Key Trends (continued)

The New Zealand Superannuation Fund

The NZS Fund is an important component of the Government’s fiscal strategy. The NZS Fund’s assets provide the means for the Government to partially pre-fund future fiscal pressures, particularly those pressures arising from an ageing population.

The NZS Fund’s assets are to be built up through a combination of investment returns earned on the Fund’s portfolio and Government contributions. The Government’s contributions to the NZS Fund are calculated over a 40-year rolling horizon on the basis of funding superannuation payments over the next 40 years with a constant contribution rate over that period. The Government is forecast to make the required minimum annual contribution for 2007/08 and 2008/09 as calculated by the formula set out in the NZS Act.

The underlying assumptions in calculating the contributions for 2008 are the nominal GDP series to 2048, the New Zealand Superannuation expense series to 2048 and the expected long-term, net after-tax annual return of the NZS Fund (6.1%) (6.1% Budget Update). The forecast rate of return is based on the Treasury’s assumptions for the rate of return on financial portfolios of Crown financial institutions. The Treasury website contains further information on the NZS Fund, as well as a copy of the NZS Fund model.

The Fund’s assets are forecast to grow over the forecast period to $31.1 billion, an increase of $18.1 billion. Over $6.7 billion of this increase is expected to come from the NZS Fund’s investment performance, with the remaining increase from Government contributions.

Introduction of an Emissions Trading Scheme

On 4 December 2007, the Government introduced legislation to establish an Emissions Trading Scheme (ETS) to encourage industries and businesses to reduce greenhouse gas emissions. Key features of the ETS from a forecasting perspective are:

• The ETS creates a limited number of tradable units (the NZ Unit), which the Government can allocate freely or sell to entities.
• Specified emitters (“points of obligation”) will be required to surrender NZ Units or International Units to the Crown based on the level of carbon dioxide equivalent they emit or that will be emitted downstream of their activities.
• The Government will exchange NZ Units for internationally tradable units if parties holding NZ Units wish to sell their units offshore.

Detail on the operation of the ETS is available at www.climatechange.govt.nz/

Reporting of the ETS

The economic impacts of the ETS are not included in these forecasts, as Cabinet’s decisions on the ETS were made after the HYEFU’s economic forecasts were finalised.

The fiscal forecasts do, however, capture the core policy decisions made by Cabinet (ie, transactions associated with the Government’s allocation of NZ Units to forestry and industrial process sectors and payment of units to the Crown by emitters). There is little guidance on how to report Emission Trading Schemes, with practices varying internationally. The following outlines the approach reflected in this Half Year Update. This approach is being discussed with the Office of the Auditor-General.

The allocation of NZ Units creates a liability (and an expense if allocated for free). The liability arises from the Crown being prepared to swap allocated units into International Units. This is similar to how currency issued by the Crown is reported. The liability is reduced, and revenue recognised, as NZ Units are paid back to the Crown by emitters. The forecast revenues and expenses are transacted in NZ Units (valued at the recent international carbon prices) – no cash is exchanged.

The ETS impact on the fiscal forecasts is:

Reporting of the Kyoto liability

The ETS is designed to encourage reductions in greenhouse gas emissions at least cost. Reductions in emissions will in turn reduce the Crown’s international Kyoto obligations. For the Half Year Update, the Kyoto liability has been updated for exchange rates and international carbon prices only, bringing the carbon price in New Zealand dollars to $21.01 ($15.48 at 30 June 2007). The price change increased the liability to $956 million (up $252 million since 30 June 2007).