Future Fund accounting switch saves AAA rating

The Australian11:27AM December 23, 2016

David Uren

Bill Shorten has accused the Turnbull government of using an accounting trick to improve the budget bottom line.

The Australian reported today that the Coalition’s wafer-thin projected 2020-21 surplus, the linchpin of the nation’s AAA rating, is achieved entirely by a change in accounting for the Future Fund headed by Peter Costello — the man responsible for the last budget surplus in 2007-08.

The projected budget surplus of about $1.1 billion will be achieved only because of a reclassification of about $4bn in Future Fund earnings in that year, not because of any improvement in under­lying budget performance.

An accounting change introduced by Labor in the 2012-13 mid-year budget review and incorporated into the medium-term outlook in the 2015 Inter-generational Report, means the Future Fund profit will be included in the government’s accounts for the first time in 2020-21. The budget papers count on strong growth in ­Future Fund earnings, rising from $2.8bn this year to $3.9bn by 2019-20.

Deloitte Access Economics partner Chris Richardson said it appeared that much of the predicted improvement in the budget bottom line — from a $10bn deficit in 2019-20 to the small surplus in 2020-21 — would come from the change in treatment of Future Fund earnings.

“Australia still has a lot of hard yards ahead of it in the budget, and nobody is going to like those decisions,” Mr Richardson said.

“We need to be wary of the easy fix — the money that appears thanks to changed accounting treatment rather than genuine savings.”

Economist Saul Eslake, who first detected the changed ­accounting treatment contained in a footnote to a chart in last year’s budget, said the government lacked transparency. “An ASX-listed company would not have gotten away with presenting such a material accounting change by way of a footnote to a graph,” Mr Eslake said.

Since the government set the standards for private companies, it should meet them itself, he said.

Mr Shorten told reporters in Melbourne that “this is another accounting trick from a government who’s lost control of its budget”.

In Monday’s mid-year economic and fiscal outlook, Scott Morrison unveiled a projected $1.1bn surplus in 2021, gaining him a reprieve on the nation’s AAA credit rating despite posting bigger deficits in the next four years.

When, as treasurer, Mr Costello launched the Future Fund in 2006 to help cover the future cost of public-sector superannuation, he excluded the fund’s earnings from the budget cash balance. Although there was no accounting- standard requirement for this, Mr Costello argued the budget cash balance should show whether the government’s cash revenue was covering its expenses and should not include profits from unrealised capital gains from earlier investments made by the fund.

From 2020-21, the government will be able to draw on the Future Fund to help meet the cost of public servants’ defined benefit superannuation schemes.

Without the change in accounting treatment, the budget not only would be in deficit in 2020-21 but would scarcely do better than break even out to 2026-27, under Treasury’s medium-term projections. These projections show the budget would achieve, at most, a surplus equivalent to 0.3 per cent of gross domestic product in that period. Future Fund profits have averaged between 0.2 and 0.3 per cent of GDP.

The Future Fund has been highly successful since it was established with seed funding of $60bn, drawn from Mr Costello’s budget surpluses and proceeds from the sale of the government’s final tranche of shares in Telstra. The fund has more than doubled this to $123bn, achieving earnings growth averaging 7.6 per cent and exceeding its mandate to achieve returns of at least 4.5 per cent more than inflation.

However, in the fund’s latest annual report, Mr Costello warned this earnings growth could not be sustained without taking greater risks. “Taking higher levels of risk means having an appetite for greater volatility and accepting the potential for larger losses,” he said.

The fund’s profits have been inflated by falling global interest rates that have boosted the value of its bond portfolio. With rates now rising around the world, there is a risk the earnings growth of the past could be reversed.

Mr Richardson said future earnings growth would be more difficult for all financial institutions. “Reasonable returns have been made, at least until a couple of months ago, as interest rates edge down, but then you hit a plateau where ongoing earnings are more a function of rates of return rather than capital gains,” he said. “We’ve had our capital gains.”

Mr Costello — appointed to the Future Fund board in 2009 and made chairman in 2014 — has sought a review of the fund’s investment mandate to take account of the more challenging outlook.

Monday’s budget update cut the estimate for the Future Fund’s profit this year from the $3.3bn predicted in the May budget to $2.8bn.   However, it sharply increased estimates of the fund’s likely earnings growth over the next four years.

Where the May budget predicted the fund would stick to its historic 7.6 per cent earnings growth, with a $820 million increase by 2019-20, the update shows average earnings rising 11.7 per cent a year, or $1.1bn over the next four years.