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Why Australia Should Break Its 'Surplus' Promise

Torsten Blackwood | AFP | Getty Images

The Australian economy may be one of the most resilient in the developed world, having expanded over 3 percent in the third quarter, but country analysts are sounding a warning - the government's vow to return the budget to surplus may knock the wind out of its economy.

Growth forecast for the year ending June 2013 for the A$1.4 trillion ($1.47 trillion) Aussie economy range from 1.8 percent to 2.7 percent, much lower than the 3.04 percent average annual growth for the past 10 years and from the Reserve Bank of Australia's (RBA) 3 percent estimate.

Economists told CNBC that their lower growth targets were based on the Australian government's pledge to deliver a budget surplus of A$1.1 billion ($1.2 billion) by June next year, via increasing taxes and cutting spending, even as a troubled euro zone and slowing demand from China, Australia's top export market, weighed on the nation's growth.

Australia has run a budget deficit for the past four years, with the deficit for the year ending June 2012 at about A$44.4 billion ($46.8 billion).

Declining corporate profits in the third quarter, falling job advertisements and lackluster retail sales are already pointing towards tougher conditions, which economists said should push the government to consider abandoning the surplus pledge. In fact, they agree unanimously that now is not the time for austerity.

(Read more: Australia Business Confidence Slumps in November: Survey)

"It's time to give austerity a rest," said Shane Oliver, head of investment strategy and chief economist with AMP Capital in Sydney. "More austerity will only further weaken the economy."

The government's projected gross domestic product (GDP) growth of about 3 percent and a surplus this fiscal year are simply too optimistic, according to Oliver. Attempting to turn a surplus would knock at least half a percentage point off the already low GDP, he said.

"Growth is more likely to come in around 2.5 percent and the deficit around $8 billion or so, even with the spending cuts and tax increases," he said. "And to close the gap would imply a fiscal tightening of 0.5 percent of GDP at least."

The higher taxes will also cut into economic growth for this fiscal year, according to Clifford Bennett, chief economist of Orb Global Investments. He forecasts growth of just 1.8 percent because the new taxes will cut into investment.

"We need to remove the mining tax, which while not securing much revenue is nonetheless a significant regulatory burden. Such a move would also help restore global investor sentiment," he said.

The government introduced the mining tax this year to cash into the resources boom, but since then the sector has slowed. The government acknowledged in September that it would collect less income than anticipated because of falling commodity prices. Any further falls in those prices could weaken Australian export revenue, see more resources projects shelved, and lead to job cuts in the resources sector, said experts.

(Read more: Australia Cuts Iron ore Export Revenue Forecasts)

GDP to Weaken in Election Year

Much of this talk on surplus can be attributed to the fact that 2013 is a politically important year as federal elections have to take place by November 30, economists said.

Prime Minister Julia Gillard's Labor government had promised a balanced budget after she was came to power in June 2010 in a party shakeup. Complicating those plans now is slower global economic growth and falling commodity prices and taxes, together with polls showing the opposition Liberal-National coalition would win.

"It's more a political imperative than an economic one to turn a surplus in 2012/13," Paul Bloxham, chief economist with HSBC in Sydney, told CNBC. "The net government debt is 10 percent of GDP and compared to a lot of Western countries and emerging economies, that's fairly low."

Australia is one of 14 countries that have a triple-A rating from Standard & Poor's and the Aussie dollar remains resilient. While the RBA has cut interest rates by 125 basis points since May, Australia's interest rates are still among the highest in the advanced industrialized economies at 3 percent, making the country's sovereign bonds a huge draw for international investors.

(Read more: Australia Central Bank Cuts Rate to Record Low)

Comparatively, the United States is likely to keep rates at record lows of between zero and 0.25 percent until at least 2014.

"There's still a great deal of interest in holding Aussie paper. Look, 77 percent of Aussie bond holders are foreigners," Bloxham said.

This means that the country should have no problem funding its debt, economists added, so where was the need to cut debt.

Bloxham expects GDP growth to come in at about 2.7 percent in the current fiscal year. Like the rest of the economists, Glenn Levine, senior economist at Moody's Analytics in Sydney also said now is "absolutely not the time for the government to be belt-tightening."

"There's no point in cutting costs so severely to try to meet a politically-motivated surplus target," Levine told CNBC. "It makes no sense to be running a surplus while the economy is slowing to well below its potential."

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