Budget on path to surplus but no fiscal easing: CommSec's Craig James

EXPERT OBSERVER

Australia’s public finances remain in good shape with the Federal Government on course to deliver its first Budget surplus in 12 years. But new spending measures since the April 2 Budget and the 2019 Pre-election Economic and Fiscal Outlook (PEFO) have been limited at a time when Australia’s annual economic growth rate has slowed to decade lows.

Prior to the release of today’s Mid-Year Economic and Fiscal Outlook (MYEFO), the Federal Government claimed that around $9.5 billion worth of stimulus had already been rolled out over the next two years - including income tax cuts, drought-relief and infrastructure spending. The MYEFO included new net spending of $8 billion over the next four years.

So what is driving Australia’s solid Budget position? Fiscal discipline. The Government claims real spending growth of just 1.3 per cent is around the lowest in 50 years and payments as a share of GDP at 24.5 per cent are below the 30-year historical average of 24.7 per cent. In fact, spending is $1.4 billion lower this fiscal year. The annualised deficit in the year to October (latest available) is just $78 million, suggesting that a surplus is tantalisingly close – even if the government doesn’t increase spending considerably.

Also, our exporters are going gangbusters. The weaker Aussie dollar, reduced seaborne supply out of Brazil and Chinese stimulus have boosted demand for steel-making ingredient iron ore, keeping ferrous prices elevated. And with most commodity prices higher, Australian miners - which account for around 40 per cent of total company profits - have lifted overall company tax revenue. In fact, company profits were up 10.2 per cent over the year to September to record highs. That said, overall company tax revenues are still expected to be down by $700 million this fiscal year and almost $8 billion over the forward estimates.

The estimated Budget surplus has been revised down from $7.1 billion to $5.0 billion this fiscal year; downgraded from $11 billion to $6.1 billion in 2020/21; and lower by $9.4 billion to $8.4 billion in 2021/22. Sluggish economic growth and tepid wages growth have weighed on GST receipts (down $1.8 billion in 2019/20) through lower consumer spending. And lower superannuation taxes paid and non-tax revenues have also lowered revenue by $32.6 billion over the 4-year forward estimates.

As expected, the Government has downgraded its near term forecasts for economic growth, inflation, wages growth and business investment in the near term. But the unemployment rate is expected to remain steady around current levels of 5.3 per cent. And Federal Treasurer Josh Frydenberg has stressed that “the outlook for the Australian economy is positive”, with economic activity expected to return to its long-run average growth of 3 per cent by 2021/22, supported by personal income tax cuts and infrastructure spending.

Petrol prices are irritatingly high across Australia at the moment. Unleaded retail petrol prices have hit peaks near $1.75 a litre in major capital cities in the past week – well above the national wholesale or Terminal Gate Price (TGP) of around $1.35 a litre. Prices are set to gradually ease by the weekend, but will remain elevated at $1.60-$1.70 a litre for most of this week. Of course, the timing couldn’t be worse. Most of us are about to hit the road for summer holidays and there is increased traffic on the road as the ‘mad dash’ for the shopping malls and Christmas parties continue. Airport drop-offs and pick-ups are also increasing too in the lead-up to New Year.

So why are petrol prices so high? Australia is a net importer of oil and the weaker Aussie dollar against the greenback has pushed up the cost of refined petroleum product from Singapore this year. Oil charges have also lifted at a time when crude oil prices are hovering near 3-month highs. Supply restraint by OPEC and Russia along with better demand sentiment associated with the US-China trade truce have pushed up crude oil prices.

What do the figures show?

Mid-Year Economic and Fiscal Outlook (MYEFO) 2019/20

The Federal Government is projecting a $5.0 billion underlying cash surplus (0.3 per cent of GDP) for the current financial year. The April 2019 Budget had forecast a surplus this fiscal year of $7.1 billion. A Budget surplus of $6.1 billion (0.3 per cent of GDP) is now expected in 2020/21. By 2021/22, the surplus is expected to be $8.4 billion or 0.4 per cent of GDP, before falling to a forecast surplus of $4.0 billion or 0.2 per cent of GDP in 2022/23.

The net operating balance is expected to be in surplus by $8.0 billion this fiscal year (2019/20). The April Budget had forecast a $12.9 billion surplus this year. The surplus is forecast to lift to $12.1 billion in 2020/21.

