By Stephen Halmarick, Chief Economist at CBA:
- A stronger economy than that expected at the time ofthe March 2022/23 Budget is helping deliver a better-than-expected budget outcome for 2021/22 –as we anticipated.
- As signalled by the new Treasurer, it will be important for fiscal policy to tighten along with monetary policy to help the economy manage through this period of higher inflation. Full details of the government’s fiscal strategy will be provided in an updated 2022/23 Budget on 25 October.
- The 2021/22 Budget deficit could now come in approx. $A40bn lower than the most recent estimate of $A79.8bn, with the deficit to May 2022 almost half as large as previously expected.
- We would also expect the improved starting point for the Budget to carry forward into 2022/23, holding out hope that the deficit for the new financial year could be lower than the current $A78bn estimate. However, this positive outlook may be negatively impacted by lower commodity prices in the year ahead and a slower economy as interest rate hikes bite.
A stronger economy means a lower budget deficit
The new Treasurer, Dr Jim Chalmers, has set 25 October as the date for a fresh 2022/23 Budget, which will update the budget position, outlook and all the key economic variables that were contained in the original 2022/23 Budget of the previous government.
Treasurer Chalmers has already been publically discussing the need for fiscal policy to aid the Reserve Bank (RBA) in the fight against high and rising inflation –that is, both monetary and fiscal policy will need to tighten in the near-term to help the economy combat the higher inflation trend.
This is very much in-line with our views, where back in April 2022 we stated that “it will be important that fiscal policy is allowed to tighten via the automatic stabilisers in 2022/23 and beyond –as this will help limit the need for higher interest rates and help contain the risks from higher inflation.”
At the time, we also stated that “the better economic outlook points to Budget deficits…that could be meaningfully lower than those set out in the recent 2022 Budget.” Fortunately, this is exactly what is happening.
As shown in the table over, for the year to May 2022 the cumulative underlying cash deficit has come in at $A33.4bn(-1.4% of GDP). This is a whopping $A27.1bn lower than the estimated budget deficit profile up to May 2022 of $A60.5bn (-2.6% of GDP).
On current estimates, the 2021/22 budget deficit could come in around $A40bn lower ie. at approx. $A40bn (-1.7% of GDP), compared to the Budget-time estimate of $A79.8bn (-3.5% of GDP).
Most of the improvement in the budget position up to May 2022 has come from the revenue side. Total revenue to May was $A525.7bn, some $A16.2bn better-than-expected as at the eleventh month of the year.
Revenue flowing from ‘individuals’, ie. including income tax, was $A241.4bn, an increase of $A3.2bn expected for the year to May. Company tax receipts were running at $A112.2bn, which is $A8.5bn higher than expected.
On the outlays side to the budget, spending in the year to May was $A11bn lower-than-expected, with total outlays at $A559.0bn or 24.4% of GDP, relative to the revised budget profile estimate of $A570bn or 24.9% of GDP. The largest area of reduced spending was in unemployment benefits, thanks to the strength of the labour market.
A lower Headline deficit means lower net debt
Importantly, not only is the underlying cash budget deficit for 2021/22 expected to come in substantially lower than expected in the March Budget, but so too is the Headline budget deficit. For the year to May the Headline budget deficit was running at $A34.6bn (-1.5% of GDP), well below the revised profile to May of $A63.7bn (-2.8% of GDP) and the Budget-time estimate of $A85.8bn (-3.7% of GDP).
This is important because the borrowing program for the Australian Office of Financial Management (AOFM) is based on the Headline budget outcome. At the March 2022 Budget the AOFM noted that for 2021/22 they expected to issue a total of $A100bn in Treasury bonds and $A5bn of Indexed bonds. These volumes cover both the Headline deficit for 2021/22 and the refinancing of maturing bonds.
The AOFM notes that as at 28 June they had issued $A95.4bn in Treasury bonds for 2021/22, plus $A5.1bn in Indexed bonds. For 2022/23 the AOFM has indicated a borrowing program of $A125bn in Treasury bonds and $A2.5bn in Indexed bonds.
Speaking publically on 28 June1, the CEO of the AOFM stated that the AOFM will continue to base their 2022/23 borrowing program on the information contained in the original March Budget for 2022/23, with any updates to be based on the new budget deficit estimates that will be contained in the October 2022/23 Budget.
Between now and then, the budget estimates for 2022/23 will not only be influenced by the better starting point for 2022/23 from the lower deficit in 2021/22, but also by expectations of a slower global economy, lower commodity prices and the impact on the Australian economy of higher interest rates. Any new policy decisions from the government will also have an impact.
Importantly, the improved Budget position in 2021/22 means that net debt of the Commonwealth stood at $A516.8bn, or 22.6% of GDP, as at May 2022, well below the previous estimate for June 2022 of $A631.5bn, 27.6% of GDP. This better-than-expected outcome holds out the prospects that Australia’s net government debt will peak below the Budget-time estimate of 33.1% of GDP at June 2025.
Implications for monetary policy
As noted previously, a tightening of fiscal policy –by either allowing the automatic stabilisers to work and/or through deliberate policy action, will be an important part of the policy response to high and rising inflation.
Put plainly, in order to return inflation sustainably into the 2%-3% target range will require both monetary and fiscal policy to work together. While this seems like a simple concept, it has not always been the case.
As our Australian Economics team has noted consistently, we continue to expect that this monetary policy tightening cycle will be shallower than that priced into markets –even though markets have recently reversed some of the more extreme cash rate expectations priced in. And while our view of a shallow rate hike cycle, ie. to a peak in the cash rate of 2.1%-2.35%, is based predominantly on the impact on household balance sheets and spending from the coming large increase in mortgage funding costs, a tightening of fiscal policy will also support our monetary policy views.