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Budget 2011 Home Page Budget Economic and Fiscal Update 2011

Risks and Scenarios

Economic and fiscal forecasts always involve a significant amount of uncertainty. The first part of this chapter outlines the key risks to the outlook, both global and domestic. The second part explains how two of the most likely risks could play out in alternative scenarios.

Economic Risks

Key risks continue to surround the global economy...

The robust growth in emerging market economies in 2010 led to a rebound in global commodity prices, especially when combined with supply constraints affecting some agricultural commodities. This increase in global commodity prices has been positive for New Zealand's terms of trade, but rising food and fuel prices also pose a threat to the global recovery. Inflation is already beginning to increase in both developed and developing economies and some countries, especially in emerging Asia, have started to tighten monetary conditions. Rising food and fuel prices also pose a threat to growth in that they reduce households' disposable income, especially in developing economies where these items account for a larger share of expenditure. A combination of high inflation and monetary tightening could cause an abrupt adjustment in emerging economies and is explored in the downside scenario below.

There are other risks to the global outlook as well. Sovereign debt remains a serious issue in the euro area with Portugal receiving assistance and increasing speculation of a restructuring of Greece's debt. Any deterioration in this issue would have implications for commercial banks in Europe given their exposure to sovereign debt.

There is still considerable need for fiscal consolidation in many advanced economies, in particular the United States, where there is no consensus yet on how best to reduce budget deficits. There is still some uncertainty about how sustainable the economic recovery is in some of the developed economies, particularly once monetary and fiscal stimulus is withdrawn. Labour and housing markets are still weak in many countries and will delay a recovery in private consumption.

So far, global imbalances have not been reduced significantly. While this is a longer-term issue, the lack of resolution may make the current recovery unsustainable. Political instability in the Middle East and North Africa has the potential to further disrupt oil supplies, leading prices to spike. There is uncertainty about the impact of the Japanese earthquake. We have assumed a short-term negative impact, largely offset by the subsequent recovery. There are also likely to be some benefits for a commodity exporter such as New Zealand as the reconstruction phase gets under way.

Other positive risks exist, although they are not as obvious or large. The global recovery is more assured than it was in 2010 as the recovery has become more strongly established. Emerging market economies are leading the recovery and their growth is particularly robust. Corporate balance sheets in the developed economies are stronger and industrial production data have generally been positive.

...while domestic risks relate to timing issues around the Christchurch rebuild…

The Canterbury earthquakes caused loss of life and damage on a scale not seen in New Zealand since the 1931 Napier earthquake. Judgement around the timing of the rebuild has been informed by studying similar events both here and abroad, and incorporating the latest information on frequently-revised damage estimates. Given the fluid nature of developments, the timing and extent of the rebuild are difficult to forecast with a high degree of confidence.

Our main forecasts assume construction grows strongly over calendar year 2012 and maintains a high level of activity throughout the forecast period and beyond. If the rebuild were to intensify sooner and more quickly than expected, residential and non-residential construction, imported goods and employment would all be stronger than in the main forecasts. The potential for skill shortages to be more acute than expected would manifest itself in higher wages and stronger-than-expected inflation, particularly for housing goods and services. In addition, a more rapid rebuild would boost confidence in the economy, providing a lift to consumer spending and business investment. Conversely, a slower rebuild would have the opposite effect, leading to softer economic outcomes in the short term. A slower-than-expected rebuild could be driven by a more drawn-out planning period, particularly if seismic activity increased in the near term, or capacity constraints are more binding than assumed in the main forecasts. A consequence of a slower rebuild is the potential for a net outflow of people from New Zealand in the first half of 2012, as departures continue rising and arrivals are pared back in line with weaker job prospects than in the main forecasts.

…and the degree of consolidation by households and the agriculture sector

There are other risks to the domestic outlook as well. Private consumption growth is expected to be tempered by weak house price growth and limited appetite, on the part of households, to increase debt. The risk is that a combination of increased willingness of banks to lend and households to borrow flows through to increased demand for housing and consumer spending. While this would drive a stronger economy in the near term, it would result in more subdued activity further out as the inevitable household rebalancing occurs. Conversely, the degree of consolidation over the next four years could be more intense than currently expected, with households unwilling to free up income for spending until debt is at a level that they deem to be sustainable. Such a scenario would lead to greater weakness in the near term but a stronger recovery later on, as household finances are more robust than in the main forecasts.

Similar to the household story above, the degree of consolidation by the agriculture sector could be more or less intense than assumed. In recent months, agricultural credit has fallen in absolute terms at the same time as commodity prices have reached historic highs. A more aggressive approach to debt reduction would slow growth in the near term, but would put the agriculture sector in a stronger position further out. On the other hand, there could be a more rapid pass-through of high export earnings to the rest of the economy, as commodity exporters increasingly consider that current returns for agricultural commodities are permanent. The perception of more persistent higher income would manifest itself in increased spending and investment, driving a more rapid recovery than assumed in the main forecasts, and is one of the drivers of the upside scenario outlined below.

There are also non-economic risks, particularly climatic events, that may impact on the economy. Over the past year, poor weather has adversely affected agricultural production, both here and overseas, and is partly behind the current high level of our terms of trade. Finally, there is a risk that tax outturns are either higher or lower than forecast. The Economic and Fiscal Outlook chapter features a more in-depth discussion of these risks.

Table 3.1 - Summary of key economic variables for main forecasts and scenarios
(Annual average % change,
Year ended 31 March)
Real GDP (production measure)            
Main forecast -0.7 1.0 1.8 4.0 3.0 2.7
Upside scenario   1.0 2.0 4.7 3.0 2.5
Downside scenario   1.0 0.9 4.0 3.0 2.6
CPI inflation1            
Main forecast 2.0 4.5 3.1 2.4 2.5 2.6
Upside scenario   4.5 3.4 3.2 3.3 2.9
Downside scenario   4.5 3.3 2.2 2.7 2.7
Unemployment rate2            
Main forecast 6.0 6.8 5.7 4.8 4.8 4.6
Upside scenario   6.8 5.7 4.6 4.5 4.4
Downside scenario   6.8 6.2 5.5 5.1 4.7
Nominal GDP ($billion)            
Main forecast 187 197 207 220 232 243
Upside scenario   197 207 223 237 249
Downside scenario   197 203 215 227 238


  1. Annual percentage change, 2011 is actual figure
  2. March quarter, seasonally adjusted
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