The Economy of New Zealand: Overview
New Zealand has a small open 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 goods exports. Exports of goods and services account for around one third of real expenditure GDP.
Recent Economic Performance and Outlook
Between 2000 and 2007, the New Zealand economy expanded by an average of 3.5% each year as private consumption and residential investment grew strongly. Annual inflation averaged 2.6%, comfortably within the Reserve Bank's 1% to 3% target range, while the current account deficit averaged 5.8% of GDP over this period.
The New Zealand economy entered recession in early 2008, before the effects of the global financial crisis set in later in the year. A drought over the 2007/08 summer led to lower production of dairy products in the first half of 2008. Domestic activity slowed sharply over 2008 as high fuel and food prices dampened domestic consumption while high interest rates and falling house prices drove a rapid decline in residential investment.
The outlook for the New Zealand economy deteriorated sharply following the intensification of the global financial crisis in September 2008. Similar to experiences across advanced economies, business and consumer confidence plummeted as uncertainty dominated the global financial and economic environment. In addition, local banks' access to funding in overseas markets was temporarily curtailed at the height of the crisis. Economic activity contracted 0.9% in the December quarter 2008, with production GDP affected by a reduction in manufacturing, construction and wholesale and retail trade. On the expenditure side, investment fell sharply while the extent of uncertainty in the global economy was evident in large declines for both services and goods exports. Overseas importers ran down stocks in the face of the uncertainty, while inbound tourism continued to weaken as fears around job security and declining incomes weighed on decisions to travel.
The government and the Reserve Bank responded to the crisis with a range of measures designed to alleviate its effects. The Reserve Bank lowered the OCR from its level of 8.25% over the year to July 2008 to a low of 2.5% at the end of April 2009. The Reserve Bank also introduced a range of facilities to ensure that adequate liquidity was available to the banking sector. The government introduced retail and wholesale bank guarantees aimed at restoring confidence in the banking sector and providing banks with improved access to wholesale funding. The Labour-led government proceeded with personal income tax cuts on 1 October 2008 and the new National-led government, which came to power in November 2008, introduced further tax reductions effective from 1 April 2009.
Other measures were also taken by the new government in December 2008 aimed more directly at alleviating the effects of the downturn, including:
- an accelerated package of ‘ready-to-roll' infrastructure projects spanning the housing, transport, education and energy sectors at an estimated cost of almost $500 million; and
- a temporary relief package designed to assist small and medium-sized businesses (which make up the largest proportion of New Zealand businesses) in order to reduce compliance costs and improve the business environment in the face of the crisis.
Global uncertainty intensified in the March quarter 2009, as the global crisis extended and the New Zealand economy fell a further 0.8% from the previous quarter, resulting in a 1.4% decline in annual average terms. As in the December quarter 2008, manufacturing fell sharply, along with wholesale and retail trade. New Zealand's manufacturing and export sectors were affected less by the global financial crisis than many other countries, partly because of the country's dependence on primary commodity exports, which remained in demand even though world prices fell in most cases, and because the main market for manufactured exports, Australia, was also less affected by the global financial crisis. On the expenditure side, private consumption fell 1.2% - the largest quarterly decline since 1991 - while weak domestic demand was reflected in a third consecutive fall in both goods and services imports, with total imports down 20% from their peak in June 2008.
Mid-March 2009 marked a turning point in global sentiment, as equity markets around the world rallied from exceptionally low levels and risk aversion began to wane. The Reserve Bank made its seventh consecutive reduction in the OCR in April 2009, lowering official rates to 2.5%, 575 basis points lower than the July 2008 peak. Borrowing rates fell in line with reductions in official rates, with fixed mortgage interest rates reaching historic lows in early 2009. At the same time, net permanent and long-term migration increased sharply, with arrivals remaining strong while departures plummeted as job prospects offshore continued to deteriorate.
The combination of exceptionally low fixed mortgage interest rates and rapidly increasing net migration led to house prices increasing in the June 2009 quarter, after having declined 9.8% from the December 2007 peak. Renewed optimism in the global economic situation resulted in a sharp increase in business confidence, helping the economy record modest positive growth of 0.2% in the three months to June. This quarterly expansion marked the end of a five-quarter recession which began in the March quarter 2008, during which the New Zealand economy contracted a cumulative 3.3%. The depth of the recession compared favourably with other nations in the OECD, with New Zealand seventh least affected out of the 30 member nations.
The economy again grew modestly in the September quarter 2009, with production GDP up 0.2%. The small increase was largely due to increased primary production (particularly mining) offsetting further declines in manufacturing and construction. The expenditure measure of GDP also increased 0.2% in the September 2009 quarter, as strong private consumption more than offset weakness in exports and investment.
