World-leading state deficits threaten inflation fight, say economists

Big-spending state and territory governments, ploughing billions in extra spending into the economy, risk undermining the Reserve Bank’s inflation fight.

Mammoth public infrastructure projects and a waning appetite for budget repair has pushed state and territory finances deep into the red. Picture NewsWire / Ian Currie

Big-spending state and territory governments are recording some of the highest deficits in the developed world, with economists saying the blowout in public spending is undermining the Reserve Bank’s efforts to tame high inflation.

Analysis by ratings agency S&P Global predicts combined state and territory debt piles are set to triple from pre-pandemic levels to $750bn by mid-2027, with state deficits far outstripping comparable “subnational” governments in Japan, Germany, Spain, Canada and the Nordic states.

As state budgets sink further into the red, fuelled by public infrastructure spending and a waning appetite for budget repair, traders are tipping a one-in-four chance that the RBA will be forced to deliver a 14th rate hike next Tuesday.

Wednesday’s inflation report for the three months to June looms as a make-or-break moment for homeowners hoping their mortgages won’t rise again, with analysts predicting an underlying inflation rate of 1.1 per cent or higher would force the central bank’s hand.

Jim Chalmers labelled suggestions big-spending governments were adding to inflationary pressures as “ridiculous” and welcomed assistance provided by state and territory counterparts.

“Budgets aren’t the primary determinant of inflation or prices in our economy – in the commonwealth sense, $12bn out of a $2.6 trillion economy last year,” the Treasurer said on Sunday. “The states cumulatively wouldn’t be much different to that.”

Economist Chris Richardson said the start of stage 3 tax cuts alongside new federal and state spending amounted to an extra $46bn being poured into the economy in this financial year – equivalent to the “best part” of 2 per cent of national income.

“That’s huge relative to the amount of money the RBA’s rate rises have taken out of the economy,” he said. “If your yardstick is the size of the Australian economy, then he (Dr Chalmers) has a point). If your yardstick is (whether governments are) helping or hurting the Reserve to fight inflation, then they’re clearly hurting.

“No government, state or federal, has been taking the tough decisions around budget repair.

“The difference is that the feds have benefited from good news in export prices and inflation, both of which boost their tax take massively, whereas the states have had the downside costs of rapid population growth and infrastructure pressures. Nobody has covered themselves in glory, but luck has helped the feds, and hurt the states.”

Ahead of the RBA’s two-day board meeting, economists are focused on the bank’s preferred measure of underlying price growth to gauge whether we are losing ground in the battle to bring inflation under control.

The Australia Bureau of Statistics’ trimmed mean inflation rate – which strips out volatile items like petrol – is expected to rise by 1 per cent in the June quarter, according to the consensus view, holding the annual rate at 4 per cent and above the RBA’s forecast of 3.8 per cent.

NAB head of market economics Tapas Strickland said he expected the RBA to stay on hold next week, but a quarterly increase of 1.1 per cent could be enough to tip the balance in favour of a hike – while faster growth would force a reluctant central bank’s hand.

“Quarterly underlying inflation of 1.1 per cent or higher would suggest that not only are we not making enough progress (in taming price pressures), but that we are going in the wrong direction,” Mr Strickland said.

After the RBA in June said recent state and federal budgets risked stoking demand, the S&P report warned that a flurry of spending initiatives would push combined state debt north of $750bn by 2027 – or nearly ­triple 2019 levels. The ratings agency said Victoria would soon overtake NSW as the most indebted state in the country, despite being the second largest economy.

Under the Allan government, major public infrastructure projects have faced repeated cost blowouts, including the $26bn North East Link, initially costed at $15.8bn, and the Suburban Rail Loop, now budgeted to cost $125bn, or 2½ times the original estimate of $50bn.

S&P separately on Monday reaffirmed Victoria’s AA credit rating, but warned that if Victoria “pushes ahead with the (Suburban Rail Loop) without additional central government funding, it could weaken the state’s fiscal outlook”.

Victorian state debt will increase fourfold from $51bn pre-pandemic to $214bn by mid-2025.

NSW has similarly struggled to contain burgeoning debt levels, the report said, where net debt is set to climb north of $200bn next year.

S&P analyst Rebecca Hrvatin said there was a clear divergence in fiscal fortunes between the “commodity haves and have-nots”, as iron ore and coal ­royalties have flooded Treasury coffers, leading to much lower­­ debt levels.

“Western Australia is reducing debt, (and) Queensland has arguably the largest surplus in Australia’s history,” Ms Hrvatin said.

“Meanwhile, Victoria con­tinues to pile on debt, and NSW struggles to narrow its deficits,” she said.

Tasmania, South Australia, and the ACT have also seen debt increasing, albeit from low bases, the S&P report showed.

“Ratings may be negatively ­affected if expenditure control deteriorates, which would signal weakening financial management,” the report said.