The Economy of New Zealand: Overview
Introduction
New Zealand has a small export-dependent economy which operates on free market principles. It has sizable manufacturing and service sectors complementing a highly efficient agricultural sector. New Zealand is highly dependent on the primary sector with commodities accounting for around half of total exports. Exports of goods and services account for around one third of real expenditure GDP.
Background
New Zealand emerged from World War II with an expanding and successful agriculture-based economy. In the 1950s and 1960s, a period of sustained full employment, GDP grew at an average annual rate of 4%. Agricultural prices remained high, due in part to a boom in the wool industry during the Korean War. However, even during this period there were signs of weakness. In 1962, the Economic and Monetary Council advised the government that between 1949 and 1960 New Zealand's productivity growth had been one of the lowest amongst the world's highest earning economies.
In the late 1960s, faced with growing balance of payments problems, successive governments sought to maintain New Zealand's high standard of living with increased levels of overseas borrowing and increasingly protective economic policies.
Problems mounted for the New Zealand economy in the 1970s. Access to key world markets for agricultural commodities became increasingly difficult. The sharp rises in international oil prices in 1973 and 1974 coincided with falls in prices received for exports. As in many OECD countries, policies in New Zealand were principally aimed at maintaining a high level of economic activity and employment in the short term. High levels of protection of domestic industry had greatly undermined competitiveness and the economy's ability to adapt to the changing world environment. The combination of expansionary macro policies and industrial assistance led to macroeconomic imbalances, structural adjustment problems and a rapid rise in government indebtedness. After the next major shift in oil and commodity prices in 1979 and 1980, New Zealand's position deteriorated further.
From around 1984 onwards, the direction of economic policy in New Zealand turned away from intervention toward the elimination of many forms of government assistance. On the macroeconomic level, policies were aimed at achieving low inflation and a sound fiscal position while microeconomic reforms were introduced to open the economy to competitive pressures and world prices.
The reforms included the floating of the exchange rate, abolition of controls on capital movements, the ending of industry assistance, the removal of price controls, deregulation across a number of sectors of the economy, corporatisation and privatisation of state-owned assets, and labour market legislation aimed at facilitating more flexible patterns of wage bargaining.
After a period of weak growth during the late 1980s, New Zealand's economic performance improved significantly during the 1990s. From mid-1991, the economy grew strongly with particularly strong output from 1993 to 1996, with annual average growth in real GDP peaking at 6.8% in June 1994.
Growth slowed during 1997 and 1998 due to a slowdown in key Asian trading partners together with a drought that affected large parts of the country over the 1997/98 and 1998/99 summers.
After this period, the economy performed strongly with the exception of a short weaker period during 2001. However, the economy regained momentum, with a combination of two good agricultural seasons, relatively high world prices for New Zealand's export commodities, a low exchange rate and a robust labour market contributing to strong income flows throughout the economy.
Over 2002 to 2004, growth in GDP was generally in the 3.5% to 4.5% range, peaking at 5.2% annual average growth in December 2002. This period of strong growth included a period in which the economy was subject to several temporary negative events. These included travel disruptions and uncertainty due to the conflict in Iraq, the outbreak of SARS in Asia and the effects of dry weather on hydro-electricity production and farm output.
After 2004, growth eased as a result of high oil prices, interest-rate increases and weakness in the external sector, with the economy remaining flat in the second half of 2005. There was a recovery during 2006 as the exchange rate depreciated, but annual average growth of 1.7% for the year to December 2006 was well down from the recent peak of 4.4% in the year to 30 September 2004.
The current account deficit increased from the 2.7% to 4.1% range which had prevailed between 1990 and 1994, to 6.4% in 2000. The increase in the deficit was primarily caused by the international income deficit increasing, reflecting New Zealand's increased net international liability position. A depreciation of the exchange rate from 2000 saw the annual current account narrow to 2.8% of GDP in September 2001. A subsequent appreciation of the exchange rate saw the current account deficit reach 9.3% of GDP in the year to June 2006 as strong consumption and investment demand drove strong import growth.