The decline in business investment in plant and machinery had been particularly sharp since the second half of 2008, down 14.7% in September 2009 on an annual average basis. This large decline reflected the lagged impact of the weaker dollar and the uncertain economic environment, which, along with soft domestic demand, meant annual average import growth fell 16.5% in September 2009. Imports are expected to recover in the near term, as both business and consumer confidence flows through to greater demand for investment and consumption goods.
The Trade Weighted Index (TWI), which is a basket of exchange rates for New Zealand's major trading partners, began retreating from historically high levels in March 2008, as the market assessed monetary policy in New Zealand shifting towards a loosening bias and a weaker outlook for growth. With prospects for the New Zealand economy continuing to weaken, the deteriorating global economy led to further downward momentum, with reduced risk appetites leading to a 25% fall in the TWI in the year to March 2009. As the outlook for global growth became more optimistic, the US dollar weakened and risk appetite returned, particularly for commodities. As a result, the TWI appreciated rapidly from early 2009, rising to 65.5 in September 2009, but still well below the earlier peaks of over 76 in mid-2007.
The terms of trade reached a 33-year high in March 2008 and remained elevated throughout the remainder of the year, owing to previously record-high commodity prices continuing to be reflected in export prices, particularly for dairy products, the supply of which had been sharply reduced due to the 2007/08 drought. The terms of trade fell over the first half of 2009, as significantly lower export prices for dairy products more than offset lower import prices, notably for oil. The terms of trade are forecast to increase from the end of 2009, reflecting recent rapid commodity price increases, especially dairy, as the global economy continues to strengthen.
The services balance increased during 2009, as exports remained more resilient than imports, resulting in a small surplus in the September quarter. The goods balance also went into surplus in early 2009 for the first time in six years and stood at $734 million for the September quarter. Similarly, the investment income deficit narrowed in the year to September 2009, reflecting lower income payments to overseas-owned firms operating in New Zealand. As a result, the current account deficit fell from 8.9% of GDP in September 2008 to 3.1% in September 2009. The deficit is expected to have narrowed to 2.8% by the end of 2009, reflecting a further shrinking of the investment income deficit and exports growing stronger than imports. The deficit is expected to rise gradually as a proportion of GDP over the medium term in line with increased demand for imported goods and higher domestic interest rates.
Annual CPI inflation increased to 5.1% in September 2008, largely driven by higher fuel and food prices, before retreating to within the Reserve Bank's 1% to 3% target band in early 2009. In December 2009, annual inflation measured 2.0%, with weakening resource pressures driving in non-tradables inflation to its lowest increase in eight years (2.3%). Inflation is expected to increase slightly and remain above 2% per annum over the medium term, reflecting continuing spare capacity in the economy, offset in part by an expected decline in the value of the currency.
The weaker trading environment over 2008 and early 2009 led to firms reducing their demand for labour. The unemployment rate rose from a record-low 3.5% in late 2007 to 7.3% in December 2009 and is expected to remain above 7% throughout most of 2010, as firms increase hours for existing staff (which were significantly reduced during the downturn), before increasing staff levels again.
The New Zealand Treasury expects annual average growth in the economy to improve from the -2.2% recorded in September 2009 to -0.4% in March 2010 and 2.4% in March 2011, driven by a recovery in domestic demand. In its October 2009 World Economic Outlook, the International Monetary Fund also projected an annual decline in GDP of 2.2% for 2009, followed by growth of 2.2% in 2010 and increasing to 3.3% for 2014. The Organisation for Economic Cooperation and Development projects, in its November 2009 Economic Outlook No. 86, a decline in GDP of 0.7% in 2009 followed by growth of 1.5% in 2010 and 2.7% in 2011. Similarly, in its Global Economic Prospects report released in January 2010, the World Bank forecasts a decline in GDP of 0.7% for 2009, followed by growth of 1.5% in 2010 and 2.1% in 2011.
In addition to stronger residential investment resulting from the housing market recovery, the Treasury expects stronger consumer confidence and a higher population base to have a positive impact on private consumption in the near term. Further out, the strengthening global economy and a lower exchange rate are forecast to result in stronger export volumes driving economic growth.
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 falters and credit conditions tighten again, both businesses and households will be adversely affected. New Zealand's performance through the crisis has, however, demonstrated a degree of resilience, with no major bank failures, only a moderate fall in GDP from peak to trough, and with modest growth resuming from the June 2009 quarter. Risks remain around a resumption in domestic demand in the near term, particularly if the labour market deteriorates more rapidly than anticipated. The path taken by the exchange rate is an additional source of uncertainty.