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Recent Economic Performance and Outlook

Background

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%, inside the Reserve Bank of New Zealand's 1% to 3% target range, while the current account deficit averaged 5.5% 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 (GFC) 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.

Response to Global Financial Crisis

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 Official Cash Rate (OCR) from its level of 8.25% prior to July 2008 to a low of 2.5% at the end of April 2009. The 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 taken by the new government in December 2008 were aimed more directly at alleviating the effects of the downturn, including infrastructure projects and a temporary relief package to assist small and medium-sized businesses.

Growth

In total, New Zealand experienced five quarters of negative economic growth between the March quarter 2008 and the March quarter 2009, totalling 3.7% of real GDP. The relative shallowness of the recession compared favourably with other nations in the OECD, with New Zealand seventh least affected out of the 33 member nations.

The economy then grew for five consecutive quarters up to mid-2010, totalling 1.6% of real GDP. The recovery was led by exports, with strong demand from major trading partners, Australia and China. This was helped by historically-high prices for New Zealand's commodity exports, which flowed through to a high terms of trade. The strength in the external sector was led by a boom in demand from China, which boosted dairy and log exports.

The economy grew 1.4% in the year ending December 2011, the fastest pace in over three years. The Rugby World Cup (RWC), exceptional pastoral growth and high export prices provided an effective antidote to the disruptions caused by natural disasters at home and abroad and by soverign debt woes overseas.

The RWC lifted private consumption spending and tourism numbers; however natural disasters in New Zealand and Japan, combined with economic weakness in Europe and the United States, meant tourist spending was lower than it might have been. The result was a moderate increase in total tourist numbers and spending.

Increased activity in the property and business services industry, likely reflecting activity related to both the RWC and the Canterbury earthquakes, accounted for half of the rise in total GDP. Exceptional pastoral growth helped lift dairy export volumes to record levels in the December quarter.

Canterbury Earthquakes

On 22 February 2011, the Canterbury region on the east coast of the South Island experienced a devastating 6.3-magnitude earthquake. A total of 181 people were killed; the second deadliest natural disaster in New Zealand history. This followed a 7.1-magnitude earthquake on 4 September 2010, in which there were no casualties. The earthquakes (including subsequent aftershocks) caused wide-spread damage, in particular to the CBD and eastern parts to the city.

The New Zealand Treasury estimates the damage from the earthquakes at around $20 billion (10% of GDP), much of which is covered by private insurance, which is reinsured through overseas insurance companies, and the government-owned Earthquake Commission (EQC). Despite the significant amount of disruption caused by the earthquakes (in particular the February earthquake), the clean-up and demolition operations helped minimise the immediate growth impact. Many businesses were able to relocate out of the badly-damaged CBD and keep trading. Primary and manufacturing production in the region was not significantly affected.

The Canterbury rebuild is expected to be a significant driver of economic growth over the next five to ten years. The timing and speed of the rebuild is uncertain, in part due to ongoing aftershocks, but the New Zealand Treasury expects it to commence around mid-to-late 2012.

Labour Market

The labour market recovery from the downturn following the GFC has been fairly muted, with unemployment still at a relatively high level of 6.3% in the December quarter 2011. This comes after the unemployment rate rose from a low of 3.4% in the December quarter 2007 to peak at 7.0% in the December quarter 2009. The Canterbury earthquakes have had a significant effect on the labour market, with employment 8% lower in the region in the year to September 2011. Excluding Canterbury, employment rose 2.8% over the same period, giving overall growth of 1.1%.

External Trade

The prices of commodities that New Zealand exports were at record high levels in early 2011, after more than recovering the significant falls experienced during the GFC. The high commodity prices were widespread, including dairy products, meat and logs owing to surging demand from China. The high commodity prices flowed through to a historically high terms of trade, as export prices rose much faster than import prices. The terms of trade rose above their previous March 2008 peak, after falling 15% during the GFC. The strong terms of trade provided an offset to the weaker real economy, helping to boost nominal GDP. Since early 2011 global conditions have deteriorated somewhat; the terms of trade came slightly off its peak in the September quarter, with further moderation expected.

Balance of Payments

External strength and a subdued domestic economy resulted in the current account and the net international investment position improving during the recovery from the GFC. The annual current account deficit fell from 8.9% of GDP in the December quarter 2008 to a low of 2.1% in the March quarter 2010. The narrowing of the current account deficit was helped by a positive balance on the goods account since the start of 2010, with goods exports outpacing goods imports. Net international liabilities fell from 85% of GDP in March 2009 to 69% in March 2011, due to the smaller current account deficits, valuation changes and outstanding reinsurance claims related to the Canterbury earthquakes.

After the low of 2.1% recorded in March 2010, the current account deficit widened to 4.3% in the September 2011 quarter, as the services and investment income balances deteriorated, in part owing to a strong New Zealand dollar constraining exports, as well as an improving domestic situation boosting imports. The current account deficit is expected to widen further over the medium term owing to increased imports for the Canterbury rebuild, as well as increasing debt servicing costs and more profit outflows. New Zealand's net international liabilities increased from 69.0% of GDP in the June 2011 quarter to 72.9% of GDP in the September quarter and are expected to gradually rise further.

Exchange Rate

The Trade Weighted Index (TWI), 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. As the outlook for global growth became more optimistic, the US dollar weakened and demand for commodities improved. As a result, the TWI appreciated rapidly from early 2009, rising from 52.3 in February to 66.5 in October. Recently, continued high commodity prices, as well as a relatively strong economy, resulted in further increases in the TWI to 72.1 in August 2011, before retreating to around 70 in November as global risk aversion increased.

Inflation

Annual CPI inflation was comfortably within the Reserve Bank's 1% to 3% target band over the six quarters prior to December 2010, with the September quarter 2010 marking the low point of the period at 1.5%. Inflation increased significantly in the December quarter 2010 as an increase in the rate of goods and services tax (GST) from 12.5% to 15% on 1 October 2010 was passed on to consumers. The CPI rose 2.3% in the quarter, taking annual inflation to 4.0% well above the target range. Inflation increased further during 2011, rising to 4.6% on an annual basis in September before falling to 1.8% in the year to December 2011. This fall was mainly the result of the GST rate rise falling out of the calculation, but falls in food and communication prices also contributed.

Outlook

The New Zealand Treasury expects annual average growth in the economy to be 2.3% in the March 2012 year and 3.1% in the March 2013 year, driven mainly by the Canterbury rebuild and recovery in domestic demand. Recovering world demand, as well as still-high commodity prices should also assist export growth, although this is dependent on the global outlook.

The performance of the global economy exceeded expectations in 2010, but then slowed significantly as public stimulus measures faded, natural disasters in Japan and Australia caused disruption, and Europe sovereign debt issues re-emerged. However, New Zealand's increasing exposure to the faster growing areas of the world, in particular Australia and Asia excluding Japan, resulted in exports holding up better than otherwise would have been expected. New Zealand trading partner growth is expected to moderate in 2012, before picking up again in 2013. While private consumption is expected to pick up, spending is likely to remain subdued as households remain cautious. Investment is expected to grow strongly as the Canterbury earthquake rebuild gets underway. The housing market is expected to remain subdued, with weak house price growth constraining household spending.

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