The Federal government sharply downgraded the fiscal outlook in its Mid-Year Economic and Fiscal Outlook.
Over the four years, the forecast budget surpluses were reduced by $21.5 billion, the key driver being the downgrade in the growth of nominal GDP – the size of the economy – in 2020-21 from 3.75 per cent to 2.25 per cent.
New policy measures cost $8.1bn over the period – the focus being on aged care, the drought, and infrastructure – while the weaker economy costs the budget $13.5bn (receipts are down by about $33bn, partially offset by around $19.5bn in lower payments).
In terms of the outlook and economic forecasts, the government went further than we expected on wages growth, reducing the expectation for 2020-21 to 2.5 per cent – or no lift from the 2019-20 forecast and in line with the Reserve Bank’s thinking.
MYEFO also included a lower profile for commodity prices, largely centred around coal.
While there are upside risks to the commodity price forecasts for the Budget, we can understand why the government would be cautious around these forecasts in MYEFO – wanting to avoid a further fiscal downgrade when the 2020 Budget is announced on May 12.
We have consistently argued that the struggling economy needs some fiscal support to complement monetary policy as the cash rate nears the effective lower bound of 0.25 per cent.
The $8.1bn of net new spending over four years in MYEFO was more than we had anticipated but insufficient to make much of a difference.
We have recommended bringing forward the legislated personal tax cuts in two tranches of $7bn per year in both 2020-21 and 2021-22, which under previous fiscal estimates could have still resulted in modest surpluses. Under the new fiscal estimates from MYEFO, the fiscal position would change to deficits of $0.9bn and $5.6bn, respectively, if the tax cuts were to be brought forward.
However, the downbeat forecasts in MYEFO only emphasise the need to provide some additional policy stimulus for the economy on top of more easing by the RBA. Indeed, yesterday’s minutes of the December monetary policy meeting of the Reserve Bank Board strengthened our conviction that the RBA will reduce the cash rate from 0.75 per cent to 0.5 per cent in February.
It is reasonable to expect that as we move towards the May Budget the government will recognise the need to also use fiscal policy to boost demand at the possible expense of sustained budget surpluses.
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