1

Rob BrookerHead of Australian Economics

2010/11 Budget Commentary & Economic Overview

2

Overall reaction to the Budget

This is very much a budget aimed at repairing the medium term fiscal outcome: surplus returning 3 years early in 2012/13

Deficit reduction involves policy tightening together with strong growth

Overall budget decisions broadly neutral over 4 year period– But really around $2bn p.a.early, neutralised by resources tax

kicking in fully in 2012/13. Monetary & fiscal policy now aligned Economic forecasts appear credible

3

Revenue/savings mostly known beforehand

Miners super profits tax: $9 bn PBS reduced drug prices: $0.5 bn Tobacco excise: $1.3 bn ATO increased compliance (especially GST): $0.5 bn

4

Likewise spending/reduced taxes

Lower corporate tax rate (SME fast track): $2.3 bn Small business depreciation: $1.0 bn Superannuation concessions: $1.9 bn Discount on interest income: $0.5 bn Health: $1.7 bn Training & infrastructure fund: $0.8 bn Resource exploration tax offset: $0.7 bn

5

How credible..

Politics– Clearly lot depends on super profit tax

Issues include at what rate (Govt bond rate hard to defend) and will it be retrospective

– Govt linking it to other measuresLow-income & related super concessionsInfrastructure fundCut to company tax rate

– Will it get through the Senate??

6

Credibility

Economics– Forecasts

we find the forecasts credible■ Govt sees fiscal stimulus withdrawn from 2011/12

That is we see tighter fiscal policy taking around 2% from GDP■ But no scope for pre election spending if want fiscal repair

■ But fiscal position of Australia relatively remarkable■ Net debt to peak at 6% and moving down thereafter

7

Looking at the Budget from the policy viewpoint (Structural Surplus deficit)

Tightening starting in 2010/11

Much more in 2011/12

Budget repaired by 2012/13

-3.5

-3

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

1990

/91

1991

/92

1992

/93

1993

/94

1994

/95

1995

/96

1996

/97

1997

/98

1998

/99

1999

/00

2000

/01

2001

/02

2002

/03

2003

/4

2004

/5

2005

/6

2006

/7

2007

/8

2008

/9

2009

/10

2010

/11

2011

/12

2012

/13

Ch

ang

e (%

of

GD

P)

88

90

92

94

96

98

100

102

104

106

Lev

el 2

000/

01

=10

0

Change - LHS Level of Structural Surplus / Deficit

Structural Deficit / Surplus - Annual Movement % of GDP and Implied Balance

Surplus

Deficit

8

On forecasts

We were surprised by the extent of the tightness implied in the public sector numbers

We actually reduced our domestic forecasts a touch But locally we still expect stronger growth – coming earlier due to terms of trade and investment

In 2010/11 we expect 4% vis a vis Govt’s 3 ¼% And better unemployment

Global forecasts very similar

Domestic Demand - Private & Public

-6%

-4%

-1%

2%

4%

7%

9%

Dec

-86

Dec

-87

Dec

-88

Dec

-89

Dec

-90

Dec

-91

Dec

-92

Dec

-93

Dec

-94

Dec

-95

Dec

-96

Dec

-97

Dec

-98

Dec

-99

Dec

-00

Dec

-01

Dec

-02

Dec

-03

Dec

-04

Dec

-05

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Ann

ual %

cha

nge

-6%

-4%

-1%

2%

4%

7%

9%

Underlying Public Demand

Private Demand

9

Resource super profits tax

Extractive industries taxed differently– Susceptible to ‘super profits’ (profits > needed to invest)

Shifts tax from production to profit– Marginal mines currently pay royalties (deductible from RSPT)

Fiscal stabilisation case But uncertainty

– How to calculate ‘super profit’?– How does it affect project evaluation?

10

Global Economy : Key Messages

It is now clear that global growth has returned But it is very varied by region China very strong and Non Japan Asia has bounced back USA also surprising – with potential upside risks Japan also improving from a very low base Europe still very disappointing – with growth downgrades New twist is sovereign risk – which would have dangerous and large

effects if allowed to develop– EURO/IMF package of E750bn should calm markets– But growth prospects very poor

11

The latest estimates suggest Chinese GDP increased by around 3% in Q1 2010 implying growth still accelerating – currently 11.9% y/yAnd heavily driven by secondary industry (i.e. big users of coal / iron ore)

0

4

8

12

16

2000 2002 2004 2006 2008 2010

0

4

8

12

16

% %

China - Real GDPYear-to-date percentage change

Tertiary

Secondary

Primary

0

3

6

9

12

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

0

3

6

9

12

% %

China - Real GDPPercentage change

Year-ended

Quarterly

12

The strongest “V” has been in Non Japan Asia (ex China). China strength and increased global trade the key drivers. While China off its peaks production still robust. Indian production strong and accelerating.

