2015 – 16 Federal BudgetOverview & Assessment

13 MAY 2015 Peter Jolly, Global Head of Research

A century ago - 1915 Budget“War Budget” – 1915-16

Operating Statement

£ mn’s % GDP

Total Revenue £23.56.3%

Total Expenditure £74.019.9%

Balance/Deficit £50.5-13.5%

War Expenses £47.6

Financed by

£ mn’s

British loan£10.4

Commonwealth War Loan £20.0

New Income Tax£4.0

Not sure!!£16.1

Total Finance£50.5

Source: SMH, Australian Historical Statistics, Editor Wray 1987

Page 2

The 1915 commentary

Page 3

Near term fiscal jaws open

United States12 month rolling sum

Outlays

Receipts

Deficit/Surplus 0

Tri

llio

n U

SD

's p

er

yea

r , tr

illio

n

-2

-1

0

1

2

3

4

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Source: National Australia Bank, Macrobond

Australia12 month running total

Expenses

Revenues

Budget Balance

bill

ion

-100

-50

0

50

100

150

200

250

300

350

400

450

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Source: National Australia Bank, Macrobond

Page 4

Longer term fiscal challenge

-20

0

20

40

60

80

100

120

140

-20

0

20

40

60

80

100

120

140

1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Per cent of GDP

Commonwealth Government Debt

Gross Debt

Net Debt.Forecasts from MYEFO andIntergenerational Report (currently legislated scenario)

WW1

Depression

WW2

Source: Australian Budget. Intergenerational Report. A history of public debt in Australia Katrina Di Marco, Mitchell Pirie and Wilson Au-Yeung

AA credit rating

Page 5

Assessing the Budget

Page 6

How should one assess an Australian budget?

1. Short-term macro: Good for the economy?

2. Long-term macro: Does it address long-term budget pressures

3. Governance:

1. Expenditure – is the level correct & appropriately targeted?

2. Revenue – do the tax system create the correct incentives; are the various agents paying appropriate tax?

4. Micro: Does it support business/jobs. Does it deliver the appropriate amount and type of infrastructure spending for Australia’s evolving demographics?

5. Redistribution/equity/social/safety net: Is it fair?

Key MeasuresBusiness: $5.5bn Jobs and Small Business Package

• Tax cut for SMEs (to 28.5%) from 1 July 2015, but not for large businesses (>$2m revenue)

• $20,000 deduction for each and every asset purchased by SMEs until 30 June 2017 (double expectations) – quite a positive for smaller businesses

• Unincorporated small businesses to get a 5% tax discount of up to $1000 per annum

Households: $4.4bn Families Package

• Childcare incentives ($3.5bn) - Child Care Subsidy from 1 July 2017 (and a nannies trial from 1 July 2016) - linked to stalled cuts to Family Tax Benefits from last year

• Tightening Paid Parental Leave scheme to eliminate double dipping

• Pension reforms – increased assets test thresholds and taper rate (Jan 17); increased payments to the poor ($2.4bn saving)

• $1.6bn for new drugs in PBS

Economy

• Farmers: extension of drought relief loan schemes; incentives to improve land (tax deductions) and accelerated depreciation on fodder storage assets)

• $0.5bn for WA to compensate for lower GST distributions

• Extension of preschool funding to states for further 2 years

• $5bn for Northern Australia Infrastructure Facility to provide concessional loans for major projects in the NorthPage 7

Key MeasuresTax/Tax Integrity

• Multinational Anti-Avoidance Law (Profit shifting by multinationals – “Google” tax) – punitive level of twice the tax owed plus interest. (30 large multinationals suspected) [figures not incorporated in this budget]

• GST on intangibles - “Netflix” tax (1 July 2017) – extended GST compliance regime

• No new taxes on superannuation by this government

• No mention of negative gearing

Expenditure cuts

• Abandonment of the Paid Parental Leave Scheme

• East-West Link payment to Victorian Government reversed

• Public service efficiency drive

Page 8

The Budget balance

Page 9

-5

-4

-3

-2

-1

0

1

2

3

1990 1995 2000 2005 2010 2015

Per cent of GDP

Underlying Cash Balance

MYEFO

Source: Australian Budgets

Budget 2015-16

Australia now a middling AAA

-100

-50

0

50

100

150

200General Government Net Debt

% of GDP2016 Forecast

Source: IMF Fiscal Monitor, April 2015.Projections are based on staff assessment of current policies

AAA Countries

Other Advanced Countries

-249%

Page 10

Just below S&P 30% threshold

Page 11

-5

0

5

10

15

20

25

30

35

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

% of GDP

Net General Government Debt - Standard and Poors Definition

Currrent - MYEFOBudget

Source: S&P plus NAB calculations

30% threshold for downgrade

General Government Net Debt – S&P Measure

Credit rating?• Downgrade unlikely in next few years. Credit watch negative possible.

