The Budget’s happy revenue foundations

00f208834cb76f0586525a8d9661258d-d5fespz

By Leith van Onselen

Well, the 2013-14 Federal Budget is in the bag and apparently Australia is headed back into Budget balance by 2015-16 and into surplus by 2016-17:

btb

For this year rather than a small surplus we will see an $18 billion deficit and $19.4 billion miss from last year’s forecasts.

Here are the major items (both charts courtesy of Westpac, full report below):

Capture

To say that I am sceptical of the Budget forecasts is an understatement. Despite the Kouk’s bizarro reading, I see a number of potential problems with the Treasury’s forecasts, which appear to be based on unrealistic underlying assumptions and mis-reading of the stiff headwinds facing the economy.

First of all, consider the Treasury’s assumed growth in nominal GDP, which is forecast to expand from 3.25% in 2012-13 to 5.0% in both 2013-14 and 2014-15 (see below table).

ScreenHunter_38 May. 15 00.13

For the uninitiated, nominal GDP is the dollar value of what’s produced and earned across the economy. It’s also the measure that drives taxation revenue. Nominal GDP grew by just 2.0% in the year to December, far below real GDP growth of 3.1%, which is the quantity of goods and services produced. While the fall in nominal GDP below real GDP is unusual, having happened only a handful of times since the late-1950s, it has happened twice under the current Labor Government’s watch –  during the GFC and currently – on both occasions driven by sharp falls in commodity prices (reducing the dollar value of Australia’s exports) and the terms-of-trade (see next chart).

ScreenHunter_12 Apr. 16 15.18

The terms of trade forecasts are very aggressive. they assume significant uplift for the March and June quarters for this year. An almost non-existent fall next year and 2% in 2014/15. These figures do not come terms with a  China adjustment at all.

Indeed, the Budget recognises the unusual factors pushing down nominal GDP, noting the following in Budget Paper 1:

Nominal GDP growth has historically exceeded real GDP growth by around 2½ percentage points, but this relationship has reversed recently (Chart 3). Nominal GDP grew by only 2.0 per cent through the year to the December quarter 2012, well below the rate of real GDP growth of 3.1 per cent. This was the third consecutive quarter where nominal GDP growth was outpaced by real GDP growth, the first time this has happened in at least the past half‑century.

Chart 3: Difference between nominal and real GDP growth (through the year)

The chart shows the difference between through-the-year growth in nominal and real GDP between the December quarter 2000 and the December quarter 2012.? It also shows the 20-year average of the difference, which is around 3 per cent. Through-the-year growth in nominal GDP has fallen below real GDP growth, a rare event in the history of the National Accounts. The last time this occurred was during the Global Financial Crisis.

Source: ABS cat. no. 5206.0.

Notwithstanding some volatility in iron ore prices toward the end of 2012, non‑rural bulk commodity prices have fallen over the past twelve months. Iron ore spot prices in early May 2013 are around 30 per cent lower than their peak in 2010‑11, while thermal and metallurgical coal prices have fallen from peaks in 2008‑09 and 2010‑11 respectively. With overall export prices expected to continue to weaken over the forecast period, the terms of trade are expected to decline by 14 per cent from their peak in late 2011 to 2014‑15, placing continued downward pressure on nominal GDP growth.

So according to the Treasury, commodity prices are forecast to continue their decent from 140-year highs, dragging down nominal GDP, yet nominal GDP growth is still forecast to rebound to 3.25% in 2012-13 (from only 2% in the year to December 2012) and to 5% in both 2013-14 and 2014-15? Moreover, nominal GDP is expected to rise to levels that are well above real GDP throughout the forecast period, from -1.1% below real GDP in the year to December 2012?

In light of the ongoing slump in the terms-of-trade, the Treasury’s nominal GDP forecasts appear highly optimistic. According to the Budget papers, a 1% change in the value of goods and services generates a $2.8 billion shift in the budget bottom line in the first year and a $7 billion shift in the second. Therefore, by assuming stronger growth in nominal GDP, the Treasury has likely overestimated Budget revenues and the path back to surplus.

