At Almost $1 Trillion, Australia’s Government Debt Is Surprisingly Seen as Small

It says a lot about the state of the world that Australia is considered to have a low government debt, when by our own standards our debt is very high.

At some stage this year or early next year gross Government debt is expected to cross over $1 trillion for the very first time.

At this stage, however, that is perceived as a reason to get a more active bond market with more participants.

Two Reasons to Avoid Big Debt

There are two main reasons why countries don’t want to have too much Government debt.

The first is that it reduces the government’s flexibility in paying for government services because interest payments become larger than many government departments and act like lead in the saddle bags when considering budget sustainability and flexibility.

The second is that high debt levels leave countries susceptible to a rapid change in investor sentiment, potentially jacking up long term interest rates compared to the rest of the world and also leading to a fall in that country’s currency.

Australia is well short of reaching an unsustainable debt level but that does not mean we should be complacent, because recent events have shown that countries such as the US and France can be subjected to limitations when it comes to selling their government bonds.

Once the bond vigilantes start to swing into action, it can be too late to make the sort of meaningful budget changes that are required for a country that is deemed to have too much government debt.

Certainly, the numbers show Australia is in a much better position than many other countries, even though our debt has climbed to record levels in absolute terms and also as a share of the economy.

Debt up to 37% of GDP and Still Rising

Australia’s gross government debt has jumped from just 5% of GDP to 37% of the economy in the past 15 years – even more if you add in an accelerating load of state government debt as well.

That sounds really bad and in some ways it is but compared to many other players we are just beginners.

One of our major trading partners, Japan, holds an incredible 216% of its economy in debt while the United States has a substantial 124% of its economy in government debt.

In both cases there is some degree of logical rationale which explains why these countries can survive such high GDP percentages of debt, with Japan holding a massive amount of direct consumer cash savings and the United States getting some major advantages from having a currency that is effectively a global default.

Even so, potential US debt buyers or bondholders have required some higher long-term rates of late to keep them interested in the massive amounts of bonds that are being offered and to offset the potential for currency depreciation as the tariff wars continue to rage.

Is the Economy Still Growing Faster than Debt Interest Rates?

Here in Australia, government debt has seldom been a problem because the economy has been growing faster than the interest rates paid on debt.

However, former RBA Governor Philip Lowe has warned that is quickly changing.

“For 40 or 50 years, debt ratios came down without governments having to do too much hard work because nominal growth was greater than the interest rate,” Dr Lowe said.

“I don’t think we’re going to be in that situation anymore.’

Raw Numbers Show a Worrying Trend

If that is the case – which is likely, given Australia’s poor performance in recent times on productivity and per capita economic growth – it is worth considering the size of the actual raw numbers here.

Australia’s Treasury has estimated that the government is currently paying about $2 billion every month in interest costs alone, an amount that could hit $3 billion a month by the end of this decade.

Even with Australia’s relative austerity on government debt, this is a substantial impost on the government’s overall budget and ability to spend money on other priorities.

One of the reasons for this large financial impact is that Australia offers quite high interest rates on its bonds to attract investors.

Benchmark 10-year yields are around 4.3% which is higher than a similar country in the form of Canada which is running at around 3.4%.

Japan does not feel as many constraints as it could because its bond yields sit at around 1.6%, although given the Mt Fuji style height of its debt that is still a massive cost.

Debt Tends To Beget More Debt

Perhaps one unappreciated impact of continually climbing government debt is that to some extent, the more debt you have, the more demand there can be for it.

Already hedge funds have become big buyers of government debt around the world and here in Australia, in many cases using repurchase agreements as they attempt to make a profit by trading the bonds.

The Australian Office of Financial Management – which oversees debt issuance for Treasury – estimates that up to 10% of its bonds in circulation are held by hedge funds and many experts expect this percentage to rise to the higher percentages present in many offshore markets.

Hedge Funds Demand a Premium

There is a price to pay for hedge fund interest though, with estimates that long-term bond yields on government bonds will need to rise about 10 basis points relative to the expected short-term rates over the life of the bonds to maintain the hedge fund interest.

Another danger is that the bigger the bond market gets, the more liquid it becomes, drawing in even more foreign investors.

That can lead to lazy thinking and an attitude that debts can continue to rise even as low productivity and poor economic growth is making that debt sticky and harder to repay.

Treasurer Jim Chalmers has admitted that the current budget projections are unsustainable in the long term and that more needs to be done to raise revenue and reduce spending.

That’s an important goal not to lose focus on just because the pool of potential buyers of Australian Government bonds is getting bigger.