Pre-election Economic and Fiscal Update 2005

Statement of Responsibility#

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On the basis of the economic and fiscal information available to it, the Treasury has used its best professional judgement in supplying the Minister of Finance with this Economic and Fiscal Update. The Update incorporates the fiscal and economic implications both of Government decisions and circumstances as at 8 August 2005 that were communicated to me, and of other economic and fiscal information available to the Treasury in accordance with the provisions of the Public Finance Act 1989.

John Whitehead

Secretary to The Treasury

11 August 2005

 

This Economic and Fiscal Update has been prepared in accordance with the Public Finance Act 1989. I accept overall responsibility for the integrity of the disclosures contained in this Update, and the consistency and completeness of the Update information in accordance with the requirements of the Public Finance Act 1989.

 

To enable the Treasury to prepare this Update, I have ensured that the Secretary to the Treasury has been advised of all Government decisions and other circumstances as at 8 August 2005 of which I was aware and that had material economic or fiscal implications.

Hon Dr Michael Cullen

Minister of Finance

11 August 2005

Ministerial Statement#

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Hon Dr Michael Cullen

It has been a relatively short time between the presentation of Budget 2005 and the preparation of the Pre-election Economic and Fiscal Update. The Pre-EFU outlook has changed little from that outlined in the Budget.

The Government’s key messages still hold true:

• sustainable economic growth is a core focus
• delivering real and sustainable improvements in the lives and living standards of all New Zealanders remains a priority, and
• future uncertainty and costs associated with an ageing population mean that a commitment to responsible fiscal management is imperative.

Since 1999 the Government has remained committed to a sound fiscal strategy and has delivered a strong record of achievement:

• sustained economic growth over the last six years has led to significant employment and income growth. The 1999 Pre-EFU forecast an unemployment rate of 7.0 percent in the year to March 2000 compared with a rate of 3.9 percent forecast in this Pre-EFU for the year to March 2006. Average GDP growth since the March 2000 year has averaged 3.9 percent per annum
• continued investment at many levels has delivered real improvements in health and education, services for older citizens and families, and improvements to infrastructure and law and order. Between the year to June 1999 and the year to June 2006 expenditure on vote health will have increased 63.4 percent and expenditure on vote education will have increased by 51.2 percent
• sensible management of the public finances enabled the Government to deliver a sizeable social dividend to low- and middle-income families via the Working for Families package in Budget 2004, and
• the Government’s prudent approach to fiscal management has allowed the Government to deliver on two fronts:

• -significantly reducing the ratio of debt to GDP from 32.8 percent at June 2000 to 23.3 percent at June 2005, and
• -accumulating financial assets through contributions to the New Zealand Superannuation (NZS) Fund: the NZS Fund now stands at $6.6 billion and returned an impressive 14.1 percent in the year to June 2005.

The nation is now well placed to deal with the coming demographic transition and any unexpected external shocks.

The current economic and fiscal position is starkly different from that which was inherited by the Government in 1999 and has improved significantly across all fronts. The economy is much healthier and the Crown financial statements are much stronger than they were six years ago.

The sound fiscal outlook will allow further investment in the things that are important to all New Zealanders – health, education, business growth and our future security.

This Government is proud of what it has achieved over the last two terms. We remain committed to delivering on our promise of a stronger fairer New Zealand for all our people. Our country is on the way up and is well placed to enter the future with confidence, security and optimism.

Hon Dr Michael Cullen

Minister of Finance

11 August 2005

Treasury Forecast Update Process#

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The Public Finance Act 1989 requires a Pre-election Economic and Fiscal Update (Pre-EFU) to be published between 20 and 30 working days prior to an election.

With the announcement of an election date of 17 September 2005, there has been limited time available for the Treasury to update its 2005 Budget Economic and Fiscal Update (Budget Update) forecasts.

A complete set of macroeconomic forecasts have been produced taking into account the most recent economic developments since Budget Update. We have not however, undertaken the usual process of drawing on information from many private sector businesses and government organisations, and no independent panel has reviewed the Pre-EFU macroeconomic forecasts.

The Pre-EFU macroeconomic forecasts were finalised on 27 July 2005. Since the forecasts were finalised the Quarterly Employment Survey and Household Labour Force Survey for the June 2005 quarter were released. These releases show a labour market that is marginally stronger than forecast. This does not, however, change our view of future labour market developments, and our overall view of the economy.

The preparation of the Pre-EFU fiscal forecasts has involved:

• reassessing tax revenue (in conjunction with IRD) and benefit expense forecasts in light of the revisions to the macroeconomic forecasts
• updating the operating results and expense forecasts using the pre-audited financial information of departments, the NZS Fund, GSF and ACC
• considering the impact of additional actual financial information that has occurred since the finalisation of the Budget Update forecasts on 9 May 2005, and
• incorporating the fiscal impact of significant cabinet decisions made since the Budget Update, up to and including 8 August 2005.

In line with established practise, IRD has prepared an independent set of tax forecasts, based in the short term on more detailed analysis of taxpayer information, and in the longer term on the same underlying macroeconomic trends that underpin Treasury’s tax forecasts.

The Pre-EFU fiscal forecasts were finalised on 8 August 2005.

The Specific Fiscal Risks have been updated to reflect all developments since the Budget Update up to and including 8 August 2005.

1 Economic and Fiscal Outlook#

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Summary#

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After a number of years of strong performance, economic growth is forecast to slow…

• Real Gross Domestic Product (GDP) growth of 2.2% is forecast for the March 2006 year and 2.6%, 3.5%, and 3.1% in the following three years. This is very similar to the forecast in the Budget Update.
• While still easing, growth in real private consumption and residential investment is expected to be stronger in the March 2006 year than was forecast in the Budget Update. This reflects the stronger housing market and residential investment activity that has been recorded recently, including house price inflation remaining more robust than expected. Other factors include slightly higher wage growth, and a relatively slow pass-through of higher wholesale interest rates to the effective mortgage rates faced by households.
• Government consumption and investment contribute to domestic demand growth throughout the forecast period.
• Relative to the Budget Update,export prices are expected to be higher over most of the forecast period. Import prices are also expected to be higher, partly as a result of the fall in the New Zealand dollar and also higher oil prices. In the near term higher import prices, higher import volumes and lower export volumes relative to the Budget Update are forecast to result in the current account deficit increasing to around 7¾% of GDP by the end of calendar 2005.
• Overall, relative to the Budget Update, domestic demand makes a greater contribution to growth over the near term. The associated higher imports, as well as lower export volumes, detract from growth.

Figure 1.1 – Growth in real GDP

Sources:Statistics New Zealand, The Treasury

… allowing room for some of the “imbalances” that have begun to appear to unwind  

• Annual Consumers Price Index (CPI) inflation is now expected to remain near 3% for most of the next two years after surpassing 3% in the September 2005 quarter. This reflects more persistent, albeit slowing, domestic demand growth (especially in the stretched construction sector), a depreciating exchange rate and higher oil prices.
• Higher and more persistent CPI inflation and a larger and increasing current account deficit reflect an economy that is showing more signs of macroeconomic imbalance than in previous forecasts.
• Taking account of assumed monetary and fiscal policy settings and what we currently know about the forces at work in the economy leads us to predict that these imbalances will unwind in a fairly benign manner. A continued build-up of these imbalances - through, for instance, domestic demand growth not slowing as expected - would increase the risk of further monetary policy tightening and/or a rapid and substantial market-led exchange rate depreciation. In either case a much more pronounced growth cycle may eventuate.

Tax revenue forecasts are higher than in the Budget Update, especially in 2005/06 and 2006/07…

• Tax revenue was $541 million higher in the 2005 June year than forecast in the Budget Update. Over the forecast period total tax revenue is forecast to be $731 million higher than in the Budget Update in the 2006 June year, $1,001 million higher in the 2007 June year, $334 million higher in the 2008 June year and $229 million higher in the 2009 June year.

…despite recent outturns for nominal GDP coming in lower than expected…

• Nominal GDP was $1.2 billion lower than forecast in the Budget Update in the 2005 March year. Most of this ground is expected to be made up over the next year with nominal GDP growth forecast to be stronger than the Budget Update, reflecting stronger domestic price pressures and a higher terms of trade. With nominal GDP growth also stronger in the 2007 March year the level of nominal GDP is forecast to be around $500 million higher than the Budget Update in this year before ending the forecast period around $250 million lower than the Budget Update in the 2009 March year.

This combination implies a temporary jump in the tax-to-GDP ratio

• Lower than expected nominal GDP and higher than expected tax revenue results in a jump in the ratio of tax-to-GDP over 2004/05. This jump is sustained into the initial part of the forecast period before unwinding back to 2003/04 levels.

The fiscal position follows a similar trend to that of the Budget Update

• The OBERAC is forecast to decline to around 3.1% of GDP by the end of the forecast period from an estimated 5.6% in 2004/05.
• With largely unchanged operating and capital spending plans, the increase in tax revenue forecasts has resulted in an increase to the operating balance and a decrease in the financing requirement forecasts from 2005/06 onwards, relative to the Budget Update.
• No change has been made to the Government’s 2005/06 domestic debt programme.
• Gross sovereign-issued debt is forecast to be higher than the Budget Update in 2004/05 due to the additional issuance of Treasury bills and increased Reserve Bank holdings. The increase in residual cash available for debt repayment from 2003/04 and 2004/05 results in gross debt being $1.9 billion lower in 2008/09 than at the time of the Budget Update.
• Net core Crown debt is forecast to be lower than the Budget Update in 2004/05 and the forecast years due to the accumulating impact of the cash available for debt repayment.

Figure 1.2 – OBERAC

Source: The Treasury

Recent Developments in Economic and Tax Outlook#

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Aggregate economic activity has been largely in line with expectations …

Since the finalisation of the Budget Update, data outturns and indicators of economic activity at an aggregate level have been broadly in line with the forecast. March quarter GDP data released on 24 June 2005 showed annual average growth in real production GDP slowing to 4.2% for the year ending 31 March 2005, identical to the Budget Update forecast. Seasonally adjusted production GDP expanded by 0.6% in the 2005 March quarter, below the Budget Update forecast of 0.9%. The March quarter result may have been influenced by the timing of Easter this year but no adjustment was made in the national accounts data for this.[1]

… but more of the growth has come from domestic demand than was forecast…

March quarter growth in domestic demand was stronger than forecast, largely due to renewed strength in residential investment and higher than expected private consumption growth. Reflecting this stronger domestic demand, import growth was higher than forecast. Export volumes fell 2.6% in the March quarter, a much weaker result than was forecast in the Budget Update. Overall real expenditure GDP growth came in lower than forecast and this, combined with downward revisions to historical data and a lower deflator, resulted in nominal GDP for the year ending 31 March 2005 being $1.2 billion lower than forecast.

