Tuesday 12 May was to have been budget night, until Covid-19 intervened and the government moved the 2020–21 budget release to 6 October. This gives Prime Minister Scott Morrison and his team time to focus on the crisis and to gauge its impact on the economy and the government’s own financial position. We don’t have clarity on that yet.

ASPI normally releases its annual The cost of defence budget brief a fortnight after budget night. Since there’s no budget to analyse, we’ve delayed this year’s publication to October. But since there’s naturally speculation about the future of the defence budget, it’s worth recapping what we know (this post) and outlining some possible futures (stay tuned next week).

Back in that distant era BCV ^[1], readers may recall that, despite the media and political attention paid to the government’s commitment to return defence spending to 2% of GDP by 2020–21, the 2016 defence white paper ^[2] noted that tying the defence budget to GDP created planning uncertainty because defence funding would go up and down as GDP predictions changed. Consequently, the white paper presented a fixed funding line out to 2025–26 (page 180). Since the white paper, the government has delivered ^[3] that funding and the 2019–20 budget looked like being no different.

Because forecast GDP growth has slowed since the white paper was released, that fixed funding line has gone up faster than GDP, and it looked like it would reach 2.2% ^[4] in the next few years. So, what takes precedence? The fixed funding line or 2%? In Senate estimates hearings on 29 November 2020 ^[5], Labor asked that question. The defence minister responded that the government was ‘absolutely committed’ to the white paper funding line, even if it grew past 2% of GDP. That was, of course, BCV.

In February, the government published ^[6] the portfolio additional estimates statements for 2019–20 updating the May budget. In the update, the defence budget had grown by $587 million since the budget was published, due mainly to almost half a billion dollars in compensation for loss of buying power from the falling Australian dollar, plus $88 million in supplementary funding for Operation Bushfire Assist (see table 1).

Table 1: Change in defence portfolio funding from budget to additional estimates, 2019–20 ($m)

	Department of Defence	Australian Signals Directorate	Total
Budget 2019–20 (May 2019)	37,825	917	38,742
Additional estimates 2019–20 (February 2020)	38,388	941	39,329
Change	+563	+24	+587

Source: Portfolio additional estimates statements 2019–20: Defence portfolio ^[6].

When it was issued, the 2019–20 budget for defence equalled 1.93% of the government’s GDP prediction. If we compare the revised defence budget with the government’s GDP prediction ^[7] in its mid-year economic and fiscal outlook, the defence budget reaches 1.96% of GDP. But the outlook was released on 16 December—before the worst of the bushfire crisis—so its revised GDP prediction doesn’t reflect the economic impact of that emergency, let alone the Covid-19 crisis.

Before Covid-19, the force structure in the 2016 white paper was looking increasingly unaffordable, even with a defence budget that reached 2% of GDP. The former secretary of defence who presented that white paper to the government recently admitted ^[8] as much. The evidence can be seen in many places; for example, the sustainment costs for some major incoming and future systems (like the F-35s and land combat vehicles) are expected to be several times higher than corresponding costs for the systems they’re replacing.

As always, funding pressures manifest themselves in delays to the capital acquisition program. Defence informed the Senate ^[9] in late January that:

To accommodate changing priorities within Defence’s budget, investment proposals can be reprioritised, funding re-profiled, re-scoped, deferred or divested. Since the release of the 2016 IIP [integrated investment program ^[10]], 106 IIP capability projects have been affected through reprioritisations to accommodate Government and Departmental priorities.

Since there’s been no public update to the white paper’s investment plan in the four years since it was released, there’s no way of knowing what those 106 projects are or what the capability impact is. But it seems clear that projects have been delayed due to funding pressure.

Then the virus arrived, with the associated hit to the economy and consequently to government revenue. Nobody knows how big a hit it will be, or how long it will last for, or what its impact on the defence budget will be. Nevertheless, in early April the finance minister implied that the government was sticking to the white paper’s funding line ^[11] regardless of changes to GDP:

The Government agreed back in the 2016 Defence White Paper that there would be no further adjustments to funding as a result of changes in Australia’s GDP growth estimates.

This was to provide funding certainty in the context of a massive investment program and to avoid the need to have to regularly adjust Defence’s force structure plans.

As part of the annual Budget processes, a 10-year Defence funding profile is agreed by Government which is designed to provide planning certainty to Defence.

If the government continues to deliver that funding line while the economy suffers prolonged doldrums, the defence budget will continue to grow as a percentage of GDP, potentially even to 2.4%. That relative growth is likely occurring already. If we assume that there will be no GDP growth at all in 2019–20 due to Covid-19, the defence budget presented in the mid-year budget outlook has already hit 2% of GDP, a year early. If GDP goes backwards this year, the defence budget could now be at 2.1% of GDP.

But, of course, it only counts if Defence spends it, and spending that money could be difficult. Defence has reduced its activity to manage the impact of Covid-19—for example, by suspending training missions ^[12] in Iraq and Afghanistan and cancelling ^[13] exercises ^[14] here. The annual rotation of US marines through Darwin has been postponed ^[15]. That reduced activity will reduce the spend.

Similarly, spending on acquisitions will likely slow. The US Department of Defense is predicting ^[16] a three-month delay across most of its major projects. Here things seem to be mixed. Some projects appear to be tracking well. Work is starting on the first of the offshore patrol vessels in Western Australia. HMAS Waller’s full-cycle docking, the first to install sonar upgrades on a Collins-class submarine, should be finished on schedule mid-year. But there may be delays to other projects, such as the Tindal ^[17] airbase upgrade.

Small to medium enterprises with less ability to absorb disruptions to cash flow are especially vulnerable to a slowdown—and if they go broke it can have disproportionately large impacts on the major projects they feed components into. Defence is trying to support them by keeping the cash flowing, telling ASPI that ‘$4.5 billion [has been] paid earlier than the contracted payment terms’. Still, it’s hard to see all projects delivering as planned with local and global supply chains disrupted by the virus. That’s likely to continue into next financial year.

So, it could be hard for Defence to spend all its money this year. Traditionally, when the department has big underspends, it tries to make quick acquisitions, like additional C-17As. If the government wanted Defence to spend, it could try to get more F-35As sooner than planned. F-35 production has been hit ^[18] by Covid-19, but some European partners might offer us their slots to save cash.

Nevertheless, when it’s all done and dusted, Defence probably won’t spend its budget this year and hit 2% of GDP a year early. But should the government still honour its commitment to get to 2% next year? There have been suggestions ^[19] that defence should take a budget cut ^[20] as its share of the country’s economic pain. Next week, I’ll look at the potential impact on Defence of a cut.