Budget Economic and Fiscal Update 2018

An introduction to the Budget Economic and Fiscal Update#

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The Treasury is New Zealand's economics and finance ministry. We advise on the direction of New Zealand's economic policy with the aim of achieving a strong and sustainable economy, and raising New Zealand living standards. This includes reporting on the expenditure of government (fiscal) revenue, and assisting to ensure spending is fit for purpose and can improve outcomes for New Zealanders.

Sharing what we do

As the government's lead economic and financial adviser we forecast the economic outlook for New Zealand and the Government's fiscal outlook. This Budget Economic and Fiscal Update (Budget Update) is part of a suite of documents we release as required by the Public Finance Act 1989.

This Update primarily outlines what the Treasury observes in our current economic and fiscal climate, what we might see in the future, and what risks we may face over the next four years (our forecast period).  This gives an indication of what the economy is most likely to do to inform decision-making.

Making it New Zealander-centric

Our advice is not just based on facts and figures. Improving outcomes means we need to understand which outcomes to improve, and what is important to New Zealanders. We use the Treasury's Living Standards Framework to recognise the different aspects of New Zealanders' living standards and well-being. Our framework is based on four areas:

• financial and physical capital eg, housing, machinery, buildings, money
• human capital eg, health, skills
• social capital eg, institutions, trust
• and natural capital eg, water, biodiversity.

We took this approach further and last year presented a living standards perspective that stretches over the next 40 years. He Tirohanga Mokopuna: 2016 Statement on the Long-term Fiscal Position, shares our take on long-term fiscal issues facing New Zealand. We know that sustainable government finances are a requirement to improving long-term living standards, and vice versa.

Understanding our path

The Treasury is in a unique position to focus on improving the way our economy can raise New Zealand living standards. Along with delivering first-rate economic and financial advice, we are committed to providing it in a way so New Zealanders understand how we work to achieve our goals. If you would like to know more about who we are and what we do, or want a simpler overview of the Budget Update please go to our website at https://treasury.govt.nz

Statement of Responsibility#

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I make this statement in accordance with section 26W of the Public Finance Act 1989.

On the basis of the economic and fiscal information available to it, the Treasury has used its best professional judgement in preparing, and supplying the Minister of Finance with this Economic and Fiscal Update. The Update incorporates the fiscal and economic implications of both government decisions and other circumstances as at 26 April 2018 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 26 April 2018. 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

10 May 2018

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 26 April 2018 of which I was aware and that had material economic or fiscal implications.

In accordance with section 26W of the Public Finance Act 1989, I accept responsibility for the integrity of the disclosures contained in the Update, responsibility for the consistency and completeness of the Update information with the requirements of Part 2 (Fiscal responsibility) of the Public Finance Act 1989 and responsibility for the omission from the Update under section 26V of the Public Finance Act 1989 of any decisions, circumstances or statements not incorporated in it.

 

Hon Grant Robertson
Minister of Finance

10 May 2018

Executive Summary#

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Sources: Stats NZ, the Treasury

• Growth in the economy is being supported by strong population growth, accommodative monetary policy, rising household wealth and steady growth in household incomes. Further support for growth is coming from the global economy, which has strengthened over the past year, underpinning rising prices for New Zealand's exports. These forces are expected to continue to support growth, although easing net migration inflows and rising interest rates contribute to slowing growth over 2020/21 and 2021/22.
• Following several years of above trend growth, the economy appears to be operating at close to full capacity. In the labour market, the pace of employment growth remains more than sufficient to employ new entrants to the labour market and the unemployment rate has fallen to 4.4%. However, wage and price pressures remain subdued and consumer price inflation is low.
• Increased government operating and capital spending, including the introduction of the Families Package, is expected to contribute to a pick up in the pace of growth over 2018/19. Thereafter, growth in total government spending is forecast to slow and tax revenue to strengthen, which helps to restrain the build up of demand pressures in the economy.
• The pick up in growth is expected to lead to further declines in the unemployment rate and to put additional pressure on wages and prices to rise. Inflation is forecast to rise gradually towards 2.0%, the mid-point of the Reserve Bank's 1%-3% target range. Interest rates are projected to rise.
• The outlook for net migration continues to be a source of uncertainty, although net inflows have slowed in recent months. As in previous forecasts, net migration inflows are assumed to decrease over the forecast period, contributing to slower growth beyond 2019/20. However, net inflows are assumed to decline more slowly than previously, which raises population growth and economic growth beyond 2019/20 relative to the Half Year Update 2017.
• Tax revenue in the nine-months ended March 2018 was $1.1 billion higher than anticipated in the Treasury's Half Year Update 2017. This higher revenue is expected to persist. New tax measures proposed by the Government further increase revenue. Overall, tax revenue is forecast to be cumulatively $5.7 billion higher over the period to June 2022 than in the Half Year Update 2017.
• Forecasts of government operating and capital expenditure are higher than in the Half Year Update 2017, primarily reflecting the Government's decision to raise current and future budget allowances.
• Budget 2018 provides, on average, $2.8 billion per year of net new operating spending and a total of $3.8 billion of new capital investments. The operating allowances for Budgets 2019, 2020 and 2021 are now $2.4 billion for each Budget, an increase of $525 million in each year. Capital allowances are $3.7 billion for Budget 2019, $3.4 billion for Budget 2020 and $3.0 billion for Budget 2021, an increase of $300 million in each Budget.
• Reflecting increases in both revenue and expenses, the operating balance before gains and losses (OBEGAL) is still expected to increase over the forecast period, reaching a surplus of $7.3 billion (2.1% of GDP) in 2021/22.
• Over the five year forecast period, the cumulative changes in both OBEGAL and residual cash since the Half Year Update 2017 are modest. Therefore net Core Crown debt in 2021/22 is little changed from the Half Year Update 2017.
• Residual cash deficits are forecast until 2020/21, reflecting capital spending exceeding operating cash flows. As a result, the value of net core Crown debt is forecast to increase from $60.4 billion in 2017/18 to $67.0 billion in 2021/22, but to decline as a share of GDP from 20.8% in 2017/18 to 19.1% in 2021/22.

Economic Outlook#

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Overview#

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• GDP growth has slowed over the past year from 4.0% to 2.9% in the year to December 2017 and is expected to remain around these rates over the first half of 2018. Thereafter the demand outlook is broadly positive with activity underpinned by low interest rates, migration-led population growth, rising government spending and robust international growth. Annual average growth is forecast to pick up from 2.8% in the June quarter 2018 to a peak of 3.6% in the December 2019 quarter, as private consumption growth remains solid, increased government spending bolsters the economy, and both residential and business investment pick up. Growth is expected to slow to 2.5% by June 2022 as net migration inflows ease, and interest rates rise.
• Growth is expected to support a gradual decline in unemployment but also add to capacity pressures in the economy, contributing to rising inflationary pressures and increases in interest rates. International growth underpins demand for New Zealand exports and supports a historically high level for the terms of trade over the forecast period. The combination of the profile for real activity and the upwards pressure for prices results in higher nominal gross domestic product (GDP) across the forecast period.
• Changes in the outlook since the Half Year Economic and Fiscal Update 2017 (Half Year Update) reflect recent economic data, new government policies and changes to some key judgements. Revisions to historical data raise the starting point for GDP growth but show a greater slowing of momentum over 2017. Employment has continued to expand with unemployment falling more than expected. Increases to government spending mean that while still easing, growth in government consumption adds more to demand. An increase to the Treasury's long-run net migration assumption means population growth supports economic growth more in the later years of the forecast.
• Forecasts of nominal GDP are cumulatively $46 billion higher over the five years to June 2022 than forecast in the Half Year Update. However, around $40 billion of this increase is owing to revisions to historical GDP data and therefore does not directly change the outlook for tax. Overall, recent strength in tax revenue and the stronger forecasts for growth of the nominal economy increase core Crown tax revenues by $5.7 billion over the forecast period. The implications for the Crown's financial accounts are explored in the Fiscal Outlook chapter on page 23.
• The assumptions and judgements underpinning these forecasts are subject to a range of risks and uncertainties. These are discussed in the Risks and Scenarios chapter on page 47.

Sources: Reserve Bank of New Zealand, Stats NZ, the Treasury

Economic forecasts are presented on a June year basis for consistency with the fiscal forecasts. Longer time series for these variables are provided on page 142.

Notes:

1. Business investment is the total of all investment types excluding residential building.
2. Contribution to GDP growth.
3. 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.
6. Quarterly Employment Survey, average ordinary-time hourly earnings, annual percentage change.
7. Annual percentage change.
8. System of National Accounts (SNA).
9. Quotable Value House Price Index, annual percentage change.
10. Percent of household disposable income (HHDI), March years.
11. Average for the June quarter.

Recent Developments#

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This section discusses recent developments and their impact on the economic outlook.

Economic growth slowed over 2017…

Economic growth slowed over the past year. Real production GDP grew 0.6% in the December quarter, weaker than the 0.8% in the Half Year Update forecasts, partly owing to weak agricultural production following volatile weather conditions. Historical GDP data have been revised higher by Stats NZ with the revised data also highlighting a more pronounced slowing in economic momentum. Quarterly growth is expected to pick up slightly from 0.6% in the December quarter to 0.7% in the March and June quarters as the impact of adverse weather conditions on agricultural production growth lessens.

…with recent weather conditions disrupting activity…

September quarter GDP growth was in line with the Half Year Update, although there were significant revisions to historical data (discussed below). December quarter GDP on the other hand, came in slightly weaker than forecast. Volatile weather conditions over the past six months have disrupted agricultural production. In particular, a wet spring and then a very dry start to summer adversely affected milk production. The dry weather hindered pasture growth and saw some animal slaughter brought forward in response to lower feed levels. This negatively impacted December quarter GDP. This weakness is likely to persist, albeit to a lesser extent, through the March quarter, before GDP gradually recovers as farming conditions improve.

…while historical revisions have changed the starting point…

Large revisions to historical quarterly data, announced alongside the release of the September quarter GDP data, meant that the estimated size of the economy at the beginning of the forecast period is now larger than at the Half Year Update. Revisions to GDP data are common in the September quarter as Stats NZ aligns the quarterly data with their latest annual data release. Annual GDP measures are based on more comprehensive sets of data but are less timely than the quarterly estimates. Revisions at the September 2017 quarter were larger than usual and with new household consumption data replacing previously modelled data, drive large upward revisions to private consumption data. New data measuring construction activity also resulted in upward revisions to residential investment.

Annual average growth was generally in the 3.5% to 4.0% range over most of the past three years, whereas prior to the revisions it was generally estimated to be in the 2.5% to 3.5% range (Figure 1.1). The revisions help to explain the strong tax revenue seen in recent years, with upward revisions to consumption, investment and exports. Measured consumption is also now more consistent with the upward trend in population growth over this period.

Sources: Stats NZ, the Treasury

While these changes raised estimates of the size of the economy, they also highlighted a faster slowdown in economic growth over 2017. Annual average growth for the year ended December 2017 was 2.9%, compared with 4.0% in 2016. This loss of momentum presents a risk going forward. If GDP growth continues to slow, the weaker outlook would result in less employment and lower tax revenue than presented in these forecasts. Real growth is forecast to remain around current rates over coming quarters before picking up to a pace of 3.6% in the year to December 2019 as agricultural conditions normalise, government spending increases and investment lifts.

…particularly for nominal GDP

In contrast to the loss of momentum in the real economy, nominal GDP, which measures economic activity in current prices, has continued to grow solidly. Nominal GDP growth captures increases in the price of consumption goods (similar to the consumers price index (CPI)) but also in the price of other areas of GDP including the prices of investment goods, and the prices of exports and imports. Nominal GDP growth was 1.4% in the December 2017 quarter, exceeding the Half Year Update forecast of 0.5%, owing to a rise in the terms of trade. The improvement in the terms of trade is the result of strong export prices alongside relatively cheaper imports. This stronger growth builds upon the higher starting point for nominal GDP owing to historical revisions. In the year to June 2017, nominal GDP has been revised up by $6.2 billion and, by $2.0 billion in the June quarter alone.

Consumption and investment have continued to support growth

Revisions from Stats NZ lifted growth rates of consumption, supporting the upward revision to GDP. Consumption growth peaked in March 2017 and has been supported by a number of factors. Migration has continued to add to the population and therefore demand, although it is now slowing in line with our forecasts. Rising house prices have lifted household wealth and underpinned growth in spending. Consumer confidence has been mixed recently although it remains above long-term averages. Overall, consumption looks set to continue to support growth in coming quarters, although this contribution to growth is likely to continue to ease (Figure 1.2).

Figure 1.2 - Household consumption

Sources: Stats NZ, the Treasury

House price growth has picked up again since July 2017 following a brief lull, particularly in Auckland. Building consents recovered from their dip last year, but have been volatile in recent months. Looking through this volatility, there has been little growth in consents since October 2017, suggesting growth in residential investment over the first half of 2018 may be subdued.

Wage pressures begin to build but inflation remains mixed

Labour market data in the December 2017 quarter pointed to a tightening of the labour market. Unemployment dropped to 4.5% with employment growth at 4.2% and the participation rate remaining around its record level at 71.0%. We now assume the participation rate will remain around these levels throughout the forecast period. Labour market data for the March quarter, released after these forecasts were finalised, was roughly in line with these forecasts. Employment growth was as expected, but a slight dip in the number of unemployed saw the unemployment rate fall to 4.4%. Wage growth was slightly stronger than forecast at 3.5% as measured by the quarterly employment survey. This compared with wage growth in these forecasts of 3.2%. Further data are needed to confirm the persistence of stronger wage pressures than currently assumed.

CPI inflation in the December 2017 quarter came in at 0.1% compared with the Treasury's Half Year Update forecast of 0.5% (Figure 1.3). In contrast, inflation for the March 2018 quarter, which was released after these forecasts had been finalised, came in above expectations (0.5% compared with our forecast of 0.2%). The difference was largely owing to higher-than-expected petrol prices, seen as a ‘one-off' surprise. This suggests little persistence and therefore limited implications for our forecasts. However, increases in oil prices since the finalisation of these forecasts present some upside risk to tradable inflation in the next few quarters.

Sources: Stats NZ, the Treasury

Export prices have continued to rise…

Commodity prices have generally been performing well in recent months. Meat prices have increased and remain high, buoyed by growing international demand. Dairy prices have slipped recently but remain well above the level required for farm profitability. Import prices have been constrained by technological improvements, increasing competition and relatively subdued international inflation. This combination led to a historically high terms of trade in the December quarter.

…driven largely by a robust international outlook

Growth amongst New Zealand's trading partners strengthened and broadened over 2017. In the US, the announcement of fiscal stimulus has buoyed markets and confidence, only somewhat offset by growing geopolitical risks. For the first time in a decade, economic growth in China was higher than the previous year. Growth in Japan and Europe continues to improve, supported by strong indicators of domestic activity. Risks from an abrupt exit of the UK from the EU have diminished, with a longer time horizon likely to support a more stable transition.

In a number of advanced economies, growth is estimated to be above sustainable rates and is beginning to place upwards pressure on wages. Global inflation remains subdued for now, although fiscal stimulus in the US and reducing slack in the labour market have led to expectations of a faster monetary policy tightening and higher global bond yields. For the first time in 20 years, bond yields in the US have risen above those in New Zealand. This could put downward pressure on the exchange rate as capital shifts towards higher interest rates in the US. However, it is difficult to forecast exchange rates and we assume the trade-weighted index (TWI) will remain around 75 over the forecast horizon.

