Commsec’s Analysis of the 2009/10 budget

Budget 2009: “Recession exit strategy”

· A record budget deficit of $57.6 billion or 4.9 per cent of GDP is projected for 2009/10.

1. Big Picture

· It’s hard to imagine a more challenging environment to set a budget. The global economy is tipped to contract for the first time in over 60 years; Australia’s record-breaking economic expansion appears to be ending; and spooked consumers and businesses are trying to make sense of it all.

· After ten surpluses in the past 11 years, the budget is firmly back in deficit. A deficit of $32 billion is expected in the current year ending June and a record deficit of $58 billion is tipped for next financial year. After a global recession, it usually takes around six years to get back into surplus, and a similar result is expected this time.

· It’s important to remember that Australia went into the global financial crisis (GFC) in great shape: the strong banking system; hefty budget surplus; no government debt, the shortage, not over-supply, of homes; and companies with solid balance sheets. Unlike other countries, the Government could afford to protect the economy through increased spending. But the increased budget deficit also reflects the drying up of revenues from the global downturn.

· Australia has the lowest debt of any major economy by a huge margin – even with the increase in the latest budget. So nobody should be spooked by the large increase in debt. And there is currently more than $68 billion sitting in the so-called ‘nation building’ funds like the Future Fund, some of which will be used to boost our productive capacity.

· The government already made the hard decisions with the emergency stimulus packages in December and February. In a somewhat calmer environment, this budget is all about setting a framework to move forwards.

· There are more measures to support spending like the increase in the age pension and tax cuts. And there is the lift in infrastructure spending to boost jobs now, and production in the future. There is little attempt to cut costs – now is not the time to slash and burn, now is a time to build a recovery. But the real cost-cutting needs to be done once the economy is back on its feet.

· This budget will give Australians confidence and ensure that the recovery will be stronger and faster. If there is any criticism, it is that the Government is being too generous. Once the economy is back on its feet, the government will have to make the hard choices about trimming spending.

2. What are the major changes?

• ‘Nation Building’ Infrastructure spending totalling $22 billion.
• The aged pension has been increased.
• Tax cuts as promised.
• Extension of the Small Business Tax Break.
• Extension of the First Home Owners Boost for another six months.

3. Winners & losers

· Low-income earners: This is no ‘horror budget’. The average person will be better off from July 1, courtesy of another round of tax cuts.

· Middle-income earners: Generally winners. They will receive the tax cut but some will be affected by the increase in the Medicare levy, phase out of Private Health Insurance rebate and changes to concessional superannuation contributions.

· High-income earners: Losers. While they will receive a tax cut, the Medicare Levy is increased, and the Private Health Insurance rebate is phased out for those on high incomes. And like middle-income earners, changes to concessional superannuation contributions will hurt some.

· Pensioners: Winners. An increase of $32.49 a week for singles and $10.14 per week for couples on the full rate.

· Investors: Generally winners, but some will be affected by changes to concessional superannuation contributions. The boost to infrastructure spending will lift activity by listed industrial companies. The budget is pro-growth.

· Companies: Winners – especially small business. Small businesses will be able to claim a 50 per cent tax deduction on eligible equipment. The infrastructure program is positive for industrial and transport companies.

· Housing: Winners. First Home Owners Boost extended by six months.

4. The economy

· To begin with it’s important to note that forecasts are just that – forecasts – they may miss their mark, and perhaps by a wide margin. Having said that, Federal Treasury expects the economy to be flat in the year to June before contracting 0.5 per cent in 2009/10, and then growing 2.25 per cent in 2010/11.

· The last time the economy went backwards was 18 years ago when GDP fell by 0.6 per cent in 1990/91. The previous drop was in the 1982/83 recession when the economy fell by 2.4 per cent.

· Last year, Treasury thought the economy would grow by 2.75 per cent – but that was before the GFC really hit. The slowdown in the economy has a big impact on the budget with Treasury estimating that a 3 per cent fall in GDP could slice up to $15 billion off the budget surplus by the second year.

· While the economy is tipped to go backwards next year, it’s important to put it in a global context. The latest survey of economists in The Economist newspaper suggests that Australia will post the smallest contraction of all major developed economies. The US economy is tipped to fall by 2.7 per cent in 2009 with Japan expected to slide by 6.5 per cent, the UK to contract by 3.5 per cent and Germany to shrink by 4.3 per cent.

