Budget Economic and Fiscal Update 2016

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 2016 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 2016. This Update does not incorporate any decisions, circumstances or statements that the Minister of Finance has determined, in accordance with section 26V of the Public Finance Act 1989, should not be incorporated in this Update.

Gabriel Makhlouf
Secretary to the Treasury

16 May 2016

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 2016 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 Part 2 (Fiscal responsibility) of the Public Finance Act 1989.

Hon Bill English
Minister of Finance

16 May 2016

Executive Summary#

• Economic growth is forecast to strengthen from 2.6% in the year ending June 2016 (the 2015/16 fiscal year) to 3.2% in the year ending June 2018 driven by strong population growth, sustained increases in services exports, particularly tourism, and the stimulatory effects of low interest rates.
• The operating balance before gains and losses (OBEGAL) is expected to increase from a position of broad balance in the current year to a surplus of $6.7 billion (2.2% of gross domestic product (GDP)) in the 2019/20 fiscal year (Figure 1).
• As a share of GDP, net core Crown debt is forecast to peak at 25.6% ($66.3 billion) in the 2016/17 fiscal year and to decline to 20.8% ($62.3 billion) in the 2019/20 year (Figure 1).

Figure 1 - Operating balance and net debt

Source: Statistics New Zealand, the Treasury

In New Zealand, the pace of growth picked up in the second half of 2015 and was stronger than anticipated in the Half Year Update. This strength is reflected in upward revisions to the Treasury's forecasts of nominal GDP, tax revenue and OBEGAL in the current fiscal year. These gains are sustained across the forecast period by ongoing strength in net migration inflows, construction activity and spending by visitors to New Zealand.

Growth among New Zealand's major trading partners eased in 2015, particularly in China and other Asian economies. Global monetary policy remains extremely accommodating and a modest pick-up in trading partner growth is expected in 2017 and subsequent years.

Risks of more pronounced weakness in the global economy remain high, with China's transition towards greater consumption-driven growth and the impacts of reduced monetary policy stimulus in the United States (US) potential sources of further volatility. Other risks, including the United Kingdom's (UK's) European Union membership referendum, are adding to uncertainty.

The New Zealand economy is continuing to adjust to the effects of lower commodity prices, particularly for dairy exports. Commodity export values are forecast to weaken over the year ahead leading to a wider current account deficit. International dairy prices are expected to recover gradually over 2017 and 2018, contributing to a narrowing of the current account deficit.

Compared with the Half Year Update, net migration inflows are significantly higher over the forecast period, which raises the Treasury's estimate of the economy's productive capacity (or potential output), and flows through to higher real GDP. However, a larger proportion of growth is expected to occur in the relatively low productivity sectors of construction and hospitality. Consequently, growth in real GDP per capita is slightly slower than forecast in the Half Year Update.

Consumers Price Index (CPI) inflation is expected to rise to 2.0%, the middle of the Reserve Bank's 1% to 3% target range, in late 2017. This is around one year later than in the Half Year Update, reflecting the effects of recent falls in fuel prices and the impact of lower inflation expectations on wage- and price-setting behaviour.

Compared to the Half Year Update, the lower inflation forecast reduces growth in nominal GDP and tax revenue in the 2017/18 and 2018/19 fiscal years. Nevertheless, the strength of recent outturns underpins nominal GDP and tax revenue forecasts that remain higher than in the Half Year Update (Figure 2).

Figure 2 - Nominal GDP (annual)

Source: Statistics New Zealand, the Treasury

The number of people in employment increased by 120,000 in the past two years, broadly matching growth in the labour force. However, the proportion of the working-age population in the labour force has been variable and the unemployment rate has fluctuated between 6.0% and 5.4% over the past two years.

Employment is forecast to grow around 2.0% per annum over the next four years and, as net migration inflows ease, to exceed growth in the labour force. The unemployment rate is expected to remain within its recent range (6.0% to 5.4%) until mid-2017, before steadily declining to 4.6% at the end of the forecast period.

Budget 2016 incorporates an increase in the Government's 2016/17 operating and capital allowances and lower future allowances. The net effect of the Government's revenue and expenditure decisions (the fiscal impulse) is to provide modest support for economic growth over the 2015/16 and 2016/17 fiscal years. Thereafter, the combination of stable operating allowances and increasing tax revenues generates a mildly contractionary fiscal impulse.

Although OBEGAL is expected to record small surpluses this year and in 2016/17, increases in capital spending lead to larger core Crown cash deficits (residual cash) and higher net debt. Residual cash returns to surplus in 2018/19 and net debt declines. Overall, the outlook for residual cash flows has improved since the Half Year Update, and net debt is forecast to be $8.8 billion lower in 2019/20.

Net worth attributable to the Crown is expected to increase over the forecast period, driven by OBEGAL surpluses.

The economic and fiscal forecasts are based on a number of assumptions and judgements concerning economic developments. The Risks and Scenarios chapter presents two scenarios to show how the economy might evolve under some alternative judgements. The weaker world scenario is assumed to reduce visitor arrivals and to lower the terms of trade, which results in weaker growth. OBEGAL remains close to balance until the 2017/18 year before increasing, and net debt is around four percentage points higher in 2019/20 than in the main forecast. In the sustained domestic momentum scenario, stronger GDP growth and higher inflation flow through to increases in nominal GDP and tax revenue. OBEGAL increases to almost 3.0% of GDP in 2019/20 and net debt is well below 20.0% of GDP.

Notes:

1. Real production GDP, annual average percentage change.
2. Percent of labour force, June quarter, seasonally adjusted.
3. Annual percentage change, June quarter.
4. Percent of GDP.
5. Total Crown operating balance before gains and losses (OBEGAL).
6. Net core Crown debt excluding the New Zealand Superannuation (NZS) Fund and advances.

Sources: Statistics New Zealand, the Treasury

Economic Outlook#

Overview#

• Growth in the New Zealand economy picked up in the second half of 2015 and was higher than anticipated in the Half Year Update on the back of strong net migration inflows, residential construction and elevated tourist spending. On the other hand, trading partner growth eased in 2015 in line with the Half Year Update and the outlook is weaker than previously forecast. China's growth slowed as the economy transitions from investment to more consumption as the key driver of growth, weighing on growth in other Asian trading partners and Australia.
• Annual average GDP growth in New Zealand is expected to accelerate from 2.6% in June 2016 to 2.9% in June 2017, as net migration inflows, low interest rates and tourist spending drive growth in consumption, residential investment and services exports. However, previous falls in commodity prices are expected to reduce goods exports.
• GDP growth is forecast to increase to 3.2% in the 2018 June year. A pick-up in growth in New Zealand's key trading partners and slower growth in global dairy supply are expected to lead to a lift in commodity export prices. The consequent recovery in farm incomes is expected to support business investment and a rebound in exports growth, and previous strong population growth boosts construction.
• Some spare capacity in the economy is expected to remain in the near term as higher labour supply lifts the economy's productive capacity, resulting in low non-tradables inflation, which is reinforced by weak inflation expectations. However, labour supply growth is expected to slow from 2017 and productivity growth is expected to remain subdued, leading to a reduction in spare capacity and a rise in inflationary pressure.
• Nominal GDP growth is expected to remain low in the near term as a result of the relatively subdued terms of trade and low inflation, although it is held up by solid real GDP growth. Nominal GDP growth is expected to increase in later years, as the terms of trade and inflation recover and real GDP growth remains solid.
• There are key risks to the New Zealand economy. Global risks remain skewed to the downside, including a sharp slowdown in China's growth, persistently low global inflation, a possible British exit from the European Union and geopolitical risks. Domestic risks are more balanced, relating to inflation dynamics, the current migration cycle and house price growth. These risks are discussed in the Risks and Scenarios chapter.

Data in the table are in June years unless otherwise specified, and March year tables are provided on page 138.

Longer time series for these variables are provided on page 137.

Notes:

1. Forecasts finalised 13 April 2016.
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, June quarter, seasonally adjusted.
5. Percent of the working-age population, June 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 goods basis.
9. Quotable Value New Zealand (QVNZ) House Price Index, annual percentage change.
10. % of household disposable income (HHDI), March years.
11. Average for the June quarter.

Recent Developments#

Economic growth picked up on the back of solid domestic demand…

The pace of economic expansion accelerated in the second half of 2015. Real GDP grew 0.9% in both the September and December quarters, faster than the Half Year Update forecasts of 0.6% (Figure 1.1), on the back of strong growth in the service industries, reflecting high net migration and tourist inflows. Residential construction growth picked up from earlier in the year, as housing supply in Auckland responded to high demand. However, weaker global dairy prices started to flow through to lower dairy export receipts, although elevated tourism spending provided a positive offset for export growth. Per capita real production GDP growth fell to 0.6% in the calendar year 2015 from 2.2% in 2014, as aggregate growth was driven largely by population growth.

Figure 1.1 - Real GDP growth

Source: Statistics New Zealand, the Treasury

…as population growth increased…

Net inward migration reached a record of 68,000 in the year to March 2016, exceeding its Half Year Update forecast peak of 62,700. Increased arrivals drove net migration gains, and are likely to give a larger near-term boost to demand than supply compared with lower departures as the main driver. Working-age migrants require accommodation and other necessities following arrival, but may take some time to enter the labour market. Private consumption expanded 1.6% in the second half of 2015, up from 0.9% in the first half, reflecting strong population growth and low interest rates.

…strong housing demand persisted…

Strong housing demand continued to support residential investment. While house sales fell in the December quarter 2015 as the market adjusted to regulatory changes (Figure 1.2), the impact of these changes on demand softened in early 2016 as the fundamentals underpinning strong demand - population growth and low mortgage rates - reasserted themselves, leading to a rebound in house sales (see the box on page 13 for details on construction and other recent developments in the housing market). Residential investment expanded 5.0% in 2015, exceeding the pace of GDP growth, and was driven increasingly by Auckland, where annual growth in the median house price reached 25% in the middle of 2015 before slowing in the December quarter.

Figure 1.2 - House sales and mortgage rates

Source: Real Estate Institute of New Zealand, Reserve Bank

…and interest rates fell

Further monetary easing added support to domestic demand. The Reserve Bank reduced the Official Cash Rate (OCR) by 125 basis points (bps) between June 2015 and March 2016, leading to a large fall in short-term interest rates, although the fall in floating mortgage interest rates was less pronounced owing to increased overseas funding costs. The Reserve Bank stated that its recent rate reduction in March was in response to a weaker global outlook and recent falls in inflation expectations, which are likely to negatively affect wage- and price-setting behaviour throughout the economy.

However, subdued demand from New Zealand's key trading partners…

Trading partner growth eased in 2015, chiefly as growth slowed in China and other emerging economies, while growth in developed economies remained moderate. China's growth slowed as the economy transitions from an investment-led model to greater emphasis on consumption as a driver of growth, and as authorities balance reform and short-term stimulus. Slower growth in China had flow-on effects to other Asian trading partners, and concerns over its growth outlook contributed to high financial market volatility in early 2016, which was characterised by increased demand for safe-haven assets and volatile equity markets.

The slowdown in China affected Australia through a further fall in its terms of trade. However, the Australian economy is shifting from mining investment towards other investment, consumption and exports as drivers of growth, supported by low interest rates and currency depreciation. The recovery in the US and UK slowed as low oil prices reduced investment in oil exploration and strength in their exchange rates constrained their manufacturing sectors, although both currencies fell recently. Growth remained subdued in Japan and the euro area as these economies continue to experience weak demand.

Commodity prices fell owing to weaker global demand and increased supply. Crude oil prices declined around 30% in the March 2016 quarter from a year ago to US$33/barrel, their lowest level since 2008, after a fall of around 50% in the year to March 2015. Reflecting slow global growth and falls in commodity prices, global inflation remains weak and monetary policy remains highly accommodative across developed economies.

…continued to weigh on dairy prices...

Global dairy prices fell by more than 50% over 2014 and 2015 as they came under pressure from increased supply and weak demand (Figure 1.3). Dairy prices rose briefly in late 2015 on expectations that El Niño might curb New Zealand milk production, but these price gains were reversed in early 2016 as it became apparent that the impact of El Niño was not as great as expected and global supply growth remained strong. Fonterra lowered its farmgate milk price forecast for the 2015/16 season to $3.90/kg of milk solids, lower than the price of $4.40/kg in the 2014/15 season.

Figure 1.3 - Dairy prices

Source: GlobalDairyTrade, the Treasury

The goods terms of trade fell 4.9% in the December quarter 2015 from December 2014, to be down 13.6% from their peak in December 2013, as lower export prices, led by dairy, more than offset the drop in import prices, driven by crude oil.

The El Niño weather pattern has had a smaller impact on agricultural conditions to date than projected in the Half Year Update, but the anticipation of it influenced farm production decisions. Meat export volumes grew strongly over the second half of 2015 as farmers sent livestock to slaughter in anticipation of dry conditions. Meanwhile, lower dairy prices were likely the main factor behind the fall in dairy production in the 2015/16 season. Falls in export prices and a drop in dairy production reduced export receipts, contributing to a widening in the annual goods trade deficit in the December quarter. Despite a wider goods deficit, the annual current account deficit narrowed to 3.1% of GDP in the December quarter from 3.3% in the September quarter, driven by a rise in the services surplus and a fall in income earned by foreign investors in New Zealand.

...but the impact on the current account was offset by tourist spending

Elevated tourist arrivals supported services exports. Overseas visitor arrivals rose 9.6% in 2015, driven by an increase in Chinese and Australian visitors, as travellers perceive higher personal risks in some other parts of the world, China incrementally loosened travel restrictions and depreciation in the New Zealand dollar reduced the cost of visiting New Zealand. Reflecting high tourist arrivals, travel services exports (chiefly tourism) rose 26% in the year, leading to a 17% increase in the value of services exports.

Strong growth in labour supply leads to higher spare economic capacity…

While labour demand in the economy was solid, it was matched by increases in labour supply, owing to elevated net migration inflows. The working-age population grew 2.3% in 2015, up from 2.1% in 2014, with three-quarters of the growth in 2015 driven by net migration inflows, lifting the economy's productive capacity. Consequently, spare capacity in the economy is estimated to have remained significant in the second half of 2015, despite solid domestic demand.

…weighing on inflation and nominal GDP growth

Annual inflation remained low at 0.4% in the March quarter 2016.[1] Annual tradables inflation remained weak at -1.2% owing to falling petrol prices. Non-tradables inflation was low at 1.6%, reflecting significant spare capacity in the economy. Low inflation and falls in the terms of trade led nominal GDP growth to slow to 3.3% in 2015 from 5.1% in 2014.

