Half Year Economic and Fiscal Update 2009

Statement of Responsibility#

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On the basis of the economic and fiscal information available to it, the Treasury has used its best professional judgement in supplying the Minister of Finance with this Economic and Fiscal Update. The Update incorporates the fiscal and economic implications both of Government decisions and circumstances as at 25 November 2009 that were communicated to me, and of other economic and fiscal information available to the Treasury in accordance with the provisions of the Public Finance Act 1989.

John Whitehead
Secretary to the Treasury

8 December 2009

This Economic and Fiscal Update has been prepared in accordance with the Public Finance Act 1989. I accept overall responsibility for the integrity of the disclosures contained in this Update, and the consistency and completeness of the Update information in accordance with the requirements of the Public Finance Act 1989.

To enable the Treasury to prepare this Update, I have ensured that the Secretary to the Treasury has been advised of all Government decisions and other circumstances as at 25 November 2009 of which I was aware and that had material economic or fiscal implications.

Hon Bill English
Minister of Finance

8 December 2009

1 - Economic and Fiscal Update#

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Overview#

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The economic and fiscal outlook is stronger...

The economic environment presented in this Half Year Update is stronger than predicted in Budget 2009, which means the Crown's fiscal deficits are expected to be smaller than anticipated earlier in the year.

However, the broad economic and fiscal challenges presented in the Budget persist. Imbalances in the economy are likely to return to the fore as domestic demand leads an anticipated upturn, while ongoing fiscal deficits are expected to push government debt levels significantly higher in the years ahead.

The heightened uncertainty surrounding the outlook for the world economy has diminished in recent months, but a degree of uncertainty remains and alternative scenarios are presented alongside the main predictions.

...as the world pulls out of its deepest recession in over 60 years...

The world economy has begun to recover from its most severe recession in more than 60 years, assisted by significant international government and central bank interventions, and the rebuilding of previously-depleted inventories by firms. Increased global optimism has already boosted the local economy through some easing of credit constraints, higher confidence levels and a recovery in world commodity prices. A stronger world economy is expected to raise New Zealand's terms of trade and thus national income, although a related rise in the exchange rate will continue to dampen the profits of some exporters.

A gradual recovery in the economy is now expected to be led initially by domestic demand rather than be export volume-led. After a 0.4% contraction in the March 2010 year, real GDP is forecast to rise 2.4% in the March 2011 year owing to higher consumer spending and a recovery in residential investment. Growth is forecast to accelerate to 3.2% in the March 2012 year owing to higher export volumes as the exchange rate is projected to fall, and the Rugby World Cup and stronger world growth boost tourism. Price inflation, combined with stronger real activity, is forecast to lift growth in nominal GDP from 1.7% in the March 2010 year to around 5% per annum for the rest of the forecast period. Over the four years to June 2013 as a whole, nominal GDP is predicted to be $44 billion or nearly 6% higher than expected at Budget 2009, of which a little under half reflects the impact of higher prices, including both higher terms of trade and domestic inflation.

...but the rise in tax revenue will initially be muted...

A stronger economy is expected to lead to more tax revenue over the forecast period as a whole. However, the initial recovery in tax revenue is expected to be muted by a lower starting position and by lags between economic activity and tax revenue, both of which are associated with business income tax. The recent recession led to declining profits and larger losses among firms than were expected at Budget. This accumulation of tax losses will likely hinder growth in income tax paid by firms in the recovery. Tax revenue is forecast to be $400 million lower than expected at Budget in the June 2010 year. With growth in PAYE and GST, tax revenue is forecast to behigher than previously expected in the following four June years.

Compared to pre-recession trends, there remains a permanent loss of future output and therefore tax revenue. Nominal GDP is $29 billion or nearly 4% smaller over the four years to June 2012 than had been forecast prior to the crisis in Budget 2008. This loss reflects the crisis itself; for example, by reducing business investment and thus growth in the stock of capital in the economy. It also reflects a re-evaluation of how sustainable previous growth in the economy actually was, particularly growth in consumption. The loss is smaller than expected in Budget 2009 largely because of higher population growth and stronger terms of trade.

...while core Crown expenses are higher and surpluses do not return until 2016/17...

Core Crown expenses remain high relative to revenue across the forecast period and are higher than expected in the Budget. The stronger economic outlook is expected to result in higher expenditure on benefit payments as higher inflation and wage growth raise payment rates. Overall, expenses are forecast to rise despite the Government's new operating allowance being kept unchanged at $1.1 billion from the June 2011 year (adjusted by 2% per annum to account for inflation thereafter). A larger economy, bigger population and stronger-than-foreseen wages and inflation will place more pressure on these operating allowances than had been anticipated at Budget time.

The operating balance (before gains and losses) is expected to remain in deficit over the forecast period, peaking at 4.0% of GDP in the June 2010 year before falling gradually to 2.2% by the June 2014 year. A large proportion of these forecast deficits is structural, reflecting the sharp rise in public spending and tax cuts in recent years and the effects of a smaller economy. Financing the deficits is expected to push core Crown net debt higher from 9.5% of GDP at 30 June 2009 to 29.0% of GDP at 30 June 2014, the end of the forecast period.

In the medium-term projections to 2024, the operating balance is not expected to return to surplus until the June 2017 year and net debt is projected to rise further to a peak of 30.4% of GDP at 30 June 2016. The projected return of surpluses allows net debt to fall over the remainder of the projection period - meeting the Government's long-term objective for net debt of around 20% - and, once the surplus is of sufficient size, leads to New Zealand Superannuation Fund (NZS Fund) contributions resuming in the June 2020 year.

Notes:

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

Sources: Statistics New Zealand, the Treasury

...and uncertainty continues to surround the global and domestic outlook

The most significant risks to the outlook have eased since earlier in the year but uncertainty remains, particularly around the strength and sustainability of the recovery here and abroad. One of the key judgements made in the main forecasts is how private demand will respond when the restocking of inventories is complete and when governments and central banks around the world withdraw their stimulus measures. Another judgement concerns how imbalances are unwound. For nations such as New Zealand, imbalances that built up prior to the global crisis, such as large current account deficits and high household debt levels relative to income, are expected to continue to make the economy vulnerable to a loss of investor confidence.

Different paths of recovery are explored in the alternative scenarios. Small differences in economic growth can have a large impact on the level of economic activity and the fiscal position over time. Under a faster recovery scenario, higher trading partner growth and domestic demand in New Zealand in the short term would push nominal GDP higher by a cumulative $26 billion or 3% higher over the 2010-14 June years than in the main forecast. The additional tax revenue generated would flow through to a lower peak in the core Crown’s net debt levels of 24.4% of GDP in 2015. A more pessimistic assumption including a slower recovery and a weaker medium-term path for the economy would, in contrast, lower nominal GDP by a cumulative $18 billion or 2% over the June years 2010-14. The resulting lower tax revenue would raise net debt levels to a peak of 35% of GDP in 2016, which means this lower-output medium-term scenario is nearly as weak as the main fiscal outlook presented in Budget 2009.

Main Forecasts#

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The economic environment is stronger than previously expected

The Half Year Update forecasts higher economic activity and prices over the forecast period relative to the Budget. The Budget forecasts, which were finalised in mid-April, were made at a time of global pessimism and a large amount of uncertainty. The outlook incorporated in these forecasts reflects stronger economic activity and price inflation in New Zealand and abroad than was predicted in the Budget and a judgement that the recovery in the world economy will be faster than previously expected. The upward revision to real GDP growth is largely confined to the short term.

The New Zealand economy experienced its longest recession since the 1970s...

The New Zealand economy entered recession in early 2008 ahead of most of the developed world. Drought reduced agricultural production, high interest rates led to a fall in residential investment, a high exchange rate constrained exports and rising food and fuel prices curtailed consumer spending. The recession intensified in the December 2008 and March 2009 quarters reflecting the global financial crisis. New Zealand was vulnerable to this shock and the associated world economic downturn because of international linkages and the economy’s high level of reliance on overseas borrowing.

The impact on New Zealand was transmitted through the reduced availability and higher cost of credit, a sharp drop in business confidence to a 40-year low, and a smaller drop in consumer confidence. The global downturn also contributed to a fall in export demand and in export prices, which lowered New Zealand's terms of trade, and declines in equity and house prices, which reduced household wealth. As a result, real GDP fell by a total of 2.9% over five consecutive quarters in the deepest recession in New Zealand since 1991 and the longest since the 1970s.

...although, together with Australia, was less affected than most nations...

However, New Zealand's recession was one of the shallowest in the OECD. The most significant impacts of the global crisis were avoided as the Australasian financial system remained sound, notwithstanding the collapse of some finance companies in New Zealand. The Reserve Bank of New Zealand reduced the Official Cash Rate by nearly six percentage points from 8.25% as recently as July 2008 to 2.5% by April 2009, while the exchange rate fell from a peak above US$0.80 in early 2008 to below US$0.50 a year later. Fiscal policy was also stimulatory during the recession, partly reflecting personal income tax cuts on 1 October 2008 and 1 April 2009 and the bringing forward of infrastructure projects.

Additional factors underpinning the domestic economy were higher net migration inflows as departures fell when overseas job prospects weakened, a relatively small fall in house prices and an unemployment rate that remained well below levels seen in previous recessions despite rising sharply from 3.5% to 6.5%. Overall exports also held up owing to ongoing demand from China, a recovery in agricultural output from the previous year's drought and a lesser dependence on manufacturing exports than many other economies.

The Australian economy is expected to avoid contraction in 2009 for the 18th consecutive year and this relatively strong performance benefited New Zealand. In particular, the number of tourists from Australia rose strongly, also attracted here by factors such as a good ski season and a favourable exchange rate, which offset weakness in other markets caused by the global downturn and H1N1 influenza.

Notes:

1. Forecasts finalised 6 November 2009
2. Contribution to GDP growth
3. Estimated as the percentage difference between real GDP and potential GDP
4. Household Labour Force Survey, percent of the labour force, March quarter, seasonally adjusted
5. Quarterly Employment Survey, average ordinary-time hourly earnings, annual percentage change
6. Annual percentage change
7. SNA basis, annual average percentage change
8. Average for the March quarter

A longer time series for these variables is provided on page 129.

Sources: Statistics New Zealand, Reserve Bank of New Zealand, the Treasury

...and began recovering in the June quarter, in line with global developments

The New Zealand economy began a tentative recovery from recession in the June 2009 quarter with a rise in real production-based GDP of 0.1% after five quarters of contraction. With most industries failing to expand, the slight rise was mainly owing to large increases in output in the forestry and mining industries as demand for logs from China rose and the Maari oilfield increased production. Dairy exports were also boosted by demand from China, but this demand was largely met from a rundown in dairy product stocks. The tentative recovery in New Zealand was in line with global developments.

The world economy reached a trough of activity in the March 2009 quarter and began to expand in the June quarter, with growth recorded in France, Germany, Japan and most emerging Asian economies. Other nations such as the United States returned to growth in the September quarter. The stabilisation in global output reflects the unprecedented loosening of monetary conditions, including quantitative easing by some central banks, large fiscal stimulus in most economies and steps to support financial institutions by authorities in the United States, United Kingdom and euro area. International financial markets have stabilised and many indicators, such as credit spreads in the United States, have returned to pre-crisis levels. Inventory restocking, after sharp falls in stock levels in late 2008, has also boosted output.

The recovery in the New Zealand economy is expected to continue...

The New Zealand economy is expected to recover further in the second half of this year with real GDP growth of around 0.5% per quarter. This pace of expansion is expected to continue until late 2010, which is also when the level of real GDP is expected to return to its December 2007 quarter peak. After a fall of 0.4% in the March 2010 year, annual average growth in real GDP is forecast to rise to 2.4% in the March 2011 year and accelerate further to 3.2% in the March 2012 year. As output approaches its potential level at the end of the forecast period, real GDP growth is expected to ease to 3.0% in the March 2013 year and 2.8% in the March 2014 year (Figure 1.1).

Figure 1.1 - Real production GDP growth

Source:  Statistics New Zealand, the Treasury

The recovery in the economy over the coming year is expected to be more gradual than in previous recoveries, owing to factors such as continued high levels of indebtedness among households, ongoing challenges in parts of the finance sector and the rebound in the exchange rate. Imbalances in the economy, which built up prior to the recession and made New Zealand vulnerable to external shocks, are expected to persist as domestic demand leads the recovery. For example, the current account deficit is forecast to widen back to 7% of GDPafter temporarily narrowing to 2.9% in the March 2010 year. The Treasury does not expect growth to be supported by stronger export volumes until the March 2012 year.

...broadly in line with the outlook for trading partner growth...

The path taken by the global economy continues to be the most important factor underpinning the outlook for the New Zealand economy, as it was at Budget. New Zealand's top-12 trading partners are expected to contract 1.5% in the calendar year 2009 and grow 2.9% in 2010 before settling at growth of around 3.2% per annum thereafter, below rates of around 4% per annum seen in the years before the crisis. This assumed growth is broadly in line with November 2009 Consensus Forecasts. The short-term outlook for real GDP in New Zealand's top-12 trading partners is notably higher than we assumed in the Budgetforecasts, which were prepared near the trough of the downturn (Figure 1.2).

Figure 1.2 - Trading partner real GDPFigure

Source:  IMF, the Treasury

Strong expansions in China and other emerging Asian economies are expected to continue to lead growth among New Zealand's trading partners. Australia is predicted to experience economic growth of over 3% per annum by 2011, while annual growth rises to around 2.5% in the United States but remains at or below 2% per annum in Europe and Japan. From 2011 to 2014, most trading partners are assumed to remain slightly below their trend growth rates because of the medium-term effects of the global financial crisis on both capital accumulation and employment.

However, uncertainty remains over the strength of the global recovery, particularly over the medium term. Key areas of uncertainty are how private sector demand responds when inventory restocking is over and monetary and fiscal stimulus is withdrawn. There are additional concerns around the need for re-balancing both within and between economies as households, businesses and governments in most advanced economies need to reduce debt and re-orient economic activity from consumption to production and exports. Some risks also remain to the stability of financial institutions. Alternative assumptions regarding the global outlook and the corresponding potential impacts on the New Zealand economy are considered as scenarios presented later in the chapter.

...which flows through into higher terms of trade

As the global economy has started to recover from the effects of the financial crisis, prices for New Zealand's export commodities have begun to rise from lows earlier in the year, especially for dairy products. International spot prices for New Zealand's key exports, as measured by the ANZ Commodity Price Index, rose 39% between February and November 2009, with a 75% rise for dairy products. The lag between spot prices and prices received by New Zealand producers should see increases in export prices occurring in late 2009 and early 2010.

World prices for imports are also likely to rise over the forecast period, particularly oil prices, which are assumed to rise from US$68 a barrel in the September 2009 quarter to US$87 a barrel in mid-2014. However, on balance, the merchandise terms of trade are expected to rise over the forecast period. This forecast increase in the terms of trade is expected to provide a boost to national incomes.

Higher profits fail to raise business income tax owing to the build-up of losses...

Firms faced a very challenging trading environment in 2008 and 2009 owing to lower world and domestic demand. Compressed margins, combined with lower volumes sold, have led to falling profits and losses for many businesses, particularly those in agriculture, construction, forestry and finance. Net operating surpluses, a proxy for business profits, are forecast to fall in both the March 2009 and 2010 years and the build-up of losses has important implications for tax revenue across the forecast period.

