; Erring on the side of surplus
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Erring on the side of surplus


  • pg 1
									  Erring on the side of a surplus
  The 2012/13 Budget
Michael Blythe               Michael Workman             John Peters                    James McIntyre
Chief Economist              Senior Economist            Senior Economist               Economist

Richard Grace                Joe Capurso                 Peter Dragicevich              Diana Mousina
Chief Currency Strategist    FX Strategist               FX Economist                   Associate Economist

Adam Donaldson               Philip Brown                Alex Stanley                   Ai-Quynh Mac
Head of Debt Market Research Quantitative Analyst        Associate Analyst              Information Services

May 2012


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                                                         Chart No.
   Our view                                                 4-5
   Budget overview
     – key numbers                                           6
     – key themes                                           7-10
   Fiscal issues                                           11-17
   Economic issues                                         18-28
   Financial market issues                                 29-42
   Sectoral issues                                         43-48


  Small Budget surpluses are projected for next year and beyond, rising from
  $1.5bn (0.1% of GDP) in 2012/13 to $7.5bn (0.4% of GDP) in 2015/16.
  The surplus objective at a time of sub-trend growth and structural pressures on
  key revenue components requires significant savings.
  S the Budget is dominated by savings measures – relative to the November
  So th B d t i d     i t db      i                  l ti t th N       b
  MYEFO, savings measures of $22.3bn over the next four years more than offset
  new spending of $15.6bn.
  The Government deserves credit for sticking with its fiscal strategy and finding
  sufficient savings to fund some new measures.
  Much is made of the need to return to surplus. But fiscal settings also need to
  take account of economic requirements. It is not clear if we need to get to
     p           g        p                      p
  surplus in one giant leap. The trend is more important than the timing.
  Budget figuring is based on a return to trend real growth. The mining boom will
  underpin growth. But households also need to make a “normal” contribution.
  Fiscal consolidation is a growth risk. The swing in the underlying Budget
  position from a deficit of 3.0% of GDP in 2011/12 to a surplus of 0.1% in 2012/13
  would be the largest consolidation in at least sixty years.

Summary (Cont’d)

    The impact of fiscal consolidation on economic activity should be milder – State
    government capex and off budget items (eg NBN) provide an offset.
    The scrapping of some measures that would have assisted the non-mining
    economy (eg the 1% cut in the company tax rate) is disappointing.
    New measures favour households over business. Fiscal measures and the drop in
    mortgage rates are worth 1¾% of household income.
    Terms of trade and nominal GDP assumptions are critical for revenue projections.
    These assumptions look pessimistic. Some revenue risks to the upside.
    Fiscal settings feed into RBA deliberations but there isn’t a mechanical tradeoff.
    The RBA has room to move if fiscal settings prove inappropriate.
    Financial markets were largely unmoved by the Budget.
    The return to surplus means net government debt peaked at 9.6% of GDP in
    2011/12 and should slowly decline from here.
    The financing task involves nominal bond issuance of $9bn and $2bn of Linkers in
    2012/13. Reduced issuance should flatten the curve and narrow spreads over
    Features of the Budget story are AUD supportive (eg support for AAA rating).

Budget Overview

Key numbers                                                       Underlying cash surplus for 2012/13
                                                                  put at $1.5bn (0.1% of GDP) vs a deficit
               FISCAL INDICATORS                                  of $44.4bn (3.0% of GDP) now
  % of                                                 % of
  GDP            (deficit(-) / surplus(+))             GDP        expected in 2011/12.
   3                                                    3
                                                                  Small surpluses expected in the
                                                                  outyears, culminating in a $7.5bn
                                                                  (0.4% of GDP) surplus in 2015/16.
   0                                                    0

                                                                  The headline cash deficit is projected
               Underlying                                         to shrink to $8.7bn in 2012/13 from an
              cash balance
                                                                  expected $48.4bn in 2011/12.
   -3                                                   -3

                                                                  Net debt is expected to peak at 9 6% of
                                        balance                   GDP in 2012/13 and decline slowly to
                                                                  7.3% of GDP by 2015/16.
   -6                                                   -6
    1996/97   2001/02   2006/07   2011/12    2016/17
                                                                  Net debt is projected to return to zero
                                                                  in 2020/21.


Budget Overview

Key themes – Pt I

                                                                The Government believes a surplus
             BUDGET ARITHMETIC                                  position is an economic imperative.
   $bn     (cumulative 2011/12 to 2014/15)          $bn
   0                                                  0
                                                                Sub-trend growth and structural issues
                                                                S bt     d     th d t      t   li
                                                                are weighing on revenues – economic
 -10                                                  -10
                                                                & parameter variations since the 2011
                                                                Budget cost $39bn over four years to
 -20                                                  -20

 -30                                                  -30       Focus on savings measures in Budget
                                                                2012 as a result – Budget savings
  40                                                   40
                                                      -40       initiatives worth $22bn over next four
                                                                years. A dip into the Contingency
 -50                                                  -50       Reserve is worth another $6bn.
         May'11    Economic & Net new     May'12
         Budget     parameter   policy    Budget
         balance    variations measures   balance               Budget policy initiatives limited -
                                                                $16bn over next four years.


Budget Overview

Key themes – Pt II

         The Government sees a surplus as appropriate given the return to trend growth
         and the medium-term fiscal strategy. The surplus provides scope for fiscal
         stimulus at some future point. And scope for the RBA to cut rates. A surplus
         is important for global confidence and ratings agency support.

         The structural and cyclical pressures on revenues are highlighted.

         The Budget is a also political document. So key themes involve skewing
         spending towards households, especially at the low-to-middle end of the
         income range. Savings measures, in contrast, are skewed towards business
         and higher income earners.

