Defence budget shows the government is keeping its powder dry—for now
26 Oct 2022|

The Albanese government just released its first budget, but it’s the second one for 2022–23. In this article I’ll focus on what’s changed between the March budget (B1) and the October one (B2). The key takeaway is that the government is keeping its powder dry on defence spending until it hears back from the strategic review it has commissioned. The review’s independent leads, former Australian Defence Force chief Angus Houston and former defence and foreign minister Steven Smith, have been instructed to work out what the Australian Defence Force should look like as we enter an era of uncertainty and strategic competition—and to tell the government what it will cost.

Until then, the government is sticking with the defence funding line it inherited from the previous government. That was itself an artefact created for the 2016 defence white paper. It’s well past time to revisit that funding line, but we’ll have to wait until March when the strategic review’s report is due to see whether the government is willing to do that. So, for now, the defence budget is in a holding pattern with little difference between B1 and B2.

But there are a few developments of interest in B2 below the top-level stasis. First, there are the mandatory adjustments to compensate for the plummeting Australian dollar. The foreign exchange adjustment is a surprisingly (to me, at least) small $382.3 million in 2022–23, but that grows to more than $1 billion by 2025–26, the last year of the budget’s forward estimates. When you are the fourth biggest arms importer in the world, a weak Aussie dollar brings a lot of pain.

That’s the main increase, but there are also decreases. Defence must find $144.6 million in ‘savings from external labour and savings from advertising, travel and legal expenses’. At only 0.3% of the department’s budget, that’s nowhere near the most challenging efficiency dividend it’s ever had to deliver.

But that comes on top of paying back $113.3 million in ‘no win – no loss’ supplementation for operations it was overpaid for last year. It’s also had to absorb another $98 million in support to Ukraine on top of 2021–2022’s $87.6 million, although most of this appears to be ‘in kind’ rather than cash. In fact, there’s about $250 million in various measures, including transfers to other departments, that Defence has to absorb over the forward estimates. It’s certainly nowhere near the $3.6 billion over the forward estimates that it had to provide to the Australian Signals Directorate for the REDSPICE program in B1, but it all adds up.

When all adjustments are taken into account, B2’s consolidated defence spending (the Department of Defence and the Australian Signals Directorate combined) is $48,699.7 million. That’s only $84.7 million more than B1’s despite the $382.2 million foreign exchange increase. That means B1 and B2 are virtually identical in all the key cost categories of workforce, acquisition, sustainment and operating. However, because GDP predictions have increased dramatically by around 8%, Defence spending as a percentage of GDP has fallen from 2.11% in B1 to 1.96% in B2.

That gets us to the nub of the problem for Defence. A key factor behind that increase in GDP is inflation which is running hot. When the 2016 white paper funding line was developed, planners assumed annual inflation of 2–2.5%. In 2020–21 it was somewhat higher at 3.8%. It jumped to 6.1% last year and the budget papers predict 5.75% this year. So while B2’s funding line is a 7.1% increase on 2021–22 in nominal terms, once we take inflation into account, it may be around 1% in real terms. That translates into billions of dollars of lost buying power.

Of course, Defence doesn’t bear the full, immediate brunt of inflation—its employees don’t get automatic pay raises with every adjustment to CPI, for example. But the optimistic predictions in the last two budgets of inflation quickly returning to normal have been replaced by B2’s view of high inflation until at least 2023–24. It’s hard to see Defence being able to afford the ambitious acquisition program in its force structure plan with its budget stagnating in real terms. And while one of the government’s key aims in the budget was to address cost of living pressures on Australians, Defence is getting no relief from the corrosive effects of inflation. At some point, this will have an impact on capability—and that’s before we contemplate anything new out of the strategic review.

For those who follow Defence capability there are a few points of interest in B2’s top 30 acquisition projects. There’s the usual mix of projects spending more or less than planned for the year. The Boxer combat reconnaissance vehicle, Hunter-class frigate and offshore patrol vessel projects are spending more than predicted in B1. Generally that’s a good thing; if you are spending money, you are getting work done. In contrast, the F-35A and the MC-55A Peregrine aircraft projects are spending less. The Peregrine’s first in-service flying hours have slid by a year, as have the Triton uncrewed aerial vehicle’s.

A number of new projects appear in the top 30, including Abrams tanks and Apache attack helicopters. While we haven’t heard much about the MQ-28A Ghost Bat since its first flight early last year, it now appears in the top 30 with an encouraging explanatory note that states ‘during 2022–23, the project will continue to mature the Generation 2 MQ-28 design and begin manufacture’.

SEA 1000, the Attack-class submarine, was in B1’s top 30 even though it had been cancelled, and has now gone from B2, but there’s nothing there to say what the final cost was. When we add up the project itself, cancellation payments, earlier phases of the program and funds spent on the shipyard, it could well be $4 billion.

There’s also another example of new capabilities being approved and acquired with no public announcement, although it’s not clear which government approved it. Apparently Defence is acquiring an ‘undersea support vessel’ for $155 million. B2 notes ‘this project seeks to deliver a Navy capability to support trials and integration of undersea warfare and surveillance systems.’ There’s nothing of this name in the 2020 force structure plan. Presumably it is part of the ‘integrated undersea surveillance system’ mentioned in that document. Since the full $155 million is being spent this year, one can only assume we are buying an existing ship. That’s probably why there was no announcement; as was the case with the Pacific support vessel, ships that aren’t built in Australian shipyards show up with little fanfare.

Finally, a thought about the situation looming in March when both the strategic review and the nuclear-powered submarine taskforce are set to report their findings. The government has identified defence as an area requiring additional spending. But the competition for resources isn’t going to ease up: the National Disability Insurance Scheme, health and an ageing population all require substantial increases in funding, likely much more than defence will ever get. Meanwhile, the government’s fiscal position is still very challenging. It got a big revenue windfall this year, reducing the $78 billion deficit predicted in B1 to $36.9 billion. But for the remainder of the forward estimates, B2’s anticipated deficit is virtually the same as B1’s. Put another way, for the next three years, the government is borrowing an amount almost equivalent to the entire defence budget. Smith and Houston are unlikely to be given a blank cheque.