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Budget 2007 Home Page Budget Economic and Fiscal Update [2007]

1 Economic and Tax Outlook

Summary

Real Gross Domestic Product (GDP) growth has re-accelerated after a short period of below-trend growth

  • The economy expanded by 0.8% in the last quarter of 2006, a pace estimated to have been matched in the first quarter of this year.
Figure 1.1 - Growth in real production GDP
Figure 1.1 - Growth in real production GDP
Sources: Statistics New Zealand, The Treasury
  • Quarterly real GDP growth is expected to be maintained at or just below potential (around ¾%) before easing in late 2007. The pace and duration of the current rebound is the main uncertainty of these forecasts.
  • The central forecasts see annual average real GDP growth of 2.6% over the year to March 2008, up from 1.7% in the March 2007 year. Key risks and two alternative scenarios are explored in the Risks and Scenarios chapter.

The upswing is being driven by a rebound in domestic demand

  • Household consumption and investment spending have rebounded. The recent momentum is expected to be sustained for the next few quarters on the back of ongoing strong labour income growth. Additional support has come from somewhat lower oil prices, the recent pick-up in house price growth and immigration flows, the final stage of Working for Families and the high exchange rate keeping prices for imported goods and services low.
  • Business investment has rebounded sharply, while government consumption and non-market investment are forecast to contribute around a total of 0.2 percentage points to quarterly growth.

The brief period of slower growth was not enough to lower inflation pressures which remain elevated and the exchange rate is near post-float highs 

  • Despite an expected temporary easing in annual Consumers Price Index (CPI) inflation to 1.7% in September 2007, associated with volatile petrol prices and the high exchange rate, the domestic, non-tradables bias of growth means strong medium-term inflation pressures are forecast to persist. CPI inflation is expected to return to near the top of the 1% to 3% target range by March 2008.
Figure 1.2 - Output Gap and annual nontradables inflation
Figure 1.2 - Output Gap and annual nontradables inflation
Sources: Statistics New Zealand

  • Recent increases in the prices of some major export commodities have boosted the terms of trade, which is forecast to contribute to a fall in the current account deficit over 2007. Nevertheless the current account deficit is expected to remain above its long-run average.
  • In response to more persistent inflation pressures, short-term interest rates are expected to be higher for longer than forecast in the Half Year Update.

The upswing in growth is not expected to be sustained, allowing inflation to ease eventually

  • Effective mortgage interest rates are expected to increase to an even greater extent, reflecting the rise in swap rates and the recent increase in bank margins on fixed rate loans. This contributes to an eventual decline in household spending growth.
  • Real GDP growth is expected to slow to 1.6% in the March 2009 year. The unemployment rate is forecast to rise to around 4½% in mid-2009 from 3.7% at the end of 2006.
  • The slower period of growth during the March 2009 year is forecast to lead to an easing of non-tradables inflation. CPI inflation is forecast to decline to 2.4% in March 2009, despite solid tradables inflation owing to a forecast depreciation of the exchange rate.

Eventually growth returns to trend and the pattern of growth becomes more balanced as interest rates and the exchange rate fall

  • Export volume growth is expected to increase in the later forecast years as growth in services and manufactured exports accelerates following the forecast exchange rate depreciation from 2008. A lower exchange rate also acts to reduce import growth. The current account deficit is forecast to fall to around 6% of GDP.
  • Despite lower interest rates, weak household spending growth is forecast to continue for a sustained period as people respond to higher debt servicing costs, falling house prices and net wealth, and slower income growth. Somewhat higher unemployment will also make households less sure about job security.
  • Real GDP growth of around 3% is forecast for the March 2010 and 2011 years – around potential.

The more cyclical outlook for growth and inflation will be mirrored in tax revenue growth

  • A higher level of inflation, a lift in the terms of trade and near term strength in domestic demand all contribute to a higher level of nominal GDP than forecast in the Half Year Update until the middle of 2009.
  • Forecasts of tax revenue growth have been revised up for the 2007 and 2008 fiscal years, mainly on the back of higher growth in source deductions (PAYE), GST and Resident Withholding Tax (RWT).
  • In the 2009 June year, the Business Tax Reform (BTR) announced in the Budget sees corporate tax revenue decline and overall tax grow at a pace below nominal GDP growth.
  • Notwithstanding the tax policy changes which reduce the tax take, the ratio of tax revenue is forecast to end the forecast period little changed from what it was in the year to June 2006, and higher than forecast in the Half Year Update. This reflects the removal of the judgement concerning corporate tax losses built into recent forecasts, and labour receiving a greater share of nominal GDP.

