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Half Year Economic and Fiscal Update 2015

Medium-term Outlook

Growth increases in the medium term…

Economic growth is expected to pick up in the second half of 2016. Annual average growth is expected to lift to 2.4% in the year to March 2017, peak at 3.6% in the year to March 2018 and then ease over the remainder of the forecast period. Exports are expected to increase in response to the lift in the terms of trade and weaker dollar, and as the agricultural sector recovers from El Niño. Monetary policy settings stimulate the domestic economy. The shortfall in the supply of housing together with low interest rates and high population growth underpin residential investment growth. Market investment also picks up in response to the increasing terms of trade and low interest rates. Increase in the Government's operating and capital allowances increases public consumption and non-market investment respectively. Unemployment falls as spare capacity in the economy declines.

The economy's potential growth rate has been revised downwards compared to the Budget Update, largely owing to slower growth in investment.[11] Higher population growth, owing to higher net migration, provides a partial offset to lower investment. The annual average potential growth rate is estimated to increase from around 2.5% currently to 2.6% in 2017 as productivity growth rises from low levels (Figure 1.12). Potential growth averages around 2.5% over the forecast period as a whole. The implications of lower productivity growth than assumed are discussed further in Scenario One in the Risks and Scenarios chapter. The contribution of productivity to growth is explored further in the Composition of growth box on page 25.

Figure 1.12 - Actual and potential GDP
Figure 1.12 - Actual and potential GDP.
Source: Statistics New Zealand, the Treasury

…as the terms of trade recover…

The terms of trade begin to recover from the middle of 2016, largely as a result of increasing export prices. Dairy prices are expected to pick up from around this time as surplus Chinese inventories clear and as global milk production growth slows sufficiently to rebalance supply and demand in the market. Dairy prices steadily increase towards their assumed long-run level of around US$3,500 by the end of 2017. Prices for New Zealand's other key commodity exports are also expected to pick up from the middle of 2016 in response to strengthening global demand. The implications of a faster recovery in export prices than assumed are explored in Scenario Two of the Risks and Scenarios chapter.

Slowly rising import prices, in line with low global inflationary pressures, provide a modest drag to the terms of trade. Oil prices are assumed to trend slowly but steadily higher, to reach around US$70/barrel by the end of the forecast period.

These assumptions on balance result in lower terms of trade than in the Budget Update. At the end of the forecast period that difference narrows to around 1.5%. The lower end-point reflects the view that lower production costs and structural changes in the dairy market outweigh the effects of lower prices for oil (and other commodities) on the terms of trade. The Structural fiscal balance indicators box on page 39 estimates the fiscal position adjusted for the terms of trade.

…and accommodative monetary policy stimulates domestic activity

After remaining at low levels in 2016 and into early 2017, short-term interest rates are assumed to rise gradually to the long-run assumption of 4.5%, keeping inflation near 2%. The long-run interest rate assumption has been lowered by 0.25 basis points compared to the Budget Update, with recent research by the Reserve Bank[12] and the Treasury pointing to a lower neutral interest rate than previously estimated. The trade-weighted exchange rate index appreciates from early 2017 onwards in line with the gradual rise in interest rates and improvement in the terms of trade (Figure 1.13).

Figure 1.13 - Trade-weighted exchange rate
Figure 1.13 - Trade-weighted exchange rate   .
Source: Statistics New Zealand, the Treasury

Exports are expected to grow strongly from 2017 (Figure 1.14). Agricultural output is expected to begin recovering in the 2016/17 season, assuming a return to normal climatic conditions and no lasting impact from El Niño, leading to strong growth in agricultural exports in the year to March 2018. The recovery in the terms of trade as well as depreciation of the New Zealand dollar contributes to sustained growth in these exports over the medium term. The depreciation of the dollar is also expected to boost the competitiveness of non-commodity and services exports, leading to strong volume growth in these areas. Growth in services export volumes is expected to be further supported by continued growth in travel services exports (chiefly tourism-related). Taken together, these factors see exports making a substantial contribution to real GDP growth in the latter years of the forecast.

Figure 1.14 - Total exports
Figure 1.14 - Total exports   .
Source: Statistics New Zealand, the Treasury

The shortfall in the supply of housing, together with low interest rates and relatively high population growth, underpins residential investment growth throughout the forecast. Although construction activity associated with the Canterbury residential rebuild is thought to have peaked, it is expected to remain at a relatively high level through the forecast period.[13] Construction resources will progressively move from Canterbury to other regions, notably Auckland, in order to reduce the existing shortfall of housing.

