Weekly Reports | May 14 2012
By Andrew Nelson
The almost unanimous opinion of Australia’s major brokers on last week’s federal budget was: yes, the federal government has worked hard to return to a surplus, on paper. However, there was more than a bit of scepticism about the Treasurer’s optimism and accounting and how it’ll all apply to the real economic world.
The 2012-13 budget is set to return to an underlying cash surplus of $1.5bn in the 2012-13 fiscal year from an underlying of $44bn deficit the year prior. This target is in line with market expectations and will apparently happen despite further downgrades to projected tax revenues.
Bank of America/Merrill Lynch notes there are large spending cuts in the budget, although it points out that nearly half of these come from defence and foreign aid programs. That said, there is also a fair bit of new spending, including new entitlement programs. Thus, points out BA-ML, most of the hard work is going to have to be done on the revenue side.
The broker points out that ultimately, the new budget strategy is hoping to force a shift in the “macro policy mix”, with a move towards tighter fiscal policy settings bringing about easier monetary policy settings. And a slightly more optimistic than the rest BA-ML thinks, Treasurer Wayne Swan could be right.
Meanwhile, an analyst team at Goldman Sachs points out that if the budget is delivered as planned, it would equate to a change in the underlying cash balance as a percent of GDP of 3.1%. This, notes the broker, would be the largest turnaround since data became available in 1970. However, the broker also estimates such an outcome would subtract about 1.25% from real GDP growth in 2012-13.
Loosely speaking, GS admits that the government’s economic assumptions seem to be in line with its own forecasts. However, the broker notes that Treasury’s 2011-12 forecasts are just too optimistic. In fact, the team from GS calculates that economic growth would need to grow at a 4% annualized rate in 1H12. Not likely given 1Q12 looks set to expand by only about 0.25%qoq.
Thus, it is a budget built on a shaky foundation, or rather on the assumption that the economy is already running at trend. But the broader evidence is that the economy is far from trend, points out GS. Thus, the strategy underpinning this Budget is a political one and a high risk one at that.
Goldman Sachs explains that if the economy were to continue to lose momentum, or if there were a rise in the unemployment rate, this current fiscal strategy could quickly become a political time bomb. The strategy ultimately assumes that a fiscal contraction in order to simultaneously induce a lower interest rate environment, while demonstrating an ALP government can post Budget surpluses, is more about the next election than it is about stabilizing near-term Australian economic conditions, posits the broker.
UBS points out that the key savings in the budget are to come from cancelled corporate tax cuts, reduced defence and foreign aid spending, plus superannuation changes. The savings have underwritten some large hand-outs to low/middle income households, and given extra cash to key Labor objectives like national disability and aged care. Add in bonus payments to households and the broker concluded the consumer is the clear winner in this budget.
For fixed income markets, UBS predicts that an unchanged 2012/13 surplus will mean the peak in net debt will only be a little higher at 9.6% of GDP.
Analysts at Citi were surprised by the extent of redistribution measures, also noting the considerable hand-outs for lower income earners. To pay for these, we are seeing what are at least politically acceptable cuts to defence and foreign aid, with some tax concessions for higher income earners and a shelving of promised company tax cuts. However, the broker notes the new spending measures leave little room for budget slippage, so an undershot this year will mean more measures will have to be announced later in the year to keep the surplus on track.
In the meantime, the new budget does little to deliver any productivity enhancing initiatives, remaining silent on cutting government regulation on businesses, or reforming inefficient and overlapping state and Federal taxes to remove some deadweight, notes Citi. Also, the broker saw few expenditure measures to promote investment, given the goal of cutting the corporate tax rate has been completely binned for the time being.
The good news is: on Citi’s numbers Australia’s budget position and low net debt, which should peak at 9.6%, will remain the standout amongst global peers.
Credit Suisse thinks Treasury’s forecast for real GDP growth of 3.75% in FY13 is simply too optimistic, with considerable downside on offer if exports and business capex are weak. Given the budget cuts made to support the strategy, CS can’t see any help for capex on the horizon. And with leading indicators already pointing to a capex slowdown, the broker notes the consumer may ultimately end up doing the heavy lifting.
Credit Suisse warns that with the economy currently growing at 2.5% a year on its numbers, the planned amount of fiscal tightening could cause a marked slowdown, with the only lever remaining an intervention by the RBA.
Looking forward, the broker notes that rate cuts and reduced government bond issuance will be positive for bonds and bond proxies, but they will also weigh on the AUD/USD, which will only benefit equities with USD exposures, although, the broker notes that when the market starts to believe that the RBA is getting ahead of the curve, a turn towards easing will start to help a downtrodden consumer discretionary sector.
An analyst team from Macquarie thinks that the government’s budget surplus hopes are, for the most part, being driven by overly optimistic growth forecasts that are expected to deliver some sort of a revenue surge. However, the theoretical upside is based partly on financial tricks, with spending being shifted out of 2012-13, and by spending cuts and revenue increases that it feels will ultimately harm growth.
All that will happen, thinks the broker, is that poorer households will receive a short-term income boost in the next couple of months, but this temporary support will vanish given the prospect of little additional government spending and higher tax payments are likely to weigh on growth.
And if we don’t see better growth and stable employment over the next six to nine months, Macquarie thinks the Government will be forced to either abandon the surplus, or to undertake another round of spending cuts and tax increases in an already weak economy.
RBS, on the other hand, thinks the the corporate sector has fared better than it could have and could actually benefit from an improvement in sentiment from budget beneficiaries i.e., lower to middle income households.
The broker thinks that equities markets have dodged a bullet, with corporate tax concessions cut nowhere near as much as feared, while firmer household sentiment should provide a boost for spending. This will be especially so after the initial effects of the carbon tax are seen through, predicts RBS.
Last, but not least, the team at Deutsche Bank thinks it’s a bit of a nothing budget and the government is just taking money from one pocket and putting it into the other (or from one year to another).
Says Deutsche, “we would describe the sum of the policy decisions taken by the Government as immaterial as far as the broader macro outlook is concerned.”
Although, the broker does see some risk that Treasury will need to revise down revenue estimates for 2012-13 at some point, meaning the surplus may not end up being delivered.
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