01/09/2014 - 14:03

True test for money managers

01/09/2014 - 14:03

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The premier and treasurer have some tough choices to make if they’re to salvage the state’s economic fortunes.

True test for money managers
CHOICES: The challenges are mounting for Colin Barnett (left) and Mike Nahan (right). Photo: Attila Csaszar

Does Colin Barnett want to do the right thing when it comes to the re-election prospects of his conservative government, and does he want to do the right thing by Western Australia?

That’s the test he faces over the next year as the embarrassment of a downgraded credit rating is translated into genuine financial hardship.

The choice is one of either ignoring the fact that the WA government blew the boom and that now is a time to slash government spending, or hope that the loss of the AAA rating will be forgotten by the next election, and that today’s problem does not morph into a crisis.

Opposition leader Mark McGowan faces the same test, though he has the luxury of not having to act on his suggested remedies. That bucket of iced water will come if he wins government and discovers that there is no money to pay for his promises, without tax rises.

The challenge for both political leaders is to acknowledge that financial and commodity markets have turned against WA and that plans made in better times for pet projects – such as a new football stadium – are luxuries that are no longer affordable.

Middle-class welfare payments, such as rebates on council rates for people over 65 no matter how rich they are, have also become an unaffordable extravagance.

The easy excuse for what’s happening is to blame a lower iron ore price for the deterioration of the government’s revenue base, because cheaper ore means reduced royalties.

Forecast failure

The problem actually goes much deeper than iron ore and in a way is a variation of the mistake made by the former federal government led by Kevin Rudd, Julia Gillard and Wayne Swan.

Those three people did what Mr Barnett and his treasurer, Mike Nahan, are doing today; they prefer to believe the forecasts (best guesses) of civil servants working in Treasury than the tougher, more realistic, forecasts of the private sector.

In the national example, a set of ridiculously optimistic forecasts encouraged Mr Rudd and Mr Swan to create a special tax designed to milk the boom-time profits of mining companies.

Not only did the mining tax not work, it actually cost the government revenue when commodity prices fell.

Now it’s the WA government being exposed for its hopeless optimism in assuming the boom will last forever. Then, even when that dream was clearly fading, it failed to adjust revenue forecasts and cut spending (before it was too late).

The really nasty bit is starting to emerge, because not only has the boom disappeared – the hangover lingers, and will soon be evident in the shape of:

  • • falling property prices, which will further erode government revenue by cutting income from stamp duty; and
  • • special pleading for tax breaks, or direct financial help, from the mining sector that was supposed to be funding the government’s big spending plans.

Stunning as it might sound after the biggest resources boom in the history of WA, the seeds for both of those events have been sown.

Mining, the most important part of the economy, has hit a wall built of low prices and high costs, which have shattered profits.

Special treatment

The gold industry’s fight to avoid an increase in royalty payments is a case study of what happens in tougher times. Its campaign is based on the claimed importance of goldmining to WA, which the industry wants to be translated into special treatment in the form of a lower royalty rate than other minerals.

Without considering the merits of special treatment for gold, if only to avoid a barrage of letters from the industry, it is beyond doubt that the current gold royalty at 2.5 per cent of the value of metal produced is half the 5 per cent paid by the producers of most other mineral products, and one-third the 7.5 per cent paid on high-grade ‘lump’ iron ore, bauxite and diamonds.

Pleading for special treatment is one of the key signs of an industry under pressure, with the potential for that pressure to flow directly into government revenue if it pushes too hard for higher royalties and kills the golden goose.

The nickel industry is also on the verge of producing its own version of special pleading, with BHP Billiton’s Nickel West business facing the prospect of closure if it cannot be sold.

It hasn’t happened yet but there’s a fair chance that either BHP Billiton or a new owner of Nickel West will be copying the gold industry in seeking a royalty holiday, or a direct injection of taxpayer funds to keep the Kambalda nickel smelter and Kwinana nickel refinery in production.

Stamp duty revenue is potentially the worst of the problems that lie ahead. It is a major source of government revenue but the seeds of a decline have already sprouted in the form of falling residential property rents, which will be flow into property values.

How Mr Barnett and Dr Nahan handle today’s financial challenges will be the making of their reputations.

They can do the right thing by WA now and make the painful spending cuts that should have started last year, or they can pretend that the government is not on the cusp of a crisis and continue spending in the hope that global commodity markets save the day.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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