Pre-Election Economic and Fiscal Update 2008

How the Pre-election Update is organised#

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The 2008 Pre-election Update sets out the Treasury’s latest economic and fiscal forecasts for the current year and the next four years. The document is organised as follows:

• A Statement of Responsibility from the Secretary to the Treasury and the Minister of Finance is included on page 1.
• A Ministerial Statement from the Minister of Finance is provided on page 3.
• The Executive Summary (page 5) provides a short summary of the economic and fiscal forecasts.
• The Economic and Tax Outlook chapter (page 11) sets out the Treasury's economic and tax forecasts, including forecasts of major economic aggregates (eg, output, inflation, employment and the current account), and a statement of significant assumptions.
• The Fiscal Outlook chapter (page 21) sets out the Treasury's fiscal forecasts, including forecasts of revenue and expenses, operating results, the cash position, debt and the NZS Fund. It also contains projections of key fiscal indicators for the ten years following the forecast period. In previous Pre-election Updates these ten-year projections, which by their nature are less precise than the forecasts, have been published separately on the Treasury website. They are now incorporated into the document to make this information easier to access and to provide a fuller picture.
• The Risks and Scenarios chapter (page 49) describes some of the key risks to Treasury's central economic forecasts, and sets out two alternative scenarios for how the economy might develop.
• The Specific Fiscal Risks chapter (page 57) sets out material risks and contingent liabilities that could have an impact on the fiscal forecasts if decisions being considered by ministers are taken, or if particular circumstances eventuate. This chapter also discloses commitments that have been made against future budget allowances.
• The Generally Accepted Accounting Practice (GAAP) Series Tables chapter (page 83) provides a set of forecast financial statements, and a statement of accounting policies and assumptions.
• The Core Crown Expense Tables chapter (page 113) provides information on core Crown expenses broken down into functional classifications; a glossary of terms; and a time series of fiscal and economic indicators.

Finalisation Dates#

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The dates on which particular elements of this Pre-election Update were finalised are set out below.

Between the finalisation of the economic forecasts on 28 August and the finalisation of the text of the Pre-election Update on 26 September, a number of developments have taken place, including:

• The international financial crisis has continued to develop, with the US government taking control of Fannie Mae and Freddie Mac; US investment bank Lehman Brothers filing for bankruptcy protection; retail brokerage Merrill Lynch being bought by Bank of America; the US Federal Reserve announcing a rescue package for insurance company AIG; and the US Treasury developing a comprehensive plan to purchase “troubled assets” in order to stem further financial collapse.
• On 11 September the Reserve Bank of New Zealand cut the official cash rate by 50 basis points to 7.5%.
• The price of oil (West Texas Intermediate) fell to a low of US$91/barrel on 16 September, but increased again to US$111 on 25 September, just below its close of US$116 on 28 August.
• The NZ dollar fell to 61.9 on the Trade Weighted Index on 16 September but strengthened again to 64.2 on 26 September.

These international financial crisis developments, while not leading us to change our overall view of the economy, have increased the risks of a sharper downward correction.

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 17 September 2008 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

24 September 2008

 

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 17 September 2008 of which I was aware and that had material economic or fiscal implications.

 

Hon Dr Michael Cullen
Minister of Finance

24 September 2008

Ministerial Statement#

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In the time between the publication of Budget 2008 and the preparation of this Pre-election Economic and Fiscal Update there have been a series of significant events in world financial markets. The fallout on New Zealand's housing market and on business and household incomes arising from higher international credit costs has compounded the effects of a weakening domestic economy. This has resulted in a Pre-EFU noticeably weaker than at Budget time.

Nine years of prudent fiscal management and sustained economic growth means that New Zealand is well placed to deal with these challenging times. Despite calls to spend the surpluses in recent years this government has adhered to our fiscal objectives and has reduced Gross Sovereign Issued Debt (GSID) so that we can meet the economic challenges ahead, while still delivering tax cuts and support for families.

While the international position has worsened over recent months New Zealand has been in what is forecast to be a short and relatively shallow recession. Treasury is forecasting a return to positive growth in the last quarter of 2008. These forecasts, however, do highlight the importance of fiscal restraint during favourable economic times to enable us to have room to respond in less favourable times.

New Zealand is well placed to manage the external shock that our economy has endured. So while today's report card highlights how critically important it was to utilise more favourable international and domestic economic times to save for a rainy day, it also tells us that the rainy day has arrived and that the Crown's fiscal position has taken a big hit. Changes in the operating balance from the Budget forecasts are predominantly driven by the weaker economic outlook (reductions in revenue and associated finance costs).

The New Zealand economy has come a long way since 1999:

• the 1999 Pre-EFU forecast an unemployment rate of 7.0% in the March 2000 quarter compared with this Pre-EFU forecast of 4.4% unemployment in the March 2009 quarter
• real gross domestic product (GDP) growth averaged 2.9% from 1990 to 1999 compared with 3.5% from 1999 to 2007
• in 1999 net core Crown debt sat at 21.8% of GDP but this moved into a positive net financial asset position (including NZ Super Fund assets) since 2006, and
• in 1999, GSID was above 35% of GDP but it has been brought down to below the government's medium-term target.

And we have achieved all this while enhancing social equality and while delivering significant gains for New Zealanders including:

• the longest period of economic expansion since WWII
• strong investment in New Zealand's infrastructure after the 1990s decade of neglect
• lower primary health care costs
• restoring and lifting entitlements in superannuation
• tax relief for businesses, savers and families with children, and
• personal tax cuts for all workers.

This Government is proud of what it has achieved during the past three terms. The New Zealand economy of 2008 is much stronger and more sustainable than that of 1999 and it is also fairer.

Executive Summary#

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The economic and fiscal outlook has deteriorated since the Budget Update

In the five months since the Budget Update was finalised, we have witnessed a number of significant domestic and international developments: in particular, the deepening of the international financial crisis, the slowing housing market, and growing pressure on households and businesses. These developments are key factors in our updated view of the economy and the government's finances set out in this Pre-election Update.

We are now expecting weaker economic growth over the next few years, resulting in slower growth in tax revenue and higher government expenditure. Combined with increases in the costs of some existing policies, these factors lead to sustained operating balance deficits and higher debt-to-GDP ratios.

The economic outlook is weaker …

Imbalances have built up during nearly a decade of sustained growth, including inflation pressures, an overvalued housing market, high household debt and a large current account deficit, with implications for interest rates and the exchange rate. With the economy slowing, these imbalances are starting to unwind - as are imbalances in the global economy - but there is a long way to go.

As expected in the Budget Update, the drought has had a significant negative influence on the economy, and was a chief factor in the recession in the first half of 2008 – reducing dairy production, hydro electricity generation and manufacturing output.

Figure 1 - Real GDP growth

Source:  Statistics New Zealand, The Treasury

Figure 1 shows a much weaker economic outlook than in the Budget Update, driven by a number of developments:

• The domestic slow-down has been sharper than expected, with declines in consumption and residential investment.
• Households and businesses have come under increasing cost pressures – electricity, interest rates, fuel and food – which are dampening private consumption and firm profitability. It will take time for these pressures to dissipate, though some relief in terms of oil prices and interest rates has emerged since the finalisation of our economic forecasts.
• The housing market has weakened more quickly than expected. It will remain depressed over the next year as a result of high effective interest rates, low net migration flows and falling consumer confidence, which will affect private consumption and residential investment.
• The international financial crisis has deepened and is having an adverse impact on global economic growth. New Zealand is expected to feel the effects of the financial crisis principally through the tighter availability and increased costs of credit, but also through a fall in business and consumer confidence, falling asset values and lower demand and prices for our exports.

While there are some positive factors for growth in the short term - eg, recovery from the drought and personal tax cuts boosting consumption - the factors above point to the recovery being gradual.

A more sustained pick-up in growth is forecast from mid-2009. We expect impetus to come particularly from the export sector, as primary export volumes increase and a lower exchange rate stimulates demand for manufactured products and services.

Note: Employment is on a full-time equivalent basis; unemployment is a percentage of the labour force, March quarter, seasonally adjusted; consumer price inflation is measured as an annual percentage change.

Source: The Treasury

… meaning lower tax revenue and higher government spending

The weaker economic growth that we are forecasting is reflected in reductions in our tax revenue forecasts. Compared with the Budget Update, we expect tax revenue to be on average around $900 million lower for each of the next three years.

• The weak outlook for the household sector will have a direct impact through GST, which is forecast to grow by around 4% per annum over the next five years, compared with 7.5% over the six years to 2007.
• With firms' margins under pressure and profitability low, underlying corporate income tax is forecast to decline by 3% in the 2009 June year, and growth is expected to be negligible in 2010 as accumulated tax losses offset profits.
• A relatively robust forecast for wages over the next few years helps to keep underlying growth in PAYE up at around 5% per annum.

The largest single change in government spending in the Pre-election Update is an increase in the expected costs of benefits. Compared with the Budget Update, benefit expenses are around $500 million per annum higher, reflecting both an increase in numbers of beneficiaries as a result of the slowing economy, and the impact of higher inflation on the costs of indexing benefits.

The cost of some existing policies is higher …

The cost of some existing policies has increased since the Budget Update, particularly:

• education spending is around $200 million per annum higher, driven by higher-than-expected take-up of the 20 hours free early childhood education initiative, and
• KiwiSaver costs are higher, reaching an extra $280 million per annum by 2012, driven by higher-than-expected take-up rates.

… and debt servicing costs have increased

As a result of the various factors set out above, the government's debt outlook deteriorates. This leads to higher debt servicing costs, which are forecast to be around $500 million per annum higher.

These developments lead to a sustained period of operating balance deficits …

Figure 2 - OBEGAL excluding NZS Fund retained revenue

Source:  The Treasury

As a result of the combination of weakening tax revenue and higher expenditure outlined above, we are forecasting the operating balance before gains and losses (OBEGAL) excluding New Zealand Superannuation (NZS) Fund retained revenue to move into a deficit of $31 million in the current year, which worsens to $3.2 billion by 2012/13. Projections beyond this do not return to surplus until 2017/18.

This contrasts with the position in the Budget Update, where we were expecting a track of modest surpluses through time.

Figures 2 to 4 show the Pre-election Update forecasts (solid lines) and projections (dotted lines) of key fiscal indicators.[1]

Figure 3 - GSID excluding Reserve Bank Settlement Cash

Source:  The Treasury

… and larger cash deficits, leading to higher levels of debt

The deterioration in the operating outlook results in a worsening of the government's residual cash outlook. We are forecasting a cash deficit of $5.9 billion in 2008/09, growing to $7.3 billion in 2012/13.

Figure 4 - Net core Crown debt, net core Crown debt including NZS Fund assets

Source:  The Treasury

These larger cash deficits flow through into higher gross sovereign-issued debt (GSID) excluding Reserve Bank Settlement Cash. By 2012/13 we forecast GSID excluding Settlement Cash to rise to 24.3% of GDP.

Beyond 2012/13, we project GSID excluding Settlement Cash to rise to 30.1% of GDP in 2018/19 before falling to 27.7% of GDP in 2022/23.

The outlook for net debt has also weakened. We now forecast net core Crown debt excluding NZS Fund assets to rise to 13.2% of GDP by the end of the forecast period, and we project it to peak at 20.3% of GDP in 2018/19.

Figure 5 - Sensitivity of GSID projections to assumptions: changing the real GDP growth rate in the projection period

Source:  The Treasury

The increase in net core Crown debt in the forecast period is more pronounced than the increase in GSID excluding Settlement Cash. This is because some of the cash deficits in the forecast period are financed by a reduction in financial assets which have built up in recent years. These financial assets are captured in net core Crown debt, but not in GSID excluding Settlement Cash.

Projections of debt are particularly sensitive to assumptions: small changes can compound and have large impacts in the future. For example, as illustrated in Figure 5, if real GDP growth from 2013/14 onwards was 3% rather than the assumed 2.5% because productivity was higher, by 2022/23 this would reduce GSID excluding Settlement Cash as a percentage of GDP by ten percentage points. This is because in the projections the higher productivity would lead to higher wages, GDP and tax revenue, but most government spending is assumed to continue to grow at 2% per annum.

Source: The Treasury

Further risks remain

These forecasts are subject to a number of risks, which are discussed in the Risks and Scenarios and Specific Fiscal Risks chapters. It is worth highlighting a couple of risks:

• The international financial crisis has been moving rapidly, and considerable uncertainty remains. Developments subsequent to the finalisation of our economic forecasts on 28 August, while not leading us to change our overall view of the economy, have increased the risks of a sharper downward correction.
• The funding allowances for future Budgets, particularly for Budget 2009, are expected to come under considerable pressure. (Details of charges against future Budgets are set out on page 28.) The fiscal forecasts assume that spending and revenue pressures can be managed within these funding allowances. If they cannot, the fiscal position would deteriorate further.

 

1 Economic and Tax Outlook #

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Introduction#

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This chapter presents the most likely path for the New Zealand economy and tax revenue and forms the basis for the Fiscal Outlook chapter. The forecasts were prepared during a period of heightened uncertainty in the global economy and they depend on a number of judgements about the associated risks. The Risks and Scenarios chapter discusses those risks in more detail and develops two scenarios based on different judgements about them.

Economic Growth and Tax Revenue Lower than Previously Forecast#

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Figure 1.1 - Real gross domestic product

Source:  Statistics New Zealand, The Treasur

The New Zealand economy, like a number of others, is currently facing imbalances in the areas of inflation, household debt, house prices and the current account. As a result of drought, higher consumer prices and previous monetary tightening, output declined in the first two quarters of 2008 and is expected to have declined marginally in the September quarter. Growth is forecast to be positive in the final quarter of 2008 thanks to the recovery from the drought and tax cuts, but will remain subdued throughout most of 2009 as negative influences continue to affect the economy. As the world economy recovers, the domestic economy picks up and inflation and monetary conditions ease, growth will return above trend later in the forecast period, driven initially by increased exports (Figure 1.1). With economic activity forecast to be lower than in the Budget Update, core Crown tax revenue is expected to be $3,148 million lower in aggregate over the next four years.

