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Budget 2008 Home Page Budget Economic and Fiscal Update 2008

Recent Economic and Tax Developments (continued)

Higher fuel and food prices drive inflation as easing demand is yet to fully impact …

Inflation remained elevated in early 2008. Consumer price inflationof 3.4% in the year to March 2008 was above the Half Year Update forecast of 3.1%. Some of the major sources of inflation pressure have not been affected by lower demand, especially fuel and food prices. In the year to March 2008, petrol prices rose 20.5% as world oil prices rose above US$100 a barrel on a West Texas Intermediate basis (and have since risen above US$125). In addition, food prices rose 5.1% in the year to March 2008 on the back of higher prices for soft commodities, with price rises of at least 20% for many dairy products. So far, the effects of easing demand on inflation have not been fully felt.

Monetary conditions are tighter than expected, partly because of global credit conditions. In the March 2008 quarter, 90-day bank bill rates averaged 8.8% (the Half Year Update forecast was 8.5%) and the Trade Weighted Index (TWI) averaged 71.9 (the Half Year Update forecast was 70.0).

… and growth in nominal GDP led to further growth in tax revenues

Figure 1.4 – Nominal GDP and tax receipts
Figure 1.4 – Nominal GDP and tax receipts.
Source: Statistics New Zealand, The Treasury

Nominal GDP has continued to expand at a fast pace. Excluding data revisions, nominal GDP in the December 2007 quarter was around 1% above forecast as a result of higher terms of trade and, to a lesser extent, higher economic growth and inflation. Annual average growth in nominal GDP rose to 7.7% at December 2007 and is expected to have risen to 7.9% at March 2008, similar to growth in tax receipts (Figure 1.4). Growth in tax receipts remained high at March 2008 and was similar to that expected in the Half Year Update.

Source deductions, largely PAYE on wages and salaries, maintained higher-than-expected growth into early 2008, consistent with growth in jobs and wages. Company tax receipts over the nine months to March 2008 were similar to the Half Year Update forecast. Despite a slowing of consumer spending in early 2008, GST receipts were also similar to forecast, partly owing to higher inflation.

Economic and Tax Outlook

The forecasts are for a more cyclical path for the economy

Figure 1.5 – Real GDP
Figure 1.5 – Real GDP.
Source: Statistics New Zealand, The Treasury

The Budget Update forecasts show a more cyclical path for the economy than the Half Year Update. Economic growth in the second half of 2007 was slightly higher than expected in the Half Year Update, but a deeper slowdown in the years to March 2009 and 2010 is now forecast (Figure 1.5). After real GDP 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% and 2.3% in the years to March 2009 and 2010 respectively. Growth is forecast to rebound to 3.2% in 2011 and then return to trend of around 3% in 2012.

Compared to the Half Year Update, several factors play more important roles in shaping the outlook for the economy. These factors relate to the world economy and financial markets, drought conditions and the housing market. Importantly, the key positive factors in the Half Year Update, strength in the terms of trade and personal tax cuts, are still predicted to support the economy.

External Factors

The world economic outlook has weakened considerably since the Half Year Update …

The outlook for economic growth among New Zealand’s trading partners has been revised down significantly in recent months. In the Consensus Forecasts for March 2008 (the latest when these forecasts were finalised), the growth outlook for our top 20 trading partners was revised to 3.3% in calendar year 2008 and 3.5% in 2009 from 3.8% and 3.7% respectively in October 2007. The downward revisions were mainly in the major economies, with forecasts for the United States, Japan and the Euro area revised down considerably for 2008 and 2009. The outlook was revised down only slightly for non-Japan Asia and Australia.

