–      The Budget is forecast to be back in balance by 2018–19 with surpluses building to at least 1 per cent of GDP by 2023–24.

• Over the four years to 2017–18 accumulated deficits are estimated to total $60.2 billion.

–      At the time of MYEFO, deficits for the four years to 2017–18 were estimated to total $104.1 billion (using the medium–term projection for 2017–18 of a deficit of $28.4 billion).

• General government sector receipts are estimated to be $363.5 billion (23 per cent of GDP) in 2013‑14, $385.8 billion (23.6 per cent of GDP) in 2014–15 and $468 billion (24.9 per cent of GDP) by 2017–18.
• Tax receipts are estimated to be $341.6 billion (21.6 per cent of GDP) in 2013–14, $360.3 billion (22.1 per cent of GDP) in 2014–15 and $437.6 billion (23.2 per cent of GDP) in 2017–18.
• General government sector payments are estimated to be $410.7 billion (25.9 per cent of GDP) in 2013–14, $412.5 billion (25.3 per cent of GDP) in 2014–15 and increase to $467.1 billion (24.8 per cent of GDP) by 2017–18.
• In terms of total general government receipts and payments (reflecting both the influence of existing policy settings and new measures in this Budget), the revenue side is forecast to make the biggest contribution as a share of GDP to bringing the Budget back into surplus.
• General government sector net debt is estimated to be $197.9 billion (12.5 per cent of GDP) in 2013‑14, $226.4 billion (13.9 per cent of GDP) in 2014–15 and $264.2 billion (14 per cent of GDP) by 2017–18.
• The face value of Commonwealth Government Securities on issue is expected to fall from $667 billion in 2023–24, as estimated at the time of MYEFO, to $389 billion, assuming future tax relief.

The economic context

The domestic economic outlook

Over the last year the Australian economy has been growing at a solid rate but below its trend rate (estimated to be around 3 per cent per annum). During 2013, a decline in mining and non-mining investment, subdued growth in consumer spending and the high level of the exchange rate all weighed on activity. However, the Reserve Bank of Australia (RBA) reports in its latest Statement on Monetary Policy that growth looks to have strengthened a little over the past six months.[1] This improvement has been underpinned by very strong growth in resource exports and slightly stronger consumption growth despite weak growth in household income.

Treasury is forecasting below trend growth of 2.5 per cent in 2014–15 firming to 3 per cent in 2015–16 (Table 1).[2] The RBA is also forecasting below trend growth in 2014–15 but marginally stronger than Treasury at between 2.25 and 3.25 per cent. The RBA also appears marginally more optimistic about the outlook for 2015–16, forecasting growth of between 2.75 and 4.25 per cent.[3]

Table 1: Treasury and the Reserve Bank of Australia’s growth forecasts (real GDP, per cent)

Source: Australian Government, Budget strategy and outlook: budget paper no. 1: 2014–15, Statement 2, Table 1, p. 1‑7, accessed 14 May 2014; Reserve Bank of Australia, Statement on Monetary Policy, May 2014, Table 6.1, p. 63, accessed 14 May 2014.

With growth running below trend, Treasury is forecasting the unemployment rate will drift higher, peaking at around 6.25 per cent in 2014–15 and 2015–16. Notwithstanding the recent improvement in the labour market, the RBA also considers it likely the unemployment rate will increase marginally over the next year. It is not forecasting the unemployment rate to decline on a sustained basis until after mid-2015 when GDP growth is expected to rise above trend. Even then, the fall in the unemployment rate is expected to be relatively modest by mid-2016.[4] Both Treasury and the RBA expect inflation will remain well contained and consistent with the RBA’s inflation target. Treasury is forecasting the Consumer Price Index (CPI) will be 2.25 per cent in 2014–15 and 2.5 per cent in 2015–16.

A challenging transition is underway

As the Australian economy continues to move into the production and export phase of the resources boom, a re-balancing of economic growth is under way.

Resources investment, the key driver of growth in recent years, is expected to fall sharply over the next few years, detracting from growth. At the same time fiscal consolidation at the federal and state levels means that the contribution to growth from government spending is likely to be low by historical standards. The exchange rate remains at a relatively high level, putting pressure on trade-exposed sectors. And, Australia’s terms of trade are forecast by Treasury to fall by 6.75 per cent in 2014–15 and 1.75 per cent in 2015–16, which will weigh on nominal income growth.

