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Economics | May 11, 2021

Australia’s Budget 2021/2022

1. Your Essential Guide Page 4

2. Analysis Page 5,6

3. Economy Page 7

4. Impact – Interest Rates, Aussie dollar, Shares Page 8-9

5. Outcomes, Payment and Revenues Page 10

6. Selected Charts Page 11

7. Budget Detail Page 12-13

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Your Essential Guide to Federal Budget 2021/22

At a glance… Budget deficit of $161 billion (7.8% of GDP) expected this year (2020/21) Budget deficit of $106.6 billion (5% of GDP) expected next year (2021/22) A $7.8 billion extension of the Low and Middle Income Tax Offset $20.7 billion in tax relief to extend temporary full expensing and temporary loss carry-back for businesses $17.7 billion for aged care over four years $15.2 billion for infrastructure projects to be spent over the next decade $13.2 billion over four years for the National Disability Insurance Scheme (NDIS) $3.4 billion for women’s safety measures $2.3 billion for improved and expanded mental health care and suicide prevention $2 billion over four years for early childhood education $1.9 billion for the Covid-19 vaccination rollout $1.9 billion over the decade to strengthen our national security and law enforcement capabilities $1.7 billion for expanding child care subsidy $1.5 billion to extend a range of health responses $1.5 billion Modern Manufacturing Strategy Employers will be given an extra $1.5 billion to hire 100,000 apprentices and trainees in the next year $1.2 billion in support for aviation and tourism Extra $1.2 billion in Digital Economy Strategy $1.2 billion over 10 years to encourage investment in regional hydrogen hubs $878.7 million to support access to affordable medicines through the Pharmaceutical Benefits Scheme (PBS) $850.4 million to help farmers reach their goal of increasing farm gate output $780 million to extend the HomeBuilder construction commencement period and the New Home Guarantee $747 million to upgrade four key military training areas $385.5 million for biosecurity systems $480 million in new funding for the environment $464.7 million to bolster domestic detention capabilities $300 million to support Australia’s creative and entertainment sector $696 million over the next 4 years for the Agriculture 2030 initiative $225 million in excise tax relief for small-scale alcohol brewers and distillers A new SME Recovery Loan Scheme building on the SME Guarantee Scheme Family Home Guarantee for eligible single parents $506 million to extend the JobTrainer fund Additional $460.4 million for veterans $1.2 billion to establish Australia at the forefront of low emissions technology innovation $265 million for the Building Better Regions Fund People over 60 years who sell their home and downsize will be able to put $300,000 into their superannuation

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Analysis

Full steam ahead to ‘full employment’ Last year the Federal Budget had a simple aim – to get the economy back on its feet. And at the heart of the strategy was job creation. Measures were put in place to keep businesses in business and to save people’s jobs. At the heart of the measures was the JobKeeper wage subsidy scheme.

The measures to support Australians were costly. Even with the recent ‘savings’, the 2020/2021 budget deficit will be the biggest budget deficit in dollar terms. It is the biggest budget deficit as a proportion of GDP in 75 years since 1945.

Now it is still relatively early days, but it could be argued that the strategy has worked. The economy experienced only a relatively brief ‘recession’ – whether you measure that via economic activity (GDP) or via the job market. The economy contracted 0.3 per cent in the March quarter 2020 and then slumped 7 per cent in the June quarter before recording the biggest six-month lift in output on record. The jobless rate peaked at a 22-year high of 7.5 per cent in May 2020 and has since fallen to 5.6 per cent. And employment is at record highs with hours worked back at pre-pandemic levels.

This budget, the Federal Government has again focussed on job creation, but also on lifting wages. Ultimately the goal is one of ‘full employment’ – the fabled ‘sweet spot’ – the point where further falls in the jobless rate would produce negative effects such as price inflation.

The hard part is getting the sums right, as it is not possible to accurately define in practice (as opposed to theory), the precise level of ‘full employment’. Get the sums wrong and you create a boom that may be unfortunately followed by a bust.

Economic and Fiscal Strategy The first phase of the Government’s strategy focuses on economic recovery. The second phase focuses on securing fiscal sustainability. We are still in the first phase. While the economy is now expanding, the Government argues that now is not the time for austerity – or actively seeking to lower the budget deficit and reduce debt. Rather with interest rates close to zero, maintaining or lifting debt can produce returns that more than offset debt costs. In fact, rock bottom borrowing costs are supportive of household spending, business investment, hiring and government spending on infrastructure.

