolution and c

Caucus rules. To date no response has been received from Dr Coghill.

3.9 Mr Bannon wrote to the Committee on 22 January 1992, declining to mak

a submission. On 2 February he wrote to the Committee respectfully declining it

request that he appear before it, saying that he did not think it appropriate for him t

do so as the South Australian Government had indicated that it was happy to provid

any specific information requested by the Committee. Mr Bannon also understood the

Interim Report - Dissent by Government Senators 239

the matters the Committee was inquiring into had been dealt with appropriately at the

7 December 1992 Loan Council meeting.

3.10 The Committee received a letter from the South Australian Under

Treasurer dated 8 December 1992, advising that the South Australian Government did

not wish to make a submission, but offering to provide any specific information which

could help the Committee.

3.11 Premier John Fahey responded on 2 February 1993 to the Committee's

request for him to appear before it. He drew attention to the wide range of reforms to

the operation of Global Borrowing Limits which had been agreed to at the Loan

Council meeting of 7 December 1992. These reforms closely mirrored the proposals

he had put to the Commonwealth Treasurer on 23 November 1992 (of which he had

advised the Committee by letter dated 4 December 1992) and it was fair to say that

New South Wales was now satisfied with the current arrangements. He did not believe

that his appearance at a public hearing was warranted or useful until the main players

in the 'Victorian Loans Affair' had come before the Committee. He would reconsider

his decision if advised that the Commonwealth Treasurer and the former Premier and

former Treasurer of Victoria would be appearing before the Committee.

3.12 The Premier of Western Australia, the Hon Dr Carmen Lawrence,

responded on 11 December 1992 to the Committee's invitation to make a submission.

Dr Lawrence said that her Government believed that the issues raised in the

Committee's terms of reference were being fully addressed as a result of decisions

taken at the Loan Council meeting in Perth on 7 December 1992 and, on that basis,

her Government considered that the ongoing need for the Senate inquiry should be

re-assessed.

3.13 Dr Lawrence pointed out that the function of the Loan Council was to

provide a forum for the heads of government to agree, in a co-operative environment,

on governments' borrowing requirements in light of general economic circumstances

240 Appendix L

(and the need to prevent destabilisation in the macro economy). The powers of the

Loan Council reflected the fact that its members were the heads of governments and

responsibility in this area was shared between governments.

3.14 The Loan Council, Dr Lawrence emphasised, was not an agency which

was subordinate to any one level of government, including the Commonwealth

Treasurer in his function as Chairman. The longevity of the institution (since 1927)

owed much to the principle of co-operative federalism. The Loan Council process had

adapted over the years to changing circumstances and emerging problems. The

global approach had been evolving since 1984/85 with agreements between members

of the Loan Council resulting in changes to the approach, such as the exclusion of

purely commercial enterprises and overseas subsidies from the limits, inclusion of

operating leases from 1993/94 and general administration changes.

3.15 Dr Lawrence said that while there was considerable and justifiable

public concern that Victoria's new money borrowings had been above that State's limit,

and were not reported to the Loan Council, the Loan Council was best placed to

respond to that problem. The need for improved reporting and monitoring

arrangements had been recognised in the detailed principles to govern future Loan

Council operations agreed at the 7 December 1992 meeting.

3.16 Following deregulation and the agreement for the States to redeem

Financial Agreement debt held by the Commonwealth on the State's behalf, the States

were very sensitive to the judgements of credit rating agencies. Poor ratings had

significant budgetary consequences as the cost of debt financing increased, Dr

Lawrence said.

3.17 As a consequence of the 'market discipline' on governments, through

credit ratings, the shared responsibility for regulating government borrowings, the

goodwill between members of the Loan Council, the evolutionary nature of the Loan

Council arrangements, and the improved monitoring arrangements agreed at the 7

Interim Report - Dissent by Government Senators 241

December 1992 Loan Council meeting, Western Australia considered that it would be

inappropriate to empower the Commonwealth Treasurer to sanction member

governments for breaches of limits. In the view of Dr Lawrence, the Loan Council as

currently structured, with the moral force of all heads of Australian governments, had

the capacity and will to correct any problems as well as the financial incentive, given

market discipline.

