Joe Hockey’s second budget is built on a risky forecast that Australia will roar through an unprecedented three decades of continuous economic growth, raising questions about why the government has opted to slow the pace of budget repair.

Growth is set rebound from a short-term dip back to its long-term average pace by no later than next year, according to Treasury’s estimates.

And that will happen despite the fact that this year’s budget will create a modest drag on growth, equal to about 0.5 per cent of gross domestic product over the next two years.

The burst of growth – built on a rebound in the terms of trade later this decade – will generate a flood of new revenue that will start producing surpluses early next decade, according to the forecasts.

The budget papers show the government will rely on an ever-rising share of taxes, rather than spending restraint, to close the deficit.

Helping spur the virtuous circle will be a fall over the longer term in unemployment, partly because softer wages growth will make it easier for companies to hire more people.

Mr Hockey said the government’s optimism is based on the ongoing boost to growth from lower interest rates, falling petrol and energy costs, and the lower Australian dollar.

With the Reserve Bank of Australia having cut the official cash rate last week to a record-low 2 per cent, dwelling investment will surge 6.5 per cent in 2015-16, while household spending gains 3 per cent.

The budget papers do caution, however, that the extent to which the household savings ratio declines is a “key risk” to this outlook.

The second-major driver of growth will come via the falling exchange rate, which is boosting the competitiveness of exporters, such as tourism operators, education providers and even long-suffering manufacturers.

GDP growth will accelerate from 2.75 per cent in financial 2016, as revealed this week by The Australian Financial Review, to 3.25 per cent in 2016-17, just above the pace economists normally say is the level at which the jobless rate falls.

The unemployment rate – currently at 6.2 per cent – will drift back to 5 per cent by early next decade, with the terms of trade to remain at its current level from 2019-20.

From financial year 2018 through to 2021-22, Australians will be blessed by one of the most sustained periods of economic  performance in the nation’s history, with GDP expected to expand 3.5 per cent in every one of those years.

Most significantly for revenue, nominal GDP growth is set to return to its long-run average of 5.5 per cent as soon as 2016-17, from 3.25 per cent in 2015-16.

While Treasury officials described the forecasts as conservative and based on long-run trends, the improved outlook comes at a time when the government has decided to slow the pace of fiscal repair. This is likely to prompt some budget experts to warn the government is effectively missing an opportunity to use the positive outlook to fix the budget before the economy runs into an unexpected crisis.

Mr Hockey acknowledged on Tuesday that he would have liked to do more, but was forced to find a balance between what is right for the economy and what’s right for fiscal repair.

One challenge that may cause ongoing problems is likely to come from any further falls in commodity prices. Iron ore has been forecast to remain at US$48 a tonne, below the forecasts of most financial market predictions, which range from about US$52 a tonne to US$60 a tonne.

If producers win prices above Mr Hockey’s level, revenue will be higher than forecast.

The terms of trade, a measure of export income, will fall 8.5 per cent in 2015-16, after this year’s 12.25 per cent drop. In fiscal 2017, the terms of trade will rise 0.75 per cent.

Officials said the terms of trade is expected to edge higher, partly because the cost of imports is likely to continue declining. Over the longer term, the terms of trade will remain about its 2005-06 level.

Looking offshore, the budget assumes an ongoing recovery in the US, Japan and eurozone, while China’s economy will further slow. GDP growth in China, Australia’s biggest trade partner, will slow from 6.75 per cent in 2015 to 6.5 per cent next year and 6.25 per cent in 2017.

China’s growth is “now moderating to a more sustainable pace” but faces long-term challenges, including that of an aging population. “A key risk is that China’s transition to a more sustainable growth model may not be smooth,” the government said in the budget papers. The outlook for India is more bullish.

While Mr Hockey is banking on a strong upswing in growth, Treasury’s estimates do provide a note of caution. Officials have put a 70 per cent probability on the chance that growth in 2015-16 will be between 1.75 per cent and 3.5 per cent.

Extracted in full from the Financial Review.