More than ever before, the outlook for state finances seems to be dictated not by the policy decisions as by the underlying assumptions, with three being particularly important this year.
More than ever before, the outlook for state finances seems to be dictated not by the policy decisions as by the underlying assumptions, with three being particularly important this year.
The assumed exchange rate, the assumed iron ore price, and Treasury's estimate of WA's share of GST revenue played a critical role in determining the budget outlook.
In each case, Treasury has employed an established methodology rather than trying to make an informed estimate of the likely outcome.
The result is that many people will scratch their heads when they see the wide discrepancy between the economic parameters in the budget and current prices.
The parameters are critical because they have a huge impact on revenue.
Every US1 cent rise in the Aussie dollar cuts $60 million from revenue, and every US$1 per tonne increase in iron ore prices adds $28 million to revenue.
The budget assumes an exchange rate of US97.5 cents in 2011-12, compared with the current rate of about US107 cents. What's more, treasury assumes the exchange rate will fall gradually to 76.9 cents in 2014-15.
How did Treasury reach these numbers?
Its starting point is the actual exchange rate in the six weeks up to the budget cut-off date, in mid April. It then assumes the exchange rate will move from that level back to its 15-year long-run average.
It adopted this approach two years ago because its previous approach, of assuming the prevailing rate would continue long term, proved wildly misleading when market rates moved.
It remains to be seen whether the current approach is any better, especially with many pundits suggesting long-term growth in China will underpin a strong Aussie dollar.
Treasury employs the same methodology for iron ore prices; on this basis, it assumes they will decline from US$149 per tonne in 2011-12 to US$87.5 per tonne in 2014-15.
The consensus view among market analysts is that the Aussie dollar will stay higher than Treasury assumed and that iron ore prices will also be higher.
If that proves to be correct, the two will tend to cancel out the impact of the other on the budget.
In regards to GST grants, Treasury has estimated that WA's relativity will fall to 33 per cent by 2014-15. That means the state will get back just 33 cents for every dollar of GST it collects.
This estimate is much lower than earlier estimates, and factors in an expected rise in mining royalties.
Treasury says that under the current formula employed by the Grants Commission in Canberra, WA will be effectively be penalised because of the higher royalties.
Treasurer Christian Porter told a media briefing today he doesn't believe WA's share will ever get as low as 33 per cent.
He said the recently established review into the Grants Commission process was likely to recommend a cap and a floor on the amount each state gets.
Premier Colin Barnett has previously suggested a floor of 75 per cent, which means WA would continue to subsidise other states but to a lesser extent.
If the WA Treasury is right, then such a change is sorely needed.
