I have never seen a more uncertain economic outlook than we currently face both domestically and globally.
Nevertheless it is important to try to set out a framework for assessing the outlook. In this note we take the unusual approach of looking at the prospects of the states and build the national picture up from the individual states.
Victoria has entered Stage 4 lockdown which is likely to continue until mid-September.
Developments in Victoria have been rapid. When the government released its economic forecasts on July 23 the underlying assumption was that Stage 3 lockdown in Victoria would ease from mid-August.
That assumption was in line with our original figuring where we assumed that activity in Victoria had lifted by 1.5% with the gradual reopening of the economy between early June and the renewed lock down in early July. We expected that the renewed lock down would “lose” that 1.5% through July and August. Using the same underlying assumption as the government, which assumed a reopening by mid-August we expected growth to lift in the second half of the quarter by 1.5% for a flat growth result for Victoria.
Hours worked data subsequently indicated that, both in Victoria and nationally, the recovery in June was indeed faster than that 1.5% estimate – nearer 4%.
Hours worked had collapsed by 12% in April/May highlighting the impact of the original lock downs across the country. The introduction of Stage 4 restrictions in Melbourne and regional Victoria (Stage 3) can be expected to see activity fall below the April/May levels (“only” Stage 3 across the whole state) losing that 4% gain in July plus a further 5% through the September quarter (this forecast is based on the official guidance that jobs affected over that six week period will total around 250,000 – or around 10% of the existing workforce) . In total we now expect the Victorian economy to contract by 9% in the September quarter.
Note that the base fall of 12% in April/May represents the extreme initial response to a shutdown from “normal” activity levels. This forecast is consistent with activity in the Victorian economy contracting by 16% over the June and September quarters. (7% in the June quarter and 9% in the September quarter) taking activity below that low point in April/May. With the Stage 4 restrictions now likely to stay in place for most of September Victoria’s recovery will be delayed until the December quarter when we expect the 9% loss in the September quarter to be partially reversed (growth of 6%) as the state moves from Stage 4 through to Stage 2.
The National Growth Outlook
In considering the outlook for activity in the September and December quarters for the nation as a whole we assume that a key influence on growth will be government policy associated with the health crisis.
Because of widely differing successes in containing the virus there are significant disparities between policies and the sensitivity of economies to these policies. The current design of government policy means support tapers over time as virus disruptions ease.
Our national estimates are based around the weightings from the relative sizes (as measured by gross state product) of the state economies 33% (NSW); 24% (Victoria); 29% (QLD;SA; TAS; and NT) and 14% (Western Australia).
Our estimated growth profiles across the states are: NSW: 2% in the September quarter and 2% in December quarter; QSTN: 3% in the September quarter and 1.5% in the December quarter; Western Australia: 4% in the September quarter and 3% in the December quarter; and Victoria: –9% in the September quarter and +6% in the December quarter.
There has been some concern around NSW with various local “outbreaks” being reported. Those concerns are likely to slow progress in the September quarter relative to the other states outside Victoria as government policy and community attitudes remain cautious. But we must remember that NSW entered the September quarter with considerable momentum through June and, despite consistent reports of 10-20 cases per day there has been no dramatic “lift off” in the way we have experienced in Victoria.
NSW is also a net beneficiary of the closure of international tourism since Australia as a whole and NSW in particular suffers a net income loss from international tourism with so many citizens embracing international travel.
Our base case for NSW is that these incidents will be contained, with no significant new disruptions, and NSW will maintain solid momentum into the December quarter.
A major outbreak in NSW is the dominant risk to these national growth forecasts.
Queensland; South Australia; Tasmania and Northern Territory (QSTN) have been successful in containing the spread of the virus. We expect that success to continue through the September quarter although the pace of recovery will slow in the December quarter as the states near a new equilibrium of activity which will still be below the activity levels at the end of 2019.
We would expect activity in these states to continue to lift by 3% in the September quarter reflecting the ongoing reopening of the economies supported by the substantial fiscal stimulus from the Commonwealth government. A further 1% lift in those economies in the December quarter would see activity levels in those economies around 97% of activity levels at the end of 2019. That shortfall reflects the ongoing spillover from weakness in the two major states; disruption from foreign border closures (although all domestic borders expected to be opened in the December quarter); and the winding down of the fiscal stimulus in the December quarter.
Western Australia has benefitted from its tight border controls with the Eastern states; a relatively low reliance on international students and tourism; and a booming mining sector. Those factors point to an outperformance from Western Australia relative to the other states.
