Budget Economic and Fiscal Update 2019

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#

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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 Budget 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.

Other information#

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On the Treasury's website is a series of other information that provides users of the Budget Update with further detail. This other information should be read in conjunction with the published document. This includes detailed economic forecast tables, a comparison of the Treasury and Inland Revenue tax forecasts, tax policy changes, additional fiscal indicators and fiscal tables presented under the Government Finance Statistics (GFS) framework and accounting policies.

This other information can be accessed at: https://treasury.govt.nz/publications/efu/budget-economic-and-fiscal-update-2019

Making it New Zealander-centric#

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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 wellbeing. Our framework builds on 30 years of New Zealand and international evidence on wellbeing and provides a high-level framework on intergenerational wellbeing. Page 2 provides further information on the Living Standards Framework.

Understanding our path#

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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 8 May 2019 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 8 May 2019. 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

22 May 2019

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 8 May 2019 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

22 May 2019

 

Executive Summary#

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Sources: Stats NZ, the Treasury

• The pace of economic growth eased back to trend over the six months to December 2018, reflecting slowing population growth together with subdued growth in business investment. This contributed to the economy growing at a slightly slower rate of 2.8% in the year to December 2018 than the 3.1% growth recorded in 2017.
• Recent economic data point to a continuation of current quarterly growth rates, resulting in annual growth of 2.4% in the year to June 2019. Growth in the economy over the initial year of the forecast horizon continues to be supported by migration-led population growth, government spending, accommodative monetary policy and solid (although slower than recent years) growth abroad.
• Increased government spending and stronger investment see real gross domestic product (GDP) growth reach 3.0% in the year ended June 2020. Growth then eases to 2.4% over the latter part of the forecast period, as the fiscal stimulus from the increased government spending fades, net migration growth eases and interest rates increase.
• The economy continues to operate near full capacity, with the unemployment rate at low levels, and labour force participation rates at historic high levels. The unemployment rate falls to 4.0% in the year ending June 2020 before rising slightly over the remainder of the forecast period to reach 4.3% in 2023. This continued tightness in the labour market supports an acceleration in wage growth, which in turn provides impetus for household spending.
• Annual Consumers Price Index (CPI) inflation fell to 1.5% in the March quarter of 2019 as the increases in fuel prices experienced over 2018 unwound. CPI inflation increases to around 2.0% in 2020 and remains broadly stable thereafter.
• Economic growth for New Zealand's main trading partners was slightly slower than expected over the latter half of 2018. A further slowing in growth to 3.4% over the year ended December 2019, reflects a softening in data outturns, continued uncertainty around trade negotiations, a decline in business confidence, tightening financial conditions, and higher policy uncertainty across many economies. The Treasury assumes trading partner growth is stable at 3.4% over the remainder of the forecast horizon. The outlook for export commodity prices remains positive, with dairy and meat prices supported by continued global demand and tightening global supply.
• Core Crown tax revenue increases steadily over the forecast period, reaching $105.6 billion in 2022/23, $25.4 billion higher than in 2017/18. This is primarily owing to expected growth in wages and employment, as well as domestic consumption, residential investment and corporate profits. As a percentage of GDP, core Crown tax revenue stays relatively stable across the forecast period.
• In nominal terms core Crown expenses increase by $25.1 billion over the forecast period. Key drivers of this increase are the 2019 Budget decisions, which were higher than previously forecast and the operating allowance for Budget 2020 is now $3.0 billion (up $0.6 billion) while the operating allowances for Budget 2021 and Budget 2022 are unchanged at $2.4 billion.
• While the operating balance before gains and losses (OBEGAL) remains in surplus, it decreases from $5.5 billion in 2017/18 to surpluses of $3.5 billion and $1.3 billion in the following two years. The surpluses then increase over the rest of the forecast period to reach $6.1 billion (1.7% of GDP) in 2022/23 as revenue starts to grow at a faster pace than expenditure.
• For Budget 2019, the multi-year capital allowance provides funding for Budgets 2019 to 2022, and uses $10.4 billion of the $14.8 billion available. This leaves $4.4 billion available for Budgets 2020 to 2022.
• Capital spending exceeds operating cash flows until the final year of the forecast, resulting in residual cash deficits for the first four years, while 2022/23 sees a residual cash surplus of $1.2 billion. As a result, net core Crown debt is forecast to increase in nominal terms, peaking at $69.9 billion (19.9% of GDP) in 2021/22 before falling to $68.5 billion (18.7% of GDP) in 2022/23.
• As a result of these additional borrowings, gross debt is forecast to increase by $4.8 billion by 2022/23, to stand at 25.3% of GDP.

Economic Outlook#

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Overview#

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• The pace of economic expansion lost some momentum over the second half of 2018, largely reflecting slower business investment growth and a continued easing in population growth. More timely indicators of economic activity point to a stabilisation of annual economic growth over the six months to June 2019.
• Real gross domestic product (GDP) growth is projected to rise from 2.4% in the 2018/19 fiscal year to 3.0% in 2019/20, supported by an increase in government spending, partly reflecting Budget 2019 decisions, and stronger investment. Since the Half Year Update, government spending is a cumulative $7.2 billion higher over the forecast period.
• Beyond 2019/20, GDP growth gradually eases as the stimulus from higher government spending fades, population growth declines and monetary conditions tighten. GDP growth averages 2.6% per year across the five years to June 2023.
• The unemployment rate declines to 4.0% in 2019/20, supported by the acceleration in economic growth, before gradually rising to 4.3% by 2022/23. A tight labour market and labour market policies add to wage pressures over the forecast period, supporting household income and spending.
• Capacity pressures are expected to underpin an increase in Consumers Price Index (CPI) inflation to the middle of the Reserve Bank of New Zealand's (RBNZ) target range (2.0%) by 2019/20. Since finalising the Treasury's economic forecasts, RBNZ's Monetary Policy Committee reduced the Official Cash Rate (OCR) from 1.75% to 1.50%. The OCR cut does not substantially alter the Treasury's economic outlook.
• Economic growth in New Zealand's top trading partners slowed over the year ended December 2018 and this recent weakness is expected to persist into 2019. The Treasury assumes trading partner growth is stable at 3.4% over the forecast period, at a lower rate than experienced in recent years.
• Annual real GDP growth over the 2018/19 fiscal year is lower than in the Half Year Update, reflecting a mix of weaker business investment and export growth. Nominal GDP growth, a key factor driving tax revenue, is also weaker.
• The balance of risks is broadly similar to the Half Year Update. Risks to the economic outlook are discussed in detail in the Risks and Scenarios chapter.

Sources: Reserve Bank of New Zealand, Stats NZ, QV Limited, 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 135.

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.
7. System of national accounts
8. Quotable Value House Price Index.
9. Percent of household disposable income (HHDI), March years.
10. Trade-weighted index, average for June quarter.
11. Average for the June quarter.

Current Economic Conditions#

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Economic growth has eased back to trend over recent years…

Economic growth has eased from above trend growth of around 4.0% over 2016 to 2.8% in the year ended December 2018 (Figure 1.1), broadly in line with the Treasury's estimate of potential growth. Migration-led population growth supported an expansion in domestic demand from 2014 to 2017. Working-age population growth peaked at 2.7% in 2017 and has been declining since, weighing on the productive capacity of the economy and domestic demand more broadly. Rising house price inflation also supported household consumption over 2016, but house price inflation has since declined, reflecting easing population growth and regulatory changes.

Figure 1.1 – Real GDP growth

Sources: Stats NZ, the Treasury

Text description of Figure 1.1 – Real GDP growth.

Real GDP increased 0.6% in the December 2018 quarter following growth of 0.3% in the September quarter. Business investment growth was a key driver of this slowing, likely reflecting uncertainty regarding the international and domestic outlook, tightening profit margins and some temporary factors. Temporary factors include a wind down in Kaikōura earthquake-related infrastructure repairs. Other temporary factors, such as outages at the Pohokura gas field and low hydro-lake levels, also hampered production more broadly.

More timely indicators including goods exports, building consents and survey measures of sentiment point to a stabilisation of annual economic growth over the six months to June 2019. However, the global growth outlook remains uncertain posing a risk to the domestic economic growth outlook.

…but the labour market remains tight

Despite slowing economic growth, the labour market continued to tighten with the unemployment rate falling to 4.2% in March 2019.[1] Wage growth has begun to pick up and firms are reporting high levels of difficulty finding labour. The relatively low unemployment rate points to strong capacity pressures across the economy as a whole and is around levels that have not been seen since before the global financial crisis. Despite this, CPI inflation remains below the midpoint of RBNZ's target range (2.0%) and the Treasury's measures of potential output suggest that supply and demand in the economy are broadly balanced.

Rising petrol prices and higher non-tradables inflation saw headline annual CPI inflation reach 1.9% over the six months to December 2018. However, quarterly petrol prices fell in March 2019 and CPI inflation fell to 1.5%. Measures of core inflation, which give little weight to irregular price movements such as fuel, have increased modestly over the past year. A more sustained increase in inflation requires a pick-up in economic growth above current rates.

Since the finalisation of these forecasts, RBNZ's Monetary Policy Committee reduced the OCR from 1.75% to 1.50% on 8 May 2019. RBNZ stated that slowing domestic and international economic growth prompted the need for additional monetary stimulus to meet its objectives of maximum sustainable employment and keeping inflation near 2.0%.

This decision was made after the Treasury's economic forecasts were finalised, but before higher government spending was announced as part of Budget 2019. The OCR cut does not substantially change the Treasury's economic outlook. In general, the economic growth outlook for the next three years is similar for both the Treasury and RBNZ, with accommodative monetary and fiscal policies supporting growth.

Global growth eased over the six months to December 2018

Trading partner growth softened over the six months to December 2018, following above average growth in the preceding 18 months. Goods exports and export commodity prices have remained relatively resilient in the context of slowing global growth. Real goods export growth remained buoyant over the six months to December 2018 and dairy production was strong. However, dry weather conditions over the three months to March 2019 constrained dairy production, likely limiting dairy export volume growth over 2019.

Growth in exports of services held up, although the Treasury's business talks highlighted that the tourism sector is experiencing weaker-than-expected forward bookings. Imports fell over the second half of 2018, reflecting, in part, the timing of petroleum and crude oil imports following the shutdown at the Marsden Point oil refinery and delays to motor vehicle imports owing to biosecurity issues. Net exports provided a small positive contribution to economic growth over the same period.

As a small open economy, New Zealand's economic growth is particularly affected by external flows of goods, services and finance, which can change quickly. The outlook for world growth is fragile and has become more uncertain. Trade tensions and a range of country-specific factors have seen global growth slow over 2018, with higher frequency indicators suggesting this weakness has persisted into 2019. The set of forecasts presented in this chapter assume a stable outlook for trading partner growth, albeit at a lower rate than experienced over recent years. Risks to the international outlook remain prevalent and skewed to the downside. The Risks and Scenarios chapter expands on such risks further, including a scenario on how the New Zealand economy may evolve if the outlook for trading partner growth were weaker than anticipated.

Domestic Outlook#

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Real GDP growth peaks around 3.0% in 2020 supported by government spending…

Real GDP growth is projected to pick up over the six months to December 2019 and peak around 3.0% in 2020, supported by solid growth in government spending, accommodative monetary conditions and rising investment. Since the Half Year Update, government operating spending is around $7.2 billion higher as a result of Budget 2019 decisions (of which around $0.5 billion is a transfer package) and higher operating allowances at Budget 2020.

The majority of this spending relates to the expansion of new and existing government services. Government spending growth rises to 4.2% in 2019/20 (Figure 1.2), contributing 0.8 percentage points to economic growth in that year. Thereafter, government spending grows at a slower rate, reflecting relatively lower operating allowances. (This is discussed in more detail in the Fiscal Outlook chapter.)

Figure 1.2 – Public consumption

Sources: Stats NZ, the Treasury

Text description of Figure 1.2 – Public consumption.

Higher government spending adds to capacity pressures across the economy. Stronger domestic demand is expected to promote business investment and contribute to higher wage and price pressures.

As the impulse from higher government spending fades, economic growth gradually eases to 2.4% in the 2022/23 fiscal year. Population growth is also projected to continue to slow further, contributing to slower economic growth. The slowdown in GDP per capita growth is less marked, declining from 1.5% in the 2020/21 fiscal year to 1.2% in 2022/23.

Growth in the nominal economy is supported by the pick-up in real GDP growth, rising terms of trade, higher inflation and government labour market policies. Annual average nominal GDP growth peaks at 5.9% in the year ending September 2020, easing to 4.7% by 2022/23, reflecting slowing real GDP growth. Compared with the Half Year Update, nominal GDP is a cumulative $4.7 billion lower over the forecast period.

…and slowing population growth sees GDP growth ease from 2020

Slowing population growth is a countervailing force for aggregate economic growth over the forecast period. Indeed, growth in the working-age population accounted for around two-thirds of GDP growth over the three years to June 2018. Easing population growth reduces both domestic demand growth and the rate at which the economy can expand without generating rising price inflation (potential growth).

