Budget Economic and Fiscal Update 2011

Statement of Responsibility#

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On the basis of the economic and fiscal information available to it, the Treasury has used its best professional judgement in supplying the Minister of Finance with this Economic and Fiscal Update. The Update incorporates the fiscal and economic implications both of Government decisions and circumstances as at 2 May 2011 that were communicated to me, and of other economic and fiscal information available to the Treasury in accordance with the provisions of the Public Finance Act 1989.

 

John Whitehead
Secretary to the Treasury

9 May 2011

This Economic and Fiscal Update has been prepared in accordance with the Public Finance Act 1989. I accept overall responsibility for the integrity of the disclosures contained in this Update, and the consistency and completeness of the Update information in accordance with the requirements of the Public Finance Act 1989.

To enable the Treasury to prepare this Update, I have ensured that the Secretary to the Treasury has been advised of all Government decisions and other circumstances as at 2 May 2011 of which I was aware and that had material economic or fiscal implications.

 

Hon Bill English
Minister of Finance

9 May 2011

1 Economic and Fiscal Outlook#

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Overview#

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The economy is expected to gather momentum through 2011 and into 2012 and grow by an average of around 3.0% per annum over the next four years, following a subdued recovery so far. This growth in economic activity, together with Budget 2011 decisions to lower operating allowances, is expected to result in the Crown's operating balance returning to surplus (before gains and losses) in 2014/15.

The impact of the tragic earthquake in Canterbury on 22 February 2011 plays a major part in the economic outlook, from the initial disruption to activity through to the rebuilding phase. The fiscal outlook is also affected by the earthquakes, with one-off expenditures contributing to the operating deficit (before gains and losses) increasing to 8.4% of Gross Domestic Product (GDP) in 2010/11. The full impact of the earthquakes is outlined in Chapter 2.

There are some key uncertainties surrounding this outlook. In particular, the impact of the earthquakes and the degree of restraint by households and firms could differ from that outlined in our main forecasts. There are also ongoing uncertainties associated with the global economy that on balance pose downside risks to New Zealand. Some of these risks are explored in alternative scenarios in Chapter 3.

Economic Outlook

The economy has been more subdued than we expected in the Half Year Update, largely reflecting greater caution from households and businesses. Spending was lower and saving was higher as they looked to strengthen their financial positions. There were growing signs the economy was staging a recovery prior to the earthquake on 22 February, but the disruption caused by this disaster has pushed this out. The rebuilding of Canterbury is anticipated to get firmly underway from 2012 and is expected to see economic growth peak at 4.0% in the year to March 2013.

An underlying recovery in growth is also anticipated alongside this rebuilding. Higher farm incomes owing to the current surge in commodity prices are expected to flow through the wider economy, while consumer spending is expected to recover as incomes rise more strongly and household debt ratios return to more comfortable levels. Lower growth in government spending will provide room for private spending and rebuilding activity to increase with less pressure on resources. As a result, monetary policy, while gradually withdrawing current stimulus as the economy moves back onto a stronger growth path, will not need to tighten as much as it otherwise would.

Fiscal Outlook

The gap between core Crown revenue and expenses closes over the forecast period, returning the Crown's operating balance (before gains and losses) to material surplus in the June 2015 year, a year earlier than forecast in the Half Year Update. This is primarily the result of net savings in the current year's Budget package as well as a reduction in the forecast new operating spend in the next two Budgets.

The operating deficit (before gains and losses) in the short term, however, is higher than previously expected, reaching 8.4% of GDP in the current fiscal year. The increased deficit compared with what was forecast in the Half Year Update largely reflects the costs associated with the February earthquake.

Core Crown operating cash flows also reach surplus by the end of the forecast period. When capital spending is included, residual cash deficits are expected to decrease from 7.5% of GDP in the June 2011 year to 1.6% of GDP by the June 2015 year. As a result of these residual cash deficits, net core Crown debt is expected to peak at 29.6% of GDP in the June 2015 year. As outlined in the Fiscal Strategy Report (FSR), net debt is projected to reduce in subsequent years and the Government's long-term fiscal objective is for net debt to be brought back to a level no higher than 20% of GDP by the early 2020s.

Economic and Fiscal Outlook#

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The New Zealand economy has been more subdued than we had anticipated in December's Half Year Update (Figure 1.1). Economic growth slowed sharply in mid-2010 and real GDP in the December 2010 quarter was just 0.8% higher than a year earlier. By comparison, the average increase across the OECD was 2.9% over the same period. The weakness of the New Zealand economy has largely reflected households and businesses being cautious in their spending and investment, opting instead to increase saving and strengthen their financial positions in the wake of the global financial crisis. At the same time, an elevated New Zealand dollar against most major currencies has also limited the ability of the tradable sector (exporters and import-competing firms) to drive overall growth higher.

Figure 1.1 - Real production GDP

Sources: Statistics New Zealand, The Treasury

There were signs of the economy regaining momentum in early 2011, but this was disrupted by the tragic events in Canterbury on 22 February. A recovery in activity is now expected from mid-2011, with economic growth rising to 1.8% in the year to March 2012 and peaking at 4.0% in the year to March 2013. Higher growth in consumer spending is expected as households become more comfortable with the state of their own balance sheets and as incomes rise more strongly alongside an improving labour market. Domestic demand will also be supported as the recent increases in commodity prices flow through the wider economy. The exchange rate is forecast to remain elevated in the near term and thus remain a constraint on export growth, before falling owing to fundamental forces such as New Zealand's high level of international indebtedness and a recovering global economy. A lower New Zealand dollar will then boost export volumes, particularly service exports such as tourism. These factors are expected to provide an offset to a withdrawal of monetary stimulus and tighter fiscal policy from 2012/13, including lower growth in government consumption as operating allowances are reduced (Figure 1.2).

Figure 1.2 - Components of real GDP growth

Sources: Statistics New Zealand, The Treasury

The impact of the Canterbury earthquakes plays a major part in the economic cycle, from the initial disruption, which delays the recovery, to the positive impact of the rebuild to regain what was lost, which amplifies the expansion. The rebuilding of Canterbury is expected to get firmly underway from 2012, which will cause the upswing in national investment to be much stronger than would have been forecast in the absence of the earthquake.

While the annual current account deficit is forecast to rise above 6% of GDP by late 2013, this is largely driven by investment, including for the Canterbury rebuild. National saving rates are expected to rise as a result of a return to Budget surplus and a higher household saving rate. The forecast economic recovery is expected to be far less reliant on debt-funded household consumption and investment than was the case in the mid-2000s.

Global economy continues to recover…

The outlook for world growth has generally been revised up as the recovery from the global financial crisis has progressed, although there have been some set-backs recently. The recovery is being driven by emerging economies, in particular China and other Asian countries, with additional benefits for New Zealand via Australia. Activity in the major developed economies has been slower to rebound as they were more directly affected by the global crisis and their economic challenges are more entrenched. Temporary shocks have also adversely affected economic activity, in particular the Queensland floods in Australia and the earthquake in Japan. These events are expected to reduce growth in the short term, but rebuilding in Australia and Japan will boost it subsequently.

Figure 1.3 - Trading Partner Growth

Source:  International Monetary Fund, The Treasury

Growth in our main trading partners in calendar 2010 was estimated to be 4.6%, a rapid recovery from a 0.5% decline in output in 2009 (Figure 1.3). The outlook for 2011 is for 3.7% growth, taking account of the adverse events above, before increasing to 4.4% in 2012 and reverting to a trend of just above 4.0% thereafter. These figures take account of the increasing share of New Zealand's trade directed to the faster-growing Asian economies.

Notwithstanding this positive headline picture, there remains an elevated level of risk around global growth. While there are some upsides, on balance the risks are weighted to the downside for the forecast period as a whole. As a result, the international economy remains a source of potential downside risk to New Zealand, with the possibility of rising global imbalances causing increased policy tension, the need for significant structural and fiscal policy change in many developed economies, continued financial difficulties in a number of peripheral European economies, and the possibility of higher oil prices. Some of these risks are explored further in the Risks and Scenarios and Fiscal Risks chapters.

...and boosts world prices for New Zealand's commodity exports

World prices for New Zealand's key commodities have exceeded the very high levels of 2007/08. This is pushing the merchandise terms of trade (the ratio of export prices to import prices) higher than was previously expected despite oil prices also being higher (Figure 1.4). A key judgement in these forecasts is the degree to which commodity prices can be sustained at such high levels. Some fall is expected as weather-related price increases reverse this year, but commodity prices over the next five years are then forecast to rise again and contribute to a rising profile for the terms of trade. This assumption is based on the strength of demand for food and other primary products from emerging markets, most notably China and India. Another feature of commodity prices is likely to be ongoing volatility, which makes it more difficult to differentiate longer-term trends from short-term movements. The increase in commodity prices could be larger than forecast, particularly in the near term as a result of the tightness of supply. However, anything that curbs demand from major markets such as China could see commodity prices weaken by more than expected. This possibility is explored in a downside scenario from page 108.

Figure 1.4 - Merchandise terms of trade (SNA)

Source: Statistics New Zealand, The Treasury

The Trade Weighted Index (TWI) of the exchange rate is forecast to remain around its March 2011 quarter average for the remainder of this year, supported by high terms of trade and a persistent interest rate differential. The terms of trade also provide longer-term support to the exchange rate, but ultimately long-term fundamentals such as the requirement for external balance are expected to see the exchange rate fall. A narrowing of the positive differential between local and global interest rates also contributes to the lower exchange rate. However, there is considerable uncertainty surrounding the path of the exchange rate.

There is also uncertainty about how the exchange rate will impact on export volumes. In terms of export receipts, the exchange rate is being more than offset by historically high world prices for commodity exporters. For manufacturing exporters, the effect of the exchange rate depends crucially on the markets they export to; the New Zealand dollar has appreciated strongly against the United States dollar and United Kingdom pound but is relatively low against the Australian dollar. A high exchange rate has made New Zealand less competitive in export services over recent years, but the forecast depreciation of the New Zealand dollar from 2012 is expected to gradually boost the volume of export services. In the near term, the Rugby World Cup is forecast to have a one-off positive impact on export services (ie, tourist spending), which is estimated to lift real GDP by around 0.3% in the second half of 2011.

Post-recession household behavioural change evident but expected to moderate...

The level of real or inflation-adjusted household spending is fundamentally linked to real income and real wealth, with temporary deviations reflected in saving and changes in borrowing. Between 2002 and 2007, house prices doubled, driving a significant lift in household wealth. At the same time, borrowing increased and demand for new and existing housing increased. Spending on durable goods (eg, appliances) rose in line with new housing investment. Spending on other goods and services also increased, reflecting confidence that robust income and asset price growth would continue in the medium term.

In early 2008, real private consumption began declining, as households faced higher prices for food and fuel, rising interest rates and, crucially, falling house prices. For the past three years, households have remained circumspect in their spending decisions, consistent with a recognition that debt levels (relative to income and assets) and debt servicing are unsustainably high, and concerns over job security (see the box on page 74 for more discussion on household deleveraging). In December 2010, real household spending per person was still 2.5% lower than three years earlier (Figure 1.5).

Figure 1.5 - Real private consumption

Sources:  Statistics New Zealand, The Treasury

The lack of consumer spending growth since the end of the recession has occurred against a backdrop of low mortgage interest rates, linked to large reductions in the Official Cash Rate between mid-2008 and early 2009. Typically, low interest rates would encourage additional borrowing, but we have not seen this to date. The latest Reserve Bank data show household credit growth fell to a record low 1.4% in March 2011 from a year earlier, with the level of debt falling in the March month for the first time in the history of the series. We anticipate credit growth will remain weak for some time as households continue to consolidate their financial positions. In recent years, house prices have been flat and we expect annual increases to rise to only 3.0% per annum over the forecast period.

In addition to concerns around debt, real household spending growth since the recession has been impacted by petrol prices, which have risen 38% between March 2009 and early May 2011. With petrol being an important component of household budgets and subject to relatively inelastic demand, the large increase in prices has led to reduced spending on discretionary goods and services, such as motor vehicles and entertainment. While we expect oil prices to retrace slightly over the forecast period, the level is expected to remain high. The exchange rate is assumed to fall from 2012, flowing through to higher petrol prices and placing further pressure on household budgets.

With the outlook for housing and borrowing flat, real consumer spending growth is, therefore, expected to grow in line with real income. We expect the labour market to be broadly flat over the first half of 2011, before picking up thereafter, with incomes driven by higher growth in employment and wages. Rising incomes are expected to allow consumer spending to grow moderately over the forecast period. On average, private consumption is forecast to grow 2.4% per year over the next five years. This is lower than the 4.5% average growth rate during the 2002 to 2007 housing boom but higher than the 0.6% recorded in the three years to the end of 2010.

...as income growth strengthens with an improving labour market

Employment will be impacted significantly by the earthquake. Some firms in and around Christchurch were unable to reopen after the February earthquake, while some workers living in affected areas did not return to work in the immediate aftermath. Although much activity was able to be relocated, we have assumed nationwide employment is around 15,000 lower by mid-2011 as a result of February's earthquake than it otherwise would have been. Despite this impact, total national employment is still expected to grow over 2011 as economic activity recovers.

Figure 1.6 - Unemployment rate

Sources:  Statistics New Zealand, The Treasury

Once the rebuilding of Canterbury gets firmly underway, employment growth is expected to rise relatively quickly, facilitating a fall in the unemployment rate from 6.8% in mid-2011 to below 5% by the end of 2012 (Figure 1.6).[3] As the labour market tightens, wage growth is forecast to rise from recent low rates, peaking at 4.2% per annum in 2013/14. Some occupations directly related to reconstruction work are likely to see faster wage gains as capacity constraints in the building industry are approached. The annual net inflow of permanent and long-term migrants is expected to rise above 10,000 as the economy strengthens, after falling to around zero later this year largely because of the relatively strong Australian labour market and the disruption caused by the earthquakes.

Budget decisions impact on government consumption and investment...

Fiscal policy is currently having a stimulatory impact on the economy. Earthquake-related expenditure in Canterbury will add to this in the short term. In the June 2012 year, the overall fiscal stance is expected to be broadly neutral. Fiscal tightening is expected to begin in the following year. This tightening will occur at a time when rebuilding work in Canterbury is expected to peak.

Figure 1.9 - Real government consumption

Sources:  Statistics New Zealand, The Treasury

The Government's Budget decisions have an impact on the economy through public consumption, private consumption and non-market investment. The main impact is slower growth in government consumption (Figure 1.9), with reprioritisation of existing spending in Budget 2011 and lower operating allowances of $800 million in Budget 2012 and Budget 2013 (returning to $1.19 billion from Budget 2014, growing at 2% per annum). Changes to government transfers such as Working for Families will negatively impact private consumption, although this impact is expected to be limited by the nature of the changes (eg, Working for Families changes are targeted at higher-income families). Non-market investment, meanwhile, is forecast to grow, but this growth will be slower than previously expected reflecting lower gross capital allowances of $900 million per Budget.

...and private investment rises strongly owing to rebuilding in Canterbury...

Although growth in non-market investment is expected to be lower than previously expected, total investment is expected to rise very strongly from 2012 on the back of the rebuilding of Canterbury (Figure 1.10). In these forecasts, investment is able to make up a larger share of the real economy than in recent upswings owing to the nature of the funding. Much of the extra investment will be funded through insurance, ultimately reinsurance flows from overseas and from government. Another factor supporting this rise in investment relative to the experience of the 2000s is an anticipated fall in private and public consumption as a share of the economy, allowing room for interest rates to be lower.

