In the second of a three-part series focusing on Bermuda’s public debt situation, Nathan Kowlaski looks at the the different scenarios that could unfold in the coming years.In assessing potential outcomes in the trajectory of the debt profile in Bermuda we are going to have to make additional assumptions in regards to the Government’s ability and willingness to run a primary budget surplus. A recent historic snapshot of the government’s track record can assist in developing potential outcomes. We note that prior history does not necessarily denote future action but the exercise gives scope for consideration. Exhibit 4 gives a historic snapshot of the government’s record of primary budget surpluses and deficits.It suggests that historically, at least, the government has on average been unable to generate a primary budget surplus. Keynesian economics suggest one can go into deficit to support the economy in times of weak growth but it also assumes that one runs surpluses in the good times. It appears the last time the Bermuda Government ran a budget surplus was in 2003. The key then is what happens going forward. We have projected the debt path based on three scenarios (see Exhibit 5):1. Scenario 1 assumes primary budget deficits continue with expenses outstripping revenues by two percent. Nominal GDP growth flat lines and interest rates rise over time to reflect the market’s increasing concern with escalating indebtedness.2. Scenario 2 assumes a balanced budget but not a primary budget surplus. Nominal growth continues at three percent and the cost of debt remains relatively stable until later periods.3. Scenario 3 assumes budget deficits revert to a surplus over time as expense growth is maintained at two percent and revenues grow four percent a year in line with accelerating nominal GDP growth of four percent. In this case debt cost remains constant at 5.7 percent as the market sees a credible plan to tackle the debt.If Bermuda continues on a path similar to what it has done over the last five years, debt levels will escalate to the point where they exceed the levels set by the Maastricht Treaty in Europe, leading to worrisome levels in excess of 60 percent (see Scenario 2).If however, budget discipline is adopted, growth can be reinvigorated and debt costs do not escalate from current levels, the debt level will not become an excessive threat. In fact it appears to be manageable in the long run if primary budget balances can be adhered to.Of course the assumptions could prove to be incorrect. Growth could be worse or better than estimated. Furthermore, investors in the bond market might revolt and demand higher interest rates than the historic cost of borrowing. This would be a factor of the perceived risk escalating for Bermuda. We will cover this in the next section.Let’s first determine what needs to happen to maintain debt levels and/or begin to reduce the indebtedness. To do this, as calculated above, the government needs to run a primary budget surplus of 0.66 percent of nominal GDP or better.To accomplish this the primary budget would need to be in surplus of roughly $38 million in fiscal 2013. This means the current estimated budget deficit for 2011 of about $166 million will need to be adjusted by $204 million through expenditure cuts and/or revenue increases. This seems rather challenging.To put this in perspective a pure revenue boost of $204 million would represent a 23 percent jump. This would assume reaching a government revenue level higher than it has ever been at a time when nominal GDP is eight percent below the peak levels seen in 2008 of $6.1 billion. It also assumes that associated tax and fee hikes would not have a negative reciprocal effect on growth in Bermuda.If we look at the other side of the income statement, assuming flat revenues for 2013, the amount of spending that needs to be cut is equivalent to the size of the entire Department of Health (estimated Health Department spending for 2012 is $191 million).If the government were to reverse the current payroll concession afforded the hospitality, retail and restaurant sectors, approximately $49 million in revenue could be raised. It would still, however, need to reduce capital projects and/or general expenditures by some $155 million, which is double the current budgeted capital projects or the entire budgeted expenditure for the Department of Education.Obviously pure discretionary spending cuts are not feasible. As a result we would not be surprised to see both dramatic expenditures cuts in capital projects coupled with attempts to raise revenue through increased taxation and expiry of payroll tax concessions. The implications of this analysis suggest adjustments will not be easy.Very difficult decisions are necessary to deal with the debt problem and tackling it will create a headwind to growth. Harsh austerity at this stage would only perpetuate the recession but government spending does need to be brought in line with revenues.Tackling the deficit is important but if it is done hastily and abruptly, Bermuda is at risk of entering a debt deflationary spiral of falling GDP and escalating debt levels. Policies to stimulate growth could offset the negative impact of higher taxes and reduction in Government jobs.Once again the focus should be on policies to promote international business and tourism. For countries, too much debt impairs the Government’s ability to deliver those essential services to its citizens. A credible plan must be made to tackle escalating levels of debt.