Figure 1.3 –March 2005 quarter GDP growth

Source: Statistics New Zealand, The Treasury

… contributing to domestic price pressure …

The CPI increased 0.9% in the June quarter taking annual inflation to 2.8%. Consistent with continued strength in the housing market, the housing group made the largest contribution to the quarterly CPI increase.

While labour market conditions remain tight, the labour market data received since the Budget Update was slightly weaker than forecast. The unemployment rate increased to 3.9%, above the forecast of 3.4%. Contributing to this was weaker than expected employment growth, which was flat in seasonally adjusted terms. Consistent with this, the number of firms finding the lack of labour and capacity as constraints to further expansion fell somewhat in the latest Quarterly Survey of Business Opinion (QSBO). Marginally higher than forecast wage growth has resulted in labour income being in line with forecast, despite the weaker employment growth.

…and an increase in the current account deficit despite export prices having been stronger than forecast

The world price received for many of the goods New Zealand exports, as measured by the ANZ Commodity Price Index, remains near historical highs. Current world price levels are higher than expected in the Budget Update, particularly for dairy and meat. In the short term several supply related issues are likely to remain supportive of these prices. These factors include dry weather in parts of Australia which is slowing the recovery of Australian dairy volumes and a BSE case in the US resulting in a continuation, or in some cases a reintroduction, of import bans on US beef products in some key Asian markets.

Import prices in New Zealand dollar terms are also above the levels forecast in the Budget Update. Machinery prices made a large contribution to higher import prices and recently oil prices have increased above the level assumed in the Budget Update, with oil futures prices suggesting they may remain above the Budget Update level for some time. Overall the terms of trade have been in line with our expectations, with the increased import prices being offset by the higher export prices.

Higher import prices and volumes, as well as lower export volumes, contributed to the annual current account deficit increasing to 7.0% of GDP in the March quarter. This was a larger deficit than both the market and we were expecting.

The net result is an economy showing more signs of “imbalance” than previously expected

Recent economic data indicates that some of the rebalancing of the drivers of growth that we have been expecting to take place and relieve some of the pressures in the economy have not yet eventuated, or at most are only progressing at a very gradual pace. In particular, the easing in domestic demand growth we had been anticipating has progressed only very slowly, with residential investment growth actually picking up again over recent quarters. Household spending is the main factor behind the recent durability of domestic demand, with households continuing to accumulate debt against the rising value of their housing assets. Ongoing wage and salary income and low unemployment have also no doubt contributed to general consumer confidence. Alongside this, export volume growth has slowed more than expected. Part of this has been lower agricultural production, but the exchange rate is also acting as a significant drag on other parts of the export sector, discouraging volume growth.

The recent strength in domestic demand and weak exports, together with strong company profitability, high oil prices and the exchange rate making imports very price competitive have seen the current account deficit move much higher than expected over the last six months. While headline CPI inflation has so far tracked in-line with Budget Update forecasts, its component drivers, particularly housing related costs, are pointing to more persistence in underlying inflation. Some rebalancing of the drivers of growth and correction of these imbalances is desirable, sooner rather than later, in order to reduce the risk of the economy going through a disruptive and pronounced cycle at some point in the future. Macroeconomic developments over the next year are likely to be important in this regard.

The exchange rate appears to be depreciating earlier than was incorporated in the Budget Update

In early July the New Zealand Dollar (NZD), as measured by the Trade Weighted Index (TWI), began to depreciate from its historic highs, taking the TWI average for July to 69. This was a fall of 2.8% relative to its average level in June and below our assumed average level for the September 2005 quarter of just below 70 in the Budget Update. The decline was mostly due to a strengthening of the US dollar against most currencies. In early July the NZD fell nearly 4% against the US dollar. In addition there have been negative factors associated with the NZD, such as slowing growth and an increasing current account deficit, leading to a smaller easing against other currencies as well, including falling below $0.90 against the Australian dollar. As a consequence we have revised down our exchange rate assumption by bringing forward the fall in the NZD by one quarter.

Tax revenue has continued to exceed forecast since the Budget Update…

Source: The Treasury

Despite economic data pointing to a slowdown in growth, tax revenue has continued to surprise on the upside. All of the major income tax types (ie, source deductions, other persons tax, corporate taxes and withholding tax on resident interest) came in above expectations. The main factors behind this were:

• current-year incomes of individuals, trusts, and companies were higher than expected at the time of the Budget Update, and
• terminal assessments of company income tax made an unexpectedly high contribution to tax revenue in the June quarter.

Goods and Services Tax (GST) and other indirect taxes were marginally below forecast.

… somewhat at odds with nominal GDP

In contrast to tax revenue, nominal GDP for the year to March 2005 was $1.2 billion below the Budget Update forecast. Since tax revenue is dependent on what is happening in the economy, this is somewhat of a surprise. Economic data, including nominal GDP, at any point in time are estimates and are subject to future revision.[3] Tax revenue outturns, on the other hand, are not subject to revision and may thus be regarded as certain, in as much as they represent tax actually received by the Crown. There seem to be no major timing issues in the tax data, so we view the estimated actual tax position to June 2005 as an appropriate starting point for these Pre-Election Update tax forecasts.[4]

Assumptions Underlying the Economic Forecasts

Global economic activity – global economic growth, inflation and interest rate forecasts are assumed to conform to those presented in the April 2005 and July 2005 Consensus Forecasts and Asia Pacific Consensus Forecasts. Economic growth for New Zealand’s major trading partners is forecast at 3.0% for calendar 2005, a fall from the estimate of 3.9% for 2004. Growth then picks up over the next 3 years, reaching 3.5% in calendar 2008.

Sources: Consensus Economics, The Treasury

Oil prices – Brent crude oil prices have increased since the Budget Update and are assumed to rise from their estimated level of US$56.00 per barrel in the September quarter 2005 to US$59.10 per barrel in the first quarter of 2006, before declining gradually over the remainder of the forecast period to US$53.60 per barrel in the March quarter 2009. This outlook is based on futures pricing at the time the forecasts were finalised.

Net migration – net migrant inflows have continued to decline and are assumed to fall to 6,000 in calendar year 2005, before increasing again to their assumed long-term average of 10,000 per annum in calendar year 2006.

Monetary conditions – the New Zealand dollar exchange rate as measured by the TWI is assumed to depreciate from its level of 70.8 in the second quarter of 2005. The TWI declines steadily to its estimated equilibrium level of around 59. A neutral short-term interest rate of 5.8% is assumed.

Climate – agricultural growing conditions and the level of hydro electricity storage lakes are assumed to be normal over the forecast period.

Sources:Statistics New Zealand, Reserve Bank of New Zealand, The Treasury

NOTES:

1. Forecasts finalised on 27 July 2005.
2. 1
3. The forecast profile for public consumption is influenced by government defence spending.
4. Contribution to GDP growth.
5. Household Labour Force Survey, full-time equivalent employment.
6. Household Labour Force Survey, percentage of the labour force, March quarter, seasonally adjusted.
7. Quarterly Employment Survey, average hourly ordinary time earnings.
8. Overseas Trade Index basis, annual average percentage change, March quarter.
9. Average for the March quarter.

Economic and Tax Forecasts#

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Looking ahead we see the growth outlook for the New Zealand economy as similar to that presented in the Budget Update. We expect the near term composition of growth to differ with relatively more growth coming from domestic demand and less from exports, while stronger imports make a larger negative contribution.

We are predicting quarterly growth for the June quarter of 0.7%, slightly stronger than the 0.6% growth recorded for the March quarter. Influencing the slightly higher June quarter estimate is a degree of technical recovery in June quarter GDP due to the ‘Easter-effect’ that resulted in relatively more production and trading days than is normal after lower than normal production and trading days in the March quarter. Growth in real annual GDP is expected to slow from a peak of 4.8% in the 2004 calendar year to 2.2% in the March 2006 year and 2.6% in the March 2007 year. Contributing to the slowdown are the lagged effects of the high exchange and interest rates, a continued slowing in net migration inflows, slower trading partner growth over 2005 and a forecast decline in the terms of trade.

Government consumption and investment are expected to make a positive contribution to growth in the economy throughout the forecast period, with growth in public consumption at its strongest in the March 2007 year. Despite a pick-up in export growth in the March 2007 year, weak residential investment growth results in overall GDP growth remaining relatively muted.

GDP growth is forecast to pick up to 3.5% in the March 2008 year and 3.1% in the March 2009 year. Underlying this pick-up is robust export growth following its recovery in the March 2007 year. A degree of recovery in private consumption growth, due to increasing labour and export incomes and a projected fall in interest rates, also plays a part in the recovery as does residential investment growth as the decline in residential investment comes to an end. Import growth remains relatively muted due to the low exchange rate.

These forecasts, like any, are subject to uncertainty. These forecasts incorporate a reasonably rapid export response as the exchange rate depreciates and this means that despite a considerable slowing in domestic demand the bottom of the growth cycle is reasonably modest. As discussed in the Budget Update, there is uncertainty as to the timing and magnitude of the impact of exchange rate changes on export levels. Should the recent high level of the exchange rate have a greater impact on export volumes, or if the exchange rate does not depreciate as is assumed, it is possible that the economy may face a more protracted slowdown period with the recovery pushed further out.

We believe that the most likely path for the economy is one in which imbalances, such as continued inflation pressures and an increasing current account deficit, gradually unwind in a fairly benign manner. There is however the risk that any adjustment may occur in a less orderly manner with the potential that economic growth could prove more volatile than the profile incorporated in these forecasts. The potential for a less orderly adjustment would increase if the current imbalances were to become significantly larger.

The outlook for the labour market is similar to the Budget Update

With similar overall growth to that forecast in the Budget Update, the outlook for the labour market is little changed from the Budget Update. The main difference relates to the unemployment rate which is higher throughout the forecast period. Wage outturns are also suggestive of slightly higher wage growth, resulting in marginally higher labour income throughout most of the forecast period.

The tax type most closely linked to the labour market is source deductions, which is mostly PAYE tax deducted at source on salaries and wages. Outturns of source deductions since the Budget Update were above forecast, reflecting wage growth in the June quarter.

Growth in aggregate salaries and wages (compensation of employees) is forecast to grow at an average rate of nearly 5% through the forecast period. Source deductions growth is a little higher than this, owing to the progressive nature of the personal tax system. Source deductions growth slows towards the end of the forecast period owing to the introduction of the triennial tax threshold indexation.

