Budget Economic and Fiscal Update 2014

Statement of Responsibility#

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 2014 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 2014. 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 2014

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 2014 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 2014

Executive Summary#

• The economy is entering its fourth year of expansion with real gross domestic product (GDP) estimated to be currently growing at around a 4% annualised pace. Employment is increasing and both annual Consumers Price Index (CPI) inflation and the current account deficit are low at present. Growth has become more broad-based, although it is still dominated by domestic demand.
• Following estimated real GDP growth of 3.0% in the year to March 2014, 4.0% growth is forecast this March year, 3.0% in the year to March 2016, then easing to around 2% in the last two years of the forecast period. Over the five years to March 2018, real GDP growth averages 2.8%, a little above the Treasury's estimate of potential output growth over this period. The latter is forecast to increase from a low of around 1.5% during the recession to around 2.6% on average over the forecast period, as a result of lower unemployment, strong growth in the working-age population and a rebound in trend productivity growth on the back of higher investment.

Figure 1 - Real GDP and potential output growth

Source: Statistics New Zealand, the Treasury

Figure 2 - Contributions to real GDP growth

Source:  Statistics New Zealand, the Treasury

• The Canterbury rebuild, near record-high terms of trade, strong net migration and stimulatory monetary policy settings are all contributing to robust household and firm spending, while fiscal policy and the elevated exchange rate are providing some offset. Real private spending growth is forecast to accelerate to nearly 7% during the year ahead, supported by higher income growth and asset prices, application of insurance payouts and high consumer and business confidence. Credit growth is increasing but remains moderate.
• Looking forward, the strength of some of the positive influences on GDP growth are expected to moderate, including monetary policy moving to a more neutral stance in response to emerging inflationary pressures. The latter reflects the expectation that the economy will be operating at or above capacity over much of the forecast period. Further increases in the Official Cash Rate (OCR) are expected, leading to a gradual but steady increase in short-term interest rates through 2014 and 2015, the precise pace depending on how inflation pressures evolve.
• The global backdrop to these forecasts is steady, but uneven, economic growth, notwithstanding stronger growth in advanced economies. Trading partner growth is likely to be similar to that recorded in the mid-2000s with moderate inflation. Risks overall remain skewed to the downside.
• Global financial conditions continue to be very accommodating. While the US Federal Reserve has begun to reduce its asset purchases, so-called “tapering”, it is likely to be some time yet before central banks in the major advanced economies begin to increase their policy interest rates.
• The unemployment rate is forecast to decline to below 5%, annual CPI inflation to move back to around the middle of the 1% to 3% target band and the current account deficit to increase to over 6% of GDP by the end of the 2017/18 forecast period. Growth in imports, partly associated with strong investment growth, means net exports make a negative contribution to GDP growth over the first three years of the forecast period.
• Fiscal policy restraint and the high exchange rate imply interest rates are lower than would otherwise be the case. The recent application of Loan-to-Value Ratios (LVRs) is also reducing the amount of work monetary policy needs to do over the short term. In the absence of these downward forces, the impetus to demand from the Canterbury rebuild and the high terms of the trade would have likely forced interest rates to rise earlier and by more.
• The operating balance before gains and losses (OBEGAL) is forecast to move from a deficit of $2.4 billion this fiscal year to a surplus of $0.4 billion in the year ending June 2015, and to $3.5 billion in the year ending June 2018. Net core Crown debt is forecast to peak at $65.5 billion in June 2017 from $59.4 billion in June 2014.

Figure 3 - OBEGAL, core Crown residual cash and net core Crown debt

Source:  The Treasury

• Budget 2014 incorporates net new operating initiatives of $1 billion per annum on average over the next four years. The indicative operating allowance for Budget 2015 and beyond is $1.5 billion per annum, growing at 2% per Budget. Increasing tax receipts mean core Crown operating cash flows are forecast to return to surplus in the year ending June 2015. When combined with net capital spending, core Crown residual cash returns to surplus in the year ending June 2018 (one year later than forecast in the Half Year Update of December 2013). This includes $4.7 billion of gross proceeds from completion of the Government Share Offer programme.
• Following a decline over recent years, the Crown's share of net worth is expected to increase modestly over the forecast period, as the Government begins to record surpluses and the growth in assets outpaces liabilities. Within the balance sheet, financial assets are forecast to increase (particularly the Crown's investment portfolios) to over 50% of total Crown assets and around 50% of GDP. Liabilities begin to fall in nominal terms by the end of the forecast period as earthquake obligations are settled and the Crown begins to pay back debt.
• There is a mix of upside and downside risks, including the size and pace of the Canterbury rebuild, the size and duration of the current upswing in net migration, the path of the terms of trade, the path and pass-through of the exchange rate and the saving behaviour of households, particularly in light of current house price increases.
• The Budget Update contains two alternative scenarios to illustrate how the economy could evolve if some of the judgements underpinning the main forecasts turn out differently. One scenario maps out a stronger net migration driven cycle, while the other shows the impact of a larger fall in the terms of trade.
• In addition to the fiscal impact of changes to economic activity, the Government is exposed to other fiscal risks that could impact both the operating balance and the balance sheet. For example, the Crown's financial position is susceptible to market movements in variables such as interest rates, exchange rates and equity prices. The final fiscal cost of the Canterbury earthquakes is also still uncertain. 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. CPI, annual percentage change, outturn for March 2014
4. % of GDP
5. Total Crown operating balance before gains and losses (OBEGAL)
6. Net core Crown debt excluding the New Zealand Superannuation Fund and advances

Sources: Statistics New Zealand, the Treasury

Economic Outlook#

Overview#

• The pace of expansion in economic activity quickened and broadened over the second half of 2013. This trend is likely to have continued in 2014. Over the second half of 2013, agricultural production recovered from the drought earlier in the year and exports rose strongly; business confidence increased and investment in capital goods accelerated; and economy-wide employment rose sharply, supporting growth in household incomes.
• Household and business incomes have been further boosted by high prices for New Zealand's export commodities, which have underpinned record high levels in the terms of trade. The rise in incomes has been reflected in faster growth in private consumption expenditure and in market investment. Low interest rates, the Canterbury rebuild and strengthening net migration inflows are also adding to domestic demand.
• Growth in demand has reduced spare capacity in the economy and consumer price inflation has increased, particularly for non-tradable goods and services. Prices in the tradable sector have continued to fall, reflecting weak import prices and the ongoing appreciation of the exchange rate, and have helped keep overall inflation moderate. At the same time, the high exchange rate is reducing the price competitiveness of firms in the tradable sector, and restraints on high loan-to-value mortgage lending are reducing the impact of low interest rates on parts of the economy.
• Growth in New Zealand's major trading partners is gaining momentum, supported by expansionary monetary policy. However, inflation is low in many countries, public and private debt is high and financial stability risks, while reduced, remain a threat to the recovery. Internationally, monetary policy accommodation is expected to remain in place for some time.
• Domestically, the pace of expansion in the economy is expected to quicken to 4.0% over the next year and employment is forecast to increase by 3.0%. The relatively positive growth outlook and the accompanying inflationary pressures have led the Reserve Bank to begin returning interest rates to more neutral settings. Short-term interest rates are forecast to rise to 4.3% in the March 2015 quarter and to 4.8% a year later, and consumer price inflation is expected to peak at around 2.5% in mid-2016 and to ease to 2.0% in early 2018.
• Expectations of widening interest rate differentials are providing support for the current high level of the New Zealand dollar. The trade-weighted exchange rate is assumed to remain elevated throughout the forecast period, which slows growth in the tradables sector and contributes to a widening of the current account deficit.
• Beyond 2015, tighter monetary conditions, combined with a decline in the terms of trade and slowing net migration inflows, contribute to a period of more moderate growth that enables inflation to stabilise and the exchange rate to depreciate. Nonetheless, the exchange rate remains high at the end of the forecast period and continues to constrain export growth, while import demand continues to be supported by the Canterbury rebuild. This is reflected in a current account deficit of 6.3% of GDP in 2018.

Higher terms of trade and increased net migration inflows provide a temporary boost... 

The terms of trade (the price of exports relative to imports) have risen to 40-year highs, leading to an increase in national income and purchasing power. These gains are reflected in increased consumer spending and business investment. Higher net migration inflows are also adding to demand. As a consequence, the near-term growth outlook is slightly stronger than forecast in the Half Year Update (Figure 1.1). However, recent gains in the terms of trade and net migration are expected to be temporary.

Figure 1.1 - Real GDP growth

Source:  Statistics New Zealand, the Treasury

Rising dairy export prices have been a major contributor to the higher terms of trade but, more recently, dairy prices have moved lower and further falls are anticipated as global supply increases. Demand from Asia, and China in particular, is expected to remain strong and to provide support for historically high prices over the medium term. Prices for many other export commodities are also at high levels but, like the market for dairy products, increases in supply are expected to result in lower prices over the next 12 to 18 months.

Overall, the terms of trade are projected to decline by about 9% over the next year but to remain at a high level over the medium term. This is a small decline relative to many of those experienced over the past 40 years and the historical experience suggests that the terms of trade will, in all likelihood, be much more volatile than projected. Nonetheless, over the medium term the terms of trade are expected to settle at a level that is well above their long-run trend (see Box on the outlook for the terms of trade on page 13). The Risks and Scenarios chapter explores the likely effects of a large and sustained fall in the terms of trade.

Notes:

1. Forecasts finalised 17 April 2014.
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.
8. System of National Accounts (SNA) and merchandise basis, annual average percentage change.
9. QVNZ House Price Index, annual percentage change.
10. Average for the March quarter. CPI, TWI and interest rates are actuals for 2014.

Longer time series for these variables are provided on page 132.

Net permanent and long-term migration inflows have continued to rise in recent months, increasing the population and adding to demand in the housing market and to private consumption demand more broadly (Figure 1.2). Net inflows reached nearly 32,000 in the 12 months to March 2014, almost double the inflow at the time of the Half Year Update, and have contributed to a doubling in annual population growth over the past 18 months.

Figure 1.2 - Private consumption and net migration

Source:  Statistics New Zealand, the Treasury

Much of the rise in net migration inflows is accounted for by fewer departures, mostly to Australia, reflecting the relatively positive outlook for employment growth in New Zealand. Arrivals from Australia have also strengthened, driven by returning New Zealanders. Annual net migration is expected to increase further, to around 38,000 later this year, before declining gradually to its long-run average inflow of 12,000 per year. However, like the terms of trade, movements in net migration are hard to predict and can change rapidly. The implications of a greater increase in net inflows are discussed in the Risks and Scenarios chapter.

...while the Canterbury rebuild has a longer-lasting impact

The Canterbury rebuild is expected to provide significant impetus to demand over the forecast horizon and beyond, chiefly through additional residential and business investment, but also through related consumption spending on consumer durables. Reconstruction investment is estimated to total around $40 billion, with around half of this expenditure expected to have taken place by the end of the forecast period in mid-2018. Construction activity is also expected to increase elsewhere, particularly in the Auckland area where there is a shortage of housing.

Construction activity rose strongly over the first half of 2013 and continued at a high level over the remainder of the year. The number and value of residential building consents has continued to trend upward in recent months, indicating a strong pipeline of activity ahead (Figure 1.3). Employment in the industry has continued to expand and the labour market has tightened, particularly in Canterbury, where unemployment has fallen to low levels. Construction costs in the Consumers Price Index (CPI) have increased and are likely to increase further as capacity pressures become more acute, underpinning non-tradables inflation in coming years. While these costs are assumed to have limited implications for other industries, the risk of stronger cost pressures remains high.

Figure 1.3 - Real residential investment

Source:  Statistics New Zealand, the Treasury

House prices rose 9% in the year ending December, although the rate of increase has eased in recent months, likely reflecting loan-to-value restrictions on mortgage lending imposed by the Reserve Bank on 1 October 2013, as well as higher mortgage interest rates. Further interest rate rises are projected and house price inflation is expected to ease further (Figure 1.4). In these forecasts, short-term interest rates rise to 4.8% by the March quarter 2016, up from 3.0% in the March quarter 2014, a little faster than projected in the Half Year Update, reflecting stronger growth.

Figure 1.4 - House prices and interest rates

Source:  Quotable Value, Reserve Bank, the Treasury

Projected interest rate increases flow through to higher household debt servicing expenses (Figure 1.5), which constrains the rate of growth of consumption demand and the demand for housing assets. Although interest rates are projected to rise, the timing and extent of future increases are uncertain; for example, interest rates may not rise as quickly as forecast if the terms of trade fall more sharply than expected (as in the Risks and Scenarios chapter).

