Half Year Economic and Fiscal Update 2013

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 other circumstances as at 3 December 2013 that were communicated to me by the Minister of Finance in accordance with the requirements of the Public Finance Act 1989 and of other economic and fiscal information available to the Treasury as at 3 December 2013. This Update does not incorporate any decisions, circumstances, or statements that the Minister of Finance has determined, in accordance with the Public Finance Act 1989, should not be incorporated in this Update.

Gabriel Makhlouf
Secretary to the Treasury

9 December 2013

To enable the Treasury to prepare this Economic and Fiscal Update I have ensured the Secretary to the Treasury has been advised, in accordance with the requirements of the Public Finance Act 1989, of all Government decisions and other circumstances as at 3 December 2013 of which I was aware and that had material economic or fiscal implications.

I accept responsibility for the integrity of the disclosures contained in the Update and responsibility for the consistency and completeness of the Update information with the requirements of Fiscal Responsibility in the Public Finance Act 1989.

Hon Bill English
Minister of Finance

9 December 2013

Executive Summary#

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• The economic expansion is becoming increasingly embedded, with growth becoming more broad-based although still dominated by domestic demand.
• Growth in the second half of 2013 appears to have been stronger than expected at Budget time with real gross domestic product (GDP) estimated to be growing at around a 3% annualised pace. Real GDP growth is expected to be 3.6% in the 2015 March year, but eases to around 2% in the last two years of the forecast period. Over the five years to March 2018, real GDP growth averages 2.6%, a little above the Treasury's estimate of potential growth over this period.

*Private final demand comprises private consumption, residential and market investment spending

Figure 1 - Real GDP and private final demand*

Source:  Statistics New Zealand, the Treasury

• A stronger economy sees the underlying fiscal position improve faster than in the Budget Update, although developments outside the core Crown see the overall total Crown operating balance before gains and losses (OBEGAL) being little changed this year and next. OBEGAL is forecast to move from a deficit of $4.4 billion last year to a small surplus of $0.1 billion in the year ending June 2015, and to $5.6 billion in the year ending June 2018.
• Government net core Crown debt peaks a year earlier and at a lower level than previously forecast at $64.5 billion in the year ending June 2016.
• The main influences on the outlook for the economy are broadly similar to those in the Budget Update.
• The Canterbury rebuild remains a key driver of demand, along with a high terms of trade and strengthening labour market conditions supporting income growth and associated household and firm spending. Credit growth is increasing but overall remains moderate.
• Higher-than-expected net migration and household wealth inflows are also contributing to near term demand, as are stimulatory monetary policy settings, although all are forecast to diminish in importance over the forecast period. Private spending growth is forecast to accelerate to over 5% in the year ahead.
• The Half Year Update sees a continuation of low government spending growth. This, together with some recovery in effective tax rates sees fiscal policy exerting a restraining influence on demand and interest rates, notwithstanding planned reductions in Accident Compensation Corporation (ACC) levies in the June 2015 and 2016 years.
• The global backdrop for these forecasts is for steady, but uneven, economic growth with the possibility of further economic and financial market turbulence. It is likely to be some time yet before the major advanced economies begin to “normalise” monetary and fiscal conditions, contributing to an elevated New Zealand dollar in the meantime.
• The exchange rate is assumed to remain high for much of the forecast period, acting as a drag on export and import-competing sectors but spreading the income gains from the high terms of trade to the broader economy. Growth in imports, partly associated with strong investment growth, means net exports make a negative contribution to GDP growth over the first three years of the forecast period.
• In sum, the economy is expected to be operating at, or above capacity over most of the forecast period, leading to some increase in price pressures and the current account deficit. The unemployment rate is forecast to decline to below 5%, annual Consumers Price Index (CPI) inflation to move back to around the middle of the 1% to 3% target band and the current account deficit to increase to around 6.5% of GDP.
• Higher inflation will lead to an eventual withdrawal of macroeconomic stimulus. Short-term interest rates are expected to begin increasing next year and to rise gradually thereafter.

Figure 2 - OBEGAL, core Crown residual cash and core Crown net debt

Source:  The Treasury

• Fiscal policy restraint and the high exchange rate imply interest rates are lower than otherwise would be the case. The recent application of macro prudential tools also assists monetary policy over the short term. In the absence of these downward forces, the size of the Canterbury rebuild would likely force interest rates to rise earlier and by more.
• The estimated size of the Christchurch rebuild is unchanged from the Budget Update at $40 billion, although the precise timing of activity remains a key uncertainty. The Government's fiscal costs are currently assessed to be $14.9 billion.
• Core Crown operating cash flows also return to surplus in the year ending June 2015, but when combined with net capital spending, core Crown residual cash does not return to surplus until the year ending June 2017 (both a year earlier than in the Budget Update).
• There is a mix of upside and downside risks, including the size and pace of the Canterbury rebuild, the extent of the turnaround in net migration currently underway, the path of the terms of trade, the path and pass-through of the exchange rate and the saving behaviour of households, particularly in light of current house price increases.
• Global risks, although more even than in recent years, remain skewed to the downside, which if crystallised, would act to accentuate the domestic orientation of forecast growth.
• We see a risk of a more cyclical path for the economy, with stronger domestic demand driven growth in the short to medium term, necessitating a stronger macro policy response and eventual slowing in growth.
• The Half Year Update contains two alternative scenarios to illustrate some of the risks to the main forecasts. One scenario maps out a more pronounced domestic demand driven cycle while the other shows the impact of weaker Asian trading partner growth.
• In addition to the fiscal impact of changes to economic activity, the Government is exposed to other fiscal risks. For example, the Crown's financial position is susceptible to market risk with regards to movements in market variables such as interest rates, exchange rates and equity prices. There are also a number of contingent liabilities and fiscal risks outlined in the Specific Fiscal Risk chapter.

Notes:

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

Sources: Statistics New Zealand, the Treasury

Economic Outlook#

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Overview#

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The near-term outlook for the New Zealand economy is robust, with an increasingly embedded and broad-based pick-up in activity anticipated following a drought-affected first half of 2013. Real GDP growth is expected to exceed its potential rate over the coming years, peaking at 3.6% in the March 2015 year, before easing to a more moderate rate of around 2.0% towards the end of the forecast period.

Growth outlook reflects net influence of supportive and constraining factors

The growth outlook continues to reflect the net impact of a number of large supporting and constraining forces. The Canterbury rebuild remains a key factor on the supportive side, along with a high terms of trade, stimulatory monetary policy settings and rising incomes on the back of a strengthening labour market.

The supportive influences on the domestic economy are set against a backdrop of familiar constraining factors. These include the forecast reduction in the fiscal deficit, which will continue to lean against demand, an elevated exchange rate that will remain a near-term headwind for growth in the export sector, and a steady, but uneven, outlook for global economic growth.

The main influences on the outlook for the economy are broadly similar to those in the Budget Update. However, higher-than-expected net migration inflows over the year to date contribute to stronger near-term demand growth, and add to the supply potential of the economy further out.

Figure 1.1 - Real GDP growth

Source: 

Domestic demand pressures building in the near term...

The Canterbury rebuild is expected to provide significant impetus to demand over the forecast horizon and beyond, chiefly through additional residential and business investment, but also through related consumption spending on consumer durables.

The merchandise terms of trade are forecast to remain elevated and close to historic highs across most of the forecast period, supported by rising demand for New Zealand's commodity exports. This is a key driver of income growth and nominal GDP growth.

An additional inflow of approximately 26,000 net migrants compared to the Budget Update will boost the productive capacity of the economy over time, but will add to demand pressures in the near term - particularly in the housing market in Auckland.

Households are assumed to be broadly comfortable with the amount of debt reduction undertaken over recent years (as a share of income). That said, households are expected to remain cautious in their spending decisions, with increases in consumption coming from rises in income, rather than from running down assets or increasing debt.

...against a backdrop of familiar offsetting factors

Ongoing steps to reduce the fiscal deficit will remain a constraining factor on demand over the coming years, but will free up resources enabling additional activity elsewhere, such as the Canterbury rebuild. The reduction in the deficit will also allow interest rates and the exchange rate to remain lower than they would otherwise be.

The elevated New Zealand dollar will constrain activity in exchange rate-sensitive parts of the economy over the coming years, including the non-commodity and service export sectors, but will also support investment and consumption by making imported goods cheaper. The assumed decline in the exchange rate is expected to begin to stimulate activity in the external sector towards the end of the forecast period.

The near-term outlook for trading partner growth is slightly weaker than forecast in the Budget Update, primarily owing to slower growth in the Australian economy as mining investment moderates. Although the medium-term outlook for this growth is relatively benign, there are risks arising from the diverging trends in the global economy.

Interest rates expected to begin to rise next year

With the economy set for a period of above-potential growth, increasing price pressures are expected to see the Reserve Bank begin to increase the Official Cash Rate (OCR) in the first half of 2014. The forecast track for short-term interest rates in the Half Year Update is broadly similar to that in the Budget Update, but is around 30 basis points lower than it would have been in the first half of the forecast period if loan-to-value (LVR) lending restrictions had not been implemented.

Having been the subject of a range of revisions since the Budget Update, the annual current account deficit is expected to narrow further in the near term, before widening to 6.4% of GDP in the March 2018 quarter.

Notes:

1. Forecasts finalised 11 November 2013.
2. Contribution to GDP growth.
3. Estimated as the percentage difference between actual real GDP and potential real GDP.
4. Percent of the labour force, March quarter, seasonally adjusted.
5. Percent of the working-age population, March quarter, seasonally adjusted.
6. Quarterly Employment Survey, average ordinary-time hourly earnings, annual percentage change.
7. Annual percentage change.
8. System of National Accounts (SNA) and merchandise basis, annual average percentage change.
9. Average for the March quarter.

Longer time series for these variables are provided on page 129.

Economic Outlook#

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Economy set for period of above-potential growth in the near term...

The near-term outlook for the New Zealand economy is robust, with an increasingly embedded and broad-based pick-up in activity anticipated following a drought-affected first half of 2013. The Canterbury rebuild is showing signs of gaining momentum, the labour market is strengthening and monetary conditions remain stimulatory. Strong external demand for New Zealand's commodity exports, particularly dairy, has underpinned a rebound in the terms of trade to near-record highs and domestic demand has received further support from a marked turnaround in net migration inflows since the start of the year.

Overall, real GDP growth is forecast to accelerate above its potential rate in the coming years, peaking at 3.6% in the March 2015 year. This will result in an increase in price pressures and will necessitate withdrawal of monetary policy stimulus in the first half of 2014. There is likely to be some variation in growth and activity at a regional level.

...followed by a moderation in the later years

Real GDP growth is expected to moderate to a more sustainable pace later in the forecast period, in line with the Treasury's estimate that potential growth will average around 2.4% over the forecast period. This reflects the Treasury's assessment of growth in the labour force and productivity in the longer run.[1]

The assumed depreciation in the New Zealand dollar is forecast to begin to stimulate activity in the exchange rate-sensitive parts of the economy, such as the services and non-commodity export sectors, towards the end of the forecast period.

Outlook reflects net impact of large influencing factors

The growth outlook for the New Zealand economy reflects the net influence of a number of large supportive and constraining forces.

Many of the supportive factors that are expected to influence domestic activity over the forecast period do so in a similar manner, and to a similar extent, as forecast at the Budget Update. These include the impetus from the Canterbury rebuild, stimulatory monetary policy settings and a strengthening labour market.

Overall, however, the net impact of the supportive influences on demand in the near term is slightly stronger than forecast at the Budget Update, including a larger-than-expected turnaround in net migration flows reflecting the recent weaker performance of the Australian economy. We judge the balance of risks to the central forecast to be balanced, but explore alternative economic scenarios in the Risks and Scenarios chapter.

Canterbury rebuild remains a key influence across the forecast period...

The Canterbury rebuild is expected to provide significant impetus to demand over the forecast horizon and beyond, chiefly through additional residential and business investment, supported by higher private consumption, particularly of consumer durables.

Estimating the level of investment activity associated with the Canterbury rebuild is inherently difficult and subject to much uncertainty. The Treasury's estimate of the total level of investment that relates to the Canterbury rebuild is similar to that in the Budget Update at around $40 billion. Approximately half of this total investment is forecast to have taken place by the end of the forecast period in mid-2018.

...underpinning strong growth in residential investment...

After a soft patch in the middle of the year, a surge in building consents in the Canterbury region in the September quarter suggests that residential rebuild activity is about to increase significantly. Annual real residential investment growth is forecast to accelerate to a peak of around 26% in the March 2015 year. This peak in growth occurs slightly later and at a lower level than forecast in the Budget Update, but the broad picture is similar in level terms. Over two-thirds of the residential rebuild is expected to be completed by the end of the forecast period in 2018.

While the Canterbury rebuild is expected to provide a large proportion of the impetus for the surge in residential investment over the forecast period, activity in other parts of the country is also expected to rise significantly, particularly in the Auckland region. The drivers of the underlying growth include a catch-up for past population growth, expected future population increases (including through migration), rising household income, and low, albeit rising, interest rates. Figure 1.2 shows the share of real residential investment with and without the Canterbury rebuild. Including rebuild-related activity, residential investment is forecast to peak at around 6% of real GDP - in line with the share reached in the early-2000s.

Figure 1.2 - Real residential investment[2]

Source: Statistics New Zealand, the Treasury

Rapidly rising house prices, particularly in the Auckland region, are expected to encourage an increase in new home building, although this will take time. The implementation of LVR lending restrictions by the Reserve Bank makes it less certain how the supply and demand dynamics in the housing market will play out. Higher-than-expected net migration inflows mean that annual house price inflation is forecast to be stronger in the near term than in the Budget Update. However, the impact from migration is offset to some extent by the LVR lending restrictions, which are expected to impose a modest dampening effect on house price inflation in the near term. Annual house price inflation is forecast to peak at around 10% in the December 2013 quarter, before moderating to 2.4% towards the end of the forecast period.

The forecast track for short-term interest rates in the Half Year Update is broadly similar to that in the Budget Update, but is around 30 basis points lower in the first half of the forecast period than it would have been if LVR restrictions had not been implemented (consistent with the Reserve Bank's estimates).

...as well as market investment

The current environment of low interest rates, strong business confidence and an elevated exchange rate (which makes imported capital goods cheaper) is also expected to drive a sharp increase in market investment in the near term. The Canterbury rebuild is expected to contribute to an increase in market investment as well. Later in the forecast period, higher interest rates and a lower exchange rate are expected to see market investment growth moderate.

Robust outlook for private consumption...

The large increase in residential investment over the forecast period is also expected to provide significant impetus to private consumption in the form of related and additional spending on consumer durables. Private consumption growth is expected to accelerate to 3.7% in the March 2014 year – its fastest pace since the end of 2007 – as consumer confidence remains elevated and real incomes are boosted by the current subdued inflation environment.

The pace of private consumption growth is expected to slow later in the forecast period as real income and house price growth slow, and interest rates rise (Figure 1.3).

Figure 1.3- Private consumption and house prices

Source:  Statistics New Zealand, QV, the Treasury

...supported by the historically-high terms of trade...