Net migration is the main driver of cyclical changes in population growth for New Zealand and is influenced by a range of relative economic conditions between New Zealand and

the rest of the world. New migration data from Stats NZ show that net migration peaked earlier and at a lower level than reflected in the discontinued intentions measure (64,000 in 2016, compared with 72,000 in 2017), and has been declining since.[2] The new migration data have been subject to large revisions (Figure 1.3). Based on the size of revisions, relative labour market conditions between New Zealand and the rest of the world, and alternative measures of migrant arrivals, the Treasury has put more weight on earlier data and assumed the declining trend since 2016 will continue.

Figure 1.3 – Annual estimated net migration

Sources: Stats NZ, the Treasury

Text description of Figure 1.3 – Annual estimated net migration.

Net migration is projected to add 131,000 people to the population over the next four and a half years, around 50% lower than the preceding four and a half years. Relative to the Half Year Update, net migration is assumed to add 11,000 fewer people as a result of the lower starting point. Risks to the migration outlook are present in both directions.

The labour market remains tight, with the unemployment rate declining…

The unemployment rate is forecast to decline to 4.0% by June 2020 (Figure 1.4) as stable employment growth supported by strong domestic demand outstrips growth in the labour force. Beyond 2020, employment growth eases as the stimulus from higher government spending fades and interest rates rise, which sees the unemployment rate gradually rise to 4.3%.

Figure 1.4 – Unemployment and labour force participation rates

Sources: Stats NZ, the Treasury

Text description of Figure 1.4 – Unemployment and labour force participation rates.

The labour force participation rate is projected to rise to 71.4% by early 2021/22 and remain stable thereafter, supported by further increases in participation rates for females and people over the age of 65. Participation rates for these two demographic groups have been steadily increasing over recent years, reflecting longer-term trends and regulatory changes (eg, improved health outcomes, higher life expectancies, technological change and part-time work entitlements).

…and, combined with labour market policies, supports an acceleration in wage growth…

Wage growth is projected to accelerate over the forecast period (Figure 1.5), reflecting the tight labour market and a range of labour market policies. Across the four and a half years to June 2023, a number of pay equity settlements and collective employment agreements are expected to be negotiated. In addition, the minimum wage rises to $20.00 per hour by April 2021, in accordance with government policy. Wage growth averages 3.4% across the forecast period.

Figure 1.5 – Labour income

Sources: Stats NZ, the Treasury

Text description of Figure 1.5 – Labour income.

Growth in inflation-adjusted wages (real wages) is stable at around 1.4% across the forecast period. Real wage growth sits a little above recent averages, as labour productivity recovers supported by solid business investment growth (the outlook for business investment is discussed later in the chapter). Higher real wages support household consumption. However, there is significant uncertainty around the outlook for labour productivity.

Annual growth in the compensation of employees, which captures growth in employment and wages (or total gross labour income), is projected to rise to 5.1% in the 2020/21 fiscal year driven by rising wage growth and stable employment growth. Compensation of employees growth – a key driver of source deductions revenue – gradually eases to 4.8% by 2022/23, reflecting the outlook for employment growth.

…supporting a stable outlook for household spending

The outlook for household spending is broadly stable, reflecting higher wage growth and supportive labour market conditions. However, the rate of consumption growth is lower relative to recent years (Figure 1.6), owing to a continued slowing in population growth and lower house price inflation compared with recent years.

Figure 1.6 – Private consumption growth

Sources: Stats NZ, the Treasury

Text description of Figure 1.6 – Private consumption growth.

These forecasts assume households will continue their relatively cautious behaviour of recent years, with consumption growth slightly above income growth. This sees the aggregate household savings rate sitting a little below zero across the forecast period (Figure 1.7).

Figure 1.7 – Household debt and savings

Sources: Stats NZ, the Treasury

Text description of Figure 1.7 – Household debt and savings.

Over recent years, households experienced strong gains in non-financial wealth, which is heavily weighted towards residential housing. Despite a relatively low rate of dissaving, rising non-financial wealth supported consumption growth and growth in debt in excess of household income growth. High debt levels increase the sensitivity of household spending to changes in interest rates and a deterioration in financial circumstances. Household consumption could be weaker than forecast if households lower their expectations of gains in income or wealth. Such an outcome would be consistent with weaker than expected wage growth or slower house price inflation.

House price inflation is projected to remain relatively muted…

House price inflation is projected to be lower over the forecast period compared with recent years, reflecting slowing population growth, an expanding housing supply and regulatory changes (Figure 1.8). House price inflation is assumed to pick up slightly over the year ahead supported by low mortgage rates.

Figure 1.8 - House price inflation and non-financial wealth

Sources: QV Limited, Stats NZ, the Treasury

Text description of Figure 1.8 – House price inflation and non-financial wealth.

There are risks to the outlook for house prices. House prices may grow more slowly if supply expands more rapidly than projected or if demand is less supportive, which could be the case if households choose to save more or pay down debt at a faster rate. On the other hand, demand and house prices could be stronger than assumed if net migration inflows are higher or income growth is stronger.

…and residential investment activity is projected to pick up

Growth in residential investment has been modest over the past two years (Figure 1.9), particularly in the context of strong population growth, with skill shortages and general constraints across the sector holding back activity. These forecasts assume urban development reforms and other policies unlock capacity constraints in the construction sector, supporting residential investment growth.

Figure 1.9 – Residential investment growth

Sources: Stats NZ, the Treasury

Text description of Figure 1.9 – Residential investment growth.

Indicators including building consents suggest rising residential investment growth over the year ending December 2019. House sales have been broadly flat over recent months according to the Real Estate Institute of New Zealand (REINZ), consistent with relatively stable house price inflation.

Residential investment growth is forecast to accelerate to 5.4% in the 2020/21 fiscal year, supported by government residential investment initiatives. Thereafter, growth eases as interest rates rise and population growth continues to slow.

Assumptions on the economic impact of government residential investment initiatives are unchanged since the Half Year Update.

Recent economic developments have weighed on business investment…

A range of forces, including the exchange rate, the terms of trade, financial market conditions, business confidence and profitability, affect business investment. On balance, these forces have deteriorated a little over recent quarters. Uncertainty around both the domestic and international outlook is likely to have been a contributor to lower investment growth over 2018 (Figure 1.10). This slowdown was compounded by the temporary effect of a wind-down in Kaikōura-related road repairs dragging on growth. Growth in Other Construction activity (which includes expenditure on roads and other major civil works) fell from an annual average rate of 18.7% in the year ended June 2018, to 2.4% in the year ended December 2018.

Figure 1.10 - Business investment

Sources: Stats NZ, the Treasury

Text description of Figure 1.10 – Business investment.

…but ongoing capacity pressures and a pick-up in economic growth support an acceleration in business investment growth…

Business investment growth is projected to rise slightly over the six months to June 2019, supported by aviation industry investment, which tends to be quite lumpy. Business investment growth is then projected to accelerate over the 2019/20 fiscal year, as an increase in government spending stimulates economic activity supporting sentiment, the terms of trade remain high, supporting profitability, and businesses respond to the need to expand capacity in the context of a tight labour market and rising wages.

In addition, government spending provides direct support to business investment growth. The Government's net capital expenditure activity (excluding New Zealand Superannuation Fund contributions) is $31.5 billion across the forecast period, the composition of which is discussed in more detail in the Fiscal Outlook chapter.

Business investment growth peaks at around 4.0% over the year ending June 2021, before easing as the stimulatory impact of higher government spending fades, interest rates rise and population growth slows further.

…which underpins productivity growth

Labour productivity growth is assumed to average 0.9% over the forecast period, supported by rising business investment and easing net migration flows. The rate of productivity growth is higher relative to recent history. If productivity growth is weaker than expected and is not offset by stronger labour input growth, then GDP growth may be lower.

A higher rate of productivity growth relative to recent history helps to partly offset the impact of slowing population growth on the productive capacity of the economy. The Treasury's estimate of potential output growth slows from 2.9% in the 2018/19 fiscal year to 2.6% in 2022/23.

CPI inflation gradually stabilises at 2.0%, reflecting emerging capacity pressures

The sharp rise in petrol prices experienced over 2018 unwound over the March 2019 quarter, resulting in annual inflation declining to 1.5%. Measures of core inflation, which give little weight to irregular price movements such as fuel, increased modestly over the past year. Annual CPI inflation is forecast to increase to around 2.0% in the 2019/20 fiscal year and remain around this rate thereafter.

Despite the small rise in measures of core inflation, easing capacity pressures and economic activity suggest that interest rates have been less stimulatory than previously assumed. Consistent with the direction of changes in the Half Year Update, the Treasury has further reduced the extent to which it believes the current level of interest rates is stimulatory. This is reflected in the outlook for interest rates, which are expected to increase later and by less than the Half Year Update over the forecast period (Figure 1.11).

Figure 1.11 – Monetary conditions

Sources: RBNZ, the Treasury

Text description of Figure 1.11 – Monetary conditions.

The trade-weighted exchange rate index is assumed to remain broadly flat around 74.0 across the forecast period. However, there is a high degree of uncertainty around this judgement.

External Outlook#

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Global economic growth has eased…

After solid growth over the 2017/18 fiscal year, global economic growth slowed over the six months to December 2018, reflecting trade tensions, tightening financial conditions and a decline in business and consumer sentiment. Recent reports from the Organisation for Economic Cooperation and Development (OECD) and International Monetary Fund (IMF) project this weakness to persist into 2019.

Slowing global growth and trade tensions saw global trade volume growth fall sharply over the six months to December 2018 (Figure 1.12) and more timely indicators of trade, such as survey measures of new export orders, continued to decline across many countries. As trade tensions escalate or financial conditions deteriorate, the risk of significant adverse impacts on the real economy from uncertainty, reduced investment and lower exports increases (the Risks and Scenarios chapter contains further discussion). In the medium term, growth faces structural challenges from population ageing and weaker productivity growth since the global financial crisis.

Figure 1.12 – World trade volume growth

Source: Netherlands Bureau of Economic Policy

Text description of Figure 1.12 – World trade volume growth.

Labour markets remain strong across advanced economies, reflecting past growth, and wage growth is beginning to pick up, supporting household incomes and spending.

Global growth could surprise on the upside if trade tensions are resolved quickly, supporting a recovery in business sentiment. However, the balance of risks to the global outlook remains skewed to the downside. Trade tensions remain prevalent, although the direct impact of tariff measures to date, which is included in forecasts from the IMF and OECD, appears to be modest. Following the finalisation of these forecasts, the US raised tariffs on US$200 billion of Chinese imports from 10% to 25%, increasing the risk to the outlook for global trade.

Over the six months to December 2018, US monetary policy uncertainty and a deterioration in financial market sentiment placed pressure on emerging market currencies and caused considerable volatility in financial markets. Although these pressures unwound over early 2019, there remains the risk that a sharp deterioration in market sentiment could lead to tighter global financial market conditions. Persistently weak global economic developments or the UK withdrawing from the European Union (EU) without a deal could cause such a deterioration in market sentiment.

…and there are challenges in the medium term

The outlook is for a general slowing of economic growth across New Zealand's major trading partners over the year ending December 2019, after which growth is projected to remain stable at 3.4%, albeit at a lower level than experienced over recent years.

In the US, the unwinding of the stimulus from fiscal policy will become a drag on growth, while in other economies, reduced spare capacity and higher interest rates will slow growth. In addition to this cyclical slowing, an ageing population and weak productivity growth in the past point to weaker medium term growth prospects than experienced in previous expansions.

In China, growth is expected to ease, but a shift to more consumption-led activity should support demand for New Zealand's exports.

Commodity prices remain buoyant amid slowing world growth…

Export prices are projected to remain stable (Figure 1.14). Dairy and meat (around 40% of total goods exports values) prices rebounded over the three months to March 2019, despite an easing in global growth. Dairy auction prices strengthened following the sell-off of EU intervention stocks.

Figure 1.14 – Goods terms of trade

Sources: Stats NZ, the Treasury

Text description of Figure 1.14 – Goods terms of trade.

Import price inflation is projected to remain relatively muted. Oil prices are assumed to be stable, reflecting solid supply supported by past investment in exploration, technological advancements, and weaker global demand compared with recent years.

Over the medium term, the terms of trade are projected to rise gradually as Chinese demand for food continues to expand amid tighter global supply, particularly in the meat and dairy industries.

…and the outlook for exports is stable…

The outlook for exports growth is broadly stable over the forecast period, reflecting a stable outlook for trading partner growth (Figure 1.15). In the near term, the contribution of dairy production to export growth will be limited as dry weather conditions hampered agricultural production over the three months to March 2019. Meat exports should partly offset this weakness as farmers held onto stock as a result of favourable feed conditions early in the season, likely boosting eventual slaughter weights.

Figure 1.15 – Trade volumes

Sources: Stats NZ, the Treasury

Text description of Figure 1.15 – Trade volumes.

Service exports are expected to be supported by a lower exchange rate relative to recent years and continued economic growth in key trading partners. Growth in service exports is projected to be slightly weaker in the year ending December 2019, compared with the year prior. This reflects slowing visitor arrivals growth over the first three months of 2019 and weaker forward bookings in the tourism sector signalled through the Treasury's business talks.

