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Monthly Economic Indicators

Analysis

Data in March 2010 were generally stronger than expected in the Treasury’s Half Year Update, released on 15 December 2009. However, the recovery to date has not been particularly strong and has not yet led to higher tax revenue.

Recovery gathers strength in late 2009...

The recovery in the New Zealand economy accelerated at the end of last year. Real production GDP rose 0.8% in the December 2009 quarter, the largest increase since the same quarter in 2007 (Figure 1). After a five-quarter recession beginning in early 2008, growth had been subdued at 0.2% in the June 2009 quarter and 0.3% in the September 2009 quarter. The December quarter expansion was the first to exceed population growth in two years, with real GDP per capita rising 0.5%.

Figure 1 – Real production GDP
Figure 1 – Real production GDP.
Source: Statistics NZ

Growth in the December quarter became more broad-based as output contracted in just three main industries, two of which had been boosted by one-off factors in the previous quarter. The strongest growth was in manufacturing, up 4.5% following seven consecutive quarters of contraction. Both primary processing and other manufacturing expanded strongly to meet rising demand in domestic and global markets. In contrast, construction output fell a further 0.6% in the quarter due to weaker non-residential work, despite support from infrastructure spending and stadium upgrades for the Rugby World Cup.

Real expenditure GDP also rose 0.8% in the December quarter, driven by growth in private consumption. Residential investment rose 4.8% in the quarter, although is still a third lower than its peak in 2007. Business investment also remains well below its peak and fell further in the latest quarter due to lower investment in intangible assets (fall in oil exploration) offsetting higher investment in capital (eg, plant and machinery).

Exports fell 0.9% in the quarter, led by a fall in dairy products after stocks had been run down earlier in the year and a fall in services exports as spending by overseas visitors declined. In contrast, goods import volumes rose sharply in the December quarter, although were offset by an increase in the level of stocks of $172 million after large rundowns during the rest of the year.

The acceleration of growth was in line with the experience of many other developed nations. In particular, real GDP in Australia rose 0.9% in the December 2009 quarter and 0.3% in the previous quarter, almost identical to New Zealand’s growth. Although the overall impact of the global crisis was smaller in Australia, per capita growth in the second half of 2009 was stronger in New Zealand given Australia’s higher population growth.

...although nominal GDP and taxes were soft...

Nominal GDP rose 0.5% in the quarter, less than expected despite a rise in the terms of trade (ratio of export prices to import prices). Prices for both private consumption and investment declined, suggesting discounting helped lift real expenditure. Weaker nominal GDP growth than expected in the 2009 Half Year Update helps explain why tax revenue has been below forecast, despite real GDP recovering more strongly. Tax revenue in the seven months to January 2010 was 1% below forecast excluding the impact from the settlement of structured finance transactions after the Half Year Update was released.

Compared to GDP, real gross national disposable income (RGNDI) is a wider measure of living standards as it measures the volume of goods and services New Zealand has command over. RGNDI fell 1.0% over the year to December 2009 as a whole, but dropped 5.7% in the December quarter, its largest fall in over 20 years. Despite being boosted by higher terms of trade, RGNDI was lowered by a sharp rise in the investment income deficit, discussed below.

...and impact of recession continues to be felt

The National Bank Business Outlook (NBBO) for March is consistent with ongoing recovery in the economy as a net 39% of firms expect their own activity to rise in the next year, similar to a net 42% in the previous month. However, a recovery in the labour market and stronger export demand are required for a sustained recovery. For the labour market, job growth is likely to remain weak in the near term as firms make better use of their workers, although the NBBO suggests job growth will return later in 2010 (a net 9% of firms expect to raise staff numbers in the next year). For exports, the NBBO showed a slight worsening of the outlook but a relatively high net 37% of manufacturing firms in March 2010 still expected to raise export volumes in the year ahead. The Treasury’s business and tax talks also pointed to encouraging signs for the export sector (see special topic for a summary of these talks).

Although the recovery is expected to continue, the rate of growth in the March quarter may not be as strong as in December. Consumer spending may be slightly lower this quarter based on subdued retail activity in January, weaker electronic card transactions in retail industries in February, and a small fall in consumer confidence in March. Consumer confidence, as measured by Westpac McDermott Miller and ANZ Roy Morgan, had been lifted by expectations of future conditions, rather than current conditions, but future expectations have now begun to fall back. Negative factors weighing on consumers since the start of the year have been increases in long-term interest rates, higher petrol prices, and a reported jump in surveyed unemployment. In addition, households may also be saving more.

