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Budget 2012 Home Page Budget Economic and Fiscal Update 2012

Economic Risks

Global outlook remains uncertain...

The global economy faces several medium-term challenges. Actions by euro area authorities have alleviated some financial market tensions and the risk of extremely negative outcomes. Nonetheless, further measures are required to restore sovereign balance sheets to sustainable positions. Our main forecasts assume that European authorities manage through further crises as they arise. However, any worsening of the euro area debt crisis would lead to tighter financial conditions and increased risk-aversion worldwide, subduing growth.

Also, many developed-economy governments face the challenge of continuing fiscal austerity measures without overly compromising fragile recoveries. Failure to manage this process will have effects on growth in parts of the euro area, the UK and US, with spillover effects on growth in other regions of the global economy. Political uncertainty around structural reform and changing governance arrangements may similarly lead to increased risk aversion and lower growth.

A sharp slowing in emerging market economies (eg, from a tightening in bank lending standards in Asia) would lead to slower world growth. Geo-political tensions in the Middle East could lead to an increase in oil prices, and, if prolonged, would hinder the global recovery. On the other hand, growth slowing at a manageable pace and inflation easing in China, as well as room for authorities to stimulate the economy, if necessary, could underpin a more sustainable medium-term growth outlook.

Any positive or negative risks to the outlook for China will be amplified through Australia. With a mining-related investment boom largely locked in, risks to Australian growth over the forecast period are small. However, with consumer confidence modest, the economy outside of mining remains subdued.

Other positives include recent US data indicating that growth is stabilising. In addition, positive corporate earnings may underpin growth in the short term. Overall, while extreme or “tail” risks have receded, the global outlook remains skewed to the downside.

...posing risks to New Zealand's economy

If international activity turns out to be weaker than we have built into our main forecasts, demand for our exports would fall. Reduced demand would lead to lower volumes of manufactured goods exports and lower tourist arrivals and spending. For commodity exports, production tends to respond less to reduced demand; instead, the reduced demand is reflected in falling prices of commodity exports. Lower export prices would result in a lower terms of trade.

Our main forecasts assume that the terms of trade decline in the near term, but remain high relative to historical standards over the five-year forecast period. Should the terms of trade, in contrast, fall much further and reach their 30-year average, a sharp drop in incomes for agricultural producers would flow through into weaker domestic demand, less income for investment and debt repayment, and a significantly wider current account deficit. Lower commodity prices could also impact on New Zealand goods and services providers that export to Australia, which would also experience a cut in its national income from international commodity sales.

On the financial side, a drop in confidence and pick-up in global risk-aversion would be expected to reduce the availability, and raise the cost, of credit for New Zealand. With a high current account deficit, there is a risk that markets would demand a higher risk premium for New Zealand's debt in the future. That said, there is room for the Reserve Bank to provide liquidity as needed and, if the outlook for inflation permits, to facilitate easier monetary conditions to help domestic borrowers adjust.

Finally, lower world growth may lead to falls in consumer and business confidence. With lower confidence, households may lower their spending and increase their saving more than assumed in the main forecasts. Similarly, businesses may invest less and hire fewer workers than assumed in the main forecasts.

The economy faces domestic challenges as well...

There are risks to our forecasts arising from domestic sources as well. Private consumption growth is expected to be held back by modest house price growth and households' aggregate desire to reduce their debt-to-income ratios to more comfortable levels. Given the greater potential for tighter conditions in global funding markets, the risk is that the degree of household consolidation could be more intense than expected, with households seeking to move to an even lower level of debt than we have forecast. While this might bring forward some rebalancing in the economy from later years, such a scenario would involve weaker domestic activity in the near term. At present, the risk of a large-scale increase in borrowing by households, reflecting an increased willingness by banks to lend, seems small. If this were to occur, it would drive a stronger economy in the near term and defer household rebalancing until later years.

...including ongoing uncertainty over the timing of the Canterbury rebuild ...

The timing and extent of the Canterbury earthquake rebuild is difficult to forecast. If large aftershocks cause further damage, the risk is that the current $20 billion damage estimate factored into our main forecasts would clearly rise, as would the risk that the rebuild would be slower and overall economic activity lower in the short term. Conversely, if the issues delaying the process (including aftershocks and insurance claim delays), were to be rectified sooner than assumed, the rebuild could gather pace more quickly. Accordingly, residential and non-residential construction, imported goods and employment would all be stronger than in the main forecasts. As a result, we would expect wages in and around the rebuild area to come under upward pressure, as well as prices for some goods - particularly housing construction-related goods and services.

On the other hand, higher worker migration into Canterbury, as well as increased productivity in the construction sector owing to the localised nature of the rebuild, may help to relieve pressure on prices in the construction sector. On top of this, a more rapid rebuild could boost wider confidence in the economy, providing a lift to consumer spending and business investment.

...and risks from non-economic events

There are also non-economic risks that may impact on the economy, particularly climatic conditions here and abroad. Poor weather and droughts have adversely affected domestic agricultural production in the past; equally, climatic conditions can lift production as we have seen in New Zealand over the past season. Any impact on agricultural incomes from production may be offset by prices moving in the opposite direction, although this will depend on many factors, particularly production abroad. Other risks may impact on the economy, including the potential for biosecurity issues to hit the agricultural sector.

Table 3.2 - Summary of key economic variables for main forecasts and scenarios
March years 2011

Real GDP (annual average % change)

Main forecast 1.2 1.6 2.6 3.4 3.1 2.9
Upside scenario 1.6 3.0 4.2 3.5 2.6
Downside scenario   1.6 2.5 2.6 2.1 2.7

CPI inflation (annual % change)1

Main forecast 4.5 1.6 2.6 2.5 2.4 2.4
Upside scenario 1.6 2.6 2.6 2.9 3.0
Downside scenario   1.6 3.2 2.8 1.7 1.6

Unemployment rate2

Main forecast 6.6 6.3 5.7 5.2 5.0 4.7
Upside scenario 6.3 5.7 5.1 4.6 4.3
Downside scenario   6.3 6.0 5.7 5.9 5.8

Nominal GDP
(expenditure measure, $billions)

Main forecast 198 206 215 229 241 253
Upside scenario 206 215 231 246 258
Downside scenario   206 211 223 235 245

Current account balance (% of GDP)

Main forecast -3.6 -4.2 -4.6 -5.9 -6.3 -6.7
Upside scenario -4.2 -4.6 -6.3 -7.0 -7.5
Downside scenario   -4.2 -6.6 -8.3 -6.8 -6.7


  1. Annual percentage change, 2012 is actual figure
  2. March quarter, seasonally adjusted

Source: The Treasury

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