In the Mid-Year Economic and Fiscal Outlook published on October 22, the government was forecasting a surplus of $1.1 billion in 2012-13, a marked turnaround from -$43.7 billion for 2011-12 but in line with the budget forecast of $1.5 billion. The government stepped back from that goal yesterday, stating that it was "unlikely" to bring in a surplus in the 2012-13 year, with revenues $3.9 billion below forecast as of the October financial statement (four months into the financial year).
With little time left in the year, and a large number of strings already pulled attempting to achieve the surplus, the government has taken the prudent approach by accepting that a surplus in 2012-13 is now unlikely. An additional concern is the impact of weak revenue performance on the estimates for 2013/14.
The government has deferred forecasting any new estimates for the 2012-13 and 2013-14 fiscal positions until the new year. Without the benefit of detailed "bottom up" estimates from Finance we can only provide estimates on the basis of our own macro forecasts and the sensitivity analysis which the government provided in the MYEFO. On that basis the revised estimates would be for a deficit of around $3 billion in 2012-13 and $6.5 billion in 2013-14. With current receipts for 2012-13 running at an annualised deficit pace of around $8 billion for the first four months these estimates clearly have downside risks.
The treasurer has emphasised that the key reason for the budget revisions is around the considerable downward revisions to nominal GDP growth resulting from the persistent high Australian dollar and the lower than expected price pressures in the domestic economy. The treasurer was reluctant to provide any guidance on the new budget estimates and that is a reasonable position to take given the complexities of the calculations and the significant changes to the MYEFO economic forecasts which are now likely.
We are able to at least apply the sensitivity analysis which the government has provided in the MYEFO to our own growth forecasts to provide an estimate of the new budget position. The sensitivity analysis indicates that a 1 per cent lower outcome for nominal GDP growth which resulted from a permanent fall in the terms of trade of around 4 per cent (and no resulting adjustment in the level of the Australian dollar) in 2012-13 would lead to a weakening of the budget position of $2.6 billion in 2012-13 and $6.7 billion in 2013-14.
The table sets out our forecasts for nominal GDP growth in 2012-13 and 2013-14 and the current MYEFO estimates. We expect nominal GDP growth in 2012-13 to be 2.75 per cent compared to the MYEFO estimate of 4 per cent. That indicates a shortfall of $3.25 billion in 2012-13 pushing the MYEFO "surplus" of $1.1 billion into deficit. An additional concern would be the impact in 2013-14 with a further shortfall of $8.4 billion against a MYEFO estimate of a $2.2 billion "surplus".
The deficit estimate for 2012-13 is driven more by Westpac's estimate of real GDP growth of 2.75 per cent compared to 3 per cent for MYEFO and an assumption of zero growth in the GDP deflator compared to the MYEFO estimate of 1 per cent. We are broadly in agreement with MYEFO's terms of trade estimate of a fall of 8 per cent.
With the shortfall in government estimates of $3.9 billion in the first four months already higher than the annual shortfall indicated using the sensitivity analysis the risks to this estimate must be to the downside. But it would also be inappropriate to flatline the first four months to arrive at an annual estimate. We are mindful that the economy was transitioning through a soft spot in the initial months of 2012-13.
Also, the spending numbers for the first four months are $1.2 billion under MYEFO estimates, providing a partial offset to the revenue shortfall.
From this analysis the big issue for the budget outlook will be 2013-14 where we expect to be looking at a $6.5 billion "hole" already.
Our estimates for nominal growth in 2013-14 are broadly in line with MYEFO with 5.75 per cent compared to MYEFO's 5.5 per cent. We expect lower real growth (2.6 per cent versus 3.0 per cent) but we expect a much stronger terms of trade ( 6 per cent vs -2.75 per cent in MYEFO) and a much softer increase in the domestic deflator than MYEFO. Overall we would not expect the 2013-14 position to deteriorate further than the $8.5 billion which will mechanically result from the 2012-13 under performance of nominal GDP growth.
It is important to emphasise the risks around the estimates we have provided. They rely upon the MYEFO sensitivity analysis. For example, while the sensitivity analysis uses lower nominal GDP growth due to a terms of trade effect our estimate of the lower nominal GDP growth is due to real effects and lower inflation in the domestic economy.
Furthermore, for 2013-14 we have a much more positive view on the terms of trade due to our outlook for Chinese growth and a slow supply response in iron ore and metallurgical coal. If we adopted the MYEFO terms of trade forecast then the further deterioration of the fiscal position in 2013-14 would be around $5 billion.
Bill Evans is Westpac's chief economist.
WEEKEND ECONOMIST: Budget bleed
In addition to the revenue shortfall that led to this week's surplus backflip, there are predicted reduced takings for the year 2013-14 which has that budget already staring into a multi-billion dollar hole.
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