Half Year Economic and Fiscal Update 2010

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 22 November 2010 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

6 December 2010

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 22 November 2010 of which I was aware and that had material economic or fiscal implications.

Hon Bill English
Minister of Finance

6 December 2010

Economic and Fiscal Update#

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Overview#

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Economic outlook

Growth has been weaker than forecast at Budget and activity is anticipated to have lifted only gradually over the second half of 2010. The economic recovery is expected to continue to be gradual, with growth weighed down by subdued domestic demand. Temporary factors and events are expected to lift growth to 3.4% in the March 2012 year, but the current expansion is forecast to be weaker than recent recoveries, with growth expected to be slightly under 3% beyond 2012.

The outlook is characterised by muted growth in private consumption as households are expected to remain cautious in their spending and investment decisions. Business investment is forecast to increase from current levels, boosted by the earthquake recovery and a degree of catch-up by firms. Even so, the forecast recovery is weaker than what would typically have been expected following the sharp contraction that occurred during the recent recession. Government spending is also expected to be restrained, reflecting difficult fiscal circumstances.

Goods exports have been stronger than forecast at Budget 2010, reflecting increased demand for commodities such as dairy and meat. Strong demand has also been reflected in elevated prices for these goods. While this helps to partially offset the weaker outlook for domestic demand than at Budget 2010, the export response is expected to be gradual, constrained by the high exchange rate and the pace at which commodity production can increase. As a result, economic growth is forecast to continue, but at a slower rate than anticipated earlier this year.

The current account deficit is expected to widen as import demand increases and rising firm profitability sees greater income accruing to overseas owners of New Zealand firms. However, the current account deficit is not expected to widen to the same degree as in Budget 2010, contributing to a lower level of external indebtedness than at Budget 2010.

Slightly weaker real activity and lower prices for consumer goods and services than anticipated earlier in the year contribute to nominal Gross Domestic Product (GDP) being lower over the coming five years than was expected at Budget 2010.

Short-term uncertainties include the impact of the Canterbury earthquake, adverse weather conditions as well as the recently implemented tax reforms. In such an environment, households and businesses may exercise considerably more caution than is anticipated in the main forecasts.

The global economy remains a major source of uncertainty and risk. The recovery from the global financial crisis (GFC) remains fragile, with the current turmoil in Europe being one source of downside risk. On the other hand, New Zealand's exposure to fast-growing developing markets and the Australian economy means that the risks associated with developments in our trading partners are not all negative. These risks in relation to the international outlook are explored as alternative scenarios.

Fiscal outlook

The fiscal position has weakened significantly since 2008, with tax revenues falling as the economy contracted and income tax cuts taking effect. Core Crown expenditure has increased primarily owing to past policy decisions; for example, KiwiSaver and Working for Families, and the indexation of benefits. Operating deficits continue to widen in the current year reflecting one-off expenditure such as that associated with the Canterbury earthquake and the Weathertight homes scheme, as well as weaker tax growth stemming from the slower economic recovery. An operating deficit (before gains and losses) of 5.5% of GDP is expected in the current fiscal year.

The deficit then narrows as the economy recovers and slower growth in expenditure is expected. The operating balance (before gains and losses) is forecast to break even in the June 2015 year, with the first surplus of note projected for the June 2016 year.

A sustained period of cash deficits is expected, with net debt forecast to double from 14.1% of GDP in June 2010 to 28.5% of GDP by June 2015. Net debt is then projected to return to the Government's long-run target of 20% of GDP in June 2022, in line with Budget 2010 projections.

Notes:

1 Real production GDP, annual average percentage change

2 Consumers Price Index (CPI), annual percentage change

3 Percent of labour force, March quarter, seasonally adjusted

4 Total Crown operating balance before gains and losses

5 Net core Crown debt excluding the New Zealand Superannuation Fund and advances

6 Total Crown net worth

Sources: Statistics New Zealand, the Treasury

Main forecasts#

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The economic expansion is expected to be more gradual compared to previous upturns…

Figure 1.1 - Real production GDP per capita

Sources: Statistics New Zealand, the Treasury

The New Zealand economy contracted over 2008 and early 2009, with output falling 3.5% from peak to trough. While the economy has been recovering since June 2009, GDP remains 1.5% below the pre-recession level. The fall in output per person was even larger at 4.9% and per capita output is not expected to return to its pre-recessionary peak until June 2012, significantly later than in the two previous recessions (Figure 1.1).

…characterised by modest household spending…

Figure 1.2 - Private consumption

Sources:  Statistics New Zealand, the Treasury

Household spending is expected to move in line with incomes, with real growth averaging just 2.4% per year and both real and nominal measures declining as a share of the economy (Figure 1.2). The outlook is forecast to be subdued when contrasted with spending last decade, some of which was financed through increased borrowing. High demand for imported goods and services, coupled with increased debt-servicing costs on a large stock of debt, saw the current account deficit lift to reach nearly 9% of GDP at the end of 2008, a manifestation of imbalances in the economy.

…with less reliance on borrowing…

Household credit growth has eased considerably since the onset of the 2008/09 recession and is expected to remain weak as borrowers continue to be averse to taking on more debt. While nominal house prices have fallen 5% since their peak at the end of 2007, they remain elevated relative to disposable income. House prices are expected to increase only gradually over the next five years, while falling in real terms through to 2013 as inflation exceeds nominal house price growth. With housing accounting for the majority of household wealth, borrowers will remain reticent about funding consumption out of wealth.

…and a stronger relationship with incomes

As householdwealth is expected to provide little support, developments in the labour market become the key driver of private consumption over the medium term. With changes in the job market lagging economic developments, the continued economic recovery is anticipated to translate into modest employment growth, with one-off factors, including the Rugby World Cup, driving stronger growth over the 2011 calendar year. Wage growth appears to have troughed and is expected to lift, supporting consumer spending, although rising inflation and interest rates will provide significant offsets.

Imports of goods and services are expected to rise in coming years, in line with the recovery in domestic demand, and are boosted significantly in the March 2012 year from the purchase of goods and materials owing to the rebuild following the Canterbury earthquake. A forecast depreciation of the New Zealand dollar is expected to limit import demand, particularly from the March 2012 year, as imported goods become more expensive.

Residential investment lifts owing to earthquake recovery and population growth

Residential investment is forecast to lift strongly in the March 2011 and 2012 years, with some of the increase accounted for by the rebuild following the Canterbury earthquake (see the box on the impacts of the earthquake on pages 22 and 23). Despite a theme of household consolidation and increasing interest rates, population growth and catch-up from recent low rates of investment support housing investment over the medium term.

Goods and Services Tax (GST) is collected on many of the components of consumption, and residential investment. A more subdued household sector than expected earlier in the year contributes to slower GST revenue growth relative to Budget 2010. However, the 1 October lift in the GST rate from 12.5% to 15.0% contributes to the amount of GST collected increasing sharply from its 2010 level.

Businesses have been deleveraging…

Business borrowing from banks has contracted sharply in recent times, with Reserve Bank of New Zealand (RBNZ) data showing a decline of $5 billion (6.6%) in the level of business credit in October 2010 compared with a year earlier. The decline in business borrowing is likely driven by a combination of some businesses strengthening their balance sheets by paying off debt, others postponing or cancelling investment in plant and machinery in response to uncertainty around the strength of the economic recovery, and a degree of conservatism among lenders. Some of the fall in business credit can also be put down to large corporates obtaining alternative funding by accessing capital markets.

…and are expected to remain cautious as the recovery progresses

Market investment experienced large falls during the recent recession, falling 22% between June 2008 and March 2010. Market investment is expected to pick up in the near term, driven by post-earthquake activity, a high exchange rate keeping prices low, improved profitability and necessary replacement investment following deferral over the past two years. Despite the boost to construction following earthquake-related repairs, market investment growth remains weaker than typically expected following such a large fall.

Table 1.2 - Economic forecasts¹

Notes:

1 Forecasts finalised 5 November 2010

2 Contribution to GDP growth

3 Estimated as the percentage point 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 124.

Sources: Statistics New Zealand, RBNZ, the Treasury

Growing profits to boost business tax but past losses will dampen tax growth

Recent tax outturns and talks with firms around New Zealand point to weaker business profits than assumed at Budget 2010. Provisional tax payments have also been lower than expected earlier in the year, as economic conditions have been softer than anticipated by corporates and other businesses.

Tax losses accumulated during the recent recession may now be playing a part in restraining business income tax growth. Based on currently-available data, gross losses incurred by all companies reached more than $18 billion in the 2009 tax year, an increase of more than 30% on the previous year. This pushed the stock of tax losses up to about twice its level after the recession of the late 1990s. These losses will be progressively offset against profits in future tax years, thereby reducing business income tax revenue. The forecasts include an assumption that loss usage will be at an elevated level for the next few years, reducing business income tax revenue by around $350 million each year, compared to what would have been the case in the absence of the recent loss build-up. The level of loss utilisation is anticipated to fall back to a more normal level in the June 2015 year.

These factors result in forecasts for total business tax to increase from $10.3 billion in the June 2011 year to $13.4 billion in the June 2015 year, although over the four years to June 2014 business income tax is forecast to be a cumulative $2.6 billion lower than forecast at Budget 2010.