Figure 1.5 - Household saving and debt servicing

Source:  Statistics New Zealand, the Treasury

Household debt has declined from its earlier peak as a share of household income, but remains elevated. These forecasts assume that some of the income gains from the rise in the terms of trade are saved (Figure 1.5), but the response of consumers to increased income is uncertain. There is a risk that, rather than increase their saving, households may instead prefer to increase their debt levels to fund the purchase of houses or the consumption of other goods and services and, as a consequence, house price inflation and domestic demand pressures do not ease as anticipated. The implications of stronger private consumption are modelled in the Risks and Scenarios chapter.

Private consumption expenditure is supported by a stronger labour market... 

Growth in private consumption is supported by rising labour income and the terms of trade. Employment growth accelerated over the second half of 2013, reflecting increased demand in the economy and greater confidence in the economic outlook, and the unemployment rate fell to 6.0% (Figure 1.6). With demand continuing to strengthen and confidence remaining high, further gains in employment are anticipated. The unemployment rate is expected to decline to around 5.0% in 2016, underpinned by a labour force participation rate that is assumed to return to its pre-recession peak in coming quarters and to remain at an historically high level. The higher labour force participation rate, coupled with rising net migration inflows, partly offsets the impact of stronger labour demand and results in only a gradual increase in wage growth.

Figure 1.6 - Labour market

Source:  Statistics New Zealand, the Treasury

Similarly, although rising net migration adds to demand pressures in the short-run, in the medium term it increases the productive capacity of the economy. This increase is reflected in potential GDP growth, which expands at an average rate of 2.6% per year over the forecast period, slightly higher than in the Half Year Update.

Over the year ahead, employment is expected to grow 3.0% and to be the primary factor contributing to increased output. From the year ending March 2015 onward, growth in the capital stock, which partly reflects the Canterbury rebuild, makes the largest factor contribution to increases in output. These trends are reflected in above-average labour productivity growth over the March years ending 2013 to 2016 when output growth is strongest, but slower productivity growth thereafter as output growth slows. As a consequence, the forecast pickup in GDP per capita growth to over 2.0% per year in 2014 is expected to subside by 2016, and to average around 1.7% over the forecast period, a little above its post-2000 average.

...and higher real incomes

Increases in the terms of trade, which measure the prices of goods and services New Zealand exports relative to those it imports, mean that the purchasing power of New Zealand residents has improved. The terms of trade effects are not captured directly by the measures of real GDP, which measures production, but are included in real gross national income (GNI). The recent rise in the terms of trade has caused a significant divergence between the movements of real GDP and real GNI; that is, real incomes are increasing faster than real output or GDP (Figure 1.7). Although real income growth slows as the terms of trade ease, the ongoing high level of the terms of trade means that real incomes also remain high. Some of these income flows will be required to meet increased depreciation as the capital stock expands, but a large proportion of the gains from the terms of trade are likely to be available to support domestic consumption.

Figure 1.7 - Real income and real output

Source: Statistics New Zealand, the Treasury

Outlook for New Zealand's Terms of Trade

Until the late 1980s, New Zealand's terms of trade appeared to be on a downward trend. This was considered a serious issue for the economy and was often explained in terms of a long-term decline in commodity prices relative to manufacturing prices.[1]The trend decline in the terms of trade appears to have stopped in the late 1980s, followed by a period of stability in the 1990s and an upward trend from around 2000.

One of the main factors responsible for this change is the entry of China into the world economy, increasing the demand for commodities and contributing to falling prices for manufactured goods. This combination has resulted in a rise in New Zealand's terms of trade over the past 10-15 years (Figure 1.8).

The terms of trade are an important influence on New Zealand's nominal GDP which in turn is a key driver of tax revenue. Higher export prices flow through directly to the tradables sector and indirectly to the rest of the economy.

An elevated outlook for the terms of trade has been one of the key features of recent Treasury forecasts. The headline merchandise terms of trade reached a fresh 40-year high in the December 2013 quarter and were only 3.5% short of their 1973 high.[2] The terms of trade are expected to fall over the second half of 2014 as high dairy prices drive increases in global production. This is expected to reduce global prices and to lower returns to New Zealand producers.

Nonetheless, rising demand from China and other emerging economies is expected to support demand for our commodity exports, and to underpin the terms of trade, into the medium term as total world production is unable to keep pace. In the 2014 Budget Update, the merchandise terms of trade are assumed to remain around 25% higher than their 50-year average.

The Treasury's forecasts are supported by international research, particularly with regard to dairy prices, which the OECD-FAO expects to remain high in real terms for the next decade (Figure 1.9). The Risks and Scenarios chapter contains a scenario based on a greater fall in the terms of trade that is maintained at a lower level over the medium term.

Figure 1.8 - Merchandise terms of trade

Source:  Statistics New Zealand, the Treasury

Figure 1.9 - Forecasts of dairy prices

Source:  OECD-FAO, the Treasury

Market investment has accelerated...

The current environment of low interest rates, positive business sentiment and an elevated exchange rate (which makes imported capital goods cheaper) has supported a marked acceleration in investment in plant, machinery and equipment, which comprises about half of market investment. These supportive factors are expected to continue to drive investment growth over the next year or so (Figure 1.10). Thereafter, the influence of tighter monetary policy and the gradual decline of the exchange rate lead to slower investment growth. Furthermore, increases in demand from the Canterbury rebuild are expected to fade over 2015 as construction activity reaches its peak and continues at a high level for a number of years beyond the end of the forecast period in 2018.

Figure 1.10 - Investment demand

Source:  Statistics New Zealand, the Treasury

...but fiscal policy remains tight   

The Government's fiscal objectives of achieving an operating balance surplus in the year ending June 2015 and then reducing debt are consistent with moderate growth in real government consumption over the forecast period (Figure 1.11). The increased operating allowances announced in the Budget are assumed to result in higher government consumption expenditure. The composition of spending will be revisited when government policy decisions are confirmed in future Budgets, that is, the operating allowances may be used for either higher spending or revenue reductions (see the 2014 Fiscal Strategy Report).

Figure 1.11 - Public consumption

Source:  Statistics New Zealand, the Treasury

Despite the increased allowances, government consumption is forecast to continue to decline as a proportion of GDP and the fiscal impulse or stimulus to the economy maintains its contractionary trend. That is, the net impact of the Government's spending, taxation and borrowing programmes is to reduce the share of the economy's productive resources it utilises, which enables other sectors of the economy to expand more vigorously.

Trading partner growth is supporting export demand... 

Economic growth in our major trading partners has been slightly higher than anticipated in the Half Year Update for most of the advanced economies, and the UK and US in particular; Japan and some of the emerging Asian economies underperformed relative to the forecasts.

The trend in world growth forecasts since late last year is for improvement in most advanced economies as their recoveries take hold, but some downgrades for emerging economies as capacity constraints, structural issues and tighter financial conditions, driven by greater investor concerns about vulnerabilities, affect their outlook. Inflation in the major advanced economies has remained subdued and the period of low interest rates is likely to be sustained for some time (Figure 1.12).

Figure 1.12 - Short-term interest rates in advanced economies

Source:  Haver, the Treasury

In the US, adverse winter weather has likely contributed to a period of slower growth, but a return to the moderate growth evident at the end of 2013 is expected. The labour market has continued to strengthen, albeit at a somewhat slower pace in recent months, and the unemployment rate has fallen to 6.3%. Ongoing monetary stimulus and slowing fiscal consolidation are expected to support growth of around 3% per year over the forecast period. A prolonged period of low interest rates and supportive monetary policy is also expected for the euro area and Japan.

Growth in the Australian economy continues to reflect the rebalancing of activity from mining investment to exports and to other sectors. This transition has been accompanied by slower growth in 2013, but there are signs that demand is picking up, supported by low interest rates and strong demand in the housing market. However, the labour market remains subdued and the unemployment rate has been little changed over the past year, averaging around 5.8%. Growth is expected to remain below average for the next two years or so.

Figure 1.13 - Trading partner growth and inflation in the US and euro area

Source:  Haver, the Treasury

In China, growth also appears to have eased early in 2014, but is expected to recover, partly reflecting additional fiscal support. Over the medium term, growth is expected to moderate to around 7.0% as more restrained rates of credit growth and the impacts of reforms to promote a transition to a more balanced and sustainable growth path take effect. Although growth is expected to be more moderate, demand for New Zealand's export commodities is likely to remain strong as ongoing increases in per capita incomes and changing dietary tastes drive continued increases in protein consumption.

Overall, trading partner growth is expected to increase at a similar pace to that experienced through the mid-2000s (Figure 1.13). Rising demand, particularly in China, will support export growth and underpin strong export prices. Despite the improved outlook, significant downside risks remain. Public debt remains high in many advanced economies and credible medium-term plans to reduce the stock of debt are yet to emerge. Similarly, private and banking-sector debt remains high and credit conditions generally remain weak. In the euro area, the additional challenges of structural reform remain and risks to activity from very low inflation have emerged. The potential for a financial crisis in emerging markets and/or China also poses threats to the outlook. Risks to the global outlook are explored in more detail in the Risks and Scenarios chapter.

 ...but the high exchange rate is dampening the impact...

Expectations of future interest rate increases, combined with high commodity prices and New Zealand's relatively favourable growth outlook, lifted the trade-weighted index (TWI) to a record high in the March quarter (Figure 1.14).

Figure 1.14 - Services and manufactured goods exports and the exchange rate

Source:  Statistics New Zealand, the Treasury

In the services export sector, which is dominated by tourism, the elevated exchange rate is making New Zealand a more expensive destination for tourists and foreign students who tend to have fixed foreign currency budgets. As a result, the New Zealand dollar value of export receipts for travel services and services exports more broadly has been static over the past year despite a 6% increase in visitor arrivals. The price competitiveness of manufactured goods exports is also reduced when the exchange rate appreciates, and export receipts in this sector have fallen over the past year. Trading conditions are expected to remain challenging in both sectors, although trading partner growth and the assumed depreciation of the exchange rate, particularly after 2016, provide some relief.

...and contributing to a widening current account deficit 

In the final quarter of 2013 the strength of commodity export prices, combined with the recovery in dairy production from the earlier drought, increased the trade surplus and narrowed the current account deficit. Further increases in the trade surplus are expected in the near term reflecting ongoing high prices over the March quarter (Figure 1.15). More recently, dairy export prices have fallen and further falls are anticipated, leading to a decline in goods export receipts over the next two years or so. In addition, goods imports are expected to increase as investment and consumption demand continue to grow. As a consequence, the goods surplus is eroded over the year ahead and a widening deficit develops. This widening trend is halted late in the forecast period when the falling exchange rate supports export revenues.

Figure 1.15 - Current account

Source:  Statistics New Zealand, the Treasury

The long-term downward trend in the services surplus is forecast to continue, reflecting the depressing effect of the high exchange rate on export volume growth and its positive impact on services imports, which include holidays abroad by New Zealand residents.

Figure 1.16 - Savings and investment

Source:  Statistics New Zealand, the Treasury

Interest rates in the major developed economies are expected to remain on hold over the next year at least, but long-term rates are expected to rise gradually and to drive increases in interest outflows. Dividend outflows are also expected to increase, reflecting improved profitability, and overall the income deficit widens to around $12 billion from around $10 billion in the year ending March 2014. As a share of GDP, the income deficit is broadly stable at around 4.5% of GDP.

Over the forecast period investment demand rises more rapidly than saving, partly as a result of the Canterbury rebuild, which is reflected in a wider current account deficit (Figure 1.16). However, a large share of the Canterbury rebuild is assumed to be financed by overseas insurance inflows, which means that a proportion of the current account deficit is not generating additional international liabilities. Statistics New Zealand estimates a total of $19 billion of reinsurance claims from all the Canterbury earthquakes, with $13 billion of these claims having been settled.

In summary, the annual current account deficit is forecast to widen to 6.3% of GDP by the end of the forecast period in June 2018 and net international liabilities rise to 77% of GDP from 67% currently. In these forecasts, further depreciation of the exchange rate is required to stabilise the net international liability position.

Domestic sources of inflation are rising... 

The strong pace of expansion evident in the economy is reducing spare capacity and contributing to price increases, particularly in non-traded sectors of the economy, including housing and household utilities. Falling tradable prices have provided an offset to rising non-tradable prices with the New Zealand dollar's appreciation, although the pace of falls has eased recently (Figure 1.17). Price pressures are expected to intensify, consistent with business survey measures of pricing intentions and with the expected stabilisation of the New Zealand dollar, which reduces opportunities for further tradable price falls.

