Australian Federal budget 2017: a preview
- Budget 2017 is to be announced by the Federal Treasurer on Tuesday night, May 9. We expect that the existing profile for the underlying cash balance, with a return to surplus in 2020/21, will be largely confirmed.
- Westpac Economics expects the underlying deficit for 2017/18 to be announced as $27.7bn, an upgrade of $1bn from the Government’s December forecast in the Mid-Year Economic and Fiscal Outlook (MYEFO). Across the four years to 2020/21 the improvement is $3bn.
- The budget deficit narrows only gradually across the four years, by around 0.5% of GDP each year, and edges into surplus in 2020/21 (0.2% of GDP), after 12 consecutive years of deficit.
- These estimates are likely to be based on the commodity price forecasts used in the December MYEFO. Notably, the iron ore price is expected to be US$55/t fob, reaching that point in December 2017, one quarter later than assumed in MYEFO. Currently, the fob price is around $63/t.
- However, based on our own more pessimistic forecast profile for commodity prices we expect that the budget will still print a deficit in 2020/21 of around $5 billion.
- The economic outlook is slightly more positive than MYEFO based on an improved global backdrop although the good news on higher commodity prices has already been factored into MYEFO.
- On the Government's forecasts for real GDP growth we expect an upgrade to 2017/18, to 3.0% from 2.75%, but a downgrade to 2018/19, to 2.75% from 3.0%, as home building activity turns down. We concur with that expected slowdown.
- That yields a profile for real GDP growth from 2017/18 of: 3.0%, 2.75%, 3.0% and 3.0%.
- The profile for nominal GDP growth from 2017/18 is: 4.25% (+0.5%), 4.0% (-0.25%), 4.5% and 4.5%. By comparison our nominal GDP profile is: 3.8%, 2.8%, 4.25% and 4.25%.
- On policy measures, we expect a net neutral impact on the budget. The 'zombie' savings measures - those stuck in the Senate since 2014 and estimated at $12.4 billion over the four years are to be removed. There will be some modest new spending, such as on schools.
- We expect savings measures, a mixture of expenditure (including universities and welfare) and revenue (possibly including extending the Medicare levy surcharge to all high income earners), to fully offset new spending and the removal of the 'zombie' measures.
- Key themes will be: delivering on election promises, including cutting the company tax rate; a growth focus, notably increased spending on infrastructure; energy affordability and reliability; and social housing and housing affordability.
- We are most attracted to the likely infrastructure initiatives including a second airport for Sydney ($5-6 billion) and the Brisbane to Melbourne inland freight rail link ($10 billion).
- The government is likely to finance these infrastructure projects through capitalising special purpose companies rather than grants. Under this approach the budget balance will only be impacted by the interest costs from the resulting debt.
- These projects, which have been fully assessed by Infrastructure Australia as part of its $60 billion, 15 year Infrastructure Plan, are an extremely welcome development and, hopefully, will be complemented by other such announcements on Budget Night.
- The assessment process involving Infrastructure Australia should be contrasted with the NBN which is now requiring funding of $49bn including $29.5bn of equity and $19.5bn of debt and was approved without the appropriate assessment of an independent body such as Infrastructure Australia.
- Our estimate of the timing of the drawdowns of the debt associated with these projects has net debt peaking at 19.2% of GDP in 2018/19. Of course, if more projects are announced, as we hope, the peak ratio and its timing will change.
Underlying cash balance
The 2017 Budget will largely confirm the existing profile for the underlying cash balance.
The Government expects the budget deficit to narrow gradually over coming years, returning to a wafer-thin surplus in 2020/21, as in MYEFO.
This overall picture reflects the key judgements that:
- changes to the economic growth forecasts will be minimal;
- the net impact of new policy measures will be neutral; and
- new infrastructure spending will be largely funded 'off balance sheet', akin to the NBN approach (more on that below).
The budget deficit is expected to come in at $36.5bn (2.1% of GDP) in the current financial year, 2016/17, as in MYEFO. This represents a lack of progress on the past five years, when the deficit averaged $37.6bn a year (2.4% of GDP). The improvement in the budget largely remains confined to the forecast period.
The deficit narrows by around 0.5% of GDP each year across the four year period to 2020/21.
For 2017/18, the deficit is a forecast $27.7bn (1.5% of GDP), a $1.0bn improvement on the MYEFO forecast. The deficit declines to $20.2bn in 2018/19 (a $0.5bn deterioration on MYEFO); and then to $9.5bn in 2019/20 (a $0.5bn improvement on MYEFO). The budget position edges into surplus in 2020/21, $4.0bn (0.2% of GDP), a $2bn improvement on MYEFO.
Across the four years, the cumulative improvement in the budget position is $3.0bn. An improved economic outlook adds $5bn to the budget bottom line, partially offset by $2bn in funding for new infrastructure. The net impact of new policy measures is neutral in our calculations.
