Higher interest rates, slow growth ‘a risky mix’

A dangerous mix of higher borrowing costs and slower growth over coming decades could cause a doubling in government debt and undermine the country’s financial health.

Finance Minister Simon Birmingham says Australia’s debt is ‘manageable’, despite being larger than anticipated as a result of pandemic spending. Picture: Jane Dempster

A dangerous mix of higher borrowing costs and slower growth over coming decades could cause a doubling in government debt and undermine the country’s long-term financial health.

Macroeconomics Advisory chief economist Stephen Anthony projected federal net debt could rise from $750bn in 2022-23, or 30 per cent of GDP, to $1.7 trillion in 2032-33 – equivalent to 47 per cent of GDP.

Mr Anthony, who spent 30 years across Treasury, the Department of Finance, the IMF and the private sector, said “our analysis says we should take remedial ­action now to guard against the uncertain but possible prospect of a loss of policy flexibility in the ­future”.

That included addressing ballooning costs across programs such as aged care and superannuation, as well as tax reform and policies aimed at boosting the country’s growth potential.

The government’s sanguine approach to debt and deficits relies on the economy growing at a ­faster pace than the rate of interest – a combination that allows debt to be paid down over time, all other things being equal, without the need for wholesale spending cuts or tax hikes.

Such an assumption “runs contrary to a global interest rate environment that appears to have reached a 1970s-like inflection point with surging inflation, ­especially in the US”, Mr Anthony said.

His analysis found that a return to the patterns observed between the 1980s and 2010s, where growth habitually came in below interest rates, “would see Australia’s fiscal prospects diminished and lessen our optionality to ­manage future crises”.

Ahead of Tuesday’s budget, Fin­ance Minister Simon Birmingham said debt – which may now peak at less than $1 trillion in coming years – was “manageable”.

“The budget is better than we would have expected, but it is still a budget running significant deficits,” Senator Birmingham said.

“The deficit and debt we’ve had to incur to get through Covid-19 is of a scale that none of us had ­anticipated. But it’s manageable, and that’s evidenced by the fact all three major international ratings agencies have upheld Australia as having a triple-A credit rating.” CBA head of fixed income Martin Whetton said the threat of higher interest costs and ballooning debt were overstated. He noted that government ­interest costs were below 1 per cent of GDP, compared to 3 per cent historically, and had been “flat­lining” for the past decade.

“That is a very low number and it’s a very affordable number,” Mr Whetton said. “As rates rise, that does lift the cost of new debt, but Australia ­issues fixed rate debt, and there’s a really important word there: fixed.”

Mr Whetton said the average duration of federal borrowing now stood at 7½ years, or about two election cycles. “That’s important because it means as interest rates rise, the cost of new debt does rise, but it’s such a small percentage of the overall debt that gets redone each year,” he said.

“It doesn’t mean we are suddenly paying a whole lot more ­interest (when rates rise) and therefore we have fewer choices with what we do with our money.

“That is a really critical thing to understand. Because you do hear a lot that the interest costs will stop us spending money on education or healthcare and so forth, but it’s not how it works in reality.”

Standard & Poor’s this week said Australia’s reduced reliance on foreign capital meant small federal deficits in the order of 2.5 per cent, as well as ongoing debt, was consistent with a AAA credit rating.

Global bond rates have moved sharply higher in 2022 as inflationary pressures have proved more intense and less transitory than central banks had hoped. This is particularly true in the US, where the US Federal Reserve this month began hiking rates.