Mathias Cormann bells the cat on the budget


Finance Minister Mathias Cormann has presented some pretty clear evidence that the blow-out in the budget deficit for 2013-14 between the Pre-Election Fiscal Outlook (August 2013) and the Mid Year Economic and Fiscal Outlook (December 2013) is all the result of policy decisions of the Abbott government.

Last week, Cormann released the government’s monthly financial statement – here http://www.finance.gov.au/financial-reporting-and-accounting-policy/annual-and-monthly-reporting-processes/mfs-october-2013.html

The financial statement compares the key budget aggregates for the first four months of 2013-14 against the profile assumed at budget time in May 2013.

Recall that at budget time, the 2013-14 budget deficit was estimated to be $18.0 billion, and this was revised higher, to $30.1 billion, with the PEFO in August. This rise in the budget deficit was due entirely to a down grade to the economic outlook. It is a wider deficit to the tune of $1 billion a month, on average.

According to Cormann’s own figures, which are up to and including October 2013, there has been a deterioration in the budget deficit of less than $1.8 billion over four months or $450 million a month, on average. It is critical to note that this is compared with the budget numbers (a deficit of $18 billion) and not PEFO.

In other words, PEFO was probably close to the mark on what the budget deficit would be in 2013-14 on a no policy change. Indeed, PEFO may have even been too gloomy based on the numbers for the first 33% of the year with the deficit potentially on track for $25 billion.

But of course the new government has changed policy.

According to MYEFO, there is an extra $17 billion blow out in the budget deficit in 2013-14 to a thumping $47 billion. Obviously, this had nothing to do with decisions of the previous government, but all to do with the policy decisions and number distortions from the Abbott government.

No more, no less.



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The economy and markets in 2014


As is normal at this time of the year, economists are pretty much compelled to outline their main themes for the economy and markets in the year ahead.

I am not different so here we go.

1.              Economic Growth

The economy is accelerating into the end of 2013 and with very easy monetary policy, a competitive Australian dollar, more favourable conditions in the global economy and fiscal policy moving to neutral, GDP growth is poised to accelerate to around 3.5% by the end of 2014. It might even be stronger than that as the world economy grows at an above trend pace. While every Joe, Glenn and Martin know that mining investment will be a significant drag of GDP, a pick up in household consumption, a housing construction boom and solid export gains will swamp the mining downturn.

2.              Labour market

With the economy on a clear upswing, jobs growth is likely to follow to a stronger phase, of course allowing for the usual 6 to 9 months lag. In the near term, the unemployment rate is likely to nudge 6% before it starts to tick lower from around the June quarter. Around 225,000 jobs are likely to be created in 2014 which will see the unemployment rate around 5.25% at the end of the year.

3.              Inflation

There are some tentative signs that inflation is now less benign than it was a year ago. The surge in asset prices (housing and shares) is underscoring a huge gain in wealth which is spilling over to higher spending and possibly consumer prices. The lower Australian dollar is adding some stimulus to the economy which is also likely to see inflation edge up into the upper half of the RBA’s 2 to 3% target band. Headline inflation to hit 3% by end 2014, but underlying inflation will lift to around 2.75%.

4.              Monetary policy

The RBA will be hiking interest rates during 2014, perhaps aggressively. The growth, labour market and inflation dynamics suggest the current 2.5% official cash rate is just too low. The best bet for now is to expect the RBA to snug and tap interest rates up by around 25 basis points each quarter in 2014 with the cash rate ending 2014 at 3.5%.

5.         Fiscal policy

By the time the government brings down the MYEFO for 2014-15 in the final months of 2014, there will be a clear trajectory to budget surplus for 2016-17 and beyond, largely because the budget’s automatic stabilisers will be super-charging revenue but also as some of the money shuffling from the government pays back the current out-years from the smoke and mirror budgeting that will see the 2013-14 deficit hit something close to $50 billion. In net terms, the government is unlikely to do much to deliver a structural fiscal policy tightening. Most savings measures announced to date have been fully offset to a ramp up of spending elsewhere. The infrastructure spending program is likely to be captured in the budget figuring which will mean the path to surplus will be not much different to that proposed by the previous government.

