Australia’s New Government Faces an Economic Trial-by-Fire

“There’s a hole in your budget, dear Labor,” sang the Coalition’s parody attack ad on the Labor party during Australia’s recent election campaign.

Yet the attempted critique of center-left Labor’s economic credentials failed to make an impact with voters, with the center-right Coalition government having recently overseen a blow-out in public debt, including more than A$300 billion of coronavirus pandemic-related spending.

With Labor securing a parliamentary majority in the May 21 poll, can the party achieve its promised “stronger and more inclusive” economy amid accelerating inflation, trade troubles, and global turmoil?

Labor’s five-point economic plan and budget strategy promoted “smart, targeted investments,” improving the “quality of spending” and trimming spending on consultants while cracking down on tax loopholes for multinational companies. It was a deliberately “small target” approach compared to the major policy platform that saw the party rejected at the 2019 election.

Yet after winning office and inspecting the books, the nation’s new federal treasurer, Jim Chalmers, has quickly set the scene for harder times ahead for the world’s 13th largest economy.

Speaking after the latest gross domestic product (GDP) data showed the economy growing at the seemingly robust annual pace of 3.3 percent, Chalmers said he had inherited a “dire” situation from the previous Coalition government led by Scott Morrison.

“There are elements of strong demand, [a] tight labor market, there are some pleasing aspects of the national accounts, but there are far more troubling aspects in our economy,” Chalmers said at a press conference.

“The situation we’ve inherited is serious. In some instances, it is dire.”

Chalmers pointed to the “big challenges” of inflation, falling real wages, rising interest rates, and growing cost of living pressures. Inflation has surged to 5.1 percent, its highest level since 2001, with household power bills surging on the back of soaring electricity prices and rising fuel costs.

Unemployment has dropped to a 48-year low of 3.9 percent, but labor and material shortages following the COVID-19 pandemic have resulted in rising cost pressures.

On May 3, the Reserve Bank of Australia (RBA) responded to rising inflation by raising its official cash rate to 0.35 percent, its first official interest rate hike since November 2010. The RBA was widely anticipated to increase the rate by another 0.25 percentage points in its June 7 meeting, with many economists tipping as much as 0.4 percentage points. In the end, the bank surpassed even the more aggressive predictions with a raise of 0.5 points, the biggest jump in 22 years.

RBA Governor Philip Lowe said in a statement that the Board made its decision based on “the current inflation pressures in the economy, and the still very low level of interest rates.”

“The Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead,” Lowe added.

The Coalition government’s pre-election budget predicted gross debt would peak at A$1.2 trillion, or 45 percent of GDP, compared to around 28 percent pre-pandemic. However, adding borrowings by state governments could result in total government debt approaching nearly 65 percent of GDP.

Labor’s election campaign promises could further worsen the nation’s fiscal position, with the party promising up to A$15 billion extra over four years on social services such as aged care, childcare, healthcare, and the National Disability Insurance Scheme.

The party also touted another A$50 billion in “off-budget” investments, including A$10 billion on social housing, A$20 billion on the electricity grid, and A$15 billion on manufacturing.

Analysts have warned the nation’s coveted “triple-A” credit status might be endangered if such promises come to fruition.

“Talking about the A$40 billion to $50 billion, if it was all spent in the next couple of years, and if we were to see a much slower reduction in deficits than we were expecting, then that could pressure the AAA [credit rating],” Standard & Poor’s analyst Anthony Walker told the Australian newspaper.

Australia is currently only one of nine nations to hold a triple-A rating from the three major agencies of Standard & Poor’s, Moody’s, and Fitch. Any change to this status could see the government and private companies face higher borrowing costs, increasing the cost of debt amid already rising interest rates.

Walker said he was expecting government deficits to “narrow sharply” in fiscal 2023, anticipating a tough budget from the new treasurer in October.

“Reasonably Sensible”

Can Chalmers deliver a budget surprise?

Former Treasury adviser Gene Tunny says Chalmers seems “reasonably sensible” given his background as a key member of former Treasurer Wayne Swan’s staff.

“I’m reasonably comforted by the fact that Chalmers seems both competent and reasonable,” he told The Diplomat.

“I recall he was Wayne Swan’s deputy chief of staff, he’s in the right faction of the Labor party, so I don’t think we’ll see anything radical from him, and there are some other sensible voices in Labor too.”

Tunny, principal at Adept Economics, does not see any major economic changes from the new government.

“The government has a parliamentary majority so it won’t need to make concessions to the Greens or ‘Teals’ [newly elected independent, climate activist lawmakers], such as an aggressive response to climate change,” he said.

