Australia Plots Early Return to Surplus By Defying Global Forces

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(Bloomberg) -- Australia’s government will balance its books earlier than expected thanks to a revenue windfall ahead of a looming general election.

In its annual budget released in Canberra Tuesday, the government burnished its economic credentials by forecasting a A$2.2 billion ($1.6 billion) surplus in fiscal 2020 -- that would be the first since the global financial crisis. The reward for voters: modest tax cuts for low and middle-income earners and some financial perks for baby boomers heading for retirement.

Australia Budget 2018: Winners and Losers

“This budget is providing tax relief to encourage and reward hard-working Australians,” Treasurer Scott Morrison said Tuesday. “Through disciplined fiscal management and improved receipts from stronger economic growth, the budget position is improving.”

In its path to surplus, the government relies on some heroic assumptions: it’s positioned Australia’s economy as defying the experiences of developed-world peers. The budget projects wages growth will accelerate even while spare capacity remains in the jobs market, in contrast with the U.S. example of unemployment falling well below assumed full employment and pay packets still seeing slow gains.

Key Budget Numbers:

  • Budget deficit forecast at A$14.5b in 2018-19, compared with economists’ expectations of A$15b
  • After returning to surplus, balance predicted to widen to A$11b in 2020-21 and to A$16.6b in 2021-22
  • Net debt to peak at 18.6% of GDP in 2017-18 before declining to 18.4% the following year and 14.7% by 2022

“The return to surplus is built on some of those probably overly-optimistic wage and hence inflation numbers,” said Su-Lin Ong, head of Australian economic and fixed income strategy at Royal Bank of Canada. “You run the risk that some of the forecasts are still a little bit on the optimistic side here, and they underpin the revenue assumptions.”

Returning to the black a year earlier than expected is a political boon for Prime Minister Malcolm Turnbull, ahead of a ballot that has to be called within a year. Australian voters generally judge a government’s economic performance by whether it manages to deliver a budget surplus. Furthermore, net debt is forecast to peak in the current fiscal year, also earlier than expected.

The headline numbers don’t show the full story. Morrison, in his speech to parliament, lauded the retention of the nation’s AAA credit rating from the three main agencies. But of the 10 holders of such a distinction, Australia is in the weakest fiscal position. While the economy is entering its 27th year without a recession, that’s also an indictment on governments from both sides for running a decade of deficits.

For the central bank, the budget’s stimulus is unlikely to be sufficient to change an economic equation that’s had interest rates wedged on hold at a record-low 1.5 percent since 2016. It’s waiting for a tighter labor market to drive up wages and inflation.

Australia’s budget is currently benefiting from unexpected commodity price strength, due to synchronized global growth that’s boosted corporate profits and tax receipts; and a hiring bonanza last year that lifted the personal tax take and reduced welfare costs.

Shortly after the report’s release, S&P Global Ratings said the government had shown a commitment to fiscal prudence, adding there were significant risks for an earlier return to surplus.

Key Policies in Tuesday’s Budget:

  • A seven-year plan for lower and simpler income taxes
  • A crackdown on tax avoidance, including stopping multinationals loading up on debt to shift profits offshore
  • Extending goods and services tax to hotel bookings made through overseas websites
  • Limits on fees charged by funds overseeing Australia’s pensions savings pool
  • Tighter rules on stapled structures and fewer tax concessions for foreign pension funds and sovereign wealth funds
  • Outlawing cash payments greater than A$10,000 to crack down on the Black Economy

The budget sees economic growth accelerating to 3 percent in the year through June 2019, fueled in part by investment and consumption. That’s despite households being saddled with record-high debts and stagnant wage growth.

Unemployment is predicted to fall to 5.25 percent in the 12 months through June 2019, and hold there for the ensuing two years. The jobless rate has hovered around 5.5 percent for the past year, with the participation rate near a seven-year high.

But on wages growth, the government remains particularly ambitious. It sees the pace climbing to 3.25 percent in fiscal 2020 and 3.5 percent the year after that, compared with the current sluggish 2.1 percent.

The budget even spells out the contradiction. It notes that in major advanced economies, particularly Japan, Germany and the U.S.: “despite stronger labor markets and a pick-up in overall economic performance, wage growth and inflation have remained largely subdued.”

Beyond the blueprint’s initial tax relief of A$530 a year for people earning between A$48,000 and A$90,000, the government plans to lift tax brackets in the longer term and lift the threshold for the 45 percent top rate to A$200,000 in 2024.

Turnbull’s administration remains committed to corporate tax cuts that, except for small firms, have been stifled in the upper house of parliament. It’s trying to maintain Australia’s competitiveness in the wake of the Trump administration’s swingeing cuts to U.S. corporate rates.

“The politics are clear here: the fiscal position is stronger, the trajectory’s better,” said RBC’s Ong. “It’s very clear that they’re laying that groundwork and narrative for the next election.”

©2018 Bloomberg L.P.

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