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Budget 2007 Home Page Half Year Economic & Fiscal Update 2007

1 Economic and Tax Outlook

Introduction

This chapter summarises the recent course of the New Zealand economy and the most likely path for its future development. Economic growth has slowed recently following a sustained expansion, but it is expected to continue, although at a slower pace. Higher dairy prices will boost returns to the agricultural sector, but global financial turmoil poses risks for the world economy. Domestically, the assumed reduction in tax revenue and continuing momentum in the labour market will be partially offset by tight monetary conditions, high oil prices, lower net migration inflows and high household debt. Tax revenue is forecast to be higher, even with the assumed reduction in tax revenue.

Growth slows after a long expansion

The New Zealand economy has experienced a period of sustained growth …

Figure 1.1 – Real GDP
Figure 1.1 – Real GDP.
Source:  Statistics New Zealand

The New Zealand economy has expanded on an annual basis for nearly nine years and the expansion looks likely to continue, albeit at a slower pace. Real Gross Domestic Product (GDP) has increased 34% since the trough of the previous recession in 1998 which was marked by the Asian financial crisis, two successive droughts and monetary tightening (Figure 1.1). A number of factors, some related to the international economic environment and some arising from specifically New Zealand origins, have sustained the recent period of growth.

… thanks to a number of international and domestic factors

  • Growth in the world economy has been robust since the late 1990s, apart from a brief dip in 2001 following the bursting of the “tech boom” in the United States.
  • This sustained expansion, combined with reductions in supply for some commodities, took the terms of trade to a 30-year high in 2007.
  • The greater participation of China in world trade helped suppress global inflation as its low labour costs reduced the price of manufactured products.
  • A surplus of savings and low investment rates in Asia, in conjunction with increased oil revenues being available for investment, increased global liquidity.
  • Low inflation and a ready supply of capital led to low long-term interest rates becoming embedded in the major economies and provided a cheap source of debt.
  • Financial market innovation and a greater willingness to borrow led New Zealand households to increase their debt levels.
  • Net permanent and long-term (PLT) migration inflows averaged 20,000 per annum in the six years to 2006, twice their average in the past decade.
  • Labour income increased by nearly 7% per annum in current dollar terms in the six years to 2006 as both employment and wages expanded rapidly.
  • House prices more than doubled between 1998 and 2007, boosting wealth for homeowners and providing additional collateral for borrowing.
  • The economy is more flexible and resilient, which has made it better able to respond to changes in the global economy and sustain growth.

The combined effect of these developments has been a period of sustained growth in the New Zealand economy, especially in nominal GDP thanks to the higher terms of trade. The value of nominal GDP has increased by 64% since mid-1998 and tax revenue increased by 70% over the same period.

Economic growth dipped in late 2005-early 2006 …

Figure 1.2 – Real GDP
Figure 1.2 – Real GDP.
Source:  Statistics New Zealand

The rate of expansion began to slow on a quarterly basis in the second half of 2005 as some of the drivers of growth weakened (Figure 1.2). Net PLT migrant inflows fell to 6,000 in the year to October 2005 (from 17,000 the year before) as a result of lower student arrivals and a continuing increase in departures, especially to Australia. The Reserve Bank increased the Official Cash Rate by 50 basis points to 7.25% in late 2005 to counter increasing inflationary pressures. As a result, the housing market began to cool in late 2005-early 2006 and residential investment declined. Increases in oil prices in the second half of 2005 reduced disposable income and detracted from household consumption growth. In addition, the appreciation of the exchange rate through this period curtailed growth in exports, particularly of services. Growth in production GDP fell to 1.7% in the year to September 2006 and remained at that rate for three quarters, its lowest rate since the late 1990s.

… but picked up again in late 2006-early 2007

The slowdown in the economy was relatively short-lived as some of the same factors recovered towards the end of 2006 and brought a rebound in growth in late 2006 and early 2007. Net migration inflows increased from their low point in late 2005 to peak just below 15,000 in late 2006 as departures fell and arrivals increased. The faster population growth contributed to a recovery in the housing market, with house sales nearly one-fifth higher in the 2006/07 summer than a year before and a recovery in annual house price growth to just below 14% in June 2007.

Dwelling consents picked up in the first half of 2007 and residential investment increased in mid-2007 following the recovery in the housing market in late 2006. A fall in retail fuel prices in the December 2006 quarter boosted household disposable income and retail sales recovered in the second half of the year and the first quarter of 2007. The anticipation of higher dairy prices and the increase in the exchange rate in mid-2007 may have also played a role in higher consumption growth. Quarterly growth in real GDP accelerated from no change in the second quarter of 2006 to a 1.2% increase in the first quarter of 2007, boosted by consumption growth of 2.1% in the quarter.

Nevertheless, the economy was slowing from mid-2007

Figure 1.3 – Annual net migration and house sales
Figure 1.3 – Annual net migration and house sales.
Sources:  Statistics New Zealand, REINZ

After the pick-up in the economy in late 2006-early 2007, there are signs that growth started to ease in mid-2007. Growth in real GDP declined to 0.7% in the second quarter of 2007 from 1.2% in the first quarter. Fuel prices have increased throughout 2007 as a result of higher international oil prices, the Reserve Bank increased the Official Cash Rate a further percentage point to 8.25% between early March and late July, net PLT migration inflows tracked down to 7,500 in the year to October, house prices were practically unchanged in the six months to September and annual house sales have fallen nearly 10% in the past six months (Figure 1.3). As a result of these developments, growth in retail sales and building consents has slowed, pointing to lower growth in private consumption and residential investment.

But some negative factors have had less impact than expected …

The New Zealand dollar exchange rate has strengthened again, after falling in the immediate aftermath of the global financial turmoil in July-August. Despite the high exchange rate, export volumes were still robust in mid-2007 and manufacturers’ outlook for exports remained positive in September. Local finance company collapses, while significant for those directly affected, are not considered likely to have much impact at the aggregate level. They may have some impact on consumer confidence, however.

… and there are still some positives

There are also some factors which have supported growth in the second half of 2007. Higher dairy prices (discussed in the next section) have started to flow through, unemployment remains low and wage growth high, consumer confidence is moderately positive, and businesses’ outlook for their own activity – although easing – is also still positive, pointing to ongoing growth next year. We expect growth in real GDP of around ½% in each of the September and December quarters of 2007. Combined with high growth over the first half of the year, this will lift growth to 3.0% on an annual average basis in March 2008.

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