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Pre-election Economic & Fiscal Update 2011

Economic Outlook

Trading partner growth is slowing

In recent months the outlook for the world economy has deteriorated. In Europe, concerns about public debt, the stability of the financial system and the slowdown in growth have generated considerable volatility in global financial markets. Growth in the United States has also weakened and forecasts of growth in both regions have been reappraised as business confidence has faded and financial market volatility has increased. Euro area growth is forecast to slow to 0.9% in calendar year 2012, and forecast growth in the United States of 1.8% in 2012 is up only marginally from 2011 (see box on page 9).

Figure 1.1 - Trading partner growth
Figure 1.1 - Trading partner growth.
Sources: IMF, Consensus Forecasts, The Treasury

Our forecasts assume that European governments implement measures to manage the region's debt issues and stabilise financial markets, and that additional fiscal stimulus is adopted in the United States in 2012, while recognising the need for consolidation over the medium term. Weaker demand in these economies is expected to flow through to slower export growth in other countries. How substantive these flow-on impacts will eventually be is difficult to gauge and there is a significant risk that trading partner growth will slow further than assumed in these forecasts. Trading partner growth of 3.0% in the year to December 2011 is forecast, down from 4.6% last year, which was boosted by cyclical factors, such as inventory rebuilding and policy stimulus. Despite the deterioration in the world outlook, trading partner growth is expected to rise to 3.8% in 2012. The increase in 2012 is largely a reflection of the recovery from temporary disruptions to output in Australia and Japan early in 2011 - growth in China slows in 2012 and growth in Other Asia is steady (see Table 1.1). The gradual recovery in the United States, United Kingdom and euro area and continued solid growth elsewhere lift trading partner growth to around 4% by 2015 (Figure 1.1).

New Zealand's trade links with Other Asia and China, in particular, have strengthened in recent years and they now take around a third of New Zealand exports. Recent data point to an easing in activity across the region and, while further moderation is expected, the rate of expansion will likely remain solid. Economies in this region have scope to use fiscal and monetary policies to stimulate demand, although there are risks to inflation and asset prices to be navigated. The reasonable rates of growth expected in this region will provide opportunities for New Zealand exporters and support for commodity prices.

Outlook for the World Economy

The outlook for the world economy is one of the main assumptions in our forecasts and also one of the major uncertainties. The greatest uncertainty is associated with the euro area sovereign debt crisis, which we expect to be resolved only gradually, with risks around key developments. The outcome of meetings of European leaders scheduled to occur between the finalisation of this text and its publication, and in the period closely following publication, could change the outlook for the euro area and the global economy. Future developments and responses will carry similar risks.

Our forecasts for economic growth in our main trading partners have been revised down from the BudgetUpdate as outturns have been lower and the outlook has deteriorated (Table 1.1). While temporary factors, including natural disasters, account for some of the weaker growth to date, there is increasing acceptance that the recovery from the global financial crisis will be more protracted as household income growth is low and governments reduce debt.

Table 1.1 - Trading partner growth (calendar years)
PREFU forecasts 2008 2009 2010 2011 2012 2013 2014 2015
percent change actual actual actual estimate forecast forecast forecast forecast
Australia 2.6 1.4 2.7 1.7 3.5 3.2 3.2 3.2
China 9.6 9.2 10.3 9.3 8.8 8.7 8.7 8.5
United States -0.3 -3.5 3.0 1.5 1.8 2.0 2.2 2.4
Euro area 0.4 -4.3 1.8 1.5 0.9 1.5 1.5 1.5
Japan -1.2 -6.3 4.0 -0.7 2.3 1.5 1.4 1.4
United Kingdom -0.1 -4.9 1.4 1.0 1.6 2.0 2.1 2.2
Canada 0.7 -2.8 3.2 2.3 2.2 2.5 2.5 2.5
Other Asia* 3.2 0.3 8.3 5.0 5.0 5.2 5.1 5.1
Trading Partners 2.0 -0.5 4.6 3.0 3.8 3.8 3.9 4.0
Consensus (October) 2.0 -0.5 4.6 3.0 3.7 3.9 4.0 4.0
IMF WEO (September) 2.0 -0.5 4.6 3.1 3.8 4.1 4.2 4.3
Pre-Election Update Downside 2.0 -0.5 4.6 2.8 1.7 3.5 3.7 3.8
Budget Update 2011 (May) 1.9 -0.5 4.6 3.7 4.4 4.1 4.1 4.1