Firms are now experiencing higher demand as overseas and domestic consumers respond to the stronger economic environment. A rebuilding of margins and higher volumes are expected to result in rising profits, with net operating surpluses forecast to recover from the March 2011 year. However, the amount of income tax revenue from businesses does not rebound as quickly. Revenue from business income taxes (ie, corporate tax and other persons tax) fell sharply in the June 2009 year and is forecast to fall further this fiscal year before recovering in the remainder of the forecast period. Income tax paid by firms is forecast to be lower than expected at Budget across the forecast period because the accumulation of tax losses during the recession appears to have been larger than expected.

...and investment is expected to recover slowly…

Business investment is forecast to recover gradually from early 2010 after a period in which major investment plans had largely been shelved. Business surveys show investment intentions have rebounded from record lows earlier in the year but remain below historic average levels. The availability of finance remains constrained with banks and other lenders still cautious about the level of funds they provide, although large firms have sought funds by raising equity and issuing corporate bonds. Intangibles investment has been an area of relative strength owing to increased mining exploration and drilling, which is likely to continue based on recent reports. Investment over the next year is also expected to be supported by a high exchange rate lowering the cost of imported capital goods.

...while unemployment rises further...

Figure 1.3 - Unemployment rate

Source:  Statistics New Zealand, the Treasury

Employment is expected to lag the recovery as many firms are likely to increase the hours of their staff before hiring new workers. Firms reduced working hours significantly in the recession, equivalent to the loss of nearly 50,000 full-time workers, through measures such as job sharing and extended leave. A lack of job creation is expected to lead to a further rise in the unemployment rate from 6.5% in the September 2009 quarter to a peak of 7.0% in the March 2010 quarter and the remainder of that year (Figure 1.3). This forecast is lower than a peak of 8.0% expected in the Budget.

Higher net migration inflows are expected to provide a boost to aggregate demand growth in the short term. Net migration inflows rose sharply from under 4,000 in 2008 to an expected 23,000 in 2009 as arrivals remained high and fewer New Zealanders departed after the global financial crisis led to weaker labour markets overseas. Net migration inflows are forecast to fall to 10,000 per annum by early 2012 as departures are assumed to rise in line with a recovery in offshore economies and labour markets, particularly in Australia.

...and wage growth flows through to PAYE tax

Wage growth, which tends to lag changes in the economy, is expected to ease sharply over the coming year before stabilising just below 3% per annum. Annual growth in average ordinary-time earnings rose to 5.1% in the September 2009 quarter, but this measure is overstating underlying wage pressure as it can be volatile on a quarterly basis and is subject to changes in the composition of the workforce. An easing in the rate of wage growth, and a gradual recovery in employment growth, are expected to deliver growth in PAYE tax of 5% per annum on average over the 2010-14 June years.

Consumer spending growth is expected to rebound from next year...

Consumer spending is expected to remain subdued in the second half of 2009, as a result of relatively subdued income growth and rising unemployment, but rebound with growth of 2.3% expected in the 2011 March year and 2.5% in the next year. This rebound reflects higher consumer confidence, a more stable employment market and a recovery in house prices. After a fall of over 9% in the year to March 2009, house prices are expected to rise nearly 10% in the March 2010 year, of which around half has already occurred on the back of historically low short-term interest rates, higher net migration inflows and a constraint on supply. Thereafter, an easing of house price growth to around 4% per annum, together with a tightening of monetary conditions and easing net migration inflows, is expected to lower private consumption growth to 1.7% and 1.5% in the final two years of the forecast period.

…and residential investment to recover, resulting in higher revenue from GST

Residential investment is expected to stage a recovery over the 2011 and 2012 March years from its current very low levels. This forecast reflects greater confidence in the sector by households owing to factors outlined above, including low floating mortgage rates and population growth. However, the volume of residential investment takes time to make up for the large 25% fall in the June 2009 year because funding for property developers remains constrained and building consents have only picked up recently after falling to their lowest level in over 25 years earlier in the year. Therefore, an undersupply of housing in some areas is also likely to contribute to higher house prices.

A strengthening of private consumption and residential investment is expected to underpin growth in GST of 7% in the June 2011 year and 4% per annum on average over the rest of the forecast period. This follows a lack of growth in the June 2010 year owing to weakness in both consumer spending and investment in residential buildings.

Fiscal policy continues to provide stimulus in the near term

Public consumption is expected to grow across the forecast period, but growth is forecast to slow from 2.3% in the June 2009 year to 1.7% in each of the next two years, reflecting the decision in Budget 2009 to reduce the operating allowance for new spending.

Figure 1.4 - Fiscal impulse

Source:  The Treasury

The fiscal impulse indicator provides a summary guide to the amount of fiscal stimulus across government consumption, investment, transfers and tax (where these last two areas affect household consumption).[1] As noted above, fiscal policy was stimulatory during the recession. In the June 2009 year, the fiscal impulse was 3.7% of GDP, which partly reflected policy decisions such as cuts in personal income taxes in October 2008 and April 2009, the bringing forward of infrastructure spending and other packages related to the recession (Figure 1.4). The fiscal impulse is estimated to reduce but remain expansionary at 2.2% of GDP in the June 2010 year and is forecast to be negligible in the June 2011 year, before fiscal stimulus begins to be withdrawn over the remainder of the forecast period.

Imports forecast to grow quickly as domestic demand rebounds…

Imports are forecast to begin strengthening in late 2009, led by a recovery of domestic demand in New Zealand and a higher exchange rate making imported goods and services relatively cheaper. This follows a very large fall in import volumes in the first half of 2009 across most categories, particularly capital goods, intermediate goods and services imports, which contributed to a narrowing of the trade balance. Imported services are expected to grow particularly strongly as more New Zealanders holiday overseas after having delayed their international trips during the recession, particularly with the high exchange rate.

…but the high exchange rate constrains exports over the next year

Exports are forecast to be relatively flat in the 2010 and 2011 March years owing to an assumption that the exchange rate remains high. The Trade Weighted Index (TWI) is assumed to remain at 66.5 in the first half of 2010, which dilutes the effect of stronger trading partner growth. However, the elevated exchange rate partly reflects high export commodity prices, which have boosted the terms of trade. Also, the New Zealand dollar is high against some currencies, particularly the United States dollar and United Kingdom pound, but is below its long-term average against the Australian dollar. A low cross rate against the Australian dollar and the strong Australian economy are particularly important for exporters of manufactured goods and of services.

Export growth is expected to accelerate to around 4% to 5% per annum over the 2012 to 2014 March years as global growth strengthens and the exchange rate is assumed to depreciate from mid-2010. The rebound in goods exports is not expected to be as large as in other nations because agricultural production is largely determined by supply constraints. However, service exports are expected to grow very strongly in 2011 as New Zealand hosts the Rugby World Cup towards the end of that year.

Inflation pressures contained as interest rates expected to rise from mid-2010

Consumers Price Index (CPI) inflation is expected to rebound from 1.7% in the year to September 2009 to 2.5% in the year to March 2010, largely because of past increases in retail fuel and food prices. Inflation is then expected to ease gradually to 2.0% per annum by March 2014 as inflationary pressures are contained by a rise in interest rates from mid-2010. As the economy recovers, interest rates are expected to increase with 90-day rates rising from below 3% towards 6% over the forecast period. The profile for inflation includes a revised assumption for the Emissions Trading Scheme, particularly the impact on stationary energy and liquid fuels from 1 July 2010. This assumption is outlined on page 45.

Current account deficit narrows temporarily before returning to 7% of GDP

Figure 1.5 - Annual current account balance

Source:  Statistics New Zealand, the Treasury

The annual current account deficit narrowed from 8.9% at December 2008 to 5.9% at June 2009 as exports were boosted by a rundown in stocks, imports fell and interest paid to foreign investors and profits going offshore fell. These factors are expected to drive a further fall to below 3% in the short term, partly as the fall in profits going overseas includes provisions by trading banks arising from their structured finance tax cases with Inland Revenue. However, the fall is expected to be largely temporary as the current account deficit is forecast to rise back to 7% of GDP by 2012 (Figure 1.5). The tax cases will only have a short-term impact, a recovery in domestic activity is forecast to lead to higher imports and a high exchange rate is expected to constrain exports.

The economy is larger than previously expected...

Figure 1.6 - Real production GDP per capita

Source:  Statistics New Zealand, the Treasury

Stronger real activity levels are expected over the forecast period compared to what was expected in Budget 2009 because of stronger terms of trade and higher population growth. However, higher population growth means forecasts of real activity per capita have not changed as much (Figure 1.6). Furthermore, there is still expected to be some permanent loss of future output compared to pre-recession trends. This loss partly reflects a re-evaluation of how sustainable previous growth in the economy actually was, particularly growth in consumption, both private and public. It also reflects the crisis itself; for example, by reducing business investment and thus growth in the stock of capital in the economy. These forecasts still incorporate a level of real GDP per capita that is 5.5% lower in the June 2012 quarter than had been forecast in Budget 2008, prior to the crisis. This judgement is subject to considerable uncertainty.

Figure 1.7 - Nominal expenditure GDP

Source:  Statistics New Zealand, the Treasury

Price developments, including higher terms of trade and domestic inflation, combined with stronger real activity levels, result in higher nominal GDP. Nominal GDP over the four years to June 2013 as a whole is expected to be around $44 billion or 5.9% higher than forecast in the Budget. However,the level of nominal GDP in the June 2012 quarter remains 3.7% below the level expected in Budget 2008 (Figure 1.7).

...and generates more tax revenue...

The increase in core Crown tax revenue across the 2010 to 2013 June years is around $7 billion relative to the Budgetforecasts. As discussed above, weakness in business income taxes has muted the forecast increase in tax revenue compared to the increase in the size of the economy. However, most other taxes are higher than in the Budget forecasts. Forecasts of source deductions (mostly PAYE) and GST have increased in line with compensation of employees and domestic consumption respectively, and forecasts of resident withholding tax on interest have increased as a result of higher interest rates.

Note: Forecast changes calculated from unrounded values so numbers may not add to total

Source: The Treasury

…although higher inflation contributes to a rise in government expenses...

Core Crown expenses, which represent the operating spending of the government excluding State-Owned Enterprises (SOEs) and Crown Entities (CEs), are forecast to rise by 19.1% from $64.0 billion in the June 2009 year to $76.2 billion in the June 2014 year (Figure 1.8). This forecast rise is an easing from growth of 52.8% in the five years to June 2009, mainly reflecting the decision in Budget 2009 to reduce the operating allowance for new spending to $1.1 billion per annum from the June 2011 year,growing at 2% per annum thereafter to account for inflation.

Figure 1.8 - Core Crown expenses and revenue

Source:  The Treasury

The operating allowance for new spending is one of the main drivers of growth in core Crown expenses in the forecast period (Figure 1.9). Growth in expenses of a similar size comes from an increase in benefit costs. Excluding unemployment benefits, these benefit costs are expected to rise from $19.7 billion in the June 2009 year to $24.1 billion in the June 2014 year, largely reflecting payments being adjusted for inflation or wages. Expenses are also expected to be driven by higher unemployment benefit costs, as unemployment rises further, and higher finance costs, which are forecast to rise from $2.4 billion to $4.6 billion in the next five years as cash deficits are financed. Excluding unemployment benefits and finance costs, core Crown expenses are expected to rise by 15.9% or $9.7 billion between the years to June 2009 and 2014.

Figure 1.9 - Forecast new operating spending

Source:  The Treasury

Core Crown expenses are expected to be higher than in the Budget 2009 forecasts. In particular, benefit costs and New Zealand Superannuation are expected to be higher than previously forecast, owing to higher-than-expected inflation and wages, and education costs are above forecast, owing to increased demand for early childhood education and higher teacher salaries. Expenses have been revised higher despite operating allowances being unchanged. The larger economy, bigger population and stronger than previously forecast wage and price inflation are all expected to place more pressure on the operating allowances than anticipated in Budget 2009.

...leading to a sustained period of operating deficits...

With expenses exceeding revenue in the forecast period, the total Crown operating balance (before gains and losses) is expected to remain in deficit, peaking at $7.5 billion (4.0% of GDP) in the June 2010 year. By the June 2014 year, the operating deficit (before gains and losses) is expected to fall to $4.9 billion (2.2% of GDP) as a result of a rise in tax revenue, increased revenue generated from ACC levies, and slower spending growth. Compared with the Budget forecasts, the operating deficit was slightly larger than expected in the June 2009 year, but is now forecast to be smaller, reflecting the stronger economic outlook (Figure 1.10). The total Crown operating balance (including gains and losses) is also in deficit across the forecast period. The deficit is forecast to be smaller when gains and losses are included because Crown financial institutions such as the NZS Fund are forecasting to make gains on average over the forecast period.

Figure 1.10 - Total Crown operating balance (before gains and losses)

Source:  The Treasury

The medium-term projections in the next section show the total Crown operating balance (before gains and losses) is projected to be in surplus from the June 2017 year, two years earlier than projected in the Budget.

Notes:

1. Net core Crown debt excluding the NZS Fund and advances
2. Gross sovereign-issued debt excluding Reserve Bank bills and settlement cash

A glossary and longer time series for these variables are provided on pages 124 to 128.

Source: The Treasury

…and cash deficits are met by increased borrowing and so increase net debt

As with the operating balance, residual cash is expected to be in deficit over the forecast period. Residual cash deficits are predicted to rise from $8.6 billion in the June 2009 year to over $10 billion in the 2010-12 fiscal years before reducing to $7.4 billion in the June 2014 year (Table 1.6). Cash deficits are expected to be higher than operating deficits as the cash indicator is a core Crown measure and also includes capital spending. The recovery in cash deficits is weaker than the operating balance because the cash forecasts include the impact of expected defaults under the deposit guarantee scheme already provided for and exclude higher ACC revenue.

The Government is expected to invest close to $20.8 billion in capital over the forecast period. The capital spending comprises around $7.3 billion to purchase physical assets primarily so departments can maintain their current level of assets to deliver services. The government is also expected to provide loans and capital injections of around $9 billion. Around two-thirds of this funding is to SOEs and CEs, which is generally used to purchase physical assets in the health, education, housing and transport sectors. The rest of the funding primarily relates to student loans. In addition, the Government has set aside $4.5 billion for future new capital spending. The allowance for new capital spending is $1.45 billion for Budgets 2010to2012, increasing to $1.65 billion for Budget 2013.

Source: The Treasury

Cash deficits represent the amount the Government has to fund, either by raising debt or reducing financial assets. Over the forecast period as a whole, cash deficits are expected to be nearly $48 billion and, as a result, net debt is expected to rise from $17.1 billion (9.5% of GDP) at 30 June 2009 to $64.9 billion (29.0% of GDP) at 30 June 2014. Net debt at 30 June 2009 was slightly higher than expected in the Budget. Although forecasts of net debt are now lower than expected at Budget owing to slightly smaller cash deficits, a large rise in net debt is still expected (Figure 1.11). As a proportion of GDP, medium-term projections in the next section show that net debt is expected to continue rising to a peak of just over 30% at 30 June 2016.