Growth in nominal GDP to support tax revenues

Revisions to, and continued growth in, nominal GDP aligns with the recent strength in tax revenue data. In particular, in the year to March 2018, tax revenue has come in $1.1 billion ahead of the Half Year Update forecasts. The strength was fairly broad-based, driven by growth in corporate tax (owing to strong company profits), goods and services tax (GST) (reflecting solid consumption and residential investment) and source deductions (reflecting tighter labour market conditions). The positive economic outlook is forecast to continue to support increasing tax revenues (see the Fiscal Outlook chapter for more details).

Economic Outlook#

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This section discusses the economic outlook for the period ending June 2022. The outlook is conditioned on a number of judgements and assumptions that are outlined on page 7. Should these assumptions and judgements prove incorrect, economic and fiscal outcomes would deviate from the outlook presented here. The Risks and Scenarios chapter discusses some of the key risks facing the economy and uses scenarios to assess the implications if some key assumptions and judgements were altered.

Economic growth to pick up…

GDP growth is expected to rise from 2.8% in the 2018 June quarter to a peak of 3.6% in the December 2019 quarter (Figure 1.4). Growth is underpinned by strong (albeit slowing) population growth, low interest rates, increased government spending and an expanding international economy. Thereafter, growth is forecast to ease to 2.5% by June 2022 as interest rates rise, and population and employment growth slows. Economic growth supports a gradual decline in the unemployment rate, a lift in inflation back towards 2.0% per year and tax revenue growth.

Figure 1.4 - Economic growth (production GDP)

Sources: Stats NZ, the Treasury

Compared with the Half Year Update, growth is weaker in the near term. The pick up in growth is slightly delayed, reflecting the impact of weather on agriculture as well as the slowing momentum in GDP growth evident in the revised data. Thereafter, stronger government spending, and a higher end point for migration, support higher growth in the latter half of the forecast period than in the Half Year Update. In the five years to June 2022, nominal GDP is cumulatively around $6 billion higher than forecast in the Half Year Update, after adjusting for the revised starting point.

…supported by increases in government spending…

Higher government spending is forecast to support a lift in economic growth. The Government's capital spending profile is forecast to pick up with capital allowances having increased by a total of $1.3 billion since the Half Year Update. This adds to business investment in the forecasts. [2] Higher operating allowances for future Budgets lead to higher forecast government consumption. Operating allowances, the total amount available for funding new ongoing initiatives in a Budget, have increased by $525 million per year, for Budgets 2019, 2020 and 2021. The fiscal impulse, which estimates the impact of changes in government activity on the economy, shows that government activity is more stimulatory than at the Half Year Update over the period 2019-2022. The fiscal impulse is discussed in more detail in ‘Summary fiscal indicators' in the Fiscal Outlook chapter.

However, there are a number of offsetting factors that are likely to limit the growth captured from higher government spending within the forecast period. Capacity constraints and wage pressures mean some of the allocated spending is expected to go into higher prices, rather than an expansion of services. The stimulus is also partly offset by an increase in interest rates sooner than would otherwise have been the case. Finally, changes to assumptions around the profile of KiwiBuild mean less of the impact of KiwiBuild on residential investment occurs in the forecast period.

KiwiBuild is expected to add to growth in residential investment, particularly in the latter part of the forecast period, and for a considerable period beyond. However, changes in the timing of capital expenditure on KiwiBuild since the Half Year Update mean the boost to growth occurs later in the forecast period than previously assumed. For further information on the new profile of KiwiBuild and other changes to government spending, see the ‘Economic impacts of new government policies' box below.

Residential investment growth more generally is expected to pick up over the forecast period. While capacity constraints limit the extent of this pick up in the near term, government policies including KiwiBuild visas, and technological improvements such as prefabricated housing, are assumed to ease capacity constraints to enable further growth in the medium term. This enables a further boost to residential investment towards the end of the forecast period than would otherwise be the case.

Figure 1.5 - Residential investment

Sources: Stats NZ, the Treasury

The economy is estimated to be operating broadly at capacity, although there will be considerable variation across sectors. For example, the construction sector appears to have limited room to expand without adding to inflationary pressure. The forecast pick up in growth will see capacity pressures build and lead to increased price pressures and therefore higher interest rates. These capacity pressures are unlikely to be completely unwound by 2022 with the impact of KiwiBuild-related construction becoming progressively larger over the forecast period (and beyond).

…which adds pressure to interest rates

Rising inflationary pressures, along with rising rates globally, and a tightening labour market, add pressure to monetary policy, and therefore interest rates increase. Interest rates are assumed to rise steadily in order to dampen the rising inflationary pressures created by capacity constraints. This is similar to the interest-rate profile forecast at the Half Year Update (Figure 1.8). This reflects the offsetting impacts of our view that inflation expectations are likely to remain constrained, with the more stimulatory nature of government policy adding to capacity pressures.

Figure 1.8 - 90-day interest rates

Sources: Reserve Bank of New Zealand, the Treasury

Higher interest rates help keep inflation subdued for some time, with inflation rising only gradually towards 2.0%. Growth in prices is constrained by well-anchored inflation expectations following years of inflation below 2.0%, and rising interest rates. These dampening effects are offset by robust domestic activity, increasing government spending and rising inflation globally.

Solid population growth supports domestic activity

Net migration continues to drive population growth, with annual net migration still close to the peak reached in July 2017. Population growth is expected to continue to be supported by high levels of net migration across the forecast period, although this is expected to diminish over time as net migration falls towards its trend level. Since the Half Year Update, we have revised up our assumption of the net migration end point. In the past, we have taken Stats NZ’s assumption of the long-run level of net migration (of 15,000 annually) as the end point of our forecasts. Following a review, we have revised this end point assumption to 25,000. This reflects structural changes in both student and work visa arrivals in recent years. This revision is relatively small compared with historical errors, which have tended to be to under-estimate net migration flows. While we have revised our long-run assumption higher, there remains a risk that migration may continue to surprise on the upside. This is explored further in Scenario Two in the Risks and Scenarios chapter.

Strong population growth, rising house price growth, the implementation of the Families Package, and higher student allowances all support consumption growth in the forecasts. The contribution of private consumption to overall GDP growth is expected to decline gradually over the forecast period as net migration eases, house price growth returns to trend and interest rates rise.

The labour market continues to strengthen

The participation rate is assumed to remain around recent record highs across the forecast period. Combined with strong, migration-led population growth, the labour force is expected to expand significantly. Economic growth results in employment continuing to expand and is forecast to see a steady decline in the unemployment rate towards 4% (Figure 1.12). Over most of the forecast period, the unemployment rate is expected to be at, or below, the assumed level of the NAIRU.[6]

Figure 1.12 - Unemployment rate

Sources: Stats NZ, the Treasury

Falling unemployment, alongside a rising minimum wage and labour-market reforms, are assumed to lift wage growth throughout the forecast period. Alongside this we assume that labour productivity will recover to around its historical rate, contributing to annual hourly wage growth increasing to 3.4% by the end of the forecast period.

A strong international outlook…

The international outlook has continued to improve, with solid growth and falling unemployment. While inflation and wage pressures have been slow to emerge, they are now beginning to take hold as many countries are growing faster than is likely to be maintained in the medium term. This is placing increasing pressure on monetary policy around the world, and leading to a tighter outlook for interest rates.

The improvement in the global outlook has been fairly broad-based, albeit with much of the improvement led by the US. In the US, increased fiscal stimulus, both in the form of lower taxation and higher spending, is expected to bolster the US economy in coming years, adding around 1.2% to growth over the next three years as estimated by the IMF. This stimulus is adding to an economy that is already growing above its sustainable growth path, causing tighter capacity constraints, particularly in the labour market. We expect this to continue to add to wage and price inflation pressures in the US economy and to cause the Federal Reserve to continue tightening monetary policy.

As previously noted, growth in other trading partners is expected to remain strong in the near term. In the medium term, this growth is expected to ease somewhat. Economic growth in a number of areas, including the UK, the euro area and Japan, is estimated to be above the long-run sustainable level for these regions. As monetary and fiscal policy become less accommodative, growth is likely to ease towards sustainable limits.

Growth in Australia is expected to pick up to around 2.7% in 2018 and 2019. Business confidence is high and non-mining business investment is increasing, while private consumption growth remains moderate. Employment growth has been strong over the past year, although the unemployment rate has been broadly stable at around 5.5% in recent months. The economy continues to operate with a degree of spare capacity and inflation is low. As growth strengthens, spare capacity is expected to gradually reduce and inflation to increase.

In China, growth rates are expected to decline as the Government continues to shift its focus towards the quality, rather than the quantity, of growth. In particular, the Chinese Government is increasingly focused on how to ensure growth is inclusive and environmentally friendly, while the focus on the pace of growth continues to diminish. This shift to consumption-led growth is likely to see demand for New Zealand exports remain solid, even as growth rates in China decline.

…supports international trade

In the near term, export prices are expected to fall owing to increased production, as weather becomes more supportive of growth. This will likely cause a modest retracement in the terms of trade. Thereafter, growing international demand for New Zealand's commodity exports is likely to see the terms of trade continuing to support nominal GDP (Figure 1.13).

Figure 1.13 - Terms of Trade

Sources: Stats NZ, the Treasury

On the volumes side, export growth is expected to continue to add to real GDP growth over the forecast period. Near-term weakness is expected to fade as domestic weather conditions revert to normal and global demand continues to grow. We have recently changed our modelling framework, which has led us to revisit some of our medium-term judgements (see ‘The Treasury's new macroeconomic forecast model' box below for further detail on our new modelling approach). Since the Half Year Update, the end point for net exports has been lifted. This reflects a higher forecast end point for exports and a lower forecast end point for imports. Revisions to GDP data show that imports make up a smaller share of consumption and investment than previously thought. For exports, insights from our new model have suggested that export growth in the medium term is likely to be higher than we had previously thought, reflecting strong global demand, the shift towards consumption-led growth in China and the potential for trade agreements expanding our current export markets.

Risks around future trading conditions remain. In particular, geopolitical tensions, and protectionist sentiment have intensified in recent months. Our forecasts incorporate announced barriers to international trade. However, if tensions escalate further, or further trade barriers are announced, there would be a number of impacts to the domestic economy. This is explored in further detail in Scenario One in the Risks and Scenarios chapter.

The current account deficit is forecast to widen by less than at the Half Year Update. The December quarter 2017 current account was a deficit of 2.7% of GDP. Over the forecast period, this is expected to widen gradually to 3.1% of GDP in 2022, less of a widening than the 4.1% forecast at the Half Year Update (Figure 1.14). The narrower current account deficit is consistent with a stable net international investment position as a percentage of GDP.

Figure 1.14 - Current account balance

Sources: Stats NZ, the Treasury

Stronger nominal GDP means higher tax revenue

The solid international outlook, high terms of trade, increased government spending, and continued growth in domestic economic activity are all expected to support growth in the nominal economy. Compared with the Half Year Update nominal GDP is cumulatively $46 billion higher over the five years to June 2022. However, $40 billion of this is owing to revisions to the starting point for nominal GDP (Figure 1.16). These revision-related changes are not expected to impact tax revenue as the larger nominal GDP is offset by a lower ratio of tax to GDP over history. This leaves around a $6 billion increase in nominal GDP driven by stronger growth. This increase is expected to contribute to stronger tax revenue.

Figure 1.16 - Change in nominal GDP since the Half Year Update

Sources: Stats NZ, the Treasury

Solid employment and wage growth are forecast to drive growth in compensation of employees and, along with the Families Package, growth in consumption. This supports pay as you earn (PAYE) and GST revenues respectively. Strong export growth combined with a robust domestic outlook will support business profits and corporate tax. Compared with the Half Year Update the combination of stronger growth in the nominal economy, some persistence in the recent strong tax outturns, along with some policy changes, leads to a lift in tax revenue across the forecast period. Over the five years to June 2022, core Crown tax revenue is forecast to be cumulatively $5.7 billion higher than forecast at the Half Year Update. Changes in the macroeconomic forecasts account for $3.4 billion of this increase, while policy changes add $0.7 billion. The remainder is largely owing to recent strong tax outturns. The implications of this stronger tax take are explored in more detail in the Fiscal Outlook chapter.

Fiscal Outlook#

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Overview#

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• The fiscal outlook is strong over the forecast period. The current year's results to 31 March tracked ahead of previous forecast levels as tax revenue has come in higher than that forecast in the Half Year Economic and Fiscal Update 2017 (Half Year Update). This strength has been built into the forecast.
• Core Crown tax revenue increases by $23.4 billion reaching $99.0 billion in 2021/22 (28.3% of GDP). This increase in tax revenue reflects the continued growth in economic activity discussed earlier in the Economic Outlook chapter.
• Budget 2018 provides on average $2.8 billion per year of net new operating spending. The operating allowances for Budgets 2019 to 2021 are now $2.4 billion, an increase of $525 million in each Budget.
• The operating balance before gains and losses (OBEGAL) is expected to continue growing across the forecast period, reaching a surplus of $7.3 billion (2.1% of GDP) in 2021/22.
• In addition to operating expenditure, core Crown capital spending totalling $41.8 billion is included in the forecast to 2021/22. Capital allowances have increased and are set at $3.7 billion for Budget 2019, $3.4 billion in Budget 2020, and $3.0 billion in Budget 2021 onwards, an increase of $300 million in each Budget.
• While revised tax receipt forecasts result in an improvement to operating cash flows, capital spending is still expected to exceed net operating cash flows over the first four years of the forecast period. As a result, residual cash deficits are forecast for these years, before returning to a residual cash surplus in the final year of the forecast.
• To fund these residual cash deficits, net core Crown debt is forecast to increase in nominal terms before tracking down in the final year of the forecast. As a percentage of GDP, net core Crown debt is expected to stay relatively flat over the next four years, before reducing to 19.1% in 2021/22.
• The Crown's balance sheet continues to grow, with net worth attributable to the Crown reaching $154.7 billion (44.2% of GDP) in 2021/22. This growth is largely the result of continued forecast surpluses across the forecast period.
• Total assets are forecast to grow by $61.2 billion to be $374.8 billion by 2021/22, primarily due to growth in physical and financial assets. Total liabilities are expected to grow by $17.4 billion to be $214.5 billion by 2021/22, primarily as a result of increased borrowings and insurance liabilities.
• OBEGAL is expected to be higher in the first three years and lower in the last two years than what was forecast in the Half Year Update. Tax revenue in the first three years is higher than the increased expenditure. Decisions in Budget 2018 and increased future operating allowances results in a reduction in the last two years.
• Net core Crown debt is lower in the first four years of the forecast, but is $0.2 billion higher than the Half Year Update by 2021/22. Additional tax receipts are expected to reduce net core Crown debt by $6.1 billion, however these are more than offset by increased operating and capital expenditure and increased future budget allowances by 2021/22.
• Comparisons against the Half Year Update can be found on page 41.
• The Forecast Financial Statements and Core Crown Expense tables can be found on pages 97 to 134, and provide more detailed information on the fiscal forecasts.
• These forecasts are sensitive to a number of judgements and assumptions and should be read in conjunction with the Risk and Scenarios and Specific Fiscal Risks chapters.