Growth in market investment picks up from 2017 in response to low interest rates, strengthening trading partner growth and the resultant recovery in the terms of trade. Non-market investment is increased by a one-off $1.0 billion increase in the Government's capital allowance. The majority of this increase is assumed to occur in the year to June 2017. However, approximately half of the total increase in the capital allowance is expected to be used for imported capital goods, which has an offsetting effect on GDP. See the Fiscal Outlook chapter for further details on the change in the capital allowance. The commercial and the social and infrastructure elements of the Canterbury rebuild will also support market and non-market investment respectively.

Private consumption growth eases to around 2.3% in early 2017 and then remains stable around this level for the remainder of the forecast. This reflects lower labour and farm incomes and the relatively higher price of consumption owing to the lower exchange rate. Low interest rates provide a partial offset to these factors by reducing household debt servicing costs. Households are assumed to lower their saving rates somewhat to buffer reduced incomes and smooth their consumption. If households are more sensitive to slower income growth then private consumption growth could be slower.

Public consumption growth lifts in 2018 as a result of the increase in the government operating allowance from $1.0 billion to $2.5 billion in fiscal year 2018 (Figure 1.15). Growth eases thereafter. For the purpose of the economic forecast, the increase in the operating allowance is assumed to increase expenditure. See the Fiscal impulse box on page 40 for further details on how discretionary changes in the fiscal position impact on the economy.

Figure 1.15 - Public consumption
Figure 1.15 - Public consumption    .
Source: Statistics New Zealand, the Treasury

Unemployment declines as spare capacity is reduced...

As economic growth picks up in 2017, the degree of spare capacity in the economy declines. The output gap, a measure of this spare capacity, closes rapidly through 2017 before turning positive. This is reflected in the steady decline in the unemployment rate from 6.5% in 2016 to 4.5% in 2020. The main driver of the fall in unemployment is the increase in employment growth, with the participation rate assumed to remain at relatively high levels. Slower working-age population growth, as net migration returns to its long-run average of 12,000 per year, will also contribute to a lower unemployment rate.

...while inflation remains stable

The shift in the output gap from negative to positive is also reflected in non-tradables inflation, which steadily picks up from below 2.0% at the end of 2016 to 3.4% by the end of the forecast. The increase assumes that the historical relationship between the output gap and non-tradables inflation reasserts itself. In contrast, tradables inflation falls steadily from 2.4% at the end of 2016 to below 1.0% from 2018 onwards, in line with the gradual appreciation of the exchange rate. Taken together, increasing non-tradables inflation and decreasing tradables inflation are broadly offsetting, leaving headline CPI inflation relatively stable at around 2.0% across most of the forecast.

However, strong nominal GDP growth in later years does not return nominal GDP to previously forecast levels

Nominal GDP growth is forecast to pick up strongly, with annual average growth accelerating from 1.8% in the middle of 2016 to 6.4% in 2018. Growth then eases to 4.0% by the end of the forecast. High nominal GDP growth in 2018 and 2019 reflects high real GDP growth, the recovery in the terms of trade and the increase in inflation. The contribution from the terms of trade is evident in the annual current account deficit, which narrows from 6.0% of GDP in 2016 to 4.0 - 4.5% in later years.

However, the strong growth in nominal GDP is from a lower base in the year to June 2016 than in the Budget Update. As a result, nominal GDP is cumulatively lower by around $17 billion over the five fiscal years to 2018/19 (Figure 1.16). The downward revision to nominal GDP reduces forecast tax revenue from the Budget Update. In addition, lower short-term interest rates contribute to a fall in tax revenue from Resident Withholding Tax (RWT). The Fiscal Outlook chapter discusses changes in tax revenues in more detail.

Figure 1.16 - Nominal GDP
Figure 1.16 - Nominal GDP   .
Source: Statistics New Zealand, the Treasury


  • [11] Potential growth is the rate at which the economy can expand while maintaining stable inflation. It depends on how many people are available to work and how many hours they are willing to work (labour); the number of buildings, machines and computers (capital); and the efficiency with which they are used (multi-factor productivity).
  • [12] Richardson, A. and Williams, R. (2015). Estimating New Zealand's neutral interest rate. Reserve Bank of New Zealand Analytical Note AN2015/05.
  • [13] Approximately $1 billion of land repair activity has been reclassified from residential rebuild to commercial and other. This does not significantly alter the residential investment growth profile, with the level of residential rebuild remaining at relatively high levels.
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