Pre-election Economic and Fiscal Update 2014

Treasury Forecast Update Process#

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

With the announcement of an election date of 20 September 2014, the Treasury has prepared a set of forecasts taking into account the most recent economic and fiscal developments since its May 2014 Budget Economic and Fiscal Update (Budget Update). As in 2005, the last time there was a September General Election, the process has been slightly truncated given the proximity to the preparation of the Budget Update forecasts.

A complete set of macroeconomic forecasts has been produced taking into account the economic developments since the Budget Update. In line with established practice, Inland Revenue (IRD) has prepared an independent set of tax forecasts based, in the short term, on more detailed analysis of taxpayer information, and, in the longer term, on the same underlying macroeconomic trends that underpin the Treasury's tax forecasts.

The fiscal forecasts have been prepared using the same accounting policies used for the audited Financial Statements of the Government of New Zealand. They comply with generally accepted accounting practice (GAAP) as required by the Public Finance Act 1989 and have been prepared in accordance with Financial Reporting Standard 42: Prospective Financial Standards.

The preparation of the Pre-election Update fiscal forecasts has involved:

• reassessing tax revenue (in conjunction with IRD) and benefit expense forecasts in light of the revisions to the macroeconomic forecasts
• updating the operating results and expense forecasts using the 2013/14 pre-audited financial information of departments and other significant reporting entities
• considering the impact of additional financial information that has occurred since the finalisation of the Budget Update fiscal forecasts of 29 April 2014
• incorporating the fiscal impact of significant Cabinet decisions made since the Budget Update, up to and including 4 August 2014. The forecasts, for example, incorporate the decision to reduce ACC motor vehicle levies in the 2015/16 fiscal year, and
• the forecasts also taking into account the Budget 2014 decision to raise the operating allowance for Budget 2015 to $1.5 billion (compared with $1.0 billion previously) and to increase the operating allowance by 2% in each Budget after that.

Where government policies, including those under active consideration, are known at the date of finalisation and would have a material effect on the fiscal forecasts, but which are not certain enough (in terms of their likely timing or measurement) to incorporate into the fiscal forecasts, they are disclosed in the Specific Fiscal Risks chapter.

Projections are also included in the document and represent potential future paths of variables. They are usually based on historical averages of the levels or growth rates of the relevant variables, and depend on both the forecast base from which they arise and the assumptions used to generate them. They differ from forecasts, which have a higher level of precision.

Finalisation Dates for the Update

Economic data     16 July 2014

Economic forecasts     18 July 2014

Tax revenue forecasts     25 July 2014

Fiscal forecasts     5 August 2014

Specific fiscal risks     5 August 2014

Projections     6 August 2014

Text finalised     13 August 2014

Since the macroeconomic forecasts were finalised on 18 July, there have been a number of data releases. They do not change the Treasury’s overall view of the economy. The Risks and Scenarios chapter describes some of the key risks to the Treasury's central economic forecasts, and sets out two alternative scenarios for how the economy and fiscal position might develop.

Other Information

On the Treasury's website is a series of other information that provides users of the Pre-election Update with further detail. This other information should be read in conjunction with the published document.

Additional Pre-election Update information includes:

• detailed economic forecast information – tables providing breakdowns of the economic forecasts
• Treasury and IRD tax forecasts – detailed tax revenue and receipts tables comparing Treasury’s forecasts with IRD’s forecasts
• additional fiscal indicators – estimates of the cyclically-adjusted balance and fiscal impulse, and
• accounting policies – outline of the specific Crown accounting policies. The published forecast financial statements only provide a summary.

This other information can be accessed at: www.treasury.govt.nz/budget/forecasts/prefu2014

NZ Budget App

Smartphone and tablet users can also access the Pre-election Update through the NZ Budget App. The App is available on the Apple Store for iOS devices and the Google Play store for Android devices.

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 other circumstances as at 5 August 2014 that were communicated to me by the Minister of Finance in accordance with the requirements of the Public Finance Act 1989 and of other economic and fiscal information available to the Treasury as at 5 August 2014. This Update does not incorporate any decisions, circumstances, or statements that the Minister of Finance has determined, in accordance with section 26V of the Public Finance Act 1989, should not be incorporated in this Update.

Gabriel Makhlouf
Secretary to the Treasury

13 August 2014

To enable the Treasury to prepare this Economic and Fiscal Update I have ensured the Secretary to the Treasury has been advised, in accordance with the requirements of the Public Finance Act 1989, of all Government decisions and other circumstances as at 5 August 2014 of which I was aware and that had material economic or fiscal implications.