Given this outlook, other sources of growth will need to strengthen if the Australian economy is to make a smooth transition. Part of the slack will be taken up by stronger export growth as the massive expansion of production capacity in the resources sector continues to come online. However, it is generally felt that this will not be sufficient to fully offset the effects of the expected decline in resources investment.

There are encouraging signs that household consumption and dwelling investment are strengthening in response to the current low interest rate environment. The RBA reports that household consumption gradually strengthened over 2013 and forecasts it will continue to rise to a bit above the trend pace of GDP growth by mid–2016. Despite subdued labour market conditions households appear to be responding to low interest rates and rising household wealth (largely the result of rising house prices). Leading indicators suggest that a pronounced pick-up in dwelling investment is under way after a period of several years when it has been relatively weak, as both a share of GDP and relative to population growth.

However, the outlook for non-resources business investment remains subdued. The RBA reports firms continue to indicate through its liaison program that they are waiting to see a sustained pick-up in demand before committing to further investment.[5] The RBA argues that such an improvement is in prospect. It considers non-resources business investment will pick up gradually, supported by low interest rates, increasing activity in the housing sector and a gradual increase in the growth of consumption. Treasury is also forecasting growth in non‑resources business investment which will remain below trend in 2014–15 but will pick up in 2015–16 as firms begin to respond to improving demand, existing levels of spare capacity are absorbed and GDP growth returns towards trend.[6]

While things have gone pretty smoothly thus far it is important to recognise the Australian economy has yet to feel the full negative impact on economic activity from the fall in resources sector investment. It is not clear whether the pick‑up in other sources of growth will be sufficiently strong to not only maintain current momentum but also to get back to trend growth on a sustained basis.

Risks

On the domestic front, Treasury argues the risks are evenly balanced. On the upside, business investment might be stronger than forecast in response to an improvement in domestic or external demand. Further, a depreciation of the Australian dollar associated with declining terms of trade would benefit trade‑exposed sectors of the economy. The downside risks include uncertainty about the fall in resources investment and the timing of the rise in resources exports; the still high Australian dollar weighing on trade exposed sectors; a softening labour market weighing on household consumption; and further large increases in house prices prompting a policy response.

Much would appear to hinge on the timing and magnitude of the expected fall in resources sector investment relative to a further pick‑up in other sources of growth. The RBA argues that:

For the domestic economy, the key uncertainties surrounding the outlook relate to the balance of two key forces: the decline in mining investment and the pick‑up in activity in the non-mining economy (which is being helped in large part by stimulatory monetary policy). The timing and strength of these remain subject to considerable uncertainty.[7]

The Organisation for Economic Cooperation and Development (OECD) considers that Australia continues to face sizeable downside risks:

Domestically, the extent to which non-mining investment will increase and the degree to which households will dip further into their savings to sustain consumption are also uncertain as is the degree to which real-estate construction will pick up.[8]

The level of the Australian dollar may be crucial to how smoothly this plays out over the next few years. Professor Ross Garnaut in his book Dog Days cautioned that a large real depreciation in the Australian dollar would be required to bring forth investment in Australia’s non-resources trade‑exposed sectors.[9] Essentially, he argued that if the Australian dollar remains at relatively high levels, the demand for Australian goods and services will not be sufficiently strong to encourage increased investment in export and import competing industries.

The global economic outlook

The global economic recovery finally appears to be building some sustained momentum. Growth began to pick up in the second half of last year and it looks as if this has continued into 2014. The Treasury, International Monetary Fund (IMF) and OECD are all forecasting the recovery will continue at a moderate pace through 2014 and 2015 (Table 2).

The advanced economies have accounted for much of the recent pick-up in momentum. The recovery has been strongest in the United States but has also been marked in the United Kingdom and Germany. Private sector confidence appears to be strengthening, fiscal consolidation is easing and investment and trade have started to rebound. Nevertheless, the recovery remains uneven across these economies.

While emerging market economies continue to contribute more than two thirds of global growth, their momentum has slowed.[10] As the OECD notes, part of this slowdown is benign, reflecting cyclical slowdowns from overheated starting positions.[11] However, the slowdown also reflects a less favourable external financial environment and, in some cases, continued weak investment and other domestic structural constraints. Looking ahead, the growth momentum of emerging market economies should benefit from stronger exports to advanced economies.

