A review of national security says funding for key agencies is set to drop by 10 per cent over the next two years.
And the shedding of staff to meet budget targets is putting national security operations at risk.
Prime Minister Tony Abbott says the government is considering the review's recommendations to address long-term funding as part of the budget process.
In August last year the government announced $632 million in extra funding over the next four years for agencies involved in counter-terrorism.
But the review, published on Monday, found that the nominal value of government funding being provided to security agencies was set to fall by 10 per cent from 2014/15 to 2017/18.
Half of the cut was due to the budget efficiency dividend and the remainder due to programs that are winding up.
National security agencies had particular constraints that "make it difficult to achieve administrative efficiencies without ceasing activities".
The report gave the example of the Office of National Assessments, which in a bid to meet its budget savings did not replace its retiring Russia analyst, leaving only one analyst to cover Russia, all the former Soviet states and western Europe.
This is at a time when the Ukraine is a central focus of global security.
The report said in order to meet efficiency targets, the Australian Federal Police planned to axe 451 staff to 2017/18 including intelligence support.
Customs and Border Protection would downsize by 231 staff to 2018/19.
ASIO's response to the tightening would be to "prioritise resources on the high end of the threat spectrum, with less scope to address other threats or to identify emerging issues".
In overall terms, the cuts would lead to "inadequate domestic coverage of national security threats".
The report called for the suspension of the efficiency dividend from ASIO, its overseas counterpart ASIS and the Australian Federal Police in 2015/16 and ending the application of the cut altogether from ONA from 2015/16.
The government should also remove the budget cut from Customs and Border Protection from 2015/16.
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