5 Things MYEFO Tells Us

As we come to the end of 2019, you’d be forgiven for being confused about the health of the economy. Via The Conversation.

Treasurer Josh Frydenberg regularly points out that jobs growth is strong, the budget is heading back to surplus, and Australia’s GDP growth is high by international standards.

The opposition points to sluggish wages growth, weak consumer spending and weak business investment.

Monday’s Mid-Year Economic and Fiscal Outlook (MYEFO) provides an opportunity for a pre-Christmas stock-take of treasury’s thinking.

1. Low wage growth is the new normal

Rightly grabbing the headlines is yet another downgrade to wage growth.

In the April budget, wages were forecast to grow this financial year by 2.75%. In MYEFO, the figure has been cut to 2.5%.

Three years ago, when Scott Morrison was treasurer, the forecast for this year was 3.5%.

Each time wages forecasts missed, treasury assumed future growth would be even higher, to restore the long-term trend.

Today’s MYEFO is a long-overdue admission from treasury that labour market dynamics have shifted – in other words, lower wage growth is the “new normal”.

Even by 2022-23, wages are projected to grow at only 3% (and even that would still be a substantial turnaround compared to today).

Of course, wages are still rising in real terms (that is, faster than inflation), a fact Finance Minister Mathias Cormann is keen to emphasise.

But Australians will have to adjust to a world of only modest growth in their living standards for the next few years.

2. Economic growth is underwhelming, especially per person

Economic growth forecasts have received a pre-Christmas trim.

Treasury now expects the economy to grow by 2.25% this financial year, down from the 2.75% it expected in April.

Particularly striking is the sluggishness of the private economy, with consumer spending expected to grow by just 1.75%, despite interest rate and tax cuts, and business investment idling at growth of 1.5%, down from the 5% forecast in April.

The longer term picture looks somewhat better, with growth forecast to rise to 2.75% in 2020-21 and 3% in 2021-22, although treasury acknowledges there are significant downside risks, particularly from the global economy.

The government has made much of the fact our economy is strong compared to many other developed nations. But much more relevant to people’s living standards is per-person growth. Australia’s international podium finish looks less impressive once you account for the fact Australia’s population is growing at 1.7%.

As one perceptive commentator has noted, while Australia is forecast to be the fastest growing of the 12 largest advanced economies next year, it is expected to be the slowest in per-person terms.

3. The government is at odds with the Reserve Bank

You can imagine the government’s collective sigh of relief that it is still on track to deliver a surplus in 2019-20, albeit a skinny A$5 billion instead of the the $7 billion previously forecast.

Given the treasurer declared victory early by announcing the budget was “back in the black” in April, missing would have been awkward, to say the least.

And another three years of slim surpluses are forecast ($6 billion, $8 billion and $4 billion respectively).

The real issue for the treasurer is how to deal with the growing calls for more economic stimulus, including from the Reserve Bank.

Depending on what happens to growth and unemployment in the first half of 2020, he will come under increased pressure to jettison the future surpluses to support jobs and living standards.

4. High commodity prices are a gift for the bottom line

High commodity prices are the gift that keeps on giving for the Australian budget.

Iron ore prices in excess of US$85 per tonne, well above the US$55 per tonne budgeted for, have helped to keep company tax receipts buoyant.

Treasury is maintaining the conservative approach it has taken in recent years by continuing to assume US$55 per tonne.

This provides some potential upside should prices stay high – Treasury estimates a US$10 per tonne increase would boost the underlying cash balance by about A$1.2 billion in 2019-20 and about A$3.7 billion in 2020-21.

The budget bottom line remains tied to the whims of international commodity markets for the near future.

5. The surplus depends on running a (very) tight ship

The forecast surpluses over the next four years are premised on an extraordinary degree of spending restraint.

This government is expecting to do something no government has done since the late-1980s: cut spending in real per-person terms over four consecutive years.

The budget dynamics are helping. Budget surpluses and low interest rates reduce debt payments, and low inflation and wage growth reduce the costs of payments such as the pension and Newstart.

But the government is also expecting to keep growth low in other areas of spending, in almost every area other than defence and the expanding national disability insurance scheme.