• United States: The United States economy strengthened in the second half of last year. Although a harsher than usual winter slowed activity in early 2014, growth is forecast to rebound over the rest of the year. Growth should be supported by stronger final domestic demand and more moderate fiscal consolidation. Steady job creation and higher equity and home prices should continue to support household consumption and residential investment. Going forward business investment is expected to provide ongoing momentum reflecting stronger profit levels and easing credit conditions.
• Euro area – The Euro area is finally experiencing positive growth again with the core economies recording at least moderate growth and the periphery economies no longer contracting. The systemic risks that have weighed heavily on confidence in recent years have been reduced and large external and internal imbalances have receded.[12] Economic activity is forecast to continue to recover, albeit at a relatively slow pace, as confidence improves, financial market fragmentation declines and fiscal consolidation eases.
• China – In China economic growth moderated in early 2014 as investment slowed in response to tighter credit conditions. Both Treasury and the OECD are forecasting growth will be marginally lower than the official target of 7.5 per cent in 2014. China faces the challenge of gradually reining in rapid credit growth, phasing out excess industrial capacity and rebalancing growth away from investment and toward consumption. While growth is forecast to slow marginally, China is expected to avoid a ‘hard landing’.
• Japan – In Japan economic growth is expected to slow moderately. Although the Japanese economy will receive a boost from private investment and stronger exports, this will be offset by fiscal consolidation. A number of structural constraints are also weighing on growth such as a declining working age population and relatively low female labour force participation. A stronger recovery will depend on the implementation of bold structural reforms and achieving the Bank of Japan’s inflation target of 2 per cent on a sustained basis.
• India – The Indian economy is expected to strengthen gradually, reflecting improved export competitiveness, a rebound in investment following the general elections and the implementation of a number of large investment projects recently approved by the Cabinet Committee on Investment.[13] Nevertheless, structural impediments are likely to mean that growth will be below trend.

Table 2: Treasury, IMF and OECD international growth forecasts (per cent)

Source: Australian Government, Budget strategy and outlook: budget paper no. 1: 2014‑15, 2014, Statement 2, Table 2, p. 2‑6, accessed 14 May 2014; International Monetary Fund, World economic outlook: recovery strengthens, remains uneven, April 2014, accessed 15 May 2014; Organisation for Economic Cooperation and Development, OECD economic outlook: preliminary version, May 2014.

• Other East Asian economies[14] – Treasury reports that growth in the major ASEAN economies moderated in 2013 reflecting tighter financial conditions, lower commodity prices and structural impediments to growth. However, these economies are expected to grow solidly in the period ahead because domestic demand remains resilient; and for the trade exposed economies, an improving global outlook should translate into stronger external demand.

Treasury is forecasting that growth for Australia’s major trading partners will strengthen slightly to 4.75 per cent in 2014, 2015 and 2016. This is above its trend rate of 4 per cent. For its part, the RBA is forecasting growth of Australia’s major trading partners to be around trend in 2014 and 2015.

Both Treasury and the RBA note that since early 2014 iron ore and coal prices have fallen sharply.[15] This reflects a weakening in Chinese steel demand, a period of negative sentiment around China’s economic growth and rising global supply of these commodities.

The outlook for commodity export prices is relatively weak. Treasury expects iron ore prices will fall further in 2014–15 and 2015–16, reflecting slower demand for steel and further growth in global supply. Metallurgical coal prices are expected to rise slightly over this period as global supply growth slows, while thermal coal prices are forecast to remain stable. LNG export prices are expected to increase over the forecast period as the contracts associated with projects that are starting up come into force.

Treasury is forecasting the terms of trade to fall by 6.75 per cent in 2014–15 and 1.75 per cent in 2015‑16.

Risks

During the past year, downside risks have eased but remain significant. Reflecting this, Treasury’s assessment is that international risks are more balanced than previously but are still tilted on the downside.

Specific downside risks include:

• Among advanced economies there is a risk from very low inflation especially in the Euro area. Deflationary pressures could intensify in the event of a negative demand shock, further currency appreciation or a downward drift in inflation expectations. This would likely result in higher real interest rates, an increase in private and public debt and weaker demand and output.
• Emerging market economies could slow by more than currently forecast. Of particular concern are structural and financial vulnerabilities among some emerging market economies such as Turkey and the risk of bouts of renewed financial instability. This could be triggered by the United States’ continuing exit from its highly accommodative monetary policy or a reversal in capital flows as investors rebalance their portfolios in favour of advanced economies.

