Saturday, May 05, 2007

Tuesday's 2007-08 Commonwealth Budget: "Christmas in May"

Below are three preview pieces I have written, one based on the work of Access Economics, and two based on the Reserve Bank's quarterly economic statement and also the work of a number of banks.

The key points to come out of all three are

-> that Costello will go for a projected surplus in 2007-08 of around 1 per cent of GDP - say, $10 billion

-> that Costello (more likely Howard, and his department Prime Minister and Cabinet) have a lot of money to throw around,

-> that they will, in a way that shamelessly advantages particular electorates and interest groups, and

-> that a chunk of the spending will be in THIS financial year 2006-07 to make the projected surplus for 2007-08 still look good.

I have to stress that I have no inside information.

The budget documents will be available here from 7.30pm eastern time Tuesday May 8.

The best net coverage will be here at the same time.

ABC radio and TV will carry the speech and anaysis and reaction live.

I'll be on Nightlife that night at 11.00pm on ABC local radio, and Life Matters on Radio National at 9.00am the next morning.

All clear from the Reserve

The Reserve Bank has given the Treasurer Peter Costello a green light for big tax cuts and spending in Tuesday’s budget, making it clear that it now has no plans to push up interest rates in the year ahead.

In what appears to be a deliberate attempt to hose down speculation about rate rises this year the Bank said in its quarterly statement released yesterday that it felt it had “adequate time to respond as needed to the possibility of higher medium-term inflation”.

The Bank cut its forecast for inflation this year to an underlying rate of 2.5 per cent, right in the middle of its target, and while predicting slightly higher inflation in 2008 said there was no need for preemptive action.

Indeed, it said it expected the next inflation figure due in July to begin with the number one. It is forecasting a headline inflation rate of 1.75 per cent, a result that would make a pre-election interest rate hike impossible to justify.

The Bank admitted to some concern about wages, which it said were increasing faster than at any time for more than a decade, but it said they were not accelerating and were not fully flowing through into prices.

In further encouraging news for the Treasurer ahead of the budget the Bank lifted its forecast of economic growth. It now expects Australia’s non-farm economy to grow by 3.75 per cent in the year ahead, up from its previous forecast of 3.5 per cent.

The Bank even expects a recovery in farm GDP, which it says is on track to fall by 20 per cent during the current financial year, but it warned that its forecast of a recovery depended on the return of rain and it said “there remains a risk that this will not occur”.

Westpac’s chief economist Bill Evans said last night that the Bank had been sidelined by low inflation.

With it no longer able to credibly threaten higher interest rates the Mr Costello was free to spend aggressively, particularly on projects that would benefit the electorally sensitive state of Queensland.

Westpac expects spending or tax cuts both in what is left in the current financial year as well as the year ahead.

Mr Costello’s 2004 pre-election budget included year with immediate spending of $4bn in one-off family payments that detracted from the 2003-04 surplus rather than the better watched 2004-05 surplus.

Mr Evans said he expected the Treasurer to try the same trick again, spending billions in the current financial year, perhaps even halving its projected surplus, leaving room for an impressive-looking forecast surplus for 2007-08.

The ANZ Bank told its clients yesterday it expected a forecast surplus of around $10 billion, or 1 per cent of GDP – which it said would still allow the Treasurer to present “Christmas in May”, orchestrating a feast of gifts from a jolly man reaching into a sack of goodies.

The ACT Chief Minister Jon Stanhope said yesterday he was hoping for a commitment to fund elements of the Griffin Legacy and a new Canberra convention centre as well as a significant sign of support for the capital’s centenary in 2013.

“The Commonwealth injected about $50 million into the Federation Square development in Melbourne to help mark the centenary of federation,” he said.

“It would be wonderful if a similar commitment was made to the creation of a physical legacy of the first century of the nation’s capital city and I look forward to working with the Commonwealth to start firming up a year-long program of events and celebrations for 2013, a program that will involve the entire nation”.

A beautiful set of numbers

Australia’s longest-serving Treasurer can relax. Peter Costello now has every reason to have a smile on his face and a spring in his step as he puts the final touches to his Tuesday night Budget. Australia’s Reserve Bank, which only weeks ago was raising the spectre of an interest rate hike anytime between the budget and the election has got out of the way.

Not only that, on Friday it delivered him with an assessment of the economy that couldn’t have been more pleasing.

