Wednesday, April 27, 2011

Budget reality check. We've also made $20 billion

Much of the government’s posturing ahead of the budget should be taken with a grain of salt according to a leading economic consultancy who says its financial position is improving by the day.

Deloitte Access says higher coal and iron ore prices are outpacing the impact of the floods and cyclone making it easier rather than harder to return the budget to surplus.

Treasurer Wayne Swan this week warned Australians not to expect “a repeat of the rivers of gold that flowed into government coffers in the last mining boom”. The floods and Cyclone Yasi would slice $9 billion from economic output.

But Deloitte Access director Chris Richardson expects the past few months export price increases to give Australia double that.

“The floods and cyclone cost us a lot,” he told The Age. “But at the same time as we were worrying about the floods and cyclone and the earthquakes and tsunami, the world prices for what we sell were sharply rising; the impact on our nominal gross domestic product in the year ahead is $20 billion"...

Mr Richardson is Australia’s most experienced budget forecaster outside the public sector and during the 1980s did the numbers for the government inside the Treasury.

“That $20 billion flows from just a few months worth of commodity price rises, the world is now begging us to grow faster,” he said.

Asked why his assessment was so at odds with the pessimism emanating from the treasurer and prime minister Mr Richardson said some of their concern was genuine but “some of it is just the usual scene setting, to prepare us for the worst so we react well on budget night”.

In the lead up to the May 10 budget Mr Swan has acknowledged the next mining boom “will mean extraordinary new levels of income flowing into Australia” but has said the high dollar will be a “stronger drag on trade-exposed industries” and that cautious consumers and tighter credit will dampen the rest of the economy.

Mr Richardson agreed the 107 US cent dollar would dampen government revenues but said it was climbing as a result of the new minerals prices that would boost them.

“This financial year and next financial year things will be worse than forecast in November budget update, but for 2012-13, the year they have promised to return to surplus, it’ll be easier than forecast and after that they should be well ahead of previous forecasts.”

Government sources have claimed that mining tax revenues are set to stall as the companies invest in new mines, but Mr Richardson says the investment would be written off against tax over time acting as a slow drain on the budget rather than a sudden hit.

The mineral resources rent tax due to start next July should further boost government revenue in the year it plans for a surplus.

In its March quarter business outlook released this morning (WED) Deloitte Access says low rates of immigration are Australia’s biggest economic constraint. Net migration has has almost halved from 320,000 to 186,000 in just three years.

“Policy has deliberately lowered the speed limits on what Australia has achieved just as the world wants us to do the opposite,” Deloitte Access says in the note. “An unfortunate side effect will be some interest rate increases in the next year or so.”

Access is forecasting one further Reserve Bank interest rate hike in 2011-12 followed by three more in 2012-13 taking the cash rate to around 5.7 per cent.

Wage growth would climb to a peak of 5 per cent in 2012-14 and the unemployment rate would fall to 4.3 per cent.

Published in today's SMH and Age



Thanks for that very warm welcome and thanks Barton [Green] for those words of introduction. I'm really grateful for this opportunity to talk about the upcoming Budget – the fourth for this Labor Government and the first of this parliamentary term.

When someone told me the other day that this one means only Ben Chifley and Paul Keating have handed down more Labor Budgets than me, I told them it probably says more about what this job does to your health than anything else.

Back in 2008 I described our first Budget as the "responsible Budget our nation needs at this time of international turbulence, and high inflation at home". I copped some criticism for not cutting hard enough, by some commentators who did not grasp the risks down the track. Of course the global recession that followed vindicated the fiscal policy we put in place.

The second Budget I described as "forged in the fire of the most challenging global economic conditions since the Great Depression". That Budget helped us avoid recession, and spare hundreds of thousands of Australians the hardship of unemployment.

And the third, just 11 months ago, met "the highest standards of responsible economic management", implementing strict spending limits in an election year – something our predecessors dared not even contemplate. That Budget began the fastest fiscal consolidation since records were first kept half a century ago.

This year we continue the hard slog back to surplus. That will mean some very difficult decisions and, let's face it, a political hit as well. We will also build the even bigger workforce we need to succeed during mining boom mark II, and stay true to the productivity push we championed for years of opposition and began to implement when we were first elected.

As you know, in the last couple of years I have addressed this forum in the immediate aftermath of the Budget, to explain the decisions we took and the reasons we took them. This year I want to do things a little differently. Instead of explaining decisions already taken, I want to try and give you a sense of the context in which we are putting this Budget together. I want to explain to you why that surplus in 2012-13 is so important, and why building a bigger workforce is so important. But most of all I want to give you a detailed understanding of the two main factors influencing our thinking, and playing on my mind and the minds of my colleagues just 20 days out.