3.18 The Hon Ray Groom, Premier and Treasurer of Tasmania, wrote to the

Committee on 24 December 1992 to say that the Tasmanian Government would not

be making a submission to the inquiry. As a result of what he regarded as the

productive discussions at the Loan Council meeting in Perth on 7 December 1992, he

was of the view that a framework now existed for rectifying the weaknesses which

were exposed by the breach of Loan Council processes by the previous Victorian

Government. Tasmania would be using its best endeavours to ensure that the new

monitoring and control arrangements worked effectively and fulfilled the objective of

providing transparency in government financial management and reporting.

3.19 The Premier of Queensland, the Hon Wayne Goss, wrote to the

Committee on 5 February 1993, saying that he had nothing to add to the information

the Committee had already received from the Commonwealth Treasury on the revised

procedures agreed at the Loan Council meeting of 7 December 1992, and that he did

not propose to make a submission.

3.20 The Under Treasurer of the Australian Capital Territory wrote to the

Committee on 16 December 1992, drawing attention to the agreement reached at the

Loan Council meeting on 7 December 1992 to strengthen monitoring and reporting

arrangements and to improve public information on Loan Council activities and

State/Territory budgetary performance. In the light of the ACT's current observer status

on the Loan Council, the Territory would not be making a submission to the

Committee.

242 Appendix I

3.21 The Hon Barry Coulter, Northern Territory Treasurer, wrote to Senato

Coulter on 10 December 1992, referring to the new arrangements agreed to by the

Loan Council on 7 December 1992 and advising that, in the light of these

developments, the Northern Territory would not be making a submission.

CHAPTER FOUR

ROUE OF THE LOAN COUNCIL

INTRODUCTION

4.1 The Australian Loan Council was initially established as a body to assist with

the co-ordination of Commonwealth and State debt raisings, but has become

increasingly an instrument of Commonwealth macro-economic policy making. While

the States and their authorities have been given considerable flexibility over the terms,

conditions and sourcing of their borrowings, the Commonwealth continues to impose

constraints on the overall level of such borrowing.

4.2 Recently, the Loan Council has adopted a number of new reporting and

monitoring arrangements in relation to public sector borrowings by the Commonwealth

and the States. These measures aim to promote greater disclosure and accountability

of each government's financial performance. This increased transparency of

government finances also aims to assist financial markets and the public generally to

make more informed judgements about each government's financial position.

4.3 The measures adopted at the Loan Council meeting of 7 December 1992

involved agreement on Net Public Sector Borrowing Requirements and improvements

in Loan Council reporting requirements and monitoring. These measures are outlined

below.

Interim Report - Dissent by Government Senators 243

NEW ARRANGEMENTS

Net public sector borrowing requirements

244 Appendix L

4.4 The present Loan Council arrangements are directed at gross new

borrowings by the public sector. It was proposed that Loan Council arrangements in

the future will be directed to the total Public Sector Borrowing Requirements (PSBR)

for Australia and to each jurisdiction's PSBR, covering both the general government

sector and public trading enterprises (PTEs).

4.5 In broad terms, the difference between gross and net borrowings is the

change in the financial assets of the public sector. Public sector demands on the

nation's savings are better measured by the net PSBR and the net debt of a

jurisdiction is more likely to be the principal focus of financial markets.13

4.6 Global limits will continue to be set during the two to three year transitional

period, but when all jurisdictions move to the reporting requirements focussed

primarily on PSBR, the monitoring of global new borrowings will cease.

Reporting requirements and monitoring

4.7 The 1991 Premiers' Conference agreed to the publication by each

jurisdiction of uniform annual financial statements showing public sector outlays,

revenue and financing transactions for the past financial year and current year, plus

financial assets and liabilities at the end of the past financial year. In addition to these

arrangements, it was agreed at the 7 December 1992 meeting of the Loan Council that

the following public reporting arrangements be established in the medium term:

- Quarterly Financial Statements showing:

. outlays, revenue and financing transactions for the general

government sector on a uniform basis; and

13

Treasury, Official Hansard Report, 15 December 1992, p.5.

Interim Report - Dissent by Government Senators 245

. net debt for the entire public sector but split between general

government and public trading enterprises.

- Annual Financial Statements:

. Financial Assets and Liability Statements supplemented with

explanatory notes disclosing the total values of contingent liabilities

and guarantees as well as asset sales.

. Borrowings and Net Debt Statements showing the level of, and

changes in, net debt at current capital value during the preceding

year.

4.8 It is anticipated that full implementation of the proposed quarterly reporting

arrangements will be achieved within 2-3 years. From June 1993, as a transitional

arrangement while uniform reporting standards and reporting systems are

implemented, the Loan Council will require jurisdictions to report total public sector

borrowing, on a quarterly basis, split between the existing global and non-global

categories, with the latter being itemised and their classification as non-global justified.

