July economic and fiscal update from Pitcher Partners

The Federal Government released its July Economic and Fiscal Update (JEFU) statement, painting a picture that Australia is performing better than many of its OECD equivalent economies.

However, the reality is that COVID-19 has had, and will continue to have, a major impact on the domestic economy, unemployment, debt and GDP into the future. To put this in context, the GFC resulted in an estimated 1.7% reduction in global GDP for the 2008-09 financial year. In comparison, the global economy is estimated to decline by approximately 4% this year due to the effects of COVID-19.

In Australia, real GDP experienced its sharpest fall on record in the June quarter, reducing by approximately 7%. In 2020, the Australian economy is expected to endure its largest annual fall in economic activity on official record, being approximately 3.75%. This compares favourably to the United States and the United Kingdom that are estimating contractions of 8% and 10% respectively.

The Government is estimating that Australian GDP will rise to 2.5% in 2021, with many of the estimates put forward in the JEFU outlining improvements to GDP and unemployment into the 2020-21 financial year. However, with the daily rates of COVID-19 infections at the highest level ever (currently around 1.6 million infections worldwide over the last week) and the uncertainty that this poses for many industries in Australia and globally, it is difficult for the Government to forecast these positions with any degree of certainty.

With increasing levels of government debt and uncertainty with respect to global economies, it is critical that Government measures continue to be targeted to help support those businesses that will need it the most. It is also important for businesses and individuals in the middle market to plan for COVID-19 over the long term and to ensure that they are making the right strategic choices during this time of uncertainty.

Fiscal spending

The overall cost of support by the Government is budgeted to be around $289 billion in fiscal and balance sheet measures, which is equivalent to around 14.6% of GDP. This will (in turn) result in estimated deficits of $85.8 billion in 2019-20 and $184.5 billion in 2020-21. The global economy is forecast to contract by 4.75% in 2020. This is significantly higher than that experienced during the GFC and is the single most significant contraction to the global economy that occurred since the Great Depression in the 1930s. However, the Government has estimated that the stimulus spending has resulted in additional GDP growth of 0.75% in 2020 and is estimated to provide growth of 4.25% in 2021. The significant stimulus spending has been effective in reducing the overall impact of COVID-19 on the Australian economy.

Unemployment rates

In April 2020, the unemployment rate rose to 6.37% and increased to 7.45% by June 2020. Prior to COVID-19, the unemployment rate was at a historical low of 5.09% as at the end of February 2020. However, these numbers do not include employees that are currently working zero hours (i.e. under JobKeeper) or those that are underemployed. The underemployment rates for April and June respectively were 13.77% and 11.68%, with the effective unemployment rates closer to 15% and 11% for both April and June respectively. These numbers show the real impact that JobKeeper has in terms of reducing the unemployment rates in the short term.

The Government has continued to forecast the measured unemployment rate rising as more people are pushed into the labour market, with an estimation that the unemployment rate will peak at around 9.25% in the December quarter, before returning to around 8.75% in 2020-21. Accordingly, the forecasts outline the significant impact that COVID-19 will have on the economy over the longer term.

Net debt

Prior to COVID-19, net debt was estimated to be 19.5% of GDP in 2019-20, falling as a share of GDP to 16.0% by 2022-23. With funding of the stimulus measures, net debt is expected to be $488.2 billion (24.6% of GDP) at 30 June 2020 and increase to $677.1 billion (35.7% of GDP) at 30 June 2021. While these amounts appear high, the percentages are relatively low comparatively to other OECD counties. For example, these ratios are currently approximately 80% and 110% for the United Kingdom and the United States respectively.

With the current weighted average yield for future issuances of Treasury Bonds being around 0.8%, the additional debt from stimulus measures will likely result in a comparatively low servicing cost for these measures. Furthermore, since the onset of COVID-19, each of the three major ratings agencies have affirmed Australia’s AAA credit rating.

Accordingly, the low cost of financing in the current climate provides an opportunity to fund these stimulus measures with little cost at the moment to the economy. The alternative would have been to reduce government funding, which could have resulted in significantly higher unemployment rates and significant impacts to the economy that may have been more difficult to recover from.

How do we compare globally?

There are more than 6 million active COVID-19 cases globally with cases of infection increasing to 1.6 million over the last week, being three times that in April 2020. Comparatively speaking, Australia has performed well in containing the outbreak of the virus, even taking into account what is happening in Victoria. Australia currently has approximately 156 cases per 1 million people, which compares favourably to the United Kingdom and the United States which have around 3700 and 7700 per 1 million people respectively. This has helped to reduce the overall impact of COVID-19 on our economy compared to other OECD countries.

Outside of Victoria, COVID-19 restrictions have been eased in accordance with the three-step plan outlined by the Prime Minister on 8 May 2020. These restrictions will see the majority of the country moving to a 100-person limit to indoor activities by the end of September, with that requirement being removed by the end of 2020. The four square metres per person rule is intended to apply post 31 December 2020. These are key assumptions that are built into the JEFU and underpin many of the estimates of economic performance.

However, the recent outbreak in Victoria has resulted in further lockdowns for a six-week period. We expect this to have a significant impact to the Victorian economy and will delay its recovery. Essentially, this may result in a two-tiered economy, with certain states moving at a much slower pace. The same impact may occur in other states should a second wave occur.

Targeted stimulus

One of the most successful stimulus measures has been the JobKeeper regime, with 960,000 organisations and over 3.5 million individuals currently covered by the regime. As at 16 July 2020, payments totalled $30.6 billion over the six JobKeeper Payment fortnights to 21 June 2020. This week, the Federal Government announced changes to the regime, which extends the stimulus measures for another 13-fortnights, with reduced payment amounts and more stringent eligibility tests. To be eligible, a business will need to demonstrate a cumulative decline in turnover of 30% (or 50% for large business) for each quarter since 1 April 2020.

While this may be a suitable test for some states that are easing their way out of restrictions, this may not be an appropriately targeted measure in Victoria (or any other state that suffers a second wave). This is because the full effects of COVID-19 may not be seen until the September 2020 quarter.

To continue to ensure that the economic impact of COVID-19 is minimised, we believe that it is essential for the Government to appropriately target the JobKeeper regime to take into account these potential effects. For example, we believe that the cumulative quarter test could be replaced with an average monthly test, coupled with testing the last previous quarter (to more appropriately target those businesses that are still being impacted by COVID-19 at the end of September). We believe these types of slight modifications could better ensure businesses are eligible for the JobKeeper regime where they continue to be significantly impacted by COVID-19.

For more information regarding stimulus measures visit www.pitcher.com.au