You can read UE on the optimistic assumptions underpinning last night’s Budget. They are now universally understood as risky.
The question is, why?
We could assume Treasury is a fatal optimist. It would not be without foundation. It’s embrace of the “sell ’em dirt” policy over the past few years has been spectacular. And Treasury economists, as well as those more broadly, do have a awful reliance upon trend lines for forecasts. They do tend to draw a line from the past into the future and anything that intervenes is by definition a “black swan”. Then again, maybe they are just doing their master’s bidding.
But there is another possibility. Treasury must by now be waking up the fact that the China boom is not what it expected into the future. Even if one remains bullish, it takes a blind man to ignore the rising consensus about Chinese rebalancing and lower bulk commodity demand. As such Treasury may well be presenting a raw prawn to financial markets and the polity quite deliberately.
If Treasury were to forecast 5% falls in the terms of trade for the next two years (which is about my forecast) then that would translate into nominal growth of around 2% per annum for the next two years. By its own admission that would knock Budget revenue by $9 billion per annum in the first year and $20 billion in the second. Multiplied by two! There’d be no gesture at future surpluses.
Think about it. Ratings agencies have declared that the AAA rating hangs upon a medium term path to surplus. They say this in part because the budget guarantees the major banks’ offshore borrowings.
Honest terms of trade projetions would immediately pressure the rating and trigger a moral panic in the Opposition resulting in much deeper fiscal cuts, which would themselves exacerbate the economic downtrend.
Instead of this, today we have the following from S&P:
MELBOURNE (Standard & Poor’s) May 14, 2013–Standard & Poor’s Ratings Services said today that its unsolicited ratings and outlook on the Commonwealth of Australia (AAA/Stable/A-1+) are not affected by the government’s budget for 2014. The federal government plans to return its budget to surplus over a longer period than previously anticipated, largely due to downward revisions to revenue projections.
Australia’s credit metrics remain supportive of the ‘AAA’ sovereign rating despite the revised budgetary projections. While the 2014 budget represents some slippage in achieving the government’s strategy of returning the budget to surplus following moderate deficits in recent years, the government continues to demonstrate a commitment to prudent fiscal policy over the medium term, in our view. Given the low level of public debt in Australia, the anticipated delay in achieving budget surpluses compared to our and the government’s previous projections does not put immediate downward pressure on the rating.
We continue to consider the Australian government’s fiscal position to be a key rating strength, which offsets the weakness resulting from the country’s high external indebtedness. While the 2014 budget projects a somewhat weaker fiscal performance than we had earlier anticipated, this does not fundamentally change our view in this regard. Based on our expectation of Australia’s medium-term economic prospects, we anticipate that the government will achieve balanced budgets in the medium term, and public debt will remain low despite some modest additional borrowing in the next few years.
We affirmed the ‘AAA’ ratings on Australia with a stable outlook on Sept. 18, 2012. The stable outlook reflects our view that Australia’s public finances will continue to withstand potential adverse financial and economic shocks, and our belief that the country’s consensus in favor of prudent budgetary policies will remain. We could lower the ratings if external imbalances were to grow more than we currently expect, either because the exchange rate no longer adjusts to terms of trade movements, the terms of trade deteriorates quickly and markedly, or the banking sector’s cost of external funding increases sharply. Such an external shock could lead to a protracted deterioration in the fiscal balance and the public debt burden. It could also lead us to reassess Australia’s contingent fiscal risks from its financial sector.
Markets too love a trend line.
