Dr Shane Oliver, Head of Investment Strategy & Chief Economist at AMP, discusses the Mid-Year Economic and Fiscal Outlook.
Key points:
- The Federal Government’s Mid-Year Economic and Fiscal Outlook (MYEFO) confirms a return to budget deficit this year and has revised up its deficit projections sharply reflecting increased spending in existing programs, less corporate tax revenue and policy changes.
- The deficit for this year is now forecast to be $26.9bn (from $28.3bn in the May Budget), but subsequent years are now worse with a total deterioration of nearly $22bn over four years.
- Structural pressures on spending remain for the years ahead and are expected to see spending as a share of GDP remain well up on pre pandemic levels.
- The MYEFO implies continued strong growth in government spending and a big easing in fiscal policy as the deficit swings from surplus to deficit.
- This easing in fiscal policy makes the RBA’s job in getting inflation down a bit harder, but we continue to expect at least three rate cuts next year starting in the first half.
- The Government is now forecasting slightly lower economic growth this year and it sees lower inflation than the RBA in 2026.
Economic growth revised down for this year, more optimistic on inflation than the RBA for 2026
Reflecting the reality of recent softer growth data, the Government has revised down its near term growth forecasts to be similar to the RBA’s.
However, it made no change to its inflation forecasts and continues to be more optimistic than the RBA regarding inflation for 2026.
After net migration came in about 50,000 stronger than expected in 2023-24 the Government now sees a slower easing in net migration to a still high 340,000 this financial year and then 255,000 next financial year. With dwelling completions remaining well below the Government’s target for 240,000 a year this implies no progress in reducing the housing shortage this year.
Source: Australian Treasury, AMP
Back to bigger budget deficits
With structural spending pressures intensifying and the good luck – flowing from stronger than expected commodity prices and jobs driving stronger revenue flows to Canberra – having come to an end, the budget is now moving back into deficit.
And the Government is actually projecting worse budget deficits than it was in the May Budget. This year’s deficit is projected to be slightly better than expected at $26.9bn, but the deficits in subsequent years are now worse with a total deterioration of $21.7bn over the four years to 2027-28.
As can be seen in the next table some of the deterioration over the four years is due to parameter changes, ie changes which occur in current programs and tax collections without changing any policies. This includes stronger than expected payments to veterans, disaster relief, Medicare and child care and reduced expectations for corporate tax collections due to lower commodity export volume assumptions on the back of slower growth in China. The latter has only been partly offset in the near term by higher assumed prices for commodities like iron ore.
But the main driver of the deterioration has been new policy stimulus of $2.1bn this financial year and a total of $17.5bn out to 2027-28. The new policy stimulus includes more spending on childcare with a move towards universal childcare, aged care and school funding and $5.6bn over four years on “decisions taken but not yet announced” which are basically election goodies to be announced ahead of next year’s election.
Source: Australian Treasury, AMP
The budget outlook for the next four years is now in worse shape than projected in the May Budget. But because the budget numbers are better for 2023-24 and 2024-25 net debt is expected to be lower in the near term before worsening to $709bn, or 22.4% of GDP, by June 2028, up from 21.9% in the May Budget.
Source: RBA, Australian Treasury, AMP
The key structural spending pressures are evident in the next chart – interest costs, the NDIS, health, defence, aged care and now childcare. New policy decisions – with childcare now growing more rapidly – are also affecting this, so its not just due to things like the aging of the economy.
As a result, the level of Government spending as a share of GDP over the decade ahead is expected to run well above the 24.8% of GDP that prevailed pre-covid. Note that the dip in the spending share from 2026-27 shown in the next chart reflects optimistically low level of spending growth assumed in two years’ time – but past experience tells us that once we get out there the spending growth numbers will be revised up. Ever bigger government won’t help improve Australia’s deteriorating productivity performance and hence living standards.
Source: Australian Treasury, AMP Capital
Assessment
The good luck flowing from extra revenue on the back of the strong jobs market and higher than expected commodity prices that combined to push the budget into surplus over the last two years is now fading in the rear view mirror. Instead the budget is now being exposed to big spending pressures made worse by policy decisions that keep adding to spending.
The problem for the economy is that it means continued strong growth in public spending which adds to demand in the economy and the swing from a surplus to a deficit this financial year implies around $42bn of stimulus or 1.6% of GDP being pumped into the economy.
Source: Australian Treasury, state budgets, AMP
All of which makes the RBA’s job in getting inflation down unnecessarily harder and puts more pressure on the private sector – particularly Australian households – to keep a lid on their spending. In other words, it runs the risk of higher interest rates than would otherwise be the case. Fortunately most of the new policy stimulus in the MYEFO impacts from 2025-26, by which time inflation should be lower.
We continue to see lower underlying inflation and soft growth enabling the RBA to start cutting rates in the first half next year – hopefully in February but if not then by May – and to cut them at least three times next year. But were it not for all the extra spending and fiscal stimulus they could have been cutting earlier and by more.
An additional and growing concern is the widening gap between the underlying cash balance (which is the difference between budget revenue and payments) and the headline cash balance (which allows for net cash flows from investments). During the time of big privatisations in the 1990s, the focus shifted to the former as the latter was making the budget look better than it really was. But in recent times increasing amounts of “off-Budget” spending have been excluded from the underlying cash balance on the grounds that they are investments (eg the NBN, various investment vehicles relating to things like housing and manufacturing and changes to student debt). The problem is that this is resulting in a widening negative gap between the headline and underlying balances. Unfortunately, some of these expenses are not necessarily wise investments on commercial terms and may have to be written down in value – but they still add to Government borrowing and hence to Federal debt. In the interest of budget honesty perhaps the focus should shift back to the headline cash balance.
Source: Australian Treasury, state budgets, AMP
The good news though is that Australia’s budget deficits running around 1-1.5% of GDP and gross general government debt of around 50% of GDP are small compared to many comparable countries. For example, gross general government debt averages around 110% across advanced economies and in the US its around 120%.
Ends
Important note: While every care has been taken in the preparation of this document, neither National Mutual Funds Management Ltd (ABN 32 006 787 720, AFSL 234652) (NMFM), AMP Limited ABN 49 079 354 519 nor any other member of the AMP Group (AMP) makes any representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided. This document is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.