The positive outlook for the terms of trade is another strongly supportive factor in the Half Year Update forecasts. This will continue to underpin incomes and nominal GDP over the forecast period. The near-term rebound in the merchandise terms of trade reflects sustained high dairy prices as well as support from forestry and meat during the middle of the year. In keeping with commodity price indicators, the merchandise terms of trade are expected to be around 15% higher in the December 2013 quarter than in the same period a year ago (Figure 1.5). Dairy prices are expected to fall back as global supply increases. The timing is uncertain and global supply remains constrained, but the Half Year Update forecasts assume a drop in dairy prices, and a corresponding modest correction in the terms of trade, during the first half of 2014.

Figure 1.5 - Merchandise terms of trade (SNA) and ANZ commodity price index

Source:  Statistics New Zealand, ANZ, the Treasury

Overall, though, the terms of trade are expected to remain near record highs over the medium term, at a similar level seen in the Budget Update, supported by structural factors including rising demand for New Zealand's commodity exports, particularly from China.

...and a strengthening labour market

Having shown signs of improvement over the past year, the labour market is expected to strengthen further over the forecast period, with the unemployment rate falling gradually and employment continuing to increase. The Canterbury rebuild will be a large contributor to the strengthening in the near term, along with rising activity in the Auckland region. (See the Migration and Regional Activity box.) Nominal wage growth is expected to be solid throughout the forecast period, with annual growth remaining broadly in the range of 2.5% to 3.5%. This is consistent with moderate real wage growth of around 1% per year on average over the forecast period.

The labour force participation rate is expected to increase over the coming years as stronger employment conditions encourage more workers to enter the labour force. Ongoing welfare reform is expected to strengthen job-search incentives and have an additional positive influence on labour force participation. The participation rate is expected to moderate slightly towards the end of the forecast period reflecting the effect of an ageing population.

Figure 1.6 - Unemployment rate and participation rate

Source:  Statistics New Zealand, the Treasury

However, consumers expected to remain cautious...

As outlined in the Budget Update, developments in household net worth, partly driven by house price movements and reduced uncertainty about future growth, underpin our assumption that households are broadly comfortable with the amount of debt reduction undertaken over recent years (as a share of income). That said, households are expected to remain cautious in their spending decisions in the coming years, with increases in consumption coming from rises in income, rather than from running down assets or increasing debt further.

All told, household saving as a percentage of household disposable income is expected to remain broadly flat over the forecast period, as it has been for the past few years.[3] This represents a shift in behaviour from the mid-2000s and its continuation will be an important factor influencing demand in the economy.

...and there is a backdrop of familiar constraining factors, including fiscal restraint...

The supportive influences on the domestic economy are set against a familiar backdrop of factors that will constrain growth, including continued steps to reduce the fiscal deficit, an elevated exchange rate and a steady, but uneven, outlook for global economic growth.

Ongoing steps to reduce the fiscal deficit will remain a constraining factor on demand over the coming years. The combined impact of fiscal decisions in the 2013 and previous Budgets will see real government consumption rise only modestly over the forecast period, averaging growth of just 0.5% per year compared to around 4% over much of the 2000s (Figure 1.7). As a proportion of real GDP, government consumption declines over the period towards the past decade's low of 16.0%. A lower share of government spending in the economy will free up resources enabling additional activity elsewhere, such as the Canterbury rebuild. In doing so it also allows interest rates and the exchange rate to remain lower than they would otherwise be.

Figure 1.7 - Real government consumption

Source:  Statistics New Zealand, the Treasury

...an elevated exchange rate...

An elevated exchange rate will also continue to present a near-term headwind to growth in parts of the external sector, particularly for non-commodity exporters and import-competing firms. Having weakened during the middle of the year on the back of market expectations of a “tapering” of quantitative easing in the US, the trade-weighted index (TWI) climbed back close to its record highs in the September quarter. The New Zealand dollar has gained particularly strongly against its Australian counterpart, with the cross rate currently near a five-year high.

An elevated exchange rate makes New Zealand a more expensive destination for tourists and foreign students, and is expected to constrain growth of services and non-commodity goods exports in the near term. Given that many of New Zealand's commodity exports are priced in US dollars, an elevated exchange rate also dampens New Zealand dollar export receipts from commodity exports, but spreads income gains to the broader economy.

Over the longer term, goods and services export volumes are expected to grow more strongly, driven in large part by an assumed depreciation in the New Zealand dollar. Both goods and services volumes are also expected to rise as global demand picks up, generating additional demand for New Zealand's goods and services. A weaker New Zealand dollar will boost New Zealand dollar receipts for commodity exports too, but will also increase import prices. As mentioned before, demand for dairy and other commodity exports is likely to continue to benefit from links with fast-growing Asian markets over the long term.

...and steady, but uneven, global growth

The near-term outlook for trading partner growth is slightly weaker than forecast in the Budget Update, primarily owing to slower growth in the Australian economy as mining investment moderates, and a weaker outlook for emerging economies including China. The outlook over the rest of the forecast period is broadly similar to that in the Budget Update, with growth of around 3.8% per year.

* South Korea, Taiwan, Hong Kong, Singapore, Malaysia, Indonesia, Thailand, Philippines, India

Sources: IMF, Haver Analytics, Consensus Economics, the Treasury

The factors behind the weaker near-term trading partner growth - particularly the gradual rebalancing of Australian GDP growth away from investment towards consumption, residential investment and exports - are unlikely to result in significant direct negative implications for New Zealand exporters. Ongoing income growth and increased demand for protein in Asian economies, particularly China, are also expected to underpin strong demand for New Zealand's commodity exports over the medium term.

However, the global economy continues to face significant challenges, and diverging trends pose risks to the relatively benign medium-term outlook for trading partner growth. The major developed economies are showing signs of more sustainable growth - particularly the US, Japan and the UK - while growth in emerging market economies (including some of New Zealand's trading partners in Asia) is slowing as a result of both structural and cyclical factors. As the developed economies begin to withdraw monetary stimulus, emerging market economies that have benefited from the loose global monetary conditions may come under pressure as capital inflows are reversed. Meanwhile, a combination of rapid credit growth and inflated property values poses risks to financial stability in China. The risks to the global outlook are explored in more detail in the Risks and Scenarios chapter.

Forecast widening in current account deficit reflects composition of growth

The current account has been subject to a range of historical revisions since the Budget Update, most recently in the annual set of National Accounts for the year ended March 2013, which were released after the Half Year Update forecasts were finalised. Estimates of the current account deficit from 2000 onwards are now on average 1.1% of GDP narrower than previously recorded. (See Revisions in the 2013 Annual National Accounts box for further details.)

Figure 1.8 - Current account balance

Source:  Statistics New Zealand, the Treasury

The annual current account deficit is expected to narrow further in the near term on the back of a narrower income deficit and a wider goods surplus than in the Budget Update. The wider goods surplus is mainly attributable to the dairy sector, in which prices have remained higher than expected, and also production has recovered more quickly than expected from last summer's drought.

The annual current account deficit is forecast to widen from 2014 onwards to 6.4% of GDP in the March 2018 quarter. This is expected to be driven by a widening in the income balance as business profits and international interest rates pick up.

The goods balance is expected to register a small deficit in 2015, primarily owing to increased goods imports associated with the expected pick-up in investment. The balance is expected to recover in the final years of the forecast period as investment growth slows and the assumed weakening in the exchange rate makes New Zealand's non-commodity exports more attractive overseas.

The services deficit is forecast to widen towards the end of the forecast period as the assumed fall in the exchange rate feeds through into increased services import prices (an example of the so-called “J-curve” effect). However, over time, a weaker exchange rate will make New Zealand a more attractive destination for tourists and also make service imports less attractive. As a result, the services deficit would be expected to narrow outside the forecast period, contributing to a narrower current account deficit.

Inflation expected to pick up as spare capacity is used up...

With the economy set for a period of above-potential growth in the near term, non-tradables inflation is forecast to accelerate to a peak of around 4% in mid-2016, before easing back as real GDP growth moderates towards the end of the forecast period. Tradables inflation is expected to move back into positive territory over the coming years and to come under increased upward pressure from the assumed decline in the exchange rate. Overall, headline CPI inflation is forecast to peak at 2.6% in late-2015 and to decline gradually thereafter, albeit remaining slightly above the 2.0% mid-point of the target range. Increases in tobacco excises are expected to add 0.2 percentage points to annual inflation in each of the March 2014, 2015 and 2016 quarters.

Figure 1.11 - Inflation

Source:  Statistics New Zealand, the Treasury

...leading to a withdrawal of monetary stimulus next year

Increasing price pressures are expected to see the Reserve Bank begin to increase the OCR in early 2014. As mentioned earlier, the forecast track for short-term interest rates in the Half Year Update is broadly similar to that in the Budget Update, but is around 30 basis points lower than it would have been if LVR restrictions had not been implemented.

Nominal GDP growth expected to remain strong

Nominal GDP is particularly important for generating forecasts of tax revenue. The main components of nominal income GDP, namely compensation of employees and business operating surplus, are inputs for generating forecasts of PAYE and corporate tax revenues respectively.

Underlying growth in the volume of output, alongside strong gains in the terms of trade and a pick-up in pricing pressures, are expected to support nominal GDP growth in the near term. Nominal GDP is forecast to grow by 6.5% and 4.9% in the March 2014 and 2015 years respectively. Growth in nominal GDP is expected to ease somewhat later in the forecast period, as real GDP growth moderates, the terms of trade level off and pricing pressures are restrained by higher interest rates.

Figure 1.12 - Nominal GDP and terms of trade

Source:  Statistics New Zealand, the Treasury

Fiscal Outlook#

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Overview#

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• The Crown's fiscal position is broadly unchanged from the Budget Update in the first two years of the forecast but has strengthened in the medium term.
• With stronger economic growth expected, core Crown tax revenue is forecast to grow more rapidly, while expenses remain relatively stable.
• The operating deficit narrows in the current year and a surplus of $86 million is forecast in 2014/15. By 2017/18, the surplus is expected to reach $5.6 billion. These surpluses help fund the Government's capital spending and enable the repayment of debt.
• Net core Crown debt starts to fall in nominal terms as residual cash returns to surplus in 2016/17, a year earlier than previously expected.
• The improved cash position, coupled with a lower starting base in 2012/13, means net core Crown debt falls as a share of GDP to stand at 22.3% by 2017/18.
• The Government Share Offer programme is expected to conclude in the current year with proceeds between $4.6 billion and $5.0 billion now expected to be available for the Future Investment Fund.
• The Crown's balance sheet continues to strengthen as operating surpluses are expected to steadily increase.

Notes:

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

Source: The Treasury

Overall, growth in the economy, and continued management of spending levels, is expected to result in the Crown returning to surplus, starting to reduce debt and rebuild the Crown's net worth.

In preparing these fiscal forecasts, key assumptions have been made in relation to the performance of the economy, and managing new spending within Budget allowances. As with all assumptions, there is inherent uncertainty and a change in any one of these could negatively or positively impact the Crown's forecast surpluses and net debt position. The Risks and Scenarios chapter and the Specific Fiscal Risks chapter outline the key risks to the Crown achieving these forecasts.

Core Crown tax revenue increases in each year of the forecasts and by 2017/18 is expected to be $19.2 billion higher compared to 2012/13, reflecting the forecast growth in nominal GDP, as discussed in the EconomicOutlookchapter.

While core Crown operating expenses are expected to increase by $8.7 billion over the next five years, they fall to just under 30% of GDP by the end of the forecast period.

These forecasts shows the Government is expected to achieve its fiscal objective of a return to surplus in 2014/15. While a surplus of $86 million is forecast in 2014/15, beyond 2014/15 surpluses are expected to increase by between $1.5 and $2.5 billion each year.

With net debt finishing in a stronger position at 30 June 2013 and a strengthening in the residual cash balance since the Budget Update, the net debt track is lower on average by 2.4% of GDP each year. Net debt falls to 22.3% by 2017/18 in line with the Government's medium-term target of net debt brought back to a level no higher than 20% of GDP by 2020. In nominal terms, net debt starts decreasing from 2016/17 as cash surpluses are forecast to return for the first time since 2007/08.

Source: The Treasury

Core Crown Tax Revenue#

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Tax revenue grows by around 5.8% per annum on average over the forecast period...

Core Crown tax revenue is forecast to rise in each year of the forecast period, with the 2017/18 forecast being $77.9 billion, which is $19.2 billion higher than in 2012/13. These annual increases also see forecast tax revenue increasing relative to nominal GDP, reaching 28.8% by the end of the forecast period (Figure 2.1).

Figure 2.1 - Core Crown tax revenue

Source:  The Treasury

Most of the 5.8% average annual growth in tax revenue forecasts comes from growth in the economy with nominal GDP forecast to grow at 4.9% on average over the forecast period. Tax revenue growth slows a little towards the end of the forecast period as nominal GDP growth slows (refer Figure 2.2). The remainder of the forecast tax growth largely relates to increased residential investment, largely owing to the Canterbury rebuild, and the progressive nature of PAYE tax.

Figure 2.2 - Core Crown tax revenue growth

Source:  The Treasury

All tax types are expected to increase across the forecast period, with particular strength in tax from employees (PAYE) and goods and services tax (GST), as shown in Table 2.3.

Employment earnings growth (forecast at just below the GDP growth rate) combined with the progressive nature of the personal tax scale add $7.3 billion to source deductions over the forecast period with the average PAYE growth rate of 5.8% per annum.

The level of residential investment is forecast to grow at an average rate of 16% per annum over the forecast period, largely as a result of rebuilding in Canterbury. This increase in investment is expected to boost GST by $1.7 billion by 2017/18.

These forecasts also see an expected rise in 90-day bank bill interest rates from 2.6% on average in 2012/13 to 5.2% by 2017/18, with flow-on increases to tax on interest earned on residents' savings (RWT).

Note: 1 Fiscal drag is the additional tax revenue generated from source deductions as an individual’s average tax rate increases as their income increases.

Source: The Treasury

...and is higher than the Budget Update

Compared to the Budget Update, tax revenue forecasts have been revised up by $0.1 billion in 2013/14 rising to $1.4 billion by 2016/17.

The bulk of the upwards revision occurs beyond 2014/15 (refer Figure 2.3), with the largest increases from individuals' taxation and GST. A stronger labour market, with higher wages and salaries, is expected to increase PAYE relative to the Budget Update, with the change further boosted by fiscal drag. Net other persons’ tax also increases as a result of higher forecast profits for unincorporated businesses. Increased employee compensation and profitability lead to higher consumption, boosting GST growth.

Although corporate tax is expected to increase over the forecast period in nominal terms as business profitability improves, annual growth is broadly similar to that forecast at the Budget Update.

Figure 2.3 - Movement in core Crown tax revenue since the Budget Update

Source:  The Treasury

Core Crown Expenses#

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Growth in core Crown expenses is subdued over the forecast period...

Core Crown expenses are forecast to increase in nominal terms by $8.7 billion in total over the forecast period (Figure 2.4). The growth in core Crown expenses is expected to be at a slower rate than economic growth, so as a result they fall from 33.1% in 2012/13 to 29.2% of GDP by 2017/18, in line with the Government's target of reducing expenses to around 30% of GDP.

Figure 2.4 - Core Crown expenses

Source:  The Treasury

Nominal growth in core Crown expenses is largely attributable to new spending for future Budgets, social assistance spending and finance costs as shown in Figure 2.5.

Figure 2.5 - Increase in core Crown expenses

Source:  The Treasury

The forecast includes new spending to be allocated in future budgets of around $1.0 billion for the next four budgets. Including the impact of spending decisions from Budget 2013, budget allocations are forecast to increase core Crown expenses by $5.1 billion by the end of the forecast period.

