Australian Economy

‘Stunning pay rise’: commodity boom to fuel improved Australian budget | Australian economy

Soaring commodity prices and a shrinking jobless rate will combine to slice almost $90bn from projected federal budget deficits out to 2024-25, although excessive pre-election promises would undermine the government’s fiscal repair efforts, according to Chris Richardson, a senior economist at Deloitte.

The predicted improvement compares with forecasts in the government’s mid-year outlook (Myefo) released last December. The current year’s deficit alone will be cut almost a third from a projected $99.2bn to $69bn as the economy’s rebound from Covid disruptions quickens, Richardson said.

The falling unemployment rate – now at its lowest since 2008 – is helping to lift tax revenues and reduce welfare payments. However, about half of the improvement in the budget outlook stems from the commodity price surge, further increased by Russia’s invasion of Ukraine and the subsequent sanctions.

“The world is giving us a stunning pay rise,” Richardson said. “It’s not just that we have recovered faster and better than expected – it’s that the world is handing us money at a rate we’ve never seen before.”

Deloitte predicts the deficits out to 2024-25 will be $87.6bn smaller than the Myefo forecasts. The treasurer, Josh Frydenberg, who will present his fourth budget on 29 March, said on Friday “the time for large-scale economic stimulus is behind us”, and that “fiscal settings need to be normalised” as part of the government’s fiscal strategy.

A looming election, though, meant a rising risk of extravagant spending, particularly by a government that was trailing badly in the polls, as the Morrison government is.

“It’s a danger period, as we know from history,” Richardson said, citing promises by the Howard government for big tax cuts in 2007 and the Rudd government’s national disability insurance scheme in 2013, that had long-lasting budget effects.

“We don’t seem to be looking at something as big as either of those past experiences, but it’s certainly risky,” he said.

Any normalisation of finances should include dropping the low and middle income tax offset (LMITO) that was meant as a temporary relief and has now doubled to $1080 a year for those eligible.

Dubbed “lamington” for its LMITO acronym, the $8bn offset is scheduled to end in June unless extended, although the government may be wary of scrapping it before the election.

The benefits, though, amount to “middle-class welfare” as it excludes the half of Australia’s adult population that doesn’t pay income taxes, such as retirees, students or those on salaries too low to pay personal tax, Richardson said.

Modelling by Deloitte also indicates the injection of $8bn in the present economic state would trigger action by the Reserve Bank to quell the inflationary consequences, requiring an increase in the cash rate of 0.3 percentage points.

The cash rate is currently at a record low 0.1% with the central bank now saying a rate rise this year is “plausible” as inflationary pressures mount. Investors and some banks predict a move by July or sooner.

Longer term, Deloitte expects the government will spend more than currently forecast for areas such as social service, the NDIS and defence. To meet those costs, “you’ve got to save out of the budget something like 2% of national income a year, or about $40bn”, Richardson said.

“The economics of it is entirely doable, the politics of it is entirely disastrous.”

Frydenberg said the Deloitte forecast was “a further vote of confidence in Australia’s economic resilience, noting ‘Australia’s economy is booming’”.

“Australia’s economy has outperformed all major advanced economies since the pandemic began in both employment and output terms with our recovery stronger than that seen in the United States, United Kingdom, Canada, France, Germany, Italy and Japan,” he said.

Jim Chalmer, Labor’s shadow treasurer and Katy Gallagher, the shadow finance minister, welcomed the predicted deficit narrowing, but said the government “won’t take responsibility for a trillion dollars in debt or falling real wages”.

“The Coalition is showing all the signs of yet another budget full of secret slush funds before the election and secret cuts after it,” they said in a statement.

PwC Australia, another consultancy, also expects Frydenberg will reveal a smaller deficit for the 2021-22 fiscal year than projected, coming in at $80bn.

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Chief economist, Jeremy Thorpe, said: “[The] Australian economy has been remarkably resilient and deficit projections since the onset of Covid-19 have proven to be overly pessimistic as the labour market has remained strong, reducing the need for unemployment support, and increasing tax revenues.”

The recent floods in Queensland and New South Wales will be one budgetary drag, and the war in Ukraine would fan inflation risks. The latter was “not necessarily a terrible outcome from the budgetary perspective, ironically, because inflation means higher prices, and that means there’s more revenue”, he said.

So far, the major political parties have avoided major spending commitments, at least compared with the same stage ahead of the 2019 election. “This is not a time to be over-stimulating the economy,” Thorpe said. “The economy’s been humming along quite nicely, and inflation is a growing issue and a growing risk.”

Thorpe shared Richardson’s view that it was “hard to believe in an election year” the government would dump the LMITO despite it originally being meant to be temporary.

“Pensions, disability support, rental assistance – there’s a range of mechanisms that you might start to think of, if you’re really trying to target the most vulnerable,” he said.

To prepare for the future, when prices for commodities such as iron ore and coal drop, the government should use the budget to prepare the economy for the next generation of industries.

“How do we support green, cheap hydrogen or solar, … or extracting critical minerals and leveraging that into battery technology, rather than iron ore and coal?” Thorpe said. “We can’t rely on what we’ve done over the past 10 years to sustain a high level of growth going forward.”

“We project that the Commonwealth budget will not return to balance until 2036-37,” he said.

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