MS: MYEFO bad for economy

From Morgan Stanley:

We expect Australia will lag the global rotation from monetary to fiscal easing, with the Mid-Year Budget update still focused on austerity and preservation of the sovereign AAA-rating. This leaves our below-consensus outlook for growth, RBA cash rates and the AUD over 2017 intact.

Fiscal policyfrozen in the AAA headlights: The 2016-17 MYEFO (Mid-Year Economic and Fiscal Outlook) delivered no policy surprises, retaining an austerity agenda and a fiscal drag of -0.5ppt of GDP per annum.Fiscal options are constrained by the government’s intent to retain the AAA-rating,and as such we expect Australia will lag the stimulus seen in China and Japan,and that planned in the UK and the USA. On the rating itself, we are not convinced that modest legislative progress (e.g., on superannuation tax reform) will be enough to offset weaker growth and increasinghousing risks, but we see any downgrade as more likely to come after the May 2017 Budget.

Forecasts still a little optimistic: Weaker growth and forecast tax receipts drive a A$10bn (-0.1ppt p.a.) increase in deficit over the next four years, despite our estimate of a A$16bn boost from higher commodity prices. The Treasury has retained its forecast of a surplus in FY21, but this relies on an optimistic recovery in wages growth (3.25/3.5% in FY19/20) and the passage of A$13bn in unlegislated spending cuts. And following the sharp rally in bulk commodity prices, the deficit profile assumes iron ore reverts to US$55/t FOB in 3Q17 and met coal to US$120/t from 1Q18 – a little above our upgraded house forecasts.

Persistent deficits as reform-scope limited: The Budget outlook sees a 2016-17 deficit of A$36.5bn (-2.1% of GDP), falling to -A$10bn (-0.5% of GDP) over four years. Net debt is forecast to peak at -A$359bn (-19% of GDP) in FY19,and while there was a -A$1bn reduction in the forecast for CGS on issue to A$496bn for June 2017, the governmenthas confirmed that it will borrow an additional A$19.5bn on behalf of the NBN. The MYEFO contained no new policy reforms, once again under-delivering on necessary changes.

Australia out of sync with DM reflation: While stronger commodity prices are helpful,activity multipliers will be limited by the balance sheet repair of resources companies and the government. Instead,higher bond yields will pose a headwind to financial conditions onshore,and the economy will remain reliant on a lower AUD (and likely lower RBA cash rates) to secure growth.


Whether or not fiscal becomes a drag or not rather depends upon the underlying growth rate. Given the economy is not going to get near the forecast 3% in the forward estimates, the 2.5% government spending growth rate could actually turn out to be stimulus if sustained.

Even so, yes, fiscal is not going to provide enough support.

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