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Economic and Fiscal Forecasts December 2008

Risks to Fiscal Forecasts

Risks to the fiscal forecasts take two forms:

  • Policy decisions not yet taken by the Government. These consist of the policy priorities that the Government intends progressing through the Budget process and Specific Fiscal Risks. Specific Fiscal Risks are policies or proposals about which the Government has not yet made a decision but which are being actively considered by the Minister of Finance and relevant portfolio Ministers. Specific Fiscal Risks were last reported in the 2008 Pre-Election Update (see pages 57-82). The Government is currently working through the Specific Fiscal Risks, confirming those that will fall by the wayside and identifying new risks. Updated Specific Fiscal Risks will be provided in the 2009 Budget Update. The forecasts assume that the costs arising from future spending decisions will be met from within existing baselines and the operating and capital allowances provided in each Budget for new spending.
  • Forecasting risks. A normal half-year fiscal forecast process would involve obtaining detailed forecasts from all Government departments along with significant Crown Entities and State-owned Enterprises (a “bottom up” approach). As this Update was performed so soon after the Pre-election Update, and was intended to present a high level view of the impact of current economic conditions on the fiscal outlook, a top down approach has been adopted (i.e. the fiscal forecasts are based on the 2008 Pre-election Update adjusted for significant assumptions detailed on pages 49 and 50. Overall, this top down approach is considered appropriate and robust. Some forecasting risks also contain a policy element around which ministers may have to take an active decision.

Outlined below are the forecasting risks relevant to these forecasts.

Forecasting Risks

Economic forecasts

A number of the components of the fiscal forecasts (e.g. tax revenue and benefit costs) are based on the main macroeconomic forecasts. Any variation from the main macroeconomic forecasts will affect the fiscal forecasts.

Tax policy changes

There have been many tax policy changes that have been enacted recently and/or are in the pipeline; e.g. the company tax rate has been cut, personal income tax rates and thresholds have been changed and more changes are yet to come, the PIE and FDR regimes for the taxation of investments have been introduced, etc. The increased complexity in the tax system, as well as the uncertainty around the resulting impact on taxpayer behaviour, has increased the risks around tax revenue and receipts forecasts.

KiwiSaver risks

The fiscal forecasts incorporate an assumed take-up rate profile for the KiwiSaver regime. The actual take-up rate could be higher or lower than assumed, or faster or slower than assumed.

Early Childhood Education risks

The fiscal forecasts incorporate an assumed take-up rate profile for the ECE scheme. The actual take-up rate may be higher or faster than assumed.

Bond issuances

The fiscal forecasts include a significant increase in bond issuances across the forecast period. This increase may result in a corresponding increase in the interest rates relating to those issuances, a “volume premium”. As the occurrence or extent of such a premium is uncertain, it has not been included in the fiscal forecasts. By way of illustration, a premium from 2009/10 rising steadily from an initial 20 basis points to 50 basis points by 2012/13 would add approximately $240 million to finance costs across the forecast period.

Investment portfolios

A number of entities included in the fiscal forecasts hold large investment portfolios. Entities holding significant equity portfolios (the NZS Fund, ACC and EQC) have been adversely impacted by the continuing volatility of financial markets.

The fiscal forecasts include the actual results of these entities to 31 October 2008 and, subsequent to 31 October 2008, an estimated long-term rate of return. Any deviation from this long-term rate will affect the fiscal outcome.

Value of goodwill

At 31 October 2008, the Crown recognised goodwill of just under $450 million. The value of goodwill as an asset of the government is dependent on the value of the underlying investment. The worsening economic conditions increase the risk that this investment will decrease in value to less than its current carrying value. This would lead to an impairment of goodwill and a reduction in the operating balance.

Long-term liability valuations

The Government Superannuation Fund and ACC liabilities included in these forecasts have been valued as at 31 October 2008 and 30 June 2008 respectively. While the ACC liability valuation has been updated for changes to the discount rate since 30 June 2008, it has not been updated for other assumption changes.

The liabilities are to be next valued for the 2009 Budget Update. Any change in the underlying assumptions of this subsequent valuation will affect the fiscal outcome. For example, if the discount rate rises, the value of the liabilities will decrease.

The fiscal forecasts also include an estimate of the funding requirements in relation to those long-term liabilities. Actual funding may differ from these estimates as a result of subsequent valuations.

Financial sector guarantees

The Government recently announced the introduction of two guarantee schemes in relation to the financial sector; the retail deposit scheme and the wholesale funding guarantee facility. Details of these schemes are available on the Treasury website and in the latest published financial statements of the Government. At 30 November 2008, 40 institutions had joined the retail scheme and deposits of approximately $125 billion had been guaranteed, while no guarantees had been issued under the wholesale facility.

The fiscal forecasts include an estimate of fee income from the retail scheme. No guarantee income has been included in the forecasts from the wholesale funding guarantee facility, as the timing and magnitude of any income cannot be reliably estimated.

Uncalled capital, indemnities and guarantees

The worsening economic conditions increase the possibility that some contingent liabilities such as uncalled capital, indemnities and guarantees will be realised at a future date. Any realisation would most likely result in an increase in the Government's debt as well as a reduction in its operating balance.

ACC funding

The fiscal forecasts include an estimate of additional funding requirements in relation to the ACC non-earners account ($297 million per annum across the forecast period). While the Government has approved interim changes to appropriations, it has announced its intention to review ACC funding.

Emissions Trading Scheme

The forecasts in relation to the ETS are based on a number of assumptions and projections, all of which may change through time. In addition, the Government has indicated it will review the ETS. At the time of finalising the forecasts it is unclear what changes will be made to the Scheme from the review and how these changes will impact the fiscal position.

Treaty of Waitangi settlements

The Government has signalled settling all Treaty claims by 2014. If this timeframe is agreed this would increase the cost of Treaty claims currently built into the forecasts, as settlement expenses will be compressed into a shorter time frame.

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