THE Victorian government's half-year budget report card is not as bad as it looks at first glance. Low Australian government bond rates have produced a new $6.5 billion non-cash loss that will be backed out just as rapidly when the bond rate rises.
The accounts are tight, though. Tight enough to show the weakness that is being imported as demand stays weak and the resource boom forces up the value of the Australian dollar. Tight enough perhaps to raise questions about whether the Baillieu government can continue to have a defence of its AAA credit rating at the core of its strategy.
Let's get Victoria's "loss" out of the way first. It relates to superannuation liabilities in the future, and it's unlikely to be permanent. About $1 billion of it reflects market weakness and the impact of that on existing superannuation assets: the markets were in disarray in the December half and are higher now, so some of that shortfall should already have been recovered.
The balance is a bookkeeping adjustment that flows from the way the government values future super payouts to public servants. It arrives at a current-day value for the liabilities by discounting them using Australian government bond yields as the benchmark and Australian government bond yields are unusually low right now as investors seek havens amid global uncertainty.
The lower government bond yield produces a lower discount rate for the state's future superannuation liability, and the lower discount rate in turn magnifies the size of the liability. When the detritus of the global crisis is cleared and global growth gets back to normal, Australian government bonds yields will rise again, and the net present value of the state's superannuation liability will fall.
Victoria's December-half accounts nevertheless show pressure. Taxation revenue was flat in the December half compared with a year earlier, and sales of goods and services were softer, in the government sector and also on a broader measure that ropes in state-owned enterprises and corporations.
Cost were reined in as the government worked to keep its budget in the black, and its triple A credit rating secure: it stepped up its search for savings in December in its mid-year economic statement. But the government still posted a deficit of $341 million from transactions in the half-year compared with a $484 million surplus a year earlier, and an $810 million deficit if government corporations are included.
The government says that the December-half result is an "imperfect guide" to the annual result, because revenue including Commonwealth grants for specific projects will flow more heavily between now and June 30. It has also not changed the June-year revenue or expense predictions that were trimmed in last December's budget update, and is still shooting for a surplus of $147 million for the full year.
There are still formidable headwinds, however. Victoria's industrial economy is being hurt by relatively high interest rates and a high Australian dollar, as the Reserve Bank tries to moderate demand in the resources sector and keep inflation under control. House sales and house prices have softened, pulling down stamp duty and other property-related income. And consumer sentiment and consumer demand remain chronically weak.
The cyclical weakness was underlined by Myer chief executive Bernie Brookes, who yesterday reported that the department store chain's first-half profit fell by almost 20 per cent, and said that he saw no signs that the consumer spending strike was easing materially. Myer now says its full-year sales will be flat at best. And the structural pressure on Victoria from a high Australian dollar and relatively high interest rates will continue as the Reserve Bank focuses on containing inflation flowing from the nation's resources boom.
The Baillieu government says the pressure on the state reinforces the need for sound economic management that can deliver consistent surpluses that rein in debt, and generate funds in the medium term for infrastructure renewal. The strategy aims at entrenching the state's triple A rating, it said in December, adding that it was "the cornerstone of the government's agenda to build confidence, boost growth and improve productivity".
This year's surplus is contingent on the state not losing more economic momentum between now and June 30, however, and that is far from assured given last week's news that state final demand in Victoria expanded only 1.6 per cent in 2011 compared with 11 per cent in Western Australia and 10 per cent in Queensland. February's job numbers also showed Victoria, New South Wales and Tasmania lost 66,900 jobs in a year: Queensland, WA and South Australia added 83,400.
The downturn in the non-resources states is creating a vice for Victoria and NSW. To maintain their balance sheets and their triple A ratings they are being pushed towards spending cuts to offset revenue shortfalls. That, in turn, is further undermining their economic growth.
An increase in spending, for example on infrastructure projects that provided jobs in the short term and a boost to productivity in the longer term, would see their debt rise. Their surpluses could become deficits, and ratings downgrades would loom.
But as the south-eastern states struggle, the pros and cons become less clear-cut. A rating downgrade that marginally increases borrowing costs might yet be seen as an acceptable price for spending programs that boost productivity and protect Victoria and NSW from the backwash of the resources boom.
mmaiden@theage.com.au
Frequently Asked Questions about this Article…
What caused Victoria’s $6.5 billion half‑year non‑cash loss in the budget report?
The $6.5 billion non‑cash loss mainly comes from how the state values future superannuation payouts. Unusually low Australian government bond yields lower the discount rate used to calculate the present value of those liabilities, which inflates the liability on the books. About $1 billion of the loss reflects recent market weakness in super assets, while the rest is a bookkeeping effect that should reverse if bond yields rise.
How do low Australian government bond yields affect Victoria’s superannuation liabilities?
Low government bond yields reduce the discount rate used to convert future super payouts into a present‑day liability. A lower discount rate increases the net present value of those liabilities, creating a larger reported book loss even if the underlying obligations haven’t changed. When bond yields rise again, the reported liability should fall.
Does the half‑year deficit mean Victoria will lose its AAA credit rating?
Not necessarily. The government emphasises cost control and has been hunting savings to protect its AAA rating. The half‑year showed tighter accounts and a $341 million transaction deficit (or $810 million including government corporations), but the result is only a partial guide to the full year. Maintaining the AAA rating is a core strategy, though continued revenue weakness could put pressure on that goal.
What do the December‑half budget figures tell everyday investors about Victoria’s economic health?
The half‑year shows cyclical weakness: flat taxation revenue, softer sales of goods and services, and a move to rein in costs. These point to weaker consumer demand and property activity in Victoria, which can affect businesses and state revenues. Investors should be aware that some of the headline loss is non‑cash and tied to bond yields, but underlying economic indicators are signalling real pressure.
How are high interest rates and a strong Australian dollar hurting Victoria’s economy and state revenues?
Relatively high interest rates and a strong Australian dollar—driven by the resources boom—are moderating domestic demand and exporting pressure onto non‑resources sectors. Softer house sales and prices have reduced stamp duty and property‑related revenue, while weak consumer sentiment has hit retail and services, all of which reduce state income.
What did Myer’s results indicate about consumer spending in Victoria?
Myer’s CEO Bernie Brookes reported a nearly 20% fall in first‑half profit and warned of ongoing weak consumer spending, saying full‑year sales are likely to be flat at best. This underlines that consumer demand remains weak and reinforces the budget’s signals about retail and household spending pressures.
What are the policy trade‑offs the Victorian government faces that investors should watch?
The government can cut spending to protect balance sheets and its AAA rating, but that may further weaken growth. Alternatively, it could increase spending—especially on infrastructure—to boost jobs and productivity, which would raise debt and risk a ratings downgrade. Investors should watch budget updates, infrastructure plans, and any shifts in spending priorities.
Which macro indicators from the article should everyday investors monitor for signs of improvement or deterioration in Victoria?
Key indicators to watch are Australian government bond yields (which affect the super liability accounting), state tax and stamp duty receipts, retail and services sales (consumer sentiment), state final demand growth, and employment figures. The article highlights weak state final demand (Victoria 1.6% v WA 11%) and recent job losses in Victoria, NSW and Tasmania as important signs of economic momentum.
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