         Some measures will help strengthen the economy over time and set it up to
         deal with longer-run challenges (such as the age care reforms, training and


Budget Overview

                Underlying Cash Balance ($bn)
                          2011/12   2012/13   2013/14   2014/15       2015/16               A surplus in 2012/13 has been in
                            (e)       (f)       (f)       (p)           (p)
                                                                                            the projections since May 2010.
   May’11 Budget           -22.6      3.5       3.7       5.8            ~
    (% of GDP)             (-1.5)    (0.2)     (0.2)     (0.3)          (~)
                                                                                            Economy weaker than expected and
 Plus:                                                                                      structural issues weighing on
   Parameter & oth ch      -9.6      -4.9      -5.5      -7.4           ~                   revenue – cost to Budget:$39bn over
       Policy decisions    -4.9       2.9       3.7       4.7           ~                   four years.
                           -37.1      1.5       1.9       3.1           ~                      Policy measures worth a net
   Nov’ 11 Review
                           (-2.5)    (0.1)     (0.1)     (0.2)          ~
     (% of GDP)                                                                                $13bn over four years announced
 Plus:                                                                                         since May ’11 Budget.
   Parameter & oth ch      -4.6      -2.9      -3.8      -0.3           ~
       Policy decisions    -2.7       2.9       3.9       2.5           ~
 Equals:                                                                                             Implied starting point
                           -44.4      1.5       2.0       5.3           7.5
   May’12 Budget
                           (-3.0)    (0.1)     (0.1)     (0.3)         (0.4)
                                                                                                     for 2012/13 was a
     (% of GDP)                                                                                      surplus of $1.5bn.
  Headline Balance         -48.4      -8.7      -6.8     -0.1           2.0
     (% of GDP)            (-3.3)    (-0.6)    (-0.3)    (0.0)         (0.1)                     Movement to small
                                                                                                 surplus means net debt
                                                                                                 will slowly decline.


Budget Overview

Budget forecasts                                                                                 2011/12     2012/13     2013/14
                                                                                                   (e)         (f)         (f)

   Budget numbers based on a return to trend                      Real GDP (% ch)                   3          3¼           3
   growth. 2011/12 forecast looks ambitious.
                                                                  Of which:
   Consumer spending growth at trend. The main                    H/hold consumption (% ch)        3¼           3           3
   d    ti d     id i k
   domestic downside risk.
                                                                  Dwelling Investment (% ch)       -1           0         21/2
   Residential construction subdued till 2013/14.
                                                                  Business Investment (% ch)       18         121/2         8
   Mining construction boom underpins growth.
                                                                  Public demand (% ch)             11/   2     -1/   2      0
   Public demand is only slightly negative despite
   size of fiscal contraction.                                    GNE (% ch)                        5           4         31/2

   CPI includes ¾% from carbon tax in 2012/13.                    Net exports (contrib)            -2          -3/4        -1/2
   Wages growth does not slow as assumed in RBA                   CPI (% ch yr to June)            11/4       31/4        21/2
                                                                  WPI(% ch yr to June)             31/2       33/4        33/4
   Terms-of-trade declining from record levels.
   Forecasts look pessimistic.                                    Terms of trade (%ch)             31/   4    -53/   4    -31/4

   Unemployment lifts but remains near full                       Nominal GDP (% ch)               51/2         5         51/4
   employment level.
                                                                  Employment (% ch)                1/          11/4        11/2
   Mining capex boom drives current account
   deficit higher initially.                                      Unemployment (%, June)           51/   4    51/    2    51/2

                                                                  Current A/c def (% GDP)          -3         -43/4        -6

Fiscal Issues                                               AUSTRALIA: NET LENDING BY SECTOR
                                                             %                         (% of GDP)                     %
                                                              8                                                        16

Do we need a surplus?                                         4                                   Households          12

   Accommodating the mining boom requires                     0                                                       8

   a degree of “restructuring” in the economy.               -4                                                       4

   Australia’s net borrowing status leaves us                 8
                                                             -8                                                       0
   exposed to financial problems elsewhere.
                                                            -12                                                       -4

   Implications:                                                                                Business
                                                            -16                                                       -8
       – households need to make room for the               -20                                                       -12
         mining boom;                                         8                                                       24

       – a shift back to net lender status by                 4                        Government                     20
         government would reduce the need for
                                                              0                                                       16
         households to do all of the heavy lifting;
                                           y     g
                                                             -4                                                       12
       – a shift back to net lender status by
         government would also reduce reliance on            -8                                                       8

         tapping the savings of the rest of the world;
                                                            -12                                                       4

       – households need to remain net lenders and          -16                                                       0
         there is a need for caution in amount of                                      Rest of World
         stimulus applied to household sector.              -20                                                       -4
                                                                  1980   1985   1990     1995   2000   2005    2010         11

Fiscal Issues
Do we need a surplus in 2012/13?
                                                          Fiscal settings need to be
                                                          benchmarked against near-term
                      REAL GDP
   %              (annual % change)               %       economic requirements as well as
   6                                              6       medium-term adjustment needs.

                                        Trend             The IMF argues that “in countries
   4                                              4
                                                          with fiscal space, the pace of near-
                                                          term fiscal adjustment should be
                                                          calibrated to avoid undue pressures
                                                          on activity and employment”.
   2                                              2

                                                          The trend in the budget balance is
                                                          more important than the timing of a
   0                                              0
   Sep-98    Sep-01   Sep-04   Sep-07    Sep-10           return to surplus.


Fiscal Issues
How tough was it?
                                                                  Previous fiscal initiatives have done little
                     FISCAL POSITION                              more than keep the budget on track for a
  %              (underlying balance, % of GDP)              %    surplus in 2012/13.
  3                                                          3
                                Budget                            This Budget maintains that broad theme
                                                   Budget         although policy makers have had to
                                                                  work harder to get there.
   0                                                         0
                                                   Budget             –   tendency to spend savings measures in
  -3                                                         -3           excess of parameter shifts less evident
                                                                          this time;
                   May'09              Nov'11                         –   projected surpluses remain wafer thin;
                   Budget              MYEFO                              and
  -6                                                         -6
       2005/06      2008/09       2011/12       2014/15
                                                                      –   the actual outcome will depend on the
                                                                          economic cycle.


