It’s that time of year again it seems.
Unlike past examples where we have gone into specific detail on measures included in the 2018 Federal Budget, this note has been written from a bigger picture perspective today.
The 2018 Budget itself is a reasonably simple one in many respects, so there isn’t a massive need to cover technicalities.
More so, I feel like it is worth discussing the big picture behind this Budget and the overarching drivers and considerations behind many of the policy decisions taken, and what we can all learn from the context in which this Budget was formed.
The 2018 Budget Summary
I have mixed emotions this year.
Where there is a lot to like, I can’t help feeling a heavy cynicism over the politics behind much of the future policy plans.
On the positive, the government has grasped the nettle with its explanation of ‘good’ and ‘bad’ debt, and its entirely appropriate embrace of public-sector infrastructure spend.
Australia is crying out for infrastructure spend and the associated productivity gains that will come from upgraded transport links and energy generation in particular. This is good policy and will repay itself in the future through its impact on Australian corporate competitiveness.
It is also good policy in the very near term because it will contribute to employment gains and economic activity in the construction sector, counteracting an impending residential construction slowdown – yesterday March Building Approvals collapsed to their lowest level in 3.5 years, effectively confirming what ought be a quite severe slowing in construction activity from later in 2017.
Flat and apartment approvals are down -40% on the 3 year average, and new home building approvals are running -10% on the average over that time.
Yesterday’s $75bn 10-year infrastructure package couldn’t have come at a better time.
The decision to extend the $20,000 instant capital depreciation write-off by a further 12 months is also good policy and will provide further assistance to small business.
But much beyond that I kind of feel a little cynical.
There is no doubt this is a politically expedient Budget.
Much of the Coalition policy has been borrowed from the Labor opposition in a rather overt grab for the populist high ground.
The decision to introduce a Major Bank levy for the coming 4 years to raise an eye-watering $6.2bn is opportunistic, and though the major banks can undeniably afford this sum, the tax equates to around 5% of their profits and will surely create some nervousness on future dividend payouts (National Australia Bank in particular might find they need to lower their dividend by 15-20c in the coming years).
More concerning on the major bank levy is the message this sends to investors both at home and abroad. That the Australian Federal Government are willing to impose a surprise and rather arbitrary tax on Australia’s biggest corporates does them no favours when seeking foreign investment.
Further, the tax itself in many respects acts as a stealth impost on superannuants in the sense that it will tax what are surely the largest contributors to self-managed savers income. The knock-on effect of an additional 5% tax on major bank profits not only limits dividend growth, but the ability of the banks to accrue excess capital at a time when APRA and global regulators are encouraging banks to get their capital to ‘unquestionably strong’ levels.
Not only does the Major Bank levy impact share prices, but it has a second-round effect on bank hybrid capital too given its direct impact on capital accrual.
Yes the banks can afford it, but that’s precisely not the point.
The other item I took cynically was the continued government assumption of a return to past norms in terms of wage growth, and the float these assumptions provide to Budget estimates of a return to surplus by 2021.
As I have highlighted on numerous occasions …
Australia’s wage growth is at a 20-year low and running at a meagre +1.9% annualized. Underemployment is endemic in our economy, and this is causing wages to stagnate.
To make the heroic assumption that Australian wage growth will recover to +2.5% in the current year precisely as residential construction tails off (construction is the 3rd largest employer by sector), but then to leap further to +3% in 2018-2019 and then +3.5% in 2019-20 beggars belief.
These assumptions are flimsy and will almost surely be missed, meaning that Australia’s path to budget surplus in 2021 is fanciful. This matters simply because as soon as the cracks around these assumptions truly widen, the ratings agencies will be quick to downgrade Australia’s AAA sovereign credit rating.
Mark my words, a rating downgrade will happen, it’s just been deferred a year.
A rating downgrade isn’t the end of the world, but it will impact domestic interest rates marginally and it will likely pressure the AUD lower when it comes.
When it happens we will feel it.
So what we should all take from this?
Australia is rapidly running out of runway.
Our nation’s net government debt is fast heading north of $350bn having been ZERO only a decade ago.
Household debts are at a staggering 190% of disposable income having been 130% only 15 years ago, and after having seen one of the greatest one-off boons to national income ever in the China commodity boom.
Though the government can be criticised for the cynical tax grab on the banks and the questionable assumptions underlying our return to surplus, the truth is they were left with little choice.
Dreadful political leadership in this country for the last decade has meant the electorate no longer trusts government and is hence unwilling to be tempted by pragmatic policy – the policy needed to earn Australia out of its dramatically increasing indebtedness.
As an electorate, we seemingly wont stomach the hard medicine, and that is something I find most frustrating.
And it is here that you must pay attention, because until such time as our economy is afforded a significant productivity tailwind through either genuine policy reform or by way of a significant external event and a rebasing of our currency (AUD into the 60s), then we will continue to stagnate and underperform the rest of the world.
Australia needs industry, productivity and employment. It doesn’t need more tax breaks for housing.
If the Major Bank levy hasn’t convinced you of the need to diversify your portfolio further into offshore equity markets then perhaps nothing will.
Last night we saw the imposition of a largely arbitrary tax, worth 5% of sector profits, imposed on what is likely 30% (or more) of most client share portfolio’s. Indirectly it impacts on a large proportion of those same investors ‘defensive’ positions by way of their hybrid holdings.
That this levy is being imposed because genuine sources of government income can’t be increased must surely demonstrate that the well in this country is drying up.
Sorry to hop on my soapbox, but these are the points that matter to your portfolio’s and will continue to matter in the months and years ahead.
In the last week alone Australia’s share-market has underperformed the U.S by over 6% when adjusted for currency. I would expect this trend has a lot further to run.
If you have any queries or would like to speak with us regarding the above recommendation please contact your financial adviser or Client Services on 1800 064 959.
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