Government spending to account for a smaller share of the economy

As was the case at Budget 2010, government consumption is expected to continue to play less of a role in the economy, based on lower levels of new spending than occurred over the middle of this decade. The operating allowance for new spending adds $1.12 billion to government expenses in the June 2012 year, and is forecast to grow at 2% per annum thereafter. This represents significantly slower growth than occurred over the 2004 to 2008 period when new operating spending (excluding revenue initiatives) ranged between $2 billion and $3.5 billion per annum.

Developments in Asia are increasingly important for export growth

Figure 1.3 - World growth rate comparisons

Sources: International Monetary Fund (IMF), the Treasury

New Zealand is expected to continue to benefit from strong growth in emerging Asia, especially China, which expanded rapidly over the first three quarters of 2010. Although growth is expected to ease in the near term, the region is set to continue to outperform advanced economies. The economies of New Zealand's top 16 trading partners are assumed to grow by 4.5% in 2010, before easing back to just under 4% on average through to 2015 (Figure 1.3).

Strength in Asia has also had significant benefits for our largest single trading partner, with Australia being the strongest performing advanced economy over the past two years. While the outlook for other advanced economies is less optimistic, the weight of New Zealand's trading partners (based on export shares) is expected to continue to shift towards Asia, providing fundamental support for goods and services exports over the medium term (see the box on page 34 on New Zealand's economic and fiscal outlook in an international context).

Higher demand is putting upward pressure on prices for our key commodities…

The value of exported goods increased over the first half of 2010, aided by the ongoing recovery in China and Australia. Higher demand has led to a broad-based lift in prices for New Zealand's main commodities, with the ANZ commodity price index at a record high in world price terms in November. High commodity prices are positive overall for New Zealand and help drive the merchandise terms of trade. It is anticipated that the terms of trade will remain elevated over the medium term, as demand for soft commodity goods grows, in line with developments in emerging Asia, particularly China, which include strong income growth and urbanisation.

…but the elevated exchange rate is limiting exports in other industries

Figure 1.4 - TWI and bilateral exchange rates

Sources: RBNZ, the Treasury

Note: The long-run average applies from the March 1999 to September 2010 quarters for the Euro and the 20 years to September 2010 for all other rates. Budget 2010 forecasts finalised 16 April 2010.

Past recoveries have been characterised by a low exchange rate providing support for the export sector. Although the Trade Weighted Index (TWI) fell sharply through late 2008 and early 2009, it bounced back strongly as the outlook for the global economy improved over 2009 and is currently around the same level as it was prior to the recession and high by historical standards (Figure 1.4). Although strong commodity prices are providing a buffer and the Rugby World Cup is expected to boost services exports next year, the level of the exchange rate is limiting the contribution of exports to the economic recovery. The exchange rate is forecast to remain elevated in the near term, reflecting current market forces, before falling owing to fundamentals, such as New Zealand's high level of international indebtedness and a recovering global economy.

Annual current account deficit to widen, but not to previous levels

Several factors led to the annual current account deficit falling sharply earlier this year: exports suffered less of a fall than imports during the recession; low interest rates led to a fall in net interest payments offshore; and net profits accruing to overseas-owned firms declined. The latter partly arose from the structured finance cases brought against the major banks by the Commissioner of Inland Revenue.

Earthquake-related reinsurance inflows are expected to help drive the current account deficit below 2% of GDP in 2011, before the deficit peaks at 6.8% of GDP in 2013 as interest payments and profits accruing to overseas-owned firms lift in line with rising interest rates and the economic recovery respectively. The annual current account deficit falls to 5.8% of GDP by March 2015, as the falling exchange rate dampens import growth, while export growth remains steady. Compared with Budget 2010, the current account deficit is smaller throughout the forecasts, and it peaks earlier and lower, reflecting a higher degree of household consolidation.

Figure 1.5 - Net international investment position

Sources:  Statistics New Zealand, the Treasury

In these forecasts, net international liabilities fall as a proportion of GDP in the near term. However, current account deficits are still expected to grow more quickly than the nominal economy beyond 2011, lifting net international liabilities to just over 90% of GDP by 2015. This is still significantly lower than what was expected at Budget 2010 (Figure 1.5). Data revisions play a role in this, along with smaller current account deficits, discussed above.

Economic activity is forecast to remain below potential over the next five years…

Potential output is the highest level of output that can be sustained without generating excess inflation over the medium term and is a function of the capital stock, labour inputs and productivity. The expected recovery in business investment, continued population growth, together with labour productivity, which is forecast to grow at average levels of around 1.5% over the medium term, contribute to potential output growing on average by 2.5% per annum. Growth in potential output is estimated to have eased back from what was expected prior to the 2008/09 recession, largely accounted for by a marked fall in capital investment over the past two years, and partly owing to a reassessment of the level of potential output before the recession. Over the next five years, actual output growth is expected to exceed growth in potential output. Consequently, the gap between the two measures narrows gradually and is approximately closed by 2015.

…keeping a lid on underlying inflation pressures

Given the negative output gap, underlying non-tradables inflation (excluding the effects of government policy) remains well contained as policy changes are assumed not to have lifted inflation expectations materially. Nevertheless, with spare capacity in the economy gradually diminishing, interest rates rise gradually from mid-2011 to achieve an inflation track that returns to the middle of the 1% to 3% policy target band during 2014. Lower-than-average non-tradables inflation helps offset a slightly higher track for tradables inflation resulting from the falling exchange rate.

Figure 1.6 - CPI and CPI ex cigarettes, tobacco, GST

Sources:  Statistics New Zealand, the Treasury

Increases in GST, other government charges and excises should see the headline rate of annual inflation spike to 5% in June 2011 (Figure 1.6). The significant lifts in cigarette and tobacco excise rates have reduced, and will continue to reduce, the amount of product purchased. As a result, the impact on the typical consumer of higher prices is likely to be lower than that implied by increases in the CPI, which uses fixed weights.

Weaker growth in nominal GDP results in lower tax revenue than at Budget

Nominal GDP is expected to grow from $189 billion in the June 2010 year to nearly $248 billion in June 2015. However, weaker domestic prices and lower real activity relative to that forecast in Budget 2010 result in nominal GDP being a cumulative $5.2 billion lower than in Budget 2010 over the four years to June 2014. Tax revenue is expected to be a cumulative $3.2 billon lower, with weaker nominal GDP accounting for around two-thirds of the change since Budget 2010. The remainder of the difference is explained by changes in the assumed magnitude of the tax loss cycle over the next four years and re-estimation of the average effective tax rate of the various major tax types relative to their notional underlying economic drivers, such as employees' compensation, private consumption and residential investment.

Source: The Treasury

In line with established practice, Inland Revenue has also prepared a set of tax forecasts, which is also based on the Treasury's macroeconomic forecasts. The two sets of forecasts differ because of the different modelling approaches used by the two agencies and the various assumptions and judgements made by the forecasting teams in producing their forecasts.

In total, the Treasury's forecast is lower than Inland Revenue's in June 2011, mainly owing to differing views on the likely level of GST refunds and the implications of the current level of provisional tax. From June 2012 onwards, the Treasury's forecasts are higher than Inland Revenue's as the Treasury has a larger pro-cyclical response to the economic recovery built into its tax forecasts than does Inland Revenue. The aggregate differences between the two sets of forecasts are not large and reach just over 1% of total tax by June 2015.[3]

Fiscal outlook

Notes:

1 Net core Crown debt excluding the New Zealand Superannuation Fund and advances

2 Gross sovereign-issued debt excluding Reserve Bank bills and settlement cash

A glossary and longer time series for these and other indicators are provided on page123

Source: The Treasury

Core Crown revenue grows slowly as taxes respond to the subdued recovery…

Figure 1.7 - Core Crown expenses and revenue

Source:  The Treasury

Core Crown revenue is forecast to increase from $56.2 billion in the June 2010 year (29.7% of GDP) to $76.6 billion in the June 2015 year (30.9% of GDP). Higher tax revenue is expected to be the main source of growth, owing to:

• growth in nominal GDP
• fiscal drag, which is the result of an individual's average tax rate increasing as their income rises
• an assumed run-down of tax losses accumulated during the recession, and
• forecast deposit interest rate rises and growth in the amount of money on deposit over the next four years lead to an expected increase in interest withholding tax.

As discussed earlier, tax revenue is expected to be a cumulative $3.2 billon lower than expected at Budget 2010. This lower tax revenue is a key driver behind more-negative operating and cash deficits compared to Budget 2010.

…and core Crown expenses increase but fall as a share of the economy

Core Crown expenses are forecast to rise from $64.0 billion in the June 2010 year (33.8% of GDP) to $78.6 billion in the June 2015 year (31.7% of GDP), which is a similar trend to the Budget 2010 forecast. Key factors behind the rising profile are increases in benefit expenses, finance costs and forecast new spending through the operating allowance.

• Benefit expenses are forecast to increase from $22.4 billion in the June 2011 year to $25.7 billion in the June 2015 year. This increase is mainly owing to the indexation of social assistance benefits, which increases expenses by around $2.1 billion, and growth in New Zealand Superannuation (NZS) recipient numbers of around 20,000 per annum, adding an extra $1.4 billion over the next four years.
• Finance costs are forecast to increase from $2.3 billion in the June 2010 year to $4.9 billion in the June 2015 year owing to the flow-on impact to debt servicing costs from recent and forecast increases in debt.
• The operating allowance for new spending adds $1.12 billion to expenses in the June 2012 year (ie, the original $1.1 billion increased by 2%). The operating allowance grows at 2% per annum thereafter, adding a further $4.8 billion by the June 2015 year.