I accept responsibility for the integrity of the disclosures contained in the Update and responsibility for the consistency and completeness of the Update information with the requirements of Part 2 (Fiscal responsibility) of the Public Finance Act 1989.

Hon Bill English
Minister of Finance

13 August 2014

Executive Summary#

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• The New Zealand economy is expanding at a robust pace, although growth momentum has eased from earlier in the year. Looking forward, real production gross domestic product (GDP) is forecast to grow by 2.8% on average over the four years to March 2018, essentially unchanged from the Budget Update. The near-term outlook remains for growth faster than potential driven by residential investment, positive migration inflows and still-high terms of trade.
• Real GDP growth for the year ending March 2014 was faster than expected in the Budget Update - 3.3% compared with 3.0% forecast - while growth for the year ending March 2015 is forecast to be lower at 3.8% (compared with 4.0% in the Budget Update). Growth is expected to slow later in the forecast period as the factors currently supporting growth decline and monetary conditions tighten (Figure 1).

Figure 1 - Real GDP growth

Source:  Statistics New Zealand, the Treasury

• Rising construction activity is expected to be a key driver of growth, with earthquake rebuilding supplemented by a rebound in residential construction in Auckland in response to pent-up demand. Business investment is also forecast to pick up as productive capacity is more heavily utilised.
• Net migration inflows continue to rise, adding to both demand and the productive capacity of the economy. The net inflow is expected to reach 42,500 this year and overall to add an additional 3,500 to the population compared with the Budget Update, with risks skewed to the upside.
• Household income growth is underpinning consumption and residential investment activity. Over the forecast period household disposable incomes are forecast to increase 4.0% on average per year, after an estimated 7.1% increase in the year to March 2014. Employment and wage growth is expected to be the main driver of this growth, with labour income growing by 4.6% on average over the next four years.
• Recent falls in commodity prices (mainly dairy and forestry) have occurred earlier than envisaged in the Budget Update. As a result, the forecast decline in the goods terms of trade is occurring sooner than previously expected and consequently will provide less support to growth. The terms of trade are forecast to stabilise during 2015, recovering some of the decline currently being seen. Over the forecast period the terms of trade are expected to remain above the average experienced over the past decade (Figure 2). A more substantial and sustained short-term decline in export prices is an area of downside risk for the forecasts.

Figure 2 - Goods terms of trade (SNA basis)

Source:  Statistics New Zealand, the Treasury

• The global backdrop to these forecasts is steady, but uneven, economic growth. Trading partner growth is likely to be similar to that recorded in the mid-2000s with moderate inflation. Risks overall remain skewed to the downside, with heightened geopolitical tensions adding to economic uncertainties.
• The exchange rate has remained elevated for some time, but is assumed to depreciate as the global outlook improves, foreign interest rates rise and the terms of trade fall from their recent peaks.
• The current account deficit is forecast to increase from around 2.6% of GDP in mid-2014 to 4.8% in the year to March 2015 owing to lower export volumes in the near-term and a decline in the terms of trade. The deficit is forecast to stabilise at 6.4% of GDP from late 2016.
• Fiscal policy is expected to exert a dampening influence on economic activity over the forecast horizon as slow growth in spending, combined with rising tax revenue, see the fiscal balance improve. The average fiscal impulse over the forecast period is unchanged from the Budget Update at -0.4% of GDP, but the timing and magnitude have changed with the impact of weaker tax receipts and changes in the expected timing of some forecast expenditure.
• Despite higher than forecast growth, annual Consumers Price Index (CPI) inflation in June 2014 was 1.6%, below the Budget Update forecast of 1.8%. With real GDP growth exceeding our estimate of potential growth, upward pressure on resources is forecast to continue to increase and lead to higher inflation. We forecast annual CPI inflation to peak at 2.5% in late 2016 before declining to around 2% by the end of the forecast period.
• Reflecting increased inflation pressures, we expect further increases in the Reserve Bank's Official Cash Rate (OCR) over the forecast period. Ninety-day interest rates are forecast to rise to 5.3% by late 2017.
• Nominal GDP increased 7.0% in the year to March 2014, 0.3 percentage points higher than expected in the Budget Update. In contrast, forecast growth for the year to March 2015 is 0.5 percentage points lower at 5.2% taking the level of nominal GDP below that forecast in the Budget Update. This mainly reflects the earlier decline in the terms of trade. The lower level of nominal GDP is expected to continue over the remainder of the forecast period. See the box Real and Nominal GDP on page 7 for an explanation of the different measures.
• The operating balance before gains and losses (OBEGAL) is forecast to move from an estimated $2.6 billion deficit in the year ending June 2014 to a surplus of $0.3 billion this fiscal year, and increasing thereafter to $3.0 billion in the year ending June 2018 (Figure 3). The OBEGAL surplus is $0.5 billion lower in the year ending 2018 than forecast in the Budget Update.