Figure 1.11 - Net debt

Source:  The Treasury

The expected cash shortfall is forecast to be met by additional borrowings and the run-down of financial assets held by the New Zealand Debt Management Office (NZDMO) which have been built up over recent years. The majority of the borrowing requirement will be met through the issuance of bonds (Table 1.7). Issuances total $53.7 billion over the forecast period (taking the current year into account). After meeting debt maturities, net bond issuances total $34.4 billion (including net non-market issuances to the Earthquake Commission).

Source: The Treasury

Net worth declines as operating deficits are ongoing

Net worth is forecast to fall from $99.5 billion (55.2% of GDP) as at 30 June 2009 to $79.2 billion (35.3% of GDP) as at 30 June 2014. The fall reflects the flow-on impact to assets and liabilities from the operating deficits expected in the forecast period. The forecast fall in net worth is slightly smaller than expected in the Budget owing to smaller operating deficits.

The underlying nature of these deficits can be measured by the cyclically-adjusted, or structural, balance, which gauges how much of the operating balance before gains and losses reflects temporary cyclical factors rather than long-lasting factors. The cyclically-adjusted balance is estimated to remain in deficit in the forecast period, rising from 1.8% in the June 2009 year to 3.7% in the June 2010 year before falling to 2.0% in the June 2014 year, which means that operating deficits are largely structural.[3]

Medium-term Projections#

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Projections take forecasts forward a further 10 years to 2024...

This section takes the main forecasts covering the period through to June 2014 in the previous section and projects them forward to June 2024. Projections differ from forecasts in both the manner they are produced and the sense of accuracy they portray. The projections grow forward economic and fiscal variables from the forecast base, using both demographic projections and assumptions, with the latter usually based on long-term averages. Some variables require a transitional period in the early projected years to reach stable, long-term values. These assumptions are discussed on page 46.

Projections are very sensitive to changes in the assumptions and changes in the forecast base. For this reason, and owing to inherent uncertainty in such medium-term projections, it is best to focus on the general trajectory over time, particularly the near term. Alternative medium-term scenarios are presented in the next section.

The main projections assume an easing of growth in real GDP from 2.8% in the June 2014 year to around 2% in the June 2024 year. Labour productivity growth is assumed to average around 1.5% per annum over the later years of the projection period, while annual labour force growth is projected to fall from 2% in June 2014 to 0.4% by June 2024 because of an ageing population. With real GDP growth projected to ease to around 2% and inflation of 2% per annum, projected growth in nominal GDP falls to 4% per annum from 2018.

...and show that surpluses are not projected to return until 2016/17...

The total Crown operating balance (before gains and losses) is projected to be zero in the June 2016 year and return to surplus in the June 2017 year for the first time since 2008. The projected operating balance returns to surplus two years earlier than was projected at Budget 2009, driven by changes in the forecast period that flow into projections of higher revenue that more than offset higher expenses. The core Crown operating balance returns to surplus in the June 2018 year and is of sufficient size for a full contribution to the NZS Fund in the June 2020 year, a year earlier than projected at Budget 2009.

...while net debt is projected to peak at around 30% of GDP...

Net debt is projected to continue lifting until the June 2016 year, when it peaks at just above 30% of nominal GDP (Figure 1.12). After this, it is projected to fall to just below 20% of GDP by June 2024. The peak of net debt is both lower and slightly earlier than was projected at Budget. By the June 2023 year, the last year shared by both projections, net debt is around 10 percentage points of GDP lower than the Budget projection.

Figure 1.12 - Net debt

Source:  The Treasury

The projections of net debt assume an operating allowance of $1.1 billion per annum from the June 2011 year, growing by 2% per annum in future years to account for inflation. This is significantly lower than operating allowances in recent years and will be challenging to maintain over the medium term. The net debt projections also assume full fiscal drag on tax on wages and salaries for the entire projection period. This assumption, combined with rising incomes, results in a substantial increase in tax revenue and would mean the average wage earner would have some of their income taxed at the top marginal tax rate by 2024.

Ongoing operating deficits are reflected in declining total net worth, until surpluses return in 2016/17 (Figure 1.13). To complement net worth, the Treasury is introducing a new fiscal indicator to provide a more complete picture of the Crown's position. Net worth excluding social assets provides the Government with an idea of how its assets that earn a financial return match the Government's liabilities. The measure consists of the financial assets of core Crown and CEs, all assets of SOEs and total liabilities, but excludes the physical assets of KiwiRail. Net worth excluding social assets follows a similar pattern to overall net worth.

Figure 1.13 - Net worth indicators

Source:  The Treasury

...and then fall towards 20% of GDP, in line with the Government's long-term fiscal objectives

The decline in net debt to around 20% of GDP towards the end of the projection period is in line with the Government's long-term fiscal objective. Meeting this objective would mean the Crown is better placed to absorb economic shocks. It would also put New Zealand in a better position when the long-term fiscal pressures from an ageing population and other factors begin to escalate. The Treasury recently published its Long-term Fiscal Statement, which showed significant fiscal challenges posed by an ageing population and the unsustainable nature of growth in government spending in recent years. The Statement also showed ongoing cost pressures and an ageing population would likely require reductions in some areas of services, even with annual operating allowances of $1.1 billion (growing at 2% per annum) and growth in public sector productivity.

Given the uncertainty around the Half Year Update projections, and the forecasts these projections build on, the next section examines alternative scenarios that fall within the range of possible outcomes. Economic and fiscal indicators could turn out to be stronger than outlined in the main projections above. It is also possible to conceive a situation in which the fiscal position worsens by nearly as much as projected in Budget 2009.

Alternative Scenarios#

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The most significant risks to the outlook have eased since the Budget. However, the level of uncertainty associated with any forecast made in the current environment remains larger than has typically been the case. Particular uncertainty surrounds the strength and sustainability of recovery in the world economy, including New Zealand. The amount of stimulus from monetary and fiscal policy currently supporting the global recovery is unprecedented and the impact in the short and medium term is uncertain. Although activity may be stronger than forecast in the near term, growth could weaken more sharply further out if private demand falls when policy stimulus is removed and the restocking of inventories is complete.

Two alternative scenarios are presented below to show how the most significant risks to the main forecast could play out. The scenarios are extended into the projection period in the same way as the main forecasts were in the preceding section. While the scenarios below do not represent the most likely track for the economy, the possibility of such outcomes occurring should not be ignored and the scenarios should be considered an integral part of the Half Year Update. The scenarios below consider how the economy and fiscal position could differ from the main predictions presented above under different paths of recovery.

Upside Scenario

The upside scenario focuses on a stronger recovery. Real GDP in New Zealand's trading partners in this scenario is assumed to rise 3.6% in the 2010 calendar year after a smaller decline of 1.1% in 2009 owing to a greater response to monetary and fiscal stimulus and the recovery in confidence levels. Although less than in 2010, there is still uncertainty over real GDP in 2009 as actual outturns are currently only available for two to three quarters of the year. The stronger recovery could be led by growth in emerging markets, particularly China, and trading partners that would benefit from this growth, including Australia. There is also uncertainty as to how the New Zealand economy will recover. Therefore, the upside scenario includes a judgement that domestic demand in New Zealand rises more strongly over the next year in response to low interest rates and high confidence levels.

A stronger world economy raises the terms of trade…

A stronger global recovery would lead to higher demand for New Zealand's exports, particularly non-commodity goods and services, and to higher export prices. Higher export prices raise the terms of trade by around 6% on average over the next five years relative to the main forecast (Figure 1.14). Higher terms of trade are a distinct possibility, with world dairy prices as measured by Fonterra’s globalDairyTrade auction up 95% since July 2009.

Figure 1.14 - Merchandise terms of trade (SNA)

Source:  Statistics New Zealand, the Treasury

…and domestic demand recovers earlier

In this scenario, domestic demand is also assumed to rebound more strongly than in the main forecast, reflecting greater momentum in consumer spending from higher levels of consumer confidence and rising house prices. Higher export incomes and confidence abroad are also assumed to flow through to domestic demand, including higher business investment. As a result, consumption would likely recover more quickly in the second half of the March 2010 year and then rise by just over 3% per annum in the following two years, compared with peak annual average growth of around 2.5% in the main forecasts. Investment also grows more strongly over the coming year in the upside scenario.

Notes:

1. Percent of labour force, March quarter, seasonally adjusted
2. Average for March quarter
3. Annual percentage change, March quarter

Sources: Statistics New Zealand, Reserve Bank of New Zealand, the Treasury

A stronger recovery sees unemployment fall more rapidly...

The stronger outlook would flow through to higher real GDP than in the main economic forecasts, with a smaller contraction of 0.2% in the March 2010 year followed by a larger rebound in growth to 3.2% and 3.9% in the 2011 and 2012 March years. Higher levels of activity would result in the unemployment rate falling more quickly from a peak of 7.0% in the March 2010 quarter, the same as in the main forecast, to 6.3% a year later, compared with 6.9% in the main forecast.

...and leads to higher nominal GDP and more tax revenue…

Stronger real activity, higher terms of trade and increased inflation lead to nominal GDP being much higher than in the main forecasts. Nominal GDP in the final June year of the forecast period is $6.3 billion higher and the cumulative difference over the 2010 to 2014 June years is $27.5 billion. As a result, core Crown tax revenue would likely be $2.4 billion higher than in the main forecast by the end of the forecast period, with a cumulative difference of around $10 billion across the 2010 to 2014 June years. Higher tax revenue relative to the main forecast reflects higher personal and corporate income tax revenue owing to higher incomes, more GST revenue from stronger domestic demand and a larger increase in tax on interest income as interest rates rise by more. Fiscal drag also has a larger impact in this scenario than in the main predictions because of faster wage growth.

Government expenses are only slightly lower than in the main forecasts. While there are fewer people on the unemployment benefit in this scenario, higher inflation adjustments for benefits and the impact of higher inflation and wage growth on superannuation payments would see overall welfare payments rise. This is offset by lower debt-servicing costs as a result of lower debt levels.

…resulting in lower deficits and a slower build-up of debt

Owing to the impact of higher tax revenue, the operating deficit would be slightly smaller than in the main forecast at 3.8% in the June 2010 year and would narrow over the following two years (Figure 1.15). The operating balance (before gains and losses) in the upside scenario reaches balance in the June 2015 year and returns to surplus in the following year, which would be one year earlier than predicted in the main projections. With smaller deficits in the upside scenario, core Crown net debt would be expected to rise by less than in the main predictions, rising to a peak of 24.4% in the June 2015 year before falling below 10% of GDP at the end of the projection period. However, it would be harder to live within the $1.1 billion operating allowance given a stronger economy would, for example, put more pressure on public sector wages.

Figure 1.15 - Operating balance (before gains and losses)

Source:  The Treasury

Downside Scenario

The downside scenario outlined below centres on risks to medium-term growth in New Zealand and overseas. It assumes the recovery continues in the short term as in the main forecasts, but that growth in the New Zealand economy weakens in line with the world economy once monetary and fiscal stimulus are removed around the world, the inventory cycle is complete and household demand does not fill the gap because of a desire to deleverage and rebuild balance sheets. In this scenario, New Zealand's top-12 trading partners are assumed to contract by 1.5% in the 2009 calendar year as in the main forecasts, but grow only 2.6% in 2010 and 2.9% in 2011. This slower recovery could result from renewed credit difficulties or a larger impact from monetary and fiscal tightening. Domestic demand in New Zealand also weakens in late 2010 as stimulus begins to be removed. The implications of this scenario continue to flow through in the medium-term projections.

Notes:

1. Percent of labour force, March quarter, seasonally adjusted
2. Average for March quarter
3. Annual percentage change, March quarter

Sources: Statistics New Zealand, Reserve Bank of New Zealand, the Treasury

A weaker recovery in the world economy would impact on New Zealand's trade and contribute to a weakening of domestic demand in late 2010...

Lower growth in the world economy contributes to a smaller rise in the terms of trade relative to the main forecasts, with the terms of trade just over 2% lower than in the main forecasts on average over the forecast period. Lower demand from abroad would also adversely affect New Zealand's exports. As a result, export volumes are forecast to be weaker than in the main forecasts in the years to March 2011 and 2013, with tourism particularly affected. The more subdued recovery in the world economy would also flowthrough to weaker domestic demand in New Zealand via its impacts onconfidence and asset prices.

There are also questions about how sustainable the recovery in New Zealand is for anygiven level of global demand, particularly if there is lower growth in credit. Credit growth could be affected either because of difficulties accessing finance as banks and finance companies become more cautious in their lending or because of lower demand as households look to rebuild their balance sheets. With lower growth in credit, the downside scenarioincludes an assumption in the medium-term projections that labourproductivity growth takes longer to get back up to 1.5% per annum than in the main projections owing to lower growth in the stock of capital.

...resulting in slower economic growth…

Under the downside scenario, real GDP growth rebounds only to 2.0% in the 2011 March year and 2.5% the next year, compared to 2.4% and 3.2% respectively in the main forecasts. An eventual recovery in trading partner growth coupled with relatively low interest rates and a lower exchange rate would eventually result in increased investment, export and consumption growth at the end of the forecast period. However, the level of nominal GDP is predicted to be significantly lower than the main forecast across the entire forecast period. Over the 2010 to 2014 fiscal years, nominal GDP would be a cumulative $18 billion or nearly 2% lower.

…and lower tax revenue and higher net debt

The effect on tax revenue in the final year would be similar in magnitude, but in the opposite direction to that of the upside scenario as tax revenue is estimated to be $2.3 billion lower than the main forecast in the 2014 June year. However, the overall difference in revenue calculated across the forecast period, at around $6.5 billion, is smaller than in the upside scenario because this scenario has more effect in the medium term. Lower incomes and domestic demand in the downside scenario would produce less income tax and GST revenue, and a lower interest rate profile would result in less tax on interest income.

Figure 1.16 - Net debt

Source:  The Treasury

More people would receive benefits in the downside scenario, but the adjustments to benefit rates because of inflation would be lower. The operating deficit (before gains and losses) under the downside scenario in the June 2010 year is estimated at 4.0% of GDP, the same as in the main forecast, but declines more slowly to 3.1% of GDP by 2014. The downside scenario then shows the operating balance (before gains and losses) returning to surplus in the June 2017 year, the same as predicted in the main projections. However, these surpluses would be smaller, rising to around 3% of GDP in the June 2024 year. Larger deficits relative to the main predictions mean borrowing would be higher under the downside scenario and would result in net debt peaking at 35.0% of GDP by the June 2016 year (Figure 1.16). This scenario is not dissimilar to the main projections in Budget 2009, in which net debt peaked at 35.9% in the June 2017 year.

Other paths for the economy are also possible

Other paths for the economy are certainly possible. Global financial markets have experienced a high degree of volatility over the past two years, particularly since the global financial crisis in late 2008. A stronger recovery, led by higher domestic confidence and a stronger international recovery, is also possible. The situation has stabilised over the past six months, but there is a risk of further difficulties being experienced and New Zealand remains vulnerable to a loss of investor confidence because of its high reliance on overseas debt.

