Deloitte decribes giant Budget suckhole

Chris Richardson and the chaps at Deloitte Access Economics have a done stellar job in outlining the total Budget disaster unfolding before our eyes today. As you read the following, bear in mind that DAE has a track record of sobriety and non-partisan politics. Then weep.

The hole is getting bigger

Budget has two drivers:  China and Canberra.  China is continuing to make Canberra’s task harder.  China’s boom initially sent commodity prices soaring, which poured money into Canberra’s coffers.  The chart below uses Treasury data to show how an improving economy saw ‘rivers of gold’ flood in.  But the GFC rained on the parade, and now China’s slowdown is combining with a surge in global mine output to cut the legs out from underneath commodity prices.  The poster child for Joe’s woes is the iron ore price.  We’ve circled our estimate of the extra $45 billion that Treasury will downgrade the Budget due to this worsening backdrop.

The impact of the economy on the Budget

That chart says the China-driven Budget bubble of the past decade was magnificent, but that it was also temporary.  And right now that boom is threatening to become a Budget bust, making the task of getting the Budget back on to a healthier
1footing ever harder.  As a simple illustration of that, even if you extended the GST to cover fresh food you wouldn’t fill the ongoing Budget hole left by the iron ore price falls of the last six months.

We estimate revenues will fall shy of the latest official estimates by $5.2 billion in 2014-15 and by an ugly $10.8 billion in 2015-16.  Much of the damage remains in profit taxes such as company taxes (with the oil price collapse meaning the pain is worse still in PRRT, and with superannuation taxes falling well shy of official estimates).  But record low wage growth means PAYG revenues have joined the writedowns in earnest this time around.

And the politics is getting harder too

Yet it isn’t only the economy that is making budgeting harder.  So too is politics.  It’s true that:

  • Many of the proposed Budget repair measures weren’t flagged ahead of the election.
  • The ‘temporary Budget repair levy’ aside, fairness wasn’t central to the proposed repair.
  • Many savings come from the States, so there isn’t yet a saving for Australia as a whole.

Those are big caveats.  Yet you’d still have to say our body politic has failed.  Glenn Stevens has summarised that:  “Our politicians need to start talking the real talk on how we are to collectively afford some of the expensive initiatives the Australian public want”.  The chart below again uses Treasury numbers to show that permanent promises built up over the past decade.  Mostly that was extra spending, thanks to family payments and baby bonuses, compensation for the carbon and mining taxes, and disability insurance.  But taxes were cut too, with a series of personal tax cuts only partly offset by higher excise on cigarettes and an increase in the Medicare levy to help pay for disability insurance.

The impact of the economy and of policy decisions on the Budget

Yet although past policy costs have been huge, recent months were as “dull” as promised:

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  • The small business tax cut and families package mostly rejig the old paid parental leave (with the families package said to be contingent on the Senate passing other savings),
  • Age pension savings may come via tightening the assets test rather than via indexation,
  • A ‘kinder, gentler’ government is extending funding for the homeless, for drug and alcohol services, for legal aid, and for mental health,
  • There have been two further rounds of troop commitments into Iraq, while
  • There have also been partial backdowns on Defence pay and on car sector assistance.

Yet that is just rats and mice compared to the extravagance of the past decade.  The big cost is the delay to start dates from savings announced in last year’s Budget that still haven’t made it through Parliament.  Adding those in, we’ve circled our estimate of ‘new’ policy costs.

The Budget bottom line for 2014-15 and 2015-16

Although the Budget may be ‘dull’ in terms of new policies, it is all-too-exciting in terms of the costs of the economy and the cost of a year’s worth of policy gridlock.  That means that ‘dull’ new policies won’t mean dull deficit figures.

Deloitte Access Economics projects an underlying cash deficit of $45.9 billion in 2014-15.  That is a substantial $5.5 billion worse than projected at Budget time and shows little improvement from the recorded deficit of $48.5 billion in 2013‑14.

