A matter of public sector financial management is turning into a risky political stoush. The government’s plan to increase the debt ceiling to $300 billion is an essential element of maintaining financial stability, fully functioning capital markets and deep liquidity in the market for Commonwealth government securities (CGS).

The opposition is railing hard against lifting the debt ceiling for reasons that have nothing to do with governance or economics, but a lot to do with a political scare campaign. National Party member Barnaby Joyce says: “If you do raise the debt ceiling, you have a rather large train rolling off the edge of a rather large cliff.” This obscure metaphor and other unsubstantiated criticisms from the opposition on the debt ceiling rise highlight a misunderstanding of the role CGS plays in Australia’s economic and financial market stability.

The global financial crisis taught governments and investors alike that liquidity in government-guaranteed securities is paramount when market ructions are at their worst. Those with a deep knowledge of financial markets, such as JPMorgan’s interest rate strategist, Sally Auld, noted that raising the debt ceiling “is the prudent thing to do. I would hope it is an uncontroversial issue.”

Her hope reflects a risk that an escalation in the political hoopla from the opposition will spill over to a change in market confidence. For now, investors are content with the debt ceiling. Government bond yields are at record lows and more than three-quarters of CGS is held by foreigners. Liquidity must bemaintained to retain this confidence.

Last year, the government consulted market participants and regulators who said: “To maintain a liquid and efficient bond market that supports the three and 10-year futures market and the requirements of the new global bank liquidity standards, the panel agreed that the CGS market should be maintained around its current size – that is, around 12 to 14 per cent of gross domestic product over time.”

Linking government debt to the size of the economy means the debt ceiling will rise for at least another few decades. Reducing gross debt in a growing economy will stifle liquidity and risk scaring off foreign investors. Unfortunately, the opposition is willing to risk overseas investor confidence in Australia for the sake of a cheap political point.

If there is a change of governmentat the next election and the Coalition cuts government debt, bond market liquidity would be eroded and big investors would have good reason to sell their bond holdings. This risks market disruption not only for bonds but for the Australian dollar and official interest rates.

Stephen Koukoulas is managing director of market economics and a former adviser to Prime Minister Julia Gillard.

The Australian Financial Review