Hooray, we might lose the AAA

The headlines this morning declare that Australia’s AAA credit rating is “under threat”. Actually they should say something like: “Hooray, the AAA yoke might be thrown off”.

Being one of only eight countries with the highest credit rating and a stable outlook is one reason Australia’s manufacturing industry is being killed by a high currency: the shortage of AAA bonds globally boosts our investment inflow.

One way to get the currency down and stimulate the economy would be to keep stimulating the economy with government spending until the AAA rating is lost. Growth would be boosted twice.

I’m half joking. Well, maybe just a quarter joking.

In any case there is very little actual threat to Australia’s AAA rating, unfortunately. The headlines on this morning’s stories quoting S&P associate director Craig Michaels could just as easily have focused on his other statement that Australia’s credit rating is not under threat from the current situation of small and declining deficits, even if they extend to 2016-17.

The AAA rating would only be lost sometime in the future if there were “no intention” of returning to surplus, which there is. So the “AAA rating under threat” story is an old-fashioned beat-up designed to boost S&P’s tattered credibility as the investors’ guardian, but that doesn’t mean the budget is in good shape – it’s not.

The cash deficit for 2012-13 will be something north of $20 billion rather than the $1.1 billion surplus forecast six months ago in the Mid Year Economic and Fiscal Outlook and the $1.5 billion forecast in last year’s budget.

From that starting point, a surplus for 2013-14 is now impossible, as both political parties have acknowledged. In his sixth and final budget Wayne Swan will bring down a deficit of $10-15 billion, saying: “it’s not my fault - the terms of trade made me do it”.

That, and too much spending. The budget is in structural deficit because Treasury’s forecasts of growth have been out by about 1 per cent a year for four years and the government has been spending to just under the revenue forecasts, which have been wrong.

Various boffins are now calling for tough measures to return the budget to surplus, but not only is this an election year, the ALP has chosen this moment to increase the funding for the nation’s schools and disabled people, both unarguable propositions with which the Opposition is not arguing. Separately, the Coalition has also chosen this moment to publicly fund parental leave.

There is always a worthy cause or two, or three. But unfortunately the boost to national income from the terms of trade has now peaked and is declining, so the current crop of worthy causes must be paid for by spending cuts rather than revenue windfalls plus over-optimistic forecasts from Treasury.

Company tax collections doubled between 2003 and last year but are now contracting, both because gross profits are lower and depreciation is higher because of the investment boom.

There have also been decisions by the Labor government over the past four years that have added about $50 billion to revenue, of which $60 billion has been spent (MRRT and carbon tax revenue was wildly overestimated but the money was spent anyway).

But according to the Grattan Institute, the problem is not mainly caused by government decisions, but a blowout in health spending, mainly hospitals, caused by the fact that Australia’s health system is demand-driven – and everyone is demanding more.

Health expenditures by Australian governments grew by 74 per cent in real terms over the last decade, or $42 billion, of which $30 billion was due to “new, improved and more services per person” – not the ageing of the population or rising per unit costs (The rise and rise of health spending, April 23). Spending on hospitals has grown $11 billion more than GDP growth would have implied.

As a result of this blowout in health expenditure, the budget is now in the position where it can’t grow its way out of deficit, which is the shorthand definition of a structural deficit. That means to return to surplus there must be a meaningful fiscal contraction – either spending reductions or increased taxes, or both.

That won’t happen this year, that’s for sure. We will have to wait for next year, and the traditional tough budget in the first, and maybe second, year of a new government, before it starts spending again in time for the next election.