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Pre-election Economic and Fiscal Update 2014

General Fiscal Risks

The remainder of this chapter focuses on the links between the risks to the performance of the economy and the Crown's fiscal position. For more on fiscal risks, see the Specific Fiscal Risks chapter on page 61.

Fiscal Sensitivities

Table 3.2 provides some rules of thumb on the sensitivities of the fiscal position to small changes in specific variables. For example, if nominal GDP growth is one percentage point faster than forecast in each year up to June 2018, tax revenue would be around $3.2 billion higher than forecast in the June 2018 year as a result. The sensitivities are broadly symmetric and if nominal GDP growth is one percentage point slower each year than expected, tax revenue would be around $3.1 billion lower than forecast in the June 2018 year. The figures are indicative and can be influenced by the composition of growth as different types of activity have different effective tax rates.

A different interest rate path from that forecast would also impact on the fiscal position. A one percentage point lower interest rate would result in interest income on funds managed by the Treasury's New Zealand Debt Management Office (NZDMO) being $145 million lower in the June 2018 year. This would be more than offset by interest expenses being $338 million lower in the June 2018 year.

Table 3.2 - Fiscal sensitivity analysis
Years ended 30 June

1% higher nominal GDP growth per annum on

Tax revenue 675 1,435 2,270 3,190

Tax Revenue impact of a 1% increase in growth of

Wages and salaries 285 605 965 1380
Taxable business profits 130 300 480 675

Impact of 1% lower interest rates on

Interest income1 (73) (77) (136) (145)
Interest expenses1 (22) (187) (275) (338)
Overall operating balance1 (51) 111 139 194

Note: 1 Funds managed by the Treasury's NZDMO only.

Source: The Treasury

Revenue Risks

One of the major sources of risk to the fiscal position arises from the inherent uncertainty about future tax revenue. The amount of tax revenue that the Government receives in a given year is closely linked to the performance of the economy.

Figure 3.9 plots the central tax revenue forecast, along with confidence intervals around these forecasts based on the Treasury's historical tax forecast errors and the assumption of an even balance of risks around the central forecast.[8] The outermost shaded area captures the range ± $6.4 billion in the June 2018 year, within which actual tax outturns should be expected to fall 80% of the time.

The tax revenue forecasts from the two scenarios are also shown in Figure 3.9. The 2008/09 global financial crisis showed that exogenous shocks can have severe impacts on government revenue. Should any of the uncertainties outlined in the Economic Riskssection eventuate, government revenue would be different from forecast, with scenarios one and two being examples of possible outcomes.

Figure 3.9 - Core Crown tax revenue uncertainty
Figure 3.9 - Core Crown tax revenue uncertainty.
Source: The Treasury

Expenditure Risks

One-off and unexpected expenditure shocks can have a large impact on the Crown's operating balance in the year that they occur. Persistent over-forecasting of expenditure can also have substantial ongoing effects on the fiscal position, along with the uncertainty inherent in forecasting the cost of new policy initiatives.

There is also considerable uncertainty regarding the effect of the performance of the economy on Crown expenditures. This uncertainty relates largely to the operation of the so-called automatic stabilisers. For example, if the economy performs better (worse) than expected in a given year, official expenditures on social programmes may be lower (higher) than planned.

Balance Sheet Risks

In addition to risks around revenue and expenditure, which appear in the balance sheet through their impact on the operating balance, the Crown's financial position is also exposed to asset and liability risks. The largest source of balance sheet risk is volatility in asset and liability values owing to movements in market variables such as interest rates, exchange rates and equity prices.

For additional detail, refer to the 2014 Investment Statement which provides information on the shape and health of the Crown's portfolio of assets and liabilities at the end of the previous financial year.[9] It outlines how the balance sheet has changed in recent years and includes forecasts of its anticipated composition and size through to 30 June 2018.

Funding Risks

The New Zealand Crown remains in the top-20 rated sovereigns globally, with the top Aaa foreign-currency rating from Moody's and AA foreign-currency ratings from Standard & Poor's and Fitch. Ratings outlooks are stable for Standard & Poor's and Moody's, and the rating outlook from Fitch is positive.

In the case of an increase in global risk aversion and in the absence of a marked improvement in the external position, New Zealand may be more likely to face a degree of funding pressure in the future. All else being equal, any improvement in the ratings outlook could serve to lower debt-servicing costs for the Crown.

The Crown is also susceptible to “liquidity risk” with respect to its ability to raise cash to meet its obligations. This risk is relatively small, however, given ongoing management of the core Crown's liquidity position by the Treasury's NZDMO.


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