Half Year Economic and Fiscal Update 2022

Executive Summary#

The global and Aotearoa New Zealand economies are facing multiple challenges that are expected to lead to slower growth in the period ahead.

For Aotearoa New Zealand, this comes after overall economic activity was relatively robust over 2021/22, continuing the recovery from the COVID-19 pandemic. Both economic and fiscal indicators point to this robustness continuing in the first half of the 2022/23 fiscal year. We now expect real gross domestic product (GDP) to expand 1.8% across the six months to end-December 2022. Activity is being supported by strong employment and wage growth, high levels of investment and the rebound in international visitor spending.   

Increasingly, however, ongoing demand growth has come up against supply constraints both foreign and domestic. One area this was evident is the labour market. Although real GDP growth fell short of the forecast in the Budget Economic and Fiscal Update 2022 (Budget Update), demand for labour has been strong. This, combined with the marked fall in labour supply growth experienced over recent years, has seen the unemployment rate at or around historical lows since late 2021, and nominal wage growth has picked up sharply as a result.

Decades-high consumers price index (CPI) inflation, rapid growth in nominal wages and to some extent, the increase in the current account deficit, are indicators the economy is operating above capacity. These imbalances and especially their unwinding are costly for current and future wellbeing. The distribution of these costs will be uneven across firms, households and regions.

We forecast the economic cycle to be nearing a turning point, with a number of the forces shaping economic outturns having intensified over the past six months, with negative implications. Chief among these are the rise and persistence of domestic and global inflation pressures that have seen sharply higher interest rates and large exchange rate realignments; ongoing, albeit abating, supply chain challenges; adverse spill-overs from the Russian invasion of Ukraine; deteriorating global growth; falling house prices; and low consumer and business confidence.

Global growth in 2023 is likely to be the lowest since the early 1990s excepting the global pandemic and global financial crisis. Many economies are expected to contract for at least two quarters by the end of 2023. Growth in China continues to be impacted by its zero COVID-19 policy approach. The global outlook is highly uncertain and will be dependent on the effectiveness of central banks’ monetary policy tightening and the absence of further negative geopolitical shocks. Even weaker global growth would likely see a faster abatement of global inflation pressures, lower export prices and reduced demand for Aotearoa New Zealand exports.  

Notes:

1. Operating balance before gains and losses.
2. A series of net core Crown debt (the previous headline net debt indicator) can be found on page 159.

Sources: Stats NZ, the Treasury

Since the Budget Update, inflation has been higher and more persistent than forecast, and interest rate expectations have risen markedly. While we think annual CPI inflation is near its peak, we forecast it will be relatively slow to fall away – not moving back inside the 1 to 3% target band until end-2024 – and interest rates will need to rise to a higher level than previously expected to help slow growth and reduce price pressures.

While the precise timing is uncertain, our base case is that real GDP growth is forecast to slow materially through 2023, with a contraction of 0.8% over the three quarters to end 2023 before a slow, gradual recovery in 2024 and beyond.  

Figure 1 – Real GDP growth

Sources: Stats NZ, the Treasury

Overall, the outlook for real GDP growth over 2022/23 and 2023/24 is more cyclical than was forecast in the Budget Update. The forecast unemployment rate is higher.

All the components of domestic demand are forecast to decline through 2023, as household and firm incomes and balance sheets come under increasing pressure, savings built up during the COVID-19 period run down and the terms of trade decline. The unwind of COVID-19 related expenditures contributes to real government spending falling.

The unemployment rate is forecast to increase through 2023 to a peak of around 5.5% in mid-2024, from the near-record low level of 3.3% recorded in the September 2022 quarter.

The timing of the forecast slowdown in growth, the decline in CPI inflation and consequent implications for monetary policy are key uncertainties for the forecasts. An earlier easing in inflation pressures could see a moderation of the forecast interest rate cycle. Conversely, more persistent inflation could see a stronger interest rate and growth cycle. The impact of alternative judgements for the persistence of inflation pressures and global growth is explored further in the Risks to the Economic and Fiscal Forecasts chapter.