Figure 1.10 - Real investment (ex large items)

Source:  Statistics New Zealand, The Treasury

The regional pattern of economic activity will likely be quite different from previous cycles. Most notably, the expansion from 2012 will be weighted heavily to the Canterbury region. The rebuilding will put pressure on all parts of the construction industry - residential, commercial and infrastructure - in contrast to more typical expansions in New Zealand, which traditionally witness upturns in these different parts at different times. There is a risk that the rebuilding does not scale up as quickly as expected in these forecasts, either owing to ongoing aftershocks or greater capacity constraints being experienced. Alternatively, there is also a risk of the same volume of work being done in Canterbury but with more displacement of work outside the region or more inflation pressures than we have factored in our main forecasts. These issues are discussed further in the Risks and Scenarios chapter.

...to replace lost capital, which has reduced the productive capacity of the economy

Potential growth is an estimate of how fast the economy can grow without generating inflation pressures, but is subject to much uncertainty owing to the unobservable nature of potential output. Potential output is expected to grow by around 2.5% per annum over the forecast period. Our forecasts for the level of potential output remain lower than we forecast prior to the global financial crisis. As a result, the level of real GDP per capita is forecast to be lower than we had expected at the time of Budget 2008 as we have re-evaluated both past and future potential output (Figure 1.11). Compared to the Half Year Update, the productive capacity of the economy has been further reduced by the February earthquake in Canterbury, initially owing to the loss of physical capital. Although this impact is small, it still means that inflation pressures in these forecasts are slightly higher for any given level of economic activity.

Figure 1.11 - Real production GDP per capita

Sources:  Statistics New Zealand, The Treasury

Inflation eases from mid-2011 but pressure remains from Canterbury rebuild

Headline Consumers Price Index (CPI) inflation is forecast to reach 5.3% in the year to June 2011, reflecting the 1 October 2010 increase in GST, higher excise rates for cigarettes and tobacco and recent sharp fuel price increases (Figure 1.12). The increase in the GST rate (which we assume added 2% to inflation) was offset by income tax cuts and, according to Treasury business talks in early March, is not expected to be a feature in wage setting. Furthermore, inflation expectations have remained relatively unchanged since the tax changes were announced. The two-year-ahead measure in the Reserve Bank's Survey of Expectations rose to 2.8% in the June 2010 quarter, but fell in the following quarter to 2.6%, where it has remained through to the March 2011 quarter. Inflation expectations are likely being tempered by the lack of demand pressure in the economy, as evident in recent inflation outturns. In the March 2011 quarter, the CPI rose 0.8%, but excluding fuel, and cigarette and tobacco price increases, prices were broadly flat, reflecting the weak trading environment. From mid-2012, the annual inflation rate is expected to remain within the Reserve Bank's 1% to 3% target band. Subdued pricing pressure, reflecting the gradual nature of the economic recovery, is expected to be countered by inflationary pressure associated with the Canterbury rebuild. We expect the output gap (the difference between actual and potential output) to close by mid-2012 as the rebuild gathers momentum. Tradable inflation averages around 2%, which is higher than its historical average because of a falling exchange rate from 2012.

Figure 1.12 - Consumers Price Index

Source:  Statistics New Zealand, The Treasury

Fiscal policy becomes contractionary from 2012/13, with government spending more restrained than was forecast in the Half Year Update, freeing up resources and reducing pressure on non-tradable inflation. As a result, monetary policy will not need to tighten as much, allowing interest rates to stay lower for longer and take pressure off the exchange rate. This mix is more conducive to tradable sector growth. We expect 90-day interest rates to lift gradually to 5.0% by March 2015, as the output gap closes. During the global financial crisis, the gap between the Official Cash Rate and funding costs for banks and other financial institutions lifted sharply (to around 150 basis points), meaning retail borrowing rates for households and businesses were higher than they otherwise would be for a given Official Cash Rate. The funding gap is expected to remain at 150 basis points over the next few years before falling to around 100 basis points by the end of the forecast period. The 10-year rate is assumed to lift slightly to 6.0% by the end of the forecast period, in line with its long-term average.

Current account deficit rises as investment increases by more than saving

An annual current account surplus is expected for the year-ended March 2011 for the first time since the early 1970s. This surplus will partly reflect subdued domestic demand and strong terms of trade, but is mainly the result of a higher current transfers balance in the September 2010 and March 2011 quarters owing to reinsurance payments related to the Canterbury earthquakes. New Zealand’s net international investment position (IIP) also improves because of reinsurance inflows (Figure 1.13).

Figure 1.13 - Current account and net IIP

Sources:  Statistics New Zealand, The Treasury

The current account balance is forecast to return to deficits above 6% of GDP by late 2013, while the net international liability position is expected to rise again as a result. The rise in the current account deficit is expected to be driven by higher investment-related imports, including for the rebuild of Canterbury, while export growth remains subdued. This experience would be different from the mid-2000s in both cause (increasing household debt) and magnitude (current account deficits rose above 8% of GDP). The forecast depreciation of the New Zealand dollar from 2012 is expected to boost service exports and dampen the demand for imports, twin developments that will together assist to strengthen the trade balance and contribute to a narrowing of the current account deficit towards the end of the forecast period and beyond.

The current account balance can also be examined as the difference between national saving and investment (Figure 1.14). The national saving rate is expected to rise over the forecast period, supported by an increasing rate of household saving. Higher government saving also helps to increase national saving as the operating balance (before gains and losses) returns to surplus.

Figure 1.14 - National saving and investment

Sources:  Statistics New Zealand, The Treasury

The nominal size of the economy grows by around 5% per annum...

Nominal GDP is expected to rise by 5.3% in the year to March 2011, which reflects higher terms of trade and high inflation including the rise in GST on 1 October 2010 (nominal GDP is GST-inclusive). After easing back to 4.7% in the March 2012 year, growth in the nominal economy is then forecast to expand 6.4% in the March 2013 year, boosted by the rebuilding of Canterbury, before once again easing back gradually. Over the 2011 to 2015 March years, nominal GDP is expected to be a cumulative $13.1 billion (or 1.2%) lower than assumed in the Half Year Update, largely because of the delayed recovery caused by subdued domestic activity and the February earthquake.

...and supports a recovery in tax revenue...

Tax revenue has returned to growth over the past six months, after two years of contraction, but this growth remains weak. Most tax types have shown nil or only modest growth recently, although GST was boosted by the 1 October 2010 rate increase and offset by accompanying personal income tax rate cuts. Growth in tax revenue is expected to rise to an average of 7.5% per annum between the June 2011 and 2015 years. This increase is expected to be underpinned by growth in the nominal economy of around 5% per annum, together with an increase in core Crown tax revenue as a proportion of GDP from 25.6% in 2011 to 27.8% in 2015 owing to the following factors:

• Corporate taxes have dropped by around 30% since the June 2008 year (Figure 1.15). Taxable corporate profits also appear to have dropped by about 30% through this period. In addition, recent data suggest there was a significant build-up in tax losses through the 2008/09 recession, which are now being offset against taxable profits, thereby reducing corporate tax. We expect loss usage to remain at an elevated level, peaking in the 2013 year. Once the loss effect abates, corporate tax growth is expected to accelerate. This loss effect causes corporate tax to be pro-cyclical, which means it falls by more than GDP during downturns but grows more rapidly than GDP at the top of the cycle.
• Given the progressive personal income tax scale, higher incomes attract a higher rate of income tax, which means the tax on those incomes increases at a faster rate as incomes increase. In aggregate, this is known as “fiscal drag”. Fiscal drag has been absent from source deductions (mostly PAYE) collections over the past few years owing to personal income tax cuts. PAYE growth will again be negative in the June 2012 year as income tax changes only took effect on 1 October 2010. From 2013 to 2015, fiscal drag is anticipated to add an average of around $400 million per annum to PAYE, which would see PAYE rise as a proportion of GDP from an estimated 10.1% in 2012 to 10.7% in 2015.
• We are also yet to see a full year of GST at the new 15% rate. Therefore, GST revenue will grow at a faster rate than private consumption and residential investment in the June 2012 year. Thus, GST is also expected to add to the tax-to-GDP ratio over the forecast period, growing from 6.6% of GDP in 2011 to 7.5% in 2015.
• The level of interest rates also affects tax revenue because interest earned by lenders is taxable and interest incurred by borrowers is deductible from taxable business profits. Over the 2011 to 2015 period, average deposit rates are expected to rise by around 50%. This, together with growth in the amount of money on deposit, is forecast to increase resident withholding tax on interest (RWT) from 0.9% of GDP in 2011 to 1.3% in 2015.

Figure 1.15 - Operating surplus (proxy for business profits) and corporate tax revenue

Source:  Statistics New Zealand, The Treasury

...although taxes are lower than expected in the Half Year Update...

In total across the five June years 2011 to 2015, core Crown tax revenue is expected to be $5 billion lower than forecast in the Half Year Update, as shown in Table 1.4. The largest reduction is expected to occur in corporate tax, mainly because operating surpluses (ie, profits) are expected to be lower. A slightly longer and larger tax loss effect than was previously assumed has also reduced the forecast of corporate taxes.

GST forecasts have been reduced in response to a softer near-term outlook for domestic consumption, albeit with reductions weighted more to the earlier years of the forecast period than the later years. This profile is, in part, a result of the Canterbury earthquakes. Insurers are expected to receive GST refunds from their GST-inclusive insurance payouts, mainly in the 2011 and 2012 years. Once the insurance claimants spend their insurance proceeds, either by purchasing replacement goods or constructing replacement buildings, the GST will flow back to the Crown. This is expected to happen mainly from 2012 onwards.

Net other persons tax is also expected to be lower than previously forecast, but not all of the tax types have had their forecasts reduced. The source deductions forecasts are slightly higher than in the Half Year Update in all years except for 2015, mainly owing to higher forecasts of aggregate wages and salaries.

Note: Numbers in tables may not add exactly to the stated totals owing to rounding

Source: The Treasury

...with other outcomes possible, both lower and higher

In line with established practice, Inland Revenue also prepared a set of tax forecasts. The Treasury and Inland Revenue forecasting teams compare forecasts to provide quality assurance for each other. Both sets of tax forecasts were based on the Treasury's economic forecasts. Using slightly different assumptions and forecasting models, Inland Revenue has produced a set of tax forecasts that are much lower than the Treasury's. In this Update, the total difference between the tax forecasts across the five June years 2011 to 2015 is nearly $4 billion, a larger difference than is usually the case (Table 1.5). The bulk of the difference occurs in estimates for corporate tax. The Treasury forecasts corporate tax growth to remain subdued through the early part of the recovery as tax loss usage increases, and growth will accelerate through 2013 to 2015 as tax loss usage abates. Inland Revenue, however, does not forecast such a rapid acceleration as it makes no explicit assumption regarding the utilisation of tax losses in corporate tax.

The lower forecasts of tax revenue from Inland Revenue indicate there may be some downside risk to our tax forecasts. At the same time, there are also upside risks. The economic recovery could turn out stronger than forecast, or tax revenue could be higher if we have underestimated the size of the pro-cyclical response in corporate tax. The Canterbury earthquakes also present risks to the tax forecasts. What is currently being interpreted as underlying weakness in taxes could be a timing effect caused by earthquake-related business disruption. If so, tax revenue will likely be higher than in the Budget forecasts.

Sources: The Treasury, Inland Revenue

The gap between core Crown revenue and expenses closes over the forecast period...

Core Crown revenue falls in the current financial year to 28.5% of GDP before recovering to 31.0% by the end of the forecast period (Figure 1.16).

Figure 1.16 - Core Crown expenses and revenue

Source:  The Treasury

The largest component of core Crown revenue is tax revenue. As previously discussed, forecast tax revenue is lower than in the Half Year Update. However, it increases in absolute terms over the forecast period, reaching 27.8% of GDP by June 2015.

While core Crown expenses increase this year as a result of the Canterbury earthquake, they fall as a percentage of GDP across the forecast period to be 31.3% of GDP by June 2015. This decrease reflects the cessation of “one-off” expenditure such as costs associated with the Canterbury earthquakes, provision for weathertight homes payments and the Deposit Guarantee Scheme, as well as a decrease in the amount of new spending forecast over this time.

Notes:

1. Net core Crown debt excluding the New Zealand Superannuation Fund and advances
2. Gross sovereign-issued debt excluding Reserve Bank bills and settlement cash

A longer time series for these variables is provided on page 186.

Source: The Treasury

...with core Crown expenses[4] lower than previous forecasts...

Relative to GDP, core Crown expenses are lower than the Half Year Updateby the end of the forecast period primarily as a result of the current year's net savings package and a reduction in new spending in the next two Budgets (Figure 1.17).

Figure 1.17 - Core Crown expenses

Source: The Treasury

Overall, though, core Crown expenses are forecast to increase in nominal terms. Table 1.7 details the movements.

Source: The Treasury

The Budget 2011 package is a net savings package which results in a decrease in core Crown expenses (Table 1.8). This compares to the $1.12 billion additional spending each year forecast in the Half Year Update.

Source: The Treasury

In addition to the net savings in Budget 2011, the forecast includes a reduced operating allowance for new spending in Budget 2012 and Budget 2013. These forecasts now include an allowance for new spending of $800 million a year in those two Budgets (compared to $1.12 billion in the previous forecast).

However, the cost of existing programmes continues to increase over the forecast period.

Most notably, social assistance expenses are forecast to increase by $3.1 billion over the forecast period when compared to the year ended June 2011. The majority of this increase is in relation to New Zealand Superannuation which increases by $2.8 billion over that period.

This increase in social assistance expenses is owing to both growth in the number of recipients (Figure 1.18) and the effect of wage and CPI indexation.

Figure 1.18 - Beneficiary numbers

Source: Ministry of Social Development

In addition, finance costs increase substantially in the next few years (Figure 1.19) with the borrowing programme largest in the current year (reaching $20 billion). The Government is borrowing more now while conditions are favourable, reducing borrowing requirements in future years.

Figure 1.19 - Finance costs

Source: The Treasury

The “pre-borrowing” portion of debt is then invested in financial assets. Therefore, while finance costs increase over the forecast period, some of this is offset by an increase in interest revenue from the invested assets (Table 1.9).

Source: The Treasury

...returning the Crown to surplus by the end of the forecast period...

When combined with the forecasts of State-owned enterprises and Crown entities, the total Crown is expected to record a material surplus in the June 2015 year (one year earlier than forecast in the Half Year Update).

The operating deficit[5] peaks in the current year at 8.4% of GDP (Figure 1.20). Excluding the direct costs of the earthquakes, the deficit would be around 5.2% of GDP.

Figure 1.20 - Total Crown operating balance before gains and losses

Source:  The Treasury

Current weak economic growth is also playing a part in the large operating deficit in June 2011. Figure 1.20 shows the cyclically-adjusted,[6] or structural, operating balance. This cyclically-adjusted deficit reaches 4.8% of GDP in the current year, compared to the 5.2% above. The small difference between the two balances implies a small cyclical component to the operating deficit. For example, the automatic stabilisers (such as unemployment benefits) do temporarily add to the deficit, reflecting the negative output gap and high unemployment rate.

The structural deficit in the June 2011 financial year is gradually eliminated over the forecast period. The pace of improvement in the structural balance averages 1.5% of GDP per annum from June 2012 to June 2015 financial years.

When forecast net gains are included, the total Crown operating balance (including gains and losses) is forecast to reach a surplus of $2.3 billion a year earlier in the June 2014 financial year. These net gains are forecast predominantly by the Crown's financial institutions (eg, the New Zealand Superannuation Fund).

