The 2017 Federal Budget – “Steady as we recover”

Boasts of Infrastructure spending & Debt choices for better days ahead

  • 7.4 Bil Surplus by 2020/21 affirmed
  • Growth to pick to +3% by 2019
  • End in sight of the Mining drag to help the transition to broader based growth
  • Global backdrop helping
  • Paid for by Medicare levy rise in +2019 and a tax on big banks
  • Interest rates unlikely to respond either way to a “steady as we recover” budget.

Budget Overview

This year’s budget is a tweak of last years. Benefiting from an improving international backdrop together with a forecast trough of the mining sector’s drag on growth belies the boast of better days to come.

But not to leave things to chance, the Government is undertaking a significant infrastructure spend in the form of commitments to transport and regional development projects and financing agencies.
To help things along, we will all chip in with an increased Medicare levy and a new levy on the Big Banks.

Economic Outlook

The global economic backdrop has materially improved on last year’s projections with bullish hopes for the crucial Chinese and US economies affirmed by observed gathering momentum.

The Treasury forecasts for commodity prices though have been held back and has not chased the most recent gains of the country’s metals and energy export prices with a responsible degree of conservativism in the face of this uncertainty.

Consistent with the ‘better days ahead’ thesis, national economic growth is expected to pick up from a current estimated 1.75% to 2.75% into 2017/18 fiscal year to +3% on the back of the drivers mentioned.
This growth picture is overlays a continuing switch from mining to non-mining activity as the main drivers of growth. [Interestingly the forecasts include a sober expectation of slowing housing construction as well as fragile retail sector into 2018].

Overall it looks for moderately improving prospects with hopes of above average growth pushed into the +2020 timeframe.

Fiscal Strategy

Fiscally the promise made last year for a balanced budget by 2020 is kept with the boast of a $7.4 billion surplus into the following 2020/21 tax year.
This though is off a starting base line of a running $29.4 billion dollar deficit, shrinking to 21 billion into the next then to a fraction either side of zero and finally to that said surplus in four years’ time.

In balance sheet terms the government remains committed to keeping net national debt below 20% (peaking around 19.8% in 2019) before beginning a sustainable decline into the decade of 2020-30.

Major taxing and spending plans

Significant changes in taxing and spending plans were not revolutionary. Aside from already leaked increases in university fees and levies on foreign workers we will have the Medicare levy going up to 2.5% in 2019 and beyond to pay for the unsurprising blow out in forward expenditures on the National disability Insurance Scheme (NDIS).

While the second largest revenue measure of the budget is the now infamous $6.2 billion tax on the Big banks [i.e. Big Four + Macquarie] over the next 4 years will go a long way to help with the boasted fiscal consolidation. And is also a clear show of favouritism for the smaller banks and deposit taking institutions.

Many feared changes to superannuation, the taxing of housing and negative gearing concessions have not eventuated and so soon after last national election – personal tax cuts have been held back. Same too for stalled commitments to their Ten Year Enterprise plan for business taxation.

The government’s commitment to infrastructure spending continues with $75 billion in spending committed into the following decade.
The emphasis in this year’s budget is on distinguishing debt issued to fund infrastructure versus recurring spending.

Economic and funding Implications

Economic implications of the budget is the fiscal consolidation continues at a moderate pace as Treasury’s forecast glide path (at 0.6% of GDP per year) to a surplus keeps the focus on a balanced budget by 2021. Something that if achieved is to be applauded in a world that does seem that ambitious nor keen sovereign thrift.

That said, the value of gross debt of the federal government is expected to rise to $606 billion from current $540 billion figure, ensuring the short/medium term supply of government bonds will continue to increase in line with the combined effect of past federal deficits and funded infrastructure spending.

Interest Rate Implications

The budget needs to be read in the context of the RBA’s just published and more sanguine views around inflation, growth and interest rates of their May 5 Statement of Monetary policy.

As a bottom line reading, the budget cannot be read as a particularly tough budget in the front end of our time frames (accommodating as it does lingering doubts as to the unfolding international and more fragile domestic recoveries) and, alternatively not particularly inflationary going forward as the new tax measures will bite into the expected growth that is expressly expected to pick up into 2018 and 2019.

While not stating rates will remain low for longer as such, it certainly gives space for a further prolonged pause in short term rate directions for another quarter or two if not firmly into 2018. The promise further out being for rates to rise and lag the optimistic growth paths forecast both here and overseas of the just released budget.

This rate change hiatus is supported by indications of a subsiding Sydney-Melbourne housing market pressures plus renewed retail competition as well a less than at capacity economy keeping consumer inflation in check and at the lower end of RBA’s 2-3% target (and trigger) bands.

Conclusion

Comparatively speaking the interest rate implications of the budget complement the already stated position of the Reserve Bank that at some stage interest rates will rise, but most likely in the intermediate time frame, meaning into next year not this one.

The firmer growth story, while backing a secular view of higher backend rates in the face of such a near rate neutral budget for investors means better value will be in looking for and be alert to other emerging interest rate head winds investors to come in the form of;

  • the big banks’ responses to their increased taxes as well as the competition from their peers for funding
  • The coming APRA liquidity rules that will make short term deposits less valuable to all banks and put renewed pressure on deposit rates to fall or at least stagnate regardless of pressures seen elsewhere or the RBA
  • Consider longer term floating rate bonds structures that can be readily sold for liquidity at short notice for maximum flexibility and minimal sacrifice of yield.

Peter Pontikis – Director Please note these comments and observations are strictly my own

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