Although expenses rise in absolute terms, as a share of the economy they decline from 2011, in part owing to a pick-up in nominal GDP, but also as a result of:

• the decision to manage within smaller operating allowances for new spending
• Emissions Trading Scheme (ETS), related expenses are expected to decline, and
• no further expenditure being expected in relation to the Weathertight homes scheme as it is a one-off expenditure item in 2011.

As a result, expenses grow more slowly than the economy and the gap between expenses and revenue as a percentage of GDP narrows considerably.

The operating balance deficit peaks in the June 2011 year…

Source: The Treasury

The operating balance (before gains and losses) deficit is forecast to peak at $11.1 billion in the June 2011 year (Table 1.5). Although tax revenue is forecast to increase compared to the June 2010 year, the growth in tax revenue in 2011 is somewhat subdued owing to the slow nature of the economic recovery. The key factors driving the deterioration in the operating balance since June 2010 are:

• one-off expenditure including costs in relation to the Canterbury earthquake and the Weathertight homes scheme
• the impact of previous policy decisions such as the Budget 2010 tax package and introduction of the ETS
• increasing debt levels leading to higher debt financing costs, and
• demographic changes driving an increase in eligibility for NZS benefit payments.

…but breaks even in the June 2015 year

Figure 1.8 - Total Crown operating balance before gains and losses

Source:  The Treasury

After peaking in the June 2011 year, the operating deficit narrows and is expected to return to a break-even point by June 2015 (Figure 1.8). The first surplus of note is projected to be recorded by June 2016 (see Medium-term projections on page 36).

The total Crown operating balance (including gains and losses) is also in deficit in the June 2011 year and returns to surplus by the June 2014 year. The deficit is forecast to be smaller than the operating balance before gains and losses because Crown financial institutions such as the NZS Fund are expected to make gains, on average, over the next five years.

Figure 1.9 - Cyclically-adjusted operating balance

Source: The Treasury

The underlying nature of these operating deficits can be measured by the cyclically-adjusted, or structural, operating balance, which gauges how much of the operating balance before gains and losses reflects temporary cyclical factors rather than long-lasting factors. The operating deficit is largely structural, evidenced by a cyclically-adjusted deficit of 5.2% of GDP in the June 2011 year. Beyond 2011, a gradual improvement in the structural position is expected, such that a cyclically-adjusted surplus of 0.2% of GDP is forecast in the June 2015 year.[4]

Figure 1.10 - Net core Crown debt

Source:  The Treasury

Cash deficits are met by increased borrowing

Residual cash deficits are forecast to continue over the next five years. The trend is similar to that for operating deficits, peaking in the June 2011 year at $15.6 billion before reducing to $4.9 billion in the June 2015 year. Overall, cash deficits total $44.4 billion over the next five years.

Cash deficits represent the amount the Government has to fund, either by raising debt or reducing financial assets. Cash deficits are expected to raise net core Crown debt from $26.7 billion (14.1% of GDP) in the June 2010 year to $70.5 billion (28.5% of GDP) by the June 2015 year. Net debt is forecast to peak in the June 2015 year (Figure 1.10).

Source: The Treasury

The expected cash shortfall is forecast to be met by additional borrowing and the utilisation of financial assets held by NZDMO. The majority of the borrowing requirement will be met through bond issuance in the New Zealand domestic market (Table 1.7). Issuance totals $59.7 billion over the next five years. After meeting debt maturities, net bond issuance totals $31.8 billion. On a comparable period basis (ie, June 2011 to June 2014), forecast net bond issuance to the market has increased by $8.5 billion relative to the Budget 2010 forecast. This reflects an increase in the forecast cash deficit and an assumption that the June 2014 borrowing programme now includes some pre-funding of the June 2015 bond maturity. It also reflects the forecast for EQC's redemption of a portion of its government securities, which affects the market issuance of bonds; however, there is no effect on the overall debt position of the Crown.

The current June 2011 government bond programme has been increased by $1 billion to $13.5 billion ($14 billion net cash proceeds). Having already completed over half of the original $12.5 billion programme following strong demand for New Zealand government bonds, the increase provides flexibility for continued regular nominal bond issuance should market conditions remain favourable and given the potential issuance of an inflation-indexed bond.

Source: The Treasury

Net worth declines because of continued operating deficits, then rises by June 2015

Net worth is forecast to fall from $95 billion (50.2% of GDP) in June 2010 to $79.5 billion (35.3% of GDP) in June 2013 and then rise to $83.1 billion (33.6% of GDP) by June 2015. Although net worth declines, the Government is still expected to increase total assets from $223.4 billion in June 2010 to $256.3 billion by June 2015.

1 Further breakdown is provided in note 14 of the forecast financial statements.

Source: The Treasury

Although total assets are expected to increase by around $32.9 billion, the overall level of capital investment is expected to be double this figure. The key areas of investment include:

• the purchase of around $36.1 billion of physical assets over the next five years, primarily in the areas of transport, energy, education, health and defence
• Accident Compensation Corporation (ACC) and NZS Fund reinvesting returns in financial assets of $15.6 billion and $7 billion respectively
• an expected issuance of student loans of $7.9 billion, and
• funding for future capital investments over the next five years of $3.9 billion.

This investment in assets will be offset by $20.5 billion of expected depreciation and an anticipated reduction in financial assets held by the RBNZ and NZDMO.

Medium-term projections#

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Projections cover the period 2016 to 2025...

This section takes the main forecasts covering the period through to June 2015 in the previous section and projects them forward to June 2025. 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 outlined on pages 45-49.

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.

Labour productivity growth is projected to continue to increase before stabilising at 1.5% per annum from June 2017. Annual labour force growth declines to 0.5% in June 2020, contributing to a slowing of real GDP growth over this time. Beyond 2020, annual real GDP growth stabilises at 2% through to the end of the projection period in June 2025. With inflation expected to be in the middle of the RBNZ's 1%-3% target band, changes in nominal GDP growth are driven by real activity, with nominal GDP growth falling to around 4% from 2018 onwards.

…and show a similar track for the operating balance (before gains and losses) as expected at Budget 2010

Figure 1.14 - Total Crown operating balance (before gains and losses)

Source:  The Treasury

Beyond 2015, the projected profile of the total Crown operating balance (before gains and losses) is very similar to that projected at Budget 2010, but lifts at a slightly faster pace (Figure 1.14). This is because the gap in tax revenue seen over the forecast period closes over the projected period as the economy returns to full potential. Furthermore, projected expenditure is coming off a lower base compared with Budget 2010, which helps offset lower tax revenue, especially in the initial projection years. After breaking even in the June 2015 year, the total Crown operating balance (before gains and losses) is projected to be 0.5% of GDP in the year to June 2016 and lift gradually thereafter to reach just under 5% by 2025.

The core Crown operating balance is expected to return to surplus in 2017 and is of sufficient size for a full contribution to the NZSF in 2019, the same year as projected at Budget 2010.

Net debt declines as a proportion of GDP…

Figure 1.15 - Net debt

Source:  The Treasury

Net debt starts from a slightly higher forecast base than at Budget 2010. However, the improved operating balance track closes the gap by around the year ended June 2021 and then sees net debt drop below the Budget 2010 track. As was the case at Budget, net debt is projected to fall below 20% of GDP by 2022 (Figure 1.15).

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.

…and net worth lifts in line with the improving fiscal position

Figure 1.16 - Total Crown net worth

Source:  The Treasury

Increasing operating balances over the projected years, with their consequent impact of reducing debt levels, are reflected in total net worth increasing over time. By 2025, net worth is projected to reach 57% of GDP, similar to the level it attained in 2008 before the GFC (Figure 1.16).

Given the uncertainty around the HYEFU projections, and the forecasts these projections build on, the next section examines alternative scenarios that fall within the range of possible outcomes.

Risks and scenarios#

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There are always uncertainties and risks associated with forecasts. These can be sourced from both the international economy and domestic developments.

Global developments present both upside and downside risks…

Although most economies are now growing again after the GFC, there is considerable uncertainty about the pace and durability of the recovery in many developed economies.

One source of downside risk relates to sovereign and banking system funding problems in some European economies and associated risks of contagion. An intensification and broadening of these problems to other countries would likely have significant negative impacts on activity levels, official interest rates and capital flows, particularly in Europe, with spill-overs to the rest of the world.

Another uncertainty relates to the response of the private sector to the ending of fiscal stimulus and in some economies the switch to fiscal consolidation. Consolidation will act to dampen domestic demand in the shorter term. As a result, the pace of growth will depend on the degree of offset coming from any crowding-in of private sector investment or higher net exports.

Other risks include the pace of recovery in the US, where there is continuing weakness in the labour and housing markets, and the extent of global imbalances which could lead to an increase in trade and capital barriers. These would impair world growth and, depending on the nature of the barriers, could adversely affect New Zealand export volumes.

Risks in China and emerging Asia are tilted to higher growth as these economies continue their economic development. Although China is currently taking steps to constrain credit growth, with some consequent short-term risks to growth, ongoing infrastructure investment and the scope for private spending to expand could see higher average growth over the next five years and further boost demand for minerals and soft commodities. It is also possible that the US and European economies could grow more quickly than expected if the current headwinds to growth dissipate faster than currently expected.

Economic strength in developing countries has helped support global commodity prices and boosted New Zealand's terms of trade, which are expected to remain elevated over the next five years. Past experience, however, indicates that negative shocks to commodity prices cannot be ruled out. Disappointing growth from emerging markets would be one factor that could result in lower demand and commodity prices than in the main forecasts.

