The federal budget contains modest upgrades on the mid-year economic and fiscal outlook and appears broadly consistent with the outlook provided by the Reserve Bank of Australia last week. Nevertheless there remains considerable uncertainty surrounding the economic outlook -- particularly with regards to the collapse in mining investment and export growth.
The Australian economy has improved since the government released its MYEFO in December last year. Low interest rates continue to support activity in the non-mining sector -- particularly in household spending and dwelling investment -- but there remains considerable uncertainty surrounding the collapse of mining investment.
As a result, readers should take the estimates contained within the budget with a grain of salt. We might spend a lot of time analysing the data but these budget forecasts will prove as inaccurate as any of the budgets compiled by Wayne Swan, Peter Costello and Paul Keating.
The budget assumes that real GDP in 2013-14 grows by 2.75 per cent -- consistent with those by the Reserve Bank of Australia in its recent Statement on Monetary Policy. In 2014-15, the budget estimates that growth will slow to 2.5 per cent -- towards the bottom of the RBA’s estimates.
Low interest rates will continue to support the non-mining sector but there remains considerable uncertainty surrounding the size and timing of the mining investment collapse. Business investment is set to fall sharply over the forecast horizon -- and the government has downgraded its forecasts for investment since MYEFO.
The budget assumes fairly modest consumption growth in 2013-14, at just 2.5 per cent. To achieve that, household spending must grow by around 0.6 per cent in both the March and June quarters. With retail sales volumes rising by 1.2 per cent in the March quarter, household spending should easily meet the near-term projections in the budget.
But the government’s medium-term outlook is difficult to square away with its assessment of labour market conditions. The government believes that the unemployment rate will head above -- and then remain at -- 6 per cent throughout the forecasts.
Despite that, the budget estimates that household spending growth will actually pick up over the next few years. The supporting documents offer no plausible reason as to why this might take place, and strike me as particularly unusual, given the welfare cuts contained in the budget.
Certainly it is possible that the labour market might deteriorate further -- particularly given the uncertainty surrounding mining investment -- but if that eventuates then it is highly unlikely the consumption growth will improve.
The near-term outlook for dwelling investment remains positive and the high level of building approvals is set to support the economy over the next few years. The budget estimates that dwelling investment will rise by 7.5 per cent in 2014-15 and a further 5.5 per cent in 2015-16.
Nevertheless, building approvals may have already peaked, suggesting that the residential investment boom may be short and sweet. The forecasts point to a fairly sustained boost to investment, but that appears unlikely to eventuate.
The forecast for public demand is stronger than I anticipated pre-budget, and provides some upside risk to the RBA forecasts released last week. The budget estimates that public demand will rise by 1.5 per cent in 2014-15.
The budget is relying on strong contributions from net exports to meet growth targets in 2014-15 and 2015-16. Iron ore exports are set to rise further as more mining projects transition towards the production stage, but a reliance on export growth is not without its risks.
Trade is a fairly volatile component of GDP and relying on it to drive growth only increases the considerable uncertainty facing the Australian economy. If the dollar falls further -- which is likely to happen as iron ore production expands -- then exports will be awfully strong.
However, if the dollar falls in response to slower demand from China then the trade boom may be much weaker than expected. A slowdown in China meeting a collapse in mining investment is pretty much the worst case scenario -- but it is far from an implausible scenario.
The budget assumes that nominal GDP -- an input driver of tax revenues -- will rise by 4 per cent during 2013-14, before dipping to just 3 per cent during the following financial year. This requires nominal GDP to rise by around 0.7 per cent in both the March and June quarters, providing some modest upside tax revenues and the deficit during the 2013-14 financial year.
The economic outlook contained in the budget is broadly consistent with the forecasts released by the RBA last week. Nevertheless there remain a number of challenges for the Australian economy and considerable uncertainty surrounding the outlook.
Understanding the economic outlook requires an appreciation of the risks involved. Focusing too much on the headline data is not particularly helpful and readers should give careful consideration to the factors creating uncertainty around both the budget and the economic outlook.
The key takeaway point though is that the outlook remains fairly soft and the major drivers of growth are exceptionally uncertain. Successfully navigating these choppy waters will require a fair bit of luck in addition to good economic management from both the RBA and government.