Me in the AFR: Still on target for budget surplus

 

My Op Ed article in today’s AFR is here:

http://www.afr.com/p/opinion/still_on_target_for_budget_surplus_5dZNosKvtVw8GvcgmZ8UXP

The budget is less than a month old and there is a perception unfolding that the projected surplus for 2012-13 is under threat due to the deterioration in global economic conditions and the associated ruction in financial markets.

To be sure, weaker than projected conditions in the global economy may yet undermine government revenue, risk higher spending and result in the budget slipping into deficit. This was always the case, just as a stronger than projected world economy would deliver extra revenue and a larger surplus.

Before there is any concession on the budget bottom line for 2012-13, it is worth delving into some of the facts that Treasury used to construct its economic forecasts for Australia and, with them, the projected levels of government spending and taxation.

Probably of most importance for now are the global growth projections. At the time the budget was framed, Treasury clearly erred on the pessimistic side for the global economy as it was factoring in a decline of 0.75 per cent in euro area gross domestic product and it was projecting 2 per cent GDP growth in the United States.

Both of these forecasts were below the general consensus at the time but are now looking increasingly prudent. The deterioration in these two parts of the global economy are more or less as Treasury was forecasting.

Put another way, the decision of Treasury to tilt its global forecasts to the downside means there was some “fat” in the projections for the economy and, implicitly, the fiscal side of the budget. There are other important issues in the framing of the budget that are relevant to the perceptions of a fiscal deterioration.

As is the usual budget practice, Treasury made the technical assumptions that the Australian dollar would remain near the level prevailing when the budget was framed – 77 points on the trade weighted index (TWI) and US103¢.

In framing the forecasts, there was another standard technical assumption that interest rates would move “broadly in line with market expectations at the time the forecasts were finalised”.

Markets have clearly moved on from when these technical assumptions were made, with the changes more supportive of growth than was assumed.

Reflecting the global funk unfolding since the budget, the Australian dollar is trading at about 73 on the TWI and is under US97¢, a fall of about 5 per cent. This lower exchange rate will help to cushion any negative impact on the economy from the global weakness and decline in commodity prices.

The technical assumption regarding interest rates has also been superseded by events, with the whole yield curve about 0.5 to 0.75 of a percentage point lower than at budget time. Like the exchange rate, this change in the interest rate outlook largely reflects the deterioration in the global economy.

If the current interest rate structure were factored into the budget forecasts, there would be some growth benefit to consumption, housing and business investment that would be some offset to the negativity prevailing from offshore.

From these issues alone, there is little hard evidence to suggest that the return to budget surplus in 2012-13 is any more or less likely than when the budget was framed in early May.

This does not mean that a surplus is guaranteed as global conditions may deteriorate further, assets prices may remain weak and the jobless rate may move above the level Treasury was forecasting.

If these trends do unfold, it would mean the budget surplus would be difficult to deliver. Having said that, it is worth noting that in these circumstances there would likely be further falls in the dollar and interest rates that would work to support economic growth, jobs and, with those, the budget bottom line.

For now, there is nothing to seriously suggest the Treasury forecasts will be wrong, or rather, in which direction any errors will be.

The surplus in 2012-13 is still more likely than not.