Source: The Treasury

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Assumptions for the Forecasts#

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Trading partner growth - Consensus forecasts for economic growth in New Zealand's top 20 trading partners in 2008 and 2009 have been revised down steadily over the course of 2008. In anticipation of further revisions, we have reduced the August Consensus forecasts from 3.1% and 3.0% in 2008 and 2009 (respectively) to 2.9% and 2.8%. Growth is estimated to recover subsequently to around 3.5%. Recent developments in financial markets since these forecasts were finalised on 28 August have increased the risks of further downward revisions in the forecasts. The Risks and Scenarios chapter presents a case based on lower world growth.

Global inflation and interest rates - Inflation has increased in all our major trading partners as a result of rising food and fuel prices but is expected to decline as these prices stabilise or fall. Despite higher inflation, policy interest rates have been lowered in all major economies except Japan and the Euro area in response to the financial crisis and weaker economic growth. Commercial interest rates, however, are higher as inter-bank rates have increased. Interest rates are expected to return to neutral levels by 2010.

Figure 1.2 - West Texas Intermediate oil price

Source:  Datastream, The Treasury

Oil prices - We have assumed that the price of West Texas Intermediate (WTI) oil will decline from an average of US$124/barrel in the June quarter of 2008 to US$115/barrel at the end of the forecast period. These forecasts were based on the average futures prices in August 2008 and average 13% higher throughout the forecast period than in the Budget Update (Figure 1.2). Since the end of August, the price of WTI has fluctuated widely, showing the increased uncertainty associated with these forecasts.

Terms of trade - The merchandise terms of trade (as measured in the System of National Accounts) are estimated to have peaked in the March quarter of 2008 and to decline 7.0% in the following five years as commodity prices fall from their peaks. The terms of trade are approximately 1.5% lower throughout the forecast period than in the Budget Update mainly because of lower dairy prices and higher oil prices.

Monetary conditions - We have assumed that the New Zealand dollar (NZ dollar) exchange rate will decline 22.7% from 69.2 on the Trade Weighted Index (TWI) in the June quarter of 2008 to 53.5 at the end of the period. Ninety-day interest rates are assumed to fall from 8.8% in the June quarter of 2008 to 6.3% at the end of the period. These forecasts were finalised before the Reserve Bank reduced the Official Cash Rate by 50 basis points on 11 September 2008. That may hasten the fall in interest rates in the near term.

External migration - The net inflow of permanent and long-term migrants is assumed to increase from a low of 4,700 in the year to June 2008 to its 10-year average of 10,000 per annum by March 2010 as outflows, particularly to Australia, ease and inflows, including returning New Zealanders, increase as economic growth slows elsewhere.

Policy and tax - The forecasts assume no change in government policy and incorporate the tax cuts effective from 1 October 2008 and 1 April 2010 and 2011, as did the Budget Update.

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

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Weaker Growth as Global Economy Adjusts to Imbalances#

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The global economy is adjusting to significant imbalances

Figure 1.3 - World commodity prices

Source:  Commodity Research Bureau, Goldman Sachs

High consumption growth in developed economies in recent years and increased production in developing economies led to developing economies building up large trade surpluses which provided funding for the rapid growth in the developed economies. The greater integration of low-cost developing economies into the world trade system helped suppress inflation and allowed interest rates to become established at low levels, encouraging investment in housing and inflating house prices. The search for higher yields led investors to under-estimate the risks of some investments. At the same time, growth in the developing economies was resource-hungry, pushing up commodity prices (Figure 1.3).

The sub-prime mortgage crisis, which developed in the United States (US) in mid-2007, was the trigger for the unwinding of these imbalances and the world economy, especially the US economy, is now undergoing the necessary adjustment. House prices have fallen in many countries and market interest rates have increased. High commodity prices, particularly for food and fuel, are impacting on household budgets in both developed and developing economies. Production costs are increasing in the developing economies, making them a source of inflation rather than deflation in the world economy. Trade imbalances are being corrected as the pattern of growth in developed economies shifts away from consumption towards exports. This process of adjustment is expected to be protracted and to involve both developing and developed economies.

Performance of the Australian economy is key for New Zealand

So far, these developments have had little direct impact on the New Zealand economy. In this regard, the performance of the Australian economy is particularly important for New Zealand as it is our largest single merchandise trade export market, our main tourist market, the top destination for emigration and our main investment partner. In addition, our major retail banks are Australian-owned. The Australian economy has performed strongly until recently, but it is currently undergoing a significant re-appraisal as the domestic economy slows despite the high terms of trade resulting from the continuing strong demand from China and other emerging economies for mineral resources. Any slowdown in the Australian economy arising from the global financial crisis is likely to have a direct impact on the New Zealand economy.

Since our forecasts were finalised at the end of August, there have been further developments in the global financial crisis, particularly in the US. These developments increase the downside risks to these forecasts. The Risks and Scenarios chapter discusses these risks in more detail and develops a scenario based on lower world economic growth.

International developments will be transmitted primarily via the cost of credit, …

We expect that developments in the international economy will be transmitted to New Zealand by four main channels, the most important of which is the cost and availability of credit. Because New Zealand has a low domestic saving rate, local banks were dependent on borrowing from other countries to fund the growth in consumption and investment in housing in recent years. This borrowing is mostly short term, transmitting the tighter availability and increased cost of credit rapidly to the local financial sector and from there to businesses and households.

… a fall in confidence and lower wealth …

Figure 1.4 - Business and consumer confidence

Source:  NZIER, Westpac McDermott Miller

Confidence is the second channel by which international developments are likely to affect the New Zealand economy. Concerns about the strength of the global economy have been a factor in lower business and consumer confidence as firms expect a reduction in demand and consumers reduce their expenditure because higher prices have eroded disposable incomes. Business and consumer confidence both fell to low levels in mid-2008 (Figure 1.4). Consumer confidence recovered in September and business confidence was higher in monthly surveys, but both remained low.

Loss of wealth is a less direct transmission channel for international developments. Asset values have fallen across a range of classes, from shares to housing, internationally as well as locally, with resultant effects on firms' ability to raise finance to fund investment and on households' wealth and access to collateral for borrowing. This is likely to constrain both firms' expansion plans (especially those with overseas ownership) and households' current consumption and investment in housing. It is also likely to lead to a consolidation of household balance sheets through an increase in precautionary saving and reduction in debt.

… and a lower terms of trade …

Lower world growth arising from the current international financial turmoil is also expected to result in weaker demand for New Zealand's export products and services, including tourism. The most direct effect of this is on the prices of commodities which have already declined as weaker world demand has become evident. International dairy prices peaked in late 2007 and their rate of decline increased in August 2008. Partially offsetting this, meat export prices increased in early 2008. Lower export prices (and higher import prices) have reduced the terms of trade by an average of 1.6% from our previous forecasts, leading to lower incomes for commodity exporters.

… leading to a lower exchange rate

Figure 1.5 - NZ dollar Trade Weighted Index

Source:  Reserve Bank of New Zealand, The Treasury

The NZ dollar has started to depreciate, consistent with the lower commodity prices, weak growth in the economy, the beginning of the interest rate easing cycle and the prospect of further cuts leading to a narrowing of the interest rate differential with other developed economies. The exchange rate is forecast to fall quickly in the near term, averaging 62.7 on the TWI in the March quarter 2009. In the longer term, we expect the NZ dollar to continue to decline because the current account deficit remains large and net external debt continues to grow (Figure 1.5). A lower exchange rate will offset some of the fall in world export prices, but will also raise the price of imported goods and services, restricting demand for them.

Export growth will chiefly reflect increased production …

Dairy production is expected to increase in late 2008 as a result of the recovery from the drought, as well as underlying growth in the industry. The drought and dairy conversions will have a negative effect on sheep meat production in the 2008/09 season, with some forecasts of lamb production down by a quarter from the previous season. Some increase in meat export volumes is expected from 2010 as higher dairy production leads to more dairy beef. Log exports are expected to increase as prices become more favourable with higher international prices and a fall in the NZ dollar, and a large quantity of forest plantings reach maturity.

Increases in some other non-traditional export products are also expected to boost export volume growth. New Zealand's oil exports have become significant, with oil the third largest export category after dairy and meat in the year to June 2008 and equivalent to 40% of the value of oil imports in the year to June 2008. The Maari oil field and the Pike River coal mine are scheduled to begin production later in 2008 and methanol exports are scheduled to recommence later in 2008. The fall in the NZ dollar is expected to boost services exports (chiefly tourism) and manufactured exports from mid-2009.

… and the current account deficit will narrow

In the near term the current account deficit is expected to increase as a proportion of Gross Domestic Product (GDP) as a result of high import prices and lower export volumes owing to the drought. A lower exchange rate and slower growth in domestic demand help to bring about some rebalancing in the economy and the deficit on goods and services gradually diminishes as export values grow more strongly than imports. Services exports and imports respond strongly to the fall in the exchange rate and are chiefly responsible for the reduction in the deficit. The investment income deficit is the main constraint on the overall deficit because of the need to service the substantial net international debt. Despite a positive balance on goods and services, the overall deficit is still forecast to be 5.0% of GDP at the end of the forecast period.

Domestic Imbalances Lead to Protracted Downturn#

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Domestic demand is expected to start to recover in the final quarter of 2008 with a modest pick-up in consumption as a result of the first instalment of the tax cuts on 1 October. In the following year, a number of the negative influences will continue to affect the economy, making the downturn protracted and the recovery only gradual. Eventually these negative influences will diminish and growth in domestic demand will begin to recover.

Tax cuts will boost household disposable incomes …

Figure 1.6 - Private consumption

Source:  Statistics New Zealand, The Treasury

The October tax cuts will boost the disposable income of the average tax-payer by $16 per week. In aggregate, we assume that a large proportion of this fiscal stimulus will be spent, given the pressures currently faced by households. Most of the impact will be felt in the December quarter, but with a small amount anticipated in the September quarter. Although prices for food and fuel are expected to ease slightly as a result of weaker world growth, their rapid rise represents a shock to household budgets which will be relieved only slowly, constraining growth in consumption for some time. As a result, growth in private consumption will be lower than previously forecast (Figure 1.6).

… but firms are still under pressure …

Higher global commodity prices, especially for oil, are also adversely affecting firms' costs. Price pressures for a range of inputs are expected to dissipate only slowly and may be offset by the expected fall in the exchange rate which will also make imported capital items more expensive. These factors will mean that firms' margins remain under pressure and that profitability is low, constraining market investment. There are some supportive factors for business investment in the near term with the reduction in the company tax rate on 1 April 2008 increasing after-tax profitability and lowering the threshold for projects; in addition, ongoing dairy conversions and capacity constraints in some parts of the economy will also support investment expenditure. After a period of weak quarterly growth throughout 2009, market investment is forecast to pick up from 2010.

… leading to lower corporate tax revenue

With margins under pressure and profitability low, underlying corporate income tax is forecast to decline by 3% in the 2009 June year. Factoring in the company tax rate cut brings the total drop in corporate tax revenue to around 9% (close to 15% on receipts). In a period of low profitability, there are likely to be a significant number of firms making losses. Tax losses can be offset against profits when a firm returns to profitability and so have a small, but noticeable, lagged effect on corporate taxes. Thus growth in corporate tax is expected to be negligible in 2010, as tax losses offset profits, but is then forecast to exceed 5% per annum from 2011 onwards once those losses work their way out of the tax system.

Higher wage growth than in BEFU …

As a result of cost pressures and slower growth in demand, firms are expected to reduce their hiring in the second half of 2008, especially in the construction and retail industries. They are forecast to reduce staff levels marginally in mid-2009 and then to hold them unchanged until mid-2010. In the final years of the forecast, firms are expected to increase employment modestly by around 1.5% per annum as demand recovers. Wage growth is expected to remain relatively high in the near term, peaking at 5.8% annual growth in September 2008 as a result of a continuing shortage of skilled labour and increases in the cost of living. The net effect of softer employment and higher wage growth is slightly faster growth in labour incomes which will help offset some of the negative factors bearing on households and help support consumption growth.

… will lead to higher PAYE tax income …

Despite the weak employment outlook, the wage growth forecasts would normally be sufficient to keep growth in PAYE at around 5.0% per annum owing to the effects of fiscal drag. However, three rounds of personal income tax rate/threshold cuts more than offset fiscal drag during the forecast period, bringing average growth in PAYE down to around 3% per annum over the next five years.

… but higher unemployment will constrain consumption growth …

Figure 1.7 - Unemployment and participation

Source:  Statistics New Zealand, The Treasury

With employment growth low over the next two to three years, the unemployment rate is forecast to increase from 3.9% in the June quarter 2008 to 5.1% in the March quarter 2010 and to remain at that level for the following five quarters. After that, it will decline to 4.5% at the end of the forecast period as growth in employment picks up with faster growth in output in the economy (Figure 1.7). The weaker outlook for the labour market, including a lower participation rate, will act as a constraint on private consumption growth in the forecast period and help bring about a reduction in the rate of accumulation of household debt necessary for rebalancing the economy.

… leading to lower GST revenue

The weak outlook for the household sector is the key economic factor underpinning the tax forecasts. The most direct effect of this on tax is via GST, which is forecast to grow by around 4% per annum over the next five years. This growth rate is much lower than the average of around 7.5% in the six years to 2007 when household consumption and residential investment increased rapidly. However, it also has flow-on effects for other taxes. For example, less household spending contributes to lower business profits, which ultimately feeds into the relatively weak forecasts for corporate taxes and “other persons” tax (income tax on the profits of unincorporated businesses and trusts).

The housing market is expected to remain depressed …

High interest rates, low net migration inflows and a lack of investor confidence will lead to continuing falls in residential investment. In addition, fallout from finance companies which have either failed or frozen investment funds, in some cases because of difficulties in the property development sector, will also inhibit investment in residential property. Confidence is also an important driver of residential investment and with economic growth expected to remain low, developers and households are less likely to start new residential projects.

