Half Year Economic and Fiscal Update 2016

Statement of Responsibility#

Print this section

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 21 November 2016 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 21 November 2016. This Update does not incorporate any decisions, circumstances or statements that the Minister of Finance has determined, in accordance with section 26V of the Public Finance Act 1989, should not be incorporated in this Update.

Gabriel Makhlouf
Secretary to the Treasury

30 November 2016

 

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 21 November 2016 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, responsibility for the consistency and completeness of the Update information with the requirements of Part 2 (Fiscal responsibility) of the Public Finance Act 1989 and responsibility for any decisions, circumstances or statements not incorporated in this Update, in accordance with section 26V of the Public Finance Act 1989.

Hon Bill English
Minister of Finance

30 November 2016

Overview#

Print this section

The New Zealand economy is currently performing well with sustained growth and an operating balance before gains and losses (OBEGAL) surplus expected for the year to June 2017. We expect this performance to be maintained despite the impact of the recent Kaikōura earthquakes (see page 6). We also expect the fiscal position to improve steadily. However, many factors could affect the outlook. Global volatility and a risk of lower trading partner growth could reduce forecast growth in the next four years, and higher net migration, domestic demand and more binding capacity constraints in the New Zealand economy could mean that inflationary pressure rises faster than expected.

The New Zealand economy

Growth in the New Zealand economy is being supported by an increasing number of people arriving in New Zealand, to live, work, study and visit. Combined with low interest rates, this is supporting consumer spending, housing construction, other building, and investment more broadly.

These forces, which are proving to be considerably stronger than anticipated at the time of the Budget Update, have combined with recent increases in dairy export prices to underpin forecast annual average growth of 3.6% over the current fiscal year and 3.5% in the following year.

This period of strong demand growth is expected to increase opportunities for people to work. At the same time, net migration inflows are assumed to subside from current levels as foreign labour markets improve, which means that growth will be less rapid in future. In combination, this is forecast to increase upwards pressure on wages and prices. In response to increasing price pressures, interest rates are forecast to begin rising in late 2018, which would contribute to slower demand growth and stabilise consumer price inflation at 2.0%. Real gross domestic product (GDP) growth is forecast to slow to 2.3% in 2020/21.

Growth in nominal GDP, which reflects growth in both real activity and prices and drives tax revenue, is expected to average 4.8% over the forecast period. Compared to the Budget Update, nominal GDP is cumulatively $23.7 billion higher over the four years ending June 2020, reflecting a higher starting point and stronger near-term outlook for prices and real activity.

Our place in the world

Given the importance of exports to New Zealand's economy, the performance of overseas economies can affect our growth. New Zealand's trading partners are not growing as strongly as before, and this is expected to keep global inflation and import prices low.

Future trading partner growth is expected to be lower until 2017, but then pick up from 2018, increasing opportunities to work in those countries. Growth in China is slowing at a steady pace, but if their economy was to slow down sharply, that would affect New Zealand as well as other trading partners. In addition, uncertainty around the outlook for the US economy is heightened following the election, as is uncertainty around the UK economic outlook after the vote to leave the European Union.

The international economy faces other risks, including persistently low global inflation, limited room for governments and central banks to stimulate growth, terrorism and military tensions, and a bigger debate in some countries about the value of free trade.

Government finances

The Crown's fiscal position has been improving over recent years with surpluses returning in 2014/15 and debt stabilising as a share of GDP. The fiscal outlook is expected to continue to steadily improve, reflecting a growing economy which will drive growth in tax revenue at a higher rate than government spending. By June 2021, OBEGAL surpluses are expected to rise to $8.5 billion, net debt to reduce to 18.8% of GDP and contributions to the New Zealand Superannuation Fund (NZS Fund) will resume. To support solid economic growth and delivering better public services, the Government has announced its intention to increase capital allowances from $0.9 billion to $3.0 billion in Budget 2017 and $2.0 billion from Budget 2018 onwards.

The Crown's forecast fiscal position will be subject to economic risks (noted below), market risks mainly associated with the Crown's balance sheet, and future policy decisions (discussed in the Specific Fiscal Risks chapter).

Preliminary estimates, based on available information about known damage, suggest that the direct costs of the Kaikōura earthquakes could be between $2 to $3 billion, including operating expenses (eg, Earthquake Commission (EQC) claims costs) and capital expenditure (eg, rebuilding state highways). We assume that some of these costs will be met from existing funding, and have added $1 billion of operating costs to the 2016/17 forecasts, representing the net costs of the earthquakes that are not expected to be funded from other sources (see page 6).

Preparing for risk

This Half Year Update looks at two alternative scenarios as examples of different ways in which the economic outlook could play out. In one scenario, an international event would lead to lower trading partner growth and increased volatility in global financial markets, which is associated with falls in export demand, asset prices, the terms of trade and investor and consumer confidence. In this scenario, nominal GDP, tax revenue and OBEGAL would be likely to turn out lower than in the main forecast.

The second scenario illustrates what might happen if the economy's capacity was tighter than expected. Inflation would be likely to rise more rapidly than in the main forecast as demand pushes up prices, while supply is slower to respond. Nominal GDP, tax revenue and OBEGAL would then likely be higher over the forecast period.

Notes:

1. Real production GDP, annual average percentage change.
2. Percent of the labour force, June quarter, seasonally adjusted.
3. Consumer Price Index (CPI), annual percentage change.
4. Annual balances as % of GDP.
5. Total Crown operating balance before gains and losses (OBEGAL).
6. Net core Crown debt excluding the NZS Fund and advances.

Sources: Statistics New Zealand, the Treasury

Finalisation dates for the Update

Economic and fiscal impacts of the Kaikōura earthquakes#

Print this section

Economic Outlook#

Print this section

Overview#

Print this section

• Growth in the New Zealand economy over the first half of 2016 was stronger than expected in the Budget Update as high net migration inflows, elevated tourist arrivals and low interest rates supported residential construction, services exports, market investment and private consumption. Annual average real gross domestic product (GDP) growth is forecast to accelerate from 2.8% in June 2016 to a peak of 3.6% in 2017 as these factors persist.
• Over the medium term, real GDP growth moderates to 2.3% by 2021 as space capacity is exhausted and interest rates rise. Growth in the labour supply slows as net migration inflows subside, leading to higher wage and price pressures.
• Trading partner growth eased in the first half of 2016 largely reflecting slower growth in the US. The outlook for trading partner growth is weaker than in the Budget Update, as a result of the impact of Brexit and lower long-term growth in the US.
• The recovery in global dairy prices over the second half of 2016 is expected to lead to a higher terms of trade in the near term. Over the medium term, ongoing moderation in global milk production helps drive a gradual rise in dairy prices. Weak global inflation keeps import prices muted, supporting the terms of trade.
• Nominal GDP growth is expected to pick up in the near term, supported by solid real GDP growth and the terms of trade. Over the forecast period, nominal GDP growth averages 4.8% per year and is cumulatively $23.7 billion higher than in the Budget Update in the four years to June 2020, reflecting a higher starting point (first half of 2016) and a stronger near-term outlook for prices and real activity.
• The outlook is subject to a range of risks and uncertainties. As outlined in the Risks and Scenarios chapter, global risks are skewed to the downside while domestic risks are more balanced.
• The 7.8 magnitude earthquake that struck the Kaikōura region on 14 November occurred after the economic forecasts were finalised - see Economic and fiscal impacts of the Kaikōura earthquakes on page 6 for discussion of the economic and fiscal impacts.

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

Notes:

• Forecasts finalised 10 November 2016.
• Contribution to GDP growth.
• Estimated as the percentage difference between actual real GDP and potential real GDP.
• Percent of the labour force, June quarter, seasonally adjusted.
• Percent of the working-age population, June quarter, seasonally adjusted.
• Quarterly Employment Survey, average ordinary-time hourly earnings, annual percentage change.
• Annual percentage change.
• System of National Accounts (SNA) and merchandise basis.
• Quotable Value New Zealand (QVNZ) House Price Index, annual percentage change.
• Percent of household disposable income (HHDI), March years.
• Average for the June quarter.

Key economic forecast judgements and assumptions

Recent Developments and Near-term Outlook#

Print this section

Economic expansion has continued at a solid pace…

Strength in domestic activity in the latter part of 2015 continued into the first half of 2016, with real GDP growth of 0.9% in each of the March and June quarters, faster than 0.6% expected in the Budget Update.Low interest rates and high levels of inward migration have continued to support private consumption, construction activity and construction-related services. Services exports (chiefly tourism) have remained buoyant despite some moderation in trading partner growth and goods export volumes held up higher than expected in the Budget Update,particularly for dairy, following a less severe impact from drought in 2015.

…with momentum expected to be maintained in the near term…

On a quarterly basis, real GDP growth is forecast to remain around 0.9% in the near term, with annual average growth expected to accelerate, peaking at 3.6% in 2017, faster and sooner than expected in the Budget Update (Figure 1.1). Stronger growth is largely owing to an upgrade to the domestic outlook, and with tourism remaining buoyant. Solid growth in private consumption, market investment and residential investment in the near term will remain supported by low interest rates and high net migration. Public consumption growth is expected to remain moderate in the near term. While government spending on infrastructure and private residential investment may be higher in the aftermath of the recent earthquakes in the Kaikōura region, the impact on the economy is expected to be small at the national level (see Economic and fiscal impacts of the Kaikōura earthquakes on page 6 for further detail). Increased cull in the dairy herd is expected to reduce export volumes in the near term, but with a partial offset from solid growth in other goods exports, including horticulture and wine. Growth among our key trading partners is expected to slow slightly in the near term, with low global inflation and interest rates expected to persist.

Figure 1.1 - Real GDP growth

Source: Statistics New Zealand, the Treasury

…underpinned by high inward migration… 

Annual net inward migration rose to around 70,000 in the year to September 2016 which is assumed to represent the peak in the current cycle, broadly consistent with the Budget Update. However, migration is assumed to decline from its peak more gradually than in previous forecasts, with the annual inflow in June 2018 around 26,000 higher than forecast in the Budget Update. Migration, population growth and potential output on page 22 provides detail on this assumption change, along with key drivers of migration, such as economic and labour market conditions in Australia relative to New Zealand. High migration and consequent population growth will remain a driver of growth in the near term, supporting private consumption and residential investment.

Real GDP per capita rose 0.7% in the year ended June 2016, up from 0.5% in the previous quarter, but below the average of 1.5% for the past five years. GDP per capita is expected to rise to 1.7% in the year ended June 2018, reflecting the solid pace of expansion in the economy.

…and low interest rates…

Accommodative monetary policy has continued to support demand, with the Reserve Bank reducing the Official Cash Rate (OCR) a further 25 basis points (bps) to 1.75% in November. Since June 2015, the OCR has been reduced a total of 175 bps, leading to a similar decline in short-term interest rates. Floating mortgage rates have come down around 100 bps, as offshore credit conditions have tightened and increased competition for deposits has driven up commercial banks' funding costs.

In its November 2016 Statement, the Reserve Bank stated that current monetary policy settings are sufficient to return inflation to the middle of the target band by late 2018. These forecasts also assume no further easing in the near term, although a number of risks remain that could lead to further easing. Scenario One in the Risks and Scenarios chapter provides an example where such risks eventuate and the OCR is reduced further.

…which drive housing demand and construction activity…

Strong house price growth resumed in 2016 following a brief slowdown in late 2015 (owing to tighter lending conditions for investors)[1] as solid demand for housing, driven by population growth and low mortgage rates, has continued against the backdrop of a shortage in supply. House price growth has increasingly been driven by regions outside Auckland, as buyers look for more affordable options outside the city and where lending conditions for investors had not been tightened as much. In response to high demand for housing, residential investment grew 8.2% in the year to June 2016, significantly stronger than expected in the Budget Update and led by strong activity in Auckland. Strong consents issuance in recent months suggests that activity will increase further (Figure 1.2). Annual residential investment growth rises to a peak of 15.3% in the March quarter 2017 and moderates thereafter.

Figure 1.2 - Real residential investment and dwelling consents

Source: Statistics New Zealand, the Treasury

In Auckland there is scope for building consents issuance to rise further as the Auckland Unitary Plan (AUP) takes effect and loosens regulatory constraints on development and, in the longer term, increases the availability of residential land. However, the AUP still faces significant challenges in its implementation and is not expected to have a significant impact on residential development in the near term.

Strong activity in housing has been reflected in growing household debt, which has reached 165% of household disposable income. If income growth were to slow significantly or if interest rates were to rise sharply, debt servicing could become difficult for some households. This has the potential to constrain GDP growth as households adjust by reducing consumption and residential investment. See the Risks and Scenarios chapter for further discussion.

Market investment grew strongly in the June 2016 quarter as strength in the construction sector was complemented by a broader pick-up in business confidence and lower interest rates. However, lower investment in mining and oil exploration provided some offset. Real market investment is expected to remain solid in the near term, reflecting the large programme of construction work.

…supporting employment growth and private consumption

Figure 1.3 - Real private consumption

Source: Statistics New Zealand, the Treasury

Strong construction and tourism activity has continued to drive growth in employment. Even with net migration inflows and the participation rate at record highs, labour demand has kept pace with supply and the unemployment rate has been broadly stable at around 5%.[2] Nominal wage growth has been muted, reflecting ample labour supply growth and employment growth concentrated in less productive sectors. However, with slow growth in consumer prices, real wages have continued to grow at a steady pace. That said, aggregate nominal income growth has been solid as total hours worked have increased strongly. More people active in the labour market and earning higher incomes has translated into strong private consumption growth.

These factors are expected to persist in the near term, with private consumption stronger than in the Budget Update (Figure 1.3). In addition, solid consumption growth will be supported by low interest rates and increased spending on durable goods, reflecting the strong outlook for residential investment.

The Government's fiscal strategy of restrained public spending growth and reducing debt means growth in public consumption will remain modest in the near term. Accordingly, government spending is estimated to have a mildly stimulatory impact on aggregate demand over the next two years, but is broadly neutral over the forecast period on average.[3] In addition, fiscal spending associated with the recent earthquakes (discussed on page 6) is expected to have a relatively small impact on aggregate demand.

Implications of changes to the Household Labour Force Survey

Growth among New Zealand's key trading partners remains soft…

Trading partner growth continued to slow in 2016 and is expected to remain steady at around 3.4% in 2017 (Table 1.2), slightly weaker than in the Budget Update.

The weaker growth outlook is driven partially by the UK following the vote in favour of an exit from the European Union (Brexit) in June 2016. The immediate impact of Brexit on financial markets was large with the pound depreciating more than 10%, making UK exports more competitive but also increasing input costs for producers and eroding consumers' purchasing power through higher inflation. The longer-term implications of Brexit are uncertain and this uncertainty itself is expected to result in slower growth, by delaying investment decisions and deferring consumption. Less favourable trade access to Europe is also expected to reduce the UK's potential growth rate, although there may be some pick-up in growth towards the end of the forecast period as new trade arrangements become established.

Table 1.2 -Trading partner growth (annual % change)

* South Korea, Singapore, Taiwan, Hong Kong

^ Malaysia, Indonesia, Thailand, Philippines

Sources: IMF, Consensus Forecasts, the Treasury

The US economy had a weak first half of 2016, as low oil prices took their toll on investment in exploration and the higher US dollar constrained growth in manufacturing. Growth is expected to pick up in the second half of 2016 as consumer spending remains robust and the labour market continues to steadily improve. Evidence that inflationary pressures are building means interest rates are expected to rise in the near term. However, in the longer term, trend growth in the US economy is expected to be lower than previously forecast, reflecting the downward revision of potential growth estimates by the Federal Reserve.