6.         House prices 

Having risen a solid 10% or so in 2013, house price growth is likely to taper somewhat in 2014. A rise of less than 5% for the year is more likely as tighter monetary policy, a rebound in supply and some satisfaction of pent up demand works to take some house price heat out of the market. Indeed, if the RBA hikes a little more than I expect, house prices may be dead flat in the second half of 2014.

7.         The Australian dollar      

The AUD is ending 2013 about 15% lower than the peak reached during the first half of 2013. There is a very hearty debate being driven by the RBA about fair value for the currency with the RBA judging that the AUD is overvalued. This assessment has some substance although with a lift in the global economy, strong domestic activity and probably wider interest rate differentials all AUD supportive. The recent fall in the AUD has seen a lot of international investors lighten what were very overweight positions. They and others may be tempted to re-enter the AUD market, especially when interest rates rise. All up, it is a scenario where the AUD could easily lift through 95 US cents or regain parity during 2014. Range for the year, 84 US cents to 97 US cents with more time in a 90 to 95 range, especially in the second half of 2014.

8.         Stocks

The favourable growth and earning story is likely to be offset by monetary policy tightening not only in Australia, but in the US and some other major countries around the world. The ASX200 is likely to record a decent gain and should hit 5,750 points during the year although it is likely to be biased nearer 5,500 over the latter part of 2014. The risk to this forecast is to the high side – that the more positive conditions spark a more solid increase in the ASX200 to above 6,000. In other words, buying stocks now, around 5,150 points is a good trade.

9.         Bond yields

The bear market for bonds that unfolded in 2013 is likely to continue into 2014. The 10 year government bond is likely to break above 5% with the rate hikes skewing short end yields higher, meaning a flatter yield curve. The higher inflation rate that is likely to be printed over 2014 will be critical in driving yields higher, as will a reallocation of cash to stocks and away from bonds.

10.       Politics

There will be a plethora of political matters that will be important in 2014. There will be, in no particular order, the by election for Kevin Rudd’s old seat of Griffith, the new Senate election for Western Australian and then the State elections in South Australia, Tasmania and Victoria. All will be interesting but largely irrelevant for those looking for clues for implications for Federal politics given the next Federal election will not be held until the end of 2016.

I will, as always, revist these calls during 2014.

Happy new year.

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Boiling down MYEFO to two simple variables


UPDATED: Reflecting ABC story that the cumulative budget deficits will be $120 billion over the four years from 2013-14 to 2016-17.

It is possible to boil down tomorrow’s MYEFO to a couple of simple points to see just how the budget deficit widening that will be reported has come about.

The starting point for MYEFO comparisons are, of course, the last Treasury estimates of the fiscal position which were published in August in the PEFO. That fiscal position was for total cumulative net budget deficits of $54.6 billion over the four years of the forward estimates from 2013-14 to 2016-17.

The key point almost always overlooked in the so-called ‘blame-game’ narrative is that there can only be two reasons for changes in these budget numbers:

  • Policy decisions taken by the government of the day.
  • Changes to the economic forecasts or the so-called parameters that are the foundation of estimates of government spending and revenue.

There can be no other factors that have changed the budget bottom line between PEFO and MYEFO.

I’ll repeat for emphasis – there can be no other factors other than policy decisions and changes to economic parameters that can influence budget bottom line estimates in the MYEFO results.

According to the ABC, it looks like the aggregate budget balance for the four years from 2013-14 to 2016-17 will be a deficit of approximately $120 billion, some $65 billion more than was estimated at the time of PEFO.

This $65 billion budget blow out can be due to only two things, government policy decisions and changes in economic parameters.

The good news is that Treasury have always published the dollar value of these components. I assume it will again tomorrow.

These two numbers should be the key big picture take on MYEFO:

  • how much of the budget blow out was because of decisions like spending $8.8 billion on the RBA, abolishing the carbon price and changes in education funding, to take a few on that side, and
  • how much is due to Treasury changing its view on economic conditions, especially GDP growth, inflation, employment and wages?

On the second point, the chatter is that Treasury has taken the lower bound of the consensus forecasts for the economy and that this is adding a few tens of billions to the aggregate deficit. This is sheer dumb luck and has been a factor driving budget changes for decades.

The other number – the change in the budget balance due to policy changes – will be the more interesting. What decisions has the Abbott government taken to change the budget balance? Has its decisions added to or reduced the budget deficit?

It is that simple and there is, or should be, no blame game. Just facts.