Debt: Net debt is projected to be $392.3 billion in 2019/20 or 19.5 per cent of GDP. Net debt is expected to fall to $379.2 billion (18.4 per cent of GDP) in 2020/21 then $360.8 billion (or 16.0 per cent of GDP) by 2022/23.

Gross debt, in per cent of GDP terms, is estimated to decline from 27.7 per cent of GDP in 2019/20 to 25.5 per cent of GDP by the end of the forward estimates.

Revenue: Since the 2019 Pre-election Economic & Fiscal Outlook (PEFO), expected total receipts have been revised down by around $3.0 billion in 2019/20 and $32.6 billion over the four years to 2022-23. The near-term downward revisions are largely attributable to downgrades to superannuation fund taxes, GST and non-tax receipts. Downward revisions from 2020/21 to 2022/23 reflect falling individual taxes, company tax and GST receipts. Tax receipts are projected to remain below the Government’s tax-to-GDP cap of 23.9 per cent over the medium term.

Expenses: The payments-to-GDP ratio is expected to be 24.5 per cent in 2019/20, rising to 24.8 per cent by 2020/21, near the 30-year historical average of 24.7 per cent. Average annual real growth in payments is expected to be 1.3 per cent across the forward estimates.

Policy decisions: Since the 2019 PEFO, new policy decisions in the 2019/20 MYEFO have reduced payments by $1.3 billion over the four years to 2022/23. And the estimated impact over the forward estimates of remaining unlegislated Budget repair measures, announced prior to the 2019/20 MYEFO - after taking account of parameter changes - is now +$4.9 billion. This comprises around $2.3 billion of receipt increases and around $2.5 billion of payment savings.

Commodity assumptions: The iron ore spot price is assumed to remain at US$55 per tonne free-on-board (FOB) over the forecast period. The metallurgical coal price is assumed to remain around current levels of US$134 per tonne FOB over the forecast period, below the assumed by the 2019 PEFO of US$150 per tonne FOB. The thermal coal price is assumed to be US$64 per tonne FOB over the forecast period, below the 2019 PEFO assumption of US$91 per tonne FOB.

Economic outlook: Economic (real GDP) growth is forecast to be 2.25 per cent in 2019/20, down from 2.75 per cent estimated in the April Budget. Real GSP growth is forecast to lift to 2.75 per cent in 2020/21 and 3 per cent annually by 2021/22. Wage growth, which was forecast at 2.75 per cent in the April Budget, has been downgraded to a weaker 2.5 per cent for the next two years, with the government not forecasting a return to 3 per cent growth until 2022/23. Inflation forecasts have also been lowered by 25 basis points to 2.0 per cent this fiscal year (2019/20) and 2.25 per cent in 2020/21. The unemployment rate has been revised up to 5.25 per cent over the next couple of fiscal years before falling to 5 per cent in 2021/22 and 2022/23. Estimated business investment is now forecast to be 1.5 per cent this fiscal year, down from the 5 per cent projected in the 2019 PEFO.

Credit rating implications: S&P Global Ratings has reiterated that it expects the Government to maintain strong fiscal discipline and policy settings in order to retain Australia’s prized sovereign AAA credit rating.

Petrol prices

According to the Australian Institute of Petroleum, the national average price of unleaded petrol rose by 9.9 cents to 154.8 cents a litre last week. The metropolitan price rose by 14.5 cents to 157.8 cents a litre and the regional price lifted by 0.6 cents to 148.6 cents a litre.

Average unleaded petrol prices across states and territories over the past week were: Sydney (up 20.6 cents to 159.2 c/l), Melbourne (up 20.7 cents to 161.1 c/l), Brisbane (up 26.0 cents to 168.3 c/l), Adelaide (down 18.5 cents to 142.9 c/l), Perth (down 0.6 cents to 145.6 c/l), Darwin (down 0.6 cents to 142.1 c/l), Canberra (unchanged at 147.7 c/l) and Hobart (unchanged at 156.0 c/l).

The smoothed gross retail margin (2-month rolling average) for unleaded petrol rose from 13.51 cents a litre to 15.00 cents a litre (24-month average: 13.2 cents a litre).

The national average diesel petrol price was unchanged at 149.0 cents a litre over the week. The metropolitan price fell by 0.1 cent to 147.5 cents a litre and the regional price was flat at 150.2 cents a litre.

