Victoria's budget outlook improves on stronger revenue

Kieran Davies

Coolabah Capital

After posting very large deficits during the pandemic, Victoria's budget has turned around and continues to rapidly improve, with the state government reducing its forecast cash shortfalls by about $1bn per annum over the next few years in its latest budget update.  

The budget update has been released ahead of the 25 November state election, where the state treasury will soon issue a pre-election economic and fiscal outlook that should be a photocopy of the update.

The government's update provides revised estimates of both the accrual and cash budgets, where the cash estimates are what matter for financial markets because they drive the state's funding task.  

Although the updated cash estimates are only for the general government sector, we expect there will be a similar improvement in the outlook for the broader non-financial public sector. 

This view is based on the better starting point for both the general government and non-financial public sector deficits in 2021-22. 

That is, the general government shortfall came in at $23.8bn last financial year, which was $1.2bn better than the government's May forecast of a $25bn shortfall, while the non-financial public sector deficit was about $3bn better than expectations at $25bn.  

This better starting point has carried over to reduced deficits for the next few financial years, with the forecast general government deficit for 2022-23 marked down by $1.2bn from $13.2bn to $12.0bn.  

The expected improvement in the budget this financial year represents a more than halving of the cash deficit from the worst point of the pandemic, placing it on par with the 2019-20 deficit.  

The substantial narrowing in the deficit in 2022-23 is driven by a large fall in current payments and higher revenue, with capex spending holding at an extraordinarily high level given the government's ambitious multi-year program of infrastructure investment.  

More specifically, though, the revision to the forecast deficit in 2022-23 in the budget update is driven by stronger revenue, which outpaces a pick-up in payments that reflects higher public-sector wages and more grants/subsidies to households and businesses given recent flooding.  

Even with the improvement in the forecast budget bottom line, the budget update factors in a sharp slowdown in the state economy, with state GDP growth reaching a nadir of 1¾% in 2023-24.  

The weaker economy - including a weaker housing market - reflects the impact of higher interest rates, although its impact on state revenues is cushioned by higher inflation, which boosts GST and other receipts, and higher wage growth, which boosts payroll tax. 

A key domestic risk around the outlook relates to the risk that the RBA may need to engineer a sharp downturn in order to rein in inflation, although that would affect 2023-24 more than 2022-23 given interest rates work with a lag. 

Another domestic risk is the damage from natural disasters, where the Commonwealth will nearly completely compensate Victoria for spending on flooding, albeit with a lag.  

The improved fiscal position should flow through a reduced funding task for the Treasury Corporation of Victoria (TCV), which will release an updated issuance program later this year (in July, TCV had estimated it had $15.7bn of remaining issuance in 2022-23). 

Note that the New South Wales government plans to follow in Victoria's footsteps and publish a budget update on 7 February, ahead of the state election on 25 March.   

Although New South Wales is yet to publish its final budget outcome for 2021-22, it seems likely that the starting point for its budget outlook will also come in better than expectations, in line with the Commonwealth, Victorian, Queensland, and Western Australian budgets.