...and reducing cash deficits

In line with the operating balance before gains and losses, operating cash does reach surplus by the end of the forecast period. However, when capital spending is added, residual cash remains in deficit by $4.1 billion (or 1.6% of GDP) in the final year of the forecast (Table 1.10). These cash deficits represent the amount the Government has to fund, either by raising debt or reducing financial assets, and result in an increase in net debt.

Capital spending includes purchases of physical assets, advances (eg, student loans), capital injections (eg, investment in the New Zealand Transport Agency) and future new capital spending.

Contributions to the New Zealand Superannuation Fund are not expected to recommence during the forecast period.

Source: The Treasury

The forecast for future new capital spending has been decreased to $900 million per Budget (spread over five years) from the $1.39 billion in the Half Year Update. This allowance is spread over the forecast period as outlined in Table 1.11.

Source: The Treasury

The Government has decided that, rather than fund this new spending through an increase in debt, existing capital on the Crown balance sheet will be utilised. New capital spending has therefore been forecast as a reduction in the Crown's assets. This is represented as “reprioritisation of assets to fund new capital spending” in Table 1.10.

As a result, net debt peaks at the end of the forecast period...

The continuation of cash deficits across the forecast period results in net debt peaking at 29.6% of GDP in the June 2015 financial year (Figure 1.21). Current projections estimate that net debt will begin falling as a percentage of GDP in the following year.

Figure 1.21 - Net core Crown debt

Source:  The Treasury

As discussed in the Fiscal Strategy Report, net debt is projected to decrease as a percentage of GDP after the forecast period.

While net debt increases steadily over the forecast period, gross debt increases markedly in the short term. The 2010/11 borrowing programme run by the New Zealand Debt Management Office has recently been increased to $20 billion, which is larger than the current forecast cash deficit. This increase is possible owing to strong investor demand and means borrowing requirements in future years are reduced (Table 1.12). Net debt does not follow a similar trend as the surplus proceeds from these bond issuances are forecast to be invested in financial assets (resulting in no increase in net debt).

Source: The Treasury

...with continued focus on the management of the balance sheet

Net worth is forecast to fall to $76.9 billion by 2013 as operating deficits continue before rising to $83.9 billion by June 2015. Assets are forecast to reach $257.7 billion by the end of the forecast period while liabilities total $173.8 billion.

When compared to June 2010, total Crown liabilities increase by $45.5 billion by June 2015. The majority of this increase reflects the increase in gross debt. The Accident Compensation Corporation claims liability also increases by $5.1 billion over the same period.

In contrast, total assets are set to increase by $34.3 billion from June 2010 (Table 1.13).

¹ Further breakdown is provided in note 14 of the forecast financial statements.

Source: The Treasury

Major increases in assets include:

• the purchase of around $38.5 billion of physical assets over the next five years. A breakdown of purchases of physical assets by the main sectors is provided on page 161
• an expected issuance of student loans of $8.1 billion
• growth in Crown Financial Institutions (eg, Accident Compensation Corporation) of around $24.2 billion
• forecast for new capital spending over the next five years of $2.1 billion, and
• net increase in Kiwibank mortgages of $5.1 billion.

These increases will be offset by around $20.7 billion of expected depreciation and an anticipated reduction in financial assets held by the New Zealand Debt Management Office and the Reserve Bank to fund the forecast cash deficit of around $15.0 billion.

While the forecast for new capital spending over the next five years is $2.1 billion, it is expected that existing capital will be reprioritised to meet this investment. This means that instead of borrowing to fund these investments, the Government will source funding from its existing balance sheet. As previously mentioned, the forecasts therefore assume that the allowance for new capital spending ($900 million per Budget spread over five years) will be met through a corresponding reduction in assets. This reprioritisation is to be applied for five Budgets for a total of $4.5 billion of new capital spending.

2 Economic and Fiscal Impacts of the Canterbury Earthquakes#

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Overview#

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The earthquakes in Canterbury were very destructive, resulting in significant loss of life and turmoil for those involved. They have also had a significant effect on the economy, and will continue to do so for many more years. This, combined with the Government's response, means that the Government's fiscal position has also been significantly affected. This chapter provides a summary of the Treasury's current analysis of these economic and fiscal effects.

Damage Estimates#

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It is still too early to estimate with confidence the financial cost of the damage caused by the Canterbury earthquakes, and there will always be uncertainty around the exact cost. Nevertheless, information received over the past couple of months suggests that the Treasury's initial assumptions made in late February remain reasonable[7]. Allowing for some double counting for cases where prior damage has been compounded, the Treasury estimates the combined financial cost of the damage caused by the two earthquakes to be around $15 billion - about 8% of GDP and 2.5% of the nation's capital stock. Although there will be a significant boost to economic activity during the rebuild, it is clear that New Zealand's wealth and living standards have suffered as a result of these earthquakes. Resources will be used to rebuild the capital stock rather than grow it.

* Totals do not sum to avoid double counting of damage

Source: The Treasury

Economic Impacts#

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Economic activity in Canterbury fell significantly in the immediate aftermath of both earthquakes as people stayed at home and businesses did not open. Business and consumer confidence declined sharply, including the confidence of those outside Canterbury less directly affected, further dampening economic activity. Beyond exports of services, the impact on export activity has been relatively limited.

As businesses have re-opened, people have recommenced work, initial reconstruction activity has gotten underway and economic activity has increased again. The Treasury estimates that nationwide GDP will be around 1.5% lower in 2011 than it would have been otherwise, although it is worth noting there will be difficulties for Statistics New Zealand as it tries to measure economic activity in the earthquake-affected area.

The Treasury is working on the assumption that at least $15 billion is spent repairing, replacing or renewing damaged properties over the next seven years - acknowledging the considerable uncertainty around the extent, cost and timing of rebuilding. It is not expected that rebuilding activity will fully get underway until early 2012, but that it will accelerate quickly thereafter. The rebuild will be assisted by the combination of the settling of insurance claims and a subdued construction sector elsewhere in New Zealand.

A significant amount of the financial costs associated with the damage and rebuild will be covered by private and public (in the form of the Earthquake Commission) insurance, with the majority of the insurance claims subsequently covered by international reinsurers. These reinsurance flows could be in the area of $10 billion - enough to push New Zealand's current account balance temporarily into a rare surplus. The remainder of the costs will be largely borne by the Government, with individuals and private businesses covering the rest.

Figure 2.1 – Indicative timing of Canterbury rebuilding

Source:  The Treasury

Although the Treasury expects rebuilding to occur in all three sectors simultaneously, it is assumed that the big increase in residential investment activity will take place in calendar 2012, with commercial activity building up steadily, and infrastructure spending this year and next. It is expected construction activity will remain at a high level throughout most of the forecast period, before starting to trend down in 2014.

While some of the construction activity in Canterbury will come at the expense of activity elsewhere, nationwide construction activity is expected to remain above where it would have been otherwise throughout most of the next seven years. The Treasury also forecasts higher private consumption as damaged possessions are replaced and to some extent higher public consumption and transfers owing to earthquake-related expenditure. The extra activity over the medium term is expected to broadly offset the near-term weakness, such that nominal GDP, and hence tax revenue, return to pre-earthquake levels by the end of the forecast period.

It is likely that inflation pressures next year and beyond will be higher than what they would have been otherwise, as the rebuilding activity absorbs currently underutilised labour and capital. The unemployment rate is forecast to fall to 4.8% in March 2013. Construction cost inflation is forecast to increase to around 6% per annum. Lower forecast government consumption growth provides some offset to the extra private consumption and investment activity, providing some reduced pressure on non-tradable inflation. It is likely that recent natural disasters around the world, including the Canterbury earthquakes, will prompt (potentially significant) increases in insurance premiums over time. Finally, as noted above, the Canterbury earthquakes are estimated to have destroyed around 2.5% of the nation's capital stock, reducing the level of potential output and meaning slightly more inflation for any given level of economic activity.

The Reserve Bank of New Zealand will likely be required to have higher interest rates than otherwise over the medium term in order to keep the resulting inflation pressures in check. Higher interest rates imply somewhat greater upward pressure on the New Zealand dollar than would be the case in the absence of the earthquakes, with lower export volume growth as a result. The current account deficit over the forecast period is forecast to be higher because much of the rebuild will involve increased capital imports, although reinsurance inflows have reduced the deficit over recent quarters.

Fiscal Impacts#

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The earthquakes will have a significant impact on the Government's fiscal position. Operating spending and debt will be higher as a result of providing short-term income support and assistance, paying for reconstruction of infrastructure and repairing government-owned property, land remediation and Earthquake Commission (EQC) payments to households. Each of these areas is discussed in more detail below. The changed outlook for the economy will also affect tax revenue as noted earlier. The tax forecasts included in the Budget Update are based on an economic outlook that includes the impact of the earthquake on economic activity and therefore incomes and expenditure.

The current estimate of the total cost to the Crown is $8.8 billion, with the vast majority of this figure expected to occur within the 2010/11 to 2014/15 period. Around $5.5 billion of this cost impacts on the core Crown sector and $3.3 billion on the State-owned enterprise and Crown entity sector, mainly via the EQC. Only the core Crown element adds to core Crown net debt although total government net worth is reduced by the full amount. The direct impact of these expenses means net debt is about 3% of GDP higher by the end of the forecast period than it would be without the earthquakes.

Table 2.2 outlines the assumed timing of when the major spending hits the operating balance at both the core and total Crown levels. This timing reflects a combination of accounting rules about when events are recognised and our current best estimate of when decisions are likely to be made. To help manage the costs of the earthquakes a Canterbury Earthquake Recovery Fund of $5.5 billion has been set up. Around $2.3 billion of this fund has already been allocated.

Residential property

EQC has reinsurance for its costs above $1.5 billion, up to $4 billion for each of the two earthquakes. Given current information, the total cost to EQC of its share of the damage to residential property is forecast to be $3.1 billion. This forecast cost has increased the 2010/11 forecast total Crown operating deficit (by the $1.6 billion) from that in the Half Year Update, but has not impacted on core Crown net debt because EQC's assets and liabilities are not part of the core Crown. The impact on EQC and the National Disaster Fund (NDF) is discussed further in the Investment Statement Supplement.

Local infrastructure

The Government is committed to contributing 60% of the cost of repairing essential local infrastructure (water, storm water, sewerage systems and stop banks). A provision for around $0.8 billion in 2010/11 has been included in these forecasts based on current estimates of the amount of damage to underground systems.

The primary government contribution to repairing local roads comes from the National Land Transport Fund. The New Zealand Transport Agency (NZTA) assesses damage estimates and formulates a special funding assistance rate, which determines the split of central and local government funding for repair of local road infrastructure. The current Christchurch City Council estimate of total damage is $0.7 billion. However, it is too soon to know how much is eligible for funding from the National Land Transport Fund. Preliminary estimates from NZTA indicate that around $0.4 billion will be eligible, thus the forecasts apportion this over a number of years. The National Land Transport Fund contribution to local road costs may be absorbed using the provision for emergency work built into the National Land Transport Programme, or if this is exhausted, the costs will be absorbed by reprioritising projects within the National Land Transport Programme. In the event that the Government decides to assist the region to meet its share of roading costs, the additional costs will be met from the Crown contingency allowance discussed below.

Local roads and essential infrastructure repair costs are dependent on decisions around land remediation. The current local road estimates do not attempt to reflect any land remediation policy outcomes.

State-owned assets

The cost of repairing state highways is not expected to be significant and may be absorbed using the provision for emergency work built into the National Land Transport Programme, or if this is exhausted, the costs will be absorbed by reprioritising projects within the National Land Transport Programme.

Costs associated with repairing other government infrastructure, including schools, housing and health facility assets, are largely covered by insurance and no additional provision for these costs, other than for insurance excesses, has been factored into the forecasts.

Welfare Support and Emergency Response

The Government has provided other assistance for the community and the cost of these initiatives is estimated to be $0.5 billion, most of which occurs in 2010/11. This includes the immediate costs incurred during the state of national emergency and various support initiatives such as the Earthquake Employment Support package.

AMI Insurance

On 7 April the Government agreed to provide a back-up financial support package for AMI Insurance (AMI) to give policyholders certainty and to ensure an orderly rebuild of Christchurch. As a result, the Government has entered into a five-year arrangement to subscribe for $500 million in convertible called, but unpaid, preference shares in AMI.

The full extent of the costs faced by AMI for the Canterbury earthquakes will remain unclear for several months until AMI has completed a detailed assessment of claims. Even then, the actual cost will remain uncertain and dependent on factors such as the basis on which claims are settled, potential building cost inflation and the time taken to rebuild. Therefore, it is uncertain if AMI will require the government injection over the next five years, and if it is required, when it would be needed and how much it would require.

Given the significant uncertainties and the limited information available at this time, the forecasts incorporate a high level of caution and prudence. Therefore, the AMI support package is included in the fiscal forecast as follows:

• Recognise a payable of $427 million to AMI in 2010/11 (being the value in today's dollars of a $500 million payment in 2014/15).
• Forecast an expense of $427 million in 2010/11. This expense reflects a very cautious assumption that if funds were injected in 2014/15, the Government's investment would not be recouped on eventual exit.
• Record an “interest” expense of $73 million over four years (which represents the difference between $427 million in today's dollars and the nominal payment of $500 million in 2014/15).
• Forecast a payment of $500 million in 2014/15.

Given the high level of uncertainty around these estimates, a fiscal risk has been included in the Fiscal Risks chapter. It is possible some of the Government's investment could actually be recouped on exit, while it is also a possibility that the Government may have to commit to more than a $500 million support package if AMI's shortfall for claims payments, after exhausting its own resources, is greater than $500 million.

Unallocated

As noted in Table 2.2, the fiscal forecasts incorporate unallocated funds of $3.2 billion. The unallocated funds will be used for any additional costs flowing from current obligations or decisions, as well as for policy decisions that have not yet been made, such as temporary housing and any remediation of land damaged in the February earthquake.

Sources of funding in Budget 2011

Budget 2011 provides funding to meet these costs via the creation of the Canterbury Earthquake Recovery Fund of $5.5 billion. This represents the core Crown costs discussed above. Around $0.7 billion of funding has already been either charged against the Budget 2010 contingency or met from existing baselines and thus was built into the Half Year Economic and Fiscal Update (HYEFU) 2010. The remaining $4.8 billion represents a new addition to net debt as of Budget 2011.

As noted above, the earthquake costs impact mainly on the 2010/11 and 2011/12 fiscal years. The timing of cash disbursements and hence the impact on net debt is somewhat different. The impact on net debt gives a better indication of the potential impact on economic activity, although it is still not precise. Figure 2.2 summarises the assumed cash profile of the above earthquake costs. This cash profile represents our current best estimate of likely timing of the impact on net debt, and has been factored into the macro and fiscal forecasts, including estimates of the fiscal impulse. Although the bulk of the increase in net debt will be in the form of standard New Zealand Government bonds, a proportion of the funding will be raised via the issuance of Canterbury Earthquake Kiwi Bonds.

Figure 2.2 – Expense and cash profile of earthquake costs

Source:  The Treasury

Uncertainty Around Economic and Fiscal Impacts#

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There is a high level of uncertainty surrounding both the economic and fiscal impacts of the earthquakes. In terms of impact on the economy, a range of factors could see the effects differ from those built into the Treasury's economic forecasts. These include the quantum and timing of reconstruction activity. With respect to the fiscal impact, there is uncertainty attached both to costs where decisions have already been taken, and to areas where there is either still too much uncertainty or where decisions have not yet been made.