Notes:

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

Source: The Treasury

Core Crown Tax Revenue#

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Core Crown tax revenue is expected to increase over the forecast period…

Core Crown tax revenue (Figure 2.1) is forecast to rise in each year of the forecast period in nominal terms, while remaining relatively stable as a percentage of GDP. By 2021/22, core Crown tax revenue is expected to reach $99.0 billion, $23.4 billion higher than in 2016/17.

Figure 2.1 – Core Crown tax revenue

Source: The Treasury

Recent strength in the tax outturns has been included in the current year of this forecast. Table 2.3 shows the largest tax types leading the way in nominal growth.

Source deductions are forecast to grow by $9.9 billion over the forecast period, with nearly half of that growth coming from forecast wage growth. Growth in employment is expected to add $2.8 billion to source deductions over the forecast period, with a further $1.6 billion from fiscal drag (the effect whereby, owing to the progressive nature of the personal income tax scale, pay as you earn tax (PAYE) growth is boosted by rising average tax rates as wages increase).

Goods and services tax (GST) is forecast to increase by $5.7 billion over the forecast period, mainly owing to expected growth in nominal domestic consumption and a significant contribution from forecast residential investment.

Corporate tax is forecast to grow by $3.5 billion over the forecast period, mainly owing to expected growth in corporate profits.

Source: The Treasury

…in line with a growing economy

The average annual nominal GDP growth over the five years to 2021/22 is forecast to be 5.0%. Over the same period, core Crown tax revenue is forecast to grow at a rate of 5.5% per year on average.

This means that, as a share of the economy, core Crown tax revenue is forecast to increase from 27.6% of GDP in 2016/17 to 28.3% in 2021/22.

Figure 2.2 shows that Core Crown tax revenue growth is forecast to ease in 2017/18, mainly owing to some unusually large one-off effects in the 2016/17 results, which increased corporate tax revenue significantly.

Figure 2.2 – Core Crown tax revenue and nominal GDP growth

Source: The Treasury

Tax revenue is then forecast to grow at a higher rate than GDP, owing to a number of factors:

• Fiscal drag is forecast to add 0.5% of GDP to tax revenue by 2021/22.
• New tax policy measures (eg, ring-fencing of residential property tax losses and GST on low-value goods imports) plus some previously-announced policy measures, such as the Base-Erosion and Profit Shifting rules first introduced in the Budget Economic and Fiscal Update 2017 (Budget Update), are expected to increase tax revenue by 0.4% of GDP over the course of the forecast period.
• A forecast up-swing in deposit interest rates is expected to add 0.3% of GDP in total to resident withholding tax (RWT) on interest.

Somewhat offsetting these increases, some tax types are forecast to grow more slowly than GDP, thereby reducing forecast tax revenue relative to GDP. This occurs mainly within customs and excise duties, owing mainly to trends in tobacco and fuel consumption, and transport-related taxes (such as road user charges and motor vehicle fees), which tend to move more in line with real GDP than nominal GDP. This has the effect of decreasing forecast tax revenue by 0.3% of GDP by 2021/22.

Comparison with Inland Revenue forecasts

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 Treasury's forecasts of core Crown tax revenue are, on average, 0.2% higher than Inland Revenue's forecasts. Most of the forecast differences in tax forecasts arise from differences in the modelling methods used by the respective agencies to forecast some of the larger tax types, particularly source deductions, RWT on interest and road user charges.

This comparison is included in the Additional Information on the Treasury website at https://treasury.govt.nz/publications/budgets/budget-2018

Core Crown Expenses#

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Core Crown expenses are expected to remain stable compared with GDP…

Core Crown expenses, while remaining relatively stable, are expected to peak at 28.5% in 2018/19 before declining to 28.0% at the end of the forecast period (Figure 2.3).

Figure 2.3 – Core Crown expenses

Source: The Treasury

Nominally, core Crown expenses are expected to increase by $21.8 billion from $76.3 billion in 2016/17 to $98.1 billion in 2021/22, an increase of around $4.4 billion each year.

The nominal growth is largely attributable to Budget decisions and new spending set aside for future Budgets. In addition, social assistance spending is forecast to increase by $7.8 billion across the forecast period, largely as a result of the forecast increase in those 65 and over (refer to page 31).

…however, increase in nominal terms primarily owing to Budget spending and allowances…

The increase in core Crown expenditure is made up of a number of factors. Figure 2.4 [8] shows these components across the forecast period relative to 2016/17. Decisions from Budget 2017 and Budget 2018 are expected to add $1.9 billion and $3.5 billion respectively. The 100-Day Plan adds $2.3 billion to core Crown expenditure and allowances add $7.1 billion to forecast future expenditure.

Figure 2.4 – Increase in core Crown expenses, relative to 2016/17

Source: The Treasury

Future operating allowances are currently set at $2.4 billion for Budget 2019 and each subsequent Budget.[9] These forecasts assume any additional costs in relation to government commitments and future cost pressures will be met from operating allowances. For forecasting purposes, these allowances are assumed to be all operating expenditure and are net of identified savings. However, they can be used for a combination of revenue and expense initiatives when allocated.

…an increase in the cost of New Zealand superannuation contributes to expenditure growth…

New Zealand superannuation (NZS) is forecast to increase as recipient numbers increase.

NZS payments account for $4.3 billion of the increase in core Crown expenses over the forecast period. This increase reflects the growth in the number of recipients and the increase in payment rates and other factors. By the end of the forecast period, NZS is around 53% of the core Crown social assistance spending and 18% of core Crown expenditure (compared with 52% and 17% respectively in 2016/17).

Recipient numbers are forecast to increase from almost 717,000 in 2016/17 to over 850,000 by the end of the forecast horizon (an increase of 18.7%). The remaining increase is largely owing to indexation of entitlements to wage growth (Figure 2.5).

Figure 2.5 – Growth of NZS recipients and expenses

Source: The Treasury

…and judgements continue to be made regarding the level of spending

The fiscal forecasts are a culmination of individual forecasts provided by departments and other government entities (a ‘bottom-up' forecast).

Parliament provides the authority for departments to incur expenses (appropriations). History suggests that the actual level of spending is usually below these upper limits and that there is a bias towards over-forecasting expenditure.

This is owing to a number of reasons, such as expenditure being delayed or programmes not being implemented. The Treasury therefore estimates the extent to which expenditure is over-forecast and reduces the forecast accordingly. This adjustment is referred to as a ‘top-down' adjustment (Figure 2.6).

Figure 2.6 – Variance in core Crown expenses to original budget¹

Note

1. Original budget refers to the relevant Budget Update first full forecast year (ie, Original budget for 2017 is Budget 2016).

Source: The Treasury

To make this judgement, the Treasury analyses large departments' forecasts, including the past history of spending against forecasts and appropriations. Without the top-down adjustment the variance to forecast would be much larger.

Source: The Treasury

The top-down adjustment is higher in the 2018/19 year as departments' appropriations (and therefore forecast expenses) tend to be higher in these years, reflecting the flexibility departments have around transferring spending not incurred into the following years.

Operating Balance#

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OBEGAL is expected to climb over the forecast period…

The forecast movement in OBEGAL in the current forecast year largely reflects the higher-than-expected outturn for 2016/17 and the impact of spending decisions made in Budget 2017 (although partially offset by the 100-Day-Plan decisions).[11]

The forecast decline in OBEGAL in the current year is followed by growth in the remaining years of the forecast, as revenue grows at a faster pace than expenditure, reaching a surplus of $7.3 billion in 2021/22 (Figure 2.7).

Figure 2.7 – Components of OBEGAL by segment

Source: The Treasury

Crown entities (CEs) and State-owned enterprises' (SOEs) contribution to OBEGAL remains fairly stable. See pages 99 to 102 for a list of CEs and SOEs.

…while investment returns contribute to the growth in the operating balance

The total Crown operating balance, inclusive of gains and losses, is forecast to be in surplus across all years of the forecast period, and expected to reach $11.7 billion in 2021/22 (Figure 2.8).

Figure 2.8 – Components of operating balance

Source: The Treasury

The 2016/17 gains made on the Crown's large investment portfolios, largely ACC and the NZS Fund, reflected strong performance in the global equity markets. These forecasts then assume investment income returns to a long-term rate, resulting in stable returns going forward.

Partially offsetting these investment gains are expected net losses on non-financial liabilities of $1.6 billion in 2017/18, primarily driven by changes to discount rates used to calculate the ACC claims liability of $0.9 billion (compared with actuarial gains of $0.4 billion in 2016/17). As future actuarial gains or losses are not forecast, they do not impact the operating balance beyond 2017/18.

The level of operating balance plays a significant part in increasing the Government's financial assets and contributing to growth in the Crown's net worth.

Core Crown Capital Spending#

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The Government is forecast to spend $41.8 billion cumulatively on net capital spending over the next five years, similar to the Half Year Update.

In total, Budget 2018 has allocated around $3.8 billion of new capital spending over the forecast period, with the largest areas being health and education. The Government has committed spending on the KiwiBuild programme (refer to page 14). This has been forecast to occur in the first four years of the forecast. Contributions to the NZS Fund have resumed in the current financial year and are forecast to continue across the period. Other key areas of capital spending include the roading network (through New Zealand Transport Agency (NZTA)), schools, City Rail Link and district health boards.

The estimated increase in the forecast capital spend from 2016/17 increases the risk that spending may be pushed into future periods as capacity constraints are tested.

Source: The Treasury

Table 2.8 outlines core Crown capital spending that has a net core Crown debt impact. It excludes capital spending undertaken directly by CEs and SOEs funded from their own resources (including third-party financing).

Approximately $0.6 billion of capital commitments, relating to City Rail Link, Housing Infrastructure Fund and Crown Infrastructure Partners, are expected to fall outside of the forecast horizon.

Capital allowances represent new capital spending expected to be allocated over the forecast period. The capital allowance for each Budget is spread over five fiscal years, reflecting the expected profile of spending. This profile is illustrated in Figure 2.10.

Figure 2.10 – Future capital allowances

Source: The Treasury

Capital allowances are set at $3.7 billion for Budget 2019, $3.4 billion in Budget 2020 and $3.0 billion in Budget 2021 onwards. These allowances are expected to add $6.0 billion in total to the forecast period, with $6.0 billion expected to fall outside the forecast period.

Residual Cash and Net Core Crown Debt[15]#

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After an initial decline, operating cash flows are expected to improve across the forecast period…

After initially declining, net operating cash flows are expected to rise over the forecast period. However, capital spending is forecast to exceed operating cash flows in the first four years of the forecast resulting in a forecast residual cash deficit in these years.

As capital spending steadies and forecast tax receipts continue to grow at a faster pace than operating payments, a residual cash surplus is forecast in the final year of $0.7 billion (Figure 2.11).

This expected growth in operating cash flows largely mirrors the trend shown in OBEGAL and reflects the growth in tax receipts exceeding the growth in operating payments.

Figure 2.11 – Core Crown residual cash

Source: The Treasury

…with net core Crown debt reducing as a percentage of GDP…

Net core Crown debt as a percentage of GDP is expected to decline across the forecast period from 21.7% in 2016/17 to 19.1% at the end of the forecast period (Figure 2.12).

Figure 2.12 – Net core Crown debt

Source: The Treasury

However, as cash flows from operating activities are not expected to be sufficient to meet the increase in core Crown capital spending, nominal net core Crown debt grows until a residual cash surplus is achieved in 2021/22, at which point net core Crown debt is forecast to decline. Net core Crown debt peaks at $67.6 billion in 2020/21 before reducing to $67.0 billion in 2021/22.

This forecast nominal increase in net core Crown debt in the short-term is expected to be funded through a combination of using existing financial assets of the Crown and funds raised through debt.

Net core Crown debt and other relevant debt indicators are discussed further on page 39.

...while overall, gross debt also declines as a percentage of GDP

Gross debt (of which the core Crown borrowing programme is the major component) is expected to decline as a percentage of GDP across the first four years of the forecast (Figure 2.13).

Figure 2.13 – Gross debt

Source: The Treasury

By 2020/21, gross debt is expected to decrease to 24.8% of GDP, from 31.8% at the end of 2016/17. In the final year of the forecast, gross debt climbs again to 25.2% of GDP, as steady bond issuance continues during a year with no forecast bond maturity.

The Government recognises the importance of maintaining a sustainable New Zealand Government Bond (NZGB) market. This is necessary to:

• Ensure ongoing government access to debt funding, supporting fiscal resilience in the event of future economic shocks.
• Reduce volatility of government borrowing programmes through economic cycles.
• Provide wider capital markets benefits, including reliable pricing benchmarks for other issuers.

As previously confirmed, the Government intends to maintain levels of NZGBs on issue at not less than 20% of GDP over time.

The core Crown borrowing programme includes forecast issuance for both government bonds and short-term borrowing (eg, Treasury Bills). Table 2.9 shows the bond programme is expected to raise funds of $37.8 billion over the forecast period. Bond maturities will result in $35.4 billion of existing debt being repaid. Short-term borrowing is expected to be $2.0 billion lower at the end of the forecast period.[16]

Source: The Treasury

Total Crown Balance Sheet#

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Growing operating balance surpluses result in a stronger balance sheet…

Figure 2.16 shows that in nominal terms, net worth attributable to the Crown has recovered from the decline that began in 2008 and is expected to grow across the forecast period reaching $154.7 billion by 2021/22. As a percentage of GDP net worth attributable to the Crown is forecast to reach 44.2% by 2021/22, albeit still below the peak of 55.6% in 2007/08.

Figure 2.16 – Net worth attributable to the Crown

Source: The Treasury

…reflected through continued asset growth over the forecast period…

Total assets are forecast to grow by $61.2 billion over the forecast period to $374.8 billion in 2021/22, made up of additional investments in assets, both physical and financial (Figure 2.17).

Figure 2.17 – Total Crown assets

Source: The Treasury

The largest asset growth over the forecast period is in the social assets portfolio (around 52% of the total Crown balance sheet). Social assets (eg, schools, hospitals, social housing and infrastructure) are expected to increase by $31.6 billion over the forecast period to be $194.3 billion in 2021/22. This increase largely reflects the capital spending discussed earlier (refer to page 35).

...and a slower rate of growth is expected for the Crown's liabilities…

The Crown's liabilities across the forecast period reach $214.5 billion by 2021/22, an increase of $17.4 billion, primarily owing to the expected increase in total Crown borrowings of $13.6 billion and insurance liabilities. Insurance liabilities are expected to increase by $7.4 billion (17.4%), owing to an increase in the ACC claims liability (reflecting a growth in both volume and cost of claims), while the EQC and Southern Response liabilities are both expected to decrease ($1.6 billion and $0.7 billion respectively).

…the Crown's balance sheet remains sensitive to market movements

Many assets and liabilities on the Crown's balance sheet are measured at fair value to show current estimates of what the Crown owns and owes. This 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.

The Specific Fiscal Risks and Risks and Scenarios chapters include a section on balance sheet risks and should be read in conjunction with the fiscal forecasts.