Overall, headline CPI inflation is forecast to rise to around 2.5% in 2016 and decline gradually thereafter. Increases in tobacco excise taxes are expected to add 0.2 percentage points to annual inflation in each of the March 2015 and 2016 quarters.

Figure 1.17 - Consumer price inflation

Source:  Statistics New Zealand, the Treasury

...leading to a withdrawal of monetary stimulus

As mentioned earlier, the Reserve Bank has begun to remove the stimulus to demand imparted by low interest rates. Further increases over the next two years are projected to lift short-term interest rates to around 4.8% from 3.3% currently. The higher interest rates have a direct impact on household disposable incomes through higher interest payments and an indirect impact on business investment demand, both of which result in slower growth. Although 90-day interest rates are expected to be neutral at around 4.8%, further increases may be required to offset the upward price pressure generated by the projected fall in the exchange rate and to keep inflation expectations anchored close to 2%.

Nominal GDP growth accelerates in the near term

The economy-wide price effects of movements in the terms of trade are captured in broad price measures including the GDP deflator, which is increasing sharply (Figure 1.18). With real GDP growth also rising briskly, nominal GDP growth is expected to accelerate to over 8% in the year ending June 2014. As the terms of trade fall later this year, nominal GDP growth slows to 4.5% in the year ending June 2015 and averages a little over 4% for the remainder of the forecast period.

Figure 1.18 - GDP deflator and nominal GDP

Source:  Statistics New Zealand, the Treasury

In the income measure of nominal GDP, which underpins the Treasury's tax revenue forecasts, compensation of employees grows at an average rate of 4.7% per year and remains broadly stable as a share of GDP. The net operating surplus, which drives forecasts of corporate tax, cycles around a more moderate growth rate of 3.8% per year, largely reflecting movements in commodity producer incomes.

Economic Forecast Assumptions

• Net permanent and long-term migration inflows rose to 31,900 in the year ended March 2014, although only data up to the February month (29,000) were available when the Budget Update was finalised. Net migrant inflows are forecast to rise to 38,100 in the September 2014 year before returning to the long-run assumption of 12,000 per year in 2017.
• The non-accelerating inflation rate of unemployment (NAIRU) is assumed to be around 4.5% by 2018.
• Average hours worked per week are assumed to decline from their current level of 33.0 to 32.8.
• Economy-wide labour productivity growth is assumed to average 1.3% per year between the years ending March 2014 and March 2018.
• Investment associated with the rebuild following the Canterbury earthquakes is assumed to be around $40 billion in 2011 prices (rounded to the nearest $5 billion), spread across residential property ($18 billion), commercial property ($9 billion) and infrastructure and social assets ($11 billion). Around $18 billion of the total is forecast to be undertaken within the forecast period to June 2018.
• WTI oil prices are assumed to fall from around US$99 per barrel in the March 2014 quarter to around US$81 in the March 2018 quarter, in line with oil futures prices.
• 90-day interest rates are assumed to increase from 3.0% in the March 2014 quarter to 5.3% in the March 2018 quarter and 10-year interest rates to rise from 4.6% in the March 2014 quarter to 5.2% in the March 2018 quarter.
• The TWI is assumed to remain around 79.0 from the June 2014 quarter until late 2016, and then to decline to 72.2 in the June 2018 quarter.
• Tobacco excise tax increases add 0.2 percentage points to annual inflation in each of the March 2015 and 2016 quarters.
• Reduced ACC levy rates will reduce contributions by households and employers by about $400 million in the 2014/15 levy year and around $480 million in the following levy year, with the latter to be finalised following ACC's public consultation.

Fiscal Outlook#

Overview#

Notes:

1. Operating balance before gains and losses.
2. Net core Crown debt excluding the New Zealand Superannuation Fund (NZS Fund) and advances.

Source: The Treasury

• Core Crown tax revenue is expected to increase across the forecast period and by 2017/18 is expected to be $18.9 billion higher than 2012/13, reflecting the growth in the nominal economy, as discussed in the EconomicOutlookchapter.
• The 2013/14 tax forecast has been revised downwards owing to weakness in the current year's results to date. However, this weakness is expected to dissipate by 2014/15 owing to higher growth in the drivers of tax revenue that year.
• The Budget 2014 operating allowance averaged $1.0 billion per annum, with the Government's decision to set future allowances at $1.5 billion per annum from Budget 2015 (growing at 2% per annum per Budget). When an increase in social assistance spending is added, core Crown expenses are expected to rise by $11.1 billion by the end of the forecast period. This increase is slower than growth in the nominal economy so by the end of the forecast period core Crown expenses fall to below 30% of GDP.
• These forecasts show that the Government is expected to achieve its fiscal objective of a return to surplus in 2014/15 with an OBEGAL surplus of $0.4 billion. Beyond 2014/15 these surpluses are expected to increase by between $0.9 and $1.1 billion each year and by 2017/18, the OBEGAL surplus is expected to reach $3.5 billion.
• In nominal terms, net core Crown debt increases before falling in 2017/18 as residual cash returns to surplus. As a share of GDP, net core Crown debt declines after 2015, falling to 23.8% by the end of 2017/18.
• The Government Share Offer programme has concluded, with gross proceeds of $4.7 billion available for the Future Investment Fund.
• The Crown's balance sheet continues to strengthen, enabling buffers to be built to sustain government services in the event of future shocks.
• In preparing these fiscal forecasts, key assumptions have been made on the performance of the economy and new operating allowances. As with all assumptions, there is inherent uncertainty and a change in any one assumption could negatively or positively impact the Crown's forecast surpluses and net core Crown debt position. The Risks and Scenarios and the Specific Fiscal Risks chapters outline the key risks to the Crown achieving these forecasts.

Source: The Treasury

Core Crown Tax Revenue#

Tax revenue grows by 5.8% per annum on average over the forecast period...

Core Crown tax revenue is forecast to rise in each year of the forecast period, although at a lower rate than previously expected. While tax in the current year is weaker than previously forecast, growth of 5.8% per annum across the forecast period is still expected.

By 2017/18 core Crown tax revenue is expected to reach $77.6 billion, $18.9 billion higher than in 2012/13. Forecast tax revenue increases relative to nominal GDP, reaching 28.5% by the end of the forecast period compared to 27.5% in 2012/13 (Figure 2.1).

Figure 2.1 - Core Crown tax revenue

Source:  The Treasury

Most of the growth in tax revenue forecasts can be attributed to growth in the nominal economy, with nominal GDP forecast to grow at 5.1% per annum on average over the forecast period. Tax revenue growth increases in 2014/15 before slowing over the remainder of the forecast period as the growth in nominal GDP slows (Figure 2.2).

Figure 2.2 - Core Crown tax revenue growth

Source:  The Treasury

All tax types are expected to increase across the forecast period, with individuals' source deductions (PAYE) and goods and services tax (GST) showing the most significant growth, as shown in Table 2.3.

Source: The Treasury

Growth in employees' compensation (contributing $6.2 billion to the growth in source deductions and the progressive nature of the personal tax scale (fiscal drag) see source deductions increase by $7.5 billion over the forecast period.

Growth in corporate profits are the main drivers behind corporate tax increasing by $2.0 billion over the forecast period, while growth in private consumption contributes to a $5.4 billion increase in GST.

Increased residential investment continues to contribute to the forecast growth in tax revenue, boosting GST by $1.4 billion by 2017/18 as residential investment is forecast to grow at an average rate of 13.8% per annum. This growth is partly offset by GST refunds to insurers, as a large part of the Canterbury residential rebuild is funded by insurance claims.

The 90-day bank bill interest rate is expected to rise from 2.6% on average in 2012/13 to 5.2% by 2017/18. This rise, together with growth in the interest-bearing deposit base, results in growth in tax on interest earned on residents' savings (RWT) of about $1.8 billion across the forecast period.

Source: The Treasury

Budget 2014 includes policy changes totalling $0.3 billion across the forecast period. The largest positive changes come from an Inland Revenue initiative targeting unfiled tax returns and a reduction in the duty-free tobacco concession ($0.2 billion each), with other minor changes slightly reducing tax. These policy changes are discussed in further detail in the Additional Information document (on the Treasury website).

Although growth in tax revenue is forecast, risks to the forecast tax outturn remain, particularly if the assumptions on the economic outlook do not materialise as expected. The Risks and Scenarios chapter provides further discussion of the risks around tax revenue.

...but is weaker than at the Half Year Update

Overall, tax revenue is $1.1 billion less than the Half Year Update across the forecast period, with $0.6 billion relating to the 2013/14 year.

The downward revision in tax revenue in the current year is partly owing to assumptions made at the Half Year Update not eventuating - in particular, in individuals' tax, GST and excise duties (eg, higher earthquake-related insurance refunds than previously assumed and strength in excise that was previously assumed to be permanent but is timing-related). The reduction in the current year forecasts of $0.6 billion consists of $0.2 billion for individuals' tax, $0.3 billion for GST and $0.1 billion for other taxes (Figure 2.3).

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

Source:  The Treasury

While the current year's tax take is lower than previously forecast, this weakness is not expected to flow through to 2014/15, as stronger economic growth in that year is expected to boost tax revenues and offset the current year's weakness. Tax policy changes (as discussed above) since the Half Year Update also contribute to the increase in tax in 2014/15. However, the forecast for nominal GDP growth from 2015/16 onwards is lower than in the Half Year Update, reducing the core Crown tax revenue forecast in those years.

Tax Revenue Relative to GDP: Change Since the Half Year Update

Core Crown tax revenue as a percentage of GDP is lower than in the Half Year Update for all years of the forecast period. The average reduction across all forecast years is 0.3% of GDP. The largest movement is -0.6% and this occurs in the current year.

Source: The Treasury

Since the Half Year Update, values of nominal GDP for the recent past have been revised up by Statistics New Zealand (reducing the tax-to-GDP ratio for the year ended 30 June 2013). Since the 2013 year is the base year from which subsequent years' tax revenue is forecast, this has reduced the tax-to-GDP in all forecast years (by around 0.06%). Revisions to nominal GDP occur regularly as Statistics New Zealand updates for new information or incoporate new statistical standards and classifications.

Also, not all components of GDP grow at the same rate as total nominal GDP. Since the various tax bases are taxed at different rates (eg, salaries and wages are taxed at personal tax rates and domestic consumption is taxed at a flat rate of 15%), changes in the composition of GDP will affect the overall tax-to-GDP ratio. This effect is shown in the “Composition of GDP” line in Table 2.5.

There are many other factors that can cause tax revenue to grow at a different rate to GDP, thereby affecting the tax-to-GDP ratio. These might be timing effects that shift tax revenue from one year to another, or changes in tax on income that is not included in GDP (eg, investment income).

The 2013/14 “Other factors” include changes to the timing of earthquake-related GST refunds, growth in source deductions that is not as strong as underlying economic drivers, and changes to assumptions on tobacco excise.

Core Crown Expenses#

Core Crown expenses grow across the forecast period...

Core Crown expenses are expected to increase in nominal terms by $11.1 billion over the forecast period (Figure 2.4). However, as growth in core Crown expenses is forecast to be at a slower rate than growth in the nominal economy, they fall from 33.0% of GDP in 2012/13 to 29.9% of GDP by the end of the forecast period. In 2015/16, core Crown expenses are expected to stand at 30.1% of GDP, consistent with the Government's target of reducing expenses to around 30% of GDP by 2015/16.

Figure 2.4 - Core Crown expenses

Source:  The Treasury

Nominal growth in core Crown expenses is largely attributable to new budget spending, along with increased social assistance spending as shown in Figure 2.5.

Figure 2.5 - Increase in core Crown expenses

Source:  The Treasury

Offsetting these increases, core Crown expenses for the Canterbury rebuild decrease over the forecast period as the most significant operating expenses have already been recognised and the Crown moves into more of an investment phase (refer to box on page 34 for details of the profile and phasing of earthquake expenses).

The Budget 2014 package includes an average net spend of $1.0 billion each year (Table 2.6). As a portion of the package relates to revenue initiatives, the gross increase in expenditure averages $1.2 billion.

Figure 2.6 - Budget 2014 and future Budget allowances

Source:  The Treasury

Future operating allowances are $1.5 billion per annum from Budget 2015 (increasing by 2% each Budget thereafter). Without further information on how these will be allocated, these allowances are assumed to flow through as expenses. When combined, new spending reaches $6.0 billion by 2017/18 (Figure 2.6). However, these operating allowances can be used for a combination of both revenue and expense initiatives when allocated.

The following table summarises the impact of the Budget 2014 package on core Crown revenue and expenses.

