Main forecasts (continued)
Economic and fiscal impacts of the Canterbury earthquake
Damage from the Canterbury earthquake and the subsequent recovery in activity affect the economic and fiscal outlook. These effects are summarised below.
Damage assumptions
Exact damage levels remain unknown but influence the amount of repair and replacement activity that will occur as well as influencing costs to the Government. The economic forecasts assume $5 billion worth of damage across residential properties and contents, commercial buildings and assets, and infrastructure.[1]
Economic impacts
The earthquake is expected to have reduced economic activity by around 0.4% in the September quarter relative to what it would have been in the absence of the earthquake. Not all indicators of GDP will pick up this impact and therefore the forecasts incorporate a 0.2% adverse effect.
The amount of recovery activity is related to the damage estimates. These have been adjusted to allow a combination of non-replacement and that some of the recovery activity will crowd out investment that would have occurred in the absence of the earthquake.
Relative to a situation in which the earthquake had not occurred, the main economic impacts are that real GDP growth is 0.4 percentage points higher as a result of earthquake recovery activity over the March 2012 year. This additional growth will be concentrated in residential and other investment, partly offset by higher imports. Growth is then slightly lower in the next three years. This is because, while earthquake recovery activity continues to occur, it is not as large as in the March 2012 year. Overall, the level of activity remains higher than it would have been in the absence of the earthquake through to 2015. Employment is boosted by the higher activity, resulting in the unemployment rate in the March quarter of 2012 being around 0.3 percentage points lower than it would have been in the absence of earthquake-related recovery activity. The current account deficit will be reduced in the March 2011 year as a result of reinsurance inflows, while higher imports, to support rebuilding, will widen the deficit relative to what it would have been in the absence of the earthquake over the next few years.
Fiscal impacts
The tax forecasts included in the Half Year Economic and Fiscal Update (HYEFU)are based on an economic outlook that includes the effect of the earthquake on economic activity and therefore incomes and expenditure. The Government will face earthquake-related costs in the following areas:
Residential property
The Earthquake Commission (EQC) has reinsurance for its costs above $1.5 billion, up to $4 billion. The damage assumption for residential propertyis less than $4 billion, so EQC's net costs are forecast to be $1.5 billion. This has increased the 2010/11 forecast total Crown operating deficit by $1.5 billion, but has not affected core Crown net debt because EQC's assets and liabilities are not part of the core Crown. Although there is no impact on net debt, the New Zealand Debt Management Office (NZDMO) has incorporated the expected funding implications arising from EQC's redemption of government securities into the Government's debt programme.
EQC's reinsurance covers any damage caused by aftershocks up to 30 days after the original event. While aftershocks have continued after this period, the additional damage is not expected to have been significant and no provision for this has been included in the fiscal forecasts.
Local authorities
Under current Civil Defence Emergency Management policy, local authorities are eligible for government funding of 60% of the costs of repairing essential infrastructure. These include water, stormwater and sewerage facilities and river management systems where there is major community disruption or continuing risk to life. However, no provision for these costs has been included in the fiscal forecasts because a reliable estimate of the amount will not be available until a review of underground systems (currently underway) is completed.
The Government's contribution to repairing local roads is determined under a different arrangement through the National Land Transport Programme (NLTP). The current estimate of total damage is $110 million, with the Government's share estimated at $66 million, spread over three years. It is expected that the Government will absorb these costs through the NLTP by reprioritising projects, meaning the costs are already included in these forecasts. However, any future emergency events could affect this - see the Fiscal Risks chapter.
Government-owned assets
The cost of repairing state highways is not expected to be significant and will be absorbed by reprioritising projects. Costs associated with repairing other government infrastructure, including schools, housing and health facility assets, are largely covered by insurance and no additional provision for these costs has been factored into these forecasts.
Additional assistance
The Government has provided other assistance for the community and the cost of these initiatives is estimated to be less than $100 million.[2] This assistance has been funded within the existing operating allowance, thereby decreasing the amount of new funding available for other projects.
Fiscal uncertainty
The overall cost faced by the Government remains uncertain as there are still some costs that the Government has not yet committed to, or that cannot yet be reliably measured. When such costs are committed to, or when they can be reliably measured, they will be recorded in the Crown's financial statements and forecasts. Recording these costs is likely to have an adverse impact on the Crown's operating balance and net debt position. However, given that the amount of residential property damage appears unlikely to exceed $4 billion, the most significant cost, EQC's $1.5 billion net cost, is captured in these forecasts, as are the costs directly related to Government-owned assets and the additional assistance provided by the Government.
Growing profits to boost business tax but past losses will dampen tax growth
Recent tax outturns and talks with firms around New Zealand point to weaker business profits than assumed at Budget 2010. Provisional tax payments have also been lower than expected earlier in the year, as economic conditions have been softer than anticipated by corporates and other businesses.
Tax losses accumulated during the recent recession may now be playing a part in restraining business income tax growth. Based on currently-available data, gross losses incurred by all companies reached more than $18 billion in the 2009 tax year, an increase of more than 30% on the previous year. This pushed the stock of tax losses up to about twice its level after the recession of the late 1990s. These losses will be progressively offset against profits in future tax years, thereby reducing business income tax revenue. The forecasts include an assumption that loss usage will be at an elevated level for the next few years, reducing business income tax revenue by around $350 million each year, compared to what would have been the case in the absence of the recent loss build-up. The level of loss utilisation is anticipated to fall back to a more normal level in the June 2015 year.
These factors result in forecasts for total business tax to increase from $10.3 billion in the June 2011 year to $13.4 billion in the June 2015 year, although over the four years to June 2014 business income tax is forecast to be a cumulative $2.6 billion lower than forecast at Budget 2010.
Government spending to account for a smaller share of the economy
As was the case at Budget 2010, government consumption is expected to continue to play less of a role in the economy, based on lower levels of new spending than occurred over the middle of this decade. The operating allowance for new spending adds $1.12 billion to government expenses in the June 2012 year, and is forecast to grow at 2% per annum thereafter. This represents significantly slower growth than occurred over the 2004 to 2008 period when new operating spending (excluding revenue initiatives) ranged between $2 billion and $3.5 billion per annum.
Developments in Asia are increasingly important for export growth
- Figure 1.3 - World growth rate comparisons
- Sources: International Monetary Fund (IMF), the Treasury
New Zealand is expected to continue to benefit from strong growth in emerging Asia, especially China, which expanded rapidly over the first three quarters of 2010. Although growth is expected to ease in the near term, the region is set to continue to outperform advanced economies. The economies of New Zealand's top 16 trading partners are assumed to grow by 4.5% in 2010, before easing back to just under 4% on average through to 2015 (Figure 1.3).
Strength in Asia has also had significant benefits for our largest single trading partner, with Australia being the strongest performing advanced economy over the past two years. While the outlook for other advanced economies is less optimistic, the weight of New Zealand's trading partners (based on export shares) is expected to continue to shift towards Asia, providing fundamental support for goods and services exports over the medium term (see the box on page 34 on New Zealand's economic and fiscal outlook in an international context).
Notes
- [1]The $5 billion assumption contained in these forecasts updates the earlier estimate provided in http://www.treasury.govt.nz/economy/reports/econbrief-eice-10sep10.pdf. This amount is an estimate of the total cost, of which government costs are only a part.
- [2]For example wage subsidies, trauma counselling and restoration of historic buildings.
