A statement of recovery

About the author:

Michael Knox
Author name:
By Michael Knox
Job title:
Chief Economist and Director of Strategy
Date posted:
03 August 2020, 4:05 PM

On 23rd July 2020, the Australian Treasurer Josh Frydenberg and Finance Minister Mathias Cormann presented their Economic and Fiscal update July 2020. The government has provided timely economic support of $289 billion by fiscal and balance sheet measures equivalent to around 14.6% of GDP in 2019-2020. This, together with large declines in taxation receipts and increases in payments has seen a major deterioration in the budget position.

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The deficit in the year just past in 2019-2020 of $85.4 billion is a deficit of 4.3% of GDP. The budget deficit of 2020-21 of an estimated $184.5 billion is a budget deficit of 9.7% of GDP. The Government estimates that output will fall by 3.75% this year and grow by 2.5% next year.

This estimate of a decline of 3.75% it is better than our own estimate of a decline of 4.6%. They then suggest that the Australian economy will then grow by 2.5% in the year ahead. We think it will grow by 3.2% in the year ahead. The reason that we have a faster estimated growth than they do is because we have a higher estimate for iron ore prices than they do.

This higher estimate is based on our own model of Australian export prices of iron ore. By mid-2021 they suggest that unemployment will be 8.75%. They believe that by mid-2021 employment will have gone up by 1%, that the consumer price index will rise 1.25%, that the wage index will have risen the same amount by 1.25%.

With the much larger budget deficits, they expect that gross debt expanded to 34.4% of GDP or $684 billion on the 30th June 2020. They expect gross debt to expand to $851.8 billion or 45% of GDP by 30th June 2021.

However, what we’re interested in is Net Debt. That is expected to be $488.2 billion or 24.6% of GDP on 30th June 2020 and increase to $677.1 billion or 35.7% of GDP on 30th of June 2021.

Even with these high levels, our level of debt to GDP will be significantly lower than the United States or the United Kingdom where we anticipate debt to GDP by the end of 2021 to rise to not less than 100% of GDP. One of the best things that the Australian Government has done in this crisis is the Jobkeeper payments.


The government tells us that the Jobkeeper payment has covered over 96,000 organisations and over 3.5 million individuals. As of 16th July, payments have totalled $30.6 billion over the six Jobkeeper payments to 21st June.

Our own estimate is that this Jobkeeper program, has reduced unemployment by 5.4%, in allowing that amount of the workforce to move from full-time employment to part-time employment, but be retained within the firms that employed them. That means that they can return most rapidly as the demand for their firms’ products returns.

Support for individuals has also been provided by expanding additional welfare payments by the coronavirus supplement.

The Coronavirus supplement is $550 per fortnight from the 27th of April 2020 until the 24th of September 2020. This was meant to support people who could not go back into the work force. As the economy reopens this payment is being extended from the 25th of September 2020 to the end of this year. It will be reduced to $250 a fortnight. It's being reduced so as not to be a disincentive to people from re-entering the workforce.

The Australian economy is expected to fall by 7% in the June quarter of 2020. Together with that decline of 7% in GDP in the June quarter; they also note that output declined by 0.3% in the March quarter.

So that means a decline in the first half of 2020 of 7.3%. They estimate that the end the year will be down by 3.75%. The economy has to grow very rapidly in the second half in order to limit the decline to 3.75%.

The economy needs to grow at a very rapid level of 3.6% in absolute terms in the second half of the year. This would arguably be the fastest rate of growth of the Australian economy since World War 2.

They say that the economy will grow by 1.5% in the September quarter. If they’re right it will be even stronger in the December quarter. Still, they think that unemployment will peak at the end of the December quarter at about 9.25%.

International outlook

The global economy is forecast to contract by 4.75% in 2020.

The global economy is forecast to expand by 5% in 2021. However, it's expected that continual social distancing restrictions, business restructuring and the levels of sovereign debt may keep business activity down below their pre-pandemic emergency levels till the end of 2021.

