A further downturn in China would leave Australia exposed, without sufficient tools to avoid a recession, one of Australia's leading forecasters says.
Stephen Anthony is a former BusinessDay forecaster of the year. In 2015 he took up a role as the chief economist for Industry Super Australia after having run his own economic consultancy and worked on forecasting in both the Treasury and Department of Finance.
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World stocks fall to near 2-1/2 year lows as a fresh pounding for Chinese markets left Asia at a four-year trough and sent oil and commodity markets sprawling again.
"I think the risk of a recession is higher than most people would price it," he told Fairfax Media. "Most people are talking about a less than 30 per cent chance this year. I think it is higher."
Dr Anthony said the government had far less "wriggle room" to avoid a recession than it had before the onset of the global financial crisis in 2008.
In January 2008 the Reserve Bank's cash rate was 6.75 per cent, giving it plenty of room to cut interest rates. In January this year the cash rate is just 2 per cent.
In January 2008 gross government debt totalled just $55 billion. It's now $415 billion, or 25 per cent of GDP, giving the government less room to borrow more without alarming rating agencies.
Australia is going into 2016 with an expected budget deficit of $35.1 billion. In 2008 it had an expected surplus of $19.7 billion.
"The real question is how severe is China's downturn going to be," Dr Anthony said. "Are we going to see Chinese growth fall to 6 per cent, to 5 per cent, or to 4 per cent? A Chinese economy growing at 4 per cent is probably very bad news for Australia because it will cut the volume of our exports as well as the prices."
To date real estate investment had been propping up Australia's economy, but it had been deliberately slowed as the authorities had tightened conditions on investor loans.
Forecaster Nicki Hutley, of Urbis Consulting, said the probability of a China-linked crisis in the next 12 months was "pretty low, about a one in 10 chance".
"Some people might say that's not low," she added. "But the point is it's nowhere near the central case."
If Australia needed to respond to a downturn it would be unable to rely too much on the Reserve Bank.
"Not only does the Reserve Bank only have two percentage points left, but the experience of Europe and the United States suggests that those last few percentage points won't do much," she said.
"Investors don't respond in the same way to dropping rates from 2 per cent to zero as they do from 7 to 5 per cent."
The government had plenty of room to expand the budget.
"Australia has a very low debt-to-GDP ratio. Even the Prime Minister and Treasurer have significantly changed their language on this. Subject to the need for a path to recovery in the budget, they shouldn't feel uncomfortable about spending to stave off a recession."
"In fact a massive recession would itself damage the budget, so they would be better off making use of the budget to stop it."
Economist Saul Eslake said the government had far less budget firepower than it did in 2008 but that if necessary it should abandon its commitment to maintain a AAA credit rating.
"If needed, we should do what we did in 2008 - go early, go hard and go households," he said.
"The best option is too much rather than too little. If you do too much you can wind it back later. If you do too little it won't work, and you will have undermined the credibility of any attempts to do more."
The 8 per cent collapse in the Chinese share market in the first days of the year was important not because it meant China's economy was in trouble but because it showed China's leadership was no longer in control.
"It was almost a Wizard of Oz moment. Far from the Wizard being as omniscient as Dorothy and all the munchkins believed, he was just an old man behind a green screen."
Dr Anthony said the best thing Australia's government could do was to focus on its core business of creating a stable environment.
"It should remove the ephemera, the noise; crazy stuff like beating up on unions or creating disputes over television programs. It should remove impediments and instil confidence."