4.9 If a jurisdiction is likely to exceed its PSBR (or in the transitional phase, its

global limits), it would be expected to report to the Loan Council as soon as possible

with any instances of non-compliance being dealt with by the Loan Council on a case-

by-case basis. However, it is envisaged that market sanctions should play the key role

in penalising those jurisdictions consistently failing to meet their requirements.

IMPROVEMENTS TO LOAN COUNCIL ARRANGEMENTS

4.10 Some submissions received by the Committee suggested that, while

the new arrangements announced at the Loan Council meeting on 7 December 1992

had gone some way towards improving the operations of the Loan Council,

246 Appendix L

improvements could still be made in a number of areas. The main issues raised tc

date during the inquiry include:

- the need for greater accountability;

- breaches of the borrowing program;

- revision of the Financial Agreement;

- other methods of regulating borrowings;

- facilitating private sector investment; and

- role of the Australian Bureau of Statistics.

These issues are discussed below.

A need for greater accountability

4.11 Mr Des Moore, Senior Fellow at the Institute of Public Affairs, in his

submission to the inquiry called for 'greater transparency regarding State ( and

Commonwealth) public sector borrowings so as to improve the awareness of financial

and other markets of changes in the amount and terms of such borrowings'.14

4.12 He noted that for the Commonwealth to seriously influence the States'

contribution to PSBR, it needed a more comprehensive approach than a focus only

on borrowings. He advocated a Federation Budget approach to determine the targets

for spending, taxing and borrowing levels for each government and its authorities.15

4.13 Under this approach, the Commonwealth and State Governments

would agree at each Premiers' Conference on the broad guidelines for public sector

spending and borrowing for the year ahead. For this purpose, it would be necessary

for the latest forward estimates of the Commonwealth and the States to be available

Mr Moore, Official Hansard Report, 19 January 1993, p.265.

Mr Moore, Official Hansard Report, 19 January 1993, p.266.

Interim Report - Dissent by Government Senators 247

for discussion at the Premiers' Conference. Governments would also issue estimates

that reflected decisions on the desired level of overall public sector spending and

borrowing for three years ahead. This would not involve the Premiers' Conference

making detailed decisions on the components of spending by each government, but

rather in setting overall taxing, spending and borrowing targets for each level of

government.

4.14 Mr Moore explained that the main purpose of this strategy:

...would be to try to give public sector budgeting a more medium term perspective, along similar lines to the trilogy of fiscal commitments specified by the Commonwealth Government in the mid-1980s under which certain undertakings were given in regard to the maximum proportion of GDP to go on the Commonwealth Government's expenditures, taxes and borrowings.16

4.15 Mr Moore argued that the process of setting targets for spending and

borrowing would have the potential to exert competitive pressures within the public

sector in regard to, in particular, achieving improvements in efficiency and meeting

best-practice benchmarks. It would further provide a discipline on governments and,

if accompanied by an appropriately targeted monetary policy, provide a better

framework for private sector decision-making. It would also require both the

Commonwealth and State Governments to justify the rate of growth of their 'own

purpose' outlays.17

4.16 Mr Moore stated that his approach had the potential to encourage the

Commonwealth Government, as national economic manager, to 'make such a process

work and it can exert pressure on the States to 'play the game', at least so long as

they are reliant for a substantial part of their revenue on Commonwealth financial

assistance'.18 The States would also have an incentive to participate 'in that they

16 Mr Moore, Official Hansard Report, 19 January 1993, pp.266-7.

17 Ibid, p.267.

18 Ibid, p.267.

Interim Report - Dissent by Government Senators 251

argued, however, that the Agreement should be 'redrafted completely' as its 'objects

have changed so significantly that it would benefit from general rethinking... sixty-five

years is a very long time for a single agreement to govern an activity such as

government borrowing, even when its continuing authority is more apparent than

real'.32

Other methods of regulating borrowings

4.26 Evidence to the Committee suggested that alternative or

complementary methods of regulating State borrowings should be considered. One

alternative raised during the inquiry was that borrowings be limited to the financing of

capital expenditure only and not be approved for recurrent purposes. Schraders

Australia Limited argued there was considerable merit in this approach as it allowed

flexibility to borrow for productive investment while preventing borrowing to cover

recurrent costs.33

4.27 Another alternative suggested to the Committee was that projects to

be financed by borrowings be ranked on a national basis by the Loan Council and

approved in order of merit.34

4.28 A third alternative raised the possibility of introducing the institutional

arrangements which apply in other federations, particularly Germany, Canada, the

United States and the European Community. In the United States and Canada, the

borrowing constraints of a Loan Council-type body do not apply. The German

federation has a system of fiscal co-ordination but this does not involve the application

of quantitative borrowing controls on the Lander governments. In the European case,

32

33

34

Professor Saunders, Official Hansard Report, 20 January 1993, p.312.