Comparison to the Half Year Update#

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The Half Year Update was published on 14 December 2017. Since then, there have been a number of developments that have impacted the fiscal outlook. Table 2.10 below summarises the changes in the key fiscal indicators.

Source: The Treasury

Core Crown tax revenue is expected to be higher than the Half Year Update...

Core Crown tax revenue is forecast to be $5.7 billion higher than in the Half Year Update over the five-year period up to 2021/22 (Table 2.11).

The increase is spread across a number of tax types:

• Source deduction revenue forecasts increased by $2.5 billion in total across the forecast period, mainly owing to a higher track for forecast employment growth which has been boosted by the change in the migration assumption (refer to page 17), particularly towards the end of the forecast period.
• GST forecasts have increased by $1.7 billion in total. The majority of this increase is owing to the current year's strength in residential investment and private consumption, with a further $0.5 billion arising from revised economic forecasts, particularly net tourist spending in New Zealand and residential investment. In addition, approximately $0.2 billion is expected to be raised within the forecast period from the collection of GST on low-value goods imports.
• Net other persons' tax revenue forecasts are in total $1.0 billion higher than in the Half Year Update, with $0.3 billion expected to be raised from the ring-fencing initiative within the forecast period, and most of the remainder coming from a higher outlook for growth in entrepreneurial income.

Forecasts of other tax types are, in total, similar to the Half Year Update values.

Source: The Treasury

…while OBEGAL growth slows across the period, as new spending takes effect…

The major movements in OBEGAL since the Half Year Update are outlined in Table 2.12 below. Cumulatively, OBEGAL is $0.4 billion lower across the forecast period.

Source: The Treasury

Core Crown tax revenue has increased as a result of both forecasting changes and changes in tax policy (refer to page 41 for a discussion of the increase in tax revenue since the Half Year Update).

Future Budget operating allowances have increased since the Half Year Update and impact on the last three years of the forecast. The updated allowances are $2.4 billion for Budget 2019 and all subsequent Budgets. This is higher than was previously forecast and results in a reduction in OBEGAL across the forecast period compared to the Half Year Update.

Budget 2018 new operating spending has reduced OBEGAL across the forecast period. This primarily relates to higher expenditure for Budget 2018 when compared with what was previously forecast in the Half Year Update for Budget 2018. For further information on Budget 2018 new operating spending, refer to the box on page 30.

Social assistance spending has increased since the Half Year Update with forecasting increases mainly caused by an increase in expected NZS recipient numbers and wage revisions. These increases are partly offset by a lower CPI track compared to the Half Year Update.

Net core Crown finance costs have reduced across the forecast period largely owing to a reduction in interest expense along with a small increase in interest revenue. This change is driven by changes in the Crown's mix of financial assets and liabilities.

Updated ACC forecasts have resulted in a decrease in OBEGAL across the forecast, largely owing to a growth in claim volumes and higher insurance expenses compared with that forecast at the Half Year Update. An updated valuation of EQC's outstanding claims liability has resulted in an increase in insurance expenses in the current year since the Half Year Update.

...and net core Crown debt is higher across the forecast period compared with the Half Year Update

Core Crown residual cash is $0.8 billion lower than the Half Year Update. This results in an increase to net core Crown debt, which is expected to be around $0.2 billion higher than previously forecast across the forecast period (Table 2.13).

Source: The Treasury

Increases to both the operating and capital allowances for future budgets, as well as the increases in Budget 2018, have increased net core Crown debt by $5.3 billion across the forecast.

In addition to the new Budget 2018 capital decisions, there have been a number of changes to phasing assumptions to existing capital programmes such as KiwiBuild and the Crown Infrastructure Partners programme which together result in a $0.1 billion decrease in net core Crown debt by the end of the forecast period.

Tax receipts have increased across the forecast period since the Half Year Update while social assistance payments have also increased. These are largely consistent with the OBEGAL movements discussed earlier although with slightly different profiles, reflecting the timing difference of when cash is received or payments are made.

Net finance costs have reduced by $0.3 billion across the forecast period since the Half Year Update. This is largely owing to the change in interest receipts exceeding the change in interest costs as a result of higher short-term interest rates.

Key Economic Assumptions used in the Forecast Financial Statements#

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

A summary of the key economic forecasts that are particularly relevant to the forecast financial statements is provided in Table 2.14 below.

Notes:

1. Production measure.
2. Expenditure measure.

Source: The Treasury, Statistics New Zealand

Risks and Scenarios#

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Overview#

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• This chapter discusses some of the key risks facing the economy and uses two alternative scenarios to assess the implications of different assumptions and judgements.
• Scenario One shows the impact of growing trade protectionism, which leads to weaker trading partner growth, lower prices for New Zealand commodities and less nominal gross domestic product (GDP). Scenario Two shows how higher net migration would lead to a stronger business cycle and boost nominal GDP.
• More generally, the outlook for the domestic economy may differ from the forecast in the Economic Outlook chapter in a number of ways. Growth in real residential investment may be weaker than forecast if capacity constraints are more binding than assumed. If capacity generally is more stretched than assumed, less growth is possible before increased inflationary pressures result in the need for higher interest rates. Higher wage growth or lower unemployment have the potential to keep net migration higher for longer, which would likely lead to higher house prices and consumption growth.
• Changes in the international economy also have the potential to impact the economic outlook. Stronger-than-forecast growth in our trading partners could increase demand for exports and result in higher terms of trade. A more rapid tightening in monetary policy in the US could lead to higher global interest rates and weaker growth. Geopolitical tensions and growing trade protectionism also remain as risks to the global economy.
• The Crown's balance sheet is exposed to a number of risks beyond those associated with the operating balance. The Crown's financial position is exposed to risk through changes in the value of the Crown's assets or liabilities and through the potential impact of the Crown's fiscal obligations that arise from policy choices.

Risks to the Economic and Fiscal Outlook#

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Key risks are discussed below, and the section that follows presents two alternative scenarios. Key risks are those that are either relatively likely to occur, or would have a significant impact to the economy if they did. Risks to the economic outlook represent risks to the Government's fiscal position, because tax revenue varies with the performance of the economy.

Supplementing this, the Specific Fiscal Risks chapter details potential government decisions, contingent liabilities and contractual obligations that may also have a material impact on the economic or the fiscal outlook.

Less spare capacity in the economy could lead to higher inflation…

Capacity constraints in the economy may be more binding than assumed. Strong population growth, high house prices and low interest rates have motivated strong household consumption, boosting demand in the economy. To keep pace with growing demand, businesses have been expanding, with increasing reports of difficulty finding labour and the unemployment rate falling steadily to 4.4% in March 2018, from 5.3% in December 2016.

The risk from capacity pressures being stronger is that less economic growth is possible before it begins to drive up inflation. Costs and prices are bid higher as businesses struggle to keep up with demand.

There is also uncertainty around how quickly higher inflation returns. Weak inflation over recent years has weighed on expectations, making businesses slow to increase prices in order to stay competitive. Lower expectations could persist even with early signs of inflation, or expectations could turn around sharply, leading to an acceleration in inflation.

…leading to higher interest rates and less real growth

The emergence of stronger inflation would likely see monetary policy respond via higher interest rates. Higher inflation would boost nominal growth, but higher interest rates would constrain real growth. Businesses invest less with higher borrowing costs and households switch away from spending now in favour of investing for a higher return or paying down debt. Households could be especially sensitive to higher interest rates, given that current levels of household debt are at record highs relative to income.

The risk that capacity is tighter than expected also applies to the rest of the world. Tighter world capacity would raise the cost of sourcing funding overseas for New Zealand banks, and could cause the New Zealand dollar to depreciate with capital leaving the country in search of a better return. If both New Zealand and the rest of the world had tighter capacity than expected, we could see a compounding effect on interest rates in New Zealand, slowing economic growth. However, a lower New Zealand dollar would likely provide some offset by boosting export returns.

Alternatively, tight capacity could be specific to construction

Rather than being generalised, capacity pressures may be more concentrated in particular sectors. To the extent that spillover effects on general prices were limited, this may exert less pressure on interest rates. Capacity is particularly stretched in the construction sector, especially in the form of labour shortages. The construction sector also faces constraints, like credit restrictions and limited land supply. Limited capacity could prevent KiwiBuild from adding to residential investment as much as expected, with the risk that it instead substitutes for different developments that would have otherwise taken place.

The Government has identified a number of policies to promote capacity which are factored into the forecasts. Potential policies include KiwiBuild visas to attract more builders, or a focus on modular housing to improve productivity. The exact nature and timing of these policies is still being developed, and so the impact is difficult to assess at this stage. We will update our forecasts as more policy detail emerges or evidence of easing constraints becomes available.

House prices could rise faster…

House price inflation over the past few years has made home owners wealthier and contributed to consumption growth. House prices appeared to be settling down in the middle of last year, but have picked up over the past six months. The re-emergence of stronger price growth is not expected to continue. In part, this is because already high prices are keeping people from entering the market. There are also a number of government policies taking effect from the middle of the year which are expected to limit demand, such as the restriction on foreign buyers. If house prices continue to rise, households may choose to spend more for longer.

…especially if net migration stays higher for longer

The risk of higher house prices is particularly sensitive to changes in migration: if net migration is higher than expected it will add to demand and create further pressure on house prices. There is a high degree of uncertainty when forecasting net migration, especially trans-Tasman flows which are not controlled by visa requirements. If the Australian economy changes relative to New Zealand's, incentives for New Zealanders to leave or return change. We may also see higher arrivals of non-New Zealand citizens. In the central forecast we revised up the end point assumption to a net inflow of 25,000 from 15,000 previously (see page 17 for more on this change). The impact of higher net migration than the central forecast is explored in Scenario Two.

Low business confidence could dampen investment and employment growth

Various measures of both consumer and business confidence fell in the second half of 2017. While consumer confidence appears to have mostly rebounded, business confidence is still well below the average of the past few years. Our current forecasts assume this to be temporary and to have limited effect on investment and hiring decisions. However, there is a risk that the measures of confidence flow through to reduced investment or keep businesses from hiring new staff, and ultimately curb growth. We have heard that a number of businesses expect minimum-wage changes to have little impact on their own activity, but it is possible that uncertainty around any other reforms and their combined impact leads to more cautious behaviour.

Trade growth at risk from volatile weather…

New Zealand experienced volatile weather over the past year, from flooding in the middle of 2017 to drought over the summer. This weather caused weaker-than-expected exports of meat and dairy. As climate change progresses, there is a risk that greater extremes in weather conditions will become the new normal. This hurts exports of dairy, meat and other products, and could impact whether people choose New Zealand as a tourist destination.

At different stages, New Zealand might benefit from extreme weather at the expense of other countries: dry weather limiting the milk production of competitors would boost the price and therefore profits for New Zealand dairy farmers. However, competitors could respond by shifting to less weather impacted alternatives, like synthetic milk products. Climate change is a prevalent issue, but is unlikely to change the economic outlook materially over the forecast period. Dependence on exports vulnerable to weather conditions could adversely affect New Zealand's long-run growth prospects.

…and swings in global equities markets

Asset prices in the US have increased strongly since 2016 and there is a risk that they are overvalued. Asset prices started to fluctuate at the start of this year, perhaps suggesting a slight shift in business confidence, although they have not fallen far from January peaks. A financial market correction may be triggered by expectations of a more rapid tightening in financial conditions, arising from signs of increased inflation pressure in the US. Higher US interest rates would raise the cost of borrowing in New Zealand, but if higher US interest rates triggered a sharp fall in asset prices, they would also lower global business confidence and demand for New Zealand goods overseas.

…and other global developments, including trade protectionism

There is a range of international risks to trading partner growth. There have been developments in trade protectionism, particularly with China and the US imposing new tariffs, and there is potential for more countries to respond. There is still a high degree of uncertainty over the way the economic relationship will evolve between the UK and the EU. The risk remains that conflict in the Middle East could escalate and embroil more countries.

In China, authorities continue to implement measures to address risks in the financial system. Nonetheless, risks remain high given the rapid growth and high level of corporate sector debt, and the lack of transparency in some parts of the system.

We explore a negative shock to global trade growth and prices for New Zealand exports in Scenario One.

Alternative Scenarios#

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The following scenarios show how the economy might evolve if some of the assumptions in the main forecast are altered. They illustrate only two of the many ways that the economy may deviate from the main forecasts.

Scenario One illustrates the economic and fiscal impacts of increasing trade protectionism, particularly focused on agriculture. In this scenario, trading partner growth falls and prices for New Zealand exports fall, leading to a lower exchange rate. New Zealand receives less income from exports and more expensive imports cause slower growth in both consumption and investment. Lower nominal GDP and tax revenues generate a weaker fiscal position.

Scenario Two illustrates the economic and fiscal impacts of higher migration. In this scenario, higher migration pushes house prices higher, and boosts consumption and residential investment. The added growth drives inflation higher and the unemployment rate lower. Stronger nominal GDP and tax revenues generate a stronger fiscal position.

Source: The Treasury

Scenario One - Rise in Trade Protectionism

In the first scenario, increasing trade protectionism causes a general fall in global income growth. We also assume that protection focuses on agriculture, causing commodity prices to fall.

Weaker global income growth triggers a fall in trading partner growth. However, the largest impact on nominal GDP comes from the lower commodity prices, reducing income received from exports and lowering the trade-weighted index (TWI). The lower TWI makes imports more expensive for both consumers and businesses wishing to invest. GDP and tax revenue are lower.

Weaker commodity prices dampen exports and investment…

Weaker commodity prices cause the TWI to fall, with the TWI staying around 8.0% lower over most of the forecast period (Figure 3.1). The volume of goods exported falls by little but the lower prices hurt exporter income (Figure 3.2). Lower commodity prices also cause businesses to anticipate weaker future profits and to carry out less investment.

Figure 3.1 - Trade-weighted index

Sources: Reserve Bank of New Zealand, the Treasury

Figure 3.2 - Annual growth in nominal goods exports

Sources: Stats NZ, the Treasury

...and lower real wages lead to less real consumption growth

Higher import prices cause tradables inflation to rise more strongly, lifting overall consumers price index (CPI) inflation. Nominal wages are slow to adjust to higher inflation, and less investment eases pressure in the labour market, making real wages lower. Weaker real wages reduce growth in real consumption.

The weaker economy lowers labour demand, and the unemployment rate does not fall below its current rate of 4.4%, compared with a low of 4.1% in the central forecast.

On the positive side, the weaker dollar attracts more visitors to New Zealand, causing a slight lift in services exports.

Weaker economy causes slower rise in interest rates

Despite stronger inflation, the weaker economy means interest rates rise more slowly than they do in the main forecast. Lower interest rates provide some offset to weaker economic activity, but annual growth in real GDP is still lower throughout the entire forecast period.

…with a much larger current account deficit

The lower TWI leads to a fall in nominal net exports, causing the current account deficit to expand to 4.8% of GDP by the end of 2019. The current account deficit stabilises near 4.6% of GDP, compared with 3.1% in the central forecast.

…and lower GDP and tax

Nominal GDP is lower by around $26 billion cumulatively by June 2022 compared with the main forecast and results in lower tax revenue of $6.4 billion.