Consensus Forecasts are used as the basis of our trading partner growth forecasts, but they are typically slow to adjust to changing economic conditions so are likely to understate the extent of the current downturn. As a result, we assume trading partner growth will be 3.0% in calendar year 2008 and 3.2% in 2009, 0.3 percentage points below the March 2008 Consensus Forecasts. We expect that developments in the world economy will affect the New Zealand economy through four main channels:

  • Credit constraints: The increased cost and reduced availability of credit will have a negative impact on private consumption, residential investment and business investment directly. This effect is already being felt as higher funding costs are being reflected in higher mortgage rates. The consequent cooling in the property market is expected to have a knock-on effect on private consumption and residential investment. We assume the credit constraint will gradually unwind in the year ahead but, in the Risks and Scenarios chapter, we acknowledge the risk it could worsen and continue for longer than expected in an alternative scenario for the economy.
Table 1.1 – Economic forecast1
Annual average % change, year to 31 March 2007
Private consumption 2.7 3.6 1.9 1.9 1.6 1.4
Public consumption2 4.3 4.6 3.7 3.1 3.3 3.3
Total consumption 3.1 3.8 2.3 2.2 2.0 1.8
Residential investment -2.7 4.5 -9.7 -3.1 2.4 3.0
Central government investment -4.9 1.9 22.7 4.2 2.0 2.0
Other investment -1.2 6.8 2.8 -0.9 2.1 3.5
Total investment -2.3 5.2 1.1 -0.9 2.2 3.4
Stock change3 -0.9 0.7 0.1 0.0 0.0 0.0
Gross national expenditure 1.0 5.0 2.0 1.4 2.0 2.2
Exports 3.1 3.1 -0.9 4.0 4.4 4.1
Imports -1.7 9.6 0.9 1.3 1.0 2.0
GDP (production measure) 1.5 3.1 1.5 2.3 3.2 3.0
 - annual % change 2.3 2.4 1.6 2.9 3.2 2.8
Real GDP per capita 0.3 2.1 0.6 1.4 2.2 2.0
Nominal GDP (expenditure basis) 5.0 7.9 3.6 3.2 4.9 5.0
GDP deflator 2.5 4.8 2.3 0.8 1.7 2.0
Employment4 2.0 1.4 1.4 0.2 0.3 1.0
Unemployment5 3.7 3.5 3.7 4.4 4.5 4.3
Wages6 4.8 4.1 4.2 4.7 4.4 4.0
CPI inflation7 2.5 3.4 3.2 2.8 2.8 2.8
Export prices8 9.1 2.5 7.4 3.1 6.1 4.7
Import prices8 7.2 -4.8 4.2 5.0 7.5 5.6
Current account balance            
  - $billion -13.5 -13.1 -13.3 -13.7 -14.1 -13.8
  - % of GDP -8.2 -7.4 -7.2 -7.2 -7.1 -6.6
TWI9 68.8 71.9 68.6 63.1 59.1 56.7
90-day bank bill rate9 7.8 8.8 8.5 7.9 7.9 7.2
10-year bond rate9 5.9 6.3 6.3 6.3 6.2 6.1


  1. Forecast finalised 1 May 2008 incorporating data up until 15 April 2008.
  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 ordinary-time hourly earnings.
  7. Annual percentage change.
  8. Overseas Trade Index basis, annual average percentage change.
  9. Average for the March quarter.

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

  • Wealth effects: Falls in share and other asset prices will make consumers more cautious in their spending plans. This effect will also negatively affect businesses’ ability to raise capital and their investment plans.
  • Confidence: A lower level of confidence among firms and consumers, partly due to a slowdown in the global economy, is expected to increase precautionary saving and thus reduce consumption growth. It is difficult to separate out the impact that global developments are having in this area from local ones (eg, the weaker housing market), but they will compound the effect of local developments.
  • Export demand: Weaker world growth will affect demand for New Zealand export products and their prices, particularly for commodities. Although this effect has yet to have any material impact, it is expected to take longer to show up than the first three channels.

… but the extent of this weakness and its impact on New Zealand remain uncertain

The outlook for trading partner growth remains uncertain. The overall effect of a downturn in the United States on the New Zealand economy depends on how it spreads to the rest of the world. The downturn in the United States could affect New Zealand via Asia and demand from that region for New Zealand exports, particularly soft commodities. So far, there is little sign of a severe slowing in emerging Asian economies and, while some commodity prices are down a little, they remain high. Although still dependent on exports to the United States, there is also now significant intra-regional trade in Asia and investment is a major source of growth in China, along with exports. A further channel would be the effect of a downturn in Asia on Australia via demand for hard commodities and the effect that might have on New Zealand exports to Australia of manufactured products and tourism services. The Risks and Scenarios chapter has more discussion of these risks and how they might affect the New Zealand economy.

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