Fiscal Issues
Structural or cyclical?
                                                                  The economy will determine the degree
                                                                  of difficulty in achieving surplus.
   %                        (% of GDP)                      %
  27                                                        27    Sub-trend growth now means revenues
                                                                  falling short of Budget.
  26                                                        26
                                                                  But structural issues weighing. These
  25                                                        25
                                                                      –   a large stock of capital losses
                                                            24            dampening CGT receipts;
                                         Average                      –   weaker GST receipts due to consumer
  23                                                        23
                                                                          caution, the high AUD, & shift to GST-
                                                                          free services (rents, health, education &
  22                                                        22
                                                                          food); and
  21                                               21                 –   mining capex writeoffs and a weak non-
   1979/80 1986/87 1993/94 2000/01 2007/08 2014/15
                                                                          mining economy denting company tax.


Fiscal Issues
The cyclical                                                                      Nominal GDP is the revenue base –
                                                                                  so nominal GDP forecasts are critical.
                   MTP GROWTH & THE TOT
    %pa                       (annual % change)                 Change            Assumptions about the terms of
    30                                                             5.0
                        Australian                                                trade are the key for nominal GDP.
                         terms of
                                                                                  Terms of trade assumptions look
    15                                                                 2.5        “conservative” given expectations for
                                                                                  Major Trading Partner growth.

        0                                                              0.0
                                                                                   –    each 1% rise in the terms-of-trade
                                                                                        adds ¼% to nominal GDP and each
    -15                                                                -2.5             1% rise in nominal GDP is worth
                                        Major Trading
                                          Partner              (f)                      $3¾bn to
                                                                                        $3¾b t revenue (CBA estimates).
              Source:                                                                                         Terms of   Nominal   Revenue
              IMF/Treasury/          growth momentum
              CBA                     (adv 1 year, rhs)                                                         trade      GDP      impact
    -30                                                                -5.0
                                                                                                               (% ch)     (% ch)     ($bn)
            1988    1993        1998      2003      2008     2013
                                                                                  Budget forecast for 12/13     -5¾        5         ~

                                                                                  Scenarios                      -3        5½       +1.9
                                                                                  CBA forecast                   0         6        +4.5


Fiscal Issues
The structural

                                                                              Structural changes are weighing on
                        MINING INDICATORS                                     revenues – company tax and capital
   Index                        (start=100)                      Index
  350                                                              350        gains tax are suffering from the post
            Mining Boom Mk I           Mining Boom Mk II
                                                                                   f ll t
                                                                              GFC fallout.

                                                  Capex                       But some of the structural story may
                                                                              be cyclical as well.
  250                                                                 250

                                                                              Taxes from mining is one example. The
                                         Net                                  argument is that the high AUD and
                                                                              deductions generated by rising mining
  150                                                                 150     capex is diluting revenues from mining
                                                                              boom Mk II relative to boom Mk II.

                                     Source:                                  But the correlation between mining
                                                                      50      profits/capex/tax is still there. Revenue
        03/04       05/06      07/08      09/10     11/12    13/14            collections reflects cyclical profit
                                                                              weakness associated with the GFC.


Fiscal Issues
Real spending slashed by 4.3% in 2012/13
                                                                               A key component of the Government’s
        REAL GOVERNMENT SPENDING                                               surplus strategy is the 2% limit placed
   %                  (annual % change)                          %             on real spending growth in the 2009
  16                                                              16
                Long run average: 3 2%pa
                                  3.2%pa                                                              GFC
                                                                               Budget in wake of the GFC.
  12                                                              12           The 2012 Budget delivers in spades
                                                                               on this strategy, with real spending
   8                                                              8            falling by 4.3% in 2012/13.

   4                                                              4            The 2012/13 real spending contraction
                                                                               is the largest in living memory and
   0                                                              0            dwarfs Paul Keating’s “Banana
                                                                               Republic” Budget in 1987/88 which
   -4                       Early Coalition                       -4
          "Banana              Budgets                                         saw real spending cut by 3¾%.
   -8                                                             -8           Projected real spending growth
    1979/80   1987/88     1995/96      2003/04     2011/12
                                                                               averages 1.8% over the five years from


Economic Issues
Never change a good forecast!

              BUDGET GDP FORECASTS                                             Budget forecasts in recent years
                      (annual % change)                            %           based on the idea of a sizeable
                                                                               bounce back in GDP growth after
                                                                               the GFC-induced slowdown and an
   4                                                                   4       ultimate return to trend economic
                                                                               growth (3-3½%pa).

                                                                               The 2012 Budget based on a similar
            GDP                         11/12
   2                                                                   2
                                                                               Reality has fallen short of
                                               Government                      expectations in recent years.
                                                o ecasts
                                               forecasts at
                                              various points
                                                2009-2012                      But trend forecasts look relatively
        Source: CBA/Budget estimates                                           “safe” given underlying drivers.
   0                                                                   0
    2004/05       2007/08      2010/11          2013/14      2016/17


Economic Issues
Trend or bust?
                                                                       Trend growth is a popular forecast
       HOW TO GET TO TREND GROWTH                                      (RBA, IMF and market economists).
    %pt       (Budget forecasts for 2012/13)
  contrib                                                              The mining boom and related activities
                                                                       will underpin trend growth.

                                                                       Some leakage through imports and
                                                                       fiscal consolidation.

                                                                       Household spending needs to make only
                                                                       a “normal” contribution.
                                                                       Growth drivers also highlight key
                                                                       domestic risks:
                                                                           –   size of fiscal contraction;
        Higher      Higher        Import      Fiscal   Required            –   absorbing the mining boom; and
       business     exports      leakage     consol-   household
        capex                                idation   spending            –   reliance on a respectable contribution
                                                                               from household spending.


Economic Issues
Domestic risks: fiscal contraction – Pt I
                                                                       Budget forecasts imply an aggressive
   FISCAL POLICY & PUBLIC SPENDING                                     fiscal consolidation.
  %                                                              %
  10                                                             10
                                                                       The swing in the underlying budget
                   Public                                              position, a proxy for the policy stance,
                                                                       is equivalent to 3% of GDP from 2011/12
                                                                       to 2012/13.
  5                                                              5

                                                                       If achieved, this consolidation would be
                                                                       the largest in at least sixty years.