However, stronger-than-expected real (or volume) GDP growth led nominal growth to exceed its Half Year Update forecasts. Consistent with stronger-than-expected nominal GDP growth, tax revenue in 2015/16 has so far exceeded forecast, driven by source deductions and goods and services tax (GST), which reflect faster growth in total labour income and consumption than expected. See the Fiscal Outlook chapter for recent developments in tax revenue.

Near-term Outlook to June 2017#

Domestic demand is expected to drive higher GDP growth in 2016…

Real GDP growth is forecast to accelerate to 2.8% in the calendar year 2016 from 2.5% in 2015, faster than the Half Year Update forecast of 2.3%. On a quarterly basis, GDP growth is forecast to moderate to 0.6% per quarter in the first half of 2016 from 0.9% in the second half of 2015. Annual average GDP growth is expected to rise to 2.9% by the middle of 2017 from 2.6% in June 2016, chiefly reflecting solid domestic demand.

Domestic demand is expected to be the main driver of growth in the near term, although robust demand for tourism services exports is also expected to continue. Elevated net migration inflows are expected to boost aggregate household spending, contributing to growth in private consumption and residential investment. Public consumption growth is expected to remain moderate in the near term, with the fiscal impulse exerting a mildly stimulatory effect on growth (see the Structural balance indicators box on page 38 for further details). However, weak global demand and increased supply are expected to restrain dairy prices, leading to a reduction in farm incomes and negatively affecting business investment.

...as net migration inflows lift aggregate consumption…

The annual net migration inflow is expected to peak at 70,700 in the middle of 2016, higher than its Half Year Update forecast peak of 62,700 (Figure 1.5). This, combined with a slower fall from the peak, results in approximately 50,000 more people than in the previous forecast, with most of this expected to occur over the next two years, adding impetus to demand. However, annual average per capita GDP growth is expected to remain low at 0.5% in June 2016 and increase modestly to 0.9% in June 2017.

Figure 1.5 - Net migration

Source: Statistics New Zealand, the Treasury

Private consumption growth is expected to remain solid. In addition to elevated net migration inflows, other factors supporting household spending are low interest rates, solid real wage growth and the wealth effects from house price growth, all of which more than offset the impact of lower farm incomes. Low interest rates are expected to provide strong support to consumption, given that household debt is expected to remain high at around 90% of GDP in the next two years.

…and residential investment growth picks up…

House price growth in the near term is expected to remain high and to be driven increasingly by regions outside Auckland, which reflects a broadening of housing demand to the rest of New Zealand, supported by strong net migration and low interest rates. Scenario Two on page 61 in the Risks and Scenarios chapter shows how sustained strong house price growth could partly contribute to stronger-than-forecast domestic demand by boosting private consumption and residential investment.

Construction in Auckland is responding to elevated house prices, and is expected to support residential investment growth of 6.5% per year over the next two years. The pick-up in house prices across other regions is also expected to support residential investment growth. The Canterbury residential rebuild is projected to remain high in level terms over the next two years, but is not expected to contribute to growth in residential investment. The box on page 13 discusses recent developments in housing demand and construction.

…while growth in tourist arrivals boosts real services exports

Tourist spending is also expected to support demand. Real services exports are forecast to grow around 6.9% per year over the next two years. Chinese visitor arrivals are projected to rise owing to China's loosening of travel restrictions and continuing income growth across emerging Asian economies. Visitor arrivals from New Zealand's traditional source markets of Australia, the US and Europe are also expected to increase as New Zealand is perceived as a relatively safe place to visit. In addition to the boost to services exports, tourism is expected to support construction activity over the next couple of years through increased pressure on infrastructure and accommodation capacity.

However, weak global demand continues to weigh on commodity prices...

While the outlook for domestic demand is positive, TPG is expected to ease slightly in 2016. The Chinese economy is expected to continue to transition from investment-led growth towards a more consumption-based model, leading to slower growth. The slowdown in China's investment growth, which is commodity-intensive, is expected to weigh on growth in commodity-exporting economies including Australia, but growth in Australia is expected to be supported by a gradual rebalancing in investment from mining to other sectors, facilitated in turn by low interest rates.

The recovery in the US and UK is expected to continue, but at a slower pace than in the past year, owing to weak demand for their exports and slower private consumption growth. Growth in the euro area and Japan is expected to remain low, owing to weak investment growth and low Chinese demand. All told, TPG is expected to ease slightly from 3.5% in 2015 to 3.4% in 2016, before increasing gradually from 2017 (Table 1.2).

*South Korea, Singapore, Taiwan, Hong Kong

^ Malaysia, Indonesia, Thailand, Philippines

Sources: IMF, Consensus Forecasts, the Treasury

…reduces global inflation…

Slower growth in the world economy reinforces a weaker outlook for global inflation. Consequently, monetary policy settings across most economies are expected to remain highly stimulatory. Central banks in the euro area and Japan are expected to continue with large-scale asset purchases for some time, while the US Federal Reserve signalled that policy rate rises over 2016 may occur slower than previously indicated. Nevertheless, further tightening in US monetary policy is expected as US domestic conditions improve, putting upward pressure on global interest rates over the forecast period.

Risks to global growth and inflation remain skewed to the downside. The risks with the largest potential impact on the New Zealand economy include a sharp slowing in China's growth, which would impact on other trading partners, and a further moderation of growth in advanced economies leading to a more prolonged period of low inflation. Other risks, including the possibility of Britain exiting the European Union, may lead to high volatility in global markets. The realisation of any of these risks would weigh on demand and inflation in New Zealand. Scenario One on page 59 in the Risks and Scenarios chapter shows how weaker-than-forecast TPG could impact on the New Zealand economy.

...and restrains the terms of trade…

Subdued global demand and excess supply are expected to continue to weigh on world prices for many of New Zealand's key commodity exports, including dairy, lamb and forestry. The goods terms of trade are expected to remain around their current levels, following large falls over the past two years (Figure 1.6). Lower import prices, partly reflecting a fall in oil prices, provide some positive offset. Dairy prices are expected to remain around their current levels over the first half of 2016 before recovering as excess global supply is absorbed by the market.

Figure 1.6 - Goods terms of trade (SNA basis)

Source: Statistics New Zealand, the Treasury

The annual current account deficit is expected to widen. The goods deficit is expected to rise as falls in export prices and reduced dairy production continue to flow through to lower export receipts. While the services surplus is expected to remain high, its pace of increase is expected to moderate. The annual current account deficit is expected to rise to 4.6% in the June quarter 2017 owing to a wider goods deficit, but this represents a lower peak than in the Half Year Update, reflecting a sustained high level of tourist spending.

...which presents a drag on business investment growth in the first half of 2016

Low export prices have reduced farm incomes, which negatively impacts on investment in the agricultural sector. In addition, previous New Zealand dollar depreciation has flowed through to price rises for imported capital goods, weighing on business investment. Annual average growth in market investment is forecast to be soft at 2.2% in June 2016, driven by a contraction in market investment in the December quarter 2015. According to the Quarterly Survey of Business Opinion, investment intentions for the first half of 2016 remained soft, firms' own activity expectations declined and business confidence fell, reinforcing a relatively slow recovery in business investment in the first half of 2016.

Growth in labour supply keeps spare capacity in the economy high...

When considered in isolation, the soft investment outlook in the near term will reduce growth in the productive capacity of the economy, but is offset by the boost from net migration. Growth in the working-age population is expected to be historically high at around 2.5% in 2016 and is expected to outpace employment growth. As a result of increased labour supply, spare capacity in the economy is expected to remain significant over the remainder of 2016 despite solid demand. The unemployment rate was forecast to peak at 5.7% during 2016, but recent data suggest the peak may be somewhat higher.[3]

Wage growth is expected to fall below 2.0% in 2016, but real wage growth is projected to be solid owing to low inflation. However, real wage growth is expected to slow in 2017 as inflation rises and the high level of real labour costs leads firms to substitute more capital for labour in their input to production, which supports a recovery in investment growth.

…which reduces price pressures and nominal GDP growth…

Annual inflation is expected to remain low over 2016 (Figure 1.7), contrary to the Half Year Update forecast for a pick-up, chiefly reflecting a fall in oil prices in the March quarter 2016. In addition, low inflation has reduced households' and firms' expectations of future inflation, which is expected to weigh on non-tradables inflation. The box on page 19 discusses how lower inflation expectations affect inflation. The appreciation of the New Zealand dollar in early 2016 will put downward pressure on tradables inflation, partly reversing the effect of past depreciation. Inflation is expected to rise from 2017, as falls in fuel prices drop out of the annual calculation, oil prices steadily recover and the tobacco excise tax is increased.

Figure 1.7 - Consumer price inflation

Source: Statistics New Zealand, the Treasury

Nominal GDP growth is expected to remain low in the near term, reflecting low inflation, falls in the terms of trade and a soft outlook for business investment and goods exports. However, continued strong growth in real private consumption and residential investment is expected to lead to stronger nominal GDP growth in 2016 than previously forecast.

...and monetary policy is expected to stay accommodative

Monetary conditions are assumed to become more accommodative over the next two years as the OCR is reduced and the New Zealand dollar falls following an appreciation in early 2016. One further 25-bps OCR reduction is assumed to occur in 2016, and short-term interest rates are expected to remain low over 2016 and 2017. The exchange rate is assumed to fall over the remainder of 2016, driven by a depreciation against the US dollar as US monetary tightening continues.

Medium-term Outlook from June 2017 to 2020#

Growth increases in 2018 before declining later in the forecast…

June year annual average real GDP growth is forecast to lift from 2.9% in 2017 to 3.2% in 2018, and then decline to 2.8% in 2019 and 2.5% in 2020. Key drivers of growth are expected to steadily return to their long-run average levels. Growth in goods exports is forecast to pick up in the 2018 June year owing to a recovery in soft commodity prices as trading partner growth gains traction and dairy supply growth slows. Rising terms of trade are expected to support business investment growth, while previous high population growth boosts residential investment growth. However, the decline in net migration from previously elevated levels and softening real income growth in 2017 are expected to lead to slower private consumption growth, while real public consumption growth moderates as inflation rises and growth in government spending slows. The slowdown in GDP growth over the last two years of the forecast reflects lower net migration inflows, a steady rise in interest rates and the levelling-off in the terms of trade after a period of increases.

Annual growth in the labour force is expected to slow from 1.9% in June 2017 to 1.1% by June 2020. A relatively solid outlook for GDP growth is expected to support employment growth, which encourages people to seek work, and the participation rate is projected to rise from 68.4% in the June quarter 2017 to 68.9% in June 2019.

The economy's potential growth rate is expected to be high over the first half of the forecast period (Figure 1.10), owing to historically high population growth boosted by net migration inflows. Potential growth is expected to fall in annual average terms from 2.9% in June 2017 to 2.4% by the end of the forecast period, as net migration inflows taper off. Potential growth has been revised up across the forecast period from the Half Year Update (Figure 1.10), owing to a higher projection for population growth.

Figure 1.10 - Potential growth

Source: Statistics New Zealand, the Treasury

…as export prices recover as a result of adjustment in global supply and demand…

The goods terms of trade are expected to recover following a forecast pick-up in late 2016, driven by commodity export prices rising from a low level. An anticipated slowdown in global supply growth is a key driver for some commodities, including dairy, lamb and forestry, alongside broad-based higher demand as world growth regains momentum. Accommodative monetary conditions are expected to support the recovery in advanced economies, while higher commodity export prices lift growth in emerging economies.

Dairy prices are projected to increase steadily towards their assumed long-run average level of around US$3,400/mt by June 2018. On the other hand, rising import prices over the forecast period, as crude oil prices rise from a low level, will be a partial offset to the strengthening export prices. Oil prices are assumed to trend incrementally higher to reach US$63/barrel by June 2020. Owing to a continued rise in import prices, the terms of trade are expected to ease again after 2018 following a recovery.

…leading to a pick-up in commodity exports…

Goods exports are expected to rebound strongly in 2017 (Figure 1.11). Agricultural production is expected to recover in the 2016/17 season, as rising dairy prices stabilise milk production and meat production normalises. The assumed depreciation of the New Zealand dollar over 2016 is also expected to support exports from the middle of 2017. Rising exports growth is expected to be sustained into 2018 before moderating. Services exports are projected to grow steadily over the forecast period, on the back of travel services exports (chiefly tourism), supported by solid income growth in the source countries of tourist arrivals to New Zealand.

Figure 1.11 - Real goods exports

Source: Statistics New Zealand, the Treasury

…and monetary policy is expected to remain accommodative…

After remaining at low levels in 2016 and 2017, short-term interest rates are assumed to gradually rise to 4.2% by June 2020 (Figure 1.12), still below their assumed long-run level of 4.5%, as monetary policy is tightened in New Zealand in response to higher inflation. However, short-term interest rates are expected to be lower than in the Half Year Update over the forecast period, owing to the OCR reduction in March and one additional reduction this year. Long-term interest rates are expected to rise from late 2017, to 4.4% by June 2020, as monetary policy is expected to be tightened in New Zealand and the US. However, the long-term interest rate forecast has been revised lower, as the US Federal Reserve slowed its anticipated pace of policy tightening in early 2016 from its previous projections.

Figure 1.12 - 90-day interest rates

Source: Reserve Bank, the Treasury

…together supporting investment growth…

Annual average growth in market investment is expected to begin to rise in late 2016, to 6.4% in 2017 and 7.3% in 2018. The pick-up partly reflects increased capital spending by farmers after several seasons of deferred investment and maintenance, and is supported by low interest rates and a recovery in farm incomes. Low interest rates are also expected to support business investment in other industries. The commercial and public sector elements of the Canterbury rebuild will also increase market and non-market investment respectively. However, non-market investment growth is expected to fall after the middle of 2017, reflecting the assumption of lower capital spending than the previous year and the relatively low dollar value of public infrastructure construction projects commencing over the next two years. See the Fiscal Outlook chapter for details on the capital allowance.

…including residential investment

House prices are expected to remain elevated in many parts of the country, particularly Auckland, after strong growth in 2016 and 2017, reflecting limits in the housing supply response to growth in housing demand. High house prices continue to underpin strong residential investment growth in the second half of 2017 and in 2018, but residential investment growth is expected to slow from 2019 (Figure 1.13), as declines in net migration inflows and higher interest rates lead to slower growth in housing demand.

Figure 1.13 - Residential investment

Source: Statistics New Zealand, the Treasury

Positive domestic drivers more than offset declining net migration inflows

Net migration is projected to decline from its forecast peak of 70,700 in the middle of 2016, and return to its assumed long-run level of 12,000 per year in 2019, leading population growth to fall from 2.0% in 2016 to 0.9% in 2019. Reflecting slower population growth and rising interest rates, private consumption growth slows to 2.9% in 2017 and 2.5% in 2018, from 3.5% in 2016, and continues to ease for the rest of the forecast period. Real income growth is expected to slow as inflation picks up, and households are assumed to lower their saving rates to buffer reduced incomes and smooth their consumption to an extent.

