In real terms, the Australian economy is forecast to grow by 2½ per cent in both 2015-16 and 2016-17 — then to pick up to 3 per cent in 2017-18 as the detraction from falling mining investment eases.
The Australian economy is transitioning from a mining investment boom to broader-based drivers of growth. As mining projects are completed, mining investment is expected to fall steeply, with falls of 27½ per cent in 2015-16 and 25½ per cent in 2016-17, before easing to a fall of 14 per cent in 2017-18. At the same time as falling mining investment is detracting from growth there is a ramp up of mining export volumes, particularly from iron ore and LNG, helping to cushion the impact on GDP growth.
Historically low interest rates and a lower exchange rate since its peak in 2011 are helping to support growth. Consumption is forecast to grow steadily over the forecast period supported by a continuing decline in the savings rate. Investment in housing is expected to grow strongly in 2015-16 and then to remain at a high level, although the rate of growth is forecast to slow. Non-mining business investment is expected to pick up over the forecast period in line with a forecast increase in domestic demand.
The pick-up in non-mining investment has been slower to materialise than previously forecast and any further delays — or a more gradual pick-up — in non-mining investment continues to be a significant risk to forecast real GDP growth. Analysis presented in the 2016-17 Budget shows that if non-mining business investment were to be flat in 2016-17 and 2017-18, the level of real GDP would be ½ per cent lower than the 2016-17 Budget forecasts after two years. Nominal GDP would be ¾ per cent lower by 2017-18, reducing the underlying cash balance by around $1.5 billion in 2016-17 and around $3.9 billion in 2017-18 (see Statement 7 of Budget Paper No.1, Budget Strategy and Outlook 2016-17).
Since the 2016-17 Budget, the exchange rate has fallen somewhat and market participants have lowered their expectations of the official cash rate. Should a weaker exchange rate persist or should the official cash rate fall further, this would be expected to provide further support to real GDP growth, other things being equal.
Employment growth is expected to remain solid across the forward estimates, albeit slightly slower than the strong pace seen last year, with the unemployment rate forecast to fall to 5½ per cent in the June quarter of 2017 from 5¾ per cent in the June quarter of 2016.
Nominal GDP growth is forecast to be 2½ per cent in 2015-16 before rising to 4¼ per cent in 2016-17 and 5 per cent in 2017-18.
Nominal GDP growth has been weighed down recently by weak inflation and wages growth. Inflation has been soft so far in 2015-16 — in the March quarter of 2016, the trimmed mean (a measure of underlying inflation) recorded its lowest through the year growth since 1999. Inflation is expected to remain at the lower end of the Reserve Bank of Australia’s (RBA’s) target band over the forecast period. Wage growth has also been subdued, with the most recent result indicating wage growth of 2.1 per cent through the year to the March quarter of 2016, the lowest it has been since the series began in 1997. The risks to inflation and wages remain on the downside and, if inflation and wages remain persistently weak, they would detract from nominal GDP growth with negative consequences for tax receipts, somewhat offset by a reduction in payments. For example, if inflation outcomes were consistent with the lower bound of the range presented in the RBA May 2016 Statement on Monetary Policy in the forecast period from 2015-16 to 2017-18, nominal GDP could be around 1¼ per cent lower by 2017-18.
Nominal GDP is also sensitive to movements in commodity prices and, hence, the terms of trade. The Budget forecasts reflect a technical assumption for commodity prices based on an average of the preceding weeks.
Clearly, commodity prices are volatile and the outcomes could vary from the prices assumed in the 2016-17 Budget. The recent averages for some commodity prices are slightly higher than at Budget. By contrast, the latest spot prices are lower. Given short term volatility in prices, these differences are considered not material and so the technical assumptions have not been changed from Budget. Analysis reported in the 2016-17 Budget suggests that a ten per cent fall in non-rural commodity prices could reduce nominal GDP by 1 per cent by 2017-18 compared with levels forecast in the Budget. This, in turn, would be expected to affect tax receipts and payments worsening the underlying cash balance by around $2.2 billion in 2016-17 and $5.4 billion in 2017-18 (see Statement 7 of Budget Paper No.1, Budget Strategy and Outlook 2016-17).
The global economy continues to provide downside risks for domestic growth. While growth in excess of 3 per cent is expected in the global economy and 4 per cent in Australia’s major trading partners, over the coming year, risks to the global outlook are high and are present in both advanced and emerging market economies.