  0                                                              0     A negative for economic growth but not
                                                                       to the extent that the headline figures
                           Fiscal stance                               suggest.
                            (% of GDP)                  Budget
                  ((+) stimulus / (-) contraction))       (f)
  -5                                                             -5
                                                                       State governments account for a
   1979/80   1987/88       1995/96    2003/04     2011/12              sizeable part of public spending and
                                                                       some spending is off budget (eg NBN).


Economic Issues
Domestic risks: fiscal contraction – Pt II
                                                                        There are also some timing issues that
                                                                        magnify the fiscal turnaround but
                 FISCAL CONTRACTION                                     mean less of an economic impact:
   %                            (%of GDP)
   2                                                                    –   some spending has been pulled
          contraction      Core                                             forward into 2011/12 (carbon tax
   1          3%        contraction                                         compensation, Queensland floods
                                                                            compensation prepayment,
                                                                            infrastructure spend acceleration,
                                                                            schoolkids bonus); and
                                                                        –   some spending has been pushed
  -2                                                Core                    back into later years (defence,
                                                                            foreign aid).
                                                                                 g     )
  -3                                             Prepayments,
                                                 modifications          The “adjusted” fiscal consolidation is
                                 2011/12           2012/13
                                                                        equivalent to ≈2% of GDP – still large
                                                                        but more in tune with previous
                                                                        consolidation efforts.


Economic Issues

Domestic risks: absorbing the mining boom
                                                                        Consensus has trend GDP growth
                                                                        over next few years and the resources
                ECONOMIC ACTIVITY                                       sector accounting for ⅔ of that growth.
  Index                 (2010/11 = 100)                   Index
  145                                                       145
            Source: RBA , CBA                                             p
                                                                        –   mining-related economy to expand at
                                                                            ≈16%pa over next two years;
  130                             GDP                        130
                                                                        –   non-mining economy to grow at just
                                                                            1½%pa if overall economy to be kept
                                                                            within the “speed limits”.
  115                                      Non-mining        115
                                             GDP                        Budget forecasts assume a large but
                                                                        less extreme divide (mining 9%pa and
                                                                        non-mining 2%pa).

  100                                                        100        Mining boom benefits spread through
            2010/11             2011/12        2012/13                  payments to families on low-middle
                                                                        incomes and small business support.


Economic Issues
Domestic risks: the unhappy consumer – Pt I

                                                                                 Perception is that household finances
                      USE OF INCOME
                          (Jun'08 to Dec'11)                                     under pressure. Reality is households
                                                 Other                           have consumed at “normal” rates,
                                               Extra debt                        lift d savings and paid off debt
                                                                                 lifted    i      d id ff d bt
                                              (mortgage &
                                                                                 courtesy of strong income growth.
                                              credit cards)
                                                                                 Disposable income has increased at
                                                                                 ≈7%pa since mid 2008.

  20                                                                             Key consumer question is how
                                                Extra                            spending-saving-repayment equation
                                                                                 is adjusted if income growth slows.
                                                                                 Elevated job security concerns
   0                                                                             suggest downside risks to household
            Increase in          Use
            disposable            of                                             spending.
              income           income
                                                                                 The unemployment rate is forecast to
                                                                                 stabilise at 5½% in the Budget.


Economic Issues
Domestic risks: the unhappy consumer – Pt II

                                                                                 General feeling that the “benefits” of
             SENTIMENT & FISCAL POLICY                                           the resources boom are not being
   %                                                                Index
   40                                                                 140        shared around while the “costs” are:
                                * Source: WBC/Melbourne Institute

                 Expected                                                         –    payment of carbon tax
                   family                                                              compensation may help;
                 next year
        0                                                            123          –    tax cuts will deliver a boost to
                                                                                       taxpayers on <$80k pa1 and
                                                                                       improve participation;
                                                                                  –    higher income earners will
   -40                                                               107
                                                                                       welcome confirmation the flood
                                                                                       levy will end on 30 June 2012; and
                    GST          Net % recalling
                              favourable news about                               –    May rate cut delivers interest
                              Budget & taxation (lhs)
   -80                                                               90                savings worth 2¾%pts of income.
     Mar-99        Mar-02      Mar-05     Mar-08        Mar-11
                                                                             1Average annual earnings were $53.7k in QIV 2011. Average
                                                                             FT earnings were $72.2k.


Economic Issues

The Budget and the RBA                                                   Recent debate has centred on the
                                                                         idea that there is a trade-off between
                                                                         monetary and fiscal settings.
                FISCAL POLICY & RATES
            (episodes of large fiscal consolidation)
  Change in
                                                                         OECD analysis shows that real short
   real short
  term rates                      (1993-98)                              term interest rates are often higher
                                    (1993-98)                            at the end of periods of significant
             (1984-88)                                                   fiscal consolidation.
                          (1994-98)                                      Fiscal settings feed into RBA
                                                                         deliberations but there isn’t a
                                                                         mechanical tradeoff.

                                                                         If fiscal settings prove inconsistent
                                                 (1993-00)               with economic conditions, or if
            Source: OECD/CBA                                             activity is under pressure for other
        0             5           10           15              20        reasons, the RBA has room to move.
                   Reduction in Government financial
                         balance (% of GDP)
                                                                         We have a 25bpt cash rate cut
                                                                         pencilled in for August.

Economic Issues

The global backdrop – assessing the Australian government’s global economic forecasts

        Budget Global Growth Forecasts                                      US growth estimates are below the Fed’s
                   2011    2012    2013                                     estimates of 2.7% (2012) and 2.9% (2013).
                                  (a)            (f)          (f)
                                                                            Eurozone GDP forecasts appear
  United States                  1.7            2.0          2.25           plausible, but imply a slightly weaker
                                                                            2013 recovery than the ECB’s forecast
  Euro area                      1.5            -0.75        0.75           (1.1%).
  Japan                          -0.7           2.25         1.75           China’s solid GDP growth forecasts
                                                                            appear plausible (if not too low). The
  China                          9.2            8.25         8.5
                                                                            China GDP growth forecasts imply a solid
  India                          7.3            6.25         7.75           backdrop for Australian commodity
  Other East Asia                4.2            3.75         5.0
                                                                            Firm recovery anticipated in major
  Major trading                                                             trading partner growth isn’t a major
                                 4.2            4.25         5.0
  partners                                                                  surprise – commodity price supportive.
  World                          3.9            3.5          4.0
                                                                            Global growth forecasts match the IMF’s
                                                                            April 2012 forecasts.