As the Parliamentary Budget Office points out, it is hard to keep holding down spending as the budget improves.

It is even more true while long term spending squeezes on things such as Newstart and aged care are hurting vulnerable Australians.

Where does it leave us?

The real lesson from MYEFO is that Australians are right to be confused: there is a disconnect between the health of the budget and the health of the economy.

MYEFO suggests both that the government is on track to deliver a good-news budget surplus underpinned by high commodity prices and jobs growth, and that the economy is in the doldrums with low wage growth in place for a long time.

Top of Frydenberg’s 2020 to do list: how to reconcile the two.

Authors: Danielle Wood, Program Director, Budget Policy and Institutional Reform, Grattan Institute; Kate Griffiths, Senior Associate, Grattan Institute

APRA Launches Westpac Investigation

The Australian Prudential Regulation Authority (APRA) has today formally commenced an investigation into possible breaches of the Banking Act 1959 by Westpac Banking Corporation (Westpac).

APRA will focus on the conduct that led to the matters alleged last month by AUSTRAC, as well as the bank’s actions to rectify and remediate the issues after they were identified. The investigation will examine whether Westpac, its directors and/or its senior managers breached the Banking Act – including the Banking Executive Accountability Regime (BEAR) – or contravened APRA’s prudential standards.

Given the magnitude and nature of the issues alleged by AUSTRAC, APRA is aiming to ensure that fundamental deficiencies in Westpac’s risk management framework are identified and addressed and that Westpac and those responsible are held accountable as appropriate.

In addition, APRA will:

  • impose an immediate increase in Westpac’s capital requirements of $500 million, to reflect the heightened operational risk profile of the bank. This brings the total operational risk capital add-ons that Westpac is required to hold to $1 billion, following the increase announced by APRA in July 2019; and
  • initiate an extensive review program focused on Westpac’s risk governance. The review program will include risk management, accountability, remuneration and culture. An element of the review will be an examination of the steps Westpac has been taking to strengthen risk governance in recent years, including through its self-assessment.

APRA Deputy Chair Mr John Lonsdale said: “AUSTRAC’s statement of claim in relation to Westpac contains serious allegations that question the prudential standing of Australia’s second largest bank.

“While Westpac is financially sound, there are potentially substantial gaps in risk governance that need to be closed.

“Given the nature of the matters raised by AUSTRAC, the number of alleged breaches and the period of time over which they occurred, this will necessarily be an extensive and potentially lengthy investigation.”

The investigation affords APRA the opportunity to exercise legal powers that have been expanded and strengthened since 2017’s CBA Prudential Inquiry, including enhanced investigative powers and the implementation of the BEAR in 2018.

APRA will conduct its investigation simultaneously with an investigation by the Australian Securities and Investments Commission (ASIC), as well as AUSTRAC’s legal proceedings, with each agency cooperating where appropriate.

The scope of APRA’s investigation is below.


Attachment – Scope of APRA’s investigation into Westpac

The prudential matters that are the subject of APRA’s investigation are:  

Whether Westpac, its directors, and/or its senior managers have contravened the Banking Act 1959 and the prudential standards by engaging in, and in the way they responded to, the conduct set out in and otherwise related to the AUSTRAC proceedings.  

In considering possible contraventions of the Act and the prudential standards, the investigation will examine whether:  

(a) Westpac’s governance, control and risk management framework was adequate; and appropriately implemented;  

(b) Westpac’s accountability and remuneration arrangements were adequate, and appropriately implemented to effectively manage non-financial risks;  

(c) there has been a failure to comply with accountability obligations under the Banking Executive Accountability Regime;  

(d) there has been a failure to comply with the requirements of the prudential standards including Prudential Standard CPS 510: Governance, Prudential Standard CPS 520: Fit and Proper, and Prudential Standard CPS 220: Risk Management; and

(e) there was a failure to promptly notify APRA of any significant breaches and/or a breach of accountability obligations.

“Reality” Hits The Budget, Sort Of…

MYEFO has been released, and as expected the Government is still forecasting a surplus, this year down from $7.1 billion to $5 billion, but still a surplus for the first time in 12 years. The surplus for 2020/21 is now seen at $6.1 billion instead of $11 billion as previously estimated. Tax receipts are down 32.6b over 4 years.

