Half Year Economic and Fiscal Update 2017

An introduction to the Half Year Economic and Fiscal Update#

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The Treasury is New Zealand's economics and finance ministry. We advise on the direction of New Zealand's economic policy with the aim of achieving a strong and sustainable economy, and raising New Zealand living standards. This includes reporting on the expenditure of government (fiscal) revenue, and assisting to ensure spending is fit for purpose and can improve outcomes for New Zealanders.

Sharing what we do#

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As the government's lead economic and financial adviser we forecast the economic outlook for New Zealand and the Government's fiscal outlook. This Half Year Economic and Fiscal Update (Half Year Update) is part of a suite of documents we release as required by the Public Finance Act 1989.

This Update primarily outlines what the Treasury observes in our current economic and fiscal climate, what we might see in the future, and what risks we may face over the next four years (our forecast period).  This gives an indication of what the economy is most-likely to do to inform decision-making.

Making it New Zealander-centric#

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Our advice is not just based on facts and figures. Improving outcomes means we need to understand which outcomes to improve, and what is important to New Zealanders. We use the Treasury's Living Standards Framework to recognise the different aspects of New Zealanders' living standards and well-being. Our framework is based on four areas:

• financial and physical capital eg, housing, machinery, buildings, money
• human capital eg, health, skills
• social capital eg, institutions, trust
• and natural capital eg, water, biodiversity.

We took this approach further and last year presented a living standards perspective that stretches over the next 40 years. He Tirohanga Mokopuna: 2016 Statement on the Long-term Fiscal Position, shares our take on long-term fiscal issues facing New Zealand. We know that sustainable government finances are a requirement to improving long-term living standards, and vice versa.

Understanding our path#

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The Treasury is in a unique position to focus on improving the way our economy can raise New Zealand living standards. Along with delivering first-rate economic and financial advice, we are committed to providing it in a way so New Zealanders understand how we work to achieve our goals. If you would like to know more about who we are and what we do, or want a simpler overview of the Half Year Update please go to our website at www.treasury.govt.nz

Statement of Responsibility#

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I make this statement in accordance with section 26W of the Public Finance Act 1989.

On the basis of the economic and fiscal information available to it, the Treasury has used its best professional judgement in preparing, and supplying the Minister of Finance with this Economic and Fiscal Update. The Update incorporates the fiscal and economic implications of both government decisions and other circumstances as at 27 November 2017 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 27 November 2017. 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

7 December 2017

 

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 27 November 2017 of which I was aware and that had material economic or fiscal implications.

In accordance with section 26W of the Public Finance Act 1989, I accept responsibility for the integrity of the disclosures contained in the Update, responsibility for the consistency and completeness of the Update information with the requirements of Part 2 (Fiscal responsibility) of the Public Finance Act 1989 and responsibility for the omission from the Update under section 26V of the Public Finance Act 1989 of any decisions, circumstances or statements not incorporated in it.

 

Hon Grant Robertson
Minister of Finance

7 December 2017

Executive Summary#

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Summary of the Treasury's Economic and Fiscal Forecasts#

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Sources: Statistics New Zealand, the Treasury

The context in which this Half Year Economic and Fiscal Update 2017 (Half Year Update) has been prepared means that it differs from the Treasury's more typical economic and fiscal updates. With a change of Government, there is a programme of new policies that have fiscal and economic implications. Following this Executive Summary is an outline of how the Government's policy commitments have been incorporated into the Half Year Update.

Nominal GDP over the four years to June 2021 is expected to be $1.5 billion higher than in the Pre-election Economic and Fiscal Update 2017 (Pre-election Update). GDP growth is forecast to expand at an average rate of 2.9% per year, supported by population growth, low interest rates, increased government spending, a positive international outlook and high terms of trade.

Growth in activity is expected to absorb spare capacity in the economy, support a gradual decline in the unemployment rate and contribute to stronger inflationary pressures than in the Pre-election Update. Solid international demand for New Zealand's exports is forecast to contribute to the current account deficit narrowing to 2.1% of GDP in mid-2018, before widening as export growth slows and import growth rises.

Changes to the economic outlook since the Pre-election Update primarily reflect recent economic data and the new Government's policies.Growth in the year ending June 2018 is a bit lower than previously forecast, mainly reflecting expectations of slower growth over the second half of 2017. Over 2018/19 the new Government’s policies increase government spending but reduce private expenditure, which leaves expected GDP growth unchanged. In 2019/20 and beyond faster growth in household incomes and the Government’s KiwiBuild programme contribute to higher GDP growth.

The fiscal outlook is anticipated to keep improving across the forecast period, though at a slower pace than in the Pre-election Update. By 2021/22 the operating balance before gains and losses (OBEGAL) is forecast to reach a surplus of $8.8 billion (2.5% of GDP), while Core Crown expenses rise in nominal terms but fall as a percentage of GDP to 27.6%.

The fiscal forecast includes core Crown capital spending totalling $41.7 billion to 2021/22. Capital spending is expected to lead to a residual cash deficit over the first three years of the forecast, before returning to a residual cash surplus. The residual cash position has an impact on net core Crown debt, which is expected to increase in nominal terms before tracking down later in the forecast. As a percentage of GDP, net core Crown debt reduces to around 19.3% in 2021/22. The Crown's balance sheet continues to grow. In 2021/22 net worth attributable to the Crown is anticipated to reach $154.6 billion (44.7% of GDP). Including the impact of Government policy changes and the changes in the economic outlook, core Crown tax revenue is $6.6 billion higher than in the Pre-election Update.

The economic and fiscal outlook is subject to a range of assumptions, risks and uncertainties. For the economic forecasts, uncertainties include how households respond to rising interest rates, given high household debt levels; the extent to which capacity constraints in the construction market prove binding; weakness in labour productivity and domestic demand persisting; and ongoing debate on the merits of trade liberalisation in some parts of the world. Any changes to the economic outlook would be expected to flow through to changes in the fiscal position. In addition, risks to the fiscal forecasts include changes in the value of the Crown's assets or liabilities and the potential impact of the Crown's fiscal obligations that arise from policy choices. More detail and discussion of assumptions, risks and uncertainties are included in each chapter.

Economic Outlook#

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Overview#

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• The New Zealand economy is expected to expand at an average rate of 2.9% per year over the next five years, slightly above the growth rate the economy can sustain before it leads to higher inflation. Factors supporting growth include low interest rates, population growth, government spending, a positive international outlook and high terms of trade. In the labour market, the unemployment rate is expected to decline to around 4.0% and, with more people in work, wage growth is expected to pick up and to contribute to rising inflation pressure. To ensure inflation remains around 2.0%, interest rates are projected to increase steadily from late 2018.
• Over the year ahead, export volume growth is expected to strengthen and export commodity prices, which have risen over the past year, are expected to remain high and to contribute to a narrowing of the current account deficit to around 2.0% of GDP. Thereafter, the current account deficit is projected to widen as export growth slows and as domestic demand growth feeds through into faster import growth.
• Changes in the outlook since the Pre-election Update primarily reflect both recent economic data and the new Government's policies. Growth in the year ending June 2018 is a bit lower than previously forecast, mainly reflecting expectations of slower growth over the second half of 2017, albeit with improving labour market conditions and higher inflation. Over 2018/19, the new Government's policies increase government spending but reduce private expenditure, which leaves expected GDP growth largely unchanged. In 2019/20 and beyond, increased household income growth, partly reflecting larger Government-mandated minimum wage increases, and the Government's KiwiBuild programme contribute to higher GDP growth. The faster pace of GDP growth and increased wage growth leads to greater inflationary pressures and slightly higher interest rates.
• Compared to the Pre-election Update, the total cumulative increase in nominal GDP is higher by $1.5 billion over the four years to June 2021 (the final forecast year in the Pre-election Update). Including the impact of Government policy changes and the changes in the economic outlook, core Crown tax revenue is cumulatively $6.6 billion higher than in the Pre-election Update.
• The assumptions and judgements underpinning these forecasts are subject to a range of risks and uncertainties. These are discussed in further detail in the Risks and Scenarios Chapter on page 51.

Economic forecasts are presented on a June year basis, where practicable, for consistency with the fiscal forecasts. Longer time series for these variables are provided on page 144.

Notes:

1. Business investment is the total of all investment types excluding residential investment.
2. Contribution to GDP growth.
3. Percentage difference between reported real GDP and potential real GDP.
4. Percent of the labour force, June quarter, seasonally adjusted.
5. Quarterly Employment Survey, average ordinary-time hourly earnings, annual percentage change.
6. Annual percentage change.
7. System of National Accounts (SNA)
8. Quotable Value House Price Index, annual percentage change.
9. Percent of household disposable income (HHDI), March years.
10. Trade-weighted index, average for the June quarter.

Recent Developments#

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Growth over the second half of 2017 similar to the first half…

This section discusses recent developments and their impact on the starting point of the economic outlook.

Compared to the Pre-election Update, underlying momentum is a little weaker across the second half of 2017. Economic growth appears to have slowed in the 2017 September quarter with wet weather hampering agricultural production, continued weakness in the housing market, and slower growth in private consumption. Quarterly GDP growth is expected to pick up from 0.6% in the September quarter to 0.8% in the December quarter as agricultural production rebounds and growth in residential construction, consumer spending and business investment picks up (Figure 1.1). Overall, growth over the second half of 2017 is expected to be similar to outturns recorded over the first half of the year.

Figure 1.1 – Economic growth (production GDP)

Sources: Statistics New Zealand, the Treasury

…as housing market remains subdued…

Reflecting high capacity constraints and what is expected to be a temporary dip in demand, forecasts for residential investment activity begin from a weaker starting point than expected in the Pre-election Update.

The residential construction sector faces a high degree of capacity constraints: construction firms are reporting that their ability to expand is constrained by difficulty finding skilled labour; measures of capacity utilisation in the sector are near record highs; and pressure on materials is pushing construction costs higher. In addition to these physical constraints the sector has faced tightening financial market conditions. Banks have become more restrictive when lending to developers, in part owing to heightened risks associated with periods of rapid expansion, and growth in lending to investors has slowed following the implementation of higher loan-to-value ratio restrictions.

In addition, demand appears to have softened, with house prices and sales contracting in recent months. However, the fundamental drivers of demand have persisted, including strong population growth and low interest rates.

Reflecting these developments, the easing in residential investment activity over the first half of 2017 (from record-high levels in late 2016) is expected to persist into the September quarter, but to begin to recover from the December 2017 quarter, in line with the recent rise in dwelling consents (Figure 1.2) and reflecting solid demand fundamentals.

Figure 1.2 – Quarterly dwelling consents and residential investment

Sources: Statistics New Zealand, the Treasury

…and uncertainty increases….

Business investment contracted 0.4% in the June 2017 quarter and was weaker than forecast in the Pre-election Update.[4] The lengthy pipeline of infrastructure and non-residential construction projects, including those associated with government projects, is expected to support a partial rebound in business investment over the remainder of 2017 and beyond (Figure 1.3). That said, business confidence has declined in recent months, possibly reflecting uncertainty during the election and government formation period. If this uncertainty persists, business investment could be weaker than forecast.

Figure 1.3 – Real business investment

Sources: Statistics New Zealand, the Treasury

A key judgement underpinning these forecasts is that the recent dip in business confidence is short-lived and that domestic activity begins to pick-up at the end of 2017. Scenario One in the Risks and Scenarios Chapter discusses the impact on the outlook should the assumed rebound in confidence not materialise (see page 56).

…but the fundamental drivers of growth remain intact…

Recent indicators suggest growth in household spending eased in the September quarter, possibly reflecting election-related uncertainty and the softening housing market. The latter was evidenced by weak spending on durable goods, such as household furnishings. As uncertainty recedes, an increase in private consumption growth is expected in the December quarter.

Net migration inflows have remained high, adding 71,000 people to the population in the year ending September 2017 and contributing to demand for goods and services. Employment growth has more than accommodated the larger population, with the unemployment rate falling 0.2% points to 4.6% in the September quarter. Wage growth was bolstered by the pay equity settlement in the September quarter, but underlying wage pressures appear subdued relative to history. Looking through some of the volatility in recent labour market statistics suggests conditions are tracking broadly as expected in the Pre-election Update (that is, an ongoing but modest strengthening in labour market conditions).

Despite annual CPI inflation coming in a little stronger in the 2017 September quarter than expected in the Pre-election Update,underlying inflationary pressures remain subdued, with indicators of core inflation, such as the Reserve Bank's Sectoral Factor Model and inflation excluding food and energy, broadly unchanged. Since September, the rise in oil prices and depreciation of the New Zealand dollar have been greater than anticipated. These developments will support stronger tradables inflation in the near term but are unlikely to have a sustained impact on inflation over the medium term. Accordingly, the near term outlook for short-term interest rates is unchanged from the Pre-election Update, with the 90-day rate remaining around its current level before rising steadily from late 2018 as the Reserve Bank begins to remove monetary stimulus.

…including a stronger international backdrop

Recent developments in the international economy have been positive on balance. Growth has strengthened in a number of advanced economies, including the US, euro area and Japan, and labour market conditions have continued to tighten. Growth in Australia picked up in the June quarter, while solid employment growth and buoyant business confidence suggest momentum will persist. If so, this will continue to support the pick-up in net trans-Tasman migrant outflows that has occurred in recent months and a decline in net migration inflows more broadly. In China, economic expansion has been buoyed by policy stimulus, particularly for property construction and infrastructure and consumption growth has remained robust while Chinese authorities continue to address debt risks through tighter financial market regulation. Despite many of New Zealand's key trading partners demonstrating broad-based improvement in activity, alongside tightening labour market conditions, wage growth has remained weak and inflationary pressures subdued. While policy makers expect inflationary pressures to pick-up over the medium term, uncertainties remain around the degree to which low inflation and wage growth may have become embedded.

