23 Jul. 2020

July Fiscal Update: A Rock and a Hard Place

By Jo Masters

EY Oceania Chief Economist

Economist. Pundit. Keen tennis player. Referee to teenage girls. Paddle board lover.

23 Jul. 2020

The Federal Government is stuck between a rock and a hard place. The economic devastation caused by the coronavirus has rattled the confidence of households and businesses. Melbourne’s second outbreak has fortified these jitters. 

The government knows that the only way to grow itself out of the worst budget deficit since the second world war, is to stimulate household and business investment. They were quick to pull the trigger on business stimulus in March shoring up supplies of credit and lending incentives among other things.

Now, they’re giving the right signals that further investment support is very likely to be announced at the October 6 Budget. But what we’ve seen so far suggests it’s not enough to outweigh the nervousness people have about how the pandemic is going to play out both at home and in global markets.

The question Government needs to grapple with is, how do you convince business to take risk when they were already risk averse before COVID-19 struck? 

Fiscal Update: Key Numbers

The economic forecasts underpinning the July Economic and Fiscal Update released by Treasurer Josh Frydenberg and Finance Minister Mathias Cormann this week are broadly credible given underlying assumptions, which are conservative for iron ore forecasts but perhaps optimistic on the health front.

The Government has stressed that while real GDP fell by 0.25 per cent in annual average terms in the financial year to June 2020, and is forecast to fall by 2.5 per cent by June 2021, the impact of Government stimulus has had a positive effect. It calculates that its fiscal support means real GDP is about 0.75 per centage points higher to June 20, and will be 4.25 per centage points  higher in FY21 than it would have been otherwise.

It tallies with the Government’s narrative that while the numbers look bad, Australia is in fact doing OK and that what the Government has done so far in terms of an economic response, is working. 

The policy costings were largely known and the estimated deterioration in the fiscal accounts no great surprise. The hope for a $5bn surplus in FY20 is now a nearly $90bn deficit, which will become a $189bn deficit by July next year. That’s partly due to the lower company and income tax receipts, but also the $289bn the government has slated to try and keep households and businesses afloat.

Australia remains in a strong relative position – while the Government estimates gross debt with rise from 28% of GDP in FY19 to 45% of GDP by mid 2021, this is low compared to IMF forecasts for comparable economies.  The IMF estimates that average gross government debt for the G20 economies will be 111% of GDP in 2021.

It is clear the economy will need some support for years to come, but to ensure growth we need to continue to ask if ongoing policies are best practise and doing their job of supporting the economy in the most efficient manner.

The impact of ongoing uncertainty underpins our description of the likely economic recovery profile. It won’t be a V or a U and thankfully not an L, or even a W. It’s likely to be a ‘sawtooth’ pattern – something like the Nike Swoosh with a potholed bottom. That bodes for a slow recovery where setbacks create bumps, not sufficient to derail the gentle upward slope but enough to present challenges in particular geographies or sectors of the economy. The Melbourne lockdown has shown this play out.

While much of the focus has been on the household stimulus in the form of JobKeeper and JobSeeker, it’s equally important for businesses to start to invest and hire. Supporting that is a longer-term play than supporting household spending, partly because the process takes longer to effect, but also because investment and hiring require confidence that your business is not only viable, but likely to expand.

Business Confidence as Important as Consumer Confidence

The Government will be hoping that investment takes off so that private domestic demand will recover and lessen the need for Government support. However, even with JobKeeper 2.0 and JobSeeker 2.0, income support programs are expected to be about 1/6th of the boost in Q4 than in Q3, that’s a big hole for the private sector to fill. 

At the moment while outbreaks continue to occur the focus is, as it should be, on maintaining the initial support structures put in place to lessen the impact of the economic shutdown. If the economic contraction can be reduced as much as possible in the first instance, there will be less long-term scarring, including fewer people who never return to the workforce. 

Confidence for the recovery phase will come in large part from how well the Government is able to provide a sense of what the economy will look like, and what the important policies will be, as far out as they can.

That means business can have confidence that the recovery phase will begin off the best possible base. That the Treasurer confirmed this week the October Budget will contain four-year forecasts, is a positive step towards helping businesses plan and feel more in control. It suggests the Government is working towards providing a longer roadmap for existing and new policies, structural reform and the economy (including some tax initiatives), in three months’ time.

What is becoming clear now, however, is that even when the economic cycle picks up, there is still structural adjustment that has to happen in the economy, which the Government flagged in this update. Some of that might have been on the cards whether the coronavirus had occurred or not. COVID-19 has certainly sped up trends towards working from home, online retail and structural reform around large issues such as energy transformation.

But it has also introduced new potential trends that will influence how Australia’s economy looks in the next decade – including diversified supply chains and advanced manufacturing. It may be that during the recovery phase companies opt for more expensive but robust supply chains. One possible adjustment could then be that companies will choose to be less profitable but more resilient.  