Wage growth forecasts were reduced, but are still too optimistic, while the unemployment rate was expected to be higher than hoped at 5.25 per cent, rather than five per cent for this financial year and next.

Treasury still is sticking with a 5% employment threshold below which inflation is expected to rise, while the RBA has this at 4.5%.

The forecast for economic growth has reduced from 2.75 per cent, to 2.25 per cent. The downgrade to growth was blamed on weak momentum in the global economy, as well as domestic challenges such as the effects of drought and bushfires. The drought in Australia that had already taken a quarter of a percentage point off GDP growth and reduced farm output by a significant amount over the last two years. Growth is then expected to strengthen to 2¾ per cent in 2020-21.

They have shrunk the expected surpluses over the next four years due to a downgrade of tax receipt expectations, with total receipts revised down by $3 billion in 2019/20 and by $32.6 billion over the four years to 2022/23. GST to the states is down nearly 2 billion in the next year, due to weaker activity.

Australia’s interest bill on its debt will fall from $19 billion last year to $14.5 billion (thanks to lower interest rates). Over the next four years this amounts to $13.5 billion savings.

While the mid-year update included a $623.9 million aged care package, there were no other new major spending measures to lift economic growth. This will keep the pressure on the Reserve Bank of Australia to reduce the cash rate even further next year.

In essence, the Treasury is leaving the action to the Reserve Bank, further confirmation we are likely to get more cuts next year.

But they are also counting on stronger house prices leading to a positive wealth effect.

After a recent period of significant falls in housing prices from mid-late 2017 to mid-2019, the established housing market has stabilised. In July 2019, combined capital city housing prices rose for the first time in almost two years, and this has continued in recent months. Although increases have been largest in Sydney and Melbourne, increases have now spread to all cities except Darwin. Overall, combined capital city housing prices are now almost 6 per cent higher than their recent trough in June, although they are still around 5 per cent lower than their peak in September 2017.

This increase in housing prices is expected to support the outlook for household consumption, particularly as corresponding increases in housing turnover should see a pick-up in spending on household goods such as furnishings. More broadly, continued rises in housing prices should provide a boost to confidence and household wealth, as well as increasing borrowing capacity given changes in collateral.

Ownership transfer costs — various fees incurred when fixed assets such as dwellings are sold (including legal and real estate agent fees, stamp duty, and other government charges) — were negatively affected by low rates of housing market turnover in 2018-19 and detracted from real GDP growth. Ownership transfer costs rose by 4.5 per cent in the September quarter 2019 and a further increase supported by stronger housing turnover and prices should contribute to economic growth over the forecast period.

Movements in housing prices impact dwelling investment activity through changes to expected returns to residential construction. However, recent price gains will affect new dwelling investment with a delay. This is because planning and approval processes take time to work their way through into new construction. On average, depending on the type of dwelling, it can take around 2 to 5 months for new dwellings to commence following approval, and a further 6 to 20 months for activity to be completed. High-density dwellings have the longest approval and construction times, and houses the shortest on average.

New dwelling approvals have trended down since late 2017, with the total number of building approvals over the year to October 2019 down by more than 20 per cent from the preceding 12 months and below the 10-year average. The falls in building approvals have been particularly stark in medium-high density dwellings, which also have the longest lag between approval and completion. This means that further moderation in dwelling investment is likely over the forecast period (Chart A). This weakness should be partly offset by a solid pipeline of housing construction work yet to be done.

The other area of sensitivity is the iron ore price and commodity prices in general.

Iron ore spot prices increased sharply in the first half of 2019, mainly due to supply issues in Australia and Brazil, and stronger-than-expected demand from China. Iron ore prices peaked in early July at almost US$120 per tonne free-on-board (FOB). Prices have since fallen, but remain above the price assumed at PEFO. The decline in the price has mainly been due to uncertainty about demand from Chinese steel mills and the recovery in supply. As such, prudent assumptions have been retained and the iron ore spot price is assumed to decline to reach US$55 per tonne FOB by the end of the June quarter 2020. This is one quarter later than was assumed at PEFO.

