What does the mid-year budget update mean for the economy?

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After a terrible year, Australia’s economy is recovering.

There’s strong momentum in jobs growth as we head into the summer break.

The Federal Government’s budget is in slightly better shape than it was two months ago.

And some economists think there’s more room for optimism than forecasts suggest — but don’t mention the trade tensions with China.

What can we learn from today’s update to the 2020-21 budget?

An unusual budget update

In a normal year, the Federal Government typically releases its annual budget in May and updates it in December.

But this year it couldn’t release its budget until October, so today it has updated a budget that’s only two months old.

However, there have been enough positive developments in the economy in the past two months to make today’s release noticeably different.

First comes jobs growth

Most importantly, new data released on Thursday showed Australians were still returning to work by the thousands.

Before the Government released its budget update, the Bureau of Statistics released its November labour force figures.

They showed employment increased by 90,000 people last month, with the bulk of those jobs (74,000) coming from Victoria, which is still emerging from its strict lockdowns.

Australia’s official unemployment rate has now fallen to 6.8 per cent, down from 7 per cent in October.

The underemployment rate (which measures those who are working but who would like to work more hours) has fallen to 9.4 per cent, down from 10.4 per cent.

The participation rate has also increased, from 65.8 per cent in October to 66.1 per cent in November, to be just shy of its pre-COVID level.

Citi’s economists said the Federal Government’s decision to start slowly withdrawing its JobKeeper wage subsidy had obviously not resulted in a negative shock to employment.

“With domestic borders reopening, we should see further job gains over the holiday period,” Citi economists Josh Williamson and Faraz Syed wrote in a note to clients.

“The economy has likely already passed its peak unemployment rate, which is a remarkable achievement.”

Momentum in the economy is supporting the budget recovery

Treasury officials are now forecasting the economy to grow this financial year, rather than shrink.

They had been forecasting the economy to shrink by 1.5 per cent in 2020-21, but now they’re expecting it to grow by 0.75 per cent.

With that stronger than expected growth, and with employment recovering strongly, they have revised slightly lower the budget’s forecast deficit and debt.

The budget’s forecast deficit has been revised down by $15.9 billion in 2020-21 to $197.7 billion (or 9.9 per cent of GDP), down from $213.7 billion (or 11 per cent of GDP).

Its net debt is now forecast to be $691.9 billion in June 2021 (34.5 per cent of GDP), down from $703.2 billion (36.1 per cent of GDP) in the budget.

Economists say there’s a strong chance those budget numbers will keep getting smaller over the next six months, depending on how the economy tracks.

What about Australia’s trade tensions with China?

One thing conspicuously absent from the budget update is any explicit mention of the trade tension with our large neighbour to the north.

The budget update hardly mentions China, and when it mentions “trade tensions” it doesn’t mention China by name.

For example, it says “recent trade actions on Australian exports” have so far affected “a relatively small proportion of total exports”, despite material impacts on specific firms and regions.

“However, ongoing global trade tensions and the potential for further trade actions present a key downside risk to the outlook, notwithstanding significant opportunities for diversion of goods into alternative markets for some sectors,” it says.

Economists say we clearly need to keep an eye on the escalating trade tensions, because they are having a genuine impact on economic activity.

“The goods and services currently targeted by China are already worth nearly 2 per cent of gross domestic product,” Marcel Thieliant, senior Australia and New Zealand economist at Capital Economics, said.

“However, we still expect iron ore and liquefied natural gas (LNG) to be spared as China will have great difficulties finding sufficient supply elsewhere and LNG exports are protected by long-term contracts.”

Other risks remain

So despite positive developments in the labour market, other risks could still impact the budget’s recovery.

Much depends on Australia’s ability to manage local outbreaks of COVID-19, when a coronavirus vaccine will be available, and how other countries track over the next 12 months and more.

Jo Masters, EY’s chief economist, said the fact there was no upward revision to wages growth forecasts in the budget update was important too.

It means wages growth is expected to remain “stubbornly low” at just 1.25 per cent in 2020-21 and 2021-22.

“Despite this, the economic recovery in 2021-22 is underpinned by a recovery in household consumption, which is expected to increase by 5 per cent over the year,” Ms Masters said.

“This imbalance implies a strong reliance on consumers to draw down on their savings.

“This presents a risk for the economic outlook, particularly as unemployment is expected to remain above pre-COVID levels for the next four years — a faster recovery than seen in the recessions of the 80s and 90s, but it does represent economic scarring and spare capacity in the labour market.”

By business reporter Gareth Hutchens (Original ABC Article)

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