The lower residential investment will be accompanied by fall in demand for existing houses. We expect house prices to continue to fall in nominal terms, recording a 10% annual fall in March 2009 and a total fall of 11.3% from their peak in the December quarter of 2007. Prices are expected to remain essentially flat from mid-2009 until late 2010 when they will start to increase again.

… but government expenditure will help sustain growth

On the basis of Budget 2008, public consumption expenditure is expected to continue to increase by around 4% per annum throughout the first part of the forecast period, before easing off to around 3% in the final two years. Growth in non-market investment remains strong in the near term but reverts to around 2% per annum in later years.

Inflation forecast to ease from its peak in late 2008 …

Figure 1.8 - Consumers price index

Source:  Statistics New Zealand, The Treasury

High fresh produce prices in August make it likely that consumer price inflation will exceed our forecast of 4.9% in the year to September 2008. Non-tradables inflation is expected to ease as a result of the recent fall in output and weak growth over the next year. Lower demand in the economy will reduce capacity constraints and inflation pressures in key sectors such as construction and services. Tradables inflation is also expected to ease as commodity prices decline (Figure 1.8). The introduction of the Emissions Trading Scheme for stationary energy (primarily electricity) from 1 January 2010 and liquid fuels from 1 January 2011 will boost inflation by approximately 0.4 and 0.5 percentage points respectively, including indirect impacts which are spread over the subsequent period. (These figures are based on a price of €12.50/tonne for carbon credits.) As economic activity strengthens again towards the end of the period, headline inflation is still relatively high at 2.4% at the end of the forecast period.

… allowing interest rates to decline

As growth in consumption remains low and the outlook for inflation declines, the Reserve Bank is expected to continue to ease monetary policy. Ninety-day interest rates are expected to average 7.5% in the March quarter 2009 and to fall to 7.1% in the September quarter of 2009. The Reserve Bank's 50 basis point reduction in the Official Cash Rate on 11 September may bring forward some of the easing in 90-day interest rates. Easing tradables inflation later in the forecast period should allow the Reserve Bank to continue to ease policy so that 90-day rates fall to 6.3% by the end of the forecast period.

Lower level of nominal GDP …

The level of real GDP is forecast to be approximately $12.5 billion lower in aggregate over the next four March years than in our previous forecasts, chiefly because of lower consumption and residential investment, partly offset by lower imports. Since the general price level in the economy is higher than previously forecast, mainly because higher commodity prices result in higher consumer price inflation, the level of nominal GDP is forecast to be $8.1 billion lower in aggregate over the next four March years than in our previous forecasts.

… leads to lower tax revenue

The lower level of nominal GDP is forecast to lead to lower core Crown tax revenue over the forecast period as a whole relative to the Budget Update. The major revisions are for corporate taxes (down by $1,391 million), GST (down by $1,314 million) and other persons tax (down by $609 million). There are also downward revisions in resident withholding tax and other taxes. These reductions are offset by an increase in source deductions (primarily PAYE) of $494 million, leaving total core Crown tax revenue $3,148 million lower in aggregate over the next four years.

Source: The Treasury

2 Fiscal Outlook#

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Introduction#

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The Pre-election Update fiscal forecasts show a weakening in the fiscal outlook since the Budget Update. There are two key factors influencing this change. Firstly, the economic slowdown discussed in the previous chapter has resulted in slower tax growth and increased costs for social welfare benefits. Secondly, some past policies (such as KiwiSaver subsidies and 20 hours free early childhood education) have proven more expensive as a result of higher take-up rates. The combination of these two factors is forecast to result in a sustained period of deficits in both the operating balance before gains and losses (OBEGAL) and residual cash leading to higher debt and its associated financing costs.

The extended period of growth during the past decade has led to a fiscal position as at 30 June 2008 with gross sovereign-issued debt (excluding Settlement Cash) at 17.4% of GDP, net core Crown debt in a net financial asset position of $19 million and $14.2 billion in net assets held by the New Zealand Superannuation Fund (NZS Fund). Therefore the weakening in the fiscal outlook starts from a strong fiscal position.

This chapter outlines key trends for each of the following five areas:

• revenue and expenses
• operating results
• cash position
• debt, and
• the NZS Fund.

The chapter has two sections:

• Short-term outlook - This covers the fiscal results for the forecast period from 2008/09 to 2012/13.
• Medium-term and long-term outlook - This covers the fiscal projections out to 2022/23. The medium term projections differ from the forecasts. The forecasts are based on comprehensive modelling, whereas the projections extrapolate the conditions existing in the final year of the forecast period.

Following these two sections is a summary of the key risks associated with the fiscal forecasts. In particular, the Fiscal Outlook chapter should be read in conjunction with the Specific Fiscal Risks chapter (Chapter 4).

Short-Term Outlook#

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Source: The Treasury

Revenue and Expenses#

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Core Crown Revenue

Core Crown revenue growth falls …

Figure 2.1 - Core Crown revenue excluding the NZS Fund

Source:  The Treasury

Core Crown revenue excluding the NZS Fund is forecast to fall from 34.2% of GDP in 2007/08 to 32.7% of GDP by 2012/13, while in a nominal sense over the same period it is forecast to increase by around $10 billion. The trend in core Crown revenue is primarily driven by what happens in tax revenue.

… as the economy slows ...

As mentioned in Chapter 1, the forecasts for nominal GDP have been reduced by just over $8 billion since the Budget Update (on a June year basis), with GDP in 2011/12 (the final forecast year in the Budget Update) being about $2 billion lower than in the Budget Update.

Figure 2.2 - Core Crown tax revenue

Source:  The Treasury

A reduction in the forecasts for domestic consumption as past imbalances start to unwind over all forecast years is a key feature of the macroeconomic forecasts. This reduces the GST forecasts. It also has flow-on effects for business income taxes as reduced spending leads to lower profits, which have also been squeezed by an increase in the forecast wage growth track. The increased wage forecast provides some offset to the forecast reductions in tax revenue via an increase in the source deductions (PAYE) forecast.

… and personal tax cuts began to come into affect from 1 October 2008

The introduction of personal tax cuts announced in Budget 2008 means there has been a structural reduction in tax revenue of $1.6 billion in 2008/09 rising to $4.3 billion by 2012/13. The tax cut was included in the fiscal forecasts at the time of Budget 2008.

The tax cuts were the primary driver for the fall in tax revenue as a percentage of GDP over the forecast period.

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Inland Revenue Tax Forecasts#

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In line with established practice, the Inland Revenue Department has also prepared a set of tax forecasts, which, like the Treasury's tax forecast, is based on the Treasury's macroeconomic forecast. Inland Revenue's forecasts are shown here for comparative purposes. The Treasury's forecasts are the Crown's official forecasts.

Sources: The Treasury, Inland Revenue

The differences between the two sets of forecasts are much smaller than has been the case in recent forecasting rounds. The only significant difference is in corporate taxes where the two agencies have differing opinions on the degree of tax losses accumulating in the short term and on the effect these will have on income tax during the upswing in the business cycle.

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Core Crown Expenses

Core Crown expenses represent the day-to-day operating spending of the Government (ie, this measure does not include purchases of physical assets or capital spending).

Core Crown expenses rise then stabilise in line with growth in the economy

Figure 2.3 - Core Crown expenses

Source:  The Treasury

Core Crown expenses are forecast to increase as a percentage of GDP in 2008/09 and then remain relatively stable at around 34.5% over the rest of the forecast period. In nominal terms, core Crown expenses grow over the forecast period from $57 billion in 2007/08 to $76.2 billion by 2012/13.

Some increases in expenses were forecast at the time of the Budget Update because of the normal processes of cost of living adjustments to social welfare benefits, and the inclusion in expenses of allowances to cover new spending in future Budgets. In addition, some of the policy decisions announced in recent Budgets were to be gradually implemented (eg, KiwiSaver), with a consequent rising profile of expenses.

The expected profile for core Crown expenses is higher in this Pre-election Update than in the Budget Update due to:

• higher social welfare benefits mostly associated with the economic slowdown and higher expected inflation rate
• increased costs of existing policies (such as KiwiSaver and early childhood education) arising from take-up rates being higher than previously forecast, and
• as a consequence of lower tax and higher expenses, a higher debt track is forecast, so higher debt servicing costs are also expected.

Slowing growth leads initially to higher social welfare benefit costs …

The growth of benefit expenses initially exceeds economic growth, but slows after 2009/10 so that by 2012/13 social welfare expenditure, as a percentage of GDP, is slightly lower than its 2008/09 level.

Faster growth in benefit costs in the early years of the forecast period is largely due to higher-than-normal inflation indexation and a lift in recipient numbers, especially in relation to the unemployment benefit. The latter is a consequence of a forecast weaker labour market in these years.

… and there are additional costs from existing policies …

The fiscal costs for the following policies have been revised upwards since the Budget Update.

KiwiSaver

Take-up rates for the KiwiSaver scheme over its first year of operations far exceeded original assumptions. The Pre-election Update revisions are based on an assumption that growth in applications will continue and membership will reach 56% of the total labour force by 2012/13 (46% at Budget Update).

Early childhood education

Forecast costs have been revised upwards for the policy of 20 hours per week free early childhood education announced in Budget 2006. This increase is due to an increase in the volume of funded child hours claimed by service providers and an increase in the number of service providers offering the free 20 hour per week programme.

Treaty of Waitangi settlements

The pace of settlement of Historical Treaty of Waitangi claims is expected to pick up over the forecast period, resulting in an increase in expenses.

… as a result, debt servicing costs also rise

With slower growth in tax revenue and higher government spending, annual core Crown finance costs are forecast to rise from $2.5 billion in 2007/08 to $3.9 billion by 2012/13.

Recent spending decisions have been charged against the Budget 2009 allowance …

As in previous Economic and Fiscal Updates, the forecasts include allowances for new operating initiatives for future Budgets. Budget allowances represent a level of funding that will be allocated to spending and revenue initiatives over the Budgets covered in the fiscal forecasts.

The Budget 2009 allowance was set at $1.75 billion in the 2008 Fiscal Strategy Report (FSR), and this grows by 2% for each Budget as shown in Figure 2.4.

Figure 2.4 - Net amounts of forecast new operating initiatives

Source:  The Treasury

The fiscal forecasts assume that spending and revenue pressures can be managed within these funding allowances.

The Government has made a number of spending decisions since the Budget. Table 2.4 shows decisions already charged and signalled as pre-commitments against Budget 2009. In addition the Specific Fiscal Risks chapter outlines a number of decisions under active consideration which need to be managed within the remaining allowance.

As a result, the Budget 2009 allowance is expected to come under pressure, and, if exceeded, the fiscal position would weaken from that shown in the fiscal forecasts.

Source: The Treasury

Operating Results#

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Total Crown OBEGAL (excluding the NZS Fund retained revenue)

OBEGAL deficits expected …

Figure 2.5 - Total Crown OBEGAL (excluding the NZS Fund retained revenue)

Source:  The Treasury

The OBEGAL (excluding the NZS Fund retained revenue) shifts into a deficit position in the current year of $31 million which worsens to $3.2 billion by the end of the forecast period.

As discussed earlier, slower growth in tax revenue and increases in government spending are the key factors driving the downward trend in the OBEGAL (excluding the NZS Fund retained revenue).

Table 2.5 provides a detailed reconciliation of the changes since the Budget Update, while Table 2.6 shows the changes since the Budget Update by the key drivers.

Total Crown Operating Balance

The operating balance shows whether the government sector has generated enough revenues to cover its expenses in any given year.

… while the operating balance is close to breakeven point

Figure 2.6 - Total Crown operating balance

Source:  The Treasury

The operating balance is forecast to remain positive until 2009/10 before moving into modest deficits thereafter.

The main difference between the OBEGAL trend and operating balance is valuation gains on assets and liabilities are forecast of $1.6 billion in 2008/09 growing to $2.6 billion in 2012/13.

The expected growth in gains primarily relates to the asset portfolio of the NZS Fund which is forecast to increase by around $3 to $4 billion per annum. The forecast gains on financial instruments are based on long-term benchmark rates of return, in conjunction with the exchange rate and interest rate curves prevailing at the forecast reference date. Gains and losses on assets and liabilities are volatile in the short term. Since completing the fiscal forecasts, equity market conditions have deteriorated so there is a risk that valuation gains in the current year may be lower than forecast.

The total Crown operating balance is not available to be drawn upon to fund core Crown operations, as current policy is for SOEs and CEs to retain a portion of their surpluses for the purpose of achieving their long-term objectives and for the NZS Fund to retain all of its after tax surpluses. Over the forecast period, SOE and CE surpluses total $9.4 billion. Approximately $2.4 billion of these surpluses will be returned as dividends. This becomes cash available to the core Crown.

Cash Position#

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Core Crown Residual Cash

Core Crown residual cash represents core Crown operating cash flows less capital investment and contributions to the NZS Fund.

Source: The Treasury

A sustained period of large cash deficits is forecast

Figure 2.7 - Core Crown residual cash

Source:  The Treasury

Core Crown residual cash is in deficit over the entire forecast period ranging from $5.9 billion in 2008/09 to $7.3 billion in 2012/13.

The decline in the OBEGAL is broadly mirrored in net core Crown cash flow from operations.

Table 2.8 - Application of core Crown residual cash from 2008/09 to 2012/13 inclusive ($billion)

Source:  The Treasury

After taking into account contributions to the NZS Fund of $10.7 billion, purchases of physical assets (including new capital spending) of $10.6 billion and advances and capital injections of $6.1 billion, there is a residual financing requirement of $31.9 billion. The cash shortfall will be mainly met by additional borrowings of around $22 billion with the rest met by reducing financial assets that have accumulated from recent strong cash outturns (refer Table 2.13).

