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Half Year Economic and Fiscal Update 2012

Upside Scenario

As discussed in the earlier section of this chapter, there are a number of potential upside risks to the Treasury's main forecasts, but most are only modest in size. This scenario presents a generalised upside scenario, where a number of factors together lead to faster-than-expected growth over the forecast period, resulting in higher tax revenues and a larger surplus in 2014/15.

World growth is stronger, leading to higher terms of trade...

It is possible that New Zealand's trading partner growth will be stronger than forecast in the main economic forecasts. In this upside scenario we assume that trading partner growth is about 0.2% to 0.3% points higher than the main forecast in each year, with a number of factors that could lead to this, as mentioned earlier in the chapter. These include a faster-than-expected resolution in the euro crisis, a strong medium-term fiscal plan in the US or faster flow through of the benefits of structural reforms. Any one of these could be expected to improve global demand, leading to higher commodity prices and increased demand for New Zealand exports. New Zealand's terms of trade would be slightly higher across the forecast period, leading to higher incomes.

...with a faster Canterbury rebuild and stronger household spending...

There is a large degree of uncertainty around the timing and scale of the Canterbury rebuild. In this upside scenario, we allow for a faster rebuild compared to the main forecasts and bring more of the rebuild inside the forecast period ending March 2017. Net migration is higher, peaking at an annual 16,000 (and earlier) compared with 13,000 in the main forecasts. Most of the increase is assumed to be workers moving into Canterbury from abroad.

The faster rebuild leads to an increase in residential investment, with growth 3.8% points higher in the March 2014 year than in the main forecasts. As a result, inflationary pressures are higher, as capacity constraints are reached sooner. Wage rates in the region are higher (particularly in the construction sector), with modest spill-over to the rest of the country.

Figure 3.4 - Real private consumption
Figure 3.4 - Real private consumption.
Sources: Statistics New Zealand, the Treasury

In addition, we assume stronger private consumption in the upside scenario, in part owing to the higher incomes from the higher terms of trade. Private consumption growth is 0.4% and 0.3% points higher in the March 2014 and 2015 years respectively than the main forecasts (Figure 3.4). This flows on to the labour market, with the unemployment rate coming down faster than the main forecasts, finishing at 4.6% in March 2017 compared to 5.1%. However, there is also lower household saving and higher imports than in the main forecasts.

A combination of higher incomes, a faster rebuild and stronger consumption leads to higher inflation than in the main forecasts. The Reserve Bank responds by increasing interest rates sooner than otherwise, leading to tighter monetary conditions. The level of nominal GDP is about $16 billion higher in total over the period to June 2017.

…leading to a modest increase in the operating surplus in 2015

Core Crown revenue is a cumulative $3.7 billion higher in the upside scenario than the main scenario by June 2017, led by a $1.6 billion increase in source deductions, attributable to the higher incomes of New Zealand households. More household spending leads to $800 million in additional GST revenue, while higher business profits contribute to a $500 million boost in corporate tax revenue. Higher interest rates in later periods lead to $300 million in additional resident withholding tax.

Core Crown expenses (excluding financing costs) are $0.2 billion lower, as the stronger labour market flows through to fewer Unemployment Benefit recipients. In addition, finance costs are lower, owing to less government borrowing.

In this scenario, the operating balance (before gains and losses) moves into surplus in the June 2015 year, the same year as the main forecasts, with the surplus 0.4% of GDP. Net core Crown debt as a proportion of GDP peaks at 28.7% of GDP in the June 2014 year.

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