Source: The Treasury

Refer to the Minister's Executive Summary document for further details of the Budget 2014 package.

Outside new budget spending, social assistance spending is expected toincrease by $3.6 billion across the forecast period. New Zealand Superannuation payments (which makes up around half of social assistance costs), grow by $3.4 billion as payments are linked to wage growth and recipient numbers increase (Figure 2.7). Other benefit types also increase marginally over the forecast period.

Figure 2.7 - Social assistance spending

Source:  The Treasury

Finance costs increase by $0.8 billion over the forecast period as gross debt continues to increase alongside rising interest rates.

...and have increased since the previous forecasts

While current year's expenses are slightly lower than forecast at the Half Year Update, by the end of the forecast period expenses are around $2.4 billion higher than previously expected (Figure 2.8). This increase is largely owing to the Government's decision to increase operating allowances for future Budgets to $1.5 billion, up from $1.0 billion at the Half Year Update.

Figure 2.8 - Changes in core Crown expenses since the Half Year Update

Source:  The Treasury

Slightly stronger real growth coupled with the ongoing impact of welfare reform see unemployment-related benefit recipient numbers reduce over the forecast period and associated social assistance expenses fall compared to the Half Year Update. Refer Table 2.7 in the Operating Balance section for changes to benefit expenses since the Half Year Update.

Operating Balance#

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

The operating balance before gains and losses (OBEGAL) is expected to return to surplus in 2014/15 with a surplus of $0.4 billion forecast. Beyond 2014/15 surpluses are expected to increase by between $0.9 billion and $1.1 billion per annum.

Figure 2.9 shows the composition of OBEGAL from the different segments of the Government.

Figure 2.9 - Components of OBEGAL by segment

Source:  The Treasury

The core Crown segment moves from a forecast OBEGAL deficit of $3.8 billion in 2013/14 to a forecast $3.2 billion surplus by 2017/18, largely reflecting growth in tax revenue.

The State-owned Enterprise (SOE) and Crown entity (CE) segments together contribute $2.1 billion to the OBEGAL surplus in 2013/14, halving to $1.0 billion by the end of the forecast period largely reflecting reductions in ACC levy rates announced in Budget 2013. The SOE segment's contribution stays relatively static across the forecast.

Surpluses are achieved in 2014/15 and continue to increase over the forecast period to a level that translates to being sufficient to fund the Government's capital spending as well as a reduction of debt. Maintaining a level of fiscal restraint while the economy grows will allow surpluses to be built up. These surpluses are important to enable a buffer to be built in the case of future shocks such as a global financial crisis or another large natural disaster.

...although post-2014/15 OBEGAL is lower compared to previous forecasts

OBEGAL is lower in all years with the exception of 2014/15. While lower than what had previously been forecast, nevertheless by the end of the forecast period an OBEGAL surplus of $3.5 billion is expected (Table 2.7).

Source: The Treasury

Major changes include:

• Tax revenue is slightly weaker than the Half Year Update (refer page 25).
• The Budget 2014 package has a positive impact in the first two years as spending is rephased to later years. The Government has made a number of decisions in Budget 2014 to manage the fiscal impact of spending on the 2014/15 year.
• An increase in new operating allowances from Budget 2015 ($1.5 billion increasing by 2% annually per Budget thereafter) reduces OBEGAL in the later years.
• Social assistance expenses, while higher than previously forecast in 2014/15, are expected to be less than previously forecast largely as a result of the declining number of benefit recipients.
• The positive ACC result largely reflects updated assumptions on the 2015/16 proposed reductions in the Work Account levy (now less than expected). In addition, a reduction in insurance claim expenses is expected, reflecting lower rates of growth in the cost of claims.
• Earthquake Commission (EQC) results are more positive owing to lower forecast insurance expenses after an updated valuation of EQC's insurance liabilities at 31 December 2013.
• Finance costs have increased compared to the Half Year Update largely as a result of rising interest costs and higher nominal net core Crown debt than previously forecast.

... and 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 across the forecast period. While growth in the operating balance is initially subdued, from 2014/15 the operating balance grows steadily (Figure 2.11). The current year's surplus is largely a result of gains expected to be made by Crown financial institutions (CFIs), largely ACC and NZS Fund, and reflects strong global equity returns (eg, by 31 March 2014 NZS Fund had made year-to-date gains of $2.6 billion). While the 2013/14 year reflects the current strong market growth, future years assume a lower long-term rate of return, resulting in 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 2.11 - Components of operating balance

Source:  The Treasury

In addition, updated long-term liability valuations for ACC (at 31 December 2013 updated for movements in discount rates to 31 March 2014) and the Government Superannuation Fund (GSF) (at 28 February 2014) have led to significant actuarial gains in the 2013/14 year (around $1.8 billion) which also contribute to the Crown's operating balance.

Given the size of the balance sheet, market movements can have a significant impact on the operating balance, as can be seen by comparing the current year's forecast with that of the 2012/13 year (Figure 2.11). The 2012/13 year included net gains of around $11.3 billion, largely as a result of gains on the investment portfolios of ACC and NZS Fund ($6.2 billion) and changes in discount rates leading to actuarial gains ($3.6 billion). While the current year's forecast includes strong returns for ACC and NZS Fund, the market is not as strong as the 2012/13 year, leading to a reduction in investment gains contributing to the operating balance. In addition, actuarial gains are forecast at just under half of the 2012/13 level, owing to smaller movements in discount rates in the year.

Net Core Crown Debt#

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

Cash deficits are funded by an increase in net core Crown debt⁴ (through additional borrowing or a reduction in financial assets), while cash surpluses reduce net core Crown debt.

While operating cash flows return to surplus in 2014/15, net capital spending is forecast to exceed operating cash flows until 2017/18, resulting in core Crown residual cash[4] remaining in deficit until then.

Figure 2.12 - Net core Crown debt

Source:  The Treasury

Over the forecast period, the Government is expected to generate cash flows from core Crown operations of $11.4 billion and will receive the remaining proceeds ($2.9 billion) from the Government share offer. The core Crown is forecast to spend $23.7 billion on capital items, which include purchasing physical assets (eg, school buildings), advances (eg, student loans) and future new capital spending. Overall, there is therefore a residual cash shortfall of $9.4 billion. As a result of the residual cash shortfall, net core Crown debt is expected to increase in nominal terms and to peak on an annual basis in 2016/17 at $65.5 billion, and then reduce once residual cash surpluses are achieved.

Net core Crown debt as a share of GDP peaks in 2014/15 at 26.4% (Figure 2.12). By 2017/18 net core Crown debt is expected to be 23.8% of GDP, consistent with the Government's medium-term target of net core Crown debt at a level no higher than 20% of GDP by 2020.

...but is higher than the Half Year Update...

Core Crown residual cash returns to surplus one year later and at a lower level than forecast in the Half Year Update (Figure 2.13), largely owing to higher operating allowances and lower tax receipts than previously forecast. As a result, net core Crown debt in nominal terms is forecast to be higher than at the Half Year Update. However, as a shareof GDP, it is similar to that previously forecast.

Figure 2.13 - Core Crown residual cash

Source:  The Treasury

...with government bond issuances funding residual cash deficits

The bond programme to 2017/18 is $3.0 billion higher than forecast in the Half Year Update, largely owing to a greater cash shortfall over the forecast period ($9.4 billion compared to the previous forecast of $4.4 billion). In order to fund this shortfall, along with bond maturities, the bond programme is expected to raise funds of $36.3 billion over the forecast period, while $25.3 billion of existing debt will be repaid, providing net cash proceeds of $11.0 billion (Table 2.10). Any excess cash proceeds raised from the bond programme will be invested in financial assets and used to meet future debt maturities.

Source: The Treasury

Total Crown Balance Sheet#

Operating balance surpluses result in a stronger balance sheet...

Following on from the 2012/13 increase (the first increase in five years), net worth attributable to the Crown is forecast to grow steadily in nominal terms across the forecast period largely owing to forecast operating balance surpluses. Beyond 2014, net worth attributable to the Crown is expected to grow by $19.4 billion to stand at $89.5 billion by 2017/18. As a share of GDP this is 32.8%, still below the peak of 56.6% of GDP in 2007/08 as shown in Figure 2.14.

Figure 2.14 - Net worth attributable to the Crown

Source:  The Treasury

...with assets increasing by $38 billion over the forecast period...

Total assets are forecast to grow by $37.6 billion over the forecast period, made up of additional investments in assets (both physical and financial) of $76.2 billion, partially offset by reductions (largely depreciation) of $38.6 billion.

The largest asset growth over the forecast period is in the financial assets portfolio (Figure 2.15). This growth reflects investments in Crown Financial Institutions (CFIs), with much of this growth recognised as gains in the Crown's operating balance.

Figure 2.15 - Total Crown assets

Source:  The Treasury

The commercial asset portfolio is expected to increase by $9.6 billion over the forecast period, with growth in Kiwibank mortgages comprising $8.0 billion of this increase, with the remainder from SOEs increasing their investment in physical assets.

Social assets (eg, schools, hospitals and social housing) are expected to increase by $13.3 billion by the end of the forecast period, primarily as a result of new capital spending. The Future Investment Fund contributes to the funding of these asset purchases, as detailed on page 41.

...and liabilities beginning to fall by the end of the forecast period

The Crown's liabilities are expected to increase by $12.5 billion (Figure 2.16) over the forecast period, largely driven by increased borrowing ($14.6 billion over the forecast period) (Figure 2.17) before beginning to fall in 2017/18. Borrowings are mostly held by the Treasury's Debt Management Office and the Reserve Bank, and are forecast to peak at $118.5 billion in 2016/17 before decreasing slightly to stand at $114.7 billion by 2017/18.

Figure 2.16 - Total Crown liabilities

Source:  The Treasury

Figure 2.17 - Total Crown borrowings

Source:  The Treasury

Borrowings in the financial portfolio increase by $4.9 billion over the forecast period 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, of which two-thirds relates to Kiwibank deposits, which continue to grow in line with Kiwibank's mortgages.

Partially offsetting the growth in borrowings are reductions in liabilities as a result of settling the Crown's obligations related to the Canterbury earthquakes (around $9.4 billion at 30 June 2013). These are all expected to be settled by 2017/18.

The Crown's balance sheet remains sensitive to market movements...

Many of the assets and liabilities on the Crown's balance sheet are measured at “fair value” in order to disclose current estimates of what the Crown owns and owes. While the measurement at fair value is seen as the most appropriate value of these items, it can be volatile, resulting in fluctuations in the value of the assets and liabilities reflecting changes in the market and underlying assumptions.

Financial assets are the largest asset group on the Crown's balance sheet and have increased significantly in recent years. CFIs (eg, NZS Fund and ACC) hold investments to make financial returns, and those asset values are dependent on market prices, interest rates and exchange rates, which can all be volatile. For example, a 10% change in the New Zealand dollar exchange rate or share prices can impact the Crown's operating balance by $1 billion to $2 billion.

In addition, the Crown has a number of significant long-term liabilities (eg, ACC claims and GSF retirement liability) which are actuarially valued based on estimated future cash flows 50 years into the future. As part of the actuarial valuation, inflation rates are used to help estimate future cash flows, while discount rates are used to obtain the value of those future cash flows in today's dollars (their present value). Even small changes in these assumptions can have significant impacts on the valuation because the cash flows are so large and over such long periods.

...and judgements and estimates will also impact on the balance sheet...

Outside of market factors, valuations are subject to a number of judgements and estimates. In general, as time goes on, better information becomes available and initial estimates are updated to reflect current information. Some examples of this include: ACC rehabilitation costs, earthquake-related insurance liabilities, and student wage growth.

...while other risks still remain

In addition to those items on the balance sheet there are a number of liabilities (and assets) that may arise in the future but are not yet included in our forecasts, either because they are contingent on an uncertain future event occurring (eg, outcome of litigation) or the liability cannot be measured reliably. If these liabilities crystallise, there will be associated costs with a negative impact (or positive in the case of contingent assets) on the operating balance or net debt. Refer to page 76 for a list of the contingent liabilities that the Crown was exposed to at 31 March 2014. The Risks and Scenarios chapter also includes further discussion on risks to the Crown's balance sheet.

The Treasury recently released its 2014 Investment Statement, which further discusses the Crown's balance sheet. In particular, it provides information on the shape and health of the Crown's portfolio of assets and liabilities, as well as a discussion on balance sheet management, including financial risk management.

