The Distillery: PEFO pile-up

If the Pre-Election Economic and Fiscal Outlook were a movie, it would be Todd Phillips’s The Hangover Part II. It was effectively a remake of the original, which in this case is the government’s post-budget economic statement, rather than another chapter that delivers anything new – and the critics are disappointed.

Perhaps the main difference between Treasury’s forecasting and The Hangover trilogy is that the Phillips movies are far more believable. Fairfax’s Malcolm Maiden, like every commentator this morning, points out that its forecasting skills have been questioned lately.

“The July 2010 PEFO predicted a surplus of $3.5 billion in 2012-13. The actual result was a $41.4 billion deficit. It predicted a $4.5 billion surplus in 2013-14. The new PEFO predicts a deficit of $30.1 billion. It was the revenue estimates that went most badly awry, as spending shifted from consumers who pay tax to businesses that can claim tax concessions, as paper capital gains were vaporised by the crisis, as credit expansion collapsed, and as the Australian dollar stayed stronger for longer than expected, defying a slide in commodity prices and the terms of trade, and delaying a baton pass from the resources investment boom to the non-resources sector. The question is how much forecasting risk still exists, and there are some brave assumptions in the new outlook.”

Indeed, Business Spectator’s Stephen Bartholomeusz writes that the PEFO is based on some guesswork about economic events both at home and abroad.

“As the PEFO said, the forecasts and projections are based on an expectation that the Australian economy will transition away from resource investment-led growth towards more broadly-based growth ‘although this transition may not occur as smoothly as forecast’. That transition was needed, the department said, to deliver sustained economic growth – which says that if it doesn’t occur there won’t be sustained economic growth. Global economic uncertainty and the question marks over the rate at which growth will settle in China’s economy as its new leadership grapples with their own attempted transition from export and investment-led growth to a greater emphasis on consumption means that trying to forecast commodity prices and Australia’s terms of trade over the next four years with any precision is, as the departments essentially acknowledged, a near-impossible task.”

The Australian’s Judith Sloan has a more emphatic way of expressing that same scepticism.

“It continues to run with ludicrously optimistic projections on revenue growth. Receipts are expected to grow by 22 per cent between 2013-14 and 2016-17, moving the ratio of receipts to GDP from 23.6 per cent to 24.8 per cent over a period of time when growth is at or below trend. Sounds implausible? It is. Certainly, Treasury is a tad defensive about the inexplicable drop in the rate of unemployment from 6 1/4 per cent in 2014-15 to 5 per cent in 2015-16 as outlined in the projections…But here's the real kicker. An alternative scenario is presented in which unemployment declines more gently but GDP growth increases, thus presenting offsets gains and losses in terms of expenses and revenue. But hang on: the more likely combination is a smaller drop in unemployment and a lower growth in GDP, the combination of which would produce a deficit in 2016-17. We couldn't have that, though.”

The Australian Financial Review’s David Bassanese does have some explanation for some of the curious elements of the PEFO.

“As is usual with these projections, the budget improvement largely reflects ‘bracket creep’ – or a lift in average income tax rates faced by workers as nominal incomes rise over time. Treasury’s projection that the unemployment rate miraculously drops back to 5 per cent by June 2017 remains odd, but it is a quirk of its technical projection methodology. Importantly, this assumption does not cost the budget too much as it also assumed economic growth will remain at only a trend pace over 2015-16 and 2016-17.”

And the Herald Sun’s Terry McCrann absolutely smashes anyone who takes anything away from the PEFO other than a big, long belly laugh.

“Treasury has officially announced it is a complete joke. The PEFO is an exercise in utter institutional incompetence and quite simply an embarrassing disgrace. With this document Treasury has finally, finally, jumped the shark. It has announced it is utterly useless as either a source of competent analysis of the economy, or in advising on the nation's fiscal affairs. Or, providing an independent assessment of the fiscal position for the election campaign.”

Fairfax’s Michael Pascoe isn’t so much unswayed by the scepticism towards the numbers, but does get a giggle out of Treasurer Joe Hockey’s dismissiveness towards them and their authors at Treasury.

“Hockey was getting his denial in early when he declared he didn't believe the ES figures and, therefore, he can't believe the PEFO figures either. If the man who would be Treasurer doesn't believe his department's best efforts, one might assume his first big slash at the Canberra public service will be to sack the entire Treasury and put government bean-counting out to tender – departmental secretaries come much cheaper in Mumbai.”

At the end of the day, as The Australian Financial Review’s highly respected political editor Laura Tingle points out, this is a baseline for the election spending promises of both parties.

“The PEFO has established the base from which the debate about economic management will be fought. No matter how much the Coalition may raise questions about Labor’s budget position, no matter how much credibility the government, Treasury and Finance may have lost over their regularly collapsing revenue forecasts, these are now the best estimates of the public servants charged with overseeing the budget process, the same public servants who will serve Tony Abbott and his government if they win on September 7.”

Meanwhile in company news, The Australian Financial Review’s Chanticleer columnist Tony Boyd writes that Mark Steinert has put on such a clinic at Stockland Group that his turnaround efforts stands out as a prime case study.

The Australian’s John Durie reports comments from Westpac boss Gail Kelly that the housing market is unlikely to overcook.

And finally, Fairfax’s Elizabeth Knight says the iron ore price surge has divided analysts into two distinct camps. One believes that the seasonal demand will subside and with it the price of iron ore will come down to where it should be. The other is already revising up its price forecasts.