Solid foreign demand is supporting export prices and the terms of trade, which rose further in the September quarter. While a small fall in dairy prices and rising oil-related import prices are expected to drive a small decline in the terms of trade in the December quarter, the terms of trade are expected to remain near historically-high levels over the forecast horizon. The unusually wet spring in 2017 and subsequent dry spell demonstrate the risks to agricultural production from weather conditions.

Services exports were boosted by the World Masters Games and Lions rugby tour in the June and September 2017 quarters. While a pull-back is anticipated in the December quarter, services exports are expected to remain robust, reflecting ongoing strength in New Zealand tourism. Solid income growth abroad, reflecting a strengthening global economy and the recent depreciation of the New Zealand dollar (if sustained) will provide a supportive backdrop for tourism and exports in general.

Figure 1.4 – Trade-weighted index

Sources: Reserve Bank, the Treasury

The trade-weighted index (TWI) is around 6.0% lower than assumed in the Pre-election Update. If sustained, this will support New Zealand exporter incomes for goods sold in foreign currency-denominated prices. The tourism sector and services exports will also benefit as the lower dollar makes New Zealand more attractive to international visitors, while supporting a substitution towards domestic tourism by New Zealanders. Overall, a sustained depreciation will support a rebalancing in the economy towards the tradables sector but risks remain. These forecasts assume the recent depreciation in the TWI is sustained over the forecast horizon.

Growth in nominal GDP to support tax revenues

The nominal economy, measured as the combination of real activity and prices, increased 5.8% in the year to June 2017 to $268 billion.[5] Consistent with the solid uplift in nominal GDP, core Crown tax revenues grew 7.6% to $75 billion in the year ending June 2017, driven by growth in corporate tax (owing to strong company profits), GST (reflecting solid consumption and residential investment) and wage and salary income tax (reflecting improving labour market conditions). The positive economic outlook is forecast to continue to support increasing tax revenues (see Fiscal Outlook Chapter).

Economic Outlook#

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This section discusses the economic outlook for the period ending June 2022. The outlook is conditioned on a number of judgements and assumptions, which are outlined on page 13. Additional assumptions and judgements have been made regarding the impact of the new Government's policies on the economic outlook (see page 6). Should these assumptions and judgements prove incorrect, the economic and fiscal outlook would deviate from that presented here. The Risks and Scenarios Chapter on page 51 discusses some of the key risks facing the economy and uses scenarios to assess the implications if some key assumptions and judgements are altered.

Growth expected to average 2.9%…

The New Zealand economy is expected to expand at an average rate of 2.9% per year over the next five years (Figure 1.5). Factors supporting growth include low interest rates, population growth, government spending, a positive international outlook and high terms of trade.

Figure 1.5 – Economic growth (production GDP)

Sources: Statistics New Zealand, the Treasury

Compared to the Pre-election Update, the new Government's policies have altered the drivers of growth and contribute to stronger growth over the latter part of the forecast horizon. Government spending makes a stronger contribution to GDP growth over 2018/19, which offsets downward revisions to private consumption growth, reflecting the net impact of the Families Package replacing the Family Incomes Package. Growth in private consumption is a little stronger over the latter part of the forecast horizon owing to stronger household income growth, as both wages and employment are expected to be higher. From a weaker starting point, residential investment activity increases more than previously forecast, reflecting the impact of KiwiBuild. Stronger GDP growth over the latter part of the forecast horizon puts additional pressure on resources, leading to higher inflationary pressures and interest rates. Further information is provided on page 7.

…supported by a range of forces…

Low interest rates and net migration inflows are expected to support domestic activity for some time. Growth in government spending, residential investment and business investment drive a pick up in GDP growth to a peak of 3.6% in the year ending June 2019. Thereafter, growth eases to 2.1% by June 2022 as interest rates rise, population growth eases and growth in government spending slows. Growth in GDP per capita peaks in the year ending June 2019 at 1.7% and eases to 1.1% in June 2022.

Growth in the working-age population will continue to be driven by high, albeit declining, net migration inflows (Figure 1.6). Relative to history, solid growth in the working-age population, together with a strengthening labour market, is expected to support household income growth and consumption.

Figure 1.6 – Net migration

Sources: Statistics New Zealand, the Treasury

Annual net migration inflows are assumed to ease over the forecast horizon, gradually declining from a peak of over 72,000 in June 2017 to 15,000 by 2022. In part, the gradual decline in net migration represents an assumption that the recent pick up in net trans-Tasman outflows (associated with a strengthening Australian labour market) will continue. The long-run net migration assumption is unchanged from the Pre-election Update but will be reviewed prior to the 2018 Budget Update.

…including government spending

Following a period of strong growth and a decline in the household saving rate, a slower pace of private consumption growth is expected over the next year or so (Figure 1.7). Thereafter, the Government's Families Package and other commitments in the 100-Day Plan provide additional impetus to household income growth and private consumption. Nonetheless, slower population growth and increasing interest rates will drive an easing trend in consumption growth over the latter part of the forecast period. The household saving rate is assumed to increase and to remain positive, although with interest rates projected to rise and to reduce disposable income, the saving behaviour of households is a source of uncertainty.

Figure 1.7 – Real private consumption growth

Sources: Statistics New Zealand, the Treasury

Reflecting constraints in the housing market, residential investment activity is expected to increase only gradually over 2018. Growth in real residential investment is expected to gather pace over 2019 and activity is expected to rise to a higher level than forecast in the Pre-election Update, primarily reflecting the impact of KiwiBuild and associated policies to lift capacity in the construction sector (see page 7 for details).

Past forecasts have tended to overestimate the degree to which residential construction activity is able to respond to high demand (Figure 1.8). The Pre-election Update included a downgrade to expected residential investment activity, reflecting a change in view towards more binding capacity constraints in the sector. In the 2017 Half YearUpdate, the outlook is revised higher over the latter part of the forecast horizon. This reflects an assumption that capacity pressures will be partially alleviated by policies associated with KiwiBuild. Should capacity pressures prove to be stronger than assumed, the outlook for residential investment would be weaker than presented here.

Figure 1.8 – Residential investment

Sources: Statistics New Zealand, the Treasury

Consistent with the Government's operating allowance profile and a more stimulatory fiscal impulse (see summary fiscal indicators on page 38), public consumption makes a stronger contribution to the acceleration in GDP growth in 2018/19 than forecast in the Pre-election Update.

Increased government capital spending is also expected to contribute to stronger activity. This, alongside a strong tourism sector, low interest rates, generally solid domestic demand and sustained improvement in export prices, supports a solid uplift in business investment. However, a sustained drop in business confidence would likely result in weaker business investment than forecast (this is included as part of Scenario One on page 56).

The labour market strengthens…

The pace of expansion in economic activity is expected to support ongoing strengthening in the labour market and a gradual decline in the unemployment rate to around 4.0% (Figure 1.9). Tightening labour market conditions and building inflationary pressures support a pick up in wage growth, which receives additional impetus from the Government's policy to increase the minimum hourly wage to $20 by 2021.

Figure 1.9 – Unemployment rate and wages

Sources: Statistics New Zealand, the Treasury

One of the assumptions underpinning the outlook is that labour productivity growth recovers to average 1.1% over the forecast period. Weaker growth in labour productivity would lower the rate at which economic activity is able to expand (for a given working-age population and labour force) without driving up inflationary pressures and interest rates. That is, it would lower potential growth. If labour productivity were to evolve at a more subdued pace than assumed, real economic activity would likely be slower and/or inflationary pressures stronger. The impact of slower productivity growth is investigated as part of Scenario One in the Risks and Scenarios Chapter on page 56.

…and inflationary pressures rise

Sustained growth in economic activity is expected to put pressure on resources, such as materials and labour, leading to higher input costs, which flow through to rising consumer prices. Annual CPI inflation is forecast to pick up to a little above 2.0% from mid-2019 (Figure 1.10). A stronger growth profile in the latter part of the forecasts than in the Pre-election Update contributes to stronger inflationary pressures. Interest rates are assumed to rise from late 2018, which is similar timing as in the Pre-election Update. However, to dampen stronger inflationary pressures, the 90-day interest rate is 25 basis points higher than in the Pre-election Update over 2020/21.

Figure 1.10 – Inflation and the 90-day interest rate

Sources: Statistics New Zealand, Reserve Bank, the Treasury

Stronger international outlook…

The outlook for New Zealand's trading partners is a little more positive than at the Pre-election Update (Figure 1.11). The IMF, OECD and private sector forecasters have lifted their expectations for global growth in 2017 and 2018.

Figure 1.11 – Trading partner growth

Sources: Haver Analytics, the Treasury

In the US, euro area, Japan and Australia, above-trend economic growth is expected to lift household incomes and reduce the rate of unemployment. Inflation pressures are expected to build and to allow the gradual withdrawal of monetary stimulus. In China, economic activity is expected to slow modestly over the forecast horizon as authorities continue to pursue sustainable growth through a consumption- and services-led economy.

…supports exports and the terms of trade…

Solid demand from New Zealand's trading partners is expected to support export prices and maintain the terms of trade around historically-high levels (Figure 1.12). The ongoing transition towards consumption-led growth in China is expected to underpin demand for New Zealand dairy, meat and food and beverages. Oil prices can have significant impacts on New Zealand's goods imports bill, directly though the price of fuel imports and shipping costs and indirectly through higher input costs for the production of imported goods. Oil prices are assumed to pick up very gradually over the forecast horizon, and remain low relative to recent pre-shale oil history.

Figure 1.12 – Goods terms of trade

Sources: Statistics New Zealand, the Treasury

High export prices are expected to support a pick-up in goods export volumes. Growth in dairy export volumes is forecast to quicken in 2019 as milk production continues to recover over the remainder of the 2017/18 season and into the 2018/19 season. As always, unusually wet winter and spring conditions, or drought in the warmer months present risks to agricultural production. Strong activity in the domestic economy is expected to drive growth in goods import volumes and a widening of the goods deficit from early 2018. A strong tourism sector is expected to support growth in services exports and a gradual lift in the services surplus.

From a deficit of around 2.0% of GDP in mid-2018, the current account deficit is forecast to gradually widen to around 4.0% of GDP. Growth in imports is forecast to outstrip export growth leading to a wider goods deficit, while rising global interest rates contribute to a growing income deficit (Figure 1.13). From 57.0% of GDP at the end of 2017, New Zealand's net international liability position improves slightly in the next two years, before increasing modestly to just under 59.0% of GDP by June 2022.

Figure 1.13 – Current account balance

Sources: Statistics New Zealand, the Treasury

…and nominal GDP

Continued growth in economic activity, rising inflation and a terms of trade near historically-high levels are expected to support an expansion in the nominal economy (Figure 1.14). Solid employment and wage growth is forecast to drive growth in compensation of employees and consumption, supporting PAYE and GST revenues respectively. Strong domestic demand coupled with a positive international outlook will support business profits and corporate tax.

Figure 1.14 – Nominal GDP[6]

Sources: Statistics New Zealand, the Treasury

In the four years to June 2021 (which was the final forecast year of the Pre-election Update), nominal GDP is cumulatively $1.5 billion higher than forecast in the Pre-election Update. Including the impact of Government policy changes and the changes in the economic outlook, core Crown tax revenue is cumulatively $6.6 billion higher than in the Pre-election Update. After accounting for changes in government policy, such as the removal of personal income tax threshold adjustments, this supports a small macroeconomic-driven lift in tax revenues of around $0.7 billion.

Fiscal Outlook#

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Overview#

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• Overall, the fiscal outlook is expected to improve across the forecast period.
• The operating balance before gains and losses (OBEGAL) is expected to continue growing across the forecast, reaching a surplus of $8.8 billion (2.5% of GDP) in 2021/22.
• The fiscal forecasts include the operating and capital allowances outlined in the 2018 Budget Policy Statement (BPS), and the estimated costs of the Government's 100-Day Plan (refer to page 6).
• Core Crown expenses as a percentage of GDP are expected to initially increase in the first two years of the forecast, reaching 28.6% before declining to 27.6% of GDP in 2021/22. In nominal terms, core Crown expenses continue to increase, reflecting the growing costs of New Zealand Superannuation and new spending in future budgets, as well as some expenditure transferred from 2016/17.
• In addition to operating expenditure, core Crown capital spending totalling $41.7 billion is included in the forecast to 2021/22. Of this, $2.0 billion has been committed to the KiwiBuild programme and $7.7 billion to recommencing contributions to the NZS Fund.
• Capital spending is expected to exceed operating cash flows over the first three years of the forecasts. As a result residual cash deficits are forecast for these years, before returning to a residual cash surplus.
• Funding these residual cash deficits over the next three years, net core Crown debt is forecast to increase in nominal terms before tracking down later in the forecast. As a percentage of GDP, net core Crown debt reduces to around 19.3% by 2021/22.
• The Crown's balance sheet continues to grow with net worth attributable to the Crown reaching $154.6 billion (44.7% of GDP) in 2021/22.
• While the fiscal outlook is expected to improve, it is at a slower pace than the Pre-election Update. Comparisons against the Pre-election Update can be found on page 45.
• The Forecast Financial Statements and Core Crown Expense Tables can be found on pages 97 to 136, and provide more detailed information on the fiscal forecasts.
• These forecasts are sensitive to a number of judgements and assumptions and should be read in conjunction with the Risk and Scenarios and Specific Fiscal Risks chapters.