Government Share Offer Programme#

The Government's Share Offer programme has now concluded. Minority shareholdings in Mighty River Power, Meridian Energy and Genesis Energy have been sold, and the Crown has reduced its shareholding in Air New Zealand. Since the Half Year Update, the Genesis Energy share offer has been completed and the proceeds from the Crown reducing its shareholding in Air New Zealand have been finalised. Refer to Table 2.11 for the final proceeds of the programme.

Note:

1. Net of direct costs and present value discounting of the Meridian Energy deferred settlement.
2. This represents the additional reduction in the Crown's shareholding as part of this programme.

Source: The Treasury

Total gross proceeds for the programme are $4.7 billion, compared to a range of $5.0 billion to $7.0 billion as estimated in May 2011. The May 2011 estimates included estimates for Solid Energy; however, a decision was made not to proceed with a Solid Energy share offer. For the transactions that did proceed:

• actual proceeds for the Mighty River Power share offer were slightly above the mid-point of the estimated range from May 2011
• actual proceeds for Meridian Energy were below the estimated range from May 2011, with proceeds affected by the falls in the share prices of comparable New Zealand electricity companies, and the revised contract between Meridian Energy and New Zealand Aluminium Smelters
• actual proceeds for the Air New Zealand transaction were above the May 2011 estimated range, as a result of the significant increase in Air New Zealand's share price, and
• actual proceeds for Genesis Energy were within the upper half of the May 2011 estimated range.

Although the Share Offer programme has now been completed, owing to the use of instalment receipts for the Meridian Energy share offer some proceeds (approximately $0.6 billion) are expected to be received next year.

Future Investment Fund

Proceeds from the Government Share Offer programme have been set aside to fund future capital spending through the Future Investment Fund (FIF) - a fund established in Budget 2012. So far, $3.0 billion of this fund has been allocated. A large portion of the fund is expected to be spent on investments in health and education ($1 billion each), as well as the Canterbury rebuild and irrigation initiatives.

Source: The Treasury

Budget 2014 allocates $1.0 billion of new spending from the fund, including $0.2 billion for KiwiRail, $0.2 billion for school property expansion, $0.2 billion for health initiatives, as well as smaller amounts for irrigation infrastructure. Refer to the Minister's Executive Summary document for further details of the Budget 2014 package.

With the proceeds from the Government Share Offer programme totalling $4.7 billion, the amount remaining to be allocated in future Budgets is $1.7 billion.

Note:

1. Based on an average of the fiscal forecasts subsequent to the programme being completed.

Source: The Treasury

The average profits and dividends estimated to be foregone have been updated since the Half Year Update, largely as a result of the Government selling slightly less than the 49% originally forecast, in addition to including updated forecasts from the companies.

The figures in Table 2.13 are based on the current profit and dividend forecasts supplied by the companies, and forecast interest rates on government debt.

The forecasts of company profits and dividends inherently contain more risk and uncertainty than forecasts of the Government's cost of borrowing. As a result, you would expect the return on commercial assets to reflect that additional risk and be generally higher than the Government's cost of borrowing. Whether forecast profits are actually delivered will depend on actual company performance.

The Forecast Financial Statements (Chapter 5) disclose forecasts for minority interests' share of profits and dividends for all minority interests of the Government. While these amounts include the forecasts as a result of the government share offer, they also include the pre-existing minority shareholding in Air New Zealand, along with minority interests in the Crown Fibre Holdings Group and Solid Energy (resulting from their recent restructure). As a result, the amounts in the Forecast Financial Statements are larger than those in Table 2.13 above.

Fiscal Forecast Assumptions#

The fiscal forecasts are based on assumptions and judgements developed from the best information available on 29 April 2014, 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 impact of 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 2.14 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, a number of other key assumptions are critical in the preparation of the fiscal forecasts.

Government decisions

The forecasts incorporate Government decisions and other circumstances known to the Government and advised to the Treasury up to 29 April 2014.

Tax revenue

Tax policy changes enacted and announced by the Government will take place as planned and will affect tax revenue and receipts as calculated and agreed between Inland Revenue and the Treasury.

Earthquake costs

Expenditure (accrual measure) is forecast based on estimates of when key decisions will be taken.  The timing of cash payments is based on estimates of when actual spending will take place.  Refer to page 34 for further discussion.

Operating allowance

Operating allowances are net $1.5 billion from Budget 2015, growing at a rate of 2.0% per annum for subsequent Budgets.  For further details, see note 8 of the Forecast Financial Statements.

Provision for new capital spending

Capital allowances are $0.9 billion in Budget 2015 and Budget 2016, then growing at a rate of 2% per annum for subsequent Budgets.  For further details, see note 8 of the Forecast Financial Statements.

Finance cost on new bond issuances

Based on the 5-year rate from the main economic forecasts and adjusted for differing maturities.

Top-down adjustment

A top-down adjustment is made to compensate for departments that tend to forecast upper spending limits (appropriations) rather than best estimates.

Top-down adjustment to operating and capital expenses are as follows:

The adjustment will be higher at the front end of the forecast period as departments' appropriations (and therefore expenses) tend to be higher in these years, reflecting the flexibility departments have around transferring underspends to later years.

Property, plant and equipment

For the purposes of the forecast financial statements, no revaluations of property, plant and equipment are projected beyond the current year.  Valuations as recorded for the 2013 annual financial statements and any additional valuations that have occurred up to 31 March 2014 are included in these forecasts. 

Student loans

The carrying value of student loans is based on a valuation model adapted to reflect current student loans policy.  As such, the carrying value over the forecast period is sensitive to changes in a number of underlying assumptions, including future income levels, repayment behaviour and macroeconomic factors such as inflation and discount rates used to determine the effective interest rate for new borrowers.  Any change in these assumptions would affect the present fiscal forecasts.

Investment rate of returns

The forecasts incorporate the actual results to 31 March 2014.  Beyond this time, gains on financial instruments are based on long-term benchmark rates of return for each portfolio.

GSF and ACC liabilities

The GSF and ACC liabilities included in these forecasts have been valued as at 28 February 2014 and 31 December 2013 respectively.  The ACC liability has also been adjusted for the 31 March 2014 discount rate.  Both liabilities are valued by projecting future cash payments, and discounting them to the present.  These valuations rely on historical data to predict future trends and use economic assumptions such as inflation and discount rates.  Any changes in actual payments or economic assumptions would affect the present fiscal forecast.  For example, if the discount rate decreases, the value of the liabilities would increase.

GSF's assets are offset against the gross liability and have been updated to reflect market values.  The value of assets over the forecast period reflects long-run rate of return assumptions appropriate to the forecast portfolio mix.

ACC levies

The forecasts include the Government's intention to further reduce ACC levies in the 2015/16 levy year.  A final decision on levy rates will be made after ACC's public consultation.

NZS Fund contributions

No contribution is assumed in the forecast period in line with the Government's stated intentions to commence contributions once net core Crown debt has reached 20% of GDP as set out in the Fiscal Strategy Report (FSR).

1. Calculations of annual contributions if they were to resume in 2013/14

The underlying assumptions in calculating the required contribution in each year are the previous year's NZS Fund balance and projected series, over the ensuing 40 years of nominal GDP, net (after-tax) New Zealand superannuation expenses, and the government 5-year bond rate. The latter is used in calculating the Fund's expected long-run after-tax annual return.  Over the forecast years, all Fund variables, apart from the capital contributions, are provided by the NZS Fund itself. 

Refer to the Treasury's website for the NZS Fund model. 

Risks and Scenarios#

Overview#

• This chapter outlines the general economic and fiscal risks associated with the main forecast. Domestic risks to the economic outlook are fairly evenly balanced, while global risks remain skewed to the downside.
• Domestically, the risks with potentially the largest impact on the New Zealand economy relate to the pace of the Canterbury rebuild and its interaction with the wider economy, the sensitivity of households to higher debt servicing costs, along with net migration’s impact on domestic demand.
• Stimulatory monetary policy settings appear to be succeeding in increasing demand in advanced economies, although inflation has been benign, particularly in the euro area. The risks posed to the recovery in emerging markets have increased since the Half Year Update with markets reassessing economic and financial fundamentals in some economies.
• Two scenarios are presented which represent two ways in which the New Zealand economy could deviate from the main forecast. Scenario one is based on a larger decline in the terms of trade than in the main forecast. Scenario two is based on a more robust domestic demand cycle driven by a stronger migration cycle. If these scenarios or any other significant deviations from the main forecast did eventuate, this would impact on the Government's fiscal performance and position.
• In addition to risks associated with the economy, the Crown is also subject to expenditure and balance sheet risks. In particular, volatility in market prices such as interest rates can have a significant impact on the Crown's fiscal position.
• The first part of this chapter outlines the key risks to the economic outlook. The second part of the chapter presents two alternative scenarios for the economy. The remainder of the chapter focuses on general fiscal risks that can impact the Crown’s fiscal position.

Economic Risks#

Domestic demand has grown faster than anticipated in the Half Year Update, with the economic expansion becoming more broad-based and embedded. Key areas of uncertainty remain, including the speed of the Canterbury rebuild and its wider economic implications, the reaction of households to higher debt servicing costs, and the scale of the current migration cycle and its impact on domestic demand.

Despite improvements in the prospects for some advanced economies, the balance of global risks remains skewed to the downside, with emerging economies having underperformed relative to expectations. Global economic developments may lead to adjustments in the demand for our main commodity exports and therefore affect the terms of trade (the prices of goods and services New Zealand exports relative to those that it imports) which were at a 40-year high in the December 2013 quarter. If a number of adverse global developments were to occur simultaneously, New Zealand could experience a rapid and sizeable negative adjustment in commodity prices and national income.

Other key assumptions made in the forecasts around the level and flow-through of the exchange rate, the amount of spare capacity in the economy and monetary policy developments all represent areas where deviations from forecast can exacerbate or dampen the current economic cycle.

The pace and scale of the Canterbury rebuild remain uncertain…

There is still some uncertainty around the timing and magnitude of the Canterbury rebuild. Key determinants continue to be the pace of the settlement of remaining insurance claims and the capacity of the construction sector.

While the resolution of insurance claims has continued to progress, there are risks that the greater complexity of remaining claims could slow the rate of settlement. The availability of skilled labour will also impact on the pace of reconstruction if specific skill shortages act as bottlenecks in the construction industry. If the rebuild were to progress more slowly, residential and non-residential investment and employment growth could all be weaker than reflected in the main forecast.

The Canterbury region will account for a greater share of GDP than in previous construction booms and regional resource pressures will act to crowd out activity in other parts of the economy. Inward migration and imports of capital and materials may help to alleviate local capacity issues and will mitigate some of the upward pressure on prices in both Canterbury and the wider economy.

...as does the sensitivity of households to increasing interest rates...

Figure 3.1 - Composition of residential mortgage lending

Source: Reserve Bank

After a sustained period of historically low rates, the Reserve Bank has increased the OCR from 2.5% to 3.0% with the aim of returning it to neutral levels in the medium term and then increasing it even further by 2016. It is difficult to anticipate the sensitivity of households to higher debt servicing costs. This is in view of already elevated debt levels and high exposure to interest rate increases, with a large number of households on floating or fixed mortgages of less than one year (Figure 3.1). Households could exercise more or less spending restraint than is anticipated in the main forecast. If consumption growth were to outpace income growth, then the shortfall may have to be funded by increasing levels of debt. On the other hand, if households exercise more restraint, debt levels would be lower but consumption growth would be weaker.

…and net migration's effect on domestic demand remains uncertain

Stronger employment growth in New Zealand relative to Australia and a more positive outlook have reduced the number of New Zealand resident departures, while the Canterbury rebuild has contributed to more permanent and long-term arrivals. The annual net inflow of migrants is now forecast to peak at around 38,000 in the second half of 2014 compared to a forecast of around 26,000 in the Half Year Update. The impact on the wider economy of stronger rates of net migration will depend on the skill sets of the migrants and their geographic distribution. If the migration cycle is larger than forecast it would put additional pressure on the housing market and add further impetus to domestic demand. However, higher migrant inflows to Canterbury would mitigate some of the capacity risks associated with the rebuild.

If, for any reason, key factors such as those outlined above played out differently than assumed in the main forecast and impacted on the inflation outlook, then the Reserve Bank's setting of monetary policy would be responsive to those different conditions. Interest rates could rise by more or less and the pace of tightening could be faster or slower depending on the direction of change.

Global downside risks persist…

In addition to the migration channel, global developments can also impact the New Zealand economy through both trade and financial channels. For example, strong Chinese demand for our key commodity exports has contributed to the terms of trade reaching a 40-year high, improving incomes and supporting the exchange rate at high levels. Risks posed to the outlook for key trading partners, and global financial settings in general, are all factors that can lead to rapid changes in the economic outlook for New Zealand. Overall, the balance of global risks remains skewed to the downside. Geopolitical risks have also increased, with Russia's annexation of Crimea creating ongoing diplomatic tensions with the West and greater uncertainty in financial markets.

