Amid a housing slowdown, weak wage growth and heightened external risks, investors are increasingly anticipating a new round of interest rate cuts from the Reserve Bank of Australia (RBA). However, we see fiscal stimulus as the better, more effective, way to cushion the country against economic headwinds, with positive knock-on effects for financial markets. We are encouraged by the fiscal stimulus announced in the new budget and see scope for additional measures after the election.
Strong Fiscal Position
Australia can certainly afford to loosen the fiscal purse strings. Favorable terms of trade have buoyed mining profits and lifted corporate income tax revenues while solid employment has helped boost personal income tax revenues. As a result, the 2019-20 Budget projects a surplus in the next fiscal year (July 2019-June 2020) with an eventual surplus target of 1% of Gross Domestic Product (GDP). This was earlier than projected and follows almost a decade of budget deficits.
With the net operating balance returning to surplus from 2018-19 onward, net government debt (gross debt on issuance less its financial assets) is projected to fall from about 18% of GDP currently to 0% by 2029-30. The underlying cash balance is expected to move from a deficit of A$4.2 billion in 2018-19 to a surplus of A$7.1 billion in 2019-20. A cumulative improvement of 2.1 percentage points of GDP is expected between 2019-20 and 2022-23. The budget position is expected to strengthen by an average 0.4% per year over the next four years.
This puts Australia in a much stronger fiscal position than its developed country peers. Indeed, at around 33%, Australia's central government gross debt to GDP ratio is well below the Organisation for Economic Co-operation and Development (OECD) average of 55.1% (Figure 2). This is not because the Australian government has steadfastly embraced fiscal austerity in the past. In fact, it engaged in considerable fiscal expansion in the wake of the Global Financial Crisis and general government liabilities have almost quadrupled over the past decade. However, a steadily growing economy—supported by a resilient financial sector and sustained demand for commodities from China—complemented this public spending and kept public debt as a share of GDP well contained.
While the Australian government’s indebtedness compares favourably with that of other countries, the opposite is true of Australian households. By the commonly used metric of household debt to disposable income, Australian households are by far the most indebted relative to developed market peers.
Tax Cuts Already Announced
In light of this “indebtedness disparity”, some kind of wealth transfer from the public to the household sector strikes us as useful policy. In fact, in the 2019-20 Budget, the government announced plans for an immediate tax relief of up to A$1,080 for individuals, alongside structural reform. A projected 94% of taxpayers will now face a marginal tax rate no higher than 30% in 2024-25. The government has also embarked on a plan to reduce the corporate tax rate to 25% by 2021-22, on a par with other OECD countries. The instant asset write-off threshold for eligible assets was also raised to A$30,000, with the eligibility criteria increased from businesses with turnover of A$10 million to A$50 million.
While these changes will move things in a positive direction, we believe that the current combination of slow wage growth and declining house prices—impacting the value of individual asset bases and potentially undermining consumption—call for further concerted effort after the upcoming election (May 18, 2019). There is a risk, of course, that some of the fiscal projections for the longer run—which assume a no-black swan scenario—are overly optimistic. However, given the favourable starting point and increasingly limited scope for the deployment of monetary policy, such a risk may be worth it.
Government spending has already been a strong contributor to GDP over the past few quarters. Part of that is driven by a surge in government investment, as big infrastructure projects ramp up. There is a major focus on infrastructure spending (Figure 4). The A$100 billion national infrastructure plan includes major commitments such as A$5.3 billion for the Western Sydney Airport and A$5 billion for the Melbourne Airport Rail Link. Government consumption is also expected to rise over the next three years as the National Disability Insurance Scheme is rolled out.
An Effective Macro Policy Mix
The combination of tax cuts and additional government spending should go a long way to mitigate the current pressures facing the economy, lessening the need for monetary policy intervention. That said, it may not entirely preclude it if the recent uptick in mortgage rates or house price moderation intensifies. For now, however, we see fiscal stimulus as more potent in boosting demand in the short term. Longer term we believe that a broadening of the macro policy response away from over-reliance on monetary policy and under-deployment of fiscal policy would benefit not only Australia but many economies around the globe. Could Europe be next?
The views expressed in this material are the views of Kaushik Baidya and Simona Mocuta through the period ended April 8, 2019 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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