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Pre-election Economic and Fiscal Update 2014

Medium-term Projections

The previous sections of this chapter have concentrated on the five-year forecast horizon, up to and including 2017/18. The focus now switches to the decade beyond the last forecast year, extending to 2027/28, referred to as the medium-term projections. The different names reflect different levels of precision.

Forecasts are based on comprehensive modelling of, and expert opinion on, economic and fiscal conditions. They take into account the relationships and interactions between variables, and make allowance for the impacts of existing policies. Based on the information available, they represent the best attempt to predict future outcomes.

Projections represent potential future paths of variables. They are usually based on historical averages of the levels or growth rates, and depend greatly on both the forecast base from which they arise and the assumptions used to generate them. Projections should not be viewed as accurate predictions, but rather as indicators of potential outcomes under a given set of assumptions. The projections assume an economy that is free of cycles and growing on trend, and contain no unplanned policy responses that might, in actuality, be enacted to address unfavourable trends or encourage positive outcomes.

Projected nominal GDP growth slows...

The two economic variables that most significantly influence the fiscal projections are nominal GDP and the CPI inflation measure. A table in the annex to this section shows the paths of the other main economic projections.

Annual growth of nominal GDP gradually slows over the projections, from a peak of 4.5% in the year ending June 2021 to 4.2% by the year ending June 2028. This is mainly owing to the labour force contribution, where an ageing population slowly reduces overall participation rates.

While projected nominal GDP growth rates are virtually identical to those produced for the 2014 Fiscal Strategy Report (FSR), they arise from an end-of-forecast GDP base which is $1.4 billion (0.5%) lower. This wedge is maintained over the projection decade. Because tax revenue is brought to a stable ratio of nominal GDP in projections, based both on history and current tax parameters, this results in reduced tax, in dollar terms, relative to the 2014 FSR.

Figure 2.17 - Core Crown revenue and expenses
Figure 2.17 - Core Crown revenue and expenses   .
Source:  The Treasury

Figure 2.17 illustrates the paths of core Crown revenue and expenses, as percentages of nominal GDP, in recent history and the Pre-election Update forecasts and projections.

Lower tax revenue is the main reason why the fiscal projections are not quite as strong as those of the 2014 FSR. As depicted in Figure 2.18 the total Crown operating balance before gains/(losses) tracks slightly below the previous projection.

Figure 2.18 - Total Crown operating balance before gains/(losses) or OBEGAL
Figure 2.18 - Total Crown operating balance before gains/(losses) or OBEGAL   .
Source:  The Treasury

The Pre-election Update projection of expenses, in dollar terms, is only slightly higher than the previous projection. The majority of the small difference is owing to higher interest costs, which arise from debt not reducing as quickly.

...with OBEGAL surpluses projected to continue...

Figure 2.19 - Net core Crown debt (excluding NZS Fund and advances) assuming no policy intervention
Figure 2.19 - Net core Crown debt (excluding NZS Fund and advances) assuming no policy intervention   .
Source:  The Treasury

The projection of OBEGAL continues the rising profile exhibited in the forecast years. Surpluses increase, not just in dollar terms but also as percentages of GDP, principally because revenue growth outstrips that of expenses. Allowances for new operating spending grow more slowly than nominal GDP. By contrast, most revenue types, and in particular tax revenue, grow in line with nominal GDP. The track also receives a boost in the initial years of projections as some tax types lift to their long-run stable ratios of nominal GDP.

...resulting in net core Crown debt reaching 20% of GDP in 2020/21

Weaker revenue projections also result in a projection of net core Crown debt to GDP that is marginally higher than in the 2014 FSR, as shown in Figure 2.19. The narrowing of the gap between the two net debt tracks in 2019/20, before moving apart again, reflects the assumed resumption of capital contributions to the NZS Fund shifting out one further year.

The current policy relating to resumption of capital contributions to the NZS Fund is that these will restart once net core Crown debt is no higher than 20% of GDP. This was projected to occur in 2019/20 in the 2014 FSR. However, the reduction in both forecast and projected tax revenue means that net core Crown debt is projected to fall below 20% of GDP one year later. As a result, capital contributions are now projected to also resume one year further out, in 2020/21.

Further long term projections are available in the Treasury's latest Statement on New Zealand's Long-Term Fiscal Position, which was published in July 2013. It outlines how, in common with many advanced economies, New Zealand faces an ageing population structure which will bring with it both challenges and opportunities.

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