The implications of the US election, which occurred just before these economic forecasts were finalised, are uncertain at this stage. So far, financial markets have focused on the fiscal stimulus which has been foreshadowed under the new administration, particularly the increased investment in infrastructure. Stock prices have increased, particularly in industries likely to benefit from additional stimulus, long-term bond rates have increased in anticipation of an increase in government debt and higher inflation, and the US dollar has strengthened. These responses have been reflected in New Zealand financial markets with an increase in bond yields and a fall in the New Zealand dollar against the US dollar. However, at this stage it is uncertain what policies will be enacted by the new administration and whether more restrictive trade policies will have an offsetting impact. Accordingly, no changes have been made to these forecasts in the light of the election.

Growth in China has slowed as the economy continues its transition from investment-led growth to more moderate growth led by consumption. In addition, China's trade with other countries has been soft as slowing growth in advanced economies has reduced demand for its exports, thereby reducing import demand for inputs which has had flow-on effects to some of New Zealand's other trading partners in Asia. Slowing growth in China has been addressed with renewed stimulus by authorities, but possibly at the expense of structural reform to support growth longer term. Risks around increased capital outflows and devaluation of the renminbi, China's overheated housing market and high debt levels held by local government have been reflected in financial markets, with periods of elevated market volatility over the past year. The ongoing trend of slowing growth and transition in the drivers of growth, alongside periods of elevated financial market volatility, are expected to continue in the near term.

The Australian economy has continued to transition from mining to non-mining investment, with growth around trend. The labour market has been soft as employment growth has been concentrated in part-time jobs and unemployment has remained steady at around 5.7%. However, underemployment remains high. Developments in China have continued to heavily influence prices for Australian exports. Slowing Chinese investment and demand for iron ore have driven the decline in the terms of trade from 2011. However, more recently coal and iron ore prices have spiked from low levels owing to production restrictions for coal in China and renewed stimulus. Over the near term, the Australian economy is expected to continue its gradual rebalancing in investment from mining to other sectors, with growth in consumption, residential investment and exports (as new resource projects enter production), supported by low interest rates.

In Japan and the euro area, growth has been subdued and is expected to remain so in the near term as these economies continue to experience weak demand, with limited room for further monetary or fiscal stimulus.

…with persistently low global interest rates and inflation…

Muted growth in the global economy means the recent pattern of persistently low inflation and interest rates is expected to continue in the near term. Central banks in the euro area and Japan are expected to maintain their large-scale asset purchase programmes for some time, while the US Federal Reserve is expected to increase the Federal Funds Rate in December, which is a slower pace than previously indicated.

Risks to global growth and inflation remain skewed to the downside. The risks with the largest potential impact on the New Zealand economy include a sharp slowing of growth in China, which would also impact other trading partners, changes in the timing and extent of the US economic recovery and monetary tightening cycle, the nature and timing of the UK exit from the European Union and future US trade and fiscal policy. A further moderation of growth in advanced economies may lead to a more prolonged period of low global inflation and commodity price weakness. The realisation of any of these risks would weigh on demand and inflation in New Zealand. Scenario One in the Risks and Scenarios chapter shows how a weaker global growth environment could impact on the New Zealand economy.

Despite low domestic interest rates, the exchange rate has remained elevated with the TWI-17 averaging 77.0 in the 2016 September quarter, stronger than the 72.0 expected in the Budget Update. Strength in the New Zealand dollar reflects three key factors: the New Zealand economy has continued to expand at a solid pace relative to other advanced economies; New Zealand interest rates are high compared to other advanced economies; and the terms of trade are elevated relative to historical averages. The New Zealand dollar is assumed to depreciate over the forecast period as trading partner growth, global inflation and interest rates pick up.

…suppressing import prices as dairy prices gain on falling global supply…

The weak global inflation environment has translated into weakness in world prices for imported goods, which were 2.9% lower in the 2016 June quarter than a year ago. Low crude oil prices have contributed, averaging around US$45/barrel in the September 2016 quarter. However, oil prices have recovered from US$33/barrel in March, their lowest level since 2004, as production has moderated in response to low prices and as the Organisation of Petroleum Exporting Countries (OPEC) signalled possible production cuts. Overall, in line with the low global inflation outlook, import prices are expected to remain subdued in the near term. Oil prices are also expected to remain low owing to high global supply capacity which could limit the impact OPEC production cuts have on prices.

Overall, world prices for New Zealand's exports have been subdued because of muted global demand and excess supply, particularly for dairy. However, the terms of trade have held up higher than expected in the Budget Update (Figure 1.5) as a larger-than-expected fall in import prices in the first half of 2016 more than offset a larger-than-expected fall in export prices.

Figure 1.5 - Goods terms of trade (SNA basis)

Source: Statistics New Zealand, the Treasury

The terms of trade are expected to increase in the near term, owing largely to recent gains in global dairy prices, while import prices remain weak. Prices for whole milk powder on the GlobalDairyTrade platform increased around 30% in the September quarter reflecting moderating global milk supply and high seasonal demand. Prices have continued to rise into the December quarter as auction offerings were reduced following lower-than-expected milk collection at the peak of the season. However, there is a risk of some retracement as seasonal demand from China winds down and global supply remains high overall. The recent increase in dairy prices should flow through to the terms of trade from the end of 2016 as product from September is shipped. Thereafter, dairy prices, and the terms of trade, are expected to rise gradually as steady demand is met with ongoing moderation in global supply.

Price gains over the September quarter and in the December quarter have led to Fonterra revising up its forecast farm-gate price to $6.00/kg of milk solids (MS) in the current season, following $3.90/kg MS last season. While the increased price outlook will provide some support to farmers, a strong New Zealand dollar and wet weather, which has reduced production this season, will remain headwinds to the sector as a whole. Furthermore, higher farm-gate prices will take time to fully flow through to farm incomes. Farmers are therefore likely to continue to limit expenditure in the near term (including on investment).

…with buoyant tourism contributing to sub-3% current account deficits

Supported by resilience in exported goods volumes, elevated services exports and low global interest rates, the annual current account deficit narrowed to 2.9% of GDP in the 2016 June quarter, much smaller than the 3.5% expected in the Budget Update (Figure 1.6). The smaller deficit reflects larger-than-expected export goods volumes, for dairy in particular, following a less severe impact on milk production from drought in 2015. That said, lower milk production this season, owing largely to the increased cull in the dairy herd (but also adverse weather), is expected to reduce export volumes in the near term. However, higher dairy prices will broadly offset the impact of lower production on export values. Solid growth in other goods exports, including horticulture and wine, are expected to provide a partial offset to lower dairy export volumes. On the import side, low global inflation has kept world prices muted. This, along with an elevated New Zealand dollar, will support growth in import volumes.

Figure 1.6 - Current account

Source: Statistics New Zealand, the Treasury

In annual average terms, nominal services exports rose 12.7% in June 2016, driven by elevated tourist arrivals, with overseas visitor arrivals up 11.7% in the year to October 2016. Visitors from Asia – particularly China – and Australia have continued to drive strong growth in tourism, which is owing to a number of factors including: an easing of travel restrictions in China; continued income growth across emerging Asian economies; growth in the number of airlines flying to New Zealand, particularly from Asia; and low transportation costs, owing to growing competition and low oil prices.

Given that these drivers of tourism growth are expected to persist, services exports are expected to remain buoyant, with real services exports growth of over 1% per quarter on average in the near term. Tourist spending is expected to support construction activity in the near term, along with employment in this sector, as infrastructure and accommodation is expanded to cater for more overseas visitors. However, relative to the Budget Update, the stronger dollar will dampen services exports to some degree (Figure 1.7) and the recent earthquakes in the Kaikōura region will likely divert tourism from the region while infrastructure and capacity to host visitors is restored. For further discussion, see Economic and fiscal impacts of the Kaikōura earthquakes on page 6.

Figure 1.7 - Nominal services exports and TWI-17

Source: Statistics New Zealand, Reserve Bank, the Treasury

Strong services exports and higher export prices are expected to contribute to annual current account deficits of around 3.0% of GDP, or slightly below, over the year ahead. The current account deficit is then expected to widen to 3.8% of GDP by June 2018 as both the goods and income deficits widen, the latter reflecting rising global interest rates.

With the exception of housing, inflationary pressures are subdued…

Annual inflation remained low at 0.4% in the September quarter 2016. Annual tradables inflation was weak at -2.1% as it continued to be constrained by weak world prices, particularly oil, and the strong New Zealand dollar. Annual non-tradables inflation was also relatively low at 2.4%.

Non-tradables inflation is assumed to respond to both increasing capacity pressures and inflation expectations. However, low inflation has reduced households' and firms' expectations of future inflation, which is assumed to dampen the rate at which inflation returns to 2% over the medium term. Increases in the tobacco excise tax in the March quarter each year are estimated to contribute 0.2 percentage points to annual CPI inflation for each of the next four years.

Housing and household utilities (which excludes existing house prices) is one area where capacity constraints are translating into rising price pressures. Within this area, the cost of purchasing new housing increased 6.3% in the year to September 2016, its fastest annual increase since the mid-2000s. Annual inflation excluding housing and household utilities has been negative since the 2014 December quarter.

As previous oil price falls drop out of the annual calculation in early 2017 (leading to higher tradables inflation) and spare capacity in the economy diminishes (leading to higher non-tradables inflation), annual headline inflation is expected to rise in the near term. Inflation is expected to rise within the Reserve Bank's 1% to 3% target band by the December 2016 quarter and lift to 2.0% by June 2018 (Figure 1.8).

Figure 1.8 - Consumer price inflation

Source: Statistics New Zealand, the Treasury

…but nominal GDP growth picks up

Nominal GDP increased 4.2% to more than $250 billion in the year to June 2016, stronger than expected in the Budget Update, largely because the terms of trade and inflation have held up higher than expected. Nominal GDP growth is expected to accelerate to over 5% in the near term, reflecting rising real GDP growth, inflation and the terms of trade.

Consistent with higher-than-expected nominal GDP, tax revenue has also been higher than forecast in the Budget Update, particularly source deductions, owing to faster-than-expected employment growth, and goods and services tax, owing to stronger inbound tourism spending and residential investment. Strong growth in these tax types is expected to continue. See the Fiscal Outlook chapter for details of tax revenue forecasts.

Medium-term Outlook#

Print this section

Growth projected to moderate to a more sustainable pace over the medium term…

From a peak of 3.6% in 2017, annual average real production GDP growth moderates to 2.3% by 2021, as the factors underpinning growth in the near term transition to their long-term trends. Growth in aggregate supply slows as net migration inflows ease, and as market investment growth moderates. Lower net migration inflows and rising interest rates drive moderation on the demand side, with real private consumption growth slowing to 2.2% in 2021. However, residential investment is projected to remain elevated over the medium term, reflecting pent-up demand for housing and past under-investment.

Per capita GDP growth slows from a peak of 1.7% in 2018 to 1.1% in 2021, as easing migration inflows and declining labour participation lead to slower growth in labour inputs. Recent changes in the HLFS lower our estimates of economy-wide productivity growth in the year ended March 2017, but thereafter labour productivity growth averages 1.5% per year. The capital stock grows relatively strongly as firms and households catch up to the high rates of labour input growth in preceding years. However, multifactor productivity growth remains subdued.

Annual trading partner growth is projected to remain steady at 3.6% over the medium term, weaker than in the Budget Update, reflecting slower growth in the UK as a result of Brexit and a downward revision of trend growth in the US owing to lower productivity growth. Growth in China is projected to moderate to below 6% in 2021 as it continues to transition from investment to consumption as the main driver of growth. The Australian economy is projected to continue its transition from mining investment to other sources of demand, with growth around trend (2.8%) over the medium term.

Goods export volumes grow modestly over the medium term as trading partner growth remains steady and as growth in global milk production eases, supporting export prices. Weak global inflation is expected to keep import prices subdued, supporting a gradual rise in the terms of trade over the medium term. Ongoing strength in tourism keeps services exports and the services surplus buoyant, while rising global interest rates drive a widening of the income deficit and a widening of the current account deficit to 4.4% of GDP by 2020.

…as net migration inflows ease and potential growth slows…

Annual net migration is assumed to steadily decline from around 70,000 in 2016 to around 20,000 by 2021. Compared to the Budget Update, net migration is higher, owing to a more gradual adjustment path over the forecast period. Further details on the migration assumption are provided in Migration, population growth and potential outputon page 22.

Figure 1.9 - Potential output

Source: The Treasury

Growth in potential output declines over the medium term, driven by slower growth in the labour force as net migration inflows ease. In annual average terms, potential output growth slows from 3.1% in the near term to 2.5% by 2021, but is higher than in the Budget Update given the largerlabour force. Growth in measured labour productivity is slightly below its historical average, although changes to the HLFS mean productivity comparisons need to be treated with caution (see Implications of changes to the Household Labour Force Survey on page 15).

Migration, population growth and potential output

…with pent-up demand for housing…

The level of residential investment is projected to be significantly higher in the medium term than in the Budget Update, reflecting a higher starting point, stronger growth in the near term, stronger demand from higher net migration and monetary policy being more accommodative. However, growth in residential investment slows over the medium term as declines in net migration inflows and eventual interest rate rises lead to slower growth in housing demand. Overall, supply constraints in the construction sector are expected to remain elevated, but ease slightly over the medium term, particularly in Auckland as the regulatory environment for dwelling construction is eased by the AUP.

House prices are projected to continue rising over the medium term, but at a slower pace than recently. House price growth in Auckland is expected to continue moderating over the medium term, given its already high level and improving supply conditions. In the regions outside of Auckland, price growth is expected to remain solid as demand continues to shift to where houses are more affordable. In Canterbury, house prices are expected to remain broadly stable as the residential rebuild continues to increase housing supply. If demand for housing holds up higher than expected, or supply constraints are more binding than anticipated, construction costs and house price growth could remain higher for longer.

Annual average growth in market investment moderates from 9.3% in June 2017 to 2.3% by June 2021 as projects in the construction pipeline are completed and interest rates begin to rise. Likewise, private consumption growth moderates from 4.0% in June 2017 to 2.2% in June 2021, reflecting slower population growth.

…supporting aggregate demand and inflation, leading to higher interest rates…

Aggregate supply and demand in the economy are projected to come into balance in the medium term, with the output gap turning positive in 2018.

Annual inflation returns to 2.0% by June 2018, driven by a rebound in tradables inflation and steady increases in non-tradables inflation. Annual tradables inflation is expected to rise to 1.0% in June 2018, and remain around this level over the medium term as world prices, including oil prices, steadily increase. Annual non-tradables inflation is expected to rise at a steady pace of around 3% over the medium term as capacity pressures in the economy and wage growth pick up. However, the possibility of low global growth and inflation over the medium term presents downside risks to tradables inflation, particularly given limited scope for monetary policy to respond to negative shocks in many advanced economies. The fall in inflation expectations in early 2016 suggests that low inflation outturns have reduced expectations of future inflation, which is assumed to dampen price- and wage-setting across the economy, slowing the pass-through to non-tradables inflation from capacity pressures.

With rising inflation, the Reserve Bank is expected to begin increasing the OCR from late 2018, with short-term interest rates gradually lifting to 3.9% by June 2021 (Figure 1.11), which is still below their assumed long-run level of around 4.5%.Long-term interest rates are expected to rise gradually to 4.3% by 2021 as inflation in advanced economies begins to rise and global monetary policy settings are tightened, particularly in the US.

