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New Zealand Economic and Financial Overview 2014

Recent Economic Performance and Outlook

Background

The New Zealand economy entered recession in early 2008, before the effects of the global financial crisis (GFC) set in later in the year. A drought over the 2007/08 summer led to lower production of agricultural products in the first half of 2008. Domestic activity slowed sharply 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 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 the Global Financial Crisis

The Government and the Reserve Bank of New Zealand (RBNZ) responded to the crisis with a range of measures designed to alleviate its effects. The RBNZ lowered the Official Cash Rate (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 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 wholesale bank guarantee facility was closed on 30 April 2010 and the retail guarantee scheme was closed on 31 December 2011.)

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.

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 185 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 had been no casualties. The earthquakes (including subsequent aftershocks) caused wide-spread damage to buildings and infrastructure, in particular to the CBD and eastern parts of Christchurch, New Zealand's second most populous city.

The New Zealand Treasury estimated the damage from the earthquakes at around $40 billion (about 20% of annual nominal GDP), much of which is covered by private insurance (reinsured through overseas insurance companies) and the government-owned Earthquake Commission (EQC).

Growth

New Zealand experienced a relatively shallow recession from March 2008 to June 2009 compared to other nations in the OECD. New Zealand was sixth least affected out of the 34 member nations with negative real GDP growth totalling 3.5%.

Despite the significant amount of disruption caused by the earthquakes (in particular the February 2011 event), the clean-up and demolition operations helped minimise growth impacts. Many businesses were able to relocate out of the badly-damaged CBD and keep trading and primary and manufacturing production in the region was not significantly affected.

Since the March quarter of 2010 New Zealand's annual growth has averaged 2.3%. Annual growth peaked at 3.3% in the December quarter of 2011. However, growth in early 2013 was subdued as a result of a late summer drought that severely impacted agricultural production, with 0.5% and 0.3% growth recorded in the March and June quarters respectively dampening annual growth to 2.2%. The economy grew 1.4% in September quarter, as agricultural production rebounded sharply, accelerating annual growth to 3.5%. Looking forward, GDP growth is expected to be boosted by gathering momentum in the Canterbury rebuild and robust private consumption.

The Canterbury rebuild is expected to be a significant driver of economic growth over the next five to ten years through residential, commercial and infrastructure investment. Outturns since mid-2012 show that construction activity has been gradually picking up in the region, while current indicators point to increasing momentum through 2014. The pace of the rebuild over the medium term is uncertain, and will depend on capacity constraints and the speed at which earthquake insurance claims are settled.

Labour Market

The labour market has begun to strengthen recently in line with a pick-up in the New Zealand economy, after the unemployment rate had remained elevated since the GFC. The unemployment rate was 6.0% in the December 2013 quarter, 1.2% point lower than its peak in September 2012, while annual employment growth accelerated to 3.0%. The labour market is expected to continue to strengthen, consistent with the positive outlook for the New Zealand economy.

External Trade

The prices of the 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 strong terms of trade provided an offset to the weaker real economy, helping to boost nominal GDP. Through 2011, global conditions deteriorated and the terms of trade eased off their peak, continuing to moderate until September 2012. Since then, commodity prices have rebounded strongly, with strong demand from China and the international situation improving. Commodity prices have been at record highs in recent quarters and remain elevated. High commodity prices are expected to provide a considerable boost to nominal GDP growth in the near term.

Balance of Payments

Renewed demand from abroad 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 narrowed from 7.9% of GDP in the December quarter 2008 to a low of 1.4% in the March quarter of 2010. The narrowing in the current account deficit was helped by a positive balance on the goods account from the start of 2010, with goods exports outpacing goods imports. Net international liabilities fell from 85.9% of GDP in March 2009 to 67.1% in March 2011 as a result of the smaller current account deficits, valuation changes and revisions, and outstanding reinsurance claims related to the Canterbury earthquakes.

After the low of 1.4% in March 2010, the current account deficit widened to 4.1% in the December 2012 quarter, as the goods and investment income balances deteriorated, partly reflecting falling commodity prices and higher profit outflows from the banking sector. The current account deficit narrowed slightly to 3.9% on the back of lower income outflows in the first half of 2013 before widening to 4.1% in the September quarter. The current account deficit is expected to widen further over the medium term owing to increased imports related to the Canterbury rebuild, as well as increasing debt servicing costs and higher profit outflows. New Zealand's net international liabilities increased from 67.1% of GDP in the March quarter 2011 to 69.5% of GDP in the September quarter of 2013 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. The TWI fell 28% between February 2008 and February 2009, cushioning the economy from the global downturn.

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, a 27% increase. 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 68.0 in December as global risk aversion increased and commodity prices eased.

The TWI appreciated again in 2012, rising to 73.0 by April 2012, before declining to around 70.0 in the middle of the year as risks around the euro debt crisis escalated. Recently, prices for New Zealand commodity exports have been at all-time highs and euro zone risks have receded, with the TWI appreciating to 77.5 in December 2013.

Inflation

Annual CPI inflation was comfortably within RBNZ's 1% to 3% target band in the two years following the GFC. Inflation increased significantly in the December quarter 2010 as an increase in the rate of goods and services tax from 12.5% to 15% in 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, although the Policy Targets Agreement allows RBNZ to look through administrative price increases. Inflation increased further during 2011, rising to 5.3% on an annual basis in June before falling to 1.8% in the year to December 2011 as the effects of the GST rate rise were no longer in the calculation.

Over 2012 and through to mid-2013, CPI inflation continued to ease, falling to 0.7%, a reflection of the strong New Zealand dollar that suppressed tradables prices. CPI inflation rebounded to 1.6% in the December quarter of 2013 as tradables inflation was less negative and non-tradables inflation lifted.

Outlook

In the December 2013 Half-Year Economic and Fiscal Update, the New Zealand Treasury forecast annual average growth in the economy to be 2.7% in the March 2014 year and 3.6% in the March 2015 year, driven mainly by the Canterbury rebuild and recovery in domestic demand. Recovering world demand, as well as elevated commodity prices should provide assistance to export growth.

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 European 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's trading partner growth was expected to be 3.4% in 2013 before rising to 3.8% in 2014 and 2015.

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