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Budget 2008 Home Page Budget Economic and Fiscal Update 2008

Summary

After annual average growth of 3.1% in the year to March 2008, the economy is forecast to record two years of sub-trend growth of 1.5% in the year to March 2009 and 2.3% in the year to March 2010. These Budget Update forecasts show a more cyclical path for the economy than in the Half Year Update.

The operating balance before gains and losses (OBEGAL) is forecast to fall from 2.9% of GDP in the year to June 2008 to 0.7% in the year to June 2009, consistent with keeping gross sovereign-issued debt excluding Reserve Bank Settlement Cash around 20% of GDP. The fall in OBEGAL reflects past and Budget 2008 decisions, including the incorporation of a cut in personal taxes from 1 October 2008.

In addition to the usual risks to any economic and fiscal forecast, there are now greater risks on the downside, particularly those arising from a lack of stability in global financial markets.

Economic Outlook

The New Zealand economy is expected to grow by 2.5% per annum on average during the forecast period, somewhat below the 3.1% per annum experienced over the past decade. Real GDP growth is expected to fall from 3.1% in the year to March 2008 to 1.5% the next year because of factors such as recent drought conditions, high interest rates, falling house prices and higher petrol and food prices. From the year to March 2011, real GDP growth is forecast to rebound to around 3% per annum.

Table 1 – Major economic parameters
March years
(annual average % change)
2007/08
Estimate
2008/09
Forecast
2009/10
Forecast
2010/11
Forecast
2011/12
Forecast
Real GDP 3.1 1.5 2.3 3.2 3.0
Employment 1.4 1.4 0.2 0.3 1.0
Wages 4.1 4.2 4.7 4.4 4.0
Consumer prices 3.4 3.2 2.8 2.8 2.8

Note: Employment is on a full-time equivalent basis; consumer price inflation is measured as an annual % change.

Source: The Treasury

Domestic demand slowed from mid-2007, and is forecast to remain subdued, as a result of factors such as higher interest rates, falling house prices, lower net migration inflows and higher prices for petrol and food. Interest rates have been elevated because of ongoing inflation pressures and global credit constraints. Personal income tax cuts, growing labour incomes and high farm incomes (albeit lower owing to drought) partially offset these forces.

The recent drought in much of the country will negatively affect agricultural production and commodity exports in the coming year. Weaker growth in the world economy is also expected to dampen export growth. However, strong export prices are expected to provide a large boost to export receipts. Higher world prices for dairy products boosted the terms of trade to a 33-year high in late 2007 and are forecast to fall but stay relatively high.

Consumer price inflation is expected to remain elevated despite a period of sub-trend growth in the economy. Ongoing inflation reflects high food and energy prices and a decline in the exchange rate from early 2009.

Nominal GDP growth is forecast to slow over the next two years, largely as a result of lower growth in real GDP. Nevertheless, strong terms of trade, driven by high world dairy prices, and an outlook for relatively high inflation continue to support nominal GDP.

There are a number of risks to the forecasts. These include the usual upside and downside risks to any economic and fiscal forecast such as different profiles for the terms of trade, the exchange rate and domestic demand. There is also a set of more extreme risks, albeit with a smaller probability, that could arise if recent financial market turmoil is more prolonged and/or deeper than we have assumed in the main forecast.

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