…as weak emerging-market fundamentals exposed…

In January, the US Federal Reserve began the tapering of its asset purchase programme. Expected rises in US bond yields contributed to capital outflows from emerging market economies and sizeable depreciations in exchange rates. Generally, borrowing costs for countries that have become accustomed to favourable global lending conditions in recent years have increased. Both the monetary policy responses (that are likely to magnify the higher costs of capital) and the higher capital cost itself, will act to constrain growth in emerging economies. The most fragile countries, with the largest imbalances and high inflation, account for only a small share of New Zealand's export demand. Contagion to other emerging market economies could impact New Zealand more significantly.

Importantly, Asian economies have larger foreign exchange reserves than they did prior to the Asian financial crisis in the late 1990s, as well as floating exchange rates, which make them more resilient to these market pressures.

…and risks to New Zealand's key trading partners remain

Our largest trading partner, China, would largely be immune to the risks outlined above because of its capital account restrictions. However, domestic risks to the growth outlook for China remain. The property investment and construction boom that stimulated Chinese growth following the global financial crisis was fuelled by rapid credit growth. Concerns around the high level of local government debt, the quality of lending in the shadow banking sector and exposure of financial institutions to housing market vulnerabilities persist. Chinese growth could slow more quickly than in the main forecasts if financial market disruption resulted in significantly tighter credit conditions.

Structurally, China is looking to rebalance its economy away from investment-led growth towards private consumption. Rebalancing could lead to slower growth in the short term, particularly if this transition is disorderly. As consumption's share of output increases and the purchasing power of Chinese consumers improves, demand for New Zealand's soft commodities, such as dairy, will strengthen and help maintain prices at high levels.

Australian data continue to show signs that demand is picking up as the economy transitions from growth in mining investment to growth in the non-mining sectors and exports. However, the labour market remains subdued and the unemployment rate has remained steady at around 5.8% for the past year. Australia remains exposed to a slowdown in China and emerging market economies, which would reduce demand for its hard commodities, such as iron ore. This channel could be a source of indirect effects on the New Zealand economy.

Upside risks to US growth are also apparent with the recent weakness in US data largely a result of the harsh winter. A large amount of investment activity has been deferred since the global financial crisis and the stock of capital has aged. A more rapid movement to capital investment could be a source of upside surprises to growth. Likewise, households have deferred purchases of durable goods over this time. That said, a stronger US economy would further exacerbate the risks to emerging economies if expectations of a faster withdrawal of monetary stimulus were to develop.

Euro area recovery exposed to deflationary risks

Inflation in the euro area has been on a declining trend since late 2011 as peripheral economies rebalance and attempt to achieve renewed competitiveness. Large negative output gaps also mean that pricing pressures remain subdued. In the absence of adequate policy responses, Europe could enter a period of sustained low inflation, increasing the risk of deflation. If long-term inflation expectations fall, demand and output would follow, stifling the euro area recovery.

Other risks around key judgements

Economic relationships are complex and judgements need to be made about key economic variables such as the exchange rate. For example, a higher exchange rate relative to forecast would decrease tradables inflation, as imported goods would become less expensive, and encourage the consumption of imported products. On the other hand, exporters and import-competing businesses would become less competitive, hindering manufacturing and service exports and production of import substitutes.

Recently, pasture conditions have been drier than usual in the North Island, with feed yields down from last year. Although there has been ample rain in most of the country in April, if dry conditions return, agricultural production could again act as a drag on gross domestic product as it did in the first half of 2013. Feed prices and availability amongst New Zealand's international competitors will also influence global supply and have a strong bearing on global commodity prices and the path of the terms of trade.

Alternative Scenarios#

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 represent two of a number of ways that the economy could deviate from the main forecast. Scenario one represents the economic impacts of a larger decline in the terms of trade. Scenario two represents the economic impacts of a larger migration cycle and stronger domestic demand.

Notes:

1. March quarter, seasonally adjusted
2. March quarter average
3. June years

Sources: Reserve Bank, Statistics New Zealand, the Treasury

Scenario One - Terms of Trade Shock

A larger fall in New Zealand's terms of trade…

Scenario one is based on a large fall in the prices received for New Zealand's merchandise exports. This scenario represents both a faster and deeper decline in the terms of trade, and a lower level over the rest of the forecast period. The fall represents a return of the terms of trade to levels prevailing near the start of the current commodity price boom in 2004. A fall in the terms of trade of this magnitude could be triggered by demand or supply factors, or a combination of the two; for example, a financial crisis in China that spills over to emerging markets more generally, could impact on the demand for our main commodity exports. Alternatively, a larger increase in global production, in combination with softer global demand, could see a more pronounced decline in the terms of trade than in the main forecast.

In this scenario it is assumed that the merchandise terms of trade decline rapidly over 2014 from their 40-year peak, and are down by around 22% in the year to March 2015 compared to around 9% in the main forecast. The terms of trade then recover slightly, but are still down around 10% relative to the main forecast at the end of the forecast period (Figure 3.2). (See the box on the terms of trade on page 13 of the Economic Outlook chapter for more details.)

...results in a sharp depreciation in the exchange rate and a spike in inflation...

The exchange rate helps to buffer the shock to the export sector and depreciates sharply, with the trade-weighted exchange rate index (TWI) at 64.0 by mid-2015 compared to 78.6 in the main forecast. Tradables inflation rapidly increases and headline inflation peaks above the Reserve Bank's policy band at 3.1% in the December quarter of 2015 (Figure 3.3). However, given the flexibility in the Policy Targets Agreement around exceptional movements in the prices of commodities traded in world markets, the Reserve Bank largely looks through the spike in inflation, keeping rates on hold in the near term. The policy response helps to limit the negative impacts on private consumption and investment growth. If the Reserve Bank were to respond to the spike in inflation this could exacerbate the negative impacts on real GDP growth but limit the inflationary impacts.

Figure 3.2 - Merchandise terms of trade

Sources: Statistics New Zealand, the Treasury

Figure 3.3 - Consumers Price Index

Sources: Statistics New Zealand, the Treasury

...with real private consumption and investment growth lower…

The decrease in the purchasing power of New Zealand households and firms, as real gross domestic income growth slows, results in lower real private consumption and investment growth. Annual real private consumption growth averages 2.2% over the forecast period compared to 3.1% in the main forecast. Real investment growth, including residential and market investment, averages 5.8% per annum compared to 7.4% in the main forecast. Net exports contribute positively to growth rather than act as a drag, as import volumes fall away sharply. Although annual real GDP growth over the forecast period is only slightly less at 2.6% (compared to 2.8% in the main forecast), the composition and timing of that growth are different.

…and a sharp widening in the current account…

The annual current account deficit widens to 7.9% of GDP in the second half of 2015 as the trade balance deteriorates, while households and firms adjust to the real income shock, and nominal GDP growth slows. The large depreciation in the exchange rate makes New Zealand's goods and services more competitive globally. This sees a strong increase in nominal services exports and the services balance over the second half of the forecast period, notwithstanding the deterioration in the near term (the so-called “J-curve” effect). The annual current account deficit narrows to 6.0% of GDP by March 2018, a slightly lower deficit than in the main forecast.

…as well as lower tax revenue and operating balance

Weaker domestic activity combined with the lower terms of trade more than offsets the higher inflation and reduces nominal GDP by a cumulative $34 billion over the forecast period.

Core Crown tax revenue is a cumulative $9.7 billion lower over the forecast period in this scenario, owing to the weaker nominal GDP. The weaker labour market and lower labour incomes reduce source deductions revenue by $1.4 billion over the forecast period. The economy's weaker nominal activity means that business profitability is reduced, resulting in corporate taxes being a cumulative $4.0 billion lower. Resident withholding tax is $1.2 billion lower over the forecast period with interest rates increasing by less than in the main forecast. Weaker nominal consumption and residential investment reduces GST revenue by a cumulative $1.6 billion over the forecast period.

Figure 3.4 - Operating balance (before gains and losses)

Source: The Treasury

Core Crown expenses are higher than in the main forecast, driven by an increase in debt servicing costs and increases in welfare payments. The increase in welfare payments results from a higher number of recipients of unemployment-related benefits than in the main forecast, reflecting the softer labour market. In this scenario, the return to surplus in OBEGAL is delayed until June 2018 (Figure 3.4). As a consequence, net core Crown debt peaks at 28.7% of GDP in the June 2017 year, compared to 26.4% in the June 2015 year in the main forecast (Figure 3.9). By the end of the forecast period net core Crown debt is 28.7% of GDP in this scenario compared to 23.8% of GDP in the main forecast.

Scenario Two - Stronger Cyclical Growth

A stronger cyclical pick-up in migration…

Scenario two is based on a more robust domestic demand cycle than in the main forecast, driven by a stronger migration cycle. The scenario is similar to scenario one in the Half Year Update in that it presents the risks around our key migration assumption. Annual net permanent and long-term migration in this scenario peaks at 41,500 in the December quarter of 2014 compared to 38,000 in the September quarter of 2014 in the main forecast (Figure 3.5). The migration profile of scenario two represents an addition of 21,500 people to the population over the forecast period compared to the main forecast. It is also assumed that currently high levels of consumer and business confidence translate into even stronger near-term private consumption and investment growth.

…leads to more robust domestic demand in the near term…

The larger migration cycle and less restrained households result in stronger annual real private consumption growth in the near term, peaking at 5.3% in the June quarter of 2015 compared to 4.2% in the main forecast (Figure 3.6). The population boost from net migration also increases demand for the existing stock of housing and provides additional support for residential investment. Stronger household demand, the current low interest rate environment and the elevated exchange rate spill over into business confidence with increased market investment and hiring intentions. Employment growth in this scenario is markedly stronger over 2015 and 2016, with the unemployment rate varying around 0.2% to 0.3% points lower over most of the forecast period compared to the main forecast.

Figure 3.5 - Annual net external migration

Sources: Statistics New Zealand, the Treasury

Figure 3.6 - Private consumption growth

Sources: Statistics New Zealand, the Treasury

…and sees increased price pressures and a faster monetary tightening cycle…

With the economy already growing faster than potential, the further boost to domestic demand sees any spare capacity in the economy used up more quickly than in the main forecast, and an even more positive output gap develop in the near term (despite net migration increasing productive capacity in the medium term). The stronger domestic outlook and expectations of higher interest rates result in a higher near-term exchange rate profile which puts downward pressure on tradables inflation. However, stronger non-tradables inflation dominates, resulting in a higher inflation track.

Given higher inflation, increased inflationary pressures and increased inflation expectations, monetary policy is tightened sooner and more aggressively to maintain price stability. The 90-day bank bill rate is around 100 basis points higher by mid-2015 than in the main forecast (Figure 3.7). The faster withdrawal of monetary stimulus acts to constrain consumption and investment growth, with lower real GDP growth over the final years of the forecast period compared to the main forecast.

…but domestic and external imbalances widen

With some of the higher consumption and investment growth met from increased imports, the goods and services balances are weaker than in the main forecast. The stronger domestic economy also sees a widening in the income balance deficit as stronger profitability leads to larger dividend outflows. Consequently, the annual current account deficit is wider over the forecast period, reaching 6.8% of GDP in the March quarter of 2018 compared to 6.3% in the main forecast (Figure 3.8).

Figure 3.7 - 90-day bank bill rate

Sources: Statistics New Zealand, the Treasury

Figure 3.8 - Current account balance

Sources: Statistics New Zealand, the Treasury

Household saving rates are also lower in this scenario, with nominal consumption growth outpacing the growth in incomes. This additional consumption is funded through increasing levels of household debt and this constrains consumption growth further as debt servicing costs increase.

Nominal GDP growth and tax revenue higher…

Figure 3.9 - Net core Crown debt

Source: The Treasury

Stronger domestic activity, combined with greater price pressures, increases nominal GDP by a cumulative $12 billion over the forecast period. Core Crown tax revenue is a cumulative $5.3 billion higher over the forecast period. Higher nominal consumption and residential investment boost GST revenue by $1.1 billion over the forecast period. The stronger labour market and increased competition for workers push up wages and salaries, boosting source deductions revenue by a cumulative $1.1 billion. The stronger economic activity allows firms to increase their margins, boosting profitability and increasing corporate tax by $1.3 billion. Higher short-term interest rates, needed to control rising inflation, boost tax on interest by $1.1 billion.

