MYEFO stinks it up, again

The Mid-Year Economic and Fiscal Outlook (MYEFO) has been released, and as expected it stinks.

The key Budget outcomes are shown in the below table, which shows the aggregates against the May Budget. As you can see, there has been a sharp deterioration in the Budget over the forward estimates:

ScreenHunter_10955 Dec. 15 13.24

As shown above, the forecast federal budget deficit has deteriorated by $2.3 billion since the May Budget, with deficits also forecast to be $23.8 billion worse over the three years from 2016-17.

The key drivers of the Budget deterioration are as follows:

  • The lower than expected iron ore price, which has lowered revenue by $7 billion over four years; and
  • Lower than expected economic growth.

The Government has also announced the following savings measures:

  • $704 million over 3 years by cracking down on welfare compliance
  • $639 million over 4 years by removing bulk billing incentives for pathology services & reducing the incentive for MRI services
  • $595 million over 4 years from health workforce programs
  • $472 million over 3 years from Aged Care funding
  • $441 million over 4 years by means testing the Child Care subsidy for families earning more than $250,000

The MYEFO is built around the following macroeconomic assumptions:

ScreenHunter_10956 Dec. 15 13.30

And here’s the comparison between MYEFO and the May Budget:

ScreenHunter_10958 Dec. 15 13.47

A few points of interest versus the May Budget:

  • Forecasts for real GDP have been lowered by 0.25% in 2015-16 and by 0.5% in 2016-17.
  • Nominal GDP has also been lowered by 0.5% in 2015-16 and by 1.0% in 2016-17.
  • Employment growth has been revised upwards by 0.50% in 2015-16 before being 0.25% lower than previously forecast in 2016-17.
  • The unemployment rate is 0.5% lower than originally forecast in 2015-16, and 0.25% lower in 2016-17.
  • Wages growth is unchanged between MYEFO and the May Budget.
  • Business investment has been revised down by 2.5% in 2015-16 and by 0.5% in 2016-17.
  • The terms-of-trade has been revised down by 2.0% in 2015-16 and by 3.0% in 2016-17.

MB views the underlying economic assumptions as still too optimistic given the upcoming collapse of mining investment (see next chart), the shuttering of the Australian car industry from October 2016 (Ford) continuing into 2017 (Holden and Toyota), and the likely falling housing market (both prices and construction) from mid-2016.

ScreenHunter_10957 Dec. 15 13.42

In particular, employment growth, while currently reasonably strong, will stall from mid-2016, driving a material rise in the unemployment rate over the forward estimates, and putting further pressure on wages growth and nominal GDP.

At least the MYEFO is more realistic on commodity prices, albeit still not bearish enough, with iron ore expected to average US$39 over the forward estimates, down from US$48 per tonne in the May Budget. The wider media is quoting this as very bearish but are universally neglecting to add $6 to bring it up the benchmark CFR. So the real assumed price is $45, which is well above the current spot price of US$37.50 and the 12-month futures price of US$35.

Again, MB views this MYEFO as still too optimistic in light of the massive structural adjustment coming Australia’s way as the mining investment boom unwinds, the car industry shutters, and housing corrects, not to mention the further falls ahead for commodity prices.

Expect more downgrades in the years ahead without fundamental reform of Australia’s taxation/expenditure system.

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