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2013 – A stock take on the calls


A year ago, I outlined my top 10 economic and policy issues for 2013 in my Business Spectator column, which can be seen here.


With 2013 all but over, the bank manager and key clients are well satisfied.

Those Top 10 calls for 2013 from Business Spectator are reproduced in full below and I have a short comment following each one.

In the next day or so, I will outline a similar top 10 for 2014. If it is as successful as this year, it may well be a bath in Billecart Salmon this time next year.




From Business Spectator:

The top 10 big issues for 2013

1. GDP growth

GDP growth is likely to muddle near 2.5 per cent early in 2013 before easier monetary policy and a more positive tone from the global economy boosts activity through the course of the year. A solid pick up in housing construction and a lift in household consumption will be significant contributors to the growth pick up, and will take up some of the slack from a less robust mining sector. With accommodative monetary policy in place, the cash flow for the household sector and business will be growth positive. Government demand will continue to act as a dampening influence on economic activity, moderated in part by the decision of the government to allow the automatic stabilisers to support activity. By end 2013, GDP growth is likely to be around 3.5 per cent.

[Comment: GDP growth was 2.3% in the year to the September quarter and looks like holding 2.75% when the December quarter data are released next year. I may have been a quarter premature with my call for stronger GDP growth. Components panning out as expected.]

2. Inflation

Inflation (RBA underlying) will be skewed towards the bottom of the RBA’s 2 to 3 per cent target as the lagged effect of softer growth through 2012 impacts on prices. The persistently high Australian dollar will further dampen import price pressures, at least for the first half of 2013. Another dampening influence on inflation is the moderate wage increases and solid growth in productivity. By end 2013, the moderation in inflation may be dissipating and the market and RBA may legitimately be factoring in inflation risks in 2014.

[Pretty much spot on. Inflation is locked in the lower portion of the 2 to 3% band, but the September quarter was high. With the December quarter CPI next month, the annualised run rate for the second half of 2013 is likely to be near 3%.]

3. Unemployment

The unemployment rate will be five-point something every month during 2013. And while it might edge up in the first half of the year as the economic expansion unfolds a little below trend, it should end 2013 near where it is now, that is 5.2 per cent. The forward indicators for jobs point to the unemployment rate moving higher in the near term and it would be no surprise to see an off month with unemployment hitting 5.7 or 5.8 per cent. But as economic growth picks up through the year, the unemployment will fall back lower to around 5.2 per cent.

[See comment on GDP but the unemployment rate has basically been in a 5 ¼ to 5 ¾% range all year. It just has not started to tick down yet but it probably will as growth accelerates.]

4. House prices

House prices have been weak for two years. Stretched affordability has finally been catching up to house prices and to the extent there ever was a bubble, it has been deflating in an orderly manner. The fundamental drivers of house prices are increasingly positive. Strong population growth is underpinning long run demand, while low interest rates, low unemployment and rising real wages are likely to underscore housing demand and therefore prices. After the weakness of the last two years, it would be no surprise to see house prices rise 10 per cent this year.

[Again, spot on, with house prices surprising just about everyone else with gains of 10% locked in for the year.]

5. Monetary policy

Monetary policy will remain accommodative through 2013. The RBA is likely to cut interest rates in the first part of the year as it catches up to the slowing growth and low inflation dynamics prevailing at the moment. The official cash rate is likely to bottom out at 2.5 per cent during the June quarter with ongoing low inflation driving the reasons for the easings. Rates are likely to remain on hold over the second half of 2013, but it would be no surprise to see financial markets starting to price in the risk of a monetary policy tightening as the year draws to a close.

[Again, close to perfect, with the only variance a month or two out on the date of the rate cut to a historical low of 2.5%. According to a Bloomberg survey in early January 2013, there were only four other forecasters out of 29 expecting the cash rate to end 2013 at 2.5%.]

6. Australian dollar

The Australian dollar ends 2012 significantly over valued. It is a classic market overshoot based on strong global investor demand for Australia’s triple-A rated assets. Markets can be prone to overshoot but in time they inevitably revert to fair value. If the Australian dollar reverts to fair value during 2013 it is likely to be trading near US90 cents at some stage. That said, a free-fall in the dollar is unlikely because of the global economic improvement through the year and the possibility that commodity prices move higher as China and the US pick up. The trading range for the Australian dollar for 2013 should be US88 to US106 cents.