Figure 1.5 – Compensation of Employees and Source Deductions tax growth

Source: Statistics New Zealand, The Treasury

The higher labour income included in these forecasts contributes to source deductions being $130 million to $160 million a year higher than Budget Update levels throughout the forecast period.

Private consumption growth is still expected to ease but is likely to be slightly stronger than forecast in the Budget Update

Real private consumption growth was stronger than forecast in the Budget Update with quarterly growth of 1.7% in the March quarter taking annual average growth to 5.7% in the March 2005 year. Factors supporting this stronger growth include slightly higher wage growth, net migration not slowing as rapidly as expected, and house price inflation holding up (rather than slowing considerably). In addition consumer confidence, while declining, remains at a high level and the pass-through of higher wholesale interest rates to the effective rates faced by households is occurring reasonably slowly due to a move to relatively attractive fixed mortgage interest rates over the last few years.

Figure 1.6 – Growth in real private consumption

Source: Statistics New Zealand, The Treasury

These factors mean that private consumption growth is expected to be 3.7% in the year to March 2006, a less rapid slowing than was forecast in the Budget Update. A slowing labour market, much lower house price growth and higher debt servicing costs mean that real private consumption growth slows to 1.8%, 2.1% and 2.4% in the 2007, 2008 and 2009 March years. While growth in these years is slower than forecast in the Budget Update, the overall level of private consumption at the end of the forecast period remains similar to that in the Budget Update.

Implicit in the forecast is the judgement that the continued accumulation of debt by households will act as a constraint on future private consumption growth. The ratio of debt to household income is expected to continue to increase over the forecast period. There is uncertainty around households’ willingness to continue to expand debt further and the impact of higher debt servicing costs. A more substantial attempt by households at debt consolidation would pose downside risk to consumption growth. Alternatively, if debt accumulation and servicing does not impinge as strongly on the spending decisions of households, there may be upside risk to household spending on consumption items and housing.

There was a resurgence in residential investment during late 2004 and early 2005, but fundamentals are inconsistent with a continuation of this renewed strength

From the end of 2003, activity in the housing market was becoming less intense; the number of house sales was declining, house price inflation was easing and the number of new house consents had started on a downward trend. However, the last couple of quarters of published data have shown a pick up in residential investment growth. House price growth has not cooled as much as we expected in the Budget Update. Annual house price inflation, as measured by the Quotable Value House Price Index, was 13.5% in the year to March 2005, stronger than the 8.0% forecast in the Budget Update. Prices appear to have continued to increase in the June quarter, a period in which we were expecting some easing of prices. Despite this, forward indicators point to eventual weakness in residential investment growth. Economic growth is still expected to slow, interest rates have increased over the last eighteen months and are not predicted to change markedly in the immediate future, and reduced net migration results in slower population growth. Nevertheless, the recent strength in residential investment has led us to revise our forecast for real residential investment growth in the March 2006 year from -8.6% in the Budget Update to -1.2%. The slowing in residential investment is then forecast to continue with a fall of 7.9% in the March 2007 year prior to recovering to a fall of only 0.5% in the March 2008 year and growth of 0.8% in the March 2009 year.

Government spending will contribute to domestic demand over the forecast period

Annual nominal government consumption spending is forecast to rise from $26.5 billion in 2004/05 to approximately $35.8 billion by the end of the 2008/09 March year, a little lower than forecast in the Budget Update.[5] The lower 2004/05 figure reflects a downward revision to historical data by Statistics New Zealand and Crown financial data indicating that departments spent less than was budgeted for in the 2004/05 fiscal year.

In real terms, government consumption growth is expected to exceed GDP growth, growing by around 3% to 5% per year, following 6% growth in 2004/05. Growth is slightly weaker than in the Budget Update, particularly in the short term, as more of the increase in nominal spending goes to meet rising prices and wages. Non-market investment (eg, roads, hospitals etc) is also forecast to record strong growth over the forecast horizon.

Figure 1.7 – Fiscal impulse

Sources: The Treasury

Taking into account transfer spending and offsetting forecast revenue flows, fiscal policy is shifting to a more expansionary stance over the forecast period, after acting as a contractionary influence over 2004/05.[6]

GST forecast similar to Budget Update

Nominal consumption and residential investment are important drivers of the level of GST collected by the government. With relatively more momentum in consumer spending than was allowed for in the Budget Update, nominal residential investment and consumption are higher than previously forecast throughout the majority of the forecast period. The relationship between GST and consumer spending on consumption and residential investment is not perfect, however, given that not all private consumption attracts GST. For example, spending by New Zealanders overseas counts as private consumption but does not attract GST.

Figure 1.8 – GST growth and growth in consumption (public and private) and residential investment

Sources: Statistics New Zealand, The Treasury

In addition, the level of public consumption also influences GST. These private and public nominal consumption influences largely offset each other so that the GST forecast is little changed since the Budget Update.

Slightly stronger corporate profit growth supports investment…

Business investment growth has been strong over the last couple of years with annual average growth in market investment of 15.1% and 12.7% in the 2004 and 2005 March years. This strong growth has been the result of strong demand, rising firm profitability, increased difficulty finding labour and lower prices for imported capital goods resulting from the high exchange rate. Investment intentions remain positive and corporate profitability growth in the March 2006 year, while still slowing, is expected to be a little stronger than was forecast in the Budget Update given relatively higher domestic demand. Market investment growth is therefore expected to hold up at a higher level than was forecast in the Budget Update, prior to slightly weaker growth over the remainder of the forecast period. Market investment growth of 7.6% is expected in the March 2006 year prior to falling to -0.9% in the March 2007 year as demand and profitability decline and capital goods become relatively more expensive with the depreciating exchange rate. Growth then picks up later in the forecast period as firms respond to the export recovery.

… and also contributes to a higher corporate tax take

The main driver of corporate tax is corporate profits. However, other elements, such as the timing of revenue recognition, tax loss generation and utilisation, and tax policy changes can also have marked effects. While underlying corporate tax is expected to grow in line with corporate profits (as proxied by the economic measure of operating surplus), changes in tax rules, such as the new thin capitalisation rules for banks and new depreciation rules, have varying effects on the corporate tax take. Aligning provisional tax due dates with GST due dates is expected to take about $600 million out of company tax in the 2008 June year, as the 7 June provisional tax due date moves out past the fiscal year boundary to 28 July.

Figure 1.9 – Corporate tax and corporate profit growth

Sources: Statistics New Zealand, The Treasury

With negligible profit growth expected at the trough of the business cycle, we expect that there will be some tax loss build-up in 2007. In the normal course of events, these tax losses would be offset against subsequent profits, thereby reducing corporate tax growth over the following years. This occurred in the mid-1990s (following the recession of the early 1990s) and late 1990s/early 2000s (following the 1997/98 recession), as can be seen in Figure 1.10.

Figure 1.10 – Company tax loss utilisation[7]

Source: The Treasury

While a repeat of the mid-1990s or even 1999 and 2001 is not present in the company tax forecasts, tax loss utilisation is assumed to be a little higher through 2008 and 2009 than has been seen in recent years. This implies that, should there be a larger response to the business cycle than is in the tax forecast, corporate tax would be somewhat lower than forecast for 2008 and 2009. However, with corporate balance sheets now more robust than in either of the last two downturns, we do not expect loss utilisation to reach the heights of the 1990s. Alternatively, in the event that there is no significant tax loss build up, corporate tax revenue would be considerably higher than the 2008 and 2009 forecasts.

A tax-loss cycle was also present in the Budget Update forecasts, but it has been delayed a year in these forecasts owing to an increased corporate profit outlook for 2006. This results in a greater increase to the forecast in 2007 than in 2008 and 2009, when corporate tax is expected to be around $100 million above the Budget Update forecast.

Stronger domestic demand draws in more imports relative to the Budget Update

The stronger domestic demand, discussed earlier, results in the economy drawing in more imports relative to the Budget Update. Import volume growth peaked at just under 16% in the 2004 calendar year as consumers and businesses took advantage of buoyant economic conditions and the high level of the exchange rate. With slowing domestic demand and a depreciating currency, import volume growth is forecast to subside. Import growth of 6.5% is now expected in the 2006 March year – just over 2% higher than forecast at the Budget Update. Growth then slows further to 1.3% in the March 2008 year as consumer demand growth slows and imports (including overseas travel by New Zealanders) become relatively more expensive as the exchange rate depreciates.

The level of demand for New Zealand’s exports is influenced by the economic performance of our trading partners. Since the Budget Update, there has been a minor decrease in trading partner economic growth forecasts for the 2005 and 2006 calendar years, and a minor increase in subsequent years. Trading-partner growth is projected to recover over the remainder of 2005 and into 2006, returning to a trend rate of around 3½% per year. An expected return to normal rates of growth in Australia, after a period of slowing over the last half of 2004, is the major source of movement in total trading-partner growth over the forecast period.

Export growth is weaker as exporters are under pressure from the high exchange rate…

Export growth was particularly weak in the March quarter with export volumes falling 2.6%. Exporters have been under pressure from the high exchange rate and, as noted in the Budget Update, there was and still is uncertainty about how negatively the high exchange rate would impact on exports over the near term. It appears that the impact may have been greater than initially incorporated and hence we have revised down our forecasts of export volume growth. Growth in the 2006 March year is now expected to be around 1.3%, about half what we were predicting in the Budget Update.

Figure 1.11 – Exchange rate assumption (TWI)

Sources: RBNZ, The Treasury

Also contributing to the weak export growth in the March 2006 year are relatively weak dairy exports due to lower than normal production over 2004/05 as a result of sub-optimal weather conditions. We assume that weather conditions will return to normal and this should result in an increase in dairy production which contributes to a recovery in export volumes in the March 2007 year.

... but forecast exchange rate depreciation will help

As a result of the recent depreciation in the exchange rate we have adjusted our exchange rate assumption underpinning these forecasts. The exchange rate begins the September quarter at a lower level and the TWI remains below the Budget Update level throughout the majority of the forecast period prior to returning to its estimated equilibrium level at the end of the forecast period. This earlier depreciation and consequently lower TWI reduces pressure on exporters and subsequently export growth recovers such that export volumes return to Budget Update levels in the 2008 calendar year despite the much lower starting point. Export growth of 5.7% is expected in the March 2007 year, supported by the return to more normal dairy production levels. The depreciation of the exchange rate contributes to robust export growth of 4.8% in the March 2008 year and 4.1% in the final year of the forecasts.