Relative to activity levels in the December quarter of 2019 we expect NSW to be at 96% by year’s end; Victoria at 90%; QSTN at 97% and WA at 99%.
For Australia overall we expect activity to be flat in the September quarter and up by 2.8% in the December quarter. That total growth of 2.8% over the final two quarters is a downward revision from the 3.3% we forecast before the announcement of the Stage 4 restrictions for Victoria and the news of pockets of outbreaks in NSW.
Nationally, activity by year’s end would be around 95.3% of the end 2019 level reflecting the 4.7% contraction in the economy over 2020.
For 2021 we continue to expect growth through the year of around 3%, including 1.2% in the March quarter. That would see activity levels in the December quarter of 2021 still 1.8% lower than the December 2019 levels.
Before the crisis, potential growth for Australia was generally assessed to be around 2.75%. If we had achieved potential through 2020 and 2021 we would have expected activity levels by the December quarter to have been around 5.5% above the December 2019 levels compared to our forecast of a shortfall of 1.8% – an undershoot of 7.3% over the two years.
The Outlook for the Labour Market
Prior to the Victorian developments we expected the unemployment rate to reach 8% by December 2020. Of course, the outlook for the labour market is complicated by the JobKeeper and JobSeeker policies which impact the normal relationships between employment growth; hours worked; and the participation rate.
We have made certain assumptions about these relationships one of the most important of which is that the participation rate will remain around 1% below the March level even by the December quarter.
However, the Shutdown in Victoria will disrupt the labour market specifically in August and September. The additional job losses in August and September are expected to push the unemployment rate up to 8.8% by September (recall the current level is 7.4% in June).
The job recovery in Victoria from October is expected to see job leakage with a portion of those employees who lose their jobs in August/ September not being re-employed either due to restructuring or the insolvency of the employer. As such we have lowered our outlook for employment growth over the remainder of the year, consistent with our slower growth recovery.
With those changes in mind we have a revised the unemployment rate forecast to 8.5% for by the December quarter. The risks to this forecast are to the upside with the participation rate and employment growth both having considerably more variability than in usual cycles. In particular we have forecast the participation rate to increase from the recent “low” of 62.66% to 64.5%.
A return to the March high of 65.92% would see the unemployment rate exceed 10% for a “no change” to our employment growth forecasts.
Coincidentally, the Reserve Bank is forecasting a 10% unemployment rate by December although its growth forecast for 2020 of –6% is significantly weaker than our –4.7%, implying a weaker outlook for employment growth and a much higher participation rate.
With growth above trend in the first half of 2021 we expect a further fall in the unemployment rate to 7.7% by June, although beyond June progress on further lowering the unemployment rate to any significant degree will be limited.
As we all agree, with the RBA’s “target” of 4.5% unemployment and inflation holding in the 1 – 1.5% range monetary policy is set to remain on hold for years.
The Fiscal Cliff
We are forecasting growth in the December quarter of 2.8% despite the so-called fiscal cliff. There is a vigorous debate as to whether the fiscal cliff will condemn the economy to much weaker growth in the December quarter with some commentators, remarkably, forecasting an actual contraction.
The government is forecasting that it will reduce its injection of funds into the economy from $120 billion in the June ($40 billion) and September ($80 billion) quarters to around $15 billion.
That estimate of $15 billion is based on a reduction in JK payments from $1500 per fortnight to $1200 (permanents) and $750 (casuals) with the number of people on JK falling from 3.4 million( say 800,000 in Victoria) to 1.4 million even though the conditions for qualifying for JK (30% reduction in turnover for small business) have not changed.
Given the recent developments in Victoria it seems likely that the number of workers who will qualify for JK in that state will increase, significantly, in the December quarter.
We estimate that in the June quarter the government transfers included $20 billion (JK); $5 billion (JS); $20 billion (one off payments to households and businesses). In the September quarter we estimate $50 billion (JK); $9 billion (JS); and $21 billion (one off’s).
In addition, households have been reported to have withdrawn $21 billion from their superannuation accounts in the June quarter with at least another $20 billion likely to be distributed across the September and December quarters.
The so-called fiscal cliff is the reduction in funds being transferred into the economy by the government between the September and December quarters from $80 billion to $15 billion – $65 billion is around 3.3% of GDP.
We saw in the June quarter that policies to close down the economy will overwhelm any boost to demand from fiscal transfers. In June, the government boosted direct transfers by $45 billion or 2.25% of GDP, yet we estimate that the economy still contracted by 7%.
