Investor implications from the "pandemic" budget

Big spending initiatives in the 2021 Federal Budget aim to drive economic growth. With the risk of inflation low, investors can expect a positive outlook for asset markets.

Dubbed as the “pandemic” budget, the Government’s billion-dollar cash splash in the 2021 Budget aimed to boost economic growth towards full employment.

Crunching the numbers, AMP chief economist Shane Oliver highlighted that the total direct stimulus to the economy pre-Covid (both spent and projected to be spent) to now is around $350 billion.

The Budget outlined massive spending on aged care ($17.7 billion) and infrastructure, with $15 billion added to the $110 billion 10-year infrastructure program.

Even for a self-confessed “big picture macro” economist, Oliver was not expecting such a considerable fiscal spend.

The 2021 Budget sees the Government ditch its plan to pull back on spending once unemployment is “comfortably below 6%”, Oliver says. Instead, the Government will “repair” the Budget by focusing on job growth and the economy.

Thanks to record high iron ore prices – elevated on average at $US160 per tonne in 2020,– the Government can still report a declining budget deficit.

By the Treasury’s estimates, by 2024-25, the Budget’s bottom line received an extra $104 billion boost in revenue thanks in part to that record high iron ore price.  

The $96 billion new spending measures in the 2021 Budget revealed that the Government decided to spend 92% of its windfall from economic growth and high iron ore prices.  

Debt concerns?

The result is that the underlying Budget deficit for this financial year is estimated to be a still large 7.8% of GDP, or $161 billion, according to the assessment of BetaShares chief economist David Bassanese.

By 2024-25, the deficit is estimated to fall to 2.4% of GDP – but even by 2031-32, the Budget is expected to remain in the red to the tune of 1.3% of GDP.

While the overall public debt will stabilise at around 40% of GDP, which is much larger than Australia has been used to, Bassanese says it is still less than that of our global peers.

However, there is still concern over rising debt levels. Bassanese notes that while we can worry about the longer-term consequences of this shift in official thinking on the dangers of public debt, the short-term implications are undoubtedly positive for both the economic and financial market outlook.

“The economy is in a ‘sweet spot’ whereby lingering spare economic capacity – in the form of higher than desired unemployment and lower than desired inflation – means both fiscal and monetary policy can remain firmly on the accelerator pedal for some time to come,” he says.

The outlook, for now, is relatively positive, underpinned by a V-shaped economic recovery without undue inflation, according to Bassanese.

On his assessment, the economy has rebounded from the COVID crisis far better than most expected.

In fact, this time last year, the unemployment rate was expected to remain elevated at 6.5% until June 2022. It is expected to be down to 5% by then – from 5.6% currently – and fall to 4.75% by June 2023.

Yet such is the “apparent inflation insensitivity of the economy”, annual consumer price inflation is still expected to be only 1.75% in June next year, up only marginally from the expected 1.5% level expected a year ago.

“We are in the early stages of a new economic cycle where growth can run hot for a time without causing inflation,” Bassanese says.

“This should be a positive environment for asset markets with fears of inflation and much higher interest rates anytime soon likely to be overblown.”

Implications for Australian asset classes

For investors, a focus on growth should be positive for equities, and the winning sectors from the Budget are aged care, childcare and infrastructure.

Biotech also benefits from tax breaks – the Government is applying a concessional taxation for biotech innovation – 17% on profits, compared with 25% for small and medium business and 30% for larger companies.

Bassanese says the big spending budget moves us closer to the Reserve Bank in terms of other asset classes, potentially bringing forward policy tightening at the margin, which is bearish for bonds but bullish for the Australian dollar.  

AMP’s Oliver forecasts cash and bank deposit returns to remain low for a long time, given that the cash rate is likely to remain at 0.1%.

Combined with a rising trend in yields resulting in capital loss mean that medium-term bond returns are likely to be low as the economy recovers.

Echoing Bassanese’s views, Oliver believes ongoing fiscal stimulus, strong growth and low rates all remain supportive of Australian shares, notwithstanding the high risk of a short-term correction.

Oliver is also optimistic over the outlook for the Australian dollar with ongoing fiscal stimulus, rising commodity prices and a declining US dollar pointing to more upside.

For property investors, Oliver believes that more home buyer incentives along with low rates and economic recovery will likely see house prices rise further this year and next, although the pace of increase is likely to slow. However, lower immigration levels will eventually impact the demand for property.

Looking ahead, the economists do see the momentum continuing.

“There seems every reason why the growth recovery can continue and perhaps somewhat more strongly than the Government assumes”, Bassanese says.

“Households are still cashed up and I suspect will be keen to run down their saving more quickly than policy makers expect.”