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The Budget – not as bad as thought

David James |  04 May 2021  |  Investment News

Australia’s Budget position is looking surprisingly sound given the damage caused by the pandemic lockdowns. It suggests that investment conditions are not as dire as they might have been.

The last year has been an extraordinary financial experiment, both locally and internationally. The Australian government stopped a large amount of economic activity in its tracks by imposing lockdowns and then spending heavily on job and unemployment support to cushion the blow? It sharply increased Federal government debt.

Morgan Stanley expects that political and economic incentives will result in further spending added to the May 11 Budget. “We forecast $50bn in discretionary spending over the forward estimates (vs $111bn in FY21 Budget and $12bn in FY21 MYEFO). As the housing stimulus rolls off, we will watch for incentives being extended to other key industries.”

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There has been great resilience in the labour market. The current unemployment rate of 5.6 per cent is a level that Treasury did not expect to reach until 2022-2023. There will be an uptick in joblessness as JobKeeper is wound back, and the underemployment rate was 7.9 per cent in March, meaning the total under-utilisation rate is over13 per cent. But a year ago an unemployment rate of 15 per cent seemed likely. It would have spelt deep trouble for the overall economy and had disastrous social consequences.

Although the Coalition will never admit it, it looks suspiciously like there has been some bi-partisan institutional learning about how to manage financial crises. If you want to stimulate an economy in times of crisis put the money directly into the economy, either into people’s pockets or to businesses who then pass it on to workers. It works far better than giving it to government departments to spend inefficiently.

It does mean that government spending as a share of the economy is at its highest level since the early 1980s. However, projections for the Budget deficit in 2020-2021 are expected to be reduced from a December estimate of $A198 billion to $150 billion, 7.4 per cent of GDP, because of better than expected economic conditions and higher commodity prices, especially iron ore. For the next financial year Morgan Stanley is forecasting the deficit to fall by half to $80 billion or 3.7 per cent of GDP.

Australia’s national debt has of course risen sharply because of the crisis response but this will not greatly increase interest payments because rates are at historical lows. Budget deficits are likely to continue to at least 2025 as the government attempts to stimulate, rather than rescue, the economy. Net debt is expected to peak at about 45 per cent of GDP, according to Morgan Stanley, which, although relatively low compared with other developed economies, is almost double the level in 2019-2020.

Another indicator of economic improvement is that consumers are likely to start opening their wallets, which have been firmly shut over the last year. During the crisis the savings rate increased by a massive 22 per cent and consumption growth fell by about 14 per cent. That is likely to return to more normal levels. “As housing stimulus rolls off, we will watch for incentives being extended to other key industries,” says MS.

It has been shown that the government can cushion severe economic blows, but that is necessarily only a temporary measure. There has been a sound understanding of timing, but the clouds hanging over the global economy have not gone away.

Just before the pandemic, in late 2019, there were events in the financial system, in the repo market, that looked suspiciously like what happened in the lead up to the 2008 global financial crisis. Financial institutions started to lose trust in each other and the system utterly depends on trust. The melt down in the real economy distracted all attention away from that. Central banks and governments pumped extraordinary amounts of money into the system, much of which benefitted financial companies and banks. But the problems exposed in 2008, which have since been made more serious because of soaring global debt, have never been solved.

 

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