Exclusive Economic Insider: WA State Budget Review
18 May 2015
Falling iron ore price puts massive squeeze on the budget’s bottom line, so deficit soars to $2.7 billion, while net debt will rise to a peak of $36 billion by the end of 2017-18.
- Plunging iron ore price causes $1.7 billion hit to the bottom line in the 2014-15 (FY15) financial year.
- While a further decline, from 38 cents in the dollar, to 30 cents, in WA’s GST allocation in FY16 exacerbates the languishing iron ore price, so the deficit rises from an already large $1.3 billion, to a whopping $2.7 billion.
- Net debt rises from $25.5 billion as at the 30th of June 2015, to $31 billion a year later, and will not peak until the end of FY18, at $36 billion.
- Land tax increases the biggest disappointment for business. Apart from those with lots of vehicles, because each one attracts a new levy to fund a no fault catastrophic motor vehicle injury insurance scheme.
- GST allocation forecast to rise back up to 35 cents in FY17, and to a giddy 67 cents by the end of the forward estimates horizon in FY19.
- Asset sales to be expanded to address soaring debt. The whole of Fremantle Port - the biggest asset to be put up for sale as part of a programme of asset sales the government hopes will net between $3 billion and $5 billion.
- Last year the iron ore price was expected to average $US123 a tonne in FY15. To date, with just 6 weeks to go, it has averaged $US73. This time the budget assumes it to average $US47.50 in FY16, which is more than $10 a tonne below what it has averaged in the last couple of weeks.
- The Australian dollar is assumed to average around 75 US cents in the next 4 years. But if it averages closer to the 80 cents that it is currently tracking at, the budget will be more than $2 billion worse off, such is the sensitivity of the government’s royalty income to movements in the Australian dollar.
- Nevertheless, if royalty receipts are hit badly by a more expensive Australian dollar and/or a lower iron ore price, WA’s GST allocation will be higher than the 67 cents projected for FY19.
The very night before the WA Treasurer delivered his second budget to Parliament, the Australian dollar rose by a full US cent, purely because retail sales data out of the US caused the US dollar to soften (Figure 1).
So just how could slower retail sales in the US possibly affect the WA budget?
The royalty receipts that the WA government relies on so heavily are extremely sensitive to movements in the Australian dollar. For every 1 cent change in the value of the local dollar against its US counterpart, the state government’s bottom line changes by $58 million.
If the dollar averages 80 cents, rather than the 75.9 cents that the budget assumes in FY16, royalty income will be around $240 million lower than the government is budgeting for. Conversely, if the dollar were to average say 70 cents, royalty receipts would be around $340 million higher than budgeted for.
And not even the federal government, let alone any one state government, can do much about the value of the Australian dollar. The RBA, as the banker to the federal government, can have some influence, by ‘jawboning’ the currency down and/or lowering the cash rate, but when it eased monetary policy earlier this month, the Australian dollar rose.
Just as it did when soft retail sales data in the US was interpreted by the global foreign exchange market as evidence that the US Federal Reserve (the Fed) will start raising interest rates over there later rather than sooner.
We are still confident that the Australian dollar will ‘do the right thing’ by falling by quite a few cents when the Fed does give the all-clear to an increase in the funds rate, but such are the vagaries of currency markets, there is no guarantee the budget’s exchange rate assumptions will be achieved.
The budget is also very sensitive to the iron ore price (Figure 2). For every $US1 a tonne change in the spot price of Australia’s biggest export, the WA government’s royalty receipts change by $A70 million.
And it’s not only the WA government that has a lot riding on the iron ore price. Even though all but a few hundred million dollars of the $66 billion of iron ore exported by the nation in 2014 (Figure 3) was from WA, the plunging price of the steel making input is also a big drag on the federal budget. So much so that the federal budget papers included a sensitivity analysis that advised that if the iron ore price were to average $US43 a tonne in FY16, rather than federal Treasury’s assumption of $US53 (ie a few dollars higher than the WA government is assuming in its budget), Canberra’s tax receipts would be $A6.5 billion lower in FY16 alone.
Very strong iron ore prices in FY14 ($US123 a tonne); FY13 ($US128); FY12 ($US146) and, wait for it, $US161 in FY11, have triggered a precipitous fall in WA’s allocation of GST revenue collected by Canberra on behalf of the states. Because the formula for the GST allocation is based on a 3-year moving average of royalties received by the states, WA will receive just 30 cents in every dollar of GST collected within the state in FY16. As the falling iron ore price is reflected in time in the 3-year moving average of royalty receipts, WA’s GST allocation is forecast to start to rise back up from FY17.
FY16 was always going to be the crunch year for the WA budget, and so it will, although a lower dollar would go some way to making fiscal consolidation (meaning budget repair) less daunting.
It is often forgotten that while the operational phase of mines is much less labour intensive than the construction phase, the new mines employ highly skilled workers to operate them over a 20-30 year life span, rather than the 2-3 years it took to construct each one of them. And they need to be maintained over their life as well.
That’s not to trivialise the impact of the mining downturn on the broader WA economy by any means, but rather to put it into proper perspective. As WA grapples with much less favourable economic conditions than it has enjoyed in recent years, it does so from a much stronger base than it did in the early 1990s. The collapse of the so-called ‘entrepreneurial boom’ of the late 1980s, which had been built on much shakier foundations than the latest mining and energy driven boom, condemned WA to a deeper recession than in any other state except Victoria all those years ago.
