budget preview 2012-13

7/28/2019 Budget Preview 2012-13

1/13

18 APRIL 2013

CONTRIBUTORS

Warren Hogan

Chief Economist

+61 2 9227 [email protected]

Katie DeanHead of Australian

Economics, IIB


Cherelle Murphy

Senior Economist


Tony MorrissHead of Interest Rates

Strategy

+61 2 9226 6757Tony. [email protected]

Zo McHughInterest Rate Strategist


AUSTRALIAN ECONOMIC UPDATE

AUSTRALIAN ECONOMICS

ANZ RESEARCH

AUSTRALIAN BUDGET 2013-14 PREVIEW IN DEFICIT FOR LONGER

ANZ forecasts the Commonwealth budget to bein deficit by aroundAUD17bn in 2012-13 and around AUD7bn in 2013-14 when it isreleased at

7:30pm AEST on May 14.These deficits are small relative to GDP at around 1%

and % respectively but do represent a deterioration from the small surpluses

projected in the October mid-year update.

Small budget deficits are expected until 2014-15. The return to surplusthat may occur in 2015-16 will require a modest further tightening of fiscal

policy supporting the view that expansionary monetary policy will remainappropriate for some time. An earlier return to surplus is very difficult without a

notable tightening of discretionary fiscal policy or an AUD decline that outpaces

the decline in commodity prices. This is not ANZs expectation, however, as we

see the AUD remaining elevated for some time.

Net debt is expected to rise only slightly, to a peak of around AUD176bnor an average of around 10.5% of GDP over the coming four years. Further

increases in net debt from budget deficits will be partially offset by a low interest

burden on this debt, in line with continued low global interest rates.

Whilst disappointing, these weaker budget outcomes should not affectAustralias coveted AAA (stable) credit rating. The Government and

Opposition are both committed to conservative fiscal policy

1

. The budget balanceis likely to continue to improve and debt levels are low by international standards

ensuring the Government retains budget flexibility to react to negative shocks. If

there were a change in the Governments fiscal strategy to achieve budget

surpluses on average over the medium-term, this would not be looked upon

favourably by rating agencies. This, however, is unlikely.

There are three principles by which we will judge the 2013-14 budget:First, is this an appropriate fiscal setting for the current economic cycle?

A further modest tightening of fiscal policy is arguably not inappropriate if

Australia is near a peak in the unemployment rate (ie. nearing the beginning of a

cyclical non-mining upturn). Fiscal contraction is less appropriate if the labour

market outlook worsens and/or downside risks to the non-mining economy rise.

Second, do the fiscal settings presented provide a credible path back tobalance, and thus Australian fiscal sustainability? The weaker budget

outcome this year due to the falling terms of trade and high AUD suggests some

structural vulnerability in the budget. Just as the broader economy needs to

adjust to a lower terms of trade and a higher AUD, so too does the Government

sector. A broadening of the revenue base and/or a reprioritisation of expenditure

is required. A Government announcement to deliver the required reforms during

an election year would be a welcome surprise.

Third, does the budget support long-term structural reform to liftproductivity growth?

1The Coalition is, however, yet to release its full suite of policies, with fewspecifics expected until the August release of the Pre-Election Economic and

Fiscal Outlook.


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Australian Economic Update / 18 April 2013 / 2 of 13

A BUDGET DEFICIT IN EXCESS OF 1% OF GDP IN 2012-13

The Commonwealths budget position is not improving as quickly as anticipated when

the October Mid-Year Economic and Fiscal Outlook (MYEFO) was released last year.Monthly Commonwealth financial statements suggest the underlying cash balance

was a deficit of around AUD24bn in the eight months to February 2013. This is

running behind where it should be in order to meet the projection of a AUD1.1bn

surplus for the 2012-13 fiscal year (Figure 1). The Government said in December that

this surplus would not be achieved.

FIGURE 1. UNDERLYING CASH BALANCE

-60

-50

-40

-30

-20

-10

0

10

20

Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

AUDbn

2007-08 2008-09 2009-10 2010-11 2011-12 2012-13

MYEFO est. 2012/13

AUD1.1bn

Sources: Minister for Finance and Deregulation and ANZ

The February Commonwealth Financial Statements suggest the deterioration

in the budget balance, relative to the MYEFO forecasts, is due almost entirely

to weaker revenue growth. The statement reports that, yearto-date:

- Revenues are currently running around 3% below MYEFO projections; and,- Expenses are a little below MYEFO expectations (i.e. better than), by around

0.3%.