Natural Disasters

The first main influence on the Budget is the economic and fiscal damage done by natural disasters. It is a little over three months since Queensland bore the brunt of the most severe flooding in a generation, with many lives lost, and terrible damage to communities throughout the state. And it is less than three months since Tropical Cyclone Yasi had such a devastating impact on Far North Queensland, where I'm headed tomorrow to show support for the tourism industry.

Since that time there have been other tragic events elsewhere in the world. The Christchurch earthquake in February killed almost 200 people and damaged many of the buildings in New Zealand's second largest city. And last month, Japan was hit by three tragedies in rapid succession: the earthquake, the devastating tsunami, and the nuclear emergency that has yet to be resolved.

As I have said before, we should never forget that these natural disasters are, first and foremost, human tragedies. They touch us very deeply. But they have also had a hefty economic and fiscal toll as well. I want to re-cap on some of the numbers here, because the scale of these costs has inevitably had an impact on framing the upcoming Budget.

The economic and fiscal costs of the summer floods and Cyclone Yasi are unprecedented. They will slice an estimated $9 billion from economic output, with our mining and farming sectors the hardest hit. The natural disasters at home will subtract around ½ percentage point from GDP growth in the current financial year. On top of that, the natural disasters in Japan – our second-biggest trading partner – are expected to subtract up to a further ¼ percentage point from growth. It's clear that the early years of the Budget will bear the brunt of these disasters – both from the rebuilding and recovery costs as well as the reduced revenues.

Natural disasters are the principal reason behind the softer economic conditions we're forecasting this year. They're also the main reason we'll have bigger deficits in the early years than we had forecast in the mid-year budget update. I want to spend a minute explaining the reasoning behind this.

As you know, we have already made room for the rebuilding and recovery costs by finding savings, reprioritising spending and introducing a modest temporary levy. And while we've put in place these savings over the budget estimates period, the rebuild task is immediate with the bulk of the budget impact falling in the next couple of years. On top of this we're faced with revenue write-downs from short-term economic weakness – this will also hit the bottom line directly. But unlike the costs of the rebuild effort, we will not offset what is only a temporary hit to revenue.

Of course, not all the damage done to our Budget is from the natural disasters. The fiscal situation is also made harder by some of the continuing effects of the global financial crisis and a high dollar. These factors, on top of a cautious consumer and a subdued recovery in household wealth, are just some of the driving forces behind Australia's patchwork economy.

All of these factors have meant that budget revenues for this financial year are tracking well below what was expected when we put together the mid-year budget update late last year. I've said before that Commonwealth tax collections over the first eight months of this financial year are down around $4.5 billion, but the reality is that figure could be even higher by the time we finalise the May Budget.

A Tale of Two Booms

These short-term conditions pose big challenges for our Budget, but they will not knock our economy off its medium-term path. The medium term story is a much more positive one. Our economy is resilient. We will withstand the impacts of the natural disasters just like we withstood the GFC, and our economic fundamentals remain very strong.

We have low unemployment and strong job creation. More than 300,000 jobs were created in the past year, 98 per cent of them full time. And we are situated in the fastest growing region in the global economy in the Asian century. The changing of the guard that we are witnessing – from the West to the East – has obvious implications for Australia and so our economic strategy shifts with it.

Recall that more than a quarter of everything we sell overseas goes to China and India. We've already seen significant increases in both the prices and volumes of our iron ore and coal exports. Our terms of trade have risen to their highest sustained level in 140 years and we're witnessing an unprecedented boom in mining investment. Based on a survey of firms' current plans, investment in the resources sector next financial year will be more than double what it was last financial year.

Mining boom mark II is gathering pace and it will mean extraordinary new levels of income flowing into Australia, building our national wealth and incomes. But it will also test the capacity of our economy and our workforce. It will benefit different Australians and businesses in different ways. And it will bring with it structural adjustments for our economy equal in magnitude to any we have seen before.

As we've already seen, the exchange rate is likely to remain high, putting immense pressure on some industries. And it will become harder and harder for employers to find the people they need for the work they've got.

You'd be forgiven for thinking that current boom conditions are just a replay of what occurred before the global financial crisis hit, and there are clearly some common elements. Both episodes have led to strong growth in incomes, lower rates of unemployment, increased capacity pressures and a high exchange rate.

But this phase of the mining boom, mining boom mark II, will be very different to mining boom mark I, the boom my predecessor presided over in the middle years of last decade. Today I want to explain these differences because they matter greatly for our Budget.

First of all, mining boom mark II carries with it some of the legacies of the GFC. This is a feature of the economic landscape that obviously didn't apply to mark I. As I touched on earlier, a striking indicator of this is the current caution that consumers are exercising.