And if you think that’s bad, then 2015-16 looks like it has been written by Stephen King and painted by Edvard Munch.  Dull it ain’t:  China continues to carve chunks out of Canberra, leading to rampant revenue shortfalls.  But the biggest ‘new bad news’ on bucks is in PAYG.  Wage growth jumped ahead of productivity gains during the boom, but it is now only limping along as businesses try to claw back their competitiveness.  That’s set to tear a new hole in the heart of the Budget.  Add in the rising cost of Senate gridlock, and we see an underlying cash deficit stuck at $45.3 billion in 2015-16.

That is a massive $14.1 billion worse than MYEFO.  And it also says that, as hard (and as bravely) as the Government has pursued Budget repair, China keeps moving the goal posts back faster than the Government can steer savings through the Senate.

The matching fiscal deficits are $45.3 billion in 2014-15 and $41.3 billion in 2015-16.

Tick off the caveats

As always, things could turn out better or worse than that.  At the very least, the Government is sure to announce policies this figuring doesn’t allow for.  But the big picture backdrop isn’t pretty, and downside risks loom larger than usual:

  • China and/or commodity prices could crumble further:  The tug of war over the economy is getting fiercer, with negatives (slowdown in China, falling commodity prices and mining-related construction) getting bigger, but positives (lower for longer interest rates and the $A’s fall) getting bigger too.
  • But although that is broadly a draw for the economy, it isn’t for the Budget (falling commodity prices and weak wages outweigh $A positives), and the increasing intensity of positives and negatives means risks are on the rise.
  • There are reasons to fear China’s slowdown could worsen, and the momentum in commodity markets is downwards.

Politics is trumping policy:  The deficit projections above assume there are merely delays in reaching a ‘value signal in health’ and over university funding.  That is, they assume the Senate comes to the party, and that the only effect of Canberra’s gridlock is a short delay.

What about 2016-17 and 2017-18?

If you are waiting for a white knight – a China recovery or a surge in capital gains – to get Australia back out of our Budget mess, then you may be reading the wrong genre.

Much Budget damage was done some time ago, back when China’s budgetary impact was so strong that the dumbness of what we were doing was buried under a comforting layer of surpluses.  But that tide turned in 2011.  China is still slowing and miners are still digging deep – a combination which continues to undercut profit taxes.  And the new kid on the bad news block is weak wage gains.  That’s good for the economy (as it helps us rebuild some of the competitiveness we lost in the boom years), but is another kick in the guts for the Budget.

At least the $A’s fall helps the Budget bottom line, as do record low interest rates on Federal debt.  And robust sharemarkets and dizzyingly pumped up house prices will eventually yield more on capital gains taxes.  And the best news of all is that last year’s Budget had a red hot go at fiscal repair.  Yet that didn’t end well – the package lacked enough fairness to garner more widespread support, and votes lay much more in opposing than in supporting.

That spells a stalled deficit, with last year’s $48 billion merely edging down to $46 billion in 2014-15 and $45 billion in 2015-16:  that’s Budget repair at a snail’s pace.  So you’ll be glad to hear that, absent further policy changes, Deloitte Access Economics forecasts the cash underlying deficit to drop back to $35.3 billion in 2016-17 and then to $24.1 billion in 2017-18 (with the matching fiscal deficits at $32.2 billion and $17.6 billion).

But those deficits are anything but dull:  they are $14.5 billion and $12.6 billion worse, respectively, than Treasury’s last forecasts.  And although they show a welcome trend, that comes with important caveats.  The improvements in 2016-17 and beyond assume:

  • The Senate merely delays rather than denies further savings of the size announced in last year’s Budget.  We can run, but we can’t hide:  policy needs to be part of the repair task, because the economy can’t and won’t get us there by itself.
  • That taxes on capital gains surge in a way that they haven’t for many years.
  • That wage gains pick up, pushing people into higher tax brackets at a faster pace.
  • And that China steadies and commodity price falls ease back to being moderate.

In isolation, each of those assumptions are brave.  In tandem, they may rank as heroic.