Core Crown expenses are slightly lower than in the main forecast owing to a fall in debt servicing costs and, to a lesser extent, a reduction in welfare payments. In this scenario, OBEGAL records a larger surplus of 0.5% of GDP ($1.3 billion) in the June 2015 year (Figure 3.4). Net core Crown debt declines to 21.4% of GDP in the June 2018 year compared to 23.8% of GDP in the main forecast (Figure 3.9).

…with fiscal policy remaining restrained

Although OBEGAL records a larger surplus in 2015 in this scenario, discretionary fiscal policy is unchanged relative to the main forecast and is restrained compared to the mid-2000s cycle. If the extra income received by the Government was used to increase spending it would add to the cycle by increasing domestic demand, contributing to price pressures which could then necessitate tighter monetary policy. This would support the exchange rate remaining higher for longer and would result in greater imbalances, such as an even wider current account deficit.

General Fiscal Risks#

The remainder 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 63.

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 nominal GDP growth is one percentage point faster than we have forecast in each year up to June 2018, tax revenue would be around $3.2 billion (1.2% of GDP) higher than forecast in the June 2018 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 $3.1 billion lower than forecast in the June 2018 year. The figures are indicative and can be influenced by the composition of growth as different types of activity have different effective tax rates.

A different interest rate path from that forecast would also impact on the fiscal position. A one percentage point lower interest rate would result in interest income on funds managed by the Treasury's Debt Management Office (DMO) being $162 million lower in the June 2018 year. This would be more than offset by interest expenses being $358 million lower in the June 2018 year.

Notes:

1. Percent of main forecast nominal GDP
2. Funds managed by the Treasury's DMO 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 receives in a given year is closely linked to the performance of the economy. Figure 3.10 plots the main tax revenue forecast, along with confidence intervals around these forecasts based on the Treasury's historical tax forecast errors and the assumption of an even balance of risks around the main forecast.[5] The outermost shaded area captures the range +/- $6.5 billion in the June 2018 year, within which actual tax outturns fall 80% of the time.[6]

The tax revenue forecasts from the two scenarios are also shown in Figure 3.10. The 2008/09 global financial crisis showed that exogenous shocks can have severe impacts on government revenue. Should any of the uncertainties outlined in the Economic Riskssection eventuate, government revenue would be different from forecast, with scenarios one and two being examples of possible outcomes.

Figure 3.10 - Core Crown tax revenue uncertainty

Source: The Treasury

Based on average historical forecast errors and an even balance of risks, Figure 3.10 suggests that tax revenue over the forecast period would be stronger than scenario two approximately 35% of the time and weaker than scenario one approximately 25% 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 over-forecasting of expenditure can also have substantial ongoing effects on the fiscal position, along with the uncertainty inherent in forecasting the cost of new policy initiatives.

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 prior 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, which appear in the balance sheet through their impact on the operating balance, the Crown's financial position is also exposed to asset and liability risks. Some of these risks are on balance sheet owing to the Crown having explicit obligations either in respect of its own assets or to the wider economy. Some are off balance sheet owing to their discretionary nature, but are implicit to the Crown from strong expectations that the Crown would respond to an event. The focus here is on balance sheet risks that can be documented, based on the Crown's contractual position.

While the Crown's exposure to risk is sometimes unavoidable, the Crown's general approach is to identify, avoid or mitigate these risks where practicable. When a risk cannot be avoided or reduced, the Government's response has been to increase the Crown's resilience by reducing debt ahead of the time when it could be needed. This helps to absorb the impact of the risk through its balance sheet so that the wider economy need not adjust immediately at a greater economic cost. For more information on balance sheet risks, see the Fiscal Outlook chapter on pages 37-39.

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”.[7] Three areas of the balance sheet are particularly susceptible:

• Financial assets held by the 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 Treasury estimates a 10% movement in world share markets would lead to around a $1.7 billion operating balance impact.
• 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 physical Crown 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.

For additional detail, refer to the 2014 Investment Statement which provides information on the shape and health of the Crown's portfolio of assets and liabilities at the end of the past full financial year.[8] It outlines how the balance sheet has changed in recent years and includes forecasts of its anticipated composition and size through to 30 June 2018.

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. Ratings outlooks are stable across all three agencies.

The cyclical 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 else being equal, a 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.

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

Specific Fiscal Risks#

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#

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:

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

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 Crown balance sheet, including the FIF/capital allowance): Capital investment decisions are risks to the fiscal forecasts only to the extent that they cannot be managed within the Crown balance sheet, including the FIF/capital allowance.
• 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 Jobseeker Support).
• 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). 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#

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 - Funding Policy Review (Unchanged)

The Government is undertaking a review of ACC's funding policy. Adopting a lower funding target band midpoint would result in a reduction in levies and reduce 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 could reduce tax revenue by $500 million a 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 Parties (Unchanged)

A wide range of government services are funded through third party fees and charges. Demand for these services can vary with a direct impact 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 services. 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 this 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. This is under active consideration, but would require an appropriate legislative vehicle. An initial adjustment to the liability, and an expense of about $650 million would need to be reported if such an amendment were to be made.

Budget Operating Initiatives (Changed)

Future Budgets may well include new operating initiatives other than those identified in other specific fiscal risks. Such new operating initiatives are risks to the fiscal forecasts only to the extent they cannot be managed through reprioritisation or from within the existing provision in the fiscal forecasts for forecast new operating spending. The Government's stated intention is that all new operating initiatives will be managed through these mechanisms.

Canterbury Earthquake Recovery - Christchurch Central Recovery Plan (Unchanged)

The Crown is partially funding the construction of Anchor Projects as part of the Christchurch Central Recovery Plan as set out in the cost-sharing agreement with the Christchurch City Council. The extent of funding will vary from project to project, dependent on final project costs. Business cases are progressing through the decision-making process. 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.

Christchurch City Council/Crown Cost Sharing (Unchanged)

The Crown is partially funding the recovery of local infrastructure in Canterbury as set out in the cost-sharing agreement with the Christchurch City Council. The agreement includes a review clause. The review is to be completed by 1 December 2014. Therefore, the fiscal forecasts make no allowance for additional costs arising from the review.

Communications - Ultra-Fast Broadband Initiative (Unchanged)

The Government has expressed support for Crown Fibre Holdings to enter into discussions with Chorus Limited to help manage potential issues for Chorus in delivering the Ultra-Fast Broadband Initiative. Depending on their nature, the outcomes of those discussions could give rise to a fiscal risk. The Government's expectation is that any options arising from the discussions will remain within the current funding envelope.

Defence Force - Operating and Capital Costs (New)

Operating and capital investment decisions may be made to achieve Defence White Paper (2010) policy over the forecast period. In 2013, the Government reconsidered New Zealand Defence Force (NZDF) funding, output requirements and capability intentions, through the Defence Mid-Point Rebalancing Review. The Government is yet to make final decisions on future funding for NZDF. However, funding increases may be approved for NZDF within the forecast period.

Finance - Concessionary Loans (New)

The Crown has provided loans to local government and iwi-based organisations on a concessionary, usually interest free, basis to achieve public policy purposes. To reflect the concession, these loans have been written down and are measured at $290 million in the financial statements. There is, however, a risk that the write-down provisions may be insufficient to cover the credit risk involved in these non-commercial loans.

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.

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. Increasing the scale or speed of change may require reprioritisation or additional funding.

Revenue - KiwiSaver Auto-enrolment (Changed)

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 and debt repayment is on track. 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 $100 million to $290 million over the first four years after auto-enrolment takes place, and are expected to be funded out of the operating allowance.

Revenue - Transformation and Technology Renewal (Unchanged)

The Government is exploring options that will change the way Inland Revenue manages its processes and data. Any changes could impact tax revenue collections and may have material costs to implement. Inland Revenue has commenced the development of a detailed business cases for Stage 1: Enabling secure digital services. The business cases will inform the Government's decision-making for the first stage of transformation and may require significant reprioritisation or new funding.

Social Development - Vulnerable Children White Paper (Changed)

The Government has begun to implement proposals to better identify and provide assistance to vulnerable children. While funding for 2014/15 has been included in the fiscal forecasts, future costs of the proposal are still being developed. To the extent that these cannot be funded from reprioritisation, additional funding from the Budget operating allowance may be required.

Social Development - Welfare Reform Costs (Changed)

The Welfare Reform package of changes to the benefit system was introduced from July 2013, following amendments to the Social Security Act 1964. The current phase is to review programmes with a view to reducing future benefit dependency and long-term liability. Additional funding was appropriated at Budget 2014. The extent of any further costs associated with the ongoing implementation of the Investment Approach is 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 in 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 negotiated 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 its current fiscal stance and that agreements will be managed within the current fiscal forecasts.

Potential Capital Decisions (Expected to be Funded from the Crown Balance Sheet, Including the FIF/Capital Allowance)

Departmental Capital Intentions (Changed)

Future Budgets may well include new capital initiatives other than those identified in other specific fiscal risks. Such initiatives are likely to be primarily from the 16 capital-intensive agencies or sectors that are required 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. New capital initiatives and departmental capital intentions are risks to the fiscal forecasts only to the extent they cannot be managed through existing balance sheets, including the FIF, and the provision in the fiscal forecasts for forecast new capital spending.

Earthquake Strengthening for Crown-owned Buildings (Unchanged)

There is a possibility that the Crown will incur costs for earthquake strengthening some of its buildings that do not meet modern building standards. The Government is currently undertaking a stocktake 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 outcome of ongoing discussions with the Crown Estate an upgrade to the building may be required. A rough-order cost estimate for this upgrade is $100 million over the forecast period.

Primary Industries - Investment in Water Infrastructure (Unchanged)

In addition to $80 million provided in Budget 2013 and $40 million provided in Budget 2014, the Government will consider providing up to $280 million in future Budgets to Crown Irrigation Investments Limited as schemes reach the “investment-ready” stage.

Transport - Auckland Transport Projects (Changed)

The Government has signalled its intention to accelerate transport projects in the Auckland Council’s Auckland Plan, including Auckland Manukau Eastern Transport Initiatives, the East-West Link and support for the City Rail Link and a second Waitemata Harbour Crossing. Decisions on further Crown financial assistance for Auckland Manukau Eastern Transport Initiatives and the East-West Link will be made as part of future Budgets.

Transport - Support for KiwiRail (Changed)

The Government has supported KiwiRail Holdings Limited (KiwiRail) with around $1 billion invested in its plan to become a commercially viable network in Budgets 2010 to 2014. Further funding is being sought by KiwiRail in support of this objective. A major review of the business has commenced and will be assessed to inform Budget 2015 and any further investment.

Matters Dependent on External Factors

ACC - Levies (Unchanged)

Revenue from the levies set for the Work, Earners' and Motor Vehicle accounts may be more or less than is required to cover the cost of claims, if factors such as claims experience, ACC performance and economic assumptions (particularly discount rates) turn out differently from what has been forecast. Any such variance will have a corresponding impact on the operating balance.

ACC - Non-earners' Account (Unchanged)

The amount of funding provided by the Crown (and included in the fiscal forecasts) for the Non-earners' Account may be more or less than is required to cover the cost of claims, if factors such as claims experience, ACC performance and economic assumptions (particularly discount rates) turn out differently from what has been forecast. Any such variance will have a corresponding fiscal impact.

Canterbury Earthquake Recovery - Residential Red Zone (Unchanged)

Some recoveries from the EQC and private insurers remain outstanding and there is a risk that final recoveries may be greater or less than forecast. In addition, potential costs associated with the future use of residential red zone are uncertain. The future value may change depending on any future alternate uses of the land.

Caregiver Employment Conditions (New)

Several cases and funding claims in the disability support and aged care sectors may involve significant costs to the Crown relating to interpretation of the Minimum Wage Act 1983, the Equal Pay Act 1972 and the Government's policy of paying certain family members through its Funded Care Policy. Changes to the existing policy could require additional funding. Successful litigation may have implications for agencies that target assistance based on family circumstances and/or employ workers under similar contracts.

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

The Government has set aside $1.345 billion to progressively capitalise Crown Fibre Holdings so that it can invest with private partners in a new network delivering “ultra-fast” broadband services. Given the contracts entered into, the extent of the recovery of this investment is particularly dependent on the number of connections made to the network. The fiscal forecasts include a provision for impairing this investment, but the final amount of the impairment may vary from this provision.

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 and Unimog trucks. Depending on market conditions, the timing of disposal and sale price received could have an impact on the Government's overall financial position. NZDF is also completing 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.