Notes:

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

Source: The Treasury

The Fiscal Outlook chapter discusses the following areas:

Key assumptions, core Crown tax revenue, core Crown expenses, the operating balance, core Crown capital spending, residual cash and net core Crown debt, the total Crown balance sheet and a comparison to the Pre-election Update.

Core Crown Tax Revenue#

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Core Crown tax revenue is expected to increase over the forecast period…

Core Crown tax revenue (Figure 2.1) is forecast to rise in each year of the forecast period in nominal terms, while remaining relatively stable as a percentage of GDP. By 2021/22, core Crown tax revenue is expected to reach $97.8 billion, $22.2 billion higher than in 2016/17.

Figure 2.1 – Core Crown tax revenue

Source: The Treasury

Table 2.3 shows that, of the major tax types, source deductions account for just over 40% of the increase ($8.9 billion), mainly reflecting expected growth in forecasts of wage rates and employment. In addition, owing to the progressive tax scale, pay as you earn (PAYE) tax growth is boosted by rising average tax rates as wages increase (also known as fiscal drag).

Goods and Services Tax (GST) is forecast to increase by $5.4 billion over the forecast period, mainly owing to expected growth in nominal domestic consumption, with forecast residential investment also expected to contribute.

Corporate tax is forecast to increase by $3.6 billion over the forecast period, mainly owing to an expected rise in companies' taxable profits.

Source: The Treasury

…in line with a growing economy

The average nominal GDP growth over the forecast period is expected to be 4.9%, while the average growth in core Crown tax revenue is expected to be slightly higher at 5.3% over the same period. As a share of the economy, core Crown tax revenue is forecast to increase to 28.3% of GDP in 2021/22.

Figure 2.2 shows that tax revenue growth is expected to drop below GDP growth in the current year of the forecast, mainly owing to some unusually large one-off effects in the 2016/17 results, which increased corporate tax revenue significantly. These are not forecast to be repeated in 2017/18, resulting in the initial decrease in tax revenue growth. Tax revenue is then forecast to grow at a higher rate than GDP.

Figure 2.2 – Core Crown tax revenue and nominal GDP growth

Source: The Treasury

Owing to the relatively strong forecast growth in wages, fiscal drag is expected to make a significant contribution to PAYE growth, adding nearly 0.5% of GDP to forecast tax revenue by 2021/22.

Increasing forecast deposit rates over the forecast period means that the Resident Withholding Tax on interest is forecast to grow at a faster rate than nominal GDP.

Previously announced policy measures (eg, base erosion and profit shifting measures for multinational corporations operating in New Zealand and successive 10% increases to tobacco excise rates) are expected to add 0.3% to the tax-to-GDP percentage over the forecast period.

Slightly offsetting these factors, some components of GDP that contribute to growth in taxes (total employees' compensation and domestic consumption) are forecast to grow at a slower rate than nominal GDP, thereby reducing the tax-to-GDP ratio.

Comparison with Inland Revenue forecasts

Inland Revenue has also prepared a set of tax forecasts, which, like the Treasury's tax forecasts, were based on the Treasury's macroeconomic forecasts. The Treasury's forecasts of core Crown tax revenue are, on average, 0.3% lower than Inland Revenue's forecasts. Most of the forecast differences arise from judgements around the relative strength of tax revenue in the current year, as the differences between the two forecasts are, in aggregate, similar across all years of the forecast period.

This comparison is included in the Additional Information on the Treasury website at: http://www.treasury.govt.nz/budget/forecasts/hyefu2017

Core Crown Expenses#

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Core Crown expenses are expected to remain relatively stable compared to the size of the economy, despite nominal growth…

Core Crown expenses are expected to grow at a slightly slower rate than the nominal economy. While slightly higher in the near term, core Crown expenses as a percentage of GDP decline from 28.0% in 2016/17 to 27.6% at the end of the forecast period (Figure 2.3).

Figure 2.3 – Core Crown expenses

Source: The Treasury

Nominally, core Crown expenses are expected to increase by $19.0 billion from $76.3 billion in 2016/17 to $95.3 billion in 2021/22, an increase of around $4 billion each year.

…primarily owing to operating allowances provided for future decision-making…

The operating allowances are set by the Government in the BPS and outline the expected level of future expenditure, although no formal decision regarding the allocation of spending has yet been taken.

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

These forecasts assume that any additional costs in relation to Government commitments and future cost pressures (whether they be from increased demand for government services, inflation or additional services) will be met from operating allowances.

Future operating allowances are currently set at $2.6 billion for Budget 2018, reducing to $1.875 billion for each subsequent Budget (Figure 2.4).[13] The fiscal forecasts include estimated costs of the 100-Day Plan (refer page 6 for further discussion). Any additional costs of the policy commitments made by the Government are assumed to be met from these budget allowances. For further details refer to ‘impact of new Government policies' box on page 6 to 9.

Figure 2.4 – Core Crown expenses with allowance break down

Source: The Treasury

The Specific Fiscal Risks chapter outlines the options the Government has to manage those commitments with these allowances (refer page 63).

…and an increase in the cost of New Zealand superannuation contributes to expenditure growth…

New Zealand superannuation (NZS) is forecast to increase as recipient numbers increase.

NZS payments account for $4.2 billion of the increase in core Crown expenses over the forecast period. This increase reflects the growth in the number of NZS recipients and the increase in payment rates and other factors. By the end of the forecast period, NZS is around 54% of the total social assistance spending and 18% of core Crown expenditure (compared to 52% and 17% respectively in 2016/17).

Recipient numbers are forecast to increase from almost 717,000 in 2016/17, to over 851,000 by the end of the forecast horizon (an increase of 18.7%). The remaining increase is largely owing to indexation of entitlements to wage growth (Figure 2.5).

Figure 2.5 – Growth of NZS recipients and expenses

Source: The Treasury

…while judgements are made regarding the level of spending.

The fiscal forecasts are a culmination of individual forecasts provided by departments and other government entities (a ‘bottom-up' forecast).

Parliament provides the authority for departments to incur expenses (referred to as appropriations). History suggests that the actual level of spending is usually below these upper limits and that there is a bias towards over-forecasting expenditure (Figure 2.6).

Figure 2.6 – Variance in core Crown expenses to original budget¹

Note

1. Original budget refers to the relevant Budget Update first full forecast year (ie, Original budget for 2017 is Budget 2016).

Source: The Treasury

Actual expenditure is often lower than these limits owing to a number of reasons; such as expenditure being delayed or programmes not implemented. The Treasury therefore estimates the extent to which expenditure is ‘over forecast' and reduces the expenditure forecast accordingly. This adjustment is referred to as a ‘top-down' adjustment.

To make this judgement the Treasury analyses large departments' forecasts, including the past history of spending against forecasts and appropriations. Without the top-down adjustment the variance to forecast would be much larger.

Table 2.4 shows forecast core Crown expenses in the Half Year Update before and after the top-down adjustment is applied.

Source: The Treasury

The top-down adjustment will be higher at the front end of the forecast period as departments' appropriations (and therefore expenses) tend to be higher in these years, reflecting the flexibility departments have around transferring spending not incurred and moved to the following year.

OBEGAL is expected to decrease initially, followed by steady growth over the next four years…

The forecast decrease in OBEGAL in the current year largely reflects the higher than expected outturn for 2016/17 and the increase in spending from Budget 2017 decisions. This decline is followed by steady growth in the remaining years of the forecast, as revenue grows at a faster pace than expenditure, reaching a surplus of $8.8 billion in 2021/22 (Figure 2.11).

Figure 2.11 – Components of OBEGAL by segment

Source: The Treasury

Crown entities (CEs) are expected to record relatively small deficits over the forecast period, while State-owned Enterprises' (SOEs') contribution to OBEGAL remains fairly stable, with operating surpluses forecast to average $0.7 billion throughout the forecast period. See page 99 to 102 for a list of CEs and SOEs.

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

The total Crown operating balance, inclusive of gains and losses, is forecast to be in surplus across all years of the forecast period.

The 2016/17 gains made on the Crown's large investment portfolios, largely ACC and the NZS Fund, reflected strong performance in the global equity markets. The forecast then assumes investment income returns to a long-term rate of return, resulting in more subdued growth going forward. The operating balance follows the OBEGAL trend growing to $13.0 billion in 2021/22 (Figure 2.12).

Figure 2.12 – Components of operating balance

Source: The Treasury

While expected financial gains on investments are positive, partially offsetting these was an actuarial loss on the ACC outstanding claims liability of $0.5 billion in 2017/18 (compared to actuarial gains of $0.4 billion in 2016/17). However, as future actuarial gains or losses are not forecast, they do not impact the operating balance beyond 2017/18.

The level of operating balance plays a significant part in increasing the Government's financial assets and contributing to growth in the Crown's net worth.

---

The Government is forecast to spend $41.7 billion on net capital spending over the next five years. Net capital spending is expected to increase significantly in 2017/18 and persist at that level across the forecast. The estimated increase in the forecast capital spend increases the risk that spending may be pushed into future periods as capacity constraints are tested.

Source: The Treasury

Table 2.8 outlines core Crown capital spending that has a net core Crown debt impact. It excludes capital spending undertaken directly by CEs and SOEs funded from their own resources. The Government has committed to spending $2.0 billion on the KiwiBuild programme (refer to page 7 for further information). This has been forecast to occur in the first three years of the forecast. Other significant areas of capital spending include Crown Infrastructure Partners, schools and the roading network (through NZTA).

Some capital commitments relating to the City Rail Link and Housing Infrastructure Fund are expected to fall outside of the forecast horizon.

Capital allowances represent new capital spending expected to be allocated over the forecast period. The capital allowance for each Budget is spread over five fiscal years, reflecting the expected profile of spending. This profile is illustrated in Figure 2.14.

Figure 2.14 – New capital spending (capital allowances)

Source: The Treasury

As with operating allowances, capital allowances are set by the Government and outline the expected level of future expenditure, although no formal decision regarding the allocation of spending has yet been taken. Future capital allowances are currently set in the 2018 Budget Policy Statement at $3.4 billion for both Budget 2018 and Budget 2019, reducing to $3.1 billion in Budget 2020, and $2.7 billion in Budget 2021 onwards.

In addition to the above capital spending, a number of capital projects have been undertaken through Public Private Partnerships (PPPs) (eg, Transmission Gully). Unlike capital spending, where cash payments are made as the asset is being constructed, cash flows in relation to PPPs do not typically commence until the completion of the project. Instead, borrowings are accumulated across the period reflecting the progress towards completion. Payments are then spread over a number of subsequent years as the assets become operational.

Residual Cash and Net Core Crown Debt#

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[15]

Operating cash flows are expected to improve across the forecast period…

Net operating cash flows are expected to rise over the forecast period. However, these are forecast to be exceeded in the first three years of the forecast by the expected capital spending as discussed earlier on page 39. This results in a residual cash deficit forecast for the first three years. However, as capital spending steadies, and forecast tax receipts continue to grow at a faster pace than operating expenditure, a residual cash surplus occurs in the final two years of the forecast, peaking at $2.3 billion in 2021/22 (Figure 2.15).

Figure 2.15 – Core Crown residual cash

Source: The Treasury

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

…while net core Crown debt falls as a percentage of GDP

Net core Crown debt as a percentage of GDP is expected to decline across the forecast period from 21.8% in 2016/17 to 19.3% at the end of the forecast period (Figure 2.16).

Figure 2.16 – Net core Crown debt

Source: The Treasury

However, as a result of the expected residual cash results, net core Crown debt is expected to increase in the short term and peak in nominal terms at $69.4 billion in 2019/20 before reducing to $66.8 billion in 2021/22.

This forecast nominal increase in net core Crown debt in the short-term is expected to be funded by reducing financial assets of the Crown, rather than increasing nominal gross debt.

This forecast nominal increase in net core Crown debt occurs as cash flows from operating activities are not expected to be sufficient to meet capital spending.

The bond programme remains stable…

While nominal net core Crown debt increases in the short term, the bond programme is forecast to remain stable over the forecast period. The issuance profile reduces the year-to-year volatility of bond programmes and ensures consistency of supply over this time.

The bond programme is expected to raise funds of $35.2 billion over the forecast period, while $35.5 billion of existing debt will be repaid, providing net repayments of $0.3 billion (Table 2.9).[16]

Source: The Treasury

…although gross debt declines as a percentage of GDP

In line with the Crown bond programme, gross debt as a percentage of GDP is expected to decline across the first four years of the forecast period. By 2020/21 gross debt is expected to decrease to 23.9% of GDP, from 31.9% at the end of 2016/17. In the final year of the forecast, gross debt climbs again to 25.1% of GDP, as steady bond issuance continues during a year with no forecast bond maturity.

In nominal terms gross debt declines to $79.4 billion in 2020/21 before peaking in 2021/22 at $86.7 billion, $0.4 billion lower than current levels (Figure 2.17), largely as a result of the net repayment discussed above.

Figure 2.17 – Gross debt

Source: The Treasury

As previously signalled in the Budget Update 2017, the Government intends to maintain the amount of bonds issued at not less than 20% of GDP over time. The BPS contains further information on this objective.

