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Budget Strategy and Outlook 2009-10 - Budget Paper No. 1 - Assessing fiscal sustainability
Home > Budget Paper No. 1 > Statement 4: Assessing the Sustainability of the Budget > Assessing fiscal sustainability
Statement 4: Assessing the Sustainability
Assessing fiscal sustainability involves examining the Government's capacity to repay debt without placing undue upward pressure on interest rates or impeding economic growth. The Government's finances are fiscally sustainable when it is expected to be able to meet its financial obligations without making unrealistically large adjustments to tax and expenditure programs.
There is no single indicator of fiscal sustainability and economic theory does not give a definitive answer as to the optimal level of debt. The capacity to repay debt depends on a wide range of factors. These include the level of net debt, the values of financial and non‑financial assets and obligations, interest rates and economic growth prospects. They also include the expenditure‑ and tax‑to‑GDP ratios, the types of expenditures financed and the quality of institutions.
Sustainability assessments begin with the headline budget balance
The global recession has led to a deterioration of budget balances in most economies. This has occurred as a result of the operation of automatic stabilisers, the use of discretionary fiscal stimulus measures and, in some countries, large 'bail out' packages for financial institutions.
In Australia, the automatic stabilisers, predominantly through falls in tax revenues, have resulted in the budget moving into deficit. Temporary fiscal stimulus measures have also contributed to the deficit. The budget deficit is appropriate to cushion the impact of the recession, and is consistent with fiscal sustainability given the plan to return the budget to surplus when the economy recovers.
In an environment where many countries are facing similar challenges, international comparisons are a useful benchmark for assessing fiscal sustainability. Australia's budget position continues to compare extremely favourably with other advanced economies (Chart 8). The collective budget deficit for advanced economies is forecast to be 8.8 per cent of GDP in 2009 and 7.7 per cent in 2010. By comparison, Australia's budget deficit is 4.9 per cent of GDP in 2009‑10 and 4.7 per cent in 2010‑11.
Chart 8: Budget balance positions for selected countries
Note: Data are general government budget balance, except for Australia which is Australian Government. Data include announcements up to 22 April 2009. UK data are for financial years beginning 2008‑09 and data for 2014 refers to 2013‑14. Australian data are for financial years beginning 2008‑09. US data include financial support measures.
Source: IMF 2009c, HM Treasury 2009 and Treasury.
Australia is also in a strong position in terms of net interest payments. As a result of the strong net debt position prior to the economic downturn, and the current low world interest rates, the net interest payments on the debt accumulated as a result of the downturn are expected to be relatively small (Chart 9). Australia's net interest payments are also small by international comparison.
Chart 9: Net interest payments
Note: Australian and US data are federal government data. Euro area data are general government data and are for calendar years beginning 1991. Data include announcements up to mid‑November 2008 for the euro area and up to March 2009 for the US.
Source: United States Congressional Budget Office 2009, OECD 2008 and Treasury.
The contribution of cyclical and structural components is important
It is worthwhile to assess whether the budget deficit is driven by cyclical or structural factors. A deficit driven by cyclical factors will gradually reduce as the economy recovers. As discussed earlier, since the 2008‑09 Budget, the change in Australia's budget position over the forward estimates period is largely due to cyclical factors. Changes in tax revenues from parameter variations are estimated to have reduced the budget balance by around $49 billion in 2009‑10 and $55 billion in 2010‑11.
The contribution of cyclical factors can also be assessed by estimating the structural budget balance. There are a range of approaches for these estimates. However, they involve considerable complexity and uncertainty (Ford 2005).
The structural budget balance estimates shown in Chart 10 use trends in productivity growth and employment levels, with the assumptions for the unemployment rate and terms of trade consistent with the end‑point of the medium term projections outlined in Appendix B of Statement 3. The cyclical component includes changes in capital gains tax revenue from its decade average.