Admittedly, there is one potential saving grace for the Treasury’s forecasts. In the event that the Australian dollar depreciated sharply against other currencies, the Australian dollar value of exports would rise (other things equal), boosting the dollar value of goods produced and nominal GDP, offsetting the fall in commodity prices.

While the Australian dollar is likely to depreciate as the interest rate differential narrows and the mining boom unwinds (possibly removing Australia’s ‘safe haven’ status), one wonders why the Treasury doesn’t err on the side of caution and base its revenue forecasts on more moderate nominal GDP growth, rather than a quite bullish 5% growth?

Weirdly enough, Wayne Swan was out yesterday afternoon declaring that:

…the unpredictability of budget forecasts, just hours before unveiling his sixth and possibly last federal budget.

Amid opposition claims that tonight’s budget numbers won’t be reliable, the Treasurer said unexpected changes in financial conditions could wreak havoc on economic forecasts.

“The truth is that the global economy is capable of changing dramatically, quickly, and having different effects on the economy at different times,” Mr Swan said, as he reflected on the toll the global financial crisis had taken on his past budgets.

Again, given these uncertainties, why is Treasury still plugging in optimistic forecasts?

The other area of concern with the Treasury’s outlook relates to the upcoming peak and then decline of mining capital expenditures (capex). Treasury remains of the view that mining capex will unwind in an orderly manner and that overall jobs growth will improve as the non-mining economy picks-up steam:

The resources sector has responded to the unprecedented growth in demand for resources from Asia with the largest investment boom in Australian history. Total resources investment surged to over $100 billion in 2011‑12, more than 600 per cent higher than it was a decade ago. LNG projects are increasingly dominating the pipeline of investment, driven by the demand for energy in Asia, but large‑scale investment in iron ore and coal extraction and transportation is also contributing to a lift in export capacity.

Resources investment is expected to peak in 2013‑14 at record highs, and then remain elevated through to at least the middle of the decade. The pipeline of resources investment remains substantial, with over $260 billion of investment either committed to or under construction. While resources investment will begin to detract from growth after it passes its peak, the resources sector will continue to make an important contribution to growth as the record level of investment fuels exceptional growth in resources production and exports…

Employment growth is expected to strengthen as growth picks up in some non‑resources sectors of the economy and the level of employment remains high in the resources sector. Employment in Australia is expected to grow by 1¼ per cent to the June quarter 2014 and 1½ per cent to the June quarter 2015, and over 350,000 jobs are expected to be created over the forecast period. However, with the resources sector transitioning to the less labour intensive production phase, and the high Australian dollar still weighing on many sectors of the economy, the unemployment rate is expected to rise by ¼ of a percentage point to 5¾ per cent in 2013‑14, but then stabilise at that level over the remainder of the forecast period and remain amongst the lowest in the developed world…

Given that around 10% of the Australian economy are employed in mining-related activities, mostly in areas unrelated to actual extraction (e.g. construction workers, engineers, and mining services), and that mining capex will soon go into an as yet ill-defined but likely sharp decline, Treasury’s steady-as-she-goes employment projections also appear overly optimistic.

[email protected]

www.twitter.com/leithvo

WestpacBudgetReport2013 (1) 

Leith van Onselen

Comments

    • Slow Joe will need a couple of months to absorb it all..

      Seriously, the media and the opposition have completely missed the optimistic GDP forecasts in the budget and instead focused on emotive arguments about booby traps and spending cuts. Well, the budget booby trap was laid a decade ago by Johny and his sidekick Costello. As for the spending cuts, you ain’t seen nothing yet.

      • As pfh (and you mav?)observes how can either side run an election campaign if they broadcast the delusional ToT and GDP forecasts.

        Maybe we can maintain GDP if we sell off our assets fast enough? This we can keep the whole stupid RE based economy going a few more years? Treasury are basing their forecasts on the RE recovery, resulting housing contsruction, and thus increased consumption. The external account dangers don’t rate.