When such costs are committed to, or when they can be reliably measured, they will be recorded in the Crown's financial statements and forecasts and charged against the $3.2 billion of the Fund yet to be allocated. Similarly, costs over and above those already built into the forecasts will be counted against the Fund. To the extent additional costs add to more than the $5.5 billion in the Fund there will be an adverse impact on the fiscal position.

3 Risks and Scenarios#

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Overview#

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The forecasts presented in the Economic and Fiscal Outlook chapter incorporate judgements about how both the New Zealand and the world economies evolve. These judgements have a number of risks surrounding them. We have balanced these risks in arriving at our view of how the economy is most likely to evolve.

The first part of this chapter discusses these global and domestic risks in more detail. Global risks have the potential to alter world growth, particularly for our main trading partners, which would flow through to the New Zealand economy. Key global risks are:

• inflation in emerging Asia being significantly higher than forecast
• sovereign debt issues in Europe driving a deterioration in the financial system
• private sector ability to compensate as fiscal and monetary stimuli ease, and
• more robust recoveries in advanced economies and emerging Asia.

Domestic risks focus on the timing of the rebuild following the Canterbury earthquakes and the extent of consolidation by the private sector. The risks that the timing and size of the earthquake rebuild differ from the main forecasts are high, given we have no recent experience of the redevelopment required. Developments in Canterbury are fluid, with changing estimates of damage and required skills. The risks related to the private sector focus on the agriculture and household sectors. These risks are based on participants' comfort with debt levels over the forecast period, with any change from the main forecasts leading to either a more rapid or a more drawn-out profile for spending and investment.

Although we consider the main forecast presented in the Economic and Fiscal Outlook chapter to be the most likely outcome, two scenarios that illustrate different paths for the economy are presented in this chapter. These scenarios do not fully illustrate the range of possibilities, but they represent key risks. The upside scenario illustrates the impact of higher confidence levels and stronger domestic demand in the short term. GDP is higher in both real and nominal terms, driven by increases in private consumption and residential investment. The downside scenario models a sharp fall in export commodity prices, which flows through to spending and investment being lower than in the main forecasts and a weaker profile for real and nominal GDP. Changes in tax revenue are the key driver of the operating balance (before gains and losses) in both scenarios, with the operating balance returning to surplus one year earlier (2013/14) in the upside scenario and beyond the forecast period in the downside scenario.

Risks and Scenarios#

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Economic and fiscal forecasts always involve a significant amount of uncertainty. The first part of this chapter outlines the key risks to the outlook, both global and domestic. The second part explains how two of the most likely risks could play out in alternative scenarios.

Economic Risks#

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Key risks continue to surround the global economy...

The robust growth in emerging market economies in 2010 led to a rebound in global commodity prices, especially when combined with supply constraints affecting some agricultural commodities. This increase in global commodity prices has been positive for New Zealand's terms of trade, but rising food and fuel prices also pose a threat to the global recovery. Inflation is already beginning to increase in both developed and developing economies and some countries, especially in emerging Asia, have started to tighten monetary conditions. Rising food and fuel prices also pose a threat to growth in that they reduce households' disposable income, especially in developing economies where these items account for a larger share of expenditure. A combination of high inflation and monetary tightening could cause an abrupt adjustment in emerging economies and is explored in the downside scenario below.

There are other risks to the global outlook as well. Sovereign debt remains a serious issue in the euro area with Portugal receiving assistance and increasing speculation of a restructuring of Greece's debt. Any deterioration in this issue would have implications for commercial banks in Europe given their exposure to sovereign debt.

There is still considerable need for fiscal consolidation in many advanced economies, in particular the United States, where there is no consensus yet on how best to reduce budget deficits. There is still some uncertainty about how sustainable the economic recovery is in some of the developed economies, particularly once monetary and fiscal stimulus is withdrawn. Labour and housing markets are still weak in many countries and will delay a recovery in private consumption.

So far, global imbalances have not been reduced significantly. While this is a longer-term issue, the lack of resolution may make the current recovery unsustainable. Political instability in the Middle East and North Africa has the potential to further disrupt oil supplies, leading prices to spike. There is uncertainty about the impact of the Japanese earthquake. We have assumed a short-term negative impact, largely offset by the subsequent recovery. There are also likely to be some benefits for a commodity exporter such as New Zealand as the reconstruction phase gets under way.

Other positive risks exist, although they are not as obvious or large. The global recovery is more assured than it was in 2010 as the recovery has become more strongly established. Emerging market economies are leading the recovery and their growth is particularly robust. Corporate balance sheets in the developed economies are stronger and industrial production data have generally been positive.

...while domestic risks relate to timing issues around the Christchurch rebuild…

The Canterbury earthquakes caused loss of life and damage on a scale not seen in New Zealand since the 1931 Napier earthquake. Judgement around the timing of the rebuild has been informed by studying similar events both here and abroad, and incorporating the latest information on frequently-revised damage estimates. Given the fluid nature of developments, the timing and extent of the rebuild are difficult to forecast with a high degree of confidence.

Our main forecasts assume construction grows strongly over calendar year 2012 and maintains a high level of activity throughout the forecast period and beyond. If the rebuild were to intensify sooner and more quickly than expected, residential and non-residential construction, imported goods and employment would all be stronger than in the main forecasts. The potential for skill shortages to be more acute than expected would manifest itself in higher wages and stronger-than-expected inflation, particularly for housing goods and services. In addition, a more rapid rebuild would boost confidence in the economy, providing a lift to consumer spending and business investment. Conversely, a slower rebuild would have the opposite effect, leading to softer economic outcomes in the short term. A slower-than-expected rebuild could be driven by a more drawn-out planning period, particularly if seismic activity increased in the near term, or capacity constraints are more binding than assumed in the main forecasts. A consequence of a slower rebuild is the potential for a net outflow of people from New Zealand in the first half of 2012, as departures continue rising and arrivals are pared back in line with weaker job prospects than in the main forecasts.

…and the degree of consolidation by households and the agriculture sector

There are other risks to the domestic outlook as well. Private consumption growth is expected to be tempered by weak house price growth and limited appetite, on the part of households, to increase debt. The risk is that a combination of increased willingness of banks to lend and households to borrow flows through to increased demand for housing and consumer spending. While this would drive a stronger economy in the near term, it would result in more subdued activity further out as the inevitable household rebalancing occurs. Conversely, the degree of consolidation over the next four years could be more intense than currently expected, with households unwilling to free up income for spending until debt is at a level that they deem to be sustainable. Such a scenario would lead to greater weakness in the near term but a stronger recovery later on, as household finances are more robust than in the main forecasts.

Similar to the household story above, the degree of consolidation by the agriculture sector could be more or less intense than assumed. In recent months, agricultural credit has fallen in absolute terms at the same time as commodity prices have reached historic highs. A more aggressive approach to debt reduction would slow growth in the near term, but would put the agriculture sector in a stronger position further out. On the other hand, there could be a more rapid pass-through of high export earnings to the rest of the economy, as commodity exporters increasingly consider that current returns for agricultural commodities are permanent. The perception of more persistent higher income would manifest itself in increased spending and investment, driving a more rapid recovery than assumed in the main forecasts, and is one of the drivers of the upside scenario outlined below.

There are also non-economic risks, particularly climatic events, that may impact on the economy. Over the past year, poor weather has adversely affected agricultural production, both here and overseas, and is partly behind the current high level of our terms of trade. Finally, there is a risk that tax outturns are either higher or lower than forecast. The Economic and Fiscal Outlook chapter features a more in-depth discussion of these risks.

Notes:

1. Annual percentage change, 2011 is actual figure
2. March quarter, seasonally adjusted

Upside Scenario#

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The domestic economy could recover more strongly than in the main forecasts...

The upside scenario incorporates a stronger economic recovery led by domestic drivers. The upturn is triggered by increased confidence from both the agriculture and household sector, with commodity exporters anticipating permanently higher returns and households more confident in house price rises.

In this scenario, commodity exporters become increasingly confident that the terms of trade will remain structurally elevated over the long term. With strong export returns viewed as permanent, spending from the agriculture sector is greater than expected in the near term, providing a boost to retailers and multiplying through the rest of the economy more rapidly than assumed in the main forecasts. In this scenario, it is assumed that commodity exporters, in general, are comfortable with their current level of borrowing, particularly in relation to income, and focus less on debt reduction than in the main forecasts.

At the same time, house prices are slightly stronger, growing 5% by mid-2012, rather than 1.8% as in the main forecasts. Higher house prices in the near term reflect current low interest rates and developing housing shortages, lifting household wealth. Higher household wealth flows through to increased consumer spending and residential investment. Residential investment is significantly boosted over the second half of 2011 as investors and home buyers begin building before skill shortages rise as the Canterbury rebuild gathers momentum.

The combined effect of increased agriculture and household confidence is evident in the profile for private consumption. The upside scenario includes a stronger profile for private consumption, with growth 1.8% points and 1.1% point higher in the March 2013 and 2014 years respectively than in the main forecasts. Despite the stronger outturn, private consumption growth remains moderate relative to history, growing an average 3.0% over the five years to March 2015.

Figure 3.1 – Real private consumption

Source:  Statistics New Zealand, the Treasury

Increased private consumption and residential construction drive a stronger economic outlook than in the main forecasts and, consequently, the labour market also strengthens, with the unemployment rate falling to 4.4% by March 2015. The stronger-than-expected domestic economy means CPI inflation is around the top of the 1% to 3% band over the forecast period which, together with increased real activity, results in nominal GDP being a cumulative $15 billion higher in March 2015 compared with the main forecasts.

…returning the operating balance to surplus sooner than in the main forecasts

Core Crown revenue is a cumulative $6 billion higher in the domestic-led upside scenario, led by increases in various tax types. The significant boost to private consumption and residential investment flows through to higher GST revenue, which, at $1.7 billion higher than the main track, makes the largest contribution to the higher tax take. Increased income driven off the stronger domestic economy lifts source deductions and corporate tax by about $1 billion each, while the more rapid increase in interest rates lifts resident withholding tax higher.

The fall in core Crown expenses, at $0.3 billion, is significantly lower than the rise in core Crown revenue described above, owing to the drivers of social assistance payments. With a stronger economy, Unemployment Benefit recipient numbers are lower than in the main case. However, benefit and superannuation payments are higher per recipient, with a higher annual indexation reflecting the more elevated track for CPI inflation.

In this scenario, the operating balance (before gains and losses) moves into surplus in the June 2014 year, one year earlier than in the main forecasts. Net core Crown debt as a proportion of GDP peaks at 27.3% of GDP over both the June 2013 and June 2014 years.

Downside Scenario#

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Growth in emerging Asia, particularly China, slows more rapidly than assumed…

The downside scenario evolves from a more rapid reduction in growth across emerging Asia, particularly China, over the second half of 2011. Weaker-than-assumed activity flows through to New Zealand in the form of lower prices for key commodity exports, particularly dairy, meat and forestry products. In addition, growth in our largest single trading partner, Australia, slows as demand for hard commodities from emerging Asia lessens in the face of a weaker expansion. The consequences of this scenario highlight the increasing trade linkages in the Asia-Pacific region, with emerging Asia and Australia currently taking over half of New Zealand's goods exports.

In this scenario, the merchandise terms of trade fall sharply, down 7.3% in the March 2012 year, reflecting lower prices for export commodities, with the assumption that oil prices remain relatively elevated as advanced economies continue to recover. The lower terms of trade result in a more rapid deterioration in the current account balance. The current account deficit increases to 5.4% of GDP in the March 2012 year (compared with 4.1% in the main forecasts) and to 7.8% by March 2015. The exchange rate is lower throughout and the TWI falls to 52.1 by March 2015, around 4 points lower than in the main forecasts.

The rapid fall in the terms of trade sparks lower consumer and business confidence, resulting in a more subdued outlook for consumer spending and market investment. With the terms of trade remaining at a lower level, private consumption growth averages around 1.6% over the four years to March 2015, compared with 2.4% in the main forecasts and 3.2% in the upside scenario. In addition, lower confidence leads to a flat outturn for market investment in the March 2012 year, compared with around 4% in the main track.

Weaker domestic activity, combined with the softer terms of trade, results in nominal GDP being a cumulative $20 billion lower through to March 2015.

…leading to lower tax revenue while raising operating deficits and net debt

The fall in cumulative nominal GDP in the downside scenario ($20 billion) is more than the rise in the upside scenario ($15 billion). However, the impact on tax revenue is less in the downside scenario (-$5 billion) than in the upside scenario ($6 billion), reflecting the relatively strong tracks for consumer and residential investment price inflation in the downside scenario. In the near term, inflation is weaker in this scenario, but is stronger than the main forecasts over the last two years of the forecast period. The relatively strong track for inflation reflects a sharper fall in the New Zealand dollar, raising prices of imported goods, along with pressure remaining on construction costs. With stronger inflation, the profile for 90-day interest rates is also higher, raising interest earnings.

In line with changes to these economic drivers, GST revenue falls by $1.1 billion, a significantly smaller change than in the upside scenario, while resident withholding taxes rise by $0.3 billion relative to the main track, providing some offset to declines in other tax types. Source deductions are $1.6 billion lower relative to the main forecast, reflecting the weaker labour market, and corporate and other persons tax are a combined $2.0 billion lower, in line with softer prices for exports and generally weaker business conditions.

Figure 3.2 – Operating balance (before gains and losses)

Source:  The Treasury

In the downside scenario, core Crown expenses are $0.8 billion higher, as the weaker labour market flows through to increased Unemployment Benefit recipient numbers. With CPI inflation holding up over the forecast period as a whole, annual indexation of benefits is broadly similar to the main track, providing little offset in the form of lower annual adjustments.

In this scenario, the operating balance (before gains and losses) does not move into surplus within the forecast period (Figure 3.2) and, consequently, the profile for net core Crown debt as a proportion of GDP has not peaked by June 2015, reaching 32.7% at that time.

Fiscal Sensitivities

The scenarios set out alternative paths for the fiscal position based on plausible assumptions for specific drivers. In addition, Table 3.2 provides some “rules of thumb” on the sensitivities of the fiscal position to changes in specific variables without identifying the drivers of change.

Note: 1 NZDMO holdings only

Source: The Treasury

 

4 Fiscal Risks#

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Structural deficits, the collapse of a number of finance institutions and a series of natural disasters have led to an increase in net government debt. As a result, the Government's fiscal buffers are smaller and fiscal policy will need to continue to be sensitive to future developments. The Government's policy response is outlined in the FSR. Policy will need to remain adaptive as global markets remain volatile and many major developed economies face significant structural challenges.

The most significant economic risks have been identified in Chapter 3. The first section of this chapter illustrates the link between these risks to the economy and the fiscal position. The second section presents a Statement of Specific Fiscal Risks.

The Statement of Specific Fiscal Risks is a requirement of the Public Finance Act 1989 and sets out all pending government decisions and other circumstances known to the Government at the finalisation of the fiscal forecasts that may have a material effect on the fiscal and economic outlook. It is not possible to identify every possible risk and disclosure is also subject to the legal requirements and materiality thresholds described at the end of this chapter.

The Economy and Public Finances

The economic and fiscal forecasts are subject to heightened forecast uncertainty as a result of a volatile external environment and domestic factors such as high levels of external debt held by the New Zealand private sector. Chapter 3 provides scenarios to illustrate a plausible range for the economic and fiscal projections. However, further shocks are possible, potentially leading to outcomes well beyond the range suggested by these scenarios.

