Upside Scenario

The domestic economy could recover more strongly than in the main forecasts...

The upside scenario incorporates a stronger economic recovery led by domestic drivers. The upturn is triggered by increased confidence from both the agriculture and household sector, with commodity exporters anticipating permanently higher returns and households more confident in house price rises.

In this scenario, commodity exporters become increasingly confident that the terms of trade will remain structurally elevated over the long term. With strong export returns viewed as permanent, spending from the agriculture sector is greater than expected in the near term, providing a boost to retailers and multiplying through the rest of the economy more rapidly than assumed in the main forecasts. In this scenario, it is assumed that commodity exporters, in general, are comfortable with their current level of borrowing, particularly in relation to income, and focus less on debt reduction than in the main forecasts.

At the same time, house prices are slightly stronger, growing 5% by mid-2012, rather than 1.8% as in the main forecasts. Higher house prices in the near term reflect current low interest rates and developing housing shortages, lifting household wealth. Higher household wealth flows through to increased consumer spending and residential investment. Residential investment is significantly boosted over the second half of 2011 as investors and home buyers begin building before skill shortages rise as the Canterbury rebuild gathers momentum.

The combined effect of increased agriculture and household confidence is evident in the profile for private consumption. The upside scenario includes a stronger profile for private consumption, with growth 1.8% points and 1.1% point higher in the March 2013 and 2014 years respectively than in the main forecasts. Despite the stronger outturn, private consumption growth remains moderate relative to history, growing an average 3.0% over the five years to March 2015.

Figure 3.1 – Real private consumption

Source:  Statistics New Zealand, the Treasury

Increased private consumption and residential construction drive a stronger economic outlook than in the main forecasts and, consequently, the labour market also strengthens, with the unemployment rate falling to 4.4% by March 2015. The stronger-than-expected domestic economy means CPI inflation is around the top of the 1% to 3% band over the forecast period which, together with increased real activity, results in nominal GDP being a cumulative $15 billion higher in March 2015 compared with the main forecasts.

…returning the operating balance to surplus sooner than in the main forecasts

Core Crown revenue is a cumulative $6 billion higher in the domestic-led upside scenario, led by increases in various tax types. The significant boost to private consumption and residential investment flows through to higher GST revenue, which, at $1.7 billion higher than the main track, makes the largest contribution to the higher tax take. Increased income driven off the stronger domestic economy lifts source deductions and corporate tax by about $1 billion each, while the more rapid increase in interest rates lifts resident withholding tax higher.

The fall in core Crown expenses, at $0.3 billion, is significantly lower than the rise in core Crown revenue described above, owing to the drivers of social assistance payments. With a stronger economy, Unemployment Benefit recipient numbers are lower than in the main case. However, benefit and superannuation payments are higher per recipient, with a higher annual indexation reflecting the more elevated track for CPI inflation.

In this scenario, the operating balance (before gains and losses) moves into surplus in the June 2014 year, one year earlier than in the main forecasts. Net core Crown debt as a proportion of GDP peaks at 27.3% of GDP over both the June 2013 and June 2014 years.