As in previous Economic and Fiscal Updates, the forecasts include allowances for new capital initiatives for future Budgets. As part of Budget 2009, the Government has allocated $900 million of new capital over the next four years. Amounts for the 2010, 2011 and 2012 Budgets have also been set at $900 million phased over four years. In total the fiscal forecasts incorporate $3.1 billion over the next five years to be spent on new capital commitments between 2008/09 to 2012/13.

Source: The Treasury

Figure 2.8 - Total purchase of physical assets by sector ($billion and % of total spend)

Source:  The Treasury

Core Crown forecasts for the purchase of physical assets ($10.6 billion) and advances and capital injections ($6.1 billion) comprise purchases met from existing baselines plus the $3.1 billion new capital allocation mentioned above.

Advances and capital injections are often used by CEs and SOEs to purchase physical assets (such as roading and rail assets). Therefore, to give an indication of the Government's capital investment it is important to consider total Crown physical asset purchases. Figure 2.8 shows the total purchases of physical assets by sector.

Taking into consideration capital and operating cash flows, the cash position is weaker than what was forecast at the Budget Update.

Source: The Treasury

Debt#

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Gross Sovereign Issued Debt (GSID) (Excluding Settlement Cash)

(GSID) (Excluding Settlement Cash) is forecast to climb ...

Figure 2.9 - GSID (excluding Settlement Cash)

Source:  The Treasury

The increase in GSID (excluding Settlement Cash) is primarily due to the need to raise finances to meet the residual cash deficits over the forecast period.

GSID (excluding Settlement Cash) is forecast to increase in both nominal terms (by around $22.3 billion) and as a percentage of GDP (by around 6.9%) over the forecast period. By the end of the forecast period in 2012/13 GSID (excluding Settlement Cash) is expected to be $53.7 billion or 24.3% of GDP.

The issuance of domestic bonds (market) for 2008/09 has been set at $4 billion and rises to $9.2 billion in 2012/13. After meeting debt maturities, the accumulated net bond issuance over the forecast period is $23 billion and this will translate into an increase in GSID (excluding Settlement Cash).

Source: The Treasury

Net Core Crown Debt

…so too is net core Crown debt …

Figure 2.10 - Net core Crown debt

Source:  The Treasury

As at 30 June 2008, net core Crown debt was in a small net asset position of $19 million. Over the forecast period, net core Crown debt is forecast to rise to $29 billion or 13.2% of GDP. The increase in net core Crown debt is due to the run-down of NZDMO financial assets and increases in borrowings expected during the forecast period. Table 2.12 provides a breakdown of core Crown net debt by portfolio. Net debt is forecast to increase faster than GSID (excluding Settlement Cash) as net debt takes into consideration the run-down of financial assets which is not captured by the GSID (excluding Settlement Cash) indicator, so it is important to look at the two indicators together.

… in order to meet the cash shortfall

Table 2.13 shows New Zealand Debt Management Office (NZDMO) borrowings are forecast to increase by $22.5 billion and its financial assets are forecast to reduce by $11.2 billion over the forecast period.

NZS Fund

Figure 2.11 - NZS Fund net worth

Source:  The Treasury

The NZS Fund is forecasting an operating surplus of $1 billion in 2008/09 growing to $1.9 billion in 2012/13.

A combination of holding gains and new investments funded by the Government's annual contribution of around $2 billion per annum is expected to increase the NZS Fund's net worth from $14.2 billion in 2007/08 to $32.2 billion in 2012/13.

Source: The Treasury

The Government's contributions to the NZS Fund are 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 to be constant at that level. The Government is forecast to make the required minimum annual contribution for 2008/09 as calculated by the formula set out in the New Zealand Superannuation and Retirement Income Act 2001.

The underlying assumptions in calculating the contributions for 2008/09 are the nominal GDP series to 2048, the New Zealand Superannuation expense series to 2048 and the expected long-term, net after-tax annual return of the NZS Fund (6.6%) (also 6.6% in the 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 (http://www.treasury.govt.nz/government/assets/nzsf/contributionratemodel).

Medium-Term and Long-Term Outlook#

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Medium-Term

The preceding parts of the Fiscal Outlook chapter have focused on the fiscal forecasts covering the period 2008/09 to 2012/13. This section provides medium-term fiscal projections, covering the subsequent 10 years (2013/14 to 2022/23). In previous Pre-election Updates these projections have been published separately on the Treasury website. For this and subsequent Pre-election Updates, the projections are incorporated into the document, to make this information easier to access and to provide a fuller picture of the medium-term implications of developments in the fiscal forecasts.

The forecasts are based on comprehensive modelling of the macroeconomy, which flows through into forecasts of tax revenue and the overall fiscal position. The projections, on the other hand, extrapolate the conditions existing in the final year of the forecast period, using assumptions about how elements of revenue and expenditure will change over time.

Updated medium-term projections

Building on the deterioration since the Budget Update in the fiscal outlook in the forecast period discussed earlier in this chapter, the medium-term projections show that this deterioration continues throughout the 10-year projection period.[6]

Figure 2.12 - OBEGAL (excluding NZS Fund retained revenue)

Source:  The Treasury

Figure 2.13 - GSID (excluding Settlement Cash)

Source:  The Treasury

Figure 2.14 - Operating balance, OBEGAL (excluding NZS Fund retained revenue), NZS Fund contributions

Source:  The Treasury

OBEGAL (excluding NZS Fund retained revenue) is forecast to be 1.5% of GDP in deficit in 2012/13. In the projection period, we assume that revenue growth exceeds expenditure growth, largely because personal income tax revenue grows faster than the allowance for new operating spending. This sees OBEGAL (excluding NZS Fund retained revenue) move into surplus in 2017/18, and end the projection period with a surplus of 1.2% of GDP in 2022/23.

Figure 2.15 shows GSID (excluding Settlement Cash) and net core Crown debt continuing to grow as a share of GDP at the start of the projection period, because of the scale of borrowing required to cover OBEGAL deficits and the Government's capital programme. As OBEGAL moves back into surplus towards the end of the projection period, GSID and net debt begin to fall as a share of GDP.

Figure 2.15 - GSID (excluding Settlement Cash), net core Crown debt, net core Crown debt including NZS Fund assets

Source:  The Treasury

Figure 2.16 shows that core Crown expenses are projected to stabilise and then fall slightly as a percentage of GDP. This is because the allowance for new operating spending grows at the rate of inflation, which is assumed to be lower than the rate of GDP growth.

Figure 2.16 - Expenses

Source:  The Treasury

Figure 2.17 shows that from the start of the projection period until 2020 the tax-to-GDP ratio is assumed to rise as fiscal drag pushes people into higher tax brackets. From 2020 the tax-to-GDP ratio then flattens as fiscal drag is assumed to be mitigated by changes to personal tax rates and/or thresholds. This is assumed so that the tax-to-GDP ratio remains at average historical levels.

Figure 2.17 - Revenue

Source:  The Treasury

The projections are sensitive to the assumptions used …

The projections are dependent on the assumptions chosen about how elements of revenue and expenditure will change over time. Differences in these assumptions would result in different medium-term fiscal projections.

The Treasury has decided to use the same assumptions in the Pre-election Update projections as those used in the 2008 FSR. These are outlined in the annex below. This reflects the Treasury's best judgement as to the most appropriate interpretation of current policy for the purposes of medium-term budgeting decisions. This is because medium-term assumptions around operating and capital allowances reflect the budgeting approach currently used and also applied in the forecast period.

Figure 2.18 - Changing the real GDP growth assumption in the projection period
(impact on GSID excluding Settlement Cash)

Source:  The Treasury

To illustrate the sensitivity of the projections to assumptions, Figure 2.18 shows the impact on GSID (excluding Settlement Cash) of real GDP growth in the projection period being 0.5% higher or lower in each year than the 2.5% rate assumed in the central projection. In this scenario an increase in real GDP growth is assumed to be driven by an increase in productivity, which flows through into higher wages and nominal GDP and higher tax revenue. Because in the projections most expenditure is not linked to wage growth and instead grows at 2% per annum, the overall impact would be to reduce GSID (excluding Settlement Cash) as a percentage of GDP by ten percentage points by the end of the projection period.

… and to the starting point

Figure 2.19 - Changing the starting point: GSID (excluding Settlement Cash) with a higher or lower starting point in 2012/13

Source:  The Treasury

The projections are also dependent on the fiscal forecasts for the period 2008/09 to 2012/13, as these are the starting point from which the projections grow. If fiscal results turn out to be higher or lower than in the forecasts, this would result in a different debt ratio in 2012/13, and debt would then develop from that higher or lower starting point.

To illustrate this, Figure 2.19 shows how GSID (excluding Settlement Cash) as a share of GDP would evolve in the projection period if the starting debt ratio in 2012/13 were to be four percentage points higher or lower.

Long-Term

Beyond the 10-year projection period presented here, the proportion of New Zealand's population aged over 65 will start to rise significantly relative to the working age population. In the Treasury's 2006 Statement of the Long-term Fiscal Position we outlined how this will put pressure on the costs of health care and New Zealand Superannuation in particular, under the assumption of continuation of existing policies and cost trends over the next 40 years. The long-term fiscal situation is still subject to the same challenges outlined in the 2006 Statement, particularly the pressures of an ageing population. We have not updated the 2006 report, but our preliminary assessment is that the long-term fiscal position has deteriorated, in that debt rises more quickly than was set out previously. A full statement is likely to be published in 2009.

Annex: Assumptions for Medium-term Fiscal Projections

The assumptions for the medium-term fiscal projections are outlined below. The full assumptions can be found in the 2008 FSR, at http://www.treasury.govt.nz/budget/2008/fsr/

* Annual average % change unless otherwise stated.

** Level of unemployment.

*** Full-time equivalent employed measure.

Sources: The Treasury, Statistics New Zealand

Source: The Treasury

Assumptions about the Emissions Trading Scheme (ETS)

The fiscal impact of the ETS depends on several highly uncertain factors, most notably future carbon prices and New Zealand's emissions targets from future international climate change agreements. The ETS has no impact on debt beyond 2012/13 in fiscal projections asa policy of full recycling of revenue is assumed. Net revenue (the value of credits received after free allocation of credits to participating industries and after meeting future emission liabilities) is assumed to be recycled back to the public through fiscally equivalent, unspecified tax reductions or spending increases.

An indication of possible net revenue from the ETS is presented in the table below based on assuming:

• a carbon price of $25 or $50 per tonne CO2-equivalent, and
• three potential emissions targets New Zealand might face under future international agreements, where the target is set relative to emissions in 1990.

These estimates assume 50% of post-1989 foresters receive credits and the associated liabilities when forests are harvested. Revenue to the Government from unallocated credits exceeds the cost of liabilities from harvesting activities each year until 2020. Beyond 2020, this reverses in line with projected increases in harvesting.

Estimates also incorporate the fiscal impact of higher revenue to renewable electricity generators who do not face a corresponding increase in fuel costs. It is assumed the Government receives 30% of the revenue gain to private companies through tax. For SOE electricity producers, the Crown receives 50% of the revenue increase through both tax and dividends.

Risks to Fiscal Forecasts#

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The fiscal forecasts were finalised on 17 September 2008 in accordance with forecast accounting policies. There are certain risks associated with the forecast results. To assist in evaluating such risks, the following chapters should be read in conjunction with the fiscal forecasts:

• Risks and Scenarios (Chapter 3) - The fiscal forecasts are based on the economic forecasts presented in Chapter 1 and any variation from the economic forecast will affect the fiscal forecasts, in particular tax revenue and benefit expenses. The Risks and Scenarios chapter discusses the effect on the forecasts under different circumstances.
• Specific Fiscal Risks (Chapter 4) - The fiscal forecasts incorporate government decisions up to 17 September 2008. 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. Given the many tax policy changes that have been enacted recently (cut in company income tax rate, movements in personal income tax thresholds, introduction of PIE and FDR regimes for taxation of investments, etc), there is considerable uncertainty around exactly how these changes will pan out and their effect on the tax take. Sensitivities of tax revenue to changes in economic conditions are also presented in the Risks and Scenarios chapter on page 56.

KiwiSaver risks

Baselines reported by Inland Revenue incorporate an assumed take-up rate profile for the KiwiSaver regime. The actual take-up rate could be higher or lower than assumed, or faster or slower than assumed, representing an unquantified risk to the operating balance.

ETS risks

Baselines reported by the Ministry for the Environment on the ETS are based on a number of assumptions and projections, all of which can change through time. Notably they incorporate an assumed take-up rate profile for forestry participation in the scheme. The actual take-up rate could be higher or lower than assumed. These potential changes represent an unquantified risk to the operating balance.

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 change in the NZ dollar (from 30 June 2008) may affect the current physical asset values included in the fiscal forecasts.

Discount rates

The Government Superannuation Fund and ACC liabilities included in these forecasts have been valued as at 30 June 2008. The liabilities are to be next valued for the 2009 Budget Update. Any change in discount rates will affect the present fiscal forecast. For example, if the discount rate rises, the value of the liabilities will decrease.

Other market rates

Forecasts use the exchange rates, interest rate curves and electricity pricing curves prevailing at the forecast reference date. Any subsequent change to these rates will affect the fiscal outcome.

Tertiary education institutes' accounting treatment

The forecast information presented in the 2008 Pre-election Update combined Tertiary Education Institutes (TEIs) on an equity accounting basis. This treatment has been under consideration by accounting standard setters. The Financial Reporting Standards Board (FRSB) has recently advised that the question of whether to consolidate autonomous and independent entities will be considered by delivering its deliberations of the International Accounting Standards Board (IASB) project on consolidation.

The combination method adopted in these forecasts is to equity account for the TEIs' net surpluses and net investment (ie, TEI revenues, expenses, assets and liabilities are not included on a line-by-line basis). This is consistent with the treatment adopted in the 2008 Financial Statements of the Government.

