Australia will have to “pay the piper”

Australia is well placed to “pay the piper” after the massive pandemic spending

The coronavirus was first detected in Wuhan, China, in mid-December of 2019; the World Health Organisation named it Covid-19 on February 11, 2020, and declared a pandemic exactly one month later.

Most governments around the world implemented social distancing and lockdowns and imposed border restrictions to limit contagion and protect lives, but “killed off” economic activity in the process, sending the world economy into its worst recession since the Great Depression of the 1930s.

The Organisation for Economic Cooperation and Development noted the economies of its 37 developed nation members shrank by 9.8% in the June 2020 quarter.

The contraction would have been deeper if not for prompt central bank responses. Central bank actions have eased financial conditions, but increased government spending has played an even bigger role in limiting a more disastrous impact and perhaps permanent damage to economies.

But it still comes at a cost. The Centre for Strategic and International Studies estimates that the G20 nations have spent around $US7 trillion ($10 trillion) - more than 10% of their combined 2019 GDP – in direct spending, tax relief and lending as at the end of May 2020.

Many governments have implemented more relief measures since then – wage subsidies, tax cuts or mortgage deferrals, healthcare services, unemployment benefits, credit guarantees, etc. – creating further strain on an individual country’s budget balance.

Australia’s case is a prime example. In the 2019-20 budget, the federal treasury estimated the country’s fiscal balance to return to a surplus (equivalent to 0.4% of GDP) in fiscal year 2019-20 after a decade of deficits, and expected that “the budget position will continue to improve with sustained surpluses projected to exceed 1% of GDP in the medium term”. These surpluses would be used to reduce net debt each year until it’s fully “eliminated by 2029-30”.

But the surplus is no more. Lower government revenues due to the economic recession, alongside increased government spending through various support programs such as JobSeeker, JobKeeper and HomeBuilder, have turned that expected 2019-20 surplus into an actual deficit amounting to around 4.3% of GDP before widening further to 11% of GDP in 2020-21. The budget papers for 2020-21 show the budget shortfall remaining at 3% of GDP by 2023-24 (the last year available in the treasury’s forecast).

This increased deficit will have to be financed by government borrowing. Not surprisingly, the 2020-21 budget papers project the country’s gross debt to rise over the next three years from 34.5% of GDP in 2019-20 to 51.6% of GDP.

Unpalatable as the deterioration in the Australian government’s fiscal balances may be, the economic cost of not doing anything, or not doing enough, would be greater in terms of the likely potential of longer-term or even permanent damage to jobs and business investment.

Having said that, the time will come when the piper needs to be paid. Countries need to bring debt back to more manageable levels because, aside from being a drag on economic growth as a portion of national income leaks into debt servicing, they risk replacing the coronavirus crisis with a debt crisis that could become a financial crisis.

The best outcome would be for economies to grow out of debt. That is, the massive government support would reap dividends such that the economic growth outpaces the increase in national debt.

More likely, though, policymakers would need to increase taxes, implement austerity measures (slash welfare spending, cut government wages, raise the retirement age, reduce pensions), sell national assets, or all of the above.

But life after debt from pandemic spending in Australia will be better than in countries with higher debt.

Treasury’s projected debt-to-GDP ratio peak of 51.6% remains relatively lower than that of most of its counterparts, suggesting that the government doesn’t need to urgently claw back the money it spent on Covid-19 support measures. Capital markets will be lending more to Australia before they do other nations with higher debt and therefore less ability to repay.

More importantly, the country’s current and projected debt levels remain below 77% – the debt-to-GDP ratio a World Bank study found to exert downward pressure on economic growth.

Australians will be breathing easier than many other countries after the pandemic passes.