Real public consumption growth begins to slow slightly in the second half of 2017 as inflation is expected to rise and growth in nominal government spending slows. The fiscal impulse is expected to be mildly contractionary in the last three years of the forecast, and to be broadly neutral over the period as a whole. See the Structural balance indicators box on page 38 for details on how discretionary changes in the fiscal position impact the economy.

Relatively low productivity growth…

Growth in labour productivity over the forecast period is projected to average 1% per year, slightly below its historical average. Below-average labour productivity growth reflects firms using a high proportion of labour in their input mix as growth is expected to be driven by the relatively labour-intensive industries. Below-trend labour productivity growth is expected to contribute to slowing growth in the productive capacity of the economy and to higher inflation. While per capita GDP growth is expected to pick up from 2017, it is forecast to decline again after mid-2019 as growth in labour productivity slows. (The box on page 24 examines in detail the relationship between labour productivity and per capita GDP.)

…contributes to a reduction in spare capacity in the economy...

The degree of spare capacity in the economy is expected to fall over the medium term, as growth in the labour force slows and labour productivity growth remains relatively subdued. The negative output gap, a measure of this spare capacity, narrows through 2017 and 2018, before closing fully in early 2019. This is reflected in a decline in the unemployment rate to 5.1% in June 2018 and 4.6% in June 2019, from a peak of 5.7% in 2016, as growth in the labour force falls below employment growth.

...leading inflation to return to two percent

Annual inflation is expected to return to 2.0% by late 2017, driven by a rebound in tradables inflation and steady increases in non-tradables inflation, although the return to 2.0% inflation is later than expected in the Half Year Update. Annual tradables inflation is expected to rise to around 0.8% in 2018 and 2019, assisted initially by the previous depreciation in the New Zealand dollar and as oil prices steadily increase and agricultural commodity prices recover. Annual non-tradables inflation is expected to rise at a steady pace, from 2.0% in June 2017 to around 3.0% by the end of the forecast, as capacity pressures in the economy and wage growth pick up and labour productivity growth remains slightly below average.

However, the possibility of low global growth and inflation over the medium term presents downside risks to tradables inflation, particularly given limited scope for monetary policy to respond to negative shocks in many advanced economies. The fall in inflation expectations in early 2016 suggests that low inflation outturns have lowered expectations of future inflation, which is expected to dampen price- and wage-setting across the economy, slowing the pass-through to non-tradables inflation from capacity pressures.

Nominal GDP growth accelerates

June year annual average nominal GDP growth is forecast to accelerate from 3.6% in 2017 to 5.6% in 2018, before declining to 5.1% in 2019. Nominal GDP growth then eases to 4.1% by the end of the forecast. Higher nominal GDP growth in 2017 and 2018 reflects high real GDP growth, the recovery in the terms of trade and rising inflation, the impact of which carries through to 2019. The large contribution from the higher terms of trade to nominal GDP growth in 2017 and 2018 is evident in the annual current account deficit, which narrows from a forecast peak of 4.6% of nominal GDP in the June quarter 2017 to a trough of 4.0% in December 2018. The current account deficit widens again in 2019 as nominal goods exports growth slows in line with growth in export prices, and as growth in import values remains high owing to solid demand and rising oil prices.

Compared to the Half Year Update, nominal GDP is cumulatively higher by around $17.3 billion over the five fiscal years to 2019/20, mainly reflecting an upward revision to growth in the 2016 June year (Figure 1.14). Higher nominal GDP increases projected tax revenue over the forecast period from the Half Year Update, particularly in 2015/16 and 2016/17. The Fiscal Outlook chapter discusses these changes in tax revenue in greater detail.

Figure 1.14 - Nominal GDP (annual)

Source: Statistics New Zealand, the Treasury

Fiscal Outlook#

Overview#

• The Crown's fiscal position has improved over the past few years and the current year’s results to 31 March 2016 are stronger than the previousforecast. The operating balance before gains and losses (OBEGAL) is expected to remain broadly in balance over the next two years.
• Beyond 2016/17, OBEGAL is forecast to rise sharply with surpluses reaching $6.7 billion by 2019/20. The Crown's cash position follows the same trend, with the residual cash deficit narrowing in 2017/18 and returning to surplus thereafter, which will reduce net debt.
• Net core Crown debt is therefore expected to peak in 2017/18 at $68.3 billion before reducing by $6.0 billion to stand at $62.3 billion by 2019/20 reflecting increasing cash flows. As a percentage of GDP, net core Crown debt peaks a year earlier at 25.6% of GDP in 2016/17 and declines to stand at 20.8% of GDP by 2019/20.
• Operating allowances have been revised since the 2016 Budget Policy Statement was released in December 2015 with some spending brought forward into Budget 2016 while the Budget 2017 operating allowance has been reduced (refer page 51).
• The Budget 2016 net operating allowance averages $1.6 billion per year for the forecast period (excluding 2015/16), with future operating allowances of $1.5 billion for Budgets 2017 onwards.
• Budget 2016 allocates additional gross capital expenditure of $2.6 billion, which is reduced to a net increase of $1.4 billion with capital savings. Net capital allowances for Budget 2017 and subsequent Budgets have been set at $0.9 billion.
• Overall net capital expenditure by the core Crown is estimated to be $23.1 billion from 2015/16 to 2019/20. In addition, Public Private Partnership agreements also contribute $1.8 billion of non-cash investment to the core Crown's capital investment activity, primarily in roading, prisons and schools (refer page 41).
• Net worth attributable to the Crown is expected to increase over the forecast period, reaching $108.9 billion by 2019/20. This growth is largely the result of forecast operating surpluses which means the growth in assets exceeds growth in liabilities.
• Total assets are forecast to grow by $32.0 billion to stand at $310.7 billion by 2019/20 with the largest growth in the social asset portfolio reflecting the core Crown capital spending. Liabilities increase in nominal terms, largely owing to the ACC claims liability increasing, while borrowings decrease in the later part of the forecast period. Total liabilities are expected to stand at $195.8 billion at the end of 2019/20, including borrowings of $115.9 billion.
• Compared with the Half Year Update, OBEGAL surpluses have improved by around $1.5 billion on average each year except 2016/17. Tax revenue forecasts have been revised upwards primarily owing to stronger nominal GDP. Social assistance expenditure forecasts have been revised down primarily owing to a stronger economic outlook and lower inflation than previously forecast, while net finance costs have been revised down owing to lower interest rates as well as lower net debt.
• Overall reductions in the operating allowances since the Half Year Update have resulted in an improvement to OBEGAL of $0.4 billion across the forecast period. When coupled with slightly less capital spending across the forecast period and excluding non-cash operating items, this has led to a reduction in net debt of $0.2 billion by 2019/20 (refer to page 51).
• Revised tax receipt and benefit expense forecasts have resulted in an improvement in residual cash with smaller cash deficits in the first three years and larger cash surpluses in the last two years of the forecast. This stronger cash position has resulted in forecasts for net core Crown debt being $8.8 billion lower than previously expected in 2019/20. Pages 47 to 50 provide a more detailed analysis of the comparison to the Half Year Update.
• These forecasts are sensitive to a number of assumptions and should be read in conjunction with the Risks and Scenarios and Specific Fiscal Risks chapters.
• The Budget Update includes fiscal forecasts for the period 2015/16 to 2019/20. Fiscal projections beyond 2019/20 and for the next 10 years out to 2029/30 are included in the Fiscal Strategy Report which can be found on the Treasury website (www.treasury.govt.nz/budget/2016/fsr).

Notes:

1. Operating balance before gains and losses.
2. Net core Crown debt excluding the NZS Fund and advances.

Source: The Treasury

Core Crown Tax Revenue#

Tax revenue grows over the forecast period...

Core Crown tax revenue is forecast to rise in each year of the forecast period. By 2019/20, core Crown tax revenue is expected to reach $84.4 billion, $17.8 billion higher than for the June 2015 year. Core Crown tax revenue increases, from 27.6% of nominal GDP in 2014/15, to 28.2% of GDP at the end of the forecast period (Figure 2.1).

Figure 2.1 - Core Crown tax revenue

Source: The Treasury

The main driver for the growth in tax revenue is forecast growth in nominal GDP (Figure 2.2). This graph also illustrates the timing lag between GDP growth and its impact on tax revenue. In addition, policy initiatives and other factors also influence tax revenue.

Figure 2.2 - Core Crown tax revenue and nominal GDP growth

Source: The Treasury

...with nominal GDP growth driving the bulk of the tax revenue growth

The stronger-than-expected tax revenue in the current year has been built in to these forecasts and is largely owing to growth in nominal GDP in the 2015/16 year with forecast nominal GDP growth of 3.5%, up from 2.8% in the 2014/15 fiscal year (Figure 2.2).

Nominal GDP and its components are the principal drivers of tax revenue growth through the forecast period, as shown in Table 2.2. Of the total $17.8 billion forecast increase in tax revenue, $14.4 billion is owing to macroeconomic factors, while $3.4 billion relates to other factors (discussed below).

However, growth in tax revenue owing to macroeconomic factors is not uniform across all years. Growth in tax revenues from corporate profits is forecast to be relatively subdued in 2015/16, owing to an expected decline in profits in the agriculture sector this year. Corporate profits and entrepreneurial income are expected to grow with contributions to corporate tax and other persons tax respectively, forecast to be larger in 2017/18 and 2018/19 than in the other years of the forecast period. Residential investment contribution to GST growth increases initially but then declines in 2019/20 (Table 2.2).

In contrast to these cyclical effects, growth arising from the two largest drivers of tax revenue, namely employees' compensation and nominal private consumption, is forecast to be comparatively steady throughout the forecast period. Employees' compensation is forecast to add $1.0 to $1.3 billion to source deductions (mainly PAYE) in each year of the forecast period and consumption adds $0.7 to $0.9 billion to GST each year.

Source: The Treasury

The other factors contributing the most to the forecast growth in tax revenue are:

• fiscal drag (ie, the effect of higher average tax rates applying to higher incomes), adding approximately $1.1 billion to PAYE and the growth of source deductions across the forecast period
• CPI indexation of excise rates adds $0.6 billion to customs and excise duties by 2019/20
• although they have a negative effect on tax growth in the early part of the forecast period, interest rates are forecast to rise from 2018, overall increasing the interest RWT forecast by $0.4 billion
• growth in the interest-bearing deposit base is forecast to add $0.2 billion to RWT in the 2015/16, and
• various policy initiatives are expected to affect tax revenue from 2017/18 contributing an additional $0.3 billion to tax revenue by 2020. The policy initiatives line includes initiatives announced in both the Half Year Update and the Budget Update. See Additional Information on the Treasury website for details of the Budget Update policy initiatives (www.treasury.govt.nz/budget/forecasts/befu2016).

Inland Revenue has also prepared a set of tax forecasts which, like the Treasury's tax forecasts, were based on the Treasury's macroeconomic forecasts. The two sets of forecasts differ because of the different modelling approaches and assumptions and judgements made by the two agencies. This comparison is included in the Additional Information on the Treasury website.

Tax Expenditure Statement

The Treasury prepares a Tax Expenditure Statement annually in conjunction with the Budget Update. The purpose of this statement is to provide additional transparency around policy-motivated “expenditures” made through the tax system. Tax expenditures impact on the Crown's operating balance by either reducing tax revenue (eg, through an exemption or a preferential tax rate) or by increasing expenditure (eg, Working for Families tax credits). Refer to the Treasury website for a copy of the 2016 Tax Expenditure Statement.

(www.treasury.govt.nz/budget/2016/taxexpenditure).

Core Crown Expenses#

Nominal core Crown expenditure increases...

Core Crown expenses are expected to grow by $12.5 billion over the forecast period from $72.4 billion in 2014/15 to $84.8 billion in 2019/20 (refer Figures 2.3 and 2.4). This nominal growth is largely attributable to Budget decisions and new spending set aside for future Budgets. Budget 2015 and Budget 2016 have added around $3.4 billion to expenses with $4.5 billion set aside for future Budgets. In addition, social assistance spending is forecast to increase by $4.1 billion, an average increase of $0.8 billion per year.

Figure 2.3 - Core Crown expenses

Source: The Treasury

Figure 2.4 - Increase in core Crown expenses relative to 2014/15 actuals

Source: The Treasury

...reflecting new budget spending...

The Budget 2016 operating allowance averages $1.6 billion in each year of the forecast (excluding 2015/16) before reducing to $1.5 billion in Budget 2017 and remaining at this level for the rest of the forecast period. While the Budget 2016 net allowance is $1.6 billion, this includes a mixture of revenue and expenditure initiatives. The impact of the Budget 2016 changes is an increase in core Crown expenses beyond 2015/16 around $1.9 billion per year (Figure 2.5). Refer page 35 for further details of the Budget 2016 package.

Figure 2.5 - Impact of Budget 2016 and future Budget operating allowances on core Crown expenses

Source: The Treasury

For forecasting purposes, Budget allowances are assumed to be all operating expenditure. However, these allowances can be used for a combination of revenue and expense initiatives when allocated. New operating spending will be allocated to department baselines when Budget decisions are made.

...and increasing social assistance...

In addition to new Budget spending, social assistance spending is expected toincrease by $4.1 billion across the forecast period. New Zealand superannuation (NZS) payments account for $3.3 billion of this increase (Figure 2.6). NZS recipient numbers are forecast to increase from 665,000 in 2014/15 to 794,000 by the end of the forecast horizon. This growth in the number of recipients accounts for around 60% of the increase in NZS costs, with the remaining increase largely owing to indexation of entitlements to wage growth (Figure 2.7). By the end of the forecast period, NZS is around 54% of total social assistance spending (compared to 49% for 2014/15).

Figure 2.6 - Social assistance spending

Source: The Treasury

Figure 2.7 - Growth of NZS expenses

Source: The Treasury

Other (non-NZS) welfare expenditure grows by $0.7 billion over the five-year forecast period with the largest growth relating to the income-related rents subsidy ($0.3 billion) driven by increases in tenancy places and market rents. While most welfare expenditure grows, expenditure on the Jobseeker Support and Emergency Benefit decreases by $0.1 billion across the forecast period, with expenditure on this benefit peaking in 2016/17.

...although as a percentage of nominal GDP, core Crown expenses reduce

Core Crown expenses peaked in 2011 and are continuing to decline as a share of GDP. Core Crown expenses are forecast to grow at a slower rate than the nominal economy, falling from 30.0% of GDP in 2014/15 to stand at 28.3% of GDP at the end of the forecast period (Figure 2.3).