Holding these relativities constant, produces an underlying cash balance estimate for

2012-13 of around AUD13bn (0.8% of GDP). 2

This, however, appears a little too optimistic when we consider how revenues andexpenses are tracking relative to 2011-12, particularly on the expenses side.

- Revenues are currently 7.2% above 2011-12 levels (year-to-date). This isbelow the 10.5% increase in revenues projected for 2012-13 in the MYEFO.

2The underlying cash balance is equal to receipts less payments less FutureFund earnings. Our workings throughout this note assume no change in Future

Fund earnings relative to the MYEFO forecasts. At MYEFO, the sale of spectrum

was expected to boost Government receipts by around AUD4bn in 2012-13.

We now expect weaker market conditions will reduce these receipts, while

some of the payments from telecommunications companies have also

reportedly been deferred until 2013-14.


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- Expenses are currently 2.2% above 2011-12 levels (year-to-date). This iswell above the 0.7% decline in expenses that was projected for 2012-13 as a

whole at MYEFO.

Assuming these relativities hold for the rest of this fiscal year produces a budget

deficit estimate of AUD28bn (1.9% of GDP) for 2012-133.

Accurately forecasting a budget outcome is fraught with difficulty given the potential

for the Government to shift the timings of payments and receipts to suit political and

other motives. The natural vagaries of the profit and economic cycles can also push

these figures around.

Taking a mid-case scenario, our assumptions for 2012-13 are:

- Receipts are 4% weaker than MYEFO. This is broadly in line with current YTDtracking relative to MYEFO, but allows for further impacts of a higher AUD

relative to MYEFO. Whilst it assumes around a 45% uplift in revenues for the

rest of this financial year, this is not atypical given April is one of the biggestmonths for tax collections.

- Payments fall as expected at MYEFO (-2.1% from 2011-12).Adjusting for the Future Fund earnings and the adjusted timing and revenue

from the sale of spectrum, these assumptions imply a budget deficit of

around AUD16.6bn (1.1% of GDP) for 2012-13 (Figure 2).

FIGURE 2. UNDERLYING CASH BALANCE, MYEFO VS ANZ FORECAST

-5

-4

-3

-2

-1

0

1

2

3

4

60 64 68 72 76 80 84 88 92 96 00 04 08 12 16

%o

fGDP

MYEFO forecast ANZ forecast

forecast

Sources: MYEFO and ANZ

Of course, there are the usual caveats around this forecast, with numerous

upside and downside risks. On the upside (i.e. assisting a smaller deficit), revenue

could be boosted by, amongst other things, an uptick in mining tax receipts in H1

2013 following the improvement in iron ore prices in Q4 2012, whilst expenses could

be constrained by additional discretionary spending cuts.

We see the balance of risks causing a larger deficit. These risks include (a) failure of

company tax revenues to match the usual seasonal pick up in April (when around

17% of payments are collected) because of ongoing pressure on profits from the

3 Note, this simple working makes an adjustment for expected earnings from

the Future Fund and for the sale of spectrum2.


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higher AUD and the possibility of lower commodity prices, among other factors4; (b)

the temptation to implement new spending, which is not fully offset ahead of the

election period; (c) a further rise in the unemployment rate (the MYEFO forecasts are

based on a stable unemployment rate of 5% in the June quarter compared to a

5.6% rate in March); and, (d) one-off spending pressures e.g. natural disaster

funding and greater-than-expected asylum seeker arrivals.

SIGNIFICANT CONTRACTIONARY FISCAL POLICY WOULD BE REQUIRED FOR

A RETURN TO SURPLUS IN 2013-14

Returning the budget to surplus over the next couple of years now looks more difficult

without very strong economic growth forecasts (unlikely) or an explicit tightening of

fiscal policy (new revenue measures and/or very significant savings). Two major new

policies, the National Disability Insurance Scheme and the Gonski Education reforms,

which are expected to cost several billion dollars each per annum and are expected to

be funded out of new savings, further challenge the speed at which the budget deficit

can be reduced. The Prime Minister announced at the weekend that the education

reforms, as they stand, would cost AUD9.4bn over the next six years and only

AUD520m of that (over four years) has been offset so far by associated spending

cuts.

The expected deterioration in the budget balance in 2012-13 considerably

worsens the starting point for the budget in 2013-14. This is because tax

receipts lag nominal GDP growth5. Scenario analysis in the MYEFO showed that a 1%

reduction in nominal GDP growth in 2012-13 that was driven by a weaker terms of

trade would reduce the underlying cash balance by AUD2.8bn in 2012-13 and

AUD6.7bn in 2013-14. Comparing ANZs nominal GDP growth forecasts with those

printed at MYEFO for 2012-13 (Figure 3) suggests the starting point for the 2013-14

underlying cash balance is already AUD8.4bn lower. Admittedly, this may be an over-estimate of the hit to the budget because not all of the current weakness in revenues

reflects a weaker terms of trade; some of it is also due to lower real GDP growth.

