The preceding parts of this chapter have focused on the fiscal forecasts to the year ending June 2016. This section concentrates on the medium-term fiscal projections, covering the subsequent decade up to and including the year ending June 2026.
At each Economic and Fiscal Update, the Treasury produces post-forecast projections of key economic and fiscal variables, such as nominal GDP and net debt. The projections arise from the forecasts, but there are fundamental differences between them. Forecasts are based on comprehensive modelling of economic and fiscal conditions, including the relationships between the two and the impacts of existing or proposed policies. Projections, in contrast, are potential paths of economic and fiscal variables beyond their end-of-forecast values, largely based on historical averages while reflecting existing policy settings. In particular, projections move towards, and then maintain, an assumption of an economy that is growing on trend and free from cycles. Projections also contain no policy responses, beyond those already in existence or to which there is a future commitment, to mitigate unfavourable outcomes or to strengthen positive trends.
Updated medium-term projections
In order to produce post-forecast fiscal variables it is necessary to project forward the economic variables which inform them. For example, tax revenue grows in line with nominal GDP, once a stable economy is attained. The two economic variables that play the biggest roles in fiscal projections are nominal GDP and the rate of inflation, as measured by changes in the CPI.
CPI inflation gradually returns to 2% per year from its end-of-forecast value. This reflects the mid-point of the Reserve Bank's Policy Targets Agreement, which is to keep the CPI-measured annual inflation rate inside a 1% to 3% band.
The CPI inflation projection is added to the projection of real GDP growth to produce the nominal GDP growth projection. This means that there is an implicit assumption that other drivers of nominal GDP, such as the terms of trade, remain at the levels attained at the end of the forecasts.
Over the projections, nominal GDP trends down from 5% annual growth in the year ending June 2017 to around 4% per year from the year ending June 2020 onwards. There are a number of factors contributing to this slowing: CPI inflation trending down to 2% per year; economic activity and the labour market returning to more normal levels as the earthquake rebuild winds down; and the aging population slowing growth in the labour force.
The medium-term fiscal projections for the Pre-election Update are similar to those produced for the 2011 Fiscal Strategy Report. The full recovery of the economy from the impacts of the Global Financial Crisis, as well as those of the Canterbury earthquakes, is still expected to be attained around the end of this decade. The total Crown operating balance before gains/(losses) returns to surplus at the same time, the year ending June 2015, and strengthens beyond that at a relatively similar rate. Core Crown net debt peaks in the forecasts and declines along a path similar to that depicted in the 2011 Fiscal Strategy Report projection.
The improvements in the fiscal position over the forecast period, which sees a surplus first achieved in the year ending June 2015, continue into projected years (Figure 2.11). Two factors are primarily responsible for the surplus improving over the projection period.
- Figure 2.11 - Total Crown operating balance before gains/(losses) or OBEGAL
- Source: The Treasury
Firstly, the growth of all core Crown expenses, except for welfare transfers and debt-financing costs, is restricted to the size of the projected allowances for new operating spending. The annual increment to the operating allowance used in the first projected year, the year ending June 2017, is $1.239 billion. In later projected years this amount is increased by 2% per year. As this level of controlled expenditure growth is lower than both historical averages and nominal GDP growth, it plays a major role in maintaining expenses below revenue levels in the projections.
The second factor is strengthening tax revenues, produced by an economy returning to trend and incorporating fiscal drag for the first five projected years. Even after tax recovers to an assumed stable ratio to nominal GDP, based on history, it then grows in line with GDP. As already indicated, this is faster than the driver of most expenses.
While the operating balance before gains/(losses) is the main indicator of fiscal flows, net core Crown debt (excluding the financial assets of the NZS Fund and advances) is the key indicator of the public sector's fiscal stocks. Figure 2.12 depicts net debt to nominal GDP, showing that it peaks at 29% in the year ending June 2015 before steadily declining over the projection period. The attainment of surpluses from the year ending June 2015 onwards enables some of the debt stock to be retired, which in turn helps surpluses to increase by reducing debt-financing costs.
- Figure 2.12 - Net core Crown debt (excluding NZ Superannuation Fund and advances)
- Source: The Treasury
Figure 2.13 shows that core Crown expenses, which spike in the fiscal year just completed mainly owing to one-off costs associated with the earthquakes, are forecast to decline. By the last year of the Pre-election Update forecasts they have returned to levels of GDP more like those seen before the Global Financial Crisis. Much of this reduction, which extends into the decade of projections, is owing to reduced operating allowances, relative to their pre-crisis levels, and restricting their growth to 2% per year. Falling debt-financing costs also play a part, as seen by the reduction in the gap between the expenditure measures with and without these costs. By the year ending June 2026 the two lines are only half a percentage point of GDP apart.
- Figure 2.13 - Expenses
- Source: The Treasury
While overall expenses are declining, this is not true of all individual spending classes. In particular, gross (of tax) expenditure on NZS increases from 4.4% of nominal GDP in the year ending June 2011 to 6.1% by the end of the projection period, the year ending June 2026. The chief driver of this expense is recipient numbers, with the “65 and over” population expected to grow nearly four times more quickly than the total population over this period.
As the economy recovers, so do tax revenues and other income sources, such as returns on financial assets. This is shown in Figure 2.14. As well as the boosts to tax from more people in employment, companies returning to profit and higher spending, fiscal drag also plays a role. This refers to the case where tax grows faster than the income that generates it, particularly when a taxpayer's income moves into a higher tax bracket. Fiscal drag is only modelled for the first five years of projections, in order to keep the tax-to-GDP ratio around average historical levels. This can be seen where the total Crown revenue line levels out from the year ending June 2021 onwards.
- Figure 2.14 - Revenue
- Source: The Treasury