[Another near perfect forecast – the range for the year (with 2 weeks to go), has been US89 to US106 cents, embarrassingly accurate. Recall that when the forecast was made, the AUD was trading at US105 cents.]

7. Australian stock market

The Australian stock market is likely to continue to move higher aided by a move positive growth and profit outlook. A bearish year coming up for bonds will also likely see an asset allocation move to stocks. At some stage during 2013, the ASX200 will break above 5000 and could well trade at 5250 as the year progresses. A positive lead from global markets will be a positive driver with super stimulatory policy prevailing in the US, Europe, Japan and the UK.

[The ASX was strong, up until a few weeks ago. The ASX200 hit 5,400 and looks like ending around 5,100. I probably was a touch too bullish.]

8. Bond yields

Bond yields will stay low in the early part of 2013 aided by the policy actions of the US Fed, the European Central Bank and the Bank of England. As the economy accelerated and the market started to become a bit more concerned about inflation risks, bond yields should move higher. It is likely the 10-year government bond yield will exceed 4 per cent from the middle of the year.

[Again a good call with the 10 year yield currently around 4.3%, up over 100 basis points for the year. It has been good to be short.]

9. Australian election

The election should be held in October, around the 19th or 26th. While an Abbott-led coalition victory is more likely than not. That said, the fickle nature of the political environment, the unpopularity of Mr Abbott and a positive policy agenda from the Labor Party could easily see the election go either way. With economic management – including interest rates – usually an important influence in election outcomes, the Labor Party could win. It will be that versus the carbon and mining taxes and issues of trust that will be driven by the coalition in forming the election campaign issues. It is not yet clear whether the election would be market moving, other than if there was a coalition victory, but without control of the senate, there may be a year or so of policy stalemate as the senate blocked policies to remove the carbon and mining taxes.

[Election date wrong, winner correct, and issues wrong. The economy was not the focus of the campaign. My error. The election outcome has been market moving, although not in the way some would expect. Markets are increasingly taking a dim view of the economic credentials of the new government.]

10. Federal budget

In terms of policy, Treasury is obviously of the view that the budget will record a small deficit in 2012-13. That outlook is premised on a half year of sub-trend economic growth, ongoing softness in commodity prices and the terms of trade remaining weak. For the 2013-14 budget, the government will be incorporating the financial cost of implementing the Gonski education reforms and the roll out of the National Disability Insurance Scheme. When incorporating these policy changes in the budget on May 14, it will find the money to fund it. Expect to see a scaling back of the generous tax treatment of superannuation and more policies that limit benefit payments to high income earners.

[Nothing much either way here. The budget deficits are small, and aside from the unexpected policy decisions from the new government, a surplus was on track in the next couple of years.]





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Stocks prices react to Abbott government


The Australian stock market is now lower than when the Abbott government came to power 3 months ago.

The so-called pro-business, Australia open-for-business, red tape cutting, mining and carbon tax eliminating administration has certainly not been a shot in the arm for the market that some thought it might be.

While it would be wrong to blame the Abbott government for all of the flaccid stock performance since 7 September, there have been a range of confidence sapping policy decisions on Graincorp, RBA funding, the budget, the debt ceiling, leaks on Qantas, the car industry, education spending and the carbon price. The handling of foreign affairs issues has also created a sense of chaos. The cumulative effect of these can only have damaged confidence and sentiment.

And by the way, other markets are also non-plussed. The yield on 10 year government bonds has risen,  not by a lot but the current yield is around 4.44% which is 30 basis points higher than when the election was held.

Not a great start for Mr Abbott, at least from a market perspective.

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The RBA poised to hike interest rates in 2014


The odds favour the RBA hiking interest rates in February or March 2014 and that by the end of 2014, the cash rate will be about 100 basis points higher at 3.5%.

It’s a climate where the Australian dollar is more likely than not to rise, with a move back above 95 cents, or even parity on a good day, in the offing.

The Australian economy is picking up in all the right areas – housing construction is booming, retail spending is accelerating, perhaps a little too rapidly, business expectations for sales and profits are buoyant and the global economy is looking stronger by the day. Lovely news on US jobs and Chinese trade over the weekend continued to flow of good global news.