New Zealand's strong fiscal track record provides confidence that the risk of default for the Crown's creditors remains remote. Reflecting this, the Crown currently holds the top Aaa foreign currency rating from Moody's and strong AA+ foreign currency ratings from Standard and Poor's (S&P) and Fitch Ratings. The ratings from S&P and Fitch, however, are currently on a negative outlook and will be sensitive to developments in the economy. Markedly slower growth or any other factor that negatively impacts on the fiscal position represents a potential risk to the current rating. A key implication of a sovereign rating downgrade could be an increase in debt-servicing costs for the Government and higher borrowing rates for New Zealand households and businesses.

The fiscal outlook is particularly exposed to structural economic shocks, which have a permanent impact on the level of national income and therefore tax revenue. High levels of external indebtedness increase the economy's exposure to shocks from the global economy. Financial markets remain volatile and many major economies are currently facing significant structural challenges. Notably, many advanced economies are dealing with high government debt, household balance sheets needing repair and a financial sector (especially in Europe) that remains weak. In this global environment, shocks could rapidly flow between countries through changes in trade, the terms of trade or interest and exchange rates.

Under constant policy settings, the main source of uncertainty about the fiscal position arises from the inherent uncertainty about future tax revenue. An analysis of historical tax forecast errors provides some guide to how unforeseen events in New Zealand or abroad can impact on the fiscal position. Tax revenue in the next fiscal year (2011/12) would normally fall within a range of two standard deviations of historical forecast errors. This range is ±6% of actual tax revenue, which equates to ±$3 billion (based on an analysis of forecast errors over 1994 to 2010). Greater variance can occur, but would be expected at more infrequent intervals (around one year in every 20 if errors are normally distributed). Figure 4.1 shows core Crown tax revenue with uncertainty estimated from historic forecast variance.

Figure 4.1 – Core Crown tax revenue uncertainty

Source:  The Treasury

Note: The coloured band represents sequential deciles such that the difference between the 10th and 90th percentiles represents an 80% confidence interval. See Treasury Working Paper 10/08 for further information about the methodology used.

Overview of Specific Fiscal Risks

Specific fiscal risks can be positive or negative and can affect revenue or spending. The links between external events and spending are indirect because new policies that change spending and revenue usually require a decision by the Government and approval from Parliament. The approach taken in this chapter is to disclose those pending policy decisions and key areas of uncertainty that may have a material effect on the fiscal outlook. The specific fiscal risks are categorised into:

• Pending policy decisions affecting revenue: Changes to tax policy or ACC levies could reduce or increase government income.
• Pending policy decisions affecting expenses: Costs of policy proposals could increase or decrease depending on decisions taken and they are risks to the extent that they cannot be managed within baselines or budget allowances.
• Pending capital decisions: Capital investment decisions are risks to the extent that they cannot be managed within balance sheets or budget allowances.
• Matters dependent on external factors: The liability of the Government for costs is sometimes dependent on external factors such as the outcome of negotiations or international obligations.

Some key examples of the risks disclosed in this chapter are outlined below:

• government decisions relating to the recommendations of the Welfare Working Group and the redesign of business processes at Inland Revenue
• specific policies that may have flow-on costs that are not accounted for within allocated funding, such as early childhood education funding, but are not likely enough to include in the forecasts
• explicit guarantees that give assurance to the public and businesses about the Crown's planned response to specific events are recognised as risks; the largest current guarantee relates to the Extended Deposit Guarantees Scheme with a total value of $1.9 billion, and
• generic cross-Government risks such as the renegotiation of collective employment agreements could have material costs and flow-on effects to remuneration in other sectors.

General cost pressures, such as those associated with an ageing population, are not recognised as specific fiscal risks.

A number of new risks have been added since the Half Year Update. Key examples are:

• the amount and timing of cash proceeds from the planned partial sale of State-owned assets are uncertain
• possible policy decisions relating to Canterbury earthquakes, social housing and legal aid may affect expenses
• pending decisions relating to irrigation are likely to require capital investment, and
• negotiations such as those on an international climate change agreement are yet to settle on final costs, which are likely to be material.

The costs of individual natural disasters, and other major events, are not recognised as specific fiscal risks in advance as they usually occur infrequently and their timing cannot be predicted. Once a disaster does occur, a number of choices arise about how to respond. Specific risks are disclosed at this point based on the range of possible responses.

A number of earthquake-related risks have been added to this chapter. In addition to policy choices for the Government, recent events in Canterbury and Japan have placed pressure on private sector insurers. As a result, the cost of insurance premiums, most notably for EQC's reinsurance, could increase over the next five years with potential flow-on effects to the Crown. This is not yet certain enough to be a risk but could be recognised in the future.

The final part of the chapter contains a current list of contingent liabilities, which are likely costs that the Crown will have to face if a particular event occurs. Typically, contingent liabilities consist of guarantees and indemnities, legal disputes and claims on uncalled capital. The largest quantified contingent liabilities are to international financial organisations and mostly relate to uncalled capital and promissory notes.

Statement of Specific Fiscal Risks#

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Summary Table

The matters listed below are disclosed as specific fiscal risks because they meet the rules for disclosure outlined at the end of the chapter. Full descriptions of the risks listed below are set out in the next section.

Statement of Specific Fiscal Risks

Pending policy decisions affecting revenue

ACC - Levies (Unchanged, Unquantified)

Changes in tax settings, economic factors, and ACC's financial performance affect ACC's levy income.

Finance - Mixed Ownership Model (New, Unquantified)

The Government is considering extending the type of Mixed Ownership Model that currently applies to Air New Zealand, Genesis Energy, Meridian Energy, Mighty River Power and Solid Energy, and further reducing the Crown's shareholding in Air New Zealand. The final amount and timing of any cash proceeds, the flow-on effects to future dividend streams and any implementation costs are uncertain.

Revenue - Apportionment Rules for High-Value Assets (New, Unquantified)

A government discussion document will be released on the apportionment rules applying to tax deductions for high-value assets that are also partly used for private purposes. Any changes to those rules could have a positive impact on tax revenue.

Revenue - Potential Tax Policy Changes (Unchanged, Unquantified) 

The tax policy work programme announced by the Government includes a number of items that are under consideration, including:

• the tax treatment of profit distribution plans
• the tax treatment of charitable giving
• the imputation system
• the tax treatment of employee benefits
• amortisation of capital raising costs
• the international tax review
• the GST treatment of cross-border business activities, and
• the tax treatment of hybrid instruments.

Measures on the work programme are expected to be revenue neutral or positive in aggregate; however, individual initiatives could be revenue negative in themselves.

Revenue - Salary Sacrifice (New, Unquantified) 

The Government is reviewing the tax treatment of employee benefits paid in lieu of salary. Any changes are expected to result in an increase in tax revenues.

Revenue - Income-Sharing Tax Credits (Changed, Quantified)

The Government has introduced legislation to establish an income-sharing tax credit. If passed as introduced, the legislation will allow couples with children under the age of 18 to pool their earnings for income tax purposes if they meet certain criteria. If implemented, the changes will reduce tax revenues by $500 million per annum once the scheme is fully operational. The Finance and Expenditure Committee has recommended the significant fiscal cost of the package be addressed before the Bill proceeds.

Risk to Third-Party Revenue (Unchanged, Unquantified)

A wide range of government activities are funded through third-party fees and charges. With a decrease in economic activity, there is a risk that decreases in third-party revenue streams will require changes to service delivery with transitional costs to the Crown. For example, decreases in Customs revenue or in levies on building activity may mean that some activities are temporarily unable to be fully cost-recovered and the Government will need to reduce the level of an activity or temporarily subsidise that activity.

Pending policy decisions affecting expenses

Climate Change - Review of the Emissions Trading Scheme (New, Unquantified)

The ETS is currently under review. Following the review, any changes to the ETS could have significant fiscal implications. The outcome of international negotiations for a post-2012 international climate change agreement may also have a significant impact on the fiscal implications of the ETS post-2012.

Communications - Recovery of Value of Broadband Investment (New, Unquantified)

The Government has committed to spend $1.5 billion on a new broadband network delivering “ultra fast” broadband services. Of this amount, $1.4 billion has already been invested, or is allocated for Crown Fibre Holdings to invest, in broadband initiatives with partners. Given the nature of the investment mechanism, it is likely that the full value of the investment will not be recovered. The fiscal forecasts include a provision for this impairment, but the final amount of the impairment may vary from this provision.

Education - Early Childhood Education Funding (Unchanged, Unquantified)

Demand for Early Childhood Education (ECE) services is continuing to increase more than forecast, raising the costs of subsidies to ECE services. If this continues, the Government will face additional cost pressures.

Education - Inflation Adjustment for School Operating Funding (Unchanged, Unquantified)

The Government has increased school operating grants in Budget 2011 to help meet increased costs associated with inflation. A risk remains in outyears that similar cost pressures will need to be addressed.

Housing - Reform of Social Housing (New, Unquantified)

The Government is considering changes to policy settings for social housing. This includes an intention to grow third party provision of social housing. The strategy remains under development, but it potentially represents a risk to the fiscal forecasts. There may be offsetting financial benefits to the Crown if significant gains in efficiency are achieved.

Justice - Legal Aid (New, Unquantified)

Based on current policy settings, legal aid expenditure will exceed available funding in future years. The Government is currently developing further options for delivering legal aid in a sustainable and affordable way. Options are due to be considered by Cabinet in September 2011 and the fiscal implications should be known subsequent to any Cabinet decisions.

Revenue - Child Support (Unchanged, Unquantified)

A government discussion document has been released which considers changes to the child support regime. The discussion document considers the costs of raising children, potential changes to the child support formula and options to improve compliance with the child support regime. Any changes would have administrative costs for Inland Revenue and could increase fiscal costs from reduced offsets to benefits.

Revenue - Redesigning Business Processes at Inland Revenue (Unchanged, Unquantified) 

The Government is investigating options to redesign business processes at Inland Revenue, which could include both policy and administrative options to simplify processes and improve the integrity of the tax system. Any changes could impact on tax revenue collections and/or have material administrative costs to implement.

Revenue - Student Loans Redesign (New, Unquantified)

The Government is making changes to student loans legislation and is modernising the IT system used for collecting student loan repayments, which is part of the tax administration system. The project could be delayed by up to a year, which may reduce forecast increases in student loan repayments. Any delay in implementation could also have an impact on the business process redesign at Inland Revenue, which could have a material impact on the administration costs of the tax system.

Social Development - ServiceLink (Changed, Unquantified) 

The Ministry of Social Development is working with Inland Revenue and the Department of Internal Affairs to develop a business case for ServiceLink, which will integrate service delivery across government. ServiceLink is designed to improve service and reduce costs by moving, where appropriate, simple customer transactions online and away from face-to-face and voice channels. Cabinet will consider business cases, including potential costs, in 2011 and 2012.

Social Development - Welfare Working Group Recommendations (Changed, Unquantified) 

On 22 February 2011 the Welfare Working Group made 43 recommendations to the Government on options to reduce long-term benefit dependency. Ministers have directed officials to develop advice for consideration. Many of the recommendations would result in large up-front costs if adopted. The Government will respond to the Welfare Working Group's report later in 2011.

State Sector Employment Agreements (Unchanged, Unquantified) 

A number of large collective agreements are due to be renegotiated in the short to medium term. As well as direct fiscal implications from any changes to remuneration, the renegotiation of these agreements can have flow-on effects to remuneration in other sectors. The Government has signalled an expectation for restraint given the current economic environment and conditions in the private sector.

Pending capital decisions

Agriculture and Forestry - Investment in Water Infrastructure (New, Quantified)

The Government has established a funding programme to support potential irrigation development projects to an investment-ready stage. The Government is also considering investing up to $400 million of equity in water harvesting, storage and off-farm distribution infrastructure after 2013. Any investment will be made by taking short to medium-term minority equity stakes in order to help attract other investors.

Departmental Capital Intentions (New, Unquantified)

The Government requires 15 capital-intensive agencies to identify their capital spending intentions over the next 10 years based on current policy settings and certain demographic and inflation assumptions. The difference between capital intentions and currently available funding is material but the Government expects that these intentions will be managed back through a range of measures such as prioritisation, changes to asset utilisation, alternative methods of service delivery and changes to policy settings. Departmental capital intentions are risks to the extent that they cannot be managed through these mechanisms or funded through existing funding sources.

Finance - Crown Overseas Properties (Unchanged, Quantified)

The Government holds New Zealand House in London on a long-term lease from the Crown Estate (UK). Depending on the Government's future intentions for this building, an upgrade may be required. Preliminary cost estimates for this upgrade total $150 million over the period 2012/13 to 2014/15.

Housing - Weathertight Homes (Unchanged, Unquantified)

The Government has agreed to offer a package to assist homeowners to repair homes affected by the weathertightness issues that occurred in the late 1990s and early 2000s. The package includes a 25% government contribution towards agreed repair costs, a 25% contribution from participating territorial authorities and credit support for the remaining repair costs for those who meet the eligibility and lending criteria. There is a risk that the costs of the package will exceed the $1.055 billion provided for in the fiscal forecasts, as uncertainty remains regarding the extent of damage to eligible homes and the level of uptake.

Reviews of the Delivery of Public Services (Changed, Unquantified)

The Government has initiated a series of reviews to improve the effectiveness and efficiency of public services. Reviews may recommend, or result in, changes to service delivery and/or free up resources for reprioritisation within Votes or be returned to the centre to meet pressures in other areas.

Transport - Support for New Zealand Railways Corporation (KiwiRail) (Changed, Unquantified)

The Government has agreed in principle to support a 10-year strategy for KiwiRail to achieve a commercially viable rail network. The overall commitment KiwiRail seeks towards the 10-year plan is $1.2 billion over the period 2010/11 to 2014/15. The Government has indicated it will provide a total of $750 million in capital over three years; $500 million of this was provided in Budgets 2010 and 2011. KiwiRail Group also has $499 million in debt owing to the Crown with $408 million maturing in the forecast period, which may need to be refinanced or restructured.

Matters dependent on external factors

ACC - Non-Earners' Account (Unchanged, Unquantified)

Changes in tax settings, economic factors and ACC's financial performance affect the Crown's liability for claims by non-earners. If ACC's performance is different from what is forecast, the amount required to cover the costs of claims for that year may be more or less than needed, resulting in unplanned savings or costs to the Crown.

Canterbury Earthquake - AMI Support Package (New, Unquantified)

There is a $500 million provision in the forecasts for the AMI support package. The timing and actual impact on the Government's fiscal position will only become known when the full extent of the claims AMI faces for the Canterbury earthquakes becomes more certain. It is possible that the provision will not be needed if AMI is able to pay all claims from its own resources or source alternatives to government funding. It is also possible that the Government may have to commit to more than $500 million if AMI's shortfall for claims payments exceeds $500 million.

Canterbury Earthquake Recovery Fund (New, Unquantified)

The Canterbury earthquakes have had a significant impact on the Government's fiscal position. The current estimate of the cost to the Crown is $8.8 billion. A breakdown of the costs is included in the Economic and Fiscal Impacts of the Canterbury Earthquakes section of this document. Around $5.5 billion of funding has been allocated to the Canterbury Earthquake Recovery Fund to cover the Core Crown costs associated with recovery from the earthquakes. The Fund includes estimated costs to cover:

• the Government's share of repairing essential local infrastructure
• repairing State-owned assets
• other policy responses such as welfare support, and
• the AMI support package (see separate risk).

As there is still a high degree of uncertainty around the costs from the earthquakes there is a risk the amounts included in the fiscal forecasts for the Canterbury Earthquake Recovery Fund may differ from the final costs.

Climate Change - Finance for Developing Countries (Changed, Unquantified)

There is an international expectation that developed countries, including New Zealand, contribute finance to developing countries to support adaptation and mitigation. Developed countries have committed to mobilising $US100 billion per year by 2020 to address the needs of developing countries. This would come from a wide variety of sources, both public and private.

