In broad terms, governments’ main source of funds is tax revenue, and governments use funds to provide services, make transfer payments and fund gross fixed capital formation. For the Australian Government, spending on social security and welfare comprises over one-third of total expenditure.73 Spending on health, defence and education together accounts for close to another third.74 Fixed capital investment is another significant component of Government expenditure.
Governments account for shortfalls in revenue over expenditure by issuing debt. Net issuance of Commonwealth Government Securities (CGS) increased sharply after 2007–08 as the budget moved into deficit with the onset of the GFC.75 The stock of CGS on issue is expected to increase to $360 billion by the end of 2014–15, which would be equivalent to 0.2 years of GDP.76
Role of government in the financial system
The CGS market plays a very important role in Australia’s financial system. The CGS market is highly liquid. It provides a risk-free interest rate curve that other debt instruments can be priced from. The Australian Office of Financial Management recently extended the length of the CGS yield curves to 20 years, which provides a benchmark for longer-dated debt securities.
Around 70 per cent of CGS on issue is held by non-residents.77 Investor confidence in the Australian sovereign debt market reflects the relative strength of Australia’s public finances and the Australian economy more broadly.
CGS (and state government debt securities) represent a major source of high-quality liquid assets (HQLAs) for the financial system. HQLAs are unencumbered assets that can be readily converted to cash with little or no loss in value, even in stressed market conditions. To manage liquidity requirements, financial institutions (particularly banks) require holdings of assets that can be converted to cash, sometimes at short notice. Financial entities active in derivatives markets also require HQLAs to use as collateral in derivatives transactions.78
73 For the Australian general government sector (excluding state, territory and local governments).
74 Commonwealth of Australia 2014, 2014–15 Budget, Budget Paper 1, Statement 6, Estimates for 2014–15 expenditure, Commonwealth Government of Australia, Canberra, page 1.
75 Commonwealth of Australia 2014, 2014–15 Budget, Budget Paper 1, Statement 10, Commonwealth Government of Australia, Canberra, page 6.
76 Commonwealth of Australia 2014, 2014–15 Budget, Budget Paper 1, Statement 7, Commonwealth Government of Australia, Canberra, page 5.
77 As at the December quarter 2013, 67.5 per cent of total CGS on issue was held by non-residents of Australia. Commonwealth of Australia 2014, 2014–15 Budget, Budget Paper 1, Statement 7, Commonwealth Government of Australia, Canberra, pages 7–10.
78 Reserve Bank of Australia 2012, Financial Regulation and Australian Dollar Liquid Assets, RBA Bulletin, September Quarter, RBA, Sydney.