[CommSec Research]Budget deficit soars to near record high

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Budget deficit soars to near record high

Federal budget

¾ The underlying budget deficit deteriorated in January and now stands just shy of record highs. In the 12-months to January, the budget deficit totalled $62.3 billion, an increase of almost $3.8 billion on the deficit for the 12 months to December. The record budget deficit was $63.3 billion for the 12 months to September 2010. CommSec estimates that the budget deficit equates to 4.6 per cent of GDP.

¾ The budget deficit of $40.7 billion for the seven months to January is also $2.1 billion above the “profile” or expected deficit for the period

¾ Over the next five months each monthly budget deficit needs to improve by over $4 billion compared with the equivalent months of 2010 ($20.8 billion in total) for the Government to meet its full year budget deficit target of $41.5 billion.

¾ In the past, the best improvement in the budget position over a six-month period in the past has been just $8.7 billion. Still, the biggest deterioration has been $37 billion. The target is not impossible, but still difficult given the slowdown of the economy and recent floods.

¾ Annual revenues dipped from seven-month highs in January but the good news was that annual expenses eased from record highs.

What do the figures show and what does it mean?

· The best way of tracking the budget position during the year is to follow the rolling 12-month totals. In that way seasonal influences and one-off effects can be accounted for. So the latest figures represent bad news for the Government. The deficit in the 12 months to January rose to $62.3 billion, just off record highs and a long way from the target of a $41.5 billion deficit in the 2010/11 year.

· Another way of looking at the deficit is to compare it with the profile – that is the estimate of where the deficit should be if the budget target is going to be met. In the 7 months to January the deficit stood at $40.681 billion, over $2 billion higher than the profile estimate of $38.504 billion.

· Whichever way you cut it, the Government has some work to do to hit the target. Clearly the floods in Queensland and Victoria have had an impact as has Cyclone Yasi in northern Queensland. And while the good news is that expenses are short of the profile estimate at present, the bad news is that revenue is falling short by an even bigger margin. It’s not just the floods but also the fact that the Reserve Bank adopted tight monetary policy settings late in 2010, serving to slow momentum in the economy.

· The government has plenty of work to do to hit its budget target. Basically for the next five months each monthly budget result needs to improve by almost $4.2 billion compared with the same month of a year ago. The annual budget deficit needs to improve by almost $21 billion in the space of five months to hit the Government target.

· The good news is that budget expenses in January were lower than a year ago. Annual budget expenses hit a record high of $353.4 billion in calendar 2010 but eased to $351.2 billion in the 12 months to January. The bad news is that budget revenues were lower than a year ago in January and annual budget revenues eased from seven-month highs.

· Annual budget revenues are up just 0.1 per cent on a year ago. By comparison annual expenses are 3.5 per cent higher than a year ago.

· GST revenues also slipped in January, a further sign that the economy has lost momentum. GST revenues totalled $47.4 billion over the 12 months to January, down from $47.6 billion in the years to November and December and below the record high of $47.9 billion in the year to October 2010. Annual GST revenues are still up a healthy 7.7 per cent higher than a year ago, no doubt a pleasing result for state and territory governments across the nation.

What are the implications for investors?

· So what does it all mean? The Federal Treasurer should advise whether the deficit target for 2010/11 is still likely to be met. That would clear the air and remove speculation. But no doubt the Treasurer will also give a commitment to hand down a very tight budget in May.

· The Federal Government is entirely committed to get the budget back into surplus. It will have to make hard decisions and reportedly this will take the form of a crackdown on welfare payments. Investors can also expect spending cuts in other areas and a possible freeze on public sector employment.

· The Government will also have to hope that the Reserve Bank does stay on the interest rate sidelines until the second half of 2011 so that the economy can motor out of the current soft patch. Consumers and businesses aren’t spending, and as a consequence margins are being constrained together with profitability and government tax collections.

· Given its minority status, the Government will have to show that it has the necessary strategy to improve the budget bottom-line or risk losing support of Independents. Certainly the Government has been thrown a curve ball from natural disasters, but it has to demonstrate that the budget numbers will start improving in the next few months.