On its reading, there will be no interest rate rises this year, and quite possibly beyond, inflation is back where it should be and even a touch lower, and economic growth is a touch higher. Not only that there was not a word in the Bank’s comprehensive 58-page quarterly statement that suggests it is the least bit concerned about tax cuts or extra spending in the budget or the lead-up to the election.

Until Friday’s statement we knew that the Bank had decided not to push up interest rates at its meetings in April and May after in March creating the expectation that it would.
But we didn’t know why. The quarterly statement tells us that it is because of an unexpected step-down in inflation. The underlying rate (which excludes volatile prices such as those of petrol and bananas) had been running at an annualised 3 ¼ per cent – beyond the Bank’s comfort zone. But in the last six months it has slumped to 2 ¼ per cent - within and towards the low side of the Banks target zone.

The Bank didn’t know this until the CPI figures released last week, and its statement suggests that it is a bit mystified as to why. Part of it is the continuing supply of what seems to be an ever-increasing range of cheap goods imported from China. The aggregate price of goods that can be imported (other than food and petrol) increased not at all in the March quarter and climbed by only 0.4 per cent over the year. The prices of many goods that can be imported are actually falling quite quickly - among them clothes, shoes, furniture, electronic goods and computers.

(In contrast to perhaps the bulk of economic forecasters, the Bank does not believe that the higher Australian dollar has had much to do with the lower price of imported goods. It believes that for some years now movements in the dollar have been absorbed by importers, whether the dollar is moving up or down.)

Surprisingly there has also been a slowing in the rate of inflation in the price of non-importable goods and services, a category that includes education and rents. The bank says this may be the result of lower oil prices in the last half of last year. Wages are increasing faster than they have been for a decade or more, but the bank says at least that rate is not accelerating and for some reason is not being reflected in prices.

The bank has revised down its forecast for inflation in 2007 from 2 ¾ per cent to 2 ½ per cent, right where in the middle of its target band. It says that should the higher dollar unexpectedly put further downward pressure on prices inflation will be lower still.

Down the track, in 2008 and 2009 it expects the underlying rate of inflation to increase to 2 ¾ per cent, but it says that won’t happen this year. It has “adequate time to respond as needed to the possibility of higher medium-term inflation”.
Reserve Bank watchers interpret these words as a deliberate signal that won’t increase rates this year. It can wait. Another way of looking at it is an indication that its earlier signal that it was examining rates “month by month” is no longer operative.

And that’s not the only good news for the Treasurer. The Bank has revised up its forecast of non-farm economic growth. Previously it was expecting growth of 3 ½ per cent. Now it says that figure could reach 3 ¾ per cent.

It says that notwithstanding interest rate hikes in May, August and November last year, both consumer spending and spending grew strongly at the start of this year. Motor vehicle sales were particularly strong, climbing 6 per cent in the first three months of this year. Increasing share prices and modestly increasing house prices have boosted household wealth.

For the first time the bank has made use of a new, potentially more reliable measure of house price movements that compares like with like - measuring the movements in the price of houses with similar characteristics such as the number of bedrooms, bathrooms and location. It finds that Australia-wide prices climbed 1 per cent in the March quarter, and 5 per cent over the year. Only in Perth, Darwin and Canberra have prices eased off since the start of this year. In Canberra prices were flat in the March quarter and up 6 per cent over the year.

The Bank says profits as a share of GDP are at close to 30-year highs and that firms surveyed expect their profits to continue to grow.

Employment has been increasing quickly and unemployment falling, and not only in the official figures. A broader measure of so-called underemployment that takes into account people who would like to work more hours is also at a 25-year low.

This has been made possible by a big increase in the proportion of females employed, and in the proportion of 55 to 64 year olds getting or keeping jobs. The number of “discouraged jobseekers” who would look for work if they thought if was there has fallen to a new low – only 50,000 Australians.

In order to get jobs Australians are more willing before to move between states. The official figures show a big inflow of jobseekers into Western Australia, and the Bank says that there are many more temporary workers moving west not captured in the official statistics.

As well migrants are helping fill skills shortages, both restraining wages and enjoying Australia’s good wages, helped by a 45 per cent increase in migrant arrivals since the start of the decade. It says many are migrating directly to Western Australia.

The bank says that traditionally migrants have suffered higher unemployment rates than the nation as a whole and many hadn’t wanted to work as soon as they arrived, but both the migrant participation rate and the migrant unemployment rate have moved to very near the Australian average.

