Last night, Treasurer Josh Frydenberg delivered a budget aimed to balance the need for government support to keep the economy going as it recovers from the COVID-19 recession, with the need to steadily reduce the budget deficit in an effort to slow the escalation in government debt.
Within that, the central theme from the budget is the explicit objective for unemployment. This welcome change sees fiscal policy framed with the goal of getting unemployment down, with Treasury forecasting an unemployment rate of 4.5 percent by 2024, a rate that is considered consistent with some growth in wages and annual inflation moving to the bottom half of the RBA target of 2 to 3 percent.
It has been more than a decade since Australia has enjoyed this economic scorecard.
At the big picture level, government spending will fall by a massive 12.6 percent in real terms in 2021-22, which equates to $72 billion less spending than in 2020-21. This is largely the result of the ending of JobKeeper and other COVID-19 stimulus measures, although there is extra spending in targeted areas.
In simple terms, with the COVID-19 pandemic well controlled in Australia, the emergency government spending of 2020-21 is no longer needed. The recovery in private sector spending and investment is more than picking up the slack left by the ending of the special fiscal measures.
The Budget, nonetheless, implemented a range of new spending measures as the Government ensures some support for the economy, but importantly with the next Federal election less than a year away, to deal with some political ‘hot button’ issues.
The list of areas targeted for extra government spending include:
The economic forecasts in the budget are positive, but not quite as strong as the private sector consensus or the recent RBA assessment.
Against all expectations from a year ago at the low point of lockdowns and fears about the impact of COVID-19, Treasury is forecasting a period of economic growth that will not only fill the gap left by the 2020 recession, but get us to a better economic position than prevailed prior to COVID-19 during the course of 2021.
Treasury is forecasting GDP growth of 4.25 percent in 2021-22, followed by growth of 2.5 percent in 2022-23.
This solid rebound from the recession is expected to drive the unemployment rate lower, to 4.5 percent by mid-2024. If the unemployment rate falls to these levels, it will underpin a long overdue and welcome lift in wages and inflation as demand for labour rises.
Treasury is nonetheless cautious in its assessment of the pass through of low unemployment to wages, forecasting the wage price index to rise 2.25 percent in 2022-23 and 2.75 percent by 2024-25. These look to be conservative forecasts with more upside to wages likely as skills shortages and booming demand for workers see employers ‘pay up’ for staff.
The Budget will deliver a deficit of $107 billion in 2021-22, down from the record $161 billion deficit in 2020-21. The bottom line deficit is forecast to narrow over the forward estimates, but the path to budget surplus is later, rather than sooner given many of the spending measures are permanent rather than temporary, like many of those implemented in reaction to the COVID-19 pandemic.
Australia will have had more than 20 consecutive budget deficits by the time the surplus is even on the cards, which means gross government debt will reach a record peak of $1.2 trillion in 2024-25 and will exceed that in the years beyond.
For now, the cost of servicing that debt is manageable, due solely to the low interest rates on government bonds. There remains a risk, however, if interest rates rise in line with the economic recovery, the high level of debt will see interest costs rise, placing further pressure on the budget.
But that is an issue for the future.
For here and now, the deficit and running up of debt are part of the economic management tools that resulted from the recession in 2020.
There is one quirk in the budget forecasts – the assumption used for the iron ore price.
The iron ore price has recently surged to a record high above US$225 a tonne as global demand for infrastructure has led to a boom in steel at a time when there are some supply constraints from a number of large global producers.
Treasury is assuming an iron ore price of US$55 a tonne in time on the assumption of a price correction when output ramps up. According to the budget documents, each US$10 a tonne rise in the iron ore price can improve the budget bottom line by $1.3 billion per annum, which means an iron ore price of even US$125 a tonne would see the budget bottom line improve by around $10 billion per annum.
All up, the Budget is generally a good one, framed against a backdrop of surprising economic strength and a rapidly tightening labour market. This has been driven by generalised containment of the COVID-19 health crisis in Australia. If the broad themes outlined in the budget forecasts come to pass, the next two years for the economy will be favourable for business and consumers.
Undoubtedly, there are sectors still under pressure from border closures – international tourism, the arts and the university sector are high profile examples. And there are still sectors being impacted by the political tensions between China and Australia, which is set to continue for the foreseeable future.
But overall, the budget has been framed to reinforce the recovery and to drive the unemployment rate lower. It may prove to be optimistic if housing stumbles or the border closures undermine immigration and growth over a longer timeframe than currently assumed.
Aided by the Reserve Bank of Australia (RBA) and near zero interest rates, the reflation of the economy is underway. How long this lasts may well be a challenge for the next Budget.
Our team of experts has been busy developing insights and analysis that breaks down what the Budget means for Australian businesses and individuals.
Check out the full coverage of the Federal Budget 2021/22, which will continue to develop throughout the week as new insights and video content are published.