Mid-year Economic and Fiscal Update: From economic recovery to economic expansion

The 2021-22 Mid-year Economic and Fiscal Update (MYEFO) principally focuses on the improved economic outlook – which has delivered an economic dividend to the overall budget position and enabled both increased spending and a slightly improved profile of budget deficits.

The economy delivers a dividend to spend

The resilience of the Australian economy through the delta disruption is evident in the 2021-22 MYEFO, with a lift in the income tax take from individuals and companies the main contributor to stronger than expected government receipts, and a better-than-expected starting point.

More importantly, an improved economic outlook is evident in upward revisions across the economic markers – from GDP, to business investment to national income to jobs, wages and inflation.

Despite the delta punch to the budget bottom line in 2021-22, and new spending, there is a slightly improved fiscal profile out to 2024-25. The budget deficit is forecast to be 2.3 per cent of GDP in 2024-25, compared to 2.4 per cent forecast in the May Budget.

The improved economic outlook flows through to a significant economic dividend of $47.1 billion over the next four years, with the majority coming in the current fiscal year. Indeed, only $9 billion of the improvement from better economic conditions is between 2022-23 and 2024-25.

However, the Government plans to spend a large portion of the economic dividend, with policy decisions on both receipts and payments totalling $44.8 billion. Some of this is the response to the delta lockdowns – although state governments bore a heavier burden this time around.

There is also significant spending on both announced known policies, and in ‘decisions taken but not yet announced’ policies equivalent to $16 billion over the next four years ($10 billion of which is expected to come in the next two years).

Clearly, ahead of the election next year, this is not a Budget that focuses on budget repair, but one that looks to take this economic recovery to an economic expansion.

In line with a somewhat smaller lift in cash deficits, net debt is expected to rise to $915 billion by 2024-25. This represents 37.4 per cent of GDP, down from the Budget estimate of 41 per cent.

While these numbers seem eye-watering, they are just a fraction of the net debt seen in other advanced economies like the US and the UK, where net debt exceeds 100% of GDP. Net interest payments as a per cent of GDP are unchanged at 0.7 per cent across the forward estimates, with slightly lower debt offset by slightly higher interest rate assumptions.

An economy in recovery mode

The upward revisions to the economic outlook are everywhere – in the GDP profile, business investment, public demand, nominal GDP, wages, inflation, participation and international migration.

Indeed, the MYEFO confirms the delta outbreak was more of short stumble than a major handbrake, with the profile for GDP revised higher from the Budget, which was before the delta threat.

Unemployment is now forecast to decline to 4¼ per cent in 2022-23, lower than the 4¾ per cent forecast at the time of the Budget.

At the centre of the improvement in the economy’s outlook is strong momentum in both household and business spending. The May Budget told a story of stronger private demand taking the mantel of growth in 2022-23, and the story remains in this set of figures – although the public sector is now expected to play a larger role in 2022-23.

The MYEFO assumes a gradual return of temporary and permanent migration from early 2022; international students in time for the first semester of 2022; and incoming tourism to see a broad-based recovery from early 2022.

As a result, population growth for 2021-22 has been revised up to 0.3 per cent from 0.2 per cent in the Budget, and to accelerate to 1.2 per cent in 2022-23 – up a noticeable 0.4 percentage points from the Budget estimate.

This will be no doubt be welcomed by many businesses, and should alleviate some of the labour market shortages constraining economic growth.

Businesses are also expected to be a tailwind for the economic recovery. Businesses are forecast to invest heavily – which capital expectations suggest they will - and hire again, confirmed by today’s labour force figures and forward indicators like job ads and vacancies.

For the household, the more than $10,000 per person lift in household bank accounts since the start of the pandemic is expected to provide the backing for a strong lift in consumer spending.

Household consumption is forecast to lift by 5½ per cent in 2022-23, following a weaker than expected 2021-22. Importantly for the States, GST-able household consumption is forecast to lift an even stronger 10¼ per cent - which clearly marks a shift to spending on discretionary spending, which tends to be taxed more than the essentials.

Critical to the Government’s economic plan playing out are consumers remaining confident, saving less and spending big on those things they couldn’t over the past couple years – with minimal disruption from omicron baked into the economic outlook.

While incoming migrants and tourism are positive for the economy, one clear unknown is just how quickly international travel for Australians will return, and how much they will chose to spend overseas rather than domestically. This MYEFO assumes a sharp lift in imports of 12½ per cent in 2022-23 – which represents a noticeable drag on GDP in that year.

The improved economy and lower than expected unemployment rate have been met with upward revisions to wages growth and inflation. In 2022-23 the wage price index has been upwardly revised by 0.5 percentage points since the Budget to 2¾ per cent, and is now expected to exceed inflation growth by 0.5 per cent. This is the first time in three financial years there will have been real wages growth.

The MYEFO, like any budget paper, makes a number of assumptions, which seem overall prudent. Critically, the Government has again used conservative forecasts for iron ore – a key driver of nominal income and tax revenue – which is forecast to decline to USD$55 a tonne by the end of the June quarter 2022, one quarter later than at Budget.

There are also declines expected in the price of metallurgical coal and thermal coal, which are currently elevated. These declines in commodity prices will see the terms of trade decline in 2022-23 – a headwind for national income and the trade balance.