The Government previously said that the first phase of the strategy would remain in place “until the unemployment rate was comfortably below 6 per cent.” But the Treasurer says there are good reasons why the strategy “remains focused on driving unemployment even lower.” Lower unemployment could erode labour market spare capacity at a time when labour supply is constrained by border closures, helping to stoke pay rises, supporting consumer spending.

The Key Measures The focus is on jobs and services. There are measures to attract global businesses and talent from overseas. There is also a $506 million expansion of the JobTrainer program to assist young people and the unemployed into jobs. And more assistance is provided to business to take on new apprentices and trainees.

Increased spending on aged care can be seen as addressing the deficiencies highlighted in the Royal Commission as well as an investment in the future. A key focus is to boost training and conditions for aged care workers. The increased

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spending on defence and infrastructure again can be rationalised as a good opportunity to expand critical spending and investment at a time of low interest rates.

The extension of the Low and Middle Income Tax offset has the potential to support spending, and thus jobs.

Clearly the extension of the instant asset write-off will be applauded by businesses across Australia.

Infrastructure has been a key feature of recent budgets and again features in this budget. While adding to economic and social capital, the projects serve to create jobs across the country. But with a raft of projects across building and construction, the question is whether all the work can be done – especially with the foreign borders essentially closed.

Winners & Losers Normally a Federal Budget would have its stream of winners and losers. But just like last year the aim of this budget is to shore up the economic recovery, thus producing more winners. The scatter-gun approach means that stimulus (such as infrastructure) is spread over many sectors and regions across the nation. Amongst winners are: women;, families that utilise child care services; residents in aged care facilities; businesses; home buyers; regional councils and construction and engineering firms.

Low and middle income taxpayers benefit from extension of the tax offset. The benefit applies at tax time rather than through the year, but if the extra dollars are spent as hoped, then consumer-facing businesses will emerge as ‘winners’.

The ongoing infrastructure spending will lift a lot of boats across the economy. And not just in agriculture, construction and mining sectors but there are key benefits for support and service businesses in the towns and regions where the projects are located.

Looking Ahead Budgets represent opportunities for Governments. They may be opportunities to advance an economic agenda; correct perceived inequities or inefficiencies across sectors or the broader economy; or implement strategies that have medium-term consequences.

This budget is short on longer-term reforms. But given the fact that the Covid-19 pandemic is still raging globally, it could be argued that shoring up our good economic circumstances is significant enough. Of course, a federal election also looms in the coming year.

Tax reform doesn’t feature in the budget, neither does industrial relations or social security reform. There are no longer-term measures to address the future effects of the ageing population. Perhaps the Government can go to an election asserting that there has been good progress made in shoring up the economy and that provides the base for future initiatives.

The foreign borders are still closed and there is no certainty that they will open this year. This has consequences across the economy. Tourism, education, agriculture and construction are just some of the industries that may well need additional support.

While budget deficits must be reduced over time together with the resultant borrowings – that is for a later time. Australia’s government debt is still low on a global scale and servicing is manageable on super-low interest rates. Advanced nation central banks and governments are not displaying much interest in paring back or removing economic stimulus. Restoring “maximum employment” is a priority across developed economies. That is appropriate in these pandemic times as it is in Australia.

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Economy

Forecasts will be made, then re-made If you want to appear to be an expert on the economy, if anyone asks you a question on the economy, answer “Covid-19” and you can’t go too far wrong.

Covid-19 has dominated the landscape for the past year. And it will dominate for much, if not all, the coming year. And just like the past year, forecasts will be made and then re-made to take into account new circumstances as they evolve.

The good news is that Australia is in the midst of a solid economic recovery with output now back at pre-pandemic levels. Quick action was taken to suppress the virus, and significant monetary and fiscal stimulus was applied to keep businesses in business and keep people in jobs.

The economy is expanding again, but the job isn’t done. Foreign borders must be re-opened so the economy can get back to greater ‘normality’. But that relies on the roll-out of the vaccine locally and abroad. It relies on continued suppression of the virus, locally and abroad with rolling shutdowns ever-present until the population is immunised.

