The fiscal repair job on Australia’s economic engine is proving not to be the horror show that many predicted, writes AICD chief economist Mark Thirlwell MAICD.
COVID-19 triggered a dramatic shift in Australia’s fiscal fortunes. In 2018–19, the deficit on the underlying cash balance was just $690m (less than 0.1 per cent of GDP), the closest the federal government had come to getting out of the red since 2007–08 and the onset of the global financial crisis. But with the beginning of the pandemic, the red ink flowed and the deficit rose to $85.3b (4.3 per cent of GDP) in 2019–20. It then ballooned further, reaching $134.2b (6.5 per cent of GDP) in 2020–21.
From there, fiscal repair was expected to be painful. As recently as the March 2022 Budget, the deficit was still expected to be about $78b (3.4 per cent of GDP) in 2022–23 and to remain in the red across both the budget forward estimates and the medium-term budget projections out to 2032–33. Even the more optimistic post-election October 2022 Budget was still predicting a $36.9b (1.5 per cent of GDP) deficit for this year.
So, the Treasurer’s announcement in the May 2023 Budget that he now expects to run a modest budget surplus of $4.2b (0.2 per cent of GDP) in 2022–23 was therefore a remarkable achievement. Provided the budget remains on track for the last few months of the current financial year, not only would he have delivered the first federal budget surplus in 15 years, but he would have done so via “the biggest budget turnaround on record”, with Australia also comfortably outperforming most other advanced economies in terms of its rate of budget repair.
Granted, the budget is not expected to remain in surplus for long. After just one year in the black, May’s budget predicts an underlying cash deficit of $13.9b (0.5 per cent of GDP) in 2023–24, although importantly that is $30.1b lower than the corresponding deficit forecast back in October 2022 and $42.6b lower than the May 2022 Budget projection. The fiscal shortfall is then projected to worsen until 2025–26, with the deficit expanding first to $35.1b in 2024–25, and then to $36.6b the following year. Taken overall, this new deficit path is still significantly lower than the one foreseen at the time of the October 2022 Budget, with a cumulative improvement in the underlying cash balance of $125.9b over the next five years.
How did Australia manage such a dramatic budget turnaround? Basically, the government has benefited from big upside surprises in terms of budget revenues, and then had the fiscal discipline to bank most of this windfall, not spend it. This was no doubt reinforced by the knowledge that with inflation running well above target, any excessive fiscal largesse would be met by offsetting RBA rate hikes. Take the current budget year. According to the Budget Papers, the effects of parameter and other variations since the October 2022 Budget have been to boost government receipts by almost $28.3b and reduce payments by more than $13.9b, for a total improvement to the bottom line of $42.1b. The government then plans to spend less than $1.1b of this in the form of new policy decisions.
Next year, budget discipline is not so strict — parameter and other variations are projected to improve the bottom line by a similar magnitude to 2022–23. But in 2023–24, new policy decisions will “spend” an additional $12b.
Even so, over the five years of the forward estimates to 2026–27, Budget 2023–24 reckons the total cumulative impact of parameter and other variations will be to reduce the deficit by $146.5b ($130.6b in higher receipts and $15.9b in lower payments) while the net impact of total policy decisions will increase it by a total of $20.6b, giving an overall net improvement of $125.9b relative to October’s projections.
The single most important driver of this transformation has been that $130.6b increase in projected government receipts. That, in turn, is mostly a tax story, with tax receipts revised up by $115.7b over the same period. High rates of employment and accelerating (nominal) wage growth have pushed up income tax receipts while higher for longer commodity prices are lifting profits and hence company tax receipts, with a supporting role for strong instalment payments due to higher turnover across the non-financial sector overall.
Improved debt burden
Meanwhile, on the payments side of the equation, lower interest payments on government debt are doing much of the heavy lifting.
That last effect reflects the way that a lower deficit trajectory also translates into an improved debt position. Due to the pandemic, net debt jumped from $373.6b (19.2 per cent of GDP) in 2018–19 to $592.2b (28.6 per cent of GDP) in 2020–21. As recently as the October 2022 Budget update, net debt was expected to still stand at $572.2b (23 per cent of GDP) by end-June this year and then to rise to $634.1b (25.8 per cent of GDP) by end-June 2024, before rising again to 28.5 per cent of GDP by the end of the forward estimates in 2025–26.
Lower financing needs in the current budget mean that net debt is now estimated to stand at “just” $548.6b or 21.6 per cent of GDP by 30 June 2023 and to rise to “only” $574.9b or 22.3 per cent of GDP by end-June 2024 — more than three percentage points of GDP lower than in the October 2022 Budget forecasts. By the end of the new budget forward estimates, the gap is larger than four percentage points, with the ratio of net debt to GDP at 24.1 per cent (in 2026–27).
Finally, that lower debt stock also means a lower debt service burden, assisted by a forecast decline in the weighted average cost of borrowing over the forward estimates in line with lower market expectations for interest rates. Over the four years to 2025–26, interest payments on Australian government securities are now projected to be $9.9b lower than estimated last October.
This article first appeared under the headline ‘Budget Turnaround’ in the June 2023 issue of Company Director magazine.
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