Oil prices are currently at historically high levels in nominal terms. The forecast assumption for oil prices that underpins these forecasts is based on available futures prices. This approach results in an oil price assumption that is significantly higher than in the Budget Update from the end of the 2005 calendar year to the end of the forecast period. Brent oil prices are assumed to reach a quarterly average peak of $US59.10 a barrel in the March 2006 quarter, just over $US3 a barrel higher than the peak in the Budget Update. Oil prices then gradually decline over the remainder of the forecast period, reaching $US53.60 a barrel at the start of 2009 compared to $US47.00 a barrel in the Budget Update.

Should oil prices continue to increase significantly this may pose downside risk to world growth. This in turn could negatively impact on demand for New Zealand’s exports and by doing so affect both export volumes and the price received for our exports. New Zealand has been receiving high world prices for a number of our important exports, in particular meat and dairy. Export prices are forecast to fall from the December quarter of 2005. However, as noted earlier, several supply factors - including dry weather in parts of Australia and a BSE case in the United States - may provide some support to prices in the shorter term.

The current account deficit initially increases

The combined result of higher import volumes, high oil prices and relatively weak export volume growth is a higher current account deficit of 7.8% of GDP by the end of calendar 2005. The current account deficit is then expected to decline over the remainder of the forecast period as export volumes recover and import growth declines due to lower domestic demand and the impact of a depreciating exchange rate. At the end of the forecast period the current account deficit is forecast to be just above 6% of GDP.

Inflationary pressures persist…

Higher oil prices, more sustained resource pressures as a result of higher domestic demand growth relative to the Budget Update, and a depreciating exchange rate contributing to greater tradables inflation, all result in more persistent inflationary pressures than were captured in the Budget Update. Annual consumer price inflation is expected to remain above the Budget Update level until mid 2007. Annual consumer price inflation is predicted to peak at 3.1% in the September quarter of 2005 and remain near 3% for much of the next two years.

Figure 1.12 – Consumer price inflation

Sources: Statistics New Zealand, The Treasury

With relatively sustained inflation pressures there is limited scope for an easing in monetary policy, resulting in 90-day bank bill rates remaining around current levels until the second half of 2006. In the Budget Update 90-day bank bill rates started to ease in the first quarter of 2006. As alluded to earlier, inflation pressures could be intensified or sustained for longer if domestic demand should continue to show greater relative strength than is currently forecast. If inflation pressures were to intensify this may necessitate further monetary policy response.

… contributing to higher nominal GDP growth over the next two years …

Higher domestic inflation and a higher terms of trade result in forecast growth in nominal GDP being higher than the Budget Update in the March 2006 and 2007 years. Nominal GDP growth of 5.0% in the March 2006 year and 3.5% in the March 2007 year are forecast. With inflation returning to similar levels to the Budget Update in the 2008 and 2009 March years, but with a slightly lower terms of trade, nominal GDP growth is forecast to be a little slower than in the Budget Update in the 2008 and 2009 March years with growth of 4.4% in 2008 and 4.9% in 2009. Nominal GDP for the year ending March 2005 came in around $1.2 billion lower than forecast in the Budget Update. The faster nominal GDP growth in the March 2006 year means that most of this lower starting point is recouped with nominal GDP around $200 million lower in the March 2006 year than was forecast in the Budget Update. The continuation of higher nominal GDP growth in the March 2007 year means the forecast level of nominal GDP surpasses the Budget Update level by around $500 million in 2007. Slower growth in the final two years of the forecast means that the forecast level of nominal GDP is just over $100 million lower in the 2008 March year and around $250 million lower in 2009. 

…and tax revenue that is higher than forecast in the Budget Update

Compared with the Budget Update, a higher tax base in the 2005 June year and higher nominal GDP growth through 2006 and 2007 produce increases to the tax forecasts across all years. A shorter, sharper corporate profit cycle than was present in the Budget Update forecast has the effect of advancing some corporate tax revenue from the 2008 and 2009 June years into 2007 (relative to the Budget Update forecast), resulting in lower increases to the tax forecasts in the later years of the forecast horizon than in the earlier years. Nominal GDP is also lower in the last two forecast years than in the Budget Update, contributing to the increase in tax relative to the Budget Update being lower than in the 2005 June year.

Inland Revenue's forecasts are generally similar to those of the Treasury, but show greater revenue in 2008 and 2009, with higher company tax in those years. A detailed comparison of Treasury and Inland Revenue forecasts can be found at www.treasury.govt.nz/forecasts/prefu/2005.

With forecast expenditure relatively unchanged, this results in higher operating balances than the Budget Update

Core Crown expenses are expected to rise by around 2% of GDP over the forecast horizon similar to the Budget Update, as no changes to future new operating spending allowances for Budgets 2006 to 2008 have been made.

Figure 1.13 – Net allowance for new operating initiatives (GST exclusive)

Source: The Treasury

Key Trends in Fiscal Outlook#

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Revenues are forecast to exceed operating expenses…

Over the forecast horizon revenue is expected to be more than sufficient to meet operating expenses (salaries, benefit payments, depreciation costs etc).

Forecast expenditure follows a similar trend to that outlined in the Budget Update. This translates into an OBERAC that is forecast to fall from $8.3 billion (5.6% of GDP) in 2004/05 to $4.2 billion (2.5% of GDP) by 2007/08, before rising to $5.5 billion (3.1% of GDP) by 2008/09.

Figure 1.14 – Total Crown revenue, expenses and operating balance

Source: The Treasury

… as a result the fiscal position is expected to strengthen…

Net worth is forecast at $41.9 billion (28.1% of GDP) in 2004/05 and is expected to rise to $65.2 billion (36.7% of GDP) by 2008/09. The forecast increase in net worth is driven by the operating surpluses expected to be run over the forecast horizon.

… by accumulating assets…

In line with the Government’s fiscal objectives the OBERAC has been applied to fund investments. The existing fiscal strategy is to strengthen public finances to prepare for future fiscal costs associated with an ageing population. Over the forecast period total assets are expected to increase by around $36.8 billion.

The OBERAC is not fully available to finance the capital programme. This is because some components of the OBERAC are non-cash (ie, depreciation) or retained by entities within the Crown (ie, SOE/Crown entity surpluses and NZS Fund returns) for the purpose of achieving their long-term objectives. Adjusting for these items gives the core Crown operating cash flows. Table 1.4 shows the cumulated balance sheet impact.

Table 1.4 – Impact of Crown operating surpluses on the balance sheet from 2004/05 to 2008/09 inclusive

Source: The Treasury

As outlined in Table 1.4, the operating balance is forecast to be in surplus by a total of $29.1 billion over the years from 2004/05 to 2008/09. Adjusting for returns retained by entities within the Crown ($11 billion) and non-cash items ($9.1 billion) gives a cash flow from operations which generates around $27.2 billion over the forecast horizon.

This will be invested primarily in NZS Fund contributions of $12.2 billion, purchases of physical assets of $8.5 billion (for example, schools and defence equipment), advances of $3.9 billion (mainly student loans and refinancing existing private sector debt of the health and housing sectors), purchase of foreign exchange reserves of $2 billion and equity injections into Crown entities for hospitals and housing of $1.7 billion.

There is a residual financing requirement of around $1 billion, which will be partially met by reducing the holdings of marketable securities and deposits which have accumulated from 2003/04 and 2004/05, and by raising some debt.

… while gross debt as a percentage of GDP slowly reduces over the forecast period

As a percentage of GDP, gross debt is expected to fall from 25.3% in 2003/04 to 19.1% by 2008/09. In nominal terms, gross debt is also forecast to fall to $32.2 billion by 2006/07 and then increase to $34 billion by the end of the forecast horizon.

Figure 1.15 – Gross sovereign-issued debt (% of GDP and $ million)

Source: The Treasury

The initial decrease in debt in nominal terms reflects residual cash available for debt repayment from 2003/04 and 2004/05. Gross debt is then expected to slowly increase, reflecting the fact that capital spending will be greater than the funding available due to the OBERAC.

No change to the Government’s 2005/06 bond programme from the Budget Update has been forecast. However, the lower financing requirement (cash shortfall) has resulted in reductions to the 2006/07, 2007/08 and 2008/09 domestic bond programmes of $750 million in each of those years.

Net core Crown debt is also expected to fall before flattening by the end of the forecast horizon

Net core Crown debt[8] in nominal terms and as a percentage of GDP is forecast to fall in 2004/05, reflecting the cash available for debt repayment in 2004/05. Net core Crown debt is expected to remain relatively flat as a percentage of GDP between 2005/06 and 2008/09. The difference in the trend of gross debt arises because some of the expected borrowing will be used to fund financial assets including student loans and reserves.

Net core Crown debt with the financial assets of the NZS Fund is forecast to be below zero by 2005/06.

Figure 1.16 – Net debt (% of GDP and $ million) and % of GDP including assets of NZS Fund

Source: The Treasury

Why is there an operating surplus?

A surplus represents the difference between operating revenues (eg, taxes) and operating spending (eg benefit payments, health and education spending, etc.). It is a measure of the ongoing operations of a government.

A government also has a capital expenditure programme whereby it provides money for student loans, saves some money by making contributions to the New Zealand Superannuation Fund, invests in asset acquisitions (eg building more roads, prisons, new hospitals, schools and defence equipment) and other capital activity. None of this shows up as operating expenses as it is the purchase of an asset (with a useful life in excess of one year and will provide benefits through time rather than an operating expense such as a benefit payment). All of this type of activity is called investment expenditure.

The cash generated from the operating balance is not always sufficient to meet all investing decisions. There may still be a need to borrow some money in many years to fund the shortfall between the forecast operating surplus and the capital programme (which is often larger than the surplus).

The following graph shows how the operating surplus (or OBERAC) is used in each year over the forecast horizon, and therefore why nominal debt can increase even when there is a “surplus”.

Source: The Treasury

The following table explains how the operating surplus/OBERAC is calculated for the 2004/05 and the 2005/06 financial years and then how it is applied.

Changes to the fiscal forecasts since the Budget Update#

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The overall trend of the fiscal forecasts is relatively unchanged from that outlined in the 2005 Budget Update.

Operating balance

The operating balance from 2005/06 is forecast to be higher than the Budget Update due to increased tax revenue (refer Table 1.6) partially offset by expense transfers of $175 million.