 Economic Issues

Global economic forecasts and risks

                                                                                           The Government has acknowledged
                                                                                           some downside risks to the global
             WORLD ECONOMIC GROWTH                                 %pa
                                                                                           economic outlook. These include:
      6                                                                  6

                                   2010                                                      –     a re-escalation of the Eurozone
      5                                          2012                    5                         sovereign debt crisis;

                                                                                             –     a potential lift in global oil prices; and

                                                                                             –     the ability of the US Congress to
      3                                                                  3                         strike the right balance between
            Long-Run Average (3.8%)                                                                short-term fiscal support and long-
      2                                                                  2                         term ffiscal consolidation.

          Source: CBA, Consensus, IMF
                                                                                           The Government recognises the
      Jan-09       Jan-10        Jan-11                   Jan-12                           limited capacity of major advanced
                     Month forecast made in
                                                                                           economies to respond to another
                                                                                           major shock.


 Economic Issues

Global fiscal position comparison                                                    Australia’s fiscal position compares
                                                                                     very favourably to the rest of the
 GENERAL GOVERNMENT NET DEBT                                                         developed world; most countries are
 %                     (% of GDP)                                   %                forecasting further deficits.
100                                                                100
                                                                                     Government Budget Balances - Selected Economices
                   G-20                                                                                             (% GDP)
75                                                                 75                             2010           2011          2012         2013      2014
                                                                                                  Actual        Actual       Estim ate   Forecast    Forecast
                                                                             Australia*            -4.3           -3.4          -3.0         0.1       0.1
50                                                                 50
                                   Emerging                                  US                    -10.5          -9.6          -8.1        -6.3       -4.9
                                    G-20                                     Eurozone              -6.3           -4.1          -3.2        -2.7       -2.2
25                                                                 25        Japan                 -9.4          -10.1         -10.0        -8.7       -7.9
                                                   Australia                 China                 -2.3           -1.2          -1.3        -0.7       -0.6
                                                                             Canada                -5.6           -4.5          -3.7        -2.9       -2.1
  0                                                                0
                                                                             New Zealand           -5.2           -6.2          -4.0        -1.4       -0.3

                                   Source: IMF Fiscal Monitor                UK                    -9.9           -8.7          -8.0        -6.6       -5.0
-25                                                                -25       International figures obtained from April 2012 IMF Fiscal Monitor
      2006    2008   2010     2012        2014     2016    2018
                                                                             * Australian figures obtained from 2012/13 Federal Government Budget.
                                                                             * Australian fiscal years used (ending in stated year).


Financial Market Issues
Treasury vs RBA – telling the same story
                                                 RBA View                                                 Treasury View
                              World growth put at 3½% in 2012 and 4% in 2013. China        World growth 3½% in 2012 and 4% in 2013 as growth in
        Global Backdrop       expected to grow at a slower but more sustainable pace.      emerging economies moderates and large advanced
                              Rest of Asia to pick up a little.                            economies pick up momentum.

                              Terms of trade assumed to decline gradually (although        Expected to decline by 5¾% in 2012-13 and 3¼% in
   Terms of trade (ToT)       near-term forecasts are higher than in the February          2013-14 as supply increases of non-rural commodities
                              SMP).                                                        puts downward pressure on prices.
                              GDP growth 3-3½% in 2012/13. Mining capex to reach           Real GDP growth “around trend”, at 3¼% in 2012/13 and
                              9% of GDP but resource exports held back by transport        3% in 2013/14. Strong business investment and export
                              bottlenecks. Housing construction to remain subdued.         growth, underpinned by surging activity in the resources
        Domestic Growth
                              Savings ratio expected to remain at elevated levels,         sector, will drive domestic growth.
                              implying modest growth in consumer spending. Public
                              spending to grow at “well below trend rates”.

                              Jobs growth expected to be “fairly subdued”. Risk that       Jobs forecast to grow by 1¼% in 2012/13 and 1½% in
         Labour market        firms cut staff to boost productivity and competitiveness.   2013/14. Unemployment rate will reach a max of 5½% in
                                                                                           2012/13 and remain there through 2013/14.

                              Underlying inflation to run in low 2’s in 2012 and 2-3%pa    Inflation should be well-contained. From 2012/13,
                              2013 and 2014. Based on a “judgement” that nominal           underlying inflation should reach 2¾%, including a ¼ppt
                              wages growth slows and productivity lifts.                   contribution from carbon tax. Headline CPI expected to
                                                                                           be 3¼% in this period.
                              Global risks posed to the downside. European sovereign       Key risk to global recovery is euro area sovereign debt
                              debt problems the greatest near-term risk to activity.       crisis, if markets judge the progress of European
                              Domestically, job losses could increase if the near-term     policymakers as “insufficient”. US economy subject to
                              outlook weakens. But, longer-term labour demand could        underlying weakness in housing and labour market as
                              exceed forecasts given pipeline of mining projects.          well as risks from fiscal consolidation. Rising global oil
                              Inflation may be pushed lower on weaker global and           prices also risk to output. The structural change in the
                              domestic output and slower employment growth. Pick-up        domestic economy poses a risk to the labour market.
                              in productivity growth likely to be required to contain      Transitional frictions could see the unemployment rate
                              labour costs and non-tradable inflation pressures.           rising above forecasts.

Financial Market Issues
Market Reaction
   TRADING AT RELEASE OF BUDGET                                                      %               BILL FUTURES CURVE
 2.72                                                            USD
                                                                 1.0250             5.75
                         released                                                   5.25
                                                                                                                              2012/13 Budget
 2.70                                                            1.0200
                                                                                    4.75                                      2011/12 Budget
                                                                                                                              1 Week Ago
 2.68                                                            1.0150

 2.66                                           (rhs)            1.0100
            3 year bond
                (lh )
 2.64                                                            1.0050                    Cash IR1 IR2 IR3 IR4 IR5 IR6 IR7 IR8
    17:30            18:30     19:30         20:30

           Virtually no change in the AUD or Australian three-year bond futures
           immediately following the release of the Australian government’s budget.
           The market continues to expect rapid easing from the RBA.