Social assistance spending is expected to increase by $3.7 billion across the forecast period. New Zealand Superannuation payments (the most significant across different social assistance payments) grow by $3.3 billion over the forecast period as payments are indexed to inflation and recipient numbers increase on average by 25,000 over the next five years (Figure 2.6). The rest of the increase in social assistance spending is owing to indexation, with recipient numbers staying relatively stable for other benefit types.

Figure 2.6 - Social assistance spending

Source:  The Treasury

Finance costs increase by $0.7 billion over the forecast period as gross debt continues to increase and interest rates are forecast to rise.

Partially offsetting this higher expenditure, the Crown's earthquake costs reduce over the forecast period as the most significant expenses have already been recognised in previous years (refer to box on page 30 for details of the profile of earthquake expenses).

...but expenses are marginally higher than the Budget Update by the end of the forecast period

Initially expenses are slightly lower than forecast at the Budget Update, but by the end of the forecast period expenses are around $0.6 billion higher than previously expected (refer Figure 2.7).

Figure 2.7 - Changes in core Crown expenses since Budget 2013

Source:  The Treasury

The strength in economic conditions and impacts from welfare reform have reduced unemployment-related benefit recipient numbers and therefore social assistance expenses compared to the Budget Update. However, by the end of the forecast period this trend reverses owing to the impact of a higher inflation track and increases in income-related rents. Refer Table 2.4 in the Operating Balance section below for changes to benefit expenses since the Budget Update.

Costs associated with the Government Superannuation Fund (GSF) are also forecast to increase above the level forecast in Budget Update. Larger impacts are expected in the last few years of the forecast owing to increases in discount rates causing the interest unwind of the GSF liability to also increase.

In addition to these expenses, some increases (eg, Emissions Trading Scheme expenses) also have a corresponding increase in core Crown revenue and therefore are OBEGAL neutral to the Crown.

Operating Balance#

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The Crown is forecast to return to surplus in 2014/15…

Increases in core Crown tax revenue and slowing expenditure growth reflect an improved outlook across the forecast period with the Crown's OBEGAL forecast to return to a surplus of $86 million in 2014/15. This stronger outlook is largely driven by economic factors impacting on tax revenue combined with the continuing programme of fiscal constraint. There are risks to achieving a surplus in 2014/15 and later years should these factors not play out as forecast. Refer to the Risks and Scenarios and Specific Fiscal Risks chapters for further discussion of risks that may impact the Crown's operating balance.

OBEGAL is a total Crown measure, of which the core Crown shows the greatest growth over the forecast period. In 2013/14 the core Crown has an OBEGAL deficit of $3.7 billion which turns around to contribute a $5.9 billion surplus to OBEGAL by 2017/18.

Both the State-owned Enterprise (SOE) and Crown entity (CE) sectors' contribution to OBEGAL in the future have been significantly changed. Together they contribute $2.0 billion to the OBEGAL surplus in 2013/14 falling to $0.4 billion by the end of the forecasts.

Figure 2.8 shows the composition of OBEGAL from the different sectors of the Government. The CE sector's contribution is expected to fall significantly owing to a reduction in ACC levy rates while the SOE sector's contribution falls owing to the Government's Share Offer programme. Refer to separate section on pages 36 to 41 for further discussion of this programme.

Figure 2.8 - Components of OBEGAL by sector

Source:  The Treasury

While reductions in ACC levies were included in the Budget Update, reductions are higher in these forecasts. Reductions in ACC levies of $300 million in 2014/15 increasing to $1 billion a year from 2015/16 were announced at the time of the Budget Update. Since that time specific levy rate reductions for the relevant levy years have now been factored into the forecasts and Cabinet has increased the 2014/15 reduction to $387 million. As a result, the reduction in income has increased in 2014/15 and the timing of the OBEGAL impact for the expected second round of reductions has been revised.

Refer Table 2.4 for a summary of the key changes to the forecasts from the Budget Update that impact on OBEGAL.

 

Source: The Treasury

ACC and NZS Fund's interest income has also decreased since Budget Update largely owing to a reduction in the expected level of interest earning assets held by ACC and NZS Fund since Budget 2013.

SOE profits have also declined across the forecast period since Budget Update largely owing to foregone profits from the Government's share programme (refer to Government Share Offer Programme section on pages 36 to 41).

The underlying nature of OBEGAL can be seen using the cyclically adjusted balance (CAB). This measure adjusts for the state of the economic cycle and significant one-off expenses. Figure 2.9 shows CAB tracking close to OBEGAL in recent years, indicating that the operating deficits between 2009 and 2013 have been largely structural. The projected size of the economy reduced following the recession, implying a smaller tax base while, in contrast, expenses continued to grow. In this forecast, tax revenue is forecast to grow more rapidly than expenses (which remain relatively stable), seeing CAB move to surplus in 2015/16[4] a year later than OBEGAL.

Figure 2.9 - OBEGAL and CAB

Source:  The Treasury

...with OBEGAL surpluses beyond 2014/15 enabling debt to be repaid

Surpluses are achieved in 2014/15 and continue to increase over the forecast period to a level that translates to being sufficient to fund the Government's capital spending and allows for the reduction of debt.

Current strength in equity markets lifts the operating balance…

When gains and losses are included, the total Crown operating balance is forecast to be in surplus across the forecast period with steady growth each year of the forecasts (Figure 2.10). The current year's surplus is a result of gains expected to be made by Crown financial institutions (CFIs), largely ACC and NZS Fund, and reflects strong global equity returns (for example, by 30 September 2013 NZS Fund had made year-to-date gains of $1.0 billion). While the current year reflects strong market growth, the forecast gains in future years assume a long-term rate of return, resulting in more subdued growth in these years. These gains play a part in increasing the Government's financial assets, and the Crown's net worth (discussed on page 33).

Figure 2.10 - Components of operating balance

Source:  The Treasury

...and valuations of long-term liabilities contribute to an improved result in 2013/14

In addition, updated long-term liability valuations for ACC (at 30 June 2013 and updated for movements in discount rates to 30 September) and GSF (at 30 September) have also led to significant actuarial gains in the 2013/14 year which also contribute to the Crown's operating balance.

Given the size of the balance sheet, market movements can have a significant impact on the operating balance. Refer to page 35 for further discussion of the impact of these valuations on the Crown's operating balance.

Net Debt#

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Net debt peaks as a share of GDP in 2014/15...

When compared to the Budget Update, net debt levels have reduced to be on average 2.4 percentage points of GDP lower than previously forecast. This reduction in net debt is owing to a stronger starting position at 30 June 2013 and an improved cash flow over the forecast period.

Similar to the operating surplus, core Crown operating cash flows[5] also return to surplus in 2014/15. However, once capital cash flows are included, residual cash remains in deficit two further years, reaching surplus of $1.2 billion in 2016/17, one year earlier than forecast in the Budget Update. By 2017/18, core Crown residual cash is expected to increase to a cash surplus of $3.1 billion.

Deficits are funded by an increase in net debt (through additional borrowing or a reduction in financial assets) while surpluses reduce net debt. In nominal terms, net debt is expected to peak on an annual basis in 2015/16 at $64.5 billion, but once residual cash surpluses are forecast, debt is expected to reduce.

Net debt as a share of GDP peaks in 2014/15 at 26.5% (a year earlier than in nominal terms). By 2017/18 net debt is expected to be 22.3% of GDP (Figure 2.11) in line with the Government's medium-term target of net debt brought back to a level no higher than 20% of GDP by 2020.

Figure 2.11 - Net debt

Source:  The Treasury

...with residual cash deficits mostly funded by issuing government bonds

Residual cash surpluses are reached earlier than previously forecast, largely owing to stronger tax receipts and a decline in cash payments. The lower proceeds from the Government Share Offer programme partially offset this increase.

Over the forecast period there is a cash shortfall of $4.4 billion. In order to fund this shortfall along with bond maturities, the bond programme is expected to raise funds of $33.6 billion over the forecast period. Over the forecast period, $26.1 billion of existing debt will be repaid, providing net cash proceeds of $7.5 billion (Table 2.6). The excess cash proceeds raised from the bond programme will be invested in financial assets and used to meet future debt maturities.

As the Crown's fiscal position is stronger at the start of the forecast period than was previously forecast, the bond programme to 2016/17 is $4.0 billion lower than forecast in Budget 2013. The higher-than-forecast starting cash position has allowed for a $2.0 billion reduction in the current year’s bond programme as well as the beginning of a buy-back programme to help manage cash flows around the record-large bond maturity in April 2015. A buy-back programme of the April 2015 bond is scheduled to commence in the second half of the 2013/14 fiscal year. Up to $3.0 billion is forecast to be repurchased by 30 June 2014, subject to market conditions.

Source: The Treasury

Total Crown Balance Sheet#

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Operating balance surpluses result in increasing net worth...

Net worth attributable to the Crown increased in 2012/13 for the first time since the global financial crisis and the Canterbury earthquakes. At its height, net worth attributable to the Crown peaked at $105.1 billion in 2007/08.

Net worth attributable to the Crown is forecast to continue strengthening in nominal terms, largely owing to forecast operating balance surpluses (of which just under half is attributable to gains on the Crown's investment portfolio), and grow to $69.2 billion by the end of the current year. Net worth is expected to grow another $23.2 billion to stand at $92.4 billion by 2017/18, as shown in Figure 2.12. As a share of GDP this is 34.2%, still well below the peak of 56.6% of GDP in 2007/08.

Figure 2.12 - Net worth attributable to the Crown

Source: The Treasury

...with assets increasing $35.5 billion over the forecast period...

Assets are forecast to increase by $35.5 billion, with the growth over the forecast period made up of investments in additional assets of $78.4 billion partially offset by reductions (largely depreciation) of $42.9 billion.

The largest asset growth over the forecast period is in the financial assets portfolio (Figure 2.13). This reflects investment growth in CFIs such as NZS Fund and ACC, with much of this growth recognised as gains in the Crown's operating balance with some growth in the asset base from reinvestment.

Figure 2.13 - Total Crown assets

Source:  The Treasury

Commercial assets increase $9.5 billion over the forecast period, largely owing to continued growth in the Kiwibank mortgage assets (that grow as their deposits from customers grow) and as SOEs increase their investment in physical assets.

The social asset portfolio (eg, schools, hospitals and social housing) increases by $10.9 billion by the end of the forecast period as a result of new capital spending (funded by the Future Investment Fund, as detailed in the Government Share Offer Programme section on pages 36 to 41), and as existing assets are replaced.

...while liabilities increase at a slower rate

The Crown's liabilities are expected to increase by $7.2 billion over the forecast period, largely driven by increased borrowing. Borrowings are forecast to increase $12.2 billion to $112.3 billion by 2017/18.

As shown in Figure 2.14, borrowing is mostly held in the financial liability portfolio (by the Treasury's Debt Management Office, and the Reserve Bank). Borrowings in this portfolio increase $2.5 billion over the forecast period to meet the Crown's cash deficits (refer to pages 31 to 32 for discussion of the bond programme). The remainder of borrowing is in the commercial portfolio, and is largely made up of Kiwibank deposits, which grow in line with the bank's mortgage assets.

Figure 2.14 - Total Crown borrowings

Source:  The Treasury

Figure 2.15 - Total Crown liabilities

Source:  The Treasury

Partially offsetting the growth in borrowings are reductions in liabilities as a result of settling obligations related to the Canterbury earthquakes. The Crown's earthquake-related insurance liabilities held in the financial portfolio (EQC and Southern Response) are forecast to decrease $8.4 billion over the five-year forecast period as all claims are expected to be settled by 2017/18.

The Crown's balance sheet is sensitive to market movements...

Many of the assets and liabilities on the Crown's balance sheet are measured at “fair value” in order to disclose current estimates of what the Crown owns and owes. Fair value can be derived in a number of ways, traditionally based on market prices, but where these are not available, values can be best estimates based on certain assumptions. While the measurement at fair value is seen as the most appropriate value of these items, it can be volatile, resulting in fluctuations in the value of the assets and liabilities with changes in the underlying assumptions. Table 2.7 shows an example of some of the key sensitivities to the valuation of the Crown's major assets and liabilities and the impact these can have on the operating balance.

1 Using 30 June 2013 sensitivities

Source: The Treasury

Financial assets are the largest asset group on the Crown's balance sheet and have increased significantly in recent years. CFIs (eg, NZS Fund and ACC) hold investments to make financial returns, and those asset values are dependent on market prices, interest rates and exchange rates, which can all be volatile.

The Crown has a number of significant long-term liabilities which are actuarially valued based on estimated future cash flows, over 50 years into the future. As part of the actuarial valuation, inflation rates are used to help estimate future cash flows while discount rates are used to obtain the value of those future cash flows in today's dollars (their present value). Changes in these assumptions can have significant impacts on the valuation because the cash flows are so large and over such long periods. Table 2.8 shows the impact that a 1% change in inflation and discount rates would have on the operating balance.

1. Using 30 June 2013 sensitivities.

Source: The Treasury

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

Outside of market factors, valuations are subject to a number of judgements and estimates. In general, as time goes on, better information becomes available and initial estimates are updated to reflect current information. Some examples of this include: ACC rehabilitation costs, earthquake-related insurance liabilities and student wage growth.

...while other risks still remain

In addition to those items on the balance sheet there are a number of liabilities (and assets) that may arise in the future but are not yet included; either because they are dependent on an uncertain future event occurring (eg, outcome of litigation) or the liability cannot be measured reliably. If these contingent liabilities crystallise, there will be associated costs with a negative impact on the operating balance. Refer to page 75 for a list of the contingent liabilities that the Crown was exposed to at 31 October 2013. Refer also to the Risks and Scenarios chapter for further discussion on balance sheet risks.

Government Share Offer Programme#

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At the time of the Budget Update, no transactions in the Government Share Offer programme had been completed. Since that time minority shareholdings in Mighty River Power, Meridian Energy and Air New Zealand have been sold and the Government has indicated that the sale of up to 49% of the shares in Genesis Energy will follow in the first half of calendar 2014. At the time the assumptions for this Half Year Update were finalised, the proceeds from the Crown reducing its shareholding in Air New Zealand were not known.

Note:

1. Net of direct costs and present value discounting.

Source: The Treasury

As a result of the progress to date (Table 2.9), two key assumptions underpinning the forecast fiscal impact of the programme have been updated in this current Half Year Update:

• Total proceeds are now expected to be within an estimated range of $4.6 billion to $5.0 billion, which is based on actual proceeds from the Mighty River Power and Meridian transactions and estimated proceeds from the Genesis Energy and Air New Zealand transactions. The Half Year Update forecasts assume the mid-point of this range of $4.8 billion. The previous $6 billion assumption was a mid-point estimate of a range of potential outcomes across the entire Government Share Offer programme. These outcomes have now narrowed considerably since the Budget Update. This section includes discussion on the changes in the estimate in proceeds over time.
• Given the Government's announcement regarding the timing of the Genesis Energy share offer, all proceeds from the programme are now expected to be received by 2014/15. The Budget Update did not forecast the timing of individual share offers, none of which had been completed by that point, and so assumed proceeds were spread evenly across the four years 2012/13 to 2015/16.

The fiscal impacts of these changes in assumptions are that, while net debt will decrease sooner than previously forecast, that reduction will be smaller as proceeds have been re-estimated. In addition, while the proceeds are received earlier (and so the estimated finance cost savings occur earlier), dividends and profits are also foregone earlier than previously forecast as the Government's share of the companies is reduced.

