Budget Economic and Fiscal Update 2013

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 other circumstances as at 29 April 2013 that were communicated to me by the Minister of Finance in accordance with the requirements of the Public Finance Act 1989 and of other economic and fiscal information available to the Treasury as at 29 April 2013. This Update does not incorporate any decisions, circumstances, or statements that the Minister of Finance has determined, in accordance with the Public Finance Act 1989, should not be incorporated in this Update.

Gabriel Makhlouf
Secretary to the Treasury

6 May 2013

To enable the Treasury to prepare this Economic and Fiscal Update I have ensured the Secretary to the Treasury has been advised, in accordance with the requirements of the Public Finance Act 1989, of all Government decisions and other circumstances as at 29 April 2013 of which I was aware and that had material economic or fiscal implications.

I accept responsibility for the integrity of the disclosures contained in the Update and responsibility for the consistency and completeness of the Update information with the requirements of Fiscal Responsibility in the Public Finance Act 1989.

Hon Bill English
Minister of Finance

6 May 2013

Executive Summary#

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• Real gross domestic product (GDP) growth is expected to increase to 3% in the year ended March 2015, and average 2.5% over the five years to March 2017, a little above the Treasury's estimate of potential growth over this period. Growth averaged 0.8% in the prior five years.
• The operating balance before gains and losses (OBEGAL) is forecast to move from a deficit of $6.3 billion this year (compared with $7.3 billion forecast in the Half Year Economic and Fiscal Update) to a surplus of $75 million in the year ending June 2015.

Figure 1 - Real GDP and private final demand*

Sources: Statistics New Zealand, the Treasury

*Private final demand comprises private consumption, residential and market investment spending

• Net core Crown debt is forecast to peak as a share of GDP at 28.7% in the year ending June 2015.
• Domestic demand is the main driver of economic growth, with private spending growth accelerating to over 6% in the year ahead.
• Strong growth in imports associated with higher investment provides a substantial offset to overall growth over the forecast period. In addition, the impact of drought lowers growth in the year ended March 2014.
• This growth outlook sees the unemployment rate decline to around 5% and annual Consumers Price Index (CPI) inflation move back to the middle of the 1% - 3% target band. As in the Half Year Update, the current account deficit is forecast to increase as the Canterbury rebuild gets into full-swing.
• The Canterbury rebuild is one of the main positive forces operating on demand over the forecast period, although the precise timing of activity remains a key uncertainty. The estimated level of investment associated with the rebuild has been revised up to $40 billion from $30 billion in the Half Year Update. This investment is expected to extend well beyond the forecast period. The government's fiscal costs are currently assessed to be $15.2 billion.
• Household and business spending growth is expected to increase, although it is more muted than that seen in the 2000s. Household saving as a share of income is forecast to track around recent levels, up around 10 percentage points from its low of the past decade.
• Monetary policy stimulus is forecast to continue for some time. As spare capacity is absorbed and inflation pressures pick up, interest rates are expected to rise gradually.
• Budget 2013 incorporates a reduction in future operating allowances that sees a continuation of moderate government spending growth. This, together with some recovery in tax revenue, sees fiscal policy exerting a restraining influence on the economy and interest rates, notwithstanding signalled reductions in Accident Compensation Corporation (ACC) levies in the June 2015 and 2016 years.
• The exchange rate is assumed to remain high for much of the forecast period. This will hold back activity in exporting and import-competing firms, especially those not experiencing what are expected to be relatively strong export commodity prices.
• The terms of trade is forecast to increase in the year ahead, leading to a rebound in nominal GDP growth and supporting faster growth in tax revenue.

Figure 2 - OBEGAL, core Crown residual cash and net core Crown debt

Source: The Treasury

• While the OBEGAL returns to surplus in the year ended June 2015, core Crown operating cash flows remain in deficit for a further year. When combined with net capital spending, residual cash remains in deficit for each year of the forecast period.
• Since the Half Year Update forecasts were released, the risks to the main forecasts have become more balanced.
• Significant risks to global growth remain. But overall, global risks have become more even as policy-makers have moved to reduce the chance of more extreme downside risks materialising or to boost growth. Domestically, there is a mix of upside and downside risks, including the size and pace of the Canterbury rebuild, the path and pass-through of the exchange rate, impact of the drought, and the saving behaviour of households particularly in light of current house price increases.
• The Budget Economic and Fiscal Update contains two alternative scenarios to illustrate some of the risks to the main forecasts. While short-term growth is higher in the higher house price scenario, OBEGAL returns to surplus in the same year as in the main forecasts. In the lower inflation scenario, associated lower nominal GDP growth means that OBEGAL remains in deficit until the year ended June 2017.
• In addition to the fiscal impact of changes to economic activity, the Government is exposed to other fiscal risks. For example, the Crown's financial position is susceptible to market risk with regards to movements in market variables such as interest rates, exchange rates and equity prices. There are also a number of contingent liabilities and fiscal risks outlined in the Specific Fiscal Risks chapter.

Notes:

1. Real production GDP, annual average percentage change
2. Percent of labour force, March quarter, seasonally adjusted
3. Annual percentage change. March quarter 2013 is actual
4. % of GDP
5. Net core Crown debt excluding the New Zealand Superannuation Fund and advances

Sources: Statistics New Zealand, the Treasury

Economic Outlook#

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Overview#

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After a slow recovery from recession, real GDP growth in the New Zealand economy picked up over 2012, reaching 2.5%, the strongest annual average rate since March 2008. Looking forward, the economy is forecast to grow at an average pace of 2.5% per year over the five years to March 2017 (Figure 1.1).

Growth outlook influenced by supportive and constraining factors

Figure 1.1 - Real GDP growth

Source: Statistics New Zealand, the Treasury

The growth outlook reflects the net impact of a number of supporting and constraining influences. On the supportive side are the Canterbury rebuild, a high terms of trade, low interest rates and less risk-averse households and firms.

An elevated exchange rate will act as a constraining force on growth as well as working against a rebalancing of growth towards exports. In the near term, the recent drought will also restrain growth as agricultural output is lowered, but it is expected to rebound later as weather conditions return to normal. The forecast reduction in the fiscal deficit will lean against demand growth and reduce pressure on resources, supporting lower interest rates.

These influences on the outlook for the economy are the same as in the Half Year Economic and Fiscal Update, with the exception of the drought that developed in early 2013.

Several global factors will impact in different ways...

The trading partner growth outlook is similar to that presented in the Half Year Update, strengthening slightly over the forecast period from 3.4% in 2013 to 3.9% in 2017. Around this outlook, risks have become more even as a result of policy action to reduce the prospects of downside risks eventuating, but on balance they remain skewed towards weaker growth.

Global demand is expected to push export prices higher, leading to an increase in the goods terms of trade over the forecast horizon. This is a key impetus for income growth and growth in the nominal economy, supporting tax revenues.

In contrast, global monetary policy settings are acting to hold the New Zealand dollar (NZD) at current high levels. The exchange rate is assumed to remain high until around 2015, before depreciating somewhat. This will constrain non-commodity export growth, including services exports.

The drought will reduce economic activity in the 2013 calendar year, with an estimated negative impact on real GDP growth of 0.7 percentage points. However, there are risks that the impact could be greater if the drought has a larger effect on agricultural output. The impact on nominal GDP is expected to be broadly similar to the 0.7 percentage point real impact in the 2013 calendar year, equivalent to around $1.5 billion.

...while the Canterbury rebuild is a significant driver of GDP growth...

The Canterbury rebuild is expected to provide significant impetus to growth over the forecast horizon, chiefly through additional residential and business investment, but also through related consumption spending. The rebuild will also contribute to an improvement in the labour market, with the unemployment rate falling to 5.2% by 2017. It is expected a significant proportion of the residential rebuild will be completed by 2017, but levels of investment should remain high beyond this as the commercial rebuild continues and there is a more widespread pick up in activity.

...as low interest rates and household behaviour also impact on output growth

Interest rates are expected to remain supportive of growth over most of the forecast horizon. Ninety-day interest rates are expected to begin increasing from record low levels in mid-2014 as inflationary pressures rise in the economy. Inflation is expected to rise to the middle of the 1% to 3% target band in the March 2014 year as the Canterbury rebuild ramps up and spare capacity is used up in the economy.

Households are now assumed to be broadly comfortable with their financial position, given the amount of debt reduction (as a share of income) undertaken over recent years. This, combined with some moderation in risk aversion, is expected to see the household saving rate remain broadly stable over the forecast period. This results in stronger consumption growth than in the 2012 and 2013 March years, as household spending grows more in line with income growth.

The mix of the high NZD and strong domestic demand growth contributes to a widening of the annual current account deficit, from 5.0% of GDP in the December 2012 quarter to 6.5% in the March 2017 quarter.

Notes:

1. Forecasts finalised 18 April 2013
2. Contribution to GDP growth
3. Estimated as the percentage difference between actual real GDP and potential real GDP
4. Percent of the labour force, March quarter, seasonally adjusted
5. Percent of the working-age population, March quarter, seasonally adjusted
6. Quarterly Employment Survey, average ordinary-time hourly earnings, annual percentage change
7. Annual percentage change, actual for 2013
8. System of National Accounts (SNA) and merchandise basis, annual average percentage change
9. Average for the March quarter, actual for 2013

Longer time series for these variables are provided on page 127.

Recent Economic Developments#

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Economic growth picked up pace at the end of 2012...

After a period of weak growth in the middle of 2012, New Zealand's real GDP rose 1.5% in the December 2012 quarter. Growth was broad-based across industries, with the forestry and logging sector performing well, in part owing to good harvesting conditions and robust demand from China. Construction activity also accelerated, as the Canterbury rebuild began to get underway in earnest. However, while real GDP growth was strong in the quarter, nominal GDP growth continued to be low, declining for the third time in four quarters, as the terms of trade fell further and pricing pressures remained weak in the economy.

The strong December quarter real GDP growth contributed to a solid 2012 year overall for the economy. Real production GDP rose 2.5% in the year to 2012, the strongest annual average growth rate since March 2008 and faster than many other developed economies (Figure 1.2). Despite solid growth in real GDP, employment growth has been weak and the unemployment rate remains elevated. The recent performance of the labour market is discussed in more detail in the box “Recent Labour Market Conditions” (page 21).

Figure 1.2 - Real GDP growth rates

Sources: Statistics New Zealand, Haver Analytics

...with indicators pointing to ongoing strength in early 2013...

Indicators point to continuing growth in early 2013. Higher business confidence points to increased activity, which should translate into additional business investment. Consumer confidence has also picked up in 2013, suggesting ongoing consumption growth, although some moderation is expected from the surge in private consumption seen in the December quarter. Other indicators, such as the Performance of Manufacturing Index (PMI) and Performance of Services Index (PSI), point to a recovery in the manufacturing sector and continuation of growth in the service sector respectively.

...but drought will provide some offset

The impact of the drought will provide some offset to the positive growth suggested by forward-looking indicators. The drought will lower agricultural output, particularly in the dairy sector, as well as have other impacts throughout the economy. The impacts of the drought are discussed in more detail in the box “Economic Impacts of the Drought” (page 17).

International Economic Outlook#

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Global growth steady, while downside risks recede

As the global financial crisis clearly illustrated, global economic conditions are an important force impacting on the New Zealand economy. The trading partner growth outlook is similar to that underpinning forecasts in the Half Year Update. New Zealand's main trading partners, weighted by export share, are expected to grow 3.4% in the 2013 calendar year. This is slightly slower than 2012, primarily owing to slower Australian growth as mining investment moderates (Table 1.2). Trading partner growth is then expected to pick up to just below 4.0% by 2017 (Figure 1.3).

Figure 1.3 - Top-16 trading partner growth

Sources: IMF, Haver Analytics, the Treasury

While the central outlook for trading partner growth remains broadly unchanged from the Half Year Update, the risks to the outlook have become more balanced. Policy actions by central banks, including the willingness of the European Central Bank to purchase government bonds, additional quantitative easing in the US and additional monetary easing in Japan, have all contributed to a reduction in extreme downside risks. There are also upside risks to the outlook, some of which are associated with the impacts of increased monetary easing in Japan and the US, but also a stronger-than-expected cyclical rebound in global demand.

However, risks are still slightly skewed to the downside. The euro area remains weak, with the region's activity expected to contract again in 2013. The bailout of Cyprus in March shows policy-makers are still only “managing through” the crisis, while the underlying issues of high government debt and a lack of competitiveness in the peripheral economies remain. Other downside risks include a greater-than-expected impact on growth from the automatic government spending cuts in the US, as well as a large housing market correction in China. More detail on the risks to the global outlook can be found in the Risks and Scenarios chapter.

* South Korea, Taiwan, Hong Kong, Singapore, Malaysia, Indonesia, Thailand, Philippines, India

Sources: IMF, Haver Analytics, Consensus Economics, the Treasury

New Zealand Economic Outlook#

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Moderate growth in New Zealand's economy expected to continue...

Overall, real GDP growth in the New Zealand economy is expected to be similar to the forecasts presented in the Half Year Update in December, averaging 2.5% per year, a little above the Treasury's estimate of potential growth over the forecast period. However, the profile of growth is slightly different to the Half Year Update, owing to a stronger-than-expected exchange rate, lower-than-expected pricing pressures, revisions to previous data and, most notably, the impact of the drought on the agricultural and related industries.

Real production GDP growth is forecast to be 2.5% and 2.4% in the years ending March 2013 and March 2014 respectively, compared with 2.3% and 2.9% forecast in the Half Year Update. The March 2014 year growth rate is lower than in the Half Year Update primarily because of the impact of the drought on the economy.

Nevertheless, growth in the March 2015 year and beyond is expected to pick up as business and residential investment rise, in part driven by the Canterbury rebuild, as well as the recovery from the drought. Growing consumption, as incomes improve, also plays a part. Net exports are expected to be a drag on growth from 2013 to 2016 (March years), as a higher NZD impacts on export and import demand. Imports also grow owing to demand arising from the Canterbury rebuild. After this, net exports are forecast to provide a positive contribution as international demand continues to grow and the NZD depreciates. Figure 1.4 shows the main contributions to expenditure GDP growth.

Figure 1.4 - Composition of Expenditure GDP growth

Sources: Statistics New Zealand, the Treasury

...as private consumption continues growing solidly...

