A Finsec View – The Budget Issue

8th April 2022

The headline grabber was cost-of-living relief in a budget centred around more spending but lower deficits thanks to a windfall from faster growth and a resources boom.

It’s hard to think of any Australian who doesn’t get something out of this budget (Treasurer Josh Frydenberg’s fourth) – High earners with big cars will enjoy the temporary cut to fuel excise, for pensioners and those on benefits there’s a one-off $250 cost-of-living bonus, and for Australians earning up to $126,000 there’s a $420 boost to the tax offset.

Perhaps the more complex dilemma for Australia will be how the government returns to a position of ‘economic repair’ via productivity growth rather than austerity.

We hope you enjoy this special Budget edition of the View.

In fact, the only superannuation announcement of note was the extension of the 50% reduction in the minimum drawdown for super pensions.

Thankfully, it would seem that superannuation has lost its proclivity as a fiscal punching bag. Apparently, deficits don’t matter as much as they used to, and the retiree vote is a lot more important.

Despite Treasurer Frydenberg benefiting from a strong economy, the budget is forecast to show a $78 billion deficit for the 2022-2023 financial year following a $79.8 billion shortfall in the current year. It should be noted that the deficits are well down on what was forecast in last year’s budget, $106.6 billion and $99.3 billion, respectively, but are still among the largest on record.

Since Treasurer Frydenberg used his 2019-20 budget to forecast a surplus, the Coalition is on track to record deficits worth a combined $524 billion by 2026, and the path back looks like a long and winding road for future governments of any persuasion.

The majority of you will have read the facts and figures and by now will have an understanding of the proposed measures. Normally our summary would not be a simple reiteration of these facts, however this year (from a financial planning perspective), there is so little that the normal ambiguities are distinctly missing. Nonetheless, we seek to report on the relevant measures with clarity.

As always, we will have to wait for the actual legislation to be passed and receive Royal Assent (which is likely subject to the May election results).

Our 2022/23 Federal Budget report can be found here.

So, what is to be made of the announcements? In summing up ‘the good, the bad and the ugly’, we share this sage perspective from AMP Chief Economist Dr Shane Oliver and Senior Economist Diana Mousina.

The budget contains a number of commendable measures:

• Medium-term structural spending is no longer being ramped up faster than the economy;
• Much of the budget windfall from stronger growth and higher commodity prices is being put to deficit reduction and hence long-term debt stabilisation (unlike last year when it was mostly spent); and
• The annual addition to infrastructure spending, along with measures like the Apprenticeship Incentive Scheme, will provide some boost to productive potential.

However, at a micro level, the budget may be criticised on the grounds that:

• The temporary fuel excise reduction is a bad economic policy in that: it may be very hard to reverse if oil prices keep rising or stay high; it will make no sense if oil prices fall back on, say, a Ukraine peace deal; and it sets a bad precedent.
• Many welfare recipients are arguably getting compensated for “cost of living” pressures twice – via the one of payment and via the indexation of payments to inflation.
• The housing measures (most notably an extra 25,000 places per year added to the First Home Loan Deposit Scheme) continue to focus more on demand than supply which may result in higher than otherwise home prices (even though they are unlikely to prevent the inevitable cyclical downturn in prices) and will boost debt levels.

At a macro level, there are two big risks flowing from the budget:

• First, the pre-election cash splash (which is about 1% of GDP in terms of new stimulus for this calendar year, but is actually more if the $16bn in “decisions taken but not yet announced” in the mid-year economic and fiscal outlook (MYEFO) are allowed for) risks overstimulating the economy at a time when it is already strong, further adding to inflationary pressures and adding to the amount by which the RBA may have to hike interest rates.
• Second, the reliance on growing the economy to reduce the budget deficit and debt is unlikely to reduce debt quickly enough and is dependent on interest rates remaining low relative to economic growth. 10-year bond yields have already gone up more than four-fold (albeit from a very low base) since their 2020 low, warning of a sharp increase in debt interest payments beyond the medium term. And economic growth is unlikely to be anywhere near strong enough to reduce the debt burden as it did in the post-WW2 period unless there is another immigration boom or 1980s style focus on boosting productivity – both of which look unlikely. In the meantime, the strategy would be highly vulnerable if anything came along to curtail the commodity boom. So, at some point, tough decisions are likely to be required either to reduce spending as a share of GDP, or raise taxes.

The full article can be found here.

