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A sound budget for today but tomorrow’s debt needs watching

·4-min read
Frydenberg is the biggest spending Treasurer on record. Source: Getty
Frydenberg is the biggest spending Treasurer on record. Source: Getty

The budget policy approach and position continue to be influenced by the COVID-19 pandemic.

Despite the relatively good health and economic news in Australia, the budget deficit is set to be $107 billion in 2021-22 after a record $161 billion in 2020-21.

There will be budget deficits totalling a further $235 billion in the three years to 2024-25 at which point government debt will hit $1,200,000,000,000 (that is $1.2 trillion).

That government debt will be around $100,000 per Australian household.

Interest has to be paid on this debt, of course, and it would be fiscally prudent to one day in future, have a policy binge that reduces the level of debt.

More from Federal Budget 2021:

- Federal Budget 2021: What it means for you

- Budget 2021: Winners and losers

- AUSTRALIAN WOMEN: This is what the Budget delivered for you

- Budget 2021 explained in numbers

- $14,040 over four years: Tax cuts at centre of Frydenberg’s Budget

-Huge superannuation changes in Federal Budget

But for now, the level of debt and reducing the potentially restrictive impact it will have in the years ahead are second order issues as the recovery from the COVID-19 recession is locked in and all arms of policy – monetary and fiscal – are targeted at getting back to full employment.

Frydenberg – the biggest spending Treasurer on record

The spending of the Morrison government would make Gough Whitlam blush. 

(For younger readers, Whitlam was Prime Minister in the early 1970s who was maligned for series of massive increases in government spending.)

The raft of policy changes in Treasurer Josh Frydenberg’s budget have a huge price tag. According to the budget papers, the impact of policy decisions taken since the December 2020 Mid Year Economic and Fiscal Update totalled $88 billion in the four years from 2020-21 to 2023-24.

Government spending as a proportion of gross domestic product hit a record 32.1 per cent of GDP in 2020-21, will ease to 27.3 per cent in 2021-22 and will remain above 26 per cent of GDP through to 2024-25.

No other government has spent this much over such an extended time frame.

These debt and deficit issues are the macroeconomic benchmarks for the budget.

The budget papers show that the annual net interest cost of servicing that debt will be $14 billion in 2021-22, rising to above $17 billion in 2024-25. And that is with interest rates around the world at record lows and expected to be similarly low over the period of the forecasts.

The elephant in the room is what happens to those interest payments if, or rather when, interest rates rise.

In calculating an annual interest cost of around $17 billion in 2024-25, the Treasury assumes that interest rates “move broadly in line with market expectations”. In other words, interest rates broadly unchanged from now.

That may well prove to be the case but with the global economy hotting up, with inflation starting to lift and the interest rate on government bonds also rising, that is a bold assumption.

The math on the potential problem with government debt is easy. With debt at $1 trillion, for every 0.1 per cent rise in interest rates on the cost of debt, there is a $1 billion addition to the annual interest payment. A rise of 1 per cent adds $10 billion to the annual interest cost.

Wow.

And that is if the level of debt is stable at around $1 trillion. Unless there is a return to a balanced budget at some stage, the interest costs will escalate as debt grow too.

If the economy remains strong, and let us hope it does, it will be the 2022 budget and the ones beyond that will need to move the policy dial towards a surplus. If not, the interest costs of servicing debt may rise to very uncomfortable levels.

A couple of years ago, Frydenberg made a good point. The annual interest cost of government debt “could have built 500 schools or a world-class hospital in each state and territory”.

If over the next few years, the average interest rate on government debt rises by just 1 per cent, there will be an extra $10 billion a year needed to pay the interest on debt which is $10 billion less for childcare, health, schools, aged care, infrastructure and tax cuts.

That is why one day, perhaps very soon, tackling the trillion dollar debt mountain will matter more than it does today.

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