· With the economy stagnating, unemployment is tipped to rise. Treasury expects the unemployment rate to reach 8.25 per cent by June quarter 2010.

· For the record, Commonwealth Research (CBA and CommSec) expect the economy to grow by 0.2 per cent this year (2008/09) and 0.8 per cent next financial year. Unemployment is expected to reach a peak of 7.0 per cent late this year/early in 2010.

· Again, international comparisons are important. In the US and Europe, unemployment stands at almost 9 per cent. In the UK, unemployment is already 6.7 per cent. The latest estimate in Australia was 5.4 per cent.

· In contrast to last year, inflation is less of a consideration in a slowing economy. Treasury expects inflation to average 1.75 per cent in 2009/10. Commonwealth Research expects a similar result.

5. Measures in detail

Main measures include:

• First home owners boost continued for a further six months. However it will remain at its current rate for only an additional three months before being scaled back to $10,500 for existing homes and $14,000 for new homes over the last three months of the year.
• Small business and general tax breaks increased from 30 per cent to 50 per cent on the cost of eligible assets ordered until the 31 December 2009 and installed by 31 December 2010
• Infrastructure spending totalling $22 billion, including:

· $3.4 billion for roads, $4.6 billion for rail and $389 million for ports and freight

· $4.5 billion on new Clean Energy Initiative – comprising on three new core elements a $2.0 billion investment over nine years in carbon capture and storage projects, a $1.5 billion investment over six years in a new Solar Flagships program, and a new independent renewable energy innovation body, - Renewables Australia,

· $2.7 billion on tertiary education, research and innovation

· $2.5 billion to be spent over five years to drive hospital and health workforce reform.

· $3.2 billion from health and hospitals fund to modernise hospitals and upgrade cancer facilities.

• The Government will partner with the private sector to build the $43 billion National Broadband Network
• The Medicare Levy Surcharge will be increased incrementally from 1 per cent to 1.5 per cent for singles earning above $90,000 (couples $180,000). Those earning above $120,000 will pay the full surcharge of 1.5 per cent.
• The private health rebate will be reduced (from 30 to 20 per cent) for singles earning above $75,000 (couples $180,000) and phased out completely for singles earning above $120,000 (couples $240,000).

• A new paid parental leave scheme will be created effective from 2011. Eligible primary carers earning less than $150,000 will receive taxable payments from their employer at the weekly rate of the Federal Minimum Wage of about $544 a week for a continuous period of up to 18 weeks.
• Pension age increased to 67 years by 2023. The pension age will increase by six month every two years starting from 2017.
• Single pensioners will get an extra $32.49 per week, pension couples are expected to get an extra $10.14 per week.
• A new $600 a year carer supplement for all Carer Payment recipients.
• An additional $1.3 billion is being committed to enhance national security and border protection.
• $1.5 billion for the Jobs and Training Compact, to provide education and services to support young people, retrenched workers and local communities.
• The Government will reduce the superannuation contributions cap on the amount that attracts the lower tax rate from $100,000 to $50,000 in 2009 and then to $25,000 in 2012.
• The Government will also temporarily reduce the superannuation co-contribution matching rate from 150 per cent to 100 per cent for contributions made in 2009-10 to 2011-12, and to 125 per cent for 2012-13 and 2013-14.
• The skilled migration target has been cut back from the revised 115,000 in March to 108,100.

6. Tax cuts & GST

· Despite the global downturn (or is it because of...) the Government will deliver tax cuts from July 1. And it intends to deliver the next instalment of tax cuts from July 2010.

· No doubt there will be plenty of debate in the community about providing tax cuts at a time when the deficit is moving from surplus to deficit. But it’s important to note that tax revenues have continued to rise over time despite on-going tax cuts.

· In the current environment, lower tax rates will support consumer spending while at the same time continuing to boost workforce participation and productivity. Australia also has to compete with other countries to attract immigrants, so tax rates must be kept as low as possible.