…and growth in imports is projected to rise, reflecting robust domestic demand

Growth in import volumes is projected to increase over the year to December 2020 as domestic demand growth accelerates. Beyond 2020, growth in import volumes slows, reflecting easing domestic demand pressures.

Overall, growth in net exports is projected to be slightly positive for economic growth over the 2018/19 fiscal year, compared with the large negative contribution over the previous two years. Over the two years to June 2021, the domestic demand growth outlook is projected to be slightly stronger than the global growth outlook, relative to their respective trend rates. This sees New Zealand's trade deficit expand and net exports are projected to provide a negative contribution to aggregate economic growth. Beyond 2021/22, domestic demand growth slows and the economic growth contribution of net exports is broadly neutral.

In the external accounts, solid domestic demand outweighs the gradual increase in the terms of trade and the goods and services balance is therefore forecast to move into a slight deficit position over the two years to June 2021. Thereafter, as domestic demand eases, imports growth declines and the goods and services balance return to surplus.

Rising global interest rates towards the end of the forecast period see the income deficit widen (Figure 1.16). The net result is a broadly stable current account deficit and a relatively flat net external liability position.

Figure 1.16 – Current account balance

Sources: Stats NZ, the Treasury

Text description of Figure 1.16 – Current account balance.

Fiscal Outlook#

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Overview#

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• The fiscal outlook remains in line with the Government's fiscal strategy.
• In the near-term, the fiscal outlook is expected to be weaker than the position at 30 June 2018, primarily owing to higher than usual growth in expenses.
• The annual growth in core Crown expenses in the current year is expected to be 8.3% and then 6.8% in 2019/20. This compares to an annual average growth of 2.9% over the previous five years.
• In nominal terms core Crown expenses are expected to increase by $25.1 billion over the forecast period. A key driver of this increase is Government decisions. As a percentage of GDP, core Crown expenses gradually increases until 2020/21 before falling to reach 28.8% by 2022/23.
• Core Crown tax revenue is also expected to increase across the forecast period. By 2022/23, core Crown tax revenue is $25.4 billion higher than in 2017/18. This is largely driven by expected growth in wages and employment, as well as domestic consumption and corporate profits. As a percentage of GDP, core Crown tax revenue stays relatively stable between 28% and 29% across the forecast period.
• OBEGAL surpluses over the next two years are expected to decline from the 2017/18 actual result with a surplus of $1.3 billion forecast for 2019/20. OBEGAL surpluses after 2019/20 slowly increase and reach $6.1 billion (1.7% of GDP) in 2022/23.
• While net operating cashflows are in surplus across the forecast period, capital spending is expected to exceed operating cashflows until the last year of the forecast period. As a result, residual cash deficits are expected over the next four years before returning to a surplus in 2022/23. Cumulatively, residual cash deficits of $10.6 billion are expected across the forecast.
• These residual cash deficits are funded from additional borrowings and utilising financial assets. As a result, net core Crown debt is forecast to increase by $11 billion. Over the forecast period, as a percentage of GDP, net core Crown debt initially increases then starts to fall from 19.9% of GDP in 2021/22 to 18.7% of GDP 2022/23.
• Gross debt is forecast to increase by $4.8 billion by 2022/23, as a result of additional borrowings. Total borrowings are forecast to increase from $115.7 billion in 2017/18 to $130.6 billion by the end of 2022/23. This growth is owing to additional government bonds across the forecast period and an increase in Crown entities borrowings.
• The Crown's balance sheet continues to grow, with net worth attributable to the Crown reaching $160.8 billion (43.9% of GDP) in 2022/23. This growth is largely the result of forecasting continued operating surpluses across the forecast period.
• Overall the fiscal outlook has weakened since the Half Year Update, primarily owing to higher Government spending. Further discussion on the comparisons against the 2018 Half Year Update can be found on page 43.
• The Forecast Financial Statements and Core Crown Expense tables can be found on pages 123 to 127, 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.
3. Excludes Reserve Bank settlement cash and bank bills.

Source: The Treasury

Table 2.2 sets out how the forecast Government revenue, operating and capital expenditure impacts the key fiscal indicators.

Source: The Treasury

Core Crown Tax Revenue#

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Tax revenue is forecast to grow over the forecast period...

Core Crown tax revenue (Figure 2.1) is forecast to increase in each year of the forecast period in nominal terms, while remaining relatively stable as a percentage of GDP. By 2022/23, core Crown tax revenue is expected to reach $105.6 billion, $25.4 billion higher than in 2017/18.

Figure 2.1 – Core Crown tax revenue

Source: The Treasury

Text description of Figure 2.1 – Core Crown tax revenue.

Table 2.4 shows the breakdown of the increase across the major tax types.

Source: The Treasury

Source deductions are forecast to grow by $10.8 billion over the forecast period. Half of this increase is expected to come from forecast wage growth. The rest of the increase comes from expected employment growth that contributes $2.4 billion and fiscal drag which contributes a further $1.9 billion.

GST is forecast to grow by $6.8 billion over the forecast period, with growth from household consumption (supported by income growth and relatively low interest rates) expected to contribute $6.3 billion and residential investment expected to contribute $1.2 billion.

Corporate tax is forecast to grow by $3.6 billion over the forecast period, mainly owing to expected growth in corporate profits.

In April 2019, Inland Revenue moved the administration of income taxes to a new accounting system, enabling the recognition of income tax more consistently during the tax year (the previous system relied on year-end assessments to a large extent, particularly for large taxpayers). This change has resulted in an earlier recognition point for income tax revenue, and is estimated to add around $1.0 billion to net company tax and reduce net other persons tax by around $0.5 billion in the 2018/19 year, with negligible effects in later years. These changes dominate the corporate tax and net other persons tax forecast movements in the 2018/19 year shown in Table 2.4 and Figure 2.1.

…broadly in line with expected economic growth

Figure 2.2 shows that core Crown tax revenue is forecast to grow at a slightly slower rate than nominal GDP in 2019/20, mainly owing to system changes at Inland Revenue discussed above.

Figure 2.2 – Core Crown tax revenue and nominal GDP growth

Source: The Treasury

Text description of Figure 2.2 – Core Crown tax revenue and nominal GDP growth.

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

• Fiscal drag is forecast to add 0.6% of GDP to tax revenue by 2022/23.
• CPI-indexation of alcohol and tobacco excise rates adds 0.3% of GDP to forecast tax revenue.
• Some previously announced policy measures first introduced in the 2018 Budget (eg, ring-fencing of residential property tax losses and GST on low-value goods imports) are expected to increase tax revenue by 0.2% of GDP over the course of the forecast period.

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, 0.4% 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, corporate tax, GST, resident withholding tax (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/efu/budget-economic-and-fiscal-update-2019

Core Crown Expenses#

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Core Crown expenses are expected to increase, particularly over the next three years…

Core Crown expenses are expected to increase across the forecast period by $25.1 billion from $80.6 billion in 2017/18 to $105.7 billion in 2022/23 (Figure 2.3).

Figure 2.3 – Core Crown expenses

Source: The Treasury

Text description of Figure 2.3 – Core Crown expenses.

Core Crown expenditure increases at a greater rate the next three years (Figure 2.4). Annual growth in core Crown expenses is expected to be 8.3% in the current year and 6.8% and 6.0% in the following two years. This is largely owing to Government spending decisions. The funding set aside for Budget 2020 initiatives also contributes to the growth in expenditure. In addition, subsidies relating to assets (eg, Housing Infrastructure Fund, which are loans with no interest being charged), have resulted in an increase in core Crown expenses over the next two years.

Figure 2.4 – Core Crown expenses annual growth and the level of Budget allowances[3]

Source: The Treasury

Text description of Figure 2.4 – Core Crown expenses annual growth and the level of Budget allowances.

Core Crown expenses as a percentage of GDP, peak at 29.6% in 2020/21 before declining to 28.8% in 2022/23.

…primarily owing to Budget decisions and allowances for future Budgets…

A significant portion of the nominal increase in expenses is attributable to decisions from theGovernment’s 100-Day Plan, Budget 2018 and Budget 2019. Overall, these decisions result in a forecast increase in core Crown expenses of $9.6 billion by 2022/23, with Budget 2019 contributing $3.8 billion each year on average to this increase (refer page 31).

Future operating allowances are set at $3.0 billion for Budget 2020 and $2.4 billion for Budgets 2021 and 2022. Over the forecast period, allowances for future Budgets increase core Crown expenses by $7.8 billion by 2022/23 (Figure 2.5).There is a pre-commitment against Budget 2020, for the PGF totalling $0.6 billion, leaving an average of $2.9 billion of spending yet to be allocated.

Figure 2.5 – Core Crown expenses with allowance break-down

Source: The Treasury

Text description of Figure 2.5 – Core Crown expenses with allowance break-down.

For forecasting purposes, Budget allowances are assumed to be all operating expenditure. However, these allowances can be used for a combination of revenue and expenses initiatives when allocated. The fiscal forecasts also assume that any additional costs in relation to Government commitments and future costs pressures will be met from operating allowances.

…the cost of social assistance also steadily increase…

Social assistance spending is forecast to increase by $6.8 billion (excluding policy changes) across the forecast period. Of this, $4.8 billion relates to growth in New Zealand Superannuation expenses reflecting an expected increase in recipient numbers from almost 741,300 in 2017/18 to over 872,900 (17.8% increase), an increase in payment rates and other factors. By the end of the forecast period, New Zealand Superannuation equals around 53% of core Crown social assistance spending and 18% of core Crown expenditure.

The remaining increase is largely owing to indexation of entitlements to wage growth (Figure 2.6).

Figure 2.6 – Growth of New Zealand Superannuation recipients and expenses

Source: The Treasury

Text description of Figure 2.6 – Growth of New Zealand Superannuation recipients and expenses .

…however, judgements on the level of spending reduce overall growth in the near term…

The fiscal forecasts are a culmination of individual forecasts provided by departments and other government entities. The actual level of spending by entities is usually below what they forecast and 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. The top-down adjustment is larger in the first two years of the forecast period ($0.8 billion in 2018/19 and $1.4 billion in 2019/20), partly owing to the significant growth in expense expected in these years. It then remains static at $0.5 billion for the rest of the forecast period (refer to page 99).

…and so does a decline in finance costs

Core Crown finance costs are forecast to decline by around $0.3 billion by the end of the forecast period, primarily owing to a reduction in the effective interest rate on borrowings. For example, at June 2018 the effective interest rate on Government bonds was 4.1% and by 2022/23 it is forecast to decrease to 2.8%. The reduction is primarily from Government bonds being issued at a lower rate (between 2.3% and 2.7%) than those maturing over the same period (between 3.6% and 5.6%). Even though borrowings are expected to increase resulting in additional finance costs, the lower effective interest rate more than offsets this increase.

Operating Balance#

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OBEGAL is expected to initially decline before climbing…

OBEGAL is forecast to remain in surplus over the forecast period, decreasing from $5.5 billion in 2017/18 to $1.3 billion in 2019/20 before reaching $6.1 billion in 2022/23 (Figure 2.7).

Figure 2.7 – Components of OBEGAL by segment

Source: The Treasury

Text descripton of Figure 2.7 – Components of OBEGAL by segment.

The initial decline in OBEGAL surpluses is a result of the growth in core Crown expenses outpacing growth in core Crown tax revenue (as discussed in earlier sections of this chapter). This trend reverses from 2020/21 and as a result, OBEGAL surpluses are expected to start rising.

Crown entities are collectively forecasting OBEGAL deficits that increase from a $0.6 billion deficit in the current year to $1.8 billion in 2022/23. The increase in these deficits is largely driven by ACC and District Health Boards (DHBs), which are both expecting growth in demand and rising costs. State-owned Enterprises' (SOEs) contribution to OBEGAL remains fairly stable with surpluses forecast across the forecast period.

…while investment returns contribute to the growth in the operating balance and net worth

The total Crown operating balance, inclusive of gains and losses, is forecast to be a deficit of $0.3 billion in the current year, before returning to surplus for the remainder of the forecast period, reaching $10.9 billion in 2022/23 (Figure 2.8).

Figure 2.8 – Components of operating balance

Source: The Treasury

Text description of Figure 2.8 – Components of operating balance .

Gains and losses on liabilities are included in the first year of the forecast but are not forecast beyond then (as happens every year). In the current year, the Crown is expected to record large losses on its non-financial liabilities (ACC outstanding claims liability and the GSF retirement plan liability) of $4.7 billion and losses on the Emissions Trading Scheme (ETS) of $0.6 billion. The losses from non-financial liabilities are primarily driven by a reduction in discount rates used to calculate these long-term liabilities. For example, the single effective discount rate for ACC's liability has decreased from 3.51% at 30 June 2018 to 2.97%. As future actuarial gains or losses are not forecast, they do not impact the operating balance beyond 2018/19. The losses relating to the ETS are a result of changes to the carbon price, which has increased to $25.67 per unit in the current year from $21.10 per unit at 30 June 2018.

Partially offsetting these losses are the year-to-date gains made on the Crown's two large investment portfolios, ACC and the NZS Fund. As the global equity markets have been weaker in the first half of 2018/19, the gains recorded are lower than in 2017/18. These forecasts assume investment income returns to a long-term rate, resulting in stable returns being forecast beyond the current year.

