The Federal Budget Looms

moneyAustralia’s new federal government today, 13 May ,will deliver its first budget.

The first budget a government brings down is typically one that contains tough political decisions because it has two years to engineer a recovery in the polls. The bluster in parliament and elsewhere about inherited large federal budget deficits and expanding government debt hints at a hard-hitting budget. But this might not be the best thing for the economy.

The economy is expanding but its unsteady growth and the risks it confronts warrant a gentle removal of fiscal stimulus, especially in the form of spending cuts. If the global financial crisis should have taught policymakers anything about fiscal policy it’s that austerity hurts economies, often in a way that is self-defeating in terms of fixing government finances. The size of Canberra’s deficit and debt don’t demand such drastic action.

Much angst about the federal government’s budget deficit stems from how each update on the government’s finances usually shows bigger deficits than previously estimated. The most recent figures from the government are in the mid-year review in December. They showed that the budget deficit for this financial year is estimated to have blown out to $47 billion, or 2.7% of GDP, from $18 billion, when former treasurer Wayne Swan delivered the budget in May last year. The mid-year review projected that Australia is headed for federal deficits each year until at least 2023-24 without any policy changes. By 2016-17, the sale of government bonds to pay for four years of federal deficits is expected to boost net government debt to $280.5 billion, which would by then equal about 15.7% of GDP. While these numbers are big, our ratio of net government debt to national output is low by international standards. The figure for Japan, for example, is headed above 140% of GDP this year.

The government’s budget is the difference between government revenue (which includes taxes) and spending. The reason behind the blowout in the deficit is not excessive government spending. The problem is that the fizzling out of the China-inspired mining boom is slowing economic growth more than expected. A slowing economy reduces government receipts as people and companies pay less tax and boosts government payments if it is forced to pay out more on welfare – which is why austerity is usually self-defeating. The mid-year review said “significantly” lower economic growth (a slowing from 3% to 2.5% in 2014-15) had resulted in an estimated drop of tax receipts of more than $37 billion over four years.

All governments should aim for a balanced budget over the longer term. In the short term, policymakers should stimulate the economy by running a budget deficit if economic growth is lagging and do the opposite if the economy is humming enough to threaten inflation. As even the government admits the economy is expected to be sluggish in the near term there is nothing wrong with the government running a deficit in the next couple of years, even if that adds to government debt.

The economy would probably have a bigger problem if the government tried to return the budget to surplus too quickly, especially if it tries to do this via spending cuts rather than higher taxes – which it is predisposed to do. While the housing market might be frothy enough to prompt the Reserve Bank of Australia to this year raise the cash rate from its record low of 2.5%, the economy faces plenty of challenges. The prices of Australia’s exports are falling as China’s economy struggles. The eurozone confronts numerous threats. While the US economy is bouncing back, its recovery is timid. While the political clock says now is the time for tough budget decisions, investors can just hope that the federal government doesn’t make it harder for the economy to surmount these risks.

Australian budget information comes from the federal government’s Mid-Year Economic and Fiscal Outlook. 17 December 2013. Other financial information comes from Bloomberg, and Fidelity’s research unless stated otherwise.

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