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Half Year Economic & Fiscal Update 2009

1 Economic and Fiscal Update

Overview

The economic and fiscal outlook is stronger...

The economic environment presented in this Half Year Update is stronger than predicted in Budget 2009, which means the Crown's fiscal deficits are expected to be smaller than anticipated earlier in the year.

However, the broad economic and fiscal challenges presented in the Budget persist. Imbalances in the economy are likely to return to the fore as domestic demand leads an anticipated upturn, while ongoing fiscal deficits are expected to push government debt levels significantly higher in the years ahead.

The heightened uncertainty surrounding the outlook for the world economy has diminished in recent months, but a degree of uncertainty remains and alternative scenarios are presented alongside the main predictions.

...as the world pulls out of its deepest recession in over 60 years...

The world economy has begun to recover from its most severe recession in more than 60 years, assisted by significant international government and central bank interventions, and the rebuilding of previously-depleted inventories by firms. Increased global optimism has already boosted the local economy through some easing of credit constraints, higher confidence levels and a recovery in world commodity prices. A stronger world economy is expected to raise New Zealand's terms of trade and thus national income, although a related rise in the exchange rate will continue to dampen the profits of some exporters.

A gradual recovery in the economy is now expected to be led initially by domestic demand rather than be export volume-led. After a 0.4% contraction in the March 2010 year, real GDP is forecast to rise 2.4% in the March 2011 year owing to higher consumer spending and a recovery in residential investment. Growth is forecast to accelerate to 3.2% in the March 2012 year owing to higher export volumes as the exchange rate is projected to fall, and the Rugby World Cup and stronger world growth boost tourism. Price inflation, combined with stronger real activity, is forecast to lift growth in nominal GDP from 1.7% in the March 2010 year to around 5% per annum for the rest of the forecast period. Over the four years to June 2013 as a whole, nominal GDP is predicted to be $44 billion or nearly 6% higher than expected at Budget 2009, of which a little under half reflects the impact of higher prices, including both higher terms of trade and domestic inflation.

...but the rise in tax revenue will initially be muted...

A stronger economy is expected to lead to more tax revenue over the forecast period as a whole. However, the initial recovery in tax revenue is expected to be muted by a lower starting position and by lags between economic activity and tax revenue, both of which are associated with business income tax. The recent recession led to declining profits and larger losses among firms than were expected at Budget. This accumulation of tax losses will likely hinder growth in income tax paid by firms in the recovery. Tax revenue is forecast to be $400 million lower than expected at Budget in the June 2010 year. With growth in PAYE and GST, tax revenue is forecast to behigher than previously expected in the following four June years.

Compared to pre-recession trends, there remains a permanent loss of future output and therefore tax revenue. Nominal GDP is $29 billion or nearly 4% smaller over the four years to June 2012 than had been forecast prior to the crisis in Budget 2008. This loss reflects the crisis itself; for example, by reducing business investment and thus growth in the stock of capital in the economy. It also reflects a re-evaluation of how sustainable previous growth in the economy actually was, particularly growth in consumption. The loss is smaller than expected in Budget 2009 largely because of higher population growth and stronger terms of trade.

...while core Crown expenses are higher and surpluses do not return until 2016/17...

Core Crown expenses remain high relative to revenue across the forecast period and are higher than expected in the Budget. The stronger economic outlook is expected to result in higher expenditure on benefit payments as higher inflation and wage growth raise payment rates. Overall, expenses are forecast to rise despite the Government's new operating allowance being kept unchanged at $1.1 billion from the June 2011 year (adjusted by 2% per annum to account for inflation thereafter). A larger economy, bigger population and stronger-than-foreseen wages and inflation will place more pressure on these operating allowances than had been anticipated at Budget time.

The operating balance (before gains and losses) is expected to remain in deficit over the forecast period, peaking at 4.0% of GDP in the June 2010 year before falling gradually to 2.2% by the June 2014 year. A large proportion of these forecast deficits is structural, reflecting the sharp rise in public spending and tax cuts in recent years and the effects of a smaller economy. Financing the deficits is expected to push core Crown net debt higher from 9.5% of GDP at 30 June 2009 to 29.0% of GDP at 30 June 2014, the end of the forecast period.

