Dr Brendan Rynne, KPMG Chief Economist, responds to the Treasurer’s statement
The budget deficit figure announced today is, in a sense, shocking but not surprising – we know the economy has been hugely damaged by the COVID-19 crisis.
The figures reflect mostly much higher government expenditures and a collapse in tax receipts generated by households and companies, which have stopped working or selling.
But the figures may err slightly on the pessimistic side – while everything depends on the health outcomes, the Australian economy does have a natural resilience, which we saw with 330,000 jobs being created between the low of early April and the end of the June quarter. If we could achieve a reasonable control on the spread of the virus then we should see a kicker in finances and the economy.
KPMG’s macro-economic modelling generates real GDP estimates that are slightly different to Treasury; we see a slightly bigger downswing in FY20 but a larger rebound by the second half of 2021 – albeit only back to the same activity levels as at the end of calendar year 2019. Treasury is anticipating unemployment to peak at around 9.25 per cent in the December quarter 2020, and gradually decreasing thereafter. This level of unemployment was last seen in 1994 as the economy and labour market was recovering from the recession Australia experienced in the early 1990s. KPMG anticipates the labour market to recover slightly faster than the Treasury forecasts.
The current conditions will not be short-term – they will have implications for years. Gross debt to GDP ratio, at 9 percent, is now at a level we’ve not seen since 1945 – but it is still low by international standards and it should be recalled that the government is correctly putting us on a wartime footing to combat the slowdown. We have had bigger deficits after WW1, Great Depression and WW2 and Australia has recovered and can do the same again.
But despite these historically large deficit figures, now is not the time to focus on paying it back. With interest rates so low the interest bill is not a huge problem and with Victoria going back into lockdown the much more pressing problem is preventing the economy slipping off a cliff. Private investment is going to be weak, with uncertainty high and confidence low, so the government has to step in and fill the gap with spending to keep up economic activity in this environment for a while yet.
One area where this is notable is in the SME credit schemes – $40bn in secured loans has been made available, yet take-up has only been $1.5bn. This just shows that businesses don’t yet have the confidence to extend their debt levels. Simply, you can’t take an investment horse to water and make it drink. What would have made sense in normal times does not apply in a pandemic, so public expenditure has to fill the void, although the government is right to try and target that spending as we have seen this week with maintained but reduced JobKeeper and JobSeeker levels.
When the time does come to pay back the debts, and now is not the time for it, we know there are really only three ways (or a combination of these) for it to happen – inflate your way out; high taxes and sharply reduced spending; or growing the economy through productivity.
Firstly, inflation can be used to reduce the real value of the debt so normal tax settings allow the debt to be repaid over time. But attempting to inflate your way out of debt is problematic because it can have significant distributional consequences (real asset holders benefit, others lose out) and undermine the credibility of the reserve bank – these problems may be compounded if many other countries are taking similar actions at the same time.
Secondly, the government can run surpluses by increasing taxes and/or reducing spending. But we need to learn lessons from the post-GFC period when many governments tried an austerity approach which was detrimental to those economies for years afterwards.
Thirdly, the best approach which is to try to achieve higher productivity growth, flowing through to higher economic growth and increases in income and tax receipts (the rising tide effect). This is why it is so important for Australian businesses to lock in the innovation gains and different ways of working many have experienced during the shutdown. We must also hope the increased sense of togetherness in the crisis has created the basis for a new normal in Industrial Relations for this country where the risk and upside is shared in a better way between employers and employees in a more flexible system.