Figure 1.11 - 90-day interest rate

Source: Reserve Bank, the Treasury

Growth in government consumption remains moderate over the medium term. As indicated by the fiscal impulse, the impact of discretionary fiscal policy on demand is estimated to be mildly contractionary over the medium term, meaning government spending is not expected to add to aggregate demand in the economy (see Structural fiscal balance indicators on page 40 for further detail).

The positive output gap is reflected in a decline in the unemployment rate, which averages around 4.3% over the medium term as sustained employment growth absorbs expansion of the labour force. The participation rate moderates over the medium term, but is higher than in the Budget Update, reflecting the stronger growth outlook and changes to the HLFS (discussed on page 15). Annual wage growth increases to around 3.0% over the medium term.

…as global interest rates rise and the current account deficit widens

Global interest rates, particularly in the US, are projected to rise over the medium term as growth picks up and inflationary pressures re-emerge. The recent increase in long-term bond yields has not been incorporated in the forecasts as it is not clear whether it will be sustained.

With global interest rates rising and growth moderating in New Zealand, the New Zealand dollar depreciates over the medium term, but remains higher throughout the forecast period compared to the Budget Update. The lower dollar later in the forecast period is expected to support farm incomes and services exports.

The goods terms of trade gradually rise over the medium term, as commodity export prices continue to lift, particularly for dairy as growth in global supply slows, alongside moderate growth in global demand. On the other hand, import prices are expected to rise more modestly than export prices. This is partly owing to constrained growth in crude oil prices, given the significant increase in production capacity over the past few years on the back of strong investment in exploration and technological advancements. Oil prices are assumed to slowly trend higher, reaching US$63/barrel by June 2021.

The current account deficit gradually widens to 4.4% of GDP by early 2020 and remains steady thereafter, with the goods deficit averaging 1.8% of GDP over the medium term. Rising global interest rates lead to a widening of the primary income deficit, from 3.2% of GDP in 2017 to 4.2% in 2021. The services surplus is expected to remain buoyant at 1.7% of GDP. Successive current account deficits lead to the net international liability position deteriorating from 65% of GDP at present to around 70% in 2021.

Overall, a larger population, higher terms of trade and faster real growth translate into higher nominal GDP than expected in the Budget Update

Annual average growth in nominal GDP peaks at 5.6% in June 2018, before steadily declining to 3.9% by June 2021. Nominal GDP growth is supported by the strong cyclical upswing in real GDP in the near term, and ongoing increases in the terms of trade and inflation over the medium term. Compared to the Budget Update, nominal GDP is cumulatively higher by around $23.7 billion over the four fiscal years to June 2020. Higher nominal GDP increases projected tax revenue over the forecast period from the Budget Update, which is discussed in greater detail in the Fiscal Outlook chapter.

Figure 1.12 - Nominal GDP

Source: Statistics New Zealand, the Treasury

Fiscal Outlook#

Print this section

Overview#

Print this section

• The Crown's fiscal outlook has improved over the past five years with an OBEGAL surplus being recorded in both the 2014/15 and 2015/16 fiscal years. The current year's results to 31 October continue to be ahead of previous forecast levels as tax revenue continues to be higher than expected in the Budget Update.
• This steadily improving fiscal outlook is expected to continue reflecting a growing nominal economy which is forecast to drive growth in tax revenue at a rate higher than the expected growth in expenses.
• Future operating allowances are set to remain at $1.5 billion for Budgets 2017 onwards. However, future capital allowances have been increased from the net $1.4 billion in Budget 2016 (gross $2.6 billion) to $3.0 billion in Budget 2017, and to $2.0 billion in future Budgets.
• OBEGAL is expected to reduce from $1.8 billion in 2015/16 to $0.5 billion in the current financial year, in part owing to Kaikōura earthquake costs recognised in 2016/17 and higher Accident Compensation Corporation (ACC) insurance costs reflecting recent claims experience (including the economic growth impact on claim volumes). In addition, the 2015/16 result was higher than expected due in part to some reversals of previous impairment expenses, which increased OBEGAL in that year. After 2016/17, surpluses are forecast to continue to rise across the forecast period, reaching $8.5 billion by 2020/21 (2.7% of GDP).
• Core Crown expenditure as a percentage of GDP is expected to be 29.6% in 2016/17 (similar to 2015/16), before falling across the forecast period to be 27.7% in 2020/21.
• Based on our current estimation the known direct (gross) fiscal costs to the Government caused by the Kaikōura earthquakes is in the range of $2 billion to $3 billion. These costs are a mixture of operating expenses (eg, EQC claims costs) and capital expenditure (eg, rebuilding state highways) (refer page 6 for more discussion on the earthquakes). Some of these costs are assumed to be met from existing baselines, insurance proceeds, existing budget allowances or existing funds such as the National Land Transport Fund. An incremental $1.0 billion has been added to the forecasts to recognise operating costs not expected to be met from other sources.
• Contributions to the New Zealand Superannuation Fund (NZS Fund) are forecast to resume in 2020/21 when net debt is forecast to fall below 20% of GDP, with $3.1 billion expected to be contributed in that year.
• Capital spending (including contributions to the NZS Fund) by the core Crown is estimated to be $32.1 billion over the forecast period. This compares to capital spending of $18.4 billion in the previous five years, largely reflecting the increase in capital allowances, resumption of NZSF contributions, and increased capital spending on education and defence assets.
• Net core Crown debt is expected to decline over the forecast period as a percentage of nominal GDP to stand at 18.8% by 2020/21, as operating cash flows are expected to rise and fund the growing capital spend. In nominal terms it is expected to increase in the first two years before beginning to decline to be $59.6 billion by 2020/21.
• The Crown's net worth is expected to increase over the forecast period, reaching $129.3 billion by 2020/21, surpassing the pre-2009 nominal levels. This growth is the result of continued forecast surpluses across the forecast period. While as a percentage of nominal GDP net worth also rises, it is not yet expected to regain its peak of 55.6% in 2007/08 by the end of the forecast period.
• Total assets are forecast to grow by $35.9 billion to stand at $328.6 billion by 2020/21. Of this, social assets have the largest growth, increasing $21.5 billion to stand at $170.9 billion by 2020/21. Liabilities fall in nominal terms, with borrowings decreasing in the later part of the forecast period. Total liabilities are expected to stand at $193.8 billion at the end of 2020/21, with borrowings making up $107.9 billion of that balance.
• OBEGAL is expected to be slightly higher in most years than the recent Budget Update with tax revenue expected to be stronger than previously forecast, offsetting increases in operating expenses. The higher tax take means the net debt forecasts have improved, despite the increasing capital spend ($4.4 billion more than previously forecast). Page 48 provides more detailed discussion on the comparison to the Budget Update.
• These forecasts are sensitive to a number of assumptions and should be read in conjunction with the Risks and Scenarios and Specific Fiscal Risks chapters.

Notes:

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

Source: The Treasury

Key judgements and assumptions

Core Crown Tax Revenue#

Print this section

Tax revenue grows over the forecast period...

Core Crown tax revenue (Figure 2.1) is forecast to rise in each year of the forecast period. By 2020/21, core Crown tax revenue is expected to reach $89.9 billion, $19.5 billion higher than in 2015/16.

Figure 2.1 - Core Crown tax revenue

Source: The Treasury

… mainly owing to nominal GDP growth...

The tax-to-GDP ratio remains flat across the forecast at around 28% (Figure 2.1). Tax is forecast to grow a little more strongly than GDP through 2019/20 and 2020/21 owing to the influence of fiscal drag[5] and increasing interest rates on PAYE and interest resident withholding tax (RWT) respectively.

Figure 2.2 - Core Crown tax revenue and nominal GDP growth

Source: The Treasury

... but with some largely offsetting influences below the headline numbers

Although headline tax revenue and nominal GDP growth rates are forecast to be broadly similar to each other over the forecast period, there are other factors at work that affect the growth rates of the component parts of the tax forecasts to varying degrees, both positively and negatively, including:

• The two largest components of total tax revenue are pay-as-you-earn tax (PAYE) and goods and services tax (GST). The principal economic drivers of these taxes, namely employees' compensation and domestic consumption, are both forecast to grow more slowly than nominal GDP, thereby reducing the growth rate of tax revenue relative to GDP by $2.0 billion across the forecast period.
• Fiscal drag is forecast to add increasing amounts to PAYE each year, increasing tax revenue by $1.4 billion across the forecast period.
• Growth in the interest-bearing deposit base (ie, the sum of cash-like investments on which interest is earned that is subject to RWT) is forecast to add $0.4 billion to tax revenue by 2021.
• Although interest rates have a negative effect on tax growth in the early part of the forecast period, rates are forecast to rise from 2018/19 onwards, overall increasing the interest RWT forecast by $0.4 billion.
• CPI indexation of excise rates adds $0.2 billion to customs and excise duties by 2021.

Further detail of these effects is shown in Table 2.3.

Source: The Treasury

Inland Revenue has also prepared a set of tax forecasts which, like the Treasury's tax forecasts, were based on the Treasury's macroeconomic forecasts. The two sets of forecasts are relatively close to each other but differ slightly because of the different modelling approaches and assumptions and judgements made by the two agencies. This comparison is included in the Additional Information on the Treasury website at http://www.treasury.govt.nz/budget/forecasts/hyefu2016

Core Crown Expenses#

Print this section

Nominal core Crown expenses increase...

Core Crown expenses are expected to grow by $13.9 billion over the forecast period from $73.9 billion in 2015/16 to $87.8 billion in 2020/21 (refer Figures 2.3 and 2.4). This nominal growth is largely attributable to the $6.0 billion of operating allowances set aside for future Budgets in addition to the new spending allocated at Budget 2016. Social assistance spending is forecast to increase by $5.0 billion across the forecast period (refer to page 34 for further details).

Figure 2.3 - Core Crown expenses

Source: The Treasury

Figure 2.4 - Increase in core Crown expenses relative to 2015/16 actuals

Source: The Treasury

...reflecting new budget spending...

Future operating allowances[6] are currently set at $1.5 billion for Budget 2017 onwards (Figure 2.5).

Figure 2.5 - Budget 2017 and future budget allowances

Source: The Treasury

For forecasting purposes, the allowances are assumed to be all expenditure. However, these allowances can be used for a combination of revenue and expense initiatives, and net of identified savings when allocated.

The Budget 2017 operating allowance of $1.5 billion compares to net $1.6 billion new spending in Budget 2016 and an average of $520 million across the previous five Budgets.

...and increasing social assistance...

In addition to new budget spending, social assistance spending is expected toincrease by $5.0 billion across the forecast period. NZS payments accounts for $3.8 billion of this increase (Figure 2.6). NZS recipient numbers are forecast to increase from 690,600 in 2015/16 to 827,000 by the end of the forecast horizon. This increase in recipient numbers accounts for just over 66% of the increase in NZS costs, with the remaining increase largely owing to indexation of entitlements to wage growth (Figure 2.7). By the end of the forecast period, NZS is around 55% of the total social assistance spending compared to 50% in 2015/16.

Figure 2.6 - Social assistance spending

Source: The Treasury

Figure 2.7 - Growth of NZS expenses

Source: The Treasury

Other (non-NZS) welfare expenditure grows by $1.2 billion over the five-year forecast period with the largest growth relating to the income-related rents subsidy ($0.4 billion) driven by increases in tenancy places and market rents. While most welfare expenditure grows, expenditure on the Jobseeker Support and Emergency Benefit decreases by $0.1 billion across the forecast period as the unemployment rate is forecast to decline, with expenditure on this benefit expected to peak in 2016/17.

...although as a percentage of nominal GDP, core Crown expenses reduce

Core Crown expenses are expected to increase slightly as a percentage of GDP from 29.4% in 2015/16 to 29.6% in 2016/17, largely reflecting a positive reduction in impairment expenses in 2015/16 and the impact on the new spending in Budget 2016. Throughout the remainder of the forecast period core Crown expenses are forecast to grow more slowly than the nominal economy, which sees core Crown expenses declining to 27.7% of GDP at the end of the forecast period (Figure 2.3).

Fiscal impact of migration and population growth

Operating Balance#

Print this section

The operating performance of the Crown strengthens…

OBEGAL is expected to decrease in the current year followed by steady growth in the remaining years of the forecasts. OBEGAL reached a surplus of $1.8 billion in 2015/16 but is expected to decrease to a surplus of $0.5 billion in the current year. This surplus is then forecast to rise to $8.5 billion by 2020/21.

The forecast deterioration in OBEGAL in the current year largely reflects a strong outcome in 2015/16, owing to impairment reversals for tax receivables and social benefit receivables. In 2016/17, expenditure is forecast to increase with ACC insurance expenses, reflecting recent claims experience and economic growth assumptions, as well as health and education expenditure increases reflecting Budget 2016 decisions. In addition, one-off costs in relation to the Kaikōura earthquakes have been recognised (for more information, refer to Economic and fiscal impacts of the Kaikōura earthquakes on page 6).

Figure 2.8 shows the composition of OBEGAL from the different segments of the Government. The core Crown segment is forecast to have an OBEGAL surplus of $2.2 billion in 2016/17, with OBEGAL surpluses continuing to rise over the reminder of the forecast period, largely reflecting growth in tax revenue outpacing growth in nominal spending.

Figure 2.8 - Components of OBEGAL by segment

Source: The Treasury

Crown entities' (CEs') OBEGAL is expected to be in deficit throughout the forecast period. The deficit increases from $0.3 billion in 2015/16 to peak at $1.4 billion in 2016/17, before reducing back to $0.8 billion in 2017/18 and then remaining fairly constant, largely reflecting ACC's results, while EQC has additional earthquake costs owing to the Kaikōura earthquakes in the current year. ACC results in particular are sensitive to movements in discount rates affecting the calculation of future claims costs in present day dollars. As such, their OBEGAL forecasts can move significantly between forecasts.

State-owned Enterprises' (SOEs) contribution to OBEGAL is fairly stable with operating surpluses forecast throughout the forecast period.

...with investment returns contributing to the operating balance…

The total Crown operating balance, inclusive of gains and losses, is forecast to be in surplus across all years of the forecast period with a surplus in 2016/17 of $3.8 billion growing to $11.9 billion in 2020/21 (Figure 2.9). This compares to net losses of $7.2 billion recorded in the previous financial year (mainly in relation to actuarial losses).

Figure 2.9 - Components of operating balance

Source: The Treasury

ACC and NZS Fund hold the largest investment portfolios and market movements in these portfolios can have a significant impact on the operating balance.

The NZS Fund incurred losses on investment in 2015/16. For the first four months of 2016/17, gains on investments have been recorded, which has resulted in the NZS Fund forecasting gains on investments for the 2016/17 year.

Beyond 2016/17, investment gains assume a long-term rate of return, resulting in investment gains increasing to $3.1 billion in 2020/21. The level of investment gains plays a significant part in increasing the Government's financial assets and contributing to growth in the Crown's net worth.

The Crown's significant long-term liabilities such as ACC and Government Superannuation Fund (GSF) use discount rates and CPI assumptions in their valuations. However, as future changes to discount rates and CPI are not forecast, they do not impact on gains and losses beyond 2016/17.

While the Crown is forecast to be in surplus across the forecast period, net debt is forecast to continue to increase in the near future. Table 2.4 below illustrates the link between OBEGAL and the movement in net debt. The key differences are that OBEGAL includes non-cash items and the results of SOEs, CEs, and the NZS Fund (that do not impact net debt), while net debt is also impacted by capital cash flows (that are excluded from OBEGAL).

