Australia Prepares to Tighten Fiscal Policy in Hit to Consumers

By Gemma Daley - May 5, 2011 10:01 PM GMT+0800


Australia’s government next week will unveil spending cuts aimed at assuring a return to a budget surplus, helping the nation’s central bank contain inflation at the expense of growth in the economy’s 20th year of expansion.

Treasurer Wayne Swan is scheduled to detail on May 10 the programs to be trimmed even after Australia’s costliest natural disasters and a currency appreciation that may undermine export competitiveness. The steps are designed to strengthen the fiscal position of a country reliant on Chinese demand for its minerals that has left what officials call a “patchwork” economy.

The plans would leave the government’s fiscal stance supporting monetary policy in the developed nation with the highest borrowing costs. Prime Minister Julia Gillard may be trying to head off rate rises that would add to challenges for an administration with a 15-year-low public approval rating.

“Officials are worried they will be blamed for rate hikes,” said Helen Kevans, an economist at JPMorgan Chase & Co. in Sydney. “This surplus promise is a political imperative and it’s the one promise they don’t want to break.”

JPMorgan says the government may toughen rules for 800,000 people on the disability pension, scrap or reduce welfare payments, cut family-tax incentives, stop higher-paid workers from receiving a private health-insurance incentive and pare back medical-testing payments.
Consumption Drag

Such steps would add to a drag on consumer spending after households boosted savings rates in the aftermath of the global financial crisis. Retail sales fell in March for the first time in five months, sending shares lower for Myer Holdings Ltd. (MYR), David Jones Ltd. (DJS) and Woolworths Ltd. (WOW) Yesterday’s retail report spurred some economists to predict a first-quarter contraction.

“The main impact of the budget on the economy will be quite contractionary in terms of growth,” said Brian Redican, senior economist in Sydney at Macquarie Group Ltd., Australia’s biggest investment bank. “The imposition of a flood levy is going to ensure that consumers stay in their holes.”

Swan has described it as a “tough” budget as the government tries to deliver a surplus in the year ending June 30, 2013, to improve its reputation for fiscal stewardship. Flooding across Australia, Tropical Cyclone Yasi, bushfires, an 18 percent gain in the local dollar from a year ago against the U.S. currency and slower consumer spending have seen revenue fall by A$6.5 billion ($6.9 billion) since a November budget forecast.
Levy for Recovery

The flood levy, applying a range of increases in income taxes, is forecast to raise about A$1.8 billion. Deloitte Access Economics forecasts the budget gap will shrink to A$21.7 billion in the 2011-12 fiscal year, from A$51.4 billion deficit this year.

Standard & Poor’s and Moody’s Investors Service, which have awarded the nation their top investment grade, have said the government could delay the budget surplus and not affect ratings.

The bonds have lured Bill Gross, who runs the world’s biggest mutual fund at Pacific Investment Management Co. He said May 3 investors should prefer Australian and Canadian government debt and shun U.S. Treasuries.

Australia will tighten fiscal policy by 3.7 percentage points of gross domestic product in the two years through 2012, the second-steepest reduction in deficits in the world, the International Monetary Fund predicted last month. GDP rose 0.7 percent in the fourth quarter, accelerating from 0.1 percent in the previous three months.

Rate Increases

The tightening would add to a monetary brake on the economy that has amounted to a 175 basis point cumulative increase in the benchmark interest rate from October 2009 to November last year. The Reserve Bank of Australia has kept the cash rate target unchanged at 4.75 percent since then.

“Interest rates have to go up, but that will have enormous damage on some sectors of the economy that aren’t doing so well,” said Gerry Harvey, executive chairman of No. 1 furniture and electrical retailer Harvey Norman Ltd.

Harvey said consumers of his items had “never had it so good” with a stronger dollar making imported electronics cheaper. By contrast, industries such as manufacturing and tourism are hurting under the currency gains, Treasurer Swan has said.

All told, a tighter fiscal stance is appropriate given job gains and strength in commodity exports, according to Art Woo, director of Asia sovereign ratings at Fitch Ratings. “Australia probably needs a combination of tightening to take place in both fiscal and monetary policy,” he said.

Worst Since ‘96

Separate efforts by the Gillard administration to impose a tax on mining companies’ profits and charge companies for their pollution to reduce greenhouse emissions have proven unpopular. Those who would choose the Labor Party as their first pick in an election fell to 31 percent, the lowest since May 1996, according to a Nielsen opinion survey of 1,400 people published in the Age newspaper on April 18.

“Voters are turned off by the carbon tax, the mining tax and the flood tax,” said Nick Economou, political analyst at Melbourne’s Monash University. “The government is drowning and because of its tenuous hold on power, this budget won’t save it,” he predicted.