After contacting 0.2 per cent in 2019/20, Federal Treasury expects growth of 1.25 per cent in the current year. But economic activity is accelerating. In 2021/22, Treasury tips growth of 4.25 per cent. Inflation is tipped to remain low at 1.75 per cent over the next year. And the jobless rate is estimated to ease to 5.00 per cent by June quarter 2022.

Commonwealth Bank (CBA) Group economists expect the economy to grow by 0.9 per cent this fiscal year (2020/21) and then lift by 4.5 per cent in 2021/22. Underlying inflation is expected to rise modestly from 1.5 per cent in mid-2021 to 2.0 per cent by mid-2022. The jobless rate is tipped to end this 2021 calendar year near 5 per cent before falling to 4.7 per cent the following year.

CBA Group economists expect the global economy to expand by 6.3 per cent in calendar 2021 before growing a further 4.0 per cent in 2022. The IMF forecasts 6.0 per cent growth in 2021, followed by 4.4 per cent growth in 2022.

Federal Treasury expects nominal GDP – the assumption that is important for projected tax receipts – to rise by 3.5 per cent in 2021/22.

One key assumption used by Federal Treasury in budget forecasts is the iron ore price. And this has been notoriously difficult to forecast. Federal Treasury continues to forecast the iron ore price to ease to US$55 a tonne. It has remained stubbornly high and breached US$220 a tonne for the first time thanks to Chinese and US stimulus.

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Impact: Interest rates, Aussie dollar & Shares

Interest rates Interest rates have never been lower – and they are set to stay that way for some time. At the May 4 Board meeting, targets were maintained at 10 basis points or 0.1 of a per cent for both the official cash rate and the yield on the 3-year Australian Government bond. These super-low rate settings have been maintained since November 2020.

The Board wants to see a regime of “full employment” – higher wages and core inflation safely sitting in its 2-3 per cent target range – before it tightens monetary policy. In fact, policymakers continue to stress that these preconditions for a higher cash rate won’t be met “until 2024 at the earliest.”

While the Board acknowledges that the economy is expanding strongly with the labour market improving, still-tepid wage and inflation growth mean that policy support is still required.

But drawings under the Term Funding Facility will end on June 30. And at the July meeting, the Board will decide whether further purchases of government bonds will occur after September. CBA Group economists expect a third round of bond purchases to be announced but halved to $50 billion over six months.

Australian dollar

The Reserve Bank will maintain stimulatory monetary policy settings over the coming year. The Federal Government will maintain stimulatory fiscal policy settings. The aim of both policymakers is to maintain the strong economic recovery, drive down unemployment and drive up wages.

Ordinarily, super-low interest rate settings would put downward pressure on the Aussie dollar. But central banks across the developed world are also maintaining similarly stimulatory settings. And Governments are focussing on infrastructure spending to drive economic recoveries, pushing up the iron ore price.

These stimulatory settings are expected to result in the world economy expanding by over 6 per cent in 2021 after contacting 2.3 per cent. Stronger global growth is expected to drive up demand and prices for raw materials and underpin a higher Aussie dollar. The current account surplus and relative success in suppressing Covid-19 will also support the Aussie dollar.

CBA currency strategists tip the Aussie dollar to be at US81 cents by end 2021 and US78 cents by June 2022.

Sharemarket implications A stimulatory Federal Budget combined with record low interest rates are supportive of Aussie shares. The S&P/ASX200 index hit a record closing high on May 10 ahead of the Budget, propelled higher by policy stimulus, soaring commodity prices and ‘V’-shaped economic and labour market recoveries. But the index fell 1.1 per cent on Budget day (May 11), dragged down by a sell-off in global technology shares. That said, Aussie shares have lifted in the trading session immediately after the past four Budgets have been handed down with last year’s 1.3 per cent gain the biggest in 18 years.

Interest rates – as flagged by the Reserve Bank – are expected to remain low for the next few years. That means the capital growth and dividend returns from listed shares will be important in attracting people to shares as an investment class. Shares remain attractive in this environment with expected 2020/21 earnings growth of 15-20 per cent and ASX200 listed companies expected to increase dividend payouts. The benchmark index 12-month forward dividend yield has eased to around 3.6 per cent, but is expected to lift to a grossed up dividend yield of around 4.5 per cent later this year.

The Budget is sharemarket ‘friendly’, with policy stimulus continuing to support job creation, household spending and business investment, while targeting specific industries and the communities that have been hard-hit by the pandemic.