The exchange rate has been volatile in 2009. The TWI of the New Zealand dollar fell to a monthly trough of 52.3 in February 2009, but a recovery in the global outlook resulted in a return of risk appetite that saw the TWI rebound to 66.5 in October 2009, before easing slightly to 65.2 in November 2009. The Half Year Update assumes the exchange rate remains around 66.5 until mid-2010 but it is always a major uncertainty in economic forecasts and recent volatility highlights how quickly sentiment can change. The exchange rate could fall sooner than assumed in our main forecast, especially if there is renewed risk aversion among financial market participants. Conversely, increased appetite for risk among financial market participants, a resurgence in domestic demand or higher commodity prices could lift the exchange rate back to the post-float high reached in July 2007.

Fiscal Sensitivities

Table 1.10 provides some “rules of thumb” on the sensitivities of the fiscal position to changes in specific variables.

Source: The Treasury

Finalisation dates and assumptions for the forecasts and projections#

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Economic forecast assumptions

Trading partner growth - The global outlook has changed significantly since the low point in activity earlier in the year when Budgetforecasts were finalised. After an estimated contraction of 1.5% in 2009, the economies of New Zealand's top-12 trading partners are expected to grow 2.9% in 2010, 3.2% in 2011 and 3.4% in 2012, before settling at growth of 3.2% in the final two years of the forecast period. These are similar to growth rates in Consensus Forecasts forOctober 2009, although are slightly lower than those for November 2009 released after the economic forecasts were finalised. Given there is continued uncertainty around these numbers, we consider scenarios based on different rates of trading partner growth.

Global inflation and interest rates - Inflation has declined dramatically from a year ago in most economies and the outlook remains subdued as the recovery in the world economy is expected to be gradual. The subdued inflation environment is expected to lead to low interest rates over the forecast period, although they are expected to be gradually normalised over time.

Figure 1.17 - WTI oil prices

Source:  Datastream, the Treasury

Oil prices - The average price of West Texas Intermediate (WTI) oil on a quarterly basis troughed at US$43/barrel in the March 2009 quarter and rose to US$68/barrel in the September quarter as demand picked up in line with the world economy. Based on the average futures prices for WTI oil in October 2009, the price of oil is assumed to rise to US$87/barrel by the end of the forecast period. Over most of the forecast period, the oil price assumption contained in the Half Year Update is approximately 25% above that assumed in the Budget forecasts(Figure 1.17).

Terms of trade - The merchandise terms of trade (as measured in the System of National Accounts) are estimated to trough in the September 2009 quarter, nearly 14% below their March 2008 peak. They are then assumed to rise gradually over the forecast period to be 11% higher in the June 2013 quarter than in the September 2009 quarter.

Monetary conditions - The New Zealand dollar exchange rate is expected to have appreciated to 66.5 on the TWI in the December 2009 quarter and is assumed to remain at this level throughout the first half of 2010. The TWI is then assumed to depreciate over the forecast period to 53. Ninety-day interest rates are expected to rise to 3.3% in the June quarter of 2010 and 4.3% a year later and continue to increase to 5.9% at the end of the forecast period.

External migration - The net inflow of permanent and long-term migrants is assumed to increase from just under 17,000 in the year to September 2009 to 24,400 in the year to March 2010 before falling to 10,000 per annum by early 2012.

Policy - The Emissions Trading Scheme (ETS) is assumed to impact on consumer prices both directly and indirectly over the forecast period. We estimate an impact on consumer price inflation of about 0.4 percentage points in the June 2011 year as the ETS impacts on the price of stationary energy (eg, coal, gas and geothermal) and fuel prices, with a further impact of about 0.4 percentage points in the 2013 calendar year, as waste is included from January 2013 and the transition phase ends.

Fiscal forecast assumptions

The fiscal forecasts are based on assumptions and judgements developed from the best information available on 25 November 2009, when the forecasts were finalised. Actual events are likely to differ from some of these assumptions and judgements. Furthermore, uncertainty around the forecast assumptions and judgements increases over the forecast period.

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

• a nominal GDP forecast is needed in order to forecast tax revenue
• a forecast of CPI inflation is needed because social assistance benefits are generally indexed to inflation
• an unemployment forecast is needed to underpin the projected number of unemployment benefit recipients, and
• forecasts of interest rates are needed to forecast finance costs, interest income and discount rates.

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

Projection assumptions

The projection period begins in the June 2015 year. These post-forecast fiscal projections are based on long-run technical and policy assumptions outlined below. The projection model can be found on the Treasury website.

Notes:

1. Annual average % change unless otherwise stated
2. Level of the unemployment rate (% of labour force)
3. Hours worked measure

Source: The Treasury

Given the difficulty in projecting cycles and shocks beyond the forecast horizon, the projections use trend or long-run averages for the growth rates or levels of key economic variables. In the Half Year Update 2009, some of these variables are not predicted to return to their trend levels within the five-year forecast period because of the persistent effects of the recession. However, these variables are assumed to return to these trend rates or levels in the first few years of the projections. These variables are: age-and-gender group labour force participation rates; CPI inflation; unemployment rate; average hours worked; and labour productivity growth. For labour force participation rates, projections produced by Statistics New Zealand are targeted. For the other variables, a rate of transition to the long-run trend rate or level is determined. These variables all contribute to the projection of nominal GDP, which is both a driver of a number of important fiscal variables, such as tax revenue, and the denominator in key fiscal ratios (eg, debt-to-GDP).

2 - Fiscal Risks#

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Introduction#

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This chapter describes the fiscal risks to the Government, including specific fiscal risks, and contingent liabilities, and notes charges against the fiscal forecasts.

Legislative Requirements

The Public Finance Act 1989 (PFA) requires an economic and fiscal update to incorporate, to the fullest extent possible consistent with the limits on disclosure requirements set out below, all government decisions and other circumstances that may have a material effect on the fiscal and economic outlook. If the fiscal implications of government decisions and other circumstances can be quantified for particular years with reasonable certainty, these fiscal implications must be included in the forecast financial statements. If the fiscal implications of government decisions and other circumstances cannot be quantified for particular years with reasonable certainty, those government decisions or other circumstances must be disclosed in the statement of specific fiscal risks.

The PFA requires the Minister of Finance and the Secretary to the Treasury to sign a statement of responsibility for each economic and fiscal update that:

• the Minister of Finance has communicated to the Secretary to the Treasury before the economic and fiscal update is finalised, all policy decisions with material economic or fiscal implications that the Government has made, and all other circumstances with material economic or fiscal implications of which the Minister is aware, and
• the Secretary to the Treasury has incorporated in the economic and fiscal update the fiscal and economic implications of those decisions and other circumstances, using the Treasury's best professional judgement (on the basis of the economic and fiscal information available to the Treasury on the day before the economic and fiscal update was finalised).

The PFA also requires the statement of specific fiscal risks of the Government to disclose the rules used to determine what is and what is not a specific fiscal risk.

The PFA requires that the fiscal forecasts must be prepared in accordance with generally accepted accounting practice (GAAP).

FRS-42 Prospective Financial Statements provides GAAP guidance for preparing fiscal forecasts. The general principle of the standard is that forecasts should be prepared using the best information that is reasonable and supportable. To ensure the accuracy of the fiscal forecasts the forecast assumptions:

• are based on the best information that is available at the time the forecasts are prepared (eg, latest economic conditions)
• are consistent with the current plans of the Government (eg, include current policies and other policies the Government are considering), and
• have a reasonable and supportable basis (eg, events are probable and measurable).

There will always be an element of judgement surrounding the assumptions that are made in preparing the fiscal forecasts. To provide a more comprehensive picture of the fiscal position FRS-42 also requires disclosure of factors that may lead to a material difference between the forecasts and the actual results. This includes matters such as new policies the Government may be considering and sensitivity around key assumptions (eg, economic conditions).

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

All government decisions and other circumstances that may have a material effect on the fiscal and economic outlook are considered against the criteria and rules set out below to determine if they are to be incorporated into the fiscal forecasts, disclosed as specific fiscal risks, or in some circumstances excluded from disclosure.

Criteria for including matters in the fiscal forecasts

Matters are incorporated into the fiscal forecasts provided they meet all of the following criteria:

• The quantum is more than $10 million in any one year.
• The matter can be quantified for particular years with reasonable certainty.
• A decision has been taken; or a decision has not yet been taken, but it is reasonably probable[4] the matter will be approved, or it is reasonably probable the situation will occur.

Additionally, any other matters may be incorporated into the forecasts if the Secretary to the Treasury considers, using his or her best professional judgement, that the matters may have a material effect on the fiscal and economic outlook and are certain enough to include in the fiscal forecasts.

Rules for the disclosure of specific fiscal risks 

Matters are disclosed as specific fiscal risks if:

• the likely cost is more than $10 million in any one year, and either
• a decision has not yet been taken, but it is reasonably possible[5] (but not probable) that the matter will be approved or the situation will occur, or
• it is reasonably probable that the matter will be approved or the situation will occur, but the matter cannot be quantified for or assigned to particular years with reasonable certainty.

Additionally, any other matters may be disclosed as specific fiscal risks if the Secretary to the Treasury considers, using his or her best professional judgement, that the matters may have a material effect (more than $10 million in any one year) on the fiscal and economic outlook, but are not certain enough to include in the fiscal forecasts.

Exclusions from disclosure

Matters are excluded from disclosure as specific fiscal risks if they fail to meet the materiality criteria (ie, are less than $10 million in every year), or if it is unlikely[6] they will be approved or occur within the forecasting period.

Additionally, the Minister of Finance may determine that an item included in the fiscal forecasts or a specific fiscal risk not be disclosed, if such disclosure would be likely to:

• prejudice the substantial economic interests of New Zealand
• prejudice the security or defence of New Zealand or international relations of the Government
• compromise the Crown in a material way in negotiation, litigation or commercial activity, or
• result in a material loss of value to the Crown.

Furthermore, the Minister of Finance has to determine that there is no reasonable or prudent way the Government can avoid this prejudice, compromise or material loss by making a decision on the fiscal risk before the finalisation of the forecasts, or by disclosing the forecast item or fiscal risk without reference to its fiscal implications.

Information Relating to all Disclosed Risks

Allowances for additional operating and capital spending in future Budgets are incorporated into the fiscal forecasts. From Budget 2010 the operating allowance is $1.1 billion per Budget (grown forward at 2% per annum) and the capital allowance is $1.45 billion per Budget from 2010 to 2012, increasing to $1.65 billion in Budget 2013.

The risks outlined in this chapter, should they eventuate, would only have an effect on the operating balance and/or net debt to the extent that they were not funded from within the allowances, by reprioritising existing expenditure, or through third party revenue.

Policy options for many risks require further development, and the quantum of the risk is often uncertain. Consequently, the final cost or saving may differ from the amounts disclosed in this chapter.

Charges Against the Fiscal Forecasts#

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The PFA requires that if the fiscal implications of government decisions and other circumstances can be quantified for particular years with reasonable certainty, these fiscal implications must be included in the forecast financial statements. This applies irrespective of whether or not a decision has been taken by the Government to provide additional funding for the matter.

ACC Non-Earner's Account

Based on the criteria outlined on pages 52 and 53 it is probable that additional funding for the ACC Non-Earners Account will be approved by the Government during the forecast period. Consequently, this matter has been incorporated into the fiscal forecasts as a potential charge against the operating allowances for future Budgets.

ACC updated its scheme valuation as at 30 June 2009 and has advised of potential changes to the Non-Earner's Account baselines in 2009/10 and outyears.

ACC Levy Increases

The Government is yet to consider ACC's final advice on levy rates for 2010/11 and the levies ultimately approved may differ from those in ACC's consultation documents.

Based on the criteria outlined on pages 52 and 53 it is probable that increases to ACC levies will be approved by the Government during the forecast period. Consequently, the effects of these increases have been recognised in the fiscal forecasts as a potential increase in the operating balance.

It is important to note that the Government has not yet taken any decision on ACC levy rates for 2010/11. The amounts below that have been recognised in the fiscal forecasts are Treasury's best estimate (at this time) of the likely effect of proposed levy increases, inclusive of the legislative changes now before Parliament.

An unquantified Specific Fiscal Risk has been included in this chapter (see page 61) to recognise the fact that the final 2010/11 levy rates may be different to those from which the amounts recognised in the forecasts were derived.

Specific Fiscal Risks#

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The matters listed below are disclosed as specific fiscal risks as they meet the rules for disclosure outlined on pages 52 and 53.

Quantified and unquantified risks are listed separately. Within each list the risks have been categorised as new or changed/unchanged since the last economic and fiscal update.

Risks are unquantified if the amount of the risk is unknown, or if the matter is partially disclosed as an unquantified risk (as full disclosure would be likely to prejudice New Zealand's substantial economic interests, security, defence or international relations; or compromise the Crown in a material way in negotiation, litigation or commercial activity; or result in a material loss of value to the Crown).

Fuller descriptions of the risks listed below are included on pages 61 to 73.

Quantified Risks

If they were to eventuate the risks outlined in these tables would, to the extent that they cannot be funded from future Budget allowances, by reprioritising existing expenditure, or through third party revenue, impact the Government's forecast financial position (as indicated in the table below).

A negative fiscal impact means an increase in net debt and possibly a decrease in the operating balance.

Unquantified Risks

If they were to eventuate the risks outlined in these tables would, to the extent that they cannot be funded from future Budget allowances, by reprioritising existing expenditure, or through third party revenue, impact the Government's forecast financial position (as indicated in the table below).

A negative fiscal impact means an increase in net debt and possibly a decrease in the operating balance.

Risks Removed Since the 2009 Budget Economic and Fiscal Update

The following risks have been removed since the 2009 Budget Economic and Fiscal Update:

Statement of Specific Fiscal Risks

ACC - Levy Increases (new, unquantified risk)

Treasury's best estimate of the likely effect of proposed levy increases (inclusive of the legislative changes now before Parliament) has been recognised in the fiscal forecasts. The finalised levy rates for 2010/11 may differ from the proposed rates on which the amounts recognised in the forecasts were derived, with either a positive or negative impact on revenue and expenses.

Climate Change - International Climate Change Obligations (changed, unquantified risk)

There is uncertainty in the level of fiscal impact the ETS and Kyoto obligation place on the Government. The net impact of variables including carbon prices, levels of net-emissions, the uptake of post-1989 foresters and allocation levels to emitters are unknown. The Government may need to purchase Kyoto Protocol emission units before 2015 to meet its Kyoto obligations.

Currently no obligation is recognised in the Government's accounts for any post 2012 international climate change agreement, given the Government has yet to ratify any such agreement and the high levels of uncertainty around its potential nature and size. Any agreement entered into will need to be recognised at the time of signing alongside ETS revenues and expenses.

Corrections - Community Probation and Psychological Services (changed, quantified risk)

The draft 2009-2017 Criminal Justice Forecast predicts a significant increase in the number of sentences and orders served in the community over the forecast period. The Department of Corrections estimates that this would require an additional 500 Probation Officers, Programme Facilitators and Psychologists over the forecast period based on current levels of service delivery. This would result in additional operating costs of $78 million per annum by 2013/14 and capital expenditure of $61 million.

Corrections - Prison Construction (changed, quantified risk)

The Government is considering options to address forecast growth in the prison population. The Department of Corrections faces prison capacity demands over the next 10 years, and has developed a plan to respond to this demand by increasing prison capacity and replacing obsolete capacity. If the Government's chosen response to the growth in the prison population is to increase prison capacity, it is estimated that this would cost up to $915 million capital over the next ten years, and up to $150 million operating per annum by 2018/19. These figures are subject to change depending on the procurement methods chosen by the Government.

