Treasury warns of second world recession

Australia’s Treasury chief has warned the world could be dragged into a second recession if Europe fails to deal with its debt problems.

European leaders are to hold a summit this weekend in a further attempt to agree a package to prevent the crisis spreading even further.

Treasury secretary Martin Parkinson told a Senate hearing on Thursday that Europe’s crisis was having an impact on the local share market and was feeding through to business and consumer confidence.

“The bigger risk to the Australian economy would be if Europe failed to deliver a comprehensive response to the sovereign debt crisis and found itself in a situation where, basically, it was dragging the rest of the world into a second global recession,” Dr Parkinson said.

“If that was the case – around 20 per cent of China’s exports go to the US and about the same to Europe – obviously the impacts on Australia would be magnified.”

He said the fiscal impact for Australia from the current turmoil would be revealed in the mid-year budget review to be released before the end of 2011.

Finance Minister Penny Wong reminded the hearing that the recently released final budget outcome for 2010/11 showed tax receipts coming in around $40 billion below the level forecast before the global financial crisis.

“We are still seeing revenues being hit as a result of what has occurred in the global economy over the last years, as evidence in the final budget outcome,” she said.

Treasury executive director of the macro-economic group David Gruen told the hearing there were “substantial downside risks” from what was happening in Europe that would have “significant implications” for the Australian economy, but that outlook was not the department’s central forecast.

Dr Parkinson advised the hearing that Australian government debt currently sits at 6.5 per cent of GDP, and is set to peak at around seven per cent.

In contrast, debt among the advanced economies of the Group of Seven nations was at 66 per cent of GDP and forecast to peak at just over 90 per cent of GDP.

However, Dr Gruen said this increase in borrowing globally, particularly among advanced economies, had not resulted in higher interest rates.

“Over this period, in which the globe is still trying to get over the effects of the global financial crisis, the big rise in government borrowing has not driven up interest rates. In fact, they have come down,” Dr Gruen said.

Dr Parkinson also said arguments about sovereign risk in Australia, stemming from the introduction of imposts such as the minerals resource rent tax (MRRT), carried “little weight”.

That was because investment in the mining sector was at record levels and conditions existed for strong growth.

“Sovereign risk is in the eye of the beholder,” Dr Parkinson told the hearing.

“All we have got are the facts of what people intend to invest in the mining sector.”

Mining investment intention of about $430 billion continued to grow “very strongly”.

“That’s equivalent of 30 per cent of nominal GDP (gross domestic product),” he said.

Dr Parkinson, under questioning from Liberal senator Mathias Cormann, conceded that lower investment over time would likely result in lower productivity.