Every year we caution our readers that the economic assumptions underpinning the budget are potentially more relevant to the bottom line than the spending and revenue measures that are the centrepiece of the federal government’s books.
And budgets are always touted as crucial – something like ‘the most important in a generation’ or the one that ‘brings home the bacon’ – so at the risk of being accused of getting caught up in budget hyperbole, it is difficult to think of a budget that relies more heavily than this one on the ‘growth dividend’ to raise the revenues needed to fund its spending initiatives, including infrastructure.
Robust economic growth has underpinned what is expected to be a 9.8 per cent increase in total taxation receipts in 2017-18, then a further 5.8 per cent in 2018-19.
The economic assumptions that have allowed Canberra to abandon an increase in the Medicare levy to fund the NDIS and deliver tax cuts are not implausible by any means, but they hinge on an acceleration of wages growth that is almost imperceptible to date. Unless wages growth does pick up, the household consumption that accounts for 55 per cent of GDP will either struggle to gain traction or be propped up by households running down their savings further.
Australia’s terms of trade are forecast by Treasury to dip a bit in 2018-19 and the following year, but to a level that leaves them 40 per cent higher than the average of the 10 years to 2004-05 - just before China’s demand for Australia’s commodities took off. As it did, a once in a multi-generational rise in commodity prices propelled the terms of trade to an extraordinary historical high. But a combination of big additions to the supply of iron ore and coal, coupled with a slackening of growth in demand from China, have triggered a significant, but only partial retreat.
As exports of iron ore from Australia and Brazil rise by another 70 million tonnes in 2018 (46 million of which will be from Australia), the sensitivity of the price of Australia’s chief export even to a mild shock to China’s economy is obvious. The budget forecasts assume the free on board (FoB) spot iron ore price averages $US55 a tonne “over the forecast horizon”, down from a March quarter 2018 average of $US67.
More generally, while upside potential to commodity prices is more than trivial, it is outweighed by downside risk, including if an unwanted appreciation of the Australian dollar erodes the local currency value of export receipts.
But if the currency remains closer to 70 than 80 US cents as the Federal Reserve further tightens monetary policy in the US, the prospect for economic growth strong enough to underpin a modest surplus in 2019-20 are credible enough. A more competitive exchange rate would do wonders for tourism, including the attractiveness of foreign students, while the benefits accruing to Australia from trade liberalisation agreements with South Korea, Japan and China will burgeon in coming years if the currency ‘does the right thing’ – unless Australia gets caught in the cross fire of a serious trade dispute between Washington and Beijing (or Seoul for that matter). But the trajectory of the Australian dollar is not something the government can do much about – except perhaps acknowledge a bit more prominently that the projected budget surplus is more sensitive to the economic cycle than is widely realised.
And so too the projected peaking in Canberra’s general government net debt at $349.9 billion in 2018-19. When expressed as a percentage of GDP, the peak is this financial year at 18.6 per cent, ahead of a gradual decline to 14.7 per cent in 2012-22. But that is too far out into the political and economic never-never to be all that meaningful. Nevertheless, the general government debt of all levels of government in Australia is low compared to most advanced economies, although it could be argued that it needs to be so Australia has a buffer to deal with a steep and/or prolonged fall in commodity prices, should it come to that.
The return to surplus on the federal budget’s underlying cash balance a year earlier than expected when last year’s budget was delivered owes a lot to a robust economy that is expected to underpin a 9.8 per cent increase in total taxation receipts by the time the current 2017-18 financial year ends, and then by another 5.8 per cent in 2018-19.
The importance of the trajectory of economic growth on the budget’s bottom line is starkly illustrated in Figure 1, which depicts actual and projected underlying cash budget balances expressed as a percentage of nominal (not inflation-adjusted) GDP, plotted alongside its real (inflation-adjusted) GDP growth cousin.
Recessions in the early 1980s, another one almost 10 years later, and even the slowing in the economy in the early 2000s all turned budget surpluses into deficits. The big deficits after the GFC were in part caused by the slowing in economic growth, but mainly by the fiscal stimulus unleashed to prevent the shock to capital markets from triggering a deep recession.