Source: The Treasury

This estimated profile is based on the mid-point of the estimated range of $4.6 billion to $5.0 billion, which was set before the proceeds from the Crown reducing its shareholding in Air New Zealand were known.

Notes:

1. Based on an average of the fiscal forecasts subsequent to the programme being completed.
2. Based on the mid-point estimated cash proceeds, the published gain from the Mighty River Power sale and loss from the Meridian Energy sale, and the published net asset position of Air New Zealand and Genesis Energy at 30 June 2013.

Source: The Treasury

The final fiscal impact of the Government Share Offer programme remains uncertain and dependent on a number of factors, including market conditions.

The figures in Table 2.11 are based on the current profit and dividend forecasts supplied by the companies, and forecast interest rates on government debt. This means the figures are a static estimate, at the current time, of the fiscal impact of the Government Share Offer programme.

The figures do not account for uncertainty and risks, and in particular the commercial risks around the estimated profits and dividends from the companies, and risks around future interest rates on government debt. The risks in relation to Mighty River Power and Meridian Energy were explained in the offer documents for these companies. Because of uncertainty and risk, a commercial entity would usually forecast profits that are greater than the Government's cost of borrowing. Whether forecast profits are actually delivered will depend on actual company performance.

Previous Economic and Fiscal Updates have disclosed annual estimated fiscal impacts of the Government Share Offer programme, as well as a five-year total. It is no longer possible to give annual figures, as the progress in the programme to date means that providing the latest annual estimates could allow forecast profits and dividends for individual companies in the programme to be calculated. Individual company forecasts are commercially sensitive, and may be “inside information” in relation to the Securities Markets Act 1988. Forecast profits and dividends are supplied to the Treasury by the companies under a confidentiality deed, under which the Treasury has agreed to preserve the confidentiality of this information, and to comply with the provisions of the Securities Markets Act 1988.

Given this, only totals or averages have been disclosed, consistent with section 26V of the Public Finance Act 1989. Future disclosures of the impacts of the Government Share Offer programme will follow the same approach.

Future Investment Fund

In Budget 2012 the Future Investment Fund (FIF) was established to allocate the estimated proceeds from the Government Share Offer programme, rather than issuing debt. So far, $2.1 billion of this fund has been allocated. A large portion of this allocation is expected to be spent on the Canterbury rebuild as well as investments in schools, hospitals, technology and irrigation.

Source: The Treasury

With the proceeds from the Government Share Offer programme now expected to be between $4.6 billion and $5.0 billion, the amount remaining to be allocated over the life of the FIF has declined since the Budget Update. However, based on current forecasts, the Government does not need to alter the current FIF spending profile as the current profile still ensures the FIF funds all new capital expenditure through to Budget 2016.

Changes to Estimate of Proceeds

Original Estimate

In the Supplement to the 2010 Investment Statement of the Government of New Zealand in May 2011[6] the Treasury estimated that the Government Share Offer programme was likely to result in gross sales in the order of $5 billion to $7 billion (Table 2.13). In part, that assessment was based on independent

Source: The Treasury

The estimated commercial values are for 100% of the companies. The figures for Mighty River Power, Meridian Energy, Genesis Energy and Solid Energy were based on the most recent independent commercial valuations of these companies by Macquarie Research, First NZ Capital and Forsyth Barr. The figure for Air New Zealand was based on its share price at the time. These valuation reports are available at: www.comu.govt.nz/publications/information-releases/valuation-reports/2010/

Solid Energy is no longer in a position to be part of the Government Share Offer programme in the near future. Excluding Solid Energy from the May 2011 estimate of proceeds gives a revised range of $4.38 billion to $6.14 billion. The Treasury's estimate of proceeds, $4.6 billion to $5.0 billion, is within this range.

Other factors that have affected the estimated proceeds from the programme include:

• falls in the share prices of comparable New Zealand electricity companies, reflecting a range of influences, and
• the revised contract between Meridian Energy and New Zealand Aluminium Smelters Limited (NZAS) which, according to Meridian Energy, reduced the value of its net assets by $476 million.

2013 Budget Update

The exclusion of Solid Energy from the programme was the only new information available at the time the fiscal forecasts for the Budget Update were finalised. The $6 billion figure used in previous fiscal forecasts was still within the revised range excluding Solid Energy, although it was towards the top of that revised range.

At that point the share offer for Mighty River Power had not been completed, and so none of the commercial valuations implicit in the $5 billion to $7 billion range had been tested by the market. At the top end of the price range in the offer document, proceeds from Mighty River Power would have been around $1.9 billion, which was above the top end of the estimated range that was part of the $5 billion to $7 billion range.

The Treasury therefore concluded that the Budget Update should retain the $6 billion mid-point estimate of proceeds.

Actual proceeds

Source: The Treasury

Total gross proceeds for the three transactions completed to date, at $3.93 billion, are towards the bottom of the May 2011 estimate. For the individual transactions:

• actual proceeds for the Mighty River Power share offer were slightly above the mid-point of the estimated range from May 2011
• actual proceeds for Meridian Energy were below the estimated range from May 2011, but proceeds were affected by the falls in the share prices of comparable New Zealand electricity companies, and the revised contract between Meridian Energy and NZAS, and
• actual proceeds for the Air New Zealand transaction were above the May 2011 estimated range, as a result of the significant increase in Air New Zealand's share price since then.

Accounting for minority interests

The treatment of the programme in the fiscal forecasts reflects that the Government retains the majority ownership and control of the companies. There is therefore no “sale of assets” reported in the consolidated financial statements. The revenue and expenses, assets and liabilities of these companies will continue to be fully consolidated by the Crown.

The key change to the financial statements is the disclosure of the non-controlling interest (often referred to as the “minority interest”) of the profits and equity in those companies.

The loss on disposal is calculated as the difference in the book value of the net assets sold and the cash proceeds. This loss is shown as a transfer within the equity section of the balance sheet as it is considered a transaction between owners. There is therefore no loss shown in the statement of financial performance.

Foregone profits represent the portion of profits that would have been recognised by the Government prior to the sale but are now attributable to the minority interests. Forecast foregone profits reduce the Government's OBEGAL. The actual change in the OBEGAL will depend on the actual profits the company generates, which may be different from what is currently forecast.

These profits are different from foregone dividends (although dividends are often a subset of profits), which represent dividend payments by the companies that will now be paid to minority interests. As dividends are a cash receipt, forecast foregone dividends increase the Government's net debt. Again, the actual change in net debt will depend on actual dividends paid by the companies.

Proceeds from the programme decrease net debt. This impact on the Government’s debt has flow-on impacts to finance costs. Overall, the programme is expected to decrease net debt by $4.2 billion by the end of the forecast period. This decrease serves to reduce finance costs for the Government.

Fiscal Forecast Assumptions#

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The fiscal forecasts are based on assumptions and judgements developed from the best information available on 3 December 2013, when the forecasts were finalised. Actual events are likely to differ from these assumptions and judgements. Furthermore, uncertainty around the forecast assumptions and judgements increases over the forecast period. The Canterbury earthquakes add further uncertainty to the economic and fiscal forecasts.

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

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

A summary of the key economic forecasts that are particularly relevant to the fiscal forecasts is provided in Table 2.15 below (on a June-year-end basis to align with the Government's balance date).

Notes:

1. Production measure.
2. Expenditure measure.

Source: The Treasury

In addition, there are a number of other key assumptions that are critical in the preparation of the fiscal forecasts.

Risks and Scenarios#

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Overview#

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• This chapter outlines the general economic and fiscal risks associated with the major assumptions underpinning the main forecast. Risks associated with the main forecast of the Half Year Update are evenly balanced, with upside risks to the domestic outlook having increased relative to recent Economic and Fiscal Updates, while risks associated with a negative global shock remain.
• Domestically, risks with potentially the largest impact on the New Zealand economy relate to the speed of the Canterbury rebuild and its interaction with the wider economy, the extent to which demand is boosted by population growth via higher net migration inflows and the degree of caution displayed by consumers.
• Major advanced economies continue to undergo significant adjustments to reduce government debt, while the effects of monetary easing remain uncertain. Emerging economies are at risk from a rise in global interest rates once the US begins tapering its quantitative easing programme, which could have negative implications for New Zealand's economy through both financial channels and the terms of trade.
• Two scenarios are presented that represent just two possible ways the New Zealand economy could deviate from the main forecast. Scenario one is based on a stronger domestically driven, cyclical pick-up in GDP growth, in part driven by higher external net migration. This scenario results in nominal GDP being $20.7 billion higher over the forecast period. In scenario two, a slowing of growth in emerging Asia negatively impacts New Zealand's terms of trade and lowers nominal GDP by $12.5 billion over the forecast period. If these economic risks or any significant deviations from the main forecast were to eventuate they would impact on the Government’s fiscal performance and position.
• In addition to risks associated with the economy, the Crown is also subject to expenditure and balance sheet risks. In particular, volatility in market prices such as interest rates can have a significant impact on the Crown's fiscal position.

Introduction#

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The first part of this chapter outlines the key risks to the economic outlook. These risks mainly relate to the key judgements associated with the main forecast. In the second part of the chapter, two scenarios are presented that represent just two possible ways the New Zealand economy could deviate from the main forecast. The chapter then focuses on the established channels between the risks facing the economy and the Crown’s fiscal position.

Economic Risks#

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Risks to the forecasts are relatively balanced

As in the BudgetUpdate, risks around the main forecasts are fairly evenly balanced, with upside risks to the domestic outlook having increased relative to recent Economic and Fiscal Updates, while risks associated with a negative global shock remain.

There are a large number of ways in which events could turn out different from forecast. The risks with potentially the largest impact on the New Zealand economy relate to the speed of the Canterbury rebuild and its interaction with the wider economy, the extent to which demand is boosted by population growth via higher net migration inflows and consumer behaviour. Global economic developments, including shocks as the world economy undergoes an extended period of transition, could lead to more rapid adjustments for the prices of some of our main commodity exports and therefore affect the path of the terms of trade.

All of these factors are likely to have a significant role in influencing the size and dynamics of the current economic cycle. Other key judgements made in the forecasts include the level and flow-through of the exchange rate, the current amount of spare capacity in the economy and monetary policy developments.

The earthquake rebuild remains a significant area of uncertainty...

There is considerable uncertainty associated with the timing and magnitude of the Canterbury earthquake rebuild. Key determinants of the speed of the rebuild include insurance settlements and the capacity and capability of the construction sector. If the rebuild were to progress more slowly than expected, residential and non-residential construction and employment could all be weaker than in the main forecast. The overall size of the rebuild will also be influenced by the extent to which private firms ultimately decide to reinvest insurance proceeds within the Canterbury region.

Another risk to the forecasts is how much the Canterbury rebuild crowds out activity in other parts of the economy. Even with inward migration and the importation of capital goods, New Zealand has limited construction capacity and consequently it is likely that some rebuild activity will crowd out other activity elsewhere. Implicitly this means that activity outside Canterbury at the peak of the building cycle is likely to be a lower share of GDP relative to previous construction upturns. If the pace and level of the Canterbury rebuild is more sluggish, there will be less displacement of activity in the rest of the country and less competition for construction resources, resulting in less upward pressure on prices.

...as does the strength of the current net migration cycle...

Despite large upward revisions to the net migration assumption since the Budget Update, there is the possibility that weaker activity in Australia and other developed economies sees even stronger net inflows into New Zealand. The impact on the economy will be influenced by the skills of migrants and the areas where they settle (or remain in the case of New Zealanders who choose not to leave for abroad). For example, appropriately skilled migrant inflows into Canterbury could mitigate some of the risks related to the Canterbury rebuild, albeit adding to accommodation pressures in the near term. However, a large proportion of the population gains from higher net migration will likely place additional pressure on the housing market in other parts of the country, such as Auckland, contributing to stronger domestic demand, which then flows through to the wider economy through multiplier effects.

…while households could be less cautious, resulting in greater cyclical volatility

If households exercise less spending restraint than is anticipated in the main forecasts, consumption may rise faster than disposable income, with the shortfall being funded by rising debt, resulting in a negative saving rate over the forecast period. While this would be positive for GDP growth in the near term, owing to a boost to private consumption, it may require a sharper adjustment in the medium term as households become more indebted and need to repair their balance sheets. Elevated debt levels also expose household balance sheets to sharp corrections in house prices.

The Alternative Scenarios section explores the risk of a more protracted and larger net migration cycle and more willingness on the part of households to spend, all resulting in a more cyclical pick-up across the economy.

Global downside risks persist…

Global risks continue in the background and remain skewed to the downside as major advanced economies continue to undergo significant adjustments to reduce government debt, and in addition the effects of monetary easing and its subsequent withdrawal remain uncertain. Some emerging Asian economies, which are significant for New Zealand's trading partner growth, could also experience weaker growth once global monetary stimulus is withdrawn, particularly in the US.

...with elevated debt levels requiring ongoing adjustment

European countries remain highly indebted, but the probability that the crisis will worsen significantly has subsided over the past year owing to actions taken by the European Central Bank and some pick-up in euro area growth. Nevertheless, there remains considerable ongoing risk of further flare-ups, which would further dampen growth in the region and trigger financial market turmoil if an event was significant enough. Peripheral countries in the euro area continue to struggle with austerity measures which, compounded by poor competitiveness, create the potential for political instability.

The US must also undergo significant adjustment to reduce high government debt. Following on from events in October when the debt ceiling was raised temporarily to prevent a default on interest payments for US Treasury debt, there is a risk that brinkmanship continues to create heightened uncertainty concerning a permanent increase in the debt ceiling. This could lead to significant volatility in global financial markets which rely heavily on US Treasury bills and bonds as collateral.

More sustained growth and therefore reduced need for monetary stimulus...

Well anchored inflation expectations and existing spare capacity mean Japan, the US and the UK are still undertaking significant quantitative easing programmes to stimulate their economies through the purchase of financial assets. However, the US economy has recently shown signs of more sustainable growth and markets are expecting a tapering of quantitative easing in early 2014, although the US remains vulnerable if the removal of stimulus proves to be premature. Japan has implemented additional fiscal stimulus and structural reforms to kick-start growth. However, whether this will translate into sustainable growth over the medium term remains uncertain, particularly following a prolonged period of economic malaise.

…could expose fragilities elsewhere...

A rise in global bond rates once the US tapers its quantitative easing programme could leave some emerging economies significantly exposed given their currently high levels of debt. This could be exacerbated by losses in the banking sector in those emerging economies if the rapid growth in credit in recent years was facilitated by easy lending standards. An increase in US bond rates, combined with a weaker economic outlook in emerging market economies, could also lead to an outflow of foreign capital, putting downward pressure on exchange rates and raising inflation.

Of New Zealand's emerging Asia trading partners, Indonesia and India are the most vulnerable, as neither is currently running a current account surplus. The risk of a severe event similar to the Asian financial crisis in 1997 appears less likely now given that most Asian economies have floating exchange rates, hold larger foreign exchange reserves and have less foreign currency-denominated external debt.

…while risks for New Zealand's key trading partners remain…

Of more significance to New Zealand are the risks to the growth outlook for China, which is our second largest trading partner after Australia. The property investment and construction boom in China following the global financial crisis led to a build-up of poor-quality debt, especially in the local government sector. The risk of a sharp correction in house prices remains, and could expose a high level of bad debts in the banking sector and may cause credit conditions to tighten even further.