Source: The Treasury

Structural fiscal balance indicators

Capital Expenditure#

Print this section

The Government is forecast to spend a net total of $32.1 billion on capital items over the forecast period, which includes recommencing contributions to the NZS Fund in 2020/21 (refer to page 30), building and acquiring physical assets (eg, school buildings), advances (eg, student loans), providing capital to CEs (eg, the New Zealand Transport Agency (NZTA)) and future new capital spending (Table 2.6).

Note: 1 Excluding assets acquired via Public Private Partnerships.

Source: The Treasury

Net capital spending is expected to increase significantly in 2016/17, with the largest capital spend in a number of years (Figure 2.11). The size of the forecast spend does increase some risk that spending may be pushed into future periods as capacity constraints are tested.

Figure 2.11 - Net capital spending history

Source: The Treasury

Figure 2.11 sets out a history of capital expenditure over the past 10 years and includes the forecast capital activity to 2020/21. The graph excludes contributions to the NZS Fund (2006-10 and 2021 years) and proceeds from the Government Share Offer programme in 2012-14 (a total of $4.6 billion) which were used to fund capital expenditure.

A net capital allowance of $3.0 billion is forecast for Budget 2017 with $2.0 billion for Budgets 2018-20. The Government's commitment relating to its share of the cost of the CRL joint project with Auckland Council ($1.4 billion in the current forecast period) is assumed to be met from these allowances. Each capital allowance is assumed to be spread over five fiscal years reflecting the assumed profile of future spending. This profile is illustrated in Figure 2.12.

Figure 2.12 - New capital spending (capital allowances)

Source: The Treasury

In addition to budget allowances, further capital spending is forecast to occur through the purchase of physical assets, investments in CEs and lending such as student loans.

Forecast net purchases of physical assets of $10.7 billion are forecast across the period and represent spending by core Crown agencies to maintain and expand their existing asset base. Over half of the spending ($6 billion) is expected to be on defence and education assets.

Net investments of $11.1 billion are forecast, and largely represent capital injections to CEs to maintain and expand their asset base. These are estimated to be between $1.9 billion and $2.8 billion a year. The largest capital injections across the forecast period are to NZTA for state highways ($7.0 billion). Capital injections to DHBs, Crown Fibre Holdings, Southern Response and ōtākaro are also included.

Net advances of $2.0 billion include issuance and repayment of student loans as well as the Housing Infrastructure Fund ($1.0 billion). Student loan repayments have been increasing over time so that, by the end of the forecast period, repayments are expected to match issuances.

Residual Cash and Net Core Crown Debt#

Print this section

[7]

Operating cash flows improve over time...

Net operating cash flows are forecast to be in surplus across the forecast period with a moderate cash surplus in 2016/17 year increasing to $10.6 billion in 2020/21. Over the forecast period the Government is expected to generate cash flows from core Crown operations of $34.9 billion.

Figure 2.13 - Core Crown residual cash

Source: The Treasury

The growth in operating cash flows largely mirrors the trend shown in OBEGAL and strengthens each year of the forecast period. The strength in operating cash flows largely represents growth in tax receipts exceeding the growth in operating payments.

...outpacing capital spending near the end of the forecast period

The residual cash deficit is forecast to increase in 2016/17 mainly owing to the increased capital spending forecast in 2016/17. Net capital spending is forecast to exceed operating cash flows until 2018/19, when core Crown residual cash returns to surplus (Figure 2.13).

Over the entire forecast period a cash surplus of $2.8 billion is expected. This cash surplus is expected to help fund future government bond repayments (Table 2.7).

Net core Crown debt declines over the forecast period...

Net core Crown debt as a share of nominal GDP is forecast to decrease over the forecast period, from 24.6% in 2015/16 (Figure 2.14) to 18.8% by 2020/21.

Figure 2.14 - Net core Crown debt

Source: The Treasury

In dollar terms, net core Crown debt is forecast to increase for the first two years as cash flows from operating activities are not expected to be sufficient to meet capital spending (as discussed above) before starting to decline once residual cash returns to surplus. Net debt is forecast to be $59.6 billion in 2020/21.

...and gross debt begins to decline after 2016/17

Gross debt is expected to peak at $92.0 billion in 2016/17. Forecast maturities are then expected to exceed new debt being issued, and gross debt begins to decline. Gross debt is forecast to be $76.7 billion in 2020/21 which is equivalent to 24.2% of nominal GDP (Figure 2.15).

Figure 2.15 - Gross debt

Source: The Treasury

Gross debt falls faster in nominal terms than net debt as bond repayments are met with a mixture of new bond issuances and a reduction in financial assets.

The bond programme is expected to raise funds of $31.9 billion over the forecast period, while $42.2 billion of existing debt will be repaid, providing net repayments of $10.3 billion (Table 2.7). Any excess cash proceeds raised from the bond programme are expected to be invested in financial assets and used to meet future debt maturities.

The issuance profile is relatively flat in order to reduce year-to-year volatility of bond programmes and ensure consistency of supply over this time.

Source: The Treasury

Total Crown Balance Sheet#

Print this section

Increasing operating balance surpluses result in a stronger balance sheet...

Net worth attributable to the Crown is forecast to grow in nominal terms across the forecast period largely owing to forecast operating balance surpluses. Beyond 2017, net worth attributable to the Crown is expected to grow over the four years by $36.3 billion to stand at $129.3 billion by 2020/21. As a share of nominal GDP net worth attributable to the Crown is expected to decline slightly in 2016/17 to 35.1%, as expected GDP growth continues to remain strong in the near term. From 2017/18 increasing operating balances outpace GDP growth for net worth attributable to the Crown to reach 40.7% by 2020/21 (Figure 2.16).

Figure 2.16 - Net worth attributable to the Crown

Source: The Treasury

Figure 2.17 - Total Crown assets

Source: The Treasury

...with assets increasing by $35.9 billion over the forecast period...

Total assets are forecast to grow by $35.9 billion over the forecast period to $328.6 billion in 2020/21, made up of additional investments in assets (both physical and financial) of $89.4 billion, partially offset by reductions (largely depreciation) of $53.5 billion.

The largest asset growth over the forecast period is in the social assets portfolio (around 50% of the total Crown balance sheet). Social assets (eg, schools, hospitals and social housing) are expected to increase by $21.5 billion over the forecast period to be $170.9 billion in 2020/21 (Figure 2.18). This increase largely reflects growing capital spending. Liabilities in relation to the social sector (eg, tax refunds, Emissions Trading Scheme (ETS) provision and payables and provisions in relation to social assets noted above) remain fairly static across the forecast period. As a result, social net worth is expected to increase.

Figure 2.18 - Social balance sheet

Source: The Treasury

The financial asset portfolio (around 30% of the total Crown balance sheet) is expected to increase by $9.0 billion to be $96.9 billion in 2020/21, primarily reflecting investment growth in the large investment portfolios (NZS Fund and ACC).

On the liability side, borrowings that are mostly undertaken by the Treasury's New Zealand Debt Management Office (NZDMO) (which manages the Crown's bond programme and funds forecast cash shortfalls), and the Reserve Bank. Borrowings in the financial sector are forecast to decrease by $14.0 billion by 2020/21. Insurance liabilities are expected to increase by $0.6 billion in the current year partly owing to claims from the Kaikōura earthquakes. Beyond 2016/17, ACC's insurance liability will continue to increase from $39.1 billion at the end of 2015/16 to stand at $47.3 billion in 2020/21. The GSF liability is forecast to be $11.9 billion in 2016/17 falling to $9.6 billion by 2020/21. Overall, net worth in the financial sector increases by $18.8 billion across the forecast period (Figure 2.19).

Figure 2.19 - Financial balance sheet

Source: The Treasury

The commercial asset portfolio (representing 20% of the Crown's balance sheet) is expected to increase by $5.5 billion over the forecast period to be $60.8 billion in 2020/21, with growth mostly coming from growth in Kiwibank[8] loan book (with a corresponding increase in liabilities as deposit balances are also forecast to rise). Commercial net worth decreases by $1.6 billion over the forecast period (Figure 2.20).

Figure 2.20 - Commercial balance sheet

Source: The Treasury

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

Many of the assets and liabilities on the Crown's balance sheet are measured at “fair value” in order to show current estimates of what the Crown owns and owes. While the measurement at fair value is intended to reflect the value of these items, it can be volatile, resulting in fluctuations in the value of the assets and liabilities reflecting changes in the market and underlying assumptions.

Refer to the Risks and Scenarios chapter page 69 for more details.

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

Apart from market factors, valuations are subject to a number of judgements and estimates with valuations based on underlying assumptions made at the time the valuations were prepared. In general, as time goes on, better information becomes available and initial estimates are updated to reflect current information. Some examples of this are noted below:

• The carrying value of student loans is based on a valuation model adapted to reflect current student loans policy. As such, the carrying value over the forecast period is sensitive to changes in a number of underlying assumptions, including future income levels, repayment behaviour and macroeconomic factors such as inflation and discount rates used to determine the “effective” interest rate for new borrowers. Any change in these assumptions would affect the present fiscal forecasts.
• GSF's assets are offset against the gross liability and have been updated to reflect market values. The GSF liability is valued by projecting future cash payments, and discounting them to the present. The value of assets over the forecast period reflects long-run rate of return assumptions appropriate to the forecast portfolio mix.
• The ACC liability has been adjusted for the latest discount rate. This liability is valued by projecting future cash payments, and discounting them to the present. These valuations rely on historical data to predict future trends and use assumptions such as inflation and discount rates. Any changes in actual payments or economic assumptions would affect the present fiscal forecast. For example, if the discount rate decreases, the value of the liabilities would increase.

...while other risks 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 in our forecasts, either because they are contingent on an uncertain future event occurring (eg, outcome of litigation) or the liability cannot be measured reliably. If these liabilities crystallise, there will be associated costs with a negative impact (or positive in the case of contingent assets) on the operating balance or net debt. Refer to page 85 for a list of the contingent liabilities at 31 October 2016.

Comparison to the Budget Update#

Print this section

The Budget Update was published on 26 May 2016. Since then, there have been a number of developments that have significantly impacted the fiscal outlook. Table 2.8 below summarises the changes in the key fiscal indicators since then.

Source: The Treasury

 A stronger economic outlook has improved the tax take...

As outlined in the Economic Outlook chapter, economic growth over the first half of 2016 has exceeded expectations, and this has likely continued into the latter half of 2016. In addition, nominal GDP growth up to the end of the 2017/18 is now expected to be much stronger than was forecast in the Budget Update.

Figure 2.21 - Movement in core Crown tax revenue since the Budget Update

Source: The Treasury

As a result of both of these factors, nominal GDP is forecast to be a cumulative (2016/17 to 2019/20 inclusive) $23.7 billion higher than in the Budget Update. This has contributed to an upward revision to the core Crown tax revenue forecasts of $7.6 billion across the forecast period. Forecasts for most of the major tax types have been increased, with the exception of interest RWT, which has followed the interest rate forecasts downwards. Table 2.9 below summarises the movements by tax type since the Budget Update.

Table 2.9 - Reconciliation of the change in core Crown tax revenue

Source: The Treasury

• A higher forecast for compensation of employees (aggregate wages and salaries) has contributed to the source deductions forecasts being increased by $3.0 billion across the forecast period.
• Increases to the outlook for private consumption and residential investment help to increase the total GST forecasts by $2.8 billion.
• An increased forecast for entrepreneurial income, partly owing to the improved outlook for dairy farmers, has contributed to a $1.6 billion increase in the other persons tax forecast.
• Corporate tax forecasts have been revised upwards by a total of $1.5 billion owing to an increased forecast for corporate profits.
• The forecasts for interest RWT have been lowered by a collective $2.0 billion through a combination of lower interest rates and a recalibration of the model used to estimate RWT.

...but the OBEGAL outlook is similar to the previous forecast …

While tax revenue is stronger than forecast in the Budget Update, increased expenses (largely social assistance) and reduced ACC forecasts (see below) mean OBEGAL is expected to be similar to the previous forecast (Table 2.10).

Source: The Treasury

An increase in expected social assistance spending across all years is mostly attributable to an increase in forecast NZS payments, a result of both indexation of payments to wage growth and higher growth in the number of NZS recipients compared to the Budget Update.

As discussed in the Overview, a portion of the operating costs ($1.0 billion) has been added to the 2016/17 forecasts on top of existing spending, representing the estimated net costs of the Kaikōura earthquakes that are not expected to be funded from other sources. The fiscal forecasts capture initial estimates of known costs. Experience with the 2010-11 Canterbury earthquakes suggests that, as more information comes to hand and the recovery plan becomes clearer, additional damage may be uncovered and that future aftershocks may cause further damage or delay the recovery. Where this occurs, cost estimates may rise over time (page 6 includes a detailed discussion of the expected increase in costs of the earthquakes).

Updated ACC forecasts have resulted in a decrease in OBEGAL in each year of the forecast owing to a number of factors:

• Lower discount rates have resulted in higher insurance expenses across all years than previously forecast.
• From 2017/18, ACC levy revenue is expected to be lower than previously forecast owing to assumptions around levy rate reductions being based on ACC's agreed funding policy.

Net finance costs are unfavourably affected by the following factors:

• Decreases in short-term interest rates have resulted in a reduction in interest income.
• Some interest income (included in OBEGAL) has been re-forecast as gains (excluded from OBEGAL). This reclassification does not impact the total Crown operating balance.

Lower medium-term interest rates have resulted in a reduction in finance costs and partially offset some of the unfavourable impacts mentioned above.

...while net core Crown debt is lower compared to the Budget Update

Residual cash deficits, which have the most direct impact on net debt, are lower than previously forecast in the short term as the stronger tax take outweighs additional spending. Overall, residual cash is $0.5 billion better than forecast in the Budget Update over the four years ended 2019/20. Changes to net debt since the Budget Update largely follow changes in residual cash (Table 2.11).

Source: The Treasury

There has been an increase of $4.4 billion in relation to forecast capital spending. While capital allowances have increased significantly since the Budget Update (Table 2.12), increased transport spending and the formation of the Housing Infrastructure Fund ($1.0 billion) also add to the expected capital programme.

Source: The Treasury

Allowances are spread over a number of years, reflecting that capital projects kay take a number of years to complete.

Allowances for new capital spending have increased from $0.9 billion in the Budget Update to $3.0 billion for Budget 2017 and $2.0 billion as the Government looks to increase spending on priority infrastructure. In total the increased capital allowances add $2.9 billion onto capital spending over the next four years compared to the Budget Update.

The Government's commitment relating to its share of the cost of the CRL joint project with Auckland Council is assumed to be met from these allowances.

Key Economic Assumptions#

Print this section

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 2.13 below.