Compared with the Budget Update the operating balance in 2004/05 is forecast to be lower by $115 million. This is due to:

• increased tax revenue of $541 million (refer table 1.6)
• increased investment income of $414 million, reflecting investment gains by the GSF, NZS Fund and ACC on their financial assets portfolios due to movements in the New Zealand and global equity markets
• an increase in tax and student loan debt provisioning of $402 million (the change to student loans reflects the impact of a movement in the doubtful debt provision from 11.4% to 12.8%)
• recognition of the Kyoto liability of $310 million (refer to page 95).
• core Crown expenditure underspends of $563 million spread over a number of departments
• an increase in the GSF liability of $843 million due to a revision of pensioner mortality rates and a lower discount rate than what was used at the time of the Budget Update
• an increase in the ACC liability of $230 million as a result of a lower discount rate than what was used at the time of the Budget Update

Cash available/(shortfall to be funded)

The cash available for debt repayment is forecast to be higher than the Budget Update in 2004/05 by $743 million mainly due to increased tax receipts. In the following four outyears increased tax receipts of $2.2 billion partially offset by transport funding of $500 million and increased New Zealand Superannuation Fund contributions of $136 million reduce the financing requirement (cash shortfall) compared to the Budget Update.

Gross sovereign-issued debt

Compared with the Budget Update gross sovereign-issued debt is forecast to be higher by $944 million in 2004/05. This is due to the additional issuance of Treasury bills and increased Reserve Bank holdings. However in 2006/07 and outyears gross debt is lower than the Budget Update as a result of the lower financing requirement (cash shortfall) which is partially offset by the increased Reserve Bank holdings.

Net core Crown debt

Net core Crown debt is forecast to be lower than the Budget Update in 2004/05 by $775 million rising to $2.3 billion by 2008/09. This is due to the accumulating impact of the lower financing requirement (cash shortfall) described above.

2005 Post Budget Decisions

Operating

The 2005 Budget incorporated new operating spending up to Budget 2006 of between $260 million and $280 million. The table below provides a summary of the post Budget decisions against this new operating spending.

Source: The Treasury

Capital

The Budget Update incorporated new forecast capital spending of $2.2 billion. The table below provides a summary of the post Budget decisions against these allowances.

Source: The Treasury

Source: The Treasury

Fiscal Sensitivities#

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Table 1.11 provides some “rules of thumb” on the sensitivities of the fiscal aggregates to changes in specific macroeconomic variables.

The forecasts of capital contributions for 2006/07 to 2008/09 are sensitive to the expected net after-tax annual return of the NZS Fund, which in turn depends on the expected gross rate of return assumed on the Fund’s assets:

A +1% change in the gross rate of return would have symmetrical, negative effects on the required capital contribution track across these years.

Risks to fiscal forecasts

The fiscal forecasts were finalised on 8 August 2005 in accordance with the forecast accounting policies. There are certain risks around the forecast results. To assist in evaluating such risks the following chapters should be read in conjunction with the fiscal forecasts:

• Specific Fiscal Risks (Chapter 2) – The fiscal forecasts incorporate government decisions up to 8 August 2005. The Specific Fiscal Risks chapter covers specific policy decisions that are under active consideration by the Government at the time of the finalisation of the forecasts.

In addition to the specific fiscal risks and the link to the economic forecasts, there are a number of forecasting issues explained below that may arise in future.

Tax forecasting risks

The tax forecasts prepared for this Pre-Election Update are based on current tax policy and on the macroeconomic central forecast.

SOEs and Crown entities’ forecasts

The forecasts for large SOEs and Crown entities were provided in March 2005 based on their best assessments at that time.

Revaluation of property, plant and equipment

Crown accounting policy is to revalue certain classes of property, plant and equipment on a regular basis. In certain circumstances the valuation will be affected by foreign exchange rates, so any appreciation in the New Zealand dollar (from 30 June 2004) will adversely affect the current physical asset values included in the fiscal forecasts. In addition from 2004/05 the accounting policy for the valuation of electricity generation assets has changed, the impact of this change is outlined in the GAAP tables on page 63.

International financial reporting standards

The New Zealand Accounting Standards Review Board announced in December 2002 that International Financial Reporting Standards (IFRSs) will apply to financial reporting by both public and private sector entities from 1 January 2007, but with entities having the option to adopt from 1 January 2005.

The Crown plans to adopt the New Zealand IFRSs in the 2007 Budget.

Tertiary education institutes’ (TEIs’) accounting treatment

The forecast information presented in the Pre-Election Update combined TEIs on an equity accounting basis. As noted in previous publications the combination treatment of TEIs remains unresolved.

The combination method adopted in these forecasts is to equity account for the TEIs’ net surpluses and net investment and not the TEI revenues, expenses, assets and liabilities on a line-by-line method. This is consistent with the treatment adopted in the 2004 Crown financial statements.

The key indicators are unchanged as a result of the combination approach for TEIs (refer page 56 of the 30 June 2004 Crown financial statements).

Foreshore and seabed recognition

The Budget Update advised that work was underway to consider whether or not the public foreshore and seabed met the requirements for reporting as an asset in the Crown financial statements. This work is now completed and is reported on page 58 of the Specific Fiscal Risks chapter.

2 Specific Fiscal Risks#

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Introduction#

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This chapter describes the specific fiscal risks to the Crown, including contingent liabilities. PFA requires disclosure of all government decisions and other circumstances that may have a material effect on the fiscal and economic outlook.

Criteria for Disclosure of Specific Fiscal Risks

To ensure a practicable and consistent disclosure approach, fiscal risks are disclosed based on the following criteria, consistent with the principles of the PFA:

• Reasonable certainty criterion - risks have not been included in the fiscal forecasts because they reflect government decisions or legislative commitments with uncertain fiscal consequences or timing.
• Materiality criterion - risks have an impact on the fiscal forecasts (operating balance, net worth or gross debt) of $10 million or more in any one forecast year.
• Active consideration criterion - risks are being actively considered by the Minister of Finance and responsible Ministers (ie, are the subject of written reports) or are decisions that have been deferred until a later date.

Exclusions from Disclosure

The PFA requires that all specific fiscal risks be disclosed, except where it is determined by the Minister of Finance that disclosing a risk is likely to:

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

Specific fiscal risks do not include:

• normal forecasting risks, such as uncertainty around welfare benefits, SOE/Crown entity surpluses, the impact of regular revaluations of physical assets, finance costs, or fluctuations in external markets
• possible changes to the interpretation of accounting policies, such as the changes to revenue recognition rules and recognition of liabilities
• discussion documents containing proposals that the Minister of Finance and responsible Ministers will not actively consider until the consultation process has been completed.

In addition, the Minister of Finance has to determine that there is no reasonable or prudent way the Government can avoid this prejudice, compromise or material loss by making a decision on the fiscal risk before the finalisation of the forecasts, or by disclosing the fiscal risk without reference to its fiscal implications.

Specific Fiscal Risks do not include political party policies.

Contingent liabilities are also included according to materiality. Contingent liabilities below $10 million are included in the “other quantifiable contingent liabilities” total. Comparatives have been adjusted where appropriate to align with the disclosure of new “material” contingent liabilities. The total amount of contingent liabilities remains unchanged.

Information Relating to All Disclosed Risks

• The risks disclosed may not eventuate into Government policy and the final cost or saving may differ from the amount disclosed if the policy is developed.
• All risks, should they eventuate, would impact on the Government’s forecast operating and/or capital spending amounts. These are forecast spending amounts already incorporated into the forecasts to accommodate policy initiatives on which decisions have yet to be made. Most risks outlined in this chapter, if they eventuate, would be covered by these amounts and therefore have no impact on the forecasts. The risks have been disclosed to indicate the pressure the risks place upon the forecast spending amounts.
• If the total of all risks considered exceeds the forecast new operating spending amounts in the forecasts, this would impact on the operating balance.
• There are a number of other pressures on the fiscal position that have not been included as risks. These pressures comprise proposals largely generated within individual departments and not yet considered by the Minister of Finance and responsible Ministers. Such items are expected to be managed within forecast spending amounts noted above.

Charges against Future Budgets#

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As part of its Budget strategy, the Government has put in place some longer-term funding paths for particular sectors. This aids long-term planning and demonstrates the Government’s commitment to specific policies.

Charges against future Budgets do not meet the definition of a “risk” under the PFA, as these items are incorporated in the fiscal forecasts. This section is provided to increase transparency about the provisions for future Budgets.

Defence Funding Package

The Defence Funding Package (DFP) is designed to provide the New Zealand Defence Force (NZDF) with the funding required to address issues identified by the Defence Capability and Resourcing Review, including capability, and maintaining equipment and reserves. Budget 2005 included $60 million per annum as the first tranche of the 10-year plan. The following table shows the additional tranches as charged against future Budgets.

Health Funding Package

In Budget 2005, the health sector received $475 million per annum as the third tranche of the Health Funding Package (HFP). A fourth tranche of $489 million per annum is charged against Budget 2006.

Official Development Assistance

The Government has committed to an Official Development Assistance to Gross National Income ratio (ODA:GNI ratio) of 0.27% for the fiscal years 2005/06 and 2006/07 and increasing this to 0.28% in 2007/08. Budget 2005 included funding for 2005/06 levels only. The 0.27% in 2006/07 is expected to cost an additional $19 million per annum to be charged against Budget 2006, and the 0.28% in 2007/08 is expected to cost $38 million to be charged against Budget 2007.

Tertiary Student Component Funding Rate Changes (The rolling funding triennium and fee and course cost maxima)

The Government has a policy of increasing Student Component funding rates for tertiary education by the rate of forecast CPI inflation on a rolling triennium. Funding is appropriated for future years at the rate of the CPI forecast plus 1%, and in the Budget preceding the relevant academic year funding rates are confirmed using a more up-to-date CPI forecast. The differential between the CPI increase and the appropriation is retained within the Vote for application elsewhere in the Student Component.

Transport Capital Decisions

The Government has made several long term capital commitments relating to Transport. This table notes the implications for the capital allowances beyond the forecast period.

Time-Limited Funding

Time-limited funding does not meet the definition of a “risk” under the PFA, but is further information that is prepared to increase transparency about initiatives with funding profiles that cease or decrease during the forecast period.

The following table outlines those areas where initiatives have time-limited funding that decreases or ceases at some point and may potentially be extended, using a $5 million materiality threshold. They are often related to pilot programmes.

The following table shows the impact on the operating balance if funding were to be appropriated to maintain funding levels for these initiatives (ie, extend the initiatives beyond their current scheduled completion dates). These amounts would need to be managed within the forecast operating spending.

Quantified Risks

The risks outlined in these tables would, if they eventuated, impact on the Government’s forecast new operating and/or capital spending amounts.

The Minister of Finance has yet to fully consider the quantum of these risks.