Total Crown Balance Sheet#

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Growing 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 expected operating balance surpluses, to stand at $154.6 billion by 2021/22. As a percentage of GDP, it remains stable in the first half of the forecast before increasing to 44.7% by 2021/22 (Figure 2.20) as growing operating surpluses outpace GDP growth.

Figure 2.20 – Net worth attributable to the Crown

Source: The Treasury

…with assets increasing by $48.5 billion over the forecast period…

Total assets are forecast to grow by $48.5 billion over the forecast period to $364.8 billion in 2021/22, made up of additional investments in assets, both physical and financial (Figure 2.21).

Figure 2.21 – Total Crown assets

Source: The Treasury

The largest asset growth over the forecast period is in the social assets portfolio (around 53% of the total Crown balance sheet). Social assets (eg, schools, hospitals and social housing) are expected to increase by $23.4 billion over the forecast period to be $189.8 billion in 2021/22. This increase largely reflects the capital spending discussed earlier.

...while liabilities are expected to grow at a slower rate…

The Crown's liabilities across the forecast period reach $204.5 billion by 2021/22, an increase of $10.7 billion. Primarily driving this is the increase in the Crown's insurance liabilities (mostly held by ACC, EQC and Southern Response). Insurance liabilities are expected to increase across the forecast by $6.3 billion, largely owing to ACC claims liability (reflecting a growth in both volume and cost of claims).

…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 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.

The Risks and Scenarios chapter includes a section on balance sheet risks and should be read in conjunction with the fiscal forecasts.

Comparison to the Pre-election Update 2017#

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The Pre-election Update was published on 23 August 2017. Since then, there have been a number of developments that have impacted the fiscal outlook, in particular the 2017 General Election resulting in the formation of a new Government and the finalisation of the fiscal 2016/17 results. Overall, the forecasts for the next four years continue to improve, however, at a slower pace than was forecast in the Pre-election Update forecasts. Table 2.10 below summarises the changes in the key fiscal indicators.

Source: The Treasury

Core Crown tax revenue is expected to be higher than the Pre-election Update...

Core Crown tax revenue is forecast to be $6.6 billion higher than in the Pre-election Update over the four-year period up to 2020/21 (Table 2.11). Of this change $6.3 billion of this change has come from repealing the Budget 2017 tax cuts and reinstating the Independent Earners' Tax Credit (IETC). Apart from this policy change, most of the change in tax revenue forecasts has come from:

• source deduction revenue forecasts increased by $0.9 billion in total (excluding policy changes) across the forecast period, mainly owing to a higher track for forecast wage rates, plus the associated increase in forecast fiscal drag, and
• GST forecasts have been increased by a total of $0.6 billion, mainly owing to increased forecasts of net tourist spending in New Zealand and residential investment, particularly towards the latter part of the forecast period.

This is somewhat offset by corporate tax being nearly $1.0 billion lower than in the Pre-election Update, mainly owing to a lower outlook for company profits across the forecast period.

Within the nominal GDP forecast that underlies the tax forecast, relative to the Pre-election Update, there has been a switch out of profits (net operating surplus) and into labour incomes (compensation of employees) caused at least in part by proposed increases in the minimum wage over the next three years (see Impact of new Government policies on pages 6 to 9). Overall, the tax gained on the components of GDP for which forecasts increased, was greater than the tax lost on the components of GDP for which forecasts were decreased.

Source: The Treasury

…while OBEGAL growth slows with recent developments before climbing…

The major movements in OBEGAL since the Pre-election Update are outlined in Table 2.12 below. Cumulatively, OBEGAL is $1.7 billion lower than the Pre-election Update across the forecast period.

Source: The Treasury

The Government's 100-Day Plan has been included in these forecasts. More detail around the 100-Day Plan can be found on pages 6 to 9.

In addition, operating allowances have been set at $2.6 billion for Budget 2018 and $1.875 billion for Budgets 2019-2021, which is higher than those forecast in the Pre-election Update.

Tax revenue and benefit expenses have been updated to reflect changes to the latest economic forecasts (refer to tax revenue on page 46). Benefit expenses have been impacted as a result of the indexation of payments to wage growth and inflation, and increases in recipient numbers.

There has also been some expenditure that was not spent in the previous financial year that is now expected to occur in the current forecast period.

Accident Compensation Corporation's (ACC's) OBEGAL result is expected to improve, primarily owing to decreases in insurance expenditure, as growth in claim volumes is expected to be lower than the Pre-election Update.

...and net core Crown debt is higher across the forecast period compared to the Pre-election Update.

Core Crown residual cash is $9.6 billion lower than the Pre-election Update increasing net core Crown debt, which is expected to be around $8.2 billion higher than the Pre-election Update across the forecast period (Table 2.13).

Source: The Treasury

In addition to the operating impacts of the 100-Day Plan, restarting contributions to the NZS Fund earlier (an additional $3.0 billion) and the commitment to the KiwiBuild programme (of $2.0 billion) have increased net core Crown debt. More details on the 100-Day Plan can be found on pages 6 to 9.

Allowances for new capital spending have also increased to $3.4 billion for Budgets 2018 and 2019, $3.1 billion for Budget 2020 and $2.7 billion for Budget 2021. This adds an additional $1.3 billion over the forecast period from allowances set in the Pre-election Update.

Net core Crown debt also had a stronger starting position for the 2017/18 financial year, with net debt being $1.1 billion lower at 30 June 2017 than previously forecast at the Pre-election Update.

Key Economic Assumptions Used in the Fiscal Forecasts#

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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 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 2.14 below.

Notes:

1. Production measure.
2. Expenditure measure. Nominal GDP has been adjusted to incorporate changes to the national accounts data released 24 November 2017. For further information refer to page 5.

Source: The Treasury

Risks and Scenarios#

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Overview#

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• In this chapter we discuss the risks and uncertainties surrounding the forecasts and how they may cause economic and fiscal outcomes to differ from those presented in the previous chapters. Risks can be positive or negative and can have an impact on the Government's fiscal position, including tax revenue, expenditure and debt. While this chapter focuses on risks and uncertainty to the economic and fiscal outlook, it does not cover specific fiscal risks such as cost pressures, contingent liabilities, or potential changes to government policy, which are discussed in Chapter 4.
• The outlook for the domestic economy may differ from what we have forecast in a number of ways. Weaker economic confidence could mean that consumption or business investment is softer than expected. The impact of falling unemployment and government policy changes could result in higher than expected growth in wages. Growth in real residential investment may be weaker than forecast if capacity constraints are more binding than we have assumed.
• Changes in the international economy also have potential to impact the economic outlook. Stronger than forecast growth in our trading partners could increase demand for exports and result in higher terms of trade. Higher wage growth or lower unemployment in New Zealand has the potential to keep net migration higher for longer than we have assumed. Geopolitical tensions and ongoing debate in some countries on the merits of trade liberalisation also remain as risks to the global economy.
• Two alternative scenarios are presented to show how the economic and fiscal outlook might evolve under a different set of assumptions and judgements. Scenario One shows the impact of the economy failing to pick up as quickly as we have forecast. Scenario Two shows how a stronger global economy might flow through to stronger growth and higher inflation in New Zealand.
• The Crown's balance sheet is exposed to a number of risks beyond those associated with the operating balance. The Crown's financial position is exposed to risk through changes in the value of the Crown's assets or liabilities and through the potential impact of the Crown's fiscal obligations that arise from policy choices.

Risks to the Economic and Fiscal Outlook#

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The main forecasts are based on a set of assumptions (such as the evolution of the exchange rate, the terms of trade and population growth) and judgements about how developments in one part of the economy impact the rest of the economy.[13] Should these assumptions and judgements prove incorrect, the economic and fiscal outlook would deviate from that presented in Chapters 1 and 2. This chapter discusses some of the key risks facing the economy and uses scenarios to assess the implications if assumptions and judgements are altered. Supplementing this, the Statement of specific fiscal risks (Chapter 4) provides details of the risk of potential government decisions, contingent liabilities and contractual obligations that may also have a material impact on the economic or fiscal outlook.

There are a number of key risks to the economic outlook that could have a significant impact on the Government's fiscal position should they materialise. In particular, recent weakness in a number of economic indicators, including retail sales, business confidence, and labour productivity are expected to unwind driving the forecast lift in growth through to 2019. If these assumptions prove incorrect, growth is likely to remain around current levels, leading to a weaker fiscal position than forecast. On balance, domestic risks are skewed towards weaker growth, although wage pressures provide some offset to this. In contrast, the global economy has continued to improve more quickly than anticipated. If this trend continues, domestic growth could be boosted by stronger exports or higher terms of trade. For the most part, uncertainty surrounding the impacts of new policy are dealt with in ‘Impact of new Government policies' on page 6.

The level and composition of net migration could impact the economic outlook

Recent net migration outturns have been broadly in line with our forecasts at the Pre-election Update. Our main forecasts continue to assume a downward trend over the forecast period. Migration inflows may not ease as expected if the relative attractiveness of living, working and studying in New Zealand is stronger than expected. In particular, changes in the Australian labour market are seen as a key driver of net migration cycles. The composition of migration also has implications for the economy. For example, a larger inflow of construction workers may help to alleviate capacity constraints in the sector. See ‘Impact of new Government policies' on page 6 for details of current policy assumptions.

There is considerable uncertainty surrounding our long-term assumption for migration. Our current assumption is drawn from Statistics New Zealand's long-term population projections. A higher long-term assumption would imply a different long-term level of output and tax revenue, given more people would be working and consuming in New Zealand. We will continue to monitor data outturns and review our long-term assumption ahead of Budget 2018.

Wage growth is uncertain, domestically and globally

The link between the unemployment rate and wage growth appears to have weakened in a number of advanced economies (for example Australia, Figure 3.1). It is unclear whether this relationship will reassert itself in the future.

Figure 3.1 – Unemployment and wage growth in Australia

Sources: Haver Analytics, the Treasury

Domestically, policy changes contribute to faster wage growth in the forecasts (see ‘Impact of new Government policies’ on page 6 for details). The impacts, and take-up, of some policies, such as further pay equity settlements, could result in stronger wage growth than in the main forecasts. However, these impacts remain too uncertain to include in the forecasts at this stage; we will continue to monitor how these policies are flowing through to the wider economy and update our assumptions as necessary.

Our main forecasts incorporate a pick-up in labour productivity growth, which has remained weak for a number of years. If labour productivity were to evolve at a more subdued pace, real economic activity per person would likely be slower, inflationary pressures stronger and wage growth weaker.

Exporters face uncertainty from the global economy...

Given the small and open nature of the New Zealand economy, changes in the global economy are of particular relevance for exporters. The global outlook has continued to improve in recent months but a number of risks remain. Stronger demand from Chinese consumers, a faster recovery in Europe and Japan, or stronger than expected fiscal stimulus in the United States, would all boost global growth, presenting an upside risk to New Zealand's export volumes and prices. Stronger growth in the near term may cause a faster withdrawal of monetary stimulus by central banks globally, creating a more cyclical profile for global growth. This is explored in more detail in Scenario Two. On the other hand, high levels of debt remain a risk for a number of economies. In particular, high debt levels in China and Australia could present a risk to consumption as interest rates begin to rise or if financial market regulations begin to tighten.

There are also a number of non-economic factors that could impact conditions for exporters. Geopolitical tensions continue to persist. Debate around the merits of trade liberalisation remains a risk, although the pursuit of new free trade deals has the potential to broaden export markets. Natural shocks, including earthquakes, drought or other severe weather conditions, could produce a shock to commodity prices, the domestic economy and the Government's fiscal position. In the medium term weather-related risks may increase in prevalence as the impacts of climate change become more pronounced.

...and the exchange rate

The exchange rate has fallen by around 6% since the Pre-election Update. Our forecasts assume the exchange rate remains around this level. However, there is a wide band of uncertainty around this. For example, faster than anticipated monetary tightening or a shift in market sentiment could lead to an increase of the exchange rate. A higher exchange rate would lower tradable inflation, and reduce exporters' incomes resulting in lower nominal gross domestic product (GDP) and less tax revenue.

Persistently weak confidence may soften domestic demand

In recent months consumer and business confidence has softened. Our main forecasts assume this weakness is likely owing to election uncertainty and that these measures will rebound in the near-term without materially impacting investment or consumption decisions. If confidence does not pick up, it is likely that business investment and private consumption will remain subdued for some time. This is explored in more detail in Scenario One.

Capacity constraints could limit growth in the construction sector

House prices have risen sharply in recent years as strong population growth has outpaced residential investment. Credit constraints, the availability of skilled labour, local planning regulations and land shortages have all constrained residential investment growth, limiting the supply of new houses. Our forecasts currently have a pick-up in residential construction in 2018/19 and stronger growth for the remainder of the forecast period owing, in part, to the KiwiBuild policy. This assumption will depend on how binding these constraints turn out to be. In particular, shortages of skilled labour or tighter credit constraints would likely restrict residential investment growth. For details of the Treasury assumptions on the impact of KiwiBuild on the construction sector, refer to ‘Impact of new Government policies' on page 6.

Alternative Scenarios#

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The following scenarios show how the economy might evolve if some of the assumptions in the main forecast are altered. They illustrate two of the many ways that the economy may deviate from the main forecasts. Scenario One illustrates the impact of recent weakness in a number of economic variables persisting through the forecast period. Specifically, labour productivity fails to pick-up as forecast and business and consumer confidence remain soft, dampening investment and private consumption growth. Weaker demand leads to lower inflationary pressure and softer nominal GDP growth, resulting in less tax revenue and higher net debt. Scenario Two illustrates the economic and fiscal impacts of higher terms of trade and stronger trading-partner growth. In this scenario, trading-partner growth picks up faster than anticipated, driving stronger export prices, which hold the terms of trade higher throughout the forecast horizon. Higher nominal GDP and tax revenues generate a stronger fiscal position.