In this scenario, we assume that the Government's operating and capital allowances are unchanged from those in the main forecast. Operating balance before gains and losses (OBEGAL) surpluses are smaller in each year, reaching $5.4 billion (1.6% of GDP) in 2022 (Table 3.1 on page 51). This is $1.9 billion lower than in the main forecast. The Government's debt position is also weakened, with the level of net core Crown debt $6.7 billion higher by June 2022, at 21.4% of GDP (Figure 3.3).

Figure 3.3 -  Net debt as a percentage of GDP

Sources: Stats NZ, the Treasury

Scenario Two - Higher Net Migration

In this scenario, net migration stays higher for longer, owing to both fewer New Zealanders leaving for Australia and stronger net arrivals of non-New Zealand citizens. Fewer New Zealanders leave for Australia if our wages rise faster and people have better employment prospects here. We assume the end point to be an inflow of around 40,000 people (see page 17 for more detail on forecasting migration).

Higher migration pushes up house prices, consumption and residential investment. The added growth drives inflation higher and the unemployment rate lower. Nominal GDP is stronger and tax revenue increases.

Figure 3.4 - Net permanent and long-term migration

Sources: Stats NZ, the Treasury

Higher net migration drives higher house prices, consumption and residential investment…

Higher net migration adds around 60,000 people cumulatively to the economy, compared with the main forecast. The additional people increase demand for housing, and house prices are around 7% higher by 2022. Higher house prices stimulate faster growth in residential investment.

The combination of more people in the country and higher house prices creating a wealth effect fuels stronger consumption growth. In response, businesses are motivated to increase investment to reduce capacity pressures and boost capital stocks.

…leading to lower unemployment, and higher inflationary pressures and interest rates

The stronger migration cycle creates greater demand, and labour supply takes some time to respond. This drives a fall in the unemployment rate, higher inflation and a faster increase in interest rates (Figure 3.5).

Figure 3.5 - 90-day interest rates

Sources: Reserve Bank of New Zealand, the Treasury

In the long-run, after additional investment has been created, the supply impact from increased migration more or less matches demand. Under this scenario, we assume a permanent increase in long-run population growth, consistent with a net inflow of around 40,000 people.

GDP increases, generating additional tax revenue

Stronger real growth combined with higher inflation result in nominal GDP being around $12 billion higher cumulatively than in the main forecast by June 2022. Total tax increases by $5.1 billion over the forecast. Resident withholding tax (RWT) increases by most as a percentage, and is around 20% higher in June 2022. RWT is charged on deposit earnings, which increase with higher interest rates.

Under this scenario, it is likely both operating and capital expenses would be higher. However, as in Scenario One, it is assumed any changes in expenses are met from the Government's operating and capital allowances, and therefore remain unchanged. OBEGAL surpluses increase to $9.7 billion (2.7% of GDP) in 2022. Net debt is lower across the forecast period.

General Uncertainties in the Economic and Fiscal Outlooks#

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While the chapter thus far has focused on key assumptions and judgements that may eventuate differently and alter our main forecasts, there are almost limitless ways the economy could evolve. It can therefore be useful to assess the general uncertainties in our forecasts and the sensitivity of these forecasts to changes in the economy.

The wide range of economic outcomes can be illustrated using fan charts that show the uncertainty in our forecasts. Figure 3.6 shows a fan chart of nominal GDP.[18] The width of the fan increases further into the forecast period, meaning the further away from the present the more uncertainty there is around the main forecast. The combined blue and green areas of the fan show where nominal GDP is expected to be 90% of the time. At the end of the forecast period, this is within +/-7% ($24.3 billion per year) of the main forecast. The green area of the fan shows where nominal GDP is expected to be 70% of the time. At the end of the forecast period, this is within +/-4.4% ($15.3 billion per year) of the main forecast. In the two scenarios considered in this chapter, nominal GDP forecasts remain within the green area fan (70th percentile).

Figure 3.6 - Nominal GDP fan chart

Sources: Stats NZ, the Treasury

The amount of tax revenue the Government receives in a given year is closely linked to the performance of the economy. For example, lower private consumption could mean less revenue from goods and services tax (GST), while higher unemployment could mean less revenue from taxes on wages and salaries.

Figure 3.7 shows the uncertainty surrounding the main tax revenue forecast.[19] At the end of the forecast period, the combined blue and green areas capture a range of approximately +/-$11.2 billion, within which actual tax outturns are expected to fall 90% of the time.[20]

Figure 3.7 - Tax revenue fan chart

Source: The Treasury

The fiscal position is also impacted by changes in government expenses, which may also be impacted by economic developments. For example, the demand for working-age benefits is closely linked to labour market conditions. Changes in net migration flows may also impact on the demand for central government services, particularly health, education and publicly funded infrastructure. Over the longer term, current policies imply population growth and population ageing will place increasing pressure on public expenditure, particularly in health and superannuation.[21]

Fiscal Sensitivities#

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While significant economic shocks will naturally flow through to changes in the fiscal position, even small changes to the economic outlook can have a fiscal impact. Table 3.2 sets out 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 2022, tax revenue would be around $5.1 billion higher than forecast in the June 2022 year as a result. The sensitivities are broadly symmetric: if nominal GDP growth is one percentage point lower than expected each year, tax revenue would be around $4.9 billion lower than forecast in the June 2022 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 the forecast would also impact the fiscal position owing to the effect on the portfolios of various government reporting entities, such as the New Zealand Superannuation Fund (NZS Fund), Accident Compensation Corporation (ACC) and the Treasury's New Zealand Debt Management Office (NZDMO). For example, at 30 June 2017, a 1.0% increase in New Zealand interest rates would have reduced the total Crown operating balance by $946 million, while a 1.0% decrease would have increased the total Crown operating balance by $1,122 million. The majority of the Government's borrowings and a large number of financial assets are managed by NZDMO. To illustrate the interest rate sensitivities on the NZDMO portfolio, Table 3.2 provides the estimated impact of lower interest rates on those assets and liabilities.

Note:

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

Source: The Treasury

The forecast financial position is based on a number of judgements and assumptions about the future. To inform these judgements and assumptions we rely on market information. Some additional assumptions include those around foreign exchange rates, share prices, the carbon price and property prices. Where the actual outcome differs from our assumptions, the Crown's actual financial position and operating balance is likely to differ from the forecasts. For example, a strengthening of share prices may result in higher returns from the Government's direct share investments.

Balance Sheet Risks#

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The Crown's balance sheet is exposed to a number of risks beyond those associated with OBEGAL. These risks affect the Crown's financial position through changes in the value of its assets or liabilities, along with the potential impact of the Crown's explicit (through policy settings) and implicit (a strong expectation the Crown would respond to an event) obligations.

Main source of balance sheet risk

A large source of balance sheet risk is owing to movements in market variables, which change the value of the Crown's assets and liabilities. As noted earlier, these changes may also impact the Crown's operating balance. Three areas of the balance sheet are particularly susceptible to market risk:

• Financial assets held by the Crown financial institutions (CFIs) are sensitive to financial-market volatility, such as movements in interest rates, exchange rates and equity prices. CFIs tend to diversify their portfolios across a range of financial assets to manage exposures to specific types of market risks.
• Insurance and retirement liabilities are prone to volatility through their actuarial valuations, including changes to expectations of future interest rates 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 sources of balance sheet risk

• Business risk: A number of commercial entities owned by the Crown have their financial performance and valuations impacted by the commercial environment they operate in.
• Funding risk: 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. In the case of an increase in global risk aversion in the future, New Zealand may face increased funding pressure. All else equal, a deterioration in the ratings outlook could raise debt-servicing costs and lessen the funding capability for the Crown.
• Liquidity risk: The Crown incurs liquidity risk with respect to its ability to raise cash to meet its obligations. This risk is managed by each agency to meet their specific liquidity risk requirements and by the Treasury's NZDMO to manage the Crown's liquidity requirements.
• Contingent liabilities: The Crown faces contingent liabilities; for example, relating to natural disasters and financial system stress. The Specific Fiscal Risks chapter discusses contingent assets and liabilities in greater detail.

Managing risk

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. However, some risks cannot be reduced. Maintaining debt at prudent levels and holding a healthy level of net worth helps manage residual risks and increases the Crown's resilience to shocks. A strong balance sheet helps by absorbing the impact from risks so that the wider economy does not need to adjust immediately, at a greater economic cost. A strong balance sheet also provides the Government fiscal space and choices on how it can respond to shocks.

Investing for Wellbeing: The 2018 Investment Statement He Puna Hao Pātiki discusses the importance, principles of and progress towards good balance sheet management, and explores how it can be extended to incorporate the Treasury's Living Standards Framework.

Specific Fiscal Risks#

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Overview#

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This statement of specific fiscal risks is required by the Public Finance Act 1989. In addition to the discussion of risks to the economic and fiscal forecasts presented in the Risks and Scenarios chapter (Chapter 3), it sets out (to the fullest extent possible) all government decisions and other circumstances known to the Government that may have a material effect on the fiscal outlook, but that are not certain enough in timing or amount to include in the fiscal forecasts. This chapter covers:

• the nature of fiscal risks to the economic and fiscal outlook
• how risks set out in the chapter are managed
• criteria for inclusion and exclusion of fiscal risks in this chapter
• statement of specific fiscal risks
• contingent liabilities and assets.

The risks disclosed in this chapter reflect those that are known at the date of the finalisation of the fiscal forecasts, 26 April 2018. Although the process for disclosure of specific fiscal risks involves a number of entities, including government departments, the Treasury and the Minister of Finance, there remains a possibility that not every significant risk is identified.

Nature of Risks to the Economic and Fiscal Outlook

Risks can be positive or negative, and can affect revenue and spending or assets and liabilities. The table below reflects a wide range of potential risks that may exist to the economic and fiscal forecasts.

Risk types 1 to 3 below are in the scope of this chapter, whereas risk types 4 and 5 were covered in the Risks and Scenarios chapter. Further detail on the criteria for disclosing a specific fiscal risk is set out in a section below.

How Risks Outlined in this Chapter are Managed

A key principle guiding the disclosure of risks is transparency. This means that risks are disclosed in this chapter regardless of whether they can be managed through existing funding sources (eg, through reprioritisation of funding already available to departments) or the Budget operating and capital allowances (future new spending built into the fiscal forecasts). This is done to ensure a prudent approach to the disclosure of risks, to improve transparency and to avoid prejudging future decisions by governments about what may or may not be funded from allowances.

The Government has a number of options to manage the risks disclosed in this chapter. Therefore, the risks disclosed in this chapter may not arise in a way that affects the fiscal forecasts presented in this Economic and Fiscal Update.

1 Re-prioritisation

Core Crown expenses for the year ended 30 June 2017 were $76.3 billion, while capital spending for the same period totalled $3.7 billion. Agencies are expected to fund pressures and new activities from within the funding already allocated to them. This could include repurposing low-value expenditure or generating efficiency savings.

2 Budget allowances

The following allowances for new expenditure have been signalled in the Government's Fiscal Strategy Report (FSR) and been included in the Treasury's fiscal forecasts (Fiscal Outlook chapter, Chapter 2).

These allowances are included in the fiscal forecasts to reflect future new spending by the Government and better link the forecasts to the Government’s fiscal strategy. This means that new spending decisions in future Budgets should not impact the Government’s fiscal targets.

The allowances are the main mechanism for the Government to allocate new expenditure each Budget. It does this through providing a self-imposed limit on expenditure that helps to ensure any new spending is targeted to areas of high priority. The allowances have been set at a level that allows the Government to achieve its broader fiscal and policy objectives and under the expectation that any new policy initiatives and cost pressures can be managed within these parameters.

3 Policy choices

For a number of risks, the Government has choices around future funding, including how much is funded and the timing of funding.

Criteria for Inclusion in Either the Fiscal Forecasts or as a Specific Fiscal Risk

Specific criteria based on section 26U of the Public Finance Act 1989 determine what is included in the fiscal forecasts as opposed to what is disclosed as a specific fiscal risk.

Change in the Treatment of the Disclosure of Cost Pressure Risks

In previous years, the Specific Fiscal Risk chapter has aggregated together a generic risk on future cost pressures agencies may face. To provide more transparency to the reader on these risks the chapter now separately discloses sectors that are likely to be significantly impacted by future cost pressures. This change has resulted in some risks previously being aggregated as a cross-portfolio risks now being disclosed as separate specific fiscal risk.

General Risks Not Included in this Chapter

A range of general 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 the Risks and Scenarios chapter (Chapter 3).
• Business risks and volatility in the returns from, and valuation of, the Government's investments relating to the broader economic and commercial environment.
• 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. Specific risks are disclosed at that point based on the range of possible responses.

Exclusions to Disclosure

Additionally, the Minister of Finance may determine, under section 26V of the Public Finance Act 1989, that a matter not be included in the fiscal forecasts or a specific fiscal risk not be disclosed, if such disclosure is 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 Government in a material way in negotiation, litigation or commercial activity, or
• result in a material loss of value to the Government.

Section 26V requires the Minister of Finance, if possible, to avoid withholding the matter, either by making a decision on it before the forecasts are finalised, or by disclosing it without quantifying the risk.

Contingency Liabilities and Assets

The final part of the chapter contains a current list of contingent liabilities and contingent assets. Contingent liabilities are costs the Crown will have to face if a particular event occurs or are current 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 for which the value of the asset, or whether it will eventuate, will not be confirmed until a particular event occurs.

Summary Table#

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

The table below is categorised based on the nature of the risk: policy changes, cost pressures and cross-portfolio risks. Within these categories, the risks have been ordered by portfolio and include the title of the risk, its status and whether it has an impact on revenue, expenses or capital expenditure. The status of the risk describes whether the risk reflects a new matter or is changed or unchanged since the Half Year Economic and Fiscal Update 2017 (Half Year Update).

Statement of Specific Fiscal Risks as at 26 April 2018

Policy Change Risks by Portfolio#

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The following section outlines risks relating to potential decisions likely to be taken by the Government relating to both new and existing policy settings.

Accident Compensation

Impacts of Changes to Accident Compensation Policy Settings (Unchanged)

The Government has signalled it will review a number of Accident Compensation scheme policy settings. Each change could result in a potential aggregated impact on expenses in excess of $100 million per year. However, all of the policy issues identified would require either legislative or regulatory change and are therefore uncertain.

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.

Biosecurity

Mycoplasma Bovis Biosecurity Response (New)

The Ministry for Primary Industries is currently managing the response to the cattle disease Mycoplasma bovis. Response options range from long-term management to full eradication, and costs are dependent on the approach taken. Any approach is likely to be a large-scale response, and the Ministry is unlikely to be able to meet operational and biosecurity costs within its baseline.

Broadcasting, Communications and Digital Media

Increased Public Broadcasting Funding (Unchanged)

The Government has committed to transforming Radio New Zealand into a multi-platform provider, including a free-to-air non-commercial television service, and the establishment of a new Public Media Funding Commission to recommend directly to Parliament funding for public broadcasting on a three-yearly rolling cycle. A Ministerial Advisory Group on public broadcasting has recently been established to advise how to support the contribution of public and private media to an informed democracy. While $15 million has been set aside in a contingency in Budget 2018 to implement any immediate recommendations of the Ministerial Advisory Group, further funding may be required in the future to address the Government's long-term intentions for the public media system.