The near term economic outlook is more favourable, at the margin, against the backdrop of an improved global economy. Critically, the positive news on higher commodity prices was largely factored into the MYEFO forecasts.
Nominal GDP growth in the current year, 2016/17, is likely to be around 5.75%, as expected in MYEFO. This follows four years of well below average income growth. While commodity prices have held higher for a little longer that's been offset by weakness elsewhere, particularly wage inflation.
For 2017/18, nominal growth is upgraded by 0.5% to a still subpar 4.25%. This reflects revisions to real output growth (lifted to 3.00% from 2.75% on a stronger global economy) and a smaller fall in the terms of trade (-1.25% vs -3.75% in MYEFO on a slightly later than anticipated fall in commodity prices).
For 2018/19, growth is downgraded, albeit by only 0.25%, with real GDP growth lowered to 2.75% from 3.00%, a revision reflecting the impact of the looming downturn in home building activity. As for nominal GDP growth, that is similarly marked lower, to 4.00% from 4.25%.
The projection years of 2019/20 and 2020/21 will likely assume 3.0% real growth and 4.5% nominal growth, as in MYEFO.
The key commodity price forecasts are expected to be as in MYEFO.
The iron ore price declines to reach US$55/t free on board in the December quarter 2017 (the timing pushed out by 1 quarter), from around $63 fob currently.
The metallurgical coal price deflates to $120/t FOB, down from around $240 currently and after spiking to $300/t late in 2016. Thermal coal prices ease to $62/t FOB, down from $80 currently fob.
Budget position - growth dividend
Importantly for the fiscal projections, the economic growth forecasts are, on balance, marginally more positive than in December. This has the Australian economy a little larger than previously anticipated, thereby generating additional tax revenue, albeit only $2bn in 2017/18 and $1bn a year thereafter.
Budget 2017: strategy/themes
This, the first budget since the 2016 election, will be portrayed as one that delivers on election promises and with a focus on growth.
The government is delivering on company tax cuts and will boost new infrastructure spending, enhancing public investment as a key growth driver.
This will be pitched as an equitable budget, potentially including initiatives on schools, hospitals and Medicare. The Prime Minister has announced $2.2bn in additional funding for schools over the next four years.
Energy, power affordability and reliability, will be a focus of this budget, as will social housing and housing affordability.
The fiscal strategy is for the deficit to narrow only gradually each year, while still achieving a return to surplus within the four year horizon.
A surplus in 2020/21 would follow 12 consecutive years of deficit, a cumulative deficit of around $410bn, 27% of GDP.
Expenditure - savings measures
The 'zombie' measures - those savings measures stuck in the Senate but still counted in the forward estimates as they remain government policy - will be excised from the budget. These measures largely date from the 2014 Budget, the first of the Abbott government.
The unlegislated measures carried forward are worth $12.4bn across the four years to 2020/21 (source: Parliamentary Budget Office, February 2017).
New initiatives, a mixture of expenditure and revenue policies, will likely fully offset the removal of the zombie measures.
We've anticipated net expenditure savings measures totalling $8.4bn, back-loaded across the four years. A new higher education package will save $2.5bn, while welfare savings will reportedly be worth $2.3bn. Other possibilities include: an additional public sector efficiency dividend, netting $1.5bn, as in last year's budget; as well as a raft of smaller measures that together could save $1.9bn, including payments to the states and the Pharmaceutical Benefits Scheme.
We assume that any new spending, such as on schools, is fully offset by savings, potentially in part through revenue measures.
The 3 year temporary budget repair levy on high-income earners, introduced in the 2014 Budget, expires on July 1 2017. The levy lifted the marginal rate on income above $180k to 47% from 45%.
With the cessation of the temporary levy giving an effective tax cut to high income earnings from July 1, expect a new 'temporary levy', in keeping with the equitable pitch.
One possibility is extending the Medicare levy surcharge applied to high-income earnings to those with private health insurance (currently it applies to those without such insurance). This could raise upwards of $4bn across the four years.
Compliance measures are expected to target the illegal cash economy - recall that last December the government announced a 'Black Economy Taskforce'. Moreover, there is the potential for yet additional compliance and anti-avoidance measures aimed at companies. This measure provides scope to achieve target savings.
Company tax cut
The government is to cut the company tax rate, a ten year plan to reduce the rate to 25% from 30% currently. The policy was included in the May 2016 Budget and taken to the July 2 2016 Federal election.
A cut to the company tax rate is expected to provide a lift to the economy, boosting jobs, investment and wages, although the impact may take some time. Treasury estimates that it will grow the economy by 1% after a decade.
The cost to the budget in the four years to 2019/20 is $2.7bn, as set out in the budget papers, increasing to around $50bn over the decade.
In a deal struck with the Senate, companies with an annual turnover of up to $50mn will see their tax rate cut to 27.5% over the next four years and to 25% over the medium term. This is at a cost of $24bn over the medium term.