Private consumption is expected to make a solid contribution to GDP growth over the forecast period. Private consumption growth is expected to pick up over 2013 and 2014 as consumer confidence remains elevated and incomes rise. Annual real private consumption growth is forecast to peak at 2.8% in the 2014 and 2015 March years, before moderating to 2.0% in the March 2017 year (Figure 1.5). The other main driver of the increase in consumption over the forecast period is the pick up in residential investment, especially with the Canterbury rebuild, resulting in additional durables consumption. It is expected that the recent rise in house prices will have less effect on consumption than in the previous cycle, as households have become more cautious. As a result, consumption generally grows with income, with only a small scope for housing equity withdrawal as a means of funding additional spending. The Government's signalled changes to ACC levies are expected to result in additional modest increases in consumption, focused mainly towards the end of the forecast period. More details on signalled changes to ACC levies can be found in the Fiscal Outlook chapter on page 35.

Figure 1.5 - Private consumption

Sources: Statistics New Zealand, the Treasury

...while the household saving rate remains steady

Household saving as a percentage of disposable income is expected to remain broadly in balance across the forecast period, as it has been for the past few years (Figure 1.6). This represents a shift in behaviour from much of the past two decades and its continuation will be an important factor influencing demand in the economy. Household saving is around 10 percentage points higher than its low a decade ago.

Figure 1.6 - Net household saving rate

Sources: Statistics New Zealand, the Treasury

It is assumed that households are now broadly comfortable with the amount of debt reduction (as a share of income) undertaken over recent years given developments in their net worth, partly driven by house price developments, reduced uncertainty about future economic growth, and income prospects. However, households are expected to remain cautious in their spending habits, with increases in consumption coming from rises in income, rather than from running down assets or increasing debt further.

GDP growth to be boosted by residential investment from the Canterbury rebuild...

Residential investment remains a key driver of demand growth in these forecasts. A significant proportion of the growth in residential investment across the forecast period is driven by earthquake-related investment associated with the Canterbury rebuild. There are signs that the rebuild is about to ramp up significantly, with building consents and anecdotal evidence from the region suggesting that a number of the factors delaying progress thus far are diminishing. Annual real residential investment growth is expected to peak at almost 30% in the March 2014 year, as the Canterbury rebuild gets into full swing.

While the Canterbury rebuild is expected to make up a large proportion of the surge in residential investment over the forecast period, activity in the rest of the country is also expected to rise significantly, especially in the Auckland region. Figure 1.7 shows the level of real residential investment with and without the Canterbury rebuild. The drivers of the underlying growth include a catch up for past population growth, expected future population increases (including through migration), rising household incomes, low interest rates and some ongoing repairs of leaky homes.

Figure 1.7 - Real residential investment

Sources: Statistics New Zealand, the Treasury

Higher house prices, particularly in the Auckland region, are expected to encourage an increase in new home building, with signs of this already in dwelling consents data. This will help to moderate growth in house prices, but will take some time, with annual house price inflation forecast at around 7% in each of the March 2013 and 2014 quarters. The growth in residential investment begins to moderate after the March 2014 year, when the pace of the Canterbury rebuild reaches its peak.

...as well as strengthening market investment...

A pick up in market investment is also expected to be a strong driver of growth over the forecast period. While market investment has recovered somewhat following the global financial crisis, it is yet to exceed its pre-crisis peak (Figure 1.8). However, improved business confidence, low interest rates, a high exchange rate (making imported capital goods cheaper) and some catch up are all expected to result in stronger growth over 2013 and 2014. Later in the forecast period, higher interest rates and a lower exchange rate will see market investment growth moderate. The Canterbury rebuild is also expected to contribute to the increase in market investment.

Figure 1.8 - Real market investment

Sources: Statistics New Zealand, the Treasury

...while government consumption growth is expected to remain low

The combined impact of fiscal decisions in the 2013 and previous Budgets will see real government consumption rise only very modestly, averaging 0.4% per year over the forecast period, compared to around 4% for much of the 2000s. This sees government consumption as a share of real GDP fall towards the past decade's low of 16% (Figure 1.9). A lower share of government spending in the economy will free up resources enabling additional activity elsewhere, such as the Canterbury rebuild. It also allows interest rates and the exchange rate to remain lower than they would otherwise be. After allowing for both operating and capital spending and revenue developments, fiscal policy is forecast to be subtracting on average about 0.6% of GDP from demand per year in the economy between the 2013 and 2017 June years.[1]

Figure 1.9 - Real government consumption

Sources: Statistics New Zealand, the Treasury

Figure 1.10 - Export and import volume growth

Sources: Statistics New Zealand, the Treasury

Net exports to provide negative contribution to growth...

Net exports are forecast to be a drag on real GDP growth across much of the forecast period. While positive export volumes growth is expected to return following the negative impact of the drought, import volume growth is expected to outstrip this, primarily as investment growth remains strong. Increased investment, chiefly on the business side, usually has a large import component. Net exports are expected to provide a positive contribution to growth again in the 2017 March year, as the pace of the Canterbury rebuild peaks. The exchange rate is also assumed to depreciate towards the end of the forecast horizon, making imports relatively more expensive and boosting demand for exports.

Goods export volumes are expected to fall in the near term, as the drought negatively impacts agricultural production in the 2013 and 2014 March years, but pick up thereafter. The impacts of the drought are examined in more detail in the box below. Services export growth is expected to remain low in the near term as the exchange rate remains elevated, making New Zealand a more expensive destination for tourists and foreign students.

Over the longer term, both goods and services export volumes are expected to grow more strongly, largely driven by an assumed depreciation in the New Zealand dollar. Both are also expected to rise as global demand picks up, generating additional demand for New Zealand's goods and services. In addition, dairy and other commodity exports are likely to benefit from links with fast-growing Asian markets (Figure 1.10).

...but increase in goods terms of trade will provide support to incomes

The goods terms of trade are expected to rebound significantly over 2013 and continue rising, providing support to incomes over the forecast horizon (Figure 1.13). The near-term rebound in the goods terms of trade is in part expected to be driven by the substantial increase in dairy prices thus far in 2013 following falls over 2012, as discussed in the drought box above.

Figure 1.13 - Goods terms of trade (SNA)

Sources: Statistics New Zealand, the Treasury

Over the medium term, the goods terms of trade are expected to continue to strengthen, supported by a number of structural factors. Global demand for New Zealand's commodity exports is forecast to strengthen over time, resulting in commodity prices remaining at or near historical highs. Demand from China in particular for New Zealand dairy products is forecast to increase, as incomes and per capita consumption rise, supporting global prices. The higher goods terms of trade are also a key driver of nominal GDP growth in the economy over the forecast period.

Higher goods import prices will provide some offset to the higher goods export prices. Rises in prices of consumer and intermediate goods imports are expected to be partly offset by the continuation of falls in prices of capital goods. West Texas Intermediate (WTI) oil market futures contracts, which form the basis for the oil price assumption, are pricing in a gradual decline in oil prices over the forecast period. WTI oil prices are assumed to fall to around $85 per barrel in the June quarter of 2017, around 10% lower than their average in the March 2013 quarter.

The current account deficit widens...

The current account, which measures economic transactions between New Zealand residents and the rest of the world, comprises balances on imports and exports of goods and services, income flows and transfers. The annual current account deficit is expected to widen from 5.0% of GDP in the December 2012 quarter to 6.5% of GDP in the March 2017 quarter. The widening is expected to be driven by a widening of the deficit on services, a fall in the goods surplus and a further fall in the income balance (Figure 1.14).

Figure 1.14 - Current account balance

Sources: Statistics New Zealand, the Treasury

The goods balance is expected to remain reasonably strong in the near term, supported by the recent increases in commodity prices. However, further out, the balance will deteriorate, primarily owing to increased imports associated with the pick up in investment across the forecast period. The balance begins to recover at the end of the forecast period as investment growth slows and the depreciating exchange rate makes New Zealand goods more attractive overseas, supporting export volumes and receipts.

Weakness in the services balance is the main driver of the deterioration in the current account deficit, as a falling exchange rate results in an increase in the value of imports of services (as overseas travel and other services imports become more expensive). Exports of services are expected to increase only moderately as the global economy recovers, in part owing to the elevated exchange rate.

The income deficit is also expected to widen - primarily in the latter part of the forecast horizon - as business profits pick up, leading to increased flows overseas of income on equity investments in New Zealand, as well as higher interest payments overseas on New Zealand's net stock of debt as a result of higher international interest rates.

...even as national saving rises

The current account deficit (equal to the difference between national saving and investment) is expected to increase over the forecast period. This is owing to investment increasing by more than saving, partly as a result of the Canterbury rebuild (Figure 1.15). However, the investment-saving gap does not flow through fully into new borrowing, with a large proportion of the Canterbury rebuild to be paid for by overseas insurance inflows; Statistics New Zealand estimates a total of $17.9 billion of reinsurance claims from all of the Canterbury earthquakes. At the end of the December 2012 quarter, $8.0 billion of these claims had been settled with overseas reinsurers, with these inflows recorded in the financial account of the balance of payments.

Figure 1.15 - Saving and investment

Sources: Statistics New Zealand, the Treasury

The rise in national saving is driven mainly by higher general government saving over the forecast period, as tax revenue increases and government consumption continues to be restrained. Gross general government saving as a share of GDP is expected to rise from a low of -1.5% in the 2011 March year to 3.5% in the 2017 March year.

Business operating surplus growth is expected to rise in the near term as output continues to grow faster than hours worked and margins are restored, improving profits and supporting corporate tax revenue. Operating surplus growth is expected to moderate thereafter, as the labour market picks up and the overall pace of nominal GDP growth slows. Household saving, as discussed above, is expected to remain broadly stable across the forecast period.

The net international liability position is forecast to rise from 71.7% of GDP at the end of December 2012 to 80.9% of GDP at the end of March 2017, partly reflecting a fall in international assets as insurance claims are settled.

Labour market conditions remain subdued...

While GDP growth was solid in 2012, the unemployment rate remains elevated and employment growth weak. Despite this, wage growth remains moderate, with skilled workers in particular demand. Indicators for the labour market have pointed to a pick up for some time, but this is yet to eventuate. Recent labour market conditions are discussed in more detail in the box below.

...but set to strengthen as business confidence and output increase

The labour market is expected to strengthen over the forecast period, beginning in the second half of 2013. The Canterbury rebuild will be a large contributor to the strengthening, particularly in the 2014 March year, but a more widespread improvement is expected to occur across the country as output continues to increase. A turn in net migration, as fewer New Zealanders leave for Australia as the mining investment boom reaches a peak and the Australian economy slows, is expected to support the filling of skilled job vacancies and keep wage growth moderate. Signalled reductions in ACC levies are expected to generate some additional demand for workers, while ongoing welfare reform is expected to strengthen job-search incentives and have a positive influence on labour force participation.

Employment growth is expected to be positive in the first half of 2013, before accelerating as the recovery becomes more entrenched, giving businesses enough confidence to employ additional workers. Annual average employment growth is expected to turn around from a low of -0.8% in the June 2013 quarter to peak at 3.1% in the September 2014 quarter (Figure 1.18). Employment growth is then expected to moderate towards the end of the forecast period.

Figure 1.18 - Unemployment rate and employment growth

Sources: Statistics New Zealand, the Treasury

The strong employment growth is expected to drive a fall in the unemployment rate across the forecast period. The unemployment rate is expected to stay broadly steady at around 6.9% over the first half of 2013, before declining steadily, to slightly above 5% in March 2017. The rise in employment, fall in unemployment and pressures from the Canterbury rebuild are expected to put upward pressures on wages in the near term, with annual growth in average hourly earnings expected to rise to 3.2% in the December 2013 quarter, before moderating the following year. Over time, wage pressures will begin to grow again as the unemployment rate continues to fall.

Growth in compensation of employees, which is driven by changes in the number of hours worked in the economy as well as wage rates, is forecast to increase 2.9% in the March 2013 year, 3.9% in the March 2014 year and 4.7% in the March 2015 year as the labour market recovers and additional hours are worked. Higher wage rates will also contribute. Annual growth in compensation of employees is then expected to moderate slightly towards the end of the forecast period as employment and hours worked growth slows. Compensation of employees is an important contributor to forecasts of PAYE revenue.

Inflation low as exchange rate remains elevated...

Annual Consumers Price Index (CPI) inflation has been lower than anticipated in the Half Year Update. The main drivers for the lower result are a greater flow-through from a higher exchange rate and ongoing heavy discounting by retailers as they try to maximise sales volumes. The elevated exchange rate has contributed to negative annual tradables inflation; this has helped retailers, particularly those who sell imported goods, to keep prices low, as they operate in a highly-competitive environment. Annual non-tradables inflation remains below its long-term average, but still relatively high at 2.4% in the March 2013 quarter, given that spare capacity remains in the economy, keeping pricing pressures lower.

...but set to increase as spare capacity is used up and exchange rate depreciates...

While inflation has been low recently, both non-tradables and tradables pricing pressures are expected to pick up over the forecast period (Figure 1.19). Pressure on non-tradables prices will come primarily through a closing of the output gap as spare capacity is used up. Potential growth is forecast to increase from just under 2% currently and approach 2.5% near the end of the forecast period.[3] While the size of the current negative output gap is subject to uncertainty, the estimated gap of 0.8% of GDP in the March 2013 quarter is expected to be eliminated by mid-2014. Another factor that is likely to contribute to additional non-tradable pricing pressures is the Canterbury rebuild. It is expected that these pressures will be moderate as productivity gains are made, although there are risks to this judgement. These risks are discussed further in the Risks and Scenarioschapter. Higher government charges are also expected to contribute to non-tradables inflation, with higher tobacco prices in particular contributing around 0.4 percentage points to annual non-tradable inflation (or 0.2 percentage points to total inflation) in each year excluding the March 2017 year.

Figure 1.19 - Inflation

Sources: Statistics New Zealand, the Treasury

The exchange rate will be the main influence on tradables inflation over the forecast period. The NZD trade-weighted index (TWI) is expected to remain elevated over 2013 and 2014, before depreciating over the rest of the forecast period. This reflects the adjustment required to reduce the current account deficit to a sustainable level over time (Figure 1.20). As the exchange rate stops appreciating and then depreciates, there will be upwards pressure on tradables inflation. Risks around the path and pass-through of the exchange rate are discussed in the Risks and Scenarios chapter.

Figure 1.20 - TWI, 90-day and 10-year rates

Sources: RBNZ, the Treasury

Overall, annual CPI inflation is expected to rise to 1.9% in the March 2014 quarter from 0.9% in the March 2013 quarter. Inflation will increase only gradually from there, to 2.2% in the March 2017 quarter.

