Markets Will Punish A Soft Budget
The Age
Monday March 27, 1995
JOHN Howard's line that the Keating Government has given the country just five minutes of economic sunshine before the clouds roll back has hit a hyper-sensitive electoral nerve.
Fear of further interest rate rises in Canberra's mortgage belt is seen as a major if not the major contributing cause to the historic swing against the Government in the weekend's byelection.
It was these mortgage-belt voters in Canberra and around the fringes of the capital cities who re-elected the Keating Government in 1993.
Housing affordability was at its lowest level in decades and young Australians rushed to realise the dream of the bungalow on the quarter-acre block.
Not only were interest rates low but competition among the banks created low-cost entry products that enticed many purchasers who punted on wages growth and housing price inflation to see them through their financial gamble.
Since the recovery began in September 1991, Australia's gross domestic product has climbed by 13.6 per cent in real terms. Over the same period, spending on dwelling construction rocketed by 43.4 per cent in real terms.
Housing was not the big engine of growth over those 36 quarters of recovery; that came from private consumption. However, these two areas of economic activity accounted for nearly half of our total growth.
They are your classic ``feel-good" activities.
Significantly over these 36 months of recovery the contribution to total growth from net exports was a hefty negative, down 16.2 per cent. Yesterday in Parliament, the Prime Minister, Mr Keating, and his Industrial Relations Minister, Laurie Brereton, were banging the drum about what a great economic performance they had pulled off since 1991 and how it was all going to continue, though of course, with low inflation and low wages growth.
In fact, this need not be an idle boast, though there is absolutely no way the present pace of growth can be continued.
However, if the implications of the growth figures outlined above are understood, Mr Keating and Mr Brereton must realise they have something of a political horror story on their hands.
Put bluntly, there is no more room for feel-good economics in Canberra. Now comes the time for the hard management decisions. In terms of economic management, the Government needs to pursue policies that encourage domestic saving, impose a brake on consumption, and encourage investment and export activity.
In political terms, implementing such policies is a marketing nightmare, especially for our born-again populist Prime Minister. His dash-for-growth strategy that began with the One Nation statement was fated from the outset to fall over. It was cynically designed to win an election. However, as so often happens in these circumstances, hubris displaced cynicism with politicians believing their own public claims to wisdom and infallibility.
The big question now is how Mr Keating et al. will respond to the conflicting messages being sent by the financial markets and the ballot box.
There is no doubt which message will ultimately prevail. The financial markets are imposing risk premiums on our bonds that are far in excess of those charged other developed economies. Our currency has been headed south since the beginning of the year and we have the largest current-account deficit among the developed economies.
These days that deficit is being largely financed by portfolio investment in our bond and equity markets. If we continue to rely on depreciation as a politically painless way of addressing our balance- of-payments problem, then foreign investors will demand much higher risk premiums than is now the case.
It will also mean an acceleration in offshore investment by superannuation funds. Unless these ugly features of our economic landscape are addressed, they will soon overwhelm the picturesque areas of employment growth, and wage and price stability that the Government selectively quotes as evidence of its good stewardship.
The idea that our problems can be solved by a promise of returning to fiscal balance by 1996-97 was always questionable. Given what has happened in the global financial markets since December, where currency and bond markets in all debtor countries have been placed under pressure, the market vigilantes will be looking for credible evidence of an accelerated move back into fiscal surplus.
Even a tough Budget offers no guarantee that monetary policy can be put on hold. However, it could mean that monetary policy is deployed where it has most effect and that is in pursuing price stability.
Following Saturday's byelection debacle, there will be even greater reluctance in the ranks of the Government to pursue unpopular fiscal policies.
The bottom line is that the Government has no option. If it does not accept that the end of its feel-good approach to economic management has now been reached, then the markets will respond accordingly.
The dollar would be threatened with free-fall and the Reserve Bank would be forced to defend it. These days when you have to defend a currency in which the market has lost confidence you do not talk about those prospective increases of 50 or 100 basis points that have the mortgage belt spooked.
© 1995 The Age
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