Notes:

1. Production measure.
2. Expenditure measure.

Source: The Treasury

Risks and Scenarios#

Print this section

Overview#

Print this section

• Overall, risks to the economic outlook have increased since the 2016 Budget Update. Internationalrisks are largely skewed to the downside, while domestic risks are more balanced. This chapter first outlines these key risks to the economic outlook, then presents two alternative scenarios for the economy, assuming some combination of these risks are realised, and outlines their implications for the fiscal forecasts. The final part of the chapter focuses on general fiscal risks.
• Internationally, the key risk to the New Zealand economy is slower trading partner growth that leads to lower export demand and prices. This risk could arise from a sharp slowing of growth in China, further deterioration of growth in the euro area and Japan, or as a consequence of Brexit. The timing and extent of the US economic recovery and monetary tightening cycle, and future trade and fiscal policy present a further source of uncertainty to these forecasts.
• Risks to the domestic outlook are more balanced, and centre around net migration, residential investment and the extent of spare capacity in the economy, tourism growth, goods exports (particularly dairy), uncertainty around inflation and housing market dynamics, and the impact of the Kaikōura earthquakes.
• Two scenarios are presented that show ways in which the New Zealand economy could deviate from the main forecast. Scenario One illustrates the impact of an international shock that lowers our trading partners' growth and increases global financial market volatility, prompting a fall in export demand, asset prices, the New Zealand dollar and the terms of trade, leading to lower investor and consumer confidence. In this scenario, nominal GDP, tax revenue and OBEGAL are lower.
• Scenario Two shows the economic impact of tighter-than-expected capacity constraints. In this scenario, inflationary pressures are stronger as prices are bid up, while in the medium term investment and consumption growth is constrained to lower than in the main forecasts. This scenario lifts nominal GDP, tax revenue and OBEGAL.
• The above risks have implications for economic activity and income, and therefore represent risks to the Crown's forecast revenue. The Crown is also subject to other risks affecting expenditure and the Crown's balance sheet. In particular, volatility in financial asset prices and interest rates can have a significant impact on the Crown's fiscal position.

Economic Risks#

Print this section

Risks to global growth, particularly in the medium term, have increased since the 2016 Budget Update with a rise in protectionist sentiment, while further fiscal stimulus in China exacerbates risks relating to its overheated housing market and high levels of government debt. Some negative medium-term risks may be accompanied by positive short-term risks; further stimulus in China and expansionary US fiscal policy would support global growth in the near term, and the short-run impact of Brexit may be less severe than previously anticipated. The current outlook, however, is for growth to slow in the near term in Australia, the UK, China and the euro area.

The scope internationally for further monetary policy easing or fiscal stimulus is limited, meaning negative growth shocks are likely to be persistent. There is a risk that slow global growth becomes entrenched, with a more prolonged period of low inflation and interest rates, while financial market risks increase as asset prices become overvalued. The realisation of any of these downside risks to the world economy would weigh on economic growth in New Zealand, materialising as lower demand and/or prices for New Zealand’s exports, a lower New Zealand dollar as well as adversely affecting confidence and bank funding costs.

Risks to the domestic outlook are more balanced, and centre around net migration, residential investment and the extent of spare capacity in the economy, tourism growth, goods exports (particularly dairy), uncertainty around inflation and housing market dynamics, and the impact of the Kaikōura earthquakes.

Other risks include adverse natural events, including aftershocks following the Kaikōura earthquakes, military tensions in the Middle East and elsewhere, terrorism and disease. In addition, economic dynamics may play out differently from these forecasts, and uncertainty remains around key judgements and assumptions (see Key economic forecast judgements and assumptions box in the Economic Outlook chapter).

Economic stability in China remains a key risk to the global outlook…

Annual average GDP growth in China has fallen from over 10% in 2010 to 6.7% in the September 2016 quarter as the composition of growth shifts from investment towards consumption. The transition is intended to lead to more sustainable growth in the long term, with the trade-off of slower growth in the near term. Authorities have tried to mitigate slower growth in the near term with greater levels of support; however, such support may prolong the transition and create further imbalances, especially if other key risks are exacerbated, such as the high level of local government and state-owned enterprise (SOE) debt and the risk of a sharp downturn in China's overheated housing market.

Slower growth and heightened uncertainty about China's outlook have been reflected in lower commodity prices, subdued growth in international trade flows, reduced confidence and increased financial market volatility. A sharper slowdown in China would be expected to be transmitted as a more severe deterioration through these channels, with a flow-on impact of slower growth in other trading-partner economies, particularly in Australia and elsewhere in the Asia-Pacific region. The direct effect on New Zealand of a slowdown in China may be offset to some extent by the rebalancing towards consumption as the main driver of growth, as a successful transition could be positive for New Zealand by increasing Chinese demand for our mostly consumer-orientated primary products in the longer term.

…alongside uncertain growth prospects in advanced economies…

While the US recovery continues, the outlook is for moderate growth in both 2016 and 2017, and consequently gradual tightening in monetary policy. Possible expansionary fiscal policy, risks to financial market stability with the proposed repeal of regulation introduced post-global financial crisis and a potential policy shift towards greater trade protectionism and reduced people flows will influence future growth, although at this stage to what extent is unclear. Uncertainty remains around the timing and extent of the Federal Reserve's monetary tightening cycle, as well as the possible unintended destabilisation of emerging market economies that have US dollar-denominated debt from tighter US monetary policy. Further out, risks remain around the rate of US potential growth, which may continue to decline with an ageing population.

In addition to the flow-on impacts of slowing growth in China to other trading partners, risks to the Australian economy centre on a more gradual-than-expected transition from mining investment to non-mining, resulting in a longer period of below-trend growth. There is some uncertainty about Australia's trend growth rate, with slower population and productivity growth. A key upside risk is the path of Australia's commodity export prices and volumes. For instance, if the recent spike in the price of coking coal is sustained, nominal GDP may be significantly higher in the near term. On the downside, Australia faces similar risks to New Zealand, in the form of elevated house prices in some areas and high levels of household debt. Trans-Tasman flows represent a large portion of New Zealand's net migration, and will be influenced by the strength of Australia's labour market.

The growth outlook for Japan and the euro area is for ongoing low and moderate growth respectively, with both economies facing policy challenges to stimulate demand. Divergence between the monetary policy stance of these two countries and the US may reduce the efficacy of Japan’s and the euro area’s monetary policy in some areas, while concerns remain around the stability of the euro area’s banking sector, particularly with regard to the adverse effects of negative interest rates. Room for fiscal stimulus is also limited given high debt levels and ongoing large fiscal deficits.

Brexit is a key source of uncertainty that is likely to last for some time to come. Much uncertainty centres on the precise nature of Brexit: the timeframes, constitutional arrangements and nature of future agreements with the European Union. This uncertainty is expected to weigh on firm investment and employment decisions, although to what extent is unclear. Prominent risks relate to the future of the UK's financial centre and the value of sterling, which at its present subdued level supports exporters in the short term, but increases producer input price pressures, which in turn is expected to erode consumers' purchasing power. These risks will influence New Zealand through UK and euro area demand for our exports (eg, lamb) and future bilateral trade agreements.

…with the risk of weaker demand for key exports…

The outlook for key exports, such as dairy and tourism, continues to be marked by uncertainty and remains dependent on the growth of our trading partners (particularly China). The dairy price outlook is uncertain, despite recent large increases. Risk centres on how international production will respond over the medium term, particularly in the European Union where further market intervention by the European Commission could continue to distort price signals. Global dairy production growth has been further supported by decreased input costs from low oil and stockfeed prices and the strength of the US domestic dairy market. There is also uncertainty around the outlook for demand, particularly from China, and how long the Russian import ban remains in place. Other risks include the outlook for oil prices, which will be influenced by potential OPEC coordination, adverse weather events and the path of the New Zealand dollar. Despite recent improvements in farm-gate prices, dairy farm cashflows will remain constrained in the 2016/17 season.

Travel services export growth has been robust, as the gradual loosening of travel restrictions in China and approval of additional flights to New Zealand has supported a record number of visitor arrivals. Similarly, arrivals on student visas from Asian countries are at high levels, although they have moderated slightly in recent months. However, the Kaikōura earthquakes may prompt a decline in tourism arrivals to New Zealand (see Economic and fiscal impacts of the Kaikōura earthquakes on page 6). A shift in travel preferences, significantly slower income growth and/or heightened uncertainty abroad pose risks to the outlook for both tourism and education services exports.

…and increasing financial market volatility

Long-term interest rates increased from record lows in the second half of 2016, with increased optimism around global growth and inflation prospects. A global financial shock, such as a banking crisis, would increase perceptions of risk and financial market volatility, and thereby increase costs for New Zealand banks accessing funds offshore, potentially further increasing the interest rate facing households (via mortgage rates) and firms, while the New Zealand dollar would likely fall on “flight to safety” sentiment. Higher interest rates may then place pressure on households' and farmers' balance sheets, particularly those borrowers who have high levels of debt relative to income.

Net migration presents a significant risk to the central forecast…

Net migration in the year to June 2016 accounted for nearly three-quarters of population growth, increasing the size of the labour force and both the actual and potential output of the economy. Net migration has historically moved in large cycles, with gross inflows and outflows often changing at the same time, leading to large swings in net flows. However, it is difficult to gauge the strength and timing of these movements. If, for example, the Australian labour market materially improves in the near term, net migration inflows could decline more sharply than in the main forecast as arrivals from Australia decline and departures pick up again. On the other hand, the large inflows to date may suggest structurally higher permanent migration gains. See Migration, population growth and potential output on page 22 for further discussion on the economic implications of migration, and Fiscal impact of migration and population growth on page 35 for the fiscal implications.

…as does the housing market…

Housing demand has been supported by rapid population growth (at 2.1%, population growth in the year to June 2016 was the fastest since 1974) and low mortgage interest rates. These two factors are expected to continue to underpin housing demand in the year ahead. Meanwhile, housing supply growth was sluggish over 2008 and 2009 and was further affected by the Canterbury earthquakes. As a consequence, the national housing stock is smaller than it would otherwise be, which – combined with robust housing demand – has led to rapidly rising house prices, with median house prices increasing nearly 50% over the past four years.

There is a risk housing demand and house prices grow more than anticipated in the main forecast, particularly if migration inflows are higher than expected or if housing supply is slower to respond. Greater housing demand could lead to stronger-than-anticipated residential investment growth. Likewise, faster nationwide house price growth than in the main forecast could boost household wealth and consumer confidence, possibly leading to higher consumption. Conversely, a lower level of net migration may reduce housing demand and soften house price growth, while the Reserve Bank's loan-to-value regulations may subdue housing demand more than anticipated.

Nationwide, house prices grew 14% in the year to October 2016.[9] Faster house price growth represents a positive risk to economic activity through its effect on home-owning households' wealth, but may also lead to higher levels of household debt relative to disposable income, presenting a risk to financial stability as households become more vulnerable to interest rate increases (although Reserve Bank regulation on loan-to-value ratios aims to mitigate this risk). Estimates of debt servicing ratios for representative new buyers in Auckland are elevated (around 46% of income) even with current low interest rates. They would pass previous peaks if mortgage rates were to return to their 10-year average of 6.7%.[10] Alternatively, slower house price growth or a sharp fall in Auckland house prices presents a downside risk to home-owning households' wealth and therefore consumption, although this is unlikely without a major external trigger given the presence of strong economic fundamentals supporting demand.

…raising questions around the economy's capacity to respond…

Strong, simultaneous growth is expected over the forecast period in residential, business and infrastructure investment. Each of these sectors of the economy requires similar resources and a key judgement has been made around how much of this work can be completed at once. Damage caused by natural disasters, such as the Christchurch and Kaikōura earthquakes, will increase demand for these resources. The economy may not be able to respond as quickly as forecast if, for example, not enough builders were able to be attracted from within or outside New Zealand, there was insufficient land or credit available for development or if bottlenecks occurred from poor resource management and coordination. That said, the economy may be able to respond faster than anticipated if, for instance, land for residential building was released more rapidly than assumed through the AUP, or if the mobility of construction workers between Canterbury and other regions is greater than expected.

…and the future path of inflation

There is a risk that inflation may be higher than expected if capacity constraints in the economy cause wages and the price of resources to be bid up. Rising construction costs are a prime example, with different regions and companies competing for workers, building materials and machinery. Rising construction costs and a shortage of workers and land may then be passed through to consumers via higher rents, wages and prices, increasing overall inflation.

In recent times, low global inflation has weighed on inflation in New Zealand through the cost of imports and price competition. Low global commodity prices, particularly for oil, have also been a factor, as has the high New Zealand dollar which has further lowered the cost of imports. In addition, non-tradables inflation has been weaker than the long-term relationship with the output gap would suggest, with low wage growth, and inflation expectations are lower than previously as persistently weak inflation weighs on expectations. These trends may continue, leading to continued low inflation.

Scenarios#

Print this section

The following scenarios show how the economy might evolve if some of the key judgements in the main forecast are altered (Table 3.1). They illustrate two of the many ways that the economy may deviate from the main forecast. Scenario One illustrates the economic impacts of an international shock that lowers our trading partners' growth and increases global financial market volatility, prompting a fall in export demand, asset prices and the terms of trade, leading to lower investor and consumer confidence. Scenario Two shows the impact if the economy is unable to respond to high domestic demand as quickly as anticipated. In this scenario, inflationary pressures are stronger as prices are bid up, while consumption and investment are dampened.

Note: 1 June quarter, seasonally adjusted.

Sources: Statistics New Zealand, the Treasury

Scenario One - An International Shock Dampens Confidence

An international shock subdues global growth…

In the first scenario, downside risks to the international outlook eventuate, causing trading partner growth to deteriorate and elevating global financial market volatility. The flow-on impact through trade and confidence reinforces slow growth in key trading-partner economies, amplifying the severity of the international shock. Increased financial market volatility and slower growth cause investor confidence and asset prices to decline, while borrowing costs increase as banks experience higher funding costs. By June 2018, real GDP growth is 2.4%, compared with 3.5% in the main forecast, although growth accelerates later as the economy recovers (Figure 3.1).

Figure 3.1 - Real production GDP growth

Source: Statistics New Zealand, the Treasury

…depressing export demand and prices…

Export demand decreases as global income declines and tourists adopt a “wait and see” mentality. The terms of trade fall and remain around 4% weaker than in the main forecast as weaker global demand prolongs the recovery in export prices across the board (relative to import prices) (Figure 3.2). The New Zealand dollar depreciates on “flight to safety” sentiment, with the TWI around 9.5% lower than in the main forecast by June 2021. The current account deficit widens further, to be 1.4 percentage points larger than in the main forecast by June 2018 at 5.2% of GDP.

Figure 3.2 - SNA terms of trade

Source: Statistics New Zealand, the Treasury

 …and translating into decreased investment and consumption…

Firms invest less as export growth falls and as the lower New Zealand dollar increases the cost of capital imports. Lower investment leads to a fall in employment and wage growth (Figure 3.3), with higher unemployment. Weaker wage and employment growth, alongside the lower terms of trade, come together to dampen household income growth and confidence, which is compounded by a slight fall in house prices. As a consequence, household consumption growth falls.

Figure 3.3 - Employment growth

Source: Statistics New Zealand, the Treasury

…followed by subdued inflation…

In this scenario, non-tradables inflation declines with softer domestic activity, while tradables inflation initially rises as the weaker New Zealand dollar increases the cost of imports, then falls owing to dampened commodity prices and global inflation (Figure 3.4). The Reserve Bank responds to weaker demand by easing monetary policy further (90-day interest rates trough at 1.2% in late 2017). However, increased bank funding costs and risk premiums in the short term limit how much Reserve Bank interest rate cuts are passed on by banks, delaying the impact of easier monetary policy on domestic demand. Inflation briefly reaches 2.0% in late 2017 as New Zealand dollar depreciation offsets weakness in non-tradables inflation (as also occurred following the global financial crisis), but later in the forecast period the effect of the lower New Zealand dollar on inflation fades and inflation does not return to target until late 2020 (Figure 3.7).

Figure 3.4 - Non-tradables inflation

Source: Statistics New Zealand, the Treasury

 …and softer real and nominal GDP

The international shock, and its flow-on effects modelled in this scenario, drive both real GDP and nominal GDP lower over most of the forecast period. As a result, nominal GDP is a cumulative $27.1 billion lower than in the main forecast (Figure 3.5).