3 Risks and Scenarios#

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Introduction#

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As presented in the Economic and Tax Outlook chapter, the main forecast relies on a number of judgements about how both the New Zealand and the world economies evolve. There is substantial uncertainty about those judgements, especially regarding how the world economy and the US financial crisis will evolve over the next few years. In the Budget Update, we noted that there were significant downside risks to the main forecast, reflecting the turmoil in international financial markets. We also developed an alternative scenario in which the finance costs faced by New Zealand would be higher than the main forecast because of a more prolonged and deeper global financial crisis.

Since the Budget Update, global developments have been more in line with the alternative scenario than the Budget forecast and global financial and economic conditions have worsened significantly. On the domestic front, finance companies have continued to face reduced debenture funding and more finance companies went into receivership or moratorium in the past three months. The speed and magnitude of the slowing in domestic demand has been more abrupt and greater than forecast in the Budget Update.

Reflecting these recent international and domestic developments, we have made significant downward revisions to our growth forecasts in this Update. However, the financial turmoil has intensified since the finalisation of our economic forecasts. As a result, we have seen the downside risks to our growth forecasts increase markedly, particularly in the years to March 2010 and 2011.

The first part of this chapter identifies major risks to the main forecast and describes how the various forces would affect the economy if these risks were to eventuate. The second part of this chapter presents two alternative scenarios for the economy. The third part of this chapter considers the implications of the alternative scenarios for the fiscal position, while the fourth part examines how sensitive the fiscal position is to changes in specific variables.

Economic Risks#

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Risks to the global outlook remain skewed to downside

Most of the downside risks to the global economy identified in the Budget Update which have started to materialise, are still compelling in this Update. As mentioned above, the turmoil in international financial markets has worsened significantly since the Budget Update, with increased risk aversion and investor uncertainty in financial markets.

The key downside risks concerning the global growth outlook are:

• The credit crisis that originated in the US in 2007 could be deeper and longer than incorporated in the main forecast. The International Monetary Fund (IMF) projected that losses on mortgages and mortgage-related securities could amount to US$500 billion and total credit-losses could potentially cost up to US$1 trillion if loans and securities related to commercial real estate, consumer credit and corporations are included. The uncertainty about the losses depends on how deep and protracted the US housing recession will be and how far house prices will decline. Furthermore, the turmoil could be more prolonged owing to the uncertainty created by lack of transparency of securitised products and derivatives.
• A further tightening of lending conditions and reduced credit availability is likely to raise the prospect of a self-reinforcing process of debt reduction. As it becomes harder to raise capital, firms and households in the US and other developed countries with large current account deficits are being forced to reduce debt and save aggressively, which in turn leads to an economic slowdown. An economic slowdown will exacerbate this process as borrowers with unsustainable amounts of debt will fail.
• A significant slowing in growth in developing economies. So far, China and emerging markets have escaped the credit crisis relatively unscathed. With exports accounting for half of China's GDP and most of these directed to Europe and North America, there is greater uncertainty about the extent of the impact of negative financial shocks in the US and Europe on the Chinese economy. A severe US recession could cause China's growth to decline to 8% or below.

As the credit crisis has become more severe and persistent, the global growth outlook may prove weaker than anticipated in the main forecast. A worse-than-foreseen slowdown in world growth could affect the New Zealand economy further through lower export prices, higher costs of funding and, possibly more importantly, increased risk aversion and investor uncertainty. This would also provide downside risks to the rebound in export growth built into the main forecast even if the exchange rate was lower than the main forecast. A lower exchange rate could arise from rising global risk aversion which could cause large exits in carry trade positions.

Households have finally entered a period of consolidation

In the past eight years, New Zealand has experienced a dramatic fall in its household savings rate: the household savings rate has declined from 0% to -14% of household disposable income over the period from 2000 to 2008 and the ratio of household debt to annual disposable income increased from 112% to 196% over the corresponding period (Figure 3.1). The increasing trend of dis-saving is not unique to New Zealand. Many developed economies such as the US and Australia have experienced a similar phenomenon. To some extent, the fall in the saving rate over this period is partly owing to a long period of stability with interest rates falling to low levels. This may have led households into thinking that they were permanently operating in a low-cost and low-risk environment. As a result, households were encouraged to take on more debt and invest in housing which in turn caused house prices to rise. Higher house prices encouraged households to invest more in housing and increased house prices further, creating a positive feedback loop.

Figure 3.1 - Household savings and debt as % of disposable income

Source:  Statistics New Zealand, RBNZ and The Treasury

The decline in households' saving contributed directly to rising current account imbalances: the current account balance has deteriorated from a deficit of 6.4% of GDP in 2000 to a deficit of 7.8% of GDP in 2008 with the current account deficit peaking at 9.2% in the March quarter of 2006. Such a high level of external indebtedness makes New Zealand dependent on overseas investors' willingness to lend at affordable rates. It appears that the current financial turmoil has triggered the long-awaited adjustment of external imbalances and households have finally begun to consolidate their balance sheets since the beginning of this year by cutting spending.

In the main forecast, consumption and residential investment growth forecasts are much weaker relative to the Budget Update, reflecting the judgement that households decide to lower their debt-to-income ratio relative to the Budget Update. However, the pace and depth of consolidation will depend on what happens to house prices, credit availability, the level of net migration and the employment outlook.

Figure 3.2 - House prices

Source:  QVNZ,  S&P/Case Shiller and Halifax

In particular, there is considerable uncertainty about the extent of the house price fall in the forecast. In the main forecast, we assume an 11% fall in nominal house prices from their peak. Some developed countries which started their housing cycles earlier than New Zealand have seen their house prices fall sharply. In the US, average house prices nationwide rose by 90% between 2000 and 2006 and have since fallen by 20%. Although there are differences in housing market conditions between the US and New Zealand, a larger decline in New Zealand house prices is possible (Figure 3.2).

A further point we can touch on here concerns the link between changes in house prices and consumption. There is greater uncertainty on the extent of the impact of wealth on consumption. Therefore, if households attempt to consolidate their balance sheets more aggressively and the estimated wealth effect is larger than assumed, we could see private consumption growth weaker than forecast.

The economy could be stronger in the near term

On the upside, while the international growth outlook has deteriorated, the domestic economy may be showing signs of having turned the corner: the business outlook improved according to the National Bank Business Outlook and the Westpac McDermott Miller measure of consumer confidence rebounded strongly to 104.8 for the September quarter from the 18-year low recorded in the June quarter. The renewed optimism is mainly attributed to falling petrol prices and expected further interest rate cuts. During the time of writing, WTI oil prices fell below $US100 per barrel at one stage from their recent peak of US$146 per barrel. Historically, the New Zealand economy, especially consumer spending, was very sensitive to changes in petrol prices. If petrol prices are lower than forecast, this will result in an upside risk to the consumption growth forecast in the near term.

In addition, higher consumer sentiment, lower petrol prices and expected further interest rate cuts together could spur households to spend more of their tax cut than is the case in the main forecast. As a result, this could see GDP growth slightly stronger in the near term than forecast.

From a medium-term perspective, the economy may be more resilient to weather the global economic storms now than in the late 1990s because of a stronger fiscal starting position and a better monetary framework. The main forecast incorporates a weak response of export services to the falling exchange rate to reflect a more protracted recovery in the world economy. It is possible that demand for our goods and services from Asia could be stronger if the Asian economies undergo only a mild slowdown and the exchange rate depreciates more sharply than incorporated in these forecasts. Finally, the fall in residential investment may not be quite as large as predicted in the main forecast because we do not have a large inventory of unsold houses as in the US.

Risks for inflation remain tilted to the upside

The balance of risks for inflation continues to be tilted to the upside even with a weaker GDP growth outlook and the recent drop in oil prices. Annual inflation is now expected to peak at around 5% in the September 2008 quarter. The Consumer Price Index (CPI) spike, driven by petrol and food price increases, could cause households and firms to revise up their inflation expectations in the medium term which in turn could lead to more sustained inflationary pressures. With implementation of the ETS, there are risks that the emissions price is higher than assumed in the forecast and the second round effects of the ETS could be greater than incorporated in the forecast. In addition, the ETS could have a larger effect on business investment than assumed in the forecast.

Besides inflation, the key drivers of the nominal economy are world export and import prices. In view of the weaker global growth outlook, the balance of risks to international prices for export and import goods is somewhat to the downside in the medium term, with the impact on the terms of trade dependent on whether it is export or import prices that are most affected.

Last, but not least, any extreme weather patterns such as drought and flooding could have a profound but temporary impact on the New Zealand economy.

Economic Scenarios#

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Given the number of risks and unusual uncertainty, two scenarios which simulate the impact of alternative judgements on the economy are presented.

Figure 3.3 - Trading partner growth

Source:  Consensus Economics, The Treasury

A deeper recession

The first scenario (downside) is based on a weaker outlook for world growth where credit risks and conditions in the US and Europe become more severe relative to the main forecast. Amid financial fears, firms are reluctant to invest and households reduce consumption further. As a result, there is a deeper and more prolonged slowdown in the US and Europe which significantly dampens economic growth in China and other Asian economies. Under this scenario, trading partner growth decelerates sharply to 2.2% in the 2009 calendar year and rebounds to only 3.0% in the 2010 calendar year (Figure 3.3). Against this backdrop, New Zealand house prices fall by 25% from peak to trough which negatively impacts on consumer confidence.

Figure 3.4 - Real GDP

Source:  Statistics New Zealand, The Treasury

Model simulations indicate that the combined effect of these judgements would reduce real GDP growth by 0.3 percentage points and 0.6 percentage points in the March 2009 and 2010 years respectively (Figure 3.4). Relative to the main forecast, we see households spend less and save more, in response to the larger house price slump and tighter credit conditions. With slower growth, businesses not only decrease investment expenditure but also cut back on employment, with the unemployment rate rising to around 6.1% in 2010 and staying at that level until the March 2011 quarter.

As global risk aversion heightens and the world economy slows, commodity prices fall more than in the main forecast. In such an environment, the NZ dollar also depreciates sharply to 57 in March 2009 on a TWI basis. Although the exchange rate declines faster than in the main forecast, CPI inflation is around 0.9 percentage points weaker than in the main forecast in March 2010 because of subdued domestic demand (Figure 3.5). With lower inflationary pressure throughout the forecast period, a more accommodating monetary policy stance is required with 90-day interest rates reaching 5% in the March 2010 quarter, almost 200 basis points lower than in the main forecast (Figure 3.6).

Lower interest rates encourage a recovery in both business and residential investment in the March 2011 and 2012 years but consumers do not regain their confidence until the March 2012 year. As a result, economic growth picks up speed from June 2010 onwards. Overall, weaker real activity combined with subdued inflationary pressures results in nominal GDP growth being lower than in the main forecast for the entire forecast period with a cumulative impact of around $12.1 billion.

Stronger short-term outlook

The second scenario (upside) presents a growth path for the economy where three key judgements are slightly different from the main forecast - (1) stronger near-term growth outlook owing to a larger impact on private consumption of the tax cuts; (2) a slightly stronger housing market and (3) higher inflationary expectations.

Figure 3.5 - Inflation

Source:  Statistics New Zealand, The Treasury

With respect to real GDP, the overall profile in this scenario is very similar to that in the main track, apart from the first year of the forecast period (Figure 3.4). In this scenario, real GDP growth in the March 2009 year is 0.5 percentage points higher than forecast in the main track. As the impact of the personal tax cuts on consumer spending is larger than assumed in the main forecast, this altered judgement increases consumption growth by 0.2 to 0.3 percentage points for the first three years of the forecast period.

Figure 3.6 - 90-day interest rates

Source:  Statistics New Zealand, The Treasury

Model simulations show that inflation holds up higher than in the main forecast as inflation expectations remain high (Figure 3.5). In addition, stronger near-term domestic demand also puts further pressure on non-tradable inflation. In this scenario, the Reserve Bank continues to lower the Official Cash Rate (OCR) with 90-day interest rates reaching 7.5% in June 2009 and holds the OCR at this level for a year. As inflationary pressures abate, the Reserve Bank begins the easing cycle again in June 2010 with 90-day interest rates reaching 6.5% by the end of the forecast period.

Higher output and inflationary pressures, relative to the main forecast, lead to higher nominal GDP. As the price level is permanently higher than in the main forecast, the divergence in the level of nominal GDP between this scenario and the main forecast increases over the forecast period with the greatest difference of $2.2 billion in the year to March 2013. Relative to the main forecast, the total nominal GDP gains amount to $7.4 billion across the forecast period.

Fiscal Scenarios

The fiscal position is strongly influenced by the economy. The major economic determinants, and how they impact on the fiscal position, are listed below.

• Nominal GDP - higher GDP levels are reflected in higher tax revenue, which increases the operating balance and lowers the Government's net debt.
• Interest rates - higher interest rates lead to increased debt-financing costs, although this would be partially offset by higher interest-based revenue on assets.
• The level of unemployment - higher levels of unemployment translate to an increase in spending because the number of unemployment beneficiaries rises. This decreases the operating balance and raises net debt levels.
• CPI inflation - as most benefits are indexed to CPI movements, higher inflation results in increased benefit costs. This reduces the operating balance and increases debt.

Of the two alternative scenarios, the differences from the main forecast are much greater in the downside scenario, reflecting the asymmetric risk profile of the main forecast. In the downside scenario, the fiscal position deteriorates markedly over the forecast horizon:

• The deficit of the OBEGAL (excluding the NZS Fund retained revenue) is greater than the main forecast throughout the period with the largest difference of 0.5 percentage points of GDP occurring in 2009/10. The deficit ranges from 0.2% of GDP in 2008/09 to 1.8% of GDP in 2012/13 (Figure 3.7).

Figure 3.7 - OBEGAL (excluding NZS Fund retained revenue)

Source:  The Treasury

• GSID is 26.2% of GDP at the end of the forecast period compared with 24.3% of GDP in the main forecast (Figure 3.8).