The government's original plan remains policy and will be reflected in the forward estimates.
Major infrastructure projects are to be included in the budget.
Projects are likely to include:
Sydney's second airport at Badgerys Creek, at $5bn to $6bn; an inland rail freight link from Melbourne to Brisbane, $10bn; and the expansion of the Snowy hydro power station, $2bn; as well as a feasibility study into a gas pipeline across the continent, from the North-West Shelf in WA to the eastern states.
Specific funding arrangements for these projects will determine how project costs are represented in the budget estimates.
Reports suggest the government is looking to take an equity position in major projects, with the expectation that these projects will generate an income. In these instances, funding is via direct equity or a loan rather than a grant. Borrowing for these projects is reflected in the general government debt numbers. The cash budget position includes the debt servicing cost and interest receipts from the loan. This preview is on this basis.
The NBN is funded using this approach, with the establishment of a separate entity. As at June 2016, the Government had contributed $20bn in equity funding to the NBN. A further $9.5 billion in equity will be subscribed in 2016/17 and that will be supplemented by a loan of $19.5 billion to be drawn over 4 years to complete the project. The impact on the underlying cash budget in 2015/16 was around $0.6bn, as estimated by the Parliamentary Budget Office - the budget papers do not separately identify this figure.
The establishment of an infrastructure project financing team, in the Department of Prime Minister and Cabinet, is likely to go ahead.
A focus on energy policy will be an element of the budget. The government is looking to deliver a power affordability and reliability policy, putting downward pressure on prices. The government is promising to enforce a “public interest” requirement on the big 3 Qld based LNG exporters to force them to deliver more gas to the domestic market.
Social housing and housing affordability
The government is to scrap what has been described as the ineffective $9bn National Housing Affordability Agreement.
The intention is to implement a government-backed bond aggregator scheme that would facilitate investment from the private sector into the rental housing market.
Boosting supply is the key focus for housing affordability, with many of the levers in this area falling within the remit of state and local government.
The level of Australian Government net debt was $296.4bn (17.9% of GDP) at June 2016. In MYEFO, net debt was forecast to peak at 19.0% of GDP in 2018/19 and to be $364bn by June 2020 (18.4% of GDP).
On our figuring, net debt rises to $373bn (18.8% of GDP) by June 2020. The $9bn in additional debt reflects the impact of infrastructure borrowing (which we've assumed will be $10bn), with a slight offset from a cumulative $1bn improvement in the underlying cash balance over the years to 2019/20.
Gross debt on issue was $420bn (25.4% of GDP) at June 2016. In MYEFO that rises to $604bn (30.6% of GDP) at June 2020. Our figuring lifts the June 2020 estimate to $613bn (31% of GDP).
Debt: the good, the bad, ...
The Treasurer has announced that in the budget papers a distinction will be made between 'good debt', that which is accrued to fund projects and policies that increase productivity and generate income, and 'bad debt'. The rating agencies have responded, they will continue to focus on total debt.
There will be a clearer focus on the net operating balance (which excludes capital expenditure although includes an allowance for depreciation). This will bring the budget papers into line with the states and countries such as New Zealand and Canada.
The underlying cash balance will continue to be the key measure reported in the budget papers and remains the basis for the government's fiscal strategy, although as discussed the major new infrastructure projects will only affect the balance through interest costs.
In this preview, we attempt to anticipate the economic and fiscal forecasts that the government will present in the budget.
Our own central case forecasts are less optimistic than the view we expect to be included in the budget. On our reading of the outlook, the risk is that the fiscal position surprises to the downside in coming years and that the budget is still stuck in deficit in 2020/21, potentially to the tune of $5bn (0.2% of GDP).
Key areas of difference centre around commodity prices, which we expect to settle at lower levels than those in MYEFO, and on real GDP. Growth will be a little more modest from 2018/19 onwards, constrained by the looming home building downturn and the associated negative spill-over effects. In addition, we expect the recent cyclical upswing in world growth to falter in 2018, led lower by a slowdown in China.
We expect commodity prices to moderate further in 2018, moving closer to cost curves. The iron ore price is expected to gravitate to $40 spot, around $37 fob (with some narrowing of the spread). Coking coal heads to $80 fob in 2018, while thermal coal declines to $57 fob.
For 2018/19, we expect nominal GDP growth of 2.8%, including a near 6% fall in the terms of trade and real GDP growth of 2.5%. The 2.8% nominal growth forecast is well below the MYEFO figure of 4.25% and the 4.00% that we expect to be included in the 2017 Budget.
By 2020/21, the size of the Australian economy is near to $40bn smaller on our central case relative to the expected budget profile, leading to fiscal slippage in the order of $10bn in 2020/21.
Bill Evans, Chief Economist and Andrew Hanlan, Senior Economist
Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.