24/10/2022
A bit of a summary with the budget that will be announced soon from Judo Bank
After a $45bn improvement last year, the Budget deficit is expected to shrink once again in 2022/23 on the back of a strong economy and high commodity prices. In March, the 2022/23 deficit was forecast to be $79bn. If the Government offsets all new spending measures from within the Budget, then the deficit could be as low as $20bn this year. But it has made a raft of election commitments, as well as new spending announcements since the election. I think the best we can hope for is a deficit of around $35bn.
The new Treasurer has a huge task with this Budget. Not only does he have to clear the decks, as every new government does when it is elected, but he must do this against the backdrop of a rapidly evolving and increasingly difficult economic environment.
The Government’s priority in next week’s Budget should be to tighten up fiscal policy and take pressure off an overheating economy. This will help the RBA fight inflation and assist in keeping interest rate rises to a minimum.
But there is a raft of other political and economic objectives that must be met, which inevitably means a bigger Budget deficit than is desirable. The detail matters, and we will have to wait until next week to know the extent to which the Treasurer has delivered on his tough pre-Budget rhetoric.
The business community want labour shortages alleviated and pressure taken off inflation and interest rates. Announced measures to implement Government-funded maternity leave, and new childcare support, will be a positive for many businesses, but the big issues are stabilising the economy and reducing red tape.
The extra funding for the NBN to expand the fibre network for outer suburbs and regional areas will be welcomed by SMEs operating in these areas. But the Government has already announced cutbacks to regional infrastructure programs, which is concerning. We will need to be watching closely for what other ‘cuts’ the Government comes up with in next week’s Budget, and who is impacted.
The big strategic challenges are to put Government finances on a sustainable footing and boosting productivity. While this Budget can lay the foundations for genuine reform on this front, in my view, the short-term inflation challenge must be the priority. The next Budget is just seven months away. This is a better time to change the big policy levers to deal with the long-run challenges of an aging population, geo-political instability and the NDIS.
Key Challenges for Australia’s Fiscal Policy: Don’t Make the RBA’s Job Harder Than It Already Is!
The first Budget of a new Government is an opportunity for a re-set. To clean out the books and create some room for new priorities. This is a strategic exercise that not only communicates the Government’s intentions but provides the financial space to execute new initiatives over the next three years.
This task has been complicated in 2022 by a radical shift in the economic environment, with implications for both the short-term economic outlook as well as the long-term sustainability of Government finances.
The four primary objectives of this Budget are:
Clean up the Government’s finances and reorientate the Budget for new strategic priorities. This includes implementing election promises, as well as priority policy measures to address the pressing economic challenges of the day - which in 2022, is all about providing cost-of-living relief to low- and middle-income earners.
Take pressure off an overheating economy by tightening up fiscal policy. Fiscal policy played a big role in creating the inflation we are now witnessing all around the world, and it now has to play a role in mitigating those inflationary pressures over the next two years. If fiscal policy continues to add to demand in the economy, it will mean higher interest rates than otherwise.
Rising inflation, geo-political instability, the NDIS and an aging population are all working to put pressure on government finances over the medium to long term. The long-term Budget position is much worse than presented back in March, and the Government needs to work out how it is going to deal with these future financial challenges. Will it increase taxes, cut spending or run a permanently larger fiscal deficit than previously forecast?
Look at policy changes that will boost the productivity of the economy over the medium to long term, which includes both policy settings which will impact private sector productivity as well as ways to get the most out of the public sector. Within this bucket, we can also add infrastructure investment, which should include a clear plan for managing the energy transition.
This Budget needs to put the short-term challenges facing the economy ahead of all other objectives. This is a new Government that can work towards a comprehensive strategic re-set at its next Budget in May, just seven months away.
There can be no compromises on what is needed from the Government’s fiscal policy for the economy right now. If it does compromise and continues to add to demand in the economy, not only does the Government risk driving interest rates up to levels that no one is currently expecting, but it also puts at risk its capacity to undertake genuine long-term social and economic reforms over the course of its first term. If the Government doesn’t nip the inflation problem in the bud right now, it will be dealing with the consequences for years to come. This will make real reform all that much harder, as the Government will be dealing with a volatile and uncertain economic environment, and an economy that would be expected to be in a far worse state at some stage before the next election.
Budget Position 2022/23: Expect a Lower Budget Deficit on the Back of a Strong Economy
The best way to think about the Government’s Budget is to start by looking at what the Budget position would be if there were no new policy decisions. This is the ‘No Policy Change’ starting point which reflects the impact of changes in the economy on the Government’s finances since the last Budget.
My estimate of the ‘No Policy Change’ Budget position is in the graph below. There has been a vast improvement in the Government’s bottom line in the short-term due to a stronger domestic economy, rising inflation and higher than expected commodity (export) prices.
At the same time, the long-run picture has deteriorated. This is a major political problem for the new ALP Government as it looks like it has inherited a strong economy and Budget position but cannot keep it going over the long run. This, of course, is an illusion, driven by a stronger economy that is simply not sustainable.
We know that the 2021/22 Budget deficit declined by almost $45bn from a forecast deficit of $78bn in March this year to an actual outcome of $33bn. The underlying economic and financial forces that drove this massive improvement in last year’s Budget will also have a big impact on the 2022/23 numbers.