Customs - Joint Border Management System Replacement (changed, quantified risk)

Customs is developing a proposal to replace the Border Management System. In accordance with the two-stage approval process for major information technology projects, funding is dependent on approval of a Stage 2 Business case, and the outcome of Budget 2010 funding decisions. The Stage 2 Business case is complete and is scheduled to be considered by Cabinet. The current funding requested is $66 million capital over the period 2009/10 to 2013/14, with operating funding of $15 million in 2011/12 and reducing to $9 million for 2012/13 and outyears.

Defence - Project Protector Warranty Issues (new, unquantified risk)

The Crown is currently in negotiations over warranty issues relating to the some of the Project Protector vessels. It has been agreed that both parties will go back to mediation to try and reach a final settlement. The likely outcome would result in an increase to revenue.

Economic Development - Broadband Investment Initiative (unchanged, quantified risk)

The Government has committed to spend $1.5 billion on a new broadband network delivering “ultra fast” broadband services. Of this amount, $290 million has been appropriated through Budget 2009. The timing and amount of further funding has not yet been determined.

Economic Development - Investment in Tourism Infrastructure (new, unquantified risk)

The Government is considering investing in tourism infrastructure. This includes possibly funding the construction of a National Convention Centre and a cruise ship terminal in Auckland. These may be either wholly or partly funded by the Government.

Economic Development - Large Budget Screen Production Fund (new, quantified risk)

The Large Budget Screen Production Fund is a fund to assist film production companies. The appropriation is set at $35.556 million, however the Fund is a demand driven programme and actual costs are dependent upon the number of productions. In any given year the number of productions underway can vary and associated costs can vary. The estimated shortfall in the Fund in 2009/10 is around $34 million.

Economic Development - Radio Spectrum Rights (changed, unquantified risk)

The Government sets the processes for the renewal or auction of property rights to radio spectrum in consultation with industry. Offers for rights of renewal to existing owners of spectrum rights are set approximately five years in advance of rights expiring from 2010 onwards with settlement being required prior to granting the new right. If any offers are rejected then they will be allocated by way of auction on the open market. In this update estimated radio spectrum sales revenue has been included in the forecasts. However there is a portion of radio spectrum sales revenue which cannot be forecast at this time.

Education - Additional Funding for Defective School Buildings (new, unquantified risk)

As in other areas of the building sector, the school property portfolio has a portion of the building stock built between 1995 and 2005 which is subject to the “leaky buildings” (defective building) issues as result of poor design, inappropriate materials, poor workmanship and deficient building project oversight.

Education - Additional Funding for School Property (changed, quantified risk)

In Budget 2009 the Government provided $434.5 million in capital funding for the school property infrastructure programme. The Government has previously indicated that this programme could total $500 million and is considering providing a further $65.5 million for school property.

The Ministry of Education advises that an additional $168 million may be required over the next two financial years to meet roll growth and demographic change. In addition, the Ministry also advises that the annual property portfolio revaluation may increase the depreciation and therefore require further funding. The Government is also committed to increasing the range of schools that parents can choose to send their children to, which could potentially increase the level of property funding required.

Education - Broadband Investment: Schools (changed, quantified risk)

Government has signalled an investment of $150 million to support the introduction of ultra-fast broadband into schools. The capital cost of upgrading school internal networks for all state, and state integrated schools has been estimated at $235 million. More comprehensive costings will be prepared as part of a Broadband in Schools business case prior to the 2010 budget process. The Government has to date committed $34 million towards this objective. The financial implications of the broadband investment in schools on other complementary actions will be reflected in the business case.

Education - Demand for Tertiary Education (changed, unquantified risk)

The current tuition subsidy baseline allows for some growth in participation, based upon demographic changes, and increases in participation in key areas. The demand for tertiary education has increased as a result of the labour market downturn. The Government will need to consider whether to manage these pressures through reprioritisation or investment of additional funding. Additional enrolments would result in flow-on student loan and allowance costs.

Education - Early Childhood Education Funding (changed, unquantified risk)

Cost pressures in early childhood education (ECE) may lead the Government to consider increasing rates in future years. Any costs would depend on the option chosen and the ability to fund proposals from within existing baselines. There is also a risk that unanticipated changes may cause forecasts to be too low (for example unanticipated increases in registered teachers and hours of participation) resulting in cost pressures for the Government.

Education - Early Childhood Education Participation (unchanged, unquantified risk)

The Government is considering ways in which ECE participation of groups which are currently under-represented might be increased. Any costs would depend on the option chosen and the ability of the proposal to be funded within existing baselines.

Education - Early Childhood Education Ratio Changes (unchanged, quantified risk)

The Government is considering decreasing the adult to child ratio in ECE centres for under-two-year-olds from 1:5 to 1:4. The Ministry of Education has estimated that the cost of implementing this ratio change would be approximately $55 million per annum.

Education - Integrated School property (unchanged, unquantified risk)

Requests have been made by integrated schools for the Government to provide funding support for property costs at new schools. The Government has not yet considered these proposals; any costs would depend on the decisions taken by the Government.

Education - School Operational Grants (changed, unquantified risk)

The Government has historically increased school operating grants in each Budget. Any funding for school operations grants would depend on the circumstances and the ability of the proposal to be funded within existing baselines.

Education - School Staffing Entitlements (unchanged, quantified risk)

Budget 2009 provided for reductions in schooling appropriations of $45 million in 2011/12 and $50 million in 2012/13. If no policy changes are made in schooling, or wider education spending to realise these savings, the appropriations may have to be increased to their previous levels.

Education - Te Whare Wānanga o Awanuiārangi (unchanged, unquantified risk)

Te Whare Wānanga o Awanuiārangi has declared its wish to discuss in the context of the Wai 718 treaty settlement process the repatriation of funding from the Crown based on its concern that there may have been a breach of the Deed of Settlement. This is in addition to the $8.5 million that was agreed with Te Whare Wānanga o Awanuiārangi as part of its settlement with the Crown in 2003.

Education - Trades Academies (changed, quantified risk)

The Government intends to establish at least five (possibly eleven) trades academies by the end of 2011. Trades academies will offer secondary students new options for training towards vocational qualifications and transitions to employment. Capital funding of $6 million for the first Trades Academy at Southern Cross Campus was included in Budget 2009, subject to approval of a detailed business case and implementation plan. The cost of establishing the further trades academies will depend on how they are designed and operated, and to what extent they can be funded from existing capital and operating appropriations, but could range between $10 and $20 million. Work is ongoing to develop funding arrangements and establish their cost.

Education - Youth Guarantee (unchanged, quantified risk)

Decisions are required on the timing and nature of the full roll-out of the Youth Guarantee. The programme could eventually have an operating cost of as much as $65 million per annum. In Budget 2009 the Government provided $94 million between 2009/10 and 2013/14 for the Youth Guarantee programme. Any further funding would depend on the development of the Youth Guarantee programme and the ability to fund proposals within existing baselines.

Education, Social Development, Health and Revenue - Medical Training Places (unchanged, quantified risk)

The Government has considered funding 200 additional medical training places over five years. Sixty additional medical places have been funded in Budget 2009. Proceeding with the remaining 140 places would require additional funding, although final costs would depend on the option chosen and the ability of the proposal to be funded within existing baselines. This is currently estimated to be $10.9 million per annum operating and $2.5 million per annum capital by 2013/14, and grows beyond the forecast period.

Finance - Crown Overseas Properties (unchanged, quantified risk)

The Government holds New Zealand House in London on a long-term lease from the Crown Estate (UK). Depending on the Government's future intentions for this building, an upgrade may be required. Preliminary cost estimates for this upgrade total $150 million over the period 2009/10 to 2013/14.

Finance - Crown Retail Deposit Guarantee Scheme (changed, unquantified risk)[7]

The Government operates an opt-in Retail Deposit Guarantee Scheme over financial institution deposits. The objective of the scheme is to ensure ongoing retail depositor confidence in New Zealand's financial system, given the international financial market turbulence. A total of 73 financial institutions have been approved under the scheme. These are listed on the Treasury website. Deposits totalling $133.1 billion are under guarantee.

The Crown also continually updates the likelihood of further default actions triggering the guarantee and assesses the expected loss given default. Based on these assessments, the Crown has provided for a net loss given default of $899 million as at 31 October 2009, being the cost of future payments under this scheme after expected recoveries. The policy decision to extend and amend the Retail Deposit Guarantee Scheme to 31 December 2011 was announced on 25 August 2009.

While the provision represents a best estimate of likely loss, a significant range of outcomes are possible under the scheme in terms of which entities may default and the eventual loss to the Crown following an a default. This reflects the significant uncertainty as to the value that can be realised from an entity's assets following a default. Except as provided on the Treasury web site, further information on the Retail Deposit Guarantee Scheme cannot be provided due to commercial sensitivity.

Finance - Government Commitments to International Financial Institutions (unchanged, unquantified risk)

The forecast level of government commitments to international financial institutions is subject to change, depending on the Government's response to any changed financial plans on the part of these institutions.

Finance - New Zealand Post Equity Injection to Fund Expansion (new, unquantified risk)

A decision to fund New Zealand Post's business expansion through the Government underwriting New Zealand Post's balance sheet or through an equity injection is currently being sought.

Finance - New Zealand Superannuation Fund (unchanged, unquantified risk)

The Government has suspended contributions to the New Zealand Superannuation Fund for the period until the operating balance returns to a sufficient surplus. The Government made a one-off contribution to the fund of $250 million in 2009/10 and will consider, on an annual basis, whether to make any further one-off contributions before the required rates of contribution are resumed. The level of contribution to the fund, and any changes to the rate of return or remeasurements of the fund, would have fiscal implications which could increase or decrease net debt.

Health - Additional WellChild Visits (unchanged, quantified risk)

The Government is considering providing funding for three additional WellChild visits during the first nine weeks of a baby's life. The initiative has not been funded in Budget 2009, and has been deferred for consideration in future Budgets.

If approved, the indicative cost of this initiative would be $15.360 million operating in 2010/11 and outyears.

Health - Building Dedicated Elective Theatres (unchanged, quantified risk)

The Government is considering funding 20 dedicated elective surgery theatres, with associated beds and facilities. In Budget 2009, $20 million in 2009/10 and outyears has been allocated to ensure that the appropriate number and mix of staff for the new theatres are trained. However, funding has not been allocated for the operating costs and capital funding above what is being provisioned for these theatres in Budget 2009.

If approved, the indicative cost of this initiative would be $20 million operating in 2010/11 and $40 million in 2011/12 and outyears and $36 million capital.

Health - Caregiver Employment Conditions (unchanged, unquantified risk)

An Employment Court case regarding caregiver sleepover employment conditions for third party employed caregivers is currently awaiting judgement. A judgement in favour of the caregivers would require consideration of the repercussions for the Crown.

Health - District Health Board Deficits (unchanged, unquantified risk)

Several District Health Boards (DHBs) have projected operating deficits in 2009/10. The Government has stated that it does not view projected DHB operating deficits as acceptable and the Ministry of Health is working with DHBs to develop financial recovery plans. The Government has set aside funding in Vote Health to meet deficit requirements in 2009/10, anticipating that the DHB deficit position will improve in future years.

Health - Funding Increase for Subsidised Medicines (unchanged, quantified risk)

Budget 2009 provided $40 million per annum to increase spending on pharmaceuticals. The Government is considering an increase of $180 million over three years. If approved, the indicative cost of this initiative would be $60 million operating in 2010/11, and $80 million in 2011/12 and outyears.

Health - National Systems Development Programme (unchanged, unquantified risk)

The National Systems Development Programme (NSDP) is a major IT project to stabilise and upgrade core national health systems and collections. The project was originally scoped and signalled to Cabinet as a $104 million capital project, of which $35 million has been appropriated to date. The deliverables for the programme are currently under review and the scope and total cost may change.

Health - Payment of Family Caregivers (unchanged, unquantified risk)

A Human Rights Tribunal case regarding compensation for family member carers of disabled children is currently awaiting judgement. Further policy work will need to be developed should the Human Rights Tribunal find in favour of family caregivers.

Health - Purchase of Pandemic Strain Vaccine (changed, unquantified risk)

In the event of a H1N1 pandemic, the Government may review and widen the access and availability criteria of the seasonal influenza vaccination programme, which now includes H1N1. There may also be other fiscal impacts as a result of an increase in demand for Tamiflu and antibiotics, and an increase in the utilisation of medical facilities.

Housing - Hobsonville Urban Development (changed, unquantified risk)

The Government has commenced the development of an integrated urban community at Hobsonville within an area known as the Buckley precinct. Funding was provided in Budget 2008 for this precinct, as well as any other costs that will be incurred concurrently in order to enable broader site works and whole of project infrastructure. Additional capital funding may be required for the subsequent precincts in future Budgets. This would increase net debt in the next four years (to 2013) when the development will begin providing a return to the Crown. This risk is unquantified as disclosure could compromise the Government in negotiations with potential private sector partners.

Housing - Tamaki (changed, unquantified risk)

The Government is considering the Tamaki Transformation Programme, a multi-agency initiative to regenerate this Auckland suburb over 20 years. The initial phase of the redevelopment proposal will be undertaken over the next three years within the existing baselines of the agencies involved. There is a risk that some options for the remainder of the development, beyond the initial phase, may require additional capital and operating funding.

Housing - Weathertight Homes (new, unquantified risk)

The Government is considering options to facilitate assistance to homeowners to repair homes affected by the weathertightness issues that occurred as a result of changes to building regulations and industry practices in the late 1990s and early 2000s.

Immigration - Immigration New Zealand Change Programme (changed, quantified risk)

The Immigration New Zealand Change Programme proposes an integrated approach to upgrading immigration services. Some work is already underway, but further work is proposed, particularly a significant upgrade of existing IT systems. Were the IT component to proceed, estimated capital costs are around $65 million. Ongoing costs of the project would be funded from fees.

 Immigration - Redevelopment of Mangere Refugee Centre (unchanged, quantified risk)

The existing refugee facilities at Mangere may need refurbishment. Initial estimated costs of the refurbishment are $5 million operating and $25 million capital, with ongoing operating costs of $25 million per annum.

Justice - Family Court Professional Services (new, quantified risk)

Trends in judicial sentencing have placed increased pressure on Family Court Professional Services resources in the Family Court.

If current trends continue, it is estimated that costs will increase by $8 million in 2009/10 rising to $22 million by 2012/13.

Justice - Greater Auckland Service Delivery Strategy (unchanged, quantified risk)

The Government is developing a strategy to address court needs in the greater Auckland region. A wide range of stakeholders are currently being consulted over a variety of service delivery options.

Initiatives that are likely to be put forward for consideration as part of this strategy include establishing dedicated civil and family courthouses, establishing specialist and purpose-built jury courthouses, establishing a service centre to deal with customer enquiries and process bulk work, moving to electronic filing and an electronic court record, moving file storage offsite to a specialist external provider and establishing Community Justice Centre(s). As the strategy develops, full business cases are expected to identify priority projects and provide detailed costings.

The total cost could be up to $265 million.