The level of the operating balance plays a significant part in increasing the Government's financial assets and is the primary reason for the growth in the Crown's net worth. As a percentage of GDP, net worth attributable to the Crown is forecast to be lower than it was in 2017/18, largely due to the increasing operating expenditure. This is discussed in more detail in the balance sheet section of this chapter.

Residual Cash and Net Core Crown Debt[7]#

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Operating cash flows improve over time…

Over the entire forecast period, a cash deficit of $10.6 billion is expected. This cash shortfall is funded partly through additional borrowing (refer to Figure 2.10).

Figure 2.10 – Core Crown residual cash

Source: The Treasury

Text description of Figure 2.10 – Core Crown residual cash.

Net operating cashflows are forecast to be in surplus across the forecast period, broadly following a similar trend to the OBEGAL forecast. Over the forecast period, the Government is expected to generate cash flows from core Crown operating activities of $30.4 billion.

…outpacing capital spending near the end of the forecast period

However, capital spending is forecast to exceed operating cashflows until the last year of the forecast, resulting in residual cash deficits for the first four years. As tax receipts continue to grow and capital spending decreases, a residual cash surplus of $1.2 billion is forecast in 2022/23.

The Government is forecast to spend a net total of $41.1 billion on capital investments over the forecast period. Net capital spending includes $15.1 billion on building and acquiring physical assets, $13.0 billion on providing capital to Crown entities (eg, the New Zealand Transport Agency for state highways ($4.2 billion) and DHBs to build or develop hospitals ($2.6 billion)) and $9.6 billion in contributions to the NZS Fund.

Similar to the adjustment to operating expenses, a top-down adjustment has also been applied to both operating payments and capital spending to account for the possibility that expenditure will be deferred into later years.

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

Source: The Treasury

Future new capital spending represents funding set aside in contingencies for projects agreed in Budgets and amounts to be allocated in future Budgets from the multi-year capital allowance. The multi-year capital allowance has been set aside for capital spending in Budget 2019 to Budget 2022. This allowance has been increased by $1.7 billion to $14.8 billion. Of this amount, Budget 2019 has allocated $10.4 billion leaving $4.4 billion remaining to be allocated. For more details, refer to page 41.

Net core Crown debt peaks as a share of GDP in 2021/22…

Net core Crown debt as a percentage of GDP is expected to increase for the first three years of the forecast period before declining to 18.7% in 2022/23 (Figure 2.11).

Figure 2.11 – Net core Crown debt

Source: The Treasury

Text description of Figure 2.11 – Net core Crown debt.

However, in nominal terms, net core Crown debt continues to grow, peaking at $69.9 billion in 2021/22, and then declines in the final year of the forecast once residual cash returns to surplus. Net core Crown debt is forecast to be $68.5 billion in 2022/23.

…while gross debt continues to decline as a percentage of GDP

Gross debt remains on a generally declining trend as a percentage of GDP, decreasing from 30.5% in 2017/18 to 25.3% by 2022/23 (Figure 2.12).

Figure 2.12 – Gross debt

Source: The Treasury

Text description of Figure 2.12 – Gross debt.

In nominal terms, gross debt is expected to increase over the forecast period, in order to partially fund the overall residual cash deficits.

The core Crown borrowing programme is a key influence in the trend in gross debt. As a result on an annual basis gross debt will vary depending on the timing of bond maturities and proceeds from bonds.

By 2022/23, New Zealand Government Bonds (NZGBs) on issue are forecast to decline to 21.6% of GDP, from 25.7% at the end of 2017/18. This is consistent with the Government's stated intention to maintain levels of NZGBs on issue at not less than 20% of GDP over time.

The core Crown borrowing programme covers the cash shortfall and maturities over the forecast period

The core Crown borrowing programme includes forecast proceeds from both Government bonds and short-term borrowing (eg, Treasury Bills). Overall, the programme will provide funds of $5.2 billion (Table 2.9) to help meet residual cash shortfalls.

In total, the bond programme is expected to raise funds of $43.6 billion. Although, bond maturities will result in $37.4 billion of existing debt being repaid. In addition, short-term borrowing is expected to be $1.0 billion lower at the end of the forecast period, relative to the end of 2017/18.

Source: The Treasury

Total Crown Balance Sheet#

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Operating balance surpluses drive the growth in the Crown's net worth…

Figure 2.13 shows that, in nominal terms, net worth attributable to the Crown is expected to grow across the forecast period, reaching $160.8 billion by 2022/23, as a result of operating balance surpluses. The nominal growth in the Crown's net worth over the forecast period is reflected by an increase in total assets of $55.0 billion, partly offset by an increase in total liabilities of $24.0 billion.

Figure 2.13 – Net worth attributable to the Crown

Source: The Treasury

Text description of Figure 2.13 – Net worth attributable to the Crown.

As a percentage of GDP, net worth attributable to the Crown stays relatively stable at around 43% across the forecast period as growth in operating surpluses is broadly in line with economic growth. This trend has changed to what was expected at the Half Year Update which showed a gradual increase in the size of the Crown's net worth as a share of the economy, owing to a higher forecast expenditure track (refer page 28).

Spending decisions and tax revenue have traditionally had the largest impact on the Crown's finances. However, as the size and nature of the balance sheet investment evolves, changes in the values of assets and liabilities will continue to have a significant effect on the overall fiscal position.

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.

Source: The Treasury

…with financial assets increasing by $31.5 billion…

Financial assets are forecast to grow by $31.5 billion over the forecast period to $189.0 billion (around 47.9% of total assets) in 2022/23 (Table 2.10) as a result of:

• The financial asset portfolio managed by the NZS Fund is expected to grow by around $25 billion. This growth in financial assets is driven by the expected investment returns that accumulate over the forecast period. In addition, the contributions from the Crown to the NZS Fund of around $9.6 billion are expected to be invested in financial assets.
• The financial asset portfolio managed by ACC is also expected to grow by $4.8 billion largely as a result of expected investment returns.
• Advances are expected to increase by $7.7 billion by 2022/23, primarily owing to growth in Kiwibank mortgages of $6.3 billion. The remaining increase in advances is from loans forecast to be provided from the Housing Infrastructure Fund and the PGF. For forecast purposes, it is assumed the unallocated portion of capital spending from the PGF will be provided for projects as concessionary loans.
• Financial assets held by the Treasury reduce to help fund the expected cash shortfall, offsetting the increases above.

…and physical assets increasing by $17.6 billion…

Overall, property, plant and equipment (PPE) is expected to increase by $17.6 billion to $176.6 billion (around 45% of total assets) by 2022/23. There are large increases expected across the PPE asset classes of buildings, state highways, specialised military equipment (SME) and aircraft.

Figure 2.14 – Increase in PPE by asset class

Source: The Treasury

Text description of Figure 2.14 – Increase in PPE by asset class.

Just over a quarter ($4.3 billion) of the overall increase in PPE comes from capital investments funded from Budget 2019, which includes:

• investment in infrastructure to help maintain health services provided by DHBs
• the purchase of four Boeing P-8A Poseidon maritime patrol aircraft, and
• investment in the rail freight network through the replacement of rolling stock (locomotives and wagons) and implementation of the Future of Rail review.

In addition, decisions from previous Budgets will also be a factor in the increase expected in PPE, as capital projects generally take a number of years to complete. For example, the decision to fund the expansion of Waikeria Prison was made in Budget 2016; but the majority of the fiscal impact from this decision on PPE is reflected across the current forecast period.

Housing New Zealand Corporation is expected to make significant investment in public housing across the forecast period, which is a key factor in the increase in the buildings PPE asset class. This investment is expected to be largely funded from third-party borrowings.

Over the forecast period the value of state highways is expected to grow by $5.5 billion, primarily reflecting roading projects to be funded from the National Land Transport Fund.

…with $3.1 billion set aside for future capital Budget decisions…

Total assets are forecast to increase by $3.1 billion over the forecast period from funding set aside for future capital initiatives. The annual profile included in the forecasts for this investment is outlined in Table 2.12.

…while liabilities are expected to increase by $24.0 billion over the forecast period

Total liabilities are forecast to increase by $24.0 billion over the forecast period to $228.3 billion in 2022/23. The increase in total liabilities is owing to borrowings being higher by $14.9 billion and insurance liabilities being higher by $10.1 billion.

Figure 2.15 – Borrowings by segments

Source: The Treasury

Text description of Figure 2.15 – Borrowings by segments.

The increase in borrowings is driven by three main factors:

• gross debt increasing by $4.8 billion (refer pages 37 to 38) to partly help meet the expected cash shortfall
• Kiwibank borrowings (eg, deposits held) increasing by $6.3 billion, which offsets the increase in Kiwibank advances discussed on page 40, and
• borrowings by Crown entities increasing by $5.9 billion to fund capital expansions. This includes a $3.0 billion increase in Housing New Zealand Corporation's third-party borrowing to increase its public housing portfolios. In addition, increased borrowing by Crown Infrastructure Partners Limited ($2.0 billion) and NZTA ($1.1 billion) has also contributed to the total increase in borrowings.

The increase in insurance liabilities of $10.1 billion is largely owing to an increase of $11.8 billion in ACC insurance liabilities. The most recent ACC liability valuation (31 December 2018), updated for discount rates at 28 February 2019, has resulted in an increase to the liability of around $3.7 billion in the current year, primarily owing to a decrease in discount rates. The remaining change in the ACC liability reflects the increase in cost of existing and new claims. Both the EQC and Southern Response insurance liabilities are expected to decline as existing claims are forecast to be largely settled by the end of the forecast period.

Comparison to the Half Year Update#

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The Half Year Update was published on 13 December 2018. Since then, there have been a number of changes that have impacted the fiscal outlook. Table 2.13 summarises the changes in the key fiscal indicators since the Half Year Update.

Source: The Treasury

Overall core Crown tax revenue is expected to be marginally higher than the Half Year Update...

Core Crown tax revenue is forecast to be $0.6 billion higher than in the Half Year Update over the forecast period. Forecasts for revenue from GST and other taxes have increased with these increases largely offset by reductions in the forecasts for corporate tax, RWT and revenue from other persons tax. Table 2.14 summarises the movements by tax type since the Half Year Update.

Source: The Treasury

The $3.4 billion increase in GST is mainly owing to increased forecasts of private nominal consumption ($1.7 billion) and more accurate information from agencies ($1.7 billion).

Corporate tax revenue forecasts are $1.6 billion lower in total, mostly driven by the inclusion of $1.3 billion of Research and Development (R&D) tax credits (which was previously recognised as an expense) as a reduction in tax revenue for the first time. As this also reduced core Crown expenses, there is no impact on OBEGAL.

The RWT forecast is $1.0 billion lower owing to a lower forecast interest rate track and the net other persons' tax revenue forecasts are $0.5 billion lower, mostly owing to a weaker outlook for growth in entrepreneurial income.

…while OBEGAL growth slows, as additional spending takes effect…

OBEGAL growth has slowed across the forecast period since the Half Year Update, as new Budget spending takes effect. The major movements in OBEGAL since the Half Year Update are outlined in Table 2.15. Cumulatively, OBEGAL is $9.2 billion lower across the forecast period.

Source: The Treasury

Core Crown tax revenue has increased as a result of forecasting changes (refer page 44 for a more detailed discussion of this change since the Half Year Update).

Final Budget 2019 decisions are larger than assumed at the Half Year Update by around $5.4 billion, which has increased core Crown expenditure, reducing OBEGAL across the forecast period. (Refer to the box on page 31 for further information on the Budget 2019 new operating spending.)

The Budget operating allowance for Budget 2020 has increased since the Half Year Update from $2.4 billion to $3.0 billion, resulting in a $0.6 billion impact on OBEGAL for each of the last three years of the forecast. However, the allowances for Budgets 2021 and 2022 remain unchanged at $2.4 billion per year.[11]

Social assistance forecasting changes have increased spending by $0.3 billion in total since the Half Year Update. This is primarily driven by higher forecast growth in recipient numbers (largely for Accommodation Assistance and Jobseeker Support benefits) partially offset by a reduction in the forecast for family tax credits reflecting ongoing strength in the labour market.

Expenditure phasing changes have also contributed to the reduction in OBEGAL. The largest changes in timing were in relation to PGF expenditure resulting in expenditure shifting out of the current year and into later years. Reforecasts of expenditure since the Half Year Update have led to expenditure being transferred from 2018/19 into the 2019/20 fiscal year improving OBEGAL in the current year. In addition, some expenditure previously forecast in the later part of the forecast is now not expected until beyond 2022/23.

Crown entity and SOE forecasts have been revised since the Half Year Update with some entities' forecasts improving and others weakening. The most significant changes were in relation to DHBs and ACC. In total, the DHBs are expecting higher deficits than previously. At the same time, ACC is expecting levy revenue to be lower and insurance claim costs higher than previously forecast. Both of these Crown entity changes result in OBEGAL being $2.1 billion lower across the forecast period when compared to the Half Year Update.

In addition, EQC's forecasts have improved in the near term by $0.2 billion as a result of higher reinsurance recoveries expected in the latest actuarial valuations improving OBEGAL since the Half Year Update.

...and net core Crown debt is higher across the forecast period, reflecting new spending decisions...

