Budget Review 2021–22 Index

Rob Dossor

The Budget projects that the Commonwealth government’s gross debt will be around $963 billion at 30 June 2022. This is around 45.1% of GDP. It is projected to increase to $1,199 billion—around 50% of GDP—by 30 June 2025 (Budget Strategy and Outlook: Budget Paper No.1: 2021–2022, Table 11.5,
p. 366–7).

Net debt is expected to be $729 billion—or 34.2% of GDP—at 30 June 2022 and peak at $981 billion or 40.9% of GDP in 2024–25 (Table 11.4, p. 364–5). Net debt is then projected to fall over the medium term to 37% of GDP at 30 June 2032 (p. 203).

Australia’s forecast debt levels are slightly lower than what was projected in the 2020–21 Budget, which forecast gross debt to reach $1,138 billion by 30 June 2024, compared to $1,134 billion for the same period, in this Budget.

These gross and net debt levels are shown, to 2024–25, in Chart 1 below.

Chart 1: gross and net debt levels

Source: Budget strategy and outlook: budget paper no. 1: 2021–22, Statement 11, p. 365 and 367.

International comparison

It is not surprising that debt levels have increased so significantly during the COVID-19 pandemic which has led to a considerable increase in government spending.

Australia’s debt level, however, remains low compared to most developed countries. As shown in Chart 2, Australia’s pre-pandemic debt was lower than most comparable countries and this remains true post-pandemic. In 2020 Gross Government Debt (for all levels of Government) increased across all major economies depicted in Chart 2, with Australia’s increase of just under 20%, similar to the UK and New Zealand, and below the US, Canada, and France.

Chart 2: gross Government debt, international comparison

Source: Oxford Economics

Debt sustainability

The amount of Commonwealth debt is causing some commentators to be concerned that the Commonwealth may have to devote an increasing share of revenue to meet interest expenses, and that this may lead to a need to increase taxes, cut spending, sell assets and/or further increase debt. Tim Colebatch, for instance, argues that this will leave the job of servicing and repaying the debt to future generations.

An alternative view is expressed in the Budget which notes that stronger economic growth expected over the coming years, coupled with low costs of servicing debt, will enable the Government to maintain a steady and declining ratio of debt to GDP over time, while running a modest deficit.

This view finds support from other observers who argue that, although Australia’s debt levels have risen dramatically in the last year, commensurate with the international experience, debt levels are not a cause for concern, largely due to low interest rates.

Guy Debelle, Deputy Governor of the Reserve Bank of Australia (RBA), for example, said in a speech in November 2020:

in Australia, public debt is very manageable. Public sector debt remains low as a share of GDP for the Australian Government … Borrowing costs are likely to remain very low for quite some time, and almost certainly until the economy is considerably stronger. This means that the debt dynamics for the Australian Government and the states and territories are absolutely sustainable.

The International Monetary Fund (IMF) outlines that a number of factors determine how much debt a country can carry before the burden becomes excessive, including the quality of institutions and debt management capacity, policies, and macroeconomic fundamentals. Generally speaking, Australia’s institutions, policies, and macroeconomic fundamentals are considered to be robust.

An earlier (2018) IMF working paper outlines that the critical factor determining a country’s maximum sustainable debt level is the difference between its future nominal interest rate and its growth in economic activity. When the growth in cost of servicing the debt (i.e. the interest) is lower than the rate of economic growth, then the debt will be sustainable, as the economy is growing faster than the debt servicing costs.  Australian economist Professor John Quiggin makes a similar point, provided that inflation stays moderate and there is productivity growth.  

Chart 3 below, shows that the cost of servicing Australia’s forecast debt is predicted to increase faster than forecast Australian Government revenue (not including GST). While this may cause some concern, it should be noted that the cost to service this debt remains consistent at 0.7% of GDP over the medium-term forecasts, as shown by Chart 4. This occurs because real GDP is forecast to increase by 4.25% in 2021–22, and then moderate to between 2.25% and 2.5% over the forward estimate periods, and the expectation is that interest rates will remain low for some years.

The Budget’s growth forecasts are consistent with those of the RBA and Oxford Economics. The RBA in its May 2021 Economic Outlook forecasts GDP growth of 4% in 2021–22 and 3% in 2022–23. Oxford Economics in its May 2021 Economic Outlook Australia forecasts GDP growth of 3.6% in 2021–22 and 2.4% in 2022–23. Both the RBA and Oxford Economics forecast that CPI inflation will remain subdued in the medium term.

Chart 3: net growth over forward estimates, cost to service Australian Government debt and Australian Government revenue

*Includes total receipts excluding GST and non-taxation receipts

Source: Budget strategy and outlook: budget paper no. 1: 2021–22, Statement 11, p. 365 and Statement 5, p. 129.=

Chart 4: Australian Government Securities Interest cost and Government revenue

Source: Budget strategy and outlook: budget paper no. 1: 2021–22, Statement 11, p. 365.

The Parliamentary Budget Office (PBO), in its recent Fiscal Sustainability Report, assessed the way that different levels of interest rates, economic growth and the Government’s budget balance would affect the sustainability of the Government’s debt position. Of the 27 scenarios tested, the PBO found:

only the highly unlikely scenario of a generation of low economic growth combined with high interest rates and large budget deficits results in debt increasing as a share of GDP, after 2050.

The scenarios also show that a sustainable fiscal position can be maintained even if the budget remains in a modest deficit position over the long term, although reaching that position will require governments to continue to increase revenue and/or contain spending to return the budget balance to the average levels recorded over time. (p. iii)

Finally, it should be noted that an economy does not need to pay off debt to bring down the relative level of debt. As an economy grows, provided the debt is stabilised, the debt will shrink relative to the size of the economy

Risks

Recently, an article in the Australian Financial Review warned that Australia could lose its AAA credit rating as soon as September 2021, due to the Budget forecast of persistent budget deficits over the next decade. A downgrading to AA+ could result in higher interest rates on new debt.

Whether Australia’s credit rating changes or not, an increase in interest rates will increase the cost of issuing new debt. If interest rates were to rise significantly, it would put upwards pressure on the sustainability of debt, in the same manner as a downgrading of Australia’s credit rating.

Only if Australia’s debt servicing costs become unsustainable would it be a cause for concern, as the PBO noted.

Australia’s relatively low pre-pandemic debt position allowed debt to increase dramatically, but within the sustainable envelope. This debt level is not forecast to begin reducing until the 2025–26 financial year, which raises the question–in the event of another economic shock, will Australia be able to further leverage the balance sheet and stimulate the economy?

The IMF notes that advanced economies with ample fiscal space (such as Australia) may not need to worry about the ability to respond to future economic shocks, but those with very high debt may need start thinking about the implications. As the comparison above shows, Australia has relatively low debt and so will likely retain fiscal capacity to respond to future economic shocks.