Financial Market Issues
Net debt stabilising

         COMMONWEALTH NET DEBT                                 The slip in the 2011/12 Budget result
   $bn                                                         means net debt is forecast to be a
   225                                  May 2009               little higher than in the MYEFO.
                                                               littl hi h th i th MYEFO

                                           Current             But the swings are now very mild
                                                               compared to changes in recent years.
    75                                        May
                                              2011             Net debt is forecast to peak at just
                                                               9.6% of GDP next month.
                                                               The peak in bond outstandings is
                                                               forecast to be about $9bn higher than
                               2008                            previously expected.
         98/99 01/02 04/05 07/08 10/11 13/14                   The Government aims to raise the
                                                               debt ceiling from $250bn to $300bn.


Financial Market Issues
Asset growth                                           A return to surplus in 2012/13 means
                                                       net debt is close to peaking.
            COMPOSITION OF
                                                       The long-term projections imply
                                                       negative net debt from 2020/21.
   450                                    Cash &
                                                       But the Govt. also plans to maintain
                                                       bonds on issue at 12-14% of GDP:
   300                                                     –    The market value of bonds is
                                                                projected to rise by $7bn over the
                                                                next two years to around $281bn.
                                                           –    It should broadly trend sideways for
                                                                about six years before then lifting in
                                                                line with GDP growth.
                       Debt               Nov-11           –    The Government will need to
  -150                                  MYEFO est..
      98/99    03/04   08/09   13/14   18/19                    eventually accumulate financial
                                                                assets if it can meet its projections
                                                                over the next five years.


Financial Market Issues
                                    2006/07   2007/08     2008/09          2009/10   2010/11   2011/12   2012/13   2013/14   2014/15   2015/16
                                      (a)        (a)          (a)            (a)       (a)       (a)       (f)       (f)       (f)       (f)
 Headline Budget deficit             -26.7     -28.2          31.3          56.5      51.1      48.4       8.7       6.8       0.1      -2.0
 Bond maturities                      6.1        2.9          5.1            7.9      18.8      14.1      25.6      22.6      26.8      23.9
 Other redemptions                    0          0.2          0.0            2.8       0.0       0.0       0.0       0.0       0.0       0.0
 Miscellaneous                       -0.1        0.1          0.1            0.1       0.1       0.1       2.5       0.1       0.1       0.1
 Sub Total                           -20.7     -25.0          36.5          67.3      70.0      62.6      36.8      29.5      27.0      22.1

 Investments                         24.4      20.8           17.3           0.0      -5.0      -1.0       0.0       0.0       0.0       0.0
 Deposits at RBA                      1.6        9.1          -3.0          -7.0      -2.6       0.0       0.0       0.0       0.0       0.0
 Total                                5.3        4.9          50.8          60.3      62.4      61.6      36.8      29.5      27.0      22.1

 Debt issuance
  - Treasury bonds                    5.2        5.0          34.1          53.7      56.0      58.0      34.8      27.0      25.5      17.1
  - Indexed bonds                                                            7.1       3.4       2.0       2.0       2.5       2.5       2.5
  - Treasury notes (net)                                      16.7          -6.1       6.0       0.3       0.0       0.0       0.0       0.0
 Total                                5.2        5.0          50.8          54.7      65.4      60.3      36.8      29.5      28.0      19.6
  - net change                       -0.9        2.1          45.7          45.9      45.8      46.2      11.2       6.9       1.2      -4.3

 Coupon bonds outstanding            47.2      49.4           78.4          124.7     161.1     206.0     215.2     219.6     218.2     211.4
 Indexed linked bonds                 6.0        6.0          6.0           11.4      14.0      16.0      18.0      20.5      23.0      25.5
 Treasury Notes                                               16.7          11.0      16.1      16.4      16.4      16.4      16.4      16.4
 Commonwealth holdings                5.0        5.0
 Total                               53.2      55.4        101.1            147.1     191.2     238.4     249.6     256.5     257.6     253.3

 Net debt                            -29.2     -44.8       -16.1            42.3      84.6      142.5     143.3     144.9     140.1     131.6


Financial Market Issues
CGS Outstandings to plateau in the next few years

                                                                                     The surplus was almost exactly equal
                    Coupon bonds                                                     to expectations. Short-term forecasts
  $bn                                                                $bn
                              g                        May-                                                        y
                                                                                     of net debt have increased only
  350                                                   09           350
                    Treasury Notes
                                                       est.                          marginally.
  300                                                                300
                    Indexed linked bonds                                             Total CGS issuance is expected to rise
  250                              May-10 est.                       250             to $238bn this financial year, $249bn
                                   May-11 est.                                       next year and around $255bn in the out
  200                                                                200
  150                                                                150
                                                                                     Coupon bond issuance is expected to
  100                                                                100                                $220bn,
                                                                                     peak at just under $220bn T-notes are
   50                                                                50              expected to remain at $10bn or higher
                                                                                     for the next few years and indexed
     0                                          0                                    bonds are set to grow by around $2-
      90/91 94/95 98/99 02/03 06/07 10/11 14/15
                                                                                     3bn per annum.


Financial Market Issues
Coupon Bond Issuance
  $bn                                                    $bn
                                                         25                 New Issuance 12-13
   25            Issuance in 11-12 to date                                  Remaining Issuance 11-12
                 30-Jun-11                                                  Today
   20                                                    20

   15                                                    15

   10                                                    10

    5                                                    5

    0                                                    0
         May -13

         May -21
         Mar -19

                                                               May -21

                                                               May -24
         Apr -12

         Apr -15

         Apr -20

         Apr -23
         Apr -27

                                                               Mar -19

                                                               Apr -15

                                                               Apr -20

                                                               Apr -23

                                                               Apr -27
         Nov -12









         Feb -17








        Liquidity in existing coupon bond lines should remain solid, despite the step-
        down in new issuance to $37bn in 2012/13.
        The AOFM may open up to two more ACGB lines next financial year. A 2024
        bond seems likely alongside a 3Y or 5Y.