Core Crown residual cash is forecast to be $6.1 billion lower than the Half Year Update. This results in an increase to net core Crown debt, which is expected to be around $5.0 billion higher than previously forecast across the forecast period (Table 2.16).

1. MYCA refers to the multi-year capital allowance.
2. Excluding reclassification of R&D tax credits previously included as an operating payment.

Source: The Treasury

Increases in Budget 2019 spending as well as the Budget 2020 operating allowance, have increased net core Crown debt by $7.2 billion.

Tax receipts have increased by $1.2 billion across the forecast period since the Half Year Update, as a result of changes in the timing of cash flows relating to R&D tax credit payments and increases in GST offset by reductions in corporate tax, RWT and other persons' tax receipts.

Social assistance forecasting changes largely mirror the OBEGAL movement with the $0.3 billion increase in payments primarily driven by higher forecast growth in recipient numbers.

Reforecasting of capital spending has resulted in a $0.6 billion overall reduction in net core Crown debt as some of this capital spending previously forecast to occur prior to 2022/23 is now expected to fall outside of the forecast period.

As a result of EQC's expected revenue changes, EQC now no longer require $0.2 billion support from the Crown.

The expected profile of capital spending by departments has resulted in changes to the cash profile in 2018/19 and 2019/20. This impacts net core Crown debt in these two years but not on net core Crown debt overall.

Net finance costs have increased resulting in a $0.4 billion impact on net core Crown debt. This is largely owing to a reduction in interest receipts arising from reductions in interest rates since the Half Year Update.

In addition, movements in gains and losses have also had an impact resulting in a $0.2 billion decrease in net core Crown debt.

...and net worth attributable to the Crown is lower across the forecast period reflecting increased government spending

Net worth attributable to the Crown is now forecast to stand at $160.8 billion (43.9% of GDP) in 2022/23 compared to $174.7 billion (48.0% of GDP) at the Half Year Update. This $13.9 billion reductionis largely driven by the impact of additional Budget spending on the Crown's operating balance across the forecast period.

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 2.17 below.

Notes:

1. Production measure.
2. Expenditure measure.

Sources: The Treasury, Statistics New Zealand

Risks and Scenarios#

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Overview#

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• The risks to the international outlook are skewed to the downside and include continued trade tensions, a more pronounced slowdown in the Chinese economy, and major adjustments in international financial markets. Should these risks materialise, global and domestic growth will deviate from that presented in the main forecast.
• The risks to the domestic outlook are more balanced and include uncertainty around the impact of business confidence on investment, the extent to which capacity pressures are binding, and uncertainty regarding the outlook of house prices, net migration and productivity growth.
• Scenario One explores weaker-­than-forecast trading partner growth driven by a combination of the risks listed above. Under this scenario, lower demand for New Zealand exports causes a fall in export prices. Weaker consumption and investment sees slower nominal GDP growth adversely affecting tax revenue and the fiscal position.
• Scenario Two illustrates the impacts of capacity pressures leading to stronger-than-forecast wage growth. Under this scenario, stronger domestic demand leads to more investment. Higher-than-forecast nominal GDP and tax revenue generate larger fiscal surpluses and lower net debt.
• The Crown's balance sheet is exposed to a number of risks beyond those associated with the operating balance, including 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 Outlook#

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Economic forecasts involve judgements about current and forecast levels of individual variables and the workings of the economy as a whole. This section outlines the risks around some of our judgements that could have a significant impact on the economy if they were to materialise. Risks to the economic outlook have flow-on implications for the Government's fiscal position as tax revenue and public spending vary with the state of the economy.

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.

Weaker trading partner growth could be driven by further trade tensions…

Trade tensions, particularly between the US and China, have escalated since early 2018. Recently, the US has implemented tariffs of 25% on US$250 billion worth of imports from China. Expectations of an agreement between the two nations supported market sentiment over the start of 2019, although, until formal agreements are made, uncertainty will continue to weigh on economic activity. Trade tensions have already weakened manufacturing activity and export growth in some of New Zealand's trading partners in Asia and Europe. Should the US implement further tariffs on Chinese imports, slower growth in China would reduce demand for New Zealand's exports. Further spill-overs are likely for Southeast Asian economies (given their role in global value chains that often include China) which are increasingly important export destinations for New Zealand.

The terms of the UK's withdrawal from the EU are also uncertain. The UK is now scheduled to leave the EU by 31 October. If no withdrawal agreement is reached, economic activity in the UK, and to some extent in the EU, could fall markedly and create uncertainty in many markets connected to the UK.

…while a more pronounced slowdown in China could lower demand for our exports

Growth in China has slowed over the past year, partly driven by regulatory measures implemented by Chinese authorities aimed at reducing shadow banking, as well as trade tensions associated with the US. Although stimulus measures are expected to support growth in the Chinese economy over the second half of 2019, authorities face a challenge between the need to support growth and the management of financial risks.

A slowdown in Chinese activity would significantly lower demand for New Zealand's exports directly, or indirectly through other trading partners such as Australia. In Australia, domestic activity could be weaker than expected, driven by declining house prices impacting household consumption, or weak business sentiment impacting investment.

These factors could lead to major adjustments in international financial markets…

The end of 2018 was a volatile period for equity markets, with many making annual losses. Lower market sentiment was driven by trade tensions, fears of a global slowdown and uncertainty regarding the pace of monetary tightening in the US. However, the turbulent period had limited spill-over implications for the real economy, and many markets have recovered. Nevertheless, a deterioration in market sentiment associated with the uncertainties listed above could lead to lower demand for riskier assets and rapidly tightening credit conditions in an environment of high private and public sector debt in many countries.

Another risk is the limited ability of central banks to stimulate economies in the event of an economic slowdown as interest rates are already low relative to their pre-global financial crisis levels. This may necessitate other measures to stimulate the economy, such as quantitative easing or the use of fiscal policy measures.

…though global growth could pick up

Despite the balance of risks being tilted to the downside, there is also a risk that global growth could accelerate faster than anticipated. Trade tensions may ease if the US and China reach a trade agreement and begin phasing out tariffs. The UK could leave the EU with an agreement in place, allowing firms in both nations to continue trading with certainty and without additional tariffs. Central banks around the world could remain accommodative, keeping borrowing costs at record lows. Monetary and fiscal policy stimulus in China could also be greater than expected and help growth accelerate, improving Chinese incomes and demand for New Zealand's exports.

The outlook for commodity prices and exchange rates is uncertain…

New Zealand is particularly susceptible to changes in global agricultural commodity prices. The risks discussed above may affect commodity prices in either direction. The adjustment in the New Zealand dollar will also play a significant role in determining the profitability of New Zealand export industries. Lower-than-forecast oil prices may support global growth, as oil is a major input cost for many industries.

…and oil prices may be lower than assumed in the main forecast

Oil prices could be lower in the long term as the break-even costs for shale oil producers in the US keep declining owing to technological advancements, pushing supply higher. Oil supply from non-OPEC members in response to price changes is also uncertain.

The effects of business confidence are hard to estimate…

Recent falls in domestic business sentiment can possibly be explained by several factors such as uncertainty about signalled changes in government policies, labour market pressures, global uncertainty and profit margins.[12] A key risk to the outlook over the next few years is weaker sentiment having a more pronounced effect on business investment.

…and measures of capacity pressures are uncertain

Measures of capacity pressure in the domestic economy are uncertain. If potential growth is lower than expected, there will be less spare capacity in the economy, constraining investment and production and resulting in higher inflationary pressures.

Capacity pressures in the labour market could lead to higher-than-forecast wage growth. Wage negotiations that are yet to be resolved also pose a risk to the wage growth forecast. The effects of higher-than-forecast wage growth are explored in Scenario Two. Similarly, capacity pressures may constrain construction activity more than anticipated.

Productivity could be weaker than anticipated…

A factor that could lead to lower potential growth is weaker-than-forecast labour productivity. Labour productivity is the quantity of goods and services produced per hour worked. If firms do not increase capital investment to compensate for lower labour supply growth (for example, owing to declining net migration), labour productivity growth could be weaker than forecast.

…while the risks to house price growth are tilted to the downside

Downside risks to our house price forecast include higher-than-expected supply growth, lower-than-expected net migration and negative sentiment associated with Australian housing market activity flowing through to New Zealand. Weaker-than-forecast house prices would lower consumption and residential investment, ultimately slowing growth. The uncertainty regarding the sensitivity of households to changes in interest rates is also a risk.

Changes in weather conditions affect agricultural output…

Weather conditions hampered agricultural production over the first three months of 2019; however, the mild El Niño should result in benign weather conditions leading into winter. Agricultural conditions and hydroelectric power generation in New Zealand remain sensitive to climate conditions.

…and net migration will depend on developments domestically and internationally

Net migration outflows to Australia tend to increase when Australia's labour market strengthens relative to New Zealand's. The prospect of relatively faster wage growth in New Zealand may lead to less people migrating to Australia than assumed in the main forecast. Equally, tight domestic labour markets may encourage employers to look offshore for workers. In addition, uncertainty around policy changes to residency requirements or visa conditions may deter potential migrants, widening the uncertainty around the outlook for net migration.

Large revisions between the most recent releases of Stats NZ's new official measure of net migration also make the outlook uncertain.

Some policies are yet to be agreed

While we anticipate the effects over the forecast period to be small, the RBNZ proposal to increase capital requirements for locally-incorporated banks will not be known until later in the year.

Alternative Scenarios#

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The following scenarios show how the economy might evolve if some of the key judgements in the main forecast were altered. This section aims to show how changes in certain assumptions have flow-on impacts to the economy as a whole. The scenarios illustrate two of the many ways that the economy may deviate from the main forecast.

Scenario One explores weaker-than-forecast trading partner growth driven by a combination of the risks listed above. Under this scenario, lower demand for New Zealand exports causes a fall in export prices. Lower sentiment and domestic demand results in weaker investment and sees GDP growth falling in nominal and real terms, affecting tax revenue and the fiscal position.

Scenario Two illustrates the impacts of capacity pressures leading to stronger-than-forecast wage growth. Under this scenario, stronger domestic demand leads to more investment. Higher-than-forecast nominal GDP and tax revenue generate larger fiscal surpluses and lower net debt. Table 3.1 summarises key economic variables under each scenario compared with the main forecast.

^a annual average % change.

Source: The Treasury

Scenario One - Weaker Trading Partner Growth

This scenario explores the impacts of weaker-than-forecast trading partner growth on the domestic economy.

Demand for New Zealand exports declines…

Weaker trading partner growth could result from uncertainty related to multiple risks. For example, rising tariffs on global trade would weigh directly on export volumes domestically, while a major financial market adjustment could lower global business sentiment, reducing investment and lowering demand for our exports. Weaker demand for New Zealand's exports lowers export prices, causing the terms of trade to fall.

…and weaker sentiment lowers business investment…

Weaker demand for New Zealand's exports also lowers domestic business sentiment. Lower sentiment and weaker export prices lower business investment across the forecast horizon. Firms also postpone hiring decisions, resulting in slower employment growth, a higher unemployment rate and lower wage growth.

…while consumption falls as households have less disposable income

Weaker wage growth means households have less disposable income, leading to lower consumption across the forecast horizon (Figure 3.1). Lower investment and consumption lead to slower nominal GDP growth.

Figure 3.1 - Lower consumption growth

Sources: Stats NZ, the Treasury

Text description of Figure 3.1 – Lower consumption growth.

The New Zealand dollar depreciates…

To stimulate the economy, RBNZ lowers the OCR, keeping inflation relatively stable around their 2.0% mid-point target. The New Zealand dollar depreciates in response to lower interest rates.

…and nominal GDP is cumulatively $15 billion lower relative to the main forecast

Declining domestic consumption and investment more than offset the positive contributions from lower interest rates, leading to lower nominal GDP growth (Figure 3.2). Cumulative nominal GDP over the five years to June 2023 is $15 billion lower than in the main forecast.

Figure 3.2 – Lower nominal GDP growth

Sources: Stats NZ, the Treasury

Text description of Figure 3.2 – Lower nominal GDP growth.

Slower growth feeds into lower tax revenue and weakens the Government's fiscal position. Core Crown tax revenue falls $4.7 billion relative to the main forecast over the five years to June 2023. Forecasts of business income taxes and tax on resident interest income are $1.6 billion and $1.5 billion lower than in the main forecast, respectively.

This scenario assumes that the Government's operating and capital allowances are unchanged from those in the main forecast (see Economic Outlook chapter for details). Under these assumptions, from 2019/20, OBEGAL surpluses are smaller in each year, reaching $4.4 billion (1.2% of GDP) in 2023 (Table 3.1). This is $1.7 billion below that in the main forecast. The Government's debt levels are also higher, with the level of net core Crown debt $4.6 billion higher by June 2023, raising debt to GDP to 20.2%, compared with 18.7% in the main forecast (Table 3.1).

Scenario Two - Higher Wage Growth Leads to Stronger Growth

This scenario investigates capacity pressures in the labour market leading to higher-than-forecast wage growth. Household incomes rise and stronger growth leads to an improved fiscal position.

