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4  Policy Directions

The remainder of the document provides a brief assessment of current policy. Building on this broad assessment the following sections indicate some policy directions and choices available to address macroeconomic conditions, improve the business environment and strengthen public sector performance:

  • maintaining a stable economic environment that supports economic adjustment
  • making New Zealand more connected to the world economy
  • creating a business environment that encourages enterprise and investment
  • increasing the contribution from skills to productivity and opportunity
  • improving the management of natural resources
  • enhancing the effectiveness and efficiency of the public sector
  • addressing the sustainability of the fiscal position.

This note is deliberately focused. Further in-depth analysis and advice can be provided to you in each of these areas.

Maintaining a stable economic environment that supports economic adjustment

While economic growth and productivity gains are core to future advances in the welfare of New Zealanders, the ongoing effects of the financial crisis are also likely to have an impact on the policy agenda over the medium term. Despite vulnerabilities, such as high indebtedness, New Zealand has fared relatively well to date, but the economy remains exposed to the global economic downturn through both higher funding costs abroad and a decline in overseas demand for exports.

Low global growth and heightened risk aversion will affect New Zealand

New Zealand's level of foreign debt is among the highest in the OECD and our banks are reliant on short-term funding

Net foreign debt per capital
Net foreign debt per capital.
Source: Statistics New Zealand
Sources of New Zealand bank funding
Sources of New Zealand bank funding.
Sources: Statistics New Zealand and Reserve Bank of New Zealand

Managing fiscal policy

Slowing economic growth, both abroad and in New Zealand, has led to a deterioration of the New Zealand Government's fiscal outlook. Tax revenue will grow more slowly, while unemployment and debt will rise alongside increases in spending on social services. In this environment it is desirable to allow the automatic stabilisers to work. However, there has been deterioration in the longer-term fiscal outlook with gross sovereign-issued debt forecast to rise to 24% of GDP by 2013 and medium-term projections that show it peaking at around 30% in 2018. It is expected that this will further worsen further from the Pre-election Fiscal and Economic Update (PREFU). In addition, the government has recently taken on significant contingent liabilities to maintain confidence in the financial system. This influences rating agency and external investors assessment of risk and funding costs for the New Zealand government and businesses. Action will be needed to ensure consolidation of this fiscal picture of the medium-term. The earlier action is taken, the easier it is to ensure your medium-term strategy is credible.

A strong public sector balance sheet allows the flexibility to respond to slower growth in the short term

Scenarios for gross sovereign-issued debt: Pre-election update
Scenarios for gross sovereign-issued debt: Pre-election update.
Source: Treasury Pre-election Fiscal and Economic Update

Tighter budgets and the deterioration in the fiscal position will raise the importance of both public sector productivity and focusing government spending on initiatives that can secure long-term economic growth. Further prioritisation of existing expenditure may be required.

Governments abroad have countered the rapid decline in economic growth with large fiscal stimulus packages. In New Zealand, the current Budget already incorporates a substantive fiscal stimulus of around 2.8% of GDP in 2008/09 in the form of the income tax reductions and spending plans. This is already larger than the stimulus being undertaken in most OECD countries that have announced fiscal stimulus packages, including Australia. The use of fiscal stimulus will be costly in the short term and may require savings later to avoid further deterioration in the medium-term fiscal outlook. Our judgement is that a stimulus package is not required at this point, although close attention will need to be given to continued developments. Should additional fiscal stimulus be used in the short term, it will need to be timely, targeted, temporary and focused on enhancing our ongoing growth performance.

Existing plans already contain significant fiscal easing, suggesting a wait-and-see approach to further fiscal stimulus

Maintaining confidence in the financial system

Maintaining confidence in the New Zealand economy, especially the financial sector, will be the policy priority in the short term. The global financial situation is still unsettled and, while the final implications of the crisis are still unclear, there are questions as to the future shape and direction of regulation in financial markets more generally.

A policy strategy will be required to exit from the significant exposure to the financial system

New Zealand banks currently have a level of high dependence on relatively short-term international funding. Threats to access to international financial markets and the large amount of government guaranteed debt now being issued by other countries led to the issuance of a government guarantee on wholesale bank funding. This aligns closely with actions taken abroad as government guarantees of private sector financial institutions have been a common policy response.

A retail deposit guarantee scheme has been offered for a two-year period to maintain depositor confidence in New Zealand's financial system. The scheme creates a contingent fiscal liability for the Crown that is estimated to grow to around $150 billion. Prior to expiry, a decision will be required as to desirability of replacing the retail deposit guarantee scheme with a permanent alternative, such as a deposit insurance scheme. Exit arrangements from the guarantee scheme will need to have regard to Australian and other country developments. Should a permanent scheme be required, the design needs to minimise moral hazard and support confidence in the broader financial sector.

The implications of the guarantees introduced will need to be carefully considered as expectations about the Government's response to financial instability and institutional failures will have changed. In future, New Zealand's relatively high reliance upon market discipline may need to be supported by strengthened prudential regulation and stricter oversight that operates to support individual decision-making and improvements in risk management. The financial crisis has also highlighted the importance of continuing to strengthen trans-Tasman coordination and cooperation for effective crisis management.

The vulnerability of the economy to future cycles

Beyond the immediate economic cycle, economic policy needs to look beyond managing risks and focus on policies aimed at securing economic growth and productivity increases. Many of the policies aimed at improving our growth prospects or strengthening the New Zealand business environment will also have a positive influence on macro-stability through reductions in the build-up of risks and imbalances in future economic cycles.

Private savings have weakened over the past economic cycle while public savings have been strong

National Savings as a % of GDP
National Savings as a % of GDP.
Sources: Statistics New Zealand and the Treasury

Policy to reduce future vulnerability could include strengthening financial sector regulation, private savings and tax treatment of investments returns

Increasing savings, a reduced reliance on international capital and a more diversified portfolio of assets on bank and household balance sheets could reduce systemic risk for banks, households and the economy. Part of the adjustment is likely to take place as individuals and households respond to lower expectations of future asset prices. Policy frameworks such as KiwiSaver and the changes we propose later in the briefing in the tax system could help address behavioural impediments tosavings and reduce remaining differences between housing and other assets.

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