13

Key fundamentals - USA

High unemployment will act as a headwind As will the withdrawal of stimulus (fiscal and monetary) But traditional drivers of growth are equally powerful unless

something else intervenes– Real rate are very low and fiscal pump priming large– Equity markets are up substantially– House prices are stabilising / turning up– Currency is low– And lags to falling oil prices

Most likely risk (outside Europe) is commercial property

14

Going forward…..model underlines why upside risk in 2010But beyond near term growth not expected to continue to accelerateCommercial property a risk on downside

Model based on - real rates - house prices - equity markets - oil prices - currency - credit crunch

US Quarterly GDP v Nab Mini Model

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

ACTUAL / FORECASTS

Interest rate/ Los Model

15

European issues: The Problem child

Growth seems to have stalled – with domestic demand negative in late 2009

Unemployment very high and falls in house prices substantial (especially outside large economies)

Some of the smaller Europeans have pump primed to such a large extent that doubts arise about ability / willingness to implement sufficiently tight policies to put fiscal position back on sustainable path– Greece, Italy, Ireland, Spain and to a lesser extent UK

Markets nervousness rampant

But package seems large enough to settle nerves in the short run. But growth stalled and prospects poor.

16

So adding up gives global growth of around 4¼% in 2010 and 2011.But key message is very different across regions – with gap widening.Australia well placed re MTP growth – now up 5% in 2010

IMF ANNUAL GROWTH TOTALSWEIGHTS 2006 2007 2008 2009 (f) 2010 (f) 2011 (f) 2012 (f)

GDP US 0.21 2.7 2.1 0.5 -2.4 3.3 3.0 3.2GDP JAPAN 0.06 2.0 2.3 -1.2 -5.2 2.2 2.5 2.5EURO GDP 0.152 3.1 2.7 0.6 -4.1 0.9 1.5 1.5UK GDP 0.031 2.9 2.6 0.5 -4.9 0.7 2.5 2.5nonjap asia 0.042 5.4 5.6 2.0 -1.0 5.4 5.2 4.5latin america 0.085 5.3 5.4 4.3 -2.0 3.6 4.0 4.0china 0.125 11.0 11.8 9.6 8.7 10.5 9.1 8.0canada 0.018 2.9 2.5 0.4 -2.6 2.7 3.0 3.0India 0.051 9.9 9.3 7.3 5.7 8.0 7.5 7.3Africa 0.024 6.1 6.3 5.5 2.1 4.7 5.9 5.3CIS 0.043 8.2 8.6 5.5 -6.6 4.0 3.8 4.0E Europe 0.035 6.7 5.7 3.0 -3.7 3.0 3.7 3.7Middle East 0.05 5.7 5.9 5.1 2.4 4.5 4.8 4.8Other advanced 0.073 4.5 4.7 1.7 -1.1 3.3 3.6 3.6

GLOBAL TOTAL 0.999 5.2 5.1 3.0 -0.8 4.1 4.2 4.0

New Zealand 2.0 3.2 0.0 -1.6 2.9 3.5 3.0

AUSTRALIAN MTP Ex weights 5.3 5.5 2.6 -0.2 5.0 4.9 4.5

17

Economic forecasts

2009-10 2010-11

NAB Budget NAB Budget

GDP 2 ¼ 2 ¼ 4 ¼ 3 ¼

Employment(a) 2 ½ 2 ½ 3 ½ 2 ¼

CPI underlying(a) 2 ¾ 2 ½ 2 ½ 2 ½

Wages(a) 2 ¼ 2 ¾ 4 ½ 3 ¾

Terms of trade -3 ½ - 3 ¾ 15 ¼ 14 ¼

(a) Through-the-year growth rate

18

Where are we now. Business confidence still strong but back from excessively strong readingsAlso signs in recent months of larger falls in retail, construction and transport as rates bite and Govt stimulus passes.

Business confidence (net balance)

-40

-20

0

20

Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10Seasonally adjusted Trend

1990s recession

19

Australian business activity – as measured by business conditions – easing back a touch but still reasonable. Main slowing recently was in sales especially retail transport and construction.

Business conditions components (net bal. s.a.)

-40

-20

0

20

40

Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10

Trading Profitability Employment

1990s recession

20

That said overall the survey is still suggesting that domestic demand is still travelling at around 4% Recent slowing would be welcomed by the RBA.