...while the impact of atypical events and the behaviour of households present domestic risks

In the domestic economy, there is uncertainty about the degree to which rebuilding from the Canterbury earthquake will boost growth, and over what period. Since the forecasts were finalised, there have been a number of adverse developments. These are the discovery of a kiwifruit disease, the disaster at Pike River coal mine and the dry conditions developing in parts of the country as a result of the La Niña weather pattern. Risks of this kind will always exist in an economy with a large natural resource base, with drought effects having potentially significant adverse impacts on output and exports. Record temperatures during November mean that the risk that drought conditions will adversely impact on economic activity is particularly high.

New Zealand households have taken initial moves towards strengthening their financial position and are much more cautious about taking on debt, but it is not clear how sustained their restraint will be. Greater restraint will lead to lower growth in the short term, but possibly more sustainable growth in the long term; less restraint would bring higher growth in the near term, but risk a sharper deleveraging and rebalancing later. Developments in the housing market will influence household behaviour, with any additional housing market weakness likely to dampen household spending levels.

Two scenarios have been developed from these risks to illustrate the uncertainty associated with the current economic outlook. The scenarios are constructed by applying relevant shocks and alternative judgements to the New Zealand Treasury Model (NZTM). They should be treated as providing a high-level representation of how the economy could differ from the main forecasts. The focus is on key economic variables, rather than the larger suite produced as part of the main forecasts.

As a result, significantly different outcomes are possible

While the main forecast represents our view of the most likely path the economy will take, the scenarios illustrate that a large range of different outcomes is possible. The upside scenario assumes a stronger outlook for China and emerging Asia flows through to the economy in the form of higher prices for commodity exports. The downside scenario represents a more severe event with larger economic and fiscal implications, but with a lower probability. In this scenario, global growth falters and New Zealand's terms of trade are adversely affected. The scenarios are extended into the projection period in the same way as the main forecasts were in the preceding section, illustrating the considerable range in fiscal outcomes that could occur.

Notes:

1 SNA basis

2 March quarter, annual % change, seasonally adjusted

Upside scenario

Stronger demand for commodities lifts the terms of trade above the main track…

Figure 1.17 - SNA merchandise terms of trade

Sources:  Statistics New Zealand, the Treasury

New Zealand is a key supplier of soft commodities to the global economy, particularly dairy products and meat. Limited global resources and long lags in production mean that changing demand manifests itself in price swings in the short term, having a significant impact on the terms of trade and the overall economy.

The main forecasts assume that the terms of trade ease off in the short run but remain elevated over the medium term. In the upside scenario, it is assumed that stronger demand from key trading partners (particularly China and Australia) results in higher commodity prices and a continuation of the upward trend seen in the terms of trade over the past decade (Figure 1.17).

…and benefits flow through the rest of the economy

A higher terms of trade places upward pressure on the exchange rate, which, coupled with stronger earnings, leads to increased domestic demand. Private consumption growth averages 3.1%, compared with 2.4% in the main forecasts, and residential investment also lifts, driving GST revenue higher. In line with recent trends, some of the income surprise is saved, lifting the household saving rate above that in the main forecasts over the medium term. Stronger export values relative to imports drive a lower overall profile for the current account deficit.

Figure 1.18 - Annual nominal GDP

Sources:  Statistics New Zealand, the Treasury

More robust demand creates some inflation pressure, but higher potential output owing to stronger investment, combined with a more elevated exchange rate, means the overall impact on consumer prices is relatively small, allowing official interest rates to remain broadly similar to those expected in the main forecasts.

…driving higher tax revenues and a more positive fiscal position

The stronger economic outlook in this scenario lifts nominal GDP $4.2 billion (2%) higher in the March 2012 year and a cumulative $23 billion higher than the main forecasts over the 2011 to 2015 June years. Such a scenario would boost demand for labour and wages, flowing through to higher PAYE tax revenue which, together with higher corporate tax and GST, results in overall tax revenue being a cumulative $6.6 billion higher than in the main forecasts.

Figure 1.19 - Total Crown operating balance (before gains and losses)

Source:  The Treasury

With expenses broadly similar to the main forecasts, higher tax revenues mean the overall fiscal outlook is stronger than envisaged in the main forecasts. The operating balance (before gains and losses) breaks even in the June 2014 year, one year earlier than in the main projections. Net debt is projected to fall below 20% of nominal GDP in the June 2020 year, two years earlier than in the main projections.

Core Crown operating surpluses (before gains and losses) are projected to be of sufficient size to trigger the resumption of contributions to the NZSF by the June 2018 year - one year earlier than in the main projections.

Downside scenario

Global growth falters and financial conditions tighten, leading to lower export demand…

The downside scenario centres on sovereign debt issues in Europe intensifying and causing financial market disruption globally. As a result, global growth prospects falter. The channels through which such an event impacts on the New Zealand economy are primarily export demand, access to credit, confidence and wealth.

In this scenario, export demand is negatively affected, with lower commodity prices reflected in a much lower terms of trade, despite weakness in prices for some of the goods New Zealand imports (Figure 1.17 above). Although we would expect to see a significant decline in the exchange rate that would help offset lower export prices, the extent of the fall in demand means that overall export values are likely to be lower than in the main forecasts.

With financial markets experiencing renewed dislocation and risk aversion rising, capital- importing countries such as New Zealand could expect to face higher global funding costs. While official interest rates are likely to be lowered in such an event to limit the impact on retail interest rates, banks' access to funding could be more limited. The net result would be a more restricted supply of credit, at a higher price, to businesses and households. With confidence levels hit by the global situation, demand for credit also falls, resulting in weaker business and residential investment growth.

…and weaker private consumption

Figure 1.20 - Real private consumption

Sources:  Statistics New Zealand, the Treasury

House prices could be expected to fall further, reflecting a lack of confidence and credit, driving household wealth lower. Lower wealth, together with a weaker labour market, results in a significantly lower profile for real private consumption (Figure 1.20)

…driving real growth lower than in the main forecasts…

With business investment, residential investment and private consumption all weaker than in the main forecasts, the overall profile for real GDP is markedly lower than in the main forecasts.

The lower terms of trade, coupled with softer domestic prices, reflecting the weaker domestic economy, results in nominal GDP in the five years to June 2015 being around a cumulative $50 billion lower than in the main forecasts, with tax revenues expected to be nearly a cumulative $18 billion lower over the same period.

…and weakening the fiscal outlook

Figure 1.21 - Core Crown net debt

Source:  The Treasury

The total Crown operating balance (before gains and losses) would still be in deficit by about 2½% of GDP in the June 2015 year, while core Crown net debt would have risen to nearly 40%. Across the 10 years of post-forecast projections there is little recovery in the nominal GDP track, relative to that arising from the main forecast. As a consequence, the tax revenue gap of the next five years is maintained, which, in turn, flows through to much-lower operating balances. With surpluses taking longer to achieve, and being smaller when they do occur, the net debt track does not begin to reduce, as a percentage of GDP, until the end of this decade. The long-term target of net debt at 20% of GDP is not attained, with the ratio falling to about 35% by the mid-2020s.

It is important to note that the fiscal scenarios do not include a fiscal policy response which would be necessary if events were to evolve in a similar manner to that outlined in the downside scenario.

Fiscal sensitivities

The scenarios presented above reflect only two of a large number of possible alternative paths the economy may take. Table 1.11 provides some “rules of thumb” on the sensitivities of the fiscal position to changes in several specific economic variables. These enable an assessment of how the fiscal position could be affected should events turn out differently.

Note:

1 NZDMO holdings only

Source: The Treasury

Fiscal Risks#

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The Government's fiscal strategy aims to return the budget to surplus, bring down debt to restore a buffer against unforeseen circumstances, and support growth in a way that minimises economic vulnerability. The ability of the Government to achieve this fiscal strategy depends on future government decisions and, to a significant extent, the level of risk inherent in the global and domestic economies. This chapter describes risks to the economic and fiscal outlook from the perspective of a taxpayer.

The Public Finance Act 1989 (PFA) requires that each Economic and Fiscal Update incorporate, to the extent that it is possible to do so, all future government decisions and other circumstances that may have a material effect on the economic and fiscal outlook. Providing this information serves two purposes. First, providing information on uncertainty ensures that any risks that are able to be identified are transparently disclosed. The only exceptions to this requirement are where disclosure might cause serious harm to New Zealand's security, economy or Government. The second purpose is to aid interpretation of the statements by providing a sense of the uncertainty surrounding the economic and fiscal outlook.

The HYEFU 2010 risk chapter has been expanded to cover how events in the wider economy can impact on the fiscal position. This expands the focus of the risk chapter beyond the traditional contingent risks and the policy under active consideration, which are now included in the second part of this chapter. In providing this information no attempt has been made to specify individual economic events. Instead the focus of the additional material is on the size of potential change (variance) relative to what is included in our forecasts. Specific economic risks, to the extent that they impact on the economic outlook and are able to be identified, are discussed in the Economic and Fiscal Update chapter.

Fiscal strategy must respond to changes in the economy

Fiscal strategy specifies the Government's future spending intentions given expectations about how much tax it is likely to collect. Changes in the economy affect the Government through changes in tax and, to a lesser extent, through changes in either spending or the value of assets and liabilities held on the balance sheet. Thus, the key risk to the Government's ability to deliver on its fiscal strategy is that the economy will not evolve in line with the Treasury's economic forecasts over an extended period.