Figure 3.8 - Gross sovereign-issued debt (excluding Settlement Cash)

Source:  The Treasury

Under the upside scenario, the overall impact of higher nominal GDP is a small improvement in the fiscal position relative to the main forecast:

• The OBEGAL is higher by around 0.2 percentage points of GDP throughout the forecast periodrelative to the main forecast.
• GSID is 23.3% of GDP at the end of the forecast period.

Fiscal Sensitivities#

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Table 3.1 provides some “rules of thumb” on the sensitivities of the fiscal position to changes in specific variables. It is important to note that this analysis does not take into account the fact that some tax types such as corporate tax and other persons tax have a larger variability than nominal GDP over business cycles. This difference in variability exists because firms can build up losses in the downswing of the business cycle and utilise these losses in the upswing.

The forecasts of capital contributions to the NZS Fund are sensitive to the rate of return assumed on the Fund's assets.

4 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. The Public Finance Act 1989 (PFA) requires disclosure of all government decisions and other circumstances that may put pressure on the forecast spending amounts, and/or 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 where government decisions or legislative commitments have uncertain fiscal consequences or timing, such that they cannot be included in the fiscal forecasts.
• 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 (eg, 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 Zealand
• prejudice the security or defence of New Zealand or international relations of the Government
• compromise the Crown in a material way in negotiation, litigation or commercial activity, or
• result in a material loss of value to the Crown.

Specific fiscal risks do not include:

• normal forecasting risks, such as uncertainty around welfare benefits, SOE/CE 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, or
• 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.

The risks described in this chapter relate to the activities of the current Government only. Political party policies do not constitute specific fiscal risks.

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 prior years' 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. In the 2008 Budget Update the Minister of Finance declared that the size of the operating allowances for spending and revenue initiatives in future Budgets had been set at $1.75 billion per annum from Budget 2009 onwards. An allowance of $900 million for capital spending over the period 2008/09 to 2012/13 was also set in the 2008 Budget Update. These amounts have been incorporated into the forecasts to accommodate policy initiatives on which decisions have yet to be made. Most of the risks outlined in this chapter, if they eventuate, would be covered by these amounts and therefore have no impact on the overall level of 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.
• The impact of capital spending initiatives is described as increasing the Government's gross debt position. This is correct but because the Government also holds some financial assets the actual impact could equivalently be described as reducing the Government's assets.
• 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 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 2008 included $69.1 million per annum as the fourth tranche of the 10-year plan. The following table shows the additional tranches to be charged against future Budgets.

Economic Transformation: Innovation - Pre-commitment

Budget 2008 included significant funding for Economic Transformation: Innovation. In addition to this, the Government has agreed that the following funding for this purpose will be pre-committed against future Budgets.

Foreign Affairs and Trade - Funding Package Pre-commitment

The Foreign Affairs and Trade Package is designed to provide the Ministry of Foreign Affairs and Trade (MFAT) with certainty to progress growth plans while also providing the Government and MFAT the flexibility to respond to emerging issues that may arise as a result of an increasingly complex international environment. The pre-commitment is $133 million operating and $39 million in capital funding to be allocated in Budget 2009 to Budget 2012.

Health - Pre-commitment

The Government has agreed that the indicative Health allocation of $750 million for Budget 2009 may be pre-committed by $2.233 million in 2010/11 rising to $13.736 million per annum in 2012/13 and outyears.

Teachers' and Principals' Collective Agreements

The Government previously set aside funding for the Teachers' and Principals' Collective Agreements in Budgets 2007 and 2008. These Collective Agreements have now been settled, and the remaining costs are $169.128 million in 2009/10 rising to $192.414 million in 2010/11 and outyears. These costs will be charged against Budget 2009.

Time-limited Funding#

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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 in the forecast period and may potentially be extended, using a $5 million materiality threshold. Time-limited funding often relates to pilot programmes, and in some cases Multi-year Appropriations (MYAs) if they are likely to require further funding in the future.

The following table shows the operating impact 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 spending.

Specific Fiscal Risks#

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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 2008 Budget Update

The following risks have been removed since the 2008 Budget Update:

Statement of Fiscal Risks#

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Agriculture and Forestry - New Zealand Fast Forward Fund (new, unquantified risk)

In March 2008, the Government announced its commitment of $700 million to the New Zealand Fast Forward initiative, promoting innovation projects in the pastoral and food sectors. The Government is now considering options to reimburse the fund for income tax and GST implications. This could decrease the operating balance or increase gross debt, depending on the method of reimbursement chosen by the Government.

Corrections – Capital Projects (unchanged, unquantified risk)

The Government is currently considering a range of options to address continued forecast growth in the prison population, including the asset management of current Corrections facilities, and increased prison capacity. This risk is unquantified as the quantum of the risk will vary greatly depending on the options chosen. If approved, any capital injections would increase gross debt while operating funding would decrease the operating balance.

Customs – Border Management System (CusMod) Replacement (unchanged, quantified risk)

Customs' border management systems (CusMod) are over 10 years old. Customs received funding in Budgets 2007 and 2008 to develop a business case for replacement systems for consideration in Budget 2009. In accordance with the two-stage approval process for major IT projects, funding for CusMod replacement is dependent on approval of the two business cases. The indicative cost of the project is $105 million capital over five years and up to $15 million operating per annum. If approved, this would decrease the operating balance and increase gross debt.

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

Source: New Zealand Customs Service

Economic Development – Implementation of the New Zealand Tourism Strategy (unchanged, unquantified risk)

The New Zealand Tourism Strategy 2015 is a joint document between the Government and industry. It includes a range of actions to progress key sector goals. Funding for these actions will come from a range of stakeholders, including Government. Ministers are yet to decide the appropriate funding mix to support high-priority actions within the Strategy, however additional capital funding would increase gross debt and additional operating funding would decrease the operating balance.

Economic Development – Radio Spectrum Rights (unchanged, unquantified risk)

The Government sets the processes for the renewal or auction of property rights to radio spectrum in consultation with industry. Any revenue from sale of rights would increase the operating balance by the full amount of the sales. Offers for rights of renewal to existing owners of spectrum rights are set approximately five years in advance of rights expiring with settlement being required prior to granting the new right. The rights in different frequency bands expire at different dates, with the initial expiry dates occurring in 2010. If any offers are rejected then they will be allocated by way of auction on the open market. (For this reason the expected revenue from sale of renewal rights is not reflected in current forecasts of revenue.)

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

Economic Development - Trilateral Projects (new, unquantified risk)

The Government is currently considering policy initiatives to support business sectors. The proposals are currently in the early stages of consideration and the Government is considering a range of funding options. Depending on the funding involved, this could decrease the operating balance and/or increase gross debt. The risk is unquantified as disclosure may compromise the Crown in commercial negotiations.

Economic Development – Venture Investment Fund (unchanged, quantified risk)

In Budget 2006, the Government agreed to additional investment commitments in the Venture Investment Fund of $60 million over the period of 2006/07 to 2008/09. The Government is also considering further commitments of $40 million over two years (2009/10 and 2010/11). This depends on the results of the evaluation of the Venture Investment Fund scheduled for completion by 31 March 2009. If approved, this would increase gross debt.

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

Source: Ministry of Economic Development

Education - Caretakers, Cleaners and Groundstaff Negotiations (new, unquantified risk)

The Government has agreed to amend the bargaining parameters for the School Caretakers and Cleaners Collective Agreement and the Secondary and Area School Groundstaff Collective Agreement. Any additional funding would decrease the operating balance. The risk is unquantified as disclosure could compromise the Crown in negotiations.

Education – Early Childhood Education Ratio Changes (changed, quantified risk)

The Government has committed to increasing teacher-to-child ratios as part of the Early Childhood Education Strategic Plan. In October 2006, the Government agreed to two stages of staffing ratio improvements to be implemented in July 2009 and 2010. The Government has also communicated that further increases in staffing ratios are being considered. Additional funding estimated as up to $35 million per annum from 2011/12 will be considered as part of Budget 2009. Any increased funding will reduce the operating balance.

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

Source: Ministry of Education

Education – Integrated Schools Property (new, unquantified risk)

The Ministry of Education is undertaking a review of integrated schools policy which is to be completed by the end of 2008. This includes consideration of the standard of integrated school property and options to bring substandard integrated school property up to the same standard as that of mainstream state schools. Any decisions on funding for integrated schools will not be considered until this review is completed. Any increased funding would reduce the operating balance.

Education – School Property (changed, quantified risk)

Capital injections for school property will be required in future years to accommodate roll growth and to establish new schools in response to regional population changes. Likely capital injections are estimated at up to $153 million in each of 2009/10 and 2010/11, and $123 million per annum from 2011/12. Capital injections result in consequential operating costs rising from approximately $13.5 million in 2009/10 (including $8.5 million in capital charge) to $89 million in 2012/13 (including $66 million in capital charge). The Ministry of Education is taking steps to reduce the level of capital funding carried forward from year to year. The carry-forward, which represents capital budgets allocated to schools but not yet expended, is currently $1.4 billion. If approved, any capital funding would increase debt, and any operating funding would decrease the operating balance.

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

Source: Ministry of Education

Education – Schools Plus (changed, quantified risk)

The Government is considering a range of policies to increase student participation and achievement in education, skills and structured learning. The Government has agreed to fund an initial $40 million in operating for the initial phase of the Schools Plus programme. The Government has also agreed that a compulsory education and training age of 17 will be introduced in 2011, and that age will increase to 18 in 2014. The Ministry of Education has estimated that the cost of all students participating until age 18 in some form of education and training would be between $134 million and $240 million. The Government is also considering other initiatives which could cost up to $100 million. If approved, any capital funding would increase debt, and any operating funding would decrease the operating balance.

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

Source: Ministry of Education

Education/Social Development – Inter-agency Plan for Conduct Disorder/Severe Antisocial Behaviour (unchanged, unquantified risk)

The Government has approved and published a six-year Inter-agency Plan for Conduct Disorder/Severe Antisocial Behaviour (2007-2012). The Inter-agency Plan commits Government to deliver a range of initiatives including new services for 3 to 7 year-olds and shared infrastructure across sectors. While amounts would depend on the policy and scaling options chosen, any additional operating funding would decrease the operating balance.

Education (Tertiary) – Tertiary Education Capital Investment Fund (changed, quantified risk)

The Government has established a contestable Tertiary Education Capital Investment Fund (The Capital Fund). This will fund the Crown's contribution to capital investments for public Tertiary Education Institutions that are approved by Cabinet on the recommendation of a panel administered by the Tertiary Education Commission. The value of this Fund has been set at $112 million over three years (this includes some funds transferred from unallocated 2007/08 contingencies). To date, $11.632 million has been appropriated against this Fund in 2008/09.

The Government has also approved in principle a one-off capital contribution of $11.15 million for the construction of a new building for the New Zealand School of Music. The funding has been set aside in a contingency pending the development of a business case.

The Government may also consider making loans or capital injections from the Capital Fund to Tertiary Education Institutions where ongoing educational provision or financial viability are at risk.

The provision of any capital injections will increase gross debt but the total quantum will be within the sum allocated to the Capital Fund.

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

Source: Ministry of Education and Tertiary Education Commission

Education (Tertiary) – Vocational Training (unchanged, quantified risk)

The Government is considering a number of policies regarding the expansion of vocational training. One of these is to have 250,000 people participating in industry training.

As at Budget 2008, funding supports participation of approximately 220,000 trainees by 2011. To achieve participation of 250,000 trainees in 2011, the Industry Training Fund would need to increase by approximately $7.5 million in 2009/10, $15 million in 2010/11 and $20 million in 2011/12 and outyears.

If approved, this proposal would decrease the operating balance.

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

Source: Tertiary Education Commission

Education (Tertiary) - Wānanga Capital Injections (changed, quantified risk)

The Government is currently negotiating with Te Wānanga o Raukawa over settlement of its Waitangi Tribunal claim. The Waitangi Tribunal recommended that Te Wānanga o Raukawa be compensated for capital expenditure it has incurred on facilities to date, and be provided with funding to bring its facilities up to a standard comparable with other tertiary institutions and to meet additional capital requirements. Negotiations are also taking place with Te Whare Wānanga o Awanuiārangi in relation to an outstanding item from the original settlement. Cabinet has agreed to fund $50.649 million in the settlement with Te Wānanga o Raukawa but this is yet to be ratified by Te Wānanga. The outstanding settlement for Te Whare Wānanga o Awanuiārangi of $8.5 million was agreed as part of its settlement with the Crown in 2003. The Crown is currently discussing with Te Whare Wānanga o Awanuiārangi the conditions required to conclude the settlement. The settlements will increase gross debt.

Source: Ministry of Education and Tertiary Education Commission

Energy - ETS household assistance package (new, quantified risk)

The Climate Change Response (Emissions Trading) Amendment Act 2008 includes provisions for a household energy efficiency fund (section 180). The Act requires $1 billion to be paid into the Fund, from money appropriated by Parliament, sometime between the Act's commencement and 1 July 2024. How the Fund will be appropriated across the 15-year period is yet to be decided, and will first require the Minister of Energy to determine the criteria for the Fund. Consequently, the Fund cannot yet be included in the forecasts. In addition, direct financial support for households of up to $180 million over 2009/10 and 2010/11 has also been agreed to be included in the 2009 Budget. This proposal would decrease the operating balance.

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

Source: The Treasury

Environment - Purchase of Kyoto Compliant Emission Units (unchanged, quantified risk)

The Government faces a potential net-exposure to the international market for Kyoto-compliant emission units. This net-exposure would come about if the emission units that are built up by Government over the first commitment period as a result of the operation of the ETS are less than the size of the Government's Kyoto liability.

Currently the forecasts indicate that the Government may have to purchase Kyoto-compliant emission units to meet its Kyoto obligations. At the 30 June 2008 carbon price of $25.89 per tonne this could cost around $500 million. However, there is significant uncertainty around both the Kyoto liability and the units that may be built up as a result of the ETS (largely given the inherent uncertainty around forecasts of New Zealand net-emissions and the assumed take-up rate of forestry into the ETS). Any purchasing would increase gross debt.