FIGURE 3. PARAMETER FORECASTS, ANZ VS MYEFO

MYEFO ANZ MYEFO ANZ

Nominal GDP 4.0 2.8 5 4.9Real GDP 3.0 2.8 3.0 2.9

Terms of trade -8.0 -10.0 -2 -0.5Unemployment rate 5 5.7 5 5.7CPI 3.0 2.9 2 2.1

Wage price index 3 3.2 3 3.5Exchange rate TWI 75 78 75 79

Exchange rate AUD/USD 1.02 1.04 1.02 1.05Unemployment rate is for the June quarterCPI and wages are through-the-year growth to the June quarter

Exchange rates are year averages

2013-142012-13

Sources: ABS, MYEFO and ANZ

A more useful way to consider the likely budget position in 2013-14 and

beyond is to consider the expected balance under different revenue and

4At MYEF0, the exchange rate was assumed to be a trade weighted index ofaround 75 and AUDUSD around 1.02, compared to averages of 77.6 and 1.039

respectively in 2012-13 to date.

5 This is because company tax instalment rates for Year 1 do not tend to be

adjusted until after a company has lodged its tax return for Year 1, which is

typically not done until six months after the end of Year 1.


5/13


expense growth scenarios. This provides a more meaningful top down analysis of

how fiscal policy needs to respond to the new reality of lower nominal GDP growth.

Below we outline the underlying cash balance for the forward estimates period basedon three different scenarios for expenses and revenues growth (Figure 4). We

consider scenarios that would be consistent with (a) very tight fiscal policy; (b)

moderately conservative fiscal policy; and, (c) explicit fiscal policy slippage

(Figure 5).

FIGURE 4. UNDERLYING CASH BALANCE (AUDBN) THREE SCENARIOS

SCENARIO 1 SCENARIO 2 SCENARIO 3 MYEFO

TIGHT FISCAL POLICY CONSERVATIVE LOOSE FORECASTS

2012-13 -16.6 1.1

2013-14 4.0 -6.8 -14.0 2.2

2014-15 19.0 -3.6 -18.8 3.32015-16 37.8 2.1 -21.9 6.4

Source: ANZ

FIGURE 5. SCENARIOS FOR REVENUE AND EXPENSE GROWTHSCENARIO 1 SCENARIO 2 SCENARIO 3 13-14 to 15-16 MYEFO

TIGHT POLICY CONSERVATIVE LOOSE AVERAGE FORECASTSREVENUE (% ch) 7.5 6.0 5.5 5.8EXPENSES (% ch) 3.0 4.5 6.0 5.4 Source: ANZ

We expect the Governments most likely course of action will be along the lines of

Scenario 2. That is, the Government will limit expenses growth in order to

present the budget returning to surplus at the end of its forward estimates

period.

This scenario analysis demonstrates that a return to surplus in the forward estimates

period is not possible unless either (a) revenue growth significantly outpaces nominal

GDP growth (unlikely without new revenue measures being put in place); or, (b)

expenses growth is limited to 1.5%-2% per annum in real terms. The latter (which

we assume will be the Governments course of action) means a slightly

tighter fiscal policy than the Governments previous policy settings.

Previously, the Government had committed to cap real expenses growth to 2% pa

over the cycle, but in the three years 2013-14 to 2015-16, had only planned to keep

expense growth to this low level in the middle year, 2014-15.

STARTING POINT IS CRUCIAL

Scenario analysis also highlights how crucial the starting point for this

budget cycle is to the possibility of being able to report a surplus. This is due

to the lags involved in revenue collection. If our forecasts for the 2012-13 underlying

cash balance (-AUD16.6bn) prove to be too optimistic, the path back to surplus will

take longer than four years unless there is a very notable tightening of discretionary

fiscal policy.

Figure 6 below applies our scenarios to a more pessimistic 2012-13

underlying cash deficit of AUD20bn. It shows that a return to surplus by

2015-16 is not possible under our middle or conservative fiscal policy

framework.

We would emphasise however that a return to surplus by a certain point in

time has never been an economic imperative as much as a political one. First,

the difficulty of forecasting means the Governments forecasts beyond the current

year often prove to be some way out. Second, a plan for an improvement in the

budget position and a return to surplus over the medium term is all we would like to

see for fiscal settings to be appropriate in the current setting. The differencebetween a 0.1% of GDP surplus and 0.1% of GDP deficit is almost nil in

terms of its impact on the economy.


