The starting position for government debt is low …
Figure 1 shows the movements in fiscal aggregates since the early 1970s. The ratio of gross debt to GDP has declined in the past 20 years.
- Figure 1 - Fiscal aggregates
- Source: The Treasury
After peaking at just below 80% of GDP in 1987, debt has steadily declined and was 17.5% of GDP in June 2008. Net worth has lifted sharply, moving from a negative position in the mid-1990s to now be strongly positive, at just below 60% of GDP. These developments mean that New Zealand is coming into a period of weak growth from a stable starting fiscal position.
… however, the forecasts of the fiscal outlook have deteriorated significantly since the Budget Update
While the starting level of government debt is low, the fiscal outlook for the future has deteriorated since the Budget Update and the Pre-election Update. At the time of the Budget Update, gross debt was forecast to be 16.8% of GDP by 2011/12 and projected to increase to 21.2% of GDP by 2017/18 before declining a little, to under 20% by 2022/23.
The latest forecasts show gross debt increasing to 33.1% by 2012/13 and it is projected to then increase to around 57% by 2022/23 in the absence of any policy changes. This is a result of a projected long period of operating deficits, which start in 2009/10 as the economy goes through a weak period of growth. The deficits are forecast to remain, even as the economy begins to grow more quickly.
- Figure 2 - Changes in forecast nominal GDP since Budget Update
- Source: The Treasury
A number of factors have combined to contribute to the projected decline in the fiscal position in the future, including:
- a weak outlook for the economy, reducing incomes and profits and therefore tax revenue. The Treasury also expects the weak economy to result in higher expenditure on benefits. The impact of weaker real economic activity on nominal GDP is shown by the change in real GDP component of figure 2;
- the effects of lower inflation reducing the nominal tax base. This should also reduce the rate of increases in fiscal costs. The impact of lower forecasts for prices on GDP is shown in the change in prices component of figure 2; and
- structural increases in spending in the past.
- Figure 3 - Core Crown revenue and expenses
- Source: The Treasury
Figure 3 shows that even once the economy starts to pick up momentum during 2010 and 2011, the forecast increase in revenue is not enough to cover rising expenses, including the impact of higher debt servicing costs as debt grows. As a result, deficits are forecast to continue.
There is a lot of uncertainty around the economic outlook at present …
Since the Budget Update, the Treasury has made sizeable downward revisions to its forecasts of activity in New Zealand and the terms of trade, in part owing to the deteriorating outlook for trading partner growth and because of the effect of financial market turmoil on the availability of credit in New Zealand. Reflecting this uncertainty, the Treasury has produced a main forecast and two additional scenarios showing how the economy could develop.
The weaker outlook for the economy is the result of a number of factors:
- Financial market turmoil and its impact on the international economy is forecast to reduce activity internationally and weaken the trading environment for New Zealand firms.
- The availability of credit has tightened and households and businesses are expected to be more cautious in their spending.
- Imbalances have emerged in the New Zealand economy during a period of above-trend growth. Exports have been weak, household debt has reached record levels and the current account deficit is high. Resolving these imbalances will take time.
Forecasts of international, and New Zealand, economic activity have been volatile recently. This uncertainty means that the possible fiscal outlook sits within a wide range of outcomes. Our fiscal strategy therefore needs to be flexible enough to deal with this range of possible outcomes.
… but sizeable fiscal stimulus is helping to buffer the economy
Fiscal stimulus is in the pipeline through changes to taxes. In addition, the forecast increase in unemployment spending is also operating to help buffer the economic slowdown. Figure 4 plots estimates of discretionary fiscal easing across the years 2007 to 2010 for OECD economies. Based on these estimates, fiscal easing in New Zealand is at the more expansionary end of what is being carried out internationally.
- Figure 4 - Change in general government structural balances between 2007 and 2010
- Source: OECD, the Treasury
The Government is conscious of the need to support economic activity at present. Falling interest rates mean that monetary policy is now more stimulatory. Our planned tax cuts and infrastructure spending will help maintain activity and we are bringing forward some further capital spending to help boost activity. At present the Government believes that the extent of fiscal stimulus is an appropriate response to the circumstances facing New Zealand.
Many countries are encountering a similar situation, with declining growth and worsening fiscal outlooks, and are considering the appropriate response. In some cases this includes revisiting fiscal strategies and targets, and the path for returning to more prudent debt levels over time.
The forecasts and projections of debt are outside the range that the Government considers prudent and we will be taking steps to ensure debt and net worth do not deteriorate to the extent projected
The 10-year fiscal projections from 2012/13 to 2022/23 in the updated economic and fiscal forecasts show what would happen if the economy develops in line with the Treasury's forecasts and projections, and in the absence of any action from the Government to prevent such developments. The updated forecasts and projections are not consistent with the long-term objectives set out by the previous Government in the 2008 Fiscal Strategy Report and are not consistent with the Government's intentions. Across the three scenarios that Treasury have prepared, the 10-year projections suggest a path that is outside of the range that the Government considers prudent in light of rising debt servicing costs and preparation for future fiscal pressures. Our initial steps to deal with these challenges are to:
- establish the true nature of the fiscal risks that exist;
- where possible, drop unfunded commitments made by the previous Government;
- establish a Budget process for 2009 that is limited to the immediate priorities of the incoming Government and any emergency pressures; and
- halt the growth in the number of people employed in back office government administration.
The fiscal objectives will be revised in the 2009 Fiscal Strategy Report
In the 2009 Fiscal Strategy Report we will set new fiscal objectives. Our focus will be on ensuring a stable economic environment, underpinned by a plan to set revised objectives, and take credible and achievable steps, which will be published in the 2009 Fiscal Strategy Report, to stop debt rising and eventually get it down and maintain net worth. Achieving this will mean a focus on influencing the fiscal aggregates, such as debt and net worth measures over a long time period, lifting growth in the economy and constraining expenditure. Our objective is to lift growth through reducing regulation, lower taxes and lifting productivity. Having a public sector that delivers quality services and better value for our investment in it is an important component of achieving the fiscal outcomes we want.
- Fiscal easing is measured as the change in the underlying general government financial balance, which removes the estimated effects of the business cycle as well as one-off factors. These are OECD estimates from the Economic Outlook released in November. The OECD finalised their estimates based on information available on 14 November 2008, basing their fiscal estimates on legislated tax and spending decisions, as well as other announced policies that are likely to be implemented in their announced form. The fast-changing nature of the global situation and policy responses across OECD economies means that these estimates are subject to change.