China is aiming to rebalance its economy away from export- and investment-led growth towards consumption. Rebalancing could lead to lower growth in the short term, particularly if the transition is disorderly, while faster progress to this goal would benefit New Zealand as it is a major supplier of food products to Chinese households. Weaker growth in China would also negatively impact on activity in emerging Asia, particularly amongst commodity producers, given their reliance on Chinese demand and tightly-linked supply chains.

One of the main risks associated with New Zealand's largest trading partner, Australia, is the transition of growth from investment to domestic demand and exports. It will take some time for the exports associated with this investment to come online, requiring increased residential and non-mining business investment to replace high levels of mining investment and maintain Australia's recent strength in economic growth. Australia is also exposed to a slowdown in China and emerging market economies which would reduce the demand for hard commodities.

…which, if they eventuate, would adversely impact on the New Zealand economy

Weaker growth in our trading partners could result in weaker demand for New Zealand's exports and commodity prices may fall. This would affect domestic incomes, confidence and asset prices as households behave more cautiously owing to higher risk aversion. The result of these developments would be lower private consumption, while more caution on the part of firms would decrease business investment growth and new hiring. The higher level of uncertainty faced by financial market participants could flow through to reduced availability, and a higher cost, of credit for New Zealand. However, in contrast to other developed countries, there is still scope for the Reserve Bank to provide liquidity as needed and lower the base interest rate (or slow increases) to mitigate the impact of higher funding costs on the interest rates faced by households and businesses.

Other risks surround key judgements...

Economic relationships are complex and developments are subject to inherent uncertainty, particularly the evolution of the exchange rate. There is a risk that the exchange rate remains supported for longer owing to the stronger domestic outlook, prolonged monetary stimulus in advanced economies and ongoing gains in global commodity prices for key New Zealand exports. A higher exchange rate would decrease tradables inflation, as imported goods would become less expensive, and encourage consumption of imported products. On the other hand, exporters and import-competing businesses would become less competitive, hindering manufacturing and services exports and production of import substitutes for the domestic market.

Another area of uncertainty is the current amount of spare capacity in the economy (the output gap) and its relationship with inflation. If the output gap is currently more negative, because potential GDP is higher than we have assumed in the main forecast, then there is greater scope for an increase in real GDP with less domestically generated inflation. Alternatively, if the strength of inflationary pressures were to surprise, perhaps owing to a stronger spill-over of rebuild costs from Canterbury into the wider economy, the response of monetary policy may be greater than anticipated. While implemented for macro-prudential reasons, the effectiveness of the recent loan-to-value restrictions in moderating house price growth is another area of uncertainty.

…including the perennial risks associated with the weather

Pasture conditions have improved since last summer and the impact of the drought on real GDP was broadly in line with estimates outlined in the Budget Update. In the near term, the agricultural sector is expected to bounce back strongly from the drought, although this is dependent on the assumption that pasture conditions remain favourable in coming quarters. Feed prices and availability amongst New Zealand's international competitors will also influence global supply and have a strong bearing on commodity prices and therefore the path of New Zealand's merchandise terms of trade.

Alternative Scenarios#

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The following scenarios show how the economy might evolve if some of the key judgements in the main forecast are altered (Table 3.1). The scenarios are only illustrative in that they are two of a large number of possible examples, and do not represent upper or lower bounds for the forecasts, with more extreme paths possible. They represent what are assessed to be key risks to the Half Year Update forecast and illustrate the impact of relatively small changes in the assumptions on key economic and fiscal variables. Although not the most likely outcome, there is a realistic prospect that these scenarios could occur.

Notes:

1. March quarter, seasonally adjusted.
2. March quarter average.
3. June years.

Sources: Statistics New Zealand, the Treasury, Reserve Bank

Scenario One - Stronger Cyclical Growth

A more cyclical pick-up in domestic growth…

Scenario one is based on a stronger domestically driven, cyclical pick-up in GDP growth, in part driven by higher external net migration which raises domestic demand and spills over to wider confidence amongst firms. In this scenario it is assumed that the peak and duration of the net migration cycle is greater than in the main forecast and reaches 33,000 in the year to September 2014, only 10,000 below the peak in the early 2000s. This results in an addition of 16,000 people to the population over the forecast period (Figure 3.1) and follows from a relatively more attractive New Zealand economy and outlook compared to other developed countries, particularly Australia. Within this, the arrival of international migrants to assist in the Canterbury rebuild is greater, particularly from the UK and Ireland, as well as Asia.

An increase in the number of international arrivals adds to demand for housing, particularly in the Auckland and Canterbury regions where job opportunities are more abundant and the pressure on the existing housing stock is already high. Stronger competition for existing homes leads to higher house price inflation relative to the main forecast. As a result, annual house price inflation peaks at about 15% in 2014, compared with around 10% in 2013 in the main forecast.

Figure 3.1 - Annual net external migration

Source:  Statistics New Zealand, the Treasury

Figure 3.2 - Private consumption growth

Source:  Statistics New Zealand, the Treasury

...with private consumption and investment growing more strongly...

Faster house price growth leads households to resume mortgage equity withdrawal to finance consumption, and the relationship seen between house prices and consumption over the 2000s reasserts itself. Annual real private consumption growth averages 4.5% in this scenario over 2014 and 2015 compared to 3.0% in the main forecast, although growth is slower beyond 2016 (Figure 3.2). Additional demand for the existing housing stock also provides further support for residential investment which is already forecast to reach a similar peak (as a percent of GDP) as in the previous housing boom. The lift in domestic demand spills over to business confidence, resulting in increased market investment and hiring. Employment growth is therefore higher, which contributes to a lower unemployment rate over the forecast period.

In the near term, the demand-driven pick-up in actual GDP sees the output gap close earlier, resulting in faster growth in domestically generated inflation. Although the influx of overseas migrants contributes to an increase in potential GDP over the forecast by lifting the working-age population, the output gap is more positive owing to the stronger pick-up in actual GDP. The output gap peaks at 1.9% of potential GDP over the medium term as opposed to 0.9% in the main forecast, but is still much narrower than the cycle in the mid-2000s.

Higher inflation and inflation expectations in the near term see the Reserve Bank react by tightening monetary policy sooner and more aggressively over the cycle to maintain price stability. The 90-day bank bill rate reaches 6.0% by March 2017, around 100 basis points higher than the main forecast, which could see floating mortgage rates rise to around 8%. Higher interest rates act to temper private consumption and investment growth and, as a result, real GDP growth beyond 2016 is weaker relative to the main forecast.

...but domestic and external imbalances become greater

As the higher consumption is partly financed by borrowing against the increased value of housing, rather than higher incomes, the household saving rate is significantly lower than in the main forecast. The household saving rate reaches a low of -3.6% of household disposable income in the March 2017 year compared to the main forecast where it is 0.1% in 2017. This negative saving rate, along with higher interest rates at the end of the forecast period, drives lower consumption growth relative to the main forecast in 2017 and 2018. It is likely that further adjustment to household balance sheets will be required sometime beyond the forecast period, which would continue to constrain future consumption growth.

The annual current account deficit is wider and reaches 7.2% of GDP in March 2018, versus 6.4% in the main forecast. This is because some of the increased consumption and investment is met from imported goods and services. The higher interest rate track also means the exchange rate remains elevated for longer, which encourages more imports and constrains services exports, further contributing to a wider current account deficit.

GDP and tax revenue increases...

Stronger private consumption and residential investment, along with greater price pressure, result in nominal GDP being a cumulative $20.7 billion higher over the forecast period. The increased activity drives a stronger labour market in the early years of the forecast period, with the unemployment rate falling to 5.1% in March 2016, 0.3 percentage points lower than in the main forecasts.

Core Crown tax revenue is a cumulative $8.6 billion higher over the forecast period as a result of the higher nominal GDP. Higher nominal consumption and residential investment boost GST revenue by $2.1 billion over the forecast period. The stronger labour market and increased competition for workers push up wages and salaries, boosting source deductions revenue by a cumulative $1.8 billion. The stronger economic activity allows firms to increase their margins, boosting profitability and increasing corporate tax by $1.9 billion out to June 2018. Higher short-term interest rates, needed to control rising inflation, boost tax on interest by $1.8 billion.

Figure 3.3 - Operating balance (before gains and losses)

Source:  the Treasury

Core Crown expenses are slightly lower than in the main forecast owing to a fall in debt servicing costs and, to a lesser extent, a reduction in welfare payments. The decrease in welfare payments is driven by a lower number of recipients receiving unemployment-related benefits, reflecting the stronger labour market. In this scenario, OBEGAL records a larger surplus of 0.6% of GDP in the June 2015 year, the same year surplus is achieved in the main forecast (Figure 3.3). Net core Crown debt as a percentage of GDP peaks at 25.9% in the June 2014 year, compared to 26.5% in the June 2015 year in the main forecast and falls away more quickly, dropping below 20% by June 2018 (Figure 3.6).

...but fiscal policy assumed to be restrained

While OBEGAL records a larger surplus in 2015 in this scenario, discretionary fiscal policy is unchanged relative to the main forecast and is restrained compared to the mid-2000s cycle. The subdued growth in government spending in the main forecast maximises the prospect of a subsequent “soft-landing” for the economy as well as minimising external vulnerabilities. If the extra income received by the Government was used to increase spending it would add to the cycle by increasing domestic demand, contributing to price pressures, which could then necessitate tighter monetary policy. This may support the exchange rate remaining higher for longer, which could result in greater imbalances such as an even larger current account deficit.

Scenario Two - Slower Growth in Emerging Asia

Increases in global interest rates trigger slower growth in emerging Asia…

Scenario two is based on a slowing of growth in emerging Asia, which would negatively impact New Zealand's terms of trade as demand for soft commodities falls. It is assumed that earlier and faster-than-expected tapering of asset purchases in the US leads to a tightening of credit conditions in emerging Asia, excluding China. Tighter credit conditions in the region constrain business investment, while household disposable income falls as servicing costs on outstanding household debt rise, limiting household spending growth.

…while domestic imbalances partially unravel in China...

Slower growth in China is triggered by relatively disorderly corrections in domestic financial and real estate markets. Specifically, these events could arise from a reduction in infrastructure investment as local government debt mounts to unsustainable levels, a sharp correction in the overheated housing market which results in a tightening of credit conditions and/or large-scale defaults in the informal banking sector. It should be noted that this scenario characterises a disorderly rebalancing event as opposed to a significant financial market failure that would have more severe implications, but is considered to be unlikely. Weaker Chinese demand for commodities produced in the rest of emerging Asia compounds the impact of the initial slowdown in the region. In addition,growth in our largest trading partner, Australia, slows as demand for hardcommodities from emerging Asia falls in the face of weaker growth.

…resulting in weaker growth in our trading partners...

Overall, the shock lowers trading partner growth between 2014 and 2016 relative to the main forecasts (Figure 3.4). The weaker-than-assumed activity in emerging Asia (including China) flows through to New Zealand in the form of lower pricesfor key commodity exports, particularly dairy, meat and forestry products, resulting in a larger drop in the merchandise terms of trade in the near term (Figure 3.5). As in the main forecast, the assumed global supply response to previously strong demand still occurs in this scenario, adding to the downward pressure on prices for key commodity exports. The terms of trade in this scenario remain at a lower level over the medium term, albeit one that is still high by historical standards, which reduces incomes and results in more cautious household spending over the forecast period. In this scenario, private consumption growth averages around 2.4% annually, compared with 2.6% in the main forecast. Risk aversion is heightened for firms, leading to lower business investment as they are less willing to commit to expenditure in a more uncertain environment.

In the main forecast we assume that the labour market continues to improve as increasing employment contributes to a gradual decline in unemployment. In scenario two, a weaker pick-up in domestic activity and more caution on the part of businesses result in subdued employment and the unemployment rate recovers to a lesser extent. The assumption of a weaker labour market sees the unemployment rate fall to 5.0% by March 2018, compared to 4.7% in the main forecast. This results in more spare capacity in the economy and less domestically generated inflation.

Figure 3.4 - Trading partner growth

Source:  Haver Analytics, the Treasury

Figure 3.5 - Merchandise terms of trade (SNA)

Source:  Statistics New Zealand, the Treasury

…causing weaker nominal GDP…

Weaker domestic activity, combined with lower terms of trade and CPI inflation, reduces nominal GDP by $12.5 billion over the forecast period compared to the main forecast. The lower terms of trade in this scenario weaken the goods trade balance over the forecast period which, along with the lower nominal GDP, increases the current account deficit as a percentage of GDP relative to the main forecast. The current account balance reaches a deficit of 7.1% of GDP by March 2018, compared to 6.4% in the main forecast.

…as well as lower tax revenue and operating balance

Core Crown tax revenue is a cumulative $3.9 billion lower over the forecast period in this scenario, largely owing to nominal GDP being $12.5 billion lower over the forecast period. The weaker labour market and less inflationary pressure lower worker incomes, which reduces source deductions revenue by $1.3 billion over the forecast period. The economy's weaker nominal activity means that business profitability is reduced, resulting in corporate taxes being a cumulative $1.0 billion lower. Resident withholding tax is $0.7 billion lower over the forecast period with interest rates increasing less than in the central forecast as inflation is closer to the mid-point of the target band. Weaker nominal consumption and residential investment reduces GST revenue by a cumulative $0.4 billion over the forecast period.

Core Crown expenses are slightly higher than in the main forecast, driven by an increase in debt servicing costs. Welfare payments are broadly similar to the main forecast as the higher number of recipients receiving unemployment-related benefits is largely offset by lower indexation adjustments to payment rates of many benefits and superannuation. This reflects both lower inflation and wage growth. In this scenario, the return to surplus of OBEGAL is delayed by one year until the June 2016 year (Figure 3.3). As a consequence, net core Crown debt as a proportion of GDP is higher at the end of the forecast period (June 2018), falling to 24.3% compared to 22.3% in the main forecast (Figure 3.6).

Figure 3.6 - Net core Crown debt

Source:  The Treasury

General Fiscal Risks#

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The remainder of this chapter focuses on the links between the risks to the performance of the economy and the Crown's fiscal position. For more on fiscal risks, see the Specific Fiscal Risks chapter on page 61.

Fiscal Sensitivities

Table 3.2 provides some rules of thumb on the sensitivities of the fiscal position to small changes in specific variables. For example, if, for some reason, nominal GDP growth is one percentage point faster than we have forecast each year up to June 2018, tax revenue would be expected to be around $4.0 billion (1.5% of GDP) higher than forecast in the June 2018 year as a result. The sensitivities are broadly symmetric and if nominal GDP growth is one percentage point slower each year than we expect, tax revenue would be around $3.9 billion lower than forecast in the June 2018 year. However, these figures can be influenced by the composition of growth as different types of activity have different effective tax rates.

A different interest rate path than that forecast would also impact on the fiscal position. A one percentage point lower interest rate would result in interest income on funds managed by the Treasury's New Zealand Debt Management Office (NZDMO) being $178 million lower in the June 2018 year. This would be more than offset by interest expenses being $384 million lower in the June 2018 year.