Notes:

1. Annual average % change.
2. For consistency with the fiscal chapter, GDP as used here is the scaled nominal GDP.

Source: The Treasury

Scenario One - Softer but Stable Growth  

The first scenario looks at the impacts of recent weakness in some economic variables continuing into the forecast period. In particular, labour productivity, business investment and household consumption fail to pick-up as quickly as we have assumed in the main forecasts. This causes growth to remain around current levels, creating a softer but stable profile for growth. GDP growth generally remains above 2.0% in this scenario implying no severe shocks to the economy (Figure 3.2). The scenario highlights that even small changes in the domestic economy can flow through to a materially weaker fiscal position.

Figure 3.2 – Real GDP growth

Sources: Statistics New Zealand, the Treasury

In recent years, growth in labour productivity has remained low. This scenario sees this trend continue for longer than assumed in the main forecasts, resulting in a lower level of potential output. In the medium term this means that household incomes will be reduced, limiting any pick-up in domestic demand.

This scenario assumes recent falls in consumer and business confidence persist for some time. Businesses are therefore less willing to invest in new technology and commit to expansions beyond current operations. This constrains the forecast pick-up in business investment, which is 5.7% lower by the end of the forecast period. Similarly, consumers remain uncertain of the economic outlook so hold off on discretionary consumption. In the medium term, weaker productivity growth and lower household income mean that households are forced to restrict consumption even further. Together, this means private consumption is 1.9% lower than otherwise, by June 2022.

Weaker domestic demand flows through to lower non-tradable inflation, causing headline inflation to begin falling in 2018 and remain below 2.0% until 2021. Consequently, the Reserve Bank takes a more cautious view of monetary policy settings and raises interest rates more gradually than in our main forecasts. By the end of the forecast period interest rates are 50 basis points lower than they otherwise would have been.

Overall, the slower pick-up in domestic demand and labour productivity mean that real GDP is weaker, with growth now peaking at 2.9% in 2020. Weaker activity, combined with softer inflation, lowers nominal GDP by a cumulative $26.6 billion over the forecast period to June 2022 (Figure 3.3). Lower wage growth, softer consumption and lower business profits, flow through to weaker tax revenue. Core Crown tax revenue is $8.9 billion lower than in the main forecast by June 2022, with source deductions and Goods and Services Tax (GST) $2.6 billion and $1.8 billion lower respectively.

Figure 3.3 – Nominal GDP and tax revenue

Sources: Statistics New Zealand, the Treasury

In this scenario we assume that the Government's operating and capital allowances are unchanged from those in the main forecast (see Chapter 2 for details). Under these assumptions, operating balance before gains and loses (OBEGAL) surpluses are smaller in each year, reaching $5.6 billion (1.7% of GDP) in 2022 (Table 3.1, see page 55). This is $3.2 billion below that in the main forecast. The Government's debt position is also weakened, with the level of net core Crown debt $10.4 billion higher by June 2022, at 22.8% of GDP (Figure 3.5).

Scenario Two - Stronger and More Cyclical World Growth

This scenario illustrates the impact of higher terms of trade and trading-partner growth on the economic and fiscal outlook. In this scenario growth of our trading-partners is assumed to pick up faster in the near term. This creates a more cyclical profile for global growth, which feeds into more of a cycle in exports, export prices and domestic growth.

Global growth is assumed to pick-up faster in 2018, peaking in late 2019. Growth is assumed to be broad based and causes central banks to withdraw stimulus faster than otherwise. This reduces the pace of future economic growth, producing a more cyclical profile for global growth.

Stronger global growth increases demand for New Zealand exports, bidding up the price. The price of imports also increases, though not as quickly. This means the terms of trade is 2.0% higher than the main forecasts at its peak in 2019 (Figure 3.4).

Figure 3.4 – Terms of trade

Sources: Statistics New Zealand, the Treasury

Domestic businesses respond to the increased demand by bringing forward investment. Higher global growth therefore flows through to increased inflationary pressure and higher interest rates, which end up around 70 basis points higher by the end of the forecast period.

Overall, nominal GDP is $16.5 billion higher over the forecast period. The pass-through to tax revenue is not as significant as we would normally expect, because the higher GDP is concentrated in business profits and residents withholding tax (RWT) rather than private consumption or wages. Core Crown tax revenue is $5.5 billion higher (Table 3.1), with higher company tax ($1.9 billion) and RWT ($1.7 billion).

As in Scenario One, we assume that the Government's operating and capital allowances are unchanged from those in the main forecast. Under these assumptions, OBEGAL surpluses are larger, increasing to $10.6 billion (3.0% of GDP) in 2022 and net debt is lower across the forecast period (Figure 3.5).

Figure 3.5 – Net debt as a percentage of GDP

Source: The Treasury

General Uncertainties in the Economic and Fiscal Outlooks#

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While the chapter thus far has focused on key assumptions and judgements that may eventuate differently and alter our main forecasts, there are almost limitless ways the economy could evolve. It can therefore be useful to assess the general uncertainties in our forecasts and the sensitivity of these forecasts to changes in the economy.

The wide range of economic outcomes can be illustrated using fan charts that show the uncertainty in our forecasts. Figure 3.6 shows a fan chart of nominal GDP.[14] The width of the fan increases further into the forecast period, meaning the further away from the present the more uncertainty there is around the main forecast. The area within the outermost (blue) edges of the fan shows where nominal GDP is expected to be 90% of the time. At the end of the forecast period, this is within +/-7% ($23.5 billion per annum) of the main forecast. The boundaries of the green fan show where nominal GDP is expected to be 70% of the time. At the end of the forecast period, this is within +/-4.4% ($14.8 billion per annum) of the main forecast. In the two scenarios considered in this chapter, nominal GDP forecasts remain within the green fan (70th percentile).

Figure 3.6 – Nominal GDP fan chart

Sources: Statistics New Zealand, the Treasury

The amount of tax revenue the Government receives in a given year is closely linked to the performance of the economy. For example, lower private consumption will mean less revenue from GST, while higher unemployment will mean less revenue from taxes on wages and salaries.

Figure 3.7 shows the uncertainty surrounding the main tax revenue forecast.[15] At the end of the forecast period, the outermost (blue) area captures a range of approximately +/-$11.3 billion, within which actual tax outturns are expected to fall 90% of the time.[16]

Figure 3.7 – Tax revenue fan chart

Source: The Treasury

The fiscal position is also impacted by changes in government expenses, which may also be impacted by economic developments. For example, the demand for working-age benefits is closely linked to labour market conditions. Changes in net migration flows may also impact on the demand for central government services, particularly health, education and publicly funded infrastructure. Over the longer term, current policies imply population growth and population ageing will place increasing pressure on public expenditure, particularly in the areas of health and superannuation.[17]

Fiscal Sensitivities#

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While significant economic shocks will naturally flow through to changes in the fiscal position, even small changes to the economic outlook can have a fiscal impact. 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 2022, tax revenue would be around $5.1 billion higher than forecast in the June 2022 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 $4.9 billion lower than forecast in the June 2022 year. The figures are indicative and can be influenced by the composition of growth as different types of activity can have different effective tax rates.

A different interest rate path from the forecast would also impact the fiscal position owing to the effect on the portfolios of various government reporting entities, such as the NZS Fund, ACC and the Treasury. For example, at 30 June 2017, a 1.0% increase in New Zealand interest rates would have reduced the total Crown operating balance by $946 million while a 1.0% decrease would have increased the total Crown operating balance by $1,122 million. The majority of the Government's borrowings and a large number of financial assets are managed by the Treasury. To illustrate the interest rate sensitivities on the Treasury's portfolio, Table 3.2 provides the estimated impact of lower interest rates on those assets and liabilities.

Note:

1. Funds managed by the Treasury.

Source: The Treasury

The forecast financial position is based on a number of judgements and assumptions about the future. To inform these judgements and assumptions we rely on market information. Some additional assumptions include those around foreign exchange rates, share prices, the carbon price and property prices. Where the actual outcome differs from our assumptions, the Crown's actual financial position and operating balance is likely to differ from the forecasts. For example, a strengthening of share prices may result in higher returns from the Government's direct share investments.

Balance Sheet Risks#

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To achieve the Government's fiscal strategy it is important to have a strong balance sheet. In particular the balance sheet can provide resilience to shocks and provide choices for how the Government responds to these shocks. The Crown's balance sheet is exposed to a number of risks beyond those associated with the operating balance. Understanding and managing those risks supports the delivery of public services, strengthens resilience to shocks, minimises costs, and improves the achievement of economic and social outcomes. The Crown's financial position is exposed to risk through changes in the value of its assets or liabilities, and also through the potential impact of the Crown's explicit and implicit obligations (including a strong expectation that the Crown would respond to an shock) as a result of policy settings.

Main sources of balance sheet risk

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. Three areas of the balance sheet are particularly susceptible to 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 types of market risks
• insurance and retirement liabilities and provisions are prone to volatility through their actuarial valuations, and
• physical assets such as land, buildings, state highways and military equipment are susceptible to valuation movements through changes in property market conditions, interest rates and changes in the costs of construction.

Other sources of balance sheet risk[18]

• Business risk: A number of commercial entities owned by the Crown have their financial performance and valuations impacted by the commercial environment they operate in.
• Funding risk: The New Zealand Government remains amongst the highest-rated sovereigns globally, with the top Aaa foreign-currency rating from Moody's and AA foreign-currency ratings from Standard & Poor's and Fitch. Ratings outlooks are stable from all three agencies.
• In the case of an increase in global risk aversion, New Zealand could 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.
• Liquidity risk: The Crown incurs liquidity risk with respect to its ability to raise cash to meet its obligations. This risk is managed by each government reporting entity to meet their specific liquidity risk requirements and by the Treasury to manage the Crown's liquidity requirements.
• Contingent liabilities: The Crown faces contingent liabilities, for example relating to natural disasters and financial system stress. The Specific Fiscal Risks chapter discusses contingent assets and liabilities in greater detail.

Specific Fiscal Risks#

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Overview#

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The statement of specific fiscal risks is required by the Public Finance Act 1989. In addition to the discussion of risks to the economic and fiscal forecasts presented in Chapter 3, it sets out (to the fullest extent possible) all government decisions and other circumstances known to the Government that may have a material effect on the fiscal outlook, but are not certain enough in timing or amount to include in the fiscal forecasts. This chapter covers:

• the nature of fiscal risks to the economic and fiscal outlook
• how risks set out in the chapter are managed
• criteria for inclusion and exclusion of fiscal risks in this chapter
• statement of specific fiscal risks, and
• contingent liabilities and assets.

The risks disclosed in this chapter reflect those that are known at the date of the finalisation of the fiscal forecasts. 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.

Nature of Risks to the Economic and Fiscal Outlook

Risks can be positive or negative and can affect revenue and spending or assets and liabilities. The table below reflects a wide range of potential risks that may exist to the economic and fiscal forecasts. However, not all of these are covered in this chapter as they are discussed in the Risks and Scenarios chapter.

Risks 1-3 above are in the scope of this chapter whereas risks 4 and 5 are covered in the Risks and Scenarios chapter. Further detail on the criteria for disclosing a specific fiscal risk is set out in the sections below.

How Risks Outlined in this Chapter are Managed

A key principle guiding the disclosure of risks is transparency. This means that risks are disclosed in this chapter regardless of whether they can be managed through existing funding sources (for example, through reprioritisation of funding already available to departments) or the Budget operating and capital allowances (future new spending built into the fiscal forecasts). This is done to ensure a prudent approach to the disclosure of risks, to improve transparency and not to pre-judge future decisions by governments about what may or may not be funded from allowances.

The Government has a number of options to manage the risks disclosed in this chapter.

1. Re-prioritisation

Core Crown expenses for the year ended 30 June 2017 were $76.339 billion, while capital spending for the same period totalled $3.734 billion. In the first instance, agencies are expected to fund pressures and new activities by reprioritising within the funding already allocated to them. This could include repurposing low-value expenditure or generating efficiency savings.

2. Budget Allowances

The following allowances for new expenditure have been included in the Treasury's fiscal forecasts (Chapter 2) and reflected in the Government's Budget Policy Statement.

These allowances are included in the fiscal forecasts to cap future new spending by the Government and better link the forecasts to the Government's fiscal strategy. This means that new spending decisions in future Budgets should not impact the Government's fiscal targets.

The allowances are the main mechanism for the Government to allocate new expenditure at each Budget. They do this through providing a self-imposed cap on expenditure that helps to ensure any new spending is targeted to areas of high value. They have been set at a level that allows the Government to achieve its broader fiscal objectives and under the expectation that any new policy initiatives and cost pressures can be managed within these parameters.

3. Policy choices

For a number of risks the Government has choices around future funding, including how much is funded and the timing of funding. Therefore, risks disclosed in this chapter may not eventuate or may not eventuate to the full extent.

Criteria for Inclusion in the Fiscal Forecasts or as a Specific Fiscal Risk

Specific criteria are used to determine what is included in the fiscal forecasts compared to what is disclosed as a specific fiscal risk.

Specific fiscal risks are submitted by individual departments based on the criteria above. If there are significant uncertainties around the timing and quantum of the risk (which is typically the case) agencies are asked to make a judgement on how the materiality criterion is applied. These judgements are tested by the Treasury in the preparation of this chapter to ensure consistency.