6/13


Deficits of up to AUD7bn are less than % of GDP. Third, the composition of the

surplus matters more than the size. For example, if spending is stripped from the

foreign aid budget to achieve surplus forecasts, this will have low multiplier effects on

the economy and a vastly different impact than if the surplus is achieved by cutting

welfare benefits (which have a high multiplier effect on the economy).

FIGURE 6. UNDERLYING CASH BALANCE (AUDBN) WEAKER STARTING POINTSCENARIO 1 SCENARIO 2 SCENARIO 3 MYEFO

TIGHT FISCAL POLICY CONSERVATIVE LOOSE FORECASTS

2012-13 -20.2 1.12013-14 0.2 -10.6 -17.8 2.22014-15 15.1 -7.6 -22.9 3.32015-16 33.8 -2.0 -26.2 6.4

Source: ANZ

STRUCTURAL REFORM NEEDED

Importantly, most of the deterioration in the budget position reflects a weaker

economy, rather than an explicit loosening of fiscal policy. This is because thedeterioration largely reflects weaker revenue growth (due to weaker profits growth,

not policy changes) and not stronger-than-expected expenditure growth.

Nevertheless, the failure of the budget to recover as quickly as the Government

anticipated highlights more than just cyclical weakness. The scenario analysis

presented above, which demonstrates the fiscal constraint required for a

return to surplus, reveals the structural weakness of the budget.

The ability of the budget to grow its way out of deficit (i.e. for revenues to recover

sufficiently from an upturn in the economic cycle to drive the return to surplus) has

been constrained by a weakening in the terms of trade to, arguably, a more normal

level and compounded by the enduring strength of the AUD.

Figure 7 below illustrates the extent to which the current projections, which feature ahigher terms of trade, drive the projected return to surplus. The 2012-13 terms of

trade forecast is represented by the pink dotted line, which is well above the dark

blue actual path of the terms of trade. Figure 8 meanwhile illustrates the still very

large gap between revenues and expenses. It shows how slowly revenues are

recovering, and hence the pressure on expenditures to weaken to close the gap. It

also shows the step down in receipts (as a share of GDP) that have occurred given

nominal GDP growth is normalising as the terms of trade normalises.


7/13


FIGURE 7: TERMS OF TRADE ACTUAL VS GOVERNMENT FORECASTS

40

50

60

70

80

90

100

110

120

90 93 95 98 01 04 06 09 12 14

Terms of t rade with ANZ Forec ast 2004- 052005-06 2006-072007-08 2008-092009-10 2010-112011-12 2012-13

Inde

forecast

Sources: ABS, ANZ and Commonwealth Treasury

FIGURE 8: RECEIPTS VS PAYMENTS

18

19

20

21

22

23

2425

26

27

28

71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

%o

fGDP

Receipts - ANZ forecast Receipts - MYEFO forecast

Payments - ANZ forecast Payments - MYEFO forecast

forecast

Sources: MYEFO 2012-13 and ANZ

This is also demonstrated by Figure 9 (below) which shows the weakening of the

Governments tax receipts, relative to the economy. This followed the income

tax cuts in the last half of the previous decade when the terms of trade boom

commenced.


8/13


FIGURE 9: NOMINAL GDP GROWTH VS NET TAX COLLECTIONS

Sources: ATO, MYEFO 2012-13 and ANZ

This analysis does not suggest the Australian budget is seriously structurally

impaired. Nevertheless, just as the broader economy needs to adjust to a

lower terms of trade and a higher AUD, so too does the government sector.

This will require more than just a promise to cap expenditure growth until the budget

returns to balance, especially given the coincident impact on expenditure as the

population ages.

It is also worth highlighting that demographic developments will mean expenditure

pressures are higher (e.g. in aged care) and revenues are likely to grow more slowly

(as there are fewer people paying taxes). Figure 10 below shows that the population

over 65 (traditionally the older end of the non-working age population) will grow by

around 140% over the next forty years, while the working age population will grow

by only around 40%. Health spending is also likely to continue to weigh on the

budget for these reasons as medical technology continues to advance. These

projections have been well-documented in recent Intergenerational Reports from the

Government and other sources6.

6We believe the planned 2013 edition of the Intergenerational Report has been put on hold. The

new Parliamentary Budget Office is expected to outline the structural budget position by June30, which may spark debate on the issue and how the structural deficit can be addressed.