Despite strong job creation and incomes growth, consumers are now saving much more of their income and borrowing a lot less. This is not surprising given what the global economy has come through, with the memory of the GFC and stock market falls still in the minds of many households. This is being reinforced by investor caution and what has been fairly subdued recovery in household wealth. This is a dramatic change relative to mark I, where strong consumption growth was accompanied by negative household savings rates, and rising indebtedness fuelled by rapidly rising asset prices. Of course, it's clear that some of this growth was unsustainable, which explains why we've seen such a significant shift in behaviour under mark II.

Just consider trends in personal credit. It rose by almost 60 per cent in the four years preceding the crisis. Since then, it has fallen by more than 5 per cent. Growth in household consumption is expected to be almost a full percentage point lower over the budget forecast horizon than it was during mark I.

On top of this, tighter financial conditions since the crisis are also reducing growth prospects for business. Many small and medium-sized businesses are under pressure from greater borrowing costs and reduced access to credit. Annual growth in business credit has slowed from 14.5 per cent during the first boom, to negative 2.2 per cent so far under the current boom. Part of this also reflects the fact that businesses, like consumers, are taking the opportunity to consolidate their balance sheets. This is a natural response to recent events in the global economy and is not a bad thing – it helps to make our economy more resilient.

The strength of the exchange rate marks another important difference between the two mining booms. During mining boom mark I, the average level of the exchange rate was only 78 cents against the US dollar, compared to an average of 98 cents under the current boom. So the exchange rate, which is now hovering at record highs of around 105 cents, is having a much stronger drag on trade-exposed industries this time around. Sectors like tourism, education and manufacturing are all feeling the threat of international competition far more acutely.

There is now a much larger divergence between the performance of the mining and non-mining sectors of our patchwork economy. While corporate profits outside the resources sector grew solidly during the first boom, they have been very weak in the early stages of this boom. Over 2010, mining sector profits grew 59 per cent, while non‑mining profits fell slightly.

A similar story can be told for business investment. Mining investment intentions for the next year have, for the first time, outstripped private business investment plans for the rest of the economy. Think about that: if realised, it will account for more than half of total private business investment in the economy, despite representing less than one-tenth of total production.

Budget Implications

This tale of two booms brings me to the second major influence on the Budget, and that's the implications of this very different boom on revenues.

During mining boom mark I, revenues were boosted by a sharply rising terms of trade, rapid credit and consumption growth, rapid asset price growth, and solid corporate profitability across the board. Between 2004 and 2007, tax revenues were revised up by a massive $334 billion cumulatively, over the budget estimates.

The current boom starts with an already very high terms of trade. And as greater supply of global commodities comes online, we should expect to see the terms of trade fall gradually over time. This means we won't see growth in nominal GDP at anything like the rates we saw during the first boom. And that means revenues won't grow at the sorts of rates we saw during the previous boom.

Now, there is another, more subtle influence at work which is also putting a brake on tax revenues, and which is best illustrated by this stunning fact: over the past decade the mining sector has accounted for around 20 per cent of total corporate profits, but only 10 per cent of company tax revenues. That's the natural result of the mining sector being highly capital intensive, with a rapidly growing capital base, which translates into rapidly growing deductions.

Added to this is the subdued recovery in household wealth, with the stock market yet to recover to its pre-GFC levels. This means that capital gains taxes are not expected to reach the levels seen in the first boom for some years yet.

All this brings me to the central point of my speech today: that mining boom mark II will have all of the pressures of the first boom, without the surge in revenues. In other words, while revenues will be much more modest than in boom mark I, this does not diminish the massive influx of activity in the private sector that will push the economy to its capacity and which will demand an intelligent policy response.

Budget Strategy

So we frame this year's Budget against a dual backdrop: natural disasters and softer economic and fiscal conditions in the near term, and a return of boom conditions that will stretch our economy's capacity over the coming years, test the capacity of our workforce, and place added pressure on wages and prices that we must not compound.

The right thing to do in these circumstances is to make room for the expansion in private activity – which will boost incomes and deliver jobs for the future. I like to sum it up this way: if we are going to be Keynesians in the downturn, we have to be Keynesians in the recovery too. Just as it was right to step in and support demand when the private economy was in retreat, it is right to step back when private demand is strengthening.

As the Prime Minister and Minister Wong and I have repeatedly said, that means tough decisions are required. Restraining spending and budgeting for surpluses will ensure that we don't compound the inevitable capacity pressures that will emerge with mining boom mark II.

I want to be upfront about the fact that some of these decisions will be unpopular. They are not decisions we take lightly. We take no joy in making these cuts to the Budget, but we take comfort from knowing they are the right and responsible thing to do for the economy. The easier alternative is to put it off for later but that means harsher cuts that hurt the people we represent even more.