The current low level of interest rates is no doubt feeding into these positive domestic dynamics, but so too is the lower Australian dollar which is helping to fuel solid export growth.

What’s more, fiscal settings are actually stimulatory, not by much, but by a little and for the first time in a couple of years, the public sector will be adding to growth which means that just about everything other than mining investment will be rising in 2014.

The RBA is misreading the economy, in the opposite way it did in 2011 and much of 2012 when it thought the Chinese economy and mining activity wouldn’t slow much. As a result, it was too slow to cut interest rates. Now it reckons the global economy will remain subdued and that the non-mining parts of the economy will only muddle along over the next 12 to 18 months. Let’s hope it is not slow to hike interest rates.

Recall that in 2011 and early 2012, the RBA got it wrong and it changed tack under a torrent of news of a weaker economy with very low inflation. It was even forced to play catch up with an unusual 50 basis point interest rate cut in May 2012 when the penny finally dropped that the economy was indeed sluggish.

A similar thing is brewing now. In recent weeks, the RBA has retained a bias to cut interest rates, based not on facts so much, but its forecasts and assessment for the economy over the next year or two.

It is important to recall that the RBA is made up of mere mortals – very good economists – but mere mortals nonetheless. Even the best economists can get things wrong from time to time and I suspect the RBA is nearing that zone now.

Once we have a few more months of solid news on the economy and jobs growth moves higher, the RBA will no doubt change its view and deliver a series of interest rate hikes.

With house prices rising at an annual rate of 10% with few signs of cooling, dwelling construction powering to record highs, the low dollar adding somewhat to inflation and bottom line economy growth poised to lift appreciably next year, a 2.5% cash rate is clearly too low. It is the wrong policy setting for the current outlook.

The RBA will need to hike interest rates during 2014, perhaps by 100 basis points or so over that time.

From a trading perspective, I would stay short the whole IB curve, but particularly the first half of 2014 which is still pricing in a chance of rate cuts early next year. And as far as the Aussie dollar goes, it is an unusually tough call right now, but given the drover’s dog is bearish and there has been some appreciable lightening of AUD holdings from foreign investors in recent times, my view is a tick up to US 95 cents or perhaps parity is more likely than not.

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Bye bye debt ceiling: Joe Hockey laughing all the way to the bank


So the government debt ceiling has gone. And good riddence in one sense, it was no big deal other than perhaps it helped with some fiscal discipline as governments were always likely to be a bit coy when asking for an increase the debt limit. It had the down side of creating market tension whenever the Opposition threatened to or actually voted against the rise in the ceiling, but that was always low risk.

The compromise the Greens were able to demand of Mr Hockey reminds me of Dr Evil, in the Austen Powers movies seeming a ransom of $1 million or else he would blow up the world.


Mr Hockey, no doubt, was having trouble holding back his laughter when the Greens demanded greater transparency over the budget and government debt in return for abolishing the debt ceiling. Even more laughable is the requirement that the government report to Parliament each time the debt level rises by $50 billion to explain why.

Mr Hockey must be pleased that there are suckers born every day and for him, it was the economic fringe dwellers in the Greens.

The Greens are obviously ignorant of the huge amount of information that is already available on debt, government spending and revenue. It just seems they haven’t bothered to ever look at it.

Every Friday, the Australian Office of Financial Management publishes the level of gross debt. It splits it into total debt ($300.7 billion as of last Friday) and that which was covered under the old debt ceiling ($296.1 billion). The AOFM publish their borrowing program for the week and year ahead with regular updates according to budget developments. It is easy to track gross debt on a daily basis by adding new borrowing and and subtracting when T-Notes and bonds mature. The proverbial monkey with a calculator can do it, but not, it seems, the Greens.

There is a lot of information on debt from the AOFM whose website is here:  http://www.aofm.gov.au

Then there is the monthly budget update from the Minister for Finance which gives an update on actual revenue and spending by the Commonwealth for the month and the bottom line run rate verses the budget or MYEFO estimates. There is also an estimate of net debt there too, for anyone interested. The Monthly Financial Statement is here:


Then, of course there are the two fiscal highlights for the year – the Budget and the MYEFO. These are the most comprehensive updates on spending, revenue, gross and net debt. There is history going back to 1970-71 and usually four years of forward estimates on most major measures. There is almost limitless information in the array of budget documents here:


Mr Hockey must still be trying hard to hold back his laughter given the Greens demand amounts to the proverbial limp lettuce leaf.

