The Treasury

Global Navigation

Personal tools

Economic Risks

Domestically oriented risks

Businesses have been facing inflationary pressures in the form of rising inputs and capital costs, as well as higher labour costs. This has been reflected in declining margins and weaker business confidence. Profits are expected to fall in 2007. One of the key judgements underpinning the central forecast is that the response to weak profits is relatively muted due to strong corporate balance sheets. There is a risk that if significant upward pressure on costs were to continue, the squeeze on business sector margins would be even greater. This would feed through into lower business sector investment and employment than outlined in the central forecasts.

In contrast to a business sector under pressure, household consumption has been strong. The Economic and Tax Outlook chapter highlighted that private consumption growth is expected to decline in line with a slowing labour market, higher effective mortgage rates, and a reduction in the positive wealth effects associated with slowing house price growth. There is a risk that the expected downward adjustment in house prices will be more abrupt than expected in the central forecast. It is also possible that the likely negative wealth effect associated with this adjustment will have a greater than expected impact on household expenditure. Both these potential outcomes could result in lower consumption growth. The longer households continue to spend more than they earn, the greater the likelihood of a more severe adjustment in the future.

If the economy does not slow as expected and domestic inflation is higher than currently forecast, interest rates may rise higher than expected. This would also be likely to impact negatively on household expenditure in the medium term. One of the scenarios in the following section of this chapter considers how the economy might evolve if the current strength in household expenditure were to dissipate faster and more deeply than expected in the central forecast.

The strong labour market, which has been a key feature of the recent economic expansion, is expected to soften over the course of the next two years. There is a risk to the central forecast that strong employment and wage growth continues for longer than expected. If employment growth were to continue - amplifying difficulties in finding labour - wage pressures may be stronger than expected. This would have flow-on impacts for household spending through higher incomes and increased confidence and potentially increased inflationary pressure, or alternatively it would provide more room for debt consolidation.

Net migration has had a significant impact on New Zealand population growth in recent years which has relevance for the size of the workforce as well as demand for goods and services. In the central forecast net migration inflows are assumed to be 7,000 in the year to March 2006, then hold steady at 10,000 people a year for the rest of the forecast period. There is a risk that as employment growth slows and the economy weakens, net migration will be lower than forecast or even turn negative. This would result in lower domestic demand than built into the central forecast. Alternatively an increase in net migration will provide a boost to economic demand.

Climatic conditions are an important influence on agricultural-related production in New Zealand. According to the National Institute of Water and Atmospheric Research (NIWA), over the next three months from November, rainfall is likely to be near normal in all regions, except in the east of the North Island where it may be below normal. A more severe outcome with drier conditions than predicted could have a detrimental impact on agricultural production and hydro electric generation.

A reasonably weak dairy season is built into the central forecast. If dairy production is higher than forecast this is likely to have a positive impact on exports as well as domestic consumption as rural incomes are given a boost.

Internationally oriented risks

Developments in the world economy are important drivers of economic activity in New Zealand through the impact on both the prices and volumes of exports and imports, and through interest rates and confidence. Over the next year, steady economic growth for New Zealand’s largest trading partners is expected. If world economic growth were to slow, New Zealand’s export volumes and prices could fall faster than forecast and economic growth would slow accordingly. China is expected to remain a significant driver of world economic growth over the forecast period and the New Zealand economy is exposed to a risk of a slowdown in demand from China.

The future path of the exchange rate and how it impacts on the future performance of the economy is a key judgement of the forecasts. The central forecast sees the New Zealand dollar depreciating over the forecast period from around 71 on the TWI to settle at 58.5. There is a lot of uncertainty around the timing and extent of the expected depreciation which will affect the economic outlook largely through the resultant growth in exports as well as the level of tradables inflation. The New Zealand dollar is susceptible to a variety of factors. For example if New Zealand’s large current account deficit causes overseas investors to lose confidence, it could fall further and faster than set out in the central scenario. Such a scenario is explored further later in the chapter.

Uncertainties around how the sizeable US current account and fiscal deficits may impact on global exchange rates are also a factor. If the US dollar were to weaken further in response to the twin deficits, the New Zealand dollar might appreciate with a subsequent impact on New Zealand’s economic outlook. In particular, there would be a greater negative impact on export volumes and on the receipts of exporters than built into the central forecast.

The high level of the terms of trade, largely driven by the record high commodity prices recently recorded for some agricultural commodities, has been one of the key contributors to growth over the past couple of years. The high prices have been due to strong world demand and some temporary supply issues including lower lamb production in the UK after the 2001 foot and mouth outbreak, the effect of the BSE scare on Canadian and US beef exports and the drought in Australia. Some of the agricultural commodity prices are forecast to fall over the forecast period as supply returns to normal and world growth weakens. If some of these tight supply conditions were to continue, world prices of these commodities may hold up for longer, resulting in higher than expected incomes for agricultural producers. On the other hand, if supply were to return to normal more quickly than expected, for example if US beef were accepted back into Asia earlier than expected, or if world growth were to slow faster than thought, it would pose some downside risk to the central forecast.

Another factor that poses risk to the global outlook and the terms of trade is the recent volatility in oil prices. Between January and September 2005 oil prices increased 67%. They have since fallen 15%. If prices were to reverse their recent fall and increase significantly, world growth would most likely be negatively affected. Conversely, if they were to fall faster than our forecast, New Zealand’s terms of trade would most likely stay higher than forecast.

The outcome of the current Doha Development Round of international trade negotiations is as yet unknown. Therefore its effects are not factored into this forecast. A successful round could raise the relative prices and volumes for some exports towards the end of the forecast period. A failure could lead to some turbulence in international trading arrangements. An intermediate outcome, with smaller price and volume effects, is also possible.

The World Health Organisation (WHO) and other health authorities have warned of the risk of an influenza pandemic with the emergence and spread of a highly pathogenic strain of avian influenza, H5N1. The continued spread of avian influenza (as an animal disease, rather than human disease) may itself pose some risks to our forecasts through its impact on trading partners and possible risks to the poultry industry in New Zealand. Moreover, the risk of a pandemic may itself have some impact on international travel, tourism, and trade in services. Finally, while the likelihood of a pandemic, and its severity should it occur, is unknown, it is clear that a serious pandemic would have major human, social and economic costs.

Page top