Finalisation Dates and Assumptions for the Forecasts

Economic forecast assumptions

Earthquake - The Canterbury earthquakes have had a significant impact on the New Zealand economy over the past year and will continue to over the forecast period. Details of the economic and fiscal impacts are in Chapter 2.

Trading partner growth - The global economic outlook has continued to be revised upwards. The economies of New Zealand's top-16 trading partners are expected to grow 3.7% in 2011 and 4.4% in 2012 before averaging 4.1% per annum growth in the final three years of the forecast period. These are similar to growth rates in Consensus Forecasts for April 2011.

Global inflation and interest rates - Inflation pressures have risen for many of our trading partners, particularly in emerging Asia, as a result of high commodity prices and resource constraints. We expect interest rates to be gradually normalised over the forecast period.

Figure 1.22 - WTI oil prices

Sources:  Datastream, The Treasury

Oil prices - The average price of West Texas Intermediate (WTI) oil was US$94/barrel in the March 2011 quarter and is assumed to rise over US$105/barrel per quarter from mid-2011, before falling to around US$100 at the end of the forecast period. At this point, the oil price assumption is approximately 12% above that assumed in the Half Year Update. These projections are based on a monthly average of futures prices from the New York Mercantile Exchange recorded on 11 April 2011.

Terms of trade - The merchandise terms of trade, as measured in the System of National Accounts (SNA), are estimated to rise further over the first half of 2011 to be around 2% higher in the June 2011 quarter than in the December 2010 quarter. This is around 8% higher than in the Half Year Update 2010.

Monetary conditions - The New Zealand dollar exchange rate is assumed to remain around its March 2011 quarter level of 67.2 on the Trade Weighted Index (TWI) throughout 2011. The TWI is then assumed to depreciate gradually from early 2012 to 56.0 in the March 2015 quarter. Ninety-day interest rates are expected to rise from 2.7% in the June quarter of 2011 to 4.0% two years later and continue to increase to 5.0% by the end of the forecast period.

External migration - The net inflow of permanent and long-term migrants is assumed to fall from 10,000 in the year to December 2010 to zero in the next year as a result of the subdued recovery and impact of the Canterbury earthquakes. Additional activity related to post-earthquake recovery eventually supports a rebound in net migration to 15,000 in the year to March 2014 before settling at our long-run assumption of 10,000 in the year to June 2015.

Several relatively minor tax policy changes have been included in the Budget forecasts:

Removal of KiwiSaver ESCT exemption - Employer contributions to KiwiSaver schemes will no longer be exempt Employer Superannuation Contribution Tax.

Exemption for non-resident investment in PIEs - The rules for non-resident investors in Portfolio Investment Entities will be aligned with those for direct investment to ensure fairness of tax treatment.

Bank thin capitalisation rules - The minimum prescribed percentage of equity for tax purposes will increase from 4% to 6%, the effect of which will limited foreign-owned banks' interest deductions against the NewZealand tax base.

Other - Several other minor policy changes that, individually, are below the $10 million per annum materiality threshold.

Fiscal forecast assumptions

The fiscal forecasts are based on assumptions and judgements developed from the best information available on 2 May 2011, when the forecasts were finalised. Actual events are likely to differ from some of these assumptions and judgements. Furthermore, uncertainty around the forecast assumptions and judgements increases over the forecast period. The Canterbury earthquakes add additional uncertainty to the economic and fiscal forecasts.

The fiscal forecasts are prepared on the basis of underlying economic forecasts. Such forecasts are critical for determining revenue and expense estimates. For example:

• A nominal GDP forecast is needed in order to forecast tax revenue.
• A forecast of CPI inflation is needed because social assistance benefits are generally indexed to inflation.
• An unemployment forecast is needed to underpin the projected number of Unemployment Benefit recipients.
• Forecasts of interest rates are needed to forecast finance costs, interest income and discount rates.

A summary of the key economic forecasts that are particularly relevant to the fiscal forecasts is provided in the table below (on a June-year-end basis to align with the Government's balance date).