Australian government announces bold fiscal stimulus package in response to COVID-19. Technical recession in 2020 still likely.
- The Government’s Fiscal Stimulus Package is a bold initiative to bolster the Australian economy’s defences against the damage likely to be wrought by COVID–19.
- It is imaginative and works through boosting investment while providing real incentives to protect jobs.
- Earlier in the week Westpac forecast that without any Stimulus Package the economy would experience a technical recession of two consecutive quarters of negative growth (in March and June). Although, with growth expected to recover strongly in the second half of 2020 the unemployment rate was unlikely to exceed 6%.
- Our analysis of the Package suggests that the initiatives are only likely to offset the contraction in the June quarter that we had estimated earlier in the week rather than lift growth into positive territory.
- However, the current domestic and global environment has deteriorated more rapidly than we had expected. The downside risks to our central case forecast that we envisaged earlier in the week are now materialising.
- For us, despite the Government’s bold efforts the June quarter is still likely to show negative growth and Australia will experience a technical recession.
Stimulus Package: the detail
The Federal government today announced a fiscal stimulus package in response to the COVID-19 crisis.
The stimulus package is valued at $22.9bn over the three years 2019/20 to 2022/23, representing 0.4% of GDP over this period. Over the five years to 2023/24 the package is valued at $17.6bn.
The package incorporates a number of elements, including: modest cash payments to households; investment incentives; and cash flow supports to businesses linked to encouraging employment.
The key measures are as follows.
(1) Cash payments to households of $4.76bn in the June quarter 2020 (representing 1% of quarterly GDP). This is a one-off $750 payment to those on income support (around half are pensioners, as well as those receiving Newstart, the disability support pension, carers’ allowance, youth allowance, veterans support payments and family tax benefits).
(2) Business investment instant asset write-off costing $2.3bn, for expenditure before mid-2020. The government has expanded the existing scheme: lifting the threshold from $30k to $150k and widening the coverage to firms with turnover up to $500mn (up from $50mn).
(3) Business investment accelerated depreciation measure, costing $1.5bn in the initial year and then $5.2bn the following year. This incentive is for the 15 months to mid-2021, for businesses with a turnover up to $500mn.
(4) Boosting cash flows for small and medium-sized businesses for the period to mid-2020, costing $5.9bn. The aim is to encourage firms to continue employing staff. The payment, up to $25k a business, is in effect a partial refund on tax withheld by the ATO on income tax paid by firms for their employees.
(5) Boosting cash flows for small businesses – via a wage subsidy for retaining apprentices and trainees. This costs $1.1bn in 2020/21. (6) Regional areas, support for those areas severely affected by COVID-19. A $1bn cost, of which $0.9bn is in 2020/21.
Of the $22.9bn, some $14.75 relates to the 2019/20 financial year (or 2.9% of GDP for the June quarter 2020) and $8.2bn to 2020/21 (0.4% of annual GDP).
Comments
Readers will be aware that on March 9 Westpac lowered its forecasts for growth in 2020 from 2.1% to 1.6% to take into account the impact of COVID-19.
The forecasts envisaged the economy contracting by 0.6% in the first half of 2020 to be followed by a solid expansion of 2.2% in the second half.
That first half included two negative quarters of 0.3% in both the March quarter and the June quarter. There is little dispute that the March quarter will contract given the sizeable shock to exports, particularly education and tourism, and the likely rundown in inventories (supply chain disruption) associated with the contraction in the Chinese economy; the travel bans; and the early stages in the month of March of disruptions to certain sectors, particularly travel, recreation, hotels and restaurants.
Our forecast for a second contraction in the June quarter did not take into account the Government’s stimulus package given that, at the time, the size and components of the package were unknown. It is interesting that as the week progressed, the reported size of the package seemed to increase and prospects for direct cash payments improved. Perhaps one reason behind that progression was a lift in the material expectation that Australia was facing a recession.
The key features behind our recession assessment included a 1.2% contraction in consumer spending in the June quarter. This is significantly impacted by an expected 13% contraction in spending on “hotels; cafes; restaurants; recreational services; and air travel)”; we also expected a 3% contraction in consumer durables consumption and a 0.5% contraction in business investment.
As the week has progressed developments in the global economy and domestically are already clearly signalling downside risks to our forecasts. Notable examples include: (1) the US suspending all travel from Europe, for 30 days at this stage; and (2) the Westpac- MI Consumer Sentiment Index for March slumping from 95.5 to 91.9, to be at a five year low and the second lowest read since the Global Financial Crisis.