Revenue uncertainty

Taxation revenue is the primary channel through which changes in the economy affect the Crown's fiscal position. For taxation revenue, it is uncertainty about the level of nominal GDP that is most important. Two uncertainties that could significantly alter our forecasts for taxation revenue include: a change in trend growth; or uncertainty about the permanence of declines in tax following a large shock. Significant changes in prices, most notably through the terms of trade, have been especially important in the New Zealand context.

Figure 2.1 - Revenue uncertainty (holding policy constant)[8]

 

Source:  The Treasury

Note: The blue bands represent sequential deciles such that the difference between the 10th and 90th pecentiles represents an 80% confidence interval.

The experience of New Zealand over the past three decades provides three clear examples:

• The 1997 Asian crisis: The shock was assumed to be more permanent than it was and, as a result, the economy recovered faster than forecast.
• Growth through the 2000s: Forecasts persistently underestimated the strength and sustained persistence of above par economic growth mainly as a result of a terms of trade shock.
• The global financial crisis: Tax revenue suffered a structural decline after forecasts overestimated trend growth in government revenues (refer Figure 2.1).

The Economic and Fiscal Update provides the Treasury's current view of how the economy is expected to evolve. The upside and downside scenarios (refer page 38) provide two possible alternative scenarios for how the economy could differ from our central forecasts, although more extreme outcomes are possible. Historic variance in taxation revenues for the next fiscal year (refer Figure 2.1), once the impacts of policy change are taken into account, would normally fall within a two standard deviation range of plus or minus $4.9 billion (8.8%) on the current revenue base of $56 billion. Outcomes beyond this range could be expected to occur one year out of every 20.

Historic estimates of uncertainty may understate the potential volatility of forecasts over the next five years. Global imbalances that have not unwound to any significant extent, a large negative net international investment position and high levels of domestic debt all create uncertainty. Structural changes in the economy that affect the rate at which revenue grows relative to spending would place pressure on the Government's fiscal strategy.

Expenditure uncertainty

Most unexpected costs are likely to be captured through reprioritisation or from within the $1.12 billion annual budget operating allowance. However, large unexpected events, such as the Canterbury earthquake (refer page 22), can still place significant pressure on the Government's other spending priorities. A summary of the risks that are able to be specifically identified at the time of writing have been included in the second part of this chapter.

On 22 November 2010 Standard and Poor's placed the New Zealand sovereign rating on a negative watch. The decision referenced declining fiscal flexibility as a result of government budget deficits and widening external imbalances with respect to growing private sector debt. A credit downgrade would likely increase the Government's expenses through rising debt servicing costs.

Valuation uncertainty

Valuations of the assets and liabilities held on the Government's balance sheet respond to changes in interest rates, exchange rates and market prices. Significant changes in the balance sheet could eventually flow through placing pressure on the Crown's fiscal position. Risks to the government balance sheet lie beyond the scope of this chapter. However, the Government's capital spending intentions and information on portfolio risk are laid out in the Budget Policy Statement, National Infrastructure Plan and Investment Statement.

Uncertainty about the buffer provided by net worth

Figure 2.2 - Variation in past forecasts for net worth

Source:  The Treasury

The impact of tax, spending and valuation changes all create significant uncertainty about the future level of the Government's net worth. Higher net worth, or lower net debt, provide the Government with the fiscal headroom to spend or avoid increasing taxes in a recession. In this way, balance sheet measures, or lower debt, can be viewed as rough indicators of the risk that policy may need to change in a future crisis or a recession.

The global financial crisis has highlighted that the value of net worth can change rapidly when the economy is hit by an unusually large shock. This chapter makes no assessment of risk to the New Zealand economy. However, the effect of the economy and the impact of unexpected events on uncertainty about the future value of net worth can be illustrated by plotting forecasts for net worth against actual outcomes (refer Figure 2.2). Net worth is forecast to decline from 50.2% of GDP in June 2010 to 33.6% of GDP by June 2015, before recovering thereafter. A summary of the assumptions and judgements underlying our expectations for net worth, net debt and the economy as a whole has been included on page 45.

Statement of Specific Fiscal Risks#

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Context of the specific fiscal risks

The Statement of Specific Fiscal Risks sets out all government decisions, contingent liabilities or contractual obligations known to the government and subject to specific materiality requirements that may have a material effect on the economic or fiscal outlook[9].

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 budget 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.

Categories of risk

Previously, risks were grouped according to whether or not they were quantified. To improve the presentation of the information, they are now categorised to help explain the impact the risk would have if it were to occur. The categories of risk are explained and listed below.

• Pending policy decisions affecting revenue: Changes to tax policy or ACC levies could reduce or increase Government income from taxes or levies.
• Pending policy decisions affecting expenses: Costs of policy proposals could increase or decrease depending on decisions taken and they are risks to the extent that they cannot be managed within baselines or budget allowances.
• Pending capital decisions: Capital investment decisions are risks to the extent that they cannot be managed within balance sheets or budget allowances.
• Matters dependent on external factors: The liability of the Government for costs is sometimes dependent on external factors such as the outcome of negotiations or international obligations.

Summary table

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

Criteria and rules for disclosure in the fiscal forecasts or as specific fiscal risks

The criteria and rules set out below are used to determine if government decisions or other circumstances should be incorporated into the fiscal forecasts, disclosed as specific fiscal risks or, in some circumstances, excluded from disclosure. Since the last Economic and Fiscal Update, the materiality criterion for disclosure has been raised from $10 million in any one year to $100 million over five years (2010/11 to 2014/15) in order to provide greater focus on the more material risks. There are 12 risks that are not published because of the revision, with a combined average value per annum of approximately $88 million.

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 $100 million over five years.
• 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[10] 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 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 $100 million over five years, and either
• a decision has not yet been taken, but it is reasonably possible[11] (but not probable) that the matter will be approved or the situation will occur, or
• it is reasonably probable that the matter will be approved or the situation will occur, but the matter cannot be quantified or assigned to particular years with reasonable certainty.

Additionally, any other matters may be disclosed as specific fiscal risks if the Secretary to the Treasury considers, using his best professional judgement, that the matters may have a material effect (more than $100 million over five years) on the fiscal and economic outlook, but are not certain enough to include in the fiscal forecasts.

Exclusions from disclosure

Matters are excluded from disclosure as specific fiscal risks if they fail to meet the materiality criterion (ie, are less than $100 million over five years), or if they are unlikely[12] to 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.

Charges against the fiscal forecasts

Communications - Broadband Investment Initiative

Based on the criteria outlined above, it is probable that additional funding to Crown Fibre Holdings Limited for a new broadband network 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 capital allowances for future Budgets.

Statement of Specific Fiscal Risks

Pending policy decisions affecting revenue

ACC - Levies and Non-earners' Account (Changed, Unquantified)

Changes in tax settings, economic factors and ACC's financial performance affect the ACC's levy income and the Crown's liability for claims.

Revenue - Income-sharing Tax Credits (New, Quantified)

The Government has introduced legislation to establish an income-sharing tax credit, which is being considered by select committee. If passed, the legislation will allow couples with children under the age of 18 to pool their earnings for income tax purposes if they meet certain criteria. If implemented, the changes will reduce tax revenues by $500 million per annum once the scheme is fully operational.

Revenue - Potential Tax Policy Changes (Changed, Unquantified)

The tax policy work programme announced by the Government includes a number of items which are under consideration, including:

• the tax treatment of profit distribution plans
• the tax treatment of charitable giving
• the imputation system
• the tax treatment of employee benefits
• amortisation of capital raising costs
• the international tax review
• the GST treatment of cross-border business activities, and
• the tax treatment of hybrid instruments.

Measures on the work programme are expected to be revenue neutral or positive in aggregate. Measures enacted since Budget 2009, and included in revenue forecasts, have increased tax revenue by around $60 million per annum. The remaining items could be revenue negative up to the same extent. Because it is unclear exactly what additional policy changes, if any, will be made at this stage, these further changes have not been included in revenue forecasts.

Risk to Third Party Revenue (Unchanged, Unquantified)

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 reduce the level of an activity or temporarily subsidise that activity.

Pending policy decisions affecting expenses

Corrections - Community Probation Services Capacity (Changed, Quantified)

Over the next 10 years sentences and orders served in the community are forecast to increase. If the growth materialises as forecast, it is estimated that additional funding will be required for Probation Officers and investment in Community Probation infrastructure. Based on current forecasts, expenses are estimated at $20 million capital expenditure in total and operating expenditure of $25 million per annum by 2014/15.

Education - Early Childhood Education Funding (Changed, Unquantified)

Demand for Early Childhood Education (ECE) services is continuing to increase more than forecast, raising the costs of subsidies to ECE services. If this continues, the Government will face additional cost pressures.

Education - Inflation Adjustment for School Operating Funding (Unchanged, Unquantified)

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 managed within existing baselines and any allocation provided during the Budget process.

Education - Operating Funding for New Schools (New, Unquantified)

Applications for the establishment of new schools or for the approval of integration agreements present an unquantified risk. Proposals for the establishment of Kura Kaupapa Māori, Trades Academies or other secondary-tertiary establishments will drive the demand for funding in this area.

Education - Repairing Leaky Schools (Unchanged, Unquantified)

A $930 million impairment has been made to the school property portfolio reflecting “leaky building” (defective building) issues. There is a risk that existing funding will not be sufficient to repair the damage to schools which has been accounted for by the impairment.

