Guess Who IMF Says Needs Fiscal Stimulus? Look Down Under

Updated on

As Australia grapples with the unwinding of its biggest-ever resources investment boom, the government is tightening its purse strings rather than helping shore up economic growth.

Even that arbiter of fiscal soundness, the International Monetary Fund -- scolder of Greece -- says Australia should be opening its pocketbook for public investment. Citigroup Inc. says if it weren’t for the drag from the Abbott administration’s budget stance, the economy would be approaching its speed limit.

The reluctance to delve into substantial deficit financing has its origins in Australia’s biggest constitutional crisis four decades ago, when balancing the federal books started becoming a touchstone for economic credibility. Failure to change means the onus will be on monetary stimulus -- at the risk of fueling a housing bubble.

“A surplus is a really simplistic concept that voters grasp and then translate into the economic management credentials of a government,” said Andrew Hughes, a lecturer at the College of Business and Economics at Australian National University. “Politicians are obsessed with it. That’s resulting in a focus on short-term economic returns at the cost of long-term structural reform and a vision for the economy.”

Tapping Brakes

While the Reserve Bank of Australia has its foot to the floor with a record-low 2 percent cash rate to aid an economy headed for a sixth year of sub-trend growth since 2008, the government is tapping the brakes as it tries to bring the budget back into balance by the end of the decade. Trend growth is regarded by analysts as a kind of speed limit -- faster than that and the economy starts stoking inflation.

Australia’s over-reliance on monetary policy is spilling into the Sydney and Melbourne property markets, where prices jumped in June in response to a rate cut a month earlier. Separate data Wednesday showed engineering starts slumped 47.8 percent in the first quarter from a year earlier to the lowest level in nine years, according to estimates by UBS Group AG.

“We’ve got the balance right in relation to fiscal policy,” Treasurer Joe Hockey told Bloomberg in a television interview Tuesday. “We’re on track with a fiscal consolidation of around half a percent of GDP every year to get back to surplus. But we have the capacity to do what is necessary to keep the Australian economy going through a record run.”

This is at odds with calls from institutions at home and abroad for increased government spending on capital projects including public transport and roads to alleviate traffic bottlenecks in the country’s largest cities.

“Australia does have fiscal space, we think it would be useful to have higher public investment,” James Daniel, the IMF’s mission chief for Australia, said in Sydney June 24. “That would help in the longer term to increase productivity, and in the shorter term it would help boost demand.”

Net Debt

Australia’s general government net debt equals 20 percent of gross domestic product, compared with an average of 72 percent for advanced economies, according to the IMF.

Yet it would require an awkward backflip from Prime Minister Tony Abbott, who prior to election in 2013 wielded rising debt and a widening deficit as baseball bats to belt the former Labor government out of office.

Abbott’s Liberal-National coalition was following a script honed by conservative oppositions since a constitutional crisis in 1975. Then-Prime Minister Gough Whitlam’s high-spending Labor administration was dismissed from office by Queen Elizabeth II’s representative after the opposition blocked the government’s funding in Parliament. Labor was thrashed at the subsequent election, as voters responded to the charge of economic incompetence.

Now, the thinking on budget deficits may be changing.

Fiscal Role

Citigroup economists estimate that if government spending was allowed to increase at its average pace then economic growth would pick up by about 0.5 of a percentage point to near its potential rate of about 3 percent.

“You need fiscal policy to play more of a role,” said Paul Brennan, chief economist in Australia for Citigroup, who is urging the government to provide a stimulus program of about 1 percent of GDP via cash to households. “Government debt is not a constraint, and the feedback we get from our clients offshore and domestically backs that view.”

Australian Treasury officials aim for surpluses because of recollections of the length of time it took the budget to recover from past downturns and wariness to preserve fiscal room in case of a banking crisis, said Kieran Davies, chief economist at Barclays Plc and a former Treasury official.

Banking Crisis

“We were lucky not to have had a banking crisis with the guarantee of the bank debt and deposit guarantee in 2008,” Davies said. “But if you compare like-with-like countries, we have actually had a pretty steep run up in debt and the deterioration in the budget set in during the mining boom.”

Even so, the IMF suggested that Australia is misguided in focusing on its headline deficit. While the budget for recurrent spending, like pensions and wages, should be kept in check, the capital budget is where the authorities need to open their pocketbooks.

“That is the way international standards are moving, towards the operational balance,” the IMF’s Daniel said. “Capital spending creates an asset, and that gives a return over time in the form of growth.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE