Risks and scenarios (continued)

Downside scenario

Global growth falters and financial conditions tighten, leading to lower export demand…

The downside scenario centres on sovereign debt issues in Europe intensifying and causing financial market disruption globally. As a result, global growth prospects falter. The channels through which such an event impacts on the New Zealand economy are primarily export demand, access to credit, confidence and wealth.

In this scenario, export demand is negatively affected, with lower commodity prices reflected in a much lower terms of trade, despite weakness in prices for some of the goods New Zealand imports (Figure 1.17 above). Although we would expect to see a significant decline in the exchange rate that would help offset lower export prices, the extent of the fall in demand means that overall export values are likely to be lower than in the main forecasts.

With financial markets experiencing renewed dislocation and risk aversion rising, capital- importing countries such as New Zealand could expect to face higher global funding costs. While official interest rates are likely to be lowered in such an event to limit the impact on retail interest rates, banks' access to funding could be more limited. The net result would be a more restricted supply of credit, at a higher price, to businesses and households. With confidence levels hit by the global situation, demand for credit also falls, resulting in weaker business and residential investment growth.

…and weaker private consumption

Figure 1.20 - Real private consumption

Sources:  Statistics New Zealand, the Treasury

House prices could be expected to fall further, reflecting a lack of confidence and credit, driving household wealth lower. Lower wealth, together with a weaker labour market, results in a significantly lower profile for real private consumption (Figure 1.20)

…driving real growth lower than in the main forecasts…

With business investment, residential investment and private consumption all weaker than in the main forecasts, the overall profile for real GDP is markedly lower than in the main forecasts.

The lower terms of trade, coupled with softer domestic prices, reflecting the weaker domestic economy, results in nominal GDP in the five years to June 2015 being around a cumulative $50 billion lower than in the main forecasts, with tax revenues expected to be nearly a cumulative $18 billion lower over the same period.

…and weakening the fiscal outlook

Figure 1.21 - Core Crown net debt

Source:  The Treasury

The total Crown operating balance (before gains and losses) would still be in deficit by about 2½% of GDP in the June 2015 year, while core Crown net debt would have risen to nearly 40%. Across the 10 years of post-forecast projections there is little recovery in the nominal GDP track, relative to that arising from the main forecast. As a consequence, the tax revenue gap of the next five years is maintained, which, in turn, flows through to much-lower operating balances. With surpluses taking longer to achieve, and being smaller when they do occur, the net debt track does not begin to reduce, as a percentage of GDP, until the end of this decade. The long-term target of net debt at 20% of GDP is not attained, with the ratio falling to about 35% by the mid-2020s.

It is important to note that the fiscal scenarios do not include a fiscal policy response which would be necessary if events were to evolve in a similar manner to that outlined in the downside scenario.

Fiscal sensitivities

The scenarios presented above reflect only two of a large number of possible alternative paths the economy may take. Table 1.11 provides some “rules of thumb” on the sensitivities of the fiscal position to changes in several specific economic variables. These enable an assessment of how the fiscal position could be affected should events turn out differently.

Note:

1 NZDMO holdings only

Source: The Treasury