Climate Change - Kyoto Protocol Obligations (Changed, Unquantified)

The fiscal impact of the Government's Kyoto Protocol obligations (2008 to 2012) is currently uncertain. An increase in New Zealand's net emissions or the future transfer of emission units offshore could reduce the net Kyoto position significantly. Increased allocation to emitters or increased participation by foresters under the ETS would negatively impact the Government's ETS position. The fiscal impact of any changes is dependent on the carbon price. The Government may also need to purchase emission units to meet its obligations, which would have a corresponding impact on net debt.

Climate Change - Post-2012 International Climate Change Obligations (New, Unquantified)

The Government is currently taking part in international negotiations for a post-2012 international climate change agreement. Currently no rights or obligations are included in the fiscal forecasts for any post-2012 agreement because of the high levels of uncertainty. Any agreement could have significant financial implications, and will need to be recognised at the time.

Defence Force - Future Operationally Deployed Forces Activity (Unchanged, Quantified)

New Zealand Defence Force personnel are deployed overseas on peace support and other operations conducted in support of the United Nations and other relevant multinational agencies. Maintaining existing deployment levels would result in an increased annual operating balance impact of between $10 million and $30 million from 2011/12.

Defence Force - Sale of Skyhawks and Aermacchi Trainers (Changed, Unquantified)

The A-4 Skyhawk and Aermacchi aircraft are now being disposed of as two separate fleets. The A-4 Skyhawk fleet will largely be gifted to museums with some proceeds expected from the sale of spare parts. The market is currently being tested for interest in the Aermacchi fleet. The net sale proceeds from the fleets are uncertain.

Education, Health, Social Development - Caregiver Employment Conditions (Changed, Unquantified)

The Employment Court and subsequently the Court of Appeal have made judgements in favour of a third-party employed caregiver regarding his sleepover employment conditions. Although the third-party employer is appealing the decision, an unsuccessful result would require consideration of the effect on the Crown. This decision would also have an impact on other service providers in health and other sectors.

Energy - Crown Revenue from Petroleum Royalties (Changed, Unquantified)

The Crown revenue from petroleum royalties is very dependent upon the US dollar value per barrel and the exchange rate. Movements up or down in either of these variables could result in a significant decrease or increase in Crown revenue. In addition, the Government is currently reviewing the regulatory, royalty and taxation arrangements for petroleum as part of the Petroleum Action Plan. Although the outcomes of this review are still uncertain, any changes to policies in this area could have a significant impact on future revenue from petroleum royalties.

Finance - Entities in Receivership under Crown Retail Deposit Guarantee Schemes (Changed, Unquantified)

Eight entities that were guaranteed under the original Deposit Guarantee Scheme and one that was guaranteed under the extended scheme are now in receivership. The Crown recognises its obligations under the schemes as liabilities and its rights of recovery from the receivers as assets. While the reported assets represent the receivers' best prudent estimates of likely recoveries from the receiverships the eventual return to the Crown is uncertain and dependent upon the value that can be realised from these entities' assets.

Finance - Extended Crown Retail Deposit Guarantee Scheme (Changed, Unquantified)

There are four financial institutions participating in the extended Retail Deposit Guarantee Scheme. These entities have deposits totalling $1.9 billion covered by the guarantee and are listed on the Treasury website. This is the maximum exposure and does not include any offset resulting from the recovery of the remaining assets of financial institutions in the event the guarantee is called upon. The entities participating in the extended scheme are currently assessed to be unlikely to default and therefore no provision is considered necessary in relation to the amount guaranteed by the Crown under the extended guarantee. While this represents a best estimate of the expected outcome, a range of outcomes is possible if entities default, including eventual loss to the Crown.

Finance - Government Commitments to International Financial Institutions (Unchanged, Unquantified)

The forecast level of government commitments to international financial institutions is subject to change, depending on the Government's response to any modified financial plans on the part of these institutions.

Health - Payment of Family Caregivers (Changed, Unquantified) 

The Human Rights Review Tribunal has declared that the Ministry of Health's policy of not employing family members to provide care to disabled relatives is in breach of s19 of the New Zealand Bill of Rights Act. The High Court has also found in favour of the family caregivers. Leave has been granted to appeal to the Court of Appeal.

Revenue - Cash Held in Tax Pools (Unchanged, Unquantified)

Funds held in tax pools are recognised as an asset of the Crown. There is a risk that funds held in these pools, over and above a customer's provisional tax liability, may be withdrawn, resulting in an unquantified loss to the Crown.

State Services - KiwiSaver Contribution (Unchanged, Unquantified)

The forecast of the costs of KiwiSaver policies for State sector employees is dependent on a number of assumptions and projections, such as uptake and contribution rates, all of which may change through time. In the current economic environment, factors such as reduced automatic enrolment, financial market disruption and low consumer confidence increase forecast uncertainty.

Treaty of Waitangi Negotiations - Treaty Settlement Forecast (New, Unquantified)

The fiscal forecasts include provision for the cost of future Treaty settlements. There is a risk that the timing and amount of the settlements could be different from what is forecast. It is not possible to reliably estimate the value of this difference.

Treaty Negotiations - Treaty of Waitangi Claims - Settlement Relativity Payments (Unchanged, Unquantified)

The Deeds of Settlement negotiated with Waikato-Tainui and Ngāi Tahu include a relativity mechanism. The mechanism provides that, where the total redress amount for all historical Treaty settlements exceeds $1 billion in 1994 present-value terms, the Crown is liable to make payments to maintain the real value of Ngāi Tahu's and Waikato-Tainui's settlements as a proportion of all Treaty settlements. The agreed relativity proportions are 17% for Waikato-Tainui and approximately 16% for Ngāi Tahu. There is a risk that the timing and the amount of the expense for the relativity payments may differ from that included in the fiscal forecasts.

Risks Removed Since the 2010 HYEFU

The following risks have been removed since the Half Year Update:

Criteria and Rules for Inclusion in the Fiscal Forecasts or Disclosure as Specific Fiscal Risks

The Public Finance Act requires that the Statement of Specific Fiscal Risks sets out all government decisions, contingent liabilities or contractual obligations known to the Government and subject to specific requirements that may have a material effect on the economic or fiscal outlook[8].

The criteria and rules set out below are used to determine if government decisions or other circumstances should be incorporated into the fiscal forecasts, disclosed as specific fiscal risks or, in some circumstances, excluded from disclosure.

Criteria for Including Matters in the Fiscal Forecasts

Matters are incorporated into the fiscal forecasts provided they meet all of the following criteria:

• The quantum is more than $100 million over five years.
• The matter can be quantified for particular years with reasonable certainty.
• A decision has been taken; or a decision has not yet been taken, but it is reasonably probable[9] the matter will be approved, or it is reasonably probable the situation will occur.

Additionally, any other matters may be incorporated into the forecasts if the Secretary to the Treasury considers, using their best professional judgement, that the matters may have a material effect on the fiscal and economic outlook and are certain enough to include in the fiscal forecasts.

Rules for the Disclosure of Specific Fiscal Risks 

Matters are disclosed as specific fiscal risks if:

• the likely cost is more than $100 million over five years, and either
• a decision has not yet been taken, but it is reasonably possible[10] (but not probable) that the matter will be approved or the situation will occur, or
• it is reasonably probable that the matter will be approved or the situation will occur, but the matter cannot be quantified or assigned to particular years with reasonable certainty.

Additionally, any other matters may be disclosed as specific fiscal risks if the Secretary to the Treasury considers, using their best professional judgement, that the matters may have a material effect (more than $100 million over five years) on the fiscal and economic outlook, but are not certain enough to include in the fiscal forecasts.

Exclusions from Disclosure

Matters are excluded from disclosure as specific fiscal risks if they fail to meet the materiality criterion (ie, are less than $100 million over five years), or if they are unlikely[11] to be approved or occur within the forecasting period.

Additionally, the Minister of Finance may determine that an item included in the fiscal forecasts or a specific fiscal risk not be disclosed, if such disclosure would be likely to:

• prejudice the substantial economic interests of New Zealand
• prejudice the security or defence of New Zealand or international relations of the Government
• compromise the Crown in a material way in negotiation, litigation or commercial activity, or
• result in a material loss of value to the Crown.

Furthermore, the Minister of Finance has to determine that there is no reasonable or prudent way the Government can avoid this prejudice, compromise or material loss by making a decision on the fiscal risk before the finalisation of the forecasts, or by disclosing the forecast item or fiscal risk without reference to its fiscal implications.

Contingent Liabilities and Contingent Assets#

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Contingent liabilities are costs that the Crown will have to face if a particular event occurs. Typically, contingent liabilities consist of guarantees and indemnities, legal disputes and claims, and uncalled capital. The contingent liabilities facing the Crown are a mixture of operating and balance sheet risks, and they can vary greatly in magnitude and likelihood of realisation.

In general, if a contingent liability were realised it would reduce the operating balance and increase net debt. However, in the case of contingencies for uncalled capital, the negative impact would be restricted to net debt.

Where contingent liabilities have arisen as a consequence of legal action being taken against the Crown, the amount shown is the amount claimed and thus the maximum potential cost. It does not represent either an admission that the claim is valid or an estimation of the amount of any award against the Crown.

Contingent assets are possible assets that may arise if a particular event occurs.

Only contingent liabilities and contingent assets involving amounts of over $100 million are separately disclosed. Contingent liabilities below $100 million are included in the “other quantifiable contingent liabilities” total.

Contingent liabilities and contingent assets have been stated as at 31 March 2011, being the latest set of contingent liabilities reported.

Quantifiable Contingent Liabilities

Unquantifiable Contingent Liabilities

 

 

A contingent liability in relation to the indemnification of the Stadel Museum's touring exhibition has been removed since the Half Year Update.

The Foreshore and Seabed Act was repealed on 31 March 2011 and has therefore been removed as a contingent asset.

Description of Contingent Liabilities

Quantified contingent liabilities over $100 million

Tax in dispute 

Tax in dispute represents the outstanding debt of those tax assessments raised, against which an objection has been lodged and legal action is proceeding. When a taxpayer disagrees with an assessment issued following the dispute process, the taxpayer may challenge that decision by filing proceedings with the Taxation Review Authority or the High Court.

$297 million at 31 March 2011 ($301 million at 31 October 2010)

Other quantifiable contingent liabilities

International finance organisations 

The Crown has lodged promissory notes with the International Monetary Fund. Payment of the notes depends upon the operation of the rules of the organisation.

$1,369 million at 31 March 2011 ($1,501 million at 31 October 2010)

Kyoto Protocol

During the first commitment period (2008-2012), the Ministry for the Environment estimates that 89.3 million tonnes of credits will be generated by carbon removals via forests. To the extent that these forests are harvested (in subsequent commitment periods) and a future international agreement is negotiated, there will be an associated liability generated that will need to be repaid.

The New Zealand Emissions Trading Scheme transfers a portion of the potential future liability to forest owners. As at 31 March 2011, approximately 13.5 million tonnes has been transferred to forest owners in the form of New Zealand Units. The Crown's contingent liability is calculated as the remaining credits the Crown is potentially liable for (75.8 million tonnes) multiplied by the carbon price of NZ$20.33 as at 31 March 2011.

$1,541 million at 31 March 2011 ($1,665 million at 31 October 2010)

New Zealand Export Credit Office

The New Zealand Export Credit Office (NZECO) provides a range of guarantee products to assist New Zealand exporters. These NZECO guarantees are recorded by the Crown as contingent liabilities.

$142 million at 31 March 2011 ($105 million at 31 October 2010)

Unquantifiable contingent liabilities

Accounting standard NZ IAS 37 Provisions, Contingent Liabilities and Contingent Assets requires that contingent liabilities be disclosed unless the possibility of an outflow of resources embodying economic benefits is remote. Disclosure of remote contingent liabilities is only required if knowledge of the transaction or event is necessary to achieve the objectives of general purpose financial reporting. This part of the Statement provides details of those contingent liabilities of the Crown which cannot be quantified (remote contingent liabilities are excluded).

Guarantees and indemnities

Airways Corporation of New Zealand Limited

The Crown has indemnified Airways Corporation of New Zealand Limited as contained in Airways' contract with New Zealand Defence Force for the provision of air traffic control services. The indemnity relates to any claim brought against Airways by third parties arising from military flight operations undertaken by the Royal New Zealand Air Force.

AsureQuality Limited

The Crown has indemnified the directors of AsureQuality Limited in the event that they incur any personal liability for redundancies arising from any agreement by international trading partners that allows post-mortem meat inspection by parties other than the Ministry of Agriculture and Forestry, or its sub contractor.

At Work Insurance Limited

The Crown has indemnified the liquidators of At Work Insurance Limited (Deloitte Touche Tohmatsu) against various employment-related claims.

Bona Vacantia property

P&O NZ Ltd sought a declaratory judgement that property disclaimed by a liquidator is bona vacantia. A settlement has been reached, which includes a Crown indemnity in favour of New Zealand Aluminium Smelters and Comalco in relation to aluminium dross disposed of in their landfill, for costs that may be incurred in removing the dross and disposing of it at another site if they are required to do so by an appropriate authority. The Minister of Finance signed the indemnity on 24 November 2003. In February 2004, a similar indemnity was signed in respect of aluminium dross currently stored at another site in Invercargill.

Building Industry Authority

The Building Industry Authority (BIA) is a joint defendant in a number of claims before the courts and the Weathertight Homes Resolution Service relating to the BIA's previous role as regulator of the building industry. The BIA has been disestablished and absorbed into the Department of Building and Housing. To prevent conflicts of interest, the Treasury was given responsibility for managing weathertight claims against the BIA on behalf of the Crown from 1 July 2005.

Contact Energy Limited

The Crown and Contact signed a number of documents to settle in full Contact's outstanding land rights and geothermal asset rights at Wairakei. Those documents contained two reciprocal indemnities between the Crown and Contact to address the risk of certain losses to the respective parties' assets arising from the negligence or fault of the other party.

Deposit Guarantee Schemes

The Crown operates an extended Retail Deposit Guarantee Scheme. The objective of this scheme was to ensure ongoing retail depositor confidence in New Zealand's financial system. As at 31 March 2011 four entities remained in the extended scheme with deposits totalling $1.9 billion under guarantee. This is the maximum exposure and does not include any offset resulting from the recovery of the remaining assets of financial institutions in the event the guarantee is called upon. The fiscal risk with respect to the Extended Crown Retail Deposit Guarantee Scheme is detailed in the Specific Fiscal Risks section of this chapter.

The Crown operated an opt-in Wholesale funding guarantee facility operated from November 2008 to May 2010. The objective was to facilitate access to international financial markets by New Zealand financial institutions, in a global environment where international investors were highly risk averse and where many other governments had offered guarantees on their banks' wholesale debt. At the time of closing the scheme, the Crown had issued 24 guarantee certificates; the benefit of those guarantees will remain in place for the underlying securities until the scheduled maturity of those securities. The terms of these securities range from two to five years. Over time, the value of securities issued with the benefit of Crown guarantees will reduce, with the last guarantee certificate expiring in October 2014. As at 31 March 2011, the value of wholesale securities guaranteed was $9.7 billion.

Earthquake Commission (EQC) 

The Crown is liable to meet any deficiency in EQC's assets in meeting the Commission's financial liabilities (section 16 of the Earthquake Commission Act 1993). In the event of a major natural disaster the Crown may be called upon to meet any financial shortfall incurred by the Commission.

Further discussion on the recent Canterbury earthquakes can be found in the Economic and Fiscal Impacts of the Canterbury Earthquakes section of this document.