Economic developments have contributed to recent fiscal outturns being better than forecast in the Budget Update. Capacity pressures and high CPI inflation contributed to both expenditure underspends and revenue outperformance, and to the operating balance before gains and losses (OBEGAL) deficit being lower than expected in 2021/22. In economic terms, fiscal policy was less expansionary than previously estimated as measured by the fiscal impulse.

Figure 2 – OBEGAL and net debt

Source: The Treasury

Looking forward, all the key operating indicators (the operating balance, OBEGAL and residual cash) are forecast to move from deficit to surplus over the forecast horizon. The OBEGAL deficit is forecast to shrink further this year and move close to a balanced position in 2023/24. The recovery in OBEGAL in the near-term is expected to be at a faster pace compared with the Budget Update and returns to a surplus ($1.7 billion) in 2024/25 – the same year as forecast in the Budget Update.

Despite a worsening economic outlook for 2023, the strength of current activity and higher inflation result in a stronger nominal GDP forecast. This, coupled with a stronger tax base at 30 June 2022, contributes to higher forecast tax revenue. In total, core Crown tax revenue forecasts are $9.0 billion higher than the Budget Update forecasts or on average $2.3 billion per annum. Total core Crown revenue is expected to increase slightly faster than the nominal GDP.

The near-term improvement in OBEGAL compared with the Budget Update is driven by a combination of higher tax revenue forecasts, higher interest income and stronger ACC results (mainly from lower expenditure due to interest rate changes). However, in the later years of the forecast, this is more than offset by the expected impact of higher finance costs (reflecting higher interest rates), benefit expenses (mainly from stronger wage growth) and an increase in the Climate Emergency Response Fund (CERF), which has been topped up since the Budget Update. Taken together, the latter three items grow from 10.3% of GDP in 2021/22 to 11.5% in 2026/27.

As outlined in the 2023 Budget Policy Statement the Government has maintained the Budget operating allowances from the Budget Update. The Budget 2023 operating allowance is $4.5 billion, however after considering pre-commitments (including the multi‑year funding announced in the Budget Update) on average $1.8 billion is still available. The operating allowances for Budget 2024 through to Budget 2026 are set at $3 billion.

The unwind of COVID-19 related expenditures is a key influence on the short-term expenditure profile with core Crown expenses being lower than last year as a share of GDP. After taking account of forecast inflation and wage movements, growth in public consumption (a sub-component of total Crown expenses) is forecast to stabilise this year and be negative in 2023/24 and 2024/25, with the level of real public consumption declining by 8.2% between the September quarter 2022 and the December quarter 2024.

The Government’s fiscal strategy of reducing fiscal deficits and returning the OBEGAL to surplus by 2024/25 is helping to reduce demand pressure in the economy and supporting monetary policy to reduce inflation.

The net debt fiscal indicator is forecast to peak at 21.4% of GDP ($88.2 billion) in 2023/24. By the end of the forecast period, net debt is expected to fall to 14.1% of GDP ($68.2 billion). Net debt is expected to be higher across all years when compared to the Budget Update. In nominal terms, net debt is just over $9.0 billion higher by 2025/26, with two‑thirds of the higher position reflecting additional funding requirements.

Net worth attributable to the Crown rises steadily over the forecast period reflecting the moderation in the rise of debt alongside ongoing growth in assets, as the operating balance is in a surplus position in most years of the forecast period.

Some of the negative economic risks noted above, such as weaker world growth or a stronger wage/inflation cycle, would drive contrasting changes to the fiscal position over the forecast horizon. The former would see a weaker outlook for OBEGAL, while the latter would lead to a stronger OBEGAL, the difference being due to the impact of inflation on nominal GDP growth. Conversely, a more positive economic picture such as inflation abating more quickly than expected, would likely leave the outlook for the OBEGAL pretty similar to the main forecast, with lower inflation and stronger activity largely offsetting each other in terms of their impact on nominal GDP.