Bleak outlook for national economy if Iran war drags on
Jacob Shteyman |
Lingering conflict in the Middle East could cause Australia’s economy to contract and unemployment to spike to pre-pandemic levels, Treasury warns in the nation’s fiscal blueprint.
While Treasurer Jim Chalmers said Australia was well placed to weather headwinds blowing in from the Strait of Hormuz as he released his fifth budget on Tuesday night, he acknowledged households and business could be hit hard by a prolonged war.
Under a severe downside scenario prepared by Treasury boffins for the budget, oil prices were assumed to rise from about $US104 a barrel to as high as $US200 a barrel, with corresponding price increases for other commodities like fertiliser.
In that scenario, Australia’s economy would only narrowly avoid a recession – which is two consecutive quarters of negative growth – but still shrink in the September quarter.
Annual GDP growth would fall from 2.6 per cent currently to 1.25 per cent in 2026/27, 0.5 per cent lower than forecast in Treasury’s base case.
Yearly inflation would peak at around 7.25 per cent in December and unemployment would hit five per cent in 2027/28.
“Price pressures stemming from the conflict are expected to broaden in the coming months, as price increases for petroleum-dependent products are passed through supply chains,” the budget warned.
That would have significant consequences for households and businesses already reeling from three straight Reserve Bank rate hikes.
Higher cost pressures will squeeze business margins and threaten viability, the budget said.
Before the budget, economists warned a spending splash would further exacerbate inflation, which was 4.6 per cent in March, by adding to demand at a time when the economy was already supply-constrained.
Dr Chalmers touted his government’s efforts to drive down real spending growth, which is now forecast to fall from 4.3 per cent in the current financial year to 1.3 per cent in 2026/27 and 0.7 per cent in 2027/28.
”We are playing a helpful rather than a harmful role in the fight against inflation,” he told reporters.
But Deloitte Access Economics partner Stephen Smith told AAP the budget would more likely hinder than help the Reserve Bank.
The forecast fall in real spending growth is largely due to a surge in inflation.
Payments as a percentage of GDP are set to rise to 26.8 per cent in 2026/27, which is the highest ratio since 1987, excluding the COVID-19 pandemic.
Almost $45 billion was slashed from cumulative budget deficits over five years compared to forecasts in the December mid-year update, but the improvement was primarily driven by a $41 billion revenue windfall.
The largest revenue upgrade was expected for 2025/26 but it was largely eaten up by a spending bill that is $18 billion higher than the December forecast, veteran budget watcher Chris Richardson said.
“That jump in the cash spend heading into the Australian economy in the near term may raise an eyebrow or two at the Reserve Bank, especially as it comes atop recent spending increases by the states,” he wrote on social media.
Despite the underlying budget deficit improving by $8.5 billion since December to $28.3 billion in 2025/26, the fiscal bottom line is projected to remain in the red until 2034/35.
At the centre of the savings package are sweeping cuts to the runaway National Disability Insurance Scheme, which will save $37.8 billion over the five years from 2025/26, with program spending falling from $56.1 billion in 2026/27 to $55.1 billion the following year.
But aged care, defence and hospital payments to the states are expected to grow faster over the medium term than they were projected to in December.
The government’s net policy decisions since December improved the cumulative bottom line by $8.2 billion, but most of the improvement is projected to happen in 2029/30.
Government decisions, including $2.55 billion for fuel excise cuts, are estimated to make the deficit $5.3 billion worse off in 2025/26 and $6.5 billion worse off in 2026/27.
AAP