–      Among the emerging market economies, the risks emanating from China are of particular importance to Australia. The main downside risk in China is that credit tightening could result in lower than expected economic growth. Since the GFC, credit growth and off-budget borrowing by local governments have provided significant stimulus to the Chinese economy.[16] There is a risk the unwinding of this stimulus could lower growth by more than currently forecast. There are also risks around the successful implementation of the reforms needed to rebalance growth and help the Chinese economy move up the value chain.

• Increased geopolitical tensions in recent months raise the possibility of disruptions to trade and financial flows and renewed risk aversion in global financial markets.

The IMF, OECD and other commentators are stressing the need for countries to pursue supply-side structural reforms to increase their potential growth if the global economic recovery is to be sustained. Such reforms include creating more competitive markets for goods and services and investing more effectively in infrastructure and human capital. The nature and extent of the suggested reforms vary depending on a country’s individual circumstances. In the short to medium term there is a risk not enough will be done to secure a sustained pick-up in the pace of global economic growth.

Further, the IMF has highlighted the possibility that rising inequality may well become a constraint on growth. Olivier Blanchard, IMF Economic Counsellor and Director of the IMF’s Research Department, commented at the release of the latest World Economic Outlook:

Until recently, it [inequality] was not seen as having major implications for macroeconomic developments. I think this belief is increasingly called into question. How inequality affects both the macro-economy and the design of macroeconomic policy will likely be increasingly important items on our agenda for a long time to come.[17]

The main channels through which a negative external shock could affect the Australian economy are via financial linkages, trade linkages and confidence and wealth effects. For example, increased resources exports make the Australian economy more sensitive to terms of trade shocks. While the IMF notes there are several factors that would help mitigate the direct effects of a sudden and sharp fall in the terms of trade (including Australia’s floating exchange rate), the indirect effects of such a shock would likely be significant.

The impact of a faster-than-anticipated decline in the terms of trade on nominal output would affect budget revenue more broadly. Income for sectors servicing the mining sector would also be reduced. The impact on domestic and foreign confidence, although difficult to predict, could be significant – consumer confidence would likely to be affected and falling profit margins in the economy’s most dynamic sector could lead financial markets to reassess more generally Australia’s prospects and increase the country’s borrowing costs. The Treasury’s sensitivity analysis suggests that absent a depreciation, a permanent fall in terms of trade around 4 per cent would cause a fall in nominal GDP of 0.75 to 1 per cent and decrease the underlying budget cash balance by around 0.25 per cent.[18]

The medium to longer-term economic outlook

Longer-term economic, social and environmental challenges and opportunities are also important. Generally, these change little from year to year but nonetheless over time have the potential to have a large cumulative impact on economic prosperity and community wellbeing.

For Australia the list of things which are likely to shape the longer-term outlook include:

• an ageing population
• the economic rise of Asia
• technological change
• climate change
• natural resource depletion and
• long-term structural change.

Of a different nature but also important is the risk of external shocks to the Australian economy, which are hard to predict but nevertheless occur not infrequently.

The OECD’s wellbeing framework provides a useful frame of reference for thinking about the implications of such changes for individual and collective wellbeing from a broad perspective.[19] The framework has three conceptual pillars: material conditions (reflecting people’s command over economic resources); quality of life (capturing the broader array of factors that shape people’s ability to pursue their goals, thrive and feel satisfied with their lives); and sustainability (encompassing the key economic, social, environmental and human assets transmitted from current to future generations and how these are affected by today’s actions).

This year’s Budget includes a narrative ‘Sustaining strong growth in living standards’ (Statement 4 of Budget Paper no. 1). It focuses on income as one of the most important determinants of living standards. The main drivers of income growth are productivity growth, changes in the terms of trade, changes in output from increased labour utilisation and growth in net foreign income. The statement discusses the challenges Australia faces in terms of its recent productivity performance, changes in the terms of trade and the changes in workforce participation associated with population ageing.