Figure 3.5 - Nominal GDP growth

Source: Statistics New Zealand, the Treasury

Core Crown tax revenue is a cumulative $9.0 billion lower over the forecast period in this scenario. Lower nominal consumption and residential investment reduce GST revenue by a cumulative $1.4 billion over the forecast period and lower interest rates reduce RWT by a cumulative $1.7 billion. A lower value of output in the economy reduces business profits, resulting in corporate taxes being a cumulative $1.3 billion lower. The weaker labour market and lower labour incomes reduce source deductions revenue by $2.5 billion over the forecast period.

Core Crown expenses are a cumulative $0.6 billion higher than in the main forecast, owing largely to increased debt financing costs. Discretionary fiscal policy is assumed to remain unchanged from the main forecast. In this scenario, OBEGAL reaches a small surplus of 0.1% of GDP in the June 2017 year, with growing surpluses thereafter (Figure 3.8). As a consequence, net core Crown debt rises to 25.0% of nominal GDP in the June 2018 year, rather than continuing to steadily decline, as in the main forecast (Figure 3.9).

Scenario Two - Capacity Constraints Curb Activity

Stronger near-term activity is curbed by tighter capacity constraints…

The second scenario tests a key judgement around the speed at which the economy can respond to elevated demand. In this scenario, the strong growth that characterised domestic demand in the latter half of 2016 accelerates in 2017. The acceleration does not last for long, however, as the stronger momentum in the economy is unable to be sustained owing to tighter capacity constraints. In particular, the speed at which the economy can respond is constrained by labour and capital shortages, further exacerbated by lower underlying labour productivity. In the construction industry, for instance, there may be greater delays or bottlenecks than anticipated owing to the industry's small-scale and fragmented nature. As such, the economy reaches its potential output sooner than anticipated in the main forecast, with the output gap peaking at 0.6% in the 2018 June quarter (Figure 3.6).

Figure 3.6 - Output gap

Source: Statistics New Zealand, the Treasury

…leading to higher inflationary pressures and interest rates…

The cost of land, workers and resources are bid up by competing firms, and then passed on to consumers through higher rents, wages and prices. This has the effect of raising overall inflation and inflation expectations (Figure 3.7). The Reserve Bank responds to the stronger inflation outlook by increasing the OCR earlier than in the main forecast, resulting in 90-day interest rates that are on average 40 basis points higher than in the main forecast from June 2018 onwards. Inflation exceeds 2.0% in September 2017 and remains elevated, driven by higher non-tradables inflation (Figures 3.4 and 3.7).

Figure 3.7 - CPI inflation

Source: Statistics New Zealand, the Treasury

…and higher nominal GDP…

Sustained momentum raises real GDP in the near term, which is then curbed by greater capacity constraints later in the forecast period, causing a more exaggerated economic cycle than in the main forecast. Stronger real GDP in the beginning of the forecast period, combined with higher inflation throughout the forecast, results in nominal GDP being cumulatively $13.9 billion higher than in the main forecast by the end of June 2021 (Figure 3.5). This figure may be larger or smaller depending on how binding the capacity constraints are and what other shocks the economy may be experiencing at the time.

…increasing tax revenue and the operating balance

Core Crown tax revenue is a cumulative $4.9 billion higher than in the main forecast over the period to June 2021. Increased nominal consumption and residential investment boost GST revenue by a cumulative $1.1 billion over the forecast period. Greater business profitability results in corporate taxes being a cumulative $1.4 billion higher. The stronger labour market and higher wage growth lift source deductions revenue by $1.2 billion over the forecast period. An earlier increase in short-term interest rates flows through to a cumulative $0.7 billion rise in RWT.

Core Crown expenses are marginally lower than in the main forecast owing largely to lower debt financing costs. OBEGAL surpluses are larger over the entire forecast period reaching a surplus of 3.1% of GDP by the June 2021 year, compared to 2.7% in the main forecasts (Figure 3.8). Net core Crown debt falls consistently across the forecast period, reaching 17.0% of GDP in the June 2021 year, compared to 18.8% in the main forecast (Figure 3.9).

Figure 3.8 - Total Crown OBEGAL

Source: The Treasury

Figure 3.9 - Net core Crown debt

Source: The Treasury

General Fiscal Risks#

Print this section

The remainder of this chapter focuses on the nexus between economic risks and the Crown's fiscal position. Specifically, we look at economic risks and how they translate to fiscal risks via their effects on Crown revenue, Crown expenditure and the Crown balance sheet. For more on fiscal risks, see the Specific Fiscal Risks chapter.

Revenue Risks

One of the major sources of risk to the fiscal position arises from the inherent uncertainty about future tax revenue, which accounts for around 70% of the Crown's revenue. As demonstrated earlier in this chapter in Scenario One and Scenario Two, the amount of tax revenue that the Crown receives in a given year is closely linked to the performance of the economy. For example - as set out in Scenario One - an international shock that depresses export demand and prices translates to decreased investment and consumption, which leads to lower core Crown tax revenue (lower GST, corporate tax revenue and source deductions) owing to the combined effects of lower nominal consumption, lower interest rates and a weaker labour market. Alternatively, an acceleration in domestic demand raises core Crown tax revenue (higher GST revenue, higher corporate taxes and source deductions) because of an increase in nominal consumption, greater business profitability and a stronger labour market (Scenario Two).

Figure 3.10 plots the main annual tax revenue forecast, along with confidence intervals around these forecasts based on the Treasury's historical tax forecast variances and the assumption of an even balance of risks around the main forecast.[11] The outermost shaded area captures the range of approximately plus or minus $7.5 billion in the June 2021 year, within which actual tax outturns are expected to fall 80% of the time.[12]

Figure 3.10 - Core Crown tax revenue uncertainty

Source: The Treasury

The tax revenue forecasts from Scenario One and Scenario Two are also shown in Figure 3.10. Should any of the uncertainties outlined in the Economic Riskssection eventuate, Crown revenue would be different from forecast, with Scenario One and Scenario Two being examples of possible outcomes.

Based on average historical forecast variances, Figure 3.10 suggests that an annual tax revenue outturn associated with Scenario One lies between the 25th and 50th percentiles. An annual tax revenue outturn associated with Scenario Two lies between the 50th and 75th percentiles in each year. On this basis, actual tax outcomes would be expected to fall within the range of the two alternative scenarios approximately half of the time, with greater or lesser outcomes also expected approximately half of the time.

Exogenous shocks can have severe effects on government revenue. The detrimental impact of the 2008/09 global financial crisis on core Crown tax revenue is shown in Figure 3.10. Although nominal core Crown tax revenue has surpassed pre-global financial crisis levels, future exogenous shocks pose a potential risk to Crown tax revenues. For the possible tax revenue effects of the recent earthquakes, see Economic and fiscal impacts of the Kaikōura earthquakes on page 6.

There are also risks around other sources of revenue including sales of goods and services, investment income, and fees and levies. This additional revenue is also subject to changes in economic conditions, such as changes in interest rates which impact investment income and changes in oil prices which impact the amount of petroleum royalties the Crown receives.

Fiscal Sensitivities

We have performed some sensitivity analysis that tests the effect of small changes in specific economic variables on Crown revenue. Table 3.2 sets out some rules of thumb on the sensitivities of the fiscal position to small changes in specific variables. For example, if nominal GDP growth is one percentage point higher than forecast in each year up to June 2021, tax revenue would be around $4.7 billion higher than forecast in the June 2021 year as a result. The sensitivities are broadly symmetric and if nominal GDP growth is one percentage point lower than expected each year, tax revenue would be around $4.5 billion lower than forecast in the June 2021 year. The figures are indicative and can be influenced by the composition of growth as different types of activity have different effective tax rates.

A different interest rate path from the forecast would also impact the fiscal position due to the effect on the portfolios of various government reporting entities, such as the New Zealand Superannuation Fund, the Accident Compensation Corporation (ACC) and the Treasury's Debt Management Office (NZDMO). A one percentage point lower interest rate would result in interest income on funds managed by the NZDMO being $118 million lower in the June 2021 year. This would be more than offset by interest expenses $330 million lower in the June 2021 year.

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

Source: The Treasury

The interest rate impacts in the table above represent the impact of lower interest rates on the financial assets and debt managed by the NZDMO. While the majority of the government's debt is managed by NZDMO, other government reporting entities hold financial assets and liabilities that are also sensitive to changes in interest rates. For example, at 30 June 2016, a 1% increase in NZ interest rates would have reduced the total Crown operating balance by $896 million while a 1% decrease would have increased the total Crown operating balance by $926 million.

The forecast financial position is based on a number of judgements and assumptions about the future. To inform these judgements and assumptions we rely on market information. Some additional assumptions include those around foreign exchange rates, share prices, the carbon price and property prices. Where the actual outcome differs from our assumptions, the Crown's actual financial position is likely to differ from the forecasts. For example, foreign currency-denominated financial assets and liabilities are converted into New Zealand dollars at the reporting date, the Government's listed share investments are reported on market prices and property owned by the Crown is valued using market information. Changes in these variables can also have flow-on effects on the Crown's operating balance. For example, a strengthening of share prices may result in higher returns from the Government's direct share investments.

Expenditure Risks

Economic risks can also affect Crown expenditure levels. There is considerable uncertainty regarding these effects. This uncertainty relates largely 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. This relationship is explored in Scenario One: a weaker than expected economy leads to a fall in employment, which drives up welfare costs. Furthermore, long-term liabilities, such as the ACC claims liability and the Government Superannuation Fund retirement plan, are sensitive to the underlying assumptions on which their discounted cashflows are based. The variables that these liabilities are particularly sensitive to are the inflation rate and the risk-free rate.

One-off and unexpected expenditure shocks can also have a large impact on the Crown's operating balance in the year in which they occur. Over-forecasting of expenditure leads to policy being tighter than otherwise, and uncertainty is inherent in forecasting the cost of new policy initiatives.

In recent years, earthquakes have demonstrated the inherent exposure of the Crown's fiscal position to unexpected events. The Crown's fiscal position will be affected by the recent M7.8 Kaikōura earthquake, although the exact fiscal costs are not certain yet. When such an event 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).

The ageing population implies increased public expenditure, especially for health and superannuation spending. If this cannot be accommodated within operating allowances, it presents risks to the medium-term fiscal position, particularly given uncertainty around demographic forecasts. Likewise, uncertainty around population growth presents a risk of increased demand for public services which may result in increased expenditure, including education and health spending. Current migration levels continue to be above historical trends. While net migration has positive impacts on the economy (eg, increased tax revenue), higher-than-expected levels can lead to pressure on demand-driven government services such as health and education. For further information, refer to Fiscal impact of migration and population growth on page 35.

Balance Sheet Risks

In addition to risks around revenue and expenditure, which affect the balance sheet through their impact on the operating balance, the Crown's financial position is also exposed to risk through change in the value of the Crown's assets or liabilities. The balance sheet can also be affected owing to the Crown having both explicit and implicit obligations (a strong expectation that the Crown would respond to an event) as a result of policy settings.

A large source of balance sheet risk can be attributed to changes in the value of the Crown's assets and liabilities owing to movements in market variables such as interest rates, exchange rates and equity prices. These changes can also have an impact on the Crown's operating balance. Of the Crown's aggregate financial risk, a significant proportion can be attributed to market risk. Three areas of the balance sheet are particularly susceptible to various types of market risk:

• Financial assets held by the Crown Financial Institutions (CFIs) are sensitive to financial-market volatility. CFIs tend to diversify their portfolios across a range of financial assets to manage exposures to specific market risks.
• 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.
• Physical assets such as land, buildings, state highways and military equipment are susceptible to valuation movements through changes in property market conditions, interest rates and changes in the costs of construction.

Other large sources of balance sheet risk are contingent and implicit liabilities relating to natural disasters and financial system stress. The Specific Fiscal Risks chapter discusses contingent assets and liabilities in greater detail.

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.

While the Crown's exposure to risks is sometimes unavoidable, the Crown's general approach is to identify, measure and treat these risks where practicable. When a risk cannot be reduced, the Government's response has been to increase the Crown's resilience by reducing debt ahead of the time when financial resources could be needed, or increasing sustainability through achieving higher levels of net worth. This helps to absorb the impact of the risk through the balance sheet so that the wider economy need not adjust immediately at a greater economic cost.

The New Zealand Government remains amongst the highest-rated sovereigns globally, with the top Aaa foreign-currency rating from Moody's and AA foreign-currency ratings from Standard & Poor's and Fitch. Ratings outlooks are stable from all three agencies.

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 face increased funding pressure in the future. All else being equal, deterioration in the ratings outlook could raise debt-servicing costs and lessen the funding capability for the Crown. The Crown is also susceptible to “liquidity risk” with respect to its ability to raise cash to meet its obligations. This risk is relatively small and managed by each agency to meet its specific liquidity risk requirements and by the Treasury's NZDMO to manage the Crown's liquidity requirements.

For additional detail, refer to the 2014 Investment Statement which provides information on the shape and health of the Crown's portfolio of assets and liabilities at the end of the 2013/14 financial year.[13] It outlines how the balance sheet has changed in recent years and includes forecasts of its anticipated composition and size through to 30 June 2018.

Specific Fiscal Risks#

Print this section

The Statement of Specific Fiscal Risks is required by the Public Finance Act 1989. It sets out, to the fullest extent possible, all government decisions and other circumstances known to the Government that may have a material effect on the fiscal and economic outlook, but are not certain enough in timing or amount to include in the fiscal forecasts. The risks disclosed in this chapter reflect those which are known at the date of the finalisation of 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 significant risk is identified. Disclosure of known risks is also subject to specific requirements and materiality thresholds.

Overview#

Print this section

Specific fiscal risks can be positive or negative and can affect revenue or spending or assets and liabilities. 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.

Established practice is that the Government sets aside operating and capital allowances 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 operating expenses or capital expenditure to be met through reprioritisation or from within the allowances 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:

• for operating expenditure, existing baselines or the allowance in the fiscal forecasts for forecast new operating expenses, or
• for capital, the existing Crown balance sheet or the allowance in the fiscal forecasts, for forecast new capital expenditure.

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 by portfolio. For example, all housing related risks are listed under the portfolios ‘Building and Housing/Social Housing'. The summary table also classifies each risk 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 the Budget operating allowance): 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 the Budget operating allowances.
• Potential capital decisions (expected to be funded from the existing Crown balance sheet, or the Budget capital allowance): Capital investment decisions are risks to the fiscal forecasts only to the extent that they cannot be managed within the existing Crown balance sheet, or the Budget capital allowance.

A range of generic risks to the fiscal forecasts exist but are not separately disclosed as specific fiscal risks:

• Risks from changes to economic assumptions; the most significant economic risks have been identified in Chapter 3.
• Business risks and volatility in the returns from and valuation of 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, biosecurity incursions, and other major events, as they usually occur infrequently and their occurrence, nature and timing cannot be predicted. Once a disaster does occur, a number of choices arise about how to respond and when potential liabilities are recognised (eg, through setting aside an allocation of funding). 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.

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.

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[14] 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 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[15] (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 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[16] to be approved or occur within the forecasting period.

Additionally, the Minister of Finance may determine, under section 26V of the Public Finance Act 1989, 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.

Statement of Specific Fiscal Risks#

Print this section

Summary Table

The matters listed below are disclosed as specific fiscal risks because they meet the rules for disclosure outlined before 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.

The table below is ordered by portfolio and includes the title of the risk, its status and the type of risk. The status of the risk describes whether the risk is changed or unchanged since the 2016 Budget Economic and Fiscal Update or reflects a new matter. The type of risk highlights whether the risk impacts on revenue, operating expenses, or capital expenditure. Cross portfolio risks to the fiscal forecasts are outlined in a separate table.

