The resilience of Australian households to soaring expenses and the nascent recovery of China’s economy will likely determine whether Jim Chalmers’ first budget is a charm or chimera.
This year’s forecast for Australia’s economy to grow 3.25% may be the best this side of the next federal election as the Reserve Bank tries to douse inflation with another 75 basis points of interest rate hikes. The outlook, though, is darkening at home and abroad, adding to looming fiscal strains.
“Beyond this year, the outlook is increasingly challenging as slowing global growth, high inflation and interest rates weigh on economic activity,” the budget said.
For now, Australia is projected to avoid a “hard landing”, with GDP growth dipping in 2023-24 to 1.5% before recovering to close to its long-run potential expansion pace of 2.5%.
No China crisis
Much, though, will hinge on the fate of Australia’s biggest trading partner, China, as it struggles with a zero-Covid policy of rolling lockdowns and an extended drop in its huge property market.
Treasury is banking on China’s economy bouncing back from 3% growth in 2022 – its second-worst result in four decades – to expand by 4.5% in 2023 and 2024. At stake are commodity prices that hover not far off record levels but won’t defy gravity if China stumbles.
Household spending
On the domestic front, the budget is predicting households will keep spending but consumption will wilt from this year’s 6.5% growth pace to barely a quarter of that next year.
Higher mortgage repayments in the wake of the RBA’s 2.5 percentage points of rate rises since May have lopped $700 a month from those with a $500,000 variable-rate mortgage.
The budget is factoring the RBA’s cash rate to peak in 2023 at 3.35% – shy of the 4.2% investors were predicting as of Monday. Still unknowable, though, is how those fixed rates will respond when they hit the “re-fi” cliff from next May, when those paying 2% interest will suddenly face as much as 5% when they refinance.
Business investment will also retreat as borrowing costs rise, with the 6% increase forecast for 2022-23 almost halving to 3.5% in 2023-24.
Jobs and wages
Demand in the economy will be shored up, though, provided Treasury is right to expect the jobless rate to rise only modestly from 3.5% in October to 4.5% by the June quarter of 2024. That rate would still be below the pre-pandemic unemployment tally of 5%.
It is also pencilling in annual wage growth continuing to pick up, reaching 3.75% by June 2023, or the quickest pace since 2012. Only in the 2023-24 year will wage increases exceed consumer price inflation, barely making inroads into the 3.5% cut in real wages during the fiscal year just ended.
Power struggle
Energy prices will be a bane as well as a boon for the economy. Elevated gas and thermal coal prices will propel household and business utility bills skyward in the next two years, adding 0.75 percentage points to inflation in 2022-23, and one percentage point in 2023-24.
That jolt implies energy will make up about one-sixth of the expected 5.75% inflation rate forecast for this fiscal year, and almost one-third of the 3.5% CPI projected for 2023-24.
That will translate into retail power prices increasing by an average of 20% nationally in late 2022 and a further 30% in 2023-24, as the impact of higher fuel costs and ageing coal plants hits home.
Despite a spurt in global energy prices, however, the government’s petroleum resource rent tax will only tip in an extra $200m in 2022-23 compared with pre-election estimates. Over the four years of the budget, receipts actually sink $450m compared with that early forecast as output from depleted fields declines and prices of oil and gas stabilise.
The burden of debt
On the positive side, buoyant commodity prices and more people in jobs will deliver a cumulative $42.7bn improvement to the underlying cash balance across the four years to 2025-26.
However, that balance will remain firmly in the red, rising from 1.4% of GDP in the year to last June to 1.8-2.0% of GDP by 2024-25 and 2025-26.
Gross debt will also pass $1tn in 2023-24, up from $895bn in the year just ended, to $1.159tn by 2025-26.
Rising interest rates will take their toll on the budget too, requiring $12bn in extra repayment costs by the end of the forecast estimates, as compared with pre-election predictions. By 2025-26, the net cost of servicing federal debt will reach $26.5bn, or 1% of GDP, or about double the $13.5bn to be shelled out this fiscal year.
However, the sting in debt repayments will come later since most debt out to 2026 will still be on low interest rates. By 2032-33, debt repayments will climb to 1.8% of GDP, with the cost climbing by an annual average of 14.4% in the decade from 2022-23, eclipsing a projected 13.8% rise in the NDIS and more than double the expansion for spending on defence, aged care, hospitals, medical costs and age pensions.
Should China’s growth hold up, so should commodity prices that help fill coffers and boost company profits. Treasury’s conservative approach means the budget is forecasting the coal price to plummet about 80% by March and halve for both coal and iron ore.
A delay in that reversion to long-term averages by one-quarter would increase nominal GDP of $43.8bn between 2022-23 and 2024-25, and bolster company tax receipts of $9.9bn.
On the flipside, should China’s infrastructure binge fail to revive growth, those bets are off.