Nevertheless, it would take quite a big recovery and/or a much lower Australian dollar to prevent the ratings agencies from downgrading WA’s credit rating, or at the very least stop one or more of them from placing the state on ‘negative credit watch’.
To placate the ratings agencies, the state government is offering a wide range of assets for sale, headed by … “The disposal, through a long term lease, of the assets and operations of the Fremantle Port Authority” (FPA).
Having already announced its intention to sell the Kwinana Bulk Terminal in an earlier round of asset sales, the sale of the whole of the FPA will subsume the sale of the bulk terminal at Kwinana.
Other assets that had already been flagged for sale before the budget include the loading facilities at Utah Point at Port Hedland and the Perth Market Authority, while other asset sales announced in this budget include:
- The TAB
- The softwood plantation holdings of the Forest Products Commission
- Government Regional Officer Housing stock
- State fleet (via a sale and lease back)
- Some Land Corporation land holdings
- Individual generation assets of Horizon Power and Synergy and non-assets of Western Power (but unlike in NSW, not the poles and wires).
The proceeds of asset sales are not included in any of the budget figures. Rather, the proceeds will be booked as and when they are sold. The Government expects to raise somewhere in the region of $3-$5 billion upon their sale.
The proposed asset sales will go some way towards placating the ratings agencies, but the timing of the sales is nebulous and the range of expected proceeds large.
Other than waiting for the state government’s GST allocation to bounce back, asset sales are not the only measure. Increases in land tax are projected to raise an extra $826 million over four years, while the abolition of the first home owners grant (FHOG) for the purchase of established dwellings is slotted to raise $109 million. The FHOG still applies, at an unchanged level of $10,000, for the construction of new dwellings.
The dwelling construction cycle is at a mature stage and still has some way to run. Accordingly, the employment of construction workers in the dwelling sector is offsetting much of the slide in resource construction employment. However, the dwelling construction cycle will soon end, although when and how quickly it will come off the boil will depend crucially on population growth.
The budget papers include an assumption that population growth will tick back up a fraction, to 2.0 per cent in FY16, from a trough of 1.9 per cent in FY15, which in turn is down from a resources boom peak of 3.6 per cent in FY13 (Figure 4).
It wasn’t always so, but WA’s population growth has been strongly driven by commodity prices in recent years, so the latter are relevant to the state budget over and above what they mean for royalty revenues.
It was never realistic to expect the state’s population to continue to grow at resource boom rates. Nor would it have been desirable, because the capacity of governments, both federal and state, to provide the necessary social and industrial infrastructure for such big increases in population would have been severely strained.
In fact, one of the reasons WA’s net debt is rising so far so quickly is that a number of big infrastructure projects currently underway or planned were commissioned when the economy was still booming. But they are also filling some of the void left by the end of the construction phase of the resources boom.
The WA government’s success in getting the federal government to cough up $499 million this financial year to compensate for the state’s measly GST allocation was signed off by Canberra after the cut-off data for inclusion in the WA government’s budget. So the estimated FY15 deficit of $1.3 billion will effectively be $0.8 billion.
Moreover, Canberra’s ‘generosity’ has allowed the state government to bring forward the extension of the Mitchell Freeway (a project valued at $261 million).
The $499 million from Canberra is spread across 9 projects, including the $1.6 billion Perth Freight Link (also known as the Roe Hwy extension), work on which is expected to begin in early in the 2016 calendar year.
A number of large infrastructure projects already under construction will continue to provide significant work over the next few years, including:
- North Link WA valued at $770 million over the next 4 years (formerly known as the Perth to Darwin Highway project).
- Great Northern Highway (Muchea to Wubin section), on which another $342 million will be spent in the next 4 years.
- Forrestfield Airport Rail Link, which is costed at $2 billion, the majority of which ($1.2 billion) is allocated to FY18 and FY19.
- New Perth Stadium. Since the last budget, the private sector has taken on 40 per cent of the cost of the new stadium, but the budget papers reveal that state government’s contribution will be $209 million in FY16, and another $225 million in FY17. Those amounts do not include the public transport component of the new stadium, which is an additional $336 million, of which $117 million is allocated to FY16, $97 million in FY17, and $37 million in FY18.
- And there is still around another $160 million of work to be done on the soon to be completed Perth Airport Gateway road project, and $130 million of completion work on the new children’s hospital.
Even with these substantial works in progress and planned, there clearly is a risk that WA’s economy could tip into recession if the iron ore price falls further without an offsetting depreciation of the Australian dollar. But that should be nobody’s (including ratings agencies) base-case expectation.
The information contained in this publication is of a general nature and is not intended to be nor should it be considered as professional advice. You should not act on the basis of anything contained in this publication without first obtaining specific professional advice. To the extent permitted by law, Bankwest, a division of Commonwealth Bank of Australia ABN 48 123 123 124 AFSL/Australian credit licence 234945, its related bodies corporate, employees and contractors accepts no liability or responsibility to any persons for any loss which may be incurred or suffered as a result of acting on or refraining from acting as a result of anything contained in this publication. BWA-6124 230215 – GEN Australian Bureau of Statistics data used pursuant to the Creative Commons Attribution 2.5 Australia license (available online at: http://creativecommons.org/licenses/by/2.5/au/ ).
Chief Economist, Bankwest