Tuesday, 19 July 2016

Budget Repair

Budget Repair is all the rage.

What is it and what can we do?

Budget Repair is eliminating the structural deficit ( currently estimated at around 2% of GDP).
We need to understand that almost all of this is due to revenue problems.  As both Treasury and the Parliamentary Budget office have both pointed out the two major policies that contributed to this are:

  • the elimination of indexation on oil by John Howard,
  • the reduction of personal income tax given the boost to  company tax revues coming from the commodities boom by Peter Costello
So two things stick out like a shag on a rock.
  1. A stronger economy will not lead to budget repair as it will not affect the structural deficit
  2. A program of only spending cuts to achieve budget repair could distort resources.
John Daley and Brendan Coates from the best think tank in the nation , the Grattan Institute, argue how to go about budget repair.

We should also remember going too far too fast in fiscal consolidation could prove self defeating.
The current deficit is 2.2% of GDP. We can assume only 0.2% of GDP is due to cyclical factors.
A full blown attack on the structural deficit would lead the cyclical deficit overwhelming any improvement thus leaving the overall deficit worse.  It would be a budget far more austere than the one Wayne Swan did which cut 0.7 percentage points from GDP.and that budget seriously reduced GDP growth!

I suspect the present Government will go slowly on budget repair as they have done already.

Update

I didn't talk about the ratings agencies.
See
Most fund managers have their own credit departments on which they rely on for advice on. They will liaise with credit agencies but not rely on them. Indeed for most investors in Government bonds this is the case.
Thus in the short term a ratings downgrade would have no impact on bond yields at all.
Indeed it probably would not in the medium term given how slow the credit agencies are to see any improvement in budget balances. Thus it is possible one might even see greater demand for Australian government bonds if a downgrade occurred as investors would still view our bonds as AAA and not AA.