Forget the argument about whether NSW has a budget deficit or a surplus, the real concern should be the $21 billion black hole in the state government’s employee superannuation scheme. So large was the shortfall in the 2011-12 year that the NSW government had to borrow $800 million to try and stabilise the situation.

In fact the government pumped a total of $4.6 billion into the super fund in the year to June, yet the black hole grew by almost 49.5%, or $16.9 billion last financial year. That brings it to a total of $21.6 billion, the highest the shortfall has been. According to the latest report from the NSW Auditor-General the culprits were falling bonds yields, the weak sharemarket and a sluggish economy. With interest rates still falling in the current financial year, and expected to fall again over the course of the next few months, NSW faces the rising chances of another substantial shortfall for the 2013 financial year and the likelihood that it will have to borrow for a second year to fill some of the black hole.

News of the enormous black hole in the state employees super fund was contained in the third report on the state’s finances from the NSW Auditor-General which attracted publicity for the unusual revelation that the NSW government couldn’t add up properly and actually under reported billions of dollars of income and outgoings in the 2012 financial year. So much so that the NSW saw a $1 billion turnaround from the reported deficit to an actual surplus of more than $600 million.

In fact, so weak were the investment returns of the fund, which were compounded by the adverse impact of falling bond yields, that as well as the $800 million in borrowings and $1.5 billion of normal contributions, the government injected into the fund the $3.8 billion return from the partial privatisation of the state’s electricity industry.

The Auditor-General commented in his report that:

“The state’s superannuation liability of $50.9 billion represents obligations for past and present employees, less the value of assets set aside to meet those obligations. Superannuation liabilities increased $16.9 billion (49.5% during 2011-12). This increase has arisen largely from the impact of global economic conditions. Returns on the assets offsetting liabilities (plan assets) have been lower than expected and liabilities have increased as a result of lower bond rates.”

The super liability was $34.1 billion at June 30, 2011.

In the previous financial year (2010-11), there was actually a fall of $474 million in the net liability because of reduction in the discount rate to “reflect the increased return” on Australian government bonds. A small improvement in returns from the sharemarket also helped. But those positive factors didn’t last.

Since November last year, the Reserve Bank has cut interest rates by 1.5%, from 4.75% to 2.25% on the cash rate, the key indicator used by the central bank to set rates. At the same time corporate profitability and property prices have also weakened or grown sluggishly, which in turn has impacted badly on share prices and the value of property holdings.

And what impact did the soaring super black hole have? The Auditor-General said in his report: “The state’s net financial liabilities have increased by about 35% in 2011-12 to about $117 billion largely driven by the increase in unfunded superannuation liabilities.”

According to the report, NSW’s super investments didn’t set the world on fire in 20111-12. The Auditor-General said the fund earned just 0.4% in the 12 months to June, well short of the 7% to 8% “expected by the government”: “The lower investment returns meant there were $2.5 billion fewer investments available to reduce superannuation liabilities.” Bond rates fell to 3.1% from 5.3% in 2011-12, increasing superannuation liabilities by around $19.0 billion and reducing the state’s net worth.

“The state borrowed extra money because the interest payable on the borrowings is expected to be less than the superannuation investment returns,” said the report.

That expectation from the government sounds pie in the sky. Investment returns haven’t been as strong as 7-8% for a number of years now (since the onset of the GFC in 2007) and every year there’s a shortfall, the government has to inject more taxpayers’ money, or borrowings to try and staunch the red ink. The national economy will have seen a substantial increase in growth for that to be remotely possible. The stronger growth would hopefully boost official interest rates, which will help narrow the gap.

But the latest economic forecasts from the RBA and federal Treasury are for a further slowing in growth in the next year, and no real improvement for 18 months or more, meaning more pressure on the NSW government’s deepest black hole.

Peter Fray

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Peter Fray
Editor-in-chief of Crikey