Every Tuesday afternoon we publish a collection of topics and give our expert opinion about the Equity Markets.

The Australian federal budget was released last week by Treasurer Jim Chalmers to mixed reviews, which is always the case in politics and how the budget impacts the lives of Australian taxpayers. While 2023-24 saw a budget surplus of ~A$9.3 billion, 2024-25 will bring about a return to deficits and it is anticipated to stay that way for a while which will see gross debt soon exceed A$1 trillion. But Australia is, by far, not the worst offender in fiscal deficit spending which is resulting in debt-to-GDP ratios skyrocketing. ABSI this week explores the debt-to-GDP issue. 

A decade of deficits is one of the overarching issues stemming from the 2024-25 budget release last week. Budget forecasts peg 2024-25 to be A$28.3 billion in deficit and 2025-26 to be A$42 billion in deficit. While these deficits are small in relation to Australian GDP, they’re coming at a time of record revenues with the terms of trade at 100-year highs, unemployment at generational lows, and expected revenue increasing by an estimated A$365 billion over the seven years to 2027/28. 

Therein lies the criticism; the government is wasting the windfall. According to Keynesian economic theory, which most governments purportedly follow, budget deficits are for times of economic downturns to stimulate aggregate demand and stabilise an economy. While Australian GDP growth isn’t strong, we’re not in a recession and any overspending by the government is only going to contribute to inflation. In these prosperous economic periods, the government should be looking to maximise its surplus and pay down debt.

In defence of the Australian balance sheet, Treasury figures point to Australia having one of the lowest debt-to-GDP ratios globally, a valid but flawed argument. If America jumped off a bridge, would you?

Source:  Australian Budget Papers

According to the Institute of International Finance, the average mature market government debt-to-GDP ratio stands at 115% at the end of Q1 2024. Furthermore, they estimate that global debt rose by US$1.3 trillion in the first quarter of 2024 which has reversed a previous negative trend in the global debt-to-GDP ratio. Importantly, the cause of this continued accumulation of debt is unsustainable budgets with irresponsible spending. Outside of Switzerland and Australia, the remaining G20 nations all record budget deficits. The worst offenders are China, Italy, South Korea, Japan, India, and the USA. 

Proponents of the high government debt point to Japan, which has sustained debt-to-GDP ratios of above 200% for decades. However, Japan is a special case in that a significant portion of the debt is held domestically, helped by a high domestic saving rate. Moreover, due to unfavourable demographics, Japan has struggled with disinflation which has kept interest rates low and even negative during some periods.

Source:  Visual Capitalist

Outside of Japan, in a world of high inflation and high interest rates to combat it, high debt-to-GDP levels are unsustainable. This is evidenced in an increasingly important expenditure on budgets: interest expense. While the US currently has an approximate government debt-to-GDP ratio of 124.7%, it has the highest absolute debt level at US$34.5 trillion and is paying US$1 trillion in annual interest on that debt burden. Fed Chair Powell is very cognisant of the issue, in a Feb 2024 60 Minutes interview he thinks that “the US federal government is on an unsustainable fiscal path…debt is growing faster than the economy.”

Australia is in an enviable position as one of the key commodity producers, which has helped in making the country one of the wealthiest on a per capita basis. Likewise, government coffers are filled with royalties and taxes from exports of iron ore, coal, natural gas, and other commodities. However, resources are finite and cyclical, and it is up to governments to foster the gains made today for future generations. It's important we learn from the mistakes of other nations when making capital allocation decisions.

A quick detour to announce the BPC NRL Tipping Competition! 

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