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Budget 2012 Home Page Budget Economic and Fiscal Update 2012

Upside Scenario

A faster earthquake rebuild and higher household spending increase growth...

There is a large degree of uncertainty around the timing and scale of the Canterbury rebuild. In the upside scenario, we allow for a faster rebuild compared to the main forecasts and bring more of the rebuild inside the forecast period. Immigration is higher in 2013 with most of the increase assumed to be workers moving into Canterbury. In addition, productivity in the construction sector is higher with the localised rebuild helping the sector to achieve more economies of scale than assumed in the main forecasts.

The higher migration of workers into Canterbury and increased productivity combine to increase residential investment, with growth around 1% point higher in the March 2014 year than in the main forecasts. Also, the higher productivity and increased supply of workers lower pressure on construction prices.

We also assume stronger private consumption in the upside scenario, with growth 0.6% and 1.6% points higher in the March 2013 and 2014 years respectively than in the main forecasts. Higher private consumption translates into lower household saving as well as higher imports compared to the main forecasts. Part of the higher spending is owing to households spending more on durables to accompany the rebuild of their homes. This would be more consistent with the historical relationship between residential investment and durables spending than assumed in the main forecasts.

With more household spending, profits improve, leading to higher employment and investment growth compared to the main forecasts, particularly in the retail sector. Reflecting employment growth, the unemployment rate falls below 5% by September 2014 - one year earlier than in the main forecasts. The stronger-than-expected domestic economy means CPI inflation is around the top of the 1% to 3% band over the forecast period. The higher inflation, together with increased real activity, results in about $15 billion higher nominal GDP cumulatively by June 2016 compared with the main forecasts.

Figure 3.4 - Real private consumption
Figure 3.4 - Real private consumption.
Sources: Statistics New Zealand, the Treasury

With higher inflation over the forecast period, monetary conditions are tighter. Ninety-day bank bill rates are 0.4% points higher than in the main forecasts on average in the year to March 2014, with the difference increasing to 1.2% points by the year to March 2016.

…giving a modest increase in the operating surplus in 2015

Core Crown revenue is a cumulative $5.4 billion higher in the upside scenario, led by increases in various tax types. Increased income driven off the stronger domestic economy lifts corporate tax and source deductions by about $1.9 and $0.9 billion respectively compared to the main forecasts. The boosts to private consumption and residential investment flow through to $1.7 billion higher GST revenue, compared to the main forecasts, while the faster increase in interest rates lifts resident withholding tax.

Core Crown expenses are $0.5 billion lower, as the stronger labour market flows through to fewer Unemployment Benefit recipients. In addition, finance costs are lower, owing to less government borrowing.

In this scenario, the operating balance (before gains and losses) moves into surplus in the June 2015 year, the same year as the main forecasts, with the surplus 0.7% points of GDP higher than in the main forecasts. Net core Crown debt as a proportion of GDP peaks at 27.8% of GDP in the June 2013 year.

These results are consistent with the balance of risks remaining on the downside

In pre-global financial crisis conditions, we might expect outcomes better or worse than the main forecasts with roughly a 50-50 split. Similarly, if the risks were balanced we would expect that the differences between the scenarios and the main forecasts would be broadly equal. However, we have assumed that the risks are skewed to the downside. This is illustrated in Table 3.1 which shows that in the downside scenario nominal GDP is $25 billion lower than in the main forecasts, compared to $15 billion higher in the upside scenario. Tax revenue is $8.1 billion lower in the downside scenario, while it is $5.4 billion higher in the upside scenario. Moreover, in the downside scenario, the operating balance remains in deficit over the forecast period, and in the upside scenario, while the operating surplus is larger than in the main forecasts, it is achieved in the same year. Overall, these results reflect our view that the balance of risks remains skewed to the downside.

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