2016 Budget new operating spending

The purpose of this box is to explain how the new operating spending allocated in Budget 2016 is incorporated in the fiscal forecasts. Details on individual initiatives can be found in the Summary of Initiatives in Budget 2016 document.

The 2016 net operating package totals $6.7 billion across the forecast period, an annual average of $1.6 billion (excluding spending in 2015/16). The package includes revenue initiatives that increase revenue by $1.2 billion and spending which increases expenditure by $7.9 billion (refer Table 2.3).

Source: The Treasury

Revenue policy initiatives include increases in tobacco excise and changes to the Emissions Trading Scheme (ETS) (removal of the “one for two” policy).

Core Crown expenses increase by around $1.9 billion a year (excluding 2015/16) from the Budget 2016 operating package compared to additional spending of around $1.4 billion per year in Budget 2015. Expenditure is spread across a number of functional areas as outlined in Table 2.4 below. The core Crown expense tables in Chapter 6 outline the total core Crown expenditure on each of these areas after these increases.

Source: The Treasury

Operating Balance#

Operating performance of the Crown strengthens…

OBEGAL is expected to be broadly in balance over the next couple of years. An OBEGAL surplus of $0.7 billion is expected in both 2015/16 and 2016/17. Surpluses are then forecast to grow, rising to $6.7 billion by 2019/20 largely owing to the growth in core Crown revenue exceeding growth in core Crown expenses.

Figure 2.8 shows the composition of OBEGAL from the different segments of the Government. The core Crown segment generally has the largest impact on OBEGAL and is forecast to have an OBEGAL surplus of $0.9 billion in 2015/16. There is a modest rise in the surplus to $1.2 billion in 2016/17 which is then forecast to double in 2017/18 and continue to rise over the remainder of the forecast period. These increases largely reflect growth in tax revenue outpacing growth in nominal spending.

Figure 2.8 - Components of OBEGAL by segment

Source: The Treasury

State-owned Enterprises' (SOEs) contribution to OBEGAL is fairly stable with operating surpluses forecast to increase slightly across the forecast period.

Crown entities' (CEs) contribution to OBEGAL is marginal with small deficits across the forecast period.

...with investment returns and changes in long-term liabilities contributing to the operating balance…

The total Crown operating balance, which includes gains and losses, is forecast to be a deficit of $2.6 billion in the current year, with surpluses forecast again from 2016/17 growing to $9.6 billion in 2019/20. Figure 2.9 shows the growth in the operating balance and its components over the forecast period.

Figure 2.9 - Components of operating balance

Source: The Treasury

ACC and NZS Fund hold the largest investment portfolios and market movements in these portfolios can have a significant impact on the operating balance. NZS Fund is expected to record net losses on its investments in the current year. In addition, gains and losses on long-term liability valuations for ACC and GSF will also impact on the Crown's operating balance. In 2015/16, net losses are forecast with actuarial losses of $3.1 billion and $0.9 billion respectively forecast for ACC's outstanding claims liability and GSF's defined benefit liability. These losses were mainly owing to the impact of changes in discount rate assumptions and claims experience.

Beyond 2015/16, investment gains assume a long-term rate of return, resulting in investment gains increasing to $2.6 billion in 2019/20. The level of investment gains plays a significant part in increasing the Government's financial assets and contributing to growth in the Crown's net worth. The Crown's significant long-term liabilities such as ACC and GSF use discount rates and CPI assumptions in their valuations. However, as future changes to discount rates and CPI are not forecast they do not impact on gains and losses beyond 2015/16.

Gains and losses can be volatile and are sensitive to balance sheet movements. Refer to the Total Crown Balance Sheet section later in this chapter for further discussion of these sensitivities.

…and an improvement in our internationally comparable fiscal indicators

In addition to OBEGAL and operating balance fiscal indicators, the Treasury also calculates the net operating balance using the Government Financial Statistics (GFS) framework developed by the IMF. This framework is specifically designed for government reporting and is particularly useful when making additional comparisons with other countries. The net operating balance represents revenue and expenses of the core Crown (excluding the Reserve Bank) and CEs. It also excludes a wider range of valuation movements than OBEGAL, such as impairments and write-offs. In general, the net operating balance is around $2.5 billion to $3.0 billion higher than OBEGAL across the forecast period.

Further information on GFS can be found in the Additional Information section of the Budget Update, which is available on the Treasury website (www.treasury.govt.nz/budget/forecasts/befu2016).

Structural balance indicators

The Treasury calculates a range of fiscal indicators to help assess the relationship between fiscal policy and the economy. Further detail on these indicators can be found in the Additional Information section of the Budget Update, which is available on the Treasury website (www.treasury.govt.nz/budget/forecasts/befu2016).

Source: The Treasury

Structural budget balance

The Treasury's headline structural fiscal balance indicator (the cyclically-adjusted balance (CAB)) is an estimate of OBEGAL adjusted for fluctuations of actual GDP around potential GDP. This means cyclical factors are removed so only the structural or underlying component remains. The economy is estimated to be operating just below its potential level in the current year, and this gap is forecast to close over time with only small differences between OBEGAL and CAB later in the forecast. This means that the forecast OBEGAL surpluses appear to be structural in nature rather than being caused by short-term cyclical factors.

Fiscal impulse

The fiscal impulse is an estimate of discretionary changes in the fiscal position, which can be expected to have an impact on aggregate demand in the economy. The average fiscal impulse across the forecast period is broadly neutral. Small positive fiscal impulses in 2015/16 and 2016/17 are caused by increases in the ratio of cash expenses to GDP in those years and by increases in capital spending. The negative fiscal impulses from 2017/18 to 2019/20 reflect reductions in operating spending (relative to GDP), and from 2017/18, a decline in capital spending.

Figure 2.10 - Structural balance indicators

Source: The Treasury

Capital Expenditure#

The Government is forecast to spend a net total of $23.1 billion of cash on capital items over the forecast period, which includes purchasing physical assets (eg, school buildings), advances (eg, student loans), providing capital to CEs (eg, New Zealand Transport Agency (NZTA)) and future new capital spending (Table 2.6).

In total, Budget 2016 has allocated around $2.6 billion in gross capital spending over the forecast period. Some of the capital spending announced in Budget 2016 ($0.4 billion) will not have a cash impact during the forecast period (eg, Public Private Partnerships; refer page 41), so are not captured in the $23.1 billion mentioned above. In addition, the gross spending announced in Budget 2016 has been partly offset by capital savings, resulting in a net impact of $1.4 billion (which is broadly consistent with the allowance set out in the 2016 Budget Policy Statement).

Source: The Treasury

Net capital spending is expected to increase significantly in 2016/17, with the largest capital spend in a number of years (Figure 2.11). The size of the forecast spend does increase the risk that some spending may be pushed into future periods as capacity constraints are tested.

Figure 2.11 - Net capital spending history (excluding NZS Fund contributions and the Government Share Offer)

Source: The Treasury

Some of the increase in 2016/17 has flowed through from delays in expenditure in 2015/16 and a large part of the increase is owing to a significant portion of the Budget 2016 spending expected to occur in 2016/17. Net capital spending then starts to decrease in 2017/18 before returning to a level consistent with previous levels.

Net capital spending consists of four main components (Table 2.6):

• Net purchases of physical assets represent forecast spending by core Crown agencies to maintain and expand their existing asset base and includes spending on defence equipment and school property and also includes capital spending related to the Canterbury rebuild.[10]
• Net investments largely represent capital injections to CEs, to maintain and expand their asset base, and are estimated to be between $1.2 billion and $2.1 billion a year. The largest capital injections across the forecast period are to NZTA for state highways (between $0.9 and $1.2 billion each year of the forecast). Capital injections to district helath boards (DHBs), Crown Fibre Holdings and Southern Response are also included.
• Net advances largely relate to the issuance and repayment of student loans. Student loan issuances peak at $1.8 billion in 2020 with repayments of $1.4 billion forecast in the same year.
• Net capital allowances of $0.9 billion are forecast for Budget 2017 and remain at $0.9 billion for subsequent Budgets. The allowances represent a net spend and may consist of a higher gross spend and capital savings when allocated. The new capital spending for each Budget is spread over four fiscal years reflecting the assumed profile of future spending. This profile is illustrated in Figure 2.12.

Figure 2.12 - Capital allowances (net)

Source: The Treasury

Public Private Partnerships

In addition to purchasing assets directly, the Crown is also expected to acquire assets over the forecast period by entering into Public Private Partnerships (PPPs). A PPP is typically an arrangement between the Crown and a private sector provider for the construction and financing of an asset and for the delivering of services associated with that asset. As the assets are progressively constructed, the Crown recognises a work-in-progress asset at cost. At the same time, borrowings of the same value are also recognised, reflecting the Crown’s obligation to pay for the assets in the future.

Over the next five years around $1.8 billion of assets are expected to be built through new PPP arrangements (eg, Transmission Gully, Auckland East prison and new schools) with a corresponding impact on borrowings. The timing of the repayment of the borrowings will be dependent on the length of the individual contracts, which will generally be long-term in nature (eg, 20 to 30 years) and beyond the forecast horizon.

With regards to the current PPPs, all, with the exception of Transmission Gully which is managed by NZTA, are included within the core Crown segment.

Impact on residual cash

Cash flows in relation to PPPs will commence on the completion of the asset. Residual cash captures the operating and capital activities of the core Crown. Core Crown cash payments in relation to ongoing interest costs and maintenance will impact on residual cash. As the repayments of the obligations from PPPs are not operating or capital but financing in nature they do not impact residual cash.

Impact on core Crown net debt

Obligations under a PPP arrangement increase borrowings and gross debt and, if the PPP is within the core Crown reporting segment, they will therefore impact on core Crown net debt. In general, during the construction phase of the asset, core Crown net debt will increase and then gradually decrease as the obligation is paid.

Impact on Budget 2016 capital allowance

Of the $1.8 billion of assets expected to be built through PPP arrangements, around $0.4 billion has been managed within the Budget 2016 capital allowance. The remaining $1.4 billion is managed outside budget allowances as the funding will be obtained from existing sources (eg, the National Land Transport Fund in the case of Transmission Gully).

Source: The Treasury

Residual Cash and Net Core Crown Debt#

[11]

Operating cash flows grow steadily...

Net operating cashflows are forecast to be in surplus across the forecast period. A surplus of $2.1 billion is forecast in the current year decreasing slightly in 2016/17 before increasing sharply to reach an operating cash surplus of $7.8 billion by 2019/20. Over the forecast period, the Government is expected to generate cash flows from core Crown operations of $20.7 billion.

The growth in operating cashflows largely mirrors the trend shown in core Crown OBEGAL. The strengthening of operating cashflows largely represents growth in tax receipts.

...outpacing capital spending near the end of the forecast period

The residual cash deficit is forecast to increase significantly in the 2016/17 year owing to increased capital spending forecast in 2016/17 exceeding the expected growth in operating surpluses. Net capital spending is forecast to exceed operating cash flows until 2018/19, when core Crown residual cash is expected to return to surplus (Figure 2.13).

Figure 2.13 - Core Crown residual cash

Source: The Treasury

Over the forecast period a cash shortfall of $2.5 billion is expected. This cash shortfall is funded largely through additional bond issuances (Table 2.8).

Net core Crown debt peaks as a share of GDP in 2016/17...

Net core Crown debt on a nominal basis increases for the first three years as a result of capital spending exceeding cashflows from operating activities (as discussed above) before starting to decline once residual cash returns to surplus in 2018/19, to stand at $62.3 billion at the end of the forecast period (Figure 2.14).

Figure 2.14 - Net core Crown debt

Source: The Treasury

Net core Crown debt as a share of nominal GDP is forecast to peak at 25.6% in 2016/17 before reducing to 20.8% by 2019/20 and continuing to decline thereafter.

...and gross debt begins to decline after 2016/17

Gross debt is expected to peak at $93.9 billion in 2016/17. From 2017/18 forecast maturities are expected to exceed new debt being issued, and gross debt begins to decline. Gross debt is forecast to be $83.6 billion in 2019/20 which is equivalent to 27.9% of nominal GDP (Figure 2.15).

Figure 2.15 - Gross debt (Gross Sovereign Issued Debt (GSID) excl Reserve Bank settlement cash and bank bills)

Source: The Treasury

The bond programme is expected to raise funds of $36.6 billion over the forecast period, while $33.0 billion of existing debt will be repaid, providing net cash proceeds of $3.6 billion (Table 2.8). Any excess cash proceeds raised from the bond programme are expected to be invested in financial assets and used to meet future debt maturities.

The issuance profile is relatively flat in order to reduce year-to-year volatility of bond programmes and ensure consistency of supply over this time.

Source: The Treasury

NZS Fund contributions

No contributions to the NZS Fund are assumed in the forecast in line with the Government’s stated intentions to commence contributions once net core Crown debt falls below 20.0% of GDP as set out in the 2016 Fiscal Strategy Report (FSR). The table below provides a calculation of the annual contribution that would have been included in the forecasts if they were to resume in 2016/17.

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) NZS expenses and the government five-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 website for the NZS Fund model.

Total Crown Balance Sheet#

Increasing operating balance surpluses results in a stronger balance sheet...

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 2016, net worth attributable to the Crown is expected to grow by $25.4 billion to stand at $108.9 billion by 2019/20. As a share of nominal GDP, net worth is relatively stable at around 33.4% until 2017/18, when it starts to increase to reach 36.4% by 2019/20 (Figure 2.16).

Figure 2.16 - Net worth attributable to the Crown

Source: The Treasury

...with assets expected to grow while liabilities remain fairly constant across the forecast

Total assets are forecast to grow by $32.0 billion over the forecast period to $310.7 billion in 2019/20 (Figure 2.17), made up of additional investments in assets (both physical and financial) of $70.2 billion, partially offset by reductions (largely depreciation) of $38.2 billion. At the same time, the Crown's liabilities increase $9.4 billion to stand at $195.8 billion in 2019/20.

Figure 2.17 - Total Crown assets

Source: The Treasury

The largest asset growth over the forecast period is in the social assets portfolio (around 50% of the total Crown balance sheet). Social assets (eg, schools, hospitals and social housing) are expected to increase by $16.6 billion over the forecast period to be $155.8 billion in 2019/20 (Figure 2.18). This increase reflects growing capital spending, particularly over the next two years. Liabilities in relation to the social sector (eg, tax refunds, ETS provision and payables and provisions in relation to social assets noted above) remain static across the forecast period. As a result social net worth is expected to increase.

