Federal Budget Review – A promise made is a debt unpaid


We review the Australian Federal government’s 2019/20 budget and assess its implications for the Australian financial markets. The table below highlights the key budget forecasts and changes since the December 2018 Mid-Year Economic and Fiscal Outlook (MYEFO).

Key highlights:

  • The 2019/20 budget was positive with the government increasing spending significantly on the back of better than expected revenues and without an increase in taxes.
  • As a pre-election budget, it was sensible yet also aggressive with fiscal top-ups, numerous easy giveaways and with a knockout punch coming from multi-year tax cuts. Unfortunately, the staged implementation of these tax cuts suggests that rounds two and three may never see the light of day if the Coalition fails to hold onto government.
  • Budget repair was a highlight with the underlying cash balance expected to return to surplus in 2019/20 for the first time since 2007/08. This should be welcomed by the ratings agencies as well as those voters who applaud solid economic management.
  • ‘Winners: low/middle income consumers (tax relief, cash handouts), infrastructure / construction (road/rail), small/medium businesses and marginal seats (local projects).
  • ‘Losers: There were few losers but we highlight the financial sector (increased funding for regulators), larger companies (no tax cuts), potential tax avoiders and welfare recipients (no handouts).
  • The overall positive tone of this budget and ongoing government expenditure, without increasing taxes, places this budget in the ‘as good as it gets’ camp and should be welcomed by investors.
  • While a potential change of government and Labor’s announcement of a September budget muddies the waters somewhat, the opposition’s tax policies on franking credits and capital gains tax leave it well placed to match tax relief measures, particularly in the absence of wage growth.

Budget forecast changes

  MYEFO forecasts 2019/20
Budget forecasts 2019/20
Direction change
Underlying cash balance ($b) $4.1 $7.1
Underlying cash balance (% GDP) 0.2% 0.4%
Net debt (% GDP) 17.1% 17.6%
Real GDP 3% 2.75%
Household consumption 3% 2.75%
Business investment 5% 5%
Public demand 3% 3.25%
Private demand 2.75% 2.25%
Dwelling investment -4% -7%
Unemployment 5% 5%
CPI 2.25% 2.25%
Wages 3% 2.75%
Major trading partners growth 4% 4%
AUDUSD $0.73 $0.71
TWI 63 61
Iron ore (US$/t) $55 $55
Metallurgical coal (US$/t) $120 $150
Thermal coal (US$/t) $93 $91

Source: Treasury, MWM Research, April 2019

 

Budget winners and losers:

Winners
Low/middle income earners - low and middle income tax offset doubles to max of $1,080. Energy assistance payment of up to $125 for pensioners, veterans and single parents.
Roads & rail - Funding for ROSI, Office of Road Safety, Black Spot program and Regional freight corridors.
Marginal seats - focus on local infra (road, rail, fixing black spots and congestion) and services within marginal seats following success of Victorian election.
SMEs - Increasing the instant asset write-off from $25k to $30k and expanding to include medium size businesses with annual turnover of $10-50 million pa.
Healthcare - increased funding for aged care, mental health, anti-drugs strategy, PBS items and indexation for GP and diagnostic imaging services.

Source: Budget.gov.au, MWM Research, April 2019

Losers
Banks - $606m funding increase for regulators and related actions to respond to the Royal Commission. Bank levy was positively not increased but is a risk under change of government.
High income earners – tax relief is very long-dated with bracket creep to continue biting into household income.
Welfare - no increase to Newstart, also excluded from energy bill payments.
Housing - no announcements that would slow the decline in house prices.

Source: Budget.gov.au, MWM Research, April 2019

As expected, this year’s budget contains mostly voter-friendly measures ahead of the May Federal election. The government finds itself in a fortunate position with revenues supported by buoyant commodity prices and supporting new spending measures rather than new taxes. Iron ore rallying to ~US$85/t was well ahead of the US$55/t MYEFO forecast. In contrast to the last few years, Australia’s AAA credit rating looks safe with the budget in a healthy position and following S&P’s upgrade to a stable outlook in September.

The government’s focus on infrastructure is a familiar theme, but this budget brought a greater focus on safety and local issues. We think the success of the Victorian Labor Party’s election strategy, which promised the removal of level crossings to combat accidents and congestion, influenced the thinking here. There were numerous smaller commitments to fix known problem areas (intersections, roundabouts, blackspots, bridges, road sealing etc) in key electorates.