Finance - Electricity Reforms (Changed, Unquantified)

In December 2009, the Government announced a series of measures related to improving the operation of the electricity market, including reconfiguring State Owned Enterprises' assets (virtual asset swaps and the sale of Meridian's Tekapo A and B power stations to Genesis and the sale of the Crown-owned Whirinaki power station to Meridian). The timing and some of the details of the SOE asset reconfiguration have yet to be decided. Given this, the impact of the reforms on the individual SOEs and the Crown cannot currently be estimated.

Housing - Housing Shareholders' Advisory Group (New, Unquantified)

The Government is considering a report by the Housing Shareholders' Advisory Group (HSAG) that includes recommendations for how to improve the effectiveness and efficiency of social housing provision, and make housing more affordable. The Government will consider and initial response before the end of the year. Until then, the magnitude of the fiscal risk will remain uncertain.

Justice - Review of the Legal Aid System (Unchanged, Quantified)

The Government is developing options for delivering legal aid services in a sustainable and affordable way. Decisions are due to be taken on proposals in late 2010. Final costs will depend on decisions taken.

Revenue - Child Support (Unchanged, Unquantified)

A government discussion document has been released which considers changes to the child support regime. The discussion document considers the costs of raising children, potential changes to the child support formula and options to improve compliance with the child support regime. Any changes would have administrative costs for Inland Revenue and could have further costs to government from reduced offsets to benefits.

Revenue - Redesigning Business Processes at Inland Revenue (Unchanged, Unquantified)

The Government is investigating options to redesign business processes at Inland Revenue, which could include both policy and administrative options to simplify customer interactions in the Pay As You Earn and Personal Tax Summary systems. Any changes could impact tax revenue collections or have material administrative costs to implement.

State Sector Employment Agreements (Unchanged, Unquantified)

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.

Pending capital decisions

Communications - Broadband Investment Initiative (Changed, Quantified)

The Government has committed to spend $1.548 billion on a new broadband network delivering ultra-fast broadband services. Of this amount, $290 million has been appropriated through Budget 2009 and $248 million through Budget 2010. Capital expenses of $300 million in 2012/13 and $200 million in each of 2013/14 and 2014/15 are included in the forecasts as potential charges against the capital allowance. However, the timing and final amount of capital contributions to Crown Fibre Holdings Limited may differ significantly from those forecast.

Corrections - Prison Capacity (Changed, Quantified)

In the next 10 years the prisoner population is forecast to increase. Based on current estimates, 600 additional prisoner places (beyond current commitments) will be needed by 2020. Some Corrections assets may also come to the end of their useful life and need to be decommissioned. This translates to $600 million additional capital expenditure in the next 10 years, with an operating expenditure impact of $90 million per annum by 2024.

Education - Broadband Investment: Schools (Changed, Quantified)

The Government has signalled an investment in Vote Communications to support the introduction of ultra-fast broadband into schools. The estimated cost of completing the upgrade of hardware in schools (School Network Upgrade Programme) has increased to $205 million and there is currently no funding set aside to manage the additional expense.

Education - School Property (Changed, Quantified)

The Ministry of Education faces financial risks in relation to school property: $165 million may be required in 2011 for new schools to meet roll growth and population movements.

Finance - Crown Overseas Properties (Unchanged, Quantified)

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 2012/13 to 2014/15.

Housing - Weathertight Homes (Changed, Unquantified)

The Government has agreed to offer a package to assist homeowners to repair homes affected by the weathertightness issues that occurred in the late 1990s and early 2000s. The package includes a 25% government contribution towards agreed repair costs, a 25% contribution from participating territorial authorities and credit support for the remaining repair costs for those who meet the eligibility and lending criteria. There is a risk that the costs of the package will exceed the $1.055 billion provided for in the forecasts, as uncertainty remains regarding the extent of damage to eligible homes and the level of uptake.

Justice - Auckland Region Property Strategy (Changed, Quantified)

The forecast level of demand for court services indicates there may be a need for additional courthouse capacity in the greater Auckland region. If additional funding is provided, the overall estimated cost will be up to $150 million with $20 million in 2011/12, $25 million in 2012/13 and $105 million in 2013/14.

Police - Digital Radio Network Full Implementation (Changed, Quantified)

The Government has previously funded the implementation of a Digital Radio Network in the Wellington, Auckland and Canterbury areas for New Zealand Police, to be completed by December 2010. Police are developing the business case for completion of a whole of government National Digital Radio Network with an Indicative Business Case planned for completion by 30 April 2011. Current estimates suggest capital costs of around $170 million over the period 2011/12 to 2017/18; and around $5 million of operating expenditure in 2012/13, rising to around $30 million per annum when fully implemented.

Transport - Support for New Zealand Railways Corporation (KiwiRail) (Changed, Quantified)

The Government has agreed in principle to support a 10-year strategy for the New Zealand Railways Corporation (NZRC, trading as KiwiRail Group) to achieve a commercially viable rail network. A total of $750 million in capital over three years is the expected Crown contribution towards the strategy, but its disbursement is dependent on the approval of suitable business cases and demonstrable progress towards objectives. Budget 2010 provided $250 million in capital as the first tranche of Crown funding for this strategy. NZRC will submit a case for the second tranche of the $750 million for Budget 2011.

The overall commitment KiwiRail seeks towards the 10-year plan is $1.2 billion over the forecast period 2010/11 to 2014/15.

KiwiRail has $408 million in debt to the Crown maturing in the forecast period, all of which may need to be refinanced or restructured. Of this, $250 million is maturing in 2011/12.

Matters dependent on external factors

Canterbury Earthquake - Land (New, Unquantified)

The total extent of damage in the region is still being determined. The Government is considering a range of options that might be made to assist the Canterbury region in its rebuilding. Options may include further remediation of private and Crown-owned land.

Canterbury Earthquake - Local Authorities (New, Unquantified)

Current government policy is to reimburse 60% of the combined eligible costs of restoring critical local government infrastructure (eg, water and sewerage), in the case of damage caused in an emergency event. The amount of the Government's contribution to restoring local government infrastructure in the Canterbury region has not yet been determined.

Climate Change - ETS and International Climate Change Obligations (Unchanged, Unquantified)

There is uncertainty in the level of fiscal impact associated with the Kyoto obligation over the 2008-2012 first commitment period. The net impact of variables including carbon prices, levels of net-emissions, the uptake of post-1989 foresters and allocation levels to emitters is highly uncertain and could change the Government's costs significantly. The Government may need to purchase emission units to meet its obligations under the Climate Change Response Act 2002 and the Kyoto protocol, with a corresponding impact on net debt. A review of the Emissions Trading Scheme (ETS) is also scheduled for 2011. Any change to ETS settings could have significant fiscal implications. After the first commitment period, no rights or obligations are forecast in the Government's accounts for any post-2012 international climate change agreement. International negotiations are currently underway but the potential nature, timing and size of any New Zealand commitment is highly uncertain. The fiscal impact of any commitment will need to be recognised at the time an agreement is made.

Climate Change - Finance for Developing Countries (Changed, Unquantified)

Following the Copenhagen climate change negotiations in 2009, New Zealand associated with the Copenhagen Accord. In the accord, developed countries committed to jointly mobilising US$100 billion per year by 2020 to address the needs of developing countries, in the context of meaningful mitigation actions and transparency on implementation. This would come from a wide variety of sources, public and private, bilateral and multilateral, including alternative sources of finance. New Zealand's contribution as a portion of this finance is currently uncertain.

Defence Force - Future Operationally Deployed Forces Activity (Unchanged, Quantified)

There are currently over 400 New Zealand Defence Force personnel deployed overseas on peace-keeping and United Nations missions. Maintaining existing deployment levels would result in an increased annual operating balance impact of some $30 million from 2011/12 subject to any decisions to change existing deployments. The forthcoming White Paper on Defence, expected to be complete by 30 November 2010, will consider future funding requirements for a range of operational commitments in the context of Government's wider policy priorities and fiscal position.

Defence Force - Sale of Skyhawks and Aermacchi Trainers (Changed, Unquantified)

The sale of the former Air Combat Force aircraft now depends on the successful conclusion of commercial negotiations. Should the sale proceed, the net sale proceeds are uncertain.

Energy - Crown Revenue from Petroleum Royalties (New, Unquantified)

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

Finance - Original Crown Retail Deposit Guarantee Scheme (Changed, Unquantified)

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. As at 31 October, eight entities guaranteed under the original Retail Deposit Guarantee Scheme had been placed into receivership. The Crown recognises its obligations under the scheme as liabilities and its rights of recovery from the receivers as assets. While the reported assets represent a best estimate of likely recoveries from the receiverships the eventual loss to the Crown is dependent upon the value that can be realised from these entities' assets. Except as provided on the Treasury website, further information on the Retail Deposit Guarantee Scheme cannot be provided due to commercial sensitivity.