Children

Oranga Tamariki Future Operating Model (Title changed, substance of risk unchanged)

Changes to the Oranga Tamariki Act 1989 coming into effect no later than 1 July 2019 include, for example, extending the scope of the Ministry to provide more support for young people aged 18 to 25. To the extent that the costs associated with the Ministry's new functions cannot be funded from within baselines, additional funding is likely to be required.

Customs

Joint Border Management System Further Development (Unchanged)

The new functionality of Tranche 1 of the Joint Border Management Systems (JBMS) went live in 2017. Customs and the Ministry for Primary Industries will now implement Tranche 2 through a series of smaller projects that will either enhance or replace elements of the current systems with the aim to realise the full benefits to the Crown and industry of the JBMS programme. Funding for these projects may be required.

Defence

Defence Funding Requirements under the Defence White Paper 2016 (Title changed, substance of risk unchanged)

In 2016, the previous Government reconsidered New Zealand Defence Force (NZDF) capability and funding requirements through the Defence White Paper 2016. The Government has indicated it will re-examine the Defence procurement programme within the context of the existing indicative funding for the Defence White Paper. It is expected that changes to NZDF operating and capital funding will be made over the forecast period to achieve the Defence White Paper settings. However, the precise quantum and timing of these changes will be dependent on a range of business cases that will be considered by Cabinet in the future.

Disposal of New Zealand Defence Force Assets (Unchanged)

The Government is considering the potential to dispose of a number of New Zealand Defence Force (NZDF) assets. Depending on market conditions, the timing of disposal and sale price received there could either be a positive or negative impact on the Government's overall financial position. NZDF regularly completes an analysis of inventory that is surplus to requirements and that is over and above the existing provision for obsolescence. The existing provision is reviewed regularly to ensure that all items comprising the provision are still relevant.

Replacement of the P3 Orion Air Fleet (New)

The P3 Orion air fleet is nearing the end of its useful life, so the Government may need to consider a suitable replacement. To the extent the purchase of the replacement aircraft cannot be managed within existing baselines, funding may need to be provided by the Crown.

Education

Additional Funding for Schools in Lieu of Parental Donations (New)

The Government has indicated that it will provide additional annual funding of $150 per student to those state and state-integrated schools that do not request donations from parents. The fiscal impact of this policy is uncertain at this point, as it will be driven by the level of uptake by eligible schools.

Addressing School Property Condition (New)

The Government has made a commitment to accelerate property works on school buildings in poor condition. It is possible this commitment will be unable to be met through existing baselines and therefore may require additional funding from the Crown.

Extension of the Fees-free Tertiary Education Policy (Unchanged)

The Government has committed to expand fees-free tertiary education to two years from 2021 and three years from 2024. The Government has indicated that the timeline for the third year may be brought forward depending on economic conditions. The behavioural changes from extending the policy, and therefore the impact on future costs, are unquantifiable at this early stage but there is an expected general increase in demand for tertiary education beyond the forecast period.

Possible School of Rural Medicine (Unchanged)

In August 2017, the previous Government agreed in principle to the establishment of a School of Rural Medicine, in part as a response to two proposals, one from the University of Waikato and Waikato District Health Board (DHB), and a joint proposal from the universities of Auckland and Otago. The previous Government also noted that funding would be required for the establishment of the school, and its operating costs, and this would be sought through future Budgets. The proposal represents a fiscal risk, as no funding has been set aside if the Government decides to progress it.

Reinstating Higher Funding Rates for Early Childhood Education Services (New)

The Government has indicated it will reinstate higher hourly funding rates for early childhood education (ECE) services with 100% qualified teachers as were a feature of the ECE funding system until February 2011. The fiscal impact of this policy depends on the number of providers with fewer than 100% certificated teachers that respond by moving to 100%, the speed at which they do so and the higher funding rate chosen. These variables are uncertain at this time.

School and Early Childhood Education Funding Review (Unchanged)

The previous Government made decisions on the Review of Education Funding Systems across the schooling and ECE sectors, agreeing that for state and state-integrated schools, ECE services and ngā kōhanga reo the decile system would be replaced by a predictive risk index to allocate funding, and to help overcome educational disadvantage. The current Government plans to take forward the review of funding arrangements, consistent with the objective of barrier-free access, but further work will be done on whether to proceed with the decision to replace the decile system. Depending on the decisions made, any revisions to the way funding is allocated may have expenditure implications.

Foreign Affairs

Hosting the Asia Pacific Economic Cooperation Forum 2021 (Changed)

The New Zealand Government has committed to hosting the Asia Pacific Economic Cooperation (APEC) Forum in 2021. This will involve hosting meetings and events throughout the year, culminating in Leaders' Week in Auckland in November.

Some funding for the operations and hosting components of APEC has been allocated through Budget 2018. However, funding has not yet been allocated for the associated security responsibilities and remaining hosting costs (approximately $100 million to $170 million over the forecast period). Funding will also depend on the assessment of threat and risk levels in the lead up to APEC.

Official Development Assistance (Changed)

Each year, New Zealand's Official Development Assistance (ODA) expenditure is measured as a proportion of Gross National Income (GNI). Budget 2018 provides a $714 million increase in funding to lift ODA to 0.28% of GNI over the next four years. The Government sets the overall budget for the New Zealand Aid Programme on a triennial basis. Therefore there remains a fiscal risk that there is a further funding decision prior to the following triennium.

Greater Christchurch Regeneration

Canterbury Earthquake Recovery Residential Red Zone (Changed)

The Crown currently owns a significant area of red-zone property in Christchurch. The Government has a number of options for future use of this land. Depending on the decisions made there may be fiscal impacts.

Christchurch Central Recovery Plan - Anchor Projects (New)

The Crown is partially funding the construction of Anchor Projects as part of the Christchurch Central Recovery Plan. The funding for the construction of Anchor Projects will vary from project to project, dependent on final scope, ownership decisions, implementation and project costs, and may to some extent eventually be recovered. Some projects are under construction while others are progressing through the decision-making process. The construction costs for planned projects will become increasingly clear through the procurement and construction phases, but the cost to the Crown of uncompleted projects may still vary from current projections. The quantum and timing of Crown contribution may differ from that included in the fiscal forecasts.

Health

Dunedin Hospital (New risk, previously included as a cross portfolio risk - Other Capital Cost Pressures)

The Government has signalled its intention to redevelop Dunedin Hospital. Funding has been set aside in Budget 2018 for initial project management, resource consents and design costs for the redevelopment. Once a detailed business case is completed the Government will consider redevelopment options and their costs and funding options.

Housing and Urban Development

Crown Infrastructure Partners (Unchanged)

The previous Government tasked Crown Fibre Holdings (now known as Crown Infrastructure Partners) with negotiating and, where viable, funding Crown investment to enable housing infrastructure development in a manner that accelerates growth. There is a high level of uncertainty in the areas noted below, which may affect the final fiscal impacts:

• the amount invested by the Crown
• the timing and amount of investments
• whether an economic return will be earned on all investments
• the amount and timing of repayments to the Crown.

Healthy Homes (Changed)

As part of the Government's 100-Day Plan, Parliament has passed the Healthy Homes Guarantee Act 2017, requiring all rental homes to be warm and dry. When this legislation comes into force it will require improvements in insulation, ventilation and heating in 30,000 Housing New Zealand properties, which is estimated to cost a minimum of $90 million over the forecast period.

Housing Infrastructure Fund (Unchanged)

In June 2016, the previous Government agreed to establish a $1.0 billion Housing Infrastructure Fund to which high-growth councils could apply to help finance roading and water infrastructure needed to unlock residential development. The previous Government approved in principle funding of $889 million for five councils. The successful councils are now preparing detailed business cases. The first of these has been completed, and negotiations on the detailed funding arrangements are continuing and final agreements are expected later this year. Actual expenditure may vary from what has been included in the fiscal forecasts owing to:

• changes in the agreed spending levels for each project
• the timing and size of drawdowns and of repayments of capital (both annual and final) varying from what is included in the financial forecasts
• the value of interest foregone
• the resultant reduction in the fair value of loans made
• a different split between capital expenditure and operating expenses.

KiwiBuild (Unchanged)

Budget 2018 includes appropriations for the acquisition of land and housing for KiwiBuild, including the guarantees and holding costs of the buying-off-the-plans approach and the monitoring function and machinery of government for KiwiBuild. In addition to the risk that costs will be different from what has been appropriated, the potential establishment of home-ownership products and likely increase in the take-up of the HomeStart grant may also have an impact on fiscal indicators.

Public Housing (Changed)

The Government has committed to taking serious action to end homelessness and improving access to public housing. Increases in demand for public housing may result in pressure to increase spending. The cost of providing public housing can increase owing to increases in market rent and higher quality requirements. If any of these risks eventuate, they may have a significant fiscal impact.

Immigration

Increasing the Refugee Quota (Unchanged)

The Government has indicated that it may increase the refugee quota to 1,500 over three years. An increase would require increased refugee settlement services and have flow-on costs to health, education and welfare. Additional work needs to be completed to properly assess the cost of this change.

Internal Affairs

Archives New Zealand Storage Capacity (Title changed, substance of risk unchanged)

There is insufficient storage capacity in the Wellington region for current and future Archives New Zealand holdings and the Wellington region storage is not fit for purpose. A business case has been prepared to assess the options for the Department of Internal Affairs to continue to meet its statutory and business requirements. The extent of the fiscal risk to the Crown will depend on the costs and funding option that the Government approves.

Justice

Justice Commitments (Unchanged)

The Government has committed to increasing access to justice and reducing and preventing family violence. This includes a commitment to increase Community Law Centre funding, establish a Criminal Cases Review Commission and increase funding to family violence prevention networks. The potential cost and timing of these initiatives is uncertain and will be subject to final Cabinet decisions.

Reducing Family Violence - Increased Investment (New)

Reducing and preventing family violence is a government priority. The Ministry of Justice and the Ministry of Social Development are currently leading the development of a range of potential investment options. While the timeframe and potential costs of this investment are not yet known, and will be subject to a final decision on any reforms in this area, initial estimates are more than $100 million over the forecast period.

Land Information

Upgrading Landonline (Changed)

After exploring a number of options for replacing the outdated Landonline technology to meet the changing technology needs of users and government, Land Information New Zealand is currently preparing a business case for its preferred option for consideration by Cabinet later this year. The extent of the fiscal risk to the Crown will depend on the costs and funding option that the Government approves.

Māori Development

Proposed Māori Land Services (New)

Cabinet has agreed that there are issues with the Crown's administration of Māori freehold land that create challenges for unlocking the value of this land. Cabinet has invited the Ministers of Māori Development and Justice to return to Cabinet with options for resolving these issues and responding to these challenges. The draft business case indicates that the recommended option will have estimated costs of around $150 million over five years.

Regional Economic Development

Provincial Growth Fund (Changed)

The Government has committed to a Provincial Growth Fund of $3.0 billion over a three-year period. The Provincial Growth Fund supports projects that lift regional productivity potential. Budget 2018 provides $1.0 billion with additional funding of $2.0 billion being sought in Budgets 2019 and 2020. The exact capital and operating split of this further funding is yet to be determined, so this cannot reliably be included in the fiscal forecasts.

Revenue

Potential Tax Policy Changes (Changed)

The tax policy work programme can be viewed on the tax policy website www.taxpolicy.ird.govt.nz. The fiscal implications of many of the policy topics under review are unquantified at this stage and the outcomes of the Tax Working Group are yet to be determined. Moreover, while the expected impact of certain policy items (eg, goods and services tax (GST) on imported goods and loss ring-fencing) has been included in the baseline forecasts, the impacts of the final policies may differ from the amounts included.

Social Development

Changes to the Welfare System (Changed)

The Government has committed to overhauling the welfare system to ensure it is fair and accessible for all New Zealanders. The behavioural change associated with overhauling the system is unknown. Such changes could have an impact on the operating balance.

Removal of Section 70A of the Social Security Act 1964 (New)

Section 70A of the Social Security Act 1964 reduces the amount of benefit payments owed to sole parents who do not disclose the identity of the other parent of their child and/or apply for child support, subject to some exemptions. The Government has indicated a commitment to remove this section from the Act, which will see more sole parents receive the full main benefit. The exact behaviour change associated with the removal of this section, in terms of applications for child support, is unknown. However, it is expected that it will lead to the cost of removing the sanction increasing over time as the amount of child support retained by the Crown each year decreases.

Tourism

Queenstown Tourism Infrastructure (New)

The Government will be asked to consider a contribution to Queenstown Lakes District Council for tourism-related infrastructure owing to the area's high ratio of visitors relative to its rating base. The Council has presented a business case to Government in 2018 which requests funding owing to local government constraints. The timing and amount of any such funding are uncertain at this stage.

Transport

Auckland City Rail Link (Changed)

The Government has committed to fund 50% of the costs associated with the City Rail Link project, which is estimated to cost $3.4 billion. Based on this estimate, the Government's contribution to the project will be around $1.7 billion. There is a risk that the timing, scope and amount of the government contribution to the project could be different from what is included in the forecasts.

National Land Transport Fund (Changed)

The Government has committed to reprioritise National Land Transport Fund (NLTF) spending to increase investment in, for example, road safety, public transport and rail. The Government has also indicated support for specific projects that might receive funding through the NLTF if prioritised and approved by the New Zealand Transport Agency Board to be included in the National Land Transport Programme (NLTP), including through the revised Auckland Transport Alignment Project (ATAP 2). The NLTP will be released by August 2018. The draft Government Policy Statement on Land Transport 2018 anticipates an increase in road-user revenue. If this is not approved, Crown funding may need to be provided for projects if they do not receive NLTF funding.

Treaty Negotiations

Government Response to WAI262 (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.

Cost Pressure and Cost Variance Risks by Portfolio#

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The following section outlines risks of cost pressures and variance risks of items included in the fiscal forecasts (where applicable). The majority of agencies are likely to face cost pressures in the future owing to changes in demand or costs of inputs used in the delivery of existing services or products. The key drivers of future cost pressures are likely to come from population changes, wage increases (both pay negotiations and progression through pay scales) and price inflation of inputs. A number of sectors (such as health, education and justice) are more likely to be materially impacted by cost pressures and are discussed further in this section. In addition, cross-portfolio risks for other operating and capital cost pressures are outlined on page 84.

Accident Compensation

Accident Compensation Corporation Levies (Unchanged)

Indicative future levy rates for the Work, Earners' and Motor Vehicle accounts have been included in the forecasts. However, final levy decisions are made by the Government and may differ from the forecast levy path. 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, Accident Compensation Corporation (ACC) performance and 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.

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.

Corrections

Prison Capacity (Changed)

The previous Government set aside funding for investment in prison capacity in Budget 2017. Decisions have yet to be taken on the exact form of this investment and there may be a risk that additional funding may be required once final decisions are taken.

Prisoner-related Costs (Changed)

The Government is committed to reducing the prison population over time and is currently considering options to do this. The fiscal forecasts include estimates for the direct costs of accommodating projected increases in the number of prisoners up to 2020. There is a risk that growth in the prison population is different from what is currently projected. The Department of Corrections is likely to seek additional funding (both operating and capital) relating to the costs of accommodating prisoners if numbers are above those projected through to 2020 and for any growth in prison numbers beyond 2020.

