Strong economy cuts the budget deficitPetrol prices at 3-year highs
Mid-Year Economic and Fiscal Outlook (MYEFO); Weekly petrol prices; New vehicle sales
Smaller 2017/18 deficit: The Federal Government is projecting a $23.6 billion deficit (1.3 per cent of GDP) for the current financial year. The May budget had forecast a deficit this year of $29.4 billion. A budget surplus of $10.2 billion is expected in 2020/21. A strengthening economy, rising company profits and labour market has boosted tax receipts, improving government revenue.
Economic assumptions: The economic growth projections are largely unchanged. There has been a slight downgrade of economic growth (GDP) assumptions for 2017/18 to 2.5 per cent from the previously reported 2.75 per cent, but the later forward estimates are unchanged. Unemployment rate forecasts have improved from 5.5 per cent to 5.25 per cent in 2018/19 and 2019/20. Wages growth is projected to bottom at 2.25 per cent (previous 2.5 per cent) in 2017/18, before gradually picking-up over the forward estimates. Inflation remains largely unchanged at a projected 2.25-2.5 per cent through the majority of the period.
The budget deficit is expected to narrow from 1.3 per cent of GDP to 0.1 per cent of GDP within 3 years. The underlying cash balance is projected to return to surplus at 0.5 per cent of GDP in 2020/21, above the May forecasts.
Petrol: According to the Australian Institute of Petroleum, the national average Australian price of unleaded petrol rose by 7.0 cents last week to 143.2 cents a litre – the highest price in 3 years.
New vehicle sales: The Australian Bureau of Statistics (ABS) reported that new vehicle sales rose by 0.1 per cent in seasonally-adjusted terms in November to be up 2.1 per cent on a year ago.
Since the release of the Commonwealth Federal Budget back in May, the Turnbull Government has attempted to realign its political agenda against an improving domestic and macroeconomic backdrop. Economic growth has picked-up since the beginning of the year, underpinned by broadly rising commodity prices, strengthening business investment and corporate profits, together with robust government spending on infrastructure.
Treasurer Scott Morrison has also re-cast the narrative around debt, highlighting in the Federal Budget the need for the government to differentiate between “good” and “bad” debt. The Treasurer has defined “bad” debt as debt accrued to fund increasing health, welfare and other government everyday expenses; while debt amassed to fund projects and policies that eventually lead to productivity and generated returns are considered “good” debt. He also sought to re-define the discussion around the Budget’s profile. Instead of focusing entirely on the “underlying cash balance”, he prefers to use “net operating balance” to describe differences between revenue and expenditure, excluding capital expenditure. For the purposes of our analysis, we are sticking with the status quo.
The Treasurer’s cautious economic forecasts, spending restraint and focus on productivity is somewhat reflected in today’s Mid-Year Budget outcomes. There have been minimal changes to the May Budget’s economic forecasts and fiscal projections. Pleasingly, the Budget bottom line has improved, driven by better-than-expected revenue growth. And the revenue outlook has not been marked down significantly, as has largely been the case over the past decade.
In the May 2017 Federal Budget, the deficit was forecast to decline from $29.4 billion, 1.6 per cent of GDP, in 2017/18 to be close to balance in 2019/20, followed by a small surplus in 2020/21, a forecast $7.4bn, 0.4 per cent of GDP. This fiscal profile was largely confirmed in today’s Mid-Year Budget update.
The Federal Government is now projecting a much improved $23.6 billion deficit (1.3 per cent of GDP) for the current financial year supported by an improvement in revenue. A strengthening economy, rising company profits and labour market has boosted tax receipts, improving government revenue. A budget surplus of $10.2 billion is expected in 2020/21, an improvement of $2.7 billion compared to May’s Budget update. Since the Budget, the underlying cash balance has improved by $9.3 billion.
It is clear that the government will need to push through further reform and budget repair measures to attempt to get the budget back to surplus by the out-years. The government is clearly factoring in that some of the spare capacity in the economy will be gradually absorbed over this period. It also plans to achieve $1.2 billion in savings in the forward estimates by broadening the criteria for waiting periods for newly arrived migrants before they can access certain welfare benefits.
Expected receipts have been revised up by $3.6 billion to $437.1 billion in 2017/18 and $0.6 billion to $463.1 billion in 2018/19, but decline by $0.7 billion to $496.2 billion in 2019/20 and by $0.7 billion to $525.6 billion in 2020/21 when compared to the May Budget.
Expected payments have declined over the forward estimates: down by $2.1 billion to $457.6 billion (2017/18); down by $0.3 billion to $480.1 billion (2018/19); down by $0.6 billion to $495.0 billion (2019/20) and down by $3.5 billion to $515.4 billion (2020/21).