Resources to the rescue

Source: Treasury, MWM Research, April 2019

Tax cuts are almost a certainty for pre-election budgets and this budget did not disappoint with low income earners the big winners. The Energy Assistance Payment (EAP), a cash handout of up to $125 to help pay energy bills, will be paid to eligible recipients before July.

Step one of the government’s Personal Income Tax Plan, which seeks to “provide immediate tax relief for low and middle income earners” has also received a significant boost. The low and middle income tax offset of up to $530 will be doubled to $1,080 and paid via tax returns. Tax payers on up to $90k will receive the maximum benefit with dual-income families on average incomes potentially eligible for a $2,160 tax reduction.

These are both short-term measures with the energy payments and tax relief potentially available in the next few months. We can’t imagine much political opposition to low-income tax relief so expect these measures will be passed.

Consumer sentiment has trended lower in recent months so tax cuts should at least provide some improvement to sentiment. Pre-election budgets typically result in an uptick to consumer confidence and, given we are coming off a low base we would expect to see some improvement. Ultimately, we expect this money will be spent rather than saved and should provide a degree of support to sentiment and the slowing domestic economy.

Treasury has taken the knife to its economic forecasts since the December MYEFO forecasts in recognition of the recent slowdown. While last year’s estimates looked optimistic this year’s look numbers are more realistic with forecasts for GDP, private demand, dwelling investment and wage growth all revised lower. Interestingly treasury assumes the iron ore price will fall from US$85/t currently to US$55/t over the next 12 months. If iron ore prices were to remain elevated this would boost 2019-20 tax receipts by $2b.

Equity market implications

This was a budget with few historical precedents, delivered less than two months out from the Federal election. Net-net we view the budget as a short term positive for sentiment and for equities.

The major positives were tax cuts / cash handouts for consumers, ongoing infrastructure spend and the better than expected budget repair. There were no big new taxes required to pay for the major policies given the revenue uplift.

We highlight the major sector impacts below:

Retail

Our retail analysts expect the boost to consumers will most likely be spent on clothing, footwear, homewares, recreational goods and department stores. This suggests support for Myer, Kmart, Big W, Target and potentially Bunnings and JB Hi-Fi. The size of this stimulus is modest compared to prior efforts, such as the $900 handouts of 2009, but will nonetheless provide support in a difficult operating environment for retailers.

Electronics are not expected to see an outsized surge in spending, but valuation multiples for Harvey Norman (HVN) and JB Hi-Fi (JBH) are expected to increase on any consumer stimulus. This has already begun to play out in recent weeks (see chart) as policies were announced. See ‘Listed Consumer Sector – Show me the money’, 20 March 2019, for a full rundown.

A much-needed shot in the arm for retailers

Source: FactSet, MWM Research, April 2019

Infrastructure: 

The other clear winner from the budget is the infrastructure sector with the government intending to invest $100b over the next decade, up materially from $75b at the last budget. Regional areas were the winners with a focus on roads and rail. Key projects announced included:

  • $3b boost to the urban congestion fund
  • $2.2b road safety including $550m boost to black spot program, $275m for bridge renewals and $275m for heavy vehicle safety
  • $2b for Melbourne-Geelong fast rail project
  • $1.5b for Adelaide North-South corridor
  • $1.1b to upgrade Melbourne roads
  • Various state-based road/rail project funding with largest for NSW ($6.1b), VIC ($2.8b) and QLD ($2.6b)

As such the infrastructure sector will continue to be largely underwritten by government spending. We view the domestic infrastructure exposed names as the key beneficiaries, namely Adelaide Brighton (ABC) and Boral (BLD) for building materials exposure and CIMIC (CIM) which continues to win regional rail & road tenders.

Public infrastructure engineering work

Source: ABS, MWM Research, April 2019

RBA rate cuts this year remains our base case. While fiscal stimulus (tax cuts, cash handouts) is welcome, it’s unlikely enough to sustainably prop up inflation or arrest the decline in house prices. Indeed, the RBA changed their language at its April board meeting to “monitor developments and set monetary policy to support sustainable growth”.

Investors will now turn their attention to the election. It remains to be seen whether this budget will be enough to sway voters, but given the number of tax cuts and local projects announced it should at least make it a closer race. We view the election as the main game with changes to franking credits, negative gearing and capital gains tax the most relevant for investors.

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