The statement outlines what the government is doing to support future growth in living standards, which is presented under two broad headings:

• improving the flexibility and competitiveness of the economy and
• budget prudence and government efficiency.

The need to improve Australia’s productivity performance to sustain future growth in living standards is well recognised. The Chairman of the Productivity Commission, Peter Harris, on releasing the Productivity Commission’s latest Productivity Update observed:

It is evident from the Update that Australia’s productivity performance has fallen well behind that of most other developed economies for more than a decade. There are various reasons for this, including differences in the rate of investment growth. But the picture painted in the statistics calls for strong policy attention, particularly in the current era where the recent record terms of trade will no longer support continued income growth.[20]

And the IMF in commenting on Australia’s long-run growth prospects stated that:

Robust income growth over the past decade has been supported in large part by the unprecedented increase in the terms of trade, which as it unwinds, is likely to detract from income growth going forward. This implies that a significant pick-up in labour productivity will be needed to maintain growth in living standards over the coming decades. While productivity in the mining sector should improve as the investments begin yielding results, this will not be enough to maintain current levels of per capita growth, and productivity growth in other sectors also needs to rise.[21]

The implications of the economic outlook for the Budget

Generally, the economic context gets reflected in the budget in a number of ways including:

• the parameters that underpin Treasury’s estimates and projections of revenue and expenditure items
• the government’s fiscal strategy including judgements about what the appropriate ‘bottom line’ is given the economic outlook and other macroeconomic policy settings and
• the government’s decisions about individual budget measures including their nature, size and timing.

Treasury’s assessment of the economic outlook is reflected in the key parameters that are used to estimate and project revenue and expenditure items. The budget forward estimates contain economic forecasts for the budget year and the subsequent year and projections for the next two financial years. Treasury emphasises these projections are not forecasts, but rather are based on a set of medium-term assumptions.

It is worth noting that Treasury has reviewed and revised its methodology for coming up with its medium term projections. This process began in the 2013–14 MYEFO and the current Budget continues to build on these changes. Treasury’s explanation for adopting a new approach is summarised in Statement 2 of Budget Paper No. 1. Essentially, the old methodology assumed that the economy was growing at its long‑term potential (that is, there was no significant output gap) and unemployment was forecast to immediately return to 5 per cent (Treasury’s estimate of the non-accelerating inflation rate of unemployment). Treasury argues that such an approach is less appropriate in the current circumstances where the economy has been growing below trend for seven of the last eight years and there is the largest output gap since the mid-1990s. The new methodology assumes that the spare capacity is absorbed over the five years following the two-year forecast period. Under this approach, real GDP returns to its trend level by 2020–21. Treasury notes that as this occurs, labour market variables, including employment and the participation rate, converge from their levels at the end of the forecast period to their long-run trend levels.

Table 3 shows how a number of the key parameters underpinning the Budget have changed over the last year, including at the time of the Pre-election Economic and Fiscal Outlook 2013 (PEFO) and MYEFO. There have been some significant revisions for 2013–14 and 2014–15 most notably in relation to the terms of trade and nominal GDP growth, which have important implications for revenue forecasts and, incidentally, for the 2013‑14 deficit.

• Appendix A of Statement 2 of Budget Paper No. 1 provides an analysis of Treasury’s recent macroeconomic forecasting performance and Appendix B provides a comparison of the Budget forecasts and those of Consensus Economics (which collects forecasts on key macroeconomic variables from a number of prominent economists) and the IMF.

–       Treasury notes that its Budget forecast of economic growth for calendar year 2014 is lower than the Consensus Economics mean forecast and broadly in line with the IMF’s forecast. The Budget forecast for 2015 is broadly in line with the Consensus Economics mean forecast and higher than the IMF’s forecast.

• Appendix B of Statement 3 of Budget Paper No. 1 provides an analysis of the confidence intervals around the Budget’s economic and fiscal forecasts. These confidence intervals highlight there is a range of plausible alternative outcomes around any given point estimate and provide a guide to the degree of uncertainty around these forecasts, typically spanning a wide range of outcomes.

The outlook for nominal GDP growth is an example of how the current economic outlook is impacting on the budget bottom line. Treasury is expecting nominal GDP growth will remain relatively subdued in the short term growing by only 3 per cent in 2014–15 and 4.75 per cent in 2015–16, which is well below the twenty year average of just over 6 per cent. This largely reflects the expected further declines in the terms of trade and subdued domestic price growth. Weak nominal growth tends to correlate with lower growth in company profits, lower growth in wages and salaries, and hence lower growth in government revenues.