Economic growth (GDP) in 2017/18, in nominal terms, is set to undershoot the Budget forecast, at a likely 3.5 per cent, below an expected 4.0 per cent in the previous update. Nominal GDP growth for the three years from 2018/19 is expected to be: 4.00 per cent (unchanged); 4.50 per cent (unchanged); and 4.75 per cent (unchanged).
National income growth had strengthened during the previous financial year 2016/17 due to broadly rising commodity prices. The terms of trade, however, is projected to decline by around 2 per cent in 2017/18, in contrast to the Budget expectation for a decline of 2.75 per cent. A 5 per cent decline is forecast for 2018/19, down from the previous forecast of -4.25 per cent on a downgrade to coking coal price assumptions.
Economic growth (GDP) in 2017/18, in real terms, is set to fall short of the Budget forecast, at a likely 2.5 per cent, below expected 2.75 per cent in the previous update. A return to trend growth of around 3 per cent is expected over the out-years.
The 2016/17 outcome for net general government debt was $325 billion, 18.4 per cent of GDP. This was $2.8 billion below that expected in the May Budget. The Mid-Year Budget shows an improved net debt profile. Net debt is projected to peak at $365.2 billion, 19.2 per cent of GDP in 2019/20, declining to $355.3 billion, 17.2 per cent of GDP, in 2020/21. The government is not expected to need to borrow for recurrent spending from 2017/18, a year earlier than predicted in the May budget.
There has been no changes to the government’s inflation forecasts. Slow wages growth has been a particular focus of both the Reserve Bank, economists and the media in recent months. The disconnect between strong employment growth and modest wages growth has baffled most, particularly with a tightening labour market. Structural changes – especially technological disruption, globalisation and the increased casualization of the workforce – are behind the capping of wages pressures. However, it is likely that there is still spare capacity in the economy, despite skilled worker shortages emerging in some occupations, resulting in subdued income growth. Nevertheless, like the Reserve Bank, the government is anticipating eventual rising wages. However, the Wages Prices Index has been revised down across all periods by 0.25 per cent since the May Budget, with wages now projected to rise from 2.25 per cent in 2017/18 to 3.5 per cent in 2020/21. This has the potential to weigh on personal income tax receipts.
The economy is heading in the right direction. Growth is currently at or near the Reserve Bank’s trend pace of growth at 2.8 per cent (September quarter). Contained inflation, however, means that we have another lengthy period of interest rate stability ahead. Employment is growing strongly with the unemployment rate projected to fall to around 5.25 per cent over the next few years. Consumer confidence is currently at 4-year highs, which is supportive of household consumption. That said, developments in the housing market will be closely observed.
Given the improving economic and fiscal backdrop, the Turnbull Government doesn’t need to “slash and burn”. Its cautious fiscal restraint is being complemented by rising revenues. Rather it needs to foster strong, sustainable economic growth and apply targeted spending cuts that seek to improve productivity and efficiency.
From July 1 2018, the current 2-year waiting period for a range of payments, including the Family Tax Benefit, Paid Parental leave and Carers’ Allowance, will be extended to three years.
Around $2.1 billion worth of cuts to university funding have now been confirmed. We believe it is likely that other major policy initiatives will now be deferred until at least the May 2018 Budget.
Prime Minister Malcolm Turnbull has recently raised the possibility of personal income tax cuts – following the well-publicised Trump Administration’s tax bill in the US. The government’s improving budget profile could provide some scope for modest tax cuts for individuals ahead of the next Federal election which is due before November 2019.
What do the figures show?
The Federal Budget is projected to be in deficit by $23.6 billion in 2017/18 (1.3 per cent of GDP) compared with May forecasts of $29.4 billion. A budget surplus of $10.2 billion is expected in 2020/21.
The Government expects the economy to grow by around 2.5 per cent this year, below its May Budget forecasts. Estimated growth for the forward estimates is unchanged at 3.0 per cent through to 2020/21.
Net government debt profile has improved and is is projected to peak at $365.2 billion, 19.2 per cent of GDP in 2019/20, declining to $355.3 billion, 17.2 per cent of GDP, in 2020/21.
Petrol prices
According to the Australian Institute of Petroleum, the national average Australian price of unleaded petrol rose by 7.0 cents last week to 143.2 cents a litre. The metropolitan petrol price rose by 9.8 cents to 144.6 cents per litre while the regional price rose by 2.6 cents to 140.5 cents per litre.
Average unleaded petrol prices across states and territories over the past week were: Sydney (up by 9.1 cents to 144.0 c/l), Melbourne (up by 11.3 cents to 143.8 c/l), Brisbane (up by 14.6 cents to 148.7 c/l), Adelaide (up by 13.8 cents to 147.3 c/l), Perth (up by 0.1 cents to 137.8 c/l), Darwin (up by 2.1 cents to 150.1 c/l), Canberra (up by 2.3 cents to 149.2 c/l) and Hobart (up by 1.6 cents to 144.6 c/l).
