Free | Global Macro & Strategy

From ‘back in black’ to ‘digging deep’: Will the budget do enough to support recovery?

If the May 2019 Budget was all about back to black, this year’s Budget is all about rescuing and repairing the economy.

Last year’s Budget forecast a small surplus of 0.4% of GDP in 2019-20, the first surplus since the GFC. In fact, a small surplus of 0.4% of GDP was indeed achieved in 2018-19, but budget deficits as large as -4.7% was forecast for 2019-20, and -10.2% for 2020-21. This compares to the -3.7% deficit at the height of the GFC, making it the deepest since World War II.

Budget net operating balance (% GDP) 

Source: Treasury, Lonsec

How did we get here?

We’ve had a tumultuous year since last year’s Budget, with bush fires, drought, and a global pandemic. Those negative shocks sank our economy into the first recession since 1991, with GDP contracting 7% in the June quarter.

With reduced economic activity, tax receipts have reduced. Income taxes collected have fallen on the back of lower employment and hours worked. Company tax receipts have also fallen as many businesses remain shut or operate below capacity. GST revenue declined too, with fewer sales of goods and services. Tax receipts fell across the board, with the one notable exception being—perhaps appropriately—taxes on the sale of spirits.

Commonwealth revenue and expenses (% GDP)

Source: Treasury

On the spending side, the government has put in place significant stimulatory measures to support the economy and employment. These include:

  • $120 billion over 2019-20 and 2020-21, primarily for the JobKeeper payment.
  • $46 billion mainly in the Coronavirus Supplement, economic support payments to households, and increased JobSeeker payment.
  • $40 billion to provide further support for apprentices, trainees, hospitals, aviation, and the infrastructure sector.

Source: Budget papers

Overall, compared to the government’s Economic and Fiscal Update in July 2020, where a small surplus of $12 billion was forecast for 2020-21 (0.6% of GDP), this Budget shows an estimated deficit of –$198 billion (-10.2% of GDP). Contributing the most to the deterioration is around $127 billion in additional spending, followed by $42 billion less in expected revenue due to reduced economic activity.

How are we going to pay for all this?

The short answer is, with debt. And a lot of it. Commonwealth Government net debt is forecast to rise to 36% of GDP in 2020-21, and even further to 43.8% in 2023-24. This compares to 19% in 2018-19.

This may sound high, but by international standards Australia’s net government debt level is relatively manageable. Prior to the COVID-19 pandemic, the average net debt level among developed economies was 43% of GDP. The US and UK both had net debt of around 77% of GDP, while Japan had the highest at 155% of GDP. Ratings agency S&P has confirmed Australia’s AAA rating with negative outlook, with Fitch and Moody’s reserving judgement for now.

With interest rates at historic lows, financing the debt should be a secondary consideration, with the primary focus being to get the economy back on track.

What are the key Budget measures?
  • $26.7 billion temporary investment tax incentives: Businesses with aggregated annual turnover of under $5 billion can deduct the full cost of eligible capital assets acquired from 6 October 2020 and first used or installed by 30 June 2022.
  • $17.8 billion of income tax cut: Bringing forward the second stage of the Personal Income Tax Plan by two years to 1 July 2020 as well as a one-off additional benefit from the low and middle income tax offset in 2020-21.
  • $15.6 billion in additional spending on the JobKeeper Payment: Eligibility has been expanded largely In light of the prolonged restrictions in Victoria.
  • $10.7 billion in infrastructure spending: Including $6.7 billion in grants to the states, $3 billion for roads and community infrastructure, and $1 billion for water infrastructure.
  • $4 billion for a JobMaker Hiring Credit: To give businesses incentives to take on additional employees aged between 16 and 35.
  • Additional measures: Including $1.2 billion to support 100,000 new apprentices and trainees with a 50% wage subsidy and undoing $2 billion cuts to R&D incentives.
When will we get out of the recession?

The Treasury forecasts economic activity to pick up from late 2020 and into early 2021. The recovery is expected to be driven by a further easing of restrictions and improvements in business and consumer confidence. Economic activity will be further supported by Government stimulatory measures, both fiscal and monetary. The RBA has also hinted at further easing, with another rate cut or announcement of further QE widely expected at its November meeting.

The IMF in its June 2020 World Economic Outlook forecast Australian GDP to decline by -4.5% in 2020 before rising by 4% in 2021. While this is our first recession since 1991, Australia’s experience with containing the virus outbreak means the economic is faring relatively well by international standards. For example, the IMF forecast US GDP to contract by -8% in 2020, -10.2% in the UK, and -12.8% in Italy and Spain.

Yesterday’s Budget forecasts GDP to fall by -3.75%—better than the IMF forecast—before growing by 4.25% in 2021. It also forecasts unemployment to peak at 8% in the December quarter of 2020, before falling to 6.5% by June 2022 as economic activity recovers. Both the GDP and unemployment forecasts are more optimistic than many leading economists believe.

While the COVID-19 pandemic should be a severe but temporary shock, the path to recovery remains a gradual and uncertain process. This Budget has taken important steps to support the economic recovery, but the speed and magnitude will depend on many other factors, including international health and economic outcomes, as well as domestic business and consumer confidence.

Broad measures such as income tax cuts and investment allowance will support overall business and consumer confidence, but more targeted measures might be welcomed by more severely affected sectors such as education and tourism. The government also failed to take the opportunity to enact structural reforms such as reforming the tax system or improving overall labour productivity, which would benefit economic growth in the long term.

Author: Amy Li

Issued by Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec). Warning: Past performance is not a reliable indicator of future performance. Any advice is General Advice without considering the objectives, financial situation and needs of any person. Before making a decision read the PDS and consider your financial circumstances or seek personal advice. Disclaimer: Lonsec gives no warranty of accuracy or completeness of information in this document, which is compiled from information from public and third-party sources. Opinions are reasonably held by Lonsec at compilation. Lonsec assumes no obligation to update this document after publication. Except for liability which can’t be excluded, Lonsec, its directors, officers, employees and agents disclaim all liability for any error, inaccuracy, misstatement or omission, or any loss suffered through relying on the document or any information. ©2020 Lonsec. All rights reserved. This report may also contain third party material that is subject to copyright. To the extent that copyright subsists in a third party it remains with the original owner and permission may be required to reuse the material. Any unauthorised reproduction of this information is prohibited.

Register for our FREE newsletter to receive investment insights, education, and SMSF trustee updates