Consumption and investment rise

Capacity pressures in the labour market lead to higher-than-forecast wage growth. This supports stronger consumption, as households have more disposable income. Stronger domestic demand encourages firms to invest and import goods, but results in intensifying capacity pressures across the economy, leading to higher inflation. In response, RBNZ raises the OCR, curbing the pace of growth. The New Zealand dollar appreciates in response to higher interest rates.

Figure 3.3 - Higher interest rates and TWI

Sources: RBNZ, the Treasury

Text description of Figure 3.3 – Higher interest rates and TWI.

Nominal GDP is cumulatively $13 billion higher relative to the main forecast…

On balance, stronger consumption and investment more than offset the impacts of rising interest rates and higher imports. Relative to the main forecast, real GDP is almost $4.2 billion higher, while nominal GDP is cumulatively $13 billion higher by mid-2023.

…raising tax revenue and improving the Government's operating balance…

Stronger economic growth feeds into higher tax revenue and strengthens the Government's fiscal position. Core Crown tax revenue is cumulatively $5.3 billion higher relative to the main forecast over the five years to June 2023, with source deductions and GST $3.5 billion and $1.1 billion higher, respectively. This scenario assumes that the Government's operating and capital allowances are unchanged from those in the main forecast. Under these assumptions, OBEGAL surpluses are larger in each year, reaching $7.8 billion (2.1% of GDP) in 2023 (Table 3.1),$1.6 billion above that in the main forecast.

…and lowering debt

Higher tax revenue from stronger growth leads to $4.5 billion lower net core Crown debt by June 2023. The debt-to-GDP ratio falls to 17.3% compared with 18.7% in the main forecast (Table 3.1). The changes in the debt-to-GDP ratio among the different scenarios are shown in Figure 3.4.

Figure 3.4 - Net core Crown debt to GDP

Sources: Stats NZ, the Treasury

Text description of Figure 3.4 – Net core Crown debt to GDP.

Fiscal Sensitivities#

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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 2023, tax revenue would be around $5.5 billion higher than forecast in the June 2023 year. The sensitivities are broadly symmetric and if nominal GDP growth is one percentage point lower than expected each year, tax revenue would be around $5.3 billion lower than forecast in the June 2023 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. For example, at 30 June 2018, a 1.0% increase in New Zealand interest rates would have reduced the total Crown operating balance by around $1,550 million, while a 1.0% decrease would have increased the total Crown operating balance by $1,697 million. The majority of the Government’s borrowings and a large number of financial assets are managed by the Treasury. To illustrate the interest rate sensitivities on the Treasury’s portfolio, Table 3.2 provides the estimated impact of lower interest rates on those assets and liabilities. A one percentage point fall in the interest rate would result in a $102 million reduction in the interest income on funds managed by the Treasury in the June 2023 year.This would be more than offset by $384 million lower interest expenses the June 2023 year. As above, the sensitivities are broadly symmetric.

Note:

1. Funds managed by the Treasury.

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 is likely to differ from the forecast. For example, foreign currency-denominated financial assets and liabilities are converted into New Zealand dollars at the reporting date, the Government's listed share investments are reported on market prices and property owned by the Crown is valued using market information. Changes in these variables can also have flow-on effects for the Crown's operating balance. 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 on 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 ACC and the NZS Fund are sensitive to financial market volatility, such as movements in interest rates, exchange rates and equity prices. The CFIs set long-term investment strategies based on underlying policy objectives. These strategies aim to look through short-term volatility and take exposures that would offset the impact of insurance or retirement liabilities.
• 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 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 about how it can respond to shocks.

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, 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, and
• 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, 8 May 2019. 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 in the table 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 prioritisation 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 2018 were $80.6 billion, while capital spending for the same period totalled $5.9 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 confirmed for Budget 2019 and are included in the Treasury's fiscal forecasts (Fiscal Outlook chapter).

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.

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.
• Business risks and volatility in the returns from, and valuation of, the Government's investments relating to the broader economic and commercial environment.
• Biosecurity incursions, as their occurrence, nature and timing cannot be predicted. Once an incursion 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.
• The costs of future individual natural disasters and other major events (including individual events resulting from climate change), as 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.

Contingent 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 2018.

Statement of Specific Fiscal Risks as at 8 May 2019

Policy Change Risks by Portfolio#

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ACC#

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Impacts of Changes to Accident Compensation Policy Settings (Unchanged)

The Government has signalled it will review a number of Accident Compensation scheme policy settings. These changes could result in a potential aggregated impact on expenses in excess of $100 million per year. All of the policy issues identified would require either legislative or regulatory change.

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 (Unchanged)

The Government and the farming sector have agreed to attempt to eradicate Mycoplasma bovis. Funding has been allocated by the Government for response activities in 2018/19 and 2019/20, and the need for further government funding and type of response over the rest of the forecast period will be considered depending on progress in eradicating the cattle disease. The rate and timing of industry contributions are not finalised and therefore are not included in the fiscal forecasts.

Broadcasting, Communications and Digital Media

Delivery of the Government's Public Media Objectives (New)

The Government has committed to strengthening New Zealand public media, with work still underway. The media sector, including both public and privately owned organisations, is coming under increasing pressure as platforms for consumption are changing. Significant additional investment may be required to deliver on the Government's public media objectives.

Customs

Tobacco Excise Proposed Change (New)

The Tax Working Group has recommended that consideration is given as to whether this increase should go ahead. The increase has been included in tax forecasts and is expected to raise $295 million over the current forecast period. The Government is considering whether this increase should go ahead. Depending on the decisions made, there may be fiscal impacts.

Defence

Defence Funding Requirements to Deliver New Zealand's Defence Strategy (Unchanged)

The Government is reviewing the Defence capability procurement programme within the context of the existing indicative funding for the Defence White Paper. It is expected that changes to New Zealand Defence Force operating and capital funding will be made over the forecast period in line with any updated capability plan. However, the precise quantum and timing of these changes will be dependent on a range of business cases and Budget initiatives that will be subject to future decisions.

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 could have either a positive or negative impact on the Government's overall financial position.

Education

Early Learning Strategic Plan (Unchanged)

The Ministerial Advisory Group has, with the support of the Ministry of Education, drafted a new 10-year Strategic Plan for Early Learning (the draft Plan) for the Minister of Education. The Government has also indicated it will reinstate higher hourly funding rates for early childhood education (ECE) services with 100% qualified teachers. The draft Plan was consulted on between November 2018 and March 2019, and will be submitted to Cabinet for consideration later in 2019.

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.

Reform of Vocational Education (RoVE) (New)

In recent years, institutes of technology and polytechnics (ITPs) have experienced significant declines in demand, which has reduced their revenue and affected some providers' sustainability, requiring capital injections. The Government is considering proposals to significantly reform the vocational education sector in light of this. Proposed changes include: structural changes to the existing ITP system by establishing a single New Zealand Institute of Skills and Technology; changes to roles and responsibilities for industry training and skills leadership; and a unified funding system for vocational education. The Government will determine the scope and scale of the reform in mid-2019. While funding has been set aside in a contingency to manage some of the costs, there is a risk that further funding will be required to manage the full costs of implementing the reform. The nature and timing of the proposed reform will influence the scale of funding needed to ensure viability of at-risk ITPs.

School and Early Childhood Education Funding Review (Unchanged)

Decisions about the future direction of the previous government's Review of Education Funding Systems were taken by Cabinet in May 2018. This included expanding previous work on replacing deciles to look more broadly at how wider system settings should address equity. Decile funding will not be replaced in 2020. However, this decision will be revisited at a future date and may have expenditure implications.

Response to the Tomorrow's Schools Review (New)

The Government is reviewing the governance, management and administration of schools - the Tomorrow's Schools Review - and will make decisions on its response in mid-late 2019. Progressing this work, and implementing decisions made as a consequence of it, will likely involve material costs.

Foreign Affairs

Official Development Assistance (Unchanged)

Each year, New Zealand's Official Development Assistance (ODA) expenditure is measured as a proportion of Gross National Income (GNI). The Government sets the overall budget for the New Zealand Aid Programme on a triennial basis. Therefore, there remains a fiscal risk that a decision to provide additional funding will be made prior to the following triennium.

Greater Christchurch Regeneration

Canterbury Earthquake Recovery Residential Red Zone (Unchanged)

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.

Health

Dunedin Hospital (Changed)

Funding has been set aside in Budget 2019 for the ongoing redevelopment of Dunedin Hospital. Once a detailed business case is completed the Government will consider redevelopment options.

Primary Care Services (Unchanged)

The Government has signalled the intention to further increase funding for Primary Care services. The implementation details and funding arrangements are yet to be finalised.

Housing and Urban Development

KiwiBuild - Fiscal and Delivery Risks (Unchanged)

Changes in the housing market and economy may have an impact on the costs of delivering 100,000 homes and associated revenue recycling. If house prices fall, Crown underwrites may be called: increasing debt, and the value of the portfolio may fall, impacting the operating balance. To achieve programme goals, there may be a need to change policy parameters or provide support to developers and/or homebuyers. The Crown also faces general commercial risks associated with development and with implementing a large and evolving programme, which pose fiscal and delivery risks.

Internal Affairs

Archives New Zealand Storage Capacity (Changed)

There are capacity and condition issues with the current property portfolio for the storage of New Zealand's documentary heritage. Budget 2019 provides funding to complete the design work and shift activities associated with the proposed upgrade and expansion of the physical infrastructure. Further funding will be sought at Budget 2020 to complete this project.

Police

Next Generation Critical Communications Programme (Unchanged)

The Next Generation Critical Communications programme seeks to replace Emergency Services' (New Zealand Police, Fire and Emergency New Zealand, St John New Zealand and Wellington Free Ambulance) critical communications networks with a modern digital capability. A detailed business case is being developed following Budget 2019. To the extent that the programme cannot be managed within baselines, additional funding will be required.

Regional Economic Development

Provincial Growth Fund (Unchanged)

The Government has committed to a Provincial Growth Fund of $3.0 billion over a three-year period. The capital and operating split and timing of this funding are likely to change, so final amounts may vary from what is included in the fiscal forecasts.

Research, Science and Innovation

Research and Development Spending Target (Unchanged)

The Government has announced a target to increase economy-wide Research and Development (R&D) expenditure to 2% of GDP over the next 10 years. To reach this target, economy-wide R&D expenditure would need to increase by approximately $3.8 billion (from $3.9 billion in 2018 to around $7.7 billion by 2028). To achieve this, the majority of growth will need to come from the private sector with the balance to come from public investment. Depending on private expenditure increases, this would require average annual increases of approximately $150 million in public research and development spending each year over 10 years.

Revenue

Potential Tax Policy Changes (Unchanged)

The tax policy work programme can be viewed on the tax policy website www.taxpolicy.ird.govt.nz. The fiscal implications of many of these policy topics are unquantified at this stage. The Government has initiated a work programme to consider the recommendations from the Welfare Expert Advisory Group (WEAG) and is currently considering a number of Tax Working Group recommendations for inclusion in the tax policy work programme.

Taxation of Digital Services (New)

The Government has stated its intent to release a discussion document on options for taxing the digital economy. The Government's preference is to continue working within the OECD framework to find a multilaterally agreed solution, but a digital services tax is a credible option if the OECD does not make sufficient progress on a multilateral solution this year. The amount of increased revenue would be dependent on the design of the tax.

Social Development

Changes to the Welfare System (Changed)

The Government has committed to overhaul the welfare system. Part of this work involved the establishment of the WEAG, which was tasked with advising on how to improve the welfare system to achieve the Government's vision (ie, deliver adequate income and standard of living, support participation, and promote dignity of clients). WEAG delivered its Report on New Zealand's social security system to the Minister for Social Development in February 2019, with public release on 3 May. The Government has responded to some of the recommendations through initiatives in Budget 2019. It is continuing work on other recommendations.

Transport

Support for KiwiRail (Changed)

Budget 2019 provides KiwiRail with a first instalment funding package for two years to maintain the rail network and initiate major procurement projects around new rolling stock and Interislander ferries. However, further Crown funding is likely to be sought in order to progress these projects beyond 2020/21 as part of the implementation of the Future of Rail programme.

Wellington Transport Investment Programme (Changed)

Development of business cases for individual projects that make up the Let's Get Wellington Moving programme are about to begin. The programme includes rapid transit, public transport, walking and cycling improvements to reduce congestion in the Wellington City area, and is expected to cost $6.4 billion over 20 years, split between local government and the National Land Transport Fund (NLTF) (at a cost of $3.8 billion to the NLTF). The NZTA board is yet to agree funding for the individual projects.

Treaty of Waitangi Negotiations

Government Response to WAI262 (Unchanged)

The Waitangi Tribunal's report on the WAI262 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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ACC

ACC 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, 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.

Legal Claims and Proceedings (New)

A recent High Court decision regarding the interpretation of section 32(1)(c) of the Accident Compensation Act 2001 found that an injury is only an ordinary consequence of treatment when it is more likely than not to occur. The effect of this is that fewer claims will be excluded as an ordinary consequence of treatment. At this stage, the impact of this decision is yet to be quantified and therefore is not reflected in the fiscal forecasts.

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.