        I’m in deep s..t for advising my wife not to buy bank shares! What the hell would i know!

      • Little wonder that Hockey would rather focus on gross debt than net debt. He’s going to strip the cupboard bare in office and try to appear like the debt reduction champion. That’s clear.

      • They can run a decent election campaign if they come to a gentlemen’s agreement to not run a MAD(*) scare campaign. I would lay the blame for the current sorry state on the media and the 24/7 news cycle.

        (*) – Mutually Assured Destruction

      • Yeah agree Mav re media. However maybe i’m past it but I doubt the more recent generations, in comfortable suburbia, can even comprehend a cut in living standards let alone actually having to do it.

  1. “As for the spending cuts, you ain’t seen nothing yet.”

    Good. Spending our way into the poorhouse. Well past time to get rid of the middle class entitlement culture Howard and Costello fostered, and which the current government was quite content to continue.

    At some point, the music has got to stop….

  2. MichealMEMBER

    “Again, given these uncertainties, why is Treasury still plugging in optimistic forecasts?”
    Because they are politicians.Labour were hoping to use the “return to surplus” narrative up until the election, but the data got the better of them. These forecasts are not about running a healthy country they are about running a healthy election campaign.

  3. Free_Market_Delusion

    Reality is that deep down they believe we are just in the dip of a “normal” cycle and “eventually” we will come out of the cycle as in times past and everything will be good.

    Rest of the world politically is in the same delusional state.

    As much as I can understand and comprehend this time it really is different. (or i’m just a rampant pessimist)

    • rob barrattMEMBER

      Maybe being a rampant pessimist is having an implicit understanding of what must happen when you spend tomorrow today while running away from your responsibilities.
      What a budget. Negative gearing didn’t get a whisper. Gonski (with all the original plan’s talk about performance ratings for teachers removed) the hero. Meanwhile, we’ve sold the mines, we’re selling off the farmland. There’s no way back from that. Eventually we will end up having to work as hard as our neighbours…

      • “Maybe being a rampant pessimist is having an implicit understanding of what must happen”

        Yep Rob but it doesn’t help my investments…I guess it keeps me out of trouble long term!

      • rob barrattMEMBER

        I hope you’re right Flawse. Like I asked a while back – Is there another planet out there I can invest in? I can’t find anything reliable on this one…

      • Alex Heyworth

        “Eventually we will end up having to work as hard as our neighbours…”

        With a bit of luck, that time will arrive at about the same time as the influence of years of substantial Asian immigration has resulted in a workforce willing to do just that.

        A big Australia might just save us yet.

    • Yep, they are all hoping and wishing that it the storm clouds will blow away and the sun will come back. They are hoping and wishing that we the punters go back to their merry way of putting everything on the credit card, tapping their home equity and generally not giving a hoot about expenses because we’re all so happy that we can spend our way to happiness. Perhaps things will return to that – someday. But to base official budget forecasts on assumptions like that is just stupid and reckless.

      Abbott is a big spending populist with no real idea what he’s going to do or how he’s going to do it when he gets into power. And on top of that, he’s a weak and flip-floppy as anything the ALP has to offer. He’s going to make a terrible PM. But Gillard, the world’s best treasurer and the rest of the ALP have so completely stuffed things up that they simply don’t deserve another chance to continue in the job. Aren’t we lucky to have such a wonderful choice!

  4. Treasury is either captured or incompetent. What a farce. I think it was Chris Caton on the Business last night hoping that the Treasury would learn its lesson. It hasn’t. And the SMH’s editorial today makes me want to vomit.

  5. mine-otour in a china shop

    Change the macro assumptions and anything is possible with the revenue forecast to justify your masters spending programs.

    With a volatile economy is it even worth going into the 2/3/4 year horizon just to keep ratings agencies fed with the crap that they feed on?

    The three card confidence trick is failing. The time to deal with necessary structural changes to the economy should have been completed 3 years ago. Now it will only be done when the crap hits the fan and when the reboot button has to be pressed. Great foresight and vision?