Finance - Extended Crown Retail Deposit Guarantee Scheme (New, Unquantified)

The extended scheme came into place on 12 October 2010 immediately upon expiry of the original scheme. A total of seven financial institutions have been approved under the extended Retail Deposit Guarantee Scheme. These entities are listed on the Treasury website and have deposits totalling $2.3 billion under guarantee. This is the maximum exposure and does not include any offset resulting from the recovery of the remaining assets of financial institutions in the event the guarantee is called upon. The Crown continually updates the likelihood of further default actions triggering the guarantee and assesses the expected loss given default. As at 31 October the Crown assessed the risk of default by the seven entities participating in the extended scheme to be unlikely and therefore no provision was considered necessary in relation to the amount guaranteed by the Crown under the extended guarantee. Although one of the entities in the extended scheme has subsequently gone into default, the Crown assesses the risk of default of the remaining six entities participating in the extended scheme to be unlikely. While the provision represents a best estimate of the likely loss, a range of outcomes is possible under the scheme in terms of which entities may default and the eventual loss to the Crown following an event of default. This reflects the significant uncertainty as to the value that can be realised from an entity's assets following an event of default.

Finance - Government Commitments to International Financial Institutions (Unchanged,Unquantified)

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.

Health - Caregiver Employment Conditions (Changed, Quantified)

The Employment Court has made a judgment in favour of two third party employed caregivers regarding their sleepover employment conditions. Although the third party employer is appealing the decision, an unsuccessful result would require consideration of the repercussions for the Crown. This decision would also have an impact on other service providers in health and other sectors.

Health - Payment of Family Caregivers (Unchanged, Quantified)

The Human Rights Tribunal has declared that the Ministry of Health's policy of not employing family members to provide care to disabled relatives is in breach of s19 of the New Zealand Bill of Rights. An appeal has been lodged in the High Court.

Revenue - Cash Held in Tax Pools (Unchanged, Unquantified)

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.

Reviews of the Delivery of Public Services (Unchanged, Unquantified)

The Government has announced its intention to deliver better public services for less. Recommendations arising from reviews may identify areas of expenditure that are not efficient, effective or aligned to government policy, or could be delivered differently. Reviews may recommend, or result in, 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 that result in improved cost-effectivenessare likely to have a positive impact on the fiscal position.

State Services - KiwiSaver Contribution (Unchanged, Unquantified)

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.

Treaty Negotiations - Treaty of Waitangi Claims - Settlement Relativity Payments (New,Unquantified)

The Deeds of Settlement negotiated with Waikato-Tainui and Ngāi 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 Ngāi Tahu's and Waikato-Tainui's settlements as a proportion of all Treaty settlements. The agreed relativity proportions are 17% for Waikato-Tainui and approximately 16% for Ngāi Tahu. There is a risk that the timing and the amount of the expense for the relativity payments may differ from that included in the fiscal forecasts.

Risks removed since the 2010 Budget Economic and Fiscal Update

The following risks have been removed since the 2010 Budget Economic and Fiscal Update:

Contingent liabilities and assets#

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Contingent liabilities are costs that the Crown 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 Crown are a mixture of operating and balance sheet risks, and they can vary greatly in magnitude and likelihood of realisation.

In general, if a contingent liability were realised 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 $100 million are separately disclosed. Contingent liabilities below $100 million are included in the “other quantifiable contingent liabilities” total.

Contingent liabilities have been stated as at 31 October 2010, being the latest set of contingent liabilities reported.

Quantifiable contingent liabilities

Unquantifiable contingent liabilities

The following contingent liabilities are no longer disclosed separately owing to the materiality criterion to disclose items separately being raised from $10 million to $100 million.

Guarantees and indemnities:

• Air New Zealand
• Cook Islands - Asian Development Bank loans
• Indemnification of receivers and managers - Terralink Limited
• Ministry of Transport - funding guarantee

Uncalled capital:

• Bank for International Settlements
• European Bank for Reconstruction and Development

Legal proceedings and disputes:

• Accident Compensation Corporation
• Health - legal claims
• Kapiti West Link Road

Other quantifiable contingent liabilities:

• Air New Zealand partnership
• Crown Health Financing Agency
• Inland Revenue - unclaimed monies
• Reserve Bank - demonetised currency
• State highway extension

Statement of contingent liabilities

Quantified 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 PFA are disclosed in accordance with Section 26Q(3)(b)(i)(B) of the same Act.

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.

$301 million at 31 October 2010 ($295 million at 30 June 2010)

Other quantifiable contingent liabilities

International finance organisations 

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

$1,501 million at 31 October 2010 ($1,529 million at 30 June 2010)

Kyoto protocol

The Ministry of Agriculture and Forestry has a liability on behalf of the Crown relating to the 84 million forestry credits. During the first commitment period, the Ministry estimates that 89.1 million tonnes of credits will be generated by carbon removals via forests (2010: 89.1 million tonnes). Of this amount, 5.1 million tonnes has been allocated to foresters through the ETS as at 31 October 2010. To the extent that these forests are harvested (in subsequent commitment periods) and a future international agreement is negotiated, there will be an associated liability generated that will need to be repaid. As the forestry credits have been incorporated when calculating the current position for the first commitment period, the associated obligation of the Crown in respect of future commitment periods has been reported as a separate contingent liability. Using the carbon price as at 31 October 2010 of $NZ19.83, this contingent liability can be measured at $NZ1,665 million ($1,590 million at 30 June 2010)

New Zealand Export Credit Office (NZECO) - export guarantees

NZECO provides a range of guarantee products to assist New Zealand exporters. These NZECO guarantees are recorded by the Crown as contingent liabilities.

$105 million at 31 October 2010 ($133 million at 30 June 2010)

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 section provides details of those contingent liabilities of the Crown that cannot be quantified (remote contingent liabilities are excluded).

Guarantees and indemnities

Airways Corporation of 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 Limited 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.

Contact Energy Limited (Contact)

The Crown and Contact 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 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.

On 4 September 2010 the Canterbury region experienced a serious earthquake - refer to pages 22 and 23 for further discussion.

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, and
• any liabilities that arise out of the split itself.

Genesis Energy (Genesis) - financial guarantees

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

Genesis 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 Energy (Genesis) - letters of credit and performance bonds

Genesis, 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.

Genesis 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.

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.

Indemnification of the Stadel Museum's touring exhibition

The Crown has a contingent liability for damages and losses under the scheme for indemnifying the Stadel Museum's touring exhibition. The amount is not disclosed in order to keep the value of the exhibition confidential to the Crown and the lending museum. This protects Te Papa's ability to hold similar exhibitions in the future.

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 Limited (Landcorp) 

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.

Meridian Energy (Meridian) - letters of credit and performance bonds

In addition to its borrowings, Meridian has entered into a number of letters of credit and performance guarantee arrangements that provide credit support of $69.1 million to support the collateral requirements of Meridian's trading business. Of the $69.1 million, $2.4 million expires in the 2011 financial year, $20 million expires in the 2012 financial year and $0.125 million expires in the 2016 financial year with the balance having no expiry date.

National Provident Fund (NPF)

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), and
• 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 to note 20).

New Zealand Railways Corporation 

The Crown has indemnified the directors of New Zealand Railways Corporation against any liability arising from the surrender of the licence and lease of the Auckland rail corridor.

The Crown has further indemnified the directors of New Zealand 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 

The Crown, under section 63 of the Corporations (Investigation and Management) Act 1989, indemnifies the Securities Commission, the Registrar and Deputy Registrar of Companies, members of an advisory committee, every statutory manager of a corporation and persons appointed pursuant to sections 17 and 19 of the Act in respect of any liability arising as a result of exercising the investigating powers conferred under the Act. The indemnity does not apply where the investigating powers have 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 New Zealand 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 outcomes 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 five class actions. One, in Australia, claims travel agents' commission on fuel surcharges and two (one in Australia and the other in the United States) make allegations against more than 30 airlines, of anti competitive conduct in relation to pricing in the air cargo business. The other two class actions (in the United States and in Canada) allege that Air New Zealand together with many other airlines conspired in respect of fares and surcharges on trans-Pacific routes. All class actions are being defended.

The allegations made in relation to the air cargo business are also the subject of investigations or proceedings by regulators in New Zealand, Australia and the United States. A formal Statement of Objections was issued by the European Commission in 2007 to 25 airlines including Air New Zealand. Air New Zealand responded to this Statement of Objections and on 9 November 2010 the European Commission advised that it had closed its file in relation to Air New Zealand, being satisfied that there was insufficient evidence of any breach of the law. On 15 December 2008 the New Zealand Commerce Commission filed proceedings against 13 airlines including Air New Zealand alleging breaches of the Commerce Act 1986. On 17 May 2010 the Australian Competition and Consumer Commission filed proceedings alleging breaches of the (Australian) Trade Practices Act 1974.

Air New Zealand is defending these proceedings. In the event that a court determined, or it was agreed with a regulator, that Air New Zealand had breached relevant laws, Air New Zealand would have potential liability for pecuniary penalties and to third-party damages under the laws of the relevant jurisdictions.

Canterbury earthquake

Apart from the costs arising from the earthquake that have been quantified and included in these forecasts, there are also some unquantifiable components and associated risks that cannot yet be quantified. Refer to the commentary provided on pages 22 and 23 for more details on the expected fiscal impacts of the earthquake and how these have been reflected in these forecasts.

Caregiver employment conditions

In October 2010, the Court of Appeal heard an appeal against an Employment Court decision relating to minimum wage requirements for employees of disability support services providers currently paid sleepover allowances. If the employer's appeal is unsuccessful, consideration will need to be given to the repercussions for the Crown.

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 the Crown has accepted liability and for which costs can be reliably measured have been included in the Schedule of Non-Departmental Liabilities.

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 $120 million ($136 million at 30 June 2010). 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 Limited

The Crown has agreed in joint venture arrangements with the New Zealand Rugby Union (NZRU) 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.

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.