• Standard and Poor’s have said the AAA rating is not “immediately affected by the Budget” but they 1) worry about revenue write-downs and 2) are looking for “passage of policy measures that support improving budget outcomes over the medium term”.

• Politics matters.

Would a downgrade matter?

• Knock on to other highly rated entities – AAA state governments and the big banks

• For markets only a little. 1) by the time of a downgrade markets are used to the and 2) AA+ is the new AAA.

• We have studied the impact of rating downgrades of currencies and found little or no sustained impact.

• Bond yields are typically 10-15bps higher.

Page 12

Budget economic forecasts

Page 13

Budget NAB Budget NABMay '15 Apr '15 May '15 Apr '15

Real GDP 2.5 2.3 2.75 3.0Nominal GDP 1.5 1.8 3.25 4.0Unemployment Rate (*) 6.25 6.4 6.5 6.5CPI (*) 1.75 1.1 2.5 3.1Iron ore, spot (**) 48 58 48 58

(*) Year ended; all other forecasts are average year.(**) Global forecasts are for calendar 2015 and 2016.Sources: Budget papers, MYEFO, NAB.

2014-15 2015-16 • Realistic.

• NAB’s forecast a touch more optimistic in 2015-16.

• Its clear that return to Budget surplus relies on this economic recovery

The mixed economy continuesPositives

• Very low interest rates.• Strong growth in residential construction.• Continuing rapid population growth (slowing

a little).• Infrastructure spending.• A$ lower now.• Significant drop in oil prices (for consumers).• Mining exports increasing.

Strengthening now evident in the non-mining economy.

Negatives

• Falling commodity prices/terms of trade = weak incomes growth.

• Large mining projects completing.• Lowest wage growth in two decades.• Consumer and business confidence fragile.• Uncertainty around Government policy and

leadership.• Fiscal policy tightening – although new Budget

less austere than previous.

Page 14

Business conditions OK

15

Business Conditions

monthly series

quarterly series

-40

-30

-20

-10

0

10

20

30

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

National Australia Bank, Macrobond

Page 15

Varied by industry

-20

-15

-10

-5

0

5

10

15

20

Feb-15

Mar-15

Apr-15

MiningManufacturing

Constructioni

Retail Wholesale Transport Business Services

Household Services

NAB Survey- 3mth m.a.

Source: National Australia Bank

Business Conditions by Industry

Total

Page 16

Varied by State

Page 17

-15

-12

-9

-6

-3

0

3

6

9

12

15

Mar-15

Feb-15

Apr-15

NSW Victoria Queensland South Australia

Total

Business Conditions by StateNAB Survey- 3mth m.a.

Western Australia

Tasmania Total

Jobs being created in non-mining states

Page 18

-10

-5

0

5

10

15

20

Non-mining(NSW, Vic, Tas, ACT)

QLD and SA Pure-mining(WA, NT)

Employment Growth - monthly trend past 12monthsP

ers

on

s, th

ou

sa

nd

s

April-15May-14

RBA cash rate on hold at 2%

Page 19

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 Oct-15 Oct-16

% RBA cash - actual vs fcsts

Source:NAB

NAB Forecast

Market Pricing

• RBA will be reluctant to ease again but for next 6-12 months that remains the risk.

• Increases from late 2016.

$A fair value 80 cents. To fall further as US Fed hikes.

Page 20

NAB's "SSR" fair value model (accounts for Fed QE)

AUD FV = fn(AU 1yr Swap - "SSR", VIX, LMEX)

AUDUSD Spot

AUDUSD model

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

0.791

0.805

-0.100

-0.025

0.050

A J O J A J O J A J O J A J O J A J O J A J O J A J O J A J O J A J O J A2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: National Australia Bank, Macrobond

Reaction: modest positive

Page 21

• Most measures pre-announced and targeted with an eye to passage through the Senate. Should avoid the negative reaction of last year

• Fiscal emphasis on gradually lower deficits in the years ahead – risk if nominal GDP and revenues do not recover

• Small positives for business – not game-changing

• Unfinished medium-term fiscal “business” with the White Papers on Taxation and Federation under way and the unfunded transfer of education and health spending to the states introduced last year still to be resolved

• The economy still presents a number of challenges with big cuts to mining investment, commodity prices lowering incomes.

• Unlikely to fundamentally change confidence – despite SME initiatives

• AAA credit rating assured for now. But medium term repair still needed

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