ScoMo Delivers Election Winning Budget

Christopher Joye

Coolabah Capital

My AFR analysis this evening comes straight from six hours in the Canberra Federal Budget lock-up crunching the numbers, which reveal a brilliant, election-winning budget delivered by a Treasurer who just gets better and better (click on that link to read for free or AFR subs can click here for direct access). Excerpt enclosed:

"Treasurer Scott Morrison has delivered a brilliant, election-winning budget that could be a game-changer by tapping into deep community discontent with political weasel-words that for a decade have overpromised and undelivered, eroding trust in our leaders.

Australians no longer seem willing to be suckered by "cash splashes" and white elephants such as the NBN, knowing that the explosion in government debt from $53 billion in 2007 to $533 billion today to underwrite this largesse has to be repaid. And the most likely culprits are higher taxes and inferior services.

It is therefore no surprise that the latest polling shows Aussies, who are famous for their world-beating thriftiness when it comes to repaying home loans, now prefer that governments reduce public debts over unsustainable tax cuts.

Morrison has tackled this mistrust head-on by being the first treasurer since Peter Costello to consistently exceed expectations, and will shortly lay claim to the first surplus since 2007-08.

And he has once again saved Australia's prized AAA credit rating, which keeps bank funding costs (and thus home loan rates) low. It is hard to imagine how Standard & Poor's could credibly retain its "negative outlook" on the rating, which is now in its strongest position in years.

On all the main variables, Australia has blown S&P's pessimistic assumptions out the water. This includes: radical reductions in realised budget deficits; the arrival of a surplus years before S&P thought possible; significantly higher commodity revenues; a skinnier current account deficit; the Turnbull government's ability to negotiate $37 billion of savings through a recalcitrant Senate, which S&P doubted; an earlier than anticipated peak in net debt, which will all but disappear by the end of the decade; and, finally, a welcome correction in house prices relative to national income levels triggered by much tighter lending standards.

Yet the odds were stacked against Morrison. Analysts and rating agencies universally panned the last budget as overly optimistic and derided the skinny 2020-21 surplus as a pipe dream. In contrast, this column (correctly) predicted that Morrison had saved Australia's AAA rating with a gutsy budget, which CBA forecast would be lost.

We were also the first to reveal in 2017 that Morrison's actual budget results were running way ahead of official projections. Indeed, over the five months to March 2018 (the most recent published accounts), Australia has remarkably reported a net operating surplus of $1.4 billion!

Based on the new budget, the $29.4 billion underlying cash deficit in 2017-18 will now be $11.2 billion smaller at $18.2 billion. The results between 2018-19 and 2020-21 are a further $15.2 billion better than Treasury expected in May 2017, bringing total savings since June 2017 to $26.4 billion. And this is after incorporating new policies such as scrapping the 0.5 percentage point increase in the Medicare levy and introducing personal income tax cuts.

The bottom line is that Morrison is now credibly projecting he will bequeath Australians with an early $2.3 billion surplus in 2019-20, one year ahead of the 2017 budget's estimate. And if his characteristically conservative assumptions for key commodity exports – iron ore, LNG, thermal coal and metallurgical coal – continue to materially underestimate actual market prices, he might even record a surplus in 2018-19, conveniently timed to coincide with the election next year.

The caution baked into Treasury's models means there could be more positive surprises if the synchronised upturn in global growth persists, which it should. The Australian dollar is, for instance, assumed to remain at US77¢, but it could slide significantly if the US Federal Reserve increases rates more aggressively than market prices presume. This would give another boost to export revenues and import-competing industries.

Business conditions are also booming – activity is at its strongest levels since the global financial crisis, according to the latest NAB survey. Yet the budget projects employment growth will fall from 2.75 per cent in 2017-18 to just 1.25 per cent in 2020-21, which could fall well short of the empirical experience. And while the wage growth assumptions do still seem a stretch, they are still miles below long-term averages at a time when we are not far from full employment.

With a little luck, Morrison will go to the polls with an even earlier "mark-to-market" surplus based on the budget's "net operating balance" over the first nine months of 2018-19. The official expectation of a tiny $2.4 billion deficit in 2018-19 could quickly swing into the black if Treasury's core assumptions again prove pessimistic. And, as noted above, the net operating balance has been in surplus over the last five months.

This Treasurer has been parsimonious where predecessors failed to exercise restraint. He has capped real annual growth in government spending at just 1.9 per cent, its lowest level in 50 years. This is pushing payments as a share of GDP from the 2009-10 Labor peak of almost 26 per cent to below the 30-year average of 24.8 per cent by 2020-21. And on the revenue side of the ledger, Morrison is prudently limiting government taxes as a share of GDP to 23.9 per cent, which is below the levels run by past Coalition and Labor governments.

The string of consecutive budget surpluses now planned through to the end of the forward estimates in 2021-20 allows Morrison to start paying back enormous amounts of public debt. The May 2017 budget concluded that gross government debt would hit $725 billion in 2027-28. One year later and Morrison has slashed this debt burden by $193 billion to $532 billion in 2028-29.

He boasts that "from this year onward the government will no longer need to borrow to pay for everyday expenses like welfare, schools and hospitals". From 2018-19, the government's gross debt burden flatlines as decent surpluses materialise, and it falls in earnest from 2026-27. It would fall faster were it not for the government's much-needed $75 billion infrastructure investment program.

Crucially, for the rating agencies such as S&P, net debt now peaks one year earlier in 2017-18 at 18.6 per cent, significantly below the 19.8 per cent level predicted in last year's budget. By 2028-29, it is well on its way to disappearing at just 3.8 per cent of GDP.

As we head into the next election, a real budget surplus coupled with sustainable tax incentives for individuals and companies, innovative relief for retirees, and a big upgrade of transport infrastructure should be potent from a credibility perspective.

Morrison was the first to successfully stop the boats as immigration minister. He is now on the cusp of securing the first surplus since the GFC. These accomplishments and rising public faith in his ability to deliver on promises in an understated way create the foundations for the Treasurer to one day argue that he is prime ministerial material." Read more here.

Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs $7 billion with a team of 33 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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