Schroders Australia Limited, Official Hansard Report, 19 January 1993, p.201.

Mr McAuley, Official Hansard Report, 20 January 1993, p.420.

Interim Report - Dissent by Government Senators 253

publishing more comprehensive, regular and timely figures on financial transactions

of individual States and their authorities'.38

4.32 The ABS, in its submission to the Committee, noted that there was a

need to co-ordinate the Bureau's collection of data from public sector authorities with

the collection of data required for Loan Council purposes. The Bureau emphasised the

need to avoid duplication in the collection of statistics by the two agencies.39

4.33 The ABS commented on the statistics used for Loan Council purposes.

The ABS noted that the 'global limits', a concept used by the Loan Council, is not an

official statistical concept and the Bureau does not compile statistics relating to this

concept. The global limits are a component of the gross Public Sector Borrowing

Requirement (PSBR). The ABS provided a description of this concept and its

relationship to the Net Financing Requirements (NFR), in its submission to the inquiry.

4.34 The Bureau noted that:

...the concept of net public sector borrowing requirement (net PSBR) used in Commonwealth budget papers is the same as the ABS concept of net financing requirements (NFR). The ABS prefers to use the term financing' rather than 'borrowing' because the measure covers both financing by

borrowing and financing by running down of financial assets.40

4.35 The concept of the gross PSBR used in Commonwealth Budget

Papers is defined in Budget Paper No 1, 1991-92, as the 'Commonwealth Budget

deficit plus total new money borrowings by Commonwealth and State semi­

government and local authorities reported to, or approved by Loan Council under the

Global Approach plus borrowings by Statutory Marketing Authorities'. The ABS noted

that new money borrowings in this context excluded conversion or re-financing of past

38 Mr Moore, Official Hansard Report, 20 January 1993, p.266.

39 Australian Bureau of Statistics, Submission, pp.12-13.

40

Australian Bureau of Statistics, Submission, p.11.

Interim Report - Dissent by Government Senators 255

The establishment of national and State financing arrangements conducive to improving Australia's economic performance requires the creation of a market driven system of allocating capital among the States which is more efficient and less distortionary than the bureaucratically determined

quantitative controls currently administered by Loan Council.42

4.39 A contrary view was put by some contributors to the inquiry. For

example, Mr Moore suggested that some degree of supervision by the Commonwealth

over the level of State borrowings was necessary. He argued that governments do not

necessarily respond to market signals, or at least not in a timely way. In addition,

markets often allow governments to borrow excessively because they realise that

governments will fall back on their taxing powers to service their debts.43

4.40 Schraders submitted that the Loan Council should confine its functions

to ensuring that an informed market in government securities was maintained; to

applying sanctions to those States or Territories which failed to maintain an informed

market in their securities; and to applying direct borrowing controls to those States or

Territories which fell below agreed prudential limits as assessed by private sector

credit rating agencies.44

4.41 Accordingly, they proposed a series of market-based measures to

replace the current Loan Council quantitative controls. These included:

- monthly disclosure of State net financing and spending on a basis

consistent with the Commonwealth's current monthly statements;

- a general exemption from borrowing limits granted to those States which

maintained a credit rating equal to the Commonwealth's foreign debt rating,

and those State-owned enterprises which achieved such a rating; and

42 Schroders Australia Limited, Official Hansard Report, 19 January 1993, p.183.

43 Mr Moore, Official Hansard Report, 19 January 1993, pp.264-65.

44 Schroders Australia Limited, Official Hansard Report, 19 January 1993, p.186.

Interim Report - Dissent by Government Senators 257

The Agency would also facilitate the progress of major national projects conducted within the private sector.

CONCLUSION

4.45 In this chapter the Committee has examined a number of proposals

for the reform of the Loan Council. These range from a series of suggestions aimed

at promoting greater disclosure and accountability of Loan Council operations to more

far reaching proposals that would see the functions and operation of the Loan Council

radically altered. The Committee considered that these proposals should be further

examined by it and therefore does not propose to make recommendations on these

matters at this stage.

