Infrastructure Push To Aggravate Fiscal Deficits

BMI View: We believe Australia's fiscal deficit will continue to grow and hit a high of AUD51.5bn (3.0% of GDP) in FY2015/16 (July-June) as alternative financing plans for the government's infrastructure projects are likely to prove insufficient. Moreover, substantial political obstacles will prevent the current federal government from implementing any tax and expenditure reforms needed to improve the short and long-term outlook of the country's finances.

Included in Australian Prime Minister Tony Abbott's plan to boost the economy is the abolition of the carbon and mining taxes, as well as a push for more infrastructure projects to lift activity in the slowing construction sector. We believe the Liberal-National government's resolve will only increase as economic activity slows, which will inevitably elevate fiscal deficits in the near-term. Indeed, subdued economic growth suggest that revenue growth will remain weak, and in combination with our expectations for alternative financing methods to be insufficient, and political hurdles to hamper the implementation of any significant fiscal reforms, fiscal finances are likely to deteriorate further. We forecast the fiscal deficit to widen to AUD51.5bn, or 3.0% of GDP in FY2015/16 (July-June), up from AUD23.0bn in FY2012/13 (1.5% of GDP) and a forecasted AUD42.0bn (2.6% of GDP) in FY2013/14. That said, we maintain that Australia's debt to GDP ratio (for total federal debt) is and will remain one of the lowest among developed countries, peaking at 26.9% of GDP in 2018.

Alternative Financing Methods To Provide Little Reprieve

Deficits To Rise In The Near-Term
Australia - Fiscal Revenue, Expenditure & Budget Balance

Infrastructure Push To Aggravate Fiscal Deficits

BMI View: We believe Australia's fiscal deficit will continue to grow and hit a high of AUD51.5bn (3.0% of GDP) in FY2015/16 (July-June) as alternative financing plans for the government's infrastructure projects are likely to prove insufficient. Moreover, substantial political obstacles will prevent the current federal government from implementing any tax and expenditure reforms needed to improve the short and long-term outlook of the country's finances.

Included in Australian Prime Minister Tony Abbott's plan to boost the economy is the abolition of the carbon and mining taxes, as well as a push for more infrastructure projects to lift activity in the slowing construction sector. We believe the Liberal-National government's resolve will only increase as economic activity slows, which will inevitably elevate fiscal deficits in the near-term. Indeed, subdued economic growth suggest that revenue growth will remain weak, and in combination with our expectations for alternative financing methods to be insufficient, and political hurdles to hamper the implementation of any significant fiscal reforms, fiscal finances are likely to deteriorate further. We forecast the fiscal deficit to widen to AUD51.5bn, or 3.0% of GDP in FY2015/16 (July-June), up from AUD23.0bn in FY2012/13 (1.5% of GDP) and a forecasted AUD42.0bn (2.6% of GDP) in FY2013/14. That said, we maintain that Australia's debt to GDP ratio (for total federal debt) is and will remain one of the lowest among developed countries, peaking at 26.9% of GDP in 2018.

Deficits To Rise In The Near-Term
Australia - Fiscal Revenue, Expenditure & Budget Balance

Alternative Financing Methods To Provide Little Reprieve

With the abolition of the mining and carbon taxes as well as our expectations for the Australia's economic growth to slow in 2014, we see little room for fiscal revenues to record significant growth. Unsurprisingly, this has led to Liberal-National coalition government to seek alternative means of financing aside from debt to finance its infrastructure plans, and these include the divestment of publicly owned assets and increasing private sector involvement through public-private partnerships (PPPs). Over the first few months of 2014, the federal government has not only announced a potential sale of Medibank, a government-owned life insurer, but also proposed to set up a fund with state governments to finance infrastructure projects. Under the proposal, the federal government would match every dollar from any asset sales that the state governments put into this fund.

While these alternative measures could offset some of the government's total capital outlay for the infrastructure projects, several factors suggest that proceeds from these tools will remain insufficient to foot the bill, forcing the government to turn to the financial markets. Firstly, the divestment of publicly owned assets remains a tricky issue - the federal government could face some legal issues in its sale of Medibank, which could reduce the sale proceeds, or even worse, prevent the sale. Meanwhile, state governments, whose own finances are deteriorating, face electorates who do not view asset sales positively, and as such, they are likely hold back or avoid selling assets completely for fear of a backlash at state elections.

Upcoming Australian State Elections
State Current Government Length Of Term Elections Due
Victoria Liberal-National coalition government has a majority in both Houses of Parliament 4 years Saturday, November 29, 2014
New South Wales Liberal-National coalition government has majority in both Houses 4 years Saturday, March 28, 2015
Queensland Liberal-National coalition government has majority in the unicameral parliament 3 years no later than 20 June 2015
Source: BMI, State Government sites

Secondly, increased involvement by the private sector through PPPs scheme is unlikely to offer as great a reprieve to the government as compared to its previous ventures. We believe that since the occurrence of several high-profile toll road failures over the past few years, private players are likely to demand greater protection against the risks inherent in these PPP projects (see, 'PPP Road Failures Prompt Risk Reallocation', June 28 2013). This could be done through loss-sharing agreements with the government, which would therefore increase the government's capital outlays for PPP projects.

Lack Of Reforms Weighs On Long-Term Fiscal Outlook

In addition, we expect political obstacles to limit the ability of the Liberal-National coalition government to push through fiscal reforms, and therefore diminish the likelihood for the country's finances to improve under its term. At the federal level, a fragmented senate increases the difficulties that the Liberal-National coalition will face in its bid to secure support. The populist slant of a number of cross-benchers, such as the Palmer United Party, further suggests that spending cutbacks may be difficult to achieve as well. Indeed, while Prime Minister Abbott has pledged to reduce welfare payments and possibly implement a temporary hike in income taxes in the FY2014/15 budget, it remains to be seen if the coalition will be able to garner sufficient cross-benchers to push through these changes.

At the state level, efforts to revamp state finances will likely remain difficult as any mooted changes will continue to be held back by the unwillingness of states to make concessions to reach a middle ground. For example, even though state governments could benefit from lowering the threshold within the Goods & Services Tax (GST), to include purchases worth less than AUD1,000 made through overseas online retailers, disputes between the states with regards to how the revenue should be distributed are likely to stall this proposal. Indeed, the states of New South Wales and Victoria are pushing to increase the proportion of GST revenues that their states should receive, which Western Australia is unlikely to accept.

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