What's happening in the US is only another reminder why it's so important for countries to have a credible fiscal consolidation strategy. While we adopted our strict fiscal strategy at the height of the GFC, the US is still struggling to put one in place now. President Obama understands the importance of doing this, and the consequences of failing to act – both for the global financial system and for the livelihood of millions of people around the world. This comes on top of sovereign debt concerns in the periphery of Europe, which also cloud the economic outlook.

For Australia, taking difficult decisions now to bring the Budget back to surplus in 2012-13, will put our economy on a stronger footing. At the same time, we need to be doing all we can to expand our productive capacity.

We need to make sure that we not only have the workers for the boom, but that we are providing opportunities for all Australians to benefit from it. It's why we as a Government will do what we can to break down barriers to participation – both in the workplace and the community. That means building people up, recognising that if we do more to harness the talents of more Australians we'll all be richer for it. Powering our economy through economic and social inclusion. These are familiar ideas from the book I wrote a few years ago and the important speech the Prime Minister gave last week.

We're also on about lifting productivity across the board – through infrastructure investments, tax reform, and putting a price on carbon so we can smoothly transition to a low-pollution future.


I'm very conscious that the story of our fourth Budget is a very difficult one to tell. It combines short-term weakness, medium-term strength, and boom conditions without the boom revenues.

We can't and shouldn't buy support for this Budget, like our predecessors did. There won't be rivers of gold like they wasted. So don't expect to see billions and billions in pro-cyclical policy measures that will compound the inflationary pressure of this boom like they compounded the inflationary pressures of the last one.

That doesn't mean we're not conscious of cost of living pressures – we certainly are. We know that for communities that are feeling these pressures acutely, talk of a boom seems divorced from their reality. We know that despite the gathering pace of this investment boom the benefits have not reached all Australians in our patchwork economy, and so many people are still feeling the pinch.

That's why we delivered three rounds of tax cuts and an historic increase in the base rate of the pension. It's also why we're going to deliver important policies to ease these pressures – like extending the Education Tax Refund, giving more money to parents of teenagers and disabled kids, introducing the work bonus for seniors, and the like.

The onus is on us to do things better than our predecessors did when they sat back and squandered the benefits of boom I. Unlike our predecessors, we won't be recycling boom revenues back into the economy and fuelling demand in an economy rapidly approaching full capacity. We won't pump up demand, without investing in supply. We won't sit back and do nothing while infrastructure bottlenecks build up and widespread skill shortages start to bite. And we won't allow short-term populism to overtake the fundamental responsibility of any government to act in the nation's long-term interest.

Instead we will ambitiously pursue an agenda that is right for our economy, including tax reform and the carbon price we're working so hard on as well.

Putting a price on carbon is a fundamental economic reform for our future. It will preserve the long-term competitiveness of Australian industry, keeping us at the forefront of new clean technologies. Just like floating the dollar and tearing down tariff walls helped unlock economic opportunity – so too will a price on carbon. It will mean that our economy will grow, and pollution will not.

Given the composition of the Parliament, the easiest thing to do would be to have sat on our hands and done nothing. But we were not prepared to put our short-term political interests ahead of the long-term national interest. We are not prepared to leave the heavy lifting to future generations. It is the same with this Budget.

Most people that talk to me about putting together the Budget seem to assume that there is something essentially cold and robotic about the process. They have an image of a Treasurer that shuffles numbers around with little or no regard to the impact the end result will have on people's lives. Nothing could be further from the truth. The decision-making process is arduous and it can even be emotional – especially when it comes to making difficult saves.

In ERC meetings I sit across the table as colleagues argue for programs they passionately believe in. It is my job to take into account the whole of government economic picture and it's their job to do their very best to make sure I understand the importance of the projects they are proposing or defending. It is often necessary to say no to your colleagues but it is rarely easy.

The Budget is obviously important to the Government and my party. But spending cuts are rarely vote winners. This will be a tough Budget for one reason and one reason only – it is what needs to be done for the economy and for the country.

On a personal level, it certainly isn't easy making difficult saves. I am in politics because, as a young man, I came to believe that for some in our society, life can be cruel and unfair. I believed then – and I believe now – that there are people who need a bit of compassion, a helping hand from the rest of us. I also believe that it's important to reward the hard-working Australians that are so fundamental to our nation's prosperity. But what I've learned is that without getting the broader economic settings right, without a strong, sustainable economy, none of this is possible.

So we'll be doing things in this Budget that won't be popular, but they'll be the right thing to do. They'll be consistent with our Labor values, driven by the recognition that leaving this task to future generations will mean even more pain for those doing it toughest in our community.

This is a defining moment for our economy, and we are on the cusp of something great if we keep getting the policy settings right. Just as we can rebuild Queensland after the worst natural disasters in our memory, we can build a new generation of prosperity in the Asian century. Not just for a fortunate few, but for the great bulk of Australians who are prepared to work hard and make our economy even stronger.

So thanks for the opportunity to explain the context in which we go about this difficult task.

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