Australia’s mistimed austerity could boomerang

May 12, 2014

By Andy Mukherjee 

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Australians are bracing themselves for what is being billed as the toughest government budget in 20 years. But untimely austerity could boomerang on the country’s shaky economy.

According to Australian media reports, Prime Minister Tony Abbott is contemplating deep spending cuts as well as a controversial but temporary “deficit reduction tax” on high-income earners in the May 13 budget.

The Liberal Party leader says the previous Labor government’s spendthrift ways have left him with little choice. That, though, is not entirely accurate. The fading mining boom and slowing economy will automatically shrink tax revenue. That is the main reason why the government’s December forecast of a cumulative A$123 billion ($115 billion) deficit over four years is A$68 billion higher than the pre-election projections in August.

Tackling this deterioration with higher levies and lower welfare spending could leave less purchasing power in private hands. People will then either tighten their belts, or borrow more against fickle housing wealth. The latter is more likely. The central bank’s policy rate is at a record low, and while unemployment is fairly high at 5.8 percent, a strong wealth effect could tempt people into taking on more debt: Sydney home prices have risen 17 percent over the past year.

Trying to balance the budget could still make sense if it helped eliminate the nation’s chronic current account deficit. Greater demand for Australian goods and services from the rest of the world would help offset government austerity. There is little chance of that, though. While slowing mining investment will curb demand for imported machinery, the outlook for commodities exports is also uncertain.

Australia is hardly staring at a debt crisis. The projected deficit amounts to just 2 percent of GDP a year over the next four years. And while public debt has risen from 10 percent of GDP in 2007 to 29 percent last year, Treasurer Joe Hockey has a sensible plan to encourage states to sell assets and build new infrastructure. This will create jobs and spur growth. A harsh fiscal correction could come back to haunt Australia.

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