Coal prices have fallen since PEFO. Metallurgical coal prices have fallen faster and further than had been assumed at PEFO, with the spot price below US$150 per tonne FOB since October 2019. The fall in the spot price is due in large part to uncertainty about demand from Chinese steel mills and policy changes in China. The metallurgical coal price is assumed to remain around recent levels of US$134 per tonne FOB over the forecast period. This is lower than the PEFO assumption, which was for the price to fall to US$150 per tonne FOB by the end of the March quarter 2020.

After reaching a peak of just over US$125 per tonne FOB in mid-2018, thermal coal prices have trended lower, mainly due to increases in seaborne supply and softer global demand. The thermal coal price is assumed to remain around recent levels of US$64 per tonne FOB over the forecast period, below the PEFO assumption of US$91 per tonne FOB.

If the iron ore price were to fall immediately to US$55 per tonne FOB, two quarters earlier than assumed, nominal GDP could be around $7.5 billion lower than forecast in 2019-20 and $0.3 billion lower in 2020-21. This would have a negative flow-on impact to company tax receipts estimated at around $0.8 billion in 2019-20 and $1.1 billion in 2020-21.

By contrast, if the iron ore price remained elevated for two quarters longer than currently assumed, before falling immediately to US$55 per tonne FOB, nominal GDP could be around $6.4 billion higher than forecast in 2019-20 and $1.0 billion higher in 2020-21. This would have a flow-on impact to company tax receipts estimated at
around $0.5 billion in 2019-20 and $1.3 billion in 2020-21.

The actual impact on company tax receipts may vary due to timing of tax collections and the availability of tax losses.

The Fragility Of Freedom In The Digital Age

We look at developments in Greece, a recent speech from the RBA and the latest on the cash restriction bill. What are we giving up?

RBA Advocates A Strong Digital Identity System

https://www.rba.gov.au/speeches/2019/sp-gov-2019-12-10.html

https://www.tornosnews.gr/en/greek-news/economy/38055-greeks-must-pay-more-online-or-face-fines-in-campaign-to-curb-tax-evasion.html

Auction Results 14th Dec 2019

Domain released their preliminary results for today. This is the last report from them until end January 2020. In addition, they did not send the detailed breakdown they normally do.

So I generated my own chart to show the results.

The current sold over listed ratio is significantly lower than their calculated clearance rates.

See our recent discussion with FreshCanvas.

Is It Time To Move Beyond Exit Polls And Tweets? – The Property Imperative Weekly 14 December 2019

The latest edition of our weekly finance and property news digest with a distinctively Australian flavour. Contents:

  1. 00:25 Introduction
  2. 00:45 Trade Deals
  3. 03:00 Impeachment
  4. 03:50 US Markets
  5. 06:20 UK Election and Brexit
  6. 08:30 ECB and Euro
  7. 09:20 Deutsche Bank
  1. 10:30 Australian Section:
  2. 10:30 ASIC Responsible Lending
  3. 12:45 BIS and Household Debt
  4. 13:00 APRA On Risks
  5. 13:30 Westpac
  6. 14:40 Citi and Deutsche Bank Action on Cartel
  7. 16:40 Home Prices and Auctions
  8. 18:15 Economics and recession fears
  9. 19:45 IMF Warns
  10. 21:00 Bank profit warnings
  11. 23:20 Markets

December Live DFA: https://youtu.be/N6QKe7IGGvc

Kitchen Sink From The Fed – Up To $365 Billion In The Next Month! [Video]

The latest from the Federal Reserve, and the trade talks – are they connected? Why the lift in repo transactions ahead?

https://www.newyorkfed.org/markets/opolicy/operating_policy_191212

IMF On Australia: Risk To The Outlook Remains Tilted To The Downside

The IMF published their latest preliminary findings at the end of an official IMF staff visit (or ‘mission’) to Australia. They recommend preparing for risk from a rapid housing credit upswing, by introducing loan-to-value and debt-to-income limits, and possibly a sectoral countercyclical capital buffer targeting housing exposures. Plus transitioning from a housing transfer stamp duty to a general land tax to improve efficiency by easing entry into the housing market and promoting labor mobility, while providing a more stable revenue source for the States. Such reforms could be complemented by reducing structural incentives for leveraged investment by households, including in residential real estate.

