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

Growth Eased in 2005 and 2006

New Zealand’s rate of economic growth slowed in 2005 and 2006 …

Figure 1.3 - Real GDP and final domestic demand
Source: Statistics New Zealand

During 2005 and most of 2006 New Zealand’s annual average rate of growth slowed, with real expenditure GDP growth falling from 4.0% at the end of 2004 to 1.5% in September 2006. This followed a period of strong growth between 2002 and 2004, in which real expenditure GDP growth peaked at 5.1% in June 2003. The slowing in domestic demand growth was particularly marked – the contribution to GDP growth from final domestic demand has declined sharply from over seven percentage points during 2004 to just over one percentage point in the year to December 2006.

… as a range of negative forces came together

Reversals in some of the same factors which contributed to the period of strong growth from 2002 to 2004 were behind the slowdown in the 2005 and 2006 calendar years. Declining migration, slowing house price growth and tighter monetary conditions in the latter period led to slower household and business spending, overcoming the effects of the generally high terms of trade, strong labour market and an increase in government consumption and investment spending, which all acted to support growth.

Net migration gains have eased from their peak, contributing to slower growth

Figure 1.4 - Net migration and residental investment
Source: Statistics New Zealand

Annual net migration inflows eased from their peak of 42,500 in mid-2003 to a trough of 6,000 in late 2005 as a result of lower student arrivals, a strengthening NZ dollar and slowing economic growth. An easing in net migration meant less additional demand for housing, with both slower growth in prices for existing houses and a decline in new housing construction. The latter directly reduced domestic demand growth, while slower house price growth acted to slow the rise in households’ wealth and hence their willingness to consume at the same pace as previously.

Annual average growth in private consumption slowed from 6.0% in 2004 to 2.0% in 2006, while growth in residential investment declined – from a peak of nearly 25% in mid-2003 to falls during most of the past two years.

Higher interest rates have slowed growth in domestic demand, but with a lag …

Figure 1.5 - Short-term interest rates and the effective mortgage rate
Source: Reserve Bank of New Zealand

Ninety-day interest rates increased from around 5% in mid-2003 to around 7.5% at the end of 2005. However, the full effect of higher short-term rates was not reflected in effective mortgage rates which increased by less than one percentage point over the same period as a result of access to lower-cost funding from offshore and competition amongst lenders that encouraged borrowers to shift to lower longer-term fixed rates. Despite this, debt servicing costs increased steadily, acting as a drag on household disposable income.

Higher interest rates also increased firms’ financing costs and reduced the attractiveness of additional capital investment. Combined with slower growth in sales, this contributed to growth in business investment declining from a peak of over 15% in mid 2004 to an absolute decline at the end of 2006. Overall, annual average growth in gross national expenditure slowed from 4.0% in 2005 to 0.4% in 2006.

… and the high exchange rate has slowed growth in exports

Increasing terms of trade and large positive interest rate differentials saw the NZ dollar appreciate from below 50 on the TWI in late 2000 to an average of 70.4 in 2005. This has contributed to slower growth in export volumes, particularly for services. Annual export growth declined from an average of 4.4% in the period from 2002 to 2004 to negative in late 2005 to early 2006.

Figure 1.6 - Services exports and TWI
Source: Statistics New Zealand, Reserve Bank of New Zealand

The terms of trade have generally boosted activity …

New Zealand’s terms of trade have trended up since 2002 as strong growth in the world economy was accompanied by increased demand for New Zealand’s export products and various disruptions affected competing agricultural producers. The continuing strength in the terms of trade supported export returns, providing a partial offset to the appreciation of the NZ dollar. The higher exchange rate also increased households’ real incomes as it lifted their purchasing power relative to the rest of the world. This provided some support to private consumption growth. However, increases in oil prices since early 2004 detracted from household disposable income and growth in private consumption during the 2005 and 2006 calendar years.

… and the labour market and government spending have also provided support

The labour market remained buoyant, even with the slowdown in growth. Employment growth was robust, participation reached a record high in mid-2006 and the unemployment rate was below 4% from the second half of 2004. Labour income growth was strong, supporting private consumption and residential investment.

Government transfers, and public consumption (averaging 4.6% growth since the start of 2004) and investment spending also supported growth in domestic demand, both directly and via household spending. However, with receipts growing at an even faster pace, the government in aggregate was withdrawing resources from the economy.

Growth in tax receipts has slowed in line with the easing in activity

Figure 1.7 - Tax component growth
The Treasury

With the slowing in economic growth, growth in tax receipts has eased in the past two years. The largest contributor to this easing was corporate tax, the growth of which declined from a peak of 26% in 2005 to around zero in the year to March 2007, reflecting the trend in corporate profits through that period. The growth rates of the two largest tax types, source deductions and GST, have slowed only marginally since 2005, supported by the recent strength in labour incomes and private consumption mentioned above. Overall, growth in total tax receipts was just under 5% in the year to March 2007, after being up around 10% in 2005.

Resource pressures remain intense and macroeconomic imbalances remain

Despite the period of slower growth, the economy still appeared to be operating at or above capacity. Indicators of firm capacity utilisation remain at a high level, the unemployment rate is near its recent low and firms continue to record difficulty in finding labour at prevailing wages. Annual non-tradables inflation remained above 4% for the three years since December 2003.

The domestic demand-dominated nature of growth led to a widening of the current account deficit from 3.2% of GDP at the start of 2002 to a peak of 9.7% in June 2006. While the deficit reduced slightly in the second half of 2006 as growth in domestic demand – and imports – began to ease and profitability of local firms levelled off, at 9.0% of GDP the deficit remained high at the end of 2006.

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