· The goods and services tax (GST) is largely the forgotten tax. However over the past eight years, revenue from the GST has broadly doubled while total taxation has lifted by 70 per cent. The government may provide special one-off handouts or tax cuts, but if consumers spend more then 10 per cent of the outlays come back to the government as revenue via the GST.

· Revenue from the GST is tipped to fall by 2.8 per cent in 2009/10 before lifting 1.2 per cent in 2010/11.

· From January 1, the tariff on cars will fall from 10 per cent to 5 per cent while the tariff on clothing will fall from 17.5 per cent to 10 per cent. While the drop in tariff rates will slice over $500 million from revenue, the higher sales will be reflected in higher GST receipts.

· All GST revenues go to the states and territories, so its always important to keep it in focus.

7. Infrastructure

· Measures like one-off payments to consumers and the first home owners boost effectively have been the ‘band-aids’ to support the economy over the past year. But the government now needs to look to longer-term measures such as the building of roads, ports, railways, schools and hospitals to lift growth, employment and productive capacity.

· As a result the Government has announced a $22 billion “Nation Building” infrastructure spending plan. The spending will support the job market in the short term while boosting productive capacity and efficiency in the longer-term.

· Land transport – road, rail and ports – get spending of $8.5 billion. The government will spend $4.6 billion on metropolitan rail networks, $3.4 billion on roads and $389 million on ports.

· Already there are signs that the Chinese economy is recovering, and it’s important that Australia doesn’t caught out, as in the past, by failing to meet its increased demands for raw materials.

· Australia’s population is also growing strongly – the fastest in 40 years – and the extra people also add to the demands on available infrastructure. However disappointingly the Government will cut the migrant intake target to 108,000 next year from 115,000 after cutting it in March from 133,500.

· In addition to spending by the Federal Government, state and territory governments will be actively increasing infrastructure spending in coming years. In the recent budget the Victorian government said infrastructure projects to the value of $11.5 billion will be started in 2009/10, securing 35,000 jobs.

· Engineers Australia has undertaken an analysis of real infrastructure spending per person. Overall, it believes that most states have been under-funding infrastructure for some time.

8. Where to for housing?

· The latest data on housing lending was highly encouraging, although substantially driven by the upgraded First Home Owners grant. The number of loans to owner-occupiers hit 13-month highs in March while loans to build new homes hit seven-year highs.

· Not only are home loans rising, but building approvals have risen solidly for the past two months and home prices are also edging higher. In most parts of the globe, housing markets are becalmed with home prices down 10-20 per cent on a year ago.

· First homebuyers have driven the housing recovery and they will continue to be a driving force until at least the end of the year.

· For builders, tradesmen and building material suppliers, the extension to the first homebuyers grant is clearly good news. The problem for the first home buyers is that the additional demand for established dwellings will continue to put upward pressure on prices.

· A key reason why the grant is in place for established dwellings is to support home prices. In other countries home prices are slumping. But in Australia, prices have been largely flat, but are now starting to edge higher again. The stability of house prices is important in supporting consumer wealth, confidence and spending.

· Surprisingly Federal Treasury expects dwelling investment to fall by 2.5 per cent in the current financial year with no change in activity in 2009/10. A strong 11.5 per cent lift in dwelling investment is expected in 2010/11.

9. Implications – shares, rates

· The Reserve Bank is likely to remain on the interest rate sidelines for the next few months. Budget measures such as tax cuts, the lift to pensions and increased spending on infrastructure will support the economy over the coming year. And the Reserve Bank has already highlighted the “substantial” stimulus applied to the economy from rate cuts and fiscal (budget) measures.

· The budget is very much pro-growth. Overall the measures should support confidence, spending and profitability and give Australia the best chance of being the first developed economy out of the global recession.

· Increased infrastructure spending will support prospects of companies in the Industrials sector, especially construction, engineering and transport firms.

· Changes to the private health insurance policies are mixed for the healthcare sector. The increase in the Medicare levy surcharge for higher income earners will “encourage’ them to take out private health insurance. But the reduction of the Private Health Insurance rebate for high income earners acts as a disincentive to stay in private cover.

· Some manufacturing businesses, retailers and industrial companies will benefit from the increase in the small business tax rebate.

Source Craig James, Chief Equities Economist, Commonwealth Securities Limited.