Budget 2018: lattes, fares and flexibility

Unexpected movements in commodity prices, the exchange rate, interest rates, the consumer price index and wages are the most likely economic and financial variables to cause receipts and payments to differ from budget projections.

Terms

The conservative view of commodity prices from Treasury is reflected in the government’s terms of trade forecasts in MYEFO at -2.0 per cent in 2017-18, after growing by 14.5 per cent in 2016-17.

This is weaker than ANZ’s +1.1 per cent forecast which is informed by more recent market data. In 2018-19, ANZ Research expects the terms of trade will fall by a similar percentage as Treasury, by around 5.4 per cent, although of course from a higher base. 

The government’s relatively conservative forecasts for iron ore and coal prices appear to be showing through in receipts data. $A3 billion of the $A5.5 billion upward surprise to receipts in the year to February was from higher-than-expected company tax receipts, though not all of this will be due to higher commodity prices.

As well as solid commodity price gains boosting revenue, ANZ Research expects there will be additional revenue flowing from the non-mining sector.

The Treasurer noted in a speech in April there would be a 7.9 per cent rise in tax receipts this year as company profits have picked up. ANZ Research also thinks there has been a boost from the end of a period of writing-off losses which had previously kept company tax liabilities down.

Response

In line with the better-than-expected corporate sector’s performance, employment growth will be stronger through 2017-18 than Treasury expected.

The response from households has been to increase labour supply so the workforce participation rate will also be higher than Treasury expected, in ANZ Research’s view. In sum, this means more workers paying more personal income tax.

Some of the upside surprise to personal income tax receipts due to strong employment growth will be offset by personal income tax cuts and lower-than-forecast wage outcomes.

In December, the government forecast wage growth of 2.25 per cent for the year to the June quarter 2018, but halfway through (year to the December quarter 2017) wages growth was running at 2.1 per cent.

ANZ Research expects it will stay at that rate until the June quarter before lifting a little, as spare capacity in the labour market declines. ANZ Reseach’s trajectory for wages growth compared to Treasury’s still suggests there may be further downward revisions for Treasury to make.

The personal income tax cuts for middle- and low-income earners are likely to begin from July 1 2018, partly to offset individuals moving into higher tax brackets. The government will no longer need to offset the previously planned increase in the Medicare levy, as previously announced.

The government will retain its plan to gradually cut the company tax rate from 30 per cent to 25 per cent for businesses with a turnover of more than $A50 million by 2016-27, despite not (yet) having Senate support.

It is conceivable – although not ANZ Research’s expectation – the government could remove these measures from the budget and use the funds elsewhere.

ANZ Research expects, therefore, the Government will introduce personal income tax cuts worth around $A3 billion in 2018-19, rising to around $A5 billion in 2019-20 and around $A8 billion in 2020-21.

In other words, the Government will use the better-than-expected receipts in the current and next financial year to fund income tax cuts for the household sector.

It is likely the Government will want lower taxes to be felt by households ahead of the next election, with greater tax cuts anticipated if they vote the incumbant back into office.

Link

Net debt is likely to be higher, with the government indicating funds will be allocated for several large infrastructure projects. These include $A5 billion for a Melbourne airport-to-CBD rail link and the $A1 billion for the M1 in Queensland. The Commonwealth also needs to fund its purchase of the Victorian and NSW shares of Snowy Hydro in this budget.

ANZ Research hopes ambitions for budget stability in the medium term projections is maintained as Australia’s fiscal position, albeit healthy by international standards, is still weaker than before the global financial crisis.

It is not until 2020-21 payments as a share of GDP are expected to come down to the last 40 year’s average (24.9 per cent). Net debt is expected to equal 18.9 per cent of GDP in the current year, and (on MYEFO assumptions) peak next financial year.

That means National Disability Insurance Scheme spending, ageing, structural changes, technological trends and community expectations of government policy need to be managed tightly.

The Australian Commonwealth Government Bond (ACGB) market has held a degree of indifference to the rise in government debt over the last few years. This is mostly because any supply has been readily soaked up by demand generated by regulatory measures and the flow of capital brought about by the global quantitative easing programs.

As the global rate structure starts to lift with gradual monetary tightening around the world, Australia’s former ‘high-yield moniker’ no longer rings true. This will become more of a headwind.

However, with both net and gross debt issuance dropping over the forward estimates, ANZ Research has little concern for demand-side pressures. Indeed, Australian yields are attractive on a hedged basis and ANZ Research expects yields to continue to contract against markets such as the US.

ANZ Research expects the longer end of the curve to be the beneficiary of reduced ACGB issuance as supply falls.

Markets will keep an eye on revenue assumptions, potential tax cuts and commodity prices as well as any changes ahead of the election due in early 2019. These factors will also be noted by credit rating agencies, though do not expect any movement on Australia’s rating.

With the government politically motivated to maintain its rating – while also needing to protect Australia’s ability to raise foreign capital – there is little room in the budget projections for deterioration in estimates.

Fiscal policy will become slightly looser over the coming two years, compared to where it would have been if there were no policy changes. For the Reserve Bank of Australia, this modest change, while welcome, is unlikely to substantively change the outlook.

Cherelle Murphy is a Senior Economist at ANZ