Justice - Review of the Legal Aid System (changed, quantified risk)

Current forecasts of overall expenditure on legal aid, within current policy settings, are substantially higher than the amounts included in the fiscal forecasts. Without any change to policy settings for legal aid, it is estimated that overall costs will increase by $18 million in 2009/10, $72 million in 2010/11, $96 million in 2011/2012, $135 million in 2012/2013 and $178 million in 2013/2014.

New Zealand Defence Force - Defence Review 2009 (unchanged, unquantified risk)

The Government has approved terms of reference for a Defence Review and subsequent Defence White Paper. This process is expected to be completed by 30 March 2010. Included in the Defence Review is an examination of financial management procedures to meet long-term defence funding requirements.

The Defence Review is likely to present a range of options with different funding implications.

New Zealand Defence Force - Future Operationally Deployed Forces Activity (changed, quantified risk)

There are currently over 400 New Zealand Defence Force personnel deployed overseas on peace-keeping and United Nations missions. Existing baseline funding is expected to provide for the deployments in Afghanistan, East Timor, the Solomon Islands and several other locations during 2009/10.

The forthcoming Defence Review 2009 will consider future funding requirements for a range of operational commitments in the context of Government's wider defence, foreign policy and fiscal position. Maintaining existing deployment levels would result in an increased annual operating balance impact of some $30 million from 2010/11 subject to any decisions to reduce existing deployments.

New Zealand Defence Force - Sale of Skyhawks and Aermacchi Trainers (changed, quantified risk)

New Zealand's application to sell the former Air Combat Force aircraft has been approved by the US Congress and now depends on the successful conclusion of commercial negotiations.

Should the sale proceed, at a contract value of US$110 million, the net proceeds from the sale are expected to be around NZ$130 million.

Police - Digital Radio Network Full Implementation (changed, quantified risk)

The Government has previously funded the partial implementation of a Digital Radio Network in Wellington, Auckland and Christchurch, to be completed by December 2010. Police are still considering options for the further rollout of a National Digital Radio Network, possibly beginning in the 2011/12 fiscal year.

Earlier estimates suggested costs of up to $150 million, comprised of $28 million in capital in 2011/12, rising to $38 million in 2013/14; and $7 million of operating in 2011/12, rising to $18 million in 2013/14.

Revenue - Cash Held in Tax Pools (unchanged, unquantified risk)

Funds held in tax pools are recognised as an asset to the Crown. There is a risk that funds held in these pools, over and above a customer's provisional tax liability, may be withdrawn, resulting in an unquantified cash loss to the Crown.

Revenue - Charitable Giving (unchanged, unquantified risk)

Officials are investigating possible tax incentives for charitable giving, including gift aid and changes in the tax treatment of non-monetary gifts.

Revenue - Child Support - Shared Care (unchanged, unquantified risk)

A government discussion document will be released on shared care in the child support formula, including taking into account the incomes of both parents and the costs of children. Any changes would have administrative costs for Inland Revenue.

Revenue - Goods and Services Tax - Business to Business Transactions (unchanged, quantified risk)

The Government is considering options around GST on property transactions. The options considered include both administrative and legislative changes, and could increase revenue collections by up to $50 million per annum.

Revenue - Impairment of Crown Debt Administered by Inland Revenue (unchanged, quantified risk)

Inland Revenue administers Crown debt relating to general tax and family support. The Crown debt included in these forecasts was last tested for impairment at 30 June 2009. The asset will next be tested for impairment at 30 June 2010. The outcome of the valuation could have a negative impact of up to $200 million or a positive impact of up to $50 million.

Revenue - Imputation (unchanged, unquantified risk)

Aspects of the current imputation system are being reviewed. This includes whether companies should be able to stream imputation credits, and the refundability of imputation credits, particularly to charities.

Revenue - International Tax Review (unchanged, unquantified risk)

A number of proposals will be considered, and possibly progressed, as part of Phase II of the international tax review. Since all these proposals involve exempting income in particular circumstances, they may, if progressed, have a negative impact on tax revenue.

Revenue - Investment in the Tax System and Related Business (unchanged, unquantified risk)

Inland Revenue is investigating options around investment in the tax system and related business processes, including replacing the FIRST tax system. Part of this work includes investigating options for transforming employer information and payments. Part of this work includes investigating options for modernising the tax system (FIRST) and redesigning the Pay As You Earn and Personal Tax Summary systems.

Revenue - KiwiSaver (unchanged, unquantified risk)

The forecasts in relation to KiwiSaver policies are dependent on a number of assumptions and projections, such as uptake and contribution rates, all of which may change through time. In the current economic environment, factors such as reduced automatic enrolment, financial market disruption and low consumer confidence increase forecast uncertainty.

Revenue - Mutual Recognition and the Australian Tax Review (unchanged, unquantified risk)

The Government made a submission in October 2008 to the review, Australia's Future Tax System, making a case for mutual recognition of imputation/franking credits. The review will be reported to the Australian Government in December 2009. The outcome of the review may affect tax revenue in New Zealand.

Revenue - Possible Structural Tax Changes (unchanged, unquantified risk)

The Government will consider the findings of the Tax Working Group, which is assessing the medium-term direction of the tax system and policy options. Options being considered include introducing new taxes to broaden and maintain the tax base and changes to the structure of personal tax and corporate tax. Any changes would either decrease or increase tax revenue, depending on the options chosen.

Revenue - Potential Tax Policy Changes (unchanged, unquantified risk)

The Government is considering changes to various tax policies as indicated in the 18 month tax policy work programme. Measures on the current work programme are expected to be revenue neutral in aggregate. Measures enacted to date, and included in revenue forecasts, have increased tax revenue by around $50 million per annum. The remaining items are expected to be revenue negative up to the same extent. It is unclear exactly what additional policy changes, if any, will be made at this stage.

Revenue - Reducing Compliance Costs for Small- and Medium-sized Enterprises (unchanged, unquantified risk)

The Government is considering measures to simplify the tax rules for small- and medium-sized enterprises, pursuant to a government discussion document released in December 2007. Any measures that are pursued could have a material impact on tax revenue.

Revenue - Reinstatement of Deferred Tax Cuts (unchanged, quantified risk)

The Government has agreed to delay the April 2010 and April 2011 tranches of the planned tax cuts. The Government will reconsider these tax cuts when economic and fiscal conditions permit.

Reinstating these particular tax cuts would cost around $900 million per annum (dependent on when they are reintroduced).

Revenue - Revenue Implications of Recommendations from the Capital Market Development Taskforce (unchanged, unquantified risk)

The Capital Markets Development Taskforce is expected to report to Government later in the year. Recommendations could include tax changes and regulatory changes which impact on tax revenue.

Depending on the options chosen, any changes implemented would either decrease or increase tax revenue.

Revenue - Tax Issues Relating to Auckland Governance Reform (new, unquantified risk)

New entities are likely to emerge from the reform of local governance in Auckland. Some of these new entities could have tax liabilities different to the tax liabilities of existing entities, which would impact on the total tax paid by Auckland local government entities beyond the 1 November 2010 transition date. Depending on the shape of entities adopted, the changes could either increase or decrease tax revenue.

Revenue - Tax Treatment of Social Assistance Programmes (unchanged, unquantified risk)

The Government is investigating legislative solutions to fix loopholes in the tax treatment of social assistance programmes. Specific measures have not yet been identified but any changes are likely to have a positive impact on tax revenue.

Reviews of the Delivery of Public Services (unchanged, unquantified risk)

The Government has announced its intention to deliver more public services, more effectively, for fewer resources. The Government may undertake one or a number of value-for-money in-depth reviews over the next 12 months. Reviews may be tasked with identifying areas of expenditure that are not efficient, effective or aligned to government policy, or could be delivered differently. Reviews may recommend changes to service delivery and/or free up resources for reprioritisation within the vote (or within the organisation) or be returned to the centre to meet pressures in other areas. Reviews of government activities which result in improved cost-effectiveness are likely to have a positive impact on the fiscal position.

Risk to Third Party Revenue (unchanged, unquantified risk)

A wide range of government activities are funded through third party fees and charges. With a decrease in economic activity, there is a risk that decreases in third party revenue streams will require changes to service delivery with transitional costs to the Crown. For example, decreases in Customs revenue or in levies on building activity may mean that some activities are temporarily unable to be fully cost-recovered and the Government will need to transition out of an activity or temporarily subsidise that activity.

Social Development - Increasing the Abatement-free Income Threshold (unchanged, quantified risk)

The Government is considering increasing the abatement-free income threshold for main benefits from $80 per week to $100 per week, including non-qualifying spouses of people receiving New Zealand Superannuation.

Increasing the abatement-free threshold to $100 would mean that people who receive a main benefit will be able to earn an additional $20 a week before their benefit payment is reduced.

If approved, the cost of this initiative would be approximately $26.5 million per annum.

State Sector Employment Agreements (unchanged, unquantified risk)

A number of large collective agreements are due to be renegotiated in the short to medium term. As well as direct fiscal implications from any changes to remuneration, the renegotiation of these agreements can have flow-on effects to remuneration in other sectors. The Government has signalled an expectation for restraint given the current economic environment and conditions in the private sector.

Transport - Tauranga Eastern Corridor (new, unquantified risk)

The Crown may be asked to provide a loan to the New Zealand Transport Agency to advance the construction of the Tauranga Eastern Corridor Roading Project. It is intended that the loan will be repaid by toll revenue from the road.

Contingent Liabilities#

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Contingent liabilities are costs that the Government will have to face if a particular event occurs. Typically, contingent liabilities consist of guarantees and indemnities, legal disputes and claims, and uncalled capital. The contingent liabilities facing the Government 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 it would reduce the operating balance and increase net debt. However, in the case of contingencies for uncalled capital, the negative impact would be restricted to net debt.

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.

Only contingent liabilities involving amounts of over $10 million are separately disclosed. Contingent liabilities below $10 million are included in the “other quantifiable contingent liabilities” total.

Contingent liabilities have been stated as at 31 October 2009, being the latest set of contingent liabilities received.

Quantifiable Contingent Liabilities

Unquantifiable Contingent Liabilities

Contingent Liabilities: The following unquantified contingent liabilities have been removed from the above list:

• Crown Retail Deposit guarantee scheme
• Indemnification of touring exhibitions
• State Insurance and Rural Bank - Tax liabilities

Statement of Contingent Liabilities

Quantifiable Contingent Liabilities

Guarantees and Indemnities

Guarantees and indemnities are disclosed in accordance with NZ IAS 37 Provisions, Contingent Liabilities and Contingent Assets. In addition, guarantees given under Section 65ZD of the Public Finance Act 1989 are disclosed in accordance with Section 26Q(3)(b)(i)(B) of the same Act.

Air New Zealand - Letters of credit and performance bonds

The letters of credit are primarily given in relation to passenger charges, airport landing charges and indemnities provided to financial institutions on limits provided on staff credit cards. The performance bonds are primarily given in respect to engineering contracts.

$32 million at 31 October 2009 ($37 million at 30 June 2009)

Cook Islands - Asian Development Bank (ADB) loans 

Before 1992, the New Zealand Government guaranteed the Cook Islands' borrowing from the ADB. These guarantees have first call on New Zealand's Official Development Assistance.

$15 million at 31 October 2009 ($16 million at 30 June 2009)

Indemnification of receivers and managers - Terralink Limited

The Crown has issued a Deed of Receivership indemnity to the appointed receivers of Terralink Limited against claims arising from the conduct of the receivership.

$10 million at 31 October 2009 ($10 million at 30 June 2009)

Ministry of Transport - funding guarantee 

The Minister of Finance has issued a guarantee of $10 million to the Transport Accident Investigation Commission. The guarantee allows the Commission to assure payment to suppliers of specialist salvage equipment in the event of the Commission initiating an urgent investigation of any future significant transport accident.

$10 million at 31 October 2009 ($10 million at 30 June 2009)

Legal proceedings and disputes

The amounts under quantifiable contingent liabilities for legal proceedings and disputes are shown exclusive of any interest and costs that may be claimed if these cases were decided against the Crown.

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 possible amount of any award against the Crown.

Tax in dispute 

Tax in dispute represents the outstanding debt of those tax assessments raised, against which an objection has been lodged and legal action is proceeding. When a taxpayer disagrees with an assessment issued following the dispute process, the taxpayer may challenge that decision by filing proceedings with the Taxation Review Authority or the High Court.

The Crown is currently in dispute with a number of financial institutions regarding the tax treatment of certain structured finance transactions. Due to a High Court ruling for one structured finance case, all structured finance assessments have been recognised as revenue in the 2009 financial year ($1,423 million). However, as legal proceedings are still ongoing, the assessed tax has been recognised as a contingent liability.

A contingent asset has also been disclosed in relation to these transactions (refer page 88).

$1,655 million at 31 October 2009 ($1,661 million at 30 June 2009)

Kapiti West Link Road

Court action has been filed against New Zealand Transport Agency to have the land held for the Kapiti West Link Road released for sale. The maximum liability is $25 million.

$25 million at 31 October 2009 ($25 million at 30 June 2009)

Health - legal claims

Claims against the Crown in respect of alleged negligence for failing to screen blood for Hepatitis C when screening had first become available, resulting in people allegedly contracting Hepatitis C through contaminated blood and blood products.

$15 million at 31 October 2009 ($15 million at 30 June 2009)

Other Quantifiable Contingent Liabilities

Kyoto protocol

During the first commitment period the Ministry of Agriculture and Fisheries estimate that 92.3 million tonnes of carbon credits will be generated by carbon removals via forests. To the extent that these forests are harvested in subsequent commitments periods there will be an associated liability generated that will need to be repaid.

$1,871 million at 31 October 2009 ($1,995 million at 30 June 2009)

International finance organisations 

The Crown has lodged promissory notes with the International Monetary Fund. Payment of the notes depends upon the operation of the rules of the organisation.

$1,561 million at 31 October 2009 ($1,995 million at 30 June 2009)

New Zealand Export Credit Office - export guarantees

The New Zealand Export Credit Office (NZECO) provides a range of guarantee products to assist New Zealand exporters. These NZECO guarantees are recorded by the Crown as contingent liabilities. The amount of future liabilities arising from these guarantees is expected to be minor.

$175 million at 31 October 2009 ($155 million at 30 June 2009)

Air New Zealand Limited

The Air New Zealand Group has a partnership agreement with Christchurch Engineering Centre in which it holds 49 per cent interest. By the nature of the agreement joint and several liability exists between the two parties.

$68 million at 31 October 2009 ($68 million at 30 June 2009)

Inland Revenue - Unclaimed monies

Under the Unclaimed Monies Act 1971, companies (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.

$46 million at 31 October 2009 ($46 million at 30 June 2009)

Crown Health Financing Agency

The agency is subject to potential legal claims plus associated legal fees in respect of the actions of the former Area Health Boards. The agency is defending those claims that have resulted in litigation and will defend any of the others that result in litigation. The agency does not accept liability for the claims.

$28 million at 31 October 2009 ($28 million at 30 June 2009)

Reserve Bank - demonetised currency

The Crown has a contingent liability for the face value of the demonetised currency issued which have yet to be repatriated.

