The Budget night routine is becoming all too familiar. Lots of rhetoric, a few policy tweaks here and there but ultimately not much that is likely to move the dial on the economy, or the government’s financial position. This year was no different.
The realists will say a modest $3.4bn deterioration in the 2016/17 budget projection from the mid-year update is a pretty good outcome just a few months out from an election. The fiscal hawks would say that this government is not only ignoring a persistent fiscal weakness but has made it worse.
The economic reality is that the government is walking a fine line between timely budget repair, the political realities of an election year and being mindful not to disrupt the fragile economy that underpins the whole thing.
The reconciliation statement shows policy decisions have cost this year’s budget $3.1bn on top of a $0.8bn deterioration due to a weaker economy. This is minor pork barrelling in the scheme of things. The good news for those of us worried about where our government’s financial position is headed is that the Treasurer has got all this back in the out years. When compared to MYEFO this budget manages to tighten things up by $1.7 billion over the next four years.
This is not an irresponsible Budget. It maintains the existing strategy to return the government to balance over the four year forecast horizon, effectively confirming a fiscal consolidation that has the public sector contributing a lot less to economic growth than it has in the past.
The government is projecting real spending growth of 1.9% over the next four years. A tight ship indeed. That is considerably less than the expected overall rate of economic growth of 2.5% to 3%. The public sector is about a quarter of the economy. By increasing government spending by less than the overall economy means that the budget is holding economic growth back.
There is nothing significant in this budget that will meaningfully alter the outlook for the economy. It could be argued that fiscal policy for 2016/17 has been ‘eased’ by about 0.1 to 0.2 percentage points of GDP. This is about the same impact on the economy as today’s interest rate cut from the RBA, assuming it is largely passed onto commercial interest rates.
Taken together, we have seen a small boost to the economic outlook. But to put it in perspective, it is a boost that could easily be overwhelmed by changes in the global economy, shifts in consumer saving behaviour, or a change in lending standards from the major banks.
Households are everything
The Treasury’s economic forecasts look fine. There isn’t really another set of numbers they could put forward. They have assumed a gradual return to a new Australian macroeconomic “normalcy” by 2017/18. Real economic growth of 3%, nominal growth of 5%, wages just under 3% and inflation in the bottom half of the RBA’s target band. Employment growth of 1.75% is the best we should hope for, enough to keep the unemployment rate steady at 5.5%.
None of these economic projections are bold or ambitious. They are a sensible, middle-of-the-road set of economic forecasts that reflects a cautious optimism. They are very dull – boring, even.
The main weakness in the forecasts is the assumption that a sizeable fall in the household saving rate will keep consumption growth at 3% each year over the forecast horizon. This solid rate of household consumption growth underpins the whole set of economic forecasts and by extension, the budget.
If households decide to hold the saving rate steady at around 8% over the next three years, then the economy will fail to pick up its pace of growth and we can kiss any prospect of a budget surplus goodbye.
Waiting for the ‘new normal’ that may not arrive
This is the real risk to the budget and indeed, the government’s financial position: that the economy does not return to some idea of normal as represented by the Treasury’s forecast. What happens if the economy continues to struggle? Right now the two largest state economies, NSW and Victoria, are booming. Excluding mining and some parts of the manufacturing sector, one could argue that economic activity in Australia is about as strong as we could reasonably expect.
The foundation of the whole budget strategy is that the Australian economy is temporarily experiencing a transition period from mining boom to some “new normal”, in which recent fragilities will soon pass and the economy will be stronger and more robust – at some stage in the future. The government’s fiscal policy must nurture the economy through this period of vulnerability.
This may not be how it plays out.
If the non-mining economy slows over the next two years as the housing cycles turns down and the world economy remains fragile, we cannot expect the government’s forecasts to come to pass. A major global economic downturn and all bets are off. Australia will be stuck with a budget deficit of between 1% and 2% of GDP.
Australia’s overall state and federal government net debt is currently projected to get to 23% of GDP in a few years’ time. Rating agencies and investors think a level of 30% would be a concern, given the high levels of debt in the private sector. The current budget projections suggest we have little room for error, particularly if the government wants to provide some economic stimulus through the next economic downturn.
As has been the case for much of the post-GFC era, the Government’s finances remain vulnerable to economic disappointment. Economic disappointment seems to be the new normal. This means we are going to be stuck with a budget deficit for some time yet.
Warren Hogan has been an economist and financial market strategist for 21 years and is the former Chief Economist of ANZ Bank.