Nearly $30 Billion of Potential Upside for State Budgets in 2021-22 and 2022-23

Upcoming Australian state budgets will reveal over $20 billion, and potentially up to $30 billion, wiped off collective deficits for 2021-22 and 2022-23, according to estimates revealed in a new report from Adept Economics.

The improvement in state budget balances is driven by a faster growing economy boosting state tax revenues, elevated commodity prices enhancing royalties (partly due to the war in Ukraine), and delays in infrastructure projects and related spending.

Australian state budget fiscal balances are forecast to improve collectively by $9-11 billion in 2021-22 (FY22) and $13-18 billion in 2022-23 (FY23), compared with estimates in mid-financial year budget updates released at the end of the 2021 calendar year. The potential improvement in state budget balances for the non financial public sector, which includes government-owned corporations, is up to $30 billion over FY22 and FY23. This also means that state debt issuance requirements are likely to be materially downgraded, which both taxpayers and credit rating agencies will welcome at a time when interest rates on government debt are soaring.

While NSW and Queensland have to spend several billion dollars in flood clean-up costs, the budgetary impact is largely offset by the Commonwealth paying up to 75% of the cost under the Disaster Recovery Funding Arrangements.

These forecasts are contained in a new report prepared by Adept Economics. The Adept Economics team that prepared the report was led by Gene Tunny, a former Australian Treasury official with expertise in budget analysis and policy. Adept Economics has previously advised state governments on policy matters.

Adept Economics forecasts these budget improvements despite assuming realistic costs for the recent NSW and Queensland floods, and also assuming a downturn in the housing market in FY23 involving a 5% fall in national house prices over the 12 months to 30 June 2023.

Adept Economics projects that as a result of much smaller than expected deficits in FY22 and FY23, the states may collectively reduce debt issuance in FY23 from the current expectation of around $84 billion to somewhere between $66 billion and $61 billion.

This is consistent with much improved budget forecasts and lower expected debt issuance at the Commonwealth level, although the latter does have potentially significant unaccounted national security expenditures that could keep deficits and debt issuance elevated despite improvements in the underlying economy.

While from a budget management perspective it may be good for state governments to be prudent in their forecasts, in recent years they have been arguably too pessimistic. This reflects a more general forecasting challenge amongst economic agencies, including the Commonwealth Treasury and the Reserve Bank of Australia. A review of economic forecasting at national and economic agencies would be desirable.

Excessive pessimism in economic forecasts has real consequences for the states’ cost of capital and taxpayers. The interest rate spread the states pay on their debt above the Commonwealth yield curve has consistently jumped following excessively negative budget forecasts in 2020-21 and 2021-22, which have thereafter been massively revised down.

Following the mid-year budget updates from NSW and Victoria in December 2020, Standard & Poor’s downgraded both states from their prized AAA ratings to AA+ and AA, respectively. The loss of these AAA ratings increased both states’ cost of capital. Yet both budget updates proved to be far too pessimistic in their deficit forecasts, with the final deficits in FY21 being substantially less than the mid-year projections.

As another example, when the NSW Government announced in June 2021 an unexpected upgrade to its debt issuance requirements in FY22 to $35.6 billion (compared with consensus market estimates of around $18 billion to $22 billion), there was an initial sharp 14-15 basis point increase in the interest rate spread that NSW services on its debt above the Commonwealth’s yield curve. By September this spread increase had drifted up to 25 basis points (see Figure 1). This would represent more than $250 million in extra annual interest on NSW’s nearly $110 billion of outstanding debt (assuming that this was a permanent shift). And yet despite the large costs of the COVID-19 lockdown, NSW ended up revising down its debt issuance needs for FY22 from $35.6 billion to $27.8 billion, which has proven to be around $2.3 billion to $3.2 billion too conservative in our central case estimates.

Figure 1. Spread on NSW 10-year government bonds above Commonwealth yield

Source: Bloomberg and Coolabah Capital Investments. 

Published on 11 April 2022. For further information, please contact Adept Economics Director Gene Tunny via or call us on 1300 169 870..

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