Here are the key challenges for forecasts in the 2017 federal budget

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Reining in the federal deficit, or that gap between spending and the revenue the government collects, is the biggest challenge facing treasurer Scott Morrison in the 2017 budget.

The latest official forecast, the MYEFO (Mid-Year Economic and Fiscal Outlook) in December, has the deficit for this current financial year coming in at $36.5 billion, or about $600 million better than expected.

This number, and the trend toward a balanced budget, 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.

At last report the federal government believes the budget is on track to be restored to surplus in 2020-21.

And there are some encouraging signs, even since the MYEFO in December.

Where successive budgets have gone wrong is not on the spending side — governments generally get this right on the nail or even shave expenditure a bit.

What’s been happening is that the forecasts for revenue collection — essentially the tax paid by individuals and companies — have failed.

Again and again, the revenue projections have fallen short of reality.

Blame it on slow economic growth, wage growth, weak inflation, the end of the mining boom and fewer companies reporting profits — but whatever the core reasons, tax collection has been weak.

However, the good news now is that the surge in commodity prices is expected to help the government’s revenue collection.

Analysis by the ANZ Bank indicates the deficit may come in smaller than expected.

The latest numbers show expenses $3.1 billion in February below where the MYEFO would have suggested they should be.

And, importantly, revenue collection was $2 billion higher than expected.

“These figures need to be read cautiously, however, as monthly swings in the various revenue and expense lines can be substantial,” says Cherelle Murphy, senior economist at the ANZ.

She says it’s likely the budget will show gradually smaller deficits both in dollar terms and as a percentage of GDP.

“This means fiscal policy will continue to be tightened over the coming decade,” she says.

“The good news is, to retain its much prized AAA credit rating the government is not likely to have to lean on the household sector with further cuts to payments or higher taxes.

“The bad news is that the government has little flexibility to produce upside budget surprises, new spending or boost the Commonwealth’s contributions towards infrastructure unless it finds offsetting savings.

“The government is highly likely, in our view, to produce a budget that projects the underlying cash balance to be in surplus in 2020-21.”

Here’s where the government’s revenue comes from:

Source: 2016-17 federal budget papers.

Another indication that the government will raise its expectations is that the IMF (International Monetary Fund) has just upped its own projections for Australia’s economic growth.

The IMF raised Australia’s 2017 GDP growth forecast to 3.1% from its 2.7% estimate made in October and it expects inflation to hit 2% this year, from 1.3% last year, and for unemployment to drop to 5.2% from 5.7%.

The IMF pointed to improved commodity prices for the change.

Natural gas prices have increased as supply tightens and oil prices are also trending higher.

The big one is coal prices which have been surging, following government-led reductions in coal production in China and outages in Australia that affected production and shipment.

The IMF’s GDP forecast is well ahead of Australian Treasury estimates.

In December, the MYEFO, Mid-Year Economic and Fiscal Outlook, showed slow wage growth and weak inflation combining to constrain GDP to 2%, down from the 2.5% forecast in the May budget. The forecasts showed GDP at 2.75% in 2016-17 and growing to 3% in 2018-19.

Deloitte Access Economics believes the nation’s finance are looking better, thanks to the housing boom and demand for Australian commodities in China.

“The current improvement in deficit trajectory simply says that the twin engines of chance — a China boom and a house price boom — are both supporting the national tax take at the same time,” says Deloitte Access Economics partner and economist Chris Richardson.

However, this improvement looks temporary.

“China is doing the Federal Budget favours at the same time as housing prices puff up revenues for some states,” he says.

“These are welcome developments, allowing a loosening of the budgetary noose, with the combined national fiscal position looking better.

“At first blush that seems to suggest the nation is making healthy and continuing progress from the peak deficits for the national public sector registered at the height of the GFC in late 2009.”

However, Richardson says spending continues to climb at a solid clip and attempts to rein it in are fruitless vote-losers.

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