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Half Year Economic and Fiscal Update 2012

General Fiscal Risks

The discussion up to this point has focused on the main near-term economic risks. The rest of this chapter focuses on the links between the risks to the performance of the economy and the Crown's fiscal position.

Table 3.2 provides some rules of thumb on the sensitivities of the fiscal position to small changes in specific variables. For example, if for some reason nominal GDP growth is 1% point slower than we have forecast each year up to the year ending June 2017, we would expect tax revenue to be around $3.6 billion (1.4% of GDP) lower than forecast in the June 2017 year as a result. The sensitivities are broadly symmetric; that is, if nominal GDP growth is 1% point faster each year than we expect, tax revenue would be around $3.6 billion higher than forecast instead. For more on fiscal risks, see the Specific Fiscal Risks chapter.

Fiscal Sensitivities

Table 3.2 - Fiscal sensitivity analysis
Year ending 30 June
($millions unless stated)

1% lower nominal GDP growth per annum on

Tax revenue (590) (1,245) (1,975) (2,750) (3,575)
(% of GDP) (0.3) (0.5) (0.8) (1.1) (1.4)

Revenue impact of a 1% decrease in growth of

Wages and salaries (255) (525) (825) (1,150) (1,500)
(% of GDP) (0.1) (0.2) (0.3) (0.5) (0.6)
Taxable business profits (115) (265) (430) (605) (790)
(% of GDP) (0.1) (0.1) (0.2) (0.2) (0.3)

Impact of 1% point lower interest rates on

Interest income1 (89) (81) (110) (70) (81)
(% of GDP) (0.0) (0.0) (0.1) (0.0) (0.0)
Expenses1 (97) (184) (361) (454) (518)
(% of GDP) (0.0) (0.1) (0.2) (0.2) (0.2)
Overall operating balance 103  250  384  438 
(% of GDP) 0.0  0.1  0.1  0.2  0.2 


  1. Debt managed by the NZDMO only

Source: The Treasury

Revenue Risks

One of the major sources of risk to the fiscal position arises from the inherent uncertainty about future tax revenue. The amount of tax revenue that the Government accrues in a given year is closely linked to the performance of the economy.

Figure 3.5 plots the main tax revenue forecast, along with confidence intervals around those forecasts based on the Treasury's historical tax forecast errors.[7] The outermost shaded area captures the range (+/- $5.7 billion in the June 2016 year) within which actual tax forecasts would typically fall for 80% of the time.[8] The tax revenue forecasts from the upside and downside scenarios are also plotted.

Figure 3.5 - Core Crown tax revenue uncertainty
Figure 3.5 - Core Crown tax revenue uncertainty.
Source: The Treasury

Based on average historical forecast errors and an even balance of risks, Figure 3.5 shows that tax revenue over the forecast period would come in weaker than shown in the downside scenario one-third of the time, and conversely come in stronger two-thirds of the time. For the upside scenario, tax revenue over the forecast period would come in stronger than shown slightly over one-third of the time, and weaker just under two-thirds of the time.

However, as discussed previously, the forecast risks are not evenly balanced - they are skewed to the downside. Accordingly, the probability of tax revenue undershooting the downside scenario is likely to be higher than one-third, and the probability of tax revenue overshooting the upside scenario is likely to be lower than one-third.

Expenditure Risks

One-off and unexpected expenditure shocks can have a large impact on the Crown's operating balance in the year that they occur. Persistent errors in forecasting the cost of various programmes (ie, policies that cost more than the Government allows for) can also have substantial ongoing effects on the fiscal position.

There is also considerable uncertainty regarding the effect of the performance of the economy on Crown expenditures. This uncertainty largely relates to the operation of the so-called automatic stabilisers. For example, if the economy performs better (worse) than expected in a given year, official expenditures on social programmes may be lower (higher) than planned, and tax revenues higher (lower).

Meanwhile, the destructive seismic events of recent years have underlined the inherent exposure of the Crown's fiscal position to exogenous shocks. The Government's fiscal position would be impacted if another catastrophic earthquake were to occur or if the costs associated with the recent events exceed the updated estimates. The ageing population also presents risks to the medium-term fiscal position, particularly to the extent that demographic forecasts may prove to be too low or high.

Balance Sheet Risks

In addition to risks around revenue and expenditure, the Crown's financial position is exposed to risks from its balance sheet. While some are unavoidable, the Crown's general approach is to identify, avoid or mitigate these risks where practicable.

The largest source of balance sheet risk is volatility in asset and liability values owing to movements in market variables such as interest rates, exchange rates and equity prices. This may result in an operating balance impact. Of the Crown's aggregate financial risk, roughly a third is estimated to be attributed to this “market risk”.[9] Three areas of the balance sheet are particularly susceptible:

  • Financial assets held by the Crown financial institutions (CFIs) are sensitive to financial-market volatility. CFIs diversify their portfolios across a range of financial assets to manage exposures to specific market risks. The Crown Ownership Monitoring Unit (COMU) estimates a 10% fall (rise) in world share markets would lead to a 4% to 5% fall (rise) in the value of the Crown's financial portfolio.
  • Insurance and retirement liabilities and provisions are prone to market volatility through their actuarial valuations, which are sensitive to assumptions about variables such as interest and inflation rates, and risk margins. For example, a 1% fall in the risk-free discount rate used is estimated to result in a $7.3 billion increase in the combined value of the Crown's liabilities from ACC, EQC, Southern Response (formerly AMI) and the GSF.[10]
  • Physical assets such as land, buildings, state highways and military equipment are susceptible to movements through changes in property market conditions, interest rates and changes in the costs of construction. This will affect the recorded value of many Crown physical assets.

Business risks, relating to the broader commercial environment, may also affect the Crown's balance sheet. A number of entities owned by the Crown, including commercial and social entities, have their financial performance and valuations impacted by these external factors.

The Crown is also susceptible to “liquidity risk” with respect to its ability to raise cash to meet its obligations. This risk, however, is small given the NZDMO's ongoing management of the core Crown's liquidity position, as well as the Government's commitment to maintaining prudent debt levels.

Funding Risks

The New Zealand Crown remains in the top-20 rated sovereigns globally, with the top Aaa foreign-currency rating from Moody's and AA foreign-currency ratings from Standard & Poor's and Fitch. The outlook is stable across all three agencies.

The downside risks identified by the rating agencies are broadly in line with the risks identified earlier in the chapter. In the case of an increase in global risk-aversion and in the absence of a marked improvement in the external position, New Zealand may be more likely to face a degree of funding pressure in the future. All things being equal, any further deterioration in the ratings outlook could serve to raise debt-servicing costs for the Crown. On the other hand, additional downward pressure on borrowing rates is possible if diversification flows, particularly away from Europe, continue in the future.


  • [7]A full summary of the methodology and critical assumptions is included in New Zealand Treasury Working Paper 10/08. Standard deviation assumptions used for 0-, 1-, 2- and 3-year ahead forecasts are 0.9%, 3.2%, 5.3% and 6.6% of the actual, respectively.
  • [8]Recent Treasury analysis shows that a shock that has a significant and persistent impact on economic growth can result in tax revenues coming in significantly below the outermost shaded area. See Fookes, C (2011), “Modelling shocks to New Zealand’s fiscal position”, New Zealand Treasury Working Paper 11/02.
  • [9]Irwin, T and Parkyn, O (2009), “Improving the management of the Crown's exposure to risk”, New Zealand Treasury Working Paper 09/06.
  • [10]For more information, see the Notes to the Financial Statements of the Government of New Zealand 2012.
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