Energy - Crown Revenue from Petroleum Royalties (Unchanged)

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

Finance - EQC (Unchanged)

The net financial position of EQC, and the size of any requirement for additional Crown funding, remain uncertain, although EQC expects the National Disaster Fund to be fully depleted during the 2014/15 financial year, after which the Crown funding will begin. The uncertainty is around EQC's outstanding claims liability - the actuarial estimate of EQC's outstanding claims liability is highly uncertain and sensitive to assumptions; for example, construction demand surge, land damage estimates, legal challenges, reinsurance recoveries and the profile of claims settlement. The magnitude of the net outstanding cost claims is large, so small percentage changes in the liability can have a material impact on the fiscal forecasts.

Finance - Goodwill on Acquisition (Unchanged)

As at 30 June 2013, the Government had goodwill on acquisition of a number of sub-entities totalling $655 million. Under New Zealand accounting standards (NZIAS 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 - Solid Energy (New)

Since Solid Energy's financial restructure in October 2013 the company's export prices have deteriorated significantly driven mainly by a decrease in US dollar coal price. The company continues to develop and implement a business strategy to adapt to these challenging market conditions and continue operating. Any changes to the restructure arrangements or further deterioration in market conditions or the company’s financial position may adversely impact the Crown.

Finance - Southern Response Earthquake Services Support (Unchanged)

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.

Housing - Divestment of Housing (Unchanged)

The forecasts reflect related divestments and redevelopments 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 forecast divestments and to the proposed funding of the related developments.

Revenue - Cash Held in Tax Pools (Unchanged)

Funds held in tax 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 by that taxpayer, resulting in a reduction in the Crown's available cash reserves.

Revenue - Student Loans (New)

The valuation of student loans in the fiscal forecasts use data compiled by Statistics New Zealand from the Ministry of Social Development, Ministry of Education and Inland Revenue. The structure of the datasets has changed to those previously used. While this change is expected to improve the accuracy of the forecasts in the future, the change may lead to revisions of assumptions in the short term which could affect the valuation of outstanding student loans.

Treaty Negotiations - Treaty Settlement Forecasts (Unchanged)

The fiscal forecasts include provision for the cost of future Treaty settlements. Given settlements are finalised through negotiations; there is a risk that the timing and amount of the settlements could differ from the profile included in the fiscal forecasts.

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 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 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 2013 Half Year Update

The following risks have been removed since the 2013 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.[10]

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[11] 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 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[12] (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 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[13] 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, or
• 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#

Contingent liabilities are possible costs that have arisen from past events, but the amount of the liability, or whether it will eventuate, will not be confirmed until 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 debt. In the case of contingencies for uncalled capital, the negative impact would be restricted to core Crown 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 aggregated in the “other quantifiable” total.

Some contingencies of the Crown are not able to be quantified. We have disclosed all unquantifiable contingent liabilities and unquantifiable contingent assets that are not expected to be remote.[14]

Contingent liabilities have been stated as at 31 March 2014, being the latest set of reported contingent liabilities.

Quantifiable Contingent Liabilities and Contingent Assets

Unquantifiable Contingent Liabilities and Contingent Assets

The following unquantifiable contingent liability was removed: Meridian Energy Limited Initial Public Offering.

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 these organisations, 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 over $100 million are as follows:

Legal proceedings and disputes

Tax in dispute

When a taxpayer disagrees with an amended 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 maximum liability Inland Revenue has in respect of these cases.

$591 million at 31 March 2014 ($641 million at 30 June 2013)

Other quantifiable contingent liabilities

Unclaimed monies

Under the Unclaimed Money Act 1971, entities (eg, financial institutions, insurance companies) hand over money not claimed after six years to Inland Revenue. The funds are repaid to the entitled owner on proof of identification.

$112 million at 31 March 2014 ($101 million at 30 June 2013)

Transpower New Zealand Limited

Transpower has a contingent liability relating to excess capital expenditure on the North Island Grid Upgrade Project (NIGU). The NIGU spend exceeds the amount initially approved in 2006. If the excess expenditure is not approved by the Commerce Commission it cannot be recovered from customers. NIGU is operational and a submission for the excess expenditure has been made.

$150 million at 31 March 2014 ($156 million at 30 June 2013)

Unquantifiable contingent liabilities

This part of the Statement provides details of those contingent liabilities of the Crown that are not quantified, excluding those that are considered remote, reported by the following categories:

1. Indemnities.
2. Legal disputes.
3. Other contingent liabilities.

a Indemnities

Indemnities are legally binding promises where the Crown undertakes to accept the risk of loss or damage that another party may suffer or to hold the other party harmless against loss caused by a specific stated event.

A number of these indemnities are provided to organisations within the Crown's control. If these indemnities were to crystallise, the Crown would compensate the individual entity for the loss and there would likely be an adverse impact on core Crown expenses and core Crown net debt.

Legal claims and proceedings

Numerous legal actions have been brought against the Crown. However, in the majority of these actions it is 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 impact than a $20 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 $20 million in costs.

Accident Compensation Corporation (ACC) litigations 

There are a number of actions involving ACC in existence, arising from the statutory review and appeal process, and in the main coming from challenges to operational decisions made by ACC. Given the nature of these proceedings and uncertainty as to their outcomes, attempting to quantify the financial effect would be unrealistic, so no estimate has been made.

Air New Zealand litigation

Air New Zealand is currently named in 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. A 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 United States class action is being defended. Claims against Air New Zealand in the Australian class action are to be discontinued under terms of a proposed settlement of the proceedings. Air New Zealand is not contributing to that settlement. The allegations made in relation to the air cargo business are also the subject of proceedings by the Australian Competition and Consumer Commission. A defended hearing in the Federal Court concluded in May 2013 and a decision is awaited. In the event that the Court determines that Air New Zealand had breached Australian laws, the Company would have potential liability for pecuniary penalties.

Television New Zealand Limited (TVNZ)

In the normal course of business various legal claims have been made against TVNZ. Given the stage of proceedings and uncertainty as to the outcomes of the claims, 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 certain 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 such actions against the Crown being heard at the Court of Appeal and the Supreme Court. Failure to successfully defend such actions may result in a liability for historical Treaty grievances in excess of that currently anticipated.

Ministry of Education litigation

Post Primary Teachers Association and several teachers have lodged a claim in the High Court alleging breach of statutory duty, and compensation, in respect of the Novopay system failures. The Ministry is defending this claim.

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. The timing and amount of any possible payments required are not able to be estimated.

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.

Any contaminated sites for which costs can be reliably measured have been included in the Statement of Financial Position as provisions.

Treaty of Waitangi claims - Settlement Relativity Payments - see page 72.

Description of Contingent Assets

Quantifiable contingent assets over $100 million

Tax disputes - non-assessed

A contingent asset is recognised when Inland Revenue 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.

$118 million at 31 March 2014 ($169 million at 30 June 2013)

Forecast Financial Statements#

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 2014.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined in the Fiscal Outlook Chapter (pages 21 to 45).

Statement of Accounting Policies#

Significant Accounting Policies

The 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. They 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 2014 Budget Economic and Fiscal Update Additional Information document which can be found on the Treasury's website at www.treasury.govt.nz/budget/forecasts/befu2014

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

The 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 Riskschapter on pages 63 to 83.

Key forecast assumptions are set out on pages 43 to 45.

Government Reporting Entity as at 29 April 2014#

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 (classified in the three institutional components used for segmental reporting):

Core Crown segment

Departments

• Canterbury Earthquake Recovery AuthorityCrown 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 segment

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

Mixed ownership model companies (Public Finance Act schedule 5 companies) 

• Genesis Energy Limited
• Meridian Energy Limited
• Mighty River Power Limited

Others

• Air New Zealand Limited

Crown entities segment

• 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 Irrigation Investments Limited
• 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 Service
• 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 (2,453)
• 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
• WorkSafe New Zealand

Organisations listed in schedule 4 of the Public Finance Act 1989

• Agricultural and Marketing Research and Development Trust
• Asia New Zealand Foundation
• Fish and Game Councils (12)
• Game Animal Council
• Leadership Development Centre Trust
• 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
• Reserves Boards (21)
• Sentencing Council
• Te Ariki Trust

Non-listed companies in which the Crown is majority or sole shareholder (Public Finance Act schedule 4A companies)

• Crown Asset Management Limited
• Crown Fibre Holdings Limited
• Fairway Resolution Limited
• Health Benefits Limited
• The Network for Learning Limited
• Research and Education Advanced Network New Zealand Limited
• Southern Response Earthquake Services Limited
• Tāmaki Redevelopment Company Limited

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

Forecast Financial Statements#

Forecast Statement of Financial Performance for the years ending 30 June

1. Minority interests include those who recently purchased shares in the Government Share Offer Programme as well as the pre-existing minority interests in Air New Zealand Limited, and the minority interests held in the Crown Fibre Holdings Group and Solid Energy.

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

Forecast Analysis of Expenses by Functional Classification for the years ending 30 June

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

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. Excludes purchases by ACC and NZSF.
2. Further information on the proceeds and repayments of government stock ("domestic bonds") is available in note 22.
3. Minority interests include those who recently purchased shares in the Government Share Offer Programme as well as the pre-existing minority interests in Air New Zealand Limited, and the minority interests held in the Crown Fibre Holdings Group and Solid Energy.

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

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 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 2014

Statement of Actual Contingent Liabilities and Assets as at 31 March 2014

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#

NOTE 1: Sovereign Revenue (Accrual)

1. Customs excise-equivalent duty.

NOTE 1 (continued):  Sovereign Receipts (Cash)

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, were 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 2014 and previous Budgets that has yet to be allocated. Forecast new spending indicates the expected spending increases from future Budgets.

Unallocated contingencies represent capital spending from Budget 2014 and previous Budgets that has yet to be allocated. Forecast new spending indicates the expected capital spending increases from future Budgets, which will be mostly 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. 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

NOTE 16: NZS Fund

NOTE 17: Payables

NOTE 18: Insurance liabilities

ACC liability

Levy reductions

The forecast includes a reduction in levy rates for the 2015/16 levy year. The amounts factored in for the 2015/16 levy year are based on a best estimate of the likely outcome, which may differ from ACC's consultation document and the final outcome.

Calculation information

PwC NZ has prepared an independent actuarial estimate of the ACC outstanding claims liability as at 31 December 2013. 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 2014. The equivalent single effective discount rate, taking into account ACC's projected future cash flow patterns, is 5.15% and allows for a long-term discount rate of 5.5% 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

ACC has available to it a portfolio of assets that offset the claims liability. The assets (less cross-holdings of NZ Government stock) are included as assets in the Statement of Financial Position.

EQC liability

Calculation information

Melville Jessup Weaver prepared an independent actuarial estimate of the EQC outstanding claims liability at 31 December 2013 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 31 December 2013 valuation form the basis of the five-year forecast of the outstanding claims liability.

Critical assumptions used in projecting the ultimate costs include apportionment of costs 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 2014. 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 2014, based on membership data as at 30 June 2013 with adjustments for cash flows to 28 February 2014. 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 2014.

Other principal long-term financial assumptions were an inflation rate, as measured by the Consumers Price Index, of 1.9% for the year to 28 February 2015, 2.3% for the two years to 28 February 2017, 2.4% for the two years to 28 February 2019 and increasing to 2.5% for all years after that. In addition an annual salary growth rate, before any promotional effects, of 3% (unchanged from 30 June 2013).

The 2013/14 projected decrease in the net GSF liability is $1,170 million, reflecting a decrease in the GSF liability of $930 million and an increase in the GSF net assets of $240 million.

The decrease in the GSF liability of $930 million includes an actuarial gain between 1 July 2013 and 28 February 2014, of $550 million, owing to movements in the discount rates. The remaining $380 million reduction is owing to lower than 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 $240 million includes a gain of $163 million reflecting the updated market value of assets at 28 February 2014. The balance of $77 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 2013/14 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 assist New Zealand in meeting its international climate change obligations and to reduce New Zealand's net emissions of greenhouse gases to below business-as-usual levels. The ETS creates a limited number of tradable New Zealand Units (NZUs) which the Government can allocate. Emitters can also surrender Kyoto compliant units to meet their obligations.

The allocation of NZUs creates a provision if allocated for free; the provision is reduced, and revenue recognised, as NZUs and Kyoto compliant units are surrendered to the Crown by emitters. The Kyoto compliant units collected through the ETS are recognised as revenue and as part of the net Kyoto Protocol position.

The prices for NZUs and Kyoto compliant units used to calculate the ETS provision are assumed to remain constant over the forecast period and are based on market prices during February 2014.

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#