...leading to a withdrawal of monetary stimulus 

Over time, as the economy continues to grow and spare capacity is used up, monetary stimulus is expected to be progressively withdrawn in order to combat increasing inflationary pressures. The withdrawal of stimulus in these forecasts is more gradual than assumed in the Half Year Update as the result of lower-than-expected inflationary pressures to date. Ninety-day interest rates are expected to remain around 2.7% until the March 2014 quarter. After this, rates should rise gradually as inflation pressures increase. Ninety-day rates are expected to be 4.8% in the March 2017 quarter (Figure 1.20).

Ten-year government bond rates have been low over the second half of 2012 and early 2013 as New Zealand bonds have received additional demand from overseas investors looking to diversify portfolios. The New Zealand economy has also performed favourably on an international stage, attracting more funds. However, 10-year interest rates are expected to increase over the forecast horizon, primarily as global risk appetite increases as growth prospects improve. Typically this will reduce the demand for government bonds and increase demand for other higher-yielding assets such as equities, increasing bond yields - this is expected to be not only a trend in New Zealand bonds, but bonds around the globe. Ten-year bond rates are forecast to increase from 3.7% in the March 2013 quarter to 5.2% by the June 2017 quarter (Figure 1.20).

Stronger nominal GDP growth expected

Despite solid real GDP growth, nominal GDP growth (which includes price effects as well as volumes) has been soft over the past year. Nominal GDP growth for the March 2013 year is expected to be a modest 2.7%, down from 4.6% and 3.8% in 2011 and 2012 respectively. Weak pricing pressures have been the main reason behind the weaker nominal GDP result, with a high exchange rate keeping downwards pressures on tradables prices, strong competition and subdued demand engraining a discounting culture among businesses, and falling terms of trade also contributing. However, a strong turnaround is expected in the March 2014 year, with nominal GDP expected to rise 6.4%. This will primarily be driven by an increase in the terms of trade, but also a levelling off in the exchange rate and a pick up in demand across the economy leading to greater pricing pressures.

Figure 1.21 - Nominal GDP and terms of trade

Sources: Statistics New Zealand, the Treasury

Nominal GDP growth is expected to moderate somewhat later in the forecast period, as the total terms of trade level off and pricing pressures are restrained by higher interest rates. Nominal GDP growth is forecast to average 4.2% per year over the 2015 to 2017 March year period.

Nominal GDP is particularly important for generating forecasts of tax revenue. The main components of nominal income GDP, namely compensation of employees and business operating surplus, are inputs for generating forecasts of PAYE and corporate tax revenues respectively.

Fiscal Outlook#

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Overview#

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• Tax revenue is forecast to increase slightly, while expenses decline, as a share of GDP over the next four years.
• Operating deficits narrow and a surplus of $75 million is forecast in 2014/15 after taking into account the proposed reduction in ACC levies.
• Net core Crown debt peaks as a share of GDP at 28.7% in 2014/15.
• The Crown's balance sheet strengthens and fiscal buffers begin to be rebuilt.

Notes:

1. Operating balance before gains and losses
2. Net core Crown debt excluding the New Zealand Superannuation Fund (NZS Fund) and advances
3. Gross sovereign-issued debt excluding Reserve Bank bills and settlement cash

Source: The Treasury

Overall, growth in the economy, and managed spending levels, sees the Crown return to surplus, slow the pace of growth in debt and increase the size of net worth, helping the Crown to begin rebuilding fiscal buffers to absorb future shocks.

The fiscal forecasts shows the Government is expected to achieve its fiscal objective of a return to surplus in 2014/15 with $75 million forecast.

Tax revenue increases in each year of the forecasts reflecting the expected growth in the economy, as discussed in the Economic Outlook chapter.

Core Crown expenses are expected to increase by $5.5 billion over the next four years, largely owing to new spending announced in Budget 2013 and Budget allowances set aside for future spending. Budget 2013 decisions have increased expenses by around $1.0 billion per annum. Coupled with revenue initiatives, the net spending in Budget 2013 reduces to $900 million per annum. As in previous years, most of the new funding is allocated to the priority areas of education, health, welfare.

Including allocations from the operating allowance and the Future Investment Fund, total Canterbury earthquake expenses are now forecast to reach $15.2 billion by 2016/17 (refer to page 33).

The improving fiscal position has provided enough headroom for the Government to signal reductions in ACC levies from 2014/15 onwards, with the expected impacts built into these forecasts (refer to page 35).

Net debt peaks as a share of GDP in 2014/15 at 28.7%, although nominal net debt continues to increase until 2017/18, one year following the end of these forecasts.

The partial share offers are expected to provide proceeds that the Government will invest largely in social assets, managed through the Future Investment Fund that was established in Budget 2012 (refer to page 38).

Source: The Treasury

Core Crown Tax Revenue#

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Tax revenue increases by around 5% per annum on average over the next four years...

Core Crown tax revenue is forecast to increase by $14.5 billion over the next four years, reaching $72.8 billion in 2016/17. These increases outpace the growth in the economy and see tax revenue rise as a share of GDP each year, reaching 28.3% by the end of the forecast period, but still below levels of the last decade (Figure 2.1).

Figure 2.1 - Core Crown tax revenue

Source: The Treasury

The tax revenue forecasts assume the underlying strength recorded this year remains and that this base then continues to grow. The strength in this year's tax take is owing to a faster growing economy and a shift in income distribution. While there has been recent weakness in the labour market, this has been concentrated at the lower end of the income scale and resulted in a higher average tax rate, owing to the progressive nature of PAYE tax. Coupled with this, strong international equity markets and base-broadening measures have boosted other persons tax. Moderate growth in the nominal economy and earnings is expected to continue across the forecast period, and translate into growth in all types of tax revenue.

In total, the growth in tax revenue is expected to be above the forecast rate of nominal GDP growth (as shown in Figure 2.2). All tax types are expected to increase across the forecast period, with particular strength in tax from employees, as shown in Table 2.3.

Figure 2.2 - Core Crown tax revenue growth

Source: The Treasury

Labour earnings growth is the key contributor to the growth in tax revenue across the forecast period. Earnings growth and the progressive nature of the personal tax scale contribute to add $5.1 billion to source deductions over the next four years.

The level of residential investment is forecast to double over the forecast period, mainly as a result of rebuilding in Canterbury. The higher investment is expected to add $1.3 billion to GST by 2016/17 (over the next four years) and is the main reason why GST is forecast to grow faster than private consumption.

Corporate tax is expected to rise over the forecast period as business profitability continues to improve as growing domestic activity allows firms to rebuild margins which have been compressed in recent years. In addition, an assumed running down of tax losses that built up over the recession contributes to the forecast growth in corporate tax.

These forecasts also see an expected rise in 90-day interest rates from 2.7% in 2012/13 to 4.7% by 2016/17, with flow on impacts to increased tax on interest earned on residents' savings (RWT).

Budget 2013 announces revenue initiatives, largely in relation to increased funding for the enforcement of tax law in the property sector.[4] This increased enforcement is expected to raise an additional $45 million of tax revenue from 2016/17 onwards.

Source: The Treasury

...and is higher than the Half Year Update

The Half Year Update forecast tax revenue of $71.9 billion by 2016/17, while Budget 2013 expects an additional $0.9 billion, taking the total to $72.8 billion in 2016/17. The reason for the increase is largely owing to the strength of the current year's outturn. While the Half Year Update included increases in both other persons tax and PAYE, the actual outturn for these tax types has outstripped those forecasts. The forecasts assume that most of the current strength will remain and the base will grow.

Figure 2.3 - Movement in core Crown tax revenue since the Half Year Update

Source: The Treasury

The signalled reductions in ACC levies (refer to page 35) also impact the tax take. With lower levies there is an increase in disposable income, which has flow on impacts to the forecasts in the form of increased tax from consumption and interest on savings.

Core Crown Expenses#

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Growth in core Crown expenses slows over the forecast period...

While core Crown expenses are forecast to increase in nominal terms by $5.5 billion in total over the next four years (Figure 2.5), this increase is relatively modest compared to the previous 10 years' growth. The annual average increase in core Crown expenses (excluding earthquake costs) from 2003 through 2012 was 6.1%. These forecasts see the annual average increase in expenses fall to 2.7%, as shown in Figure 2.4.

Figure 2.4 - Core Crown expenses growth (excluding earthquake costs)

Source: The Treasury

The lower expenditure growth is largely owing to smaller allowances for new spending in recent Budgets and the Government's decisions to reduce future operating allowances from Budget 2014 onwards by around $0.2 billion per Budget.

Figure 2.5 - Increase in core Crown expenses

Source: The Treasury

Budget 2013 decisions have increased spending by $1.0 billion[5] per year and include spending of $0.4 billion for health, $0.2 billion for education, $0.1 billion for earthquake recovery and $0.1 billion for growth-related initiatives. For more details about the Budget 2013 package, including reprioritisation, refer to the Minister’s Executive Summary.

The forecasts include operating allowances for new spending of around $1.0 billion for the next three Budgets, which in total increase the level of expenses by $3.0 billion by 2016/17.

Social assistance spending increases by $2.4 billion by 2016/17, with the increase owing to payments being indexed to inflation and increasing recipient numbers. New Zealand Superannuation increases by $2.5 billion over that period with other benefit types reducing slightly.

Finance costs also increase over the next four years as gross debt continues to grow and interest rates are forecast to rise.

Partially offsetting the increases, earthquake costs reduce over the forecast period; refer to page 33 for details of the profile of earthquake expenses.

...as a result, they fall as a share of GDP...

While expenses continue to increase in nominal terms over the forecast period, the growth is expected to be at a slower rate than economic growth, as shown in Figure 2.6.

Figure 2.6 - Core Crown expenses

Source: The Treasury

Core Crown expenses are forecast to fall from 33.5% of GDP in 2012/13 to 30.0% of GDP by 2016/17.

...and have declined since the Half Year Update

By 2016/17 expenses are $0.8 billion less than forecast in the Half Year Update, falling from $78.0 billion to $77.2 billion. As shown in Figure 2.7, the main driver of the decrease is the reduction in future Budget allowances from Budget 2014 onwards.

Figure 2.7 - Future Budget allowances

Source: The Treasury

Operating Surplus#

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The Crown is forecast to return to surplus in 2014/15…

With the increase in tax revenue outstripping spending growth, the Crown's OBEGAL is forecast to return to surplus in 2014/15 at $75 million.

The outlook has improved since the Half Year Update particularly in relation to tax revenue, which has enabled the Government to signal reductions in ACC levy rates (refer to the box on the next page). As a result of the levy reductions, OBEGAL grows at a slower rate than forecast in the Half Year Update.

Figure 2.8 - Components of OBEGAL by sector

Source: The Treasury

State-owned Enterprise (SOE) and Crown Entity (CE) sectors contribute $2.0 billion to the surplus in 2012/13 falling to $1.1 billion by the end of the forecasts. The fall is mainly owing to the reduction in ACC levy rates and forgone profits from the Government share offers (partially offset by reduced borrowing costs). Figure 2.8 shows the composition of OBEGAL from the different sectors of the Government.

The underlying nature of OBEGAL can be seen using the cyclically adjusted balance (CAB). This measure adjusts for the state of the economy and significant one-off expenses. Figure 2.9 shows that CAB has been close to OBEGAL in recent years, indicating that the recent operating deficits have been largely structural. The projected size of the economy reduced following the recession, implying a smaller tax base while, in contrast, expenses continued to grow. In these forecasts, tax is expected to grow faster than expenses, seeing CAB move to surplus in 2014/15.[6]

Figure 2.9 - OBEGAL and CAB

Source: The Treasury

...while current strength in equity markets lifts the operating balance

When gains and losses are included, the total Crown operating balance is forecast to be in surplus this year, then declines next year before growing each subsequent year of the forecasts (Figure 2.10). The current year's surplus is a result of gains made by Crown financial institutions (CFIs), largely ACC and the NZS Fund, and reflects strong global equity returns (for example, by 31 March 2013 the New Zealand Superannuation Fund had made year-to-date gains of $3.8 billion, a return of 19.9%). While the current year reflects strong market growth, the forecast gains in future years assume a long-term rate of return, resulting in more subdued growth in these years. These gains play a part in increasing the Government's financial assets, and the Crown's net worth (discussed on page 37).

Figure 2.10 - Components of operating balance

Source: The Treasury

Net Debt#

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Net debt peaks as a share of GDP in 2014/15...

While the Crown returns to operating surplus in 2014/15, core Crown operating cash flows[7] remain in deficit a further year, not reaching surplus until 2015/16. By 2016/17, the core Crown cash surplus is expected to reach $3.9 billion.

While operating cash flows are positive by 2015/16, net capital spending is expected to exceed these cash flows. As a result, residual cash remains in deficit for each year of the forecast period. These deficits are funded by an increase in net debt. In nominal terms, net debt is expected to peak in 2016/17 at $70.3 billion before beginning to decline. However, net debt peaks as a share of GDP in 2014/15 at 28.7% (Figure 2.11) as the growth in the economy is expected to outpace the increase in net debt.

Figure 2.11 - Net debt

Source: The Treasury

...with residual cash deficits mostly funded by issuing government bonds

Over the next four years residual cash deficits are expected to total $12.7 billion. In order to fund these deficits the bond programme is expected to raise funds of $30.8 billion, with $14.3 billion of existing debt due to be repaid, providing net cash proceeds of $16.5 billion (Table 2.6). The bond programme includes some pre-funding to meet debt maturing just outside the forecast period (December 2017).

Source: The Treasury

The forecast issuance over the next four years is $2.0 billion lower than was forecast at the Half Year Update, largely owing to the improvement in core Crown tax revenue and core Crown expenses.

Total Crown Balance Sheet#

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Operating balance surpluses result in increasing net worth...

Net worth attributable to the Crown is expected to increase in 2012/13 for the first time since the global financial crisis and the Canterbury earthquakes. At its height, net worth peaked at $105.1 billion in 2007/08, but has since nearly halved to stand at $59.3 billion as at 30 June 2012.

This year, net worth attributable to the Crown is forecast to increase by $2.2 billion, largely owing to the operating balance surplus (of which $5.9 billion is attributable to gains on the Crown's investment portfolio), and reach $61.5 billion. Net worth is expected to grow another $12.4 billion to stand at $73.9 billion by 2016/17, as shown in Figure 2.12. As a share of GDP this is 28.7%, roughly half the level of the peak 56.6% of GDP in 2007/08.

