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Economic and Fiscal Forecasts December 2008

Finalisation Dates and Assumptions for the Forecasts

Economic and fiscal forecasts - finalisation dates
Text finalised12 December
Economic data20 November
Economic forecasts20 November
Tax revenue forecasts3 December
Fiscal forecasts8 December

Economic Forecast Assumptions

The economic forecasts are based on the assumptions detailed below:

Trading partner growth - Consensus forecasts for economic growth in New Zealand's top 20 trading partners have been revised down steadily over the course of 2008. In anticipation of further revisions, we have reduced the November Consensus forecasts from 1.7% and 3.3% in calendar years 2009 and 2010 (respectively) to 1.2% and 2.4%. Growth is estimated to recover subsequently to around 3.5%. Given the considerable uncertainty around these numbers we consider scenarios based on different levels of world growth.

Global inflation and interest rates - In the December Update, the G-3 long-term policy rates have been revised lower to reflect weaker world economic growth. Interbank rates, while remaining at elevated levels, have been marginally revised down as lower policy rates have started to have some effects in the interbank lending markets. The inflation outlook is also lower owing to the significant softening in international fuel and commodity prices. In the medium term, the weaker economic outlook and lower fuel and commodity prices will continue to help contain inflation.

Oil prices - The price of West Texas Intermediate (WTI) oil is assumed to decline from an average of US$118/barrel in the September quarter of 2008 to under US$63/barrel before increasing to US$84/barrel at the end of the forecast period. These forecasts were based on the average futures prices in the week to 12 November 2008. Since this period, oil prices have fallen further as demand has fallen as the world economy slows. In the March quarter of 2009 the oil price assumption is 41% below that in the Budget Update and 47% below that in the Pre-election Update.

Figure 22 - West Texas Intermediate oil price
Figure 22 - West Texas Intermediate oil price.
Sources: Datastream, the Treasury

Terms of trade - The merchandise terms of trade (as measured in the System of National Accounts) are estimated to have peaked in the December quarter of 2008, and to decline 9% in the following five years as commodity prices fall from their peaks. Most of the decline is forecast to occur over the first six months of 2009.

Monetary conditions - The New Zealand dollar (NZ dollar) exchange rate is assumed to decline 19% from 65.5 on the Trade Weighted Index (TWI) in the September quarter of 2008 to 53 at the end of the forecast period. Ninety-day interest rates are assumed to fall from 8.2% in the September quarter of 2008 to 4.75% in the second half of 2009 before increasing over the final two years of the forecast. These forecasts were finalised before the Reserve Bank reduced the Official Cash Rate by 150 basis points on 4 December 2008. That may hasten the fall in interest rates in the near term.

External migration - The net inflow of permanent and long-term migrants is assumed to increase from under 4,800 in the year to September 2008 to 10,000 per annum by March 2011.

Policy and tax - The economic forecasts incorporate changes to tax rates and thresholds and the changes to capital allowances outlined below. The Emissions Trading Scheme (ETS) is assumed to impact on stationary energy and liquid fuels from 1 January 2010 and 1 January 2011 respectively, as assumed in the Pre-election Update.

Fiscal Forecast Assumptions

The fiscal forecasts are based on the 2008 Pre-election Update adjusted for the significant assumptions detailed below:

A comprehensive set of macroeconomic forecasts has been used to update taxation revenue and welfare benefit expenditure.

The fiscal forecasts include changes to personal tax rates and thresholds and introduction of the independent earners tax credit to be introduced by the Government, together with the savings from the removal of research and development tax credit and changes to the KiwiSaver scheme.