The extension of income tax cuts for low-and-middle income earners could boost household consumption, benefitting discretionary retailers and consumer staples shares. ‘Big-ticket’ electronics, homewares companies, e-tailers and grocery chains are the obvious beneficiaries.

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The Morrison Government will apply additional stimulus to the housing market through an extension to the HomeBuilder scheme. First-home buyer single parents - struggling to save for a deposit due to soaring property prices – will be able to access the Family Home Guarantee with a 2 per cent deposit. Record home lending and buoyant housing activity could support shares of financials, property developers and building materials companies.

Infrastructure spending with a focus on roads and rail remains a key fiscal policy priority with another $15 billion worth of projects earmarked in the Budget. Commercial builders and developers, infrastructure companies, construction services, building materials and steel/iron ore producers will continue to benefit from the global infrastructure boom.

Shares of listed aged care operators could receive a boost from increased government funding during the pandemic health crisis. The Government will provide money for additional aged-care workers, and increased support for vulnerable people with disabilities and mental health issues. The women’s health package focusing on cancer and reproductive health care is supportive of big health care company stocks.

Federal Treasurer Josh Frydenberg has included a significant investment in childcare. The measures are positive for childcare services and management providers.

Agriculture and agribusiness shares have been beneficiaries of the improvement in seasonal crop conditions and rising soft commodity prices amid increased rainfall following Australia’s devastating bushfires in early 2020. Farm production has increased and farmland values have jumped during the pandemic. And funding that boosts biosecurity measures - protecting farms and livestock against disease and plagues and Australia’s food supply – and the Agriculture 2030 initiative are supportive of agribusiness stocks.

Energy security is also a key focus of the Federal Government. Increased spending on lower emissions projects, including the development of four clean hydrogen hubs in regional Australia could impact energy sector shares.

The one-year extension to the instant asset write-off scheme could boost ASX-listed car dealerships as businesses purchase new work vehicles.

The announced digital games tax offset of 30 per cent is expected to help spur the development and growth of the Australian games industry, boosting earnings of listed gaming companies.

Overall, additional fiscal stimulus has the potential to be inflationary. Already investors have been positioning for reflation this year with rising bond yields driving an investor rotation into cyclical and value shares after the strong performance of growth-orientated stocks in the pandemic. Key Budget beneficiaries, such as the consumer discretionary, energy, financials and materials sectors, could see the strongest earnings growth over the next 12 months. Energy, travel and discretionary retailers could also benefit from reduced savings and increased mobility as vaccines are progressively rolled-out, boosting domestic travel and energy demand.

CommSec expects the S&P/ASX 200 index to finish 2021 at all-time highs of at least 7,200 points, supported by strongly-performing materials and financials shares. Earnings and dividends are expected to be upgraded with business confidence at record highs and consumer sentiment at 11-year highs, boosting corporate profits. Rising optimism about Australia’s economic recovery has seen initial public offerings (IPOs) increase at the fastest pace in 14 years, according to Bloomberg data.

That said, virus variants, geo-political tensions, reduced Chinese stimulus, growing inflationary pressures, the Biden Administration’s tax proposals and elevated technology sector valuations all present downside risks to shares.

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Outcomes, Payments & Revenues

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Selected Charts

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Appendix: The Budget Detail

Major Initiatives

Payments (Source: Federal Budget)

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Major Initiatives

Receipts (Source: Federal Budget)

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Craig James interprets ‘big picture’ economic and financial trends for customers and the general public.

He regularly appears on TV networks, and is often quoted in radio, digital and print media news reports. Craig has worked in banking, finance and journalism for more than 40 years and holds both Bachelor and Master degrees in Commerce (Economics) from UNSW.

Craig is an Adjunct Professor at Curtin Business School in Perth.

Ryan Felsman is responsible for the analysis of economic trends and developments in the Australian and global economy, as well as the likely impact on financial markets.

He writes regular commentaries and presents to the media and customers across the Commonwealth Bank (CBA) Group.

Ryan has been with the CBA Group for over 10 years, having previously worked as an Investment Manager, Global Resources and Senior Economist at Colonial First State Global Asset Management.

He holds a Master of Commerce (Economics, Government & Business) from the University of Sydney and a Bachelor of Commerce (Economics)

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