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3 Risks and Scenarios

Introduction

As presented in the Economic and Tax Outlook chapter, the main forecast relies on a number of judgements about how both the New Zealand and the world economies evolve. There is substantial uncertainty about those judgements, especially regarding how the world economy and the US financial crisis will evolve over the next few years. In the Budget Update, we noted that there were significant downside risks to the main forecast, reflecting the turmoil in international financial markets. We also developed an alternative scenario in which the finance costs faced by New Zealand would be higher than the main forecast because of a more prolonged and deeper global financial crisis.

Since the Budget Update, global developments have been more in line with the alternative scenario than the Budget forecast and global financial and economic conditions have worsened significantly. On the domestic front, finance companies have continued to face reduced debenture funding and more finance companies went into receivership or moratorium in the past three months. The speed and magnitude of the slowing in domestic demand has been more abrupt and greater than forecast in the Budget Update.

Reflecting these recent international and domestic developments, we have made significant downward revisions to our growth forecasts in this Update. However, the financial turmoil has intensified since the finalisation of our economic forecasts. As a result, we have seen the downside risks to our growth forecasts increase markedly, particularly in the years to March 2010 and 2011.

The first part of this chapter identifies major risks to the main forecast and describes how the various forces would affect the economy if these risks were to eventuate. The second part of this chapter presents two alternative scenarios for the economy. The third part of this chapter considers the implications of the alternative scenarios for the fiscal position, while the fourth part examines how sensitive the fiscal position is to changes in specific variables.

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