$23 million at 31 October 2009 ($23 million at 30 June 2009)

Unquantifiable Contingent Liabilities

Accounting standard NZ IAS 37 Provisions, Contingent Liabilities and Contingent Assets requires that contingent liabilities be disclosed unless the possibility of an outflow of resources embodying economic benefits is remote. Disclosure of remote contingent liabilities is only required if knowledge of the transaction or event is necessary to achieve the objectives of general purpose financial reporting. This part of the Statement provides details of those contingent liabilities of the Crown which cannot be quantified (remote contingent liabilities are excluded).

Guarantees and Indemnities

Airways New Zealand

The Crown has indemnified Airways Corporation of New Zealand Limited as contained in Airways' contract with New Zealand Defence Force for the provision of air traffic control services. The indemnity relates to any claim brought against Airways by third parties arising from military flight operations undertaken by the Royal New Zealand Air Force

AsureQuality Limited

The Crown has indemnified the directors of AsureQuality Limited in the event that they incur any personal liability for redundancies arising from any agreement by international trading partners that allows post-mortem meat inspection by parties other than the Ministry of Agriculture and Forestry, or its sub-contractor.

At Work Insurance Limited

The Crown has indemnified the liquidators of At Work Insurance Limited (Deloitte Touche Tohmatsu) against various employment-related claims.

Bona Vacantia property

P&O NZ Ltd sought a declaratory judgement that property disclaimed by a liquidator is bona vacantia. A settlement has been reached, which includes a Crown indemnity in favour of New Zealand Aluminium Smelters and Comalco in relation to aluminium dross disposed of in their landfill, for costs that may be incurred in removing the dross and disposing of it at another site if they are required to do so by an appropriate authority. The Minister of Finance signed the indemnity on 24 November 2003. In February 2004, a similar indemnity was signed in respect of aluminium dross currently stored at another site in Invercargill.

Building Industry Authority

The Building Industry Authority (BIA) is a joint defendant in a number of claims before the courts and the Weathertight Homes Resolution Service relating to the BIA's previous role as regulator of the building industry. The BIA has been disestablished and absorbed into the Department of Building and Housing and, to prevent conflicts of interest, Treasury was given responsibility for managing weathertight claims against the BIA on behalf of the Crown from 1 July 2005.

Contact Energy Limited

The Crown and Contact Energy signed a number of documents to settle in full Contact's outstanding land rights and geothermal asset rights at Wairakei. Those documents contained two reciprocal indemnities between the Crown and Contact to address the risk of certain losses to the respective parties' assets arising from the negligence or fault of the other party.

Earthquake Commission (EQC) 

The Crown is liable to meet any deficiency in the EQC's assets in meeting the Commission's financial liabilities (section 16 of the Earthquake Commission Act 1993). In the event of a major natural disaster the Crown may be called upon to meet any financial shortfall incurred by the Commission.

Electricity Corporation of New Zealand Limited (ECNZ) 

The ECNZ Sale and Purchase Agreement provides for compensation to ECNZ for any tax, levy, or royalty imposed on ECNZ for the use of water or geothermal energy for plants in existence or under construction at the date of the Sale and Purchase Agreement. The Agreement also provides for compensation for any net costs to ECNZ arising from resumption of assets pursuant to the Treaty of Waitangi (State Enterprises) Act 1988.

The Deed of Assumption and Release between ECNZ, Contact Energy Limited and the Crown provides that the Crown is no longer liable to ECNZ in respect of those assets transferred to it from ECNZ. As a result of the split of ECNZ in 1999, Ministers have transferred the benefits of the Deed to ECNZ's successors - Meridian Energy Limited, Mighty River Power Limited and Genesis Power Limited.

Under the Transpower New Zealand Limited (Transpower) Sale and Purchase and Debt Assumption Agreements, the Crown has indemnified ECNZ for any losses resulting from changes in tax rules applicable to transactions listed in the Agreements. Additionally, the Crown has indemnified the directors and officers of ECNZ for any liability they may incur in their personal capacities as a result of the Transpower separation process.

Following the split of ECNZ in 1999 into three new companies, the Crown has indemnified ECNZ in relation to all ECNZ's pre-split liabilities, including:

• existing debt and swap obligations
• hedge contracts and obligations
• any liabilities that arise out of the split itself.

Ministry of Fisheries - indemnity provided for delivery of registry services

The Crown has indemnified Commercial Fisheries Services Limited against claims made by third parties arising from Commercial Fisheries Services undertaking registry services under contract to the Chief Executive of the Ministry of Fisheries. This indemnity, provided under the Fisheries Acts 1983 and 1996, expires on 30 September 2010.

Genesis Power Ltd (Genesis Energy)

The Crown has entered into a deed with Genesis Energy to share a specified and limited amount of risk around the sufficiency of Genesis Energy's long term supply of gas to cover the Huntly e3p's (a 385 MW combined cycle gas turbine power station) minimum needs. The agreement sees the Crown compensate Genesis Energy in the event it has less gas than it needs.

Genesis Power Ltd (Genesis Energy) - Financial guarantees

The company issued financial guarantees to the alliance contractor and other agents of the Kupe joint venture for the full and faithful performance of it's subsidiaries in their capacities as joint venture partners, to the extent of their several liabilities under the development agreement.

The company issued a financial guarantee to Energy Clearing House Limited for the full and faithful performance of its subsidiary Energy Online Limited, to the extent of its liabilities for its retail electricity purchases.

These guarantees may give rise to liabilities in the company if the subsidiaries do not meet their obligations under the terms of the respective arrangements.

Genesis Power Ltd (Genesis Energy) - Letters of credit and performance bonds

The company, as a participant in the electricity market, issued letters of credit to the Energy Clearing House Limited under the markets' security requirements. These letters of credit are issued as part of normal trading conditions and are to ensure there is no significant credit risk exposure to any one market participant.

The company has also issued letters of credit and performance bonds to certain suppliers and services providers under normal trading conditions. The liabilities covered by these arrangements are already provided for in the statement of financial position, and therefore not expected to create any adverse effects on the financial results presented. These are not material to the financial statements.

Geothermal carbon tax indemnity 

As part of the sale and purchase agreement between the Crown and Mighty River Power (MRP), the Crown has agreed to provide an indemnity for the payment of carbon taxes, should legislation be passed that does not allow for an automatic pass-through of the charges to end-users. The indemnity is time bound and contractually limited in the amount that can be claimed. The indemnity is not limited to MRP and will be available to any subsequent owner of the Crown's Kawerau geothermal assets.

Housing New Zealand Corporation (HNZC) 

HNZC is liable to the owners (ANZ National Bank Limited, Ichthus Limited and Westpac Banking Corporation) of mortgages sold by HNZC during 1992 to 1999 for credit losses they may incur from specified limited aspects of their ownership of those mortgages with the Crown standing behind this obligation.

The Crown has provided a warranty in respect of title to the assets transferred to Housing New Zealand Limited (HNZL) (HNZL was incorporated into the HNZC group as a subsidiary in 2001 as part of a legislated consolidation of government housing functions) and has indemnified HNZL against any breach of this warranty. In addition, the Crown has indemnified HNZL against any third-party claims that are a result of acts or omissions prior to 1 November 1992. It has also indemnified the directors and officers of HNZL against any liability consequent upon the assets not complying with statutory requirements, provided it is taking steps to rectify any non-compliance.

Indemnities against acts of war and terrorism

The Crown has indemnified Air New Zealand against claims arising from acts of war and terrorism that cannot be met from insurance, up to a limit of US$1 billion in respect of any one claim.

Justices of the Peace, Community Magistrates and Disputes Tribunal Referees

Section 197 of the Summary Proceedings Act 1957, requires the Crown to indemnify Justices of the Peace and Community Magistrates against damages or costs awarded against them as a result of them exceeding their jurisdiction, provided a High Court Judge certifies that they have exceeded their jurisdiction in good faith and ought to be indemnified.

Section 58 of the Disputes Tribunal Act 1988 confers a similar indemnity on Disputes Tribunal Referees.

Landcorp Farming Ltd 

The Protected Land Agreement provides that the Crown will pay Landcorp any accumulated capital costs and accumulated losses or Landcorp will pay the Crown any accumulated profit, attributed to a Protected Land property that is required to be transferred to the Crown or that the Crown releases for sale. The Crown will also be liable to pay Landcorp, at the time of sale or transfer of any property deemed to be Protected Land, the amount of any outstanding equity payments on the Initial Value of the property.

Maui Partners 

The Crown has entered into confidentiality agreements with the Maui Partners in relation to the provision of gas reserves information. The deed contains an indemnity against any losses arising from a breach of the deed.

National Provident Fund

The National Provident Fund (NPF) has been indemnified for certain potential tax liabilities. Under the NPF Restructuring Act 1990, the Crown guarantees:

• the benefits payable by all NPF schemes (section 60)
• investments and interest thereon deposited with the NPF Board prior to 1 April 1991 (section 61)
• payment to certain NPF defined contribution schemes where application of the 4% minimum earnings rate causes any deficiency or increased deficiencies in reserves to arise (section 72).

A provision has been made in these financial statements in respect of the actuarially assessed deficit in the DBP Annuitants' Scheme (refer page 109).

New Zealand Railways Corporation 

The Crown has indemnified the directors of NZ Railways Corporation against any liability arising from the surrender of the licence and lease of the Auckland rail corridor. The liability expires in 2009.

The Crown has further indemnified the directors of NZ Railways Corporation against all liabilities in connection with the Corporation taking ownership and/or responsibility for the national rail network and any associated assets and liabilities on 1 September 2004. Section 10 of the Finance Act 1990 guarantees all loan and swap obligations of the New Zealand Railways Corporation.

Persons exercising investigating powers 

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

Public Trust

Section 52 of the Public Trust Act 2001 provides for the Crown to meet any deficiency in the Public Trust's Common Fund in meeting lawful claims on the Fund. This is a permanent (legislated) liability. On 7 November 2008 the Minister of Finance guaranteed interest payable on estates whose money constitutes the Common Fund.

Reserve Bank of New Zealand

Section 21(2) of the Reserve Bank of NZ Act 1989 requires the Crown to pay the Reserve Bank the amount of any exchange losses incurred by the Bank as a result of dealing in foreign exchange under Sections 17 and 18 of the Act. This is a permanent (legislated) liability.

Synfuels-Waitara Outfall Indemnity

As part of the 1990 sale of the Synfuels plant and operations to New Zealand Liquid Fuels Investment Limited (NZLFI), the Crown transferred to NZLFI the benefit and obligation of a Deed of Indemnity between the Crown and Borthwick-CWS Limited (and subsequent owners) in respect of the Waitara effluent transfer line which was laid across the Waitara meat processing plant site.

The Crown has the benefit of a counter indemnity from NZLFI which has since been transferred to Methanex Motunui Limited.

Tainui Corporation

Several leases of Tainui land at Huntly and Meremere have been transferred from ECNZ to Genesis Power. The Crown has provided guarantees to Tainui Corporation relating to Genesis Power's obligations under the lease agreements.

Other Unquantifiable Contingent Liabilities

Abuse Claims

There is ongoing legal action against the Crown in relation to historical abuse claims. At this stage the number of claimants and outcome of these cases are uncertain.

Accident Compensation Corporation (ACC) litigations

There are several legal actions against ACC in existence, arising in the main from challenges to operational decisions made by ACC. ACC will be vigorously defending these claims.

Air New Zealand litigation

Air New Zealand has been named in four class actions. One class action (in Australia) claims travel agents' commissions on fuel surcharges. Two class actions (one in Australia and the other in the United States) make allegations against more than 30 airlines, of anti competitive conduct in relation to pricing in the air cargo business. The allegations made in relation to the air cargo business are also the subject of investigations by regulators in a number of jurisdictions including the United States and the European Union. A formal Statement of Objections has been issued by the European Commission to 25 airlines including Air New Zealand and has been responded to. In the event that a court determined, or it was agreed with a regulator, that Air New Zealand had breached relevant laws, the Company would have potential liability for pecuniary penalties and to third party damages under the laws of the relevant jurisdictions. The fourth class action alleges (in the United States) that Air New Zealand together with 11 other airlines conspired in respect of fares and surcharges on trans-Pacific routes. All class actions are being defended.

Environmental liabilities

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

Departments managing significant Crown properties have implemented systems to identify, monitor and assess potential contaminated sites.

In accordance with NZ IAS 37: Provisions, Contingent Liabilities and Contingent Assets any contaminated sites for which costs can be reliably measured have been included in the statement of financial position as provisions.

Kordia Group Limited

As part of its contractual obligations with clients, Kordia Limited has an undertaking to provide services at a certain level and should this not be achieved, Kordia Limited may be liable for contract penalties. It is not possible to quantify what these may be until an event has occurred. The Company does not expect any liabilities to occur as a result of these contractual obligations.

The Company makes advances to its subsidiary companies. The Company's loan facility comprises a syndicated revolving cash advance facility between three banks, committed to a maximum amount of $136 million (2008: $150 million). The facility is supported by a negative pledge by the Company and its guaranteeing subsidiaries over their assets and undertakings. Under the negative pledge, each guaranteeing subsidiary may be liable for indebtedness incurred by the Company and other guaranteeing subsidiaries. The Company considers the negative pledge to be an insurance contract. Such contracts and cross guarantees are treated as a contingent liability and only recognised as a liability if a payment is probable.

Maui Contracts

Contracts in respect of which the Crown purchases gas from Maui Mining companies and sells gas downstream to Contract Energy Limited, Vector Gas Limited and Methanex Waitara Valley Limited provide for invoices to be re-opened in certain circumstances within two years of their issue date as a result of revisions to indices. These revisions may result in the Crown refunding monies or receiving monies from those parties.

Rugby World Cup 2011

The Crown has agreed in joint venture arrangements with the New Zealand Rugby Union to an uncapped underwrite of the costs of hosting the 2011 Rugby World Cup, on a loss sharing basis (Crown 67%, NZRU 33%). A provision for the forecast losses has been made in the Government's financial statements.

The Crown has agreed to reimburse New Zealand income tax that might be incurred by the joint venture entity (Rugby New Zealand 2011 Limited) or the NZRU in relation to the joint venture entity, and has also agreed to reimburse the NZRU for New Zealand withholding tax that might be incurred on certain payments made in relation to the tournament.

The Crown has further agreed to review its level of support to the tournament if the actual tax revenue arising from the tournament exceeds forecasts.

Television New Zealand

The Company is subject to a number of legal claims. Given the stage of proceedings and uncertainty as to outcomes of the cases, no estimate of the financial effect can be made and no provision for any potential liability has been made in the Financial Statements.

Treaty of Waitangi claims

Under the Treaty of Waitangi Act 1975, any Māori may lodge claims relating to land or actions counter to the principles of the Treaty with the Waitangi Tribunal. Where the Tribunal finds a claim is well founded, it may recommend to the Crown that action be taken to compensate those affected. The Tribunal can make recommendations that are binding on the Crown with respect to land which has been transferred by the Crown to an SOE or tertiary institution, or is subject to the Crown Forest Assets Act 1989.

