MYEFO: no surplus but smaller deficit


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By Craig James, CommSec

Mid-Year Economic and Fiscal Outlook (MYEFO)

  • Smaller 2016/17 deficit: The Federal Government is projecting a $36.5 billion deficit (2.4 per cent of GDP) for the current financial year supported by the improvement in the terms of trade. The May budget had tipped a deficit this year of $37.5 billion. A budget surplus is not expected over the forecast period.
  • Economic assumptions: There has been a slight softening of economic growth assumptions for 2016/17 and over the forward estimates. Economic growth is expected to ease to 2.0 per cent in 2016/17, rather than the previously reported 2.50 per cent. However unemployment forecasts have improved in the outer years from 5.50 per cent to 5.25 per cent in 2018/19. Wages growth is expected to hold at 2.25 per cent in 2016/17.
  • The budget deficit is expected to narrow from 2.1 per cent of GDP to 0.3 per cent of GDP in the space of four years. The underlying cash balance is projected to return to surplus in 2020-21, in line with May forecasts.

What does it all mean?

The Mid-Year Budget update, like the Federal Budget itself, is an economic and a political document. There are fundamental economic assumptions. And while you can take an optimistic or pessimistic view, the assumptions are unlikely to be significantly different from the consensus. But from a political standpoint Budgets can vary markedly depending on the policy priorities adopted by the Government of the day. Still, at the end of the day, the community expects that Governments live within their means, so there must be a strategy to keep deficits and debts at sustainable levels.

The budget deficit for 2016/17 is expected to come in lower than what was forecast in May. However the blowout in the deficit takes place over the subsequent years. Over the forecast period the budget deficit has been revised up by $10.3 billion. The weaker-than-expected economic growth outcomes not just in 2016/17 but over the forward estimates contributed substantially to the lift in the deficit.

While deficits will be pared back over time, no surplus is sighted through the forecast period. However the level of fiscal restraint being shown by the Government is commendable and balanced – essentially not strangling the economy but also ensuring that fiscal policy is partially complementing the low interest rate environment. It is clear that the Government will need to push through further reform and budget repair measures to attempt to get the budget back to surplus by 2020/21.

It is pretty clear that a path back to a surplus is not going to take place over the forward estimates of the budget. In essence any discussion on a potential surplus in 2020/21 would require a pickup in non-mining business investment to support a lift in real economic growth. In addition further growth across emerging economies – particularly China and India would in essence ensure that the recent lift in prices for commodities would support the budgets bottom line.

Of course the economic assumptions are very much just that – assumptions. If growth returns to “normal” quicker than expected, the Government will be able to claim a more dramatic improvement in the budget bottom line – that is, providing it shows discipline on future spending. And in that context the cautious forecasts to iron ore, thermal and coking coal prices could potentially provide the Government with the opportunity to under promise and over deliver come the May 2017 Federal Budget.

The concern is the impact of the budget update on consumer and business sentiment. The projected Budget deficit and the potential loss of Australia’s AAA has been widely documented over the past few days, but it is important as a community to focus on the recent improvements across the economy. As the Reserve Bank has highlighted the mid-term outlook for the economy is far more positive and confidence plays a significant part in supporting activity levels and broader growth momentum.

Interestingly, the budget deficit is expected to narrow from 2.3 per cent of GDP to 0.7 per cent of GDP in the space of four years. The Government doesn’t need to slash and burn. Rather it needs to foster strong, sustainable economic growth and apply targeted spending cuts that seek to improve productivity and efficiency.

What do the figures show?

The Federal Budget is projected to be in deficit by $36.5 billion in 2016/17 (2.4 per cent of GDP) compared with May forecasts of $37.5 billion. The deficits are expected to fall over the following three years to $10 billion (1.2 per cent of GDP) in 2019/20.

The Government expects the economy to grow by around 2.0 per cent this year, down from the 2.50 per cent rate assumed in May with the release of the Federal Budget. Estimated growth in 2017/18 has been cut from 3.0 per cent to 2.75 per cent.

Net government debt is expected to grow from $317.2 billion (18.1 per cent) of GDP in 2016/17 to $343.0 billion (18.9 per cent of GDP) in 2017/18. Debt is expected to continuing rising in the following two years to $363.8 billion (18.4 per cent of GDP) in 2019/20.

The Government says it “the Budget repair strategy is designed to deliver budget surpluses building to at least 1 per cent of GDP as soon as possible consistent with the medium term fiscal strategy.”… “In line with the 2016 PEFO, the underlying cash balance is projected to return to surplus in 2020-21”.

Budget deterioration

According to the MYEFO:

“Government receipts, although growing, are expected to be affected by softer domestic prices and wages growth. Expected tax receipts, excluding new policy, have been revised down by around $3.7 billion in 2016-17 and $30.7 billion over the four years to 2019-20 since the 2016 PEFO”.

“Recent higher iron ore and coal prices are expected to improve corporate profitability in the mining sector in 2016-17, which is expected to provide some support to tax collections in 2017-18. However, this will be more than offset by the impact of weaker growth in aggregate wages and non-mining profits across the forward estimates”.

“In this MYEFO, the iron ore price is assumed to decline from its recent average of US$68 per tonne FOB through the March and June quarters of 2017 to reach a level of US$55 per tonne FOB in the September quarter 2017. This is the average price that has prevailed since PEFO”.

The MYEFO assumption is for thermal coal spot prices to remain at US$62 per tonne FOB. This is consistent with recent averages before the recent sharp price increases. It is also consistent with the current Japanese fiscal year annual contract price of Part 2: Economic outlook 16 US$62 per tonne FOB. Prices are assumed to remain at this level over the forecast period reflecting the typically longer duration of contracts in the thermal coal market”.

What is the importance of the economic data?

The Mid-Year Economic and Fiscal Outlook report is presented by the Government around October-December each year. The report is an update on how the Federal Budget is tracking and is therefore an update on the fiscal policy stance of the Government.

What are the implications for interest rates and investors?

Uncertainty over budget outcomes and policy decisions will keep a lid on momentum and economic growth. If economic activity eases then the Reserve Bank may be forced to cut rates again.

The Reserve Bank is optimistic about the medium term prospects for the Australian economy. However a lift in non-mining business investment would provide policymakers with an added degree of comfort. Interest rates are on hold for the foreseeable future.

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