Every budget rises or falls on its key assumptions. They include the state of the economy, events overseas, the response of people to particular policies and inflation.
A key one is the price of Australia’s major exports. Lower or higher-than-expected prices can make, and do break, budgets.
Both former treasurers Wayne Swan and Joe Hockey were caught by big swings in the price of iron ore and other commodities (while former prime minister John Howard’s big budget surpluses were built, in part, on the huge lift in iron ore prices that started about 2002-03).
Given the angst that commodity prices had given previous governments, then treasurer Scott Morrison and finance minister Mathias Cormann adopted a prudent approach to future forecasts.
In late 2016, after the prices of both iron ore (up by 75 per cent) and metallurgical coal (up by 300 per cent) soared in a few months, Treasury argued the then existing policy of assuming current prices would stay at that level was just asking for trouble.
Instead, the department argued – and Morrison and Cormann agreed – that it would be better to assume that prices for key commodities fell back to their longer-run averages.
The iron ore forecast proved correct at just over the $US55 mark for about three days in mid-2017. But it’s never been at that level since. By mid-2021, for instance, it peaked at an extraordinary $US220 a tonne before “nosediving” to $US90 a tonne by November of the same year.
Cranes at work on a residential project in Shanghai. If iron ore prices fall, chances are the Chinese economy is in trouble.Credit: Bloomberg
Until 2023-24, it was assumed iron ore would fall quickly back to $US55 a tonne. It never did, delivering Morrison and former treasurer Josh Frydenberg and Chalmers hundreds of billions in extra dollars.
Treasury under Chalmers shifted the assumed price to $US60 a tonne in 2023-24 and a more gradual decline in that price, a recognition that the $US55 assumption was simply wrong.
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It’s that $US60 a tonne that this year’s budget, and its forecast deficit of $42.1 billion, is based upon.
But in the three months of the current financial year, the lowest iron ore has plumbed is $US93 a tonne. In other words, 55 per cent above what the budget assumes.
While commodity prices are important to the budget bottom line, the real fiscal heroes are working Australians.
Figures released on Friday showed that, through July and August, workers paid a record $51.3 billion in personal income tax, $2.4 billion more than had been forecast. That $51.3 billion was 62 per cent of all income tax collections for the two months.
Companies paid $23.2 billion ($1.4 billion less than expected) while superannuation funds paid $6 billion or $1.9 billion up on expectations.
A steep fall in iron ore prices would have a devastating impact on the budget (especially on Western Australia’s state finances). But if iron ore prices collapsed, chances are the prices of many other commodities will have also fallen.
That would suggest a financial or economic meltdown centred on China which, ultimately, remains the biggest threat to the federal budget and the Australian economy.
Just this week, the Reserve Bank noted that risks to the global financial system were climbing. One of three vulnerabilities on the bank’s radar is China’s financial and property sectors.
Financial distress in China, it said, would lead to a “sharp slowing in global economic activity, lower global commodity prices and reduced Chinese demand for Australian goods and services”.
