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Budget 2011 Home Page Budget Economic and Fiscal Update 2011

4 Fiscal Risks

Structural deficits, the collapse of a number of finance institutions and a series of natural disasters have led to an increase in net government debt. As a result, the Government's fiscal buffers are smaller and fiscal policy will need to continue to be sensitive to future developments. The Government's policy response is outlined in the FSR. Policy will need to remain adaptive as global markets remain volatile and many major developed economies face significant structural challenges.

The most significant economic risks have been identified in Chapter 3. The first section of this chapter illustrates the link between these risks to the economy and the fiscal position. The second section presents a Statement of Specific Fiscal Risks.

The Statement of Specific Fiscal Risks is a requirement of the Public Finance Act 1989 and sets out all pending government decisions and other circumstances known to the Government at the finalisation of the fiscal forecasts that may have a material effect on the fiscal and economic outlook. It is not possible to identify every possible risk and disclosure is also subject to the legal requirements and materiality thresholds described at the end of this chapter.

The Economy and Public Finances

The economic and fiscal forecasts are subject to heightened forecast uncertainty as a result of a volatile external environment and domestic factors such as high levels of external debt held by the New Zealand private sector. Chapter 3 provides scenarios to illustrate a plausible range for the economic and fiscal projections. However, further shocks are possible, potentially leading to outcomes well beyond the range suggested by these scenarios.

New Zealand's strong fiscal track record provides confidence that the risk of default for the Crown's creditors remains remote. Reflecting this, the Crown currently holds the top Aaa foreign currency rating from Moody's and strong AA+ foreign currency ratings from Standard and Poor's (S&P) and Fitch Ratings. The ratings from S&P and Fitch, however, are currently on a negative outlook and will be sensitive to developments in the economy. Markedly slower growth or any other factor that negatively impacts on the fiscal position represents a potential risk to the current rating. A key implication of a sovereign rating downgrade could be an increase in debt-servicing costs for the Government and higher borrowing rates for New Zealand households and businesses.

The fiscal outlook is particularly exposed to structural economic shocks, which have a permanent impact on the level of national income and therefore tax revenue. High levels of external indebtedness increase the economy's exposure to shocks from the global economy. Financial markets remain volatile and many major economies are currently facing significant structural challenges. Notably, many advanced economies are dealing with high government debt, household balance sheets needing repair and a financial sector (especially in Europe) that remains weak. In this global environment, shocks could rapidly flow between countries through changes in trade, the terms of trade or interest and exchange rates.

Under constant policy settings, the main source of uncertainty about the fiscal position arises from the inherent uncertainty about future tax revenue. An analysis of historical tax forecast errors provides some guide to how unforeseen events in New Zealand or abroad can impact on the fiscal position. Tax revenue in the next fiscal year (2011/12) would normally fall within a range of two standard deviations of historical forecast errors. This range is ±6% of actual tax revenue, which equates to ±$3 billion (based on an analysis of forecast errors over 1994 to 2010). Greater variance can occur, but would be expected at more infrequent intervals (around one year in every 20 if errors are normally distributed). Figure 4.1 shows core Crown tax revenue with uncertainty estimated from historic forecast variance.

Figure 4.1 – Core Crown tax revenue uncertainty
Figure 4.1 - Core Crown tax revenue uncertainty.
Source:  The Treasury

Note: The coloured band represents sequential deciles such that the difference between the 10th and 90th percentiles represents an 80% confidence interval. See Treasury Working Paper 10/08 for further information about the methodology used.

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