Via Westpac:
The COVID-19 shock to the Australian economy will trigger a deep recession and a sharp spike in the unemployment rate, jumping to 11% by mid-2020. The unfolding economic recession is shaping up to be more severe than the GFC.
The Federal budget position will deteriorate sharply over this year and next.
We anticipate a deterioration in the budget: from a balanced outcome for 2018/19 to a deficit of 4.5% of GDP ($90bn) for 2019/20 and then widening to a deficit of 8% of GDP ($160bn) for 2020/21.
The 2019/20 deficit of 4.5% of GDP includes 2ppts ($40bn) for policy stimulus and 2.5ppts ($50bn) for the cyclical deterioration.
The 2020/21 deficit of 8% of GDP includes 3ppts ($60bn) for policy stimulus and 5ppts ($100bn) for the cyclical deterioration.
The cumulative budget deficit over 2019/20 and 2020/21 would lift the supply of government securities on issue by an additional $250bn to $820bn by June 2021 (40% of GDP), up from an actual of $542bn at June 2019.
Australia’s Federal budget position – as a share of the economy – deteriorates materially during periods of recession (or deep economic downturns, such as the GFC). A repeat of this is likely over the next couple of years with Australia facing the crisis that is the outbreak of COVID-19.
By way of historical experience, in the past 3 recessions (downturns), the budget position deteriorated by: 3.5% of GDP during the early 1980s recession; by 5.6% of GDP in the early 1990s recession; and by 5.9% of GDP during the GFC. The deterioration from peak to trough occurred over two financial years during the early 1980s and the GFC, while it extended over three years in the early 1990s.
In each cycle, the budget deterioration partly reflects both policy stimulus (with the response more aggressive during the GFC) and the automatic stabilisers as the economy deteriorates.
The COVID-19 crisis represents a significant shock to the Australian community and the Australian economy. In prospect is a deep recession and an associated sharp spike in the unemployment rate.
The key uncertainty is the duration of the disruptions associated with the virus.
The COVID-19 outbreak is a medical shock. The key economic dynamic is the choice to shut-down and cancel events (a supply shock) in an attempt to limit the spread of the virus. Now, from late March, there are widespread shut-downs of places of social gathering (pubs, restaurants, gyms etc). These widespread disruptions to the economy are on a scale that we have not experienced in recent times – which has important implications for the labour market.
In the three months to June, we expect employment to contract by 815k, down 6.3%, sending the unemployment rate up to 11% from 5%.
For the June quarter, output contracts by 3.5%.
In time – the duration of which is highly uncertain – there will be a decision to re-open pubs and clubs and gyms, to return to work, which will see a staggered normalisation of activity. When that happens, production will snap higher – returning towards earlier levels (although capacity will be impacted by the extent of bankruptcies) implying a period of sharp growth. For now, we anticipate that the shut-downs will essentially cease by the December quarter, with only a gradual relaxation during the September quarter.
On this scenario, the unemployment rate holds at 11% in the September quarter and then moves a little below 9% by the end of 2020 and then towards 8% by end 2021.
Returning to the budget, the two key drivers of the budget balance are the labour market (a barometer of the domestic economy) and national income (which is heavily influenced by swings in the terms of trade, a barometer of the international economy). Typically, a domestic recession coincides with a global recession – such that the labour market and national income deteriorate together.
In this, the COVID-19 recession of 2020, we expect: the global economy to be in recession; domestically, real output to contract for three consecutive quarters (March, June and September); the unemployment rate to spike to 11%; and national income growth to move materially below trend.
On the unemployment rate, in a year average sense, the increase was: 3.5ppts over two years in the early 1980s recession (2.8ppts and 0.7ppts); 4.8ppts over three years in the early 1990s recession (2.3ppts, 1.9ppts and 0.6ppts); and 1.3ppts over two years in the GFC downturn (0.7ppt and 0.6ppt).
For the COVID-19 cycle, the unemployment rate is expected to peak at 11% during the second half of calendar 2020. On a financial year basis, the unemployment rate jumps by a forecast 4.3ppts (year average) in 2020/21 from two years earlier. In short, the labour market fall-out in this recession will be materially greater than during the most recent cycle, the GFC.
