Budget Review 2021–22 Index
Rob Dossor
This brief provides an overview of the key fiscal and
economic numbers from the Budget
Strategy and Outlook: Budget Paper No. 1: 2021–22.
Macroeconomic parameters
Domestic economy
Relative to the 2020–21 Mid-year Economic and Fiscal outlook
(MYEFO), Government forecasts for key domestic macroeconomic parameters have
been revised upwards, largely due to more favourable economic circumstances than
expected. The main changes include:
-
for 2020–21, real GDP growth has been revised up by 0.5% to
1.25%. For 2021–22, real GDP has been revised up 0.75% to 4.25%. For 2022–23 real
GDP growth forecasts are steady at 2.25%, as the recovery stabilises.
-
for 2020–21, nominal GDP growth has been revised up
significantly by 2.75% to 3.75%, largely due to the improvement in the terms of
trade.
-
for 2020–21, inflation, as measured by the Consumer Price
Index (CPI), has been revised up
by 1.25% to 3.5% (and up 1.75% on the 2020–21 Budget). However, the Government expects
it to fall to 1.75% by 2021–22 and then to 2.25% in 2022–23, and reach 2.5% in
2023–24, between the Reserve Bank’s target inflation rate of between 2% and 3%.
- wage price growth is unchanged, for 2020–21, at 1.25%, but
revised up slightly by 0.25% in 2021–22 and 2022–23.
- employment growth has been revised up for 2020–21, to 6.5%,
but lowered by 0.75% to 1% in
2021–22.
-
the terms of trade have been revised up significantly for 2020–21
and slightly for 2021–22, reflecting higher iron ore spot prices achieved in
2020–21 (with thermal and metallurgical coal prices forecast to remain steady).
Table 1: growth in key economic
parameters at 2021–22 Budget relative to 2020–21 MYEFO
|
Outcome
|
Forecasts
|
|
2020–21
%
|
2021–22
%
|
2022–23
%
|
2023–24
%
|
2024–25
%
|
Real GDP
|
1.25
|
4.25
|
2.5
|
2.25
|
2.5
|
Change
since MYEFO
|
0.5
|
0.75
|
0
|
-0.5
|
na
|
Nominal GDP
|
3.75
|
3.5
|
2
|
4.75
|
5
|
Change
since MYEFO
|
2.75
|
2.25
|
-1.75
|
0
|
na
|
Consumer Price Index
|
3.5
|
1.75
|
2.25
|
2.5
|
2.5
|
Change
since MYEFO
|
1.25
|
0.25
|
0.5
|
0.5
|
na
|
Wage Price Index
|
1.25
|
1.5
|
2.25
|
2.5
|
2.75
|
Change
since MYEFO
|
0
|
0.25
|
0.25
|
0.25
|
Na
|
Employment
|
6.5
|
1
|
1
|
1.25
|
1.25
|
Change
since MYEFO
|
2.5
|
-0.75
|
-0.25
|
-0.5
|
na
|
Unemployment rate
|
5.5
|
5
|
4.75
|
4.5
|
4.5
|
Change
since MYEFO
|
-1.75
|
-1.25
|
-1
|
-0.75
|
na
|
Terms of trade
|
10
|
-8
|
-10.5
|
na
|
na
|
Change
since MYEFO
|
9.25
|
5.25
|
na
|
na
|
na
|
Sources: Australian Government, Mid-Year
Economic and Fiscal Outlook 2020–21, p. 3 and p. 19; Australian
Government, Budget
strategy and outlook: budget paper no. 1: 2021–22, Statement 1, p. 9 and Statement 2, p. 37.
COVID-19 impacts on forecasts
COVID-19 restrictions continue to impact the economy; for
example, inbound and outbound international travel is expected to remain low
through to mid-2022. It is assumed, however, that there are no extended or
sustained state border restrictions in place over the foreword estimates.
The Budget assumes that a population-wide vaccination
program is ‘likely’ in place by the end of 2021. It also assumes that while
localised outbreaks of COVID-19 may occur, they are effectively contained.
These assumptions are broadly consistent with those contained in the 2020–21 Budget.
GDP projections
The Budget outlines that ‘potential GDP is estimated based
on an analysis of trends for population, productivity and participation.’ An
increase or decrease in these trends will affect potential GDP. As excess
capacity in the economy is absorbed over time, real GDP converges towards its
potential level and the unemployment rate moves towards a point where any
further fall in unemployment will accelerate inflation (known as the
Non-accelerating Inflation Rate of Unemployment (NAIRU)). This occurs because
unemployment below the critical level of the NAIRU drives up wages which causes
inflation.
Overall, the nominal GDP outlook has strengthened over the
forecast and medium-term projection period. This reflects a faster-than-expected
recovery to date, a higher level of potential GDP over the medium term, and
stronger actual and updated commodity export price assumptions.
The faster-than-anticipated recovery in output and the
labour market means that excess capacity continues to be reduced. As the
unemployment rate falls, the Budget states it will reach the estimated NAIRU band
by the June quarter 2022 (5%) and the bottom of the estimated NAIRU band by the
June quarter 2024 (4.5%).
Sensitivity analysis
Budget forecasts and projections incorporate a range of
assumptions and judgments about many factors. The extent to which forecasts and
projections are sensitive to changes in those assumptions is the subject of
sensitivity analysis. Examples of factors that can affect Budget forecasts are
iron ore prices, which affect mining company profits, and therefore tax
receipts, and exchange rates.
