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Gillard Ends 42 Years of Spending Gains for Surplus

Australia’s government will cut spending for the first time in at least 42 years as Prime Minister Julia Gillard ends four years of budget deficits, giving the central bank flexibility to lower interest rates.

The underlying cash surplus will be A$1.54 billion ($1.56 billion) in the 12 months to June 30, 2013, Treasurer Wayne Swan said in Canberra yesterday. Expenditures are forecast to fall to A$364.2 billion next year, the first drop in figures dating back to 1971. The A$44.4 billion deficit this year is the third- largest on record and 3 percent of gross domestic product.

“The surplus years are here,” Swan said in a speech to parliament after he scrapped a planned corporate tax cut. A balanced budget will “provide a buffer against global uncertainty, and continue to give the Reserve Bank room to cut interest rates for families,” he said.

Gillard’s bid for a A$46 billion fiscal reversal risks slower growth heading into an election year with polls showing the opposition Liberal-National coalition would win in a landslide. She’s betting tighter budgets will put the onus on the central bank to further reduce the highest benchmark rate among major developed nations and win a political dividend in an economy where 90 percent of mortgages have floating rates.

‘Very Large’

“The fiscal turnaround is very large,” said Su-Lin Ong, head of Australian economic and fixed-income strategy at RBC Capital Markets in Sydney. “It does keep pressure on the Reserve Bank of Australia to continue to lower rates.”

The 2013 surplus, if achieved, will amount to 0.1 percent of GDP, the budget showed. That compares with a U.S. deficit equivalent to 8.1 percent of the economy, Japan’s shortfall of 9.5 percent and the euro area’s gap of 4.1 percent of GDP, according to data compiled by Bloomberg.

Australian bonds rallied after the budget, spurred by concern Greece’s political deadlock will exacerbate Europe’s debt crisis. The benchmark 10-year yield fell as much as five basis points to a record 3.37 percent. The local currency traded as low as $1.0093, near the weakest level this year.

Gillard and Swan have struggled to protect the ruling Labor Party’s electorate from the two-speed economy -- a phrase the RBA uses to distinguish resource-rich regions in the north and west that are powering growth and hiring workers, from struggling tourism, manufacturing and retail industries of the south and east.

Two-Speed Economy

“The great bulk of Labor supporters are in the slow lane,” said Shane Oliver, Sydney-based head of investment strategy at AMP Capital Investors Ltd.

Moody’s Investors Service Vice President Steven Hess said Australia’s Aaa rating with a stable outlook remains intact. Kyran Curry, an analyst at Standard & Poor’s, said that while there’s no immediate impact Australia’s AAA rating, the strategy relies on “an accommodative economic outlook that remains highly uncertain.”

Projected surpluses through 2016 are driven by A$33.6 billion in savings.

The budget papers show spending reductions include A$5.4 billion from defense over four years and A$2.9 billion from the deferral of an increase in overseas aid by a year. It will also reduce tax breaks on pensions for higher income earners and tighten the pharmaceutical benefits scheme to lower costs.

Europe’s Austerity

As Europe faces years of fiscal austerity, Australia’s budget surplus would make it one of the first developed nations to emerge from an era of red ink caused by the worldwide financial crisis that started in 2008.

“In a global economy marked by anxiety and uncertainty, our nation is a beacon of resilience,” Swan told parliament.

The Treasury forecasts the economy will accelerate to 3.25 percent in the 12 months beginning July 1 before slowing to 3 percent growth the following year. The unemployment rate is predicted to rise to 5.5 percent in the next two years.

Consumer prices will increase to 3.25 percent in the 12 months to June 30, 2013, with the introduction of the government’s carbon pollution reduction scheme adding 0.7 percentage point, and core inflation will be 2.75 percent, the budget papers show.

The outlook is similar to the RBA’s growth and inflation forecasts released last week in its monetary policy statement.

Mining Boom

The Treasury predicts resource industries will expand at an annual pace of 9 percent, compared with 2 percent for the rest of the economy over the next two years. Energy and mining companies will invest a record A$120 billion in the fiscal year starting July 1, a 150 percent increase from two years earlier, as part of a A$450 billion resource investment pipeline, the budget showed.

Swan told parliament yesterday that for much of the country “this feels like someone else’s mining boom.” In response, he announced that A$1.8 billion in revenue from the government’s mining tax will be diverted to increases in family payments.

RBA Governor Glenn Stevens last week cut the overnight cash-rate target by half a percentage point to 3.75 percent, the deepest reduction in three years. Traders are forecasting a 54 percent chance the RBA rate will drop to a record 2.75 percent by October, according to swaps data compiled by Bloomberg.

Australia still has the highest benchmark rate among major developed nations. Central banks from Europe to New Zealand to Canada have policy rates ranging from 1 percent to 2.5 percent. Rates in Japan and the U.S. are near zero.

Chinese Demand

Stevens is trying to manage an economy powered by demand from emerging nations including China and India for iron ore, coal and natural gas. Chevron Corp., Royal Dutch Shell Plc, Woodside Petroleum Ltd. (WPL) and ConocoPhillips are among energy companies spending $180 billion to explore and develop gas fields in Australia.

Australia is undergoing what the central bank calls “historically unusual” structural change as the surge in resource investment and opportunity to bet on China’s growth drives an appreciation in the exchange rate.

The Australian dollar has been the best-performing group of 10 currency against the U.S. dollar during the past three years, rising about 31 percent, according to data compiled by Bloomberg.

While that strength helps contain inflation by making imports cheaper, it hurts exporters by making their products more expensive relative to overseas competitors. BlueScope Steel Ltd., the country’s largest steel producer, in August shuttered its export division, and Australian wine exports fell to a 10- year low in 2011.

Slumping Popularity

Labor-market weakness is taking a political toll on Gillard, who withstood a leadership challenge from predecessor Kevin Rudd in February. Her Labor Party trails opposition leader Tony Abbott’s coalition by 18 percentage points, according to a Newspoll published in the Australian on May 1.

To help non-resource industries adjust, the government will allow companies to carry back as much as A$1 million of losses against tax paid two years earlier. Swan said the measure will encourage businesses to invest and adapt as they struggle with the competitive pressure caused by the dollar.

The currency’s extended stretch above parity with the U.S. dollar is among reasons the government reduced its forecast collection from the mining tax over the next two years to A$6.5 billion, from A$7.7 billion 12 months earlier.

The government had planned to use the proceeds to cut company taxes by 1 percent. Swan said he abandoned that proposal due to a lack of support in parliament and would instead spend it on increased family benefits and support for businesses.

‘Dripping With Politics’

The budget “is ambitious for Commonwealth finances but lacks vision for the broader economy,” Peter Anderson, chief executive officer of the Australian Chamber of Commerce and Industry, said in a statement. “The decision to abandon the company tax cut is dripping with politics and a low blow to the business sector given that the quid pro quo mining tax has already been legislated.”

Australian employers probably cut 5,000 jobs last month, a Bloomberg News survey of economists showed before a government report on May 10. The unemployment rate likely rose to 5.3 percent in April, the highest level since September.

Australia’s jobless rate has held at about 5.2 percent for the past six months, less than half the level in Europe, where governments and households are reducing spending in response to the debt crisis.

“We make a forceful statement ours is one of the world’s strongest economies and fairest communities,” Swan said in his speech to parliament.

To contact the reporter on this story: Michael Heath in Sydney at mheath1@bloomberg.net

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net

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