The economic outlook is also reflected in some of the key decisions taken in this year’s budget. For example, as outlined earlier the Australian economy is making a challenging transition as growth is rebalanced away from resources sector investment and towards other sources of growth. While the economy is growing solidly at the moment, growth is nevertheless below trend and the economy is facing some significant headwinds. Accordingly, while the Government has decided to pursue significant fiscal tightening over the next decade, the timing and composition of these measures is intended to lessen the impact on growth in the short term.[22] In net terms much of the tightening is ‘back loaded’ (that is, it occurs predominantly towards the end of the forward estimates period). This is consistent with IMF and OECD advice prior to the budget that Australia should avoid heavy front-loaded fiscal consolidation in the current economic environment.[23] Further, the Government’s decision to boost infrastructure spending is intended to help pick up some of the slack as resources sector construction activity winds down, as well as improving the long-term productive capacity of the economy.

Table 3: Treasury forecasts of major economic parameters (per cent)

Source: Australian Government, Budget strategy and outlook: budget paper no. 1: 2013–14, 2013, Statement 2, Table 1, p. 2‑14, accessed 15 May 2014; Secretary to the Treasury & Secretary of the Department of Finance and Deregulation, Pre-election economic and fiscal outlook 2013, Table 2, p. 5, accessed 15 May 2015; Australian Government, Mid-year economic and fiscal outlook 2013–14, 2013, Table 1.2, p. 2, accessed 15 May 2015; Australian Government, Budget strategy and outlook: budget paper no. 1: 2014–15, 2014, Statement 1, Table 2, p. 1‑7, Statement 2, Table 1, p. 2‑5, accessed 14 May 2014.

The government’s fiscal strategy and broader policy agenda

The fiscal strategy

Consistent with the requirements of the Charter of Budget Honesty Act 1998, the Government has set out in the Budget its medium‑term fiscal strategy, which is to achieve budget surpluses, on average, over the course of the economic cycle.

This strategy will be underpinned by the following three policy elements:

• investing in a stronger economy by redirecting government spending to quality investment to boost productivity and workforce participation
• maintaining strong fiscal discipline to reduce the government’s share of the economy over time in order to free up resources for private investment to drive jobs and economic growth, with:

–      the payment-to-GDP ratio falling
–      paying down debt by stabilising and then reducing Commonwealth Government Securities on issue over time and

• strengthening the government’s balance sheet by improving net financial worth over time.[24]

In addition, the Government has articulated a budget repair strategy, which is designed to deliver budget surpluses building to at least 1 per cent of GDP by 2023–24 consistent with the medium-term fiscal strategy.

The Government’s Budget repair strategy specifies that:

• new spending measures will be more than offset by reductions in spending elsewhere within the budget
• the overall impact of shifts in receipts and payments due to changes in the economy will be banked as an improvement to the budget bottom line, if this impact is positive, and
• a clear path back to surplus is underpinned by decisions that build over time.[25]

The Government has indicated the budget repair strategy will stay in place until a strong surplus is achieved and so long as economic growth prospects are sound and unemployment remains low.[26]

The Government’s broader policy agenda

The Budget is also framed around the Government’s broader policy agenda.

The major policy themes in this year’s budget include:

• All Australians making a contribution to fiscal repair – sitting beneath this theme are measures such as: the temporary budget repair levy; changes to the eligibility thresholds for a range of transfer payments; freezing the indexation of a large number of payments and programs for two to three years; reducing the size of the public sector; and reductions in the growth of Commonwealth payments to the states and territories for schools and public hospitals.
• Building Australia’s future – this thematic area includes: the infrastructure growth package; changes to the higher education system; changes to health care and the establishment of the Medical Research Future Fund; measures to support workforce participation; reshaping and reducing industry assistance programs into a new Entrepreneurs’ Infrastructure Programme; the bringing forward of $1.5 billion of defence spending from 2017–18 to earlier years; and consolidating border protection agencies into a single agency, the Australian Border Force.

The Parliamentary Library’s research specialists have prepared briefs on the major policy decisions taken in this year’s Budget. The briefs provide information and analysis of these measures.