Whatever the politics of the issue, the debt ceiling has gone.

Long live the debt ceiling!


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Foreign debt surges but does anyone care? UPDATE



The release of the national accounts reveals that net foreign debt reached 54.0% of GDP in the September quarter. This is the second highest level on record for the foreign debt to GDP ratio (the peak was 55.6% of GDP in the December quarter 2008). It doesn’t seem to be phasing anyone, which is probably the correct approach, but it is a biggish level.

Ratings agency Fitch noted in November 2011 that “The country’s net external debt … made Australia relatively sensitive to external financing shocks, compared with its peers”.  At that time, net foreign debt was 53.2%.

Moody’s noted earlier this year that “the most important risk remains the economy’s reliance on external capital inflows” and that “the country has consistently run current account deficits and built up one of the largest negative net international investment positions among the advanced economies”.  Importantly, Moody’s “outlook is for Australia’s reliance on foreign funds to decrease”.

This isn’t happening.

A negative watch or downgrade for Australia seems a remote possibility, but many of the things that supported the triple-A rating with stable outlook are starting to turn the wrong way.

SK:   4 December 2013

From yesterday… 3 December 2013

One of the least reported bits of news in today’s economic data and policy flurry will be the lift in net foreign debt to $829.1 billion in the September quarter. This is approximately 54.5% of GDP (the September quarter GDP data are not released until tomorrow).

Net foreign debt rose about $37 billion in the quarter to be $83 billion higher than the level a year ago. It is certainly a record in dollar terms and as a share of GDP, it is close to a record high.

I generally don’t get too fussed about net foreign debt when the overwhelming majority of it is driven by the private sector, as Australia’s foreign debt currently is. But it can be a different story for the credit ratings agencies and some global investors.

In the olden days, a lift in net foreign debt of the scale seen in the September quarter would have sparked concern in markets – the Australian dollar would have been sold and there would be all sorts of pontificating about Australia living beyond its means and being in hock to the rest of the world.

Thankfully that lame debate does not happen now.  At least I don’t think it does.

Maybe the ratings agencies, already antsy about the government’s debt ceiling issue, may look to foreign debt as a further factor to give is concern about the outlook for Australia.  Maybe foreign investors, already lightening their holdings of Australia will continue to do so and the Aussie dollar will fall sharply.

Foreign debt could well come back onto the radar as an important issue if it keeps rising at the pace seen over the past year or so.


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Debt crisis, what crisis?


Treasurer Joe Hockey is playing a silly game with the debt ceiling. If his refusal to agree to a lift in the ceiling to $400 billion causes market instability, a credit rating downgrade (or negative outlook) or damages confidence in the economy, he will only have himself to blame.

Gross government debt issued under the Commonwealth Inscribed Stock Act 1911 and therefore subject to the so-called debt ceiling, will increase to $298.4 billion on Friday, 6 December.

The government borrowing program indicates that it will break above $300 billion during next week. There is an obvious problem, or potential problem, given that the debt ceiling, under the Act, is currently set at $300.0 billion.

Something has to be done very soon to ensure there is no US style debt problem here in Australia which not only causes market ructions, but risks damaging consumer and business confidence.

The Opposition has given Treasurer Joe Hockey the solution to the issue, offering to increase the debt ceiling to a record high $400 billion. The Greens, who hold the balance of power in the Senate, agree with the approach. This $400 billion should be enough to cover the government’s financial commitments for at least 18 months, possibly longer. Mr Hockey will have two budgets to frame within that time.

Mr Hockey has indicated that the ratings agencies are already ringing him about the debt ceiling issue. If this does not engender some concern or outright fear about Australia’s AAA rating being put on negative watch, I am not sure what will.

International investors have already been reducing their holdings of Australian dollars and bonds in the prospect of political games getting int he way of sensible economic management. At the moment, it is more a trickle but one wrong step by Mr Hockey could see this turn into a flood.

Mr Hockey can head off any problems by agreeing to increase the limit to $400 billion and move on to other important issues such as framing the Coalition’s fiscal strategy for the next few years.

If the stand off continues and there are market and economic problems that result, Mr Hockey will only have himself to blame for putting petty politics over pudent, sensible economic management.


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