Hurdle Rates

Confidence will be critical, but we are also hearing that despite record low business interest rates, hurdle rates have not fallen as uncertainty has lifted the risk premium.

Hurdle rates for investments are a combination of the cost of capital and the return required for the risk of the project. When the economy is so uncertain, that risk premium rises, and in the current environment likely has more than offset the fall in business interest rates, making it harder to get investment projects off the ground.

Interestingly, one risk the Government has called out in its fiscal overview is to the global economic architecture, cautioning that “substantial increases in public and private debt …could lead to credit tightening and financial instability, slowing the pace of recovery.” Reducing the risk premium requires greater certainty about the future. As there is no equation as such for the risk premium, there’s an element of judgement, confidence plays an important part.

The October Budget is likely to include additional support for the economy, including infrastructure spending, tax measures to support and encourage investment, direct support for some sectors and further (although tapered) income support for households and businesses. 

Stimulating Business Investment

Non-mining business investment was already weak before 2020 began, and the uncertainty around how the health and economic crisis will pan out is proving too great to be offset by the suite of stimulus made available in March.

Indeed, the Government’s own forecast is for non-mining business investment to be down 9 per cent for the 2020 financial year and is expected to be down 19.5 per cent by mid next year. Certainly, companies are facing tough times and company tax receipts are estimated to be down $25bn across this, and the previous financial year.

Business has been able to access ultra-low interest rates and policy supports for investment and borrowing put in place by the Federal Government, RBA and ASIC, but they haven’t. Policies are aimed at ensuring the supply of credit through the system, alongside incentives for lending to small and medium enterprises. The instant asset write-off and accelerated depreciation measures are aimed at boosting investment, while support for apprentices and trainees should support jobs.

RBA data shows businesses did crystallise more loans in March, with business credit up 3.1 per cent month on month due in large part to companies pre-emptively drawing down on existing credit lines. However, the latest RBA minutes notes that some of this has “since been repaid”, and its data  for May shows credit contracted by 0.6 per cent, only the fourth monthly contraction in the past seven years.

At the same time, APRA data shows that business deposits at ADIs were up 14 per cent year on year in May suggesting that firms are shoring up cashflow rather than investing.

Read together, it suggests firms are hesitant to spend or borrow, something the RBA minutes acknowledged, saying “demand for new loans from SMEs had been low given the uncertain outlook”.

Tellingly, of the $40 billion set aside by the Government for its Coronavirus SME Guarantee Scheme, only $1.7 billion has been taken up (the scheme has now been extended and expanded to encourage greater use). Similarly, the RBA’s Term Financing Facility has seen less than 20 per cent of the available $90 billion taken up by banks

If businesses are not taking advantage of the stimulus on offer it suggests the Government will need to look at new or different ways to spur the confidence needed to underpin growth. 

Table 1: Budget Aggregates – Treasury forecast comparison

  2019-20 Estimate 2020-21 Estimate­
  Latest estimate -23 July ($bn) MYEFO - Dec 2019 ($bn)  Latest estimate –23 July ($bn) MYEFO - Dec 2019 ($bn)
Underlying cash balance -$85.8bn $5.0 bn -$184.6 $6.1 bn
Per cent of GDP -4.3% 0.3% -9.7% 0.3%
Gross Debt $684.3bn $556bn $851.9bn -
Per cent of GDP 34.4% 27.7% 45% -
Net debt $488.2bn $392.3 bn $677.1bn $379.2bn
Per cent of GDP 24.6% 19.5% 35.7% 18.4%

Table 2: Major Economic Parameters – Treasury forecast comparison

  2019-20 Estimate 2020-21 Estimate­
  Latest estimate - 23 July ($bn) MYEFO - Dec 2019 ($bn) Latest estimate – 23 July ($bn) MYEFO - Dec 2019 ($bn)
Real GDP (% change on preceding year) -¼% 2 ¼%  -2 ½% 2 ¾% 
Unemployment rate 7% 5 ¼% 8 ¾%  5 ¼% 
Consumer Price Index -¼% -2% 1¼% 2 ¼% 
Wage Price Index 1 ¾% 2 ½%  1 ¼%  2 ½%
Nominal GDP (% change on preceding year) 2% 3 ¼%  -4 ¾%  2 ¼% 


The economic devastation caused by the coronavirus has rattled the confidence of households and businesses.  The Government is working to lessen the impact of economic scaring in the short term, but will be looking for ways to provide guidance about the future economy so businesses can have more certainty and confidence to invest during the recovery phase.  The government knows that the only way to grow itself out of the worst budget deficit since the second world war, is to stimulate this business investment. 

About this article

By Jo Masters

EY Oceania Chief Economist

Economist. Pundit. Keen tennis player. Referee to teenage girls. Paddle board lover.