A slowing housing market may also contribute to softer private consumption. The housing market has weakened with house price growth easing and sales in the three months to February 2010 down 18% on the previous three months (Figure 2). However, uncertainty related to changes in the tax treatment of property investment in the upcoming Budget may be driving this weakening.

Figure 2 – Private consumption and house sales
Figure 2 - Private consumption and house sales.
Sources: Statistics NZ, REINZ

Stronger global economic outlook

The recovery in the global economy has continued, especially among New Zealand’s key trading partners. Almost all developed nations have exited recession with at least one quarter of growth by late 2009 and the outlook has also improved. The average Consensus Forecast for growth in our top-12 trading partners in 2010 was 3.5% in March after edging up 0.1%pt in each month this year. The figure for 2011 is still 3.5%. Australia, our largest export market, and China, which became our second largest export market over the year to February 2010 year, are expected to continue growing strongly.

The recovery in the global economy has already seen a lift in commodity prices. World spot prices for our key commodities were 49% higher in February 2010 than a year earlier and nearing the historic highs of mid-2008. By commodity, dairy products were 63% higher, forestry products were 37% higher, and meat, skins and wool were 28% higher than a year ago. Some of the increase for dairy products, the largest mover, has been unwound since the start of 2010. Nevertheless, the world price of our commodities is almost certain to be stronger than expected in the Half Year Update.

Figure 3 – Terms of trade and commodity prices
Figure 3 – Terms of trade and commodity prices.
Sources: Statistics NZ, ANZ Bank

The lift in commodity prices is expected to boost the merchandise terms of trade significantly (Figure 3). This began in the December 2009 quarter, with the 5.7% increase in the Overseas Trade Index (OTI) merchandise terms of trade, the first rise since early 2008 and the largest since 1976. Dairy products were a key driver of the rise, up 5.0% in NZ dollar terms.

The terms of trade are expected to rise further in the first half of 2010 following the recent run-up in spot commodity prices. Such a rise is likely to be an important influence on the economy in the medium term. The forecast increase in the merchandise terms of trade in New Zealand, although significant, is not expected to be as large as that likely to be experienced in Australia given the larger run-up in their mineral prices.

A strong Australian economy has been, and is expected to remain, of benefit to New Zealand’s export sector, especially manufacturing and tourism. This influence will be boosted by the New Zealand dollar tracking near 10-year lows against the Australian dollar. However, the stronger Australian labour market is likely to encourage more emigration from New Zealand. This may have begun in February 2010 with a rise in permanent & long-term departures from New Zealand to an 11-month high and a fall in the net migration inflow to a 13-month low.

Imbalances remain...

The annual current account deficit narrowed to an 8-year low of 2.9% of GDP in the December 2009 quarter, similar to our Half Year Update forecast of 2.8% (Figure 4). This represented a fall from 3.2% in the September 2009 quarter, driven by a decline in imports that largely reflects the weakness in the New Zealand economy earlier in 2009 and the subdued recovery to date.

Figure 4 – Current account and net foreign assets
Figure 4 – Current account and net foreign assets.
Source: Statistics NZ

The annual investment income balance was fairly steady in the December 2009 quarter. However, the quarterly deficit on investment income was $3.4 billion in December 2009, the highest since June 2008 and up sharply from just $743 million in the prior quarter. The higher deficit was driven by a rise in profits earned by foreign-owned New Zealand enterprises. A partial reversal of tax provisions by major banks for their structured finance transaction cases was one factor behind this rise, but there was also a generalised upturn in profits earned by banks and other corporates. In the Half Year Update, we expected the current account deficit to widen from 2010 onwards to over 6% by the end of next year. Such a rise would partly reflect the one-off nature of the tax cases, which will begin to fall out of the annual calculations from the June 2010 quarter. It will also reflect a recovery in the New Zealand economy and the low rate of domestic saving. A rise in import volumes and in investment income payments accrued to foreigners is expected as domestic demand continues to recover from the 2008/09 recession.

The economy remains vulnerable to future shocks because of its high net external liability position, despite the recent fall in the current account deficit. The net external liability position did improve slightly from 93.4% of GDP at 30 September 2009 to 90.3% at 31 December 2009, but this was driven by one-off net valuation changes of $6.4 billion. The net external liability position remains very large relative to other countries and the expected widening of the current account deficit is consistent with a worsening of this position over time.

