The significance of both a nation's financial obligations and assets plays a crucial role in assessing sovereign risk.
In the financial world, Singapore stands out as a shining example of effective fiscal management. One of the key factors contributing to its success is its strong balance sheet, a concept that goes beyond the traditional gross debt-to-GDP ratio.
Debt-based fiscal rules, while commonly used, often misrepresent a government's true fiscal situation and provide poor guidance for decision-making. Instead, policy-makers in Singapore have chosen to prioritise a balance sheet approach in budget decisions, focusing on building a strong balance sheet through borrowing, rather than to meet current expenses or fund a deficit.
This strategic approach has paid off. Singapore's public wealth fund, Temasek, and sovereign fund GIC, along with the Monetary Authority of Singapore, collectively manage assets estimated to be three to four times Singapore's annual GDP. A strong net worth position is evident, with its assets managed by independent institutions that apply fair market values and have robust governance.
The significance of government net worth (assets minus liabilities) in determining sovereign creditworthiness lies in its stronger predictive power for bond yields and sovereign risk compared to the traditional gross debt-to-GDP ratio. Government net worth reflects the actual fiscal position by accounting for both the value of government assets and its liabilities, while gross debt-to-GDP considers only liabilities without offsetting assets.
Government net worth is a better indicator of credit risk because it includes asset holdings, especially liquid or commercial assets, which can improve a government's ability to service debt and respond to economic shocks. Countries like Singapore maintain high credit ratings despite having relatively high gross debt-to-GDP ratios because their strong net worth (significant assets relative to liabilities) offsets concerns about high debt levels.
An International Monetary Fund (IMF) working paper suggests that anchoring fiscal policy to net worth encourages sustainable public investment and economic growth, allowing better responses to long-term interest rate changes. Governments with stronger net worth tend to recover faster from recessions and experience lower borrowing costs, implying that net worth offers a more comprehensive and dynamic measure of fiscal health impacting sovereign creditworthiness.
In contrast, the gross debt-to-GDP ratio is a partial measure, widely used but less informative because high gross debt alone does not capture asset buffers or fiscal management quality impacting credit risks.
By diversifying revenue streams, including both tax and non-tax sources, governments can reduce their risk profile. In Singapore, approximately one-fifth of government expenditure is funded through investment returns from its sovereign funds. Over the past five years, these funds have generated an average annual (non-tax) income amounting to 7% of the country's GDP.
The success of Singapore's financial management strategy demonstrates the benefits of good governance, strict fiscal discipline, and effective balance sheet management, which other countries can emulate. However, it's important to note that poor asset management can obscure the opportunity costs and worsen economic challenges. Extensive portfolios of commercial assets, including real estate and state-owned enterprises, are often undervalued even in the official accounts of governments that produce a balance sheet. A complete balance sheet based on accrual accounting, along with high-quality, credible, and transparent auditing, is essential to understand the actual state of public finances.
In conclusion, government net worth provides a holistic and economically meaningful measure of sovereign creditworthiness, surpassing the gross debt-to-GDP ratio by integrating both sides of the balance sheet and thereby better reflecting a government's true fiscal capacity and risk profile.
- Singapore's effective fiscal management is largely due to its strong balance sheet, which emphasizes public wealth, not just the traditional gross debt-to-GDP ratio.
- The balance sheet approach in budget decisions prioritizes building a strong balance sheet through borrowing, focusing on assets, rather than meeting current expenses or funding a deficit.
- Singapore's public wealth fund, Temasek, and sovereign fund GIC, along with the Monetary Authority of Singapore, manage assets worth three to four times Singapore's annual GDP.
- Government net worth, reflecting actual fiscal position by accounting for both the value of government assets and its liabilities, offers a better indicator of credit risk compared to the traditional gross debt-to-GDP ratio.
- Anchoring fiscal policy to net worth encourages sustainable public investment, economic growth, and better responses to long-term interest rate changes.
- By diversifying revenue streams, Singapore funds approximately one-fifth of its government expenditure through investment returns from its sovereign funds, amounting to an average of 7% of the country's GDP over the past five years.
- A complete balance sheet based on accrual accounting, along with high-quality, credible, and transparent auditing, is essential to understand the actual state of public finances, as poor asset management can obscure economic challenges.