Those forecasts signalled a technical recession but it is important to note that we argued that we expected the Virus would cause a “major disruption” to growth rather than the style of recession that Australia has experienced in the past when the unemployment rate increased from 6% to 11%. We expected that the unemployment rate would peak at around 5.8% in the second half of 2020.
Confidence in that relatively benign assessment on the unemployment outlook was a little shaken by the 8.5% fall, to a four year low, in the job confidence Index which was released in conjunction with the Westpac Melbourne Institute Consumer Sentiment survey on March 11.
The issue now is whether we think that the Government’s Stimulus Package will ensure that the economy avoids this technical recession. The Package is described as a $17.6bn package. That is the impact over five years.
Our interest is in the impact of the Package over the next four months.
Firstly we note that the very responsible $2.4bn allocated to boosting the Health System was largely included in our earlier estimates. This measure is separate to the stimulus package.
The cost of the Stimulus Package in the March and June quarters is assessed as $10.95bn, dominated by the cash boost to employers ($5.9bn) and the $4.76bn stimulus payments to social security recipients and pensioners.
In addition, while the “instant asset write-off” is costed in 2020/21 at $2.3bn the spending to qualify for the “write-off” must occur before June 30 2020.
We are sceptical that the $5.9bn paid to small and medium sized businesses will boost spending in the period.
Businesses which receive the benefit (half the tax payments withheld from employees) may, at the margin, choose to retain the employee rather than dismiss. However, companies under extreme pressure (particularly in that recreational sector) may see a saving of 15%, say, of the employees cost, insufficient to justify retaining them in the face of a sharp downturn in demand.
In those industries, such as construction, that are not severely affected by the Virus the businesses will receive improved cash flow but it is unlikely, in uncertain times, that the business will choose to boost employment or lift spending.
In our assessment of the stimulus package we have not pencilled in any material boost to spending from this measure.
Of course the Cash Payments to households ($4.76bn) will have an immediate impact on spending. The unknown is the balance between spending and saving.
We note that around 50% of the payments to households will accrue to pensioners. This initiative should be applauded but it is likely in this environment that pensioners will save around 75% of the payment. In that regard note that confidence in the over 65’s in the latest consumer sentiment survey fell by 13.8% – likely reflecting factors such as low bank deposit rates and the heightened concern about health risks.
The spending rate is likely to be higher in the social security and income support groups. However with limited savings these groups are also likely to save around 60% of the $750 payment.
These estimates suggest that the cash payments to households will boost spending in the June quarter by $1.54 billion. On the assumption that there will be a 30% “leakage” of the spending to imports the net impact on GDP would be around $1.0 billion.
The most difficult component of the Package to assess is the “instant write–off” for business investment.
The impact or degree of success of investment allowances is hotly debated. By lowering the after tax cost of investment, such allowances may encourage some additional investment. However, it is important to recognise that the key motivation of investment decisions is determined by the prospect of future revenues.
In essence, investment allowances – in large part – fund investment that would have occurred anyway, at best bringing forward the investment decision. Such schemes appear to be very successful during the boom years – an example being 2017/18, when the economy was growing above trend, business confidence was at historic highs and business investment was understandably in an uptrend.
By contrast, in times of economic downturns or heightened uncertainty around future demand and profits, investment allowances will likely struggle to gain traction. For the business, the decision they face is whether they should (can afford to) spend, say, around $3 in investment in order to get $1 ($1.5 for unincorporated enterprises) back as a rebate from the government.
The Government has assessed the cost of the program at $2.3bn implying an expected boost to investment of $5-6bn.
We would expect a much more modest response in the current mood of uncertainty, weak underlying momentum, and disruptions to supplies of imports, with a boost to investment of around $2-3bn rather than the $5-6bn estimated by the government. On the reasonable assumption that 60% of investment is imported the net impact on GDP is estimated at around $1.0bn.
Stimulus package: estimated overall impact on June quarter 2020
To summarise, we expect the cash payments to households and the business investment instant write-off measure to provide a boost to the economy in the June quarter 2020.
As outlined above, we assess that the net impact of the cash payments to households (which will be largely saved) is $1.1bn. The net impact of the investment incentive is potentially around $1bn.
Taken together, that is a $2.1bn boost to the economy in the June quarter, representing in the order of 0.4% of GDP.
Hence, our analysis of the Package suggests that the initiatives are only likely to broadly offset the contraction in the June quarter that we had estimated earlier in the week rather than lift growth into positive territory.
However, the current domestic and global environment has deteriorated more rapidly than we had expected. The downside risks to our central case forecast that we envisaged earlier in the week are now materialising.
For us, despite the Government’s bold efforts the June quarter is still likely to show negative growth and Australia will experience a technical recession.