Unquantified Risks

The risks outlined in these tables would, if they eventuated, impact on the Government’s forecast new operating and/or capital spending amounts.

Risks removed since the Budget Update

The following risks have been removed since the Budget Update.

Statement of Fiscal Risks#

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ACC - Public Health Acute (unchanged, quantified risk)

ACC funding for the provision of public health acute services for 2005/06 is currently being considered. The amount of additional funding to be paid by ACC has not yet been determined, but would decrease the operating balance by up to $16 million in 2005/06 and outyears.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: Department of Labour

Department of Child, Youth and Family Services - Collective Employment Contract Negotiations (new, unquantified risk)

Child Youth and Family Services has two collective employment agreements for non-managerial employees that expired on 30 June 2005. The department is currently in negotiation with representatives of the PSA and NUPE to settle new collective employment agreements.

This risk is unquantified as disclosure may compromise the Crown in negotiations.

Child, Youth and Family Services - Residential Services Strategy 2003 (unchanged, quantified risk)

The Department of Child, Youth and Family Services has undertaken a comprehensive review of existing residential services and practices, including consideration of desired outcomes, a review of international good practice, and formal forecasting of demand. From this, the Department has developed a strategy for future residential services provision – the Residential Services Strategy 2003. The 2003 Strategy builds on the considerable investment in facilities made in implementing the 1996 Residential Services Strategy.

The Government has agreed in principle to fund the 2003 Strategy subject to fully developed and costed proposals. Some initiatives have already been agreed, and the remaining operating cost risk is $8.4 million in 2005/06 rising to $16.1 million in 2009/10 and outyears, which would decrease the operating balance. The remaining capital risk is $29.5 million, which would increase gross debt. The current proposed phasing of this is $4.4 million in 2005/06, $7.4 million in 2006/07 and $17.7 million in 2007/08.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: Department of Child, Youth and Family Services

Child, Youth and Family Services - Sustainable Levels of Funding and Service Delivery (unchanged, unquantified risk)

The Government is reviewing the Department of Child, Youth and Family Services’ funding requirements in order to identify options for sustainable levels of funding and service delivery in the medium term. Options may be submitted for consideration in Budget 2006. The risk is unquantified as it is unclear what change in departmental funding is required. Any change in funding to reflect a new baseline and/or meet necessary capital injections would impact on the operating balance and/or gross debt.

Corrections - Capital Projects (changed, quantified risk)

In Budget 2005, $206 million capital and $220 million operating was appropriated for Corrections capital projects. The Department of Corrections has estimated that a further total of $124 million capital and $118 million operating funding would be required over the forecast period to meet future prison inmate forecasts. The actual amounts depend on the specification and timing of the individual projects and the contracted prices. These estimates include consideration of funding for the Otago Region Corrections Facility and Mt Eden Prison.

Capital injections would increase gross debt while operating funding would decrease the operating balance.

The Minister of Finance has yet to fully consider the quantum of these risks.

Source: Department of Corrections

Crown Risk - Pay and Employment Equity Taskforce (unchanged, unquantified risk)

The Government has established the Pay and Employment Equity Unit in the Department of Labour to oversee the implementation of a five-year plan of action to establish pay and employment equity in the public service, public health and public education sectors. Until pay and employment equity audits and pay investigations have been undertaken in these sectors it is unclear what, if any, the fiscal implications of this process will be. However, any resulting increases in operating funding would decrease the operating balance.

Culture and Heritage - Public Broadcasting Programme of Action (unchanged, quantified risk)

On 3 February 2005, the Government released a Public Broadcasting Programme of Action. The Programme contains a set of priorities to guide public broadcasting policy over the next six years, and a series of proposals to give effect to these priorities. The Programme as a whole (if fully implemented) would have total ongoing operating costs rising to around $44 million in 2009/10. Broadcasting initiatives of $10.5 million per annum were included in Budget 2005, leaving a remainder of around $33.5 million. Other individual elements of the Programme of Action will be considered in future Budgets over the next six years. These would decrease the operating balance.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: Ministry for Culture and Heritage

Culture and Heritage - Rugby World Cup 2011 (unchanged, quantified risk)

In May 2005, the New Zealand Rugby Union (NZRU) submitted a bid to the International Rugby Board (IRB) to host the Rugby World Cup 2011 in New Zealand. The Government has agreed to provide the following direct financial support if the bid is successful: a $20 million cash contribution, and an uncapped underwrite for the tournament on a 67:33 loss sharing basis (Government:NZRU). If the bid is successful, the operating balance would decrease by approximately $20-70 million between 2005/06 and 2011/12.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: Ministry for Culture and Heritage

Economic Development - Large Budget Screen Production Fund (new, quantified risk)

The Large Budget Screen Production Fund has recently been increased by $12 million to cover payments that are likely to be made up till September 2005. In addition, the Film Commission is aware of a number of other possible applications being made later in 2005/06 that, if approved, would require up to a further $17 million. This would decrease the operating balance.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: Ministry of Economic Department

Education - Review of Tertiary Education Expenditure (changed, quantified risk)

The Government has made some progress in reviewing the quality, relevance, sustainability, and predictability of tertiary education spending. A number of decisions relating to sub-degree tertiary education provision were taken in July 2005[10]. The ongoing capital impacts of these decisions on Tertiary Education Institutions are as yet unclear, but could be up to $135 million.

Further policy development is underway and decisions are expected later in 2005 with a particular focus on policy and funding mechanisms that support teaching and/or student participation and value for money. Any resulting cost increases are likely to be partly offset by other policy decisions.

The Minister of Finance has yet fully consider the quantum of this risk

Source: Ministry of Education

Education - Schools ICT Network Infrastructure Upgrade (new, unquantified risk)

The Government is considering the roll-out of the Schools ICT Network Infrastructure Upgrade. This would assist schools to meet the costs of upgrading their computer networks to meet the new IT infrastructure standards.

The Ministry of Education has existing capital funding of $11 million which will be utilised for the initial roll-out. Additional operating funding of $0.35 million has been given for project management, communication and systems support. The Government will consider rolling out phase 2 as part of Budget 2006. This would decrease the operating balance and increase debt.

This risk is unquantified as disclosure could compromise the Crown in negotiations.

Education - School Property (unchanged, quantified risk)

The Government has provided capital of $77.5 million in 2005/06 for school accommodation. Additional capital injections for school accommodation are likely to be required in future years to meet roll growth. Additional capital injections could be up to $136 million in each of the next three years with a corresponding increase in gross debt.

In addition to capital injections, consequential operating costs of $6 million in 2006/07, $13 million in 2007/08 and $20 million in 2008/09 are likely to be incurred, which would decrease the operating balance.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: Ministry of Education

Education - Wananga Capital Injection (unchanged, unquantified risk)

Ministers are currently negotiating with one Wananga (Māori tertiary institution) over settlement of its Waitangi Tribunal claim. The Waitangi Tribunal has recommended that the Wananga be compensated for capital expenditure that has been incurred on facilities to date, be provided funding to bring their facilities up to a standard comparable with other tertiary institutions, and to meet additional capital requirements. A second Wananga claim, which has already been settled, may require a further capital injection should certain conditions be met.

Any capital injection would increase gross debt. This risk is unquantified as disclosure could compromise the Crown in negotiations with the Wananga.

Environment – Hazardous Substances and New Organisms: Compliance and Enforcement (new, quantified risk)

The Government is considering long-term funding requirements for hazardous substance compliance and enforcement. Proposals are also being developed to clarify the role of ERMA, territorial authorities and regional councils with respect to compliance, monitoring and enforcement. The policies to deliver an effective compliance and enforcement regime are still under development, but initial estimates are for costs up to $15 million per annum. Decisions are likely to be made as part of Budget 2006, and would decrease the operating balance.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: Ministry for the Environment

Finance - Crown Overseas Properties (unchanged, unquantified risk)

The Government is considering options relating to the continued use of certain Crown overseas properties.

The risk is unquantified as disclosure could compromise any negotiations the Crown may enter, but any additional operating funding would decrease the operating balance, and/or any additional capital funding would increase debt.

Finance - Meridian Energy (new, unquantified risk)

Meridian is currently investigating the possibility of selling its wholly owned Australian subsidiary, Southern Hydro Limited. A final decision on this is not expected until at least October 2005. A gain on sale would increase the operating balance.

Finance - National Rail Access Agreement (new, unquantified risk)

The Government is considering options for amending the National Rail Access Agreement between Toll and Ontrack. Any impact on the operating balance or debt would depend on the option chosen.

This risk is unquantified as disclosure could compromise the Crown in negotiations.

Finance - National Rail Network Upgrade (changed, quantified risk)

The Government has committed $200 million between 2004/05 and 2007/08 to upgrade the national rail network. Further expenditure of between $200m and $300m is likely to be required over the forecast period, but the amount and timing will depend on policy decisions yet to be made. Under the National Rail Access Agreement, additional funding of this nature would generally be recovered through track access fees. Any additional funding would increase debt.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: The Treasury

Finance - SOE Long-term Hold Reviews (new, unquantified risk)

To implement its long-term hold ownership policy, the Government is conducting reviews of each SOE. These reviews are examining the strategic direction for each SOE and therefore the appropriate capital structure to support the individual SOE's strategy. One possible outcome of current reviews is that some capital could be returned to the Crown. This may be in the form of a special dividend, which would decrease gross debt.

Fisheries - Māori Interest in Marine Farming (unchanged, unquantified risk)

The Māori Commercial Aquaculture Claims Settlement Act 2004 addresses Māori claims in commercial marine farming space from 21 September 1992 to 31 December 2004 (pre-commencement space) by providing Iwi with 20% equivalent space. This obligation is to be met through three possible options: the provision of additional new space; or Crown purchase of existing farms from 2008; or provision of the financial equivalent of space from 2013.

Under the Act, any Māori claim relating to new aquaculture space after 31 December 2004 will be met by the provision of 20% of the new space.

To the extent that financial compensation or Crown purchase of existing farms is necessary to address Māori interests (as opposed to using new space), this would decrease the operating balance. The risk is unquantified as the amount or timing of any funding is unclear, and in addition, disclosure could compromise the Crown in negotiations with either commercial marine farm owners or Iwi.

Foreign Affairs and Trade - Official Development Assistance (new, unquantified risk)

The Government is considering increasing the aid budget as and when resources allow, in line with United Nations commitments. The Government has committed to an ODA to GNI ratio of 0.27% for the fiscal years 2005/06 and 2006/07, increasing to 0.28% in 2007/08[11]. From 2008/09, the Government will investigate a range of options for increasing and allocating any additional funding, which would decrease the operating balance.

