MEI Special Topic: March 2017 Business Talks

In the second week of March, Treasury officials met with around 20 businesses in Auckland, Wellington and Christchurch to discuss the outlook for the economy. The information gathered will be used to inform the Treasury’s 2017 Budget Economic and Fiscal Update. The views summarised below are those of the businesses.

Activity remains strong…

Overall, businesses were positive regarding recent activity and the prospects for the immediate future. Supported by strong population growth, high tourist numbers and the fact that "Kiwis seem to have a bit more money in their pockets", most businesses had experienced buoyant sales, which they expect to continue in the near term.

By region, Auckland and surrounding areas continue to outperform, while the South Island, with the exception of Queenstown, seems to be moving at a more gradual pace. In Christchurch, the peak of the residential rebuild has passed and, with it, the additional boost to demand for goods and services.

…particularly for tourism and construction…

Consistent with record-high tourist numbers (in excess of 3.5 million in the year to February, Figure1), activity in the tourism sector is particularly strong.

Figure 1: International visitor arrivals (annual sum)

 

Source: Statistics New Zealand

In the past few months businesses have noticed a pickup in growth from the US and South East Asia, which has offset slowing growth from China and the UK. An increase in relatively cheap alternative options available to Chinese travellers was noted as one of the reasons for slowing growth from China, while Brexit and the depreciation of the GBP that followed was said to be driving slower growth from the UK. That said, the upcoming Lions rugby tour is expected to lead to an increase in visitors from the UK later in the year.

Seasonal peaks in the tourism sector present challenges to firms around capacity optimisation. Some firms noted there is a degree of strategic under-capacity in the sector, which prevents them from having significant idle (and costly) capacity in the off-season. One implication of this is that prices and margins are higher than otherwise, particularly during the peak season when demand is strongest. That said, firms reported they have had some success in shifting demand into the shoulder season.

Overall, the outlook for tourism remains strong, as factors such as increased air capacity and income growth, particularly in emerging Asia, continue.

The construction industry is "busy" and is expected to remain that way for some time. That said, growth in construction activity was said to be constrained by a number of factors, including difficulty navigating financial and legal restrictions, difficulty finding skilled labour, and, in Auckland, logistical challenges owing to high congestion. These factors are driving construction costs and prices higher, while competition is keeping profit margins low.

The retail sector remains buoyed by strong population growth and high tourist numbers, which are supporting growth in sales volumes and helping maintain profit levels. However, high competition, particularly from online sellers, is suppressing margins on a per unit basis. In addition, some retailers noted that poor weather over summer had dampened seasonal demand for apparel. On the other hand, demand for durable goods, such as whiteware, has been solid. This is partially attributed to ongoing strength in the housing market.

Overall, businesses noted a mild pickup in cost pressures, mostly with respect to labour, insurance and, to a lesser extent, rent. Strong domestic and international competition has limited the degree of retail pass-through of rising costs to prices, but with margins already squeezed, future cost increases are expected to drive prices higher.

…with optimism in the dairy sector building

The increase in dairy prices in the second half of 2016 and the recent improvement in weather conditions has seen farmer optimism recover somewhat. This is expected to have some positive downstream impact on businesses. However, firms anticipate this is likely to be limited largely to maintenance catch-up and possibly higher consumables spending as production this season finishes on a stronger note. With the sub-$5/Kg MS (and for most farmers, sub-cost) pay-out for the last two seasons still front of mind and some retracement of recent price gains (Figure 2), farmers are expected to remain cautious overall. Accordingly, larger-scale capital investment is expected to remain relatively muted.

Figure 2: Dairy prices

 

Source: GlobalDairyTrade

Employment and investment intentions positive

Consistent with Treasury expectations for solid employment growth and economic expansion, hiring intentions were positive overall. However, many firms noted they are experiencing difficulties finding skilled labour, particularly in IT, construction and chefs. In Auckland and Queenstown these difficulties extend to lower-skilled labour because of the high cost of living. In addition, Auckland firms noted that on top of the higher cost of living there, frustration around transport infrastructure and high commute times are adding to these difficulties. Businesses, particularly in the construction sector, said they are heavily reliant on net migration inflows to meet skill shortages. However, even with net migration inflows at record-highs, shortages remain.

Expectations for wage rises were generally in excess of medium run inflation expectations of around 2%, with skilled wage pressures significantly higher. While strong migration inflows are perceived to be keeping lower-skilled wage pressures muted, social pressures to increase wages above the minimum wage (eg. the living wage) are supporting wage growth at the lower end. Figure 3 suggests aggregate wage pressures are broadly consistent with inflation expectations.

Figure 3: Wages and inflation expectations

 

Source: Statistics New Zealand, Reserve Bank

Also consistent with a solid pace of economic expansion, a number of large-scale investment projects have either recently been completed, are underway or are due to start later this year. Investment intentions were evenly spread between IT and building physical capacity. However, in Auckland some firms noted that the benefits of expanding physical capacity were being eroded by the state of transport infrastructure, which is impairing the mobility of both customers and suppliers and making it difficult to service the city as a whole.

Implications for the outlook

The overall view of businesses was one of ongoing economic expansion, supported by solid population growth, high tourist numbers and positive employment and investment intentions. While there may be a number of factors constraining further growth in construction, the level of activity in the sector is expected to remain strong for some time. One of the bigger turn arounds in the last year has been the improvement in dairy prices. While average dairy farm incomes are likely to exceed average costs this season, there remains an understandably high degree of cautiousness within the sector, which will likely limit the benefit to downstream businesses.

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