Chart: ‘No Policy Change’ Budget Position
Source: Treasury, EQ Economics
In March this year, the previous Government forecast a deficit of $79bn for the current year. Even though there have been new policy announcements by the new Government, this year’s deficit could shrink to as little as $20bn if the Government offsets all new spending measures from within the Budget. This would be the desirable outcome for an economy facing capacity constraints.
If the Government could ‘bank’ the unexpected gains from a strong economy, not only would that reduce the deficit and moderate the growth of debt, but most importantly, it would take some pressure off inflation and interest rates.
This is unlikely to happen. Unexpected costs and unfunded commitments from the previous Government are likely to be prominent next week, which will be political cover to run a larger deficit than the Government should. There will also be cost of living support measures, which, although desirable, will still require immediate resourcing and add to demand in the economy.
Good policy is to be encouraged, but with little wriggle room in the economy, even good policy can have undesirable short-term consequences. This is the fine line the Government will have to walk, both economically and politically.
What Business wants to see
For more than a year, the biggest challenge for businesses in Australia has been labour shortages. Over recent years, the Federal Government has addressed this through a range of strategies that aimed to increase the supply of labour into the economy, including measures that raised the participation rate, skills and training support to raise the effective labour supply and easing of restrictions on international migration.
We can expect more of this next week given the urgency of labour supply constraints on the economy. A key election commitment was to undertake a broad-based reform of childcare arrangements. There will be more funding for skills and training. Will these measures have a material impact in the short term? We will have to wait and see.
Energy costs are quickly rising up the list of concerns for Australian businesses. Will the Government be doing anything on this front? The big picture energy transition is critically important, but this is a policy shift that will play out over many years. Businesses need help right now, particularly energy-intensive manufacturing businesses. Can the Government have a material impact on energy costs for Australian households and businesses without putting more inflationary pressure into the economy in the short term or jeopardising the energy transition in the long term?
Business always wants to see less red tape and a more streamlined regulatory environment. The previous Government took some steps in the right direction. If the current Government is serious about boosting productivity, it has to be serious about making it easier for business to invest and for new businesses to start up.
In the context of an overheating economy, business doesn’t want to be competing with governments for scarce inputs, particularly staff. Governments will always need to be hiring essential workers, but an unnecessary workforce expansion of the bureaucracy at either the state or federal level is counterproductive in the current economic environment. Most businesses want to see pressure taken off the economy and inflation, even though this could come at the cost of some loss of revenue growth. A more balanced economy will mean less inflation, less pressure on work forces and less upward pressure on funding costs.
Comment: Get the Economy Right
Although the last Budget was only in March, the world has fundamentally changed and so have the challenges facing our economy and the Government. The pre-election Budget from March did not anticipate the big changes in our economy and, in many ways, the previous financial plan is now out of date.
The biggest shift in the past seven months has been on inflation. Inflation is critical to the Government’s Budget; it changes everything. Higher revenues and expenses are not evenly distributed across the Government’s operations. Some taxes are producing a much higher level of revenues than previously expected while others are broadly tracking as expected. Certain expenditure items have become more expensive, while some other expense lines will only start to rise in the future.
Inflation makes forecasting Government revenues and expenses much more difficult and, hence, financial plans much less reliable. In a high-inflation environment, the Government needs to be careful with its plans or else risk putting the financial position in jeopardy.
For the Australian Government, the inflation surge of 2022 has made the cost of funding deficits and government debt significantly more expensive. Higher interest rates imply a higher interest bill for the Government, and a bigger cost to the community from continuing to run those deficits. This only adds to the case for fiscal conservatism.
Events in the UK, in recent months, highlight the risks. In a time of rising inflation and an uncertain economic outlook, now is no time for radical government policies that involve bigger deficits and higher government debt.
Beyond these concerns about the sustainability of Government finances is a particular short-term economic change that we face in Australia. Our economy has recovered so strongly from the pandemic that it is operating beyond its effective capacity. The risk is that a booming economy will transform the inflation shock from the pandemic into a stubborn domestic inflation problem via rising domestic costs.
Fiscal policy has played a big role in creating global inflationary problems during the pandemic and it is fiscal policy that must play a central role in getting inflation back under control. If we leave it solely to monetary policy to tackle inflation, there is a risk that the
RBA will be forced to take interest rates to such a high level that the end result may be a damaging recession.
The new ALP Government has no interest in making the RBA’s job any harder than it already is. In fact, it has every reason, both economically and politically, to help the RBA with a meaningful tightening of fiscal policy.
While the last Budget in March was a pre-election Budget from a Government that had been in power for almost a decade, this Budget is the first of a new Government looking to lay the foundations for a long and successful period in power. It has every reason to clear the decks, just like a new CEO. Get the bad news out early and give yourself the flexibility in the future to invest in the things that matter.
To compound the RBA’s problems by running stimulatory fiscal policy could result in a major downturn in the economy just ahead of the next election; something that this Government really doesn’t want to do.
Federal Government Budgets are complex. Not just because they are the financial plan for the biggest entity in the economy, but they must accommodate a whole range of economic, social and political objectives of the Government of the day. The Treasurer must juggle competing interests from his own ministry, the needs of industry and the economy as well as the political imperatives of the day. Getting the mix right is difficult, and compromises must be made.
This Budget will be judged by how effectively the Treasurer balances the various objectives. He needs to err on the side of fiscal conservatism. If there is a political price to pay for that, the Government still has a full term to recover. But to get the economy wrong will haunt this Government for years to come.