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

Source: The Treasury

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 gross debt.

Finance – Redevelopment of Rail (new, quantified risk)

The Government has signalled an intention to continue investment in rail transport by agreeing to establish a five-year multi-year appropriation Rail Transport Upgrade and Growth Projects and a non-departmental output expense New Zealand Railways Corporation Operating Support. The Government, as a first step, has approved funding for these two new appropriations in 2008/09. Funding for 2009/10 to 2012/13 will be considered as part of Budget 2009 but is expected to total $920 million and $383 million respectively.

If approved, this funding would increase gross debt and reduce the operating balance.

Source: The Treasury

Finance - Taitokerau Forests Limited (new, unquantified risk)

The Government is considering various options regarding the restructuring of loans to Taitokerau Forests Limited, while protecting the Crown's interest as secured creditor. These options could involve a partial write-off of the Crown loan, additional funding until harvest of the forests and/or other payments to compensate shareholders for lost opportunities. Negotiations with the company are ongoing, and the outcome is not yet known. The risk is unquantified as disclosure could compromise the Crown in negotiations.

Fisheries - Civilian Maritime Aerial Surveillance (unchanged, unquantified risk)

The Government is considering options to provide increased short- to medium-range maritime aerial surveillance for civilian agencies. Options include delivery of a range of different surveillance capabilities by either military or commercial providers. The amount of funding required would depend on the option chosen, if any. Any capital injections required would increase gross debt, while operating funding would decrease the operating balance.

The risk is unquantified as the amount or timing of any funding is unclear.

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

Draft District Annual Plans from 15 of the 21 District Health Boards (DHBs) indicate projected operating deficits in 2008/09. The Government does not view DHB deficits as acceptable and cost containment strategies are in place.

Any decision to fund such deficits would decrease the operating balance and/or increase gross debt. Specific potential pressures for DHBs include wage bargaining and financing costs of capital projects.

This risk has changed since the 2008 Budget Update to take into account the new projections of DHB deficits.

Health – Indicative Funding for Budgets 2009 and 2010 (changed, quantified risk)

The Government is considering indicative operating allocations of $750 million for Budgets 2009 and 2010. These amounts indicate the likely level of increased funding to be provided to Vote Health in future Budgets and to assist the Minister of Health to plan spending priorities over the period. The final allocations will depend on economic and fiscal conditions at the time of each Budget. Finalising the amounts and details of how these allocations will be spent will be subject to normal budget processes.

The Government has also agreed that the indicative allocation for Budget 2009 above may be pre-committed up to $13.736 million per annum in 2012/13 and outyears. This was shown in the Charges against Future Budgets section of this chapter. The operating balance would be decreased by the totals as follows:

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

Source: Ministry of Health

Housing – Affordable Home Ownership (new, unquantified risk)

The Government is considering options to provide financial assistance to households to assist them to purchase an affordable new home. The provision of additional capital funding would increase gross debt and operational funding would decrease the operating balance.

Housing – Hobsonville Urban Development (changed, unquantified risk)

The Government has agreed to the creation of an integrated urban community at Hobsonville. While funding was provided in Budget 2008 for Precinct One, as well as any other costs that need to occur concurrently with Precinct One, capital funding will need to be provided for the remaining four precincts in future Budgets. This will increase gross debt. This risk is unquantified as disclosure could compromise the Crown in negotiations.

Housing - Housing Innovation Fund (new, unquantified risk)

The Government has agreed to consider a capital funding appropriation for the Housing Innovation Fund for 2009/10 to support community-based solutions for social housing. This is provided the Housing New Zealand Corporation is able to provide the corresponding operating funding. The provision of additional capital funding would increase gross debt.

Housing - Sustainable Urban Development Approach (changed, unquantified risk)

The Government has issued a public discussion document about how a Sustainable Urban Development Approach could be established in New Zealand, including supply of affordable housing. Submissions are due by 28 November 2008. The amount and timing of costs would depend on the option chosen. Additional funding would increase gross debt and/or decrease the operating balance.

Housing - Tamaki (unchanged, unquantified risk)

The Government is considering the redevelopment of the Tamaki area. Any capital funding would increase gross debt while operating funding would decrease the operating balance. This risk is unquantified as disclosure could compromise the Crown in negotiations.

Immigration – New Immigration Service Delivery Strategy (unchanged, unquantified risk)

The Government is in the process of developing a stage-two business case for a new Immigration Service Delivery Strategy, which would aim to allow better management of the risk surrounding immigration decision-making and improve delivery of immigration services. Cabinet is likely to consider the stage-two business case in early 2009. A portion of the additional funding is expected to be funded by third-party revenue and the rest would reduce the operating balance and increase gross debt. This risk is unquantified as disclosure could compromise the Crown in negotiations.

Internal Affairs – Property Strategy (new, unquantified risk)

The Government is considering options around a long-term property strategy for the Department of Internal Affairs, subject to completion of a detailed business case.

This risk is unquantified as disclosure could compromise the Crown in negotiations, but any new funding would decrease the operating balance and/or increase gross debt.

Justice – Financial Action Taskforce Recommendations (unchanged, quantified risk)

In order to implement the recommendations of the Financial Action Taskforce, the Government is considering a new Anti-money Laundering and Counter-terrorist Financing regime. Increased supervision and enforcement is expected to result in increased costs to the following agencies: the Reserve Bank, the Securities Commission, the Department of Internal Affairs, the Financial Intelligence Unit of the New Zealand Police and the Ministry of Justice. Costs are still being finalised but could be up to $15 million per annum and would reduce the operating balance.

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

Source: Ministry of Justice

Justice – Greater Auckland Region Service Delivery Strategy (unchanged, quantified risk)

The Government is developing a strategy to address courts' needs in the greater Auckland region. A wide range of stakeholders are currently being consulted over a variety of service delivery options. The total cost could be up to $265 million. The impact on the operating balance or gross debt would depend on the options chosen.

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

Source: Ministry of Justice

Justice Sector and Other Agencies - Effective Interventions (unchanged, unquantified risk)

As part of a comprehensive approach to reducing crime and the pressures on the prison population, the Government is considering measures to address the precursors of crime, and measures to reduce re-offending. The measures focus on early interventions for vulnerable children, youth offending, restorative justice, preventing crime in local communities, reintegrating offenders and drug and alcohol treatment for offenders.

Funding of $37 million per annum was approved in 2006. The Government is currently considering a range of further options. The amount of any additional funding will depend on the specific options chosen.

Justice - Supreme Court Construction Cost Pressures (new, quantified risk)

The Government is part-way through the construction of permanent premises for the Supreme Court, including the restoration of the old High Court Building on the same site. Current funding appears likely to be insufficient to complete the project owing to increased costs for building materials, pressures from the Wellington construction market, higher than anticipated costs for restoring the old High Court Building and increased costs for design development. It is expected that between $8.3 million and $12.1 million of additional capital funding will be required and additional operating funding of $1.5 million to $4.1 million over the four years from 2008/09 to 2012/13. This would decrease the operating balance and increase gross debt.

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

Source: Ministry of Justice

Local Government - Response to Rates Inquiry (changed, unquantified risk)

The Independent Inquiry into Local Government Rates reported in August 2007. The Government has established a series of work streams to assist development of its response to issues outlined in the report. Some initiatives have already been undertaken as part of the Government's response, including $51.2 million in new funding from 2008/09 to 2012/13 for enhancements to the rates rebate scheme (included in forecasts). However, the total potential impact of additional actions on the operating balance and/or gross debt is unknown at this stage, as this would depend on the nature and scope of such additional measures subsequently pursued.

Māori Affairs - Māori Business Aotearoa New Zealand (unchanged, quantified risk)

The Government has agreed to establish an independent statutory corporation for the purposes of furthering Māori economic development, to be known as Māori Business Aotearoa New Zealand (MBANZ), subject to enactment of the Māori Trustee and Māori Development Bill.

New Crown funding required is estimated to be $40 million capital in 2008/09, with an associated ongoing operating saving of approximately $4 million per annum related to the transfer of functions from Te Puni Kōkiri to MBANZ. If approved, this would increase the operating balance and increase gross debt.

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

Source: Te Puni Kōkiri

New Zealand Agency for International Development - Adjustment of Official Development Assistance Fund (unchanged, unquantified risk)

Budget 2008 included funding to take Government Official Development Assistance to an equivalent percentage of Gross National Income (GNI) - 0.30% in 2008/09, 0.33% in 2009/10 and 0.35% in 2010/11. However, because GNI forecasts will change in subsequent years, there is a risk that funding levels may need to be adjusted to maintain these percentages of GNI. Any such changes will be considered in future Budgets. The net impact of this risk is unclear and thus may increase or decrease the operating balance.

New Zealand Defence Force - 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 Headquarters NZDF to achieve the required capability upgrades. The Government has agreed to a capital injection of up to $1.244 billion over the 10-year period from 2002 to 2012.

Of the $1.244 billion, $1.034 billion has been appropriated with up to $210 million likely to be required within the forecast period. 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 further 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 - Operationally Deployed Forces (new, quantified risk)

There are currently over 400 NZDF personnel deployed overseas on Peace Keeping and United Nations missions. Continuing to maintain deployments in Afghanistan, East Timor, the Solomon Islands and several other locations exceeds the deployment levels anticipated when the Defence Funding Package was approved in 2005. If current deployment levels are maintained, the appropriation for operationally deployed forces may need to be increased by approximately $10 to 15 million from 2009/10.

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 (changed, quantified risk)

As a result of the Government's decisions on the future structure of the NZDF, NZDF has signed an agreement with Tactical Air Services Inc for the sale of the Skyhawks and Aermacchi trainers for US$110 million. A formal contract has yet to be signed, but the net proceeds from the sale would decrease gross debt and increase the operating balance by $NZ90 million.

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

Source: New Zealand Defence Force

Police - Increases to Police Staff (changed, quantified risk)

The Government has funded an additional 1,250 Police staff over Budgets 2006 to 2008. Additional funding for property associated with these staff will be considered in future Budgets, and may be in the order of $45 million capital. If approved, additional capital injections would increase gross debt and additional operating funding would decrease the operating balance.

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

Source: New Zealand Police

Revenue – Investment in the Tax System and Related Business (unchanged, unquantified risk)

Inland Revenue is investigating options around investment in the tax system and related business processes, including replacing the FIRST tax system. Part of this work includes investigating options for transforming employer information and payments. The potential impact and timing of this are unknown at this stage, as it would depend on the nature and scope of any options that are pursued. Any additional capital funding would increase gross debt and additional operating funding would decrease the operating balance.

Revenue – Paid Parental Leave Review (new, unquantified risk)

The Government is considering options for changes to the Paid Parental Leave scheme, including changes to the eligibility criteria and the duration of payments. Possible adjustments to the Parental Tax Credit are also under consideration by the Government as a component of the Paid Parental Leave Review. The final proposals could be submitted as a budget bid as part of the Budget 2009 process. Any additional funding would decrease the operating balance.

Revenue – Rebuild of the Student Loan System (unchanged, unquantified risk)

The Government is considering options for redesigning the Student Loans IT system. The redesign aims to enable greater efficiency and enhanced student services while delivering increased integrity of the system, greater information to inform policy decisions and increased flexibility for future policy changes. This risk is unquantified as disclosure could compromise the Crown in negotiations. If approved, any funding would decrease the operating balance and/or increase gross debt.

Revenue – Reducing Compliance Costs for Small- and Medium-Sized Enterprises (unchanged, unquantified risk)

The Government is considering measures to simplify the tax rules for small- and medium-sized enterprises, pursuant to a Government discussion document released in December 2007. Consultation on a number of the measures proposed in this discussion document is underway. Some changes have been adopted as part of Budget 2008 while other changes may be adopted subsequently. The potential overall impact on the operating balance is unknown at this stage, as it would depend on the nature and scope of any measures that are subsequently pursued.

Revenue – Renegotiation of Double Tax Agreements (unchanged, unquantified risk)

A Government discussion document released in December 2006 considered the case for negotiating lower rates of Non-Resident Withholding Tax (NRWT) in New Zealand's Double Tax Agreements (DTAs). The Australia and US DTAs with New Zealand are being renegotiated this year. Although any effect on the operating balance will depend on the outcome of bilateral treaty negotiations, to the extent that lower rates are agreed, this will likely have the effect of decreasing the operating balance.

Social Development – Children, Young Persons and their Families Act (unchanged, unquantified risk)

The Government is considering a number of changes to the Children, Young Persons and Their Families Act 1989. Most of the costs relating to these changes arise from the proposal to increase the age of a young person from 17 to 18. The fiscal impacts would depend on what proposals are finally approved and the details of the legislation. Any additional operating funding would decrease the operating balance and any additional capital would increase gross debt.

Social Development – Energy Subsidy for SuperGold Card Holders (unchanged, unquantified risk)

The SuperGold Card is a discounts and concessions card issued free to senior citizens and veterans. When the card was introduced in 2006, it was with the intention of having a range of services gradually included. A major enhancement being considered by Government will offer SuperGold Card holders a winter heating subsidy to mitigate the increasing cost of energy prices when energy producers are brought into the ETS. The total cost of the subsidy would depend on policy and implementation decisions yet to be made.

Social Development – Five-year Action Plan for Out of School Services (new, unquantified risk)

The Government has approved, in principle, a Five-year Action Plan for Out of School Services. The Action Plan proposes a range of initiatives that represent a number of policy options available to Government. While the amounts are unclear and would depend on the policy options chosen, any additional operating funding would decrease the operating balance.

Social Development – Working New Zealand: Work-focused Support (unchanged, unquantified risk)

Working New Zealand: Work-focused Support is a package of policy and operational changes aimed at simplifying the benefit system and enhancing the opportunities for beneficiaries to participate in the labour market. The first stage has already been implemented and focused on getting services and support in place to help people move into work and stay employed. The Government is considering further options and costs to simplify the benefit system and further support people to stay in work. The next stage will be submitted for consideration in future Budgets. The remaining proposals are still being developed, but any additional funding would decrease the operating balance.

