2011 Australian Federal Budget Economic Implications

Key economic forecasts released by Treasury from the 2011 Budget are as follows:

Brief Overview

• The 2010/11 Budget deficit is expected to be $49.4 billion or 3.6% of GDP. This is $8.6 billion higher than originally forecast. A deficit of 1.5% of GDP is forecast for 2011/12 and then a return to surplus (+0.2% of GDP) in 2012/13.
• Domestic natural disasters, coupled with the events in Japan and earthquakes in New Zealand are expected to reduce growth by 0.75% this financial year.
• Growth is then forecast to strengthen to 4% in 2011/12 and 3.75% in 2012/13, again led by a record level of investment in the resources sector and continuing demand from China and other trading partners.
• The unemployment rate is expected to decline to 4.50% by June 2013, adding to wage pressures and hence inflation. Underlying inflation is expected to rise from around 2.25% to 2.75% in June 2012 and 3% in June 2013.
• Household consumption is expected to improve from 3% growth in 2010/11 to 3.5% in 2011/12 and 2012/13 in line with buoyant labour market projections and predicted wage rises.
• Dwelling investment though is expected to remain subdued, with growth of 1.50% forecast for 2011/12 and 3% in 2012/13.

Conclusion

Treasury projections remain very much influenced by the extraordinary resources boom driving record commodity prices and unprecedented levels of investment in mining and energy. The projections that underlie the forecast are based on the main buyer of our commodities, China, growing at a rate of 9.5% in 2011 before moderating to 9.0% in 2012.

Treasury notes the main risks in China as:

In the short term Treasury's views seem reasonable, but the key medium term risk has perhaps been ignored. By way of background, the Global Financial Crisis initially hit China hard – export orders collapsed overnight, threatening the jobs of millions. To its credit, Chinese authorities reacted swiftly, implementing a massive stimulus package focused on fixed investment (roads, rail, buildings, airports, apartments etc). This ensured that China's economy avoided a recession. But the boom in fixed investment has been unrelenting. In 2009/10 it was around 47% of GDP and in 2010/11 it has increased further to around 50%. China now has too many buildings (government and residential), many lying empty, as well as vast rail and road networks heavily under-utilised. There have also been reports of new aluminium smelters lying idle to prevent a global price rout.

In short, the investment has been excessive. When Chinese policymakers come to the realisation that the country doesn't need anymore apartments, roads or trains for a long time then two things are likely. Firstly, investors in the real estate and infrastructure boom will derive little or no return and go broke, leaving a trail of bad debts. Secondly, demand for raw materials (resources) will fall. This of course, is where things may turn ugly for Australia.

The current resources boom has triggered an unprecedented supply side response. Not only are Australian companies investing billions to increase capacity as fast as they can, the rest of the world is doing the same to take advantage of record commodity prices. If demand from China falls away at the same time as the vast amounts of new supply come on stream, then clearly commodity prices will fall heavily (unless the rest of the world has recovered sufficiently to take up the slack - perhaps unlikely given the sovereign debt problems that prevail in much of the developed world). This is a looming risk to Australia's growth prospects - but one where the timing is highly uncertain.

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