As discussed above we estimate zero GDP growth in the September quarter (despite a 1.75% of GDP increase in government transfers from $45 billion in June to $80 billion in September).
In the December quarter our base case is a steady relaxation of restrictions in NSW supplemented by a reopening in Victoria. As we expect to have seen in the June and September quarters policies around restrictions will dominate the fiscal transfers in the December quarter in setting the growth pace.
The fiscal transfers from the government of around $125 billion in the June and September quarters remain in the financial system unless there are direct leakages back to the government or offshore. Industry data shows that there has been a very sharp increase in business and household deposits. These deposits are available to business and households to cushion the impact of the reduction in transfers in the December quarter.
In addition, these deposits have been boosted by the superannuation drawdowns which are expected to increase further in the December quarter, since the government has extended the time limit out to end December. With over $21 billion already drawn down with average drawdowns less than $10,000 compared to a cumulative $20 ,000 limit there is considerable scope for the superannuation option to further boost household liquidity.
The Reserve Bank is also playing an important role. It has already purchased around $50 billion in government bonds – effectively offsetting the liquidity drain on the system from the government’s bond issuance program.
Capacity in its term funding facility has increased from $90 billion to $150 billion as banks have increased their lending to small and large business. To date only $25 billion has been drawn down while banks must draw down the facility by end September. This cheap term funding means that the banks will, almost certainly, draw down their full allocations by the cutoff date unleashing a further $125 billion of liquidity into the economy.
Banks have shown a willingness to support households and small business by rescheduling loan repayments. If we are right with our figuring that the economy will bounce back by 2.8% in the December quarter banks are likely to be patient in anticipation of improving economic conditions. The availability of a further $125 billion in cost effective funding from the RBA will also likely to boost banks’ willingness to support their customers.
The Risks
The risks with these revised forecasts revolve around developments in containing the virus.
As recently as July 23 the government based its forecasts on Victoria on an easing in Stage 3 restrictions by mid- August with the other states gradually reducing restrictions.
The clearest risks revolve around our assumptions that Victoria begins to reopen by end September and NSW manages to contain any “second wave” over the remainder of the September quarter.
The timing of these developments will dominate the growth outlook.
However, government policy will not ignore such shocks. For example, the government’s current forecast of “only” 1.4 million workers continuing to receive JK is likely to be a significant under estimate. Recall that the government has not changed the 30% reduction in turnover qualifying condition and, under more adverse economic circumstances in Victoria and NSW, the number of workers qualifying for JK could be twice the government’s current estimates.
There will also be considerable political pressure to review the current policies which will reduce the JK and JS payments, particularly in Victoria, while other “disaster” support is likely for Victoria.
Other risks for the outlook will include the timing of the retightening of the insolvency rules for directors and the banks’ policies around deferral of interest payments
in October, including a resumption of one-off payments. Note that “one off” payments totalled $36 billion in the June and September quarters.
Our current “base case” of a $15 billion boost to the deficit over 2020/2021 from new policies in the Budget has ample scope to be increased.
Note that we currently forecast a budget deficit for 2020/2021 of $240 billion compared to the government’s (no policy change) estimate of $185 billion.
We also estimate a deficit in 2021/2022 of a further $150 billion pushing the net debt to GDP ration to a “manageable” 43% (admittedly up from 19% in June 2019).
All up we could see the size of the “fiscal cliff” being reduced significantly from the current estimate of $65 billion. Recall that the government has extended the time that households have to draw the second $10,000 tranche in their superannuation. With $21 billion being drawn down already and with up to another $20 billion to be drawn down in the second tranche.
Conclusion
We have lowered our growth forecasts for the last two quarters of 2020 from 3.3% to 2.8%.
That reflects the deterioration in the handling of the virus in Victoria and the emergence of some limited cases in NSW. However, our base case is for a significant reopening of both the Victorian economy and no major set- backs in NSW.
As we have seen so far, policies related to the health risks to the economy dominate any fiscal response. For that reason we expect that despite the “fiscal cliff” in the December quarter the economy will recover by 2.8% in the December quarter under our core assumptions.
However, that will follow three quarters of near zero or negative growth leaving the economy operating still well below capacity by year’s end.
Risks remain to the downside with the failure to contain the virus more than offsetting any possible fiscal policy response. Bill Evans, Chief Economist, ph (61–2) 8254 8531
