Sharp slowdown looms if war lingers, budget papers warn
In the country’s fiscal plan, the Treasury warned that ongoing conflicts in the Middle East could cause Australia’s economy to contract briefly and unemployment to rise to pre-pandemic levels.
Unveiling his fifth budget on Tuesday night, Finance Minister Jim Chalmers said Australia was well placed to weather the winds from the Strait of Hormuz, but acknowledged that households and businesses could be hit hard by a protracted war.
According to the severe downside scenario prepared by Treasury experts for the budget, it was assumed that oil prices would rise from approximately US$104 per barrel to as high as US$200 per barrel, with corresponding price increases in other commodity prices such as fertilizer.
In this scenario, the Australian economy will narrowly avoid recession, meaning two consecutive quarters of negative growth, but will continue to contract in the September quarter.
Annual GDP growth will fall from 2.6 percent currently to 1.25 percent in 2026/27; This is 0.5 percent lower than the estimate in the Treasury’s baseline scenario.
Annual inflation will peak at around 7.25 percent in December and unemployment will reach 5 percent in 2027/28.
“Price pressures resulting from the conflict are expected to increase further in the coming months as price increases for oil-dependent products pass through supply chains,” the budget warned.
This will have significant consequences for households and businesses already reeling from three consecutive Federal Reserve rate hikes.
The budget warned that higher cost pressures would squeeze business margins and threaten sustainability.
Dr Chalmers said Australia was better placed and better prepared to deal with the global crisis than most countries.
“As Australians, we face these serious challenges with a strong stance,” he said in his speech at Parliament House.
Economists have warned that the jump in budget spending could worsen inflation, which is currently at 4.6 percent, by increasing demand at a time when the economy is already supply constrained.
Dr Chalmers praised his government’s efforts to reduce real spending growth, which is 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 beneficial, not harmful, role in the fight against inflation,” he told reporters.
Still, the decline in real spending growth is largely due to the increase in inflation.
Payments as a percentage of GDP are expected to rise to 26.8 per cent in 2026/27; this is the highest rate since 1987, excluding the COVID-19 pandemic.
At the heart of the savings package are sweeping cuts to the National Disability Insurance Scheme, which will save $37.8bn over five years from 2025/26; program spending falls from $56.1 billion in 2026/27 to $55.1 billion the following year.
The fiscal picture is projected to remain in the red until 2034/35, although the headline deficit will rise by $8.5 billion since the mid-December update to $28.3 billion in 2025/26.
This is a year ahead of the previous budget forecast, largely as a result of NDIS reforms.
But aged care, defense and hospital payments to states are expected to rise faster in the medium term than projected in December.
But “off-budget” spending continued to rise, with the headline deficit rising from $47.9bn this financial year to $64.1bn in 2026/27.
The government’s clear policy decisions since December have increased cumulative profitability by $8.2 billion, but the bulk of the improvement is expected to occur in 2029/30.
Government decisions, including $2.55 billion in fuel consumption cuts, are forecast to cause the deficit to worsen by $5.3 billion in 2025/26 and $6.5 billion in 2026/27.
Gross debt is expected to finally surpass $1 trillion in 2026-27, while net debt is expected to reach $616 billion, or one-fifth of GDP.
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