There's a $170 billion hole in Australia's budget if the RBA is right about growth

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In his Anika Foundation speech Wednesday, RBA governor Glenn Stevens hit the brakes on expectations that Australia’s trend economic growth was still around 3.25%.

“Data are hinting that our assumptions about trend growth may need to be revisited, that will be worth some discussion,” he said.

HSBC Australia’s chief economist Paul Bloxham agrees. In a note to clients yesterday afternoon he said that HSBC “recently re-ran our models” and came up results that “showed that Australia’s new potential growth rate could be 2.50-2.75%.” According to Bloxham, that means the economy would be 7.5% smaller than it could be by 2030.

“That’s a loss of over two years of growth,” he said.

Lower, slower, potential growth has important implications for the Australian government and its budget and fiscal position.

Citing Parliamentary Budget Office projections The Australian this morning says if the current rate of economic growth is the new potential, the new normal, then deficits over the next decade could be “at least $170 billion” more than the current Treasury projections.

The paper says:

The PBO modelling shows what would happen to the budget if productivity and economic growth slowed by 0.5 percentage points. Budget deficits would be $10.3bn bigger by 2019-20 and $33.1bn bigger by 2024-25. Across the decade, deficits would be $142bn bigger.

But the PBO modelling does not take account of the jump in growth in Treasury’s projections from 2017-18. That jump was ­designed to add another 2.5 per cent to growth over a five-year ­period in order to bring down ­unemployment. If that jump does not happen, and growth flatlines at the current rate of about 2.5 per cent, the budget bottom line would be at least $40bn worse than Treasury estimates by 2024-25 and $170bn worse over the decade. Instead of moving into surplus from 2019-20, the budget would remain in deficit that would get sharply worse.

Debt by 2024-25 would be at least $360bn, rather than the budget projection of $200bn.

That’s a challenge for any government, let alone one that is cash-strapped.

It’s a very different future to the one most businesses, Australians, and the government have planned. But Bloxham says that a lower potential growth rate helps square the circle on some questions about the current economy.

“This helps to explain why the unemployment rate is already steadying. It also helps explain why underlying inflation is just below the middle of the target band, at 2.3% y-o-y, rather than further below it,” he said.

It seems the RBA Governor is right. Treasurer Hockey might have some massive revisions to do to his budget forecasts.

It could be a very long time before he sees the surplus he’s promised from 2019-20.

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