When Treasurer Joe Hockey delivers the mid-year update on the federal budget, expected in the coming weeks, we can expect a nasty set of numbers.
Billions of dollars in savings measures are tied up in the unpredictable Senate. Tax revenues are expected to be lower than forecast, attributable to a range of factors, but especially to the fall in commodity prices.
The Abbott Government, which came to office promising an “end to debt and deficit”, needs to do some straight talking to the electorate about the changed economic reality Australia is now confronting.
Hockey has done a little groundwork on lowering expectations on the budget performance. When consulting firm Macroeconomics published some research last month saying there was likely to be a $51 billion deterioration in the Budget bottom line over the forecast period, Hockey didn’t exactly rush to quash it, although he did say it wasn’t accurate and there was more data to come that would complete the picture.
“The truth is that iron ore prices are between 30-40 per cent less than they were when we first made our forecasts in the budget,” he said. “That has a direct impact on our budget bottom line – there is no doubt about that.”
The Coalition finds itself in a predicament that is, in a large part, of its own making. It has positioned itself as the master of economic policy, the answer to the budget overruns that stacked up under Labor. A tiny surplus was tentatively forecast for 2017-18. Without some more dramatic “fiscal consolidation” – or cuts in government spending – we’re now looking at years of deficits further out. This unfolding fiscal mess has even prompted Andrew Bolt to note the great economic promise of the Coalition has failed to materialise, writing recently that the “weak economic growth and Budget blowouts undermine the Government’s entire argument for being“.
But a further reduction in government spending risks putting even more of a drag on the economy. Hockey has foreshadowed some of this, saying the mid-year update would not be “a mini budget. We are not going to go down the path of trying to make up lost ground immediately.”
Since the boom years under the Howard government and Peter Costello’s stunning run of budgets in the black, Australia’s political class, especially the Coalition, has developed an almost pathological addiction to announcing surpluses. It’s now time to start adjusting that expectation and admit that small deficits in a $1.5 trillion-dollar-plus economy are not a recipe for economic doom, and in fact can help the economy through rougher patches.
Some of the Budget overruns are due to inexplicably poor political strategy from career politicians who proposed savings measures without figuring out how they’d actually pass them through the Parliament. The public backlash on the perceived unfairness of the budget and its impact on vulnerable people, especially the sick, helped harden political opposition amongst the Senate cross-benchers.
And some of the economic funk, when it comes to business investment and job creation, is doubtless attributable to the sledgehammer effect on consumer and business confidence from the Budget and the ensuing political impasses.
But other problems are due to global market forces far beyond the control of the government, including China’s slowdown and the falls in commodity prices.
The recent falls in oil prices (though they bounced overnight) add yet another layer of complexity to the economic picture, as the trend is likely to lower the inflation outlook. This is great for consumers who’ll end up paying less for fuel each week, but fuel-related price reductions for consumer goods also mean less GST washing through.
With all this swirling around it’s worth looking back at some of the assumptions underpinning the forecasts in the federal budget. Here’s what it says in the footnotes for the domestic projections.
The forecasts for the domestic economy are based on several technical assumptions. The exchange rate is assumed to remain around its recent average level — a trade‑weighted index of around 71 and a United States dollar exchange rate of around 93 US cents. Interest rates are assumed to move broadly in line with market expectations. World oil prices (Malaysian Tapis) are assumed to remain around US$113 per barrel. The farm sector forecasts are based on an assumption of average seasonal conditions in 2014‑15 and 2015‑16.
Well, the Australian dollar is now trading at around US85c and the oil price is at least 30% off where it was when these forecasts were drawn up. Both of these, like the weather inputs to the farm sector, are out of the government’s hands. And the differences dramatically change the economic equation.
The falling dollar helps the export sector, especially tourism and education. But as the Reserve Bank often noted throughout the past year, the currency was higher than would normally be expected given the global economic conditions.
Then there’s the wages problem. The domestic forecasts in the Budget show expected wage growth at 2.75%. With the domestic economy continuing to grow a little less strongly than expected, wage growth is currently clocking in at 2.6%, seasonally adjusted, and falling. (The trend figure is 2.5%.) Again, this flows into the Budget bottom line with lower-than-expected tax receipts, as personal income tax makes up almost half of the federal government’s revenue.
Here’s another chart from the Budget papers, showing the recent pattern in the accuracy of Treasury’s forecasting of growth in tax receipts. As you can see, there’s been a trend of overestimating the growth of government revenue since the GFC:
As things stand it’s a reasonable prediction that when this chart is updated in next year’s budget it will be showing another negative result.
Tony Abbott’s marathon press conference yesterday in which he attempted to hit the reset button on a number of issues, including defence pay and the GP payments, show the government is now appraised of the increasingly dim public view of its performance that has been reflected in the polls.
The mid-year budget update is another potential blow to confidence. Aside from confronting the botched politics of their first Budget, Abbott and his ministers and need to start levelling with voters and explaining the new set of economic conditions that Australia’s grappling with.
And they need to have a plan for how they are going to respond with policy, and work out a strategy for actually getting things done in a way that helps restore some confidence. They are, after all, the “better economic managers”.
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