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Budget 2006 Home Page Half Year Economic & Fiscal Update 2006

Economic and Tax Outlook

Summary

Economic growth has been stronger than expected in the Budget Update

Growth in the first half of 2006 was stronger than forecast in the Budget Update.

  • Stronger than expected economic activity, and higher employment and wage growth, have led to tax revenue exceeding forecasts by around $300 million in the period from July to September 2006.
Figure 1.1 – Growth in real GDP
Figure 1.1 - Growth in real GDP.
Sources: Statistics New Zealand, The Treasury
  • Annual average gross domestic product (GDP) growth is forecast to be 1.8% in March 2007 and 2.3% in March 2008 before further recovering to 3.2% in 2009. The economy is forecast to have passed its weakest period of quarterly growth, which occurred at the end of 2005, and has entered a period of modest growth.
  • The cycle in GDP growth is forecast to be smoother than was anticipated in the Budget Update, where growth of 1% was forecast in March 2007 followed by a rebound to 3.3% in March 2008.
  • Tax revenue is forecast to be around $1 billion higher in March 2007 than forecast in the Budget Update, with this higher revenue expected to flow through the whole forecast period, largely due to increased forecasts of nominal GDP.

Imbalances in the economy are likely to exist for longer than previously forecast

  • The long period of strong growth in the economy has seen the emergence of macroeconomic imbalances – a rise in inflation pressures and a large current account deficit. The corollary of these imbalances has been tighter monetary policy and a high exchange rate that has seen the export and import-competing sectors come under pressure.
  • Imbalances are forecast to continue throughout the 2007 calendar year. At the time of the Budget Update a faster reorientation in growth away from components of domestic demand and towards exports was forecast during late 2006 and early 2007. This reorientation is now forecast to occur during 2008, with the unwinding of the imbalances expected to be slow but orderly.
  • Despite slow growth, inflationary pressures in the non-tradables sector of the economy are expected to remain during 2007. Consumer Price Index (CPI) inflation is forecast to be volatile in the short term, due to the impact of falling oil prices and the appreciation of the exchange rate in the second half of 2006. Inflation is forecast to ease to 1.9% in June 2007, before lifting back to 2.8% in December 2007.
  • Export growth is forecast to be constrained by the appreciation of the exchange rate in the middle of 2006. As a result, the current account deficit is expected to narrow at a slow rate, remaining at 8.8% of GDP in the year to March 2008.

Inflation and the current account deficit are forecast to reduce in an orderly fashion

  • Soft growth in most components of domestic demand during 2007 is expected to be the first element of some reorientation of growth in the economy. This forecast is underpinned by some consolidation in the household sector, with households less willing to take on debt in the face of high debt servicing ratios. With growth expected to be soft and profits continuing to be squeezed, market investment is expected to fall 6.9% in the year to March 2007 and 1.2% in the year to March 2008.
  • Soft domestic demand growth is forecast to lead to an easing in inflationary pressures in the economy, with inflation forecast to be 2% by 2009.
  • Exchange rate depreciation during 2007 is forecast to lead to a recovery in export growth in 2008 providing some further rebalancing of growth in the economy and boosting GDP growth to 3% or more in the remaining years of the forecast period. This recovery in export volumes, together with a rise in the terms of trade, and soft import volume growth due to a weak outlook for domestic demand, are forecast to lead to a gradual narrowing of the current account deficit to 6.3% in the year to March 2010.

There are a number of risks to the outlook

  • The behaviour of households is a key judgement underlying the central forecast. If households remain willing to take on a higher level of debt, domestic demand is likely to remain stronger than forecast and inflationary pressure is likely to be larger than forecast.
  • The imbalances in the economy present a risk to the outlook. In the central forecast, the imbalances are forecast to resolve gradually, in an orderly manner. It is possible that there could be a sharper adjustment in the economy. The Risks and Scenarios chapter considers a scenario where there is an abrupt current account adjustment and consequent sharp fall in growth and the fiscal position.

Table 1.1 – Economic outlook: central forecast 1

Table 1.1 – Economic outlook: central forecast 1
(Annual average % change, year to 31 March) 2006 Actual 2007 Estimate 2008 Forecast 2009 Forecast 2010 Forecast 2011 Forecast
Private consumption 4.5 1.6 1.6 1.0 1.3 1.5
Public consumption2 5.4 4.7 3.0 3.9 3.4 4.0
Total Consumption 4.7 2.2 1.9 1.7 1.8 2.1
Residential investment -4.7 -5.1 0.0 3.5 2.6 0.3
Central government investment 25.6 6.2 1.6 2.0 2.0 2.0
Other investment 6.7 -6.4 -1.2 4.4 5.8 5.7
Total Investment 5.6 -5.1 -0.7 4.0 4.8 4.3
Stock change3 -0.3 -0.9 0.3 0.1 0.1 0.1
Gross National Expenditure 4.5 -0.5 1.7 2.3 2.6 2.8
Exports -0.1 3.6 1.4 4.1 4.6 4.0
Imports 5.0 -2.6 0.9 2.1 3.2 3.4
GDP (Production Measure) 2.2 1.8 2.3 3.2 3.1 3.0
 - annual % change 2.1 2.0 2.7 3.2 3.1 3.0
Real GDP per capita 1.3 0.8 1.3 2.3 2.2 2.2
Nominal GDP (expenditure basis) 4.7 3.3 4.3 5.6 5.0 4.9
GDP deflator 2.5 1.5 2.0 2.4 1.9 1.9
Employment4 2.7 1.9 -0.2 0.8 1.3 1.5
Unemployment5 3.9 4.0 4.8 4.6 4.4 4.3
Wages6 4.7 4.8 3.9 3.7 3.4 3.4
CPI inflation7 3.3 2.8 2.7 2.0 2.0 2.0
Export prices8 1.0 10.1 4.7 4.5 3.4 2.5
Import prices8 1.8 9.6 4.4 2.8 2.6 2.5
Current account balance            
  - $ million -14920.0 -14975.9 -14741.0 -12027.8 -11665.6 -12261.7
  - % of GDP -9.6 -9.3 -8.8 -6.8 -6.3 -6.3
TWI9 68.3 63.5 60.1 57.3 54.9 54.4
90-day bank bill rate9 7.6 7.5 6.0 6.0 6.1 6.0
10-year bond rate9 5.7 6.1 6.0 6.0 6.0 6.0

Sources: Statistics New Zealand, Reserve Bank of New Zealand, The Treasury

NOTES:

1 Forecasts finalised on 15 November 2006.

2 The forecast profile for public consumption is influenced by government defence spending.

3 Contribution to GDP growth.

4 Household Labour Force Survey, full-time equivalent employment.

5 Household Labour Force Survey, percentage of the labour force, March quarter, seasonally adjusted.

6 Quarterly Employment Survey, average hourly ordinary time earnings.

7 Annual percentage change.

8 Overseas Trade Index basis, annual average percentage change, March quarter.

9 Average for the March quarter.

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