“They’ll run bigger deficits than the [former] government, but it was already running large deficits, so we won’t be talking big increases in relative terms.

“That said, the additional deficits will put pressure on inflation and interest rates, but probably not much more due to the existing large structural deficit.”

Tunny added: “On structural reform, they won’t do anything on IR [industrial relations] reform, which the business community has been pushing for… They do see childcare reform as a genuine reform, they have a more generous subsidy and the goal there is to get more women into the workforce, boosting workforce participation, so they’ll argue that is a positive structural reform.

“Regarding tax, I don’t think we’ll see too many changes. [Labor] got burned last election trying to make big changes to the tax system.”

Capital Economics has predicted a Labor government “will probably keep fiscal policy looser than the previous Coalition government, putting more pressure on the RBA to hike interest rates.”

It noted that the government budget deficit on the underlying cash balance since 1970 had averaged 1.6 percent of GDP under Labor, compared to 0.4 percent under the Coalition.

The consultancy’s senior Australia and New Zealand economist, Marcel Thieliant, said Labor “will make greater efforts to decarbonize the economy, [but] the bulk of mining output is exported so this won’t have a big impact on the mining industry.”

Labor aims to cut the nation’s greenhouse gas emissions by 43 percent by 2030 relative to 2005, above the Coalition’s 26 to 28 percent target. Domestic coal production is seen most at risk, yet the recent surge in power prices has led the government to re-evaluate the benefit of domestic coal production even as it targets greater renewables output.

While the left-wing Greens party called for an “immediate freeze on all new coal, oil and gas projects,” Labor’s parliamentary majority and track record when in government suggests the nation’s resource sector will not be unduly hamstrung by new green tape.

“Labor will try and look like they’re doing something [on emissions] without damaging emission-intensive, trade-exposed industries,” Tunny said.

“There’s general recognition we need to phase out fossil fuels… but the government would want to do it in a considered fashion over the long term.”

Meanwhile, newly elected Prime Minister Anthony Albanese is seen taking a “less confrontational stance” toward China than the previous government, yet even this approach may not be enough to end the trade war with Beijing.

Despite China’s moves to block Australian imports such as beef, barley, coal, and wine, the lack of available substitutes for Australian iron ore and liquefied natural gas, which account for 80 percent of Australian exports, should see overall exports “remain healthy,” Capital Economics said.

One policy where Labor and the Coalition had significant differences was housing, with the former Morrison government pledging to allow first-time home buyers to access their superannuation savings to muster a mortgage deposit. In contrast, Labor promised more social housing and a policy of supporting 10,000 Australians each year through an equity contribution of up to 40 percent.

Both policies could add further demand to a housing market suffering tight supply. Yet the latest data shows Australia’s housing boom may be over, with prices falling in May nationwide in the first decline since 2020, as higher interest rates pressure buyers.

Further hikes in interest rates are expected, with financial markets pricing in an RBA cash rate ultimately as high as 3.7 percent as it brings inflation under control.

“The Australian property market is highly sensitive to the monetary cycle as a result of very high prices and debt to income ratios,” ANZ chief economist Shane Oliver said.

“We expect the combination of worsening affordability, along with rising mortgage rates to drive a top to bottom fall of 10 to 15 percent in average home prices from mid-year out to early 2024.”

The government’s move to support a 5.1 percent pay rise for “low paid” workers at the Fair Work Commission could entrench high inflation, amid warnings of the risk of stagflation.

Yet economists see Australia withstanding a housing downturn and higher interest rates through a lower exchange rate, stronger population growth, increased business investment, and continued elevated prices for key commodity exports such as coal and iron ore.

Although there would be “some policy shifts, particularly around childcare, health, aged care, housing and climate change…[these] don’t change the economic picture over the near term,” Commonwealth Bank economists said.

The OECD projects Australia’s GDP growth will average 4.1 percent in 2022 and 3 percent in 2023, as it emerges from the COVID-19 pandemic.

Longer term though, the “Lucky Country” faces faltering productivity growth, high emissions intensity, and rising aged care, health, and pension spending as the population ages, with a worsening demographic outlook. With China accounting for around 40 percent of total exports, any additional trade restrictions by Beijing could further crimp exports and GDP growth.

Having posted the developed world’s longest economic expansion of 28 straight years through to 2020, Australians only have distant memories of the last major downturn in the 1990s.

Keeping the economic sunshine continuing amid growing global tensions and rising inflation, while balancing demands from newly installed lawmakers for increased spending, will provide a tough test for the new government.

With just a few months until his first budget and an energy crisis now threatening to further blow out cost of living pressures, Chalmers and his colleagues have little time to enjoy their political honeymoon.