This risk would, if it eventuates, be considered for funding from the Government’s forecast new operating spending amount.

Health - District Health Board Deficits (changed, unquantified risk)

Draft District Annual Plans from District Health Boards (DHBs) for 2005/06 indicate deficits in the order of $80 million in 2005/06, primarily in Auckland, with a smaller deficit in Whanganui. A similar level of deficits is forecast for 2006/07. While operating funding has been allocated to cover these forecast deficits, the Government has not accepted the size of the forecast deficits and is actively discussing actions and cost-containment measures with these DHBs.

Any deficits in excess of the forecast amount that are unable to be funded from the allocated operating funding would potentially decrease the operating balance and/or increase debt. Specific potential pressures for DHBs include wage bargaining, funding for health of older people services, and financing costs of capital projects.

This risk has changed since the 2005 BEFU to take into account the new financial forecasts submitted by DHBs.

Housing - HNZC's Long-term Capital Requirements (unchanged, quantified risk)

The Government is currently considering Housing New Zealand Corporation’s (HNZC) long-term capital requirements in light of the demand for state housing and the need to reconfigure and modernise its housing stock. While some decisions were made in the 2005 Budget regarding the acquisition of new stock, the Government is likely to review acquisition targets and has still to consider options around modernisation programmes directed at existing stock. Decisions are likely in Budget 2006.

The Government is further examining the range of options and associated costs, with initial estimates of up to $1.6 billion of capital costs over a 10 to 15 year horizon. Any new capital contributions would increase gross debt and would likely lead to an increase in the Income-Related Rent subsidy with a subsequent decrease in the operating balance.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: Department of Building and Housing

Housing - State Housing Project at Hobsonville (unchanged, unquantified risk)

In Budget 2005, HNZC has received funding of $54.3 million to acquire, under the Housing Act 1955, NZDF land at Hobsonville deemed surplus to defence requirements but suitable for state housing purposes. The Government may consider development options that would lead to the Crown giving additional capital to HNZC, which would increase gross debt.

Housing - Weathertight Homes (new, unquantified risk)

Following the transfer of the Weathertight Homes Resolution Service (WHRS) to the Department of Building and Housing on 1 July 2005, the Government is considering measures to increase the rate at which non-weathertight homes in New Zealand are repaired. These measures are being developed for consideration in October 2005 and will include administrative or legislative changes to enhance the operation of the WHRS. Government is also considering whether there is a need for targeted assistance for low income homeowners to undertake repairs. The fiscal impact, if any, depends on what measures and options are agreed, but any additional operating funding would decrease the operating balance.

Immigration - Immigration Policy (unchanged, quantified risk)

The Government has amended immigration investor policy. Migrants in the investor category will be required to invest $2 million with the Government for five years. These bonds will be used to finance infrastructure. Migrants will receive a return on their investment based on inflation, and may withdraw up to half of the total investment after two years if they have a specific business proposal in New Zealand. The policy was implemented from 30 June 2005. However, uptake of the new policy is unclear at this stage, and so has not been included in forecasts. The increase in gross debt, based on a flow of 40 to 80 people, is currently estimated to be between $80 million and $160 million per year.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: Department of Labour

Internal Affairs - 2004 and 2005 Storms Response and Infrastructure Costs (changed, quantified risk)

The lower North Island and the Bay of Plenty were hit by severe storms during 2004, and the Bay of Plenty again in May 2005. The Government reimburses some local authority costs under the National Civil Defence Plan. Several local authorities have made submissions for reimbursement, and further submissions are expected. The Government has already provided around $20 million as a contribution toward response and recovery costs. Remaining costs could be between $5 million and $20 million and would reduce the operating balance.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: Department of Internal Affairs

Justice - New Supreme Court - Cost Escalation (unchanged, quantified risk)

In order to meet revised functional requirements, the Government is considering altering the 2003 design for accommodating the new Supreme Court. This could increase construction costs. The original scheme was approved by Cabinet at a cost of $19 million; the additional capital cost could range from $15 million to $20 million, depending on the revised design option selected. This would increase gross debt.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: Ministry of Justice

Lands and Agriculture and Forestry - Implementation of Walking Access Strategy (new, unquantified risk)

The Government has agreed to the principles of a New Zealand Walking Access Strategy, with funding provided in Budget 2005. The details of how the Strategy will be implemented are still under consideration. Further funding may be required, depending on the final options chosen. This would decrease the operating balance.

New Zealand Defence Force - Defence - Capital Injections (unchanged, quantified risk)

Implementing the Government’s decisions on the future structure of the NZDF will involve a series of capital acquisitions across all three armed services and for HQNZDF to achieve the required capability upgrades. The Government has agreed to a capital injection of up to $1.244 billion over 2001/02 to 2010/11.

Of the Long-Term Development Plan funding, $690 million has been agreed, with the remainder likely to be required over the next four years. The actual expenditure profile will depend on the specification and timing of the individual projects, the contracted prices, and the prevailing exchange rate at the time of purchase.

Any capital injections would increase gross debt.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: New Zealand Defence Force

New Zealand Defence Force - Environmental Clean-up of Devonport Seabed Contamination (unchanged, quantified risk)

The Government has identified historic contamination in the seabed adjacent to the Calliope Dock at the Devonport Naval Base. Investigatory work on the contamination is underway, and it is anticipated that better information will be available shortly to determine the scope of the issue. Costs are estimated to be $13.1 million over 2005/06 and 2006/07, which would decrease the operating balance.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: New Zealand Defence Force

New Zealand Defence Force - Sale of Skyhawks and Aermacchi Trainers (unchanged, unquantified risk)

As a result of the Government’s decisions on the future structure of the NZDF, NZDF is in the process of selling the Skyhawks and Aermacchi trainers. Proceeds from the sale would increase the operating balance.

This risk is unquantified as disclosure could compromise the Crown in the sale process.

Revenue - Fringe Benefit Tax Review (unchanged, quantified risk)

The Budget 2005 Business Package included changes to fringe benefit tax policies. The Government is considering further work on changes to the fringe benefit tax rules focusing on eliminating certain anomalies in relation to motor vehicles.

The reduction in the operating balance would depend on which proposals are finally approved and the details of the legislation. However, the estimated net fiscal cost is likely to be within the range of $24 million to $64 million per annum.

The Minister of Finance has yet to fully consider the quantum of this risk

Source: Inland Revenue

Revenue - Subsidies for Payroll-Related Tax Compliance Costs (unchanged, quantified risk)

As part of the tax simplification programme the Government plans to implement a legislative framework to subsidise the use of payroll agents to meet small employers’ PAYE obligations. The structure and amount of the subsidy are contingent on successful negotiation with payroll agents and the reduction in the operating balance will depend on the final structure of the subsidy adopted. The estimated cost of the subsidy is between $7 million and $45 million per annum. On the basis that the subsidy can be negotiated, a target date of 1 April 2006 has been set for implementation. This would decrease the operating balance.

The Minister of Finance has yet to fully consider the quantum of this risk

Source: Inland Revenue

Revenue - KiwiSaver (new, unquantified risk)

Changes to the KiwiSaver proposal may allow members of registered superannuation schemes increased options to convert their existing superannuation scheme accounts. Increasing use of KiwiSaver by current savers will increase the costs of the proposal. While design work continues it is difficult to quantify the effect any changes may have. There will be a report-back on this issue by the end of 2005. Any increase in cost would decrease the operating balance.

Revenue - Review of Superannuation Contribution Withholding Tax (new, unquantified risk)

The Government is considering reforming the provisions relevant to superannuation contributions withholding tax with a view to simplifying the provisions and investigating possible equity issues arising from the current provisions. Any changes to the provisions are expected to come into effect in 2007. Whether the outcome of this review will have an impact on the operating balance is unclear and would depend on the proposals that are finally developed and approved.

Revenue - Tax and Depreciation (unchanged, unquantified risk)

The Budget 2005 Business Package included changes to depreciation policies. The Government is considering further issues related to depreciation, including the treatment of long-lived assets and potential changes to the tax treatment of rental housing in particular. However, the impact on the operating balance remains unclear as it would depend on the options chosen.

Revenue - Taxation of Offshore Portfolio Investment and Intermediaries, including Superannuation (changed, quantified risk)

The Budget 2005 Business Package included changes to the taxation of domestic intermediaries and further work is underway. This includes consideration of the taxation of both onshore and offshore investments in equity by New Zealand residents. A target date of April 2007 has been set for implementation of changes, some of which had been included in the Budget 2005 Business Package. Further proposals are being considered. Depending on the decisions made, there would be a reduction in the operating balance by an additional $80 million to $90 million or an increase in fiscal revenue by $50 million to $60 million.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: Inland Revenue

Revenue - Taxation of Partnerships Review (new, unquantified risk)

The Government is considering reform to the taxation of partnerships, including replacing the current ‘special partnerships’ tax rules with more modern and internationally comparable ‘limited partnerships’ tax rules. Any new rules are likely to take effect on 1 April 2007. The impact on the operating balance is unclear and would depend on the proposals that are finally developed and approved.

Social Development - Early Intervention (unchanged, unquantified risk)

Budget 2005 includes an initial investment of $37.6 million over four years in early intervention services for children and families. Ministers are considering proposals for further development of the early intervention programme, including enhancements and expansion of the existing initiatives. New programmes may also be considered to respond better to the needs of children and their families. Further proposals are still being developed, but any additional funding would decrease the operating balance.

Social Development - Extending Opportunities to Work (unchanged, unquantified risk)

Following on from Working for Families, the Government is considering options for simplifying the benefit system and reforming labour market assistance and service delivery in order to better support beneficiaries’ entry to employment. Decisions are likely to be made as part of Budget 2006. The impact on the operating balance is unclear, as proposals are still being developed.

Social Development - Information Technology Systems (unchanged, unquantified risk)

The Government is considering the future development and/or replacement of its income benefit payment systems (SWIFTT and TRACE) and case management system. An Information Technology Strategy has been developed taking into account the Ministry’s Statement of Intent and work on the future needs of the Ministry. Decisions will be made on development and/or replacement when appropriate concept and product evaluations have been completed. The Ministry is seeking to fund any development and/or replacement from existing capital. To the extent the project is not funded from the Department’s balance sheet and existing baselines, the proposal would increase debt and reduce the operating balance.

State Services Commission - State Sector Retirement Savings Scheme (unchanged, unquantified risk)

The Government is considering options for extending the employer subsidy for members of the State Sector Retirement Savings Scheme beyond 3% (3% is the level of employer subsidy from 2005/06), and is also considering options for extending the scheme to the wider state sector. The decrease in the operating balance would vary depending on the options chosen.

