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Budget 2012 Home Page Budget Economic and Fiscal Update 2012

Downside Scenario

Growth in emerging Asia, particularly China, is lower over the forecast period…

The downside scenario stems from a lower growth outlook across emerging Asia, particularly China, over the forecast period. The lower growth could arise from a tightening in lending standards by banks and authorities, given heightened concern about the quality of banks' commercial and residential loans.

Weaker-than-assumed activity flows through to New Zealand in the form of lower prices for key commodity exports, particularly dairy, meat and forestry products. In addition, growth in our largest single trading partner, Australia, slows as demand for hard commodities from emerging Asia falls in the face of weaker growth. The consequences of this scenario highlight the increasing trade linkages in the Asia-Pacific region, with emerging Asia and Australia currently taking around half of New Zealand's goods exports. Trading partner growth is lower in every year and 2.1% points cumulatively lower over the five years to 2016 than in the main forecasts (Figure 3.1).

An escalation of the sovereign debt crisis in Europe, leading to slower global growth, is a plausible alternative to this scenario and would have broadly similar effects. Given our larger reliance on Asia for trade, the impact may be less direct, but still large. On the other hand, Australasian banks are more reliant on Europe for funding and the impact on funding costs and its availability may be larger and more direct in a Europe-based scenario. For more discussion of a Europe-based scenario see the Pre-election Update.

...with a lower terms of trade and reduced incomes...

In this scenario, the merchandise terms of trade fall sharply (Figure 3.2), down around 9% in the March 2013 year, reflecting lower prices for export commodities. The lower terms of trade result in a more rapid deterioration in the current account balance. The current account deficit increases to 8.3% of GDP in the March 2014 year compared to 5.9% in the main forecasts. However, as the terms of trade rebound in 2015 along with growth in export volumes, the current account deficit decreases to 6.7% by March 2016, the same level as in the main forecasts.

Figure 3.1 - Trading partner growth
Figure 3.1 - Trading partner growth.
Sources: IMF, the Treasury
Figure 3.2 - Merchandise terms of trade (SNA)
Figure 3.2 - Merchandise terms of trade (SNA).
Sources: Statistics New Zealand, the Treasury

A slow-down in Australasia may mean that Australian and New Zealand banks face a higher risk premium on their international wholesale borrowing. While part of these increased funding costs may be absorbed in falling bank margins, the remainder would be passed on to household and business borrowers. This scenario assumes that households and businesses are charged an additional 50 basis point premium on their borrowing compared to the main forecasts.

The rapid fall in the terms of trade leads to lower incomes. Higher retail interest rates compound the fall in incomes, resulting in a more subdued outlook for household spending. Private consumption averages around 2% over the four years to March 2016, compared with 2.6% in the main forecasts and over 3% in the upside scenario. The higher interest rates along with falling profitability lead to around 2% and 1% lower market and residential investment for the March 2014 year respectively, compared to the main forecasts. Nevertheless, residential investment activity remains high, underpinned by the earthquake rebuild.

Weaker domestic activity, combined with lower terms of trade and inflation, results in nominal GDP being a cumulative $25 billion lower through to June 2016.

…leading to lower tax revenue while raising operating deficits and net debt

Core Crown revenue is a cumulative $8.1 billion lower in the downside scenario, owing mainly to lower income taxes. The weaker domestic economy reduces source deductions and corporate tax by about $2 billion each, compared to the main forecasts, while other persons tax falls by $0.6 billion. Also, lower private consumption and residential investment lead to $1.2 billion lower GST revenue, compared to the main forecasts, while the fall in interest rates reduces resident withholding tax.

Figure 3.3 - Operating balance (before gains and losses)
Figure 3.3 - Operating balance (before gains and losses).
Source: The Treasury

In the downside scenario, core Crown expenses are $0.8 billion higher, as the weaker labour market flows through to increased Unemployment Benefit recipient numbers. In addition, finance costs are higher, owing to higher government borrowing.

In this scenario, the operating balance (before gains and losses) does not move into surplus within the forecast period and, consequently, net core Crown debt as a proportion of GDP is still rising at the end of the forecast period (June 2016), reaching 32.0% at that time.

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