Figure 2.18 - Social balance sheet

Source: The Treasury

The financial asset portfolio (around 30% of the total Crown balance sheet) is expected to increase by $7.8 billion to be $94.8 billion in 2019/20, reflecting investment growth in the large investment portfolios (NZS Fund and ACC).

On the liability side, borrowings that are mostly undertaken by the Treasury's New Zealand Debt Management Office (NZDMO) (which manages the Crown's bond programme and funds forecast cash shortfalls), and the Reserve Bank. Borrowings in the financial sector are forecast to decrease by $3.1 billion by 2019/20. Insurance liabilities are expected to increase by $2.9 billion in the current year largely owing to increases in the ACC outstanding claims liability arising from updated actuarial valuations. Beyond 2015/16, ACC's insurance liability will continue to increase to stand at $42.1 billion in 2019/20. The GSF liability is forecast to be $11.3 billion in 2015/16 falling to $9.3 billion by 2019/20. Overall, net worth in the financial sector remains relatively static over the forecast period (Figure 2.19).

Figure 2.19 - Financial balance sheet

Source: The Treasury

The commercial asset portfolio (around 20% of the Crown's balance sheet) is expected to increase by $7.6 billion over the forecast period to be $60.1 billion in 2019/20, with growth coming from SOEs' investment in physical assets and growth in Kiwibank[12] mortgages. Commercial liabilities are expected to increase by $7.7 billion over the forecast period to stand at $39.8 billion in 2019/20, largely owing to growth in Kiwibank consistent with growth in its loan book. Commercial net worth remains static over the forecast period (Figure 2.20).

Figure 2.20 - Commercial balance sheet

Source: The Treasury

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 show current estimates of what the Crown owns and owes. While the measurement at fair value is intended to reflect the 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.

Refer to the Risks and Scenarios chapter page 65 for more details.

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

Apart from market factors, valuations are subject to a number of judgements and estimates with valuations based on underlying assumptions made at the time the valuations were prepared. In general, as time goes on, better information becomes available and initial estimates are updated to reflect current information. Some examples of this are noted below:

• 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.
• GSF’s assets are offset against the gross liability and have been updated to reflect market values. GSF’s liability is valued by projecting future cash payments, and discounting them to the present. The value of assets over the forecast period reflects long-run rate of return assumptions appropriate to the forecast portfolio mix.
• The ACC liability has been adjusted for the 31 March 2016 discount rate. This liability is valued by projecting future cash payments, and discounting them to the present. These valuations rely on historical data to predict future trends and use 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.

...while other risks 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 82 for a list of the contingent liabilities at 31 March 2016.

Comparison with the Half Year Update#

The Half Year Update was published on 15 December 2015. Since then, there have been a number of developments that have significantly impacted the fiscal outlook. Table 2.10 below summarises the changes in the key fiscal indicators since then.

Source: The Treasury

A stronger economy has improved the fiscal outlook...

Stronger economic growth since the Half Year Update has improved the fiscal outlook, with tax revenue now expected to be higher in each year of the forecast period.

Core Crown tax revenue forecasts have been revised up by a combined $3.6 billion across the forecast period, mainly owing to the cumulative $17 billion increase in the forecasts (from 2015/16 to 2019/20) for nominal GDP. Forecasts for most of the major tax types have been increased as a result of this stronger nominal GDP outlook with the exception of RWT which is lower than in the Half Year Update owing to lower interest rates (Figure 2.21). Table 2.11 below summarises the movements by tax type since the Half Year Update.

Figure 2.21 - Movement in core Crown tax revenue since the Half Year Update

Source: The Treasury

Source: The Treasury

Corporate tax forecasts are $1.9 billion higher than in the Half Year Update. Company income tax receipts were substantially above the Half Year Update forecast as at the end of March 2016, whereas company income tax revenue was only slightly above forecast. This higher forecast tax base in 2015/16, together with a profit growth profile across the forecast period similar to that of the Half Year Update, has also increased the corporate tax forecast in 2016/17 and later years.

This Budget Update forecast contains an assumption that corporate tax revenue will largely “catch up” to receipts over the remainder of the current fiscal year, resulting in a $0.7 billion increase in the corporate tax revenue forecast in 2015/16.

The forecasts for entrepreneurial income, excluding the agriculture sector, are higher than in the Half Year Update which has resulted in a $1.2 billion increase in the other persons' tax forecast.

The GST forecast is $1.0 billion higher in total than in the Half Year Update owing to stronger forecasts of nominal consumption.

A higher forecast for employment growth has pushed the source deductions forecast higher than in the Half Year Update through 2015/16 to 2017/18. However, the weaker wage growth forecast, in response to the lower inflation forecast, has decreased the source deductions forecast. Towards the end of the forecast period, the wage growth effect dominates the employment growth effect such that, by 2020, the source deductions forecast is around $0.2 billion lower than in the Half Year Update.

In contrast to the above tax types, interest rate forecasts are lower than in the Half Year Update, which is the main contributor to the $1.5 billion reduction in interest RWT forecasts across the forecast period.

...with the fiscal outlook now stronger than previously forecast...

Overall, OBEGAL is expected to be higher in each year of the forecast compared to the Half Year Update (Table 2.12).

Source: The Treasury

Overall, social assistance spending is lower across all years of the forecast compared to the Half Year Update. Revisions to the CPI inflation forecasts have reduced forecast social assistance spending (excluding NZS) and higher total employee wages have resulted in amounts claimed by beneficiaries reducing. Improvements in the labour market have also resulted in fewer benefit recipients. In addition, forecasts for Working for Families have been reduced owing to these benefits having consistently been lower than forecast over the past few years and the assumption this trend will continue. Together, these factors have reduced spending by around $0.1 to $0.6 billion each year of the forecast.

Updated ACC forecasts have resulted in a decrease in OBEGAL in each year of the forecast and are largely owing to changes in valuation assumptions. Inflation rate assumptions have resulted in an increase in the ACC claims liability and higher insurance expenses across all years compared to that previously forecast.

Budget 2016 decisions impacting both revenue and expenditure (eg, business tax package, tobacco excise and ETS policy changes and budget package phasing adjustments) have collectively resulted in reductions to OBEGAL earlier in the forecast which then have positive impacts in the last two years of the forecast.

Budget allowances have been re-phased with the Budget 2016 allowance increasing to $1.6 billion (previously $1.0 billion) per year and the Budget 2017 allowance now $1.5 billion (previously $2.5 billion) per year. These changes in allowances have had a net positive impact on OBEGAL from 2017/18 onwards (Table 2.13).

Net finance costs are affected by the following factors:

• Interest revenue has reduced in 2015/16 as a result of changes in the portfolio mix of financial instruments. A higher level of derivative instruments (earnings reported in gains and losses), rather than interest bearing instruments is now being held during 2015/16.
• Decreases in short-term interest rates have resulted in a reduction in interest income particularly in the current year. Beyond the current year, the impact is lower owing to greater holdings of financial assets.
• The stronger residual cash forecast has led to a decrease in the Government's borrowing requirements resulting in decreased debt servicing costs.
• Lower medium-term interest rates have resulted in a reduction in finance costs and offset some of the unfavourable impacts beyond 2015/16.

The forecast impairment of Inland Revenue Department's (IRD's) debt portfolio is lower across the forecast owing to a review of IRD's debt portfolio for the most recent information leading to an update of its debt impairment assumptions.

...leading to a decrease in net core Crown debt by the end of the forecast period

Core Crown residual cash increases by $8.0 billion across the forecast period compared to the Half Year Update. The majority of the stronger cash position is a result of increased tax receipts ($4.0 billion), lower benefit payments ($1.8 billion) and lower net finance costs ($0.8 billion) over the forecast horizon. In addition, net capital spending is now expected to be lower by around $1.6 billion.

Overall, the impact from Budget 2016 capital decisions has had a positive impact on residual cash of around $0.4 billion across the forecast period since the Half Year Update. Gross capital spending announced in Budget 2016 was around $2.6 billion (net $1.4 billion). However, the impact on residual cash is somewhat lower as some spending has no cash impact during the forecast period (such as school PPPs of around $0.4 billion).

The reduction in cash deficits across the forecast period has resulted in net core Crown debt forecast to be $8.8 billion lower by 2019/20 when compared to the Half Year Update.

Key Economic Assumptions#

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, and
• 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

Risks and Scenarios#

Overview#

• This chapter outlines the chief economic and fiscal risks associated with the main forecast. The first part of the chapter outlines the key risks to the economic outlook. The second part of the chapter presents two alternative scenarios for the economy, and the remainder focuses on general fiscal risks. Overall, risks are skewed to the downside, as negative risks to the global economy outweigh domestic risks which are more balanced.
• Internationally, the risks with the largest potential impact on the New Zealand economy relate to the demand and price for exports and low global inflation. These risks include a sharp slowing of growth in China and its impact on other economies, particularly in the Asia-Pacific region. In advanced economies, such as the US, further moderation of growth and persistently low inflation carry substantial risk to the outlook. Overall, slower growth increases the vulnerability of the global economy to negative shocks as it reduces the scope for monetary and fiscal policy to respond. In addition, the international economy faces other risks, including the UK’s European Union membership referendum and geopolitical tensions in the Middle East.
• Domestically, the risks with the largest potential impact on the New Zealand economy relate to downside risks around inflation dynamics in the face of the low global inflation environment and the recent decline in inflation expectations, and upside risks around a higher peak and/or prolonged migration cycle and stronger house price growth.
• Two scenarios are presented that show ways in which the New Zealand economy could deviate from the main forecast. Scenario One is based on a weaker world economy in which trading partner growth slows sharply, global inflation is weaker, services exports fall and the terms of trade take longer to recover. In this scenario, nominal GDP, tax revenue and OBEGAL are lower. Scenario Two is based on sustained momentum in the domestic economy with stronger net migration into New Zealand, faster house price growth, higher private consumption, higher employment growth and stronger inflation. This scenario lifts nominal GDP, tax revenue and OBEGAL over the forecast period.
• In addition to the risks associated with the economy, the Crown is also subject to expenditure and balance sheet risks. In particular, volatility in financial asset prices and interest rates can have a significant impact on the Crown's fiscal position.

Economic Risks#

The key judgements underpinning the economic forecasts are subject to risks (see Key economic forecast assumptions box in the Economic Outlook chapter).

Global uncertainty has increased since the 2015 Half Year Update, reflected in heightened financial market volatility in the first months of 2016, and risks to growth in both emerging market and advanced economies remain skewed to the downside. Growth is expected to slow in China, other Asian economies, the US and the euro area.

There is risk of a sharper-than-expected slowdown in China, further impairing growth in other economies, particularly in the Asia-Pacific region, with a risk that growth in Australia remains below trend for longer. While recovery in most advanced economies, such as the US and euro area, is expected to continue, albeit at a slower pace, there are risks that global growth moderates further and slower growth becomes entrenched with a more prolonged period of low inflation and interest rates.

The realisation of any of these downside risks to the world economy would weigh on economic growth in New Zealand, materialising as lower demand and prices for New Zealand's exports as well as adversely affecting confidence. Economic stability, as well as financial market stability, faces risks from multiple sources, including the possibility of a British exit from the European Union, geopolitical tensions in the Middle East and elsewhere, terrorist attacks in Europe and uncertainty regarding the impact and efficacy of highly accommodative monetary policy, particularly in the euro area and Japan.

Risks to the domestic outlook are more balanced. Risks around high net migration, tighter labour market conditions, faster growth in house prices and ongoing resilience in consumption are balanced by uncertainty around inflation dynamics, and the continuation of rapid tourism growth which has provided significant offset to weakness in goods exports, particularly dairy.

Sharper slowdown in China a key risk to the outlook…

Annual GDP growth in China has fallen from over 10% in 2010 to 6.7% in the March 2016 quarter as the composition of growth shifts from investment towards consumption. Heightened concerns about growth in China contributed significantly to elevated global financial market volatility in early 2016. In addition, falls in the Chinese stock market and the depreciation of the Renminbi in mid-2015 and early 2016 increased concerns that the Chinese economy is weaker and more fragile than headline GDP indicates.

While global financial markets have calmed recently, risks remain skewed towards a sharper slowdown in China, which carries with it the flow-on impact of slower growth in other trading-partner economies, particularly in the Asia-Pacific region. A slowdown in China may be exaggerated if authorities do not support activity in order to avoid creating further imbalances, especially if the key risks of high levels of local government debt and a sharp downturn in the housing market increase.

Slower growth and heightened uncertainty about the outlook have been reflected in lower commodity prices, international trade flows, confidence and financial market volatility. A sharper slowdown would be expected to be transmitted as a more severe deterioration through these channels.

Over the medium term, risks around slower growth in China relate to how the transition from investment-led to consumption-led growth continues to evolve. The direct effect on New Zealand of a slowdown in China may be offset to some extent by the rebalancing towards consumption as the main driver of growth, as a successful transition could be positive for New Zealand by increasing Chinese demand for our mostly consumer-orientated primary products. That said, a sharp slowdown in China’s investment-led growth would weaken demand for hard commodities from Australia, lowering demand for their exports and in turn their income, directly affecting New Zealand.

…as well as further moderation of growth in advanced economies…

The outlook is for moderate growth in advanced economies. In addition to the flow-on impacts of slowing growth in China to other trading partners, risks to the Australian economy centre on a more gradual-than-expected transition in investment from mining to non-mining sectors, resulting in a longer period of below-trend growth. There is also some uncertainty about Australia's trend growth rate with slower population and productivity growth.

While the US recovery remains underway, the outlook is for more moderate growth in both 2016 and 2017, and consequently a more gradual tightening path for monetary policy. There remains some uncertainty around the possible unintended destabilisation of emerging market economies from tighter US monetary policy, but this has abated somewhat following the signalling of more gradual interest rate increases.

Likewise, the growth outlook for Japan and the euro area is for ongoing low and moderate growth respectively, with both economies facing policy challenges to stimulate demand.

…and with global inflation low…

Falls in oil and other commodity prices, as well as weak economic growth, have kept inflation low in most economies. Inflation excluding food and energy (ie, direct commodity price effects) remains below target in the major advanced economies, including the US. As interest rates in advanced economiesare close to zero (or below), in the event of further weakness in growth there is limited or no scope for further conventional monetary stimulus to provide a boost to demand.

Both the Bank of Japan and the European Central Bank have adopted quantitative easing and negative interest rate strategies in order to combat low inflation. However, there is much debate over the efficacy of negative interest rates as they are relatively untested and can lead to financial sector distortions.