Climate Change

Emissions Trading Scheme - Fixed Price Option (Unchanged)

The Emissions Trading Scheme earns revenue and incurs expenses for the Crown, both of which are uncertain, partly owing to the market price of New Zealand Units (NZUs). Both revenue and expenses are valued based on the market price of NZUs which, for the fiscal forecasts, is assumed to be $25. Under the Fixed Price Option (FPO), emitters have an option to meet their obligations by purchasing units directly from the Crown at a fixed price of $25. If the market price of NZUs continues to be higher than the fixed price of $25, it is likely that emitters would use the FPO. As a result, the Crown would recognise a loss from selling units at below market price and receive cash that would reduce net core Crown debt. The overall fiscal impact of these risks is uncertain and depends on future market prices, unit volumes and the extent to which participants elect to use the FPO. At 29 March 2019, the market price of NZUs was $25.67.

Customs

Joint Border Management System Further Development (Unchanged)

Customs and the Ministry for Primary Industries will implement Tranche 2 of the Joint Border Management System (JBMS) through a series of smaller projects that will either enhance or replace elements of the current systems with the aim of realising the full benefits to the Crown and industry of the JBMS programme. Additional funding for these projects may be required.

Economic Development

New Zealand Screen Production Grant - International (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. It remains unclear what the fiscal impact would be if more large budget productions choose to locate in New Zealand.

Education

Education Operating Cost Pressures (Unchanged)

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 (Changed)

The Government will release the Disability and Learning Support Action Plan later in 2019 after concluding targeted consultation in October 2018. The Plan proposes a number of new Learning Support initiatives that build on the $336 million operating and $95 million capital allocated through Budget 2019 to establish Learning Support Coordinators and fund Learning Support cost pressures and system improvements. However, there will also be a number of future cost pressures building in the supply of learning support services owing to population growth and increased eligibility due to better reporting of neurodevelopmental and other conditions. To the extent that these pressures cannot be managed within existing baselines, additional funding is likely to be required.

Finance

Earthquake Commission (Unchanged)

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 remain risks that EQC's remaining settlement expenditure relating to the Canterbury and Kaikōura earthquakes will differ from (be higher or lower than) forecast. This is because 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. The risks include litigation, the resolution of liability with insurers and reinsurers, in addition to the level of future remedial claims. It is not possible at this stage to fully quantify the potential financial impact or the timing of these risks owing to the uncertainty associated with them and variation could be material.

Goodwill on Acquisition (Unchanged)

As at 30 June 2018, 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 (Changed)

The infrastructure at Scott Base is approaching the end of its functional life. The indicative cost of redeveloping the Base ranges from $200 million to $290 million over an approximately eight year period. Budget 2019 provides $19.7 million to Antarctica New Zealand to undertake further design and market testing to confirm costs ahead of seeking full redevelopment costs, yet to be determined, against a future Budget.

Greater Christchurch Regeneration

Christchurch Central Recovery Plan - Anchor Projects (Unchanged)

The Crown has funded, and is partially funding, the construction of Anchor Projects as part of the Christchurch Central Recovery Plan. The funding for the construction of Anchor Projects varies across projects, depending on scope, ownership decisions, implementation and project costs, and may to some extent eventually be recovered. Some projects have been completed, while others are under construction or progressing through the decision-making process. Construction costs for projects have, and will continue to, become clearer during the procurement and construction phases, but costs to the Crown may still vary from current estimates. The quantum and timing of Crown contributions may differ from that included in the fiscal forecasts.

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

DHB Sustainability (New)

The fiscal forecasts incorporate expected deficits from District Health Boards (DHBs) over the forecast period. This includes an estimated combined deficit of $390 million for 2018/19. Based on past results, there is a significant risk that DHBs' deficits may be higher than what has been included in the fiscal forecasts, which would adversely impact the Government's operating balance. The Government has provided some funding to support DHB deficits. However, if the deficits that are included in the fiscal forecast were to eventuate, additional funding support may be required to ensure the sustainability of the sector.

The Ministry of Health is working on a new performance management programme that seeks to reduce deficits.

Health Capital Pressure (Changed)

DHBs have submitted updated capital intentions, which identify the indicative need for Crown funding over the next four years. Budget 2019 funds two years of capital investment. However, the pressures remain significant over the forecast period. These pressures are largely driven by asset condition issues and demographic growth (population growth and an ageing population) pressures on infrastructure capacity. There is also a need to address information technology capability in the sector.

Health Operating Pressure (Unchanged)

The health sector is likely to face significant operating pressures against existing 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. This includes pressure on national disability support services like equipment and housing modifications for disabled people choosing to remain in their home (and this includes the over-65 population).

Housing and Urban Development

Divestment and Development of Housing New Zealand Corporation Housing (Changed)

The forecasts include business-as-usual divestments, acquisitions 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. A softening in the property market would reduce HNZC's revenue from divestments and therefore (all else being equal) increase HNZC's debt and/or Crown funding requirements. HNZC also faces general commercial risks associated with development and with implementing large and evolving programmes, which pose fiscal risk (in terms of increased development costs that would increase HNZC's debt and/or Crown funding requirements) and delivery risk. If development activity utilising HNZC holdings is accelerated by the new Housing and Urban Development Authority, the likelihood of this risk being realised will increase substantially.

Emergency Housing Special Needs Grants (Unchanged)

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.

Increases to Market Rent (Changed)

Over $1 billion of payments per annum for housing assistance are linked to market-based rent levels, such as income-related rent subsidies and accommodation payments for Transitional Housing. Should market rents increase above what is assumed for the forecasts, this could create a significant fiscal risk to maintain current levels of support.

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.

Police

Firearms Buyback Scheme (New)

The Arms (Prohibited Firearms, Magazines, and Parts) Amendment Act 2019 prohibits certain types of semiautomatic firearms, parts and magazines. The Act provides for an amnesty period for the surrender of all newly prohibited items and for regulations to establish a scheme for the purpose of paying compensation in respect of prohibited items. There is significant uncertainty over the quantity of firearms, parts and magazines covered by the prohibitions. Depending on the level of compensation and the volume of items surrendered, additional costs, above what has already been provided in the fiscal forecasts, may be incurred.

Research, Science and Innovation

Research and Development Tax Incentive (Unchanged)

The Government has approved the implementation of a Research and Development (R&D) Tax Incentive. This incentive allows eligible firms to deduct a percentage of their expenditure on R&D against their tax liability to the Crown. 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 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 remaining 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.

Statistics

Census Costs (Changed)

Budget 2019 has provided funding to complete Census 2018 and to commence initial work to deliver Census 2023. The remaining funding needed to deliver Census 2023 will be sought once a detailed business case has been developed.

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 $4.5 billion. Based on this estimate, the Government's contribution to the project will be around $2.25 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.

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 2019 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. Ministers are currently considering whether the expectations from rail freight and the basis of investments in rail freight infrastructure should more clearly reflect wider public benefits. A probable financial implication of committing to the wider public benefits of rail may imply that the rail network would be reported in the Whole-of-Government Financial Statements on the same basis as the state highway network - as an asset generating public benefit. This would see a $5.1 billion increase in asset value, with an approximately $300 million increase in annual depreciation expense, offset by annual capital expenditure no longer being written off.

Treaty of Waitangi 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 17.0% for Waikato-Tainui and 16.1% 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

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 Employee Benefits (New)

The External Reporting Board has recently introduced the Public Benefit Entities International Public Sector Accounting Standard (PBE IPSAS 39) Employee Benefits, for reporting periods after 1 January 2019. The Government will adopt the new standard for reporting after 1 July 2019. The resulting changes to the standard will impact the presentation of the Government Superannuation Fund results (refer page 114) and potentially the recognition of obligations for veterans’ disability entitlements. At this point, the overall impact of these new requirements is uncertain.

Increasing the Minimum Wage (Unchanged)

Government policy decisions to increase the minimum wage to $20 by April 2021 will mean increased costs to State sector employers to the extent their employees receive a direct increase in wages. Where costs cannot be absorbed within baselines without compromising service delivery, additional support may be sought.

Non-government Providers Receiving Funding from the Crown (New)

The Government is facing ongoing pressure from non-government providers who receive Crown-funding to provide services to fund a greater proportion of their costs, or to fund cost pressures that could affect service delivery. This includes providers in the health, disability, welfare, justice and child protection sectors.

Other Capital Cost Pressures (Unchanged)

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 from the multi-year capital allowance 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 Other Government Inquiries and Reviews (Unchanged)

A number of inquiries and reviews (not specifically mentioned elsewhere in this chapter) are underway or have recently released findings across government. At this point, it is uncertain what the fiscal impact from the outcomes of these reviews may be.

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

The Government has introduced legislation that proposes to change the Equal Pay Act 1972 to provide a clearer process for raising and resolving pay equity claims through employment relations bargaining. The proposed legislation reflects the recommendations of the tripartite joint working group on pay equity principles.

The forecasts include an estimate of the cost of pay equity claim settlements within the forecast period. However, there is a risk that the cost may differ from that estimated.

Policy Responses to the 15 March Terror Attacks (New)

The Government has made a number of immediate responses to the 15 March terror attacks. Further responses may be needed including policy and legislative amendments. In addition, there are likely to be further costs associated with responding to the Royal Commission of Inquiry into the Christchurch Terror Attack, which are unable to be quantified at this point.

Possible Response to the Referendum on Cannabis Law Reform (New)

The Government has committed to holding a referendum on legalising the use of cannabis at the 2020 general election. The cost of conducting the referendum has been provided in the forecasts. However, there could potentially be associated impacts on the Government's operating balance should the current legal framework change as an outcome of the referendum.

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)

All collective agreements in the State sector are due to be renegotiated over the forecast period. As well as direct fiscal implications for the employers of workforces covered by any changes to remuneration, the renegotiation of agreements can have flow-on effects to remuneration in other employers across the sector.

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 weather tight 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 an asset.

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 in this chapter. 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 unquantifiable contingent liabilities and unquantifiable contingent assets that potentially could have an impact in excess of $20 million and are not expected to be remote.[17]

The contingencies have been stated as at 31 March 2019, being the latest set of published contingencies.

Quantifiable Contingent Liabilities and Contingent Assets

Contingent liabilities

Contingent assets

Unquantifiable Contingent Liabilities and Contingent Assets

Contingent liabilities

The following contingent liabilities have been removed on the basis they are considered to be remote.

Ministry of Business Science and Innovation - Persons exercising investigating powers
The Treasury - Deed between Genesis and the Crown

Description of Contingent Liabilities

Quantifiable contingent liabilities over $100 million

Uncalled capital

As part of the Crown's commitment to a multilateral approach to ensure global financial and economic stability, New Zealand, as a member country of the organisations listed below, contributes capital by subscribing to shares in certain institutions. The capital (when called) is typically used to raise additional funding for loans to member countries, or in the case of the quota contributions to directly finance lending to members. For New Zealand and other donor countries, capital contributions comprise both “paid-in” capital and “callable capital or promissory notes”.

The Crown's uncalled capital subscriptions 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, $117 million has been called, leaving $113 million as a contingent liability. This capital support will increase net core Crown debt when called.

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 services.

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 guarantees

The New Zealand Export Credit 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.

$111 million at 31 March 2019 ($137 million at 30 June 2018)

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.

$144 million at 31 March 2019 ($146 million at 30 June 2018)

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.

$175 million at 31 March 2019 ($161 million at 30 June 2018)

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.

$123 million at 31 March 2019 ($158 million at 30 June 2018)

Guarantees and indemnities

Terracotta Warriors Exhibition

Over the period of 15 December 2018 to 22 April 2019, Te Papa hosted the Terracotta Warriors Guardians of Immortality Exhibition. The Exhibition is indemnified under the government indemnity of Touring Exhibition Scheme from mid-November 2018 to mid-May 2019 to cover the period of transit and display of these artefacts.

$136 million at 31 March 2019 ($0 million at 30 June 2018)

Unquantifiable contingent liabilities

This part of the statement provides details of those contingent liabilities of the Crown which are not quantified, excluding those that are considered remote, reported by indemnities, legal disputes, 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 core Crown net 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, or if the Crown were to lose it would be unlikely to have greater than a $20 million impact. Based on these factors, not all legal actions are individually disclosed. The claims that are disclosed individually, while they cannot be quantified, have the potential to exceed $20 million in costs.

Accident Compensation Corporation (ACC) 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 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. Due to the complexity and uncertainty of the amount of these claims the amounts are unquantified.

Kiwifruit vine disease Psa-V

Approximately 210 growers have filed a claim against the Ministry for Primary Industries alleging it is liable for damages they suffered from the kiwifruit vine disease, Psa-V. The plaintiffs have not quantified their losses, but have publicly claimed it is in the vicinity of $380 million, citing total industry losses of $885 million, the Ministry defended the claim. On 27 June 2018 the High Court found that MPI owed a duty of care to Strathboss and claimants; that it breached its duty of care at the import permit stage, and that the breach caused the Psa-V incursion. An appeal was filed by the Crown on 24 July 2018.

Treaty of Waitangi claims

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

Canterbury insurance disputes

SRES from time to time receives notification of legal claims and disputes in relation to claim settlements as a commercial outcome of conducting its business. These include a representative proceeding filed against Southern Response on 29 May 2018 proposing to represent policyholders who entered into a settlement agreement with Southern Response prior to 1 October 2014. Southern Response defends all such claims.