Economic Development

New Zealand Screen Production Grant (Unchanged)

The New Zealand Screen Production Grant is an uncapped, on-demand grant that incentivises international studios to locate production work in New Zealand by offering them a rebate on their qualifying expenditure. There is currently a high level of international interest in New Zealand as a place to do screen business. Based on the current rising trend, there is a risk that demand for the Screen Production Grant will exceed what is included in the fiscal forecasts.

Education

Education Operating Cost Pressures (New risk, previously included as a cross-portfolio risk - Other Operating Cost Pressures)

The education sector faces significant cost pressures from increasing demand in early childhood education (ECE) and schooling, largely as a result of population growth. Demographic change has an impact on expenditure on ECE subsidies, especially for the 20 hours fully subsidised entitlement for three- to five-year-olds; the per-pupil component of schools' operational funding; and schools' full-time teaching equivalent entitlement, which is based on staff-to-student ratios.

Learning Support (Unchanged)

There are a number of cost pressures building in the supply of learning support services owing to population growth and increased reporting of neurodevelopmental or other conditions meeting the eligibility criteria for particular programmes. These include the Ongoing Resourcing Scheme, English for Speakers of Other Languages (ESOL), Early Intervention and Sensory Learning. To the extent that these pressures cannot be managed within existing baselines, additional funding is likely to be required.

Finance

Earthquake Commission (Changed)

The Earthquake Commission's (EQC's) independent actuary undertakes half-yearly valuations of the total earthquake liability to the Crown. This includes settled and yet-to-settle claims (including those in litigation), an estimation of future claims not yet received, insurer finalisation and any associated reinsurance recoveries. Based on these valuations, a profile of the claims yet to settle is included in the fiscal forecasts. There remains some risk that EQC's remaining settlement expenditure relating to the Canterbury and Kaikōura earthquakes will be different (higher or lower) than forecast.

EQC's remaining settlement expenditure relating to the Canterbury earthquakes does not incorporate any liability recognition or provision for costs relating to the over-cap portion of any building claims, whether they are on-sold remedial building claims or otherwise. EQC only recognises expected future costs where it is liable for such costs under the Earthquake Commission Act 1993.

Goodwill on Acquisition (Unchanged)

As at 30 June 2017, the Government had goodwill on acquisition of a number of sub-entities totalling $744 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. The fiscal forecasts currently make no allowance for such impairment losses.

Foreign Affairs

Antarctica NZ - Redevelopment of Scott Base (New risk, previously included as a cross-portfolio risk - Other Capital Cost Pressures)

The infrastructure at Scott Base is approaching the end of its functional life. The redevelopment of Scott Base including the replacement of wind-farm assets would likely cost around $150 million. The precise cost has yet to be determined by the Government on the basis of a detailed business case.

Greater Christchurch Regeneration

Southern Response Earthquake Services Support (Unchanged)

The ultimate cost to the Crown of settling earthquake claims remains subject to significant uncertainty. Forecasts assume that the actual cost to settle claims will align with the actuary's central estimate of the claims provision. There is a risk that the actual cost could vary from this estimate, which is sensitive to its underlying assumptions such as damage estimates, legal challenges, reinsurance recoveries and the forecast profile of claims settlement. Because the net claims liability is large, small percentage changes in the liability can have a material impact on costs and forecasts.

Health

Caregiver Employment Conditions (New risk, previously included as a cross-portfolio risk - Pay Equity)

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

Health Capital Pressure (New risk, previously included as a cross-portfolio risk - Other Capital Cost Pressures)

District Health Boards (DHBs) have submitted updated capital intentions, which identify the indicative need for Crown funding over the next four years. These pressures are largely driven by asset condition issues (over 19% of hospital assets are rated in poor or very poor condition) and demographic growth (population growth and an ageing population) pressures on infrastructure capacity.

Health Operating Pressure (New risk, previously included as a cross-portfolio risk - Other Operating Cost Pressures)

The health sector is likely to face significant operating pressures against its baselines in order to maintain the delivery of existing health services. The main factors that are likely to drive operating pressures in the future include changes in population (both growth and an ageing population), wage costs (both pay negotiations and progression through pay scales) and price inflation of inputs.

Primary Care Services (Changed)

Budget 2018 provides funding for primary care services to reduce general practitioner (GP) fees for certain groups, provide additional funding for GP practices and provide for scoping an initiative to deliver one free annual health check for SuperGold card holders. There is a risk that changes in demand or pricing may impact on the cost of implementing these policies.

Housing and Urban Development

Divestment and Development of HNZC Housing (Unchanged)

The forecasts include business-as-usual divestments and redevelopments of housing property as part of Housing New Zealand Corporation's (HNZC's) asset management strategy. Proceeds from property divestments will be used to help fund investment in redeveloping and growing HNZC's stock. 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.

Emergency Housing Special Needs Grants (New)

Emergency Housing Special Needs Grants help individuals and families with the cost of staying in short-term accommodation if they are unable to access a transitional or a public housing place. If demand increases and/or the number of transitional or public housing places does not increase as forecast, this would increase demand for the grants, with associated fiscal costs.

Tāmaki Regeneration Project (Unchanged)

There are 7,500 new houses planned to be built in Tāmaki in place of about 2,500 existing houses. Development involves writing off existing public housing assets. If land sale proceeds are less than the value of the write-offs in the year that they occur, there will be a negative impact on the operating balance.

Internal Affairs

NZ Fire Service Levy (Unchanged)

The Fire Services were unified into Fire and Emergency New Zealand on 1 July 2017. The increase in levies required to meet the increase in expenditure on fire services, and to contribute to repaying a loan from the Crown, has been approved for 2017/18 and 2018/19 only. Any future levy changes beyond 2018/19 are uncertain and not yet included in the fiscal forecasts.

Research, Science and Innovation

Research and Development Tax Incentive (New)

The Government has approved the implementation of a Research and Development (R&D) Tax Incentive. This incentive will require the Crown to repay eligible firms a percentage of expenditure on R&D. Budget 2018 provides funding averaging $256 million per year, but there is a risk costs may differ owing to limited data being available for forecasting purposes and because international experience shows that costs of R&D tax credits can be significantly higher than expected.

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.

Student Loans - Valuation (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 consumer's price index (CPI). As new lending occurs, an initial write-down to fair value is made, and an expense is 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 rely on volatile factors that are subject to change.

Transformation and Technology Renewal (Unchanged)

The Business Transformation programme agreed by the previous Government in 2015 is reflected in forecasts. There are risks that the expected implementation costs, revenue gains and operating costs savings may differ from forecasts. In addition, changes in government policies could materially affect the programme's costs and benefits.

Transport

Rail Network Valuation Approach (Unchanged)

KiwiRail operates both freight and passenger transport services. The valuation approach for the assets used for these different activities is outlined in Budget 2018 Additional Information - Accounting Policies. The freight business of KiwiRail is predominantly commercially focused and therefore for financial reporting purposes assets relating to the freight business are fair-valued on a net-realisable-value basis.

For the freight infrastructure to continue to be valued on this basis, KiwiRail needs to meet certain criteria set out in the Accounting Standards Framework. Consistent with prior years, there is a likelihood of continued Crown support and a risk that KiwiRail no longer meets the criteria for valuing freight infrastructure on a net-realisable-value basis and may need to change to a depreciated replacement cost basis. The impact of this change would increase the measured value of assets by up to $4.3 billion.

Support for KiwiRail (Changed)

Budgets 2010 to 2018 supported KiwiRail with investments of around $2.1 billion in the New Zealand freight rail system. Further Crown investment into KiwiRail is likely to be required from 2019/20 to support the rail network and potentially replace the Interislander ferries. A review of KiwiRail's structure and funding arrangements is due in 2018/19, which will inform future funding decisions.

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 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.

Cross-portfolio Specific Fiscal Risks#

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Addressing the Gender Pay Gap in the State Sector (Unchanged)

The Government has made a commitment to addressing the gender pay gap in the core Public Service. Fulfilling this commitment will involve costs to the Crown.

Changes to Institutional Form of Government Agencies (Unchanged)

The Government has announced a number of policy commitments that involve changes to the machinery of government. These commitments are likely to involve changes to the composition and structure of existing government departments. Where the additional resourcing and other costs of these changes cannot be met through baseline expenditure, further Crown funding may be required.

Changes in Accounting Standard for Financial Instruments (Unchanged)

The External Reporting Board has recently issued changes to accounting standard Public Benefit Entities International Financial Reporting Standard (PBE IFRS 9) Financial Instruments and the Crown will adopt the amended accounting standard in the 2018/19 financial year. The resulting changes include new valuation methodology for some financial assets, a new impairment model for financial assets and revised hedge accounting requirements. The impact of these new requirements is uncertain, except for some initial impact analysis on the student loan asset (an estimated one-off increase of around $550 million).

Increasing the Minimum Wage (Unchanged)

Government policy decisions to increase the minimum wage to $20 per hour by April 2021 will mean increased costs to State sector employers. Funding may be sought where costs cannot be absorbed within baselines without resulting in unacceptable impacts on service delivery.

Other Capital Cost Pressures (Unchanged)

As in previous years, agencies are likely to face capital expenditure pressures related to replacing ageing infrastructure, information and communications technology (ICT) capability that is no longer fit for purpose, and other capital requirements driven by demand pressures. These pressures are risks to the fiscal forecasts to the extent they cannot be managed through agencies' existing balance sheets, new capital spending set aside in forecasts or other funding mechanisms (eg, Crown Infrastructure Partners). The Government's stated intention is that all pressures are managed through these mechanisms.

Other Operating Cost Pressures (Unchanged)

As in previous years, agencies are likely to face operating expenditure pressures in the future owing to changes in demand and price of services they provide. The majority of spending by agencies is not automatically adjusted for increases driven by demand or price pressures. These pressures are risks to the fiscal forecasts to the extent they cannot be managed through reprioritisation or new spending set aside in the forecasts. The Government's stated intention is that all pressures are managed through these mechanisms.

Outcomes from Government Inquiries and Reviews (New)

A number of inquiries and reviews are underway across government, and more have been signalled. These include inquiries into mental health, the Earthquake Commission (EQC) and a review of the National Certificate of Educational Achievement (NCEA). At this point it is uncertain what the fiscal impact from the outcomes of these reviews may be. At an aggregated level there is a risk they may meet the materiality thresholds for specific fiscal risks.

Pay Equity Claims Following the Care and Support Worker Settlement (Unchanged)

There are several funding claims, mainly from workers in the social sectors (including health, education and welfare), relating to the interpretation, and application, of the Equal Pay Act 1972. A pay equity claim for care and support workers in the aged care, disability support and home and community services sectors has already been resolved, including an extension of the same pay rates and conditions to equivalent workforces funded by the Ministry of Social Development and Oranga Tamariki. Negotiations towards a further extension are underway with mental health and addiction-support workers employed by non-government organisations.

There are a number of similar outstanding claims and a high likelihood of further claims being raised. Current claims include:

• social workers employed by Oranga Tamariki
• education support staff employed by the Ministry of Education
• school support staff employed by school boards of trustees
• support workers employed by the Ministry for Primary Industries
• nurses and midwives employed by District Health Boards.

The resolution of such claims within State-employed and State-funded sectors will likely result in costs to the Crown.

Remediation of Per- and Poly-Fluoroalkyl Substances Contamination (New)

Local and central government entities are investigating per- and poly-fluoroalkyl substances (PFAS) contamination at sites on, and in the vicinity of airports, NZDF bases, fuel storage facilities and other sites from the historic use of specialised firefighting foam. Various government agencies have been undertaking a programme to review, investigate and implement a comprehensive approach to manage the impact of PFAS at sites around New Zealand. There is a risk that the Crown will incur significant costs for the investigation, response and remediation to PFAS contamination.

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.

State Sector Employment Agreements (Unchanged)

A number of large collective agreements are due to be renegotiated over the forecast period. These include (but are not limited to) nurses and senior doctors, as well as primary and secondary school teachers. As well as direct fiscal implications for the employers of workforces covered by any changes to remuneration, the renegotiation of these agreements can have flow-on effects to remuneration in other sectors.

Unexpected Maintenance for Crown-owned Buildings (Unchanged)

There is a possibility that the Crown will incur costs when unexpected maintenance is required for the buildings it owns. Examples include earthquake strengthening some of the buildings that do not meet modern building standards and maintenance for buildings with weathertight issues. The likelihood, timing and fiscal impact of any repairs are uncertain.

Risks Removed Since the Half Year Update#

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Contingent Liabilities and Contingent Assets#

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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 fiscal forecasts.

Typically, contingent liabilities consist of guarantees and indemnities, uncalled capital and legal disputes and claims. The contingent liabilities facing the Crown are a mixture of operating and balance sheet risks, and they can vary greatly in magnitude and likelihood of realisation.

In general, if a contingent liability were realised, or the amount becomes sufficiently reliable to record as a liability, it would reduce the operating balance and net worth and increase net core Crown debt. In the case of some contingencies (eg, uncalled capital) the negative impact would be restricted to net core Crown 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.[26]

The contingencies have been stated as at 31 March 2018, being the latest set of published contingencies.

Quantifiable Contingent Liabilities and Contingent Assets#

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Contingent liabilities

Contingent assets

Unquantifiable Contingent Liabilities and Contingent Assets#

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Contingent liabilities

The following Indemnities were removed:

Housing Corporation New Zealand and New Zealand Railways Corporation (National Rail Network), as they are now considered to be remote.

Description of Contingent Liabilities#

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Quantifiable contingent liabilities over $100 million

Uncalled capital

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

The capital (when called) is typically used to raise additional funding for loans to 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 detailed above, the Crown has agreed to provide an uncalled capital facility of $230 million to Southern Response Earthquake Service Limited (SRES) to support the Christchurch earthquake recovery process. Of this amount $113 million has been called, leaving $117 million as a contingent liability. This capital support will increase core Crown net debt when called.

The Government has agreed to an uncalled capital facility of $300 million to support Kiwi Group Holdings Limited (which owns Kiwibank Limited) to help maintain Kiwibank Limited‘s external credit rating.

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.

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 specific stated event(s).

New Zealand Export Credit Office guarantees

The New Zealand Export Credit Office 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.

$ 116 million at 31 March 2018 ($136 million at 30 June 2017)

Legal proceedings and disputes

Legal tax proceedings

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 Inland Revenue has in respect of these cases.

$137 million at 31 March 2018 ($145 million at 30 June 2017)

Other quantifiable contingent liabilities

Unclaimed monies

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

$161 million at 31 March 2018 ($147 million at 30 June 2017)

Christchurch Engine Centre Partnership Agreement

The Air New Zealand Group has a partnership agreement with Pratt and Whitney in relation to the Christchurch Engine Centre (CEC), holding a 49% interest. By the nature of the agreement, joint and several liabilities exist between the two parties; the contingent liability represents Air New Zealand's share of CEC's liabilities.

$131 million at 31 March 2018 ($121 million at 30 June 2017)

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 indemnities, legal claims and proceedings, and other contingent liabilities.

The indemnities and claims that are disclosed individually, while they cannot be quantified, have the potential to exceed $20 million in costs and are not considered to be remote.

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 net core Crown debt.

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.

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. ACC's Board believes the resolution of outstanding appeals will not have any material effect on the financial statements of ACC and therefore are not material for the Crown.