The fiscal outlook

The Budget sets out a plan for substantially reducing the deficit over the four years to 2017–18. Over the next two years the decisions in the Budget can largely be characterised as a reprioritisation of resources. In net terms the budget measures do not have a particularly large impact on the bottom-line in 2014–15 and 2015–16. However, they have a large cumulative effect and involve significant fiscal tightening from 2016–17.

In the short term the decisions in the Budget are intended to stabilise the forecast deterioration in the Commonwealth’s balance sheet.

The Budget includes medium-term projections that have the budget achieving a small surplus in 2019‑20 that builds to a surplus of at least 1 per cent of GDP by 2023‑24. The medium term projections also show the Commonwealth’s balance sheet improving over time. Recent experience suggests that accurately forecasting even one or two years out can be very difficult. However, if a surplus is achieved in 2019‑20 it will be the first surplus since 2007‑08.

Table 4: The underlying cash balance

Source: Australian Government, Budget strategy and outlook: budget paper no. 1: 2014–15, 2014, Statement 10, Table 2, p. 10‑7, accessed 14 May 2014.

There is a strong case for having in place a medium-term fiscal strategy for returning the budget to surplus on a sustainable basis and strengthening the Commonwealth’s balance sheet. The experience of the global financial crisis shows very clearly the advantages of the government being in a strong fiscal position when the economy is hit by a large negative shock. It also helps create space for fiscal policy to be used to focus on addressing medium to longer‑term structural constraints on growth, thereby potentially improving the productive capacity of the economy and future living standards.

Of course, the aggregate numbers abstract from the appropriateness of individual Budget measures intended to achieve the desired fiscal consolidation. Two potential budget measures may have the same financial impact on the Budget’s bottom line but may have different effects in terms of their impact on community wellbeing. Reflecting this, individual measures need to be assessed on their merits not only in terms of the budget bottom line but from a broader perspective that encompasses their likely impact on the wellbeing of current and future generations.

How has the short-term fiscal outlook changed?

Figure 1 provides a snapshot of how the outlook for the underlying cash balance has changed since the 2013–14 Budget. The short-term fiscal outlook over the four years to 2016–17 had deteriorated from the time of last year’s Budget through to MYEFO. Taking MYEFO as the starting point for this year’s budget, an improvement in the bottom-line out to 2016–17 was already in prospect. However, when 2017–18 is added into the picture it is notable that the deficit was forecast to increase again in 2017–18 as funding associated with some large policy commitments (such as additional school funding and the national disability insurance scheme) came online. The changes made in the 2014–15 Budget reduce the forecast deficits for 2014–15, 2015–16 and 2016–17 and significantly reduce the forecast deficit for 2017–18.

Not all the revisions to the budget’s bottom line are due to policy decisions by government. Parameter and other variations have had a significant effect on the underlying cash balance (Table 5). In this table a negative number represents a worsening of the bottom line and a positive number an improvement.

Figure 1: Revisions to the underlying cash balance ($m)

Source: Australian Government, Budget strategy and outlook: budget paper no. 1: 2014–15, 2014, Statement 3, Table 5, p. 3‑21, accessed 14 May 2014.

Policy decisions in this year’s Budget are expected to increase receipts by $673 million in 2014–15, $1,916 million in 2015–16 and $2,786 million in 2016–17.

Policy decisions in this year’s Budget are expected to reduce payments by $1,045 million in 2014–15, $4,018 million in 2015–16 and $7,628 million in 2016–17.

Statement 3 of Budget Paper No. 1 includes a detailed reconciliation of the changes to the cash balance estimates since the 2013–14 Budget.

Table 5: The effect of policy and parameter variations on the underlying cash balance

Source: Australian Government, Budget strategy and outlook: budget paper no. 1: 2014–15, 2014, Statement 3, Table 5, p. 3‑21, accessed 14 May 2014.

The structural budget balance

As noted above, in the medium term the fiscal outlook is forecast to improve. Statement 3 of Budget Paper No. 1 includes a discussion of the estimates of the structural budget balance (that is the budget bottom line that abstracts from the effects of the economic cycle and one-off factors) out to 2023–24. Reflecting the improvement in the outlook for the underlying cash balance since MYEFO the structural budget balance is forecast to improve significantly. In structural terms the budget is forecast to be around balance by 2018–19 and is projected to be in surplus after that. At the time of MYEFO, the structural budget balance had been forecast to be in deficit throughout the medium-term projections period.