Figure 2.12 - Net worth attributable to the Crown

Source: The Treasury

...with assets increasing $32.8 billion over the forecast period...

Assets are forecast to increase by $32.8 billion, with the growth over the forecast period made up of investment of $79.3 billion offset by reductions of $46.5 billion, as shown in Table 2.7.

Figure 2.13 - Total Crown assets

Source: The Treasury

The largest asset growth over the forecast period is in the financial portfolio, and reflects investment growth in CFIs such as the NZS Fund and ACC. Much of this growth is recognised as gains in the operating balance; however, there is also growth in the asset base from reinvestment. For example, this year, ACC and NZS Fund financial assets grow by $8.2 billion, with roughly $5.3 billion coming from holding gains with the remaining $2.9 billion being new investments.

Commercial assets increase $9.1 billion over the forecast period, which is largely attributable to growth in the Kiwibank mortgage assets (that grow as their deposits from customers grow) and as SOEs increase their investment in physical assets.

The social asset portfolio increases as a result of new capital spending (funded by the Future Investment Fund, as detailed below), and as existing assets are replaced and student loans are issued.

Notes:

1. The full value of the assets in the companies involved in the Government's partial share sales remain on the Crown's balance sheet after the sale. The ownership of those assets does change, and this is reflected in the increase in minority interests
2. Other investments include assets managed by the Debt Management Office, which fluctuate with the borrowing programme (discussed on page 36)

Source: The Treasury

...including $1.5 billion allocated from the Future Investment Fund...

In Budget 2012 the Future Investment Fund was established to allocate the estimated proceeds from the partial share sales of certain SOEs (as discussed on page 40) to fund new capital, rather than issuing debt. Budget 2012 allocated $0.6 billion of the Fund, while this Budget allocates another $1.5 billion. A large portion of this allocation is expected to be spent on the Canterbury rebuild as well as investments in technology, irrigation and KiwiRail.

Source: The Treasury

...while liabilities increase at a slower rate...

The Crown's liabilities are expected to increase by $15.6 billion over the next four years, largely driven by increased borrowing. Borrowings are forecast to increase $22.3 billion to $123.1 billion by 2016/17.

As shown in Figure 2.14, borrowing is mostly held in the financial portfolio (by Treasury, through the Debt Management Office, and RBNZ). Borrowings in this portfolio increase $13.6 billion over the next four years to meet the Crown's cash deficits (refer to page 36 for discussion of the bond programme). The remainder of borrowing is in the commercial portfolio, and is largely made up of Kiwibank deposits, which grow in line with the bank's mortgage assets.

Figure 2.14 - Total Crown borrowings

Source: The Treasury

Partially offsetting the growth in borrowings are reductions in liabilities as a result of settling obligations related to the Canterbury earthquakes. The Crown's earthquake-related insurance liabilities held in the financial portfolio (EQC and Southern Response) are forecast to decrease $8.4 billion as all claims are expected to be settled by 2016/17. Similarly, the Crown's social liabilities are expected to reduce by $2.4 billion to $14.2 billion as the earthquake-related liabilities are settled.

Figure 2.15 - Total Crown liabilities

Source: The Treasury

...which is critical in order to rebuild the fiscal buffer to absorb future shocks

With the recent deterioration in the Crown's net worth it is important the fiscal buffer is rebuilt to allow headroom for the Government to be able to respond to future shocks, manage volatility and meet contingent liabilities and fiscal risks if they eventuate.

A significant source of balance sheet risk is volatility in asset and liability values owing to movements in external factors such as interest rates, exchange rates and equity prices. This volatility is illustrated by the level of gains and losses being recognised in the operating balance; as shown in Figure 2.16. The CFIs are particularly susceptible to market risk.

Figure 2.16 - Volatility of gains and losses

Source: The Treasury

The long-term liabilities for ACC and the Government Superannuation Fund (GSF) are sensitive to changes in discount rates as their value is based on cash flows up to 80 years into the future, discounted to estimate the current obligation. As an example of this sensitivity, losses on GSF and ACC liabilities totalled $6.8 billion in 2011/12, mostly owing to changes in the discount rate, and if the discount were to reduce by 1.0%, the liabilities would increase by around $7.5 billion.

The Crown is also exposed to risks that may eventuate if certain events occur, or if present liabilities that cannot currently be measured are quantified.[8] For example, the Crown has issued a number of guarantees and indemnities. If events occur that require the Crown to meet any of these guarantees, there will be associated fiscal costs with negative impacts on the operating balance (eg, the Deposit Guarantee Scheme that was established in the wake of the global financial crisis).

Contingent liabilities also include capital that the Crown has subscribed to in International financial institutions, such as the World Bank and the International Monetary Fund (IMF), which is callable by them. If called, the Crown's assets will increase but debt will also rise to fund the increase in capital.

A full description of the Crown's fiscal risks and contingent liabilities is provided in the Specific Fiscal Risks chapter.

Fiscal Forecast Assumptions#

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The fiscal forecasts are based on assumptions and judgements developed from the best information available on 29 April 2013, when the forecasts were finalised. Actual events are likely to differ from these assumptions and judgements. Furthermore, uncertainty around the forecast assumptions and judgements increases over the forecast period. The Canterbury earthquakes add further uncertainty to the economic and fiscal forecasts.

The fiscal forecasts are prepared on the basis of underlying economic forecasts. Such forecasts are critical for determining revenue and expense estimates. For example:

• A nominal GDP forecast is needed in order to forecast tax revenue.
• A forecast of CPI inflation is needed because social assistance benefits are generally indexed to inflation.
• Forecasts of interest rates are needed to forecast finance costs, interest income and discount rates.

A summary of the key economic forecasts that are particularly relevant to the fiscal forecasts is provided in Table 2.10 below (on a June-year-end basis to align with the Government's balance date).

Notes:

1. Production measure
2. Expenditure measure

Source: The Treasury

In addition, there are a number of other key assumptions that are critical in the preparation of the fiscal forecasts.

Risks and Scenarios#

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Overview#

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• Relative to the Half Year Update forecasts, the risks to the Budget Update central forecasts are more balanced, mainly owing to receding extreme global downside risks. However, significant global economic risks remain and are slightly skewed to the downside. The underlying euro area government debt problems still exist, there are risks around how the US manages its fiscal consolidation and the effects of developed-country monetary easing remain uncertain.
• Domestically, uncertainties surround some of the key judgements in the economic forecasts and are slightly skewed to the upside. These judgements include the size and pace of the Canterbury rebuild, the path and pass-through of the exchange rate, the saving behaviour of households and the impact of the drought.
• The more balanced profile of risks is demonstrated by the upside and downside scenarios being broadly symmetrical. In the downside scenario nominal GDP is $19 billion lower over the forecast period based on lower inflation internationally and domestically. The upside scenario results in nominal GDP being $19 billion higher over the forecast period and is driven by stronger-than-expected house prices which results in more complementary consumption spending, along with increased pricing pressures in the construction industry. The scenarios are based on their impact on nominal GDP and tax revenue over the forecast period.
• If these economic risks or any significant deviations from the central forecast were to eventuate they would impact on the Government's fiscal performance and position. These economic uncertainties also pose risks to the Government's debt servicing costs. The fiscal uncertainties are illustrated by the downside and upside scenarios. Core Crown tax revenue is $5.4 billion lower over the forecast period in the downside scenario and the operating balance (before gains and losses) reaches surplus two years later, compared to the central forecast. Core Crown tax revenue is a cumulative $6.6 billion higher in the upside scenario and a larger surplus is recorded in the 2015 June year, compared to the central forecast.
• The Crown's financial position is also exposed to risks from its balance sheet. The largest source of balance sheet risk is volatility in asset and liability values owing to movements in market variables such as interest rates, exchange rates and equity prices. These may result in operating balance impacts.

Introduction#

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The first part of this chapter outlines the key risks to the economic outlook. These risks mainly relate to the key judgements associated with the central forecast. In the second part of the chapter, upside and downside scenarios are presented which represent just two possible ways the New Zealand economy could deviate from the central forecast. The chapter then focuses on the established channels between the risks facing the economy and the Crown’s fiscal position.

Economic Risks#

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Risks to the forecasts have become more balanced…

In recent Economic and Fiscal Updates, risks around the central forecasts have been skewed to the downside, mainly owing to the relatively high probability associated with a negative global shock occurring as the euro area debt crisis evolved. The height of these elevated downside risks was shown in the Pre-election Economic and Fiscal Update 2011, where an upside scenario was not included in order to demonstrate that there was a much higher probability of a downside scenario occurring. Since then, downside risks have become less prevalent to the point where risks are now fairly symmetrical around the central forecast. The more balanced nature of risks is illustrated by the upside and downside scenarios having similar-sized impacts on nominal GDP and tax revenue.

…with extreme global downside risks receding…

The more balanced profile of risks mainly relates to a lower probability of a severe internationally-generated negative shock occurring. The euro area debt crisis has settled down somewhat, the US avoided the “fiscal cliff” and China is experiencing a relatively modest slowing in growth. Definitive decisions by officials have lessened the risk of disorderly default or break-up of the euro area. This has included Ireland, Greece and Portugal all receiving funding packages from the IMF and European organisations, while the European Central Bank (ECB) has pledged to “do whatever it takes” to keep the euro area together, including buying sovereign bonds.

More recently, Cyprus has participated in a partial “bail-in”, where large uninsured depositors have to take losses on their deposits in order for Cyprus to receive funding from the IMF and European Union. In the US, Congress was able to avoid the “fiscal cliff”; there will still be significant fiscal consolidation, including payroll tax increases and government spending cuts (“the sequester”), but not at the level feared by market participants if negotiations had failed. The Federal Reserve has also pledged to keep policy easing in place until the recovery becomes entrenched, reducing downside risks. Fears of a sharp slowing in growth in China have mostly been averted, with real GDP growth reaching a trough of 7.4% on a year earlier in the September quarter of 2012 and rebounding slightly to 7.9% and 7.7% in the December and March quarters respectively.

…but global risks remain…

While the extreme negative risks from the euro area debt crisis have receded, significant global risks remain and are still somewhat skewed to the downside. In the central forecast it is assumed that governments and officials continue to do what is necessary to avoid a disorderly default by a euro area country but that growth in the region remains weak as fiscal consolidation weighs heavily on activity. The probability that the crisis will worsen significantly has fallen recently owing to actions taken by organisations, including the ECB and IMF. However, escalation of the euro debt crisis would further dampen growth in the region and cause financial market turmoil, with spillover effects on the rest of the world.

More generally, the effects of fiscal consolidation and monetary easing by major advanced economies remain uncertain. The US and euro area must undergo significant adjustment to reduce government debt. Japan, the US and the UK are currently undertaking significant quantitative easing programmes to stimulate their economies through the purchase of financial assets. An example is the Bank of Japan pledging to double the size of its balance sheet over the next two years in order to achieve its 2% inflation target. This has driven the yen lower and boosted Japanese asset markets. How these changes flow through to the real economies remains uncertain.

…including for New Zealand's major trading partners…

One of the main risks associated with New Zealand's largest trading partner, Australia, is the source of growth after the peak in mining investment has passed this year. It will take some time for the exports associated with this investment to ramp up, requiring increased residential and non-mining business investment to maintain Australia's recent strength in economic growth.

China has grown in importance to the New Zealand economy, now being our second largest trading partner. The risk of a significant slowing in growth, as Chinese authorities tried to clamp down on rising asset prices, has eased recently. However, risks remain of a correction in the housing market, following the recent run up in prices, and the build up of poor quality debt over the recent investment boom. China is also attempting to rebalance its economy away from export- and investment-led growth, towards consumption. Faster progress towards this goal would benefit New Zealand as a major supplier of soft commodities, including dairy products.

…which, if they eventuate, would impact on the New Zealand economy

If any of the global downside risks eventuate, demand for New Zealand's exports would be lower; the opposite is true of upside risks which are considered now to be almost as likely. For products whose production is responsive to demand, including services and manufactured exports, lower world growth would depress demand and decrease export volumes; whereas for other products with supply constraints, including agricultural exports, the main impact would be through lower prices.

Downside global developments would also have a negative impact on domestic confidence and asset prices. Higher risk aversion in response to negative developments would result in more cautionary behaviour by households, which would be expected to lead to lower asset prices and less willingness by consumers to commit to major purchases. The result of these developments would be lower private consumption, while more caution on the part of firms would decrease business investment and employment as they are less willing to commit to expenditure in a more uncertain environment.

Negative global developments would increase the level of uncertainty faced by financial market participants and lower the amount of risk they are willing to take on. This would flow through to reduced availability, and higher cost, of credit for New Zealand. The effective repricing of risk would increase the borrowing costs of New Zealand banks, which they would pass on to customers. However, there is room for the RBNZ to provide liquidity as needed and lower the base interest rate to mitigate the impact of higher funding costs on the interest rates faced by households and businesses. This is different from the majority of other developed-country central banks that are at the zero lower bound of interest rates and are undertaking alternative policy (eg, quantitative easing) to ease monetary conditions.

Risks surround key judgements relating to the domestic economy…

Offsetting the somewhat negatively skewed global risks, upside risks are slightly more prevalent for the domestic economy. Domestic risks mainly relate to the key judgements that have been made in the forecasts about the size and timing of the Canterbury rebuild, the level and flow through of the exchange rate, household saving behaviour and the developments of monetary policy. In addition, the impact of the drought, the current amount of spare capacity in the economy and the current underlying strength of the labour market remain uncertain.

...including earthquake rebuilding...

The timing and extent of the Canterbury earthquake rebuild is difficult to forecast, as an event of this magnitude has never occurred before in New Zealand. The key determinants of the speed the rebuild can ramp up and be sustained include insurance settlements and the capacity and capability of the construction sector. These factors provide both upside and downside risks to the rebuild assumption influencing the central forecast (see the “Investment Associated with the Canterbury Rebuild” box [Chapter 1, page 15] for more information). If insurance settlements and construction capability progress faster than expected, residential and non-residential construction, imported goods volumes and employment would all be stronger than in the main forecast. There is also a risk that the Canterbury rebuild puts more upward pressure on prices, which is explored further in the upside scenario.

Another risk to the forecasts is how much the Canterbury rebuild crowds out activity in other parts of the economy. New Zealand has limited construction capacity, which will be added to through inward migration and the importation of capital goods, a significant part of which will be taken up by Canterbury. So while the Canterbury rebuild is a major driver of growth over the forecast period, in its absence other parts of the country would use some of the construction industry's capacity to increase activity.