Interim Report - Dissent by Government Senators 259

CHAPTER FIVE

LOCAL GOVERNMENT AND THE LOAN COUNCIL

5.1 While membership of the Loan Council has been restricted in the past to

representatives of the State and Commonwealth Governments, the Australian Local

Government Association is represented on the newly established Council of Australian

Governments.47 State government control of local government financial allocations

and borrowing programs has led to complaints by local government representatives

about their arbitrary and inequitable treatment by some State governments and to

calls for local council borrowing allocations to be made directly by the Loan Council.

The legal basis of local government

5.2 Local government in Australia is established solely under state legislation

and pre-dates federation. It is not specifically covered by the Constitution. Attempts

by the Whitlam and Hawke Governments in referenda held in 1974 and 1988, to

institutionalise local government by amendments to the Constitution both failed. Local

government therefore remains within the legislative frameworks created by the States

and subject to a variety of administrative arrangements.

Local government financial arrangements

5.3 Across the board statistics for Australia indicate that 75 per cent of local

government revenue is derived from fees, fines and taxes, (of which 94 per cent is

47

Municipal Association of Victoria, Official Hansard Report, 19 January 1993, p.150.

Interim Report - Dissent by Government Senators 261

5.6 Within each State, Local Government Grants Commissions allocate funds to

councils according to principles set out in the Local Government (Financial Assistance)

Act Section 9(2) which provide that: (a) 'a state shall consult with bodies representative

of local government in the State'; and (b) the allocation of funds for local government

purposes is made, as far as practicable, on a full horizontal equalisation basis, being

a basis that ensures that each local governing body in the State is able to function,

by reasonable effort, at a standard not lower than the average standard of other local

governing bodies in the State.'49 In addition to general revenue grants, local

government receives Commonwealth assistance in the form of specific purpose

grants. These grants are either distributed through the States (Section 96 grants) or

directly, where local government is nominated as the service provider for various

Commonwealth Government social welfare, or employment creation programs.

Submissions and evidence presented to the Committee from councils and from local

government representative associations

Municipal Association of Victoria (MAV)

5.7 The MAV is a body representing the interests of local councils in Victoria.

The MAV submission argues that local government should be represented on the

Australian Loan Council since decisions by the Loan Council affect local councils'

ability to borrow. The MAV argues that the Victorian Government has placed unfair

restrictions on local councils' borrowing programs while at the same time allowing its

own borrowings to rise to record levels.

Sub-section 9(2)(c) of the Local Government Act qualifies the application of sub-section 9(2) (b) to 'ensure that no local governing body in the State will be allocated an amount in a year that is less than the amount that would be allocated to that body if 30 per cent of the amount to which the State is entitled... were allocated amongst local governing bodies in the State on a per capita basis’.

Interim Report - Dissent by Government Senators 263

5.13 The arguments advanced by the MAV were supported by the City of

Werribee.52 The City of Werribee, as a nominated growth corridor of the Melbourne

metropolitan area, tendered a submission to the Committee which called for:

. a greater degree of accountability on the part of State governments with

regard to the administration of global borrowing allocations; and

. specific positive discrimination in favour of councils managing significant

growth areas.

5.14 In Victoria, under the Local Government Act 1989, councils are

prevented from incurring budget deficits in excess of one per cent of total expenditure

without Ministerial approval. In addition, stringent audit reporting mechanisms and the

responsibility to obtain the approval of rate-payers for major capital expenditure

programs ensure that there are sufficient controls over local government borrowing

programs in Victoria without councils being specifically subject to Australian Loan

Council supervision.

5.15 The City of Werribee also argued that the 'as-of-right' allocation of $1

million for all councils in Victoria was both inadequate and arbitrary: there has never

been adequate reporting from State level as to how much of the total notional

allocation has been taken up, nor of what subsequently happens to any unallocated

balance.'53 In Victoria, total levels of local government borrowing fell from $148 million

in 1984/85 to $77 million in 1991/92.54

5.16 Mr Gibbons drew attention to the lack of communication between local

government and the Victorian Government, as well as to the lack of a co-ordinated

52

53

54

City of Werribee, Official Hansard Report, 20 January 1993, p.378.

City of Werribee, Official Hansard Report, 19 January 1993, p.381.

Ibid, p.393.

