A spoonful of sugar for the pre-election budget

If the upside we’re seeing currently was factored into Labor’s pre-election budget, its forecasts would be vastly more positive than what we’re likely to actually get tomorrow.

The Pre-Election Fiscal Outlook will be released by Treasury and Finance on Tuesday and given the unrealistically downbeat view on global and domestic conditions from the official family, it is likely to present a set of economic and budget estimates little changed from those released by the government on August 2.

A summary of those forecasts from the government is here at Table 1 for the economy and Table 2 for the budget aggregates.

Graph for A spoonful of sugar for the pre-election budget

Graph for A spoonful of sugar for the pre-election budget

The key points from the above tables is Treasury’s forecast for real GDP growth of 2.5 per cent in 2013-14 and only 3 per cent thereafter. And linked to that, there is unusually soft employment growth, a ‘high’ unemployment rate, very weak increases in nominal GDP and a sharp fall in the terms of trade.

While it is always tough to take Treasury to task given its superior forecasting record over the Reserve Bank, the market consensus and all others, this time around it appears to have erred on the side of too much caution and plugged for a set of weak economic parameters.

These weak economic parameters are undermining the forecast revenue return and leading to the underlying cash balance deficits before a small surplus in Table 2 above.

What if the recent run of stronger global news was factored in the Treasury projections, and the signs of asset price inflation in stocks and housing fed into the estimates for nominal GDP growth?

Obviously, stronger economic growth and higher inflation mean a vastly different fiscal position, with the deficits in 2013-14 and 2014-15 somewhat narrower, the deficit in 2015-16 would turn into a surplus and the moderate surplus in 2016-17 would be a big one.

Here is an example of how a little bit of upside on the economy would show up versus what is likely to be in PEFO tomorrow.

Let’s plumb for a forecast for real GDP growth of 3 per cent in 2013-14 and 3.75 per cent in 2014-15. These look reasonable forecasts in the context of the current low interest rate climate, the coiled spring of personal consumption and dwelling investment and the no brainer of a surging export market.

Let’s now assume the rapidly improving global economic news and the recent lift in commodity prices which would see the terms of trade fall only 2 per cent in 2013-14, be flat in 2014-15 and rise 2 per cent in each of the next two years.

In these circumstances, the sensitivity analysis suggests employment growth would be 0.5 per cent higher in each of 2013-14 and 2014-15, the unemployment rate would peak at 6 per cent in 2013-14, falling to 5.5 per cent in 2014-15, and wages growth would be 0.5 per cent faster in each year.

In this case, nominal GDP growth would be around 2 per cent faster in 2013-14 and 2014-15 (this assumes some changes to the technical assumption about the exchange rate and interest rates – both of which would be higher).

In terms of the bottom line for the budget balance, the underlying cash balance would now be a deficit of around $25 billion in 2013-14 (a $5 billion smaller deficit), followed by a deficit of around $3 billion in 2014-15 (a $21 billion smaller deficit), a surplus of around $10 billion in 2015-16 (instead of a deficit of $4 billion) followed by a surplus of around $25 billion in 2016-17 (around $20 billion larger than what PEFO will likely show).

The difference in the projections above from the budget bottom line to those likely to be presented in PEFO is around $60 billion.

This is the very essence of the budget problem or overhyped fiscal emergency at the moment. The fiscal outlook depends critically on the pace of real growth in the economy and the inflation outcome from the assumptions about the terms of trade.

Like the rating agencies and most global investors, I judge there is little if anything to worry about with Australia’s economic and fiscal position. Growth is poised to lift with easy monetary policy in place, the trivial level for the budget deficit will disappear soon and Australia is still less than 1 per cent on unemployment away from everyone who wants a job, having one.

Stephen Koukoulas is managing director of Market Economics and a former economics advisor to the Prime Minister Julia Gillard. 

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