Electricity Corporation of New Zealand Limited (ECNZ) 

The ECNZ Sale and Purchase Agreement provides for compensation to ECNZ for any tax, levy or royalty imposed on ECNZ for the use of water or geothermal energy for plants in existence or under construction at the date of the Sale and Purchase Agreement. The agreement also provides for compensation for any net costs to ECNZ arising from resumption of assets pursuant to the Treaty of Waitangi (State Enterprises) Act 1988.

The Deed of Assumption and Release between ECNZ, Contact Energy Limited and the Crown provides that the Crown is no longer liable to ECNZ in respect of those assets transferred to it from ECNZ. As a result of the split of ECNZ in 1999, Ministers have transferred the benefits of the deed to ECNZ's successors - Meridian Energy Limited, Mighty River Power Limited and Genesis Power Limited.

Under the Transpower New Zealand Limited (Transpower) Sale and Purchase and Debt Assumption Agreements, the Crown has indemnified ECNZ for any losses resulting from changes in tax rules applicable to transactions listed in the agreements. Additionally, the Crown has indemnified the directors and officers of ECNZ for any liability they may incur in their personal capacities as a result of the Transpower separation process.

Following the split of ECNZ in 1999 into three new companies, the Crown has indemnified ECNZ in relation to all of ECNZ's pre-split liabilities, including:

• existing debt and swap obligations
• hedge contracts and obligations, and
• any liabilities that arise out of the split itself.

Genesis Energy Limited - Kupe offshore platform

The Kupe joint venture has had a failure on the power cable running through the umbilical line to the Kupe offshore platform. The Kupe operator has lodged a warranty claim in respect of the cable failure. In addition, an insurance claim for $95 million has been lodged relating to the cable failure. The cable failure has not had any impact on production from the Kupe field.

Genesis Energy Limited - Financial guarantees

Genesis has issued financial guarantees to the alliance contractor and other agents of the Kupe joint venture for the full and faithful performance of its subsidiaries in their capacities as joint venture partners, to the extent of their several liabilities under the development agreement.

Genesis issued a financial guarantee to Energy Clearing House Limited for the full and faithful performance of its subsidiary Energy Online Limited, to the extent of its liabilities for its retail electricity purchases.

These guarantees may give rise to liabilities in the company if the subsidiaries do not meet their obligations under the terms of the respective arrangements.

Genesis Energy Limited - Letters of credit and performance bonds

Genesis, as a participant in the electricity market, issued letters of credit to the Energy Clearing House Limited under the markets' security requirements. These letters of credit are issued as part of normal trading conditions and are to ensure there is no significant credit risk exposure to any one market participant.

Genesis has also issued letters of credit and performance bonds to certain suppliers and services providers under normal trading conditions. The liabilities covered by these arrangements are already provided for in the statement of financial position, and therefore not expected to create any adverse effects on the financial results presented. These are not material to the financial statements.

Housing New Zealand Corporation (HNZC) 

HNZC is liable to the owners (ANZ National Bank Limited, Ichthus Limited and Westpac Banking Corporation) of mortgages sold by HNZC during 1992 to 1999 for credit losses they may incur from specified limited aspects of their ownership of those mortgages with the Crown standing behind this obligation.

The Crown has provided a warranty in respect of title to the assets transferred to Housing New Zealand Limited (HNZL) (HNZL was incorporated into the HNZC group as a subsidiary in 2001 as part of a legislated consolidation of government housing functions) and has indemnified HNZL against any breach of this warranty. In addition, the Crown has indemnified HNZL against any third-party claims that are a result of acts or omissions prior to 1 November 1992. It has also indemnified the directors and officers of HNZL against any liability consequent upon the assets not complying with statutory requirements, provided it is taking steps to rectify any non-compliance.

Indemnities against acts of war and terrorism

The Crown has indemnified Air New Zealand against claims arising from acts of war and terrorism that cannot be met from insurance, up to a limit of US$1 billion in respect of any one claim.

Justices of the Peace, Community Magistrates and Disputes Tribunal Referees

Section 197 of the Summary Proceedings Act 1957 requires the Crown to indemnify Justices of the Peace and Community Magistrates against damages or costs awarded against them as a result of them exceeding their jurisdiction, provided a High Court Judge certifies that they have exceeded their jurisdiction in good faith and ought to be indemnified. Section 58 of the Disputes Tribunal Act 1988 confers a similar indemnity on Disputes Tribunal Referees.

Landcorp Farming Limited

The Protected Land Agreement provides that the Crown will pay Landcorp any accumulated capital costs and accumulated losses or Landcorp will pay the Crown any accumulated profit, attributed to a Protected Land property that is required to be transferred to the Crown or that the Crown releases for sale. The Crown will also be liable to pay Landcorp, at the time of sale or transfer of any property deemed to be Protected Land, the amount of any outstanding equity payments on the initial value of the property.

Maui Partners 

The Crown has entered into confidentiality agreements with the Maui Partners in relation to the provision of gas reserves information. The deed contains an indemnity against any losses arising from a breach of the deed.

Meridian Energy Limited - Letters of credit and performance bonds

In addition to its borrowings, Meridian has entered into a number of letters of credit and performance guarantee arrangements which provide credit support to support the collateral requirements of Meridian's trading business.

National Provident Fund (NPF)

NPF has been indemnified for certain potential tax liabilities. Under the NPF Restructuring Act 1990, the Crown guarantees:

• the benefits payable by all NPF schemes (section 60)
• investments and interest thereon deposited with the NPF Board prior to 1 April 1991 (section 61), and
• payment to certain NPF defined contribution schemes where application of the 4% minimum earnings rate causes any deficiency or increased deficiencies in reserves to arise (section 72).

A provision has been made in these financial statements in respect of the actuarially assessed deficit in the DBP Annuitants' Scheme.

New Zealand Railways Corporation 

The Crown has indemnified the directors of New Zealand Railways Corporation against any liability arising from the surrender of the licence and lease of the Auckland rail corridor.

The Crown has further indemnified the directors of New Zealand Railways Corporation against all liabilities in connection with the Corporation taking ownership and/or responsibility for the national rail network and any associated assets and liabilities on 1 September 2004.

Section 10 of the Finance Act 1990 guarantees all loan and swap obligations of the New Zealand Railways Corporation.

Persons exercising investigating powers 

The Crown, under section 63 of the Corporations (Investigation and Management) Act 1989, indemnifies the Securities Commission, the Registrar and Deputy Registrar of Companies, members of an advisory committee, every statutory manager of a corporation and persons appointed pursuant to sections 17 and 19 of the Act in respect of any liability arising as a result of exercising the investigating powers conferred under the Act. The indemnity does not apply where the investigating powers have been exercised in bad faith.

Public Trust

Section 52 of the Public Trust Act 2001 provides for the Crown to meet any deficiency in the Public Trust's Common Fund in meeting lawful claims on the Fund. This is a permanent (legislated) liability. On 12 October 2010 the Minister of Finance guaranteed interest payable on estates whose money constitutes the Common Fund. The guarantee continues until the earlier of the date the Public Trust Act 2001 is amended to provide that the guarantee in section 52 of that Act applies to both capital and accrued interest, or the date that the Minister of Finance revokes the guarantee.

Reserve Bank of New Zealand

Section 21(2) of the Reserve Bank of New Zealand Act 1989 requires the Crown to pay the Reserve Bank the amount of any exchange losses incurred by the Bank as a result of dealing in foreign exchange under sections 17 and 18 of the Act. This is a permanent (legislated) liability.

Synfuels-Waitara outfall indemnity

As part of the 1990 sale of the Synfuels plant and operations to New Zealand Liquid Fuels Investment Limited (NZLFI), the Crown transferred to NZLFI the benefit and obligation of a Deed of Indemnity between the Crown and Borthwick-CWS Limited (and subsequent owners) in respect of the Waitara effluent transfer line which was laid across the Waitara meat processing plant site.

The Crown has the benefit of a counter indemnity from NZLFI which has since been transferred to Methanex Motunui Limited.

Tainui Corporation

Several leases of Tainui land at Huntly and Meremere have been transferred from ECNZ to Genesis Power. The Crown has provided guarantees to Tainui Corporation relating to Genesis Power's obligations under the lease agreements.

Other unquantifiable contingent liabilities

Abuse Claims

There is ongoing legal action against the Crown in relation to historical abuse claims. At this stage the number of claimants and outcome of these cases are uncertain.

Accident Compensation Corporation (ACC) litigations

There are several legal actions against ACC in existence, arising in the main from challenges to operational decisions made by ACC. ACC will be defending these claims.

Air New Zealand litigation

Air New Zealand has been named in five class actions. One, in Australia, claims travel agents' commission on fuel surcharges and two (one in Australia and the other in the United States) make allegations against more than 30 airlines, of anti-competitive conduct in relation to pricing in the air cargo business. The other two class actions (in the United States and in Canada) allege that Air New Zealand together with many other airlines conspired in respect of fares and surcharges on trans-Pacific routes. All class actions are being defended.

The allegations made in relation to the air cargo business are, and in the case of the European Union were, also the subject of investigations or proceedings by regulators in New Zealand, Australia, and the United States and the European Union. On 15 December 2008 the New Zealand Commerce Commission filed proceedings against 13 airlines including Air New Zealand alleging breaches of the Commerce Act 1986. On 17 May 2010 the Australian Competition and Consumer Commission filed proceedings alleging breaches of the (Australian) Trade Practices Act 1974.

A formal Statement of Objections relating to alleged conduct in the air cargo business was issued by the European Commission in 2007 to 25 airlines including Air New Zealand. Air New Zealand responded to this Statement of Objections and on 9 November 2010 the European Commission advised that it had closed its file in relation to Air New Zealand, following consideration of the responses.

Air New Zealand is defending each of these proceedings. In the event that a court determined, or it was agreed with a regulator, that Air New Zealand had breached relevant laws, the company would have potential liability for pecuniary penalties and to third-party damages under the laws of the relevant jurisdictions.

Caregiver employment conditions

In October 2010, the Court of Appeal heard an appeal against an Employment Court decision relating to minimum wage requirements for employees of disability support services providers currently paid sleepover allowances. If the employer's appeal is unsuccessful, consideration will need to be given to the repercussions for the Crown.

Environmental liabilities

Under common law and various statutes, the Crown may have responsibility to remedy adverse effects on the environment arising from Crown activities.

Departments managing significant Crown properties have implemented systems to identify, monitor and assess potential contaminated sites.

In accordance with NZ IAS 37: Provisions, Contingent Liabilities and Contingent Assets, any contaminated sites for which the Crown has accepted liability and for which costs can be reliably measured have been included as a provision.

Kordia Group Limited

As part of its contractual obligations with clients, Kordia Group Limited has an undertaking to provide services at a certain level and should this not be achieved, Kordia Group Limited may be liable for contract penalties. It is not possible to quantify what these may be until an event has occurred. The company does not expect any liabilities to occur as a result of these contractual obligations.

Maui contracts

Contracts in respect of which the Crown purchases gas from Maui mining companies and sells gas downstream to Contact Energy Limited, Vector Gas Limited and Methanex Waitara Valley Limited provide for invoices to be re-opened in certain circumstances within two years of their issue date as a result of revisions to indices. These revisions may result in the Crown refunding monies or receiving monies from those parties.

Rugby World Cup 2011

The Crown has agreed in joint venture arrangements with the New Zealand Rugby Union (NZRU) to an uncapped underwrite of the costs of hosting the 2011 Rugby World Cup, on a loss sharing basis (Crown 67%, NZRU 33%). A provision for the forecast losses has been made in the Government's financial statements.

The Crown has agreed to reimburse New Zealand income tax that might be incurred by the joint venture entity (Rugby New Zealand 2011 Limited) or NZRU in relation to the joint venture entity, and has also agreed to reimburse NZRU for New Zealand withholding tax that might be incurred on certain payments made in relation to the tournament.

Television New Zealand

Television New Zealand is subject to a number of legal claims. Given the stage of proceedings and uncertainty as to outcomes of the cases, no estimate of the financial effect can be made and no provision for any potential liability has been made in the financial statements.

Treaty of Waitangi claims

Under the Treaty of Waitangi Act 1975, any Māori may lodge claims relating to land or actions counter to the principles of the Treaty with the Waitangi Tribunal. Where the Tribunal finds a claim is well founded, it may recommend to the Crown that action be taken to compensate those affected. The Tribunal can make recommendations that are binding on the Crown with respect to land which has been transferred by the Crown to a State-owned enterprise or tertiary institution, or is subject to the Crown Forest Assets Act 1989.

On occasion, Māori claimants pursue the resolution of particular claims against the Crown through higher courts. There are currently two such actions against the Crown - one awaiting a decision on an application at the Supreme Court and one to be heard at the High Court. Failure to successfully defend such actions may result in liability for historical Treaty grievances in excess of that currently anticipated. The fiscal risk with respect to settlement relativity payments is detailed in the Specific Fiscal Risks section of this chapter.

Westpac New Zealand Limited

Under the Domestic Transaction Banking Services Master Agreement with Westpac Banking Corporation (Westpac’s rights and obligations under this agreement were vested in Westpac New Zealand Limited under the Westpac New Zealand Act 2006), dated 30 November 2004, the Crown has indemnified Westpac:

• in relation to letters of credit issued on behalf of the Crown, and
• for costs and expenses incurred by reason of third-party claims against Westpac relating to indirect instructions, direct debits, third-party cheques, departmental credit card merchant agreements, use of online banking products and Inland Revenue processing arrangements.

Under the Supplier Payments Service - New Zealand Government Master Agreement dated 23 June 2010, the Crown indemnified Westpac New Zealand Limited against certain costs, damages and losses to third parties resulting from unauthorised, forged or fraudulent payment instructions (excluding costs, damages and losses arising from Westpac's wilful default, negligence or breach of the agreement or other applicable legal obligation).

Contingent Assets

Legal proceedings and tax disputes

Legal proceedings and tax disputes are contingent assets in relation to Inland Revenue pending assessments or Inland Revenue initiated assessments. They are net of any losses brought forward. Contingent assets arise where Inland Revenue has advised or is about to advise a taxpayer of a proposed adjustment to their tax assessment. There has been no amended assessment issued at this point or revenue recognised so these are recorded as legal proceedings and disputes – non-assessed. The taxpayer has the right to dispute this adjustment and a disputes resolution process is entered into. Inland Revenue quantifies a contingent asset based on the likely outcome of the disputes process based on experience and similar prior cases.

$637 million at 31 March 2011 ($568 million at 31 October 2010)

5 Forecast Financial Statements#

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These forecasts have been prepared in accordance with the Public Finance Act 1989.

They are based on the accounting policies and assumptions that follow. As with all such assumptions, there is a degree of uncertainty surrounding them. This uncertainty increases as the forecast horizon extends.

The forecasts have been prepared in accordance with the Statement of Responsibility and reflect the judgements and information known at the time they were prepared. They reflect all government decisions and circumstances communicated to 2 May 2011.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined on pages 90 to 94.

Statement of Accounting Policies#

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Significant Accounting Policies

These forecast financial statements have been prepared in accordance with the accounting policies that are expected to be used in the comparable audited actual financial statements of the Government.

These forecast financial statements comply with generally accepted accounting practice (GAAP) as required by the Public Finance Act 1989 and have been prepared in accordance with Financial Reporting Standard 42: Prospective Financial Statements.

All forecasts use the accrual basis of accounting. Forecasts have been prepared for the consolidated financial statements of the Government reporting entity, which includes all entities controlled by the Government (as defined by applicable financial reporting standards).

