Australia staring at “debt mountain” as economy slows

Updated: Tuesday December 17, 2013 MYT 12:32:17 PM

Australia staring at “debt mountain” as economy slows

SYDNEY/CANBERRA: Just three months in power, Australia’s Liberal National government has abandoned all thought of returning to a budget surplus and predicted deficits for the next decade without spending cuts, heralding sober times ahead for the resource-rich country.As sub-par economic growth and a cooling mining boom carve a hole in government finances, Treasurer Joe Hockey warned that Australia had to climb a “challenging fiscal and economic mountain”.

“Returning the budget to sustainable surpluses will not be achieved by piecemeal savings here and there. It will require a sustained and fundamental structural overhaul of expenditure,” said Hockey as he announced the country’s third-largest deficit on record.

The coalition government now expects a shortfall of A$47bil (US$42bil) for the year through June 2014, up from a previous forecast of A$30.1bil made only four months ago.

The gap would narrow only slowly to A$33.89bil in 2014/15, A$24bil the year after and still be at A$17.7bil in 2016/17.

“It highlights the scale of the funding challenge ahead,” said Su-Lin Ong, a senior economist at RBC Capital Markets.

“It’s not a debt path you would want to remain on, so there’s going to have to be a tough conversation on what amount of austerity lies ahead.”

The scope for drastic spending cuts or tax increases is limited by the sluggish economy, which grew 2.3% in the year to September.

Hockey forecast growth of 2.5% in both 2013/14 and 2014/15, short of the 3.25-3.5% pace considered “normal” in a country that has not suffered a recession for 22 years.

The Reserve Bank of Australia has done what it can to support growth by cutting interest rates to a historic low of 2.5%, but has appeared reluctant to ease any further for fear of stoking a speculative bubble in house prices.

Some of the deterioration in the budget bottom line is due to steps taken by the new government, in particular a plan to gift A$8.8bil to the RBA to help rebuild its reserves.

It has also scrapped revenue-raising plans including fringe benefits on car leases and taxing high pension incomes.

STILL LOW, RELATIVELY

Economists had expected a significant deterioration in the fiscal position, with Tony Abbott’s conservative government likely to “front-load” revenue shortfalls and spending to improve the outlook for later years.

Indeed, the market reaction was slight on Tuesday in part because Australia’s debt position is relatively benign compared with its developed-world peers.

Even though debt is expected to peak above A$400bil, that would be less than 30% of Australia’s A$1.5tril of annual gross domestic product.

In the US and the euro area of 15 countries, government debt accounts for more than 100% of GDP, figures from the Organisation for Economic Co-operation and Development show.

A potentially messy battle over raising the debt ceiling was also avoided when the government and the Greens party joined to abolish the ceiling entirely.

While the budget has bled red ink for months now, there has been scant sign of alarm from offshore investors. Foreigners bought a net A$15bil of government debt in the three months to September, the biggest increase since early 2012.

While borrowing costs have risen in the past few months, that was primarily driven by an increase in US Treasury yields, which act as a benchmark for bonds globally. At 4.31%, yields on Australian 10-year paper remain very low by historical standards.

Australia remains one of only a handful of countries that still boasts a triple A credit rating, making its debt especially attractive to foreign central banks and sovereign wealth funds.

Ratings agencies have signalled the outlook for Australia’s rating was stable, as long as the government had set out a credible long-term pathway to repairing the budget.

“The lowering of the GDP growth forecast next year and the resultant substantially larger fiscal deficits are clearly credit negative for the government’s debt position,”Moody’s Investors Service said on Tuesday.

But that would not alter the stable outlook as the rise in debt would still leave Australia “in a relatively favourable position compared to almost all other Aaa-rated sovereigns,” it said – Reuters.