Budget 2021: Deficit OK if it fosters growth

The debate on debt and deficit has been polarising and nonsensical for quite some time. But COVID might have fixed that.

The debate on debt and deficit has been polarising and nonsensical for quite some time. But COVID might have fixed that.

Australia’s approach to COVID was spot on — recognising that the way to save the economy was to deal with the virus.

At the forefront of this war has been fiscal policy.

First came the emergency spending. There was the JobSeeker, Keeper, Maker and Trainer. It was the spending we needed to survive the immediacy of the COVID-recession — and it characterised the federal government’s first COVID budget. It was remarkably successful, keeping hundreds of thousands of Australians in work.

Just like the response to the GFC, government spending was deployed to cushion the blow.

Tuesday’s second COVID budget — moving from survival to recovery — sees spending playing catch-up on issues long overdue. The dollars are, necessarily, big. Spending on aged care, mental health and women’s physical and economic security are desperately needed.

But it remains to be seen if the budget has enhanced productivity sufficiently.

While the budget received a $104bn windfall from a faster than expected bounce-back, the government spent $96bn of this on Tuesday night.

And all that spending sees net debt top almost $1 trillion by 2024-25. Much of the commentary on that figure focuses on its size relative to GDP; the net debt-to-GDP ratio will top 40.9 per cent by June 2025. But the measure doesn’t tell the whole story. Comparing debt to GDP, compares a stock to a flow.

What’s far more important are the repayments on that debt over time — comparing flow to flow. And that’s where the real story is. Relative to nominal GDP, interest payments on Australia’s debt sits at just 0.7 per cent over the next four years. That’s lower than it was in 2018-19.

But how can that be the case if our debt has rocketed? The answer lies in interest rates.

The reality is that the cost of borrowing has never been cheaper. And given that the interest on our debt is locked in for the term of the bond, these rates can be held for as long as 30 years. That matters not only for our new debt, but increasingly our old debt as it’s rolled over.

As it stands, the Australian government has more than $750bn of Treasury bonds on issue, with a weighted average term of 7.6 years — and with an average interest rate of just 2.3 per cent. More than $154bn of that is at less than 2 per cent. New debt taken on today can face interest rates of just 0.25 per cent for the next four years.

Of course, these low rates won’t last forever — there will be a time when they start to rise because good things are happening in the global and Australian economy. And that will see the cost of issuing new government bonds increase and the cost of servicing old debt start to rise.

But this is not an immediate threat. And nor is it something to lose sleep over. But it does highlight the importance of proper budget management.

Budget repair too soon is as much a risk to the economy as budget repair delayed.

We often think of budget management in terms of increases in taxes or cuts in spending.

But the quality of the budget matters just as much.

Budgets really do need a vision for the future. And that’s where the government’s next budget will be so important: a budget which drives sustainable private sector growth and addresses the structural challenges facing our economy.

Our debt burden becomes a lot less scary if we can build dynamism into our economy. Remember, the larger the economy and the faster its growth, the lower the burden of debt repayments. It’s not just about simplistic slogans on debt and deficits; its what you do with it that really counts.

Harry Murphy Cruise is a senior economist at Deloitte Access Economics; Dr Pradeep Philip is lead partner of Deloitte Access Economics.