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

Source: The Treasury

Revenue Risks

One of the major sources of risk to the fiscal position arises from the inherent uncertainty about future tax revenue. The amount of tax revenue that the Government receives in a given year is closely linked to the performance of the economy. Figure 3.7 plots the main tax revenue forecast, along with confidence intervals around those forecasts based on the Treasury's historical tax forecast errors and the assumption of an even balance of risks around the central forecast.[7] The outermost shaded area captures the range +/- $7.8 billion in the June 2018 year within which actual tax outturns fall 80% of the time.[8]

The tax revenue forecasts from the two scenarios are also shown in Figure 3.7. The 2008/09 global financial crisis showed that exogenous shocks can have severe impacts on government revenue. Further adverse weather conditions or a global downturn would have a negative impact on the Government's fiscal position. Should any of the uncertainties outlined in the Economic Riskssection eventuate differently from the main forecast, government revenue would likely be different from forecast, with scenarios one and two being examples of possible outcomes.

Figure 3.7 - Core Crown tax revenue uncertainty

Source:  The Treasury

Based on average historical forecast errors and an even balance of risks, Figure 3.7 suggests that tax revenue over the forecast period would be stronger than scenario one approximately 30% of the time and weaker than scenario two approximately 40% of the time.

There is also uncertainty around government revenue arising from the performance of SOEs and the path of interest rates as outlined in the Fiscal Sensitivities section.

Expenditure Risks

One-off and unexpected expenditure shocks can have a large impact on the Crown's operating balance in the year that they occur. Persistent errors in forecasting the cost of various programmes (ie, policies that cost more than the Government allows for) can also have substantial ongoing effects on the fiscal position.

There is also considerable uncertainty regarding the effect of the performance of the economy on Crown expenditures. This uncertainty largely relates to the operation of the so-called automatic stabilisers. For example, if the economy performs better (worse) than expected in a given year, official expenditures on social programmes may be lower (higher) than planned.

Meanwhile, the destructive seismic events of recent years have underlined the inherent exposure of the Crown's fiscal position to exogenous shocks. The Government's fiscal position would be impacted if another catastrophic earthquake were to occur or if the costs associated with the recent events exceed the updated estimates.

The ageing population also presents risks to the medium-term fiscal position, particularly to the extent that demographic forecasts may prove to be too low or high. An ageing population requires increased government expenditure, particularly for health and superannuation spending.

Balance Sheet Risks

In addition to risks around revenue and expenditure, the Crown's financial position is exposed to risks to its balance sheet. While some are unavoidable, the Crown's general approach is to identify, avoid or mitigate these risks where practicable. For more information on balance sheet risks, see the Fiscal Outlook chapter on pages 34 to 35.

The largest source of balance sheet risk is volatility in asset and liability values owing to movements in market variables such as interest rates, exchange rates and equity prices. This may result in an operating balance impact. Of the Crown's aggregate financial risk, roughly a third is estimated to be attributed to this “market risk”.[9] Three areas of the balance sheet are particularly susceptible:

• Financial assets held by the CFIs are sensitive to financial-market volatility. CFIs diversify their portfolios across a range of financial assets to manage exposures to specific market risks. The Crown Ownership Monitoring Unit (COMU) estimates a 10% fall (rise) in world share markets would lead to a 4% to 5% fall (rise) in the value of the Crown's financial portfolio.
• Insurance and retirement liabilities and provisions are prone to market volatility through their actuarial valuations, which are sensitive to assumptions about variables such as interest and inflation rates, and risk margins.
• Physical assets such as land, buildings, state highways and military equipment are susceptible to valuation movements through changes in property market conditions, interest rates and changes in the costs of construction. This will affect the recorded value of physical Crown assets.

Business risks, relating to the broader commercial environment, may also affect the Crown's balance sheet. A number of entities owned by the Crown, including commercial and social entities, have their financial performance and valuations impacted by these external factors.

Funding Risks

The New Zealand Crown remains in the top-20 rated sovereigns globally, with the top Aaa foreign-currency rating from Moody's and AA foreign-currency ratings from Standard & Poor's and Fitch. The outlook is stable across all three agencies.

The downside risks identified by the rating agencies are broadly in line with the risks identified earlier in the chapter. In the case of an increase in global risk-aversion and in the absence of a marked improvement in the external position, New Zealand may be more likely to face a degree of funding pressure in the future. All things being equal, any further deterioration in the ratings outlook could serve to raise debt-servicing costs for the Crown. On the other hand, additional downward pressure on borrowing rates is possible if diversification flows, particularly away from Europe, continue in the future.

The Crown is also susceptible to "liquidity risk" with respect to its ability to raise cash to meet its obligations. This risk, however, is relatively small given ongoing management of the core Crown's liquidity position by the Treasury's DMO, as well as the Government's commitment to maintaining prudent debt levels.

Specific Fiscal Risks#

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The Statement of Specific Fiscal Risks is required by the Public Finance Act 1989 to set out, to the fullest extent possible, all government decisions and other circumstances known to the Government at the date of the finalisation of the fiscal forecasts that may have a material effect on the fiscal and economic outlook, but are not certain enough in timing or amount to include in the fiscal forecasts. Although the process for disclosure of specific fiscal risks involves a number of parties, including government departments, the Treasury and the Minister of Finance, there remains a possibility that not every risk is identified. Disclosure of known risks is also subject to specific requirements and materiality thresholds, which are described after the Statement of Specific Fiscal Risks.

Overview#

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Specific fiscal risks can be positive or negative and can affect revenue or spending. The links between external events and spending are indirect because new policies that change spending and revenue usually require a decision by the Government and approval from Parliament. The approach taken in this chapter is to disclose those potential policy decisions and key areas of uncertainty that may have a material effect on the fiscal outlook.

The Government generally sets aside allowances of new funding for future Budgets to manage uncertainty and cost pressures. These allowances are included in the fiscal forecasts. Current fiscal management policy is for future policy decisions affecting expenses or capital expenditure to be met through reprioritisation or from within existing provisions included in the fiscal forecasts. Future policy decisions are risks to the fiscal forecasts only to the extent that they cannot be managed from within:

• existing baselines or Budget allowances for operating expenditure, or
• the existing Crown balance sheet for capital expenditure, including the Future Investment Fund.

Notwithstanding this, known material policy risks are identified as specific fiscal risks, even though the Government has more control in managing such risks through reprioritisation, the existing Crown balance sheet and the Budget allowances. This is done to ensure a prudent approach to the disclosure of risks, improve transparency and not pre-judge future decisions by governments.

The specific fiscal risks are categorised into:

• Potential policy decisions affecting revenue: For example, changes to tax policy or ACC levies could reduce or increase government income.
• Potential policy decisions affecting expenses (expected to be funded from reprioritisation or Budget allowances): Costs of policy proposals could increase or decrease expenses depending on decisions taken, and they are risks to the fiscal forecasts only to the extent that they cannot be managed within existing baselines or Budget allowances.
• Potential capital decisions (expected to be funded from the existing Crown balance sheet, including the Future Investment Fund): Capital investment decisions are risks to the fiscal forecasts only to the extent that they cannot be managed within the existing Crown balance sheet, including the Future Investment Fund.
• Matters dependent on external factors: The Crown's liability for costs is sometimes dependent on external factors such as the outcome of negotiations or international obligations.

A range of generic risks to the fiscal forecasts are not recognised as specific fiscal risks:

• The most significant economic risks have been identified in Chapter 3.
• Business risks and volatility in the returns from the Crown's investments relating to the broader economic and commercial environment.
• General cost pressures, such as those associated with demographic changes (eg, an ageing population).
• Potential risks from changes in demand for government services or transfer payments owing to underlying structural factors (such as changes in demand for Jobseeker Support).
• The costs of future individual natural disasters, and other major events, as they usually occur infrequently and their occurrence, nature and timing cannot be predicted. Once a disaster does occur, a number of choices arise about how to respond and when potential liabilities are recognised (eg, through setting aside an allocation of funding for the disaster). Specific risks are disclosed at this point based on the range of possible responses.

The final part of the chapter contains a current list of contingent liabilities and contingent assets. Contingent liabilities are costs that the Crown will have to face if a particular event occurs or are present liabilities that are unable to be measured. Typically, contingent liabilities consist of guarantees and indemnities, legal disputes and claims on uncalled capital. The largest quantified contingent liabilities are to international financial organisations and mostly relate to uncalled capital and promissory notes. Contingent assets are possible assets that have arisen from past events but the value of the asset, or whether it will eventuate, will not be confirmed until a particular event occurs.

Statement of Specific Fiscal Risks#

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Summary Table

The matters listed below are disclosed as specific fiscal risks because they meet the rules for disclosure outlined after this Statement. Full descriptions of the risks listed below are set out in the next section. Where quantification is possible, this is included in the description of the risk.

Potential Policy Decisions Affecting Revenue

ACC - Levies (Unchanged)

Levy rates for the Work, Earners' and Motor Vehicle accounts are set by Cabinet following a public consultation process. Claims experience, ACC performance and economic assumptions (particularly discount rates) can impact insurance expenditure, both in the current year and the estimated future liability. If any of these factors differ from what is forecast the revenue collected may be more or less than required to cover the costs of claims, resulting in unplanned savings or costs which could have a corresponding impact on the operating balance.

ACC - Funding Policy Review (Unchanged)

The Government is undertaking a review of ACC's funding policy. Adopting a lower funding target band midpoint would result in a reduction in levies and reduce Crown revenue and Crown assets, with a flow-on impact to the operating balance.

Revenue - Income-sharing Tax Credits (Unchanged)

The Government has introduced legislation to establish an income-sharing tax credit. If passed as introduced, 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 could reduce tax revenue by $500 million a year once the scheme is fully operational. The Finance and Expenditure Committee has recommended that the significant fiscal cost of the package be addressed before the Bill proceeds further.

Services Funded by Third Parties (Unchanged)

A wide range of government services are funded through third party fees and charges. Demand for these services can vary with a direct impact on revenue received. There is a risk the Government may need to provide additional funding if revenue collected is lower than the total costs of providing the services. There is also a risk that changes will be required to the way government services are delivered, which could result in costs to the Crown.

Potential Policy Decisions Affecting Expenses (Expected to be Funded from Reprioritisation or Budget Allowances)

ACC - Work-related Gradual Process Disease and Infection (Unchanged)

Under current legislation, the Government incurs an obligation for Work-related Gradual Process Disease and Infection claims when the claim is made, and an expense is recognised at this point. The liability for commercial accident and sickness insurance contracts would usually be recognised when exposure to conditions that will give rise to a claim occurs. An amendment to legislation would be required to recognise claims at the same time as for commercial contracts. There are currently no plans to make such a change. An initial adjustment to the liability, and an expense of about $650 million would need to be reported if such an amendment were to be made.

Budget Operating Initiatives (New)

The Government is yet to make decisions on any potential package of new operating initiatives for the upcoming Budget. New operating initiatives represent a risk to the forecasts only to the extent they cannot be managed through reprioritisation or from within the existing Budget allowance for new operating spending in the forecasts. The Government's stated intention is that all new operating initiatives will be managed through these mechanisms.

Canterbury Earthquake Recovery - Christchurch City Council/Crown Cost Sharing (Changed)

The Crown is partially funding the recovery of local infrastructure in Canterbury as set out in the cost sharing agreement with the Christchurch City Council. The agreement includes a review clause. The review is to be completed by 1 December 2014. As a result, the Crown's contribution could differ from that included in the fiscal forecasts.

Canterbury Earthquake Recovery - Christchurch Central Recovery Plan (Changed)

The Crown is partially funding the construction of Anchor Projects as part of the Christchurch Central Recovery Plan as set out in the cost sharing agreement with the Christchurch City Council. The extent of funding will vary from project to project, depending on final project costs. Business cases for the development of Anchor Projects are in their early stages. Project costing for construction of the Anchor Projects will become increasingly clear during the business case process and the subsequent procurement phase. An estimate of the cost has been included in the fiscal forecasts but the Crown's eventual contribution may differ.

Communications - Ultra-Fast Broadband Initiative (New)

The Government has expressed support for Crown Fibre Holdings to enter into discussions with Chorus Limited to help manage potential issues for Chorus in delivering the Ultra Fast Broadband Initiative. Depending on their nature, the outcomes of those discussions could give rise to a fiscal risk. The Government's expectation is that any options arising from the discussions will remain within the current funding envelope.

Defence Force - Mid-point Rebalancing Review (Changed)

The New Zealand Defence Force (NZDF) savings and reform programme will be on-going and integrated into normal business practice from 2014/15. The Government is yet to make final decisions on future funding for NZDF. However, funding increases may be approved for NZDF within the forecast period.

Government Response to Wai 262 (Unchanged)

The Waitangi Tribunal's report on the Wai 262 claim focuses on the protection of Māori culture and identity, with a particular focus on mātauranga Māori and associated taonga. The Tribunal's recommendations are directed towards a number of government agencies individually, as groups and across sectors. The Government has yet to respond to the Tribunal's report and recommendations.

Housing - Reform of Social Housing (Unchanged)

The Government has decided to change the policy settings for social housing. This includes growing third party providers of social housing, increasing the effectiveness of financial assistance, and Housing New Zealand Corporation focusing on providing social housing to those with the greatest housing need. Some decisions have been announced and included in the fiscal forecasts but other plans for implementation remain under development, and may require reprioritisation or additional funding.

Revenue - KiwiSaver Auto-enrolment (Unchanged)

The Government has announced its intention to consult on the design of a one-off KiwiSaver auto-enrolment exercise to increase the number of KiwiSaver members. The Government will proceed with a one-off KiwiSaver enrolment exercise only when it is confident that such a step poses no significant risks to returning to, and maintaining, an operating surplus. An auto-enrolment exercise is likely to entail a one-off cost for kick-start payments to new members and ongoing additional costs for the Member Tax Credit. Depending on the timing, design features and take-up rate, these costs could be in the order of $350 million to $550 million over the first four years after auto-enrolment takes place, and are expected to be funded out of the operating allowance.

Revenue - Transformation and Technology Renewal (Changed)

The Government is exploring options that will fundamentally change the way Inland Revenue manages its processes and data. Any changes could impact tax revenue collections and may have material costs to implement. Inland Revenue has commenced the development of a detailed business cases for Stage 1: Enabling secure digital services. The business cases will inform the Government's decision-making for the first stage of transformation and may require significant reprioritisation or new funding.

Social Development - Vulnerable Children White Paper (Unchanged)

The Government has begun to implement proposals to better identify and provide assistance to vulnerable children. Future costs of the proposals are currently being developed with a focus in the first instance on costs for the 2014/15 year. There are likely to be multi-year impacts on Votes Education, Health, Justice and Social Development. To the extent that these cannot be funded from reprioritisation, additional funding from the allowance may be required.

Social Development - Welfare Reform Costs (Unchanged)

The Government has agreed to a package of changes to the benefit system. The extent of any additional costs of implementing welfare reform, such as implementing the Investment Approach, remain uncertain.

Social Development - Welfare Reform Forecast Benefit Savings (Unchanged)

A conservative estimate of the likely benefits from Welfare Reform has been included in the fiscal forecasts. The actual impact may differ owing to behavioural factors and the complexity in implementing the reforms, with a corresponding impact on benefit expenditure.

State Sector Employment Agreements (Unchanged)

A number of large collective agreements are due to be negotiated 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 of restraint given its current fiscal stance and an expectation that agreements will be managed with the current fiscal forecasts.