Recent Developments and Outlook
A drought over the 2007/08 summer led to lower production of dairy products in the first half of 2008. Domestic activity slowed sharply as high fuel and food prices and the impact of past interest rate rises began dampening private consumption. High interest rates and falling house prices resulted in residential investment contracting sharply in the first half of 2008. The economy contracted 0.3% in the March quarter and again by 0.2% in the June quarter. Growth slipped by a further 0.4% in the September quarter on the back of lower investment and export volumes, taking annual average growth to 1.7% in the year to September 2008.
The appreciation of the New Zealand dollar during 2007, coupled with the re-acceleration of economic growth and continued capacity constraints, promoted a rebound in business investment. The resurgence in investment, coupled with the high exchange rate relative to the currencies of New Zealand's main trading partners, meant annual average import volume growth remained strong at 7.5% in the year ending September 2008. Slowing domestic activity and a falling exchange rate are expected to dampen import growth over at least the next three years.
The Trade Weighted Exchange Rate Index (TWI), which is based on a basket of rates for New Zealand's major trading partners, reached a record level of 75.42 in the middle of 2007. Despite the exchange rate remaining at historically high levels in the second half of 2007, export volumes continued to grow on the back of increased demand for agricultural products, particularly from Asia and oil-exporting countries. The currency began a swift period of downward adjustment, particularly against the US dollar, from early 2008 as the market assessed monetary policy in New Zealand shifting towards a loosening bias and a weaker outlook for growth. Annual average growth in exports slowed through 2008, increasing only 2.4% in the year to September 2008.
The terms of trade began increasing from December 2006, supporting export values (as well as private consumption) through 2007. The terms of trade reached a 33-year high in March 2008 and remained elevated in the September quarter due to record high commodity prices in late 2007 continuing to be reflected in export prices, particularly for dairy-related products. A sharp fall in oil prices is expected to result in the terms of trade peaking by year-end 2008 and gradually declining as export prices begin to fall. A declining exchange rate is expected to partly offset falling commodity prices and export volumes are expected to contract in the year to March 2009.
The current account deficit is expected to increase in the short term from the 8.6% of GDP reached in September 2008 given the surge in oil prices earlier in 2008 and the effects of the drought limiting some agricultural exports. The deficit is expected to increase from its September 2008 level of 8.6% of GDP in the short term but then to narrow over the next five years. Export price growth over 2008, along with declining imports, weak domestic demand and a pick-up in export volumes as global growth returns, is expected to contribute to the continued narrowing of the deficit.
Annual CPI inflation increased from 3.2% in September 2007 to 5.1% in September 2008, largely driven by higher petrol and food prices, before falling back to 3.4% in the December quarter. The September 2008 quarter's figure of 5.1% is expected to be the peak in the current inflation cycle as non-tradable inflation is expected to soften as resource pressures in the economy subside.
Annual growth is forecast to be just under zero in the year to March 2009 as domestic demand continues to slow. The slowdown has primarily been led by households, as private consumption and residential investment levels continue to fall. The anticipated reduction in private spending and residential construction is expected to assist in rebalancing the New Zealand economy, with the rate of household debt accumulation slowing and the household saving rate increasing. Growth is expected to pick up moderately in the year to March 2010 as domestic demand recovers in response to lower import prices and interest rates and as agricultural exports recover from drought-affected levels.
A large proportion of the risks and uncertainties around the outlook for New Zealand relate to the global economic outlook, especially around global financial markets and international commodity prices. If global growth continues to deteriorate and credit remains tight, businesses and households will be adversely affected. The degree to which the international situation deteriorates, and the extent of the impact on the real economy, is highly uncertain at this juncture. The path taken by the exchange rate and uncertainty around oil prices are additional risks to the outlook in the current economic climate.