So to make the obvious point, if Australia’s politicians can’t craft some compromises, then better Budgets will be even further away than our forecasts have them here.

We still see deficits as far as the eye can see, with the repair task getting harder both because of economics (commodity prices and wages) and because of politics.

Hang on, didn’t the latest Intergenerational Report say “we’re almost there”?

Mission accomplished, if only the pesky Senate would roll over.  That’s the quick summary of the latest IGR.  Just ask Dr Karl.  But so far the Senate isn’t playing ball.  And here’s a hot tip – it wouldn’t play ball even if there were a change of government.  That’s because those who oppose savings (Oppositions, small parties, and assorted loonies who trade preferences with the Devil) are getting two bites at the cherry.  When they oppose savings, they earn the gratitude of those whose funding was on the line (students, doctors, pensioners and the like).  But down the track they also get to bash whoever is in Government for “failing to achieve the promised surplus”.

Err, isn’t that failure partly because of your opposition?

That’s not the only caveat on the IGR.  Remember a big chunk of Budget repair comes from:

  • Shifting costs to the States, who are unlikely to be able to pay for them.
  • Assuming not only that slower indexation passes the Senate, but that it lasts many years.
  • And assuming that holes in the revenue base don’t pose problems (even though petrol excise indexation is yet to pass parliament, the

GST is a shrinking share of consumer spending, superannuation concessions become more costly as Australia ages, and ‘base erosion profit shifting’ is looming ever larger as a revenue hole).

So politics is cruelling efforts at Budget repair, while the economy is hurting the fiscal outlook further.  That says the repair task has grown, but the appetite to tackle it has faltered.

Shame that there’s still a country to run.

In conclusion, if you’re counting on government to bail you out during the next global shock (ie if you’re large bank) think again.

David Llewellyn-Smith
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Comments

  1. StomperMEMBER

    Whocouldhavenode???? This is the all too apparent train wreck about to be shown in all its glory. Budget repair BWAHAHAHAHHAHAHA
    The pain is only just begining….

  2. Well if those are the known knowns, and the outlook is disastrous, add this.
    My call is the AUD will approach parity with the USD, they are in more trouble than us, and
    The sharemarket will enter a long run of decreasing values as inflated earnings estimates are shown to be folly. Interesting times WW

  3. Mmm…. Unlikely that a fragmented senate will pass any real structure reform aimed at improving the budget, so…
    Why not do what we did with interest rates and have an independent body, like the RBA does IR, do climate and perhaps even welfare. Royal Welfare Bank get to decide the policy settings….just a thought as many western govt now face the same problem, the inability to get a mandate.

    • Will y re your independent body – not knocking your idea but….
      “an independent body, like the RBA does IR,” bwahahahaha! The RBA has a vested interest, as an institution, in negative RAT IR’s!
      Not sure the same wouldn’t happen to any ‘independent’ body. Ego is a dangerous thing. I guess it’s human nature and you just have to take the best of it.

  4. Hunson Abadeer

    Any back of the envelopes on how close / how quickly these forecasts would bring us to the S&P threshold of 30% net debt?

  5. Researchtime

    Nah – the governments will ball out the banks – its their job to do so…

    • Australia is part of the G-20.
      In 2010 the G-20 decided to look into bailing- in the banks.
      This was ratified in November 2014 in Brisbane.
      Current bank deposits are $1,850,000,000,000 ($1.85Trillion).Add this to the $400Bn debt after the budget…you get $2.25Tn.
      Interest @4% of that would be $90Bn per year….then the budget deficit is $125Billion per year.
      There will be NO bail-out of the banks.
      Depositors will be unsecured creditors.
      Who would loan money to a bank today at 2.5% without collateral?
      Not me.

      • Agree athalone – some sort of Physical asset is needed – Gold and Silver are pretty close (if not already having reached the bottom) given the current production costs and large Physical demand from Asia. Also as an assumed US dollar play as well – Even if the price drops further in US dollars this will more than likely be offset by a falling AUD at the same time so best case the value goes no where but there are any myriad of reasons why the upside has good potential if not brilliant potential given the current environment.

