Treasury likely to lower expectations for economic growth which underpinned the Budget

The wafer-thin surplus which the Budget pencilled in for 2014-15 is at some risk of disappearing when the Treasury updates its fiscal and economic forecasts tomorrow.

The $372 million surplus forecast in May's Budget is well within the margin of error.

The operating balance, excluding valuation gains and losses (Obegal), is the difference between two very big numbers, both north of $70 billion, with lots of moving parts - any forecast errors accumulate in the bottom-line gap between them.

And the Treasury is likely to revise down the expectations for economic growth which underpinned the Budget.


When its economic forecasts were finalised in mid-April, the Treasury was predicting real economic growth of 1 per cent a quarter for the June, September and December quarters this year and annual average growth for the year to March 2015 of 4 per cent.

Just six weeks later, when the Reserve Bank went through the same exercise, it thought an average 0.7 per cent a quarter and 3.5 per cent for the year would be more like it.

The more recent forecasts from ANZ's economists also have growth averaging 0.7 per cent a quarter. Those are increases in real gross domestic product, but for fiscal purposes what matters is nominal GDP which includes inflation - and not just domestic inflation but changes in export and import prices as well.

The May Budget forecast nominal GDP to grow 5.7 per cent in the year to March 2015.

That forecast did assume a decline in the terms of trade (the mix of export and import prices) from the most favourable levels for 40 years. But the extent of the most recent drops in dairy prices in particular has surprised most forecasters.

ANZ chief economist Cameron Bagrie said he could easily envisage a 1 percentage point drop in the forecast for nominal GDP growth.

The Treasury's rule of thumb is that 1 per cent less nominal GDP in a year would represent nearly $700 million less revenue for the Government.

But if tomorrow's Pre-election Economic and Fiscal Update no longer forecasts a surplus for the current year, the financial markets and rating agencies will not care, Bagrie said.

"Does it really matter if the balance is $400 million in the black or $400 million in the red?" he said.

"If they are a year out [in returning to surplus] then so be it. Step back and look at the big turnaround we have seen."

The deficit was $18 billion in 2010-11 when the Crown's books were hit by the combined effect of recession and the Canterbury earthquakes. And the recovery in the Government's finances had not required a Mother-of-All-Budgets type of austerity.

"It is the trend, the speed of improvement or deterioration, which Surplus in danger of vanishing matters for the markets," Bagrie said, "and the speed of improvement is still pretty sharp."

As of May - 11 months through the fiscal year just ended - the tax take was running just over $500 million below forecast and the running tally for the deficit was more than $300 million wider than forecast.

As forecast errors go it was less than 1 per cent.

And revenue undershot forecast even though real GDP growth was a positive surprise relative to the Treasury's forecast for the past year. It was expecting 3 per cent growth when the out-turn was 3.3 per cent.

Two explanations of the tax take undershooting forecast are possible. One is that some of the revenue the Treasury thought would accrue in the June 2014 year will turn up in the current year.

Alternatively it has miscalculated the elasticity - the relationship between economic growth and tax revenue - a bit.

The Inland Revenue at Budget time forecast $145 million less revenue than the Treasury for the current fiscal year. That is an insignificant difference relative to total tax of $74 billion, but material when compared to a forecast surplus of $372 million.

On the spending side, the labour market has proven stronger than the Budget assumed, employment growing 3.7 per cent in the year to March compared with a forecast 2.4 per cent. And changes to the welfare system have seen the number of working age people drawing any of the main benefits decline by 16,000 or 5 per cent over the past year.