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

A number of policy commitments made by the Government have been included in this chapter as ‘new' risks. This reflects that decisions have yet to be taken by Cabinet for these commitments to be included in fiscal forecasts based on the criteria above. There is an expectation that these commitments can be managed against the Budget operating and capital allowances included in the fiscal forecasts. Further information on these allowances and the Government's fiscal strategy can be found in the Budget Policy Statement.

Commitments associated with the Government's 100-Day Plan (such as the Families Package and fees-free tertiary education for the first year) have been incorporated into the fiscal forecasts. These commitments are a specific fiscal risk only to the extent that there could be variances to what is included in the fiscal forecasts.

General Risks Not Included in this Chapter

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

• Risks from changes to economic assumptions; the most significant economic risks have been identified in 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.
• 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. Specific risks are disclosed at this point based on the range of possible responses.

Exclusions to Disclosure

Additionally, the Minister of Finance may determine, under section 26V of the Public Finance Act 1989, that a matter not be included in the fiscal forecasts or a specific fiscal risk not be disclosed, if such disclosure is likely to:

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

Contingency Liabilities and Assets

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 current known 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.

Summary Table#

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

The table below is categorised based on the nature of the risk: policy changes, cost pressures, and cross-portfolio risks. Within these categories, the risks have been ordered by portfolio and includes the title of the risk, its status and whether it has an impact on revenue, operating expenses or capital expenditure. The status of the risk describes whether the risk reflects a new matter or is changed or unchanged since the Pre-election Update.

Policy Change Risks by Portfolio#

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ACC

Impacts of Changes to Accident Compensation Policy Settings (New)

The Government has signalled it will review a number of accident compensation scheme policy settings. Previous work indicates that a number of review areas entail options that could have material cost implications. Each such area could generate options with fiscal impacts in excess of $10 million to cash claims per year or to the Outstanding Claims Liability. The combined effect of the policies identified could potentially exceed $100 million per year. However, all of the policy issues identified entail optionality and would require either legislative or regulatory change to generate fiscal impacts and are therefore highly uncertain.

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.

Broadcasting, Communications and Digital Media

Increased Funding for New Zealand Programming and Journalism (New)

The Government has committed to transform Radio New Zealand into a multi-platform provider dedicated to quality New Zealand programming and journalism, including a free-to-air non-commercial television service and the establishment of a new Public Media Funding Commission to recommend directly to Parliament funding for public broadcasting on a three yearly rolling cycle. The total costs associated with this are still being finalised. The Government has indicated $38 million in 2018/19 to kick start this new public broadcasting system, to be apportioned between Radio New Zealand and New Zealand On Air. Funding beyond 2018/19 will be subject to recommendations by the Public Media Funding Commission, once established.

Conservation

Funding for Department of Conservation (New)

The Government has committed to significantly increase the Department of Conservation's funding. The exact quantum of such an increase is yet to be determined. Any significant increases in funding may have an impact on the operating balance and net core Crown debt.

Climate Change

Green Investment Fund (New)

The Government has committed to create a Government-backed Green Investment Fund of $100 million, with the aim of stimulating up to $1 billion of new investment in low carbon industries by 2020.

Customs

Joint Border Management System Further Development (New)

The Government had supported the replacement of Customs' border management systems (CusMod) with funding approved in Budget 2010 for Tranche 1 of the Joint Border Management Systems (JBMS). Tranche 1 provides enhanced border management capability but is still reliant on the ageing CusMod and Ministry for Primary Industries' Quantum systems. A series of initiatives to enhance or replace specific elements of the current CusMod and Quantum systems is planned to realise the full benefits to the Crown and industry of the JBMS programme and to mitigate the risks associated with reliance on the CusMod and Quantum systems. Funding for these projects may be required.

Defence

Disposal of New Zealand Defence Force (NZDF) Assets (Unchanged)

The Government is considering the potential to dispose of a number of New Zealand Defence Force (NZDF) assets. Depending on market conditions, the timing of disposal and sale price received could have either a positive or a negative impact on the Government's overall financial position. NZDF regularly completes an analysis of inventory that is surplus to requirements and is over the existing provision for obsolescence. The existing provision is regularly reviewed to ensure that all items comprising the provision are still relevant.

Defence Force - Operating and Capital Costs (Changed)

In 2016, the previous Government reconsidered 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. In particular, decisions on significant asset purchases may be sought earlier than planned. The Government has indicated it will re-examine the Defence procurement programme within the context of the existing indicative funding for the Defence White Paper. This may also result in changes to the quantum and timing of these costs.

Economic Development

36th America's Cup (New)

Following its successful challenge for the 35th America's Cup, Emirates Team New Zealand has indicated that the 36th America's Cup may take place in Auckland, New Zealand. While the Government has signalled that any government investment would need to demonstrate benefits to New Zealand, there is a possibility that the Government will need to invest directly or indirectly in leverage programmes, infrastructure or other facilities to ensure New Zealand delivers a successful 36th America's Cup.

Education

Extension of the Fees-free Tertiary Education Policy (New)

The Government has committed to expand fees-free tertiary education to two years from 2021 and three years from 2024. The Government has indicated that the timeline for the third year may be brought forward depending on economic conditions. The behavioural assumptions, and therefore the impact on future costs are unquantifiable at this early stage but there is an expected general increase in demand for tertiary education beyond the forecast period.

School and Early Childhood Education (ECE) Funding Review (Unchanged)

The previous Government made decisions on the Review of Education Funding Systems across the schooling and Early Childhood Education (ECE) sectors, agreeing that for State and State integrated schools and ECE services and ngā kŌhanga reo the decile system would be replaced by a predictive risk index to allocate funding, to help overcome educational disadvantage. Decisions are yet to be taken on whether to proceed with these decisions, and if so the system-wide level of funding required to mitigate disadvantage and any other components of the funding model that may also have expenditure implications.

Possible School of Rural Medicine (Changed)

In August 2017, the previous Government agreed in principle to the establishment of a School of Rural Medicine, in part as a response to two proposals, one from the University of Waikato and Waikato District Health Board (DHB), and a joint proposal from the universities of Auckland and Otago. The previous Government also noted that funding would be required for the establishment of the school, and its operating costs, and this would be sought through Budget 2018. The previous Government requested the Tertiary Education Commission (TEC) to develop a competitive tender process and report back in late 2017. Tertiary Education Commission's advice is currently before ministers, seeking decisions on next steps. The proposal represents a fiscal risk, as no funding has been set aside if the Government decides to progress it.

Foreign Affairs

Hosting the Asia Pacific Economic Cooperation (APEC) 2021 Forum (New)

The New Zealand Government has committed to hosting the Asia Pacific Economic Cooperation (APEC) Forum in 2021. This will involve hosting meetings and events throughout the year, culminating in Leaders' Week in Auckland in November. The cost of hosting APEC, including meeting associated security responsibilities, represents a fiscal risk, as no funding has been specifically set aside; funding will be determined by Cabinet on the basis of a number of business cases. Funding will depend on the assessment of threat and risk levels in the lead up to APEC 2021.

Official Development Assistance (New)

Over the last 20 years, governments have regularly increased the amount of funding for Official Development Assistance (ODA). The current Government has signalled its intent to increase ODA. Historically, funding decisions have been made in the Budget preceding the end of the funding triennium. The current triennium finishes on 30 June 2018. While the intent has been signalled, any increase is subject to a funding decision by the Government. If the Government chooses to increase funding to maintain the current ODA/GNI (gross national income) ratio of 0.27%, this is provisionally estimated to cost $569 million over the next four years, and could be higher if the Government decides to increase the ratio.

Greater Christchurch Regeneration

Christchurch Capital Acceleration Facility (New)

The Government has committed to establish a $300 million capital acceleration facility to develop the red zone, contribute towards a new stadium and deal with gaps in the horizontal infrastructure programme, in partnership with the Christchurch City Council as part of the Global Settlement. Depending on how the facility is funded, there may be an impact on the Crown's fiscal position.

Housing and Urban Development

Crown Infrastructure Partners (Unchanged)

In July 2017, the previous Government agreed to task Crown Fibre Holdings (now known as Crown Infrastructure Partners) with negotiating and, where viable, funding Crown investment to enable housing infrastructure development in a manner that accelerates growth. There is a high level of uncertainty in the areas noted below, which may affect the final fiscal impacts:

• the amount invested by the Crown
• the timing and amount of investments
• whether or not an economic return will be earned on all investments, and
• the amount and timing of repayments to the Crown.

KiwiBuild (New)

The forecasts include the Government's commitment to KiwiBuild. Funding is needed to support capital purchases of housing and land, holding costs, subsidies, rates, insurance and a potential rent-to-own programme being established. This includes the monitoring function and machinery of government for KiwiBuild. This programme is also likely to increase the take-up of the Homestart grant. There is a risk that costs may be different to what has been included in the forecasts and there is an additional impact on fiscal indicators.

Healthy Homes Legislation (New)

As part of its 100-Day Plan, the Government has passed the Healthy Homes Guarantee Bill, requiring all rentals to be warm and dry. When this legislation comes into force it will require improvements in insulation, ventilation and heating in 30,000 Housing New Zealand properties, which is estimated to cost a minimum of $90 million over the forecast period. In addition, the Bill will enable all private property owners to access grants of up to $2,000 per dwelling to pay for up to 50% of the cost of insulation upgrades and double glazing that meet or exceed the current building code, or of the cost to install a clean, fixed form of heating. Further work would be required to determine the scope of the policy, however, there are inherent risks to the current financial forecast and costings around this commitment.

Public Housing (New)

The Government has made a number of commitments to reduce homelessness and improve access to public housing. Policy settings are yet to be developed for increasing and improving support services and increased supply for those in housing need. This is likely to have a significant fiscal impact.

Housing Infrastructure Fund (Unchanged)

In June 2016, Cabinet agreed to establish a $1 billion Housing Infrastructure Fund to which high-growth councils could apply to help finance roading and water infrastructure needed to unlock residential development. The previous Government has approved in principle funding of $889 million for five councils. The successful councils are now preparing detailed business cases. Negotiations on the detailed funding arrangements are continuing and final agreements are expected in late 2017. Actual expenditure may vary from what has been included in the fiscal forecasts owing to:

• changes in the agreed spending levels for each project
• the timing and size of drawdowns and of repayments of capital (both annual and final) varying from what is included in the financial forecasts
• the value of interest foregone
• the resultant reduction in the fair value of loans made, and
• a different split between capital expenditure and operating expenses.

Immigration

Increasing the Refugee Quota (New)

Increasing the refugee quota to 1,500 over three years will require increased refugee settlement services and have flow-on costs to health, education and welfare. Additional work needs to be completed to properly assess the cost of this change.

Internal Affairs

North Island Property Review (Unchanged)

There are several issues with the current property portfolio regarding their capacity and condition, which are not covered as part of Wellington accommodation project tranche 2. There is insufficient storage capacity in the Wellington region for the Archives New Zealand holdings. Current storage capability will be reached in the next two to three years. Some of the existing storage capacity is also not fit for purpose.

A review has been undertaken to identify investment options to resolve these issues. A business case has been prepared to assess the options for the Department of Internal Affairs to continue to meet its statutory and business requirements. Crown funding for reinvestment was sought as part of Budget 2017. Some funding was approved as part of Budget 2017 to progress the option analysis and design; however, the risk still remains from 2019/20.

Justice

Justice Commitments (New)

The Government has committed to increasing access to justice and reducing and preventing family violence. This includes a commitment to increase Community Law Centre funding, establish a Criminal Cases Review Commission and increase funding to family violence networks. The potential cost and timing of these initiatives is still to be finalised and will be subject to final Cabinet decisions.

Land Information

Upgrading Landonline (New)

Land Information New Zealand (LINZ) is currently in discussions with vendors about upgrading Landonline to replace the outdated technology platform and to meet the changing business and technology needs of users and government. In April 2016, LINZ received permission from Cabinet to proceed with procurement on an ‘as a service' model, limiting the amount of capital investment required. Recent work done in conjunction with the vendor indicates that an ‘as a service’ model is currently not viable and LINZ will have to purchase the product, with the understanding that it will sell the product back to the vendor in a few years. Funding options are currently being explored.

Police

Increase in the Number of Police Numbers (New)

The Labour and New Zealand First coalition agreement notes that the Government will strive toward adding 1,800 new Police officers over three years. To the extent that this is not able to be funded within baselines, new funding will be required. Although an increase in resource for crime enforcement is likely to have flow-on costs (to the Ministry of Justice and Department of Corrections), the impact will depend on the extent to which this is able to be balanced by a focus on community prevention, greater use of alternative resolutions, and a reduction in remand prisoners.

Regional Economic Development

Provincial Growth Fund (New)

The Government is developing a Provincial Growth Fund (PGF) of $1 billion per annum. The Fund will support the Government's overall goal of productive, sustainable and inclusive growth. It is envisioned, at this stage, that the PGF will comprise three tiers of investment:

1. Small scale investments (building on the Regional Growth initiative)
2. Mid-large scale sector-based investments (such as the 1 Billion Trees Programme), and
3. Large infrastructure investments.

The scope of such a Fund has yet to be determined, including which regions and what types of projects are eligible.

Revenue

Potential Tax Policy Changes (Changed)

The Government has yet to finalise its tax policy work programme. It has stated an intent to make some changes to current tax settings, including: the reinstatement of research and development tax credits, ring-fencing of losses from residential investment property and a fuel tax in Auckland. In addition, the outcomes of the Tax Working Group are yet to be determined. The fiscal impacts of these potential changes are unquantified at this stage.