...as well as the exchange rate...

A major change in judgement between the Half Year Update and the Budget Update is the evolution of the exchange rate. Previously, it was assumed that a significant fall in the New Zealand dollar (NZD) would occur over the forecast period owing to most measures suggesting a large over-valuation. However, this depreciation has not occurred yet and other factors, including looser monetary policy in major advanced economies and a positive growth outlook for New Zealand relative to other developed economies, have supported the NZD. The forecast for the NZD has therefore been held higher for longer on a trade-weighted basis. A risk to this forecast is that the over-valuation of the NZD leads financial market participants to sell the currency, resulting in a lower exchange rate than in the central forecast. A lower exchange rate would increase tradables inflation, as imported goods would become more expensive, and discourage consumption of imported products. On the other hand, exporters and import-competing businesses would become more competitive, boosting manufacturing and services exports and production of import substitutes for the domestic market.

…and household saving behaviour

In the central scenario it is assumed that households are fairly comfortable with the current state of their balance sheets and spend close to what they earn, resulting in a saving rate around zero over the forecast period. There is a risk that households show less restraint than anticipated; for example, households use the increased house prices that are forecast to fund consumption through housing equity withdrawal as occurred over the early-to-mid 2000s. This sort of behaviour is explored further in the upside scenario. This would result in consumption rising faster than disposable income, with the shortfall being funded by rising debt, and cause the saving rate to be more negative over the forecast period. While this would be positive for GDP growth in the near term, owing to a boost to private consumption, it may require a sharper negative adjustment in the medium term as households become more indebted and may need to repair their balance sheets.

Policy developments could turn out different than expected…

Macroeconomic policy developments remain uncertain, with macro-prudential policy being added to the uncertainty surrounding interest rates. The central forecast assumes that short-term interest rates begin rising in the June quarter of 2014, in line with market pricing at the time the forecasts were finalised. If recent strong growth in house prices were to spill over into more generalised price increases through wealth effects, an earlier increase in interest rates may be required. This could put further pressure on the exchange rate to appreciate and dampen domestic demand. On the other hand, if rising credit growth in order to finance house purchases and related consumption pose a threat to financial stability, macro-prudential tools may be used to stem the credit growth.

…as could the drought…

The effects of the recent drought on the economy are uncertain, particularly its impact on nominal GDP. Previous droughts have coincided with adverse global events such as the late-1990s Asian financial crisis and the late-2000s global financial crisis, which make it difficult to isolate the impact of each drought episode on the economy. The impact of this summer's drought on the economy is discussed in the “Economic Impacts of the Drought” box (Chapter 1, page 17). While rainfall has recently increased, given the weakened condition of the dairy herd going into the winter, a return to drought conditions would be particularly damaging and would impact on growth in the 2014 calendar year. A cold, dry winter could also reduce lambing rates next season to a greater extent than assumed, and may also negatively affect hydro-electricity generation which would be negative for GDP if producers switch to more costly thermal generation. The impact of the drought on prices is also a key uncertainty. If global dairy supply conditions remain tighter than assumed, dairy prices may be supported at a higher level next season than anticipated. There are also potential second round impacts to consider if changes in incomes resulting from the drought alter spending behaviour.

 …and other key judgements

Labour market data have been volatile recently and movements in the Household Labour Force Survey have appeared at odds with other indicators. For more information see the “Recent Labour Market Conditions” box (Chapter 1, page 21). If the assumption that modest employment growth will resume in the first half of 2013, following recent labour market weakness, is incorrect and employment remains weak, the unemployment rate could rise rather than be flat as is forecast. This would result in more spare capacity and lower wage pressures in the economy, creating less domestically-generated inflation. Related to this, the current amount of spare capacity in the economy (the output gap) is uncertain. If the output gap is more negative than the 1.0% of potential GDP estimated in the December quarter of 2012, there will be less domestically-generated inflation, but a greater cyclical increase in real GDP, than we have incorporated in the central forecast.

Alternative Scenarios#

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The following scenarios show how the economy might evolve if some of the key judgements in the main forecast are altered (Table 3.1). The scenarios are only illustrative in that they are two of a large number of possible examples, and do not represent upper or lower bounds for the forecasts, with more extreme paths possible. They represent what are assessed to be key risks to the Budget Update forecast and illustrate the impact of relatively small changes in the assumptions on key economic and fiscal variables. Although not the most likely outcome, there is a realistic prospect that these scenarios could occur. The scenarios are based on their impact on nominal GDP and tax revenue over the forecast period and no judgement is made as to whether these would be beneficial or detrimental to the New Zealand economy over a longer period of time.

Notes:

1. March quarter, seasonally adjusted
2. March quarter average

Sources: Statistics New Zealand, the Treasury, RBNZ

Downside Scenario#

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Prices weaker over the forecast horizon…

While there are a number of downside risks to real GDP growth, as outlined in the Economic Risks section, the downside scenario is based primarily on weaker inflation, both internationally and domestically. In this scenario it is assumed some of the judgements made in the central forecast turn out different than expected. In particular, it is assumed that the high exchange rate places more downward pressure on tradables inflation, inflation expectations are lower than anticipated resulting in decreased non-tradables inflation, and the terms of trade are lower than assumed in the central track owing to weaker global demand and a greater global supply response to expected growth in emerging market demand. These developments lower nominal GDP and tax revenue over the forecast period.

In the central forecast it is assumed that the deflationary impact of the recent appreciation of the exchange rate dissipates and becomes inflationary as the exchange rate begins to depreciate. This results in rising tradables inflation over the forecast period. In the downside scenario it is assumed that the deflationary impact of the high exchange rate is more persistent and keeps tradables inflation lower for a longer period than in the central forecast (Figure 3.1). The positive outlook for the New Zealand economy relative to other developed countries and an increase in monetary easing by advanced-economy central banks holds the NZD up, despite a lesser increase in short-term interest rates over the forecast period in response to the weaker inflation outlook.

In the central forecast it is assumed that the labour market partially recovers in the first half of 2013 from the weak employment results in the second half of 2012. In the downside scenario employment remains weak in the first half of 2013 as firms are still not confident enough in the recovery to take on permanent staff and the unemployment rate rises. This weaker labour market and subsequent lower wage growth, along with the current low headline inflation rate, help to contain inflation expectations. Lower inflation expectations, along with marginally weaker real GDP growth, result in less domestically-generated inflation.

Figure 3.1 - Tradables CPI inflation

Sources: Statistics New Zealand, the Treasury

Figure 3.2 - Merchandise terms of trade (SNA)

Sources: Statistics New Zealand, the Treasury

In the central forecast it is assumed that the goods terms of trade increase sharply over 2013. This increase occurs as the price of the commodities New Zealand exports, especially dairy products, rises with global supply being constrained owing to dry conditions in New Zealand and adverse weather conditions and increased feed costs overseas. Over the medium term it is assumed that growth in emerging market demand results in a slight upward trend in the merchandise terms of trade. In the downside scenario a lesser recovery in New Zealand's export commodity prices in 2013 is assumed as the price of dairy products is not as affected by adverse global weather conditions as first thought and a re-emergence of global risks dampens demand for commodities. It is also assumed that the global supply response to increasing emerging market demand is strong enough to contain price increases, resulting in a flatter merchandise terms of trade in the medium term (Figure 3.2).

…causing weaker nominal GDP…

The combination of lower tradables and non-tradables inflation, as well as weaker terms of trade over the forecast period, result in lower inflation compared to the central scenario. These weaker prices, along with slightly lower real GDP, reduce nominal GDP by $19 billion over the forecast period, compared to the central track. The lower terms of trade in the downside scenario weaken the goods trade balance over the forecast period which, along with the lower nominal GDP, increases the current account deficit as a percentage of GDP relative to the main forecasts. The current account balance reaches a deficit of 7.0% of GDP by March 2017, compared to 6.5% in the central track. The assumption of a weaker labour market mentioned earlier only reduces the unemployment rate to 5.6% by March 2017, compared to 5.2% in the central scenario.

…as well as lower tax revenue and operating balance

Core Crown tax revenue is a cumulative $5.4 billion lower over the forecast period in the downside scenario. A weaker inflationary environment means that nominal consumption and residential investment are lower, which reduces GST revenue by a cumulative $800 million over the forecast period. The weaker labour market and less inflationary pressure mean that worker incomes are also lower, which reduces source deductions revenue by $2.4 billion over the forecast period. The economy's weaker nominal activity means that business profitability is reduced, resulting in corporate taxes being a cumulative $700 million lower. Resident withholding tax is $600 million lower over the forecast period with interest rates needing to increase less than in the central forecast as inflation remains in the bottom half of the target band.

Core Crown expenses are slightly lower than in the central forecast as an increase in debt servicing costs is more than offset by a reduction in welfare payments. The reduction in welfare payments, despite incorporating a higher number of recipients of unemployment-related benefits, is driven by lower rate adjustments to benefits and superannuation, reflecting both lower inflation and wage growth. In this scenario, the return to surplus of the operating balance (before gains and losses) is delayed by two years until the June 2017 year (Figure 3.3) and, consequently, net core Crown debt as a proportion of GDP is still rising at the end of the forecast period (June 2017), reaching 30.3% at that time.

Figure 3.3 - Operating balance (before gains and losses)

Source: The Treasury

Upside Scenario#

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Higher house prices…

The upside scenario is based on higher prices for existing and new houses, along with an associated increase in complementary household spending. In this scenario it is assumed that the Canterbury rebuild generates more inflationary pressures than in the central forecast. Capacity constraints, including a shortage of skilled labour, require firms to pay higher wages to attract skilled workers to Canterbury in order to complete the rebuild in a timely fashion. These higher wages spill over into the rest of the country as other regions need to retain workers and these higher wages are passed on to customers in the form of higher house-building costs. Annual growth in residential investment prices peaks around 10%, compared with the central track where productivity increases resulting from the localised and repetitive nature of the rebuild are sufficient to keep pricing pressures in check and annual growth in residential investment prices peaks around 6%.

In the upside scenario, existing house prices rise by more over the forecast period, with peak growth around 14% in 2014 compared to close to 8% in 2013 in the central forecast. House price growth also takes longer to come off its peak and prices continue increasing in real terms over the forecast period, compared to the central scenario where prices are flat in real terms by the end of the forecast period (Figures 3.4 and 3.5). The stronger house price growth is driven by higher domestic confidence resulting in increased housing demand, and the increase in building costs spilling over into existing house prices.

Figure 3.4 - House prices and private consumption in central forecast

Sources: Quotable Value Limited, Statistics New Zealand, the Treasury

Figure 3.5 - House prices and private consumption in upside scenario

Sources: Quotable Value Limited, Statistics New Zealand, the Treasury

...boost private consumption and residential investment...

In this scenario, households resume housing equity withdrawal to finance consumption, resulting in the strong positive relationship between house prices and consumption over the 2000s reasserting itself (Figure 3.5). The resulting stronger debt-funded real consumption growth allows retailers to increase prices by more and inflation picks up considerably faster from its current subdued rate. Higher inflation results in increased short-term interest rates as the RBNZ tightens monetary policy sooner to maintain price stability. Despite higher interest rates, the exchange rate does not appreciate significantly as financial market participants see the increased activity as being unsustainable, demonstrated by the widening current account deficit.

It is also assumed that there is more complementary consumption associated with the pick up in residential investment than in the central forecast. This occurs as households buy new contents to fit out their new homes, with some of this expenditure financed out of earthquake insurance payouts. As the higher consumption is partly financed by borrowing against the increased value of housing, rather than higher incomes, the household saving rate is significantly lower than in the central forecast. The household saving rate reaches a low of -4.3% of household disposable income in the March 2016 year compared to the main forecast where it is 0.0% in 2016. This negative saving rate, along with higher interest rates at the end of the forecast period, suggests a slight adjustment to household balance sheets will be required sometime beyond the forecast period, which would likely constrain future consumption growth.

...which increases GDP and tax revenue

Stronger private consumption and residential investment result in nominal GDP being $19 billion higher over the forecast period. The increased activity drives a stronger labour market, with the unemployment rate reaching a low of 5.0% in March 2017, 0.2% points lower than in the main forecasts. The annual current account deficit is wider and reaches 7.3% of GDP in March 2017, versus 6.5% in the central forecast. The current account deficit is wider as some of the increased consumption and investment is imported goods.

Core Crown tax revenue is a cumulative $6.6 billion higher over the forecast period, mainly as a result of the higher nominal GDP. The stronger nominal consumption and residential investment boost GST revenue by $2.1 billion over the forecast period. The stronger labour market and increased competition for workers pushes up wages and salaries, boosting source deductions revenue by a cumulative $1.6 billion. The stronger economic activity allows firms to increase their margins, boosting profitability and increasing corporate tax by $1.5 billion out to June 2017. Higher short-term interest rates, needed to control rising inflation, boost tax on interest by $800 million. The increase in tax revenue is higher in the upside scenario than the fall in the downside scenario, despite the change in nominal GDP being similar. This asymmetry is because much of the decrease in GDP in the downside scenario comes from exports, which are not taxed other than to the extent to which they contribute to firm profits, while most of the gain to GDP in the upside scenario comes from consumption and residential investment which are both taxed through GST.

Core Crown expenses are slightly lower than in the central forecast as a fall in debt servicing costs more than offsets an increase in welfare payments. The increase in welfare payments is driven by higher rate adjustments to benefits and superannuation, reflecting both increased inflation and wage growth. In this scenario, the OBEGAL records a surplus of 0.6% of GDP in the June 2015 year, the same year surplus is achieved in the central forecast. Net core Crown debt as a percentage of GDP peaks at 28.0% in the June 2014 year, compared to 28.7% in the June 2015 year in the central forecast (Figure 3.6).

Figure 3.6 - Net core Crown debt

Source: The Treasury

General Fiscal Risks#

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The discussion up to this point has focused on the main near-term economic risks. The rest of this chapter focuses on the links between the risks to the performance of the economy and the Crown's fiscal position. For more on fiscal risks, see the Specific Fiscal Risks chapter on page 59.