Based on these estimates, the structural budget balance deteriorated from 2002‑03, moving into structural deficit in 2006‑07. This shows that the actual underlying cash balances in previous years were primarily the result of the strength in Australia's terms of trade, which increased by almost 40 per cent over this period. While the temporary fiscal stimulus measures result in a widening of the structural deficit, the deficit narrows over the medium term reflecting savings measures and the Government's commitment to reduce spending as the economy recovers.
Chart 10: Structural budget balance
These estimates are calculated using a different approach than that used by the IMF and OECD. In addition to making an explicit adjustment for capital gains tax revenue, they are based on a medium‑term assessment of Australia's terms of trade. Movements in the terms of trade have sizeable impacts on real incomes and tax revenues. Alternative assumptions around the equilibrium terms of trade — that is, assumptions around the extent to which movements are structural rather than cyclical — can result in significantly different structural budget balance estimates.
The plan to return the budget to surplus must be credible
Fiscal sustainability requires that the plan to return the budget to surplus be credible. The plan should be clear and achievable, and should consider the full path to recovery and the risks around the return to surplus.
The Government has a clear, achievable plan for the return to budget surplus. This involves allowing tax receipts to recover naturally as the economy improves. The Government is also committed to ensuring that the effect of the fiscal stimulus packages recedes and real growth in spending is restrained to 2 per cent per year once economic growth is above‑trend.
The Government has ensured that by 2012‑13, savings measures fully offset any increases in expenditure. Moreover, the Government has also found savings measures that address major areas of fiscal pressure in the longer term (Chart 11). The value of these structural savings increases significantly over time, increasing by around half from 2012‑13 to 2019‑20. This enhances the sustainability of Australia's future fiscal position.
Chart 11: Structural savings measures
The impact on assets and liabilities is also useful to assess sustainability
It is common to use net public debt to assess fiscal sustainability. Net debt is generally preferred to gross debt as it takes into account total debt liabilities as well as some amounts owed to the Government by others.
However, balance sheet measures, such as net worth and net financial worth, provide a more comprehensive indication of financial strength as they include an assessment of broader measures than just debt. However, because net financial worth measures are not widely available across countries and over time, fiscal sustainability assessments tend to fall back on net debt comparisons. Australia's net debt is estimated to rise in the short term, but improve over the medium term (Chart 12).
Chart 12: Australian Government net financial worth and net debt
Note: The inverse of net financial worth, that is net financial liabilities, is compared with net debt.
Australia's net debt is much lower than other advanced economies (Chart 13). It is estimated that Australian Government net debt will rise from ‑0.4 per cent of GDP in 2008‑09 to 13.1 per cent of GDP in 2014‑15. The collective net debt in 25 of the largest advanced economies is estimated to be 52 per cent of GDP in 2008 and 81 per cent in 2014.
Australia's net financial worth and net debt levels show that, notwithstanding the large impact of the automatic stabilisers on the budget balance and the implementation of temporary discretionary fiscal stimulus measures, Australia has retained its strong balance sheet position and much lower debt levels than other countries. In addition, Australia's contingent liabilities related to the guarantees for large deposits, wholesale funding and state and territory government borrowing are not likely to be realised.
Chart 13: Government net debt positions for selected countries
Note: Data are general government net debt, except for Australia which are Australian Government debt. Data are as at end of calendar year, except for Australia and the UK where data refer to financial years beginning 2008‑09. UK data for 2014 refer to financial year 2013‑14.
In addition to assessing the level of net debt, debt dynamics and the capacity to service debt are important for fiscal sustainability. A strong and resilient economy will improve the capacity to respond to shocks and repay debt. Countries with AAA credit ratings have higher GDP per capita and higher net debt levels than those with AA credit ratings (Chart 14). Australia's GDP per capita is similar to other AAA‑rated countries, but government net debt is much lower.
Chart 14: GDP per capita, net debt and credit ratings, 2009
Note: All categories are medians. GDP per capita data are $US PPP from the IMF. Australian net debt data are for the Australian Government in 2009‑10. Net debt data for other countries refer to general government.
Source: IMF 2009c, Standard & Poor's 2009 and Treasury.