…there is a higher risk that slower global growth becomes entrenched…

An outlook for slower growth leaves the global economy more exposed to negative shocks as it reduces the scope for fiscal and monetary stimulus (owing to a weaker fiscal position and/or lower policy rates than otherwise), and raises the risk that slow growth over the medium term becomes self-reinforcing. The combination of low inflation, low interest rates and slow growth over a prolonged period is sometimes referred to as “secular stagnation”.[13]

…and translates to weaker demand for key exports

The outlook for key exports, such as dairy and tourism, continues to be marked by uncertainty. Within the dairy sector prices are at low levels and are expected to recover only gradually. However, there is uncertainty about how international production will respond to lower prices, as there has been an increase in European production following the removal of the EU quotas, possibly owing to EU intervention prices distorting price signals. Global dairy production growth has been further supported by lower input costs from low oil and stockfeed prices and the strength of the US domestic dairy market. There is also uncertainty around the outlook for demand, particularly from China, and the removal of Russian import bans.

Visitor arrivals from China have been at all-time highs, supported by the depreciation of the New Zealand dollar in the middle of 2015 and the gradual loosening of travel restrictions in China, leading to robust growth in travel services exports. Similarly, arrivals on student visas from Asian countries are at high levels, although they have moderated slightly in recent months. A shift in travel preferences, significantly slower income growth and/or heightened uncertainty abroad pose risks to the outlook for both tourism and education services exports.

Weak inflation also a risk to the domestic economy…

The low inflation environment that characterises many advanced economies also characterises New Zealand. If weakness in global inflation continues, tradables inflation in New Zealand is likely to remain low. While the exchange rate depreciation in the middle of 2015 has provided a boost to tradables inflation, its impact is transitory. Over the medium term, tradables inflation is forecast to pick up to around 1% on average. However, this is heavily dependent on international developments as low global inflation will keep tradables inflation muted, all else equal.

In recent times, non-tradables inflation has been weaker than the long-term relationship with the output gap would suggest. In addition, inflation expectations are lower than previously, with persistent weak inflation weighing on expectations, offsetting the impact of a narrowing output gap to non-tradables inflation (see the box on Inflation in the Economic Outlook chapter).

While interest rate settings are considered stimulatory, it is not clear how far below neutral rates are. This is further compounded by possible changes in the sensitivity of businesses and consumers to low interest rates owing to heightened uncertainty in the current environment.If businesses and consumers are less sensitive to monetary policy than in the past, the boost to investment and consumption growth from low interest rates would be smaller than in the main forecast. In addition, heightened global financial market volatility, which characterised the early part of 2016, has increased funding costs for New Zealand banks accessing funds offshore. If global financial market volatility were to persist at high levels it would limit the pass-through of easier monetary policy settings, all else equal.

…and risk remains around the extent of the current migration cycle...

Annual net migration gains are assumed to begin declining from a forecast peak of 70,700 in June 2016 as labour market conditions in Australia improve and the New Zealand unemployment rate rises. However, it is difficult to gauge the strength and timing of these effects. If, for example, the Australian labour market materially improves in the near term, net migration inflows could decline more sharply than in the main forecast. On the other hand, the large inflow of students to date may suggest structurally higher permanent migration gains should more of those students remain in New Zealand.

...and the impact of net migration on housing and consumption

Housing demand is expected to be supported by high net migration and low mortgage rates in the year ahead. However, there is a risk housing demand and house price growth are stronger than in the main forecast, particularly given the risks around higher migration inflows. Faster nationwide house price growth than in the main forecast would boost household wealth and consumer confidence, possibly leading to higher consumption. Likewise, stronger housing demand could lead to stronger-than-expected residential investment growth. On the supply side, faster release of land for residential building in Auckland would lead to stronger housing construction than forecast. In addition, if the mobility of construction workers between Canterbury and other regions is greater than assumed, industry capacity pressures would be reduced and construction costs would be lower, supporting residential investment.

While faster house price growth presents a positive risk for economic activity, a sharp fall in Auckland house prices from an elevated level presents a downside risk to household wealth and therefore consumption, although this is unlikely without a major external trigger given the presence of strong economic fundamentals supporting demand. In addition, potentially higher household debt relative to disposable income presents a risk to financial stability as households will be more vulnerable to interest rate increases.

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). They illustrate two of the many ways that the economy may deviate from the main forecast. Scenario One illustrates the economic impacts of significantly weaker trading partner growth, in China in particular, with a sharp turnaround in services exports, a slower recovery in the terms of trade, lower inflation and elevated global uncertainty. Scenario Two shows the economic impact if recent momentum is sustained. In particular, stronger net migration and house price growth support consumption and residential investment growth with stronger inflation and employment growth.

Note:

1. June quarter, seasonally adjusted.

Sources: Statistics New Zealand, the Treasury

Scenario One - A Sharp Slowdown in Trading Partner Growth

A sharp slowdown in China leads to a fall in trading partner growth…

In the first scenario, trading partner growth deteriorates sharply in the near term as downside risks to the outlook eventuate. Specifically, growth in China slows sharply as consumption growth fails to offset the ongoing slowing of investment growth and as financial market volatility lowers consumer confidence. Fiscal and monetary policy are constrained by financial market stability concerns. The flow-on impact via trade and confidence slows growth in other key trading-partner economies in the Asia-Pacific region, including Australia, amplifying the severity of the reduction in China's growth. Growth moderates in other advanced economies, including the US, which are affected by the deterioration in global sentiment, albeit to a lesser extent than the economies that are more directly dependent on China.

Figure 3.1 - Trading partner growth

Sources: IMF, the Treasury

...and lower services exports...

Slower income growth abroad is compounded by heightened uncertainty about the future, leading to a significant reduction in tourist arrivals, particularly from China and the rest of Asia. This comes both from tourists adopting a wait-and-see approach to their travel plans, and from lower student numbers as a result of uncertain employment prospects at home. Accordingly, services export volumes unwind much of their 2015 gains, leading to lower employment in the services sector, lower domestic incomes and lower private consumption.

Figure 3.2 - Services export volumes

Sources: Statistics New Zealand, the Treasury

…lower terms of trade and inflation…

The terms of trade pick up at a slower pace as the recovery in export prices is dampened by weaker global demand and inflation. Import prices decline on weaker global demand which provides some offset to the weaker export prices. The resulting slower recovery in the terms of trade reduces income growth, leading to slower growth in both private consumption and market investment.

The New Zealand dollar depreciates sharply in this scenario. The TWI-17 is around 14% lower than in the main forecast by June 2020 on the back of the heightened risk environment, lower terms of trade and widening current account deficit, which is 1.4 percentage points lower than in the main forecast by June 2020 at 6.2% of GDP.

The Reserve Bank responds to weaker demand by easing monetary policy further with the 90-day rate reaching 1.5% by 2017 (compared to 2.2% in our main forecast). However, in the near term heightened uncertainty around global growth, particularly in China, leads to increased financial market volatility and demand for safe-haven assets. Similar to the experience of early 2016, this could raise bank funding costs and risk premiums in the short term, limiting how much Reserve Bank interest rate cuts are passed on by banks and delaying the impact of easier monetary policy on domestic demand.

In the near term, tradables inflation is boosted by the lower New Zealand dollar. Until mid-2017 weaker non-tradables inflation broadly offsets stronger tradables inflation and headline inflation is similar to the main forecast. From the latter half of 2017, weaker non-tradables inflation persists, while the boost to tradables inflation from the New Zealand dollar depreciation dissipates, resulting in softer headline inflation over the remaining forecast period (Figure 3.3). Inflation does not return to 2.0% until 2020, when non-tradables inflation picks up as the output gap closes.

Figure 3.3 - Consumers price index

Sources: Statistics New Zealand , the Treasury

…and softer real and nominal GDP

Over the forecast period, weaker exports and domestic demand drive both lower real GDP and nominal GDP. Over the course of the forecast period, nominal GDP is a cumulative $25.8 billion lower than in the main forecast.

Core Crown tax revenue is a cumulative $7.1 billion lower over the forecast period in this scenario. Lower nominal consumption and residential investment reduce GST revenue by a cumulative $0.7 billion over the forecast period and lower interest rates reduce RWT by a cumulative $1.0 billion. A lower value of output in the economy reduces business profits, resulting in corporate taxes being a cumulative $2.7 billion lower. The weaker labour market and lower labour incomes reduce source deductions revenue by $1.8 billion over the forecast period.

Figure 3.4 - Nominal GDP growth

Sources: Statistics New Zealand, the Treasury

Core Crown expenses are a cumulative $1.1 billion higher than in the main forecast, owing to increased debt financing costs and welfare expenses. Discretionary fiscal policy is assumed to remain unchanged from the main forecast. In this scenario, OBEGAL reaches a small deficit of 0.2% of GDP in the June 2017 year, with growing surpluses thereafter (Figure 3.8). As a consequence, net core Crown debt peaks at 26.8% of nominal GDP in the June 2018 year, rather than peaking at 25.6% in the June 2017 year, as in the main forecast (Figure 3.9).

Scenario Two - Sustained Momentum in the Domestic Economy

Solid activity persists

In the second scenario, solid growth which characterised the latter half of 2015 continues in the near term. This is reflected widely across the economy, as the net migration cycle comes off its peak a little slower than in the main forecast (Figure 3.5), solid house price growth persists and employment growth is higher. Inflation is stronger in the near term reflecting a stronger-than-expected outturn in the 2016 March quarter and additional pass-through from the exchange rate depreciation in the middle of 2015 to tradables. In addition, non-tradables inflation picks up faster than expected on the back of higher incomes and stronger demand.

Figure 3.5 - Net permanent and long-term migration

Sources: Statistics New Zealand, the Treasury

Stronger net migration and house price growth support consumption and residential investment…

Higher net migration leads to increased demand for housing, which flows through to faster house price growth and higher residential investment. The combination of stronger net migration and house price growth leads to faster private consumption growth which is marginally higher over the forecast horizon (Figure 3.6). However, household debt relative to disposable income is higher, reflecting higher consumer confidence.

Figure 3.6 - Real private consumption growth

Sources: Statistics New Zealand, the Treasury

…leading to higher inflationary pressures and interest rates

Stronger near-term inflation outturns in combination with solid domestic demand result in inflation returning to 2% slightly earlier than in the main forecast (Figure 3.3). The Reserve Bank responds to stronger demand by increasing the OCR earlier than in the main forecast, resulting in slightly higher 90-day interest rates from September 2017 (Figure 3.7). The impact of higher household debt relative to disposable income and higher interest rates on real consumption growth is uncertain. However, given household debt and interest rates are only marginally higher than in the main forecasts, any impact is likely to be minor.

Figure 3.7 - 90-day interest rates

Sources: Reserve Bank, the Treasury

…and higher nominal GDP…

Sustained momentum in the near term and higher inflation, combined with higher residential investment and consumption, result in nominal GDP being a cumulative $15.8 billion larger than in the main forecast by the end of June 2020.

…increasing tax revenue and the operating balance

Core Crown tax revenue is a cumulative $5.0 billion higher than in the main forecast over the period to June 2020. Increased nominal consumption and residential investment boost GST revenue by a cumulative $1.1 billion over the forecast period. Greater business profitability results in corporate taxes being a cumulative $1.3 billion higher. The stronger labour market and higher wage growth lift source deductions revenue by $1.5 billion over the forecast period. An earlier increase in short-term interest rates flows through to a cumulative $0.4 billion rise in RWT.

Figure 3.8 - Total Crown OBEGAL

Source: The Treasury

Core Crown expenses are marginally lower than in the main forecast owing largely to lower debt financing costs. OBEGAL surpluses are larger over the entire forecast period reaching a surplus of 2.8% of GDP by the June 2020 year, compared to 2.2% in the main forecasts (Figure 3.8). Net core Crown debt peaks at a lower level of 25.1% of GDP in the June 2017 year, and it subsequently declines faster to 18.8% of GDP in the June 2020 year, compared to 20.8% in the main forecast (Figure 3.9).

Figure 3.9 - Net core Crown debt

Source: The Treasury

General Fiscal Risks#

The remainder of this chapter focuses on the links between the economic risks and the Crown's fiscal position. For more on fiscal risks, see the Specific Fiscal Risks chapter.

Revenue Risks

One of the major sources of risk to the fiscal position arises from the inherent uncertainty about future tax revenue, which accounts for around 70% of the Crown's revenue. As indicated by the scenarios set out in this chapter, the amount of tax revenue that the Crown receives in a given year is closely linked to the performance of the economy.

Figure 3.10 plots the main annual tax revenue forecast, along with confidence intervals around these forecasts based on the Treasury's historical tax forecast variances and the assumption of an even balance of risks around the main forecast.[14] The outermost shaded area captures the range ±$7.1 billion in the June 2020 year, within which actual tax outturns are expected to fall 80% of the time.[15]

Figure 3.10 - Core Crown tax revenue uncertainty

Source: The Treasury

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, Crown revenue would be different from forecast, with Scenarios One and Two being examples of possible outcomes.

Based on average historical forecast variances, Figure 3.10 suggests that an annual tax revenue outturn associated with Scenario One lies between the 25th and 50th percentiles. An annual tax revenue outturn associated with Scenario Two lies between the 50th and 75th percentiles in each year. On this basis, actual tax outcomes would be expected to fall within the range of the two alternative scenarios approximately half of the time, with greater or lesser outcomes also expected approximately half of the time.

There are also risks around other sources of revenue including sales of goods and services, investment income, and fees and levies. This additional revenue is also subject to changes in economic conditions, such as changes in interest rates which impact investment income and changes in oil prices which impact the amount of petroleum royalties the Crown receives.

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 higher than forecast in each year up to June 2020, tax revenue would be around $4.4 billion higher than forecast in the June 2020 year as a result. The sensitivities are broadly symmetric and if nominal GDP growth is one percentage point lower than expected each year, tax revenue would be around $4.2 billion lower than forecast in the June 2020 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 NZDMO being $110 million lower in the June 2020 year. This would be more than offset by interest expenses $340 million lower in the June 2020 year.

Note:

1. Funds managed by the Treasury's NZDMO only.

Source: TheTreasury

Expenditure Risks

One-off and unexpected expenditure shocks can also have a large impact on the Crown's operating balance in the year that they occur. Over-forecasting of expenditure leads to policy being tighter than otherwise, and uncertainty is 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 relates largely 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.

In recent years, the Canterbury earthquakes have demonstrated the inherent exposure of the Crown's fiscal position to unexpected events. The Crown's fiscal position would be affected if another catastrophic earthquake were to occur or if the costs associated with prior events exceed the updated estimates.

The ageing population implies increased public expenditure, especially for health and superannuation spending. If this cannot be accommodated within operating allowances, it presents risks to the medium-term fiscal position, particularly given uncertainty around demographic forecasts. Likewise, uncertainty around population growth presents a risk of increased demand for public services which may result in increased expenditure, including education and health spending.