Social Development – Youth Court Sentencing Orders (unchanged, quantified risk)

The Government is considering the inclusion of new Youth Court orders in the Children, Young Persons and Their Families Act 1989. The estimated cost is approximately $12 million in operating funding and $4 million in capital funding. This would have the effect of decreasing the operating balance and increasing debt.

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

Source: Ministry of Social Development

Transport - Canterbury Transport Project (new, quantified risk)

In Budget 2008 the Government provided $33.5 million for the first four years of the ten-year Canterbury Transport Regional Implementation Plan. The Government has indicated that its total contribution to the project will be $244 million. The possible cost to the Government of the remainder of the project is estimated at $210.5 million. If approved, this proposal would increase gross debt.

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

Source: Ministry of Transport

Transport - Penlink Roading Project (new, quantified risk)

The Government is considering the provision of $100-$200 million in 2009 to the Rodney District Council to build the Penlink roading connection. This proposal would increase gross debt, which would be serviced with regional fuel tax revenue.

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

Source: Ministry of Transport

Transport – Waterview Connection (new, quantified risk)

The Government is considering progressing the Waterview Connection roading project through a public-private partnership. The cost to the Government of this project is estimated at $1.5 billion between 2015 and 2050. If approved, this proposal would increase gross debt.

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

Source: New Zealand Transport Agency

Transport – Waterview Connection, risk of not tolling project (new, quantified risk)

The Government has indicated that it may toll the Waterview Connection to recover $500 million of the construction costs of the project. However, there is also a possibility that the Government may decide not to toll the road, thus the Government could be required to provide an additional $500 million for the project. This money would be required between 2015 and 2050. If approved, this proposal would decrease the operating balance and increase gross debt.

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

Source: New Zealand Transport Agency

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 GSID. However, in the case of contingencies for uncalled capital, the negative impact would be restricted to GSID.

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

Only contingent liabilities involving amounts of over $10 million are separately disclosed. 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 prior years' contingent liabilities remains unchanged.

Contingent liabilities have been stated as at 30 June 2008, being the latest set of published contingent liabilities.

Details of each of the following contingent liabilities can be accessed from the Treasury's website at http://www.treasury.govt.nz/government/financialstatements/yearend/jun08

Quantifiable Contingent Liabilities

Unquantifiable Contingent Liabilities

5 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 17 September 2008.

The finalisation dates are outlined at the beginning of this document. A summary of the key economic assumptions that are particularly relevant to the fiscal forecast is provided below. These figures are on a June year basis to align with the government's balance date of 30 June.

Statement of Accounting Policies and Forecast Assumptions

Significant Accounting Policies

These Forecast Financial Statements have been prepared in accordance with the accounting policies that are expected to be used in the comparable audited actual Financial Statements of the Government.

These Forecast Financial Statements comply with generally accepted accounting policies (GAAP) as required by the Public Finance Act 1989 and have been prepared in accordance with New Zealand equivalents to International Financial Reporting Standards (NZ IFRS), as appropriate for public benefit entities.

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

Changes in Accounting Policies

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

Forecast Policies

These Forecast Financial Statements have been prepared on the basis of Treasury's best professional judgment. Key assumptions used are set out on page 83.

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

Detailed Accounting Policies and Forecast Assumptions

The specific accounting and forecasting policies are reproduced in full on Treasury's website at http://www.treasury.govt.nz/publications/guidance/instructions/2008

Government Reporting Entity as at 17 September 2008

These forecast financial statements are for the Government reporting entity as specified in section 26Q(4) of the Public Finance Act 1989. This comprises Ministers of the Crown and the following entities:

Departments

Agriculture and Forestry
Archives New Zealand
Building and Housing
Conservation
Corrections
Crown Law Office
Culture and Heritage
Defence
Economic Development
Education
Education Review Office
Environment
Fisheries
Foreign Affairs and Trade
Government Communications Security Bureau
Health
Inland Revenue
Internal Affairs
Justice
Labour
Land Information New Zealand
Māori Development
National Library of New Zealand
New Zealand Customs Service
New Zealand Defence Force
New Zealand Food Safety Authority
New Zealand Police
New Zealand Security Intelligence Service
Office of the Clerk
Pacific Island Affairs
Parliamentary Counsel Office
Parliamentary Service
Prime Minister and Cabinet
Research, Science and Technology
Serious Fraud Office
Social Development
State Services Commission
Statistics
Transport
Treasury
Women's Affairs

Offices of Parliament

Office of the Controller and Auditor-General
Office of the Ombudsmen
Parliamentary Commissioner for the Environment

Others

Government Superannuation Fund
New Zealand Superannuation Fund
Reserve Bank of New Zealand

State-owned enterprises

Airways Corporation of New Zealand Limited
Animal Control Products Limited
AsureQuality Limited
Electricity Corporation of New Zealand Limited
Genesis Power Limited
Kordia Group Limited
Landcorp Farming Limited
Learning Media Limited
Meridian Energy Limited
Meteorological Service of New Zealand Limited
Mighty River Power Limited
New Zealand Post Limited
New Zealand Railways Corporation
Quotable Value Limited
Solid Energy New Zealand Limited
Terralink Limited (in liquidation)
Timberlands West Coast Limited
Transpower New Zealand Limited

Air New Zealand Limited (included for disclosure purposes as if it were a SOE)

KiwiRail Holdings Limited (included for disclosure purposes as if it were a SOE) *

* KiwiRail Holdings Limited was acquired by the Crown on 1 July 2008 and in turn is to be acquired by the New Zealand Railways Corporation from 1 October 2008 as its operating unit.

Crown entities

Accident Compensation Corporation
Accounting Standards Review Board
Alcohol Advisory Council of New Zealand
Arts Council of New Zealand Toi Aotearoa
Broadcasting Commission
Broadcasting Standards Authority
Career Services
Charities Commission
Children's Commissioner
Civil Aviation Authority of New Zealand
Commerce Commission
Crown Health Financing Agency
Crown research institutes (9)
District health boards (21)
Drug Free Sport New Zealand
Earthquake Commission
Electoral Commission
Electricity Commission
Energy Efficiency and Conservation Authority
Environmental Risk Management Authority
Families Commission
Foundation for Research, Science and Technology
Government Superannuation Fund Authority
Guardians of New Zealand Superannuation
Health and Disability Commissioner
Health Research Council of New Zealand
Health Sponsorship Council
Housing New Zealand Corporation
Human Rights Commission
Independent Police Conduct Authority
Law Commission
Legal Services Agency
Maritime New Zealand
Mental Health Commission
Museum of New Zealand Te Papa Tongarewa Board
New Zealand Antarctic Institute
New Zealand Artificial Limb Board
New Zealand Blood Service
New Zealand Fast Forward Fund Limited
New Zealand Film Commission
New Zealand Fire Service Commission
New Zealand Historic Places Trust (Pouhere Taonga)
New Zealand Lotteries Commission
New Zealand Qualifications Authority
New Zealand Symphony Orchestra
New Zealand Teachers Council
New Zealand Tourism Board
New Zealand Trade and Enterprise
New Zealand Transport Agency
New Zealand Venture Investment Fund Limited
Office of Film and Literature Classification
Pharmaceutical Management Agency
Privacy Commissioner
Public Trust
Radio New Zealand Limited
Real Estate Agents Authority
Retirement Commissioner
School boards of trustees (2,460)
Securities Commission
Social Workers Registration Board
Sport and Recreation New Zealand
Standards Council
Takeovers Panel
Te Reo Whakapuaki Irirangi (Te Māngai Pāho)
Te Taura Whiri i te Reo Māori (Māori Language Commission)
Television New Zealand Limited
Tertiary Education Commission
Tertiary education institutions (31)
Testing Laboratory Registration Council
Transport Accident Investigation Commission

Crown entity subsidiaries are consolidated by their parents and not listed separately in this table

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
National Pacific Radio Trust
New Zealand Fast Forward Limited
New Zealand Fish and Game Council
New Zealand Game Bird Habitat Trust Board
New Zealand Government Property Corporation
New Zealand Lottery Grants Board
Ngāi Tahu Ancillary Claims Trust
Pacific Co-operation Foundation
Pacific Island Development Trust
Research and Education Advanced Network New Zealand Limited
Reserves boards (24)
Road Safety Trust

Forecast Statement of Financial Performance

for the years ending 30 June

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

Functional Expense Analysis

for the years ending 30 June

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

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

Forecast Statement of Cash Flows

for the years ending 30 June

¹ Net issues of Government stock include movements within government stock holdings of entities such as NZS Fund, ACC and EQC. The Bonds reconciliation at the end of these accounts outlines the proceeds and repayments of domestic bonds.

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 Recognised Income and Expense

for the years ending 30 June

This statement reports changes in net worth due to the operating balance, items of income or expense that are recognised directly in net worth, the effect of certain accounting changes and corrections of errors.

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

Forecast Statement of Financial Position

as at 30 June

¹ Tertiary education institutions constitute most equity accounted investments.

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

Forecast Statement of Borrowings

for the years ending 30 June

Notes on Borrowings

1. Derivatives are included in either borrowings or marketable securities, deposits and equity investments depending on their value at balance date. This treatment leads to fluctuations in individual items within the Statement of Borrowings, primarily due to exchange rate movements.
2. Total Borrowings (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.
3. Total Borrowings (Gross Debt) can be split into sovereign-guaranteed and non-sovereign-guaranteed debt. This split reflects the fact that borrowings by SOEs and Crown entities are not explicitly guaranteed by the Crown. No debt of SOEs and Crown entities is currently guaranteed by the Crown.
4. Gross sovereign-issued debt is debt issued by the sovereign (i.e., core Crown) and includes Government stock held by the NZS Fund, ACC or EQC for example. In other words, the total sovereign-issued debt does not eliminate any internal cross-holdings held by these entities.
5. The Reserve Bank has used $1.6b of settlement cash to purchase reserves that were to have been funded by DMO borrowing. Therefore the impact of Settlement Cash on GSID is adjusted by this amount.
6. Core Crown financial assets exclude receivables.
7. Net core Crown debt is the Government Sovereign-issued debt less financial assets. This can provide information about the sustainability of the Government's accounts, and is used by some international agencies when determining the credit-worthiness of a country. However, as some financial assets are not easily converted into cash, and some are restricted, it is important to view net debt alongside gross sovereign- issued debt.
8. Adding back the NZ Superannuation Fund Assets provides the financial liabilities less financial assets of the Core Crown, excluding those assets set aside to meet part of the future cost of New Zealand superannuation.

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

Statement of Actual Commitments

as at 30 June

Statement of Actual Contingent Liabilities and Assets

as at 30 June

A detailed Statement of Contingent Liabilities and Assets (quantified and unquantified) is outlined on pages 80 to 82 of the Specific Fiscal Risk chapter.

The Statement of Specific Risks (quantified and unquantified) is outlined on pages 57 to 82 of the Specific Fiscal Risk chapter.

Notes to the Forecast Financial Statements#

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ACC payments are now classified as insurance expenses under NZ IFRS (refer note 7).

New operating spending up to Budget 2009 represents the unallocated allowance from Budget 2008.

Forecast new operating spending indicates in broad terms the potential spending increases that could be introduced in each future remaining budget round. Total potential spending increases included in the forecasts are $1.75 billion for the next four Budgets (growing 2% each budget). As some of this spending has already been allocated, this line represents the unallocated portion.

ACC liability

Calculation information

PricewaterhouseCoopers Actuarial Pty Ltd have prepared an independent actuarial estimate of the ACC outstanding claims liability asat 30 June 2008. This estimate includes the expected future payments relating to accidents that occurred prior to balance date (whether or not the associated claims have been reported to, or accepted by, ACC) and also the expected future administrative expenses of managing these claims.

The key economic variables that impact on changes to the valuation are the long-term Labour Cost Index (LCI), average weeklyearnings and the discount rate (6.63% at 30 June 2008). Other key variables in each valuation are the forecast increases in claim costs over and above the economic variables above, and the assumed rate at which long-term claimants will leave the scheme over the period. This assessment is largely based on scheme history.

Presentation approach

The projected outstanding claims liability is included within total liabilities. ACC has available to it a portfolio of assets that partially offset the claims liability. The assets (less cross holdings of NZ Government stock) are included in the asset portion of the Crown's overall Statement of Financial Position.

The GSF obligation has been calculated by the Government Actuary as at 30 June 2008. A Projected Unit Credit Method, based on balance-date membership data, is used for the valuation. This method requires the benefits payable from the GSF in respect of past service to be estimated and then discounted back to the valuation date.

The projected GSF net liability was calculated using discount rates derived from the market yield curve as at 30 June 2008. This resulted in long-term before-tax discount rates ranging from 6.06% to 6.95%. The principal long-term financial assumptions used in the calculation were an inflation rate of 2.25% and an annual salary increases rate, before any promotional effects, of 3.0%.

The 2008/09 projected movement in the net liability is $74 million, reflecting an increase in the GSF liability of $86 million and an increase in the GSF assets of $12 million.

The changes in the projected GSF net liability from 2008/09 onwards reflects the net of the expected current service cost, interest cost, investment returns and contributions.

Analysis of Provision for ETS credits

The Emissions Trading Scheme (ETS) was established to encourage reduction in greenhouse gas emissions. The ETS creates a limited number of tradable units (the NZ Unit) which the Government can allocate freely or sell to entities. The allocation of NZ Units creates a provision (and an expense if allocated for free). The provision is reduced, and revenue recognised, as NZ Units are surrended to the Crown by emitters. Emitters can also use international Kyoto units to settle their emission obligation, which will occur where emissions exceed the number of allocated NZ units.

The ETS impact on the fiscal forecast is as follows:

Forecast Statement of Segments#

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