The national average Australian price of diesel petrol rose by 0.8 cents to 137.1 cents per litre. The metropolitan price rose by 1.1 cents to 137.8 c/l, while the regional average price rose by 0.6 cents to 139 c/l.
Today, the national average wholesale (terminal gate) unleaded petrol price stands at 124.2 cents a litre, down 0.5 cents over the week. The terminal gate diesel price stands at 123.5 cents a litre, up by 0.1 cents over the past week.
Last week the key Singapore gasoline price rose by US55 cents or 0.7 per cent to US$75.25 a barrel. In Australian dollar terms the Singapore gasoline price fell by $1.40 or 1.4 per cent to $98.05 a barrel or 58.23 cents a litre.
MotorMouth records the following average retail prices for capital cities today: Sydney 142.7c; Melbourne 147.3c; Brisbane 148.0c; Adelaide 143.6c; Perth 127.2c; Canberra 145.6c; Darwin 150.4c; Hobart 129.2c.
New vehicle sales
According to the Australian Bureau of Statistics (ABS), new vehicle sales rose by 0.1 per cent in seasonally adjusted terms in November. Passenger car sales fell by 1.6 per cent, however, sales of sports utility vehicles (SUVs) rose by 1.4 per cent. Sales of “other” vehicles (includes utilities, panel vans, cab chassis, goods carrying vans, rigid trucks, prime movers, non-freight carrying trucks, and buses) rose by 0.8 per cent.
Across states & territories in November: NSW (flat); Victoria (down 0.3 per cent); Queensland (up 0.5 per cent); South Australia (down 0.8 per cent); Western Australia (up 0.7 per cent); Tasmania (up 2.9 per cent); Northern Territory (down 0.3 per cent); ACT (up 2.3 per cent).
New vehicle sales are up by 2.1 per cent over the year. Passenger car sales are down by 6.5 per cent, while SUVs sales are up 6.2 per cent and “other” vehicles are up by 11.0 per cent.
In rolling annual terms, 1,185,059 new vehicles were sold over the year to November. Sales of SUVs (460,153) and “other” vehicles (269,257) both rose to fresh record highs. Sales of passenger vehicles, however, fell to a record low of 455,649 in the year to November.
What is the importance of the economic data?
The Mid Year Economic and Fiscal Outlook report is presented by the Government around October-December each year. The report is an update on how the Federal Budget is tracking and is therefore an update on the fiscal policy stance of the Government.
Weekly figures on petrol prices are compiled by ORIMA Research on behalf of the Australian Institute of Petroleum (AIP). National average retail prices are calculated as the weighted average of each State/Territory’s metropolitan and non-metropolitan retail petrol prices, with the weights based on the number of registered petrol vehicles in each of these regions. AIP data for retail petrol prices is based on available market data supplied by MotorMouth.
The Australian Bureau of Statistics provides seasonally adjusted and trend estimates of industry data. The Federal Chamber of Automotive Industries releases estimates of car sales on the third business day of the month. The figures highlight the strength of consumer spending as well as conditions facing auto & components companies.
What are the implications for interest rates and investors?
The Mid-Year Budget update released today by the Turnbull Government shows that the Budget is on track to return to surplus in 2020/21. The Budget deficit has improved by $5.8 billion in 2017/18 due to strengthening revenue outcomes from an improving domestic macroeconomic backdrop. Robust business investment is drivingup company profits and rising employment is boosting tax receipts. Economic growth (real GDP) is expected to return to trend 3 per cent levels from 2018/19, rising from 2.5 per cent in 2017/18. That said, the government expects inflation to remain contained due to tepid wages growth and retail deflation.
The Australian Competition and Consumer Commission (ACCC) said last week that it would oppose BP’s proposed $1.75 billion deal to buy Woolworth’s 531 petrol stations. Chairman Rod Sims said; “We felt that a 1-2 cent price increase for Australian motorists really does matter. BP’s prices are significantly higher on average than Woolworths in the major capital cities”. It is reassuring that Australia’s top consumer watchdog is monitoring anti-competitive developments in the petroleum industry. Motorists are already under significant budgetary pressures in the lead-up to Christmas. Petrol prices have risen to the highest level in 3 years during the peak holiday driving period.
Aussies are continuing to purchase new vehicles with sales of SUV and “other” vehicles, such as utes, at record highs. And they are buying because vehicle affordability is the best it has been. 
Originally published by Ryan Felsman, Senior Economist, CommSec