Fiscal Sensitivities

Table 3.2 provides some rules of thumb on the sensitivities of the fiscal position to small changes in specific variables. For example, if for some reason nominal GDP growth is one percentage point faster than we have forecast each year up to June 2017, tax revenue would be expected to be around $3.0 billion (1.2% of GDP) higher than forecast in the June 2017 year as a result. The sensitivities are broadly symmetric and if nominal GDP growth is one percentage point slower each year than we expect, tax revenue would be around $2.9 billion lower than forecast in the June 2017 year. However, these figures can be influenced by the composition of growth as different types of activity have different effective tax rates; for example, the upside and downside scenario both have around a $19 billion impact on nominal GDP but their tax revenue impacts differ by $1.2 billion.

A different interest rate path than that forecast would also impact on the fiscal position. A one percentage point lower interest rate would result in interest income being $116 million lower in the June 2017 year. This would be more than offset by interest expenses being $434 million lower in the June 2017 year.

Note:

1. Funds managed by the NZDMO only

Source: The Treasury

Revenue Risks

One of the major sources of risk to the fiscal position arises from the inherent uncertainty about future tax revenue. The amount of tax revenue that the Government accrues in a given year is closely linked to the performance of the economy. Figure 3.7 plots the main tax revenue forecast, along with confidence intervals around those forecasts based on the Treasury's historical tax forecast errors and the assumption of an even balance of risks around the central forecast.[9] The outermost shaded area captures the range (+/- $7.3 billion in the June 2017 year) within which actual tax outturns fall 80% of the time.[10]

The tax revenue forecasts from the upside and downside scenarios are also plotted. The recent global financial crisis showed that exogenous shocks can have severe impacts on government revenue. The recent drought is another example of a shock which is expected to decrease government revenue. Further adverse weather conditions or a global downturn would have a negative impact on the Government's fiscal position. Should any of the uncertainties outlined in the Economic Riskssection eventuate differently from the central forecast, government revenue would likely be different from forecast, with the upside and downside scenarios being examples of possible outcomes.

Figure 3.7 - Core Crown tax revenue uncertainty

Source: The Treasury

Based on average historical forecast errors and an even balance of risks, Figure 3.7 suggests that tax revenue over the forecast period would be weaker than shown in the downside scenario around one-third of the time. For the upside scenario, tax revenue over the forecast period would be stronger than shown about one-third of the time. Tax revenue would be between the two scenarios approximately one-third of the time.

There is also uncertainty around government revenue arising from the performance of SOEs and the path of interest rates as outlined in the Fiscal Sensitivities section.

Expenditure Risks

One-off and unexpected expenditure shocks can have a large impact on the Crown's operating balance in the year that they occur. Persistent errors in forecasting the cost of various programmes (ie, policies that cost more than the Government allows for) can also have substantial ongoing effects on the fiscal position.

There is also considerable uncertainty regarding the effect of the performance of the economy on Crown expenditures. This uncertainty largely relates to the operation of the so-called automatic stabilisers. For example, if the economy performs better (worse) than expected in a given year, official expenditures on social programmes may be lower (higher) than planned.

Meanwhile, the destructive seismic events of recent years have underlined the inherent exposure of the Crown's fiscal position to exogenous shocks. The Government's fiscal position would be impacted if another catastrophic earthquake were to occur or if the costs associated with the recent events exceed the updated estimates.

The ageing population also presents risks to the medium-term fiscal position, particularly to the extent that demographic forecasts may prove to be too low or high. An ageing population requires increased government expenditure, especially for health and superannuation spending.

Balance Sheet Risks

In addition to risks around revenue and expenditure, the Crown's financial position is exposed to risks from its balance sheet. While some are unavoidable, the Crown's general approach is to identify, avoid or mitigate these risks where practicable.

The largest source of balance sheet risk is volatility in asset and liability values owing to movements in market variables such as interest rates, exchange rates and equity prices. This may result in an operating balance impact. Of the Crown's aggregate financial risk, roughly a third is estimated to be attributed to this “market risk”.[11] Three areas of the balance sheet are particularly susceptible:

• Financial assets held by the Crown financial institutions (CFIs) are sensitive to financial-market volatility. CFIs diversify their portfolios across a range of financial assets to manage exposures to specific market risks. The Crown Ownership Monitoring Unit (COMU) estimates a 10% fall (rise) in world share markets would lead to a 4% to 5% fall (rise) in the value of the Crown's financial portfolio.
• Insurance and retirement liabilities and provisions are prone to market volatility through their actuarial valuations, which are sensitive to assumptions about variables such as interest and inflation rates, and risk margins.
• Physical assets such as land, buildings, state highways and military equipment are susceptible to valuation movements through changes in property market conditions, interest rates and changes in the costs of construction. This will affect the recorded value of many Crown physical assets.

Business risks, relating to the broader commercial environment, may also affect the Crown's balance sheet. A number of entities owned by the Crown, including commercial and social entities, have their financial performance and valuations impacted by these external factors.

The Crown is also susceptible to “liquidity risk” with respect to its ability to raise cash to meet its obligations. This risk, however, is relatively small given NZDMO's ongoing management of the core Crown's liquidity position, as well as the Government's commitment to maintaining prudent debt levels.

Funding Risks

The New Zealand Crown remains in the top-20 rated sovereigns globally, with the top Aaa foreign-currency rating from Moody's and AA foreign-currency ratings from Standard & Poor's and Fitch. The outlook is stable across all three agencies.

The downside risks identified by the rating agencies are broadly in line with the risks identified earlier in the chapter. In the case of an increase in global risk-aversion and in the absence of a marked improvement in the external position, New Zealand may be more likely to face a degree of funding pressure in the future. All things being equal, any further deterioration in the ratings outlook could serve to raise debt-servicing costs for the Crown. On the other hand, additional downward pressure on borrowing rates is possible if diversification flows, particularly away from Europe, continue in the future.

Specific Fiscal Risks#

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The Statement of Specific Fiscal Risks is required by the Public Finance Act 1989 to set out, to the fullest extent possible, all government decisions and other circumstances known to the Government at the date of the finalisation of the fiscal forecasts that may have a material effect on the fiscal and economic outlook, but are not certain enough in timing or amount to include in the fiscal forecasts. Although the process for disclosure of specific fiscal risks involves a number of parties, including government departments, the Treasury and the Minister of Finance, there remains a possibility that not every risk is identified. Disclosure of known risks is also subject to specific requirements and materiality thresholds, which are described after the Statement of Specific Fiscal Risks.

Overview#

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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 potential policy decisions and key areas of uncertainty that may have a material effect on the fiscal outlook.

The Government generally sets aside allowances of new funding for future Budgets to manage uncertainty and cost pressures. These allowances are included in the fiscal forecasts. Current fiscal management policy is for future policy decisions affecting expenses or capital expenditure to be met through reprioritisation or from within existing provisions included in the fiscal forecasts. Future policy decisions are risks to the fiscal forecasts only to the extent that they cannot be managed from within:

• existing baselines or Budget allowances for operating expenditure, or
• the existing Crown balance sheet for capital expenditure, including the Future Investment Fund.

Notwithstanding this, known material policy risks are identified as specific fiscal risks, even though the Government has more control in managing such risks through reprioritisation, the existing Crown balance sheet and the Budget allowances. This is done to ensure a prudent approach to the disclosure of risks, improve transparency and not pre-judge future decisions by governments.

The specific fiscal risks are categorised into:

• Potential policy decisions affecting revenue: For example, changes to tax policy or ACC levies could reduce or increase government income.
• Potential policy decisions affecting expenses (expected to be funded from reprioritisation or Budget allowances): Costs of policy proposals could increase or decrease expenses depending on decisions taken, and they are risks to the fiscal forecasts only to the extent that they cannot be managed within existing baselines or Budget allowances.
• Potential capital decisions (expected to be funded from the existing Crown balance sheet, including the Future Investment Fund): Capital investment decisions are risks to the fiscal forecasts only to the extent that they cannot be managed within the existing Crown balance sheet, including the Future Investment Fund.
• Matters dependent on external factors: The Crown's liability for costs is sometimes dependent on external factors such as the outcome of negotiations or international obligations.

A range of generic risks to the fiscal forecasts are not recognised as specific fiscal risks:

• The most significant economic risks have been identified in Chapter 3.
• Business risks and volatility in the returns from the Crown's investments relating to the broader economic and commercial environment.
• General cost pressures, such as those associated with demographic changes (eg, an ageing population).
• Potential risks from changes in demand for government services or transfer payments owing to underlying structural factors (such as changes in demand for the Unemployment Benefit).
• The costs of future individual natural disasters, and other major events, as they usually occur infrequently and their occurrence, nature and timing cannot be predicted. Once a disaster does occur, a number of choices arise about how to respond and when potential liabilities are recognised (eg, through setting aside an allocation of funding for the disaster). Specific risks are disclosed at this point based on the range of possible responses.

The final part of the chapter contains a current list of contingent liabilities and contingent assets. Contingent liabilities are costs that the Crown will have to face if a particular event occurs or are present liabilities that are unable to be measured. 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. Contingent assets are possible assets that have arisen from past events but the value of the asset, or whether it will eventuate, will not be confirmed until a particular event occurs.

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 after this Statement. Full descriptions of the risks listed below are set out in the next section. Where quantification is possible, this is included in the description of the risk.

Potential Policy Decisions Affecting Revenue

ACC - Levies (Unchanged)

Levy rates for the Work, Earners' and Motor Vehicle accounts are set by Cabinet following a public consultation process. Claims experience, ACC performance and economic assumptions (particularly discount rates) can impact insurance expenditure, both in the current year and the estimated future liability. If any of these factors differ from what is forecast the revenue collected may be more or less than required to cover the costs of claims, resulting in unplanned savings or costs that could have a corresponding impact on the operating balance.

ACC - Review of Funding Policy (Changed)

The Government is undertaking a review of ACC's funding policy. An estimate of the cost of adopting a lower funding target band midpoint has been included in the fiscal forecasts. If levy rates differ from those assumed in the forecasts, this would impact Crown revenue and Crown assets, with a flow-on impact to the operating balance.

Revenue - Income-sharing Tax Credits (Unchanged)

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 year once the scheme is fully operational. The Finance and Expenditure Committee has recommended that the significant fiscal cost of the package be addressed before the Bill proceeds further.

Services Funded by Third Party Revenue (Unchanged)

A wide range of government services are funded through third party fees and charges. Demand for these services can vary, leading to a direct effect on revenue received. There is a risk the Government may need to provide additional funding if revenue collected is lower than the total costs of providing the service. There is also a risk that changes will be required to the way government services are delivered, which could result in costs to the Crown.

Potential Policy Decisions Affecting Expenses (Expected to be Funded from Reprioritisation or Budget Allowances)

ACC - Work-related Gradual Process Disease and Infection (Unchanged)

Under current legislation, the Government incurs an obligation for Work-related Gradual Process Disease and Infection claims when the claim is made, and an expense is recognised at that point. The liability for commercial accident and sickness insurance contracts would usually be recognised when exposure to conditions that will give rise to a claim occurs. An amendment to legislation would be required to recognise claims at the same time as for commercial contracts. There are currently no plans to make such a change. An initial adjustment to the liability, and an expense of about $1 billion would need to be reported if such an amendment was made.

Canterbury Earthquake Recovery - Christchurch City Council/Crown Cost Sharing (Changed)

The Crown is partially funding the recovery of local infrastructure in Canterbury. The extent of funding is dependent on the outcome of cost-sharing negotiations with the Christchurch City Council. The Crown’s contribution could differ from that included in the fiscal forecasts.

Canterbury Earthquake Recovery - Christchurch Central Recovery Plan (New)

The Crown is partially funding the construction of Anchor Projects as part of the Christchurch Central Recovery Plan. The extent of funding will vary from project to project, dependent on final project costs and the outcome of cost-sharing negotiations with the Christchurch City Council. Business cases for the development of Anchor Projects are in their early stages. Project costing for construction of the Anchor Projects will become increasingly clear during the business case process and the subsequent procurement phase. The Crown's contribution may differ from that included in the fiscal forecasts.

Defence Force - Funding Track Evaluation (New)

The Government is evaluating different funding tracks for the New Zealand Defence Force (NZDF) to assess the level of military capability and equipment that can be achieved with each track. The results of this work will be considered as an input into the next Defence White Paper. There is a risk that the funding provided to NZDF in the future could differ from that included in the fiscal forecasts.

Government Response to Wai 262 (Unchanged)

The Waitangi Tribunal's report on the Wai 262 claim focuses on the protection of Māori culture and identity, with a particular focus on mātauranga Māori and associated taonga. The Tribunal’s recommendations are directed towards a number of government agencies individually, as groups and across sectors. The Government has yet to respond to the Tribunal’s report and recommendations.

Health - Payment of Family Caregivers (Changed)

The Government has agreed to change its policy of not allowing payment to certain family carers (mainly parents and spouses of disabled adults) who deliver disability support services, following court rulings that have found this policy to be in breach of section 19 of the New Zealand Bill of Rights Act 1990. The Government has consulted the disability community and wider public on options for a new policy approach to be implemented in late 2013. The potential costs of the new policy are uncertain depending on how tightly payments are targeted and may differ from the level included in the fiscal forecasts.

Housing - Reform of Social Housing (Unchanged)

The Government has decided to change the policy settings for social housing. This includes growing third party providers of social housing, increasing the effectiveness of financial assistance, and Housing New Zealand Corporation focusing on providing social housing to those with the greatest housing need. Some decisions have been announced and included in the fiscal forecasts but other plans for implementation remain under development, but may require reprioritisation or additional funding.

Revenue - KiwiSaver Auto-enrolment (Unchanged)

The Government has announced its intention to consult on the design of a one-off KiwiSaver auto-enrolment exercise to increase the number of KiwiSaver members. The Government will proceed with a one-off KiwiSaver enrolment exercise only when it is confident that such a step poses no significant risks to returning to, and maintaining, an operating surplus. An auto-enrolment exercise is likely to entail a one-off cost for kick-start payments to new members and ongoing additional costs for the Member Tax Credit. Depending on the timing, design features and take-up rate, these costs could be in the order of $350 to $550 million over the first four years after auto-enrolment takes place and are expected to be funded out of the operating allowances.

Revenue - Transformation and Technology Renewal (Changed)

The Government is exploring options that will fundamentally change the way IRD manages its processes and data. Any changes could have material costs to implement (with capital and operating implications) and/or impact tax revenue collections. The Government is currently considering a programme business case and is yet to finalise the scope of the programme.