...and productivity growth has been weak

The economy may be recovering slightly more strongly than expected in the Half Year Update but this recovery has only just begun. Real GDP in late 2009 remains 2.1% below its peak two years earlier and this peak is not likely to be reached again until the second half of 2010. The output gap, the difference between actual output and our estimate of potential output, is also around -2%. The spare capacity in the economy this figure represents is also reflected in the unemployment rate, which sits at a 10-year high of 7.3% and well above estimates of a non-accelerating inflation rate of unemployment (NAIRU) of around 4.5%-5.0%.

There are also questions on the sustainable growth rate of the New Zealand economy (ie, potential growth) in the aftermath of the global financial crisis and in light of a recent weak productivity performance. Data released in March for the 1978-2009 period (March years) show productivity growth in the measured sector of the New Zealand economy. In the March 2009 year, there was a 1.5% fall in labour productivity (output per hour worked) and a 3.1% fall in multifactor productivity (output growth not accounted for by growth in capital and labour inputs). Both were the largest falls since the series began in 1978.

Weak productivity over the March 2009 year can partly be explained by recession. Real output in the measured sector fell 2.2% in the March 2009 year, the largest fall since at least 1978, but hours worked only fell 0.7% due to lags and labour hoarding by employers. However, a recession need not lead to a large fall in productivity: in New Zealand, labour productivity rose 2.9% in 1992 as output fell 1.7% and labour input fell 4.5% and, in the United States, labour productivity rose 4% in 2009 for similar reasons.

Year-to-year estimates of productivity can be volatile, but the latest year’s weak figure appears to be part of a declining trend. Statistics NZ presents the productivity data over growth cycles, which show annual labour productivity growth slowed from 3.1% between 1997 and 2000 to 1.3% between 2000 and 2006. Annual multifactor productivity growth slowed from 2.0% to 0.7% over the same period (Figure 5). Some of this fall may be explained by a large rise in labour input (ie, hours worked) as marginal employees tend to be less productive. Productivity growth fell further in the period since 2006 but this period is not a complete cycle.

Figure 5 – Multifactor productivity growth
Figure 5 – Multifactor productivity growth.
Source: Statistics NZ

Australia has similar data that can be used for comparison, although a different definition of measured sector is used that excludes business services and personal and other community services. Using these figures, Australia had a small fall in labour productivity of 0.3% and a large fall in multifactor productivity of 2.7% over the June 2009 year. This compares with a fall in labour productivity of 1.0% and a fall in multifactor productivity of 3.0% in the comparable sector for New Zealand over the March 2009 year.

As noted above, however, productivity should be examined over longer time periods than a year. Annual labour productivity growth in the 31 years since 1978 was similar in New Zealand (2.1%) and Australia (2.0%). Shorter and more recent periods tend to show higher growth in Australia. However, such comparisons are highly dependent on the starting point chosen and productivity growth has slowed in both nations in recent years from high rates over the 1990s. This slowing may have implications for how high sustainable growth may be in New Zealand and Australia in the future.

Risks to this outlook also remain

The economy appears to be recovering more strongly than expected in the Half Year Update, but there are a number of risks to this outlook. A more typical recovery would see stronger growth eventuate and confidence indicators do point to such an upturn. However, this confidence has been driven by future expectations and may be more a reflection of how deep the recession was (relief factor) than how strong the recovery will be. Notably, other domestic indicators have softened since late 2009 (eg, house sales).

There are also a number of external risks, including faltering growth in major economies once fiscal and monetary stimulus is unwound. The sustainability of public debt remains an issue, particularly in parts of Europe and the United Kingdom. In late March, an accord was reached that called for each Eurozone country and the IMF to provide loans to Greece if needed. In the United Kingdom, the budget in March disappointed markets with limited near-term fiscal cuts, although it did project large long-term budget deficit decreases and improved growth prospects.

The month of April 2010 will see the release of key data that will provide an important gauge as to the strength of the current recovery. These data are CPI inflation, the first Quarterly Survey of Business Opinion for 2010 and retail trade figures. These will be covered in the Monthly Economic Indicators for April. Further information on the outlook for the economy will be contained in the Budget due for release on 20 May 2010.

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