Chief economist update: Rosy assumptions a Budget surplus make

"The Budget is back in the black and Australia is back on track."

That's how Federal Treasurer Josh Frydenberg opened his Budget 2019-20 speech delivered last night.

Well, technically we all will have to wait until next fiscal year for the underlying cash balance to turn from a deficit of A$4.2 billion (-0.2% of GDP) this year to a surplus of A$7.1 billion (+0.4% of GDP) in FY 2019/20 before rising to 0.5% and 0.8% of GDP over the following two years.

What's not to like? The Government is splurging on its promised low and middle income tax offset, by lower tax rates for small businesses as well as lifting the threshold on write-offs on new equipment purchases, increasing spending on infrastructure, and health, and education, and older Australians, among others.

Getting extra dosh on top of a Budget surplus; you've got to hit the like button.

But as previous Federal Treasurers would agree, the Budget predictions are only as good as the economic assumptions underlying them.

Wayne Swan, Chris Bowen, Joe Hockey all promised surpluses but failed - all because events didn't live up to their assumptions. Or take the case of Peter Costello - the last time Australia enjoyed a Budget surplus (to the point that speculations back then was that Australia doesn't need a bond market no longer, it doesn't need to borrow money from the rest of the world) - when the surplus, equivalent to 1.7% of GDP in 2008 quickly flipped into a 2.1% deficit the following year and a 4.2% deficit due to the GFC.

The economic projections in the Budget Papers 2019-20 look rational enough - GDP growth of 2.25% this fiscal year and then 2.75% per annum over the next two years. This is in line with the RBA's forecasts and, presumably, factor in the fiscal boost announced in this Budget.

However, key to this is what happens to household consumption - predicted to grow from 2.25% this fiscal year to 2.75% in 2019/20 and 3.0% in 2020/21. In the previous two Budget Papers (2017/18 and 2018/19), household consumption was forecast to have been growing by 2.75% this year.

This is a big deal and reason why the RBA considers this a major risk for the domestic economy: "The main domestic uncertainty continues to be the strength of household consumption in the context of weak growth in household income and falling housing prices in some cities."

Speaking of household income, the Budget predicts the wage price index - up 2.3% in the December quarter - to grow by 2.5% in FY 2018/19 (still feasible) before accelerating to 2.75% the following year and 3.25% the next.

Whether or not this happens will have an impact - negative or positive - on consumer spending, that'll flow through into company sales and profits and then investment ... overall economic growth and through to government revenues.

However, the Treasury's optimistic outlook on wages does not compute with its labour market forecasts whereby the unemployment rate flattens at 5.0% over the next three years and employment growth weakens from an annual growth of 2.0% this year to 1.75% in the next two.

The continuing decline in the Australian property market would add to household consumption restraint.

Having said that, the Coalition's rosy scenario might still come true but it has to win government first.

Read more: BudgetChris BowenJosh FrydenbergPeter Costello
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