Economic Risks
Key risks continue to surround the global economy...
The extreme risks to the outlook have eased significantly since early 2009, when financial markets and the world economy had yet to trough after the global financial crisis. Financial markets have since recovered and the world economy has begun to recover. This recovery could prove to be stronger than incorporated in the main forecasts. A stronger recovery may occur if emerging economies, especially in Asia, maintain supportive monetary policy. Faster progress in restoring financial sector strength and rebuilding firm and household balance sheets, as asset prices recover, would lead to a quicker pace of recovery, assisted by higher credit growth. An earlier return of business and consumer confidence could also provide greater support to investment and consumption.
However, significant downside risks remain. In developed economies, these include: sovereign-debt issues emerging in parts of the Euro area, which have reached crisis levels in Greece and could worsen significantly and spread to other countries; private demand may fail to take over once public stimulus and stock rebuilding ends; credit may remain constrained; households and firms may undergo a more drastic deleveraging; and continuing weak housing and labour markets could slow the recovery in consumer spending. The probability of these risks occurring may be low, but any one of them could trigger lower growth in the world economy. At an extreme, the impact from the next shock could be larger than after the global financial crisis because the world economy is less well positioned now than it was beforehand.
...and commodity prices, drought and the impact of tax reform
The world spot price for New Zealand's commodity basket as a whole has risen substantially. Given this increase has been shared across a wider range of products than the previous peak in 2008, it may be less subject to correction. Nevertheless, there are still risks to export commodity prices. Upside risks are mainly around growing demand for commodities in emerging markets. Downside risks include a larger consumer reaction to high prices, if current high prices are only a reflection of temporary factors, or if commodity demand from China is not sustainable.
One of the temporary factors supporting dairy prices is recent drought conditions in New Zealand. Drought will likely lower agricultural production, particularly for dairy, and there is a risk this impact is larger than anticipated in the main forecasts.
The recovery in New Zealand is also subject to risks. Current high confidence levels could be signalling a stronger recovery, while recent weakness in actual consumer spending and in the housing market could portend a more subdued upturn. Once recovery is underway, there are also risks surrounding the rate of potential growth New Zealand can realistically achieve given the weakening of productivity growth over the 2000s. Recent cyclical volatility and policy changes have created additional uncertainty about longer-term trends.
As discussed on page 61, imbalances built up in the economy over the 2000s. An abrupt adjustment is possible if foreign investors react to a higher forecast current account deficit, triggering a sharp fall in the exchange rate, or if households curtail spending more sharply in the face of rising interest rates. House and farm prices are another source of risk. These asset prices remain very high, and the leverage built upon earlier price rises has not been unwound to any significant extent.
The introduction of the tax package also adds a degree of uncertainty not present a year ago, with the potential for significant changes in the behaviour of firms and households. A stronger or weaker than forecast growth response to the tax package could also contribute to the upside and downside scenarios.