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 a 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. Where costs cannot be reliably measured, they are disclosed as an unquantified contingent liability.

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, a provision has been made in these financial statements for obligations arising from those reviews. Further work continues to be undertaken by a number of entities including the Ministry of Education, DHBs, the Department of Corrections and KiwiRail Holdings Limited. These entities have complexities that are taking longer to resolve. To the extent that an obligation cannot reasonably be quantified at 31 March 2019, there is an unquantified contingency.

Remediation of Per- and Poly- Fluoroalkyl Substances Contamination

Local and central government entities are investigating per- and poly-fluoroalkyl substances (PFAS) contamination from the historic use of specialised firefighting foam at sites on, and in the vicinity of, airports, NZDF bases, fuel storage facilities and other sites. Various government agencies have been undertaking a programme to review, investigate and develop a comprehensive approach to manage the impact of PFAS at sites around New Zealand. Once a response is agreed, it is possible the Crown may incur costs for the response to PFAS contamination. However, these costs cannot be estimated without the agreed response being finalised, so an unquantified contingent liability has been disclosed.

Treaty of Waitangi claims - Settlement Relativity Payments - see page 80

Description of Contingent Assets

There are no material quantifiable or unquantifiable contingent assets at 31 March 2019.

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 8 May 2019.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined in the Fiscal Outlook chapter (pages 21 to 48).

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 are consequently not reflected in these Forecast Financial Statements. Accounting standards to be adopted within the fiscal forecasts period, where impacts may be significant, have been signalled in the note disclosures (in particular note 13 of the Forecast Financial Statements chapter).

We have adopted PBE IFRS 9: Financial Instruments in these financial statements replacing the existing standard PBE IPSAS 29: Financial instruments: Recognition and Measurement and NZ IAS 39: Financial instruments: Recognition and Measurement. The Crown has exercised the option under PBE IFRS 9 to continue to apply the hedge accounting requirements of PBE IPSAS 29.

The main changes under PBE IFRS 9 for non-hedge financial instruments are:

• New financial asset classification requirements for determining whether an asset is measured at fair value or amortised cost.
• A new impairment model for financial assets based on expected losses, which may result in the earlier recognition of impairment losses.

The specific accounting policies are included within the 2019 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-2019

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 92. Key forecast assumptions are set out on pages 24 to 25.

Reporting and Forecast Period

The reporting periods for these Forecast Financial Statements are the years ended 30 June 2019 to 30 June 2023. The “2018 Actual” figures reported in the statements are the audited results reported in the Financial Statements of the Government for the year ended 30 June 2018. The “2019 Previous Budget” figures are the original forecasts to 30 June 2019 as presented in the 2018 Budget Update.

Government Reporting Entity as at 8 May 2019#

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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). The following tables lists the entities within each institutional component. (subsidiaries are consolidated by their parents and not listed separately).

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 Housing and Urban Development
21. Ministry of Justice (Includes Te Arawhiti – Office for Māori Crown Relations as a departmental agency)
22. Ministry of Māori Development
23. Ministry of Social Development
24. Ministry of Transport
25. New Zealand Customs Service
26. New Zealand Defence Force
27. New Zealand Police
28. New Zealand Security Intelligence Service
29. Office of the Clerk of the House of Representatives
30. Oranga Tamariki, Ministry for Children
31. Parliamentary Counsel Office
32. Parliamentary Service
33. Serious Fraud Office
34. State Services Commission (Includes Social Investment Agency as a departmental agency)
35. Statistics New Zealand
36. Te Kāhui Whakamana Rua Tekau mā Iwa ­- Pike River Recovery Agency
37. 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
8. Meteorological Service of New Zealand Limited
9. New Zealand Post Limited
10. New Zealand Railways Corporation
11. Quotable Value Limited
12. Solid Energy New Zealand Limited (in liquidation)
13. Transpower New Zealand Limited

Mixed ownership model companies (Public Finance Act Schedule 5)

1. Genesis Energy Limited
2. Mercury NZ Limited
3. Meridian Energy 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. Financial Markets Authority
22. Fire and Emergency New Zealand
23. Government Superannuation Fund Authority
24. Guardians of New Zealand Superannuation
25. Health and Disability Commissioner
26. Health Promotion Agency
27. Health Quality and Safety Commission
28. Health Research Council of New Zealand
29. Heritage New Zealand Pouhere Taonga
30. Housing New Zealand Corporation
31. Human Rights Commission
32. Independent Police Conduct Authority
33. Law Commission
34. Maritime New Zealand
35. Museum of New Zealand Te Papa Tongarewa Board
36. New Zealand Antarctic Institute
37. New Zealand Artificial Limb Service
38. New Zealand Blood Service
39. New Zealand Film Commission
40. New Zealand Lotteries Commission
41. New Zealand Productivity Commission
42. New Zealand Qualifications Authority
43. New Zealand Symphony Orchestra
44. New Zealand Tourism Board
45. New Zealand Trade and Enterprise
46. New Zealand Transport Agency
47. New Zealand Venture Investment Fund Limited
48. New Zealand Walking Access Commission
49. Office of Film and Literature Classification
50. Pharmaceutical Management Agency
51. Privacy Commissioner
52. Public Trust
53. Radio New Zealand Limited
54. Real Estate Agents Authority
55. Retirement Commissioner
56. School Boards of Trustees (2,418)
57. Social Workers Registration Board
58. Sport and Recreation New Zealand
59. Takeovers Panel
60. Te Reo Whakapuaki Irirangi (Māori Broadcasting Funding Agency)
61. Te Taura Whiri i te Reo Māori (Māori Language Commission)
62. Television New Zealand Limited
63. Tertiary Education Commission
64. Transport Accident Investigation Commission
65. 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. Māori Trustee
6. National Pacific Radio Trust
7. New Zealand Fish and Game Council
8. New Zealand Game Bird Habitat Trust Board
9. New Zealand Government Property Corporation
10. New Zealand Lottery Grants Board
11. Ngai Tahu Ancillary Claims Trust
12. Pacific Co-operation Foundation
13. Pacific Island Business Development Trust
14. Reserves Boards (21)
15. Te Ariki Trust

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

1. Crown Asset Management Limited
2. Crown Infrastructure Partners Limited (previously Crown Fibre Holdings Limited)
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. Teaching Council of Aotearoa New Zealand
2. Regenerate Christchurch
3. Christ Church Cathedral Reinstatement Trust

Other entities not fully consolidated into the forecast financial statements of the Government with only the Crown's interest in them being included

Crown entities

1. Tertiary Education Institutions (27)

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

1. City Rail Link Limited

Forecast Financial Statements#

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Forecast Statement of Financial Performance
for the years ending 30 June

1. The 2019 Previous Budget comparator for other revenue and transfer payments and subsidies has been restated to eliminate Income Related Rent Subsidy transactions between government reporting entities.

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

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

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

1. The classifications of the functions of the Government reflect current approved baselines. Forecast new operating spending is shown as a separate line item in the above analysis and will be allocated to functions of the Government once decisions are made in future Budgets.
2. The 2019 Previous Budget comparator for social security and welfare expenses has been restated to eliminate Income Related Rent Subsidy transactions between government reporting entities.

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

1. Refer to note 9 for details of the impacts of adoption of NZ PBE IFRS 9: Financial Instruments on these forecast financial statements.

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

Forecast Statement of Cash Flows
for the years ending 30 June

1. Further information on the proceeds and repayments of government bonds is available in note 16.
2. Excludes transactions with ACC and NZS Fund.

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. Refer to page 112 for the impacts of the adoption of NZ PBE IFRS 9: Financial Instruments.
2. Equity accounted investments include tertiary education institutions and City Rail Link Limited.

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 government borrowing programme. 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.

1. 30 June 2018 splits by segment have been restated to correctly show inter-segment eliminations.

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

1. The 2019 Previous Budget comparator for the income related rent subsidy has been restated to eliminate the transactions between government reporting entities.
2. Clinical supplies has now been reclassified from other operating expenses to inventory expenses resulting in a restatement of the 2019 Previous Budget comparator for these two lines.

NOTE 5:  Insurance

ACC liability

Calculation information

Taylor Fry has prepared an independent actuarial estimate of the ACC outstanding claims liability as at 31 December 2018. This estimate includes the expected future payments relating to accidents that occurred prior to balance date (whether or not the associated claims have been reported to, or accepted by, ACC) and also the expected future administrative expenses of managing these claims. The assumptions underpinning this valuation form the basis of the five-year forecast of the outstanding claims liability.

The key economic variables that impact on changes to the valuation are the long-term Labour Cost Index (LCI), average weekly earnings and the discount rate. Discount rates were derived from the yield curve for New Zealand Government bonds. For these forecast statements, the claims liability has been updated for the latest discount rates as at 28 February 2019. The equivalent single effective discount rate, taking into account ACC's projected future cash flow patterns, is 2.97% and allows for a long-term discount rate of 4.75% from 2065.

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.

NOTE 6:  Forecast New Spending and Top-down Expense Adjustment

Unallocated contingencies represent expenses included in Budget 2019 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 2020 is $3.0 billion. Some of this allowance has been pre-committed as at the forecast finalisation date of 8 May 2019, with only the unallocated portion of the allowance included in this note.

Unallocated contingencies represent capital spending from Budget 2019 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 to Budget 2022 is $14.8 billion. As at the forecast finalisation date of 8 May 2019, $10.4 billion of funding has been allocated, leaving $4.4 billion of funding for future capital initiatives over the next three Budgets.

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

NOTE 8:  Financial Assets (including receivables)

NOTE 9:  Student Loans

NOTE 10:  Property, Plant and Equipment

1. From 1 July 2018, the valuation of the Student Loans Scheme moved from an amortised cost approach to a fair value approach owing to PBE IFRS 9 being adopted in the 2018/19 financial year. The new valuation approach resulted in a one-off increase of $628 million to the value of the student loan asset. The 2019 Previous Budget comparator has been restated to include the amount previously estimated to be the one-off impact.
2. Using a revaluation methodology unless otherwise stated.

NOTE 10:  Property, Plant and Equipment (continued)

NOTE 11:  NZ Superannuation Fund

NOTE 12:  Payables

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

NOTE 13:  Retirement Plan Liabilities

The net liability of the Government Superannuation Fund (GSF) was calculated by GSF's actuary as at 31 January 2019. 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 2019, based on membership data as at 30 June 2018 with adjustments for cash flows to 31 January 2019. 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 2019.

Other principal long-term financial assumptions were an inflation rate, as measured by the Consumers Price Index (CPI), of 1.52% for the 19 years to 30 June 2037, then increasing gradually each year to 2.0% in the year ended 30 June 2065 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 2018).

The 2018/19 projected increase in the net GSF liability is $423 million, reflecting a increase in the GSF liability of $252 million and an decrease in the GSF net assets of $171 million.

The overall increase in the GSF liability of $252 million includes an actuarial loss (which increases the liability) between 1 July 2018 and partly 31 January 2019, of $822 million, owing to movements in the discount and changes to some of the demographic assumptions, offset by movements in the CPI rates. The difference of $570 million 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 decrease in the value of the net assets of GSF of $171 million includes a loss of $194 million reflecting the updated market value of assets at 31 January 2019. The balance of $23 million is the total of the expected investment returns and contributions received/receivable, offset by the benefits paid/payable to members.

The changes in the projected net GSF liability from 2018/19 onwards reflect the net of the expected current service cost, interest cost, investment returns and contributions.

1. The amended accounting standard PBE IPSAS 39: Employee Benefits will be effective for periods beginning after 1 January 2019 meaning it is applicable for forecast years beginning 2019/20 onwards. The value of the net GSF liability would not change with this amendment, but there would be changes to the presentation of GSF annual movements in the Statement of Financial Performance. Some annual movements, such as the return on scheme assets above the risk-free interest rate, currently in OBEGAL and gains and losses, would move to 'other comprehensive revenue and expenses'. We estimate OBEGAL will be reduced by around $150 million in each forecast year, offset by a positive impact in 'other comprehensive revenue'.

This amended accounting standard may also lead to the Crown recognising a liability for veteran's support entitlement payments, if they qualify for that entitlement now. If this were the case, the future payments for those veterans would be valued in today's dollars (using actuarial assumptions and present value calculations) and recognised as a liability, rather than the current treatment, which is expensing the entitlements over time. We have not estimated the possible impact of this change.

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 2019.

The ETS impact on the fiscal forecast is as follows:

NOTE 15: Changes in Net Worth

1. NZ PBE IFRS 9 was adopted in the 2018/19 financial year. The adoption has resulted in a one-off increase of $628 million to the value of the student loan asset impacting on taxpayers' funds - refer note 9 for further details of this one-off adjustment. The 2019 Previous Budget comparator has been restated to include the amount previously estimated to be the one-off impact.

NOTE 16:  Core Crown Residual Cash

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

Statement of Segments#

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Statement of Financial Performance
for the year ended 30 June 2018

Statement of Financial Position
as at 30 June 2018

Forecast Statement of Segments#

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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
for the year ended 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

Statement of Financial Performance
for the year ended 30 June 2023

Statement of Financial Position
as at 30 June 2023