Treasurer Scott Morrison is using the UK example to push parliament into supporting his company tax cuts. Alex Ellinghausen
by Jacob Greber
Treasurer Scott Morrison appears to have been given until May to address an expected deterioration in the budget deficit – either through spending cuts or tax hikes – with one ratings agency warning the budget must be returned to surplus by 2020-21.
S&P Global Ratings director Craig Michaels told The Australian Financial Review that he doesn’t expect the government to use next month’s mid-year update to close likely shortfalls in the budget caused by weak wages growth.
However it was not yet clear whether the agency would put out a reassessment of the AAA credit rating in the immediate aftermath of the December 19 mid-year economic and fiscal outlook. Mr Morrison emphasised on Monday that MYEFO would not be a mini-budget.
Patience is growing thin at the agency over constant delays in budget repair. Mr Michaels pointed out that the current forecast for a return to surplus would be eight years after Labor first predicted a balanced budget for 2012-13 and more than a decade since the federal government’s books first slipped into deficit after the global financial crisis.
“If the government does meet its current target of a 2020-21 surplus that would still be consistent with the rating,” he told a conference in parliament house in Canberra hosted by Industry Super Australia.
“But if there’s more slippage beyond that then that probably wouldn’t be.”
There is growing concern within the Turnbull government that the coming budget update will see the headline deficit widen compared to the May budget. Deloitte Access Economics forecast this week that the blowout will be about $24 billion over four years, to a total of $108 billion.
S&P’s remarks imply there will almost certainly be a need for parliament to pass additional repair measures above and beyond the ones that are already slated, including fresh curbs on high-end superannuation concessions and the so-called omnibus bill of welfare savings worth just over $6.3 billion over four years.
“Unless revenue picks up in a surprising and sustained way to solve the budget problem, if you like, we would need to see further policy measures on the fiscal side to offset that if we are to maintain the AAA rating,” Mr Michaels said.
While the government’s debt levels are low by global standards and even relative to other top-rated AAA nations, Mr Michaels pointed out that overall externally sourced private debt – much of it invested in housing via the banking system – is among the highest in the world.
A slide presented by S&P to the conference, based on calculations by McKinsey, shows combined consumer, bank and government debt reached around 250 per cent of gross domestic product in mid 2014, a figure that has almost certainly risen since then given the ongoing property boom and rising government borrowing.
“[The government’s balance sheet] is quite strong, but the economy’s balance sheet is very weak,” Mr Michaels said.
“What it means is that Australia’s economic prospects are beholden to the ongoing willingness of foreign investors to roll over that debt and to continue to fund what is a structural current account deficit.
“Those things are fine provided foreign investors remain comfortable and confident in the Australian growth story.”
Even though S&P regards a sudden collapse or withdrawal of foreign lending in Australia as a “low probability scenario” thanks to underlying strengths, including bipartisan support for balanced budgets, it is growing less comfortable.
“That fiscal story is what’s starting to break down a little bit now, potentially,” Mr Michaels said.
The drum beat of warnings from S&P escalates the political stakes for the government as it pushes hard to win support for its plan to cut the 30 per cent company tax rate. Labor staunchly opposes the move because it would cut $50 billion from government revenue when the budget can least afford it.
Mr Morrison argues that the cuts would help fix a national “earnings problem” that is eating into profits and wages growth. On Tuesday, the Treasurer used a pledge by British Prime Minister Theresa May to cut the UK tax rate even further to put pressure on parliament to support his plans so Australian can remain competitive.
Mr Michaels indicated that the potential fall in revenue from company tax cuts is already built into Treasury’s 10-year budget projections, which cap tax as a proportion of GDP at 23.9 from 2021-22. That implies the government would deliver tax cuts at some point, he said.
Hopes have been raised in recent months that resurgent commodity prices will go some way to fixing the budget. Mr Michaels said that may be an “upside risk” but that the agency wasn’t convinced of a “structural lift up in prices at this point”.
“Beyond that, nominal growth could well be lower than what the budget assumes, and the wages data and CPI data that’s come in more recently could potentially be consistent with that.”
Mr Morrison insisted on Sunday that he would not take the “reckless” option of assuming coal prices would remain elevated, and that recent improvement in commodity prices “doesn’t mitigate” lower wages growth and profits, which are hurting revenues.
Offsetting the gloom, Reserve Bank of Australia assistant governor Christopher Kent said in Sydney late Tuesday that the terms of trade may have lastingly turned from a “substantial headwind” for the economy to a “slight tail breeze.”
“One notable aspect of our latest forecasts was the upward revision to the outlook for Australia’s terms of trade,” he said.
“Prices of bulk commodities have risen this year and contributed to a rise in the terms of trade of about 6 per cent in the June and September quarters. That’s the first rise in the terms of trade in some time.
“Our forecasts are for the terms of trade to remain above the low point reached earlier this year, and about 25 per cent above the average of the early 2000s before the boom.
“While our forecasts are uncertain and subject to various risks, the upward revision represents a marked change from the pattern of the past five years. If our forecasts are right, the terms of trade will shift from the substantial headwind of recent years to a slight tail breeze providing some support to the growth of nominal demand.”