Deloitte Access Economics: Budget outlook brightens has been saved
Deloitte Access Economics: Budget outlook brightens
14 December 2020: On budget night just over two months ago there was a risk that the government hadn’t done enough. Treasury was forecasting an Australian economy that would permanently be around 5% smaller than its pre-COVID forecasts, and yet policy was shifting away from income supports such as JobKeeper towards tax-driven incentives for families and businesses.
That was a bit brave: a bunch of things needed to go right for that policy mix to work best.
Yet the good news is that’s exactly what has happened since then:
- COVID numbers are strikingly low, and the news on vaccines is spectacularly good, with vaccines both better and available earlier than expected
- Related to that, the Australian economy is outperforming, bouncing back rapidly. Numbers of JobKeeper recipients are falling fast, and unemployment is below the 8% Treasury thought it would already have risen to by now
- Finally, China’s trade war with Australia has delivered taxpayers a handy – and hefty – windfall.
A windfall? That certainly isn’t true for wine, beef, barley, lobsters or even thermal coal. Those are all markets where recent Chinese moves have cost Australia money. But economists have long realised that tariffs (and ‘mystery bans’) cost both countries. For example, when China acts, it costs Chinese families at the same time as it costs Australian businesses. That’s why rising domestic thermal coal prices in China mean that it may be unlikely to do much more than sabre-rattling on Australian coal.
Where China knows it is most at risk is iron ore. China is the world’s key customer, but Australia is the world’s key supplier. That’s why analysts have said China wouldn’t act on Australian iron ore, as it would cost them lots.
However, markets are still worried that China may do something. So they’ve responded by nervously bidding up prices in fear of exactly that.
Iron ore spot price, $US tonne, CFR
This ‘fear tax’ isn’t the only thing driving up prices – markets are also worried that heavy rain may constrict supply out of Brazil, while very low interest rates and a falling US dollar are pumping up pricing too.
But spot prices have risen by a further $US18 a tonne in the days since 30 November alone. The bottom line is that China’s trade war with Australia is making us money rather than losing it.
To be clear, we’ve lost money on everything from lobsters to wine. But we’ve more than made that up in overall terms thanks to iron ore – and the taxman will be a considerable beneficiary of that.
And that’s part of a wider story of economic outperformance versus the official forecasts released in the budget. The chart below shows that Deloitte Access Economics sees the economy larger than Treasury projected by $33 billion in 2020-21 alone, a gap that widens to $106 billion by 2023-24. (Note that’s the difference in the size of the economy – the associated boost to the tax take is less than a quarter of that.)
Difference between our forecasts and official forecasts – annual nominal GDP ($bn)
So MYEFO looks set to revise expected spending down (savings on JobKeeper and the like) and taxes up (more people in jobs, plus higher-than-expected profits, especially in iron ore). And that’s true even though a range of new spending has been announced since the budget, including on:
- Vaccines (as well as vaccine manufacturing capability), at a cost of $1 billion over 12 years, and
- Extending the JobSeeker Coronavirus Supplement (at a lower rate of $150 per fortnight until
31 March 2021), at a cost of $3.2 billion this year, plus a further $240 million put into a matching extension of HomeBuilder.
Accordingly, the cash underlying deficit may beat the budget-time expectations for it by some $3 billion in 2020-21. That outperformance versus the official forecasts may lift to more than $15 billion by 2023-24.
(That said, Treasury are conservative forecasters, and they’ve become even more careful about building wriggle room into their budget forecasts during COVID. That may well limit the good news to be announced in MYEFO. But the trend is the friend of the budget right now.)
By the way, a credit rating agency just downgraded the debt of Victoria and NSW. So it is worth a brief reminder that credit ratings aren’t a measure of the quality of budget settings – they merely assess the risk that those who lend to governments will be repaid.
There isn’t usually a huge gap between ‘budget quality’ and ‘likelihood of getting repaid’. Yet there is a big gap in a crisis, and you’d much prefer to live in an Australia in which governments do the right thing by Australians in a crisis (rather than hurting the economy so as to help the repayment prospects of bond holders).
Besides, Australian federal and state government debt remains among the safest in the world. That’s why market interest rates greeted the announcement of those credit downgrades with a big fat yawn. So should you.
Lastly, something important changed during COVID, and Australia needs to understand it.
Until now, budgets could concentrate on longer term issues, and leave the Reserve Bank to handle the ups and downs of the economy by raising or lowering interest rates.
But not anymore – the RBA already has its foot to the floor. For the foreseeable future, that says budget policy has to be more agile than it’s been in times past.
That means a greater willingness to use the budget to help juggle the ordinary ups and downs of the economy. But any moves of that type (such as tax surcharges and discounts and spending shifts) will necessarily need to be temporary, which will also require an understanding of that from both the public and from the Opposition of the day.