Australia seeks to fireproof budget against a China downturn

Reuters News
Posted: May 08, 2014 5:16 PM

By Lincoln Feast

SYDNEY (Reuters) - Australia, having ridden a boom in Chinese demand for raw materials, is seeking to fireproof itself from any shocks from its top trading partner, promising a tough federal budget aimed at reining in rising debt and deficits.

China's growing hunger for iron ore, coal and natural gas saw Australia through the global financial crisis with barely a wobble. But Australia's reliance on that growth has become a major risk as Prime Minister Tony Abbott and his treasurer, Joe Hockey, prepare for their first budget next week.

"Australia's next recession will brew in China before it flowers here and to be honest we might already be too late to start the budget rebuilding programme," said Chris Richardson, director at Deloitte Access Economics. "China in the longer term is fine. China in the next few years will be fragile."

China's slowdown has been managed fairly smoothly so far, but concerns over the Chinese economy - ranging from a possible property crash to a crackdown on credit - have clouded the outlook for Australia's resource exports, especially iron ore.

Despite slowing China growth, Australia's exports to the world's second-largest economy jumped almost 30 percent in March from a year earlier as its low-cost iron ore miners ramped up output and grabbed market share from rivals in Brazil and India.

For the year to March, exports to China totaled A$100 billion ($93 billion), a tenfold rise on a decade earlier and a hefty 7 percent of GDP. Australia's next biggest export market, Japan, is worth half that amount and the United States just a tenth.

Any crisis in China would likely hammer prices for Australian commodity exports such as iron ore, coal and wheat. That would dent tax revenue and hurt investment and the balance of payments - an impact that Australia's population of just 23.5 million would struggle to offset through domestic demand.

"Without doubt, Australia is becoming more exposed to China's economic cycle," said Scott Haslem, chief economist at UBS.


Having gone into the 2008 global financial crisis with virtually no debt, latest projections show Australian deficits continuing, with net debt set to rise to almost 16 percent of GDP - the highest since the mid-1990s.

"If we pay down the debt we inherited, we can - insofar as you can - inoculate Australia against the turbulence that inevitably will come some time in the future in the global economy," Hockey told reporters last week. "We can't keep heading into a cyclone and expect everything is going to be okay."

Still, Australia's debt pales in comparison to most developed nations, spurring criticism that many of the mooted measures are unnecessary and might damage the AAA-rated economy.

"If the Chinese economy collapses, we will have serious problems. But so will Europe, so will the United States," said Raja Junankar, honorary professor at the University of New South Wales' Australian School of Business.

Government debt in the United States and euro zone account for more than 100 percent of GDP, figures from the OECD show.

"Yes, the economy is slowing down and if they did introduce the austerity measures they are talking about now, that would make the situation worse. In the short term, it would be crazy to cut back expenditure (and) increase taxes," Junankar said.

Creating a sense of fiscal crisis early in a government's term is a popular strategy with a view to loosening the purse strings closer to the next election, but the current government is also ideologically driven, said Ian Ward, a reader in politics at University of Queensland.

"They are looking at this not only with the next election in mind but also as an opportunity to reframe questions about the role and size of government."

While Australia's problems may be the envy of many of its rich-world peers, some argue that 22 years of unbroken economic growth has been squandered on a bloated bureaucracy and tax breaks for the wealthy rather than investing in infrastructure now so badly needed in many regions.

Hockey and Abbott have spoken of "an end to the age of entitlement", and have flagged cuts to welfare and the public sector, charges for previously free visits to doctors and a raising of the pension age, among other measures.

Risking criticism of breaking a promise of no new taxes, a temporary "deficit levy" of 1-2 pct for upper-income earners is on the cards. A rise in fuel taxes is also reportedly being considered.

Hockey says the unpalatable steps are needed to rein in deficits forecast to mount to A$123 billion over the next four years, a figure Deloitte's reckons could shrink to A$105 billion if the measures expected are introduced.

"Why do you have a government talking of deficit levies and fuel taxes? It's not for the jollies of it," Deloitte's Richardson said. "It's because the budget numbers are genuinely ugly."

(Additional reporting by Wayne Cole; Editing by Mark Bendeich)