Social Development - Vulnerable Children White Paper (Unchanged)

The Government is looking to implement proposals to better identify, and provide assistance to, vulnerable children. Costs of the proposals are likely to have impacts on the social development, education, health and justice areas, and are expected to be met through reprioritisation of current expenditure. However, uncertainty around the service costs and volumes as well as the implementation of new initiatives associated with the better identification and support of vulnerable children could mean additional funding is required.

Social Development - Welfare Reform Costs (Changed)

The Government has agreed to a package of changes to the benefit system. The extent of any additional costs of implementing welfare reform, such as providing more employment assistance related interventions to a broader range of clients, remain uncertain.

Social Development - Welfare Reform Forecast Benefit Savings (Unchanged)

A conservative estimate of the likely benefits from Welfare Reform has been included in the fiscal forecasts. The actual impact may differ owing to behavioural factors and the complexity of implementing the reforms, with a corresponding impact on benefit expenditure.

State Sector Employment Agreements (Unchanged)

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 of restraint given the current economic environment and an expectation that agreements will be managed within the current fiscal forecasts.

Potential Capital Decisions (Expected to be Funded from the Existing Crown Balance Sheet, Including the Future Investment Fund)

Departmental Capital Intentions (Unchanged)

The Government requires 16 capital-intensive agencies or sectors to identify their capital spending intentions over the next 10 years based on current policy settings and certain demographic and inflation assumptions. 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 fiscal forecasts only to the extent that they cannot be managed through the existing Crown balance sheet.

Earthquake Strengthening for Crown-owned Buildings (Unchanged)

There is a possibility that the Crown will incur costs for earthquake strengthening some of the buildings that it owns which may not meet modern building standards. The Government is currently undertaking a stock-take of Crown-owned earthquake-prone buildings. The likelihood, timing and fiscal impact of any earthquake strengthening are uncertain.

Finance - Crown Overseas Properties (Unchanged)

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. A rough-order cost estimate for this upgrade is $150 million over the period 2013/14 to 2015/16.

Justice - Christchurch Justice and Emergency Services Precinct (New)

The Government has set aside funding in the fiscal forecasts for the development of a Justice and Emergency Services Precinct in Christchurch. There is a risk that spending profile differs from the amount set aside.

Primary Industries - Investment in Water Infrastructure (Changed)

The Government has set aside an allocation of $80 million in the fiscal forecasts for a Crown-owned company to manage the Crown's investment in irrigation infrastructure for the first year. The Government will consider providing further capital of up to $320 million in future Budgets as schemes reach the “investment-ready” stage.

Transport - Support for KiwiRail (Changed)

KiwiRail has signalled its intention to seek $239 million of additional Crown funding over the next four years to complete the 10-year strategy for KiwiRail to achieve a commercially viable network. The Government has not considered its response to such a request.

Matters Dependent on External Factors

ACC - Non-earners' Account (Unchanged)

Funding for the Non-earners' Account is agreed as part of the annual Budget process. Claims experience, ACC's financial performance and economic assumptions (particularly discount rates) can impact insurance expenditure, both in the current year and the estimated future liability. If any of these factors differ from what is forecast the amount required to cover the costs of non-earners' claims for that year may be more or less than the agreed level of funding, resulting in unplanned savings or costs to the Crown.

Canterbury Earthquake Recovery - Residential Red Zone (Unchanged)

The Crown purchased red zone properties in Canterbury in advance of insurance payments being made to owners. Some recoveries from EQC and private insurers remain outstanding and there is a risk that final recoveries may be less than forecast. In addition, potential costs associated with the future use of residential red zone land are uncertain. The current value of the land was assessed by external valuation as at 30 June 2012. The future value may change depending on any future alternate uses of the land.

Communications - Potential Impairment in Value of Broadband Investment (Unchanged)

The Government is progressively capitalising Crown Fibre Holdings with $1.345 billion so that it can invest with private partners in a new ultra-fast broadband network delivering "ultra-fast" broadband services. Crown Fibre Holdings has entered into contracts with several partners. Given the nature of the investments made, it is possible that the full value of the investments will not be recovered. The fiscal forecasts include a provision for this impairment, but the final amount of the impairment may vary from this.

Defence Force - Potential Rationalisation, Revaluation and Disposal of NZDF Assets (Unchanged)

The Government is considering the potential to dispose of a number of NZDF assets, including the Seasprite helicopters, Unimog trucks and light armoured vehicles. Depending on market conditions, the timing of disposal and sale price received could have an impact on the operating balance. The NZDF is also completing an analysis of inventory that is surplus to requirements and is over and above the existing provision for obsolescence. The existing provision is also being reviewed to ensure that all items comprising the provision are still relevant. In addition, the revaluation of NZDF assets on 30 June 2013 could see a change in asset values across NZDF.

Energy - Crown Revenue from Petroleum Royalties (Unchanged)

Crown revenue from petroleum royalties is very dependent upon extraction rates, the USD value per barrel and the USD/NZD exchange rate. Movements up or down in any of these variables could result in a significant decrease or increase in Crown revenue. The overall impact for the Crown could be negative or positive.

Environment - Post-2012 International Climate Change Obligations (Changed)

The Government is actively considering the responsibility target New Zealand will commit to post-2012 and taking part in international negotiations for a post-2020 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 New Zealand climate change commitments post-2012 could have significant financial implications, which will need to be recognised when the commitment is considered binding.

Finance - EQC (Unchanged)

The net financial position of EQC, and the size of any requirement for additional Crown funding, is extremely uncertain. The key drivers of this uncertainly are:

• EQC's outstanding claims liability - the actuarial estimate of EQC's outstanding claims liability is highly uncertain and sensitive to assumptions; for example, cost apportionment across events, construction demand surge, land damage estimates, legal challenges, reinsurance recoveries, and the profile of claims settlement. The magnitude of the net outstanding claims cost is large, so small percentage changes in the liability can have a material impact on the fiscal forecasts.
• Reinsurance market conditions - forecast reinsurance prices are very uncertain. The price of reinsurance comprises a substantial component of EQC's annual expenses.
• EQC review and policy decisions - outcomes from the review of EQC or other policy decisions (eg, reinsurance purchases) may be implemented during the forecast period. Any significant decisions could have a material impact on the fiscal forecasts.

Finance - Goodwill on Acquisition (Unchanged)

As at 30 June 2012, the Government had goodwill on acquisition of a number of sub-entities totalling $746 million. Under New Zealand accounting standards (NZ IAS 36), such goodwill items are required to be assessed annually for impairment. If there is any indication that the goodwill may be impaired, the recoverable amount of the cash generating units to which the goodwill is allocated is required to be estimated. If the recoverable amount is less than the carrying amount of those units, the units and the goodwill allocated to them are regarded as impaired and the Government is required to recognise impairment losses in the operating statement. Such assessments will be conducted at the end of the financial year and the fiscal forecasts currently make no allowance for such impairment losses.

Finance - Government Commitments to International Financial Institutions (Unchanged)

The forecast level of government commitments to international financial institutions is subject to change, depending on the Government's response to any changed financial plans on the part of these institutions. The risk of government commitments to the IMF being called increased as a result of ongoing global financial uncertainty.

Finance - New Zealand Aluminium Smelters Contract (New)

New Zealand Aluminium Smelters and its parent company Pacific Aluminium have approached Meridian Energy to renegotiate a “contract for difference” relating to the pricing of electricity supplied to the aluminium smelter at Tiwai Point. Any significant change in the terms of this contract could have an impact on the operating balance.

Finance - Sale of Part of the Crown's Shareholding in Certain Companies (Changed)

The Government has agreed to sell part of the Crown's shareholding in Mighty River Power and Meridian Energy. It is also proposing to sell part of the Crown's shareholding in Genesis Energy, Air New Zealand and Solid Energy. The fiscal forecasts include an estimate of the cash proceeds from the sale of part of the Crown's shareholding in these companies, the dividends and profits from these companies that will be paid or are attributable to minority shareholders rather than to the Crown, and the estimated finance cost savings. However, the final amount and timing of any cash proceeds, forgone profits, the flow-on effects for the Crown and any implementation costs are uncertain, and may differ from what has been assumed in the fiscal forecasts.

Finance - Solid Energy (New)

The Solid Energy board is working with advisors, banks and the Treasury on restructuring options to return the company to a sustainable financial position. The outcome of this process could have an impact on the operating balance or the Crown's balance sheet.

Finance - Southern Response Earthquake Services Support Package (Unchanged)

AMI's earthquake claims liability and the associated financial assets, reinsurance receivables and the Crown Support Package have been retained in a new Crown company named Southern Response Earthquake Services Ltd. The ultimate cost to the Crown of settling earthquake claims remains subject to significant uncertainty. Out-year forecasts assume that the actual cost to settle claims will align with the actuary's central estimate of the claims provision. There is a risk that the actual cost could vary from this estimate.

Health - Litigation in the Disability Support and Aged Care Sectors (New)

Several related legal cases and funding claims in the disability support and aged care sectors may involve significant costs to the Crown.

Housing - Divestment of Housing (Unchanged)

The Government may undertake divestment or redevelopment of some housing property. Property sales are subject to market conditions and therefore there is an inherent level of uncertainty about the return to the Crown associated with any divestment and/or development.

Revenue - Cash Held in Tax Pools (Unchanged)

Taxpayers' provisional tax payments held in pools are recognised as a Crown asset. There is a risk that funds held in these pools, over and above a taxpayer's provisional tax liability, may be withdrawn, resulting in a reduction in the Crown's available cash reserves.

Treaty Negotiations - Treaty Settlement Forecast (Unchanged)

The fiscal forecasts include provision for the cost of future Treaty settlements. Settlements are finalised through negotiations and there is a risk that the timing and amount of the settlements could be different from what is forecast.

Treaty Negotiations - Relativity Clause (Unchanged)

The Deeds of Settlement negotiated with Waikato-Tainui and Ngāi Tahu include a relativity mechanism. Now that the total redress amount for all historical Treaty settlements exceeds $1 billion in 1994 present-value terms, the mechanism provides that 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. There is also uncertainty on how various disputes concerning the interpretation of the mechanism will be resolved.

Risks Removed Since the 2012 Half Year Update

The following risks have been removed since the 2012 Half Year Update:

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

The Public Finance Act 1989 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.[13]

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 the following criteria:

• 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[14] 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 impact is more than $100 million over five years, and either
• a decision has not yet been taken but it is reasonably possible[15] (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[16] to be approved or occur within the forecasting period.

Additionally, the Minister of Finance may determine that a matter be 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
• result in a material loss of value to the Crown.

If possible, the Minister of Finance should avoid withholding the matter either by making a decision on it before the forecasts are finalised, or by disclosing it without quantifying the risk.

Contingent Liabilities and Contingent Assets#

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Contingent assets are costs that the Crown will have to face if a particular event occurs, or present liabilities that are unable to be measured with sufficient reliability to be recorded in the financial statements (unquantifiable liabilities).

Typically, contingent liabilities consist of guarantees and indemnities, uncalled capital and legal disputes and claims. 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, or the amount becomes sufficiently reliable to record as a liability, it would reduce the operating balance and net worth and increase net debt. In the case of contingencies for uncalled capital, the negative impact would be restricted to net debt because the cost would be offset by the acquisition of capital.

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 have arisen from past events but the amount of the asset, or whether it will eventuate, will not be confirmed until a particular event occurs.

Only contingent liabilities and contingent assets involving amounts of over $100 million are separately disclosed. Quantifiable contingencies less than $100 million are included in the "other quantifiable" total.

Some contingencies of the Crown are not able to be quantified. We have disclosed all unquantifiable contingent liabilities and contingent assets that are not expected to be remote.

Contingent liabilities have been stated as at 31 March 2013, being the latest set of reported contingent liabilities.

Quantifiable Contingent Liabilities and Contingent Assets

Unquantifiable Contingent Liabilities and Contingent Assets

Description of Contingent Liabilities

Quantifiable contingent liabilities over $100 million

Uncalled capital

As part of the Crown's commitment to a multilateral approach to ensure global financial and economic stability, New Zealand, as a member country of the organisations listed below, contributes capital by subscribing to shares in certain institutions.

The capital (when called) is typically used to raise additional funding for loans to member countries, or in the case of the quota contributions, to directly finance lending to members. For New Zealand and other donor countries, capital contributions comprise both "paid in" capital and "callable capital or promissory notes."

The Crown's uncalled capital subscriptions are as follows:

Asian Development Bank

$2,772 million at 31 March 2013 ($2,988 million at 30 June 2012)

International Bank for Reconstruction and Development

$981 million at 31 March 2013 ($1,039 million at 30 June 2012)

International Monetary Fund - arrangements to borrow

$978 million at 31 March 2013 ($1,081 million at 30 June 2012)

International Monetary Fund - promissory notes

$1,089 million at 31 March 2013 ($1,174 million at 30 June 2012)

Legal proceedings and disputes

Tax in dispute

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. The contingent liability represents the outstanding debt of tax assessments raised against which an objection has been lodged and legal action is proceeding.

$363 million at 31 March 2013 ($365 million at 30 June 2012)

Other quantifiable contingent liabilities

Unclaimed monies

Administered by IRD under the Unclaimed Money Act 1971.

$103 million at 31 March 2013 ($79 million at 30 June 2012)

Unquantifiable contingent liabilities

This part of the Statement provides details of those contingent liabilities of the Crown that cannot be quantified (contingent liabilities that are considered remote are excluded).

Guarantees and indemnities

Air New Zealand 

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.

Airways Corporation of New Zealand

The Crown has indemnified Airways Corporation of New Zealand Limited as contained in Airways' contract with NZDF 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 for Primary Industries, or its sub-contractor.

Contact Energy Limited

The Crown and Contact Energy Limited 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.

Earthquake Commission (EQC)

The Crown is liable to meet any deficiency in EQC's assets that may be needed to cover 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.

EQC expects to have the necessary financing to meet its liabilities as they fall due over the next 12 months, hence a call on its Crown guarantee is not expected for the coming year. In the event that EQC cannot meet its obligations, however, the Crown would need to finance any shortfall and the Crown's net debt position would increase as a result. This support arrangement is discussed earlier in this chapter as a specific fiscal risk.

Housing New Zealand Corporation

The Crown has provided a warranty in respect of title to the assets transferred to Housing New Zealand Limited (HNZL) 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. The Crown 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.

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.

Maui Mining Companies

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.

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.

Mighty River Power Initial Public Offering

The Crown has indemnified Mighty River Power's directors and a number of external advisors against losses they may suffer as a result of any claims brought against them in relation to the Mighty River Power partial share sale.