Potential Capital Decisions (Expected to be Funded from the Existing Crown Balance Sheet, Including the Future Investment Fund)

Departmental Capital Intentions (Unchanged)

The Government requires 16 capital-intensive agencies or sectors to identify their capital spending intentions over the next 10 years based on current policy settings and certain demographic and inflation assumptions. The Government expects that these intentions will be managed back through a range of measures such as prioritisation, changes to asset utilisation, alternative methods of service delivery and changes to policy settings. Departmental capital intentions are risks to the fiscal forecasts only to the extent that they cannot be managed through existing balance sheets, including the Future Investment Fund.

Earthquake Strengthening for Crown-owned Buildings (Unchanged)

There is a possibility that the Crown will incur costs for earthquake strengthening some of its buildings that may not meet modern building standards. The Government is currently undertaking a stocktake of Crown-owned earthquake-prone buildings. The likelihood, timing and fiscal impact of any earthquake strengthening are uncertain.

Finance - Crown Overseas Properties (Changed)

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. A rough-order cost estimate for this upgrade is $100 million over the period from 2014/15 to 2016/17.

Justice - Christchurch Justice and Emergency Services Precinct (Unchanged)

The Government has included the development of a Justice and Emergency Services Precinct in the fiscal forecasts, and there is a risk that the spending profile differs from this.

Primary Industries - Investment in Water Infrastructure (Unchanged)

In addition to $80 million provided in 2013/14, the Government will consider providing up to $320 million in future Budgets to Crown Irrigation Investments Limited as schemes reach the “investment-ready” stage.

Transport - Auckland Transport Projects (New)

The Government has signalled its intention to accelerate transport projects in the Auckland Council's Auckland Plan, including a number of state highway projects, Auckland Manukau Eastern Transport Initiatives, the East-West Link and support for the City Rail Link and a second Waitemata Harbour Crossing. The Government is yet to consider the most appropriate timing, phasing of and funding for these initiatives.

Transport - Support for KiwiRail (Changed)

KiwiRail has signalled its intention to seek additional Crown funding over the next four years as it continues to:

• work towards its objective of becoming a commercially viable network
• undertake earthquake strengthening work on some of its buildings, and
• repair damage to operational facilities in Christchurch following the earthquakes.

KiwiRail has also signalled that it may require additional funding following the breakdown of the Aratere ferry. The Government has not considered how it would respond to such a request.

Matters Dependent on External Factors

ACC - Non-earners' Account (Unchanged)

Funding for the Non-earners' Account is agreed as part of the annual Budget process. Claims' experience, ACC's financial performance and economic assumptions (particularly discount rates) can impact insurance expenditure, both in the current year and the estimated future liability. If any of these factors differ from what is forecast the amount required to cover the costs of non-earners' claims for that year may be more or less than the agreed level of funding, resulting in unplanned savings or costs to the Crown.

Canterbury Earthquake Recovery - Residential Red Zone (Changed)

Some recoveries from the EQC and private insurers remain outstanding and there is a risk that final recoveries may be greater or less than forecast. In addition, potential costs associated with the future use of residential red zone are uncertain. The future value may change depending on any future alternate uses of the land.

Communications - Potential Impairment in Value of Broadband Investment (Unchanged)

The Government has set aside $1.345 billion to progressively capitalise Crown Fibre Holdings so that it can invest with private partners in a new network delivering 'ultra-fast' broadband services. Given the contracts entered into, the extent of the recovery of this investment is particularly dependent on the number of connections made to the network. The fiscal forecasts include a provision for this impairment, but the final amount of the impairment may vary from this provision.

Defence Force - Potential Rationalisation, Revaluation and Disposal of NZDF Assets (Unchanged)

The Government is considering the potential to dispose of a number of NZDF assets, including the Seasprite helicopters and Unimog trucks. Depending on market conditions, the timing of disposal and sale price received could have an impact on the Government's overall financial position. NZDF is also completing analysis of inventory that is surplus to requirements and is over and above the existing provision for obsolescence. The existing provision is also being reviewed to ensure that all items comprising the provision are still relevant.

Energy - Crown Revenue from Petroleum Royalties (Unchanged)

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

Environment - Post-2012 International Climate Change Obligations (Changed)

The Government has adopted an unconditional target to reduce emissions by 5% by 2020 relative to its 1990 levels. Its conditional commitments are subject to international negotiations and agreements. Currently no rights or obligations are included in the fiscal forecasts for either conditional or unconditional post-2012 obligations. These could have significant fiscal implications that will need to be recognised when the commitments are considered to be binding and the Government has no discretion to avoid the liabilities.

Finance - EQC (Changed)

The net financial position of EQC, and the size of any requirement for additional Crown funding, remains uncertain. The key driver of this uncertainty is EQC's outstanding claims liability - the actuarial estimate of EQC's outstanding claims liability is highly uncertain and sensitive to assumptions; for example, construction demand surge, land damage estimates, legal challenges, reinsurance recoveries and the profile of claims settlement. The magnitude of the net outstanding cost claims is large, so small percentage changes in the liability can have a material impact on the fiscal forecasts.

Finance - Goodwill on Acquisition (Unchanged)

As at 30 June 2013, the Government had goodwill on acquisition of a number of sub-entities totalling $655 million. Under New Zealand accounting standards (NZIAS 36), such goodwill items are required to be assessed annually for impairment. If there is any indication that the goodwill may be impaired, the recoverable amount of the cash generating units to which the goodwill is allocated is required to be estimated. If the recoverable amount is less than the carrying amount of those units, the units and the goodwill allocated to them are regarded as impaired and the Government is required to recognise impairment losses in the operating statement. Such assessments will be conducted at the end of the financial year, and the fiscal forecasts currently make no allowance for such impairment losses.

Finance - Government Commitments to International Financial Institutions (Unchanged)

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. The risk government commitments to the International Monetary Fund being called has increased in recent years.

Finance - Sale of Part of the Crown's Shareholding in Certain Companies (Changed)

The Government has sold part of the Crown's shareholding in Air New Zealand, Mighty River Power and Meridian Energy. It is proposing to sell part of the Crown's shareholding in Genesis Energy. The fiscal forecasts include an estimate of the cash proceeds from the sale of part of the Crown's shareholding in these companies, the dividends and profits from these companies that will be paid or are attributable to minority shareholders rather than to the Crown, and the estimated finance cost savings. There is still some uncertainty over the final amount and timing of any cash proceeds, foregone profits, flow-on effects for the Crown and any implementation costs are uncertain, and these may differ from what has been assumed in the fiscal forecasts.

Finance - Southern Response Earthquake Services Support (Unchanged)

The ultimate cost to the Crown of settling earthquake claims remains subject to significant uncertainty. Out-year forecasts assume that the actual cost to settle claims will align with the actuary's central estimate of the claims provision. There is a risk that the actual cost could vary from this estimate.

Health - Litigation in the Disability Support and Aged Care Areas (Changed)

Several cases and funding claims in the disability support and aged care sectors may involve significant costs to the Crown relating to interpretation of the Minimum Wage Act 1983, the Equal Pay Act 1972 and the Government's policy of paying certain family members through its Funded Care Policy. Changes to the existing policy could require additional funding.

Housing - Divestment of Housing (Unchanged)

The Government may undertake divestment or redevelopment of some housing property. Property sales are subject to market conditions and therefore there is an inherent level of uncertainty about the return to the Crown associated with any divestment and/or development.

Revenue - Cash Held in Tax Pools (Unchanged)

Funds held in tax pools are recognised as a Crown asset. There is a risk that funds held in these pools, over and above a taxpayer's provisional tax liability, may be withdrawn, resulting in a reduction in the Crown's available cash reserves.

Treaty Negotiations - Treaty Settlement Forecasts (Unchanged)

The fiscal forecasts include provision for the cost of future Treaty settlements. Given settlements are finalised through negotiations, there is a risk that the timing and amount of the settlements could differ from the profile included in the fiscal forecasts.

Treaty Negotiations - Relativity Clause (Unchanged)

The Deeds of Settlement negotiated with Waikato-Tainui and Ngāi Tahu include a relativity mechanism. Now that the total redress amount for all historical Treaty settlements exceeds $1 billion in 1994 present-value terms, the mechanism provides that the Crown is liable to make payments to maintain the real value of Ngāi Tahu and Waikato-Tainui's settlements as a proportion of all Treaty settlements. The agreed relativity proportions are 17% for Waikato-Tainui and approximately 16% for Ngāi Tahu. There is a risk that the timing and amount of the expense for the relativity payments may differ from that included in the fiscal forecasts. There is also uncertainty on how various disputes concerning the interpretation of the mechanism will be resolved.

Risks Removed Since the 2013 Budget Update

The following risks have been removed since the 2013 Budget Update:

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

The Public Finance Act 1989 requires that the Statement of Specific Fiscal Risks sets out all government decisions, contingent liabilities or contractual obligations known to the Government and subject to specific requirements that may have a material effect on the economic or fiscal outlook.[11]

The criteria and rules set out below are used to determine if government decisions or other circumstances should be incorporated into the fiscal forecasts, disclosed as specific fiscal risks or, in some circumstances, excluded from disclosure.

Criteria for Including Matters in the Fiscal Forecasts

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

• The matter can be quantified for particular years with reasonable certainty.
• A decision has been taken, or a decision has not yet been taken but it is reasonably probable[12] 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 their best professional judgement, that the matters may have a material effect on the fiscal and economic outlook and are certain enough to include in the fiscal forecasts.

Rules for the Disclosure of Specific Fiscal Risks 

Matters are disclosed as specific fiscal risks if:

• the likely impact is more than $100 million over five years, and either
• a decision has not yet been taken but it is reasonably possible[13] (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 their 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[14] to be approved or occur within the forecasting period.

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

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

If possible, the Minister of Finance should avoid withholding the matter either by making a decision on it before the forecasts are finalised, or by disclosing it without quantifying the risk.

Contingent Liabilities and Contingent Assets#

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Contingent liabilities are possible costs that have arisen from past events, but the amount of the liability, or whether it will eventuate, will not be confirmed until a particular event occurs or present liabilities that are unable to be measured with sufficient reliability to be recorded in the financial statements (unquantifiable liabilities).

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

In general, if a contingent liability were realised, or the amount becomes sufficiently reliable to record as a liability, it would reduce the operating balance and net worth and increase net debt. In the case of contingencies for uncalled capital, the negative impact would be restricted to net debt because the cost would be offset by the acquisition of capital.

Where contingent liabilities have arisen as a consequence of legal action being taken against the Crown, the amount shown is the amount claimed and thus the maximum potential cost. It does not represent either an admission that the claim is valid or an estimation of the amount of any award against the Crown.

Contingent assets are possible assets that have arisen from past events but the amount of the asset, or whether it will eventuate, will not be confirmed until a particular event occurs.

Only contingent liabilities and contingent assets involving amounts of over $100 million are separately disclosed. Quantifiable contingencies less than $100 million are included in the “other quantifiable” total.

Some contingencies of the Crown are not able to be quantified. We have disclosed all unquantifiable contingent liabilities and unquantifiable contingent assets that are not expected to be remote.[15]

Contingent liabilities have been stated as at 31 October 2013, being the latest set of reported contingent liabilities.

Quantifiable Contingent Liabilities and Contingent Assets

Unquantifiable Contingent Liabilities and Contingent Assets

Description of Contingent Liabilities

Quantifiable contingent liabilities over $100 million

Uncalled capital

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

The capital (when called) is typically used to raise additional funding for loans to member countries, or in the case of the quota contributions, to directly finance lending to members. For New Zealand and other donor countries, capital contributions comprise both “paid in” capital and “callable capital or promissory notes.”

The Crown's uncalled capital subscriptions are as follows:

Legal proceedings and disputes

Tax in dispute - assessed

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

$607 million at 31 October 2013 ($641 million at 30 June 2013)

Other quantifiable contingent liabilities

Unclaimed monies

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

$104 million at 31 October 2013 ($101 million at 30 June 2013)

Transpower New Zealand Limited

Transpower has a contingent liability relating to excess capital expenditure on the North Island Grid Upgrade Project (NIGU).The NIGU spend exceeds the amount initially approved in 2006. The methodology for approvals subsequently changed in 2012, which increases the potential size of the excess capital expenditure. If the excess expenditure is not approved by the Commerce Commission it cannot be recovered from customers. NIGU is operational and a submission for the excess expenditure has been made.

The excess is $156 million at 31 October 2013 ($156 million at 30 June 2013)

Unquantifiable contingent liabilities

This part of the Statement provides details of those contingent liabilities of the Crown that are not quantified, excluding those that are considered remote, reported by the following categories:

a) Indemnities

b) Legal claims and proceedings, and

c) Other unquantifiable contingent liabilities.

a) Indemnities

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

A number of these indemnities are provided to organisations within the Crown's control. If these indemnities were to crystallise, the Crown would compensate the individual entity for the loss and there would likely be an adverse impact on core Crown expenses and core Crown net debt.

Legal claims and proceedings

There are numerous legal actions that have been brought against the Crown. However, in the majority of these actions it is considered a remote possibility that the Crown would lose the case, or if the Crown were to lose it would be unlikely to have greater impact than a $20 million impact. Based on these factors, not all legal actions are individually disclosed. The claims that are disclosed individually, while they cannot be quantified, have the potential to exceed $20 million in costs.

Accident Compensation Corporation (ACC) litigations 

There are a number of actions involving ACC in existence, arising from the statutory review and appeal process, and in the main coming from challenges to operational decisions made by ACC. Given the nature of these proceedings and uncertainty as to their outcomes, attempting to quantify the financial effect would be unrealistic, so no estimate has been made.

Air New Zealand litigation

Air New Zealand is currently named in class actions. 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. A class action in the United States alleges 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 proceedings by the Australian Competition and Consumer Commission. A defended hearing in the Federal Court concluded in May 2013 and a decision is awaited. In the event that the Court determines that Air New Zealand had breached Australian laws, the company would have potential liability for pecuniary penalties.

Television New Zealand (TVNZ)

In the normal course of business various legal claims have been made against TVNZ. Given the stage of proceedings and uncertainty as to the outcomes of the claims, 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 being heard at the Court of Appeal and the Supreme Court. Failure to successfully defend such actions may result in a liability for historical Treaty grievances in excess of that currently anticipated.

Ministry of Education litigation

Post Primary Teachers Association and several teachers have lodged a claim in the High Court alleging breach of statutory duty in respect of the Novopay system failures. The Ministry is defending this claim.

Other unquantifiable contingent liabilities

Criminal Proceeds (Recovery) Act 2009

The Ministry of Justice is responsible for administering the Criminal Proceeds (Recovery) Act 2009. The Act requires the Crown to give an undertaking as to damages or costs in relation to asset restraining orders. In the event that the Crown is found liable, payment may be required. The timing and amount of any possible payments required are not able to be estimated at this time.

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.

Any contaminated sites for which costs can be reliably measured have been included in the statement of financial position as provisions.

Treaty of Waitangi claims - settlement relativity payments

The Deeds of Settlement negotiated with Waikato-Tainui and Ngāi-Tahu include a relativity mechanism. 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 Waikato-Tainui's and Ngāi Tahu's settlements as a proportion of all Treaty settlements. The agreed relativity proportions are 17% for Waikato-Tainui and approximately 16% for Ngāi Tahu.

The relativity mechanism has now been triggered and in future years additional costs may be incurred in accordance with the relativity mechanism as Treaty settlements are reached. However, the final amount payable to settle this matter cannot be quantified yet owing to uncertainty around when current and future negotiations will be settled and the value of these settlements when reached. There is also uncertainty on how various disputes concerning the interpretation of the mechanism will be resolved.