-6

-4

-2

0

2

4

6

8

10

Dec-8

9

Dec-9

1

Dec-9

3

Dec-9

5

Dec-9

7

Dec-9

9

Dec-0

1

Dec-0

3

Dec-0

5

Dec-0

7

Dec-0

9 -6

-4

-2

0

2

4

6

8

10

DEMAND 6Mthly Annualised

Forward Orders

Forward Orders (Change & Level) As an Indicator of Domestic Demand - 6 Mthly Annualised % in Demand

21

Key factors driving higher growth prospects

Australia's Terms of Trade

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

Sep-

96

Sep-

97

Sep-

98

Sep-

99

Sep-

00

Sep-

01

Sep-

02

Sep-

03

Sep-

04

Sep-

05

Sep-

06

Sep-

07

Sep-

08

Sep-

09

Sep-

10

Inde

x of E

xpor

t to

Impo

rt Pr

ices

Average - 1985 to 2000

Source: ABS, &, NAB Economics

Better major trading partner growth (5% in 2010)

Faster start to year with high confidence levels and new orders

Critically extra income in the economy from commodity price increases. As reflected in our term of trade.

22

The strength of the labour market has important flow on effects to income and housing prices and wealth

The strengthening in hours worked and lower unemployment While higher rates and the end of the first home owners boost will slow the

housing market, their impact is more than offset by lower unemployment On housing critical issues are

– Population growth: currently near 2%– Interest rates: to rise significantly– The degree of over / under building: currently under built by around 50000

per annum– Unemployment: Prospect of significant falls very important

Debt really only a big issue if unemployment rises and / or rates go too high.

23

Higher capacity, confidence and incomes likely to see investment strengthen significantly in 2010. Business still wary but intentions are improving. Mining projects – especially Gorgon – will add further.

Business investment to increase by 15% in both 2010 and 2011. Models point to some upside risk

Underlying Business Investment - Actual v Model Forecasts

-25

-15

-5

5

15

25

35

Ju

n-9

0

Ju

n-9

1

Ju

n-9

2

Ju

n-9

3

Ju

n-9

4

Ju

n-9

5

Ju

n-9

6

Ju

n-9

7

Ju

n-9

8

Ju

n-9

9

Ju

n-0

0

Ju

n-0

1

Ju

n-0

2

Ju

n-0

3

Ju

n-0

4

Ju

n-0

5

Ju

n-0

6

Ju

n-0

7

Ju

n-0

8

Ju

n-0

9

Ju

n-1

0

Ju

n-1

1

oy

a

-25%

-15%

-5%

5%

15%

25%

35%

Model Actual plus f

24

For 2010 forecasts are for growth of 3 ¼ % - stronger (3 ½ %) Dec / Dec Qtr. For 2011 expect even stronger growth at 4 %

■ GDP (fiscal years)■ 2 ¼ % in 2009/10■ 4 % in 20010/11

■ The strength of the forecasts are underlined by expected growth in domestic demand of 5¼% in both calendar years.

Real Output/Expenditure (GDP) - Quarterly

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Dec

-84

Dec

-85

Dec

-86

Dec

-87

Dec

-88

Dec

-89

Dec

-90

Dec

-91

Dec

-92

Dec

-93

Dec

-94

Dec

-95

Dec

-96

Dec

-97

Dec

-98

Dec

-99

Dec

-00

Dec

-01

Dec

-02

Dec

-03

Dec

-04

Dec

-05

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Quarterly GDP 4 per. Mov. Avg. (Quarterly GDP)

25

The strength of the growth forecasts points to employment growth of around 3 ¼ per annum. Even with stronger partipation that could see unemployment fall to 4 ½% by end 2010 and 4% by end 2011.

Australian Labour Market

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

Mar

-96

Dec

-96

Sep

-97

Jun-

98

Mar

-99

Dec

-99

Sep

-00

Jun-

01

Mar

-02

Dec

-02

Sep

-03

Jun-

04

Mar

-05

Dec

-05

Sep

-06

Jun-

07

Mar

-08

Dec

-08

Sep

-09

Jun-

10

Mar

-11

Dec

-11

% c

han

ge

- 12

mo

nth

s to

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

% -

rat

e

EMPLOYMENT - LHS UNEMPLOYMENT RATE - RHS

26

On short term interest rates dynamics…

RBA currently on hold looking at the world (Europe) and the impact of what it has already done

We see cash rates moving up to 5¼% by end 2010 – which would, in an environment of higher bank spreads, be a touch on the tight side of neutral.

While every RBA meeting is “potentially live” depending on data, we have pencilled in rate rises in August, September and December.

Moving into 2011 we expect rates to rise to 6% which is above current

market pricing and would be the best part of ¾% above neutral