* South Korea, Taiwan, Hong Kong, Singapore, Malaysia, Indonesia, Thailand, Philippines, India

Sources: IMF, Consensus Economics, The Treasury

Our forecasts for trading partner growth are similar to October ConsensusForecasts (released after we finalised) and the IMF September World Economic Outlook (WEO), released just before we finalised. Our forecasts assume an orderly resolution of the euro area debt crisis, although it is acknowledged that this may take a few years to be fully resolved. Euro area growth is expected to slow to 0.9% in 2012 and to rise to 1.5% thereafter. A scenario where the euro area debt crisis is not contained is explored in the Risks and Scenarios chapter. The scenario is based on the IMF’s recent WEO downside scenario, but the impact of the crisis is twice as large with trading partner output 3% below the main forecasts at the end of the period in our scenario.

The downside scenario does not envisage as sharp a downturn in the world economy as in the Global Financial Crisis (GFC) when our trading partners' output contracted. In essence, we think policy makers have learned from the GFC and are better placed to respond should financial markets become disorderly. A rapid recovery followed the GFC as authorities responded with monetary and fiscal stimulus and stocks were rebuilt. In the downside scenario presented here, growth dips to 1.7% in 2012 and remains subdued through the forecast period because authorities’ ability to stimulate their economies is more limited now and households and governments still need to strengthen their financial positions.

In Australia, the terms of trade are very high, providing a substantial boost to income. Investment in the resources sector is growing strongly, contrasting with more subdued growth in the manufacturing and retail sectors of the economy. Commodity prices have fallen in recent weeks, although generally they remain high. Growth in Australia is likely to slow as the weaker outlook for developed economies flows through to Asian economies, which account for around half of Australia's exports. However, while demand growth may moderate, Australia's commodity export prices are likely to remain well supported, underpinning continued growth.

Figure 1.2 - Merchandise terms of trade (SNA)
Figure 1.2 - Merchandise terms of trade (SNA).
Sources: Statistics New Zealand, The Treasury

Prices for New Zealand's major export commodities increased more strongly than expected in the BudgetUpdate. While they have fallen from their record highs, they have not slumped the way they did in 2008, although that is a distinct possibility, which we explore more fully in the Risks and Scenarioschapter. Our forecast of a 4% decline in the terms of trade over the coming year reflects both the weaker demand outlook and an easing of supply constraints. In the medium term, increasing emerging market incomes, combined with rising world production costs, suggest that recent gains in the terms of trade will endure (Figure 1.2).

High commodity export prices have been reflected in increased profits in the agriculture sector, which have flowed through to lower agricultural sector debt. Household sector credit growth has also slowed, rising 2.0% in the past year, and with household disposable incomes growing 6.4% in the year, the household debt-to-income ratio has begun to decline (Figure 1.3). Income growth is expected to continue to exceed credit growth over the next few years, leading to further declines in this measure of household leverage.

Figure 1.3 - Household saving and leverage
Figure 1.3 - Household saving and leverage.
Sources: Statistics New Zealand, The Treasury

Growth in household consumption spending has also fallen below the rate of income growth. In the year ended March 2011, the difference between income and consumption - saving - is expected to be positive for the first time in more than a decade. The change in saving behaviour is forecast to be persistent, and saving is forecast to continue rising over the forecast period. Factors behind this trend include: a desire by households to rebuild wealth lost through finance company failures and declines in financial and property values, a rise in job insecurity associated with the 2008/09 recession and changes in government policy for example, tax and KiwiSaver policies.

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