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Economic Risks

Risks to global growth, particularly in the medium term, have increased since the 2016 Budget Update with a rise in protectionist sentiment, while further fiscal stimulus in China exacerbates risks relating to its overheated housing market and high levels of government debt. Some negative medium-term risks may be accompanied by positive short-term risks; further stimulus in China and expansionary US fiscal policy would support global growth in the near term, and the short-run impact of Brexit may be less severe than previously anticipated. The current outlook, however, is for growth to slow in the near term in Australia, the UK, China and the euro area.

The scope internationally for further monetary policy easing or fiscal stimulus is limited, meaning negative growth shocks are likely to be persistent. There is a risk that slow global growth becomes entrenched, with a more prolonged period of low inflation and interest rates, while financial market risks increase as asset prices become overvalued. The realisation of any of these downside risks to the world economy would weigh on economic growth in New Zealand, materialising as lower demand and/or prices for New Zealand’s exports, a lower New Zealand dollar as well as adversely affecting confidence and bank funding costs.

Risks to the domestic outlook are more balanced, and centre around net migration, residential investment and the extent of spare capacity in the economy, tourism growth, goods exports (particularly dairy), uncertainty around inflation and housing market dynamics, and the impact of the Kaikōura earthquakes.

Other risks include adverse natural events, including aftershocks following the Kaikōura earthquakes, military tensions in the Middle East and elsewhere, terrorism and disease. In addition, economic dynamics may play out differently from these forecasts, and uncertainty remains around key judgements and assumptions (see Key economic forecast judgements and assumptions box in the Economic Outlook chapter).

Economic stability in China remains a key risk to the global outlook…

Annual average GDP growth in China has fallen from over 10% in 2010 to 6.7% in the September 2016 quarter as the composition of growth shifts from investment towards consumption. The transition is intended to lead to more sustainable growth in the long term, with the trade-off of slower growth in the near term. Authorities have tried to mitigate slower growth in the near term with greater levels of support; however, such support may prolong the transition and create further imbalances, especially if other key risks are exacerbated, such as the high level of local government and state-owned enterprise (SOE) debt and the risk of a sharp downturn in China's overheated housing market.

Slower growth and heightened uncertainty about China's outlook have been reflected in lower commodity prices, subdued growth in international trade flows, reduced confidence and increased financial market volatility. A sharper slowdown in China would be expected to be transmitted as a more severe deterioration through these channels, with a flow-on impact of slower growth in other trading-partner economies, particularly in Australia and elsewhere in the Asia-Pacific region. The direct effect on New Zealand of a slowdown in China may be offset to some extent by the rebalancing towards consumption as the main driver of growth, as a successful transition could be positive for New Zealand by increasing Chinese demand for our mostly consumer-orientated primary products in the longer term.

…alongside uncertain growth prospects in advanced economies…

While the US recovery continues, the outlook is for moderate growth in both 2016 and 2017, and consequently gradual tightening in monetary policy. Possible expansionary fiscal policy, risks to financial market stability with the proposed repeal of regulation introduced post-global financial crisis and a potential policy shift towards greater trade protectionism and reduced people flows will influence future growth, although at this stage to what extent is unclear. Uncertainty remains around the timing and extent of the Federal Reserve's monetary tightening cycle, as well as the possible unintended destabilisation of emerging market economies that have US dollar-denominated debt from tighter US monetary policy. Further out, risks remain around the rate of US potential growth, which may continue to decline with an ageing population.

In addition to the flow-on impacts of slowing growth in China to other trading partners, risks to the Australian economy centre on a more gradual-than-expected transition from mining investment to non-mining, resulting in a longer period of below-trend growth. There is some uncertainty about Australia's trend growth rate, with slower population and productivity growth. A key upside risk is the path of Australia's commodity export prices and volumes. For instance, if the recent spike in the price of coking coal is sustained, nominal GDP may be significantly higher in the near term. On the downside, Australia faces similar risks to New Zealand, in the form of elevated house prices in some areas and high levels of household debt. Trans-Tasman flows represent a large portion of New Zealand's net migration, and will be influenced by the strength of Australia's labour market.

