Treasury's forecasts will shape the election

The pre-election assessment of the shape of the economy by the Department of Treasury could hold the key for one of the parties. But which?

With fiscal policy, budget surpluses and government debt set to be a key issue at the election, a highlight during the upcoming campaign will be the release of the Pre Election Fiscal Outlook, or PEFO. 

The PEFO will be prepared by the Departmental Heads of Treasury and Finance 10 days after the writs are issued for the election and it provides the latest and up-to-date forecasts for the economy in the current year and next with projections for the forwards estimates after that.

These forecasts and projections, plus additional information since the May budget on revenue and expenditure, will be applied by Treasury and Finance to the big picture estimates which will give a new estimate of the budget deficit and surplus in this and the next three years.

Treasury and Finance will also incorporate the financial implications from government policy decisions that have been made since the May budget. PEFO will present a completely independent assessment of economic conditions and the budget bottom line.

The most obvious of these is the recent decision to drop the fixed price for carbon a year early and move to an exchange-traded price for carbon, a move that the government estimates will cost it $3.8 billion. The policy changes announced to cover the cost to the budget of this move have also been announced so the net effect is approximately revenue neutral when PEFO is released.

For 2013-14, the budget deficit looks to be a little bigger than the budget-time estimate of $18 billion. The fall in the terms of trade, a slightly weaker labour market and softer wages growth are likely to be the main drivers of this slight bottom line blow out. The lower Australian dollar helps revenue, but higher bond market interest rates are likely to add $250 million to the annual net interest bill.

A back of the envelope calculation suggests the PEFO will show the deficit of around $23 billion or around 1.3 per cent of GDP.

For 2014-15, there are conflicting pressures on the bottom line. The move to the ETS will hit mostly in this year while the savings are spread over several years. But by 2014-15, Treasury is likely to ramp up the GDP forecast from the budget time estimate of 3 per cent to around 3.5 per cent. This could see the unemployment rate forecasts to be scaled down a little to 5.5 per cent from 5.75 per cent, all of which suggests the bottom line deficit forecasts for a deficit of $11 billion should be little changed.

The interesting issue is for the year of the small surplus – 2015-16. The budget estimate was for the budget to register a surplus of $800 million although there is a range of different pressures on the likely update of this forecast.

On balance, it looks like there is some scope for this surplus to be revised up a touch, but this is dependent on the base effect of Treasury lifting its forecasts for the previous year’s GDP to 3.5 per cent. If it does this and then holds growth constant the next year, and the unemployment rate ticks lower, the budget surplus for 2015-16 could be as high as $4 billion or 0.3 per cent of GDP.

Clearly, with Australia’s annual GDP running at $1.6 trillion, in 2013-14, with budget revenue and spending close to $800 billion combined, small errors in the forecasts and even small shocks to the drivers of revenue and spending can and no doubt will yield big effects to the bottom line.

If for example, Treasury makes a 1 per cent of GDP error in its forecasts for total revenue, the budget surplus would be $4 billion higher or lower depending on the direction of the error.

Which goes to show how sensitive the PEFO will be to the fine judgments and forecasting prowess of Treasury.

Whether it takes a glass half full or glass half empty view of the economic outlook into 2013-14 and 2014-15 could make a huge difference to the bottom line and because of that, the PEFO will be a huge event in the election campaign.

It is just too early and too hard to say which side of politics will be more pleased to see it.

Stephen Koukoulas is managing director of Market Economics and was former economics advisor to the then-prime minister Julia Gillard.