By Stephen Koukoulas
13 May 2015
The budget’s prediction of a surplus in 2019-20 is based on some rather conservative estimates. If the economy performs just a bit better then this time next year the Treasurer may have some good news to share, writes Stephen Koukoulas.
The baby rabbit out of the hat in the budget was the fact that the budget deficit forecast for 2014-15 was $35.1 billion, some $5 billion below the consensus forecasts of the private sector and about $10 billion below some of the high profile “extreme” forecasts released over the past week or so.
The budget was about as frightening as an Enid Blyton Famous Five novel and nothing like the Stephen King horror novel that was being spoken of just last week.
The smaller than expected deficit was, in part, due to the fact the economy in recent months has been a little stronger than was assumed at the time of the Mid-Year Economic and Fiscal Update. Compared to the MYEFO forecasts for 2014-15, job creation is faster, the unemployment rate lower and nominal GDP growth is in line. That said, the deficit is higher than the $31.2 billion assumed in MYEFO with this blow-out largely the result of Government policy decisions and policy reversals as it grapples with the obstructionist Senate and the political reality of a raft of unpopular policies from the 2014 budget.
Going beyond 2014-15, the budget is predicated on accelerating GDP growth with the surplus in 2019-20 based on three years of above trend GDP growth. This is possible, of course, but will be challenging, particularly if the housing downturn turns ugly or the terms of trade decline drops below the Treasury estimates.
Rarely is it worth quibbling with the budget forecasts produced by Treasury. History shows that its track record with macroeconomic forecasting is better than most in the private sector and most quibbles are only over a quarter of a percentage point on real GDP growth or a percentage point on the change in the terms of trade.
The same should apply to this year’s budget forecasts. Right here and now, the GDP, employment, wages and inflation projects are reasonable. Mr Hockey’s second budget has been framed around the big picture forecasts that happen to be close to the consensus for private sector economists for the period out to 2016-17.
One area that will be vitally important to the budget position will be the iron ore price, which in the budget is assumed to trade at $US48 a tonne over the forecast horizon.
The recent spot price for iron ore has been above $US60 a tonne with the $US12 difference between the Treasury forecast and the current level worth about $3 billion a year to the budget bottom line. This is a huge amount of money that swings with the vagaries of supply and demand for iron ore.
In other words, if over the course of the forecast horizon iron ore is at the current spot price, I calculate each year’s budget deficit will be $3 billion smaller than estimated in the budget.
Treasury also appears to have taken a conservative approach to its labour force forecasts. Over recent months, the unemployment rate has edged off its recent high to be about 6.2 per cent. Treasury is forecasting the unemployment rate to increase to 6.5 per cent before slowly edging back to 6 per cent in 2017-18. This may be too pessimistic given the ongoing upturn in job advertisements which, if sustained, would suggest a sub 6 per cent unemployment rate by the end of this year.
If, as is reasonable, the unemployment rate were to be 0.25 to 0.5 percentage points lower than assumed, I calculate the budget would be a further $1 billion or so better off each year.
Such is the power of the economy in delivering (and hindering) the budget revenue and spending outcomes. A few dollars difference in the global iron ore price, a small change in employment growth or a swing in GDP growth can have a huge impact on the budget bottom line.
The economic forecasts in the budget look about right, notwithstanding some of the obvious risks in iron ore or the labour market, but if the economy is a little stronger or iron ore a little higher than currently assumed, this time next year the Treasurer may well be announcing smaller budget deficits and may even bring forward the date the budget to return to surplus.
Certainly the Government would be hoping for this, particularly given the election is scheduled for a few months after next year’s budget.