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Half Year Economic & Fiscal Update 2009

Alternative Scenarios

The most significant risks to the outlook have eased since the Budget. However, the level of uncertainty associated with any forecast made in the current environment remains larger than has typically been the case. Particular uncertainty surrounds the strength and sustainability of recovery in the world economy, including New Zealand. The amount of stimulus from monetary and fiscal policy currently supporting the global recovery is unprecedented and the impact in the short and medium term is uncertain. Although activity may be stronger than forecast in the near term, growth could weaken more sharply further out if private demand falls when policy stimulus is removed and the restocking of inventories is complete.

Two alternative scenarios are presented below to show how the most significant risks to the main forecast could play out. The scenarios are extended into the projection period in the same way as the main forecasts were in the preceding section. While the scenarios below do not represent the most likely track for the economy, the possibility of such outcomes occurring should not be ignored and the scenarios should be considered an integral part of the Half Year Update. The scenarios below consider how the economy and fiscal position could differ from the main predictions presented above under different paths of recovery.

Upside Scenario

The upside scenario focuses on a stronger recovery. Real GDP in New Zealand's trading partners in this scenario is assumed to rise 3.6% in the 2010 calendar year after a smaller decline of 1.1% in 2009 owing to a greater response to monetary and fiscal stimulus and the recovery in confidence levels. Although less than in 2010, there is still uncertainty over real GDP in 2009 as actual outturns are currently only available for two to three quarters of the year. The stronger recovery could be led by growth in emerging markets, particularly China, and trading partners that would benefit from this growth, including Australia. There is also uncertainty as to how the New Zealand economy will recover. Therefore, the upside scenario includes a judgement that domestic demand in New Zealand rises more strongly over the next year in response to low interest rates and high confidence levels.

A stronger world economy raises the terms of trade…

A stronger global recovery would lead to higher demand for New Zealand's exports, particularly non-commodity goods and services, and to higher export prices. Higher export prices raise the terms of trade by around 6% on average over the next five years relative to the main forecast (Figure 1.14). Higher terms of trade are a distinct possibility, with world dairy prices as measured by Fonterra’s globalDairyTrade auction up 95% since July 2009.

Figure 1.14 - Merchandise terms of trade (SNA)
Figure 1.14 - Merchandise terms of trade (SNA)   .
Source:  Statistics New Zealand, the Treasury

…and domestic demand recovers earlier

In this scenario, domestic demand is also assumed to rebound more strongly than in the main forecast, reflecting greater momentum in consumer spending from higher levels of consumer confidence and rising house prices. Higher export incomes and confidence abroad are also assumed to flow through to domestic demand, including higher business investment. As a result, consumption would likely recover more quickly in the second half of the March 2010 year and then rise by just over 3% per annum in the following two years, compared with peak annual average growth of around 2.5% in the main forecasts. Investment also grows more strongly over the coming year in the upside scenario.

Table 1.8 - Key economic and fiscal features of the upside scenario
(Annual average % change,
Year ended 31 March)
2009
Actual
2010
Forecast
2011
Forecast
2012
Forecast
2013
Forecast
2014
Forecast
Real GDP components:            
Private consumption -0.8 0.0 3.1 3.2 2.4 1.9
Residential investment -23.4 -7.3 32.4 17.1 2.5 -1.4
Market investment -4.7 -10.8 11.6 11.2 4.5 3.8
Gross national expenditure -2.0 -3.0 6.2 5.2 2.9 2.3
Exports of goods and services -3.3 0.4 0.0 6.6 5.4 3.3
Imports of goods and services -4.7 -13.2 11.2 10.8 5.3 3.1
GDP (production measure) -1.1 -0.2 3.2 3.9 2.8 2.3
Unemployment rate1 5.0 7.0 6.3 5.3 4.7 4.6
90-day bank bill rate2 3.7 2.9 5.5 6.0 6.1 6.1
TWI2 53.7 66.5 65.1 62.2 59.1 56.7
CPI3 3.0 2.5 2.4 2.3 2.6 2.2
Current account balance (% GDP) -8.1 -2.5 -4.4 -5.5 -6.1 -6.6
Nominal GDP level (deviation from main forecast, $billion) 0.0 1.1 4.4 7.0 7.4 6.3
(% of GDP, Year ended 30 June)            
Operating balance before gains and losses -2.2 -3.8 -2.6 -1.5 -1.3 -1.0
Core Crown net debt 9.5 14.5 18.5 21.0 22.5 23.8

Notes:

  1. Percent of labour force, March quarter, seasonally adjusted
  2. Average for March quarter
  3. Annual percentage change, March quarter

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

A stronger recovery sees unemployment fall more rapidly...

The stronger outlook would flow through to higher real GDP than in the main economic forecasts, with a smaller contraction of 0.2% in the March 2010 year followed by a larger rebound in growth to 3.2% and 3.9% in the 2011 and 2012 March years. Higher levels of activity would result in the unemployment rate falling more quickly from a peak of 7.0% in the March 2010 quarter, the same as in the main forecast, to 6.3% a year later, compared with 6.9% in the main forecast.

...and leads to higher nominal GDP and more tax revenue…

Stronger real activity, higher terms of trade and increased inflation lead to nominal GDP being much higher than in the main forecasts. Nominal GDP in the final June year of the forecast period is $6.3 billion higher and the cumulative difference over the 2010 to 2014 June years is $27.5 billion. As a result, core Crown tax revenue would likely be $2.4 billion higher than in the main forecast by the end of the forecast period, with a cumulative difference of around $10 billion across the 2010 to 2014 June years. Higher tax revenue relative to the main forecast reflects higher personal and corporate income tax revenue owing to higher incomes, more GST revenue from stronger domestic demand and a larger increase in tax on interest income as interest rates rise by more. Fiscal drag also has a larger impact in this scenario than in the main predictions because of faster wage growth.

Government expenses are only slightly lower than in the main forecasts. While there are fewer people on the unemployment benefit in this scenario, higher inflation adjustments for benefits and the impact of higher inflation and wage growth on superannuation payments would see overall welfare payments rise. This is offset by lower debt-servicing costs as a result of lower debt levels.

…resulting in lower deficits and a slower build-up of debt

Owing to the impact of higher tax revenue, the operating deficit would be slightly smaller than in the main forecast at 3.8% in the June 2010 year and would narrow over the following two years (Figure 1.15). The operating balance (before gains and losses) in the upside scenario reaches balance in the June 2015 year and returns to surplus in the following year, which would be one year earlier than predicted in the main projections. With smaller deficits in the upside scenario, core Crown net debt would be expected to rise by less than in the main predictions, rising to a peak of 24.4% in the June 2015 year before falling below 10% of GDP at the end of the projection period. However, it would be harder to live within the $1.1 billion operating allowance given a stronger economy would, for example, put more pressure on public sector wages.

Figure 1.15 - Operating balance (before gains and losses)
Figure 1.15 - Operating balance (before gains and losses)   .
Source:  The Treasury
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