What is wrong with funds?

Central government finances is a broad concept and its management requires a wide range of tools. The most important tool is the annual state budget and its revenues and expenditure. Therefore, the budget is widely discussed in public throughout the year. Central government assets, instead, are managed in ministries and in off-budget funds.

On one hand, the state budget outlines how the central government plans to collect, ultimately from Finnish citizens, more than EUR 50 billion each year as taxes and charges. On the other hand, the budget also specifies how the collected funds will be used. However, the state budget plays a less significant role in terms of the management of state assets.

State-owned companies and state enterprises, the value of which totals around EUR 40 billion, are steered at the ministerial level. The steering costs are minute compared to the size and significance of these assets. The same also applies to the main state-owned transport infrastructure. State assets are primarily recognised in the budget as revenue from business operations or sales or as investments in companies or the transport infrastructure. These sums also remain relatively small compared to the state budget as a whole.

One tool to manage state finances and assets is the use of funds. The principle behind funding is simple: it means the transfer of certain activities outside the budget. After this, the related revenues or expenditure are no longer handled as part of state finances. Funded activities are generally financed through a direct transfer of capital from the state, payments from non-state actors, or a combination of the two. Funding may also be used to prepare for undesirable events that could result in additional expenditure. For example, funds have been set up to prepare for oil disasters, storage of nuclear waste, security of supply, and securing the functioning of the financing sector. The State Pension Fund is the largest of the state funds with assets of around EUR 20 billion. It has also been set up to prepare for future expenditure — although most people would not consider retirement either an undesirable or a natural event. The assets held by other state funds total around EUR 10 billion.

Originally, the state-owned Development Fund for Agriculture and Forestry (Makera) and the National Housing Fund operated in a similar manner as banks. Initially, the state transferred capital to Makera and the National Housing Fund to lend to those in need of financing, e.g., for housing development projects or for various agricultural needs such as purchase of land. Back in the day, it would not necessarily have been possible to get any other type of financing. Loans granted by the two funds have also always contained a some type of a support element.

Repayments of loans granted by Makera and the National Housing Fund and related interest payments have generated new capital reserves for the funds to lend further to their customers. In theory, the funds could continue their operation in perpetuity — and they have already for a long time: Makera was first established in 1898 to support the purchase of land by landless citizens. Although the National Housing Fund is a more recent fund (established in 1990), it was established by transferring to the fund assets that were already outside the state budget, i.e. the Arava housing loans, which have been granted since 1949.

Thus, the original task of Makera and the National Housing Fund was to grant loans and invest the assets generated back to the lending operation. Over the last couple of decades, however, the nature of the funds’ activities has changed. Financing is now easily available and the sector no longer requires state involvement. Consequently, these days the main activity of the funds concerns the provision of direct assistance. They also provide guarantees for loans. However, the provision of direct support is not sustainable for the funds in the long term.

In the case of Makera, this problem has already materialised. Even though Makera is technically still a fund, in practice all its assets come from the state budget. The size of Makera has shrank to the extent (to around EUR 300 million) that it now needs regular budgetary transfers to be able to operate. The budgetary transfers made to the fund over the last decade or so total around EUR 300 million, i.e. the current size of the fund. In terms of sound management of government finances, this practice is not justified.

The main argument for the use of Makera is that the fund offers a flexible channel to provide support and financing. This is of course true – once assets are transferred to the fund, they can be more sustainably earmarked for the purpose in question. However, if those assets remained in the state budget, any unused assets could be subjected again to the general debate on which expenditure are necessary and which are not. The state budget is also a better tool than funds in terms of the targeting of support because the state budget allows an annual examination of the related expenditure as one contribution.

With assets of more than EUR 6 billion, the National Housing Fund is still substantial in size. Although, as in the case of Makera, the main activity of the National Housing Fund now mainly concerns the provision of assistance, the fund will not need budgetary transfers to operate for many years to come. However, the fund’s existing loan stock has resulted in a similar issue as in the case of Makera, i.e. by-passing the state budget.

The general interest rate has been at such a low level that it has been beneficial for borrowers to repay their state-issued loans in advance. In addition, financing available on the market has become cheaper and loans from the market do not involve any restrictions concerning, for example, re-selling. Advance payments of loans have increased the assets of the National Housing Fund at a fast rate, and the fund’s cash reserves already totalled EUR 1.7 billion at the end of 2017. New suggestions for how to use these assets are constantly proposed (e.g. the funds should be used to support transport infrastructure projects in growth centres). The underlying thought seems to be that the fund’s assets are extra cash that would be easy to directly allocate to various projects. As in the case of Makera, this would also enable by-passing the budgetary debate concerning state expenditure.

From the perspective of law, off-budget funds have been in the intermediate state in the management of central government finances. Already in 2001, in connection with the constitutional reform, it was stated that funds should only be used in exceptional and justified circumstances. On the other hand, it was also decided that the existing state funds may continue their operations as previously. As Makera and the National Housing Fund were what are called existing funds, they have been able to continue their operations as before. However, if assets of, for example, the National Housing Fund are to be targeted at new activities, the Government should reassess whether it is necessary for the National Housing Fund to continue as a fund. The current requirements for new funds are so strict that it is unlikely that Makera or the National Housing Fund could meet them. The Government should also re-assess whether the funds are truly needed to channel regular support; particularly in the case of Makera, whose assets are based on regular budgetary transfers and not on actual fund operations.

The National Audit Office recently published an audit on the capital management in state funds. The audit covers the National Pensions Fund, the Development Fund of Agriculture and Forestry, and the National Housing Fund. More information on the audit: Capital management in state funds.