Saturday, August 07, 2010

About those Treasury forecasts... The Reserve Bank think's they're... err...

The Reserve Bank has called into question the Treasury forecasts that were used to seal the deal with the mining companies that paved the way for the election.

When Prime Minister Gillard announced the deal on July 2 she said it would cost the budget only $1.5 billion - even though it effectively halved the proposed mining tax rate and exempted most mining companies.

Twelve days later the government conceded that it had achieved that outcome because Treasury had sharply revised up its forecasts of coal and iron ore prices between the May Budget and the July economic update.

Yesterday in its regularly-scheduled quarterly statement the Reserve Bank said its forecasts had moved in the opposite direction.

"While the May forecasts envisaged a gradual easing in prices for iron ore and coking coal over the forecast period, developments in commodity markets over the past three months have prompted a revision," it said.

"Contract prices are now forecast to decline a little more quickly, but to around the same end-point as in the previous forecasts. This implies a slightly lower level of the terms of trade over most of the forecast period."

Back in July Treasurer Wayne Swan defended the Treasury's higher forecasts by revealing that they were in part influenced by the mining companies themselves.

"We did have a much more productive, informed and detailed discussion between Treasury and major mining companies about not just current prices and volumes but their likely trends over time," he said announcing the upward revision. "That led Treasury to upgrade substantially its forecasts."

In revealing that while Treasury was revising up its forecasts the Reserve Bank was revising its down the Bank said yesterday, "spot prices for bulk commodities - which affect contract prices with a lag - have fallen since May, driven down by the moderation in growth in China, albeit from a very fast pace"...
It said spot prices for iron ore and coal had fallen 20 per cent since May and were around 10 per cent below contract prices, implying contract prices would soon fall.

If the Bank's forecasts prove closer to the mark than the Treasury's the cost of the election-eve deal with BHP, Rio and Xtrata will be billions more than the $1.5 billion announced by the Prime Minister and Treasurer and the projected return to surplus could be delayed.

Elsewhere in the statement the Bank rejects Coalition claims that government debt has making it push up interest rates saying it began increasing rates because it had become evident "the Australian economy had weathered the global downturn in better shape than many other countries".

Australia's swift economic recovery was "due in part to a strong contribution from public investment".

It confesses to being concerned that as government stimulus measures are wound back private demand might pick up quickly enough to "fully offset the contraction".

The Bank's central forecast is for economic growth to accelerate to 4 per cent by mid 2012 with with underlying inflation climbing back to 3 per cent. The forecasts imply higher interest rates although not for some time.

The Bank rubbishes claims that Australia's private banks will need to widen their margins saying that even if current conditions remain in place for 18 months the banks' funding costs will climb just 0.05 points.

Published in today's SMH and Age

Reserve Bank Statement on Monetary Policy, August 2010

TIM COLEBATCH: Mining tax backflip to cost billions Price of Gillard's peace deal revealed

TIM COLEBATCH: Mining tax revenue is a guessing game

JOHN GARNAUT: Swan in a hole on China August 3, 2010

Treasury lacks the expertise to understand the appetites of the resource-hungry Asian giant, resulting in its tax revenue targets being based on a tangle of errors.

TREASURER Wayne Swan took umbrage when this paper quoted a former official last year saying: "There's no one in Treasury who can tell up from down on China." If only the Treasurer had expended as much effort fixing his department's China problem as he did shooting the messenger, then his latest tax revenue forecasts would not be quite so embarrassing.

It should by now be a truism that Australia's national income and tax revenues rise (and will one day fall) with commodity prices, and those prices are largely a function of Chinese demand (as well as global mining output).

Yet Treasury managed to upgrade its terms of trade forecast for this financial year by a staggering 2.75 percentage points between the May budget and last month's pre-election update a period when the indicators coming from China were pointing the other way.

Some commentators smelled a conspiracy, as Treasury's revision initially enabled Swan to pretend that caving in to the big miners and eviscerating his mining tax had hardly dented revenue. Later, Swan admitted he had handed back more than half the anticipated revenue: $US13 billion in the first two years.

A more likely explanation, however, is Treasury still hasn't got its own independent and timely view on what's going on in China.

By late April, when the May budget forecasts were being put to bed, the market knew Rio Tinto and BHP Billiton would be securing huge price increases for the September-quarter iron ore contracts, because they had pushed through a new pricing system in which spot and contract prices would converge, and Chinese spot prices had soared to $US180 a tonne. The pre-election update suggests Treasury has only now caught up. In April, spot prices had started to slide in response to the Chinese government's edicts to shut down property speculation. By July, steel prices and production were edging down and the China iron ore spot price had fallen by a third.

The result was that Treasury got it wrong both ways. It massively underestimated contract prices in May and then upwardly corrected that error just as markets had tanked in July.

With luck, those multibillion- dollar errors may cancel each other out for the next two financial years. The bigger worry is what Treasury assumes beyond that point, when the mining tax cuts in.

Last year's "messenger" on Treasury's lack of China expertise was Stephen Joske, a respected analyst who had been the government's top China economist before recently joining the Beijing office of the Economist Intelligence Unit. Swan responded to the story by instructing a staffer to smear Joske's reputation he would disregard "the political views of a former Howard government staffer" apparently referring to Joske's secondment from Treasury as an adviser to former treasurer Peter Costello more than a decade earlier.

The second point that Joske made and that Swan didn't like was that BHP Billiton was filling Treasury's China analysis void and unduly influencing foreign investment policy. Now, according to Swan, the big mining companies are shaping budget forecasts, too.

He revealed that detailed discussions with the miners about production and pricing trends had "led Treasury to upgrade substantially its forecasts for commodity prices".

It is not hard to see that mining companies had an incentive to overestimate production and prices and therefore anticipated tax payments at a time when they were fighting Swan's new resource rent tax. There are competing views in China and Treasury needs to quickly get on top of them.

Ian Roper was Rio Tinto's head iron ore market analyst in Shanghai before joining brokerage CLSA two months ago as a commodities strategist. He forecasts iron ore spot prices will fall from the current $US130 to about $US100 by the end of the year, then stabilise at between $US80 and $US90, and then take another leg down to about $US60 by 2020.

At those prices, says Roper and after Swan has handed the miners accelerated depreciation on their capital expenditure during these boom years there may not be any resource rents left for Treasury to tax. "The mining companies may have actually been sold a tax cut," Roper says.

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