      • drsmithyMEMBER

        When the inevitable bail-in arrives, it will be REALLY interesting to see how mortgage offset accounts are treated.

        My impression is that these are somewhat unique to Australia – do any other countries have an equivalent ?

      • @Andy! If you’re worried about keeping your cash in case of banks not being bailed out, why not by Aus Govt Bonds? No chance that they will be defaulted on so you’re guaranteed a return of your capital plus interest payments if you hold them to maturity (at worst).

        Gold and silver have a definite place in my portfolio but I reckon it’s crazy to have them making up more than around 20% max between them.

      • Hi AB,
        Bonds won’t protect you from hyperinflation, even if only 15%…that will not only affect their value but also their liquidity.

      • @athalone

        You’re absolutely right that the bonds won’t protect you from any substantial increase in inflation or interest rates but they can be combined with physical assets like the gold and silver you mentioned above to provide a more balanced portfolio.

        I was more pointing out that I think they are an under-appreciated asset for those who are worried about bank collapses that test the government’s ability to bail out the banks. They’re also easy to buy now that they’re traded directly on the ASX.

        Edit: There’s also Treasury Indexed Bonds which indexed based on CPI and hence offer somewhat more inflation protection (of course you have to have some faith in the CPI numberwang…)

  6. Between continued NG and the population ponzi, it seems not even a bad budget can bring home prices down. Better luck next time bears?

      • Abbott has probably spent all morning on getting the wording of the congratulatory note just right.

      • Prime Minister Tony Abbott wrote his congratulations on Twitter, saying he and his wife Margie wished “the young Princess a long and happy life…I am sure that the Princess and her older brother, Prince George, will in time develop a deep familiarity and love of Australia,” Mr Abbott said.

        Stirring stuff…clearly time well spent…like the St Cripin’s day speech or “their finest hour”

  7. Even StevenMEMBER

    Yes the government will bail out the banks (if it comes to it – which I doubt). They have to. But not before a hell of a lot of shareholder equity has been written off.

    • flyingfoxMEMBER

      if it comes to it – which I doubt

      All depends on whether the body politic can avoid a housing correction. If not, then the banks will have to be bailed out due to their hideously tiny capital buffers.

      • flyingfoxMEMBER

        @athalone

        Agreed. The question is will the banks need to be bailed out in the first place?

      • We are in a balance sheet depression.
        The world had $142Tn in debt in 2008, and the McKinsey report says we added on $57Trillion to that by 2014.
        What did the central banks do?….. bring interest rates down to zero to get that extra $57Trillion in debt.
        What are central banks doing since the report came out?…..interest rates into negative territory to encourage the world to be more indebted.
        So here we are 7 years later and Australian banks are increasing their balance sheets, when they were insolvent in 2008 (Ross Garnaut/David Llewellyn-Smith).
        If this does not change, the share market will crash along with the housing market, and the banks will be insolvent once again.
        There is no wisdom in the central bank, nor in banks in general.

  8. SoMPLSBoyMEMBER

    “It’s preposterous, my learned sea faring man, to suggest this ship is sinking. ” From my vantage point at the stern, the rising deck beneath my feet reflects the exact opposite.”

    • SOS Boy. Reminds me of the Jimmy Buffett lines “Expanding the view of the captain and crew. Like a man just released from indenture” Son of a Son of a Sailor. & WW

      • SoMPLSBoyMEMBER

        Heard about the old time sailor men,
        They eat the same thing again and again;
        Warm beer and bread they say could raise the dead.
        Well, it reminds me of the menu at the Canberra Inn.

    • Good one! Like the banker falling past the 10th floor of 65 Martin Place saying: “It ain’t so bad after all, and there is a cool refreshing breeze blowing”

  9. ceteris paribus

    Never waste a good crisis. If Senate continues to hold firm, Laberals will be forced to relent on preserving tax concession feast for the few.