Significantly, in each cycle the “peak” in the budget deficit coincides with the peak in the unemployment rate (in this case 2020/21).
By implication, the hit to the budget from the COVID-19 recession – the cyclical deterioration – will be greater than during the GFC.
Turning to national income – nominal GDP growth – this is expected to slow materially in 2019/20 to 2%, moderating from the 5.3% outcome for 2018/19, which was broadly in line with the post 1990s long-run average. For 2020/21, we expect nominal GDP to contract, declining by around 2%. This view is premised upon, a global recession, including a moderation in the iron ore price – from US$90/t to around US$60/t by June 2021.
By way of comparison, during the GFC period, nominal GDP growth slowed to around 3% (in 2009/10), from 7% plus in the years prior.
During the early 1990s recession, nominal GDP growth slowed to 2.4% in 1990/91 and then slowed a little further, to 2% in 1991/92. A sharp slowing is also evident in the early 1980s recession, from 15% to 8% in 1982/83, in what was a high inflation world.
So what is the outlook for the budget in this cycle?
Recall that the budget position deteriorated by: 3.5% of GDP during the early 1980s recession over two years; by 5.6% of GDP in the early 1990s recession over three years; and by 5.9% of GDP during the GFC over two years (including a much larger stimulus package in the GFC).
In the GFC cycle, the weakening of the budget position of almost 6ppts included 2.5ppts due to policy measures and around 3.5ppts due to the economic downturn – the cyclical deterioration.
On our analysis, the cyclical budget deterioration in the COVID-19 recession will potentially be in the order of 5% of GDP, with risks to the upside. Such an outcome exceeds the move during the GFC (the 3.5ppts) and materially so – reflecting the deeper recession and the sharper rise in the unemployment rate.
As to the impact of policy measures – this is still a work in progress, with the Government having announced two packages (initially on March 12 and then on March 23).
The $66bn fiscal package announced on March 23, including the $17.6bn announced on March 12, costs the budget some $25.8bn (1.3% of GDP) in 2019/20 and $36.3bn in 2020/21 (1.8% of GDP). A third package has been flagged, potentially upwards of $40bn. For our working purposes, we assume that this lifts the budget stimulus for 2019/20 to $40bn (2% of GDP) and for 2020/21 to $60bn (3% of GDP).
Recall that the starting position for the budget was a balanced outcome for 2018/19.
Taking this together, the budget deficit for 2019/20 will be in the order of 4.5% of GDP (2% for policy and 2.5% reflecting the recession). The deficit then increases in 2020/21 to 8% of GDP (3% for policy and 5% due to the recession). The deficit then begins to moderate from 2021/22 as the unemployment rate declines. By way of historical context, the deficit “peaked” at -4.1% of GDP in 1992/93
and -4.2% of GDP in 2009/10.The Australian economy is around $2 trillion in size. Potentially, the budget position will move from balance in 2018/19, to a deficit for 2019/20 of $90bn ($40bn stimulus and $50bn cyclical) and then a deficit for 2020/21 of $160bn ($60bn stimulus and $100bn cyclical).
Over the two years to 2020/21, the cumulative budget deficit is $250bn.
By way of context, prior to COVID-19, in the December Mid-Year Economic and Fiscal Outlook (MYEFO), the government was anticipating: a $5.0bn surplus for 2019/20 and a $6bn surplus for 2020/21.
The stock of government securities on issue is set to jump, mirroring the cumulative budget deficit for the two years to 2020/21.
In MYEFO, securities on issue stood at $542bn (27.8% of GDP) at June 2019. This was forecast to rise to $558bn (27.1% of GDP) by June 2021, which included the expected underlying budget surpluses of $11bn over the two years to 2020/21.
On our numbers, securities on issue at June 2021 lifts to $820bn (40% of GDP).
Lastly, we would caution that the situation is very fluid. It remains highly uncertain how long the widespread shut-downs and cancellations wreaking havoc on the economy will persist. The full extent of the policy response – which is aiming to support households and keep businesses solvent – is also uncertain.
I’m not being personally critical of the Goverment with this title. I agree with these deficits.
But, live by the Budget, die by the Budget.
