A Federal Budget for the Record Books

Economist's View

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Next Tuesday’s release of the postponed 2020-21 Federal Budget is set to be a once-in-a-lifetime affair. We expect the government to deliver the largest deficit on record, as it continues to support the economy through the pandemic and set it on course for continued recovery. We expect the 2020/21 deficit will be in the vicinity of $225 billion, about 12% of GDP and up from a $184.5 billion 2020-21 deficit forecast by the government just over 2 months ago in the July Economic and Fiscal Update. The deficit should ease back to around $116 billion over the next financial year as the economy picks up and the government continues to wind down its income support programs – the JobKeeper payments and the JobSeeker supplement.

While the size of these deficits dwarfs even the large deficits racked up during the GFC, which for example, peaked at around 4.2% of GDP 2009-10, they are not out of line with deficits being accumulated internationally. The five major advanced economies of the US, Japan, UK, Canada and euro area are likely to run deficits of between 8% and 20% of GDP in 2020.

What are the major initiatives of the budget likely to be? To begin with, we expect further extensions of income support measures such as the JobKeeper program until the end of the 2020-21 financial year. These extensions would again be likely to be at reduced rates or tightened eligibility, and come at an additional cost of as much as $7 billion to the 2020-21 budget. We expect the federal government will follow through on infrastructure spending with an additional $10 billion spent on shovel ready projects, bringing forward some of its planned infrastructure pipeline, and funding arrangements with the states.

We expect a further extension and widening of eligibility to larger businesses of investment allowances, at a cost of $5 billion. We anticipate an extension and a widening of eligibility to access the HomeBuilder scheme, with extra funding of up to $1 billion. Finally, we think additional spending on support for the manufacturing sector and energy, support for regions, enhancing digital business and cybersecurity, targeted job training and education funding, further health expenditure and other measures could tally up to $12 billion in 2020-21.

What about the widely rumoured bring-forward of the government’s planned tax cuts? We think the government will bring forward its planned 2022-23 tax cuts by one year to 2021-22, at a cost of around $12.5 billion in that year. In 2020-21 however, we think the government would be more likely to stick to more targeted direct spending and income support measures if required.

Will this be enough to support the economy and continue a recovery over the next year? We think it should be enough to build a bridge for the economy to a time when a vaccine is found and widely distributed and allows economic activity to be once again be driven by the private sector. The Budget should help the economic recovery to consolidate as we emerge from the worst of COVID and we think that by the June quarter of 2021, GDP will be around 4% higher than it was in the June quarter of this year, at the height of the pandemic. Unfortunately, even by June next year, the unemployment rate will still be unacceptably high at around 7%, as the economy will still be operating below its capacity. This means the government will have to keep its fiscal foot to the floor into 2022, by which time, hopefully a vaccine has been widely distributed.

The next two years should certainly be the worst of the economic and budget pain, and our forecast deficits would push the net debt up to $716 billion (37.4% of GDP) in 2020-21, and $832 billion (41.2% of GDP) in 2021-22. Even after the first two years, however, we expect that the 2020-21 Federal Budget will project budget deficits for the remaining 2 years of the budget projection period (albeit at diminishing levels) with net debt continuing to rise for a number of years ahead.

Will this be sustainable? We think it will be, as helpfully for the government, the RBA is also likely to keep interest rates at historic low levels and its bond yield target policies in place for a number of years. In addition, if investor concerns or credit rating downgrades were to see yields on government bonds rise to uncomfortable levels, we’d expect to see the RBA step in with secondary market government bond purchases to keep a lid on bond yields and support the government’s bond issuance.

Table 1: Financial market movements: 24 September - 1 October 2020

Source: Bloomberg