  10. Enjoy the critical analysis from MB but in the last few months a def group-think has emerged. Every post is cheered with very few posts of disharmony. I agree with most of the discussion but this is not a healthy trend for MB. Finally, those forecasting a poor economic future for Aust… with meddling from govt in all areas who can really say when? For those adding comments like “don’t buy now” (housing) or buy gold/silver I think this is a step too far. Anyone taking such advice would likely be at a loss right now and for the foreseeable future unless this advice comes with a timeline of the the inevitable fall as noted above. We are all equally clueless in this regard and should not be giving advice. 2 cents.

    • Hi Richard,
      We used to think zero interest rates was “a step too far”.
      Then we thought negative interest rates was a step way too far….yet here we are with 31% of the value of government bonds in Europe with a negative interest rate.
      I believe removing cash from the system is “a step too far” but the other steps too far have come along so quickly that I don’t discount it.

      In 2008 the thought of our banks being insolvent was “a step too far”…but it happened (Ross Garnaut/David Llewellyn-Smith).
      Richard, I salute your fearlessness…

    • “Anyone taking such advice would likely be at a loss right now and for the foreseeable future unless this advice comes with a timeline of the the inevitable fall as noted above.”

      Anyone taking such advice from (semi-)anonymous commentators on the Internet without thinking it through and making their own decision should be wrapped in a straitjacket immediately for their own protection.

      Why would said commentators adding a timeline of the inevitable fall make the situation any different? If I said that Sydney housing was guaranteed to drop 50% in the next six months and you should immediately sell is that more or less useful than just “Hit the bid, peeps”?

      P.S. You should check out the comments at Zero Hedge one day.

  11. Comments – you are clear that you don’t give financial advice. Some pay more attention to the comments – a modern affliction.

    • Sh!t I wasn’t ment to take all the comments on here seriously! I just pulled all my money out of the bank and brought gold, silver and magic beans.

      In fairness to Richard most of the people on here have been predicting a major housing crash for years. If we would have all brought a Sydney property 4 years ago and cashed in today we would probably never have to work again with the right home improvements. We also can find all the information on home improvements on the block!

      I like this website but I think we all miss the point sometimes but intentions are in the right direction. We all just want to have affordable housing and a fair day’s pay for a fair days work!

  12. I have a question. If they banks fold, are their customer’s deposit’s lost too? Surely the government must guarantee that. That is, the depositor’s money is in tact while the bank holding them ceases to operate.

    If that’s not the case, those who have converted to cash must be holding it in non banks…. or under their bed

    • “Surely the government must guarantee that.”

      The government does guarantee deposits up to $250,000 per person per ADI – the question that some/many here have is whether the government would have the ability to pay up in the event of a major financial collapse. There’s also a relatively low number for the total government payout per ADI that I’ve seen quoted here but never actually seen listed officially.

      “… those who have converted to cash must be holding it in non banks…”

      I’ve suggested plenty of times that those who are worried about holding on to their cash in cash of major bank collapses should look at Australian Government bonds. No chance of default on those and they will absolutely rank higher in government priority than any bank bailouts.

      • If it’s 250k per ADI, then spreading it out amongst a few ADI’s could work.

        Of course, those who have just sold a 2 million dollar property will have to distribute it to many.

      • Hi AB,

        Here is the RBA document that speaks to the $20Bn per bank cap. Go to page 9, beginning of second paragraph.
        http://www.rba.gov.au/publications/bulletin/2011/dec/pdf/bu-1211-5.pdf
        Here is the List of Approved Deposit Institutions:
        http://www.apra.gov.au/adi/pages/adilist.aspx

        Example: Westpac Jan 31 from:http://www.apra.gov.au/adi/Publications/Documents/MBS-January-2015.pdf
        Deposits:$372.4Bn
        Cash:$18.3Bn
        If the bank fails, the Government Guarantee (max $20Bn per bank/ADI) gives you:
        $20Bn/$372.4Bn = 5.37 cents in the dollar.
        So with a maximum deposit of $250,000, you get $13,372.72 from the Guarantee.