On occasion Māori claimants pursue the resolution of particular claims against the Crown through higher courts. There are currently two such actions against the Crown - one awaiting a decision on an application at the Supreme Court and one to be heard at the High Court. Failure to successfully defend such actions may result in liability for historical Treaty grievances in excess of that currently anticipated.

Westpac New Zealand Limited (Westpac)

Under the Domestic Transaction Banking Services Master Agreement with Westpac Banking Corporation (Westpac’s rights and obligations under this agreement were vested in Westpac New Zealand Limited under the Westpac New Zealand Act 2006), dated 30 November 2004, the Crown has indemnified Westpac:

• in relation to letters of credit issued on behalf of the Crown, and
• 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 Inland Revenue processing arrangements.

Under the Supplier Payments Service - New Zealand Government Master Agreement dated 23 June 2010, the Crown indemnified Westpac against certain costs, damages and losses to third parties resulting from unauthorised, forged or fraudulent payment instructions (excluding costs, damages and losses arising from Westpac's wilful default, negligence or breach of the agreement or other applicable legal obligation).

Contingent assets

Legal proceedings and tax disputes

Legal proceedings and tax disputes are contingent assets in relation to Inland Revenue pending assessments or Inland Revenue initiated assessments. They are net of any losses brought forward. Contingent assets arise where Inland Revenue has advised or is about to advise 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 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.

$568 million at 31 October 2010 ($504 million at 30 June 2010)

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 it is not possible to obtain a reliable valuation of the Crown's interest, the public foreshore and seabed has not been recognised as an asset in the forecast financial statements. The Government intends to repeal the FSA by the end of 2010.

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 22 November 2010.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined on pages 43 to 49.

Statement of Accounting Policies#

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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 Financial Reporting Standard 42: Prospective Financial Statements.

All forecasts use the accrual basis of accounting. Forecasts have been prepared for the consolidated financial statements of the Government reporting entity, which includes all entities controlled by the Government (as defined by applicable financial reporting standards).

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

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.

Actual financial results for the periods covered are likely to vary from the information presented. Factors that may lead to a material difference between information in these forecast financial statements and the actual reported results in future years are set out in the chapter on Fiscal Risks on pages 51 to 80.

Key forecast assumptions used are set out on pages 43 to 49.

Government Reporting Entity as at 22 November 2010#

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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 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
• Science and Innovation*
• Serious Fraud Office
• Social Development
• State Services Commission
• Statistics
• Transport
• Treasury
• Women's Affairs

* The Ministry of Science and Innovation was listed as a Department in legislation on 1 November 2010 in the State Sector Act and will replace the Ministry of Research, Science and Technology and the Foundation for Research, Science and Technology (a Crown entity) in the 2011 financial year.

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).

*  Includes KiwiRail Holdings

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
• Crown Fibre Holdings Limited
• Fish and game councils (12)
• Health Benefits Limited
• Leadership Development Centre Trust
• Learning State Limited
• 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 (23)
• 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 (20)
• Drug Free Sport New Zealand
• Earthquake Commission
• Electricity Authority
• Electoral 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 Quality and Safety Commission*
• 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 (2,479)
• 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

*The Health Quality and Safety Commission was listed as a Crown Agent in legislation on 9 November 2010, and begins operation on 1 December 2010.

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 Ministers, Departments, Offices of Parliament, the NZS Fund and the Reserve Bank, but not Crown entities and State-owned enterprises.

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

Forecast Statement of Comprehensive Income for the years ending 30 June

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

Forecast Statement of Cash Flows for the years ending 30 June

¹ Net issues of Government stock is after elimination of holdings by 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.

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

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

Forecast Statement of 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 any 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 2010

Statement of Actual Contingent Liabilities and Assets as at 31 October 2010

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 68 to 80 of the Fiscal Risks chapter.

Notes to the Forecast Financial Statements#

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NOTE 1:  Revenue Collected Through the Crown's Sovereign Power

1. Customs excise-equivalent duty.

NOTE 1:  Receipts Collected Through the Crown's Sovereign Power

NOTE 2:  Interest Revenue and Dividends

NOTE 3: Transfer Payments and Subsidies

NOTE 4: Personnel Expenses

NOTE 5: Depreciation, Amortisation and Other Operating Expenses

NOTE 6: Interest Expenses

NOTE 7: Insurance Expenses

NOTE 8:  Forecast New Operating Spending and Top-Down Adjustment

Forecast new spending up to Budget 2011 represents expenses included in Budget 2010 that have yet to be allocated.

Forecast for future new spending indicates the expected spending increases from the operating allowances planned for future budgets.

NOTE 9: Gains and Losses on Financial Instruments

NOTE 10: Gains and Losses on Non-Financial Instruments

NOTE 11: Source of Operating Balance

NOTE 12: Financial Assets

NOTE 13: Student Loans

NOTE 14: Property, Plant and Equipment

1 These additions do not include any purchases which may result from the allocation of the forecast for new capital spending (separately disclosed in the Statement of Financial Position).

NOTE 15: Intangible Assets and Goodwill

1. The New Zealand Government has committed under the Kyoto Protocol to ensuring that New Zealand's average net emissions of greenhouse gases over 2008-2012 (the first commitment period of the Kyoto Protocol or CP1) is reduced to 1990 levels or to take responsibility for the difference. New Zealand can meet its commitment through emissions reductions and use of the Kyoto Protocol flexibility mechanisms such as Joint Implementation, the Clean Development Mechanism, and offsetting increased emissions against carbon removed by forests. The position will crystallise when the first Kyoto commitment period is settled up post-2012. These financial statements report on the New Zealand Government's obligations for the first commitment period, but not for future commitment periods which are currently being negotiated.

A full copy of the Net Position Report 2010 can be found on the Ministry for the Environment's website: www.mfe.govt.nz

NOTE 16: NZ Superannuation Fund

NOTE 17: Payables

NOTE 18: Insurance Liabilities

ACC liability

Calculation information

PricewaterhouseCoopers Actuarial Pty Ltd have prepared an independent actuarial estimate of the ACC outstanding claims liability as at 30 June 2010. 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 key economic variables that impact on changes to the valuation are the long-term Labour Cost Index (LCI), average weekly earnings and the discount rate. Discount rates were derived from the yield curve for New Zealand government bonds. For these forecast statements, the claims liability has been updated for the latest discount rate as at 30 September 2010. The equivalent single effective discount rate, taking into account ACC's projected future cash flow patterns, is a short-term discount rate of 5.42% and a long-term discount rate of 6.00%. 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.

1 The majority of the 2011 forecast balance relates to the Canterbury earthquake. Refer the text box on pages 22 and 23 for more information.

NOTE 19: Retirement Plan Liabilities

The net liability of the Government Superannuation Fund (GSF) liabilities has been calculated by the Government Actuary as at 31 October 2010. The liability arises from closed schemes for past and present public sector employees as set out in the Government Superannuation Fund Act 1956. A Projected Unit Credit method is used to calculate the liability as at 31 October 2010, based on membership data as at that date. The funding method requires the benefits payable from GSF in respect of past service to be calculated and then discounted back to the valuation date.

The net GSF liability at this valuation was calculated using discount rates derived from the market yield curve as at the balance date and then blended to the long-term discount rate of 6.00% (long-term rate unchanged from 30 June 2010). Other principal long-term financial assumptions were an inflation rate, as measured by the Consumer Price Index, of 5.90% for 2011 decreasing to 2.40% in 2012 and 2013 and then increasing to 2.50% from 2014 (unchanged from 30 June 2010) and an annual salary growth rate, before any promotional effects, of 3.00% (unchanged from 30 June 2010).

The 2010/11 projected movement in the net GSF liability is $503 million, reflecting a decrease in the GSF liability of $281 million and an increase in the GSF assets of $222 million.

The decrease in the GSF liability of $281 million includes an actuarial loss, between 1 July 2010 and 31 October 2010, of $19 million due to experience adjustments. In addition to the actuarial loss, changes in the current service cost, interest cost and benefits paid to members, give an overall net projected change of $281 million.

The increase in the value of the net assets of GSF of $222 million includes an actuarial gain, from 1 July 2010 to 31 October 2010, of $163 million. The balance of $59 million is the total of the expected investment returns and contributions received, offset by the benefits paid to members.

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

NOTE 20: Provisions

Provision for ETS credits

The Emissions Trading Scheme (ETS) was established to 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 carbon price is assumed to remain constant over the forecast period and is based on the estimates of the current carbon price of €10.75 with an exchange rate of 0.5409 (a carbon price of NZ$19.87).

Details of current climate change policies are listed at: www.mfe.govt.nz/issues/climate/policies-initiatives

The ETS impact on the fiscal forecast is as follows:

NOTE 21: Net Worth attributable to the Crown

NOTE 22: Reconciliation of core Crown operating cash flows to residual core Crown cash

Forecast Statement of Segments#

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Statement of Financial Performance for the year ended 30 June 2010

Statement of Financial Position as at 30 June 2010

Statement of Financial Performance for the year ended 30 June 2011

Statement of Financial Position as at 30 June 2011

Statement of Financial Performance for the year ended 30 June 2012

Statement of Financial Position as at 30 June 2012

Statement of Financial Performance for the year ended 30 June 2013

Statement of Financial Position as at 30 June 2013

Statement of Financial Performance for the year ended 30 June 2014

Statement of Financial Position as at 30 June 2014

Statement of Financial Performance for the year ended 30 June 2015

Statement of Financial Position as at 30 June 2015