Specific Fiscal Risks by Portfolio#

Print this section

ACC

ACC Levies (Unchanged)

Indicative future levy rates for the Work, Earners and Motor Vehicle accounts have been included in the forecasts. However, final levy decisions are made by the Government, and may differ from the forecast levy path. In addition, revenue from the levies set for these accounts may be more or less than is required to cover the cost of claims. If factors such as claims experience, ACC performance, economic assumptions (particularly discount rates and unemployment rates) turn out differently from what has been forecast, ACC's levy revenue, claims costs and liability may also differ from forecast. Any variance will have a corresponding impact on the operating balance.

Non-earners Account (Unchanged)

The amount of funding provided by the Crown (and included in the fiscal forecasts) for the Non-earners' Account may be more or less than is required to cover the cost of claims. If factors such as claims experience, ACC performance and economic assumptions (particularly discount rates) turn out differently from what has been forecast, any such variance will have a corresponding fiscal impact.

Work-related Gradual Process Disease and Infection (Unchanged)

Under current legislation, the Government incurs an obligation for Work-related Gradual Process Disease and Infection claims when the claim is made, and an expense is recognised at this point. The liability for commercial accident and sickness insurance contracts would usually be recognised when exposure to conditions that will give rise to a claim occurs. An amendment to legislation would be required to recognise claims at the same time as for commercial contracts. An initial adjustment to the liability and an expense of about $1.0 billion to $1.5 billion would need to be reported if such an amendment were to be enacted.

Building and Housing/Social Housing

Divestment and Development of Housing (Changed)

The forecasts include divestments and redevelopments of housing property as part of Housing New Zealand Corporation's (HNZC) asset management strategy. Proceeds from property divestments will be used to help fund investment in redeveloping and growing HNZC's stock. Market conditions impact on the proceeds of sale and the cost of acquisitions and development. Given these uncertainties, there is a risk that there will be variations from the fiscal forecasts. In addition, the Government has requested that HNZC investigate further opportunities for increasing large scale redevelopment of its Auckland portfolio with further business cases due in mid-2017. Due to the scale of the redevelopments, there is also a risk that the Crown will be requested to invest additional capital into HNZC impacting on net debt.

Housing Infrastructure Fund (New)

In June 2016, Cabinet agreed to establish a $1 billion Housing Infrastructure Fund (HIF) to which high-growth, financially constrained councils can apply to help finance roading and water infrastructure needed to unlock residential development. As final proposals are not expected to be received until late March 2017, and as decisions are still yet to be made about the water infrastructure governance and loan arrangements, there is a high level of uncertainty in the areas noted below, which may have additional fiscal impacts that need to be managed:

• The split between capital and operating spending, which will impact fiscal indicators. Currently the fund has been reflected as capital expenditure in the forecasts.
• Whether or not market interest rates will be applied to the loans.
• Whether or not the full amount of the fund will be repaid to the Crown.
• For the amount that is repaid, when the repayment will occur.

Social Housing Reform (Unchanged)

The Government is progressing the Social Housing Reform Programme (SHRP). The SHRP aims to improve the housing and associated services provided to those in housing need, to build the social housing market and to fully recognise the costs of social housing. Specific Fiscal Risks associated with the SHRP are as follows:

• Existing and additional social housing places may require funding above the current Income Related Rent Subsidy (IRRS) appropriation cap.
• The development of a more diverse and competitive social housing market may adversely affect HNZC's financial position.
• Proceeds from social housing transfers are likely to differ from book value.

Tamaki Regeneration Project (Unchanged)

Proceeds from housing sales in Tamaki over the next 10 to 15 years may be less than the book value of the houses sold. Over this period 7,500 new houses are planned to be built in Tamaki in place of about 2,500 existing houses.

Corrections

Additional Capacity to Address Prison Population (New)

The fiscal forecasts include provision for the Government's agreed investment to create additional prison capacity to accommodate prison population growth over the next 10 years. It is likely that the Department of Corrections will require additional funding relating to the direct costs of accommodating prison population increases, as they arise, which would impact on the operating balance. The total quantum of the cost could be between $100 and $140 million over the next four years. There is also a risk that growth in the prison population is different from what is included in the forecasts and additional funding is required.

Defence

Operating and Capital Costs (Changed)

In 2016, the Government reconsidered New Zealand Defence Force (NZDF) capability and funding requirements through the Defence White Paper 2016. It is expected that changes to NZDF operating and capital funding will be made over the forecast period to achieve the Defence White Paper settings. However the precise quantum and timing of these changes will be dependent on a range of business cases that will be considered by Cabinet in the future.

Disposal of NZDF Assets (Unchanged)

The Government is considering the potential to dispose of a number of NZDF assets. 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 an 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.

Education

School and ECE Funding Review (New)

The Minister of Education is currently engaging the sector on a review of education funding, across schooling and ECE. There is potential for fiscal costs but this depends on policy decisions that are yet to be made. Any funding changes would not be implemented until 2020.

Finance

Crown Overseas Properties (Unchanged)

The Government holds New Zealand House in London on a long-term lease from the Crown Estate (UK). Depending on the outcome of ongoing discussions with the Crown Estate an upgrade to the building may be required. Should a decision be taken to refurbish the property, a rough-order cost estimate for this upgrade is $100 million over the forecast period.

Goodwill on Acquisition (Unchanged)

As at 30 June 2016, the Government had goodwill on acquisition of a number of sub-entities totalling $602 million. Under New Zealand accounting standards (PBE IPSAS 26), such goodwill items are required to be assessed annually for impairment. If there is any indication that the goodwill may be impaired, the recoverable amount of the cash generating units to which the goodwill is allocated is required to be estimated. If the recoverable amount is less than the carrying amount of those units, the units and the goodwill allocated to them are regarded as impaired and the Government is required to recognise impairment losses in the operating statement. Such assessments will be conducted at the end of the financial year, and the fiscal forecasts currently make no allowance for such impairment losses.

Greater Christchurch Regeneration

Christchurch Central-Recovery Plan - Anchor Projects (Unchanged)

The Crown is partially funding the construction of Anchor Projects as part of the Christchurch Central Recovery Plan. The funding for the construction of Anchor Projects will vary from project to project, dependent on final scope, ownership decisions, implementation and project costs, and will to some extent eventually be recovered. Business cases are progressing through the decision-making process and construction costs will become increasingly clear during the business case process and the subsequent procurement phase. The quantum and timing of Crown contribution may differ from that included in the fiscal forecasts.

EQC (Changed)

Every six months EQC undertakes an actuarial valuation of the total Canterbury Earthquakes liability. This includes settled and yet-to-settle claims and reinsurance recoveries. Based on this valuation, a profile of the claims yet to settle is included in the Crown's fiscal forecasts. There still remains some risk that EQC's remaining settlement expenditure relating to the Canterbury earthquakes will be different (higher or lower) from that forecast.

Residential Red Zone (Unchanged)

Some recoveries from 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 or potential revenues or recoveries 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. The fiscal impact of this is not yet certain.

Southern Response Earthquake Services Support (New)

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

Internal Affairs

Fire Services Levy (Unchanged)

The Government has announced it will unify the Fire Services into Fire and Emergency New Zealand and signalled that this change will cost approximately $303 million which will be funded through a Crown contribution, a repayable capital loan and levy increases. The increase in levies required to meet the increase expenditure on Fire Services, and to contribute to repaying the repayable capital injection are uncertain and not yet included in the fiscal forecasts.

Parliamentary Agencies

Parliamentary Office Accommodation (Unchanged)

With the imminent expiry of the lease on Bowen House, the Parliamentary Service is considering options for the provision of accommodation for future Parliaments. Options for future accommodation are likely to require capital expenditure.

Primary Industries

Investment in Water Infrastructure (Unchanged)

In 2013/14 and 2014/15, $120 million was appropriated for the Crown-owned company, Crown Irrigation Investments Limited, to manage the Crown's investment in irrigation infrastructure. The Government will consider providing further capital of up to $280 million in future Budgets as schemes reach the “investment-ready” stage.

Revenue

Cash Held in Tax Pools (Unchanged)

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

Income Tax and Family Assistance Changes (New)

The Government has indicated it will give consideration to income tax changes and family assistance within the forecast period, if fiscal and economic conditions allow. A decision to implement any changes would have an impact on the operating balance.

Potential Tax Policy Changes (Changed)

Some of the items on the Tax Policy work programme could each have a significant positive impact on operating revenue: work on Base Erosion and Profit Shifting including interest allocation rules, the taxation of foreign hybrid instruments and entities, the taxation of diverted profits, and working with the OECD on a multilateral instrument to strengthen the world's double tax agreement network.

Student Loans (Unchanged)

The value of student loans is sensitive to assumptions such as the borrower's future income, and general economic factors such as interest rates, unemployment levels, salary inflation and the CPI. As new lending occurs, an initial write-down to fair value will be made, and an expense will be incurred, reflecting the cost the Crown incurs in making an interest free loan and the risk that borrowers may not repay their loans. However, the assumptions made at the time of lending are volatile and are subject to change.

Transformation and Technology Renewal (Changed)

The Business Transformation programme agreed by Cabinet is reflected in forecasts. There are risks that the expected implementation costs, revenue gains and operating costs savings may differ from forecasts. This includes a risk that, during the transition between systems, Inland Revenue discovers historic procedural issues. In addition, the Government is considering possible policy changes affecting the way Inland Revenue manages its processes and data. Any changes to procedures or policy could materially impact the programme's cost, and the additional revenue collected.

Social Development

Transformation to Ministry for Vulnerable Children, Oranga Tamariki (Changed)

The new Ministry for Vulnerable Children, Oranga Tamariki is due to start on 1 April 2017 with a new operating model to be implemented over the next few years and an expanded focus and target group. To the extent that the costs associated with the new Ministry cannot be funded from the tagged contingency established at Budget 2016 or from reprioritisation, additional funding is likely to be required.

Transport

Auckland City Rail Link (New)

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

Auckland Transport Alignment Plan (New)

The Government and Auckland Council released the final report for the Auckland Transport Alignment Project in August 2016. This report identified a funding gap of $4 billion over the next 30 years. The Government and Auckland Council are considering options to address this funding gap.

Regional State Highways (Unchanged)

Investigation into tranche three of the regional state highway acceleration being undertaken may result in additional Crown funding being sought for the construction of these projects.

Support for KiwiRail (Unchanged)

The Government in Budgets 2010 to 2016 supported KiwiRail Holdings Limited (KiwiRail) with an investment of around $1.5 billion in the New Zealand freight rail system. A major review of the business informed Budget 2015 and $400 million funding was provided for in 2015/16 and 2016/17. Further Crown investment into KiwiRail is likely to be required.

Treaty Negotiations

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.

Relativity Clause (Unchanged)

The Deeds of Settlement negotiated with Waikato-Tainui and Ngāi Tahu include a relativity mechanism. Now that the total redress amount for all historical Treaty settlements exceeds $1.0 billion in 1994 present-value terms, the mechanism provides that the Crown is liable to make payments to maintain the real value of Ngāi Tahu's and Waikato-Tainui's settlements as a proportion of all Treaty settlements. The agreed relativity proportions are 17% for Waikato-Tainui and approximately 16% for Ngāi Tahu. There is a risk that the timing and amount of the expense for the relativity payments may differ from that included in the fiscal forecasts. There is also uncertainty on how various disputes concerning the interpretation of the mechanism will be resolved.

Treaty Settlement Forecasts (Unchanged)

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

Cross Portfolio Specific Fiscal Risks

Agency Capital Intentions (Unchanged)

Future Budgets may well include new capital investments other than those identified in other specific fiscal risks. Such investments are most likely to be developed by the 25 investment-intensive agencies that are required 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, improvements in asset performance, alternative methods of service delivery and changes to policy settings. New investments are risks to the fiscal forecasts only to the extent they cannot be managed through existing balance sheets, or the provision in the fiscal forecasts for forecast new capital spending.

Budget Operating Initiatives (Unchanged)

Future Budgets may well include new operating initiatives for new policies or to address cost pressures other than those identified in other specific fiscal risks. Such new operating initiatives are risks to the fiscal forecasts only to the extent they cannot be managed through reprioritisation or from within the existing provision in the fiscal forecasts for forecast new operating spending. The Government's stated intention is that all new operating initiatives will be managed through these mechanisms.

Kaikōura Earthquakes (New)

An initial estimate has been included in the fiscal forecasts for expenses and capital expenditure arising from the Kaikōura earthquakes. The total extent of damage and support required is still being determined with key expenditure areas expected to cover short-term support and recovery assistance, reconstruction of infrastructure, repairing government owned property, and meeting costs of claims to EQC for residential property damage. There is a risk that the timing and amount of government contribution towards the rebuild and recovery could be different from what is included in the forecasts.

Pay Equity and Caregiver Employment Conditions (Changed)

There are several existing cases and funding claims, mainly in the disability support and aged care sectors, 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 that may involve significant costs to the Crown. It is also expected that there will be further pay equity claims within State-funded sectors under the Equal Pay Act. The Government has entered into negotiations over pay rates for care and support workers which will cover around 50,000 workers. A Joint Working Group was established to develop principles for dealing with claims of pay equity under the Equal Pay Act. The group has provided its recommendations to Ministers on agreed pay equity principles that could be applied in all sectors in the economy. The Government has agreed to these Principles, with one modification around choosing pay comparators. The result of the care and support worker negotiations and any other pay equity claims could require additional Crown funding.

Services Funded by Third Parties (Unchanged)

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

State Sector Employment Agreements (Unchanged)

A number of large collective agreements are due to be renegotiated over the forecast period. 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 that agreements will be managed within the current fiscal forecasts.

Unexpected Maintenance for Crown-owned buildings (Unchanged)

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

Risks Removed Since the 2016 Budget Update

The following risks have been removed since the 2016 Budget Update.

Contingent Liabilities and Contingent Assets#

Print this section

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 core Crown debt. In the case of some contingencies (eg, uncalled capital), the negative impact would be restricted to net core Crown debt because the cost would be offset by the acquisition of capital.

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

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

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

Some contingencies of the Crown are not able to be quantified. We have disclosed all unquantifiable contingent liabilities and unquantifiable contingent assets that are not expected to be remote.[18]

The contingencies have been stated as at 31 October 2016, being the latest set of reported contingencies.

Quantifiable Contingent Liabilities and Contingent Assets

Unquantifiable Contingent Liabilities and Contingent Assets

Notes:

1. Previously two cases. One legal claim has been removed from unquantifiable contingencies, as it was settled, leaving one unquantifiable claim that remains unchanged.
2. Previously two cases. One legal claim was transferred from unquantifiable contingencies to quantifiable contingencies, leaving one unquantifiable claim that remains unchanged.

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 other member countries or, in the case of the quota contributions, to directly finance lending to members. For New Zealand and other donor countries, capital contributions comprise both “paid in” capital and “callable capital or promissory notes”.

The Crown's uncalled capital subscriptions over $100 million are as follows:

Southern Response Earthquake Services Limited

In addition to the uncalled capital above, the Crown Support Deed agreed with Southern Response Earthquake Services Limited includes:

• $500 million of uncalled ordinary shares under an amended Crown Support Deed dated 30 January 2013. This capital facility has since been extended with additional $250 million during 2015/16.