Economic growth has gradually improved from the lows in the second half of 2018 but has remained below potential. Growth has been supported by public spending, including on infrastructure, and net exports, which have held up well despite headwinds from global policy uncertainty and China’s economic slowdown. However, domestic private demand has remained weak amid subdued confidence, with a widening output gap. In addition, the ongoing drought has been a drag on economic growth. Wage growth has remained sluggish, reflecting persistent labor market slack, and inflation and measures of inflation expectations have dropped to below Australia’s 2 to 3 percent target range. Following a marked adjustment over the past two years, housing prices have started to recover, particularly in Sydney and Melbourne.

Growth should continue to recover at a gradual pace. Following growth of about 1.8 percent in 2019, the economy is expected to expand by 2.2 percent in 2020.Private domestic demand is expected to recover slowly, supported by monetary policy easing and the personal income tax cuts. An incipient recovery in mining investment is also expected to contribute to growth. In addition, the house price recovery will likely reduce the drag on consumption from earlier, negative wealth effects. That said, residential and non-mining business investment are expected to take longer to recover. Over the medium term, growth is expected to reach the mission’s estimate of potential growth of about 2½ percent, supported by infrastructure spending and structural reforms. With continued labor market slack, underlying inflation will likely stay below the target range until 2021.

Risks to the outlook remain tilted to the downside.

· On the external side, Australia is especially exposed to a deeper-than-expected downturn in China through exports of commodities and services. A renewed escalation of U.S.-China trade tensions could further impair global business sentiment, discouraging investment in Australia. A sharp tightening of global financial conditions could squeeze Australian banks’ wholesale funding and raise borrowing costs in the economy.

· On the domestic side, private consumption could be weaker should a cooling in labor markets squeeze household income. Adverse weather conditions, including a more-severe-than-expected drought, could further disrupt agriculture, dampening growth. On the upside, looser financial conditions could re-accelerate asset price inflation, boosting private consumption but also adding to medium-term vulnerabilities given high household debt levels.

With below-potential growth, weakening inflation expectations, and continued downside risks, the macroeconomic policy mix should remain accommodative.

· Monetary policy has been appropriately accommodative, and continued data-dependent easing will be helpful to support employment growth, inflation and inflation expectations.

· The consolidated fiscal stance is appropriately expansionary for FY2019/20. Fiscal policy will be supportive for demand via reductions in personal income and small business corporate taxes, additional infrastructure spending, and the government’s announced support measures for small- and medium-sized enterprises (SMEs). However, fiscal policy aggregated across all levels of government will be contractionary in FY2020/21, as state-level infrastructure investment is expected to decline.[1] States should reconsider this and attempt to at least maintain their current level of infrastructure spending as a share of GDP to continue addressing infrastructure gaps and supporting aggregate demand.

The authorities should be ready for a coordinated response if downside risks materialize. Australia has substantial fiscal space it can use if needed. In addition to letting automatic stabilizers operate, Commonwealth and state governments should be prepared to enact temporary measures such as buttressing infrastructure spending, including maintenance, and introducing tax breaks for SMEs, bonuses for retraining and education, or cash transfers to households. In case stimulus is necessary, the implementation of budget repair should be delayed, as permitted under the Commonwealth government’s medium-term fiscal strategy. In addition, unconventional monetary policy measures such as quantitative easing may become necessary in such a scenario as the cash rate is already close to the effective lower bound.

The macroprudential policy stance remains appropriate but should stand ready to tighten in case of increasing financial risks. Australian banks remain adequately capitalized and profitable, but vulnerable to high exposure to residential mortgage lending and dependent on wholesale funding. While the risk structure of mortgage loans has been significantly improved, renewed overheating of housing markets and a fast pick-up in mortgage lending remain risks in a low-interest-rate environment. The Australian Prudential Regulation Authority (APRA) should continue to expand and improve the readiness of the macroprudential toolkit. This should include preparations, for potential use in the event of a rapid housing credit upswing, for introducing loan-to-value and debt-to-income limits, and possibly a sectoral countercyclical capital buffer targeting housing exposures.

