Deficit and trade war among key challenges for next term of government: CBA

The US-driven trade war and Australia’s budget deficit are among the most significant economic challenges that the Labor government will have to manage over its next term of government, the Commonwealth Bank of Australia (CBA) has said in an economic update.

“The volatile global trade war sparked by President Trump’s tariff policies is the greatest immediate economic risk facing the Government,” CBA economists wrote.

“Australia is well placed to weather the storm, so we don’t expect the Government will need to roll out large scale fiscal stimulus.”

The Australian economy has turned a corner in the past three years, with economic growth showing signs of a gradual pick-up, inflation back within the Reserve Bank’s target range and a slew of interest rate cuts expected throughout the year.

However, the US-China trade war in particular could pose headwinds for Australia’s economy, especially through its impact on China, Australia’s largest trading partner.

“A sharper slowdown can’t be ruled out, particularly if the Chinese economy slows more quickly than we anticipate, and further targeted support packages for affected industries are possible,” CBA wrote.

CBA economists added that Australia would feel pressure in navigating more intense competition between China and the US, being caught between its biggest trade partner and most significant security ally.

The government’s $1.2 billion critical minerals strategic reserve would likely be welcomed by the US, CBA economists said, as an early step in reducing China’s ongoing dominance over the global critical minerals sector.

The reserve could also be an important bargaining chip in further tariff negotiations with the US, given that Australia still faces 10 per cent tariffs in the US.

CBA flagged Australia’s budget deficit as another ongoing risk, especially following a warning from credit rating agency S&P Global that Australia’s coveted AAA rating could be at risk if the government went into further debt.

Australia’s low net debt to GDP ratio has been an important factor in retaining its AAA rating, typically sitting below 30 per cent. CBA warned that Australia’s debt-to-GDP ratio was currently hovering around the 30 per cent threshold following a spike during the pandemic.

The chasm between the underlying and headline deficit has also widened due to an increasing number of off-budget commitments. Economists have warned that this has undermined budget transparency and obscured the government’s true fiscal position.

“The increasing use of ‘off-budget’ funds which add to debt is … making a mockery of budget transparency,” AMP chief economist Shane Oliver wrote in a research note last week.

While the 2024–25 budget position is currently tracking above expectations following a better than expected tax revenue take, CBA warned that structural pressures would continue to impact the government's fiscal position.

“In the medium-term, structural pressures on the Budget will continue to build. The era of large revenue upgrades from commodity prices appears behind us and spending pressures remain evident in several areas,” CBA economists said.

Key pressures on the budget included the NDIS, a new five-year hospital funding deal with the states, and the $368 billion AUKUS security pact, CBA said.

Oliver said: “Structural spending pressures around the NDIS, health, aged care, defence and public debt interest are now taking the budget back into deficit when public debt is already high. They need to be checked and offset by savings.”

With inflation subsiding, CBA economists said that the government may feel less pressure to rein in its spending. However, they predicted that the threat of losing Australia’s prized AAA credit rating would act as a partial backstop on unconstrained spending.