Earlier this week Australia released its latest 2017-2018 budget which projects a deficit of AUD29.4bn (1.6% of GDP) a slight increase from the mid-year projection of AUD28.7bn. The budget is mildly contractionary looking to return to surplus (AUD7.4bn or 0.4% of GDP) in 2020-21, possibly cognisant of the requirements to maintain the Aaa rating. While some reports noted the budget targeted an infrastructure program of AUD70bn this is over 10 years so it is more of a support to growth than an immediate boost. The budget assumes real GDP growth of 2.75% in 2017/18 increasing to a 3% run-rate thereafter which could be considered on the punchy side. For example, Moody’s estimates real GDP growth in the 2.5-2.7% range over the next few years. A further debatable assumption is the iron ore price which has been under pressure lately: the budget assumes the iron ore price to average USD66 per tonne out to December and then decline to USD55 per tonne in the March 2018 quarter. But if this price decline were to happen 6 months earlier than expected it would hurt tax receipts by around AUD400m.
Post the budget release Moody’s commented that they still see Australia’s fiscal strength as being ‘very high’ with a budget that focused on bringing the central government budget into balance by the end of the decade. They expect government debt to increase to 42.4% of GDP by FY2018 from 39.7% in FY 2017 which they still see that as fitting with the Aaa median. However, they also note the government projection for ‘a rise in revenues as a share of GDP, a trend that has not materialized in the last three years. At 26% of GDP by FY2021, the revenue-to-GDP ratio would be the highest since FY2006 and above the average of the last 20 years. Instead, we forecast broadly stable revenues as a share of GDP.’
Another issue is the greater reliance on taxes on consumption which could be at risk particularly if the housing market were to slow. Already some are questioning whether consumption is slower after the March retail sales figure which fell 0.1% mom and the savings rate has been falling as consumers have dipped into savings to fund their expenditure; the household savings rate fell to 5.2 percent in Q4 2016 from 6.3 percent in Q3. House affordability remains a topical issue which is hardly surprising given estimates put Sydney’s price to income ratio at an eye-watering 12 times and making it the second least affordable city in the world ahead of Melbourne in fourth place. Measures in the budget look insufficient to address this problem.
Perhaps of more interest was the budget impact on the big four banks and Macquarie Bank which got lumbered with a tax of 6 basis points on liabilities (ex- tier 1 capital and government guaranteed deposits) which penalises banks reliant on wholesale funding sources. The government has estimated that this will raise AUD6.2bn over 4 years or ~5% of the targeted banks’ annual profit after tax. Not surprisingly, the equity share prices took a hit although the for bond investors Fitch sees this as credit negative for the banks ‘but not significantly enough to have an immediate ratings impact’. One issue is will it be passed on to consumers in the form of higher lending rates? Banks have already been facing higher funding costs this year and have raised lending rates out of synch with the RBA but a planned competition review could make this strategy tricky going forward.
But as ever Australia’s Achilles heel is its dependency on overseas capital. On our estimates, Australia’s net foreign liabilities are greater than our cut-off of 50% of GDP, the threshold that IMF research indicates is associated with increasing risk of external crises, making it ‘an avoid’ from an investment point of view. While periods of increased risk appetite, re-leveraging and aggressive central bank QE allows a rising tide to lift all boats investors should be more wary now central banks, most notably the Fed, are starting to take the ‘punch bowl away’: deleveraging means we continue to prefer creditor nations over more heavily indebted ones.