They provide comparisons of the performance of other countries. China is expected to grow by 1.75% this year and accelerate to 8.25% next year. We’ve talked about this in terms of the recovery of Chinese industrial production.

We note that Chinese steel production is significantly stronger than it was a year ago and that’s generating strong demand for Australian iron ore exports. However, the government estimates that Indian GDP will fall by 4% this year, Japanese GDP should fall by 6.25% this year, US GDP should fall by 8% this year (The US Congressional Budget Office estimate is 5.9%), the Euro area should fall by 8.75% and the world as a whole should fall by 4.75%.

So, a decline of 3.75% in Australia is not only better than most big industrial economies it’s also better than the world economy as a whole which falls by 4.75%. Next year, China is expected to grow by 8.25%, India is expected to grow by 4.25%, Japan at 2.75%, the United States 4.75%, Euro area 4% and the world economy is supposed to grow by 5%.

This means a strong recovery in the world economy next year. Our estimate is that the Australian economy will grow by at least 3.2% next year. Our estimate is higher than their estimate by 70 basis points.

The risk ahead

The risk in the two years ahead is from a dramatic decline in investment; in particular, non-mining investment. Mining investment is expected to have risen by 4% in 2019-2020, but non-mining investment fell by 9.7%. That disparity gets worse in 2020-2021.

They think that mining investment will accelerate by 9.5% over the year ahead, but non-mining investment will slump by 19.5%. It is that slump in non-mining investment which puts downward pressure on the Australian economy.

They see a sharp decline in the terms of trade in 2020-2021, in part because of the decline in the iron ore price.

Our view is that this is not going to happen. They provide two scenarios, one is that the iron ore price will fall from the current level of over $100 a tonne to $55 a tonne by the end of this year, and the second scenario is that it will fall by next year.

They estimate that if it doesn't fall to $55 a tonne by the end of the year, nominal GDP will be about $9 billion higher than forecast in 2021 and tax receipts will be $1.2 billion higher, but that’s in the circumstances that they think it’ll fall next year.

We don't think it will fall in either year. We believe it will finish the end of 2021 above US$100 per tonne of iron ore. We think that both the government receipts and GDP growth will be significantly higher than the government currently believes.

Rating our debt

Where are the risks to the Australian economy apart from the iron ore price? The underlying cash deficit which is expected to be $85.8 billion or 4.3% last year is also expected to be $184.5 billion or 9% of GDP in the current financial year in the middle of 2020. Net debt without this deficit would have been around $400 billion or about 20% of GDP.

With the deficit for 2019-2020 net debt increases to $488 billion or 24.6% of GDP as of 30th of June 2020. This increases further to $677.1 billion or 35.7% of GDP on 30th of June 2021.

The government notes and we agree that Australia continues to have a low level of debt to GDP compared to other countries. We would anticipate that the debt to GDP at the end of 2021 for both the US and UK would be around 100% of GDP.

Even though our debt to GDP is rising, it’s lower than other major economies. This helps rating agencies in supporting the rating for Australian debt. In addition to that, we think that strong current accounts and trade surpluses, driven by strong mining exports, continues to support our rating.

The government notes on page 44 of their publication, that “since the onset of the pandemic, each of the three major rating agencies have affirmed Australia’s triple-A credit rating, noting the resilience of the Australian economy and the government’s response to the pandemic."


The Australian economy is expected to fall 3.75% by in calendar 2020. The government then expects it to grow by 2.5% in calendar 2021.

We ourselves estimate growth of at least 3.2% for the Australian economy in 2021. Our stronger estimate for growth is driven by our model of Australian iron ore prices which suggests that the Australian iron ore export price should remain above $100 per tonne to the end of 2021.

This will allow the government to both have better growth and budget results than it has suggested in this update. As we go into the election year of 2022, the government will have significantly outperformed its own estimates for both calendar 2020 and calendar 2021.

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View more analysis from Michael Knox by clicking on 'economic strategy' in the popular topics list, or listen to his full playlist of podcasts on Soundcloud. Alternatively, contact your Morgans adviser or nearest Morgans branch.

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