Financial Market Issues

 Demand for bonds remains strong
    $bn        CGS TURNOVER VOLUME                                B/C 1.5 to 3.5        B/C 3.5 to 5.5
    350                                                           B/C 5.5 to 8          B/C 8 to 20
    100                                              2.00
        50                                           1.00

        0                                            0.00
        Jan-08 Oct-08 Jul-09 Apr-10 Jan-11 Oct-11       Jan-10   Jul-10    Jan-11   Jul-11   Jan-12
         Greater issuance in recent years and stronger offshore interest in AUD assets
         is supporting a higher turnover in the CGS market.
         Auction coverage ratios remain strong despite an increase in tender sizes.

     Financial Market Issues
      Foreign Investment
          Government is Forecasting a larger                                                                  Capital account inflows (% of GDP)
          current account deficit (% of GDP)                                                                                  Central Bank & Reserves
                                                                        F'cast                                                Non-Government
               0                                                                                         10                   Government
              -1                                                                                                              Current Account Deficit

              -2                                                                                         6

              -3                                                                                         4

              -4                                                                                         2
              -7              2012/13            2011/12 Budget Estimate
                                                                                                               00 01 02 03 04 05 06 07 08 09 10 11

        Weaker commodity prices and higher imports mean a larger current account deficit.
        Inflows into CGS more than financed current account deficit in 2011, but there is now
        scope for composition of capital account flows to shift towards the private sector.

     Financial Market Issues
     Ratings strength

          ECONOMIC VARIABLES                                                     FISCAL METRICS                                                        DEBT RATIOS
                                                                                      (% OF GDP)
      2011 Range   Aust Budget 12-13   Median    USA (AA+)              2011 Range   Aust Budget 12-13    Median   USA (AA+)             2011 Range    Aust Budget 12-13   Median   USA (AA+)

14                                                           14   100                                                     100       90
12                                                           12   80                                                      80                                                               50
10                                                           10                                                                                                                            20
                                                                  60                                                      60
8                                                            8                                                                                                                             -10
                                                                  40                                                      40       -30
6                                                            6                                                                                                                             -40
                                                                  20                                                      20
4                                                            4                                                                     -90                                                     -70
2                                                            2     0                                                      0
                                                                                                                                  -120                                                     -100

0                                                            0    -20                                                     -20     -150                                                     -130
      Real GDP Growth     U/e Rate              CPI                      Surplus /   Primary      Revenue      Expenses                     Net Debt        CAD / GDP        CAD / CAR
                                                                          Deficit    balance

               Australia’s economic performance and fiscal metrics remain consistent with a
               top tier AAA credit.
               However, net debt and the current account deficit remain much larger than
               most AAAs. Australia will have the largest CAD of any AAA.


Financial Market Issues
Demand for bonds remains strong
             FOREIGN OWNERSHIP & AUD                                  FOREIGN BOND OWNERSHIP & AUD-US 10YR
    Share of total                                     AUD/USD         Share     BOND SPREAD               bp
     80%                                                   1.10    80%                                     600
                              Foreign                              70%                           Foreign CGS
     70%                     ownership                     1.00                              bond ownership (LHS)           500
     60%                       (lhs)                               60%
                                                           0.90                    AUD-US 10yr spread                       400
     50%                                                           50%                   (RHS)
     40%                                                           40%                                                      300
     30%                                                           30%
                                                           0.60    20%
     10%                                   ( )
                                           (rhs)           0.50    10%
              * CGS
      0%                                                   0.40        0%                                                   0
           88 90 92 94 96 98 00 02 04 06 08 10 12                           88 90 92 94 96 98 00 02 04 06 08 10 12

       Strength in the Aussie dollar, strong fiscal metrics and a wide interest rate
       differential have supported a surge in foreign demand for Aussie bonds.


Financial Market Issues
Fixed income demand
           MANAGED FUND ALLOCATIONS*                                              BOND MARKET ALLOCATIONS
               (share of total assets)                                          (share of total super & life assets*)
  % of total assets                                                    share of assets
   50%                                                                 12%
                                                                                           State & local
                                            Equities                                          bonds
               Total fixed
   40%          income*
   30%                                                                                               bonds
                      Overseas                                                                                      Other
                                 Property                               3%
                       Cash d     it
                       C h & deposits

         88 90 91 93 94 96 97 99 01 02 04 05 07 09 10                          90 92 94 96 98 00 02 04 06 08 10

       Domestic fixed income allocations have been falling for years, with holdings
       of government bonds very low.

Financial Market Issues

 Sovereign risk and return

                            PUBLIC DEBT MARKET                                      %
 USD tn                                                                   USD tn              AAA 10Y SOVEREIGN YIELDS
                                ($US trillion)                                      8
 14                                                                          14
                                        Below AAA = US$ 37 9 trillion               7
 11                                     AAA = US$ 6.5 trillion (15%)          11    6

  7                                                                           7
                                                            Source: BIS
  4                                                                           4
                                                                                              Australia       Norway
  0                                                                           0     1         Switzerland     Canada
        US      EZ Japan UK        Lat. AXJ Aust. Switz. Scand.Canada                         UK              Germany
 Note: US total excludes US$4.5tn debt in "intragovernmental holdings". Ratings         00 01 02 03 04 05 06 07 08 09 10 11 12
 based on S&P.

             Australia is one of a diminishing pool of AAA-rated sovereigns.
             Australian Government bond yields are high by AAA standards.


Financial Market Issues
Fiscal discipline generally supports Australia’s AAA rating and the AUD. But there is a small risk.