Balance Sheet Risks

In addition to risks around revenue and expenditure, which affect the balance sheet through their impact on the operating balance, the Crown's financial position is also exposed to risk through change in the value of the Crown's assets or liabilities. The balance sheet can also be affected owing to the Crown having both explicit and implicit obligations (a strong expectation that the Crown would respond to an event) as a result of policy settings.

A large source of balance sheet risk can be attributed to changes in the value of the Crown's assets and liabilities owing to movements in market variables such as interest rates, exchange rates and equity prices. These changes can also have an impact on the Crown's operating balance. Of the Crown's aggregate financial risk, a significant proportion can be attributed to market risk. Three areas of the balance sheet are particularly susceptible to various types of market risk:

• Financial assets held by the Crown Financial Institutions (CFIs) are sensitive to financial-market volatility. CFIs tend to diversify their portfolios across a range of financial assets to manage exposures to specific market risks.
• 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.
• 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.

Other large sources of balance sheet risk are contingent and implicit liabilities relating to natural disasters and financial system stress. The Specific Fiscal Risks chapter discusses contingent assets and liabilities in greater detail.

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.

While the Crown's exposure to risks is sometimes unavoidable, the Crown's general approach is to identify, measure and treat 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 financial resources could be needed, or increase sustainability through achieving higher levels of net worth. This helps to absorb the impact of the risk through the balance sheet so that the wider economy need not adjust immediately at a greater economic cost.

The New Zealand government remains amongst the highest-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 from all three agencies.

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 face increased funding pressure in the future. All else being equal, deterioration in the ratings outlook could raise debt-servicing costs and lessen the funding capability for the Crown. 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 and managed by each agency to meet its specific liquidity risk requirements and by the Treasury's NZDMO to manage the Crown's liquidity requirements.

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 2013/14 financial year.[16] 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.

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 significant risk is identified. Disclosure of known risks is also subject to specific requirements and materiality thresholds.

Overview#

Specific fiscal risks can be positive or negative and can affect revenue or spending or assets and liabilities. 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.

Established practice is that the Government 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 operating expenses or capital expenditure to be met through reprioritisation or from within existing allowances 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 the allowance in the fiscal forecasts for forecast new operating expenditure, or
• for capital, the existing Crown balance sheet or the allowance in the fiscal forecasts, for forecast new capital spending.

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 the Budget operating allowance): Costs of policy proposals could increase or decrease expenses depending on decisions taken, and they are risks to the fiscal forecasts only to the extent that they cannot be managed within existing baselines or Budget allowances.
• Potential capital decisions (expected to be funded from the existing Crown balance sheet, or the Budget capital allowance): Capital investment decisions are risks to the fiscal forecasts only to the extent that they cannot be managed within the existing Crown balance sheet, or the Budget 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 exist but are not separately disclosed as specific fiscal risks:

• Risks from changes to economic assumptions; the most significant economic risks have been identified in Chapter 3.
• Business risks and volatility in the returns from and valuation of 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, biosecurity incursions, 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.

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.

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[17] 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[18] (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[19] to be approved or occur within the forecasting period.

Additionally, the Minister of Finance may determine, under section 26V of the Public Finance Act 1989, 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.

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 before 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 - ACC Levies (Unchanged)

Indicative future levy rates for the Work, Earners' and Motor Vehicle accounts are based on the funding policy agreed by Cabinet. The indicative levy path based on the policy has been included in the forecasts. However, final levy decisions are made by the Government, and may differ from the forecast levy path if the Government chooses levy rates that do not reflect the funding policy or if it subsequently changes the funding policy. In addition, revenue from the levies set for these accounts may be more or less than is required to cover the cost of claims. If factors such as claims experience, ACC performance, economic assumptions (particularly discount rates and unemployment rates) turn out differently from what has been forecast, ACC’s levy revenue, claims costs and liability may also differ from forecast. Any variance will have a corresponding impact on the operating balance.

Fire Service Levy (New)

The Government has announced it will unify the Fire Services into Fire and Emergency New Zealand and signalled that this change will cost approximately $303 million which will be funded through a Crown contribution, a repayable capital loan and levy increases. The increase in levies required to meet the increased expenditure on Fire Services, and to contribute to repaying the repayable capital injection are uncertain and not yet included in the fiscal forecasts.

Revenue - Tax Policy Work Programme (Changed)

Some of the items on the tax policy work programme could each have a significant positive impact on operating revenue: work on Base Erosion and Profit Shifting including interest allocation rules and the taxation of foreign hybrid instruments and entities.

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 effect on revenue received. There is a risk the Government may need to provide additional funding if revenue collected is lower than the total costs of providing the service. There is also a risk that changes will be required to the way government services are delivered, which could result in costs to the Crown.

Potential Policy Decisions Affecting Expenses (Expected to be Funded from Reprioritisation or the Budget Operating Allowance)

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. An initial adjustment to the liability and an expense of about $1.0 billion to $1.5 billion would need to be reported if such an amendment were to be enacted.

Budget Operating Initiatives (Unchanged)

Future Budgets may well include new operating initiatives for new policies or to address cost pressures 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.

Concessionary Loans (Unchanged)

The Crown has provided loans to local government and iwi-based organisations on a concessionary basis to achieve public policy purposes. Because of their concessionary nature, these loans are written down on draw down to reflect existing market conditions. There is a risk that future market conditions may require a different adjustment. The current carrying value of these loans on the Crown's balance sheet is $553 million.

Defence Force - Operating and Capital Costs (Changed)

A Defence White Paper is being developed to ensure the New Zealand Defence Force (NZDF) is structured and equipped to meet the Government's defence policy objectives out to 2030 and beyond. Changes to NZDF operating and/or capital funding may be made over the forecast period to achieve the Defence White Paper settings.

Fire Service Expenses (New)

The Government has announced it will unify the Fire Services into Fire and Emergency New Zealand, and signalled that this change will cost approximately $303 million which will be funded through a Crown contribution, a repayable capital loan and levy increases. While the Crown contribution has been included in the forecasts, the timing and quantum of any increases in Fire and Emergency New Zealand expenses are uncertain and not yet included in the fiscal forecasts. However, as any additional operating costs resulting from the restructure are assumed to be met largely by levy increases, the programme is not expected to have a significant impact on the operating balance.

Finance - Tamaki Regeneration Programme (Changed)

Proceeds from housing sales in Tamaki over the next 10 to 15 years may be less than the book value of the houses sold. Over this period 7,500 new houses are planned to be built in Tamaki in place of about 2,500 existing houses.

Greater Christchurch Regeneration- Christchurch Central Recovery Plan - Anchor Projects (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. Funding will vary from project to project, dependent on final scope, ownership decisions, implementation and project costs, and will to some extent eventually be recovered. Business cases are progressing through the decision-making process and construction costs 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.

Revenue - Transformation and Technology Renewal (Unchanged)

The Business Transformation programme agreed by Cabinet is reflected in forecasts. There are risks that the expected implementation costs, revenue gains and operating costs savings may differ from forecasts. In addition, the Government is considering possible policy changes affecting the way Inland Revenue manages its processes and data. Any changes could materially impact the programme's cost, and the additional revenue collected.

Social Development - Child, Youth and Family Modernisation (Changed)

Following the report of an external advisory panel, work is continuing on development of a new operating model for Child, Youth and Family that sets out the structure, systems and resources needed to help improve the outcomes for vulnerable children and young people through a fundamental shift in its operating model. This includes an expanded focus and target group, and a move towards direct purchasing of some services. Funding for the modernisation package would be significant over the forecast period and future service design and costs are still being developed. To the extent that these cannot be funded from reprioritisation, additional funding is likely to be required.

Social Housing - Social Housing Reform (Changed)

The Government is progressing the Social Housing Reform Programme. This programme aims to improve the services and assistance provided to those in housing need, to build the social housing market and to fully recognise the costs of social housing. Specific fiscal risks associated with this programme are as follows:

• Additional social-housing places may require funding above the current Income Related Rent Subsidy (IRRS) appropriation cap.
• The development of a more diverse and competitive social-housing market may adversely affect HNZC's financial position.
• Proceeds from social-housing transfers may differ from book value.

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 of benefit recipients 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 renegotiated over the forecast period. 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.

Tertiary Education, Skills and Employment - Tertiary Funding (New)

The Tertiary Education Commission is currently reviewing the recognition of tertiary funding in light of the recent transition to Public Benefit Entity accounting standards. While a number of outcomes are possible, one result may be a one-off non-cash adjustment to the operating statement in 2015/16 to reflect a change in the point at which expenditure is recognised. The amount is currently unknown but could reduce OBEGAL by between $200 million and $400 million. Any adjustment would have no impact on the amount of funding provided to tertiary institutions or the timing of any cash payments (and therefore net core Crown debt).

Treaty Negotiations - 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.

Potential Capital Decisions (Expected to be Funded from the Existing Crown Balance Sheet or the Budget Capital Allowance)

Agency Capital Intentions (Unchanged)

Future Budgets may well include new capital investments other than those identified in other specific fiscal risks. Such investments are most likely to be developed by the 25 investment-intensive agencies 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, improvements in asset performance, alternative methods of service delivery and changes to policy settings. To enable greater earlier visibility over agency capital intentions, the Treasury now regularly compiles investment pipeline reports that provide forward visibility of capital pressures at both an aggregate and individual investment level. New investments are risks to the fiscal forecasts only to the extent they cannot be managed through existing balance sheets, or the provision in the fiscal forecasts for forecast new capital spending.

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. Should a decision be taken to refurbish the property, a rough-order cost estimate for this upgrade is $100 million over the forecast period.

Parliamentary Service - Parliamentary Accommodation (Unchanged)

With the expiry of the lease on Bowen House in December 2018, the Parliamentary Service is reviewing how it provides accommodation for Parliament to ensure that accommodation meets the needs of future Parliaments at best economic value. Options for future accommodation may require capital expenditure.

Primary Industries - Investment in Water Infrastructure (Unchanged)

The Government has made a public statement that it will invest up to $400 million in equity of irrigation schemes. In addition to $120 million already appropriated, the Government will consider providing further capital of up to $280 million in future Budgets to Crown Irrigation Investment Limited as schemes reach the ‘investment-ready' stage.

Transport - Auckland Transport Projects (Unchanged)

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 City Rail Link and support for a second Waitemata Harbour Crossing. NZTA has advised that it can fund the Auckland Manukau Eastern Transport Initiatives without further Crown funding. Decisions on further Crown financial assistance for the East-West Link and other projects will be made as part of future Budgets.

Transport - Regional State Highways (Changed)

A regional state highway acceleration package of $212 million was announced by the Government in June 2014. The entire $212 million package has now been allocated to tranche one projects ($97 million in Budget 2015) and tranche two projects ($115 million in Budget 2016). Investigation into tranche three is currently being undertaken, and if these projects proceed additional Crown funding may be required.

Transport - Support for KiwiRail (Unchanged)

The Government in Budgets 2010 to 2015 supported KiwiRail Holdings Limited (KiwiRail) with around $1.5 billion invested in the New Zealand freight rail system. A major review of the business occurred before Budget 2015 and $400 million was provided for 2015/16 and 2016/17. Further Crown investment into KiwiRail is likely to be required.

Unexpected Maintenance for Crown-owned Buildings (Changed)

There is a possibility that the Crown will incur costs when unexpected maintenance is required for the buildings it owns. For example, earthquake strengthening some of the buildings that not meet modern building standards, and maintenance for buildings with weathertight issues. The Government is currently undertaking a stock-take of Crown-owned earthquake-prone buildings. The likelihood, timing and fiscal impact of any repairs are uncertain.

Matters Dependent on External Factors

ACC - 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.

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. 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 an analysis of inventory that is surplus to requirements and is over and above the existing provision for obsolescence. The existing provision is also being reviewed to ensure that all items comprising the provision are still relevant.

Energy and Resources - Crown Revenue from Petroleum Royalties (Unchanged)

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

Finance - Air New Zealand Sale of Virgin Australia Shareholding (New)

On 30 March 2016 Air New Zealand announced that it is exploring options with respect to its shareholding in Virgin Australia Holdings Limited, including a possible sale of all or part of its shareholding. Air New Zealand has not announced what it intends to do with the proceeds if it sells some or all of its shareholding. One possibility would be for Air New Zealand to use some of the sales proceeds to return capital to its shareholders, which includes the Crown. Whether any sale of Air New Zealand's shareholding in Virgin Australia Holdings Limited goes ahead, the timing of and proceeds from the sale, and following that the timing and size of any return of capital to Air New Zealand's shareholders are all unknown, and are decisions for the board and management of the company. However, if capital was returned to shareholders it would reduce Crown net debt.

Finance - EQC (Unchanged)

An actuarial estimate of the net claims liability and the rate of settlement has been included in the Crown's fiscal forecasts. There still remains some risk that EQC's remaining settlement expenditure relating to the Canterbury earthquakes will be different (higher or lower) from forecast. An obligation arises from Section 16 of the Earthquake Commission Act 1993, which provides that the Crown will fund any deficiency in EQC’s assets to cover its financial liabilities on such terms and conditions that the Minister of Finance determines.

Finance - Goodwill on Acquisition (Unchanged)

As at 30 June 2015, the Government had goodwill on acquisition of a number of sub-entities totalling $592 million. Under New Zealand accounting standards (PBE IPSAS 26), 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.

Greater Christchurch Regeneration - Residential Red Zone (Unchanged)

Some recoveries from 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, revenues or recoveries 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. The fiscal impact of this is not yet certain.

Housing New Zealand Corporation (HNZC) - Divestment and Development of HNZC Housing (Unchanged)

The forecasts reflect business-as-usual divestments and redevelopments of some housing property as part of HNZC's asset management strategy. 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 about the proposed funding of developments. Market conditions impact on the proceeds of sale and the cost of acquisitions and development. Given these uncertainties, there is a risk that there will be variations from the fiscal forecasts.

Pay Equity and Caregiver Employment Conditions (Unchanged)

Several cases and funding claims in the disability support and aged care sectors 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 may involve significant costs to the Crown. The Government has announced it will be entering negotiations over pay rates for care and support workers which will cover around 50,000 workers. A Joint Working Group has been established to develop principles for dealing with claims of pay equity under the Equal Pay Act. The group will recommend to Ministers agreed principles on pay equity that could be applied in all sectors in the economy. The result of both of these and of any related litigation could require additional funding.

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 (Unchanged)

The value of student loans is sensitive to assumptions such as the borrower's future income, and general economic factors such as interest rates, unemployment levels, salary inflation and the CPI. As new lending occurs, an initial write-down to fair value will be made, and an expense will be incurred, reflecting the cost the Crown incurs in making an interest free loan and the risk that borrowers may not repay their loans. However, the assumptions made at the time of lending are volatile and are subject to change.