Table 14 - Personal income tax rates and thresholds
Previous New
Income Tax rate Income Tax rate
From 1 April 2009   
$0 - $14,00012.5%$0 - $14,00012.5%
$14,000 - $40,00021.0%$14,000 - $48,00021.0%
$40,000 - $70,00033.0%$48,000 - $70,00033.0%
From 1 April 2010   
$0 - $17,50012.5%$0 - $14,00012.5%
$17,500 - $40,00021.0%$14,000 - $50,00021.0%
$40,000 - $75,00033.0%$50,000 - $70,00033.0%
From 1 April 2011   
$0 - $20,00012.5%$0 - $14,00012.5%
$20,000 - $42,50021.0%$14,000 - $50,00020.0%
$42,500 - $80,00033.0%$50,000 - $70,00033.0%

The forecasts also include:

  • an estimated increase in the level of ACC funding for the non-earners account; and
  • forecast revenue from the retail deposit scheme. Forecast revenue in relation to the wholesale funding facility has not been included in this forecast owing to the uncertainty of timing and amount.
  • The allowance for new operating initiatives for Budget 2009 is set at $1.75 billion (growing by 2% inflation for subsequent Budgets), which is unchanged from the Pre-election Update.
  • The allowance for new capital initiatives for Budget 2009 is set at $1.45 billion, which is an increase of $550 million compared to the Pre-election Update. Allowances for subsequent Budgets covered in the forecast period have also been set at $1.45 billion.
  • It is assumed that these allowances are sufficient to meet the indicative spending commitments made by the new Government in their election campaign.
  • The domestic bond programme and resulting finance costs have been updated.
  • The forecasts incorporate the actual fiscal position and results to 31 October 2008. The most notable change is investment returns to 31 October have been adjusted in the current year to reflect the recent financial market turmoil. Beyond the June 2009 year, gains on financial instruments are based on long-term benchmark rate of returns.

As with the economic forecasts, the fiscal forecasts assume no change to the existing ETS with the impact on stationary energy and liquid fuels taking effect from 1 January 2010 and 1 January 2011 respectively.

Projection Assumptions

The following table shows the fiscal assumptions used for the projections.

Table 15 - Summary of fiscal assumptions used in the 10-year projections
Tax revenueLinked to growth in nominal GDP, with a constant tax-to-GDP ratio assumed for all components except for PAYE.  PAYE is grown using employment growth and nominal average hourly wage growth, with the latter multiplied by a fiscal drag elasticity of 1.35.
NZSCurrently indexed to inflation, but is constrained for a married couple to the weekly rate being between 66% and 72.5% of net (after-tax) average weekly earnings. By the June 2011 year, the 66% wage floor is reached and growth in the NZS expense is driven by demographic changes and the growth of net average weekly earnings. Assumes the tax rate on average weekly earnings, being a part of overall PAYE, increases due to fiscal drag and that average weekly earnings grow at the rate of the nominal average hourly wage.
Other benefitsDemographically adjusted and linked to inflation.
Health and educationDemographically adjusted.
Finance costs A function of debt levels and interest rates.
OtherNot demographically adjusted.
Operating allowance$1.694 billion in the June 2014 year. This is equivalent to $1.894 billion with a $200 million adjustment, which is the approximate expense that is already included in projected baselines as a result of demographic growth. $1.894 billion is based on the $1.750 billion new spending allowance set for Budget 2009, with subsequent operating allowances increasing at the rate of inflation over the forecast and projection periods.
Capital allowance$1.65 billion in the June 2014 year, and remains at this level in 2015 and 2016. After that it returns to a track where values are derived from a $900 million starting point in the June 2014 year increasing at the rate of inflation each year.
Surplus DMO financial assets$0 billion 
NZS Fund Contributions to the Fund are assumed to be consistent with the New Zealand Superannuation Fund Act 2001[3].
Emission Trading Scheme (ETS) The fiscal impact of the ETS depends on several highly uncertain factors, most notably future carbon prices and New Zealand's emissions targets from future international climate change agreements.  The ETS has no impact on debt beyond the June 2013 year in the fiscal projections as a policy of full recycling of revenue is assumed. Net revenue (the value of credits received after free allocation of credits to participating industries and after meeting future emission liabilities) is assumed to be recycled back to the public through fiscally equivalent, unspecified tax reductions or spending increases.
Future emissions liabilities The Kyoto liability included in fiscal forecasts reflects the Government's obligation for Commitment Period 1, which is for the period 2008-2012. Base case projections beyond the June 2014 year do not incorporate a quantitative estimate of any net emissions liability that may eventuate from New Zealand's obligations under future international climate change agreements.


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