Description of Contingent Assets

Quantifiable contingent assets over $100 million

Tax disputes - non assessed

A contingent asset is recognised when Inland Revenue has advised, or was about to advise, a taxpayer of a proposed adjustment to their tax assessment. The taxpayer has the right to dispute this adjustment and a disputes resolution process can be entered into. The contingent asset is based on the likely outcome of the disputes process based on experience and similar prior cases.

$169 million at 31 October 2013 ($169 million at 30 June 2013)

Forecast Financial Statements#

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

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

The forecasts have been prepared in accordance with the Statement of Responsibility and reflect the judgements and information known at the time they were prepared. They reflect all government decisions and circumstances communicated to 3 December 2013.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined on pages 42 to 44.

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 included within the 2013 Half Year Economic and Fiscal Update Additional Information document which can be found on the Treasury's website at www.treasury.govt.nz/budget/forecasts/hyefu2013.

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 the Treasury's best professional judgement. Actual financial results for the periods covered are likely to vary from the information presented in these forecasts. Factors that may lead to a material difference between information in these Forecast Financial Statements and the actual reported results in future years are set out in the Specific Fiscal Risks chapter on pages 61 to 83.

Key forecast assumptions used are set out on pages 42 to 44.

Government Reporting Entity as at 3 December 2013#

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These Forecast Financial Statements are for the government reporting entity as specified in Part 3 of the Public Finance Act 1989. This comprises Ministers of the Crown and the following entities:

Core Crown

Departments

• Canterbury Earthquake Recovery Authority
• Crown Law Office
• Department of Conservation
• Department of Corrections
• Department of Internal Affairs
• Department of the Prime Minister and Cabinet
• Education Review Office
• Government Communications Security Bureau
• Inland Revenue Department
• Land Information New Zealand
• Ministry for Culture and Heritage
• Ministry for Primary Industries
• Ministry for the Environment
• Ministry of Business, Innovation and Employment
• Ministry of Defence
• Ministry of Education
• Ministry of Foreign Affairs and Trade
• Ministry of Health
• Ministry of Justice
• Ministry of Māori Development
• Ministry of Pacific Island Affairs
• Ministry of Social Development
• Ministry of Transport
• Ministry of Women's Affairs
• New Zealand Customs Service
• New Zealand Defence Force
• New Zealand Police
• New Zealand Security Intelligence Service
• Office of the Clerk of the House of Representatives
• Parliamentary Counsel Office
• Parliamentary Service
• Serious Fraud Office
• State Services Commission
• Statistics New Zealand
• The Treasury

Offices of Parliament

• Controller and Auditor-General
• The Ombudsmen
• Parliamentary Commissioner for the Environment

Others

• New Zealand Superannuation Fund
• Reserve Bank of New Zealand

State-owned enterprises

• Airways Corporation of New Zealand Limited
• Animal Control Products Limited
• AsureQuality Limited
• Electricity Corporation of New Zealand Limited
• Genesis Energy Limited
• Kiwirail Holdings Limited
• Kordia Group Limited
• Landcorp Farming Limited
• Learning Media Limited
• Meteorological Service of New Zealand Limited
• New Zealand Post Limited
• New Zealand Railways Corporation
• Quotable Value Limited
• Solid Energy New Zealand Limited
• Transpower New Zealand Limited

Mixed ownership model companies (Public Finance Act schedule 5 companies)

• Mighty River Power Limited
• Meridian Energy Limited

Others

• Air New Zealand Limited

Crown entities

• Accident Compensation Corporation
• Arts Council of New Zealand Toi Aotearoa
• Broadcasting Commission
• Broadcasting Standards Authority
• Callaghan Innovation
• Careers New Zealand
• Children's Commissioner
• Civil Aviation Authority of New Zealand
• Commerce Commission
• Crown Irrigation Investments Limited
• Crown Research Institutes (7)
• District Health Boards (20)
• Drug Free Sport New Zealand
• Earthquake Commission
• Education New Zealand
• Electoral Commission
• Electricity Authority
• Energy Efficiency and Conservation Authority
• Environmental Protection Authority
• External Reporting Board
• Families Commission
• Financial Markets Authority
• Government Superannuation Fund Authority
• Guardians of New Zealand Superannuation
• Health and Disability Commissioner
• Health Promotion Agency
• Health Quality and Safety Commission
• Health Research Council of New Zealand
• Housing New Zealand Corporation
• Human Rights Commission
• Independent Police Conduct Authority
• Law Commission
• Maritime New Zealand
• Museum of New Zealand Te Papa Tongarewa Board
• New Zealand Antarctic Institute
• New Zealand Artificial Limb 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 Productivity 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 (2,453)
• Social Workers Registration Board
• Sport and Recreation New Zealand
• Standards Council
• Takeovers Panel
• Te Reo Whakapuaki Irirangi (Māori Broadcasting Funding Agency)
• Te Taura Whiri i te Reo Māori (Māori Language Commission)
• Television New Zealand Limited
• Tertiary Education Commission
• Tertiary education institutions (29)
• Testing Laboratory Registration Council
• Transport Accident Investigation Commission

Organisations listed in schedule 4 of the Public Finance Act 1989

• Agricultural and Marketing Research and Development Trust
• Asia New Zealand Foundation
• Fish and Game Councils (12)
• Game Animal Council
• Leadership Development Centre Trust
• Māori Trustee
• National Pacific Radio Trust
• New Zealand Fish and Game Council
• New Zealand Game Bird Habitat Trust Board
• New Zealand Government Property Corporation
• New Zealand Lottery Grants Board
• Ngai Tahu Ancillary Claims Trust
• Pacific Co-operation Foundation
• Pacific Island Business Development Trust
• Reserves Boards (21)
• Te Ariki Trust

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

• Crown Asset Management Limited
• Crown Fibre Holdings Limited
• Fairway Resolution Limited
• Health Benefits Limited
• The Network for Learning Limited
• Research and Education Advanced Network New Zealand Limited
• Southern Response Earthquake Services Limited
• Tāmaki Redevelopment Company Limited

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

Forecast Financial Statements#

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Forecast Statement of Financial Performance for the years ending 30 June

1. Foregone profits from the Government Share Offer programme are not separately disclosed. Refer to pages 36 to 41 for further details.

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

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 SOEs.

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

Forecast Statement of Comprehensive Income for the years ending 30 June

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

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

Forecast Statement of Cash Flows for the years ending 30 June

1. Further information on the proceeds and repayments of government stock ("domestic bonds") is available in note 22.

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

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

Forecast Statement of 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 SOEs and Crown entities are not explicitly guaranteed by the Crown. No debt of SOEs and Crown entities is currently guaranteed by the Crown.

1. Core Crown borrowings in this instance include unsettled purchases of securities (classified as accounts payable in the Statement of Financial Position).
2. Gross sovereign-issued debt (GSID) represents debt issued by the sovereign (the core Crown) and includes any government stock held by the other Crown reporting entities.
3. Core Crown financial assets exclude receivables.
4. Net core Crown debt represents GSID less financial assets. This can provide information about the sustainability of the Government's accounts, and is used by some international agencies when determining the creditworthiness of a country.
5. Adding back the NZS Fund assets provides the financial liabilities less financial assets of the core Crown, excluding those assets set aside to meet part of the future cost of New Zealand Superannuation.
6. Net core Crown debt (excluding NZS Fund and advances) excludes financial assets which are held for public policy rather than treasury management purposes.
7. The Reserve Bank has used $1.6 billion of settlement cash to purchase reserves that were to have been funded by the NZDMO borrowing. Therefore, the impact of settlement cash on GSID is adjusted by this amount.

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

Statement of Actual Commitments as at 31 October 2013

Statement of Actual Contingent Liabilities and Assets as at 31 October 2013

More information on contingent liabilities (quantified and unquantified) is outlined in the Specific Fiscal Risks chapter.

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

Notes to the Forecast Financial Statements#

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1. Customs excise-equivalent duty.

NOTE 2: Interest revenue and dividends

NOTE 3: Transfer payments and subsidies

From 15 July 2013 the benefit categories Domestic Purposes Benefit, Invalid's Benefit, Unemployment and Emergency Benefit and Sickness Benefit, as well as Widow's Benefit, were replaced by new benefit categories. These categories are Jobseeker Support and Emergency Benefit, Supported Living Payment and Sole Parent Support.

NOTE 4: Personnel expenses

NOTE 5: Depreciation, amortisation and other operating expenses

NOTE 6: Interest expenses

NOTE 7: Insurance expenses

NOTE 8: Forecast new spending and top-down expense adjustment

Unallocated contingencies represent expenses included in Budget 2013 and previous Budgets that have yet to be allocated. Forecast new spending indicates the expected spending increases from future Budgets. The Budget 2014 allowance of $1 billion has been reduced to absorb Vote Education forecast changes which will be managed within Education's Budget 2014 allocation or through reprioritisation.

Unallocated contingencies represent capital spending from Budget 2013 and previous Budgets that have yet to be allocated. Forecast new spending indicates the expected capital spending increases from future Budgets, which will be mostly funded from the Future Investment Fund.

NOTE 9: Gains and losses on financial instruments

NOTE 10: Gains and losses on non-financial instruments

NOTE 11: Operating balance

NOTE 12: Financial assets

NOTE 13: Student loans

NOTE 14: Property, plant and equipment

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

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

NOTE 15: Intangible assets and goodwill

Net Kyoto position

The New Zealand Government has committed under the Kyoto Protocol to ensuring that New Zealand's average net emissions of greenhouse gases from 2008 to 2012 (the first commitment period of the Kyoto Protocol, or CP1) are reduced to gross 1990 emission 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.

To assist New Zealand in meeting its Kyoto Protocol commitments, an Emissions Trading Scheme (ETS) was established (refer note 20). These two initiatives should be looked at together when understanding New Zealand's international climate change obligations.

The New Zealand Government has to settle its Kyoto obligation by the completion of the true-up period which is expected to occur in late 2015.

The latest Net Position estimate can be found on the Ministry for the Environment's website: www.mfe.govt.nz/issues/climate/greenhouse-gas-emissions/net-position

NOTE 16: NZS Fund

NOTE 17: Payables

NOTE 18: Insurance liabilities

ACC liability

Levy reductions

The forecast includes a reduction in levy rates for the 2014/15 levy year agreed to by Cabinet on 2nd December 2013. In addition, the forecasts include further levy reductions for the 2015/16 levy year in line with what was signalled in Budget 2013. The amounts factored in for the 2015/16 levy year are based on a best estimate of the likely outcome which may differ from ACC's consultation document and the final outcome.

Calculation information

PwC NZ have prepared an independent actuarial estimate of the ACC outstanding claims liability as at 30 June 2013. This estimate includes the expected future payments relating to accidents that occurred prior to balance date (whether or not the associated claims have been reported to, or accepted by, ACC) and also the expected future administrative expenses of managing these claims. The assumptions underpinning this valuation form the basis of the five-year forecast of the outstanding claims liability.

The key economic variables that impact on changes to the valuation are the long-term Labour Cost Index (LCI), average weekly earnings and the discount rate. Discount rates were derived from the yield curve for New Zealand Government bonds. For these forecast statements, the claims liability has been updated for the latest discount rates as at 30 September 2013. The equivalent single effective discount rate, taking into account ACC's projected future cash flow patterns, is 5.19% and allows for a long-term discount rate of 5.50% from 2035.

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, including an adjustment to reflect projected future actuarial releases ($466 million in 2014 and a further $604 million in 2015), is included within total liabilities. ACC has available to it a portfolio of assets that offset the claims liability. The assets (less cross-holdings of NZ Government stock) are included in the asset portion of the Government's Statement of Financial Position.

EQC liability

Calculation information

Melville Jessup Weaver prepared an independent actuarial estimate of the EQC outstanding claims liability at 30 June 2013 by estimating the projected ultimate claims costs then deducting the payments made in relation to those claims on or before that date. Each component of the claims liability was split into separate groups depending upon the Canterbury earthquake event grouping or other “business as usual” claims. These event groups were further split into sub-claim valuation groups being land claims, building claims or contents claims. The assumptions underpinning the 30 June 2013 valuation form the basis of the five-year forecast of the outstanding claims liability.

Critical assumptions used in projecting the ultimate costs include apportionment of costs across earthquake events, the profile of claims settlement, claims inflation rate per annum, risk margins and claims handling costs.

There is a high level of uncertainty associated with the valuation of the outstanding claims liability, reinsurance recoveries and unexpired risk liability. Some of the key uncertainties are: cost apportionment across events; the potential for construction cost to exceed expectations; land damage estimates; reinsurance recoveries and profile of claims settlement.

The actual claims outcome may differ from the one currently forecast.

Presentation approach

EQC reinsurance recoveries are included in receivables in the Statement of Financial Position.

NOTE 19: Retirement plan liabilities

The net liability of the Government Superannuation Fund (GSF) was calculated by GSF's actuary as at 30 September 2013. The liability arises from closed schemes for past and present public sector employees as set out in the Government Superannuation Fund Act 1956. A Projected Unit Credit method was used to calculate the liability as at 30 September 2013, based on membership data as at 30 June 2013 with adjustments for cash flows to 30 September 2013. The funding method requires the benefits payable from GSF in respect of past service to be calculated and then discounted back to the valuation date.

For these Forecast Financial Statements, the net GSF liability was updated for the latest discount rates derived from the market yield curve for New Zealand Government bonds as at 30 September 2013.

Other principal long-term financial assumptions were an inflation rate, as measured by the Consumers Price Index, of 1.9% for the year to 30 September 2014, 2.3% for the two years to 30 September 2016, 2.4% for the two years to 30 September 2018 and increasing to 2.5% for all years after that. In addition an annual salary growth rate, before any promotional effects, of 3% (unchanged from 30 June 2013).

The 2013/14 projected decrease in the net GSF liability is $1,023 million, reflecting a decrease in the GSF liability of $924 million and an increase in the GSF net assets of $99 million.

The decrease in the GSF liability of $924 million includes an actuarial gain between 1 July 2013 and 30 September 2013, of $512 million owing to movements in the discount rates and changes in demographic assumptions. The remaining $412 million reduction is owing to expected benefits paid to members (reduces the liability) offset by current service cost and interest unwind (increases the liability).

The increase in the value of the net assets of GSF of $99 million includes a gain of $27 million reflecting the updated market value of assets at 30 September 2013. The balance of $72 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 2013/14 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 assist New Zealand in meeting its international climate change obligations and to reduce New Zealand's net emissions of greenhouse gases to below business-as-usual levels. The ETS creates a limited number of tradable New Zealand Units (NZUs) which the Government can allocate. Emitters can also surrender Kyoto compliant units to meet their obligations.

The allocation of NZUs creates a provision if allocated for free; the provision is reduced, and revenue recognised, as NZUs and Kyoto compliant units are surrendered to the Crown by emitters. The Kyoto compliant units collected through the ETS are recognised as revenue and as part of the net Kyoto Protocol position.

The prices for NZUs and Kyoto compliant units used to calculate the ETS provision are assumed to remain constant over the forecast period and are based on market prices during September 2013.

The ETS impact on the fiscal forecast is as follows:

NOTE 21: Net worth

NOTE 22: Core Crown residual cash

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

Forecast Statement of Segments#

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