Transformation and Technology Renewal (Changed)

The Business Transformation programme agreed by Cabinet in 2015 is reflected in forecasts. There are risks that the expected implementation costs, revenue gains and operating cost savings may differ from forecasts. In addition, changes in Government policies could materially affect the programme's costs and benefits.

Social Development

Changes to the Welfare System (New)

The Government has announced a commitment to ensure access to entitlements, remove selected sanctions in the welfare system, review tax and transfer settings and consider long-term changes that need to occur to provide for sustainable incomes. The behaviour change associated with such changes, including the removal of section 70A of the Social Security Act 1964 (which reduces the amount of benefit payments owed to sole parents who do not disclose the identity of the other parents of their children) is unknown. Such changes could have an impact on the operating balance.

Transport

Auckland and Wellington Rail Priorities (New)

The Government has identified as transport priorities a number of metro rail projects in Auckland and Wellington. Although the Government has indicated that rail investment will ultimately be funded through the National Land Transport Fund, achieving this will require further exploration that may not be completed in time for some or all of the following projects:

• the Third Main Line in Auckland
• electrification of the Papakura to Pukekohe line
• establishment of a commuter train service between Auckland, Hamilton and Tauranga
• the Wairarapa line upgrade, and
• double-tracking the Trentham to Upper Hutt line.

National Land Transport Fund (New)

The Government has committed to reprioritise National Land Transport Fund (NLTF) spending to increase investment in public transport, rail and active modes, like walking or cycling. The Government has also indicated support for specific projects that might receive funding through the NLTF if prioritised and approved by the New Zealand Transport Agency (NZTA) Board to be included in the National Land Transport Programme (NLTP). The NLTP will be released by August 2018. Crown funding may need to be provided for projects if they do not receive NLTF funding and the scope, timing and costs of some of these projects are still being finalised.

Auckland Transport Alignment Plan (Changed)

The Government and Auckland Council released the final report for the Auckland Transport Alignment Plan (ATAP) in August 2016. The funding gap identified through the mid-2017 revised ATAP was $5.9 billion for the first ten years. Early assessments of the funding gap, when taking into account the Auckland transport priorities of the new Government, is now between $5 billion and $6.5 billion. The Government and Auckland Council are currently considering how to refresh ATAP in order to align the priorities of the new Government with the existing priorities of Auckland Council. This work will also include consideration of options to address the funding gap.

Auckland City Rail Link (Unchanged)

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 this project will be around $1.7 billion, of which the first $436 million has been appropriated. There is a risk that the timing and amount of the Government contribution towards the project could be different from what is included in the forecasts.

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.

Cost Pressures by Portfolio#

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ACC

ACC Levies (Unchanged)

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

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.

Children

Investing in Children Transformation (Changed)

The Ministry for Vulnerable Children, Oranga Tamariki (Oranga Tamariki) was established on 1 April 2017, with a new operating model to be implemented over the next few years and an expanded focus and target group, and new obligations from associated legislation. Changes to the Oranga Tamariki Act 1989 coming into effect no later than 1 July 2019 will extend the scope of the Youth Justice system to include most 17-year-olds, which is expected to increase the operating cost of the Service and require additional residential bed capacity. This Act will also extend the scope of the Ministry to provide more support for young people aged 18-25. To the extent that the costs associated with the new Ministry cannot be funded from a tagged contingency or from reprioritisation, additional funding is likely to be required.

Clothing Allowances (New)

The Social Security (Clothing Allowances for Orphans and Unsupported Children) Amendment Act 2015, which was introduced as a Member's Bill, comes into force on 1 July 2018. The fiscal implications of this Act have yet to be fully assessed and incorporated in the fiscal forecasts, in part because they are dependent on the settings of the Clothing Allowance within Oranga Tamariki, which is included in the scope of future reviews on financial assistance for carers stemming from the Expert Advisory Panel review.

Corrections

Additional Capacity to Address Prison Population (Changed)

The fiscal forecasts include provision for the investment agreed by the previous Government to create additional prison capacity to accommodate prison population growth over the next 10 years. The Department of Corrections is likely to seek additional funding relating to the direct costs of accommodating increases in the number of prisoners. 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. The Government is committed to reducing the prison population over time and is currently considering options to do this.

Economic Development

New Zealand Screen Production Grant (Unchanged)

The New Zealand Screen Production Grant is a demand-driven, uncapped programme. New Zealand is attracting a much larger number of international productions. Based on the current rising trend, there is a risk that demand for the Screen Production Grant will exceed what is included in the fiscal forecasts.

Education

Learning Support (New)

There are a number of cost pressures building in the supply of learning support services. These include the Ongoing Resourcing Scheme; English for Speakers of Other Languages (ESOL); Early Intervention and Sensory Learning. To the extent that these pressures cannot be managed within agency baselines, additional funding is likely to be required.

Finance

EQC (Unchanged)

EQC's independent actuary undertakes half-yearly valuations of the total earthquake liability to the Crown. This includes settled and yet-to-settle claims and reinsurance recoveries. Based on these valuations, a profile of the claims yet to settle is included in the fiscal forecasts. There still remains some risk that EQC's remaining settlement expenditure relating to the Canterbury and KaikŌura earthquakes will be different (higher or lower) than forecast.

Goodwill on Acquisition (Unchanged)

As at30 June 2017, the Crown had goodwill on acquisition of a number of sub-entities totalling $744 million. Under New Zealand accounting standards (PBE IPSAS 26), such goodwill items are required to be assessed annually for impairment. If there is any indication that the goodwill may be impaired, the recoverable amount of the cash generating units to which the goodwill is allocated, is required to be estimated. If the recoverable amount is less than the carrying amount of those units, the units and the goodwill allocated to them are regarded as impaired and the Government is required to recognise impairment losses in the operating statement. Such assessments will be conducted at the end of the financial year. The fiscal forecasts currently make no allowance for such impairment losses.

Greater Christchurch Regeneration

Residential Red Zone (Unchanged)

Some recoveries from the EQC and private insurers remain outstanding and there is a risk that final recoveries may be greater or less than forecast. In addition, potential costs 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 alternative uses of the land. The fiscal impact of this, and whether there is any overlap with the Christchurch Capital Acceleration Facility risk, is not yet certain.

Southern Response Earthquake Services Support (Unchanged)

The ultimate cost to the Crown of settling earthquake claims remains subject to significant uncertainty. Forecasts assume that the actual cost to settle claims will align with the actuary's central estimate of the claims provision. There is a risk that the actual cost could vary from this estimate, which is sensitive to its underlying assumptions such as damage estimates, legal challenges, reinsurance recoveries, the forecast profile of claims settlement and other related policy changes. 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.

Health

Primary Care Services (New)

The Government has committed to increase funding for Primary Care services to reduce general practitioner (GP) fees, provide additional funding for GP practices, fund extra places to train GPs, and provide annual free health checks for seniors as part of the SuperGold card. The implementation details and funding arrangements for these commitments are yet to be finalised.

Housing and Urban Development

Divestment and Development of Housing (Unchanged)

The forecasts include business-as-usual divestments and redevelopments of housing property as part of Housing New Zealand Corporation's (HNZC's) asset management strategy. Proceeds from property divestments will be used to help fund investment in redeveloping and growing HNZC's stock. 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. The Government's intention is to stop the major State housing sell-off programme.

Tāmaki Regeneration Project (Unchanged)

There are 7,500 new houses planned to be built in Tāmaki in place of about 2,500 existing houses. Development involves writing off existing public housing assets. If land sale proceeds are less than the value of the write offs in the year that they occur, there will be a negative impact on the operating balance.

Transitional Housing (New)

The average cost of providing transitional housing support services is significantly higher than funding appropriated in Budget 2017, as the original costs were estimates only. Better understanding of the type and nature of support services required, combined with increased intensity in levels of support services and higher levels of complex cases than originally anticipated, are contributing to the increase in the average costs of support services. Additional capital is required to meet the existing supply target of 2,155 places, which might require adjusting upwards.

Internal Affairs

Fire Services Levy (Unchanged)

The Fire Services were unified into Fire and Emergency New Zealand on 1 July 2017. The increase in levies required to meet the increase in expenditure on Fire Services, and to contribute to repaying a loan from the Crown, has been approved for the year 2017/18 only. Any future levy changes beyond 2017/18 are still uncertain and not yet included in the fiscal forecasts.

Revenue

Student Loans - Valuation (Unchanged)

The value of student loans is sensitive to assumptions, such as the borrower's future income and general economic factors, such as interest rates, unemployment levels, salary inflation and the consumer price index (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.

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 a taxpayer's provisional tax liability, may be withdrawn by that taxpayer, resulting in a reduction in the Crown's available cash reserves.

Transport

Southern Transport Corridor Reinstatement (Unchanged)

There is a risk that the costs of reinstating the earthquake-damaged South Island Transport Corridor (Picton-Christchurch) will cost more than the $552 million of capital expenditure and $163 million of operating expenditure currently included in the fiscal forecasts. In addition, a portion of the costs of the reinstatement currently classified as capital expenditure in the fiscal forecasts may be reclassified as operating expenditure, adversely impacting the operating balance (currently estimated by NZTA to be $90 million in 2017/18). The classification between capital and operating expenditure has no impact on net core Crown debt. KiwiRail has identified a reinstatement shortfall or cashflow required in uninsured costs across 2017/18 and 2018/19. The final uninsured costs for reinstating the Main North Line will be understood when the insurance claim is completed - expected within 2018/19.

Support for KiwiRail (Unchanged)

The Government in Budgets 2010 to 2017 supported KiwiRail Holdings Limited (KiwiRail) with an investment of around $2 billion in the New Zealand freight rail system. Further Crown investment into KiwiRail is likely to be required from 2019/20. A review of KiwiRail's structure and funding arrangements will be undertaken in 2017/18, to inform future funding decisions.

Rail Network Valuation Approach (Unchanged)

KiwiRail operates both freight and passenger transport services. The valuation approach for the assets used for these different activities is outlined in Budget 2017 Additional Information - accounting policies. The freight business of KiwiRail is predominantly commercially focused and therefore for financial reporting purposes assets relating to the freight business are fair valued on a net realisable value basis.

For the freight infrastructure to continue to be valued on this basis, KiwiRail needs to meet certain criteria set out in the Accounting Standards Framework. Consistent with prior years, there is a likelihood of continued Crown support and a risk that KiwiRail no longer meets the criteria for valuing freight infrastructure on a net realisable value basis and may need to change to a depreciated replacement cost basis. The impact of this change would increase the value of assets by up to $4.3 billion.

Treaty Negotiations

Relativity Clause (Unchanged)

The Deeds of Settlement negotiated with Waikato-Tainui and Ngāi Tahu include a relativity mechanism. Now that the total redress amount for all historical Treaty settlements exceeds $1.0 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#

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Addressing the Gender Pay Gap in the State Sector (New)

The Government has made a commitment to addressing the gender pay gap in the core public service. Fulfilling this commitment may involve costs to the Crown.

Changes to Institutional Form of Government Agencies (New)

The Government has announced a number of policy commitments that involve changes to the machinery of government such as the establishment of an independent Climate Commission and changing Housing New Zealand Corporation into a public service entity. These commitments are likely to involve a number of changes to the composition and structure of existing government departments. Where the additional resourcing (and other costs of these changes) cannot be met through baseline expenditure, further Crown funding may be required.

Other Capital Cost Pressures (Changed)

As in previous years, agencies are likely to face capital expenditure pressures in the future related to replacing ageing infrastructure nearing its end of life (for example, school property and redevelopment of Scott Base), information and communications technology (ICT) capability that is no longer fit-for-purpose and other capital requirements driven by demand pressures. These pressures are risks to the fiscal forecasts only to the extent they cannot be managed through agencies' existing balance sheets, new capital spending set aside in forecasts or other funding mechanisms (eg,Crown Infrastructure Partners). The Government’s stated intention is that all pressures are managed through these mechanisms.

Changes in the Accounting Standard for Financial Instruments (Unchanged)

The External Reporting Board has recently issued changes to accounting standards Public Benefit Entities International Financial Reporting Standard (PBE IFRS 9) Financial Instruments and it is likely that the Crown will adopt the amended accounting standard in the 2018/19 financial year. The resulting changes include new valuation methodology for some financial assets, a new impairment model for financial assets, and revised hedge accounting requirements. The impact of these new requirements has not yet been assessed, except for some initial impact analysis on the student loan asset (an estimated one-off increase of around $600 million).

Increasing the Minimum Wage (New)

Government policy decisions to increase the minimum wage to $20 per hour by April 2021 will mean increased costs to State sector employers. Funding may be sought where costs cannot be absorbed within baselines without resulting in unacceptable impacts on service delivery.

Other Operating Cost Pressures (Changed)

As in previous years, agencies are likely to face operating expenditure pressures in the future owing to changes in demand and price of services they provide. The majority of spending by agencies is not automatically adjusted for increases driven by demand or price pressures. These pressures are risks to the fiscal forecasts only to the extent they cannot be managed through reprioritisation or new spending set aside in the forecasts. The Government's stated intention is that all pressures are managed through these mechanisms.