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 $1.0 billion in 1994 present-value terms, the mechanism provides that the Crown is liable to make payments to maintain the real value of Ngāi Tahu's and Waikato-Tainui's settlements as a proportion of all Treaty Settlements. The agreed relativity proportions are 17% for Waikato-Tainui and approximately 16% for Ngāi Tahu. There is a risk that the timing and 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.

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 be different from the profile included in the fiscal forecasts.

Risks Removed Since the 2015 Half Year Update

The following risks have been removed since the 2015 Half Year Update.

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.[21]

The contingencies have been stated as at 31 March 2016, being the latest set of reported contingencies.

Quantifiable Contingent Liabilities and Contingent Assets

Unquantifiable Contingent Liabilities and Contingent Assets

Description of Contingent Liabilities

Quantifiable contingent liabilities over $100 million

Guarantees and indemnities

Guarantees are legally binding promises made by the Crown to assume responsibility for a debt, or performance of an obligation of another party, should that party default. Guarantees generally relate to the payment of money but may require the performance of obligations. Guarantees given under section 65ZD of the Public Finance Act 1989 are disclosed in accordance with section 26Q(3)(b)(i)(B) of the same Act.

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

New Zealand Export Credit Office guarantees

The New Zealand Export Credit Office (NZECO) provides a range of guarantee products to assist New Zealand exporters manage risk and capitalise on trade opportunities around the globe. The obligations to third parties are guaranteed by the Crown and are intended to extend the capacity of facilities in the private sector.

$213 million at 31 March 2016 ($177 million at 30 June 2015)

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 other 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:

In addition to the uncalled capital above, the Crown Support Deed agreed with Southern Response Earthquake Services Ltd includes two capital subscriptions:

• a $500 million preference share facility under the Crown's agreement dated 5 April 2012 of which $393 million has already been called and paid, with the other $107 million called but unpaid as at 31 March 2016. The balance is forecast to be paid in the 2016/17 financial year, and
• $500 million of uncalled ordinary shares under an amended Crown Support Deed dated 30 January 2013 by which Southern Response may issue a call notice but only after Southern Response's investments, reinsurance and existing Crown support (the remaining $107 million convertible preference share facility discussed above) are exhausted.

As at 31 March 2016, no payment has been made on the uncalled ordinary capital facility. However, it is now considered probable that this subscription will be called and paid for in the future. The extent to which the subscription is called and paid depends on the ultimate cost of settling earthquake claims, which continues to be subject to significant uncertainty.

The above capital subscriptions have an impact on the core Crown net debt; however as Southern Response is part of the Crown there would be no impact on the total Crown operating balance.

Legal proceedings and disputes

Tax disputes

When a taxpayer disagrees with an assessment issued following the dispute process, the taxpayer may challenge that decision by filing proceedings with the Taxation Review Authority or the High Court. This contingent liability represents the maximum liability IRD has in respect of these cases.

$149 million at 31 March 2016 ($148 million at 30 June 2015)

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 IRD. The funds are repaid to the entitled owner on proof of identification.

$133 million at 31 March 2016 ($120 million at 30 June 2015)

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, and
3. other contingent liabilities.

a) Indemnities

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.

b) Legal claims and proceedings

There are numerous legal actions that have been brought against the Crown. However, in the majority of these actions it is considered a remote possibility that the Crown would lose the case. 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 and not considered to be remote.

Accident Compensation Corporation (ACC) litigation

Litigation involving ACC arises almost exclusively from challenges to operational decisions made by ACC through the statutory review and appeal process. No accrual has been made for contingent liabilities which could arise as these disputes are issue based and ACC's active management of litigation means that it will be either settling or defending, depending on the merits of the issue in dispute.

Air New Zealand litigation

Air New Zealand is defending two class actions in the US. One makes allegations of anti-competitive conduct against many airlines in relation to pricing in the air cargo business. Following settlements, two airlines including Air New Zealand continue to defend the claim.

A second class action in the US alleges that Air New Zealand together with other airlines acted anti-competitively in respect of fares and surcharges on trans-Pacific routes. Continuation or termination of these proceedings awaits an appeal on a critical legal issue.

Allegations of anti-competitive conduct in the air cargo business in Hong Kong and Singapore were the subject of proceedings by the Australian Competition and Consumer Commission (ACCC). Following a defended hearing, the Federal Court released its decision in October 2014, finding in favour of Air New Zealand. The ACCC won an appeal against that decision by a majority of two judges to one and Air New Zealand has applied to the High Court of Australia for further Leave to Appeal.

In the event that a Court determined that Air New Zealand had breached competition laws, the Group would have potential liability for damages or (in Australia) pecuniary penalties. No other significant contingent liability claims are outstanding at balance date.

Kiwibank

In June 2013, a group called Fair Play on Fees announced plans for a representative action against banks in New Zealand in relation to certain default fees charged to New Zealand customers. In November 2013, the group issued proceedings against Kiwibank. The potential outcome of the proceedings cannot be determined with any certainty at this stage.

Ministry for Primary Industries - Kiwifruit vine disease

In November 2014, 42 kiwifruit growers and one post-harvest operator filed a claim against the Ministry for Primary Industries alleging it is liable for damages they suffered from the kiwifruit vine disease Psa-V. The plaintiffs have not quantified their losses, but have publicly claimed they are in the vicinity of $370 million, citing total industry losses of $885 million. Although the plaintiffs were required to provide details of their claims by 4 December 2015, that information is incomplete and it is still not possible to provide a more accurate assessment of the contingent liability. It appears there are now 178 claimants, but that is not certain owing to several orchards being subject of claims by more than one entity. The Ministry is defending the claim and currently it remains unquantifiable.

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 a tertiary institution, or is subject to the Crown Forest Assets Act 1989.

c)  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 restraining orders. In the event that the Crown is found liable, payment may be required.

Environmental liabilities

Under common law and various statutes, the Crown may have responsibility to remedy adverse effects on the environment arising from Crown activities. Departments managing significant Crown properties have implemented systems to identify, monitor and assess potential contaminated sites.

In accordance with PBE IPSAS 19: Provisions, Contingent Liabilities and Contingent Assets any contaminated sites for which costs can be reliably measured have been included in the Statement of Financial Position as provisions.

Treaty of Waitangi claims - settlement relativity payments

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 $1.0 billion in 1994 present-value terms, the mechanism provides that the Crown is liable to make payments to maintain the real value of Ngāi Tahu’s and Waikato-Tainui’s settlements as a proportion of all Treaty settlements. The agreed relativity proportions are 17% for Waikato-Tainui and approximately 16% for Ngāi Tahu. There is a risk that the timing and 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.

Description of Contingent Assets

Quantifiable contingent assets over $100 million

Legal proceedings and disputes

Tax disputes

A contingent asset is recognised when the IRD has advised 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 cash collectable from the disputes process based on experience and similar prior cases, net of losses carried forward.

$106 million at 31 March 2016 ($103 million at 30 June 2015)

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 2016.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined in the Fiscal Outlook chapter (pages 27 to 52).

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 Public Benefit Entity 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 2016 Budget Economic and Fiscal Update Additional Information document which can be found on the Treasury's website at www.treasury.govt.nz/budget/forecasts/befu2016/094.htm

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 Risks chapter on pages 67 to 90.

Key forecast assumptions are set out on pages 29 and 52.

Reporting and Forecast Period

The reporting periods for these Forecast Financial Statements are the years ended 30 June 2016 to 30 June 2020. The “2015 Actual” figures reported in the statements are the audited results reported in the Financial Statements of the Government for the year ended 30 June 2015. The “2016 Previous Budget” figures are the original forecasts to 30 June 2016 as presented in the 2015 Budget.

Government Reporting Entity as at 29 April 2016#

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

• Crown Law Office
• Department of Conservation
• Department of Corrections
• Department of Internal Affairs
• Department of the Prime Minister and Cabinet
• Education Review Office
• Government Communications Security Bureau
• Inland Revenue Department
• Land Information New Zealand
• Ministry for Culture and Heritage
• Ministry for Primary Industries
• Ministry for the Environment
• Ministry of Business, Innovation and Employment
• Ministry of Defence
• Ministry of Education
• Ministry of Foreign Affairs and Trade
• Ministry of Health
• Ministry of Justice
• Ministry of Māori Development
• Ministry for Pacific Peoples
• Ministry of Social Development
• Ministry of Transport
• Ministry for Women
• 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
• Office of 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
• 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 5companies)

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

Others

• Air New Zealand Limited

Crown entities segment

• Accident Compensation Corporation
• Accreditation Council
• 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
• Heritage New Zealand Pouhere Taonga
• 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 Lotteries Commission
• New Zealand Productivity Commission
• New Zealand Qualifications Authority
• New Zealand Symphony Orchestra
• 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 (2,398)
• Social Workers Registration Board
• Sport and Recreation New Zealand
• 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)
• 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 (20)
• 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
• Education Payroll Limited
• Fairway Resolution Limited
• Health Benefits Limited (ceased operating)
• Ōtākaro Limited
• Research and Education Advanced Network New Zealand Limited
• Southern Response Earthquake Services Limited
• Tāmaki Redevelopment Company Limited
• The Network for Learning Limited

Legal entities created by Treaty of Waitangi settlement Acts (Public Finance Act schedule 6)

• Te Urewera

Other

• Regenerate Christchurch

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

Forecast Statement of Financial Performance for the years ending 30 June

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.

1. The classifications of the functions of the Government reflect current approved baselines. Forecast new operating spending is shown as a separate line item in the above analysis and will be allocated to functions of the Government once decisions are made in future Budgets.

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

Forecast Statement of Comprehensive Revenue and Expense for the years ending 30 June

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

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

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

Forecast Statement of Cash Flows for the years ending 30 June

1. Excludes transactions with ACC and NZS Fund.
2. Further information on the proceeds and repayments of government bonds is available in note 23.

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

Forecast Statement of Cash Flows (continued) for the years ending 30 June

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

Forecast Statement of Financial Position as at 30 June

1. Tertiary education institutions constitute most of the 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

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

Statement of Actual Contingent Liabilities and Assets

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#

1. Customs excise-equivalent duty.

NOTE 2: Interest Revenue and Dividends

NOTE 3: Transfer Payments and Subsidies

NOTE 4: Personnel Expenses

NOTE 5: Depreciation and Amortisation

NOTE 6: Other Operating Expenses

NOTE 7: Finance Costs

NOTE 8: Insurance Expenses

NOTE 9: Forecast New Spending and Top-down Expense Adjustment

Unallocated contingencies represent expenses included in Budget 2016 and previous Budgets that have yet to be allocated. Forecast new spending indicates the expected spending increases from future Budgets.

The forecast for new operating spending for Budget 2017 is $1.5 billion. Some of this allowance has been pre-committed as at the forecast finalisation date of 29 April 2016, with only the unallocated portion of the allowance included in this note.

Unallocated contingencies represent capital spending from Budget 2016 and previous Budgets that has yet to be allocated. Forecast new spending indicates the expected capital spending increases from future Budgets.

NOTE 10: Net Gains and Losses on Financial Instruments

NOTE 11: Net Gains and Losses on Non-Financial Instruments

NOTE 12: Operating Balance (excluding Minority Interests)

NOTE 13: Financial Assets (including receivables)

NOTE 14: Student Loans

NOTE 15: Property, Plant and Equipment

1. Using a revaluation methodology unless otherwise stated.

NOTE 15: Property, Plant and Equipment (continued)

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 16: Intangible Assets and Goodwill

NOTE 17: NZ Superannuation Fund

NOTE 18: Payables

NOTE 19: Insurance Liabilities

ACC liability

Calculation information

PwC NZ has prepared an independent actuarial estimate of the ACC outstanding claims liability as at 31 December 2015. 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 2016. The equivalent single effective discount rate, taking into account ACC's projected future cash flow patterns, is 3.78% and allows for a long-term discount rate of 5.5% from 2061.

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 below (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 2015 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 2015 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: a complex land claims environment, complexity of the remaining dwelling claims and the expectation that some claims will need to be reopened to rectify outstanding issues.

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 20: Retirement Plan Liabilities

The net liability of the Government Superannuation Fund (GSF) was calculated by GSF's actuary as at 31 January 2016. 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 31 January 2016, based on membership data as at 30 June 2015 with adjustments for cash flows to 31 January 2016. 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 31 January 2016.

Other principal long-term financial assumptions were an inflation rate, as measured by the Consumers Price Index (CPI), of 1.62% for the 17 years to 30 June 2032, then increasing gradually each year to 2.5% in the year ended 30 June 2050 and remaining at 2.5% p.a. for all years after that. In addition an annual salary growth rate, before any promotional effects, of 3% (unchanged from 30 June 2014).

The 2015/16 projected increase in the net GSF liability is $452 million, reflecting an increase in the GSF liability of $317 million and a decrease in the GSF net assets of $135 million.

The increase in the GSF liability of $317 million includes an actuarial loss between 1 July 2015 and 31 January 2016, of $702 million, owing to movements in the discount rates and demographic assumptions partly offset by the impact of movements in CPI rates. The remaining $385 million reduction is owing to the current service cost and interest unwind (increases the liability) offset by the lower than expected benefits to members (reduced the liability).

The decrease in the value of the net assets of GSF of $135 million includes a loss of $195 million reflecting the updated market value of assets at 31 January 2016. The balance of $60 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 2015/16 onwards reflect the net of the expected current service cost, interest cost, investment returns and contributions.

NOTE 21: 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.

The allocation of NZUs creates a provision if allocated for free; the provision is reduced, and revenue recognised, as NZUs are surrendered to the Crown by emitters.

The prices for NZUs used to calculate the ETS provision are assumed to remain constant over the forecast period and are based on market prices during the first week of April 2016.

The ETS impact on the fiscal forecast is as follows:

NOTE 22: Changes in Net Worth

NOTE 23: Core Crown Residual Cash

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

NOTE 24: Net earthquake expenses (operating and capital)

These net earthquake costs are the latest estimates of the net impact on the Crown of the earthquakes. These estimates reflect the known costs under current policy settings. They do not include future decisions the Government may take regarding the rebuild.

The forecasts assume that any additional costs to the Crown will be met within budget allowances.

Notes:

1. Crown assets includes capital expenditure on Canterbury hospitals, schools, Tertiary Education Institutions, housing and the Justice and Emergency Services Precinct.
2. Central city rebuild costs include land acquisition and are net of expected recoveries and contributions from third parties.
3. Some expenses are non-cash (eg, asset write-offs and impairments) and therefore do not have a cash element to them.

Forecast Statement of Segments#