The growth outlook for Japan and the euro area is for ongoing low and moderate growth respectively, with both economies facing policy challenges to stimulate demand. Divergence between the monetary policy stance of these two countries and the US may reduce the efficacy of Japan’s and the euro area’s monetary policy in some areas, while concerns remain around the stability of the euro area’s banking sector, particularly with regard to the adverse effects of negative interest rates. Room for fiscal stimulus is also limited given high debt levels and ongoing large fiscal deficits.

Brexit is a key source of uncertainty that is likely to last for some time to come. Much uncertainty centres on the precise nature of Brexit: the timeframes, constitutional arrangements and nature of future agreements with the European Union. This uncertainty is expected to weigh on firm investment and employment decisions, although to what extent is unclear. Prominent risks relate to the future of the UK's financial centre and the value of sterling, which at its present subdued level supports exporters in the short term, but increases producer input price pressures, which in turn is expected to erode consumers' purchasing power. These risks will influence New Zealand through UK and euro area demand for our exports (eg, lamb) and future bilateral trade agreements.

…with the risk of weaker demand for key exports…

The outlook for key exports, such as dairy and tourism, continues to be marked by uncertainty and remains dependent on the growth of our trading partners (particularly China). The dairy price outlook is uncertain, despite recent large increases. Risk centres on how international production will respond over the medium term, particularly in the European Union where further market intervention by the European Commission could continue to distort price signals. Global dairy production growth has been further supported by decreased input costs from low oil and stockfeed prices and the strength of the US domestic dairy market. There is also uncertainty around the outlook for demand, particularly from China, and how long the Russian import ban remains in place. Other risks include the outlook for oil prices, which will be influenced by potential OPEC coordination, adverse weather events and the path of the New Zealand dollar. Despite recent improvements in farm-gate prices, dairy farm cashflows will remain constrained in the 2016/17 season.

Travel services export growth has been robust, as the gradual loosening of travel restrictions in China and approval of additional flights to New Zealand has supported a record number of visitor arrivals. Similarly, arrivals on student visas from Asian countries are at high levels, although they have moderated slightly in recent months. However, the Kaikōura earthquakes may prompt a decline in tourism arrivals to New Zealand (see Economic and fiscal impacts of the Kaikōura earthquakes on page 6). A shift in travel preferences, significantly slower income growth and/or heightened uncertainty abroad pose risks to the outlook for both tourism and education services exports.

…and increasing financial market volatility

Long-term interest rates increased from record lows in the second half of 2016, with increased optimism around global growth and inflation prospects. A global financial shock, such as a banking crisis, would increase perceptions of risk and financial market volatility, and thereby increase costs for New Zealand banks accessing funds offshore, potentially further increasing the interest rate facing households (via mortgage rates) and firms, while the New Zealand dollar would likely fall on “flight to safety” sentiment. Higher interest rates may then place pressure on households' and farmers' balance sheets, particularly those borrowers who have high levels of debt relative to income.

Net migration presents a significant risk to the central forecast…

Net migration in the year to June 2016 accounted for nearly three-quarters of population growth, increasing the size of the labour force and both the actual and potential output of the economy. Net migration has historically moved in large cycles, with gross inflows and outflows often changing at the same time, leading to large swings in net flows. However, it is difficult to gauge the strength and timing of these movements. If, for example, the Australian labour market materially improves in the near term, net migration inflows could decline more sharply than in the main forecast as arrivals from Australia decline and departures pick up again. On the other hand, the large inflows to date may suggest structurally higher permanent migration gains. See Migration, population growth and potential output on page 22 for further discussion on the economic implications of migration, and Fiscal impact of migration and population growth on page 35 for the fiscal implications.

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