Last night's Federal budget from Australian Treasurer Wayne Swan has, as you might expect, received blanket coverage in the Australian media. Interestingly, but perhaps not unexpectedly, there has been very little global coverage to this point . That surprised me a little.
In many ways, this is quite a remarkable budget.
It is hard to believe that just twelve months ago, the official economic outlook was shrouded in gloom and doom. This time, shifts in the assumptions about the economic outlook (the things that set the budget parameters) to the very positive have delivered a projected windfall gain in tax revenues. In turn, this has delivered a projected earlier than expected return to budget surplus, along with a far lower projected peak in official borrowings.
On the policy side, nearly all the new income and expenditure items had already been announced. In that sense, the budget is best thought of as a tidying-up exercise, putting a financial and economic envelope around the various policy announcements.
The budget also continues the rise in the importance of the forward estimates. Traditionally, the focus has been on the annual budget itself. The forward estimates, estimated future income and expenditure based on current policies, were of interest but of less importance. The increasing trend to announce policy measures with implementation dates far into the future. the trend as with the resources rent tax to link specific spend to specific revenue measures, makes the forward estimates far more important.
This builds a further degree of uncertainty into budget projections since those projections can be affected not just by economic changes, but also by political uncertainties and changes. It also builds a higher degree of rigidity into future budget planning. With so much committed in advance, maintenance of the budget bottom line becomes harder.
Take the proposed resource rent tax as an example. This is a big ticket future revenue item linked to major spend areas. Should revenue be less than expected for whatever reason, then flow on-effects are likely to be substantial.
Leaving aside the political rhetoric surrounding the budget, I think that all this means two things.
First, the focus should continue to be on the Government's specific policy measures rather than on the budget as such. What do they mean, how will they work, what changes will be required? With so much still to be defined and to gain legislative approval, I don't think that it makes a great deal of sense to obsess about immediate budget numbers unless, of course, there are obvious errors in the calculations.
Secondly, given that the budget outcomes depend so heavily on a vastly improved economic outlook, the underlying economic parameters become very important. Here in monitoring the budget I will be focusing on three in particular.
The first is a pretty obvious one, the international trade position. I have phrased it in this way rather than simply resources because more is involved than just commodities. Key points:
- The budget papers assume a further improvement in our terms of trade to the highest level in 60 years. In turn, this depends on continued fast growth in a small number of countries, including China in particular. I am cautious about this. I think that there is a perhaps small but significant chance that growing imbalances in the Chinese economy will constrain Chinese growth. In a worst case scenario, that growth could stall.
- Australia's exports have become less diversified in terms of both composition and markets. The budget papers suggest that while exports will rise, imports will rise faster as the growing domestic market sucks in more imports. Should our commodity exports be less than expected, then the balance of payments could quickly emerge as a significant growth constraint.
Investment is the second thing that I will be monitoring. New investment especially in mining has been defined as one of the drivers in future growth.
In a rather cruel post on his blog, Does a resource rent tax solve the problem of sovereign risk?, Winton Bates suggested that the rhetoric used by PM Rudd to justify the resource rent tax was like a more verbose version of Venezuela's Hugo Chavez. Ouch!
Winton is a supporter in principle of resource rent taxes. His complaint lies in the way it is being done.
Leaving aside all the arguments for and against a resource rent tax, we simply don't know what impact it will have on investment.
Inflation is the third thing I will be monitoring. The budget papers assume a fairly benign inflation rate for the immediate future. If this assumption is incorrect, then we can expect higher interest rates with consequent flow on effects.
The Treasury people are far more knowledgeable than I am on current statistics. Yet when I looked at the most recent CPI numbers (Non-tradable's and the Australian CPI), I was struck by the divergence in the rates of price increase between the traded sector (below the Reserve Bank's target range) and the non-traded sector (well above). Further, the rate of price increase in the non-traded sector appeared to be increasing. I concluded that on those raw numbers, inflation could quickly become a problem.
If we take the three together, on a worst case scenario, we could end up with lower than expected exports, lower than expected investment and higher than expected inflation. This would then feed through into the budget numbers.
In saying this, I am not making forecasts, simply suggesting things to watch.