Australia’s 2016-2017 budget is broadly neutral for the country’s public finances, which are consistent with the sovereign’s ‘AAA’ rating, Fitch Ratings says. A credible consolidation strategy, rather than absolute debt and deficit levels, remains a key sovereign rating consideration.
We expected weaker nominal income growth to constrain tax revenues and slow fiscal consolidation when we affirmed Australia’s ‘AAA’/Stable sovereign rating in March. Weaker terms of trade, weighing on economic performance and pushing back fiscal consolidation timelines, have been a regular feature of recent fiscal announcements.
The projected underlying cash balances in the budget are similar to those in the December Mid-Year Economic and Fiscal Outlook (MYEFO), despite improvement in the terms of trade. The budget assumes an iron-ore price of USD55/tonne, up from USD39 in the MYEFO, but the benefits to the nominal GDP growth outlook have been more than offset by weaker global economic conditions and lower price and wage inflation. Changes to economic parameters and other variations are expected to widen the combined underlying cash deficit by AUD8.1bn (0.5% of 2015-16 GDP) over the four years to 2019-20, whereas policy decisions will modestly narrow the deficit by AUD1.7bn (0.1% of 2015-16 GDP) over the same period.
The underlying cash deficit for 2016-17 is projected at AUD37.1bn, or 2.2% of GDP, slightly wider (0.2% of GDP) than the AUD33.7bn in the MYEFO. The government projects the underlying cash deficit to narrow to 0.3% in 2019-20, no change to the MYEFO. Revenue growth, while weaker than previously projected, is expected to drive the fiscal consolidation. Commonwealth net debt is still expected to fall after 2017-18, albeit from a slightly higher peak. Projections for state and local government deficits are wider than we had anticipated, at 0.3% of GDP in 2017-2018 compared to 0.1% projected in last year’s budget.
The economic flexibility afforded by Australia’s low government debt ratio is an important support for the ‘AAA’ sovereign rating. Gross general government debt/GDP remains below the ‘AAA’ median (34.5% of GDP in 2015, versus 42.8%). The public balance sheet has acted as a shock absorber against the sharp fall in terms of trade due to falling commodity prices over the past four years.
A credible fiscal consolidation strategy, responsive to economic conditions, would help preserve fiscal buffers against potential shocks facing the Australian economy, both domestic (eg the risk of a housing market bust) and external (eg another fall in iron ore prices, or a more pronounced China slowdown). If there were a lasting improvement in economic parameters, for example a better outlook for the terms of trade, we assume the authorities would allow the deficit to narrow more quickly. The Reserve Bank of Australia’s 25bp rate cut on Tuesday may also support growth.
We also assume greater consolidation efforts should the structural deficit prove wider than anticipated. The government’s estimate of the structural deficit has narrowed, but forecasting is subject to significant uncertainties around the outlook for private investment, productivity and export competitiveness. The nation’s debt-carrying capacity could be enhanced if the government’s Enterprise Tax Plan and National Infrastructure Plan are able to unlock improvements in trend growth.
The broad political support for fiscal responsibility means we do not expect a significant change in fiscal strategy following the elections that are likely to be held in early July, although the policy mix may change.
