Budget cuts amount to small change

The first thing that struck me about this budget – taking the usual banter about it not being as bad as expected as done – is just how similar the current government’s fiscal strategy is to the previous government’s.

With all the rhetoric about a fiscal crisis and the urgent need for budget repair, I was a little surprised at the lack of any – well  – repair. The sad truth is there is not much that is different from the previous government’s budgets– change at the margin. I’m not saying there’s nothing in here you won’t like. Reintroducing indexation for the fuel tax, the debt levy, Medicare co-payments – $8 billion or so in cuts to health.  But, in each case, the measures are, by themselves, quite small. Certainly in terms of their impact on the budget, and on the overall macro landscape.

So, for instance, the debt levy only raises about $3 billion over the forward estimates, reintroducing fuel indexation raises $2 billion, while Medicare co-payments raise just over $3 billion. Total revenue measures only lift the budget position by $5 billion over four years, which is nothing when you are talking about a budget that deals with revenues of over $400 billion per year.

It’s a similar situation on the expense side. Policy decisions since MYEFO seemingly cut spending by only $12 billion over the forward estimates, which once again is nothing – $3-4 billion per year when the government’s total expenses are expected to average around $440 billion. It’s negligible. In fact, the biggest saving here won’t even affect investors, or the broader domestic economy. The government intends to save $7 billion by maintaining foreign aid at 2013-14 levels over the next two years, after which they index by consumer price inflation. As for that $8 billion or so in cumulative cuts (over four years) to health – this comes out of a health budget of over $280 billion. As I mentioned last week – enough to annoy perhaps but not enrage.  

Pre-budget hype

Against that backdrop, some of the rhetoric that we had heard in the build-up to the budget was unnecessarily alarmist, probably reflecting a view (incorrect in my humble opinion) that a sense of crisis is required in order to make unpopular (if ultimately minor) decisions –the debt levy, fuel indexation and the changes to the family tax payments etc. (which by the way are expected to save roughly $6 billion over four years; again nothing draconian). At the core, this is a budget with a lot of little things here and there –cutting a bit, shifting a bit, maybe even reprioritising a little – but nothing in the way of actually hard core budget cuts.  

That leaves us with an underlying fiscal strategy that hasn’t changed alongside the change in government.  There will be an ongoing attempt at spending restraint, while waiting for the economy to return to trend growth. Indeed, the government’s forecast surplus relies heavily on the assumption that the economy will return to trend growth over the next two years.

That’s not to say that I think that assumption is heroic. It isn’t, and I would be expecting the same – with a strong chance of trend growth over the next 12 months. So I don’t have a problem with Treasury’s forecasts. Indeed, Gross Domestic Product is expected to remain below trend over the next three years, on average, at 2.75%, which is a reasonable forecast – there is nothing of note in that. Some will have slightly higher growth, some slightly lower– they are sound and quite conservative, in my opinion.  

But investors should be aware that this budget does little to insulate us from a deterioration in global and domestic growth over the forecast horizon.  Small changes can have a significant impact on the budget’s bottom line – as we’ve seen over the last couple of years.  Recall that back in 2013-14, the budget deficit was expected to be small at 0.8%. That’s blown out to 3% now, reflecting the fact that there has been no genuine effort to really fix up the books.  That hasn’t changed today.

Nothing to worry about?

I don’t deny that, at a broad level, the general flavour of the budget is the right one for investors. Certainly the rhetoric is on the right track in the sense that it at least has the intention to “redirect spending from consumption to investments that will drive economic growth”.  

This is what the country needs, and policies that try to achieve this generally boost jobs, corporate earnings and so equity performance - and the return to cash as well I might add.  

I don’t think this budget really does that, though. Cuts to welfare are minor and indeed the cumulative hit to consumers from welfare cuts and increased taxes etc. is only about $20 billion over four years. This won’t  even be noticed given household disposable income over that period will be around $4 trillion. In addition to that, the government’s ‘infrastructure growth package’ only adds an additional $6 billion in spending  to the economy – over four years!  

Unfortunately, that means this budget is unlikely to be a confidence-building budget – something much needed in this country.  

A lot will depend on the PR and its reception tonight but, for me, I don’t think this is a budget that will inspire renewed optimism in business or the global investment community, who will likely just see it as a continuation of old policy. Certainly I do. Even the drama in the lead-up to the budget was from the same script as the last lot – with the same result.

On a final note, investors shouldn’t be concerned about claims they may see over coming days that this is a contractionary budget. That is one that will weigh on growth. At a simple level (looking at the change in the forecast fiscal balance), this budget does have a modestly contractionary influence on the economy over the next four years.

Detracting 1.2 percentage points from growth in 2014-15, another 0.9 percentage points the year after that, with net detractions to growth falling to a comparatively modest 0.3-0.5 percentage points over the next two years. Similarly, it is true that the Government has factored in a fall in spending of about 0.1% for next year. This follows an expected 8% lift in spending this year however, and is forecast to be followed by another 4% lift in 2015-16.  Average spending growth of 4% over that period – hardly contractionary.