Ministry for Primary Industries - Biosecurity Act 1993 compensation

Under section 162A of the Biosecurity Act 1993 compensation may be payable as a result of the exercise of powers to manage or eradicate organisms. Compensation is payable where there are verifiable losses as a result of the damage or destruction of a person's property or restrictions on the movement of a person's goods. The Ministry has been notified compensation will be sought for incursions including fruit fly, pea weevil, bonamia ostreae, mycoplasma bovis and myrtle rust. Owing to the complexity and uncertainty of the amount of these claims the amounts are unquantified.

Kiwifruit vine PSA-V

Approximately 210 growers, represented by the first plaintiff, Strathboss Kiwifruit Limited, filed a claim against the Ministry for Primary Industries alleging it is legally liable for damages they have suffered from a biosecurity incursion of the kiwifruit vine disease, Psa-V, in New Zealand. The total losses have not been quantified. As Strathboss Kiwifruit Limited is required to prove the Ministry owes a duty of care to the growers before losses will be assessed, the Ministry is unable to quantify the first plaintiff's claim.

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 that has been transferred by the Crown to a State-owed enterprise (SOE) or tertiary institution, or is subject to the Crown Forest Assets Act 1989.

On occasion, Māori claimants pursue the resolution of particular claims against the Crown through higher courts. Failure to successfully defend such actions may result in a liability for historical Treaty grievances in excess of that currently anticipated.

Other unquantifiable contingent liabilities

Criminal Proceeds (Recovery) Act 2009

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

Environmental liabilities

Under common law and various statutes, the Crown may have responsibility to remedy adverse effects on the environment arising from Crown activities. Entities 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 - See page 83

Holidays Act 2003 and other relevant legislation

A number of entities have commenced a review of payroll calculations over the past six years in order to ensure compliance with the Holidays Act 2003 and other relevant legislation. Where possible, provision has been made in these financial statements for obligations arising from that review. To the extent that an obligation cannot reasonably be quantified at 31 March 2018, a contingent liability exists.

Description of Contingent Assets#

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Quantifiable contingent assets over $100 million

There are no quantifiable contingent assets over $100 million at 31 March 2018.

Unquantifiable contingent assets

There are no unquantifiable contingent assets over $100 million at 31 March 2018.

Forecast Financial Statements#

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

They are based on the accounting policies and assumptions that follow. As with all such assumptions, there is a degree of uncertainty surrounding them. This uncertainty increases as the forecast horizon extends. The Risks and Scenarios and Specific Fiscal Risks chapters discuss the risks to the fiscal forecast in more detail.

The forecasts have been prepared in accordance with the Statement of Responsibility and reflect the judgements and information known at the time they were prepared. They reflect all government decisions and circumstances communicated to 26 April 2018.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined in the Fiscal Outlook chapter (pages 23 to 45).

Statement of Accounting Policies#

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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 EntityFinancial 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 Forecast Financial Statements reflect the accounting standards in place in the year that they are prepared. Adoption of new accounting standards in future financial years such as PBE IFRS 9: Financial Instruments in 2018/19 are consequently not reflected in these Financial Statements.

The specific accounting policies are included within the 2018 Budget Economic and Fiscal Update Additional Information document which can be found on the Treasury's website at https://treasury.govt.nz/publications/efu/budget-economic-and-fiscal-update-2018

Forecast Policies

The Forecast Financial Statements have been prepared on the basis of the Treasury's best professional judgement. Actual financial results for the periods covered are likely to vary from the information presented in these forecasts. Factors that may lead to a material difference between information in these Forecast Financial Statements and the actual reported results in future years are set out in the Specific Fiscal Riskschapter on pages 61 to 96.

Key forecast assumptions are set out on pages 25 to 26.

Reporting and Forecast Period

The reporting periods for these Forecast Financial Statements are the years ended 30 June 2018 to 30 June 2022. The “2017 Actual” figures reported in the statements are the audited results reported in the Financial Statements of the Government for the year ended 30 June 2017. The “2018 Previous Budget” figures are the original forecasts to 30 June 2018 as presented in the 2017 Budget Economic and Fiscal Update.

Government Reporting Entity as at 26 April 2018#

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These Forecast Financial Statements are for the government reporting entity as specified in Part 3 of the Public Finance Act 1989. This comprises Ministers of the Crown and the following entities (classified in the three institutional components used for segmental reporting):

Core Crown Segment

Departments

1. Crown Law Office
2. Department of Conservation
3. Department of Corrections
4. Department of Internal Affairs
5. Department of the Prime Minister and Cabinet
6. Education Review Office
7. Government Communications Security Bureau
8. Inland Revenue Department
9. Land Information New Zealand
10. Ministry for Culture and Heritage
11. Ministry for Pacific Peoples
12. Ministry for Primary Industries
13. Ministry for the Environment
14. Ministry for Women
15. Ministry of Business, Innovation, and Employment
16. Ministry of Defence
17. Ministry of Education
18. Ministry of Foreign Affairs and Trade
19. Ministry of Health
20. Ministry of Justice
21. Ministry of Māori Development
22. Ministry of Social Development
23. Ministry of Transport
24. New Zealand Customs Service
25. New Zealand Defence Force
26. New Zealand Police
27. New Zealand Security Intelligence Service
28. Office of the Clerk of the House of Representatives
29. Oranga Tamariki, Ministry for Children
30. (previously Ministry for Vulnerable Children, Oranga Tamariki)
31. Parliamentary Counsel Office
32. Parliamentary Service
33. Serious Fraud Office
34. State Services Commission
35. (Includes Social Investment Agency as a departmental agency)
36. Statistics New Zealand
37. Te Kāhui Whakamana Rua Tekau mā Iwa— Pike River Recovery Agency
38. The Treasury

Offices of Parliament

1. Controller and Auditor-General
2. Office of the Ombudsman
3. Parliamentary Commissioner for the Environment

Others

1. New Zealand Superannuation Fund
2. Reserve Bank of New Zealand

State-owned enterprises Segment

State-owned enterprises

1. Airways Corporation of New Zealand Limited
2. Animal Control Products Limited
3. AsureQuality Limited
4. Electricity Corporation of New Zealand Limited
5. KiwiRail Holdings Limited
6. Kordia Group Limited
7. Landcorp Farming Limited

Mixed ownership model companies (Public Finance Act Schedule 5) 

1. Genesis Energy Limited
2. Mercury NZ Limited
3. Meridian Energy Limited
4. Meteorological Service of New Zealand Limited
5. New Zealand Post Limited
6. New Zealand Railways Corporation
7. Quotable Value Limited
8. Solid Energy New Zealand Limited (in liquidation)
9. Transpower New Zealand Limited

Other

1. Air New Zealand Limited
2. Kiwi Group Holdings Limited (including Kiwibank)

Crown Entities Segment

Crown entities

1. Accident Compensation Corporation
2. Accreditation Council
3. Arts Council of New Zealand Toi Aotearoa
4. Broadcasting Commission
5. Broadcasting Standards Authority
6. Callaghan Innovation
7. Children's Commissioner
8. Civil Aviation Authority of New Zealand
9. Commerce Commission
10. Crown Irrigation Investments Limited
11. Crown Research Institutes (7)
12. District Health Boards (20)
13. Drug Free Sport New Zealand
14. Earthquake Commission
15. Education New Zealand
16. Electoral Commission
17. Electricity Authority
18. Energy Efficiency and Conservation Authority
19. Environmental Protection Authority
20. External Reporting Board
21. Families Commission
22. Financial Markets Authority
23. Fire and Emergency New Zealand
24. Government Superannuation Fund Authority
25. Guardians of New Zealand Superannuation
26. Health and Disability Commissioner
27. Health Promotion Agency
28. Health Quality and Safety Commission
29. Health Research Council of New Zealand
30. Heritage New Zealand Pouhere Taonga
31. Housing New Zealand Corporation
32. Human Rights Commission
33. Independent Police Conduct Authority
34. Law Commission
35. Maritime New Zealand
36. Museum of New Zealand Te Papa Tongarewa Board
37. New Zealand Antarctic Institute
38. New Zealand Artificial Limb Service
39. New Zealand Blood Service
40. New Zealand Film Commission
41. New Zealand Lotteries Commission
42. New Zealand Productivity Commission
43. New Zealand Qualifications Authority
44. New Zealand Symphony Orchestra
45. New Zealand Tourism Board
46. New Zealand Trade and Enterprise
47. New Zealand Transport Agency
48. New Zealand Venture Investment Fund Limited
49. New Zealand Walking Access Commission
50. Office of Film and Literature Classification
51. Pharmaceutical Management Agency
52. Privacy Commissioner
53. Public Trust
54. Radio New Zealand Limited
55. Real Estate Authority
56. Retirement Commissioner
57. School Boards of Trustees (2,406)
58. Social Workers Registration Board
59. Sport and Recreation New Zealand
60. Takeovers Panel
61. Te Reo Whakapuaki Irirangi (Māori Broadcasting Funding Agency)
62. Te Taura Whiri i te Reo Māori (Māori Language Commission)
63. Television New Zealand Limited
64. Tertiary Education Commission
65. Transport Accident Investigation Commission
66. WorkSafe New Zealand

Organisations listed in schedule 4 of the Public Finance Act 1989

1. Agricultural and Marketing Research and Development Trust
2. Asia New Zealand Foundation
3. Fish and Game Councils (12)
4. Game Animal Council
5. Leadership Development Centre Trust
6. Māori Trustee
7. National Pacific Radio Trust
8. New Zealand Fish and Game Council
9. New Zealand Game Bird Habitat Trust Board
10. New Zealand Government Property Corporation
11. New Zealand Lottery Grants Board
12. Ngāi Tahu Ancillary Claims Trust
13. Pacific Co-operation Foundation
14. Pacific Island Business Development Trust
15. Reserves Boards (20)
16. Te Ariki Trust

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

1. Crown Asset Management Limited
2. Crown Infrastructure Partners Limited (previously Crown Fibre Holdings)
3. Education Payroll Limited
4. Ōtākaro Limited
5. Predator Free 2050 Limited
6. Research and Education Advanced Network New Zealand Limited
7. Southern Response Earthquake Services Limited
8. Tāmaki Redevelopment Company Limited
9. The Network for Learning Limited

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

1. Te Urewera

Others

1. Education Council of Aotearoa New Zealand
2. Regenerate Christchurch

Other entities

Crown entities

1. Tertiary Education Institutions (27)*

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

1. City Rail Link Limited*

*These entities are not fully consolidated into the forecast financial statements of the government with only the Crown's interest in them being included.

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

Forecast Financial Statements#

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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.

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

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 16.

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. Equity accounted investments include tertiary education institutions and City Rail Link.

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#

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Note 1: Sovereign Revenue (Accrual)

1. Customs excise-equivalent duty.

NOTE 1 (continued):  Sovereign Receipts (Cash)

NOTE 2:  Investment Revenue / (Expenditure)

NOTE 3:  Transfer Payments and Subsidies

NOTE 4:  Other Operating Expenses

NOTE 5:  Insurance

ACC liability

Calculation information

PwC NZ has prepared an independent actuarial estimate of the ACC outstanding claims liability as at 31 December 2017. This estimate includes the expected future payments relating to accidents that occurred prior to balance date (whether or not the associated claimshave 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 28 February 2018. 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 4.75% from 2050.

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 2017 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, Kaikōura earthquake 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 2017 valuation form the basis of the five-year forecast of the outstanding claims liability.

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: the potential outcome of complex land litigation and the financial impact of confirming final liabilities with insurance and reinsurers.

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 6:  Forecast New Spending and Top-down Expense Adjustment

Unallocated contingencies represent expenses included in Budget 2018 and previous Budgets that have yet to be allocated to departments. Forecast new spending indicates the expected spending increases from future Budgets.

The forecast for new operating spending for Budget 2019 is $2.4 billion. Some of this allowance has been assumed to be pre-committed as at the forecast finalisation date of 26 April 2018, with only the unallocated portion of the allowance included in this note.

Unallocated contingencies represent capital spending from Budget 2018 and previous Budgets that has yet to be allocated to departments. Forecast new spending indicates the expected capital spending increases from future Budgets.

The forecast for new capital spending for Budget 2019 is $3.7 billion. Budgets 2020 and 2021 are $3.4 billion and $3.0 billion respectively. Some of the allowance has been pre-committed as at the forecast finalisation date of 26 April 2018, with only the unallocated portion of the allowance included in this note.

NOTE 7:  Net Gains and Losses on Non-Financial Instruments

NOTE 8:  Financial Assets (including receivables)

NOTE 9:  Student Loans¹

NOTE 10:  Property, Plant and Equipment

1. From 1 July 2018, the valuation of the Student Loans Scheme will move from an amortised cost approach to a fair value approach due to PBE IFRS 9 being adopted in 2018/19 financial year. The new valuation approach under PBE IFRS 9 is forecast to result in a one-off increase of approximately $537 million to the value of the student loan asset. This one-off change has not been included in the current forecasts.
2. Using a revaluation methodology unless otherwise stated.

NOTE 10:  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 11:  NZ Superannuation Fund

NOTE 12:  Payables

NOTE 13:  Retirement Plan Liabilities

The net liability of the Government Superannuation Fund (GSF) was calculated by GSF's actuary as at 31 January 2018. 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 2018, based on membership data as at 30 June 2017 with adjustments for cash flows to 31 January 2018. 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 2018.

Other principal long-term financial assumptions were an inflation rate, as measured by the Consumers Price Index (CPI), of 1.77% for the 20 years to 30 June 2037, then increasing gradually each year to 2.0% in the year ended 30 June 2049 and remaining at 2.0% p.a. for all years after that. In addition an annual salary growth rate, before any promotional effects, of 2.5% (2.5% at 30 June 2017).

The 2017/18 projected decrease in the net GSF liability is $427 million, reflecting a decrease in the GSF liability of $82 million and an increase in the GSF net assets of $345 million.

The overall decrease in the GSF liability of $82 million includes an actuarial loss (which increases the liability) between 1 July 2017 and 31 January 2018, of $452 million, owing to movements in the discount and CPI rates. The remaining $534 million reduction is owing to the current service cost and interest unwind (increases the liability) which is more than offset by benefits to members (reducing the liability).

The increase in the value of the net assets of GSF of $345 million includes a gain of $303 million reflecting the updated market value of assets at 31 January 2018. The balance of $42 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 2017/18 onwards reflect the net of the expected current service cost, interest cost, investment returns and contributions.

NOTE 14:  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 last week of March 2018.

The ETS impact on the fiscal forecast is as follows:

NOTE 15: Changes in Net Worth

NOTE 16:  Core Crown Residual Cash

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

Forecast Statement of Segments#

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Statement of Financial Performance
for the year ended 30 June 2017

Statement of Financial Position
as at 30 June 2017

Statement of Financial Performance
for the year ended 30 June 2018

Statement of Financial Position
as at 30 June 2018

Statement of Financial Performance
for the year ended 30 June 2019

Statement of Financial Position
as at 30 June 2019

Statement of Financial Performance
for the year ended 30 June 2020

Statement of Financial Position
as at 30 June 2020

Statement of Financial Performance
for the year ended 30 June 2021

Statement of Financial Position
as at 30 June 2021

Statement of Financial Performance
for the year ended 30 June 2022

Statement of Financial Position
as at 30 June 2022