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).

New Zealand Aluminium Smelter and Comalco

The indemnity relates to costs incurred in removing aluminium dross and disposing of it at another site if 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.

New Zealand Local Authorities

The Guide to the National Civil Defence Emergency Management Plan (‘the Guide') states that the Government will reimburse local authorities, in whole or in part, for certain types of response and recovery costs incurred as a result of a local or national emergency. The Guide is issued by the Director of Civil Defence Emergency Management (CDEM) under Section 9 of the Civil Defence Emergency Management Act 2002.

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.

Following the restructuring of KiwiRail Group, the New Zealand Railways Corporation Restructuring Act 1990 provides a statutory indemnity for the New Zealand Railways Corporation for the amount of the net equity lost in the vesting of assets and liabilities in KiwiRail Holdings Limited.

Persons exercising investigating powers

Section 63 of the Corporations (Investigation and Management) Act 1989 indemnifies the Financial Markets Authority (formerly Securities Commission), the Registrar and Deputy Registrar of Companies, members of advising committees within the Act, every statutory manager of a corporation, and persons appointed pursuant to sections 17 to 19 of the Act, in the exercise of investigating powers, unless the power has 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.

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.
• 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 IRD 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).

Legal claims and proceedings

There are numerous legal actions that have been brought against the Crown. However, in the majority of these actions it is only considered a remote possibility that the Crown would lose the case, or if the Crown were to lose it would be unlikely to have greater than a $10 million impact. Based on these factors, not all legal actions are individually disclosed. The claims that are disclosed individually, while they cannot be quantified, have the potential to exceed $10 million in penalties.

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. Given the stage of proceedings and uncertainty as to outcomes of the cases, no estimate of the financial effect can be made.

Air New Zealand litigation

Air New Zealand has been named in five class actions. 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. One class action (in the United States) alleges that Air New Zealand, together with many other airlines, conspired in respect of fares and surcharges on trans-Pacific routes. The likelihood of any liability in the other two cases is considered remote, so these are not disclosed.

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 third-party damages under the laws of the relevant jurisdictions.

Television New Zealand

The Company is subject to one legal claim before the courts. Given the stage of proceedings and uncertainty as to outcomes of the case, 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 an SOE 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 actions against the Crown, one being heard in the Court of Appeal and another action being heard in the High Court. Failure to successfully defend such actions may result in liability for historical Treaty grievances in excess of that currently anticipated.

Other unquantifiable contingent liabilities

Criminal Proceeds (Recovery) Act 2009

The Ministry of Justice is responsible for administering the Criminal Proceeds (Recovery) Act 2009. The Act requires the Crown to give an undertaking as to damages or costs in relation to asset restraining orders. In the event that the Crown is found liable, payment may be required.

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 costs can be reliably measured have been included in the statement of financial position as provisions.

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 profits attributed to a Protected Land property 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, the amount of any outstanding equity payments on the initial value of the property.

Description of Contingent Assets

Quantifiable contingent assets over $100 million

Tax disputes

A contingent asset is recognised when IRD has advised, or was about to advise, a taxpayer of a proposed adjustment to their tax assessment. The taxpayer has the right to dispute this adjustment and a disputes resolution process can be entered into. The contingent asset is based on the likely outcome of the disputes process based on experience and similar prior cases.

$283 million at 31 March 2013 ($150 million at 30 June 2012)

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 Risks and Scenarios and Specific Fiscal Risks chapters discuss the risks to the fiscal forecast in more detail.

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 29 April 2013.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined on pages 41 to 43.

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 included within the 2013 Budget Update Additional Information document which can be found on the Treasury's website at www.treasury.govt.nz/budget/forecasts/befu2013.

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 in these forecasts. 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 Specific Fiscal Risks chapter on pages 59 to 81.

Key forecast assumptions used are set out on pages 41 to 43.

Government Reporting Entity as at 29 April 2013#

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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

• Canterbury Earthquake Recovery Authority
• Crown Law Office
• Department of Conservation
• Department of Corrections
• Department of Internal Affairs
• Department of the Prime Minister and Cabinet
• Education Review Office
• Government Communications Security Bureau
• Inland Revenue Department
• Land Information New Zealand
• Ministry for Culture and Heritage
• Ministry for Primary Industries
• Ministry for the Environment
• Ministry of Business, Innovation and Employment
• Ministry of Defence
• Ministry of Education
• Ministry of Foreign Affairs and Trade
• Ministry of Health
• Ministry of Justice
• Ministry of Māori Development
• Ministry of Pacific Island Affairs
• Ministry of Social Development
• Ministry of Transport
• Ministry of Women's Affairs
• New Zealand Customs Service
• New Zealand Defence Force
• New Zealand Police
• New Zealand Security Intelligence Service
• Office of the Clerk of the House of Representatives
• Parliamentary Counsel Office
• Parliamentary Service
• Serious Fraud Office
• State Services Commission
• Statistics New Zealand
• The Treasury

Offices of Parliament

• Controller and Auditor General
• The Ombudsmen
• Parliamentary Commissioner for the Environment

Others

• New Zealand Superannuation Fund
• Reserve Bank of New Zealand

State-owned enterprises

• Airways Corporation of New Zealand Limited
• Animal Control Products Limited
• AsureQuality Limited
• Electricity Corporation of New Zealand Limited
• Genesis Power Limited
• Kiwirail Holdings Limited
• Kordia Group Limited
• Landcorp Farming Limited
• Learning Media Limited
• Meridian Energy Limited
• Meteorological Service of New Zealand Limited
• New Zealand Post Limited
• New Zealand Railways Corporation
• Quotable Value Limited
• Solid Energy New Zealand Limited
• Terralink NZ Limited (in liquidation)
• Transpower New Zealand Limited

Organisations named or described in Schedule 5 of the Public Finance Act 1989

• Mighty River Power Limited

Others

• Air New Zealand Limited

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

Crown entities

• Accident Compensation Corporation
• Arts Council of New Zealand Toi Aotearoa
• Broadcasting Commission
• Broadcasting Standards Authority
• Callaghan Innovation
• Careers New Zealand
• Children's Commissioner
• Civil Aviation Authority of New Zealand
• Commerce Commission
• Crown Research Institutes (7)
• District Health Boards (20)
• Drug Free Sport New Zealand
• Earthquake Commission
• Education New Zealand
• Electoral Commission
• Electricity Authority
• Energy Efficiency and Conservation Authority
• Environmental Protection Authority
• External Reporting Board
• Families Commission
• Financial Markets Authority
• Government Superannuation Fund Authority
• Guardians of New Zealand Superannuation
• Health and Disability Commissioner
• Health Promotion Agency
• Health Quality and Safety Commission
• Health Research Council of New Zealand
• Housing New Zealand Corporation
• Human Rights Commission
• Independent Police Conduct Authority
• Law Commission
• Maritime New Zealand
• 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 (2,455)
• Social Workers Registration Board
• Sport and Recreation New Zealand
• Standards Council
• Takeovers Panel
• Te Reo Whakapuaki Irirangi (Māori Broadcasting Funding Agency)
• 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

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 Asset Management Limited
• Crown Fibre Holdings Limited
• Dispute Resolution Services Limited
• Fish and Game Councils (12)
• Health Benefits Limited
• Leadership Development Centre Trust
• Learning State Limited
• Māori Trustee
• 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 (21)
• Road Safety Trust
• Sentencing Council
• Southern Response Earthquake Services Limited
• Tāmaki Redevelopment Company Limited
• Te Ariki Trust
• The Network for Learning Limited

Financial Statements#

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

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 SOEs.

1. Previously environmental protection expenses were included within the heritage, culture and recreation classification. These expenses have been reclassified to the new environmental protection functional classification.

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

Forecast Statement of Comprehensive Income for the years ending 30 June

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 Cash Flows for the years ending 30 June

1. 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 Financial Position as at 30 June

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#

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

1. Core Crown borrowings in this instance include 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 other Crown reporting entities.
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 creditworthiness 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 2013

Statement of Actual Contingent Liabilities and Assets as at 31 March 2013

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

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

Notes to the Forecast Financial Statements#

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NOTE 1: Sovereign Revenue

1. Customs excise-equivalent duty.

NOTE 2: Interest revenue and dividends

NOTE 3: Transfer payments and subsidies

From 15 July 2013 the benefit categories Domestic Purposes Benefit, Invalid's Benefit, Unemployment and Emergency Benefit and Sickness Benefit, as well as Widow's Benefit, are being replaced by new benefit categories. These categories are Jobseeker Support and Emergency Benefit, Supported Living Payment and Sole Parent Support.

NOTE 4: Personnel expenses

NOTE 5: Depreciation, amortisation and other operating expenses

NOTE 6: Interest expenses

NOTE 7: Insurance expenses

NOTE 8: Forecast new spending and top-down expense adjustment

Unallocated contingencies represent expenses included in Budget 2013 and previous Budgets that have yet to be allocated. Forecast new spending indicates the expected spending increases from future Budgets.

Unallocated contingencies represent capital spending from Budget 2013 and previous Budgets that have yet to be allocated. Forecast new spending indicates the expected capital spending increases from future Budgets, which are funded from the Future Investment Fund.

NOTE 9: Gains and losses on financial instruments

NOTE 10: Gains and losses on non-financial instruments

NOTE 11: Operating balance

NOTE 12: Financial assets

NOTE 13: Student loans

NOTE 14: Property, plant and equipment

1. Land relating to state highways, the rail network and conservation which had previously been included within the State highways, Rail network and Specified cultural and heritage assets categories has been reclassified to the Land category.

1. Other mainly includes transfers to/from other asset categories.

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

NOTE 15: Intangible assets and goodwill

Net Kyoto position

The New Zealand Government has committed under the Kyoto Protocol to ensuring that New Zealand's average net emissions of greenhouse gases from 2008 to 2012 (the first commitment period of the Kyoto Protocol, or CP1) are reduced to gross 1990 emission 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 latest Net Position estimate can be found on the Ministry for the Environment's website: www.mfe.govt.nz/issues/climate/greenhouse-gas-emissions/net-position [Treasury adjusted URL at March 2024 https://environment.govt.nz/what-government-is-doing/areas-of-work/climate-change/emissions-reduction-targets/latest-update-on-new-zealands-2020-net-position/]

NOTE 16: NZS Fund

NOTE 17: Payables

NOTE 18: Insurance liabilities

ACC liability

Calculation information

PricewaterhouseCoopers Actuarial Pty Ltd have prepared an independent actuarial estimate of the ACC outstanding claims liability as at 31 December 2012. 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 assumptions underpinning this valuation form the basis of the five-year forecast of the outstanding claims liability.

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 rates as at 31 March 2013. The equivalent single effective discount rate, taking into account ACC's projected future cash flow patterns, is a short-term discount rate of 4.66% and a long-term discount rate of 6.00% from 2035.

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, including an adjustment to reflect projected future actuarial releases ($338 million in 2013 and a further $498 million in 2014), 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 NZ Government stock) are included in the asset portion of the Government's Statement of Financial Position.

Levy reductions

The signalled levy reductions are not included in this note as the impact on specific levy rates has yet to be agreed. Instead the levy reductions have been included in the forecast as a contingency (refer to the ACC Levy Reduction box in the fiscal chapter for more information). The levy reduction will decrease the net ACC reserves.

EQC liability

Calculation information

Melville Jessup Weaver prepared an independent actuarial estimate of the EQC outstanding claims liability at 30 June 2012 by estimating the projected ultimate claims costs then deducting the payments made in relation to those claims on or before that date. Each component of the claims liability was split into separate groups depending upon the Canterbury earthquake event grouping or other “business as usual” claims. These event groups were further split into sub-claim valuation groups being land claims, building claims or contents claims. The assumptions underpinning the 30 June 2012 valuation form the basis of the five-year forecast of the outstanding claims liability.

Critical assumptions used in projecting the ultimate costs include cost of apportionment across earthquake events, the profile of claims settlement, claims inflation rate per annum, risk margins and claims handling costs.

There is a high level of uncertainty associated with the valuation of the outstanding claims liability, reinsurance recoveries and unexpired risk liability. Some of the key uncertainties are: cost apportionment across events; the potential for construction cost to exceed expectations; land damage estimates; reinsurance recoveries and profile of claims settlement.

The actual claims outcome may differ from the one currently forecast.

Presentation approach

EQC reinsurance recoveries are included in receivables in the Statement of Financial Position.

NOTE 19: Retirement plan liabilities

The net liability of the Government Superannuation Fund (GSF) was calculated by GSF's actuary as at 28 February 2013. 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 was used to calculate the liability as at 28 February 2013, based on membership data as at 30 June 2012 with adjustments for cash flows to 28 February 2013. 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.

For these Forecast Financial Statements, the net GSF liability was updated for the latest discount rates derived from the market yield curve for New Zealand Government bonds as at 28 February 2013.

Other principal long-term financial assumptions were an inflation rate, as measured by the Consumers Price Index, of 2.1% for the year to June 2013 and 2.4% for 2014, increasing to 2.5% in 2015, and an annual salary growth rate, before any promotional effects, of 3% (unchanged from 30 June 2012).

The 2012/13 projected decrease in the net GSF liability is $1,311 million, reflecting a decrease in the GSF liability of $1,053 million and an increase in the GSF assets of $258 million.

The decrease in the GSF liability of $1,053 million includes an actuarial gain between 1 July 2012 and 28 February 2013, of$690 million owing to movements in the discount rates and changes in demographic assumptions. The remaining $363 million reduction is owing to expected benefits paid to members (reduces the liability) offset by current service cost and interest unwind (increases the liability).

The increase in the value of the net assets of GSF of $258 million includes a gain of $228 million reflecting the updated market value of assets at 28 February 2013. The balance of $30 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 2012/13 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 a limited number of tradable units (the NZ Unit) which the Government can allocate. 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 surrender Kyoto compliant units to settle their obligation. The Kyoto compliant units collected through the ETS are recognised as revenue and as part of the net Kyoto Protocol position.

The carbon price used to calculate the ETS provision is assumed to remain constant over the forecast period and is based on the estimated March 2013 carbon price of €0.16 with an exchange rate of 0.65465 (a carbon price of NZ$0.24).

The ETS impact on the fiscal forecast is as follows:

NOTE 21: Net worth

NOTE 22: Core Crown residual cash

1. Short-term borrowing consists of Treasury Bills and may include Euro-Commercial Paper.

Forecast Statement of Segments#

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