As at 31 October 2016, $555 million has been called, and $143 million of this has been paid, under the uncalled ordinary capital facility. There is also a possibility that the remaining $195 million will be called owing to significant complexities that exist in settling Christchurch earthquake claims. The extent to which the subscription is called and paid depends on the ultimate cost of settling earthquake claims, which continues to be subject to significant uncertainty.

The above capital subscriptions have an impact on the core Crown net debt; however as Southern Response is part of the Crown, there would be no impact on the total Crown operating balance.

Guarantees and indemnities

Guarantees are legally binding promises made by the Crown to assume responsibility for a debt, or performance of an obligation of another party, should that party default. Guarantees generally relate to the payment of money but may require the performance of obligations.

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

New Zealand Export Credit Office guarantees

The New Zealand Export Credit Office provides a range of guarantee products to assist New Zealand exporters manage risk and capitalise on trade opportunities around the globe. The obligations to third parties are guaranteed by the Crown and are intended to extend the capacity of facilities in the private sector.

$210 million at 31 October 2016 ($211 million at 30 June 2016)

Legal proceedings and disputes

Legal tax proceedings

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

$167 million at 31 October 2016 ($172 million at 30 June 2016)

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.

$134 million at 31 October 2016 ($133 million at 30 June 2016)

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 contingent liabilities.

a)  Indemnities

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

b) Legal claims and proceedings

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

Accident Compensation Corporation litigation

Litigation involving ACC arises almost exclusively from challenges to operational decisions made by ACC through the statutory review and appeal process. No accrual has been made for contingent liabilities which could arise, as these disputes are issue-based and ACC's active management of litigation means that it will be either settling or defending, depending on the merits of the issue in dispute. ACC's Board believes the resolution of outstanding appeals will not have any material effect on the financial statements of ACC.

Air New Zealand litigation

Air New Zealand is defending a class action in the US, in which it is alleged that Air New Zealand together with other airlines acted anti-competitively in respect of fares and surcharges on trans-Pacific routes.

Allegations of anti-competitive conduct in the air cargo business in Hong Kong and Singapore were the subject of proceedings by the Australian Competition and Consumer Commission (ACCC). Following a defended hearing, the Federal Court released its decision in October 2014, finding in favour of Air New Zealand. The ACCC appealed the decision and a majority decision of the Full Federal Court found in favour of the ACCC. The High Court of Australia has granted Air New Zealand leave to appeal that decision with a hearing to be scheduled early in 2017.

In the event that a Court determined that Air New Zealand had breached competition laws, the Group would have potential liability for damages or (in Australia) pecuniary penalties.

Kiwibank

In June 2013, a group called Fair Play on Fees announced plans for a representative action against banks in New Zealand in relation to certain default fees charged to New Zealand customers. In November 2013, the group issued proceedings against Kiwibank. The potential outcome of the proceedings cannot be determined with any certainty at this stage.

Ministry for Primary Industries - Kiwifruit vine disease

In November 2014, 42 growers filed a claim against the Ministry for Primary Industries (MPI) alleging MPI is legally liable for damages they have suffered from a biosecurity incursion of the kiwifruit vine disease, Psa-V, in New Zealand. Included in the proceedings are approximately 178 grower claims represented by the first plaintiff, Strathboss Kiwifruit Limited. The total losses have not been quantified, but previous media reports claim they are in the vicinity of $380 million (and cite total industry losses of $885 million). As Strathboss Kiwifruit Limited is required to prove MPI owes a duty of care to the growers before losses will be assessed, MPI is unable to quantify the first plaintiff's claim. The Ministry is defending the claim.

Treaty of Waitangi claims

Under the Treaty of Waitangi Act 1975, any Māori may lodge certain claims relating to land or actions counter to the principles of the Treaty with the Waitangi Tribunal. Where the Tribunal finds a claim is well founded, it may recommend to the Crown that action be taken to compensate those affected. The Tribunal can make recommendations that are binding on the Crown with respect to land 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. Failure to successfully defend such actions may result in a liability for historical Treaty grievances in excess of that currently anticipated.

c) Other unquantifiable contingent liabilities

Criminal Proceeds (Recovery) Act 2009

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

Environmental liabilities

Under common law and various statutes, the Crown may have responsibility to remedy adverse effects on the environment arising from Crown activities. Entities managing significant Crown properties have implemented systems to identify, monitor and assess potential contaminated sites.

In accordance with PBE IPSAS 19: Provisions, Contingent Liabilities and Contingent Assets, any contaminated sites for which costs can be reliably measured have been included in the statement of financial position as provisions.

Treaty of Waitangi claims - Settlement Relativity Payments

Holidays Act 2003 and other relevant legislation

A number of entities have commenced a review of payroll calculations over the last six years in order to ensure compliance with the Holidays Act 2003 and other relevant legislation. Where possible, provision has been made in these financial statements for obligations arising from that review. To the extent that an obligation cannot reasonably be quantified at 31 October 2016, a contingent liability exists.

Description of Contingent Assets

Quantifiable contingent assets over $100 million

There are no contingent assets over $100 million at 31 October 2016.

Forecast Financial Statements#

Print this section

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 21 November 2016.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined in the Fiscal Outlook chapter (pages 27 to 53).

Statement of Accounting Policies#

Print this section

Significant Accounting Policies

The Forecast Financial Statements have been prepared in accordance with the accounting policies that are expected to be used in the comparable audited actual Financial Statements of the Government. They comply with generally accepted accounting practice (GAAP) as required by the Public Finance Act 1989 and have been prepared in accordance with Public Benefit EntityFinancial Reporting Standard 42: Prospective Financial Statements.

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

The specific accounting policies are included within the 2016 Half Year Economic and Fiscal Update Additional Information document which can be found on the Treasury's website at http://www.treasury.govt.nz/budget/forecasts/hyefu2016

Forecast Policies

The Forecast Financial Statements have been prepared on the basis of the Treasury's best professional judgement. Actual financial results for the periods covered are likely to vary from the information presented in these forecasts. Factors that may lead to a material difference between information in these Forecast Financial Statements and the actual reported results in future years are set out in the Specific Fiscal Riskschapter on pages 71 to 94.

Key forecast assumptions are set out on pages 29 to 30.

Reporting and Forecast Period

The reporting periods for these Forecast Financial Statements are the years ended 30 June 2017 to 30 June 2021. The “2016 Actual” figures reported in the statements are the audited results reported in the Financial Statements of the Government for the year ended 30 June 2016. The “2017 Previous Budget” figures are the original forecasts to 30 June 2017 as presented in the 2016 Budget.

Government Reporting Entity as at 21 November 2016#

Print this section

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

Core Crown

Departments

• 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 Pacific Peoples
• Ministry for Primary Industries
• Ministry for the Environment
• Ministry for Women
• 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 Social Development
• Ministry of Transport
• 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
• Office of the Ombudsman
• 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
• KiwiRail Holdings Limited
• Kordia Group Limited
• Landcorp Farming 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) 

• Genesis Energy Limited
• Mercury NZ Limited (formerly Mighty River Power Limited)
• Meridian Energy Limited

Other

• Air New Zealand Limited

Crown entities

• Accident Compensation Corporation
• Accreditation Council
• 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
• Heritage New Zealand Pouhere Taonga
• 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 Service
• New Zealand Blood Service
• New Zealand Film Commission
• New Zealand Fire Service Commission
• New Zealand Lotteries Commission
• New Zealand Productivity Commission
• New Zealand Qualifications Authority
• New Zealand Symphony Orchestra
• 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 (2,418)
• Social Workers Registration Board
• Sport and Recreation New Zealand
• 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 (27)
• Transport Accident Investigation Commission
• WorkSafe New Zealand

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
• Ngāi Tahu Ancillary Claims Trust
• Pacific Co-operation Foundation
• Pacific Island Business Development Trust
• Reserves Boards (20)
• Sentencing Council
• 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
• Education Payroll Limited
• Fairway Resolution Limited
• Health Benefits Limited (ceased operating)
• Ōtākaro Limited
• Research and Education Advanced Network New Zealand Limited
• Southern Response Earthquake Services Limited
• Tāmaki Redevelopment Company Limited
• The Network for Learning Limited

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

• Te Urewera

Others

• Education Council of Aotearoa New Zealand
• Regenerate Christchurch

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

Forecast Statement of Financial Performance for the years ending 30 June

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

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

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

1. The classifications of the functions of the Government reflect current approved baselines. Forecast new operating spending is shown as a separate line item in the above analysis and will be allocated to functions of the Government once decisions are made in future Budgets.

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

Forecast Statement of Comprehensive Income for the years ending 30 June

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

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

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

Forecast Statement of Cash Flows for the years ending 30 June

1. Excludes transactions with ACC and NZS Fund.
2. Further information on the proceeds and repayments of government bonds is available in note 23.

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 of the 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. (eg, New Zealand Superannuation Fund, ACC and EQC).
3. Core Crown financial assets exclude receivables.
4. Net core Crown debt represents GSID less financial assets. This can provide information about the sustainability of the Government's accounts, and is used by some international agencies when determining the creditworthiness of a country.
5. Adding back the NZS Fund assets provides the financial liabilities less financial assets of the core Crown, excluding those assets set aside to meet part of the future cost of New Zealand Superannuation.
6. Net core Crown debt (excluding NZS Fund and advances) excludes financial assets which are held for public policy rather than treasury management purposes.
7. The Reserve Bank has used $1.6 billion of settlement cash to purchase reserves that were to have been funded by the NZDMO borrowing. Therefore, the impact of settlement cash on GSID is adjusted by this amount.

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

Statement of Actual Commitments

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

Statement of Actual Contingent Liabilities and Assets

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

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

Notes to the Forecast Financial Statements#

Print this section

NOTE 1: Sovereign Revenue (Accrual)

1. Customs excise-equivalent duty.

NOTE 2: Interest Revenue and Dividends

NOTE 3: Transfer Payments and Subsidies

NOTE 4: Personnel Expenses

NOTE 5: Depreciation and Amortisation

NOTE 6: Other Operating Expenses

NOTE 7: Finance Costs

NOTE 8: Insurance Expenses

NOTE 9: Forecast New Spending and Top-down Expense Adjustment

Unallocated contingencies represent expenses included in Budget 2016 and previous Budgets that have yet to be allocated. Forecast new spending indicates the expected spending increases from future Budgets.

The forecast for new operating spending for Budget 2017 is $1.5 billion. Some of this allowance has been pre-committed as at the forecast finalisation date of 21 November 2016, with only the unallocated portion of the allowance included in this note.

Unallocated contingencies represent capital spending from Budget 2016 and previous and future Budgets that has yet to be allocated. Forecast new spending indicates the expected capital spending increases from future Budgets.

The forecast for new capital spending for Budget 2017 is $3.0 billion and for Budgets 2018 - 2020 is $2.0 billion. Some of these allowances have been allocated as at the forecast finalisation date of 21 November 2016, with only the unallocated portion of the allowance included in this note.

NOTE 10: Net Gains and Losses on Financial Instruments

NOTE 11: Net Gains and Losses on Non-Financial Instruments

NOTE 12: Operating Balance (excluding Minority Interests)

NOTE 13: Financial Assets (including receivables)

NOTE 14: Student Loans

NOTE 15: Property, Plant and Equipment

1. Using a revaluation methodology unless otherwise stated.

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

NOTE 16: Intangible Assets and Goodwill

NOTE 17: NZ Superannuation Fund

NOTE 18: Payables

NOTE 19: Insurance Liabilities

ACC liability

Calculation information

PwC NZ has prepared an independent actuarial estimate of the ACC outstanding claims liability as at 30 June 2016. This estimate includes the expected future payments relating to accidents that occurred prior to balance date (whether or not the associated claimshave been reported to, or accepted by, ACC) and also the expected future administrative expenses of managing these claims.

The assumptions underpinning this valuation form the basis of the five-year forecast of the outstanding claims liability.

The key economic variables that impact on changes to the valuation are the long-term Labour Cost Index (LCI), average weekly earnings and the discount rate. Discount rates were derived from the yield curve for New Zealand Government bonds. For these forecast statements, the claims liability has been updated for the latest discount rates as at 30 September 2016. The equivalent single effective discount rate, taking into account ACC's projected future cash flow patterns, is 3.78% and allows for a long-term discount rate of 4.75% from 2054.

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

Presentation approach

ACC has available to it a portfolio of assets that offset the claims liability. The assets below (less cross-holdings of NZ Government stock) are included as assets in the Statement of Financial Position.

EQC liability

Calculation information

Melville Jessup Weaver prepared an independent actuarial estimate of the EQC outstanding claims liability at 30 June 2016 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 2016 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: a complex land claims environment, complexity of the remaining dwelling claims and the expectation that some claims will need to be reopened to rectify outstanding issues.

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 20: Retirement Plan Liabilities

The net liability of the Government Superannuation Fund (GSF) was calculated by GSF's actuary as at 30 September 2016. 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 2016, based on membership data as at 30 June 2016 with adjustments for cash flows to 30 September 2016. 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 2016.

Other principal long-term financial assumptions were an inflation rate, as measured by the Consumers Price Index (CPI), of 1.46% for the 21 years to 30 June 2037, then increasing gradually each year to 2.0% in the year ended 30 June 2054 and remaining at 2.0% p.a. for all years after that. In addition an annual salary growth rate, before any promotional effects, of 2.5% (unchanged from 30 June 2016).

The 2016/17 projected decrease in the net GSF liability is $531 million, reflecting a decrease in the GSF liability of $446 million and an increase in the GSF net assets of $85 million.

The decrease in the GSF liability of $446 million includes an actuarial loss between 1 July 2016 and 30 September 2016, of $45 million, owing to movements in the discount rates and partly offset by the impact of movements in CPI rates. The remaining $491 million reduction is owing to the current service cost and interest unwind (increases the liability) offset by the (lower than expected) benefits to members (reduced the liability).

The increase in the value of the net assets of GSF of $85 million includes a gain of $71 million reflecting the updated market value of assets at 30 September 2016. The balance of $14 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 2016/17 onwards reflect the net of the expected current service cost, interest cost, investment returns and contributions.

NOTE 21: Provisions

Provision for ETS credits

The Emissions Trading Scheme (ETS) was established to assist New Zealand in meeting its international climate change obligations and to reduce New Zealand's net emissions of greenhouse gases to below business-as-usual levels. The ETS creates a limited number of tradable New Zealand Units (NZUs) which the Government can allocate.

The allocation of NZUs creates a provision if allocated for free; the provision is reduced, and revenue recognised, as NZUs are surrendered to the Crown by emitters.

The prices for NZUs used to calculate the ETS provision are assumed to remain constant over the forecast period and are based on market prices during the last week of September 2016.

The ETS impact on the fiscal forecast is as follows:

NOTE 22: Changes in Net Worth

NOTE 23: Core Crown Residual Cash

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

NOTE 24: Net Canterbury earthquake expenses (operating and capital)

These net earthquake costs are the latest estimates of the net impact on the Crown of the Canterbury earthquakes in 2010 and 2011. These estimates reflect the known costs under current policy settings. They do not include future decisions the Government may take regarding the Canterbury rebuild and do not include any costs relating to the recent North Canterbury earthquakes).

The forecasts assume that any additional costs to the Crown will be met within budget allowances.

Notes:

1. Crown assets includes capital expenditure on Canterbury hospitals, schools, Tertiary Education Institutions, housing and the Justice and Emergency Services Precinct.
2. Central city rebuild costs include land acquisition and are net of expected recoveries and contributions from third parties.
3. Some expenses are non-cash (eg, asset write-offs and impairments) and therefore do not have a cash element to them.

Forecast Statement of Segments#

Print this section