Mid-Year Economic and Fiscal Outlook highlights

MYEFO indicates improvement in federal finances, but budget remains in the red

In brief:

• MYEFO includes an $8.4 billion improvement in the underlying cash balance over the next few years, driven by a strong labour market and elevated commodity prices, but the budget remains in the red.
• This mid-year budget update included an additional $31.3 billion in spending over the forward estimates compared to PEFO, which was more than offset by yet another strong $40 billion upward revision to revenue. Growth in spending continues to far outpace revenue growth and is an issue across Australia’s governments collectively.
• Inflation forecasts were revised up to 3.75 per cent in 2025-26, given the recent reacceleration in inflation and the impact of the unwinding of electricity rebates. Combined with lagging productivity growth and elevated spending by governments, this could increase inflationary pressures.
• There is an expectation that more policy development is coming following the Economic Reform Roundtable and the Productivity Commission’s five pillar inquiries. A solid economic reform agenda is needed in next year’s Budget to improve productivity growth and lift private investment.

From Senior Economist Paula Gadsby

The Mid-Year Economic and Fiscal Outlook (MYEFO) contains an improvement in the federal government’s finances over the next few years as tax revenue came in higher than expected, but the budget remains heavily in the red as the structural deficit persists. This continues a pattern seen consistently in the post-pandemic years.

The underlying cash deficit is now expected to be $36.8 billion in the 2025-26 year. This was a $5.4 billion improvement compared to Pre-Election Fiscal Outlook (PEFO), which was published in April, due to elevated commodity prices and a strengthening economy. But despite this, the underlying cash deficit will nearly quadruple from the $10 billion cash deficit in 2024-25.

There were $8.4 billion of upgrades to the underlying cash balance forecasts over the four years from 2028-29. This was driven by changes to the economic outlook, which led to a $6.2 billion improvement, as well as $2.2 billion from policy decisions. Underpinning the improvement over coming years is higher taxation revenue due to improved economic conditions.

This mid-year budget update included an additional $31.3 billion in spending over the forward estimates compared to PEFO, which was more than offset by yet another strong $40 billion upward revision to revenue. Spending was higher mainly driven by an extra $6.3 billion on natural disaster relief, higher than expected demand for the Cheaper Home Batteries program (nearly $5 billion), with the remainder on the age pension, NDIS, Defence Force superannuation and veterans’ entitlements. Not extending energy bill relief beyond the end of this year has helped, bringing an end to the $6.8 billion already spent on energy bill relief in recent budgets.

Growth in spending continues to far outpace growth in revenue. Spending is expected to grow by 5.0 per cent per annum each year on average over the four years to 2028-29, which is above equivalent growth in revenue of 4.3 per cent. Australia’s governments collectively have a spending problem, not a revenue problem. Failing to bring expenses and revenue back into balance means a higher debt burden and less flexibility to deal with future problems.

Incorporating realistic spending forecasts is critical so that fiscal pressures can be properly evaluated, otherwise deficits and debt will be larger than forecast. Employee wage costs have consistently been underestimated across all Australian governments.

Additionally, ‘Investments in financial assets for policy purposes’ or off-balance sheet spending, will reach record high levels in 2026-27 and remain close to these levels for several years to come. This is despite actual spending on off-balance sheet items in 2024-25 coming in $7.3 billion lower than forecast in April. From 2025-26 to 2028-29, the upgraded net spending on off-balance sheet policies will total $9 billion, mainly driven by ‘net other’, which provides no insights into the $7.6 billion increase in spend, followed by the Housing Australia Future Fund at $3.8 billion, while spending for the Clean Energy Finance Corporation was revised down.

Gross debt is expected to be $993 billion in 2025-26, which is $29 billion lower than at PEFO. By June 2029, total bonds on issue will reach $1.2 trillion, relatively unchanged from PEFO. Compared to many other advanced economies, Australia’s debt remains low as a share of GDP. However, it is projected to rise over the coming years.

Total interest expense on debt in 2028-29 is expected to reach just over $41 billion given the rising debt burden, and remains the fastest growing expense for government. This interest cost comes close to the annual cost of Medicare in 2028-29, highlighting the opportunity cost of rising debt. Given the Reserve Bank appears more likely to raise rather than lower interest rates in 2026, due to fresh inflation concerns, while long term government bond yields are rising, the cost of new and refinanced debt is growing too.

GDP growth forecasts were relatively unchanged, with slight downward revisions of 0.25 percentage points in both 2026-27 and 2027-28. This was driven by a downward revision to dwelling and mining investment.

The Australian labour market remains relatively robust and compared to PEFO in April, employment growth forecasts have been revised up slightly by 0.25 percentage points across each year to 2028-29 to reach 1.75 per cent. The unemployment rate is expected to stay close to current levels at 4.5 per cent in 2025-26 and 2026-27, which is 0.25 percentage points higher than at PEFO.

Inflation forecasts were revised up by 0.75 percentage points in 2025-26, to 3.75 per cent, given the recent reacceleration in inflation and the impact of the unwinding of electricity rebates, before falling within the Reserve Bank’s target in 2026-27 at 2.75 per cent. This compares to the Reserve Bank’s estimates of headline inflation at 3.7 per cent in 2025-26, and 2.7 per cent in 2026-27. The recent uptick in inflation, combined with lagging productivity growth and elevated spending by governments at the state and federal levels, could keep inflationary pressures bubbling away in a supply constrained economy.

There were no policies or incentives to drive private investment in MYEFO. There is an expectation that more policy development is coming given the Economic Reform Roundtable was held around four months ago and the final reports from the Productivity Commission’s five pillar inquiries were sent to the Government only last week.

Improving productivity growth is important to alleviate capacity constraints and expand potential output. It can also ease pressure on the government’s finances. Improving productivity growth and economic potential is not all up to government, but governments need to ensure they set the right environment to foster investment and ensure Australia remains globally competitive.

A solid economic reform agenda is needed in next year’s Budget to improve private investment and turnaround lagging productivity growth. Australia’s economic future depends on it.