Interim Report - Dissent by Government Senators 265

5.21 Borrowing on behalf of local councils in South Australia is carried out

largely by the Local Government Finance Authority (LGFA) which was established as

an initiative of the Local Government Association of South Australia in 1984. While the

use of the LGFA was voluntary, and councils were free to use private sector finance

to borrow, in the 1991/92 financial year the Authority provided in excess of 97% of

councils' debenture loan requirements.'57

5.22 Because of the LGFA's status as a statutory authority, it was able to

borrow at more favourable rates and to pass the profits from reinvestment back to

councils. Mr Russell said that during the financial year 1991-92 the Authority made an

operating surplus of $5.4 million of which a record $775,000 was paid back to councils

as bonuses. This dividend has apparently been sufficient inducement for over 97

per cent of councils to borrow with the Authority.

5.23 The harmonious relationship which appeared to characterise the

process of allocating new money borrowing funds in South Australia may be partly

explained by the fact that South Australia had a classification system for roads which

set out a clear distinction between areas of local and State government responsibility.

Nor did local government in South Australia have any responsibility for highly capital

intensive infrastructure development, as might be the case in other States.

The process of allocating borrowings in South Australia

5.24 The LGFA first gathers information about expected borrowing

requirements from local councils. The South Australian Treasury and the Local

Government Association then negotiate about the total limit allocated to South

Australia and the proportions that should apply to local government before the

57

Mr Russell, Official Hansard Report, 20 January 1993, p.365.

Interim Report - Dissent by Government Senators 267

annual basis by the Australian Loan Council and that the relevant Minister in each

State publically advise the industry of that notional allocation.'59

5.29 While the body representing the interests of local government in South

Australia appears to be satisfied with the mechanisms in place to determine the

distribution of funds, the MAV and some Victorian councils tell a different story, one

which indicates a breakdown in communications between State and local government

and a lack of trust between the parties. Despite the different conditions experienced

by local government in South Australia and Victoria, the Australian Local Government

Association, in a letter to the Committee on 12 January 1993, endorsed the

submissions made by both the MAV and LGASA.

5.30 Representatives from local government organisations in two States,

Victoria and South Australia, made a number of proposals concerning the respective

roles of State governments and the Loan Council in determining local government

financial arrangements. These proposals were endorsed by the ALGA. At this stage

of its inquiries, the Committee has not been able to evaluate these proposals, or make

recommendations concerning them.

59

Ibid, p.384.

Interim Report - Dissent by Government Senators 269

CHAPTER SIX

CONCLUSION AND RECOMMENDATION

6.1 It is not appropriate for the Committee to reach conclusions on all the

matters within its terms of reference, given that key witnesses have not been heard,

and the Committee schedule of public hearings was postponed when the Parliament

was prorogued. However, on all the evidence available to it, the Committee finds that,

in relation to the particular matter of Victoria's breach of its global borrowing limit for

1991/92, the Commonwealth Treasurer and Treasury acted entirely properly and with

all due diligence.

6.2 In accordance with the requirement in its resolution of appointment that the

Committee report by 1 March 1993, for the reasons outlined above, the Committee

presents this report and recommends:

that the Select Committee on the Functions, Powers and

Operation of the Australian Loan Council be re-constituted in the

next Parliament and empowered to continue its inquiry under its

terms of reference.

Nick Sherry Senator for Tasmania Deputy Chairman

Rosemary Crowley Senator for South Australia

John Faulkner Senator for New South Wales

Interim Report - Dissent by Government Senators 271

APPENDIX 1

Select Committee on the Functions, Powers and Operation of the Australian Loan Council

Minutes of the Private Meeting held in Conference Room A, Golden Wings Lounge, Melbourne Airport on Saturday 27 February 1993.

M e etin g N o 7/36

Present: Senator J Coulter (Chairman)

Senator N Sherry (Deputy Chairman) Senator R Crowley Senator J Faulkner Senator J Short

Apologies: Senator R Alston

Senator B Bishop

In Attendance: Mr R J King (Secretary)

1. At 12.25pm the Chairman called the meeting to order.

Minutes

2. On motion by Senator Short, the Minutes of the meetings of 19 and 20 January 1993 were confirmed.

Interim Report - Dissent by Government Senators 273

Further Meetings

13. On motion by Senator Crowley, the Committee resolved to hold no further meetings before the final report was presented.

Adjournment

14. The Committee adjourned at 3.32pm.

CONFIRMED:

J R Coulter CHAIRMAN