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Pre-Election Economic and Fiscal Update 2008

Executive Summary

The economic and fiscal outlook has deteriorated since the Budget Update

In the five months since the Budget Update was finalised, we have witnessed a number of significant domestic and international developments: in particular, the deepening of the international financial crisis, the slowing housing market, and growing pressure on households and businesses. These developments are key factors in our updated view of the economy and the government's finances set out in this Pre-election Update.

We are now expecting weaker economic growth over the next few years, resulting in slower growth in tax revenue and higher government expenditure. Combined with increases in the costs of some existing policies, these factors lead to sustained operating balance deficits and higher debt-to-GDP ratios.

The economic outlook is weaker …

Imbalances have built up during nearly a decade of sustained growth, including inflation pressures, an overvalued housing market, high household debt and a large current account deficit, with implications for interest rates and the exchange rate. With the economy slowing, these imbalances are starting to unwind - as are imbalances in the global economy - but there is a long way to go.

As expected in the Budget Update, the drought has had a significant negative influence on the economy, and was a chief factor in the recession in the first half of 2008 – reducing dairy production, hydro electricity generation and manufacturing output.

Figure 1 - Real GDP growth
Figure 1 - Real GDP growth.
Source:  Statistics New Zealand, The Treasury

Figure 1 shows a much weaker economic outlook than in the Budget Update, driven by a number of developments:

  • The domestic slow-down has been sharper than expected, with declines in consumption and residential investment.
  • Households and businesses have come under increasing cost pressures – electricity, interest rates, fuel and food – which are dampening private consumption and firm profitability. It will take time for these pressures to dissipate, though some relief in terms of oil prices and interest rates has emerged since the finalisation of our economic forecasts.
  • The housing market has weakened more quickly than expected. It will remain depressed over the next year as a result of high effective interest rates, low net migration flows and falling consumer confidence, which will affect private consumption and residential investment.
  • The international financial crisis has deepened and is having an adverse impact on global economic growth. New Zealand is expected to feel the effects of the financial crisis principally through the tighter availability and increased costs of credit, but also through a fall in business and consumer confidence, falling asset values and lower demand and prices for our exports.

While there are some positive factors for growth in the short term - eg, recovery from the drought and personal tax cuts boosting consumption - the factors above point to the recovery being gradual.

A more sustained pick-up in growth is forecast from mid-2009. We expect impetus to come particularly from the export sector, as primary export volumes increase and a lower exchange rate stimulates demand for manufactured products and services.

Table 1 - Major economic parameters
March years
(annual average % change)
Real GDP 0.1 1.8 3.3 3.4 3.1
Employment 0.3 (0.3) 0.4 1.3 1.8
Unemployment 4.4 5.1 5.1 4.8 4.6
Wages 5.5 4.3 4.0 3.8 3.5
Consumer prices 4.5 2.3 2.4 2.4 2.4

Note: Employment is on a full-time equivalent basis; unemployment is a percentage of the labour force, March quarter, seasonally adjusted; consumer price inflation is measured as an annual percentage change.

Source: The Treasury

… meaning lower tax revenue and higher government spending

The weaker economic growth that we are forecasting is reflected in reductions in our tax revenue forecasts. Compared with the Budget Update, we expect tax revenue to be on average around $900 million lower for each of the next three years.

  • The weak outlook for the household sector will have a direct impact through GST, which is forecast to grow by around 4% per annum over the next five years, compared with 7.5% over the six years to 2007.
  • With firms' margins under pressure and profitability low, underlying corporate income tax is forecast to decline by 3% in the 2009 June year, and growth is expected to be negligible in 2010 as accumulated tax losses offset profits.
  • A relatively robust forecast for wages over the next few years helps to keep underlying growth in PAYE up at around 5% per annum.

The largest single change in government spending in the Pre-election Update is an increase in the expected costs of benefits. Compared with the Budget Update, benefit expenses are around $500 million per annum higher, reflecting both an increase in numbers of beneficiaries as a result of the slowing economy, and the impact of higher inflation on the costs of indexing benefits.

The cost of some existing policies is higher …

The cost of some existing policies has increased since the Budget Update, particularly:

  • education spending is around $200 million per annum higher, driven by higher-than-expected take-up of the 20 hours free early childhood education initiative, and
  • KiwiSaver costs are higher, reaching an extra $280 million per annum by 2012, driven by higher-than-expected take-up rates.

… and debt servicing costs have increased

As a result of the various factors set out above, the government's debt outlook deteriorates. This leads to higher debt servicing costs, which are forecast to be around $500 million per annum higher


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