Australia’s prime minister Tony Abbott is promising a “more collegiate and consultative” approach to government after seeing his political life flash before his eyes.
It’s three months until the next federal budget is handed down – just enough time to build momentum behind whatever reforms are in the mix. However, there are some challenges for the Australian economy that no change of attitude, staff, treasurer, prime minister, or government is going to solve.
One of these that has been thrust on Australia is the decline in global commodity prices. Tim Toohey and the economics team at Goldman Sachs last week revised their outlook for Australia largely because, as they see it, the world is now in an era of structurally lower commodity prices which will strip Australia of hundreds of billions of dollars of income – and tens of billions of dollars in government tax – over the coming decade.
GS believes further budget write-downs are likely because commodity prices are down and, like milk in the big supermarkets, staying down.
Two persistent themes in the debate around Australia’s export future in recent years have been:
- Tourism and education will pick up and plug the gap as the dollar falls.
- The investments in big LNG projects will start to pay off in the next couple of years, and help cushion the blow from the fall-off in other resources sectors.
Goldman slays these, in two charts.
The first thing to realise is that ‘stuff we dig out of the ground’ makes up an overwhelmingly large proportion of Australia’s exports. Look:
And while LNG will ramp up, it’s not going to surpass iron ore and will only pull in ~$60 billion by 2024 rather than the ~$80 billion estimated under Goldman’s earlier projections (pointers added):
Goldman explains in the note to clients:
Taking the four major commodities together, the consolidated revenue picture is clearly much weaker under our new baseline projections… In CY15, for example, consolidated revenues are now forecast to decline -10% to $102bn, compared to the prior expectation of a 10% increase. And looking further ahead, although ongoing volumes growth and a stabilization in prices are expected to deliver a steady lift in earnings to beyond $200bn pa by 2025, cumulative earnings forgone (relative to our prior forecasts) are estimated to be as much as $0.5trn on that timeframe.
Half a trillion dollars in 10 years – and that’s only relative to the prior forecasts.
The note from Goldman looks in detail at how that breaks down across a range of sectors. I’ve picked out a couple: iron ore and LNG.
This has a range of scenarios for iron ore earnings with at difference prices and Aussie dollar levels. The solid blue line is the new GS baseline forecast.
And this is the same chart for LNG:
Back in December, Treasurer Joe Hockey announced a further budget write-down of more than $10 billion largely because of the collapse in commodity prices. The MYEFO heavily revised its price assumptions, to $US60 per tonne compared to $US95 at the budget.
Now, Goldman sees more coming under its revised commodities outlook:
The weaker revenue environment characterized above has significant negative implications for Australia’s public finances – most evidently at the Commonwealth level. Taken together, we estimate that lower LNG and iron ore revenues will result in the Commonwealth budget position being $40bn worse off over the four years to FY18 than it would have been under our prior (higher) commodity price assumptions. Compositionally, we estimate that $17bn of this shortfall is attributable to weaker LNG-related taxes, with the remaining $24.5bn attributable to lower corporate taxes from iron ore.
To be clear, at the level of the Commonwealth Government, last December’s Mid-Year Economic and Fiscal Outlook did appear to factor in a significant portion of this downside via the adoption of meaningfully lower long run assumptions on both iron ore (US$60) and oil (Tapis: US$76)… With respect to the former, for example, the MYEFO saw corporate tax from iron ore earnings scaled back by some $16.5bn over the forward estimates. With respect to LNG, there was relatively little visibility on the size of the downgrade made in MYEFO – however, given that the total downgrade to revenues attributable to commodity lower prices was estimated to be only ~$18bn (with iron ore $16.5bn of this), we still view the risks to Australia’s public finances as skewed firmly to the downside.
The Coalition positioned itself as the party of surplus during the boom years. There was a clear differentiator when the Labor party blew out the budget, which was understandable through the GFC but excessive spending commitments over recent years showed a lack of restraint that now needs addressing. But even with heavy spending restraint, budget surpluses are receding further into the future, because the market is working against Australia.
The competition between the parties now is between who gets this, and who doesn’t.
Regardless of whether Tim Toohey’s bearish take comes to pass, the shifts in commodity prices still have some way to run and Australia is massively exposed to them.
Faced with this potential ongoing erosion of export revenues Australian governments need to find some manageable way to reduce spending and try some policies that make business and consumers feel like spending up. And the way the numbers work in parliament, the coalition needs the support of the Labor party to do it.
Here are Goldman’s revised economic projections for Australia.
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