        Deposit order in January 2015. Plenty of options with under $20bn.

        Deposits in millions.
        2 The Royal Bank of Scotland N.V.
        4 Taiwan Cooperative Bank, Ltd
        22 Taiwan Business Bank
        39 Woori Bank
        59 Bank of Baroda
        65 Hua Nan Commercial Bank, Ltd.
        82 First Commercial Bank
        104 The Bank of New York Mellon
        131 State Bank of India
        157 Agricultural Bank of China Limited
        231 Korea Exchange Bank Co., Ltd
        312 Barclays Bank Plc
        587 SGE Mutual Limited
        608 Credit Suisse AG
        656 Mega International Commercial Bank Co., Ltd.
        664 Bank of China (Australia) Limited
        721 Arab Bank Australia Limited
        860 Hume Bank Limited
        938 Bank of Communications Co., Ltd.
        1,108 Bank of Sydney Ltd
        1,152 Police Financial Services Limited
        1,206 QT Mutual Bank Limited
        1,265 Police Bank Ltd
        1,297 Defence Bank Limited
        1,344 Royal Bank of Canada
        1,477 The Royal Bank of Scotland PLC
        1,593 China Construction Bank Corporation
        1,733 Industrial and Commercial Bank of China Limited
        1,745 The Hongkong and Shanghai Banking Corporation Limited
        1,800 Victoria Teachers Limited
        1,900 MyState Bank Limited
        1,951 BOQ Specialist Bank Limited
        2,034 Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A.
        2,459 Police & Nurses Limited
        2,733 Deutsche Bank Aktiengesellschaft
        2,853 ING Bank N.V.
        2,856 Bank of America, National Association
        2,978 MECU Limited
        3,018 United Overseas Bank Limited
        3,163 Oversea-Chinese Banking Corporation Limited
        3,291 Rural Bank Limited
        3,411 Community CPS Australia Limited
        3,455 BNP Paribas Securities Services
        3,500 UBS AG
        3,534 Mizuho Bank, Ltd.
        3,755 State Street Bank and Trust Company
        4,199 Teachers Mutual Bank Limited
        5,398 AMP Bank Limited
        5,497 Citigroup Pty Limited
        5,555 BNP Paribas
        5,590 Heritage Bank Limited
        6,857 The Northern Trust Company
        7,916 Sumitomo Mitsui Banking Corporation
        8,072 JPMorgan Chase Bank, National Association
        9,286 The Bank of Tokyo-Mitsubishi UFJ, Ltd
        10,194 Bank of China Limited
        11,808 Rabobank Australia Limited
        12,376 Citibank, N.A.
        12,488 Members Equity Bank Limited
        16,985 HSBC Bank Australia Limited
        32,920 ING Bank (Australia) Limited
        34,157 Bank of Queensland Limited
        38,775 Macquarie Bank Limited
        40,317 Suncorp-Metway Limited
        46,749 Bendigo and Adelaide Bank Limited
        293,394 Australia and New Zealand Banking Group Limited
        314,662 National Australia Bank Limited
        372,357 Westpac Banking Corporation
        443,479 Commonwealth Bank of Australia

        As you can see from this shorter list of the ADIs, the top 4 banks ($millions)have a total of $1,423,892,000,000 in deposits which is 79% of total deposits($1,800,000,000,000)but the Guarantee only provides them with $80,000,000,000 ($20Bn each), which is 4.44% of the total deposits($1,800Bn)
        If people with a lot of money (retirees with life savings to protect) start taking it out and placing it in the smaller banks for their own safety so that they get 100 cents in the dollar from the Guarantee, then the reserves required for the larger banks with their huge loan book in residential property will be diminished…significantly, and would require very large injections of funds from the RBA or become insolvent…..CATCH 22.
        Much of this problem can be explained by the fatal flaw of our banks borrowing money from depositors for short periods of time and loaning it to homeowners for 30 years.
        Then there is the possibility of the G-20 bank bail-ins…..
        Steve Nordstrom.