The discussion of the forecasts that follows is separated into four parts:

  • the slowdown during the 2005 and 2006 calendar years
  • the current re-acceleration in growth
  • a forecast slowdown in the March 2009 year, and
  • a return to trend growth in the years to March 2010 and 2011.

Table 1.1 – Economic outlook: central forecast [1]

Economic outlook: central forecast
(Annual average % change, year to 31 March) 2006 Actual 2007 Estimate 2008 Forecast 2009 Forecast 2010 Forecast 2011 Forecast
Private consumption4.31.73.21.61.61.6
Public consumption[2]4.74.44.13.94.03.5
Total consumption 4.4 2.3 3.4 2.1 2.1 2.1
Residential investment-4.7-2.33.4-1.9-0.50.9
Central government investment6.4-3.44.1-0.5-1.7-0.3
Other investment7.5-4.65.80.21.44.2
Total investment 4.1 -4.0 4.9 -0.3 0.8 3.3
Stock change[3]-0.5-0.40.8-0.1-0.2-0.1
Gross national expenditure 3.9 0.6 4.4 1.4 1.6 2.3
Exports-0.33.10.43.54.14.1
Imports4.1-1.24.82.20.41.6
GDP (production measure) 2.0 1.7 2.6 1.6 2.8 3.1
 - annual % change 1.82.32.11.93.03.3
Real GDP per capita1.10.61.50.71.92.3
Nominal GDP (expenditure basis)4.64.45.63.54.24.8
GDP deflator2.12.32.61.91.41.7
Employment[4]2.71.80.81.00.51.3
Unemployment[5]3.93.83.94.54.44.3
Wages[5]4.74.84.14.04.03.6
CPI inflation[7]3.32.62.72.42.42.2
Export prices[8]1.08.8-2.64.29.15.5
Import prices[8]1.87.3-6.04.19.85.7
Current account balance      
  - $ million-14922.0-13933.2-12676.9-12593.1-12844.5-12100.9
  - % of GDP-9.6-8.6-7.4-7.1-6.9-6.2
TWI[9]68.368.869.062.356.954.5
90-day bank bill rate[9]7.67.88.06.76.36.2
10-year bond rate[9]5.75.86.16.16.16.0

Sources: Statistics New Zealand, Reserve Bank of New Zealand, The Treasury

NOTES:

  • 1 Forecasts finalised on 16 April 2007.
  • 2 The forecast profile for public consumption is influenced by government defence spending.
  • 3 Contribution to GDP growth.
  • 4 Household Labour Force Survey, full-time equivalent employment.
  • 5 Household Labour Force Survey, percentage of the labour force, March quarter, seasonally adjusted.
  • 6 Quarterly Employment Survey, average hourly ordinary time earnings.
  • 7 Annual percentage change.
  • 8 Overseas Trade Index basis, annual average percentage change, March quarter.
  • 9 Average for the March quarter.

Assumptions Underlying the Central Forecast

Global economic activity – global economic growth, inflation and interest rate forecasts are taken from the March 2007 Consensus Forecasts and Asia Pacific Consensus Forecasts. The general outlook remains positive and for steady growth of around 3.6% for our top 14 trading partners over the period. The outlook for the United States economy in 2007 has weakened recently, with growth expected to be only 2.4% in 2007, but stronger growth is now expected in Japan and the Euro Zone in the near term. Growth in Australia is expected to be 3.0% in 2007; and 2.6% in the UK.

Oil prices – prices for West Texas Intermediate (WTI) in the December quarter of 2006 matched the assumption in the Half Year Update, but lower prices in early January contributed to March quarter prices averaging US$58/barrel – around US$4 below the Half Year Update assumption. Futures pricing at the time these forecasts were finalised suggested that prices will increase to US$68/barrel in June 2008 and not fall below this point until the start of 2010. Prices end the forecast period at around US$67/barrel, about US$2/barrel higher than in the Half Year Update.

Net migration – net migrant inflows of around 13,000 are expected in the year to March 2007. Net migration levels are then assumed to fall by around 1,000 a year over the next three years so that net migration totals 12,000 in the year to March 2008, 11,000 in the year to March 2009 and 10,000 in the years to March 2010 and 2011.

Monetary conditions – the NZ dollar exchange rate as measured by the Trade Weighted Index (TWI) is assumed to average 70.0 over the June quarter of 2007 and 69.0 during the next three quarters through to March 2008, before easing to 62.3 in March 2009, 56.9 in March 2010 and 54.5 in March 2011.

Climate – agricultural growing conditions and the level of hydro electricity storage lakes are assumed to be normal over the forecast period.

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