The Government's first year in office was dominated by the global economic and financial crisis. This phase was about getting the balance right between supporting jobs and economic activity, and ensuring that the Government's longer-term finances remain sound and constrain debt accumulation.
The evidence to date indicates that the Government has achieved this balance. The severity of the downturn in New Zealand has been less than in many other Western countries and also less than was feared just six months ago. Growth is expected to be a little stronger over the next two years than forecast in Budget 2009. Unemployment is now expected to peak significantly lower than had been anticipated six months ago. Budget 2009 slowed the growth of low-value government spending and introduced a credible programme to limit debt accumulation. New Zealand's high sovereign credit rating and the ability of New Zealanders to access credit have been maintained.
Looking ahead, the Government's main priority is to get the economy growing in a sustainable fashion. While fighting the recession, the Government has also been planning ahead for the next phase - a permanent lift in growth rates. Six key areas have been identified as opportunities to lift growth. These are investment in productive infrastructure; removing red tape and improving regulation; supporting business innovation and trade; lifting skills; lifting productivity and improving services in the public sector; and strengthening the tax system. Many of these areas have been reviewed by a range of independent taskforces which are now reporting back.
Budget 2010 will also foreshadow a more comprehensive approach to managing the Government's assets and liabilities. The experiences of the past year have demonstrated the costs that can arise through falls in asset values or growth in liabilities during financial shocks. The Government has an obligation to taxpayers to provide better stewardship of Crown assets and liabilities. The 2010 Fiscal Strategy Report (FSR) will lay out a better approach to monitoring and risk management of the Crown balance sheet.
The year ahead represents an opportunity to lift the growth rate and make New Zealand stand out by making quality economic decisions. The crisis of the past year has buffeted most economies. Unfortunately many of them will be saddled with permanently higher debt levels. Ultimately this will result in higher taxes worldwide. Maintaining sound finances and low taxes can be a real point of difference in attracting business and skilled people to New Zealand.
The Government’s response to the crisis of the past year…
When this Government was elected to office, New Zealand had already been in recession for about a year - longer than almost all of our trading partners. New Zealand was vulnerable to external shocks because we had relied on overseas borrowing to fund a decade of excessive household and government spending.
The global financial crisis threatened to cut off credit to New Zealand households and businesses. As the disruption to world financial markets spread to the real economy, world growth slumped. A year ago, almost all our trading partners were in recession and credit markets were in paralysis. An economic downturn rivalling the Great Depression was a distinct possibility. Unprecedented monetary and fiscal interventions were undertaken world-wide in response.
Faced with this outlook, the Government's first priority was to support the economy through the recession. As promised, the Government delivered personal income tax cuts on 1 April 2009 which put extra cash in New Zealanders' pockets. We also implemented a number of initiatives specifically aimed at those most affected by the downturn, including retraining and redundancy support measures. The Government acted to save jobs - with a $480 million tax package to help small businesses manage through the recession; and by bringing forward nearly $500 million of infrastructure spending.
In Budget 2009, the Government focused on meeting its pre-election commitments and on helping vulnerable New Zealanders through the recession. We maintained entitlements to provide certainty in tough economic times and we invested more than ever in the frontline services of Health, Education and Law and Order. We launched a $323 million home insulation fund to support jobs, improve the environment and help reduce the household electricity bill.
Monetary policy also eased considerably. The Reserve Bank lowered the Official Cash Rate from 8.25 percent to 2.5 percent, among the largest percentage point decreases in OECD economies. In addition the Reserve Bank introduced a range of measures to ensure availability of liquidity to the financial system. Reflecting the improved economic and financial outlook, some of these measures have now been withdrawn or are in the process of being so.
…is now bearing fruit as the outlook improves
As we approach the end of 2009 the outlook has, for now, stabilised. Treasury is now expecting a stronger recovery over the next couple of years than it had forecast at Budget 2009. However, the economy will still not return to pre-recession levels until the end of 2010.
The uplift in Treasury's growth forecasts incorporates stronger trading partner growth, together with higher net immigration and higher international commodity prices. Domestic confidence has recovered strongly. In part this also reflects the Government's success in heading off a steep rise in unemployment.
The joint impact of these developments and their associated fiscal implications are summarised below.
|Real production GDP (annual average % change, March year)|
|Half Year Update||-1.1||-0.4||2.4||3.2||3.0||2.8|
|Unemployment rate (%, March quarter)|
|Half Year Update||5.0||7.0||6.9||6.0||5.3||4.8|
|Inflation (annual % change, March quarter)|
|Half Year Update||3.0||2.5||2.3||2.2||2.3||2.0|
|Net debt ($ billion)|
|Half Year Update||17.1||27.4||38.8||49.0||57.5||64.9|
|Net debt (% of GDP)|
|Half Year Update||9.5||14.8||20.0||24.1||26.9||29.0|
|Operating balance before gains and losses (% of GDP)|
|Half Year Update||-2.2||-4.0||-3.4||-2.9||-2.7||-2.2|
Source: The Treasury
This improvement is welcome. Averting a fully-fledged crisis means that we can now focus on the opportunity to come out of the downturn better placed to attract investment and innovation, and to create jobs that will attract and retain highly skilled workers. To do this we need the right policy decisions to support growth and keep taxes low.
But challenges remain
Substantial unknowns remain. The ability of world growth to be self-sustaining as stimulus is withdrawn is unproven. The New Zealand dollar has risen strongly on a trade-weighted basis. Some of this reflects our relative performance against those economies that suffered deeper recessions, notably the United States and the United Kingdom. Even so, it is a substantial negative for New Zealand exporters. The growth outlook remains moderate and risky.
The peak unemployment rate has been revised down from 8 to 7 percent. Relatively high levels of unemployment are expected to continue throughout 2010. However, this should be seen in context. The lift in unemployment has been low compared with both what has happened in some other Western economies and with the last comparable recession in the early 1990s. The Government has worked hard to support jobs, and earlier this year we enacted several measures to maintain employment. The number of unemployed is now expected to peak around 17,000 lower than was projected in the last Budget.
- Figure 1 - Unemployment
- Source: Statistics New Zealand, the Treasury
The fiscal situation remains challenging. The Government inherited a structural increase in spending that was not sustainable once the economic boom ended. The result of this structural increase is ongoing deficits. Budget 2009 forecast cash deficits of around $12 billion over the next three years. This has resulted in a borrowing programme averaging $250 million per week. The outlook is only slightly improved in these forecasts, and the borrowing programme remains uncomfortably large. Operating deficits, before gains and losses, that were expected to remain until 2018 are now expected to remain until 2016. This remains a substantial challenge for the Government.
The longer-term fiscal projections assume maintenance of current policy, including tax rates. If this happened, rising incomes mean that the Government would benefit substantially from fiscal drag. By 2024, the end of the projection period, the average income would lie above $70,000 and would therefore be in the highest tax bracket. The projected average tax rate on the average wage would rise from 18.8% today to 24.2% in 2023/24. This is contrary to the goal of an internationally competitive, low tax economy that provides incentives to a mobile labour force to stay and work in New Zealand. The Government's aim is to keep both debt and taxes low.
Budget 2010 will continue the Government's programme to address these challenges.