The Budget provides several sensitivity analyses, with one
based on iron ore spot prices. This analysis provides an indication of the
direct impacts on nominal GDP and company tax receipts of altering the timing
around the iron ore spot price assumption.
The iron ore spot price on Budget day was over $200USD per
tonne. The Budget assumes that iron ore spot prices will fall to US$55 per ton
Free on Board (FOB) by the March quarter 2022. If this fall were to occur immediately,
rather than by the end of the March quarter 2022, nominal GDP could be around
$11.6 billion lower than forecast in 2020–21 and $38.1 billion lower in 2021–22.
This would result in lower tax revenue of $600 million in 2020–21, $8.3 billion
in 2021–22 and around $3.5 billion in 2022–23.
If the iron ore spot price were to remain elevated until the
end of the March quarter 2022, before falling to US$55 per tonne FOB, nominal
GDP could be around $1.1 billion higher than forecast in 2020–21 and $48.7
billion higher in 2021–22. This would increase tax receipts of around $100
million in 2020–21,
$5.5 billion in 2021–22 and around $6.9 billion in 2022–23.
The Budget notes that there is a greater level of
uncertainty around forecasts due to the COVID-19 pandemic. The scale of economic
and social disruption is unprecedented in most Australians’ lifetimes. As such,
it is difficult to estimate the impact that the COVID-19 pandemic will have on
Australia’s economy in the short and medium term.
There are a range of other variables, changes in which could
cause different outcomes from those assumed in the forecasting process. Terms
of trade, productivity and yields have been chosen for forecasting sensitivity
analysis, as they are all fundamental to Australia’s economy and fiscal
outcomes and have varied over time.
One scenario analysis explores the consequence of a 10% increase
in non-rural commodity prices from 2021–22 relative to the Budget. This
scenario is expected to result in an increase in the terms of trade of 4.75%
and a rise in nominal GDP of 0.5% by 2022–23.
Another scenario analysis considers the impacts of both a
slower and faster pace of convergence to the long-run productivity growth
assumption of 1.5%. Under the slower convergence analysis, underlying
productivity growth is assumed to converge to the 30-year average over 15 years
rather than 10.
By the end of the projection period in 2031–32, the levels
of real GDP and nominal GDP are around 1.5% to 1.75% lower. This slower
convergence also flows through to lower wages.
By contract, a faster convergence has a positive impact on
the underlying cash balance projections and gross debt projections, of a
similar magnitude.
The final scenario analysis assesses the likely impact of
alternative bond yield pathways to the one assumed in the Budget. Bond yields
affect the Budget, as a
higher yield (i.e. the return investors receive each year) will increase a
bond’s servicing cost, which impact the underlying cash balance. The analysis
tests the likely impact of the 10-year bond yield remaining at current levels for
the entire 11-year period, rather than beginning to rise after four years, as
is assumed in the Budget.
Compared to the Budget projections, the lower yield
assumption results in a slight improvement to the underlying cash balance over
the medium term. This occurs as the cost of bonds is lower than forecast.
Cumulative improvements to the underlying cash balance are projected to reduce
gross debt by 2.0% of GDP at 30 June 2032.
The higher yield assumption assumes that yields converge
immediately from current levels over five years to the long-run yield rate of
around 5%. This results in a deterioration in the underlying cash balance of
around 1% of GDP by 2032, as the cost of bonds is higher.
Labour markets
The Budget states that the labour market recovery since
mid-2020 has been unprecedented. Employment reached a record high of 13.1
million in March 2021 (0.6% higher than a year earlier), and unemployment fell
to 5.6%. Notably, monthly hours worked is up 1.2% and the number of people on
zero hours for economic reasons has fallen below pre-pandemic levels.
The Budget does not canvass other labour market metrics,
such as the underemployment rate. A person is underemployed when they are
engaged in part time work and want more work, or usually work full time by are
only working part time for economic reasons. The unemployment
rate counts people, above the age of 15, who are not employed during the
reference week, had actively looked for work during that week and were able to
start work. The underemployment rate fell by 0.9% to 7.9% in the 12 months to
March 2021.
The Budget outlines that workers who lost their job due to
the COVID-19 pandemic were far more likely to be re-employed quickly, compared
to past downturns. Total monthly hours worked are now 1.2% higher than
pre-pandemic levels. Australia’s labour market continues to perform favourably
compared with all major advanced economies. Compared with major advanced
economies for which published data is available, Australia is the first country
to have recovered hours worked and employment to pre-pandemic level.
International
Relative to the 2020–21 MYEFO, the Budget forecasts for
world GDP growth have been revised up by 0.7% from -4 to -3.3% for 2020,
and by 1.25% from 4.75% to 6% for 2021. Although the 2020 forecast differs from
the IMF’s 2020 forecast, the 2021 forecast now matches the IMF
World Economic Outlook forecast released in April 2021, which pointed to
significantly weakened global growth due to the COVID-19 pandemic:
The contraction of activity in 2020 was unprecedented in
living memory in its speed and synchronized nature. But it could have been a
lot worse. Although difficult to pin down precisely, IMF staff estimates
suggest that the contraction could have been three times as large if not for
extraordinary policy support. Much remains to be done to beat back the pandemic
and avoid divergence in income per capita across economies and persistent
increases in inequality within countries.
Growth of major trading partners has been revised up for 2021,
reflecting progress on vaccine rollouts in advanced economies, major fiscal
policy support and accumulated household savings. The Budget notes however,
that significant uncertainty around the global economic outlook remains.
Sustained momentum in the global recovery will depend on how well governments
continue to manage the pandemic, along with people’s ongoing willingness to
adapt to life with the virus.