Treaty of Waitangi claims - settlement relativity payments

The Deeds of Settlement negotiated with Waikato-Tainui and Ngai Tahu include a relativity mechanism. The mechanism provides that, where the total redress amount for all historical Treaty settlements exceeds $1 billion in 1994 present-value terms, the Crown is liable to make payments to maintain the real value of Ngai Tahu's and Waikato-Tainui's settlements as a proportion of all Treaty settlements. The agreed relativity proportions are 17% for Waikato-Tainui and approximately 16% for Ngai Tahu. The non-quantifiable contingent liability relates to the risk that total settlement redress, including binding recommendations from the Waitangi Tribunal, will trigger these relativity payments.

Westpac Banking Corporation

Under the Domestic Transaction Banking Services Master Agreement with Westpac Banking Corporation, dated 30 November 2004, the Crown has indemnified Westpac:

• In relation to letters of credit issued on behalf of the Crown.
• For costs and expenses incurred by reason of third party claims against Westpac relating to indirect instructions, direct debits, third party cheques, departmental credit card merchant agreements, use of online banking products and IRD processing arrangements.

Other contingencies

Foreshore and seabed

The Foreshore and Seabed Act 2004 (FSA):

• vests the full legal and beneficial ownership of the public foreshore and seabed in the Crown
• provides for the recognition and protection of ongoing customary rights with respect to the public foreshore and seabed
• enables applications to the High Court to investigate if previously held common law rights have been adversely impacted, and if so, providing for those affected either to participate in the administration of a foreshore and seabed reserve or else enter into formal discussions on redress, and
• provides for general rights of public access and recreation in, on, over, and across the public foreshore and seabed and general rights of navigation within the foreshore and seabed.

The public foreshore and seabed means the marine area that is bounded on the landward side by the line of mean high water spring; and on the seaward side by the outer limits of the territorial sea, but does not include land subject to a specified freehold interest (refer section 5 of the FSA).

The FSA codifies the nature of the Crown's ownership interest in the public foreshore and seabed on behalf of the public of New Zealand. Although full legal and beneficial ownership of the public foreshore and seabed has been vested in the Crown, there are significant limitations to the Crown's rights under the FSA. As well as recognising and protecting customary rights, the FSA significantly restricts the Crown's ability to alienate or dispose of any part of the public foreshore and seabed and significantly restricts the Crown's ability to exclude others from entering or engaging in recreational activities or navigating in, on or within the public foreshore and seabed. Because of the complex nature of the Crown's ownership interest in the public foreshore and seabed and because we are unable to obtain a reliable valuation of the Crown's interest, the public foreshore and seabed has not been recognised as an asset in these financial statements.

Contingent Assets

Contingent assets are potential assets dependent on a particular event occurring. As at 31 October 2009, the Crown held quantifiable contingent assets totalling $1,563 million ($1,582 million at 30 June 2009).

The major components being:

Inland Revenue - legal proceedings and disputes

Legal proceedings and disputes are contingent assets in relation to Inland Revenue pending assessments. Contingent assets arise where Inland Revenue has advised a taxpayer of a proposed adjustment to their tax assessment. There has been no amended assessment issued at this point or revenue recognised so these are recorded on page 79 as legal proceedings and disputes - non-assessed. The taxpayer has the right to dispute this adjustment and a disputes resolution process is entered into. Inland Revenue quantifies a contingent asset based on the likely outcome of the disputes process based on experience and similar prior cases.

A contingent asset of $1,171 million at 31 October 2009 ($1,191 million at 30 June 2009) has been disclosed in relation to use of money interest on the structured finance transactions discussed on page 79. The interest has been calculated based on the maximum amount which the taxpayers are due to pay to the department at that date. However some of these taxpayers may have money in the tax pooling account which they could transfer at an earlier date, thereby reducing the actual interest received.

Shortfall penalties that Inland Revenue may impose have not been quantified as they are too uncertain at this stage. These penalties would not meet the asset definition or recognition criteria due to the fundamental uncertainty as to what penalty would be applied and the value of the penalty that Inland Revenue would impose. Penalties would be recognised following a final court decision once all appeals are exhausted.

$1,488 million at 31 October 2009 ($1,502 million at 30 June 2009)

Ministry of Education - suspensory loans

Suspensory loans issued by the Minister of Education to integrated schools.

$69 million at 31 October ($74 million at 30 June 2009)

3 - 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 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 25 November 2009.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined on pages 93 to 117.

Statement of Accounting Policies and Forecast Assumptions#

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Significant Accounting Policies

These Forecast Financial Statements have been prepared in accordance with the accounting policies that are expected to be used in the comparable audited actual Financial Statements of the Government.

These Forecast Financial Statements comply with generally accepted accounting practice (GAAP) as required by the Public Finance Act 1989 and have been prepared in accordance with New Zealand equivalents to International Financial Reporting Standards (NZ IFRS), as appropriate for public benefit entities.

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).

Changes in Accounting Policies

All policies have been applied on a consistent basis during the forecast period. There have been no changes in accounting policies during the period.

Forecast Policies

These Forecast Financial Statements have been prepared on the basis of Treasury's best professional judgment. Key assumptions used are set out on pages 44 to 49.

For the purposes of the Forecast Financial Statements, no revaluations of property, plant and equipment are projected beyond the current year.

Detailed Accounting Policies and Forecast Assumptions

The specific accounting and forecasting policies are reproduced in full on Treasury's website at http://www.treasury.govt.nz/publications/guidance/instructions/2009.

Government Reporting Entity as at 25 November 2009#

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These forecast financial statements are for the Government reporting entity as specified in Part III of the Public Finance Act 1989. This comprises Ministers of the Crown and the following entities:

Departments

Agriculture and Forestry
Archives New Zealand
Building and Housing
Conservation
Corrections
Crown Law Office
Culture and Heritage
Defence
Economic Development
Education
Education Review Office
Environment
Fisheries
Foreign Affairs and Trade
Government Communications Security Bureau
Health
Inland Revenue
Internal Affairs
Justice
Labour
Land Information New Zealand
Māori Development
National Library of New Zealand
New Zealand Customs Service
New Zealand Defence Force
New Zealand Food Safety Authority
New Zealand Police
New Zealand Security Intelligence Service
Office of the Clerk
Pacific Island Affairs
Parliamentary Counsel Office
Parliamentary Service
Prime Minister and Cabinet
Research, Science and Technology
Serious Fraud Office
Social Development
State Services Commission
Statistics
Transport
Treasury
Women's Affairs

State-owned enterprises

Airways Corporation of New Zealand Limited
Animal Control Products Limited
AsureQuality Limited
Electricity Corporation of New Zealand Limited
Genesis Power Limited
Kordia Group Limited
Landcorp Farming Limited
Learning Media Limited
Meridian Energy Limited
Meteorological Service of New Zealand Limited
Mighty River Power Limited
New Zealand Post Limited
New Zealand Railways Corporation*
Quotable Value Limited
Solid Energy New Zealand Limited
Terralink Limited (in liquidation)
Timberlands West Coast Limited
Transpower New Zealand Limited

Air New Zealand Limited (included for disclosure purposes as if it were an SOE)

(* KiwiRail Holdings was acquired on 1 July 2008 and in turn was transferred to New Zealand Railways Corporation on 1 October 2008 as its operating unit)

Others

New Zealand Superannuation Fund
Reserve Bank of New Zealand

Offices of Parliament

Office of the Controller and Auditor-General
Office of the Ombudsmen
Parliamentary Commissioner for the Environment

Organisations named or described in Schedule 4 of the Public Finance Act 1989

Agriculture and Marketing Research and Development Trust
Asia New Zealand Foundation
Auckland Transition Agency
Fish and game councils (12)
Leadership Development Centre Trust
National Pacific Radio Trust
New Zealand Fish and Game Council
New Zealand Game Bird Habitat Trust Board
New Zealand Government Property Corporation
New Zealand Lottery Grants Board
Ngāi Tahu Ancillary Claims Trust
Pacific Co-operation Foundation
Pacific Island Business Development Trust
Research and Education Advanced Network New Zealand Limited
Reserves boards (24)
Road Safety Trust
Sentencing Council
The Māori Trustee

Crown entities

Accident Compensation Corporation
Accounting Standards Review Board
Alcohol Advisory Council of New Zealand
Arts Council of New Zealand Toi Aotearoa
Broadcasting Commission
Broadcasting Standards Authority
Career Services
Charities Commission
Children's Commissioner
Civil Aviation Authority of New Zealand
Commerce Commission
Crown Health Financing Agency
Crown research institutes (8)
District health boards (21)
Drug Free Sport New Zealand
Earthquake Commission
Electoral Commission
Electricity Commission
Energy Efficiency and Conservation Authority
Environmental Risk Management Authority
Families Commission
Foundation for Research, Science and Technology
Government Superannuation Fund Authority
Guardians of New Zealand Superannuation
Health and Disability Commissioner
Health Research Council of New Zealand
Health Sponsorship Council
Housing New Zealand Corporation
Human Rights Commission
Independent Police Conduct Authority
Law Commission
Legal Services Agency
Maritime New Zealand
Mental Health Commission
Museum of New Zealand Te Papa Tongarewa Board
New Zealand Antarctic Institute
New Zealand Artificial Limb Board
New Zealand Blood Service
New Zealand Film Commission
New Zealand Fire Service Commission
New Zealand Historic Places Trust (Pouhere Taonga)
New Zealand Lotteries Commission
New Zealand Qualifications Authority
New Zealand Symphony Orchestra
New Zealand Teachers Council
New Zealand Tourism Board
New Zealand Trade and Enterprise
New Zealand Transport Agency
New Zealand Venture Investment Fund Limited
New Zealand Walking Access Commission
Office of Film and Literature Classification
Pharmaceutical Management Agency
Privacy Commissioner
Public Trust
Radio New Zealand Limited
Real Estate Agents Authority
Retirement Commissioner
School boards of trustees (2,454)
Securities Commission
Social Workers Registration Board
Sport and Recreation New Zealand
Standards Council
Takeovers Panel
Te Reo Whakapuaki Irirangi (Te Māngai Pāho)
Te Taura Whiri i te Reo Māori (Māori Language Commission)
Television New Zealand Limited
Tertiary Education Commission
Tertiary education institutions (31)
Testing Laboratory Registration Council
Transport Accident Investigation Commission

Crown entity subsidiaries are consolidated by their parents and not listed separately in this table

Forecast Statement of Financial Performance for the years ending 30 June

The accompanying Notes and Accounting policies are an integral part of these Statements.

Forecast Statement of Financial Performance - Functional Expense Analysis for the years ending 30 June

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

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 Net issues of Government stock include movements in the government stock holdings of entities such as NZS Fund, ACC and EQC. Further information on the proceeds and repayments of Government stock ("domestic bonds") is available in note 22.

The accompanying Notes and Accounting policies are an integral part of these Statements.

The accompanying Notes and Accounting policies are an integral part of these Statements.

Forecast Statement of Comprehensive Income for the years ending 30 June

This statement reports changes in net worth due to the operating balance, items of income or expense that are recognised directly in net worth, the effect of certain accounting changes and corrections of errors.

The accompanying Notes and Accounting policies are an integral part of these Statements.

Forecast Statement of Financial Position as at 30 June

¹ Tertiary education institutions constitute most equity accounted investments.

The accompanying Notes and Accounting policies are an integral part of these Statements.

Forecast Statement of Borrowings as at 30 June

Notes on Borrowings

Total Borrowings can be split into sovereign-guaranteed and non-sovereign-guaranteed debt. This split reflects the fact that borrowings by State-owned enterprises and Crown entities are not explicitly guaranteed by the Crown. Sovereign-guaranteed debt excludes Kiwibank deposits guaranteed under the retail deposit guarantee scheme. No other debt of State-owned enterprises and Crown entities is currently guaranteed by the Crown.

1. Core Crown borrowings in this instance includes 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 Government stock held by the New Zealand Superannuation Fund (NZS Fund), ACC and EQC.

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 credit-worthiness 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 NZ Debt Management Office borrowing. Therefore, the impact of settlement cash on GSID is adjusted by this amount.

The accompanying Notes and Accounting policies are an integral part of these Statements.

Statement of Actual Commitments as at 31 October 2009

Statement of Actual Contingent Liabilities and Assets as at 31 October 2009

The accompanying Notes and Accounting policies are an integral part of these Statements.

More information on contingent liabilities (quantified and unquantified) is outlined on pages 74 to 88 of the Fiscal Risks chapter.

Notes to the Forecast Financial Statements#

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1. Customs excise-equivalent duty.

Forecast new spending up to Budget 10 represents the unallocated allowance from Budget 2009.

Forecast for future new spending indicates expected spending increases that will be introduced in future budgets.

Analysis of Provision for Kyoto

1. A full copy of the Net Position Report 2009 can be found on the Ministry for the Environment's website: www.mfe.govt.nz

ACC liability

Calculation information

PricewaterhouseCoopers Actuarial Pty Ltd have prepared an independent actuarial estimate of the ACC outstanding claims liability as at 30 June 2009. 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 estimate has been updated as at 30 September 2009 to reflect material changes to those expected future payments identified since 30 June 2009.

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 of 5.79% (5.86% at 30 June 2009). Other key variables in each valuation are the forecast increases in claim costs over and above the economic variables above, and the assumed rate at which long-term claimants will leave the scheme over the period. This assessment is largely based on scheme history.

Presentation approach

The projected outstanding claims liability is included within total liabilities. ACC has available to it a portfolio of assets that partially offset the claims liability. The assets (less cross holdings of NZ Government stock) are included in the asset portion of the Crown's overall Statement of Financial Position.

The fiscal forecasts include indicative amounts for the likely impact of increases in ACC levy rates now before parliament.

The net liability of the Government Superannuation Fund (the Fund) liabilities have been calculated by the Government Actuary as at 31 October 2009. These liabilities arise 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 is used to calculate the liabilities as at 31 October 2009, based on membership data as at that date. The funding method requires the benefits payable from the Fund in respect of past service to be calculated and then discounted back to the valuation date.

The Fund liabilities at this valuation were calculated using discount rates derived from the market yield curve as at the balance date and then blended to the long-term pre-tax discount rate of 6.00% (unchanged from 30 June 2009). Other principal long-term financial assumptions were an inflation rate, as measured by the increase in the Consumer Price Index, of 2.25% reducing to 2% over the five years to 2025 (unchanged from 30 June 2009) and an annual salary growth rate, before any promotional effects, of 3.0% (unchanged from 30 June 2009).

The 2009/10 projected movement in the net liability is $72 million, reflecting an increase in the GSF liability of $110 million and an increase in the GSF assets of $182 million.

The unfunded liability increased in the four months to 31 October 2009 by $101 million. This was principally due to the change in the financial assumptions (a loss of $236 million) offset by investment performance ($161 million).

The changes in the projected GSF net liability from 2010/11 onwards reflect the net of the expected current service cost, interest cost, investment returns and contributions.

GSF net defined benefit retirement liability

Provision for ETS credits

The Emissions Trading Scheme (ETS) was established to encourage reduction in greenhouse gas emissions. The ETS creates a limited number of tradable units (the NZ Unit) which the Government can allocate freely or sell to entities. The allocation of NZ Units creates a provision (and an expense if allocated for free). The provision is reduced, and revenue recognised, as NZ Units are surrendered to the Crown by emitters. Emitters can also use international Kyoto units to settle their emission obligation, which will occur where emissions exceed the number of allocated NZ units.

The ETS impact on the fiscal forecast is as follows:

Forecast Statement of Segments#

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