So encouraging is the picture painted by the Reserve Bank that the ANZ bank has headed its advice to clients this weekend with the words “Christmas in May”. It likens next Tuesday’s budget to a feast of gifts from a jolly man reaching into a sack of goodies made in China.

It says Mr Costello is likely to go for a cash surplus of around $10bn - 1 per cent of GDP. He has said many times that he regards a surplus of 1 per cent of GDP as prudent, most recently telling the ABC’s Tony Jones that if last year’s projected surplus of 1 per cent of GDP had been spent it would “probably break the reputation of Australia in financial markets”.

But the bank says that big increases in taxation revenue will nevertheless give Santa lots of money to throw around.

Among the reported budget leaks are tax cuts aimed at Australians earning around A$50,000 a year, bonuses for working parents who depend on childcare, tax breaks for film production, billions of dollars in infrastructure spending spread over several years including a $3.6 billion inland rail network, rebates for green energy and water-saving devices in homes in response to Labor’s promise of low-interest loans, more money for doctors making evening calls, $1 billion to encourage private home ownership and lift education and health standards among aborigines, and a $1 billion boost to military recruitment in order to help sustain operations in Afghanistan.

The reassuring news for the Treasurer is that the Reserve Bank on Friday said nothing which in any way could be taken as a warning that it would be displeased by this sort of spending.

Only the Treasury has sounded a note of warning, and that was in a leaked speech that was never meant to made public.

The Treasury Secretary Ken Henry, who has been working with the Treasurer in drawing up the budget warned his staff in March that during the election year there was “a greater than usual risk of the development of policy proposals that are, frankly, bad”.

He said: “the next time any of you get an opportunity to write a coordination comment on a cabinet submission that proposes a taxpayer-funded handout for some stunning new investment proposition – and I predict that some of you won’t have to wait very long for such an opportunity – I suggest you draw attention to the submission’s failure to identify the businesses that will lose labour, and be forced to reduce output, if the proposal is agreed to.”

Dr Henry (or at least those who agree with him) will be metaphorically looking over Treasurer’s shoulder as he delivers the budget on Tuesday night, whether or not the Treasurer listened to him in drafting the speech.

Spending with surplus to spare

Australia’s resources boom has delivered the Treasurer have as much as $30 billion to spend on tax cuts and new programs on budget night next Tuesday, in the view of the respected budget forecaster Access Economics.

In its pre-budget monitor to be released this morning Access says increased tax revenue will give the government $3.7 billion more than it was expecting in the current financial year, and $3.9 billion more than it was expecting in 2007-08.

When this is added to the budget projections published by the Treasury in Access says Mr Costello will find himself with an underlying cash surplus of $15.5 billion in the current financial year and a surplus of $13.6 billion in the one ahead, much of which will be available to him to spend or give away in tax cuts.

The Treasurer has once before dipped into the current year’s surplus for immediate spending in the weeks before the financial year ends. In the pre-election budget of 2004 he spent twice on families receiving family allowances, giving them an immediate bonus payment in the financial year about to end and another bonus in the year about to begin.

The Access figures suggest that there is considerable room for Peter Costello to spend from this year’s surplus as well as next year’s leaving the surplus forecast for 2007-08 still looking healthy.

It says many of the government’s expensive-sounding announcements, including a $19 billion road spending package and a $10 billion water package have left the 2007-08 surplus virtually untouched because they are long-term programs designed to build up slowly.

The Treasurer himself has given little indication of the surplus that he will be aiming for when the 2007-08 projection is announced on budget night, telling reporters yesterday only that “we need to make sure we are not borrowing, we need to add to savings to put something aside for a rainy day and we need to keep pressure off interest rates and that is what I will be doing next Tuesday night”.

Access has called on the Treasurer not to spend up big on Tuesday saying that the budget is already in structural deficit. By that it means that the current budget settings are ones that would have put the budget into deficit were it not for the commodities boom.

Last year the government lifted the 30 per cent income tax threshold, cut the 42 per cent rate to 40 per cent and cut the top 47 per cent rate to 45 per cent. The top rate now does not cut in until $150,001.

Access says these decisions will push the 2006-07 budget into structural deficit to the tune of $1.6 billion and the 2007-08 budget into a structural deficit of $2.7 billion.

Access says the budget is likely to forecast a moderation in inflation, slowing earnings growth over time and a gently slowing rate of employment growth, with Australia’s unemployment rate remaining below 5 per cent through to 2010.