NAB’s Peter Jolly, Global Head of Research shares his assessment of what we can expect in the upcoming Federal Budget announcement.

Treasurer Joe Hockey’s first Budget is less than a fortnight away on 13 May. The information flow has increased as the Government flags a tightening fiscal stance ahead.

There will be considerable interest in the Commission of Audit’s findings that are to be released today. The Commission was tasked to come up with savings that would deliver a one percent of GDP surplus by 2024. The Commission has apparently made 86 recommendations – some, but not all, will make it into the Budget, and thus become Government policy.

From what has been released so far, there’s rightly a lot of focus on putting the Budget on a sustainable medium term path as the population ages, health and pension costs rise, and the proportion of tax payers declines. This medium term focus is good news for long term investors in Australia as an already comparatively healthy fiscal position will look even more healthy.

Policies that have been leaked/flagged so far include lifting the qualification for the aged pension from 67 to 70 by 2029, means testing co-payments for doctor visits. Over the weekend, newspapers reported a one-off 0.5% “deficit” tax is being considered. Some of this is very sensible stuff.

From a market perspective, the immediate question is the size of the fiscal tightening in the next few years and what that might mean for the economy, RBA, and $A.

Are we facing a small, medium, or huge fiscal consolidation? Small/medium is my judgement which won’t be too different from what the RBA is already assuming – the 1 April Board Minutes noted “planned fiscal consolidation at state and federal levels was likely to weigh on public demand for some time.”

On the numbers, the MYEFO forecasts showed that after a deficit of around 2½% of GDP deficit in 2013/14¹, the deficit narrows to 1% of GDP by 2015/16 before widening again as new programmes kick-in (disability care, paid parental leave) and health/pension costs continue to rise as the population ages.

From 2020 onwards the deficit is around 1½% of GDP.

As the economy has performed broadly in line with expectations recently, the Budget forecasts won’t be too different from the above.

So all up, the Treasurer’s task is to turn an around 1½% of GDP deficit into a 1% surplus by 2024. Let’s call it a 3% of GDP swing over the next decade.

This is not a trivial task but nor is it particularly large in the context of recent fiscal consolidations.

A measure of fiscal consolidation is the change in what the IMF calls the Cyclically Adjusted Primary Balance – excluding interest payments and it controls for the economic cycle. Using the IMF’s April 2014 Fiscal Monitor, we calculated the change in this balance between 2009 and 2013 and show it on the chart below. Greece has had the largest fiscal consolidation of 19.4% of GDP in four years. Ireland has done 7.5%, the G20 has averaged 2.6% and Australia has consolidated by 1.7% of GDP.

So the pace of required budget consolidation required over the next decade is about the same pace of consolidation we’ve seen over the past four years in Australia². It’s relevant that the Budget consolidation will be softened by an uplift in infrastructure spending which is 1) a balance sheet item and normally sits outside the Budget and 2) is mostly done at the State level.

All up, while we still need to see the Budget details it’s likely that fiscal policy will be a manageable ½% of GDP headwind for the economy ahead over the next 1-2 years. Not much more than most already assumed.

¹ We exclude the $8.8bn RBA capital injection in 2013/14 and we use the Treasurers assumption in last week’s speech that Government revenue is capped around 25% of GDP in the out-years.

² The IMF measure is General Government, so includes Central, State and Local Government. So not strictly comparable to MYEFO numbers. Even so, given the aggregate States are close to balance it is still a good proxy of the direction and adjustment required.

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