Short-term Outlook (continued)

Core Crown expenses[2] increase in nominal terms

While core Crown expenses are forecast to decline as a percentage of GDP, they are expected to increase in nominal terms (Table 2.3).

Source: The Treasury

When costs associated with the Canterbury earthquakes are excluded, the main components of the increase in expenses are social assistance expenses (predominantly NZS), future allowances for new operating spending, costs associated with the Emissions Trading Scheme, and finance costs relating to the increase in gross debt.

At each Budget the Government announces expenditure initiatives. In the last Budget Update saving initiatives were of a greater value than the estimated cost of new initiatives. As a result, net savings were forecast over the forecast period. The forecasts in this Pre-election Update include an allowance for future spending initiatives based on the Government's net new operating allowances for new spending over the forecast period.

New Zealand Units issued under the Emissions Trading Scheme are expected to increase as new sectors enter the scheme. These expenses are partially offset by revenue associated with the surrender of New Zealand Units by emitters. Note 20 of the Forecast Financial Statements provide further details of the scheme.

Figure 2.3 - Beneficiary numbers

Source: The Treasury

Social assistance expenses are forecast to increase by $3.7 billion over the five years of the forecast period compared to the year ending June 2011. The majority of this increase is in relation to NZS which is expected to increase by $3.6 billion over that period.

This expected increase in social assistance expenses is due to growth in both the number of recipients (Figure 2.3) and the effect of wage and CPI indexation.

Figure 2.4 - Finance costs

Source: The Treasury

Finance costs are estimated to increase over the next few years (Figure 2.4) resulting from an increase in gross debt (discussed later in the chapter). Finance costs are forecast to increase from $3.7 billion in the June 2012 financial year to $4.3 billion in the year ending June 2016.

While debt financing costs increase over time, they are forecast to be much lower than expected at the last Budget Update. For example, the Budget Update forecast finance costs of $5.3 billion in the year ending June 2015. Our estimate for that year has fallen to $4.3 billion in the current forecasts, primarily driven by a reduction in the forecast interest rates.

The credit rating downgrades, which occurred after the interest rate forecasts were completed, are not expected to have a material impact on debt financing costs (long-term yields are expected to increase by around 15 basis points).

Cash raised from debt issuance that is not immediately required to meet cash demands is invested in financial assets. Therefore, while finance costs increase over the forecast period, this is partially offset by an increase in interest revenue from the invested assets (Table 2.4).

Source: The Treasury

The Crown is still forecast to return to surplus by June 2015

When core Crown forecasts are combined with the forecasts for SOEs and Crown entities, the total Crown is expected to return to surplus in the year ending June 2015 as also forecast in the Budget Update (Figure 2.5).

Figure 2.5 - Total Crown operating balance before gains and losses

Source: The Treasury

The operating deficit[3] is expected to fall from 9.2% of GDP in the June 2011 year to 5.1% of GDP in the June 2012 year. Excluding the cost of the earthquakes to the Crown, the deficit is estimated to be 3.7% of GDP in the year ending June 2012 compared with 4.6% in the previous financial year.

The June 2015 surplus has increased slightly from $1.3 billion in the Budget Update to $1.5 billion in these forecasts. Forecast reductions in tax revenue, the recently announced reduction in ACC levies, and the forecast impact of the introduction of the agriculture sector in 2015 to the Emissions Trading Scheme are expected to be offset by a faster-than-expected decline in unemployment benefits, an increase in the EQC levy and a reduction in forecast interest rates.

When forecast net gains are included, the total Crown operating balance (including gains and losses) is forecast to reach a surplus of $1.6 billion (0.7% of GDP) in the year ending June 2014. These net gains arise predominantly from forecasts of investment returns by the Crown's financial institutions (eg, the NZS Fund).

Operating balance forecasts for the year ending June 2012 include actuarial losses of $2.3 billion on the ACC claims liability and the Government Superannuation Fund pension liability, reflecting a decrease in the discount rates since 30 June 2011 that is used to calculate these long-term liabilities.

Cash deficits persist, resulting in increasing net debt

While the Crown returns to surplus[4] in the year ending June 2015, residual cash deficits, although reducing, remain across the forecast period.

Figure 2.6 - Net Core Crown debt

Source: The Treasury

Operating cash does reach surplus by June 2016, but when capital spending is included, residual cash remains in deficit by $1.6 billion (or 0.6% of GDP) in that year.

Capital spending includes providing funding to the Earthquake Commission to cover the estimated cash shortfall of $490 million in the year ending June 2015.

The resulting residual cash deficits represent the amount the Crown has to fund, either by raising debt or reducing financial assets and they result in an increase in net debt.

The reducing cash deficits result in net debt rising in nominal terms but decreasing as a percentage of GDP from a peak of 29.0% at June 2015 to 28.2% by June 2016. This decline continues into the medium-term projections (page 38).

The profile for net debt is forecast to remain similar to the picture outlined in the Budget Update. As a result, the borrowing programme run by the New Zealand Debt Management Office (NZDMO) remains largely unchanged (Table 2.5).

The forecasts include the redemption of non-market domestic bonds held in the Earthquake Commission's Natural Disaster Fund (NDF). In addition, repayments of market domestic bonds are expected in the first two years of the forecasts and in the year ending June 2015.

Source: The Treasury