It is important to view this budget against the backdrop of an increased focus on what central banks are looking to do this year. And as previously mentioned, a significant amount of front-loaded stimulus could be enough to see the RBA raise rates faster than expected.

With this in mind, it is less about the budget deficit and more about the fiscal thrust (i.e. the change in the budget position relative to last year). Whilst the budget deficit is running close to 3% of GDP, this is very similar to last year, and thus the fiscal thrust is close to zero. In our view this reduces the risk of the RBA raising rates faster than previously predicted.

Experts are forecasting a first-rate hike around May/June and the cash rate to reach 1% by year-end and 1.5% next year. The extra stimulus in the budget increases the chance that the first-rate hike may be higher than originally predicted but is unlikely to contribute to the general upward trend.

It is important to remember that like the US, the market is well ahead of the central bankers, meaning rate hikes are already factored in well in advance. This should hopefully mean less negative reaction when the hikes arrive.

Interestingly governments have not had a great record of forecasting wages as our chart of the week depicts.

It is easy to justify actual wage growth figures coming in under budget estimates based on historically low inflation, but other forces such as imported labour, technology advancements and a benign industrial relations environment have also played a significant role. With inflation rising, if we continue to undershoot budget forecasts on wage growth, it will highlight the impact of these other forces.

Will we see the budget estimates start to miss on the downside, or are we actually about to see some wage growth?

At the margin, the support to household incomes should provide support to the consumer discretionary sector of the Australian equity market, while the increase in infrastructure spending is additive to construction earnings. The measures relating to the housing market are going to be offset by the dampening impact that rising interest rates is having on-demand, and so the impact on demand for mortgages (and earnings for the major banks) will be more mixed.

In terms of rates and government bonds, this budget is unlikely to contribute to the general upward trend in interest rates. As noted above, we don’t think that the budget announcements are significant enough to change the path of RBA cash rate increases.

Finally, on currency, given there is limited fiscal thrust and no associated impact on interest rates, it is hard to make the case that this budget will have a noticeable impact on the Australian dollar. That said, we continue to think that the Australian dollar has some more upside left, given positioning is still quite negative (i.e., a lot of negative news is still priced in), commodity prices remain elevated, and economic growth is accelerating (as compared to decelerating in many other countries).

In summary

Cash and term deposits – cash returns are poor, but they will start to rise as the RBA starts hiking from mid-year.

Bonds – ongoing budget deficits add to upwards pressure on bond yields. The rising trend in yields resulting in capital loss means that long-dated bond returns (as opposed to short-dated securities) are likely to suffer.

Shares – more fiscal stimulus, strong growth and still-low rates all remain supportive of Australian shares, but rising bond yields & RBA hikes will result in a more constrained & volatile ride.

Property – more home buyer incentives are unlikely to offset the negative impact of poor affordability and rising mortgage rates in driving a cyclical softening of house prices.

The $A – strong commodity prices point to more upside.

In March, Australia’s age pension rose to reflect inflation and the growing cost of living pressures. This change represents a pay rise of just over 2% and is the biggest increase in the payment in almost a decade.

Single pensioners will be $20.10 better off per fortnight, and couples up to $30.20 per fortnight (where both members of the couple are eligible).

Indexation also means that some people who were previously ineligible for a pension may become eligible as the cut-off amounts of assets and income are also increased.

Payments

The maximum rate of age pension payment for singles increased by $20.10 per fortnight from $967.50 to $987.60. The maximum rate for couples increased by $15.10 each from $729.30 per fortnight for each eligible member to $744.40.

A couple where both members are eligible to receive the maximum payment can receive $1,488.80 per fortnight or $38,708.80 per year combined.

Assets

For homeowners who are single, the asset test cut-off increased from $593,000 to $599,750. For couples it increased from $891,500 to $901,500.

For couples who are separated by illness, as is the case when one or both move into aged care, the cut-off increased from $1,050,000 to $1,063,500.

*It’s important to remember that the value of your home is not included in these assets.

Income

For singles, the amount of income you can earn before the age pension ceases has increased from $2,115 per fortnight to $2,155.20. For couples, the cut-off has increased from $3,237.20 per fortnight to $3,297.60.

*It’s important to remember that income earned under the work bonus (up to $7,800 per year) is not included. Income from investments is based on deemed income rather than the actual income earned.

This may be a clip from 2016, but Denzel Washington’s message is as profound as it is provocative.