Strong reform efforts to bolster the resilience of the financial sector should continue. The mission supports the authorities’ plan to further enhance banks’ capital framework, including strengthening their loss-absorbing capacity and resilience. In addition, encouraging banks to further lengthen the maturity structure of their wholesale funding would help mitigate ongoing structural liquidity risks. The authorities’ commitment to implement the recommendations made by the Hayne Royal Commission by end-2020 is welcome. The improvement in lending standards further enhances financial sector resilience, and reducing the uncertainty in the enforcement of responsible lending obligations would prevent excessive risk aversion in the provision of credit. The authorities should implement the APRA Capability Review’s recommendations to strengthen APRA’s resources and operational flexibility, enhance its supervisory approach in assessing banks’ governance and risk culture, and strengthen enforcement efforts. In addition, reinforcing financial crisis management arrangements and strengthening the AML/CFT regime should remain priorities, in line with the findings of the 2018 Financial Sector Assessment Program (FSAP).

Housing supply reforms remain critical for restoring affordability. More efficient long-term planning, zoning, and local government reform that promote housing supply growth, along with a particular focus on infrastructure development, including through “City Deals”, should help meet growing demand for housing.

Efforts to boost private investment and innovation should be stepped up. Non-mining business investment, including R&D, has been sluggish, contributing to lower productivity growth. Reducing domestic policy uncertainty, supporting SMEs’ access to finance, and accelerating structural reforms would help to improve the investment environment. Building on reforms in the 2015 Harper Review, Australia can further improve product market regulations, including by simplifying business processes through the work of the Deregulation Taskforce. The ongoing policy priority on skills and education reforms is welcome to improve the environment for innovation, and consideration should be given to faster implementation of the recommended measures in the Australia 2030: Prosperity through Innovation report. Government initiatives to relieve SME financing constraints are welcome, including the Australian Business Securitization Fund and the Australian Business Growth Fund. Incentives for banks to lend more to businesses, including through reducing the concentration in mortgages, can help support business investment, as can the promotion of venture capital. Supporting new investment through tax measures, possibly including targeted investment allowances, as well as further improving the effectiveness of government R&D support for younger firms, would also be helpful.

Australia’s continued efforts supporting international cooperation are welcome. The mission welcomes the authorities’ support to enhance the effectiveness of the WTO and pursuit of the Regional Comprehensive Economic Partnership (RCEP), which aims to liberalize trade and improve quality and environmental standards and labor mobility throughout the Asia and Pacific region. Developing a national, integrated approach to energy policy and climate change mitigation, and clarifying how existing and new instruments can be employed to meet the Paris Agreement goals, would help reduce policy uncertainty and catalyze environmentally-friendly investment in the power sector and the broader economy.

Further reforms can help to promote female labor market participation and reduce youth underemployment. There is scope to increase full-time employment for Australian women and addressing persistently high underemployment particularly among youth. The 2018 Child Care Subsidy program and the forthcoming Mid-Career Checkpoint program are expected to support women in work. This could lay the foundation for a broader review of the combination of taxes, transfers, and childcare support to reduce disincentives for female labor force participation. Pursuing ongoing reforms in vocational training can help reduce youth underemployment.

Broad fiscal reforms would help promote efficiency and inclusiveness. Australia should continue to reduce distortions in its tax system to promote economic efficiency and in doing so should be mindful of distributional consequences considering income inequality. Recent reforms in personal and corporate income taxes have helped to improve the efficiency of the tax system. A further shift from direct to indirect taxes could be made by broadening the goods and services tax (GST) base and reducing the statutory corporate income tax rate for large firms. The impact of these reforms could be made less regressive for households through targeted cash transfers. Transitioning from a housing transfer stamp duty to a general land tax would improve efficiency by easing entry into the housing market and promoting labor mobility, while providing a more stable revenue source for the States. Such reforms could be complemented by reducing structural incentives for leveraged investment by households, including in residential real estate.

The mission would like to thank the authorities and counterparts in the private sector, think tanks, and other organizations for frank and engaging discussions.