9/13


FIGURE 10: ANZS PROJECTIONS OF POPULATION AGE COHORTS

0

5

10

15

20

25

1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

65+

Working age (15-64)0-14

Totalpopulation(millions)

Forecasts

140%

40%

34%

Sources: ABS and ANZ

A modest broadening of the revenue base and/or a reprioritisation of spending is

therefore likely to be required for a number of reasons. The Government has tackled

some of its medium-term expenditure pressures in recent years, for example,

reducing access to the private health insurance rebate by means-testing it, reforming

the Pharmaceutical Benefits Scheme and most recently by reducing tax concessions

for high income superannuation recipients. But more change of this nature is required

to counter medium-term fiscal pressures. A Government announcement to deliveranother slab of the required reforms during an election year would be a welcome

surprise.

NET DEBT TO RISE TO AROUND 11% OF GDP

The expected deterioration in the budget relative to the last update in October 2012

means Australias net debt position is now likely to peak at around 11% of GDP, a

little higher than the previously estimated peak of 10% (Figure 10). Limiting the

extent of the rise in the net debt position is the continued downward pressure on

global yields, which is likely to reduce the average interest rate paid on Australian

debt, at least in the short term. Indeed, we would highlight this as the main risk to

our projections.


10/13


FIGURE 11. GENERAL GOVERNMENT NET DEBT

-5

0

5

10

15

20

1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016

%o

fGDP

2012-13 MYEFO2013-14 Budget - ANZ projections

2013-14 Budget - ANZ projections optimisic scenario

2013-14 Budget - ANZ projections pessimistic scenario

forecasts

Source: Commonwealth Treasury and ANZ

Despite this likely slight increase in Australias net debt position, this measure of

external vulnerability remains low by global standards (Figure 12).

FIGURE 12. GENERAL GOVERNMENT NET DEBT INTERNATIONAL COMPARISON

0

10

20

30

40

50

60

70

80

90

100

Australia Advanced

economies

Emerging

economies

G-20 Advanc ed G-20 Emerging

Average

%o

fGDP

2011 2012 2013 2014

Sources: IMF and ANZ

IMPLICATIONS FOR BOND MARKETS

The deterioration in the budget position will require greater issuance of

Commonwealth Government Securities (CGS) over coming years compared with the

budget update in October last year. The numbers are not large and will not bring the

AUD300bn debt ceiling into play based on the current outlook. Our new projection for

Commonwealth bonds on issue is below in Figure 13.


11/13


FIGURE 13. COMMONWEALTH GOVERNMENT SECURITIES ON ISSUE

0

50

100

150

200

250

300

350

95 97 99 01 03 05 07 09 11 13 15 17 19

AUDbn

Total Securities on Issue (AUD'000 M)

Debt Ceiling

Total CGS projected in October2012

Total CGS with projected deficit

Sources: AOFM and ANZ

This projection may trigger some cautionary headlines from rating agencies on the

apparent slippage in budget discipline over the out years. As argued above, this is not

related to a blowout in expenses but rather exogenous factors constraining revenue

growth. The general sovereign debt metrics remain very strong as can be seen by the

comparison of net debt to GDP relative to other major economies. Australias public

sector net debt position needs to be better than its high rated peers, however, given

the rating agencies continued concerns about Australias current account and

external (economy-wide) debt.

The profile means we are looking at the maintenance of a deep and liquid CGS

market over the medium-term. This should ensure ongoing investor interest in CGS,

which continue to offer the highest yields for a AAA (stable) rated market.

The Australian Office of Financial Management (AOFM) should easily manage the

increased call on markets. We would expect to see a continued focus on raising the

extra funds via longer-dated issuance considering investor demand for high quality

sovereign bonds and historically low global interest rates that are a function of

extraordinary policy settings in the developed world. In reported comments this

week, Opposition Treasury spokesman Joe Hockey said the party would issue bonds

with a duration of 40-50 years if the party were to win Government7.

We will also be interested in any new developments around the financing of

infrastructure investment via CGS in the budget. The current low level of interest

rates and numerous calls for infrastructure improvement in Australia would suggest

there is ample opportunity for the Commonwealth to work with the states on this

issue. Of course, the productivity gains that may come from infrastructure investment

would have to be balanced against increased indebtedness (and managed within

limits that would maintain the AAA rating). The Opposition has said it will ask the

AOFM to examine an Infrastructure Partnership Bonds scheme to lift private

investment should they win Government in September.

7Hockey proposes bonds up to 50 years,Australian Financial Review, 11 April2013, p11.


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