BUDGET UPDATE: Treasury cuts growth forecast, says pain to hit next year

Photo: Adrian Dennis/ AFP/ Getty Images.

The federal government believes it will end this financial year slightly ahead of budget but has acknowledged that the reality of weaker economic growth will add to the deficit in subsequent years.

MYEFO, Mid-Year Economic and Fiscal Outlook, says the deficit of $37.1 billion forecast in May for this financial year will be slightly lower at $36.5 billion, or about $600 million better than expected.

But next financial year the deficit will blow out to $28.7 billion, $2.6 billion worse than the May budget forecast of $26.1 billion.

This budget update is a crucial piece of data for Standard and Poor’s when it decides whether to not to cut Australia’s triple AAA credit rating. It has already placed Australia’s sovereign rating on negative watch.

The government says the budget is on track to be restored to balance.

The deficit will narrow to $10 billion in 2019-20 and is projected to return to surplus in 2020-21.

According to MYEFO, slow wage growth and weak inflation combine to constrain GDP to 2%, down from the 2.5% forecast in the May budget.

However, economic growth is forecast to strengthen to 2.7% in 2017-18 as the impact from the decline in mining investment eases.

This chart shows the key economic forecasts made by MYEFO:

Inflation is forecast to be weaker than expected, down to 1.75% from the 2% in the May budget.

The government says it has made significant headway in legislating repair the budget, with more than $22 billion of measures implemented since the election.

“Since our re-election in July 2016, the government has made significant progress in working with the parliament to legislate measures to repair the budget,” says treasurer Scott Morrison.

He says the government is committed to repairing the budget by controlling spending.

“Sustained discipline to offset new expenditure and pass existing budget repair measures is need to consolidate the budget and lower budget debt.”

This ability to get budget repair measures through a hostile Senate is a key issue for ratings agencies when looking at the ability of the Australian government to improve the deficit.

On the revenue side, MYEFO shows that softer wages growth will squeeze the amount of tax collected.

Tax receipts have been revised down by $3.7 billion in this financial year and $30.7 billion over the four years to 2019-20.

The recent surge in iron ore and coal prices are expected to improve corporate profitability in the mining sector which means more taxes collected.

However, the MYEFO analysis says this will be more than offset by the impact of weaker growth in wages and non-mining profits.

“A modest recovery in non-mining business investment is expected over coming years,” according to MYEFO analysis.

“The transition underway in the economy from the investment phase to the production phase of the mining boom is expected to continue.

“Exports and household consumption are expected to support growth, with dwelling investment higher in the near term.”

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