Of particular significance for Australia are the implications of the transition of the Chinese economy towards a more balanced, consumer-driven growth model. The potential for this rebalancing to lead to a greater than expected slowdown in the Chinese economy remains a key risk to Australia and the region.
That said, there will also be opportunities for Australia in China’s longer term transition. Our past trade has predominantly been focused on demand for our commodities; however, trade with China as it transitions will become more focused on demand for our services. Opportunities are also afforded by the China-Australia Free Trade Agreement.
A number of major economies continue to face financial challenges, particularly the euro area, Japan and a range of emerging market economies. Significant debt has been raised in recent years, particularly in emerging markets, which could also create challenges for both borrowers and lenders in a continued low global growth environment. In this environment, risks of renewed volatility in financial markets persist.
Inflation remains low globally reflecting, in part, the impact of low energy costs. Inflation in major advanced economies is expected to remain below policy targets for at least the near term and monetary policy in major advanced economies is expected to remain accommodative. Market expectations for further US Federal Reserve rate rises had also been scaled back, but the most recent inflation data may ameliorate this somewhat.
There has been recent strength in some key commodities but prices remain well below the peaks seen around 2011. Prices will continue to be weighed on by ample supply and uncertainty regarding demand prospects, especially from China. There is also uncertainty around the effect of oil prices on global growth due to the weaker than expected response of consumers and businesses to lower oil and energy prices in 2015 compared with historical experience.
All that said, the business cycle is unlikely to have been consigned to history. Europe, for example, could surprise on the upside and we are expecting the United States to pick up over the forecast period. But relying on a rebound in world growth in the medium term would be a dangerous strategy.
Table 2 presents the major economic parameters used in preparing the 2016 PEFO. These parameters are unchanged from those presented in the 2016-17 Budget.
|Real GDP||2.2||2 1/2||2 1/2||3||3||3|
|Employment||1.5||2||1 3/4||1 3/4||1 1/4||1 1/2|
|Unemployment rate||6.1||5 3/4||5 1/2||5 1/2||5 1/2||5 1/2|
|Consumer price index||1.5||1 1/4||2||2 1/4||2 1/2||2 1/2|
|Wage price index||2.3||2 1/4||2 1/2||2 3/4||3 1/4||3 1/2|
|Nominal GDP||1.6||2 1/2||4 1/4||5||5||5|
(a) Year average growth unless otherwise stated. From 2014-15 to 2017-18, employment and the wage price index are through the year growth to the June quarter. The unemployment rate is the rate for the June quarter. The consumer price index is through the year growth to the June quarter.
Source: ABS cat. no. 5206.0, 6202.0, 6345.0, 6401.0 and Treasury.
Detailed forecasts of the economy are prepared for the forecast period — that is, the current year, the Budget year and the subsequent year. Beyond the forecast period, there is less information on which to prepare detailed forecasts, so Australian budgets and other economic statements rely on projections of economic aggregates such as real GDP, nominal GDP and employment growth to underpin budget estimates of receipts and payments. The 2016 PEFO uses the same projection methodology that has been used in budgets and budget updates since the 2014-15 Budget.
Treasury’s medium-term economic projection methodology assumes that any estimated gap between forecast real GDP and potential GDP closes over the first five projection years (2018-19 to 2022-23) as spare capacity in the labour market is absorbed. Beyond that point, real GDP and other economic variables are assumed to grow in line with their estimated long-run trend rates.
The medium-term economic and fiscal projections are sensitive to the assumptions that underpin Treasury’s estimate of potential GDP — that is, assumptions about population, productivity and participation. They are also sensitive to the assumed pace of the economy’s return to potential — that is, the assumption that the adjustment period lasts five years.
Analysis reported in the 2016-17 Budget shows that a faster (two year) adjustment to potential requires comparatively faster growth in real GDP and employment as the output gap closes and spare labour is put to use. This leads to lower unemployment and faster growth in wages and domestic prices, increasing nominal GDP and improving the projected underlying cash balance over the medium term even as long-run real GDP is unchanged from the Budget projections. A more gradual adjustment period (eight years) is estimated to have broadly opposite effects on the projections.
Analysis in the 2016-17 Budget also shows that lower trend productivity growth than assumed in the Budget projections would directly reduce potential growth — leading to permanently lower real GDP and wages with only a small impact on prices. In this scenario, lower nominal GDP leads to lower projected tax receipts which weakens the projected underlying cash balance over the medium term. By contrast, assuming faster trend productivity growth than assumed in the Budget projections results in higher nominal GDP and tax receipts, strengthening the underlying cash balance.