The Commonwealth’s balance sheet

The measures in the Budget help stabilise the forecast deterioration in the Commonwealth’s balance sheet (Table 6).

The primary indicator of fiscal sustainability articulated in the Government’s medium‑term fiscal strategy is net financial worth (that is, total financial assets minus total liabilities). It provides a broad measure of the government’s assets and liabilities as it includes both the assets of the Future Fund and the superannuation liability the Future Fund is intended to offset.

In the medium term, net debt (which excludes superannuation liabilities and equity investments) is forecast to decline to 0.7 per cent of GDP in 2024–25, assuming that tax receipts are capped and do not increase above their long-term average of 23.9 per cent of GDP. With Commonwealth Government Securities on issue projected to fall over this period, the Commonwealth’s net financial worth is also projected to improve.

Table 6: Net financial worth, net debt and net interest payments

Source: Australian Government, Budget strategy and outlook: budget paper no. 1: 2014–15, 2014, Statement 3, Table 2, p. 3‑15, accessed 14 May 2014.

Over time the impact of servicing government debt is expected to decline. Assuming tax receipts are capped at their long term average, interest payments are expected to peak at $13.1 billion in 2018–19 and decline to $6.6 billion in 2024–25 (0.2 per cent of GDP).

Statement 3 of Budget Paper No. 1 includes a detailed reconciliation of the changes in the Commonwealth’s balance sheet since the time of MYEFO.

[1].           Reserve Bank of Australia, Statement on monetary policy, May 2014, p. 62, accessed 15 May 2014.

[2].           Unless otherwise stated the figures in this overview are sourced from Australian Government, Budget strategy and outlook: budget paper no. 1: 2014–15, 2014, accessed 14 May 2014.

[3].           Ibid., p. 63.

[4].           Ibid., p. 64.

[5].           Ibid., p. 2.

[6].           Ibid., Statement 2, p. 2–11, accessed 14 May 2014.

[7].           Reserve Bank of Australia, Statement on monetary policy, op. cit., p.  4.

[8].           Organisation for Economic Cooperation and Development, OECD economic outlook: preliminary version, May 2014, p. 122.

[9].           R Garnaut, Dog days: Australia after the boom, Redback, Collingwood, Vic, 2013.

[10].         International Monetary Fund, World economic outlook: recovery strengthens, remains uneven, April 2014, p. xv, accessed 15 May 2014.

[11].         OECD, OECD economic outlook: preliminary version, op. cit., p. 7.

[12].         Ibid., p. 94

[13].         Ibid., p. 203.

[14].         Other East Asia comprises the newly industrialised economies of Hong Kong, South Korea, Singapore and Taiwan and the Association of Southeast Asian Nationals group of five (ASEAN-5) which comprises Indonesia, Malaysia, the Philippines, Thailand and Vietnam.

[15].         Budget strategy and outlook: budget paper no. 1: 2014‑15, op. cit., p. 2‑14; RBA, Statement on monetary policy, op. cit., p. 11.

[16].         IMF, World economic outlook: recovery strengthens, remains uneven, op. cit., p. 16.

[17].          IMF, Transcript of a press briefing on the World Economic Outlook (WEO), Washington, D.C., Tuesday, 8 April 2014, accessed 15 May 2014.

[18].         IMF, Australia: 2013 Article IV consultation: staff report, February 2014, accessed 15 May 2014, pp. 15‑16.

[19].         OECD, How’s life? Measuring wellbeing, 2011, accessed 15 May 2014, pp. 18‑21.

[20].         Productivity Commission, Australia’s productivity performance, media release, 29 April 2014, accessed 15 May 2014.

[21].         IMF, Australia 2013: Article IV consultation: staff report, op. cit., p. 16.

[22].         Budget strategy and outlook: budget paper no. 1: 2014‑15, 2014, op. cit., p. 2‑16.

[23].         OECD, OECD economic outlook: preliminary version, op. cit., p. 120; IMF Australia 2013: Article IV consultation: staff report, op. cit., p. 8.

[24].         Budget strategy and outlook: budget paper no. 1: 2014‑15, op. cit., p.  3‑7.

[25].         Ibid.

[26].         Ibid.

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