The specific accounting policies are reproduced in full on the Treasury's website at http://www.treasury.govt.nz/publications/guidance/reporting/accounting

Changes in Accounting Policies

All policies have been applied on a consistent basis during the forecast period. There have been no changes in accounting policies during the period.

Forecast Policies

These forecast financial statements have been prepared on the basis of the Treasury's best professional judgement.

Actual financial results for the periods covered are likely to vary from the information presented. Factors that may lead to a material difference between information in these forecast financial statements and the actual reported results in future years are set out in the chapter on Fiscal Risks.

Key forecast assumptions used are set out on pages 90 to 94.

Government Reporting Entity as at 2 May 2011#

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These forecast financial statements are for the government reporting entity as specified in Part 3 of the Public Finance Act 1989. This comprises Ministers of the Crown and the following entities:

Core Crown

Departments

• Agriculture and Forestry
• Building and Housing
• Canterbury Earthquake Response Authority
• Conservation
• Corrections
• Crown Law Office
• Culture and Heritage
• Defence
• Economic Development
• Education
• Education Review Office
• Environment
• Fisheries
• Foreign Affairs and Trade
• Government Communications Security Bureau
• Health
• Inland Revenue
• Internal Affairs
• Justice
• Labour
• Land Information New Zealand
• Māori Development
• New Zealand Customs Service
• New Zealand Defence Force
• New Zealand Police
• New Zealand Security Intelligence Service
• Office of the Clerk
• Pacific Island Affairs
• Parliamentary Counsel Office
• Parliamentary Service
• Prime Minister and Cabinet
• Science and Innovation
• Serious Fraud Office
• Social Development
• State Services Commission
• Statistics
• Transport
• Treasury
• Women's Affairs

Offices of Parliament

• Controller and Auditor General
• Office of the Ombudsmen
• Parliamentary Commissioner for the Environment

Others

• New Zealand Superannuation Fund
• Reserve Bank of New Zealand

State-owned enterprises 

• Air New Zealand Limited*
• Airways Corporation of New Zealand Limited
• Animal Control Products Limited
• AsureQuality Limited
• Electricity Corporation of New Zealand Limited
• Genesis Power Limited
• Kordia Group Limited
• Landcorp Farming Limited
• Learning Media Limited
• Meridian Energy Limited
• Meteorological Service of New Zealand Limited
• Mighty River Power Limited
• New Zealand Post Limited
• New Zealand Railways Corporation
• Quotable Value Limited
• Solid Energy New Zealand Limited
• Terralink Limited (in liquidation)
• Transpower New Zealand Limited
• Subsidiaries of State-owned enterprises are consolidated by their parents and not listed separately in this table.

*included for disclosure purposes as if it were a State-owned enterprise.

Crown entities

• Accident Compensation Corporation
• Accounting Standards Review Board
• Alcohol Advisory Council of New Zealand
• Arts Council of New Zealand Toi Aotearoa
• Broadcasting Commission
• Broadcasting Standards Authority
• Career Services
• Charities Commission
• Children's Commissioner
• Civil Aviation Authority of New Zealand
• Commerce Commission
• Crown Health Financing Agency
• Crown Research Institutes (8)
• District Health Boards (20)
• Drug Free Sport New Zealand
• Earthquake Commission
• Electoral Commission
• Electricity Authority
• Energy Efficiency and Conservation Authority
• Environmental Risk Management Authority
• Families Commission
• Government Superannuation Fund Authority
• Guardians of New Zealand Superannuation
• Health and Disability Commissioner
• Health Quality and Safety Commission
• Health Research Council of New Zealand
• Health Sponsorship Council
• Housing New Zealand Corporation
• Human Rights Commission
• Independent Police Conduct Authority
• Law Commission
• Legal Services Agency
• Maritime New Zealand
• Mental Health Commission
• Museum of New Zealand Te Papa Tongarewa Board
• New Zealand Antarctic Institute
• New Zealand Artificial Limb Board
• New Zealand Blood Service
• New Zealand Film Commission
• New Zealand Fire Service Commission
• New Zealand Historic Places Trust (Pouhere Taonga)
• New Zealand Lotteries Commission
• New Zealand Productivity Commission
• New Zealand Qualifications Authority
• New Zealand Symphony Orchestra
• New Zealand Teachers Council
• New Zealand Tourism Board
• New Zealand Trade and Enterprise
• New Zealand Transport Agency
• New Zealand Venture Investment Fund Limited
• New Zealand Walking Access Commission
• Office of Film and Literature Classification
• Pharmaceutical Management Agency
• Privacy Commissioner
• Public Trust
• Radio New Zealand Limited
• Real Estate Agents Authority
• Retirement Commissioner
• School Boards of Trustees (2,483)
• Securities Commission
• Social Workers Registration Board
• Sport and Recreation New Zealand
• Standards Council
• Takeovers Panel
• Te Reo Whakapuaki Irirangi (Te Māngai Pāho)
• Te Taura Whiri i te Reo Māori (Māori Language Commission)
• Television New Zealand Limited
• Tertiary Education Commission
• Tertiary Education Institutions (29)
• Testing Laboratory Registration Council
• Transport Accident Investigation Commission

Subsidiaries of Crown entities are consolidated by their parents and not listed separately in this table.

Organisations named or described in Schedule 4 of the Public Finance Act 1989

• Agriculture and Marketing Research and Development Trust
• Asia New Zealand Foundation
• Crown Fibre Holdings Limited
• Fish and Game Councils (12)
• Health Benefits Limited
• Leadership Development Centre Trust
• Learning State Limited
• National Pacific Radio Trust
• New Zealand Fish and Game Council
• New Zealand Game Bird Habitat Trust Board
• New Zealand Government Property Corporation
• New Zealand Lottery Grants Board
• Ngāi Tahu Ancillary Claims Trust
• Pacific Co-operation Foundation
• Pacific Island Business Development Trust
• Research and Education Advanced Network New Zealand Limited
• Reserves Boards (23)
• Road Safety Trust
• Sentencing Council
• The Māori Trustee

Forecast Financial Statements#

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The accompanying notes and accounting policies are an integral part of these Statements.

Forecast Statement of Financial Performance - Functional Expense Analysis for the years ending 30 June

Below is an analysis of core Crown expenses by functional classification. Core Crown expenses include expenses incurred by Ministers, Departments, Offices of Parliament, the NZS Fund and the Reserve Bank, but not Crown entities and State-owned enterprises.

The accompanying notes and accounting policies are an integral part of these Statements.

Forecast Statement of Comprehensive Income for the years ending 30 June

The accompanying notes and accounting policies are an integral part of these Statements.

Forecast Statement of Cash Flows for the years ending 30 June

Note 1: Net issues of Government stock is after elimination of holdings by entities such as NZS Fund, ACC and EQC. Further information on the proceeds and repayments of Government stock ("domestic bonds") is available in note 22.

The accompanying notes and accounting policies are an integral part of these Statements.

The accompanying notes and accounting policies are an integral part of these Statements.

Forecast Statement of Changes in Net Worth for the years ending 30 June

The accompanying notes and accounting policies are an integral part of these Statements.

Forecast Statement of Financial Position as at 30 June

Note 1: Tertiary education institutions constitute most equity accounted investments.

The accompanying notes and accounting policies are an integral part of these Statements.

Forecast Statement of Borrowings as at 30 June

Notes on borrowings

Total borrowings can be split into sovereign-guaranteed and non-sovereign-guaranteed debt. This split reflects the fact that borrowings by State-owned enterprises and Crown entities are not explicitly guaranteed by the Crown. No other debt of State-owned enterprises and Crown entities is currently guaranteed by the Crown.

1. Core Crown borrowings in this instance includes unsettled purchases of securities (classified as accounts payable in the statement of financial position).
2. Gross sovereign-issued debt (GSID) represents debt issued by the sovereign (the core Crown) and includes any Government stock held by the NZS Fund, ACC and EQC.
3. Core Crown financial assets exclude receivables.
4. Net core Crown debt represents GSID less financial assets. This can provide information about the sustainability of the Government's accounts, and is used by some international agencies when determining the credit worthiness of a country.
5. Adding back the NZS Fund assets provides the financial liabilities less financial assets of the core Crown, excluding those assets set aside to meet part of the future cost of New Zealand Superannuation.
6. Net core Crown debt (excluding NZS Fund and advances) excludes financial assets which are held for public policy rather than treasury management purposes.
7. The Reserve Bank has used $1.6 billion of settlement cash to purchase reserves that were to have been funded by the NZDMO borrowing. Therefore, the impact of settlement cash on GSID is adjusted by this amount.

The accompanying notes and accounting policies are an integral part of these Statements.

Statement of Actual Commitments as at 31 March 2011

Statement of Actual Contingent Liabilities and Assets as at 31 March 2011

More information on contingent liabilities (quantified and unquantified) is outlined in the Fiscal Risks chapter.

Notes to the Forecast Financial Statements#

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Note 1: Customs excise-equivalent duty.

Unallocated new spending from Budget 2011 represents expenses included in Budget 2011 that have yet to be allocated.

Forecast for future new spending indicates the expected spending increases from future Budgets.

Unallocated new spending from Budget 2011 represents capital spending included in Budget 2011 that has yet to be allocated.

Forecast for future new spending indicates the expected capital spending increases from future Budgets.

These forecasts assume that, instead of borrowing to fund this new capital spending, the Government will source funding from its existing balance sheet. The forecasts therefore assume that the allowance for new capital spending ($900 million each Budget spread across five years) will be met through a corresponding reduction in assets.This is referred to as "balance sheet funding of new capital spending".

Note 1: These additions do not include any purchases which may result from the allocation of the net forecast for new capital spending (separately disclosed in the Statement of Financial Position).

Note 1: The New Zealand Government has committed under the Kyoto Protocol to ensuring that New Zealand's average net emissions of greenhouse gases over 2008 to 2012 (the first commitment period of the Kyoto Protocol, or CP1) are reduced to 1990 levels, or to take responsibility for the difference. New Zealand can meet its commitment through emissions reductions and use of the Kyoto Protocol flexibility mechanisms such as Joint Implementation, the Clean Development Mechanism, and offsetting increased emissions against carbon removed by forests.

To assist New Zealand in meeting its Kyoto Protocol commitments, an Emissions Trading Scheme (ETS) was established (refer note 20). These two initiatives should be looked at together when understanding New Zealand's international climate change obligations. The asset reported in these financial statements could be significantly reduced if international units are transferred offshore through foresters participating in the ETS. This, combined with other ETS variables, has a significant impact on the Government's net fiscal position from the Kyoto Protocol, which will crystallise when the first Kyoto commitment period is settled up post-2012.

These financial statements report on the New Zealand Government's international climate change obligations for the first commitment period, but not for future commitment periods which are currently being negotiated.

The latest Net Position estimate for 2011 can be found on the Ministry for the Environment's website: www.mfe.govt.nz/issues/climate/greenhouse-gas-emissions/net-position

NOTE 18: Insurance liabilities

¹The majority of the 2011 forecast balance relates to the Canterbury earthquakes.

ACC liability

Calculation information

PricewaterhouseCoopers Actuarial Pty Ltd has prepared an independent actuarial estimate of the ACC outstanding claims liability as at 31 December 2010. This estimate includes the expected future payments relating to accidents that occurred prior to balance date (whether or not the associated claims have been reported to, or accepted by, ACC) and also the expected future administrative expenses of managing these claims.

The key economic variables that impact on changes to the valuation are the long-term Labour Cost Index (LCI), average weekly earnings and the discount rate. Discount rates were derived from the yield curve for New Zealand government bonds. For these forecast statements, the claims liability has been updated for the latest discount rate as at 31 March 2011. The equivalent single effective discount rate, taking into account ACC's projected future cash flow patterns, is a short-term discount rate of 5.98% and a long-term discount rate of 6%. Other key variables in each valuation are the forecast increases in claim costs over and above the economic variables above, and the assumed rate at which long-term claimants will leave the scheme over the period. This assessment is largely based on scheme history.

Presentation approach

The projected outstanding claims liability is included within total liabilities. ACC has available to it a portfolio of assets that partially offset the claims liability. The assets (less cross holdings of New Zealand Government stock) are included in the asset portion of the Crown's overall statement of financial position.

NOTE 19: Retirement plan liabilities

The net liability of the Government Superannuation Fund (GSF) liabilities has been calculated by the Government Actuary as at 31 January 2011. The liability arises from closed schemes for past and present public sector employees as set out in the Government Superannuation Fund Act 1956. A Projected Unit Credit method is used to calculate the liability as at 31 January 2011, based on membership data as at that date. The funding method requires the benefits payable from GSF in respect of past service to be calculated and then discounted back to the valuation date.

The net GSF liability at this valuation was calculated using discount rates derived from the market yield curve as at the balance date and then blended to the long-term discount rate of 6% (long-term rate unchanged from 30 June 2010). Other principal long-term financial assumptions were an inflation rate, as measured by the Consumer Price Index, of 4.6% for 2011 decreasing to 2.6% in 2012 and decreasing further to 2.5% from 2013 and an annual salary growth rate, before any promotional effects, of 3% (unchanged from 30 June 2010).

The 2010/11 projected reduction in the net GSF liability is $668 million, reflecting a decrease in the GSF liability of $384 million and an increase in the GSF assets of $284 million.

The decrease in the GSF liability of $384 million includes an actuarial gain between 1 July 2010 and 31 January 2011, of $61 million owing to experience adjustments. In addition to the actuarial gain, changes in the current service cost, interest cost and benefits paid to members give an overall net projected change of $384 million.

The increase in the value of the net assets of GSF of $284 million includes an actuarial gain, from 1 July 2010 to 31 January 2011, of $227 million. The balance of $57 million is the total of the expected investment returns and contributions received, offset by the benefits paid to members.

The changes in the projected net GSF liability from 2010/11 onwards reflect the net of the expected current service cost, interest cost, investment returns and contributions.

NOTE 20: Provisions

Provision for ETS credits

The Emissions Trading Scheme (ETS) was established to encourage reduction in greenhouse gas emissions. The ETS creates tradable units (the NZ Unit) which the Government can allocate freely or sell to entities. The allocation of NZ Units creates a provision (and an expense if allocated for free). The provision is reduced, and revenue recognised, as NZ Units are surrendered to the Crown by emitters. Emitters can also use international Kyoto Units to settle their emission obligation, which might occur where emissions exceed the number of allocated NZ Units. In the ETS transition period to the end of 2012, emitters can also use the NZ$25 price option to settle their emission obligation.

Until the end of 2012, the Government's net position regarding its climate change obligations will be determined by the net Kyoto position and the provision for ETS credits. After 2012, the net position will depend on any future international climate change commitments.

The carbon price is assumed to remain constant over the forecast period and is based on the estimated current carbon price of €10.95 with an exchange rate of 0.5387 (a carbon price of NZ$20.33).

The ETS impact on the fiscal forecast is as follows:

NOTE 21: Net worth attributable to the Crown

NOTE 22:  Reconciliation of core Crown operating cash flows to residual core Crown cash

Forecast Statement of Segments#

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Statement of Financial Performance for the year ended 30 June 2010

Statement of Financial Position as at 30 June 2010

Statement of Financial Performance for the year ended 30 June 2011

Statement of Financial Position as at 30 June 2011

Statement of Financial Performance for the year ended 30 June 2012

Statement of Financial Position as at 30 June 2012

Statement of Financial Performance for the year ended 30 June 2013

Statement of Financial Position as at 30 June 2013

Statement of Financial Performance for the year ended 30 June 2014

Statement of Financial Position as at 30 June 2014

Statement of Financial Performance for the year ended 30 June 2015

Statement of Financial Position as at 30 June 2015