Pay Equity Claims following the Care and Support Worker Settlement (Changed)

There are several funding claims, mainly from workers in the social sectors (including health, education and welfare) relating to the interpretation, and application, of the Equal Pay Act 1972. A pay equity claim for Care and Support workers in the aged care, disability support and home and community services sector has already been resolved, including an extension of the same pay rates and conditions to equivalent workforces funded by the Ministry of Social Development and Oranga Tamariki.

There are a number of outstanding claims and the possibility of further claims being raised. Current claims include:

• social workers employed by Oranga Tamariki
• education support workers employed by the Ministry of Education
• school support workers employed by school boards of trustees, and
• mental health support workers employed by non-government organisations (funded by the Government).

The resolution of such claims within State-employed and State-funded sectors may involve significant costs to the Crown.

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 (Changed)

A number of large collective agreements are due to be renegotiated over the forecast period. These include (but are not limited to) nurses and senior doctors, as well as primary and secondary school teachers. As well as direct fiscal implications for the employers of workforces covered by any changes to remuneration, the renegotiation of these agreements can have flow-on effects to remuneration in other sectors. The Government has committed to paying core public sector staff a Living Wage.

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.

Variance in Costs of 100-Day Plan Commitments (New)

The forecasts include funding for the Government's 100-Day Plan commitments, including First Year Fees-free Tertiary Education and the Families' Package. Where costs are different to what has been reflected in the forecasts, the resulting fiscal impacts will need to be managed.

Risks Removed Since the Pre-election Update#

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The following risks have been removed or their title has changed since the Pre-election Update.

Contingent Liabilities and Contingent Assets#

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

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

In general, if a contingent liability were realised, or the amount becomes sufficiently reliable to record as a liability, it would reduce the operating balance and net worth and increase net core Crown debt. In the case of some contingencies (eg, uncalled capital) the negative impact would be restricted to net core Crown debt because the cost would be offset by the acquisition of 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.[23]

The contingencies have been stated as at 31 October 2017, being the latest set of published contingencies.

Quantifiable Contingent Liabilities and Contingent Assets

 

Contingent assets

	Status24	31 October 2017 ($millions)

Legal proceedings and disputes

 

Other contingent assets	Unchanged	103
Total quantifiable contingent assets		103

Unquantifiable Contingent Liabilities and Contingent Assets

Contingent liabilities

The following contingent liability was removed:

Ministry for Culture and Heritage – The Body Laid Bare Exhibition as this indemnity has now expired.

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:

In addition to the uncalled capital detailed above, the Crown has agreed to provide an uncalled capital facility of $230 million to Southern Response Earthquake Service Limited (SRES) to support the Christchurch earthquake recovery process. Of this amount, $113 million has been called, leaving $117 million as a contingent liability. This capital support will increase net core Crown debt when called.

Guarantees and indemnities

Guarantees are legally binding promises made by the Crown to assume responsibility for a debt or performance of an obligation of another party, should that party default.

Guarantees generally relate to the payment of money but may require the performance of 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 to 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.

$124 million at 31 October 2017 ($136 million at 30 June 2017)

Legal proceedings and disputes

Legal tax proceedings

When a taxpayer disagrees with a tax 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.

$136 million at 31 October 2017 ($145 million at 30 June 2017)

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.

$150 million at 31 October 2017 ($147 million at 30 June 2017)

Christchurch Engine Centre Partnership Agreement

The Air New Zealand Group has a partnership agreement with Pratt and Whitney in relation to the Christchurch Engine Centre (CEC), holding a 49% interest. By the nature of the agreement, joint and several liabilities exist between the two parties; the contingent liability represents Air New Zealand's share of CEC's liabilities.

$121 million at 31 October 2017 ($121 million at 30 June 2017)

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 indemnities, legal claims and proceedings and other contingent liabilities.

The indemnities and claims that are disclosed individually, while they cannot be quantified, have the potential to exceed $20 million in costs and are not considered to be remote.

Indemnities

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

Legal claims and proceedings

There are numerous legal actions that have been brought against the Crown. However, in the majority of these actions it is considered a remote possibility that the Crown would lose the cases. Based on these factors, not all legal actions are individually disclosed.

Accident Compensation Corporation (ACC) litigation

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

Ministry for Primary Industries - Biosecurity Act 1993 compensation

Under section 162A of the Biosecurity Act 1993 compensation may be payable as a result of the exercise of powers to manage or eradicate organisms. Compensation is payable where there are verifiable losses as a result of the damage or destruction of a person's property or restrictions on the movement of a person's goods. The Ministry has been notified compensation will be sought for incursions including fruit fly, pea weevil, bonamia ostreae, mycoplasma bovis and myrtle rust. Owing to the complexity and uncertainty of the amount of these claims the amounts are unquantified.

Kiwfruit vine PSA-V

Approximately 210 growers, represented by the first plaintiff, Strathboss Kiwifruit Limited, filed a claim against the Ministry for Primary Industries alleging it was legally liable for damages it has suffered from a biosecurity incursion of the kiwifruit vine disease, Psa-V, in New Zealand. The total losses have not been quantified. As Strathboss Kiwifruit Limited is required to prove the Ministry owes a duty of care to the growers before losses will be assessed, the Ministry is unable to quantify the first plaintiff's 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 that has been transferred by the Crown to a State-owned Enterprise (SOE) or tertiary institution, or is subject to the Crown Forest Assets Act 1989.

On occasion, Māori claimants pursue the resolution of particular claims against the Crown through higher courts. Failure to successfully defend such actions may result in a liability for historical Treaty grievances in excess of that currently anticipated.

Other unquantifiable contingent liabilities

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 as provisions in the statement of financial position.

Treaty of Waitangi claims - Settlement Relativity Payments - see page 84

Holidays Act 2003 and other relevant legislation

A number of entities have commenced a review of payroll calculations over the past six years 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 2017, a contingent liability exists.

Description of Contingent Assets

Quantifiable contingent assets over $100 million

There are no quantifiable contingent assets over $100 million at 31 October 2017.

Unquantifiable contingent assets

There are no unquantifiable contingent assets over $100 million at 31 October 2017.

Forecast Financial Statements#

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

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

The forecasts have been prepared in accordance with the Statement of Responsibility and reflect the judgements and information known at the time they were prepared. They reflect all government decisions and circumstances communicated to 27 November 2017.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined in the Fiscal Outlook chapter (pages 25 to 49).

Statement of Accounting Policies#

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Significant Accounting Policies

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

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

The specific accounting policies are included within the 2017 Half Year Economic and Fiscal Update Additional Information document which can be found on the Treasury's website at www.treasury.govt.nz/budget/forecasts/hyefu2017

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 63 to 96.

Key forecast assumptions are set out on pages 27 to 28.

Reporting and Forecast Period

The reporting periods for these Forecast Financial Statements are the years ended 30 June 2018 to 30 June 2022. The “2017 Actual” figures reported in the statements are the audited results reported in the Financial Statements of the Government for the year ended 30 June 2017. The “2018 Previous Budget” figures are the original forecasts to 30 June 2018 as presented in the 2017 Budget.

Government Reporting Entity as at 27 November 2017#

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

Core Crown Segment

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 Vulnerable Children, Oranga Tamariki
• 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 Segment

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) 

• Genesis Energy Limited
• Mercury NZ Limited
• Meridian Energy Limited

Other

• Air New Zealand Limited
• Kiwi Group Holdings Limited (Including Kiwibank)

Crown Entities Segment

Crown entities

• Accident Compensation Corporation
• Accreditation Council
• Arts Council of New Zealand Toi Aotearoa
• Broadcasting Commission
• Broadcasting Standards Authority
• Callaghan Innovation
• 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
• Fire and Emergency New Zealand
• 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 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 (2,408)
• 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
• 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)
• Te Ariki Trust

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

• Crown Asset Management Limited
• Crown Infrastructure Partners Limited (previously Crown Fibre Holdings)
• Education Payroll Limited
• Health Benefits Limited (ceased operating)
• Ōtākaro Limited
• Predator Free 2050 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

Other entities

Crown entities

• Tertiary Education Institutions (27)*

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

• City Rail Link Limited*

*These entities are not fully consolidated into the forecast financial statements of the government with only the Crown's interest in them being included.

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 Revenue and Expense for the years ending 30 June

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

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

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 16.

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. Equity accounted investments include tertiary education institutions and City Rail Link.

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

Forecast Statement of Borrowings as at 30 June

Notes on borrowings

Total borrowings can be split into sovereign-guaranteed and non-sovereign-guaranteed debt. This split reflects the fact that borrowings by SOEs and Crown entities are not explicitly guaranteed by the Crown. No debt of SOEs and Crown entities is currently guaranteed by the Crown.

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

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

Statement of Actual Commitments

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#

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1. Customs excise-equivalent duty.

NOTE 2: Investment Revenue/(Expenditure)

NOTE 3: Transfer Payments and Subsidies

NOTE 4: Other Operating Expenses

NOTE 5: Insurance

ACC liability

Calculation information

PwC NZ has prepared an independent actuarial estimate of the ACC outstanding claims liability as at 30 June 2017. This estimate includes the expected future payments relating to accidents that occurred prior to balance date (whether or not the associated claims have been reported to, or accepted by, ACC) and also the expected future administrative expenses of managing these claims.

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

The key economic variables that impact on changes to the valuation are the long-term Labour Cost Index (LCI), average weekly earnings and the discount rate. Discount rates were derived from the yield curve for New Zealand Government bonds. For these forecast statements, the claims liability has been updated for the latest discount rates as at 30 September 2017. The equivalent single effective discount rate, taking into account ACC's projected future cash flow patterns, is 3.89% 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 2017 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, KaikŌura earthquake 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 2017 valuation form the basis of the five-year forecast of the outstanding claims liability.

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: the potential outcome of complex land litigation and the financial impact of confirming final liabilities with insurance and reinsurers.

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 6: Forecast New Spending and Top-down Expense Adjustment

Unallocated contingencies represent expenses included in Budget 2017 and previous Budgets that have yet to be allocated to departments. Forecast new spending indicates the expected spending increases from future Budgets.

The forecast for new operating spending for Budget 2018 is $2.6 billion. Some of this allowance has been pre-committed as at the forecast finalisation date of 27 November 2017, with only the unallocated portion of the allowance included in this note.

Unallocated contingencies represent capital spending from Budget 2017 and previous Budgets that has yet to be allocated to departments. Forecast new spending indicates the expected capital spending increases from future Budgets.

The forecast for new capital spending for Budget 2018 is $3.4 billion. Some of the allowance has been pre-committed as at the forecast finalisation date of 27 November 2017, with only the unallocated portion of the allowance included in this note.

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

NOTE 8: Financial Assets (including receivables)

NOTE 9: Student Loans

NOTE 10: Property, Plant and Equipment

1. Using a revaluation methodology unless otherwise stated.

1. Other mainly includes transfers to/from other asset categories.
2. These additions do not include any purchases which may result from the allocation of the forecast for new capital spending (separately disclosed in the Statement of Financial Position).

NOTE 11: NZ Superannuation Fund

NOTE 12: Payables

NOTE 13: Retirement Plan Liabilities

The net liability of the Government Superannuation Fund (GSF) was calculated by GSF's actuary as at 30 September 2017. 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 2017, based on membership data as at 30 June 2017 with adjustments for cash flows to 30 September 2017. 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 2017.

Other principal long-term financial assumptions were an inflation rate, as measured by the Consumers Price Index (CPI), of 1.67% for the 20 years to 30 June 2037, then increasing gradually each year to 2.0% in the year ended 30 June 2048 and remaining at 2.0% p.a. for all years after that. In addition an annual salary growth rate, before any promotional effects, of 2.5% (2.5% at 30 June 2017).

The 2017/18 projected decrease in the net GSF liability is $618 million, reflecting a decrease in the GSF liability of $484 million and an increase in the GSF net assets of $134 million.

The decrease in the GSF liability of $484 million includes an actuarial loss between 1 July 2017 and 30 September 2017, of $68 million, owing to movements in the discount rates. The remaining $416 million reduction is owing to the current service cost and interest unwind (increases the liability) offset by benefits to members (reducing the liability) which were slightly lower than expected.

The increase in the value of the net assets of GSF of $134 million includes a gain of $97 million reflecting the updated market value of assets at 30 September 2017. The balance of $37 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 2017/18 onwards reflect the net of the expected current service cost, interest cost, investment returns and contributions.

NOTE 14: Provisions

Provision for ETS credits

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

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

The prices for NZUs used to calculate the ETS provision are assumed to remain constant over the forecast period and are based on market prices during the last week of October 2017.

The ETS impact on the fiscal forecast is as follows:

NOTE 15: Changes in Net Worth

NOTE 16: Core Crown Residual Cash

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

NOTE 17: Net earthquake expenses (operating and capital)

These net earthquake costs are the latest estimates of the net impact on the Crown of the Canterbury earthquakes. These estimates reflect the known costs under current policy settings. They do not include future decisions the Government may take regarding the rebuild.

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

As time elapses the ability to directly attribute costs to the original events in 2010 and 2011 becomes more difficult. To ensure unrelated expenditure is not included, estimated costs associated with the Canterbury earthquakes are limited to the reassessment of insurance claims by EQC and Southern Response, and the construction of large capital projects (eg, anchor projects being managed by Ōtākaro Limited).

Amounts recognised in the statement of financial performance (operating expenses) as well as capital expenditure in respect of the Canterbury earthquakes are:

The negative “costs” in relation to EQC and Southern Response insurance claims represents a re-estimation of their respective outstanding claims liability, resulting in a reduction in the overall costs of the Canterbury earthquakes.

Forecast Statement of Segments#

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