Tertiary Education Savings Scheme (changed, unquantified risk)

The Government has recently released a request for expressions of interest in the establishment of a Tertiary Education Savings Scheme to assist families to save for their children’s tertiary education. The responses to the request have identified a range of policy issues that the Government wishes to consider further, including options to ensure that the scheme meets the needs of middle to low-income groups. The decrease in the operating balance would vary depending on the options chosen.

This risk is unquantified as disclosure could compromise the Crown in negotiations.

Transport - Regional Transport Initiatives (changed, unquantified risk)

The Government is considering possible involvement in regional transport initiatives working in participation with Local Government to make significant and timely improvements to regional land transport outcomes. Since Budget 2005 the Government has provided $150 million over ten years to the Bay of Plenty region to improve land transport outcomes. The Government has also announced the start of a consultation process with the Waikato region.

Youth Development - United Nations Convention on the Rights of the Child (unchanged, quantified risk)

If unconditionally adopted, the United Nations Convention on the Rights of the Child would require New Zealand to confer the rights of the Convention on all children. To date, New Zealand has reserved its right to distinguish between persons according to the nature of their authority to be in New Zealand. The Government established a review to consider whether this reservation can be removed. This could involve making changes to eligibility for some health, education and social services, which would decrease the operating balance by approximately $20 million per annum.

The Minister of Finance has yet to fully consider the quantum of this risk.

Source: The Treasury

#

Contingent Liabilities#

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Contingent liabilities are costs that the Crown will have to face if a particular event occurs. Typically, contingent liabilities consist of guarantees and indemnities, legal disputes and claims, and uncalled capital. The contingent liabilities facing the Crown are a mixture of operating and balance sheet risks, and they can vary greatly in magnitude and likelihood of realisation. In general, if a contingent liability were realised it would reduce the operating balance and net worth, and increase net Crown debt. However, in the case of contingencies for uncalled capital, the negative impact would be restricted to net Crown debt.

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

Contingent liabilities have been stated as at 31 May 2005, being the last set of published contingent liabilities.

Foreshore and seabed recognition

The foreshore and seabed Act 2004 (FSA):

• vests the full legal and beneficial ownership of the public foreshore and seabed in the Crown
• provides for the recognition and protection of ongoing customary rights with respect to the public foreshore and seabed
• enables applications to the High Court to investigate if previously held common law rights have been adversely impacted, and if so, providing for those affected either to participate in the administration of a foreshore and seabed reserve or else enter into formal discussions on redress, and
• provides for general rights of public access and recreation in, on, over, and across the public foreshore and seabed and general rights of navigation within the foreshore and seabed.

The public foreshore and seabed means the marine area that is bounded on the landward side by the line of mean high water spring; and on the seaward side by the outer limits of the territorial sea, but does not include land subject to a specified freehold interest (refer section 5 of the FSA).

The FSA codifies the nature of the Crown's ownership interest in the public foreshore and seabed on behalf of the public of New Zealand. Although full legal and beneficial ownership of the public foreshore and seabed has been vested in the Crown, there are significant limitations to the Crown's rights under the FSA. As well as recognising and protecting customary rights, the FSA significantly restricts the Crown's ability to alienate or dispose of any part of the public foreshore and seabed and significantly restricts the Crown's ability to exclude others from entering or engaging in recreational activities or navigating in, on or within the public foreshore and seabed. Because of the complex nature of the Crown's ownership interest in the public foreshore and seabed and because we are unable to obtain a reliable valuation of the Crown's interest, the public foreshore and seabed has not been recognised as an asset in these financial statements.

Details of each of the following contingent liabilities can be accessed from the Treasury website at http://www.treasury.govt.nz/forecasts/prefu/2005/.

Quantifiable Contingent Liabilities

Unquantifiable Contingent Liabilities

 

3 Generally Accepted Accounting Practice (GAAP) Series Tables#

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Forecast Financial Statements#

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

They are based on the accounting policies and assumptions that follow. As with all such assumptions, there is a degree of uncertainty surrounding them. This uncertainty increases as the forecast horizon extends.

The forecasts have been prepared in accordance with the Statement of Responsibility and reflect the judgements and information known at the time they were prepared. They reflect all Government decisions and circumstances communicated to 8 August 2005.

Finalisation dates and key assumptions that underpin the preparation of the GAAP tables are outlined on the following page.

10 year trend information

Fiscal Forecasts – Finalisation Dates and Key Assumptions

Key assumptions

The fiscal forecasts have been prepared in accordance with the Public Finance Act 1989. They are based on the Crown’s accounting policies and assumptions (refer page 63). As with all assumptions, there is a degree of uncertainty surrounding them. This uncertainty increases as the forecast horizon extends. A summary of the key economic assumptions that are particularly relevant to the fiscal forecasts is provided below (on a June-year-end basis to align with the Crown’s balance date of 30 June):

Source: The Treasury

New Zealand Superannuation (NZS) Fund

The contribution to the NZS Fund for the year ending 30 June 2006 is $2.337 billion. The contribution to the NZS Fund is calculated over a 40-year rolling horizon to ensure that superannuation entitlements over the next 40 years can be met if the contribution rate were to be held constant at that level. The Government is making the required minimum annual contribution for 2004/05 as calculated by the formula set out in the NZS Act.

The underlying assumptions in calculating the contributions are the nominal GDP series to 2046, the NZS expense series to 2046 and the expected long-term, net after-tax annual return of the NZS Fund (6.1%) (6.1% Budget Update). The forecast rate of return is based on the Treasury’s assumptions for the rate of return on financial portfolios of Crown financial institutions.

The Treasury website contains further information on the NZS Fund, as well as a copy of the NZS Fund model.

Statement of Accounting Policies and Forecast Assumptions#

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General Accounting Policies and Forecast Assumptions

General accounting policies

Accounting policy

These Forecast Financial Statements comply with generally accepted accounting practice. The measurement base applied is historical cost adjusted for revaluations of property, plant and equipment (where appropriate), commercial forests and marketable securities and deposits and equity investments held for trading purposes.

Revaluations are made to reflect the forecastservice potential or economic benefit obtained through control of the assets. The accrual basis of accounting has been used.

Forecast assumptions

For forecast purposes, no revaluations of property, plant and equipment are projected beyond the current year.

Specific Accounting Policies and Forecast Assumptions

Forecast periods

The reporting periods covered by these Forecast Financial Statements are the years ending 30 June 2005, 30 June 2006, 30 June 2007, 30 June 2008 and 30 June 2009.

Certain state-owned enterprises and Crown entities have different reporting periods from the Crown.

The forecasts for 30 June 2005 have generally been prepared using actual data to 31 May or 30 June 2005 (in some instances). Transactions for the remainder of the year are forecast in accordance with the Crown’s accounting policies and forecast assumptions.

Changes in accounting policies

All policies have been applied on a consistent basis during the forecast period. There have been no changes in accounting policies during the period.

Detailed accounting policies and forecast assumptions

The specific accounting and forecasting policies are reproduced in full on Treasury’s website at www.treasury.govt.nz/forecasts/prefu/2005.

Reporting Entity as at 8 August 2005#

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

Organisations named or described in Schedule 4 to the Public Finance Act 1989

• Agriculture and Marketing Research and Development Trust
• Asia New Zealand Foundation
• Fish and game councils (12)
• Leadership Development Centre Trust
• New Zealand Fish and Game Council
• New Zealand Game Bird Habitat Trust Board
• New Zealand Government Property Corporation
• New Zealand Lottery Grants Board
• Ngai Tahu Ancillary Claims Trust
• Pacific Co-operation Foundation
• Pacific Islands Business Development Trust
• Reserves boards (26)
• Road Safety Trust

Forecast Statement of Financial Performance

The revenues and expenses are GST exclusive.

The accompanying Notes and Accounting policies are an integral part of these Statements.

Below is an analysis of total Crown expenses and core Crown expenses by functional classification. This information reconciles to segmental information within the Statement of Segments.

The accompanying Notes and Accounting policies are an integral part of these Statements.

Forecast Statement of Cash Flows

¹ Net issues of Government stock include movements within government stock holdings of entities such as NZS Fund, GSF, ACC and EQC. The Bonds Reconciliation at the end of these forecasts outlines NZDMO issues of Government stock.

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 Movement in Equity

The accompanying Notes and Accounting policies are an integral part of these Statements.

Forecast Statement of Financial Position

The accompanying Notes and Accounting policies are an integral part of these Statements.

Below is an analysis of the NZS Fund and Gross and Net Debt information. The notes to the accounts provide breakdown of other key items.

Gross and Net Debt Information

Definitions of debt:

Total Crown gross debt is the total borrowings (both sovereign-guaranteed and non-sovereign guaranteed) of the total Crown. This equates to the amount in the total Crown balance sheet and represents the complete picture of whole-of-Crown debt obligations to external parties.

The balance sheet splits total Crown debt into sovereign-guaranteed and non-sovereign-guaranteed debt. This split reflects the fact that debt held by SOEs and Crown entities is not explicitly guaranteed by the Crown. Any such debt that may be guaranteed is included in the sovereign-guaranteed total. No debt of SOEs and Crown entities is currently guaranteed by the Crown.

Gross sovereign-issued debt is debt issued by the sovereign (i.e., core Crown) and includes Government stock held by the NZS Fund, GSF, ACC or EQC for example. In other words, the gross sovereign-issued debt does not eliminate any internal cross-holdings. The Government's debt objective uses this measure of debt.

The accompanying Notes and Accounting policies are an integral part of these Statements.

Forecast Statement of Borrowings

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

The accompanying Notes and Accounting policies are an integral part of these Statements.

A detailed Statement of Contingent Liabilities and Assets (quantified and unquantified) is outlined on pages 58 to 60 of the Specific Fiscal Risk chapter.

The Statement of Specific Risks (quantified and unquantified) is outlined on pages 47 to 57 of the Specific Fiscal Risk chapter.

Forecast Statement of Segments#

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Notes to the Forecast Financial Statements#

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The forecast new operating spending represents an amount that indicates in broad terms the potential spending increases that could be introduced in each future budget round. The forecasts include $1.9 billion for Budget 2006, Budget 2007 and Budget 2008. The remaining amounts are lower as some spending has already been allocated (e.g. as part of Health sector funding packages, the Defence funding package, Official Development Assistance and some Education funding), leaving indicative totals of around $1.2 billion for Budget 2006 and $1.8 billion for Budget 2007.