Australia Considers Cuts to Rein in Second-Smallest Debt

Australia may sell assets and cut welfare spending to rein in a debt burden that is already the second-smallest among developed nations, bolstering a bond market that is off to its best start since 2000.

Australian Treasurer Joe Hockey will deliver his first budget on May 13. A five-kilogram (11-pound) tome published yesterday by the National Commission of Audit recommended savings of as much as A$70 billion ($65 billion) a year within a decade. The independent body, led by former Business Council of Australia President Tony Shepherd, wants the government to commit to achieving surpluses over the economic cycle.

Hockey faces an estimated A$123 billion shortfall for the four years through June 2017. Austerity measures may pressure an economy struggling as the resources boom fades. Benchmark 10-year yields fell 29 basis points in the first four months of 2014, the most since a 57 basis point drop in 2000. The Reserve Bank of Australia has cited expectations that fiscal tightening will weigh on growth as it holds its cash rate target at a record low.

“The Commission is being used by the new Australian government as a vehicle to allow for the slaughtering of a few sacred cows, and to give the Treasurer the cover he needs to put through some difficult and unpopular decisions,” Sean Keane, an Auckland-based analyst at Triple T Consulting and the former head of Asia-Pacific rates trading at Credit Suisse Group AG, wrote in a note yesterday. “The fiscal impact of government activity on the Australian economy is likely to be more contractionary than expected for the next couple of years, further reducing the need for the RBA to move interest rates higher.”

Pension Age

The government should sell off rail and postal assets, cut family welfare payments and make changes to age pensions and unemployment benefits, the report advised.

The Treasurer announced today that the government would raise the eligibility age for the state pension to 70 by 2035. It now stands at 65 and is scheduled to increase to 67 by 2023.

“The age pension expenditure today is currently more than what we spend on defense,” Hockey said at an event in Melbourne. “This is about the long-term sustainability of our system.”

Hockey said while he was not planning to implement an austerity budget, the fiscal strategy would be prudent and underpin the productive capacity of the economy.

The audit commission also recommended the implementation of user co-payments in the government health system and a slower rollout of the nation’s new disability insurance scheme.

Budgetary Challenge

“Australia confronts a substantial budgetary challenge,” the report said. “The fiscal situation is far weaker than it should be and the long-term outlook is ominous due to an unsustainable increase in expenditure commitments.”

Under the scenario recommended by the commission, Australia’s federal net debt would peak at 15.1 percent of gross domestic product in 2016-17 and subsequently decline to just over 5 percent of GDP. Without policy changes, the budget would remain in deficit until 2023-24 and beyond, with net debt rising to about 17 percent.

The nation’s gross debt was 28.8 percent of GDP last year, the smallest outside of Estonia among advanced nations, according to International Monetary Fund data.

High Currency

Given the state of the economy and the impact of a high currency, the government will probably backload spending cuts in areas such as the age pension, said David de Garis, a senior economist at National Australia Bank Ltd. in Melbourne.

“There will be some grandfathering of people above a certain age and that also helps to support the economy for the time being,” he said. There may be some “halo effect” for the Aussie dollar give the projected return to surplus would support the nation’s credit rating in the medium term.

Australia is one of just nine countries with a AAA credit score from all three major ratings companies and its fiscal position remains stronger than most other developed nations.

While the Reserve Bank’s cash target is at an unprecedented low of 2.5 percent, that compares with near-zero rates in the U.S., Europe and Japan. Australia’s 10-year bond yield was at 3.90 percent as of 2 p.m. today in Sydney, 128 basis points more than the equivalent U.S. rate. The Australian dollar bought 92.74 U.S. cents, down from its 2013 peak of $1.0599.

Election Promises

Prime Minister Tony Abbott, who won power in September vowing to create a path back to surplus, is under pressure to keep his pre-election promise of not introducing new or higher taxes in the government’s first term.

Hockey ordered the Commission of Audit on Oct. 22, charging it to identify efficiency and productivity improvements across all areas of government expenditure.

“Not all of the recommendations would be likely to pass the political test of voter polls, but it would be unusual if many are not adopted given this is the first budget of the new government,” Nomura Holdings Inc.’s Sydney-based interest-rate strategist Martin Whetton wrote in a note yesterday.

While the government won’t implement all of the report’s suggestions in this month’s budget, Finance Minister Mathias Cormann told reporters in Canberra yesterday that “governments can’t keep spending more than they raise in revenue.”

(Updates to add Treasurer’s comments from 6th paragraph.)
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