Today, the national average wholesale (terminal gate) unleaded petrol price stands at 134.6 cents a litre, down by 0.1 cent over the week. The terminal gate diesel price stands at 137.1 cents a litre, up by 1.0 cent over the past week.

MotorMouth records the following average retail prices for unleaded fuel in capital cities today: Sydney 163.3c; Melbourne 164.4c; Brisbane 167.4c; Adelaide 166.5c; Perth 135.0c; Canberra 147.6c; Darwin 142.1c; Hobart 156.0c.

The key Singapore gasoline price fell by US$2.58 or 3.4 per cent last week to US$73.65 a barrel. In Australian dollar terms, the Singapore gasoline price fell by $5.13 or 4.6 per cent to $106.34 a barrel or 66.88 cents a litre.

Purchasing managers’ survey - December

The Commonwealth Bank/IHS Markit ‘flash’ purchasing manager (PMI) survey for manufacturing fell from 49.9 points in November to a 3½-year low of 49.4 points in December. The services index fell from 49.7 points in November to 49.5 points in December. Any reading below 50 indicates a contraction of activity.

According to the Commonwealth Bank, “The PMI readings indicate that the Australian economy ended 2019 on a softish note. The RBA’s “gentle turning point” for the economy remains elusive. And the weakness in private spending evident in the Q3 GDP data looks to have continued in Q4, with a flow on to labour demand as well. There were also some early indications that the disruptions associated with the terrible bushfires around Sydney and elsewhere are having some impact”. New orders continue to rise, however, indicating a degree of resilience in the domestic economy. The rise in new export business also indicates a degree of resilience to the sluggish global backdrop”.

Chinese economic data - November

Retail sales rose at an 8.0 per cent annual rate in the year to November (consensus: +7.6 per cent), up from the 7.2 per cent annual rate in the year to October.

Industrial production rose at a 6.2 per cent annual rate in November (consensus: +5.0 per cent). Production had risen by 4.7 per cent in the year to October.

Fixed-asset investment rose by 5.2 per cent in the 11 months to November on a year earlier (consensus: +5.2 per cent), unchanged from the 5.2 per cent lift recorded over the 10 months to October - the weakest annual growth rate since records began in 1998.

Property investment rose by 10.2 per cent in the 11 months to November on a year earlier, down from the 10.3 per cent annual growth rate in October.

The unemployment rate (nationwide survey-based jobless rate) was steady at 5.1 per cent in November.

What are the implications for interest rates and investors?

Commonwealth Bank Group economists expect another interest rate cut by the Reserve Bank of Australia in February 2020. It appears that Governor Philip Lowe’s pleas for significant fiscal easing in today’s MYEFO have ‘fallen on deaf ears’.

Aussies are pessimistic at the moment with consumer and business confidence both in the doldrums. The export and government sectors are propping up the economy, but businesses and consumers remain on a spending strike. So an even greater fiscal response appears necessary - to complement record low interest rates - in order to cajole businesses to invest and hire with consumers currently banking tax cuts and paying down debt.

The Federal Government’s solid fiscal position gives it scope to lift spending to support economic growth when it hands down the May 2020 Budget. Aside from ‘big ticket’ public transport infrastructure projects, perhaps greater attention should be given to providing tax relief for small businesses? The asset write-off threshold could be lifted further (to above $30,000) and tax cuts (to 25 per cent) brought forward from 2021/22.

And with stamp duty money from the buoyant property market filling the coffers again, payroll tax exemptions should be a top priority for state governments – especially for agricultural and manufacturing-focused businesses. The drought continues to weigh on farm GDP and manufacturing activity is contracting by the most in 3½ years.

China’s economy appears to be stabilising into year-end. A big lift in industrial production and retail spending along with a bottoming in fixed asset investment suggests that stimulus may finally be working. The better-than-expected data dump comes after the US-China trade détente announced on Friday. While a roll-back in tariffs appears unlikely until at least February, the partial trade agreement at least provides greater certainty to businesses and may boost investment.

While Chinese authorities have maintained their desire to keep economic growth within a “reasonable range” at last week’s top level government meetings, the annual economic growth target is still expected to be adjusted lower to around 6 per cent in 2020. But in good news for Australia, it appears the policymakers plan to spend even more on infrastructure next year to stabilise growth.

CRAIG JAMES is the Chief Economist at CommSec