In years past the budget has been benign enough for investors, so what’s surprising about this ‘dull and boring’ budget is that it’s actually quite positive – if a little indirectly. On first impression it may even be a confidence building budget – a great outcome for investors - although not for the reasons the government expects.
Now you’re not going to see this by looking at some of the headline figures. Firstly, we have to assume that budget deficits will be higher than forecast – that goes without saying - yet for reasons that you see below, I don’t think it should be materially higher. At worst you could add on another 1 percentage point to the deficit by 2018-19 which gives a deficit of 1.4 per cent of GDP in that year.
Similarly, economic growth is expected to remain a little below trend – on average - for the next few years - 2.8 per cent or thereabouts. Yet that’s not drastically below trend and overall the forecasts are entirely reasonable.
The hidden positive about those forecasts and estimates however, is the implausible pessimism that underpins them. Put bluntly, the government forecasts are at the bottom of any plausible range and they assume some of the negative influences acting on the economy don’t change.
Consider this: we know the mining investment is set to fall sharply, that’s been on the cards for some time – yet treasury have mining investment collapsing by 70 per cent over the next three years. What’s even more interesting about that is that there is very little in the way of an upswing in either consumer spending, non-mining investment or public spending over the next three years!
So effectively – the government assumes no economic response to either accumulated interest rate cuts, the weaker exchange rate or an acceleration in the growth of our major trading partners.
Indeed the official expectation, is that Chinese economic growth will disappoint on the downside and be weaker than the Chinese government’s target - at 6.5 per cent on average over the forecast horizon.
Now this is all possible, I don’t dispute that, but it is a pessimistic outlook based on some unlikely assumptions - and the risks are very much to the upside. There is explicit recognition of this fact in the budget as the government notes that “It is possible that conditions could improve more rapidly, with business responding by ramping up investment … there is some upside risk to the forecasts, particularly 2016-17 if a stronger bounce back-were to materialise.” That’s an understatement. Especially as the working assumption is that the iron ore price stays at $48 (see my accompanying piece – Could iron ore deliver an unexpected boost?).
It’s in that context that the budget could end up boosting confidence –the domestic growth assumptions are unchallenging - essentially assumes no change – well little change – in growth over the next three years.
There is no basis for this expectation though, in theory or historical experience – so in the absence of any unforeseen disaster, there really is only scope for upside positive surprises.
Some of the government’s new initiatives should also act to lift confidence.
So for instance, the government’s focus on supporting small business is a very positive step. Remember that small businesses are the largest employers in Australia. Indeed most people are employed by or in a small business. To that end, measures to allow accelerated depreciation, and tax cuts to small business will boost employment and investment. In turn that will support the economy.
What about the credit rating and our banks?
In that context, and even if the government’ s pessimism proves to be correct, the budget in no way threatens our AAA credit rating, or by implication, the outlook for our banks. Recall the concern – that a deterioration in the sovereigns rating – some investment banks think a downgrade is possible - would lead to a sell off on the banks as investors attached a higher risk premium to the domestic financials sector. There is no supporting evidence for that though.
True, the debt position deteriorates in absolute terms. So as it stands, total debt on issue rises about $50bn this year to $370bn, with that expected to lift another $45bn in 2015-16 to $477bn. These are big numbers but they leave a net debt position that peaks at 18 per cent of GDP in 2016-17 with net interest payments of only 0.7 per cent of GDP – steady effectively for the next five years. That’s not a bad position. Fair to say that in calculating that debt burden, the Treasury assumes a low rate environment - the 10yr bond rates average about 2¾ per cent for the next few years. Yet even accounting for a plausible lift in bond yields, this is not a threatening position. Indeed Australia is seeing strong demand for its debt from abroad and Treasury reports that foreigners hold about two-thirds of bonds on issue.
So overall, this is a budget that highlights the positive macro backdrop for Australia – it clears the decks for growth and in so doing, should end the cycle of over promising and under-delivering, on growth, that has been so detrimental to confidence. Not by the reported headline figures - sure. No, it’s not that direct. It's more in how the budget highlights just how significant the upside risks are - and that even should the dire assumptions used by Treasury prove to be correct, the worst case is growth that is only just below trend. If that does turn out be the case, investors have ultra-low rates to look forward too. We’ll otherwise have much stronger growth than expected and only modestly higher rates outlook. Either way a great environment for investors.