                                                                                   Fiscal discipline underpins Australia’s
                                                                                   AAA sovereign credit rating; and
                  AUD & NON-JAPAN ASIA                                             stands in stark contrast to the poor
      AUD                   (VIS-A-VIS AUD)                  ASIA
      1.20                                                      139
                                                                                   achievements of major developed
                   AUD/ADXY Weighted
                   Non-Japan Asia vis-à-
      1.10                                                      125
                          vis USD (rhs)
                                                                                   Asia-led global economic growth
      1.00                                                      111                should continue to support
                                                                                   commodity prices and exports.
      0.90                                                      97
                                                                                   While Australia’s terms of trade has
      0.80                                                      83                 peaked, it is expected to remain at
                                                                                   historically hi h l  l
                                                                                   hi t i ll high levels.
      0.70                                                      69

                                                                                   The government’s assumption of
         Jan-06    Jul-07     Jan-09    Jul-10     Jan-12
                                                                                   lower interest rates to compensate for
                                                                                   fiscal contraction is a downside risk
                                                                                   for the AUD.


Sectoral Issues
Sector                                                Pluses                                           Minuses
                                        Carbon compensation payments from                 Rising unemployment forecast a
                                        May 2012 and changes to tax-free                  negative for job security concerns.
                                                                                          Higher income ($300kpa)
                                        Carbon compensation tax cuts for                  superannuation concessions reduced.
                                         iddl    d low i
                                        middle and l   income earners.
                                                                                          Termination payment tax offset cut.
                                        End of Qld flood levy.
                                                                                          Living Away From Home Allowance,
                                        Education Tax Refund replaced by                  golden handshakes curbed.
                                        Schoolkids bonus ($1.3bn in 2011/12).
                                                                                          Smokers will lose out with duty free
Households                              Increase in Family Tax Benefit Part-A.            cigarette allowance cut from 250 to 50.
                                        New Supplementary Allowance worth                 Overseas travellers will pay $8 more.
                                        $1.1bn on individuals/families on
                                        income support from March 2013.                   Higher marginal tax rates will offset
                                                                                          benefit from higher tax free threshold
                                        From July 2012, more than tripling the            for middle-higher income earners.
                                        tax-free threshold from $6,000 to
                                        $18,200. From July 2015, further                  Limit access to Family Tax Benefit A to
                                        increase in the tax-free threshold.               children under 18/full-time secondary.

                                                                                          End of standard deduction for work


Sectoral Issues
Households the main beneficiaries
                                                                                    HOUSEHOLD BENEFITS
                             TAX CUTS                                 %                   (% of household income)
     $                                                      $
                            ($ per annum)                             2.0
    1500                                                  1500

    1200                                                  1200        1.6
                                                                                                                      End of
                                  2011-12 Flood                                                                     flood levy
                                    levy ending
     900                                                  900         1.2                          mortgage

     600                                                  600
                        2015-16                                       0.8
                                                                            School kids
     300                                                  300
                       2012-13                                        0.4
                                                                                                                  Carbon price
         0                                                0                                                      (inc tax cuts)
             5000   30000   55000 95000 145000 195000
                              taxable income                          0.0

     Carbon tax compensation tax cuts and end of flood levy to deliver income boost.
     Policy initiatives (inc rate cut) will make significant contribution to H/hold income.


Sectoral Issues

Sector                              Pluses                                   Minuses

                     Loss Carry Back Tax Reform will allow      Reduction in company tax rate for
                     refunds from tax previously paid when      small business from 1 July 2012 will
                     losses are made.                           not proceed.

Small Business       Instant asset writeoff (up to $6.5k)       Additional funding for the ATO to chase
                     starts on 1 July 2012.                     outstanding tax debts.

                     $5000 instant writeoff for the purchase
                     of new or used motor vehicles.

                     Invest $1.0bn over four years into first   Decreasing the Pharmaceutical
                     stage of the National Disability           Benefits Scheme by negotiating lower
                     Insurance Scheme.                          prices.

Healthcare                   $3 7bn
                     Provide $3.7bn to reform aged care                        cut.
                                                                No company tax cut

                     Increase number of Home Care
                     packages by 40,000.

                     Increase dental services spending by


Sectoral Issues

Sector                             Pluses                                   Minuses
                     Additional assistance to increase          No company tax cut.
                     Mature Age Participation – Job Seeker
                     Assistance Program.

                     Remote Jobs and Communities
                     Program from 1 July 2013.

                     Expanding the Home Interaction
Education & Skills   Program for Parents and Youngsters.

                     National Partnership Agreement
                     changes to Vocational & Education
                     Training (VET) with $1.75bn extra
                     funding over 4 years.

                     Spending on Australian Skills Centres.
                     Increase in superannuation guarantee       No company tax cut.
                     contributions to 12% by 2019/20.
                                                                50% discount on interest income
Finance              Reduction in interest withholding tax      scrapped.
                     form 2015.
                                                                Increase in APRA charges.


Sectoral Issues

Sector                          Pluses                                     Minuses

                  Duplication of Pacific Highway by           No company tax cut.
                                                              Road User Charge for trucks, road
                  Expanded Roads Recovery program.            trains and buses rising from 23.1c/l of
                                                              fuel to 25.5c/l from 1 July.
                  Torrens & Goodwood rail project in
Transport         Adelaide.

                  Development of an intermodal terminal
                  at Moorebank in Western Sydney.

                  Continuation of Black Spots program

                  Potential boost from significant            No company tax cut .
                  assistance to households including
                  the carbon price compensation, the          Negative impact on consumer
                  end of the flood levy, the schoolkids       spending by higher utility charges, the
Retail            bonus, income support supplement.           changes to the health insurance
                                                              rebate and superannuation tax
                  Projected low unemployment ahead            concessions and some “better
                  could boost consumer confidence and         targeting” of other transfer payments.
                  spending on retail.


Sectoral Issues

 Sector                           Pluses                                      Minuses

                    Increased spending on transport             No company tax cut.
                    infrastructure outlined in transport
                    segment on previous page.

                    Delivering 76 major new regional
                    health infrastructure projects across
                    Australia, worth $475 million.

 Construction       $50 million to the Stage 2
                    redevelopment of the Sydney Cricket

                          illi to the d    l     t f the
                    $30 million t th redevelopment of th
                    Adelaide Oval; and

                    $15 million to the redevelopment of the
                    Bellerive Oval in Hobart.


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