In the medium-term projections to 2024, the operating balance is not expected to return to surplus until the June 2017 year and net debt is projected to rise further to a peak of 30.4% of GDP at 30 June 2016. The projected return of surpluses allows net debt to fall over the remainder of the projection period - meeting the Government's long-term objective for net debt of around 20% - and, once the surplus is of sufficient size, leads to New Zealand Superannuation Fund (NZS Fund) contributions resuming in the June 2020 year.

Table 1.1 - Economic and fiscal forecasts: Half Year Update compared with Budget

2009
Actual

2010
Forecast

2011
Forecast

2012
Forecast

2013
Forecast

2014
Forecast

Real production GDP (Annual average % change, March year)
Budget 2008 Forecasts 1.5 2.3 3.2 3.0 - -
Budget 2009 Forecasts -0.9 -1.7 1.8 2.9 4.0 -
Half Year Update 2009 Forecasts -1.1 -0.4 2.4 3.2 3.0 2.8
Nominal expenditure GDP ($billion, March year)            
Budget 2008 Forecasts 184 190 199 209 - -
Budget 2009 Forecasts 179 175 181 189 200 -
Half Year Update 2009 Forecasts 180 183 192 201 211 221
Unemployment rate (%, March quarter)            
Budget 2008 Forecasts 3.7 4.4 4.5 4.3 - -
Budget 2009 Forecasts 5.0 7.5 7.5 6.3 5.1 -
Half Year Update 2009 Forecasts 5.0 7.0 6.9 6.0 5.3 4.8
Operating balance1 (% GDP, June year)            
Budget 2008 Forecasts 0.7 0.5 0.2 0.1 - -
Budget 2009 Forecasts -1.6 -4.4 -5.1 -5.0 -4.2 -
Half Year Update 2009 Forecasts -2.2 -4.0 -3.4 -2.9 -2.7 -2.2
Net debt2 (% GDP, June year)            
Budget 2008 Forecasts 8.1 9.5 10.8 11.9 - -
Budget 2009 Forecasts 8.7 15.6 21.8 27.1 30.9 -
Half Year Update 2009 Forecasts 9.5 14.8 20.0 24.1 26.9 29.0
Net worth (% GDP, June year)            
Budget 2008 Forecasts 55.3 55.0 53.7 52.5 - -
Budget 2009 Forecasts 53.6 51.4 45.3 39.5 34.5 -
Half Year Update 2009 Forecasts 55.2 51.4 46.2 42.0 38.3 35.3

Notes:

  1. Total Crown operating balance before gains and losses
  2. Net core Crown debt excluding the NZS Fund and advances

Sources: Statistics New Zealand, the Treasury

...and uncertainty continues to surround the global and domestic outlook

The most significant risks to the outlook have eased since earlier in the year but uncertainty remains, particularly around the strength and sustainability of the recovery here and abroad. One of the key judgements made in the main forecasts is how private demand will respond when the restocking of inventories is complete and when governments and central banks around the world withdraw their stimulus measures. Another judgement concerns how imbalances are unwound. For nations such as New Zealand, imbalances that built up prior to the global crisis, such as large current account deficits and high household debt levels relative to income, are expected to continue to make the economy vulnerable to a loss of investor confidence.

Different paths of recovery are explored in the alternative scenarios. Small differences in economic growth can have a large impact on the level of economic activity and the fiscal position over time. Under a faster recovery scenario, higher trading partner growth and domestic demand in New Zealand in the short term would push nominal GDP higher by a cumulative $26 billion or 3% higher over the 2010-14 June years than in the main forecast. The additional tax revenue generated would flow through to a lower peak in the core Crown’s net debt levels of 24.4% of GDP in 2015. A more pessimistic assumption including a slower recovery and a weaker medium-term path for the economy would, in contrast, lower nominal GDP by a cumulative $18 billion or 2% over the June years 2010-14. The resulting lower tax revenue would raise net debt levels to a peak of 35% of GDP in 2016, which means this lower-output medium-term scenario is nearly as weak as the main fiscal outlook presented in Budget 2009.

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