Section 3 - Economic and Financial Developments - Short Term

It is difficult to discuss medium to long-term economic and fiscal policy in isolation from what is currently happening in the economy and in the financial markets. The economic situation will pose some significant challenges to the fiscal room you face in shaping your Budget choices, as we discuss later in this section. The guarantee schemes recently announced for the financial sector will further limit the room you have to move.

Financial markets considerations

You have been getting updates from Dr Cullen and from Treasury and the Reserve Bank on the government policies around financial markets. Below are some additional considerations that you need to be aware of.

The deposit guarantee scheme is a significant departure from New Zealand's established approach and consequently will change expectations about government responses to financial instability and institutional failures in the future.

• Consideration will need to be given to the implications of New Zealand's approach to financial supervision and regulation of banks and other financial institutions going forward. Among the questions to be considered is how to exit by either stopping the guarantees or whether the temporary retail deposit guarantee scheme would be replaced at the end of the 2-year period with an ongoing deposit insurance scheme. If so, what the key features of a scheme for New Zealand would be to minimise moral hazard[1] concerns and support confidence in the broader financial sector.
• While the global financial situation is still unsettled, there will also be questions as to the future shape and direction of the regulation of financial markets more generally. It will be important to monitor changes in international regulatory settings when considering the regulatory framework over the longer term. For example, it will be important to draw on the lessons from this turmoil to consider how the Trans-Tasman Council on Banking Supervision operates and how the Australian relationship can be further strengthened.
• The guarantee schemes have other implications for the Crown's fiscal position. The retail scheme creates a contingent fiscal liability for the Crown which is estimated to grow to around $130-$180 billion. It is difficult to estimate how heavily the wholesale facility will be used (that would depend largely on how quickly market access conditions improve). An assumption of $40 billion of guaranteed debt securities within 6 months would be a plausible estimate if conditions remain difficult. The granting of these guarantees (and the situation that gave rise to the need to grant them) is an extraordinary event, we would like to discuss with you options for engagement with parliament on this issue.

The retail scheme is in operation, with the names of those financial institutions that have signed deeds of guarantees with the Crown announced on the Treasury website. Applications from banks are being given priority, but non-bank deposit taking entities and collective investment schemes are also being processed.

Specimen documentation for the wholesale facility has been finalised and is also available on the Treasury website. We expect to be in a position to sign issuers up to the facility within the next few weeks.

We can provide further information when you are ready to have a conversation about this area.