Through a bit of good luck and a bit of good management, Australia’s government debt is stabilising rather than continuing to move higher as was expected when the Morrison government brought down its last budget in March 2022.
It's good news because it means the government’s finances are better placed to deal with the next financial crisis and it opens the door for a direction of sustainable tax and spending policies that are affordable. It's also taking some of the pressure off interest rates, with the government effectively dampening economic activity by running a tight budget.
In the March 2022 budget - delivered by Liberal treasurer Josh Frydenberg just before the 2022 federal election - the policy settings in place meant hefty budget deficits would be in place for at least the following decade. For the four years from 2022-23 to 2025-26, total budget deficits were forecast to be $225 billion.
At that time, gross government debt was on track to exceed $1.2 trillion by 2025-26, which was a major problem - not least because of the explosion in interest rate costs. (Yes, governments have to pay interest on their debt just like you and me.) At the same time, net government debt was projected to climb above 33 per cent of GDP, the highest level since the aftermath of World War II.
Since that budget was handed down a little over 18 months ago, the combination of a stronger economy, markedly higher commodity prices and policy discipline from Treasurer Jim Chalmers and Finance Minister Katy Gallagher delivered a $22 billion budget surplus in 2022-23. It also saw Treasury slash the budget deficit forecasts in 2023-24 and beyond.
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As things stand, the $225 billion of budget deficits in Frydenberg’s final budget are now set to be cumulative deficits of around $50 billion - a massive $175 billion turnaround.
But even that estimate is likely to be revised towards a surplus when Chalmers delivers the Mid-Year Economic and Fiscal Outlook (MYEFO) in the middle of December. The monthly budget data, plus the fact that iron ore prices are massively above Treasury’s estimates, means a small surplus is on the cards for 2023-24.
If Chalmers can ‘bank’ the windfall revenue gains from high commodity prices by keeping a firm hand on new spending, the budget will also be in or around a surplus into 2024-25, locking in three budget surpluses in a row.
Surplus goal hampered by slowing economy
There is no doubt it will be a tough task to meet this goal when the domestic economy is slowing. A weaker economy with higher unemployment will crimp government revenue growth and add to government outlays. That said, getting surpluses, even small ones, should be part of the political and economic strategy of the government.
Budget surpluses mean government debt falls in dollar terms and more markedly as a share of GDP. Governments have to borrow money to cover deficits; they can pay off debt with any surplus cash they can accumulate.
It is now likely that gross government debt will hover around $900 to $950 billion through 2025-26 rather than spiking above $1.2 trillion - as outlined in the Frydenberg budget. With sustained surpluses, gross debt would be even lower, which would reduce interest costs and give the Australian government sound finances for when the next economic problem comes along. This is why Australia is rated AAA by the major credit rating agencies.
The substantial improvement in the budget bottom line has also taken some pressure off the Reserve Bank (RBA) and the magnitude of its interest rate hiking cycle.
In the US, by contrast, where budget deficits are approaching a massive 5 per cent of GDP – around $125 billion in Australian terms – the US Federal Reserve has had to hike interest rates by 550 basis points. It was dealing with a bigger inflation problem too, in part driven by extraordinary government spending and massive budget deficits.
The RBA has hiked ‘only’ 425 basis points in the current cycle because of a less marked inflation problem and, in part, because of tighter fiscal policy.
Tight ongoing budget settings are essential if the government wants to help the RBA contain inflation. It appears the treasurer understands this, which is why next month’s MYEFO is set to show a further narrowing in budget deficits and a greater chance of surpluses in the years ahead.