• Core Crown tax revenue for the year to June 2014 has been revised downward from that expected in the Budget Update. While still expected to increase across the forecast period, core Crown tax revenue is forecast to be below the Budget Update forecasts each year as a result of lower forecast nominal GDP. Forecast core Crown expenses remain largely unchanged from the Budget Update, declining to 30.0% of GDP by the end of the forecast period.
• Net core Crown debt is forecast to peak at 26.8% of GDP in the year ending June 2015 - slightly higher than 26.4% in the Budget Update. Thereafter, net debt is expected to reduce more slowly than in the Budget Update,reflecting a lower forecast path forcore Crown residual cash (which is now expected to return to surplus in the year ending June 2019). In dollar terms, net debt is forecast to peak at $67.9 billion in June 2018, $2.4 billion higher and a year later than forecast in the Budget Update.
• In addition to the risks noted above, there are other upside and downside risks to the judgements underpinning the forecasts. These include the size and pace of the Canterbury rebuild, the path and pass-through of the exchange rate and the saving behaviour of households. The potential impacts of some of these judgements evolving differently from the main forecast are highlighted in the Risks and Scenarios chapter. One scenario assumes that growth in the United States (US) is stronger, along with stronger domestic price pressures. Another scenario explores the impact of weaker short-term domestic demand combined with a larger decline in the terms of trade.
• As well as the fiscal impact of changes in economic activity, the Government is exposed to other fiscal risks that could impact both the operating balance and the balance sheet. For example, the Crown's financial position is susceptible to market movements in variables such as interest rates, exchange rates and equity prices. The final fiscal cost of the Christchurch earthquakes is also still uncertain. There are also a number of contingent liabilities and fiscal risks outlined in the Specific Fiscal Risks chapter.

Notes:

1. Real production GDP, annual average percentage change
2. Percent of labour force, March quarter, seasonally adjusted
3. CPI, annual percentage change, March quarter
4. % of GDP
5. Total Crown operating balance before gains and losses (OBEGAL)
6. Net core Crown debt excluding the New Zealand Superannuation Fund and advances

Sources: Statistics New Zealand, the Treasury

Real and Nominal GDP#

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Gross domestic product (GDP) is a measure of the added value of goods and services produced in an economy in a quarter or a year. Changes in the level of GDP between time periods are a measure of economic growth. Quarterly GDP figures for New Zealand are produced on both a production and an expenditure basis. Production GDP measures the contribution of an industry as the value of output in that industry less the value of intermediate inputs sourced from local industries or abroad. Expenditure GDP measures the value of final demand in the economy as a whole (ie, consumption, investment, exports and any increase in stocks) minus imports. Income GDP is measured only on an annual basis in New Zealand.

The two quarterly measures of GDP correspond closely over time as they are different ways of measuring the same thing (Figure 4). However, they may diverge in the short term because of differences in data and estimation techniques. In New Zealand, production GDP is the preferred measure of growth in GDP. The Treasury forecasts expenditure GDP, but assumes that growth in production and expenditure GDP will be similar in the medium term.

Figure 4 - Production and expenditure GDP growth

Source:  Statistics New Zealand, the Treasury

Figure 5 - Real and nominal GDP growth

Source:  Statistics New Zealand, the Treasury

In addition to the distinction between production and expenditure GDP, GDP can be measured in real and nominal terms. Real GDP is a measure of the value added in the economy adjusted for price changes and is sometimes referred to as a volume or constant price measure of GDP. The level of value added is expressed in the prices of a base period, currently the 1995/96 March year. Nominal GDP is a measure of the value added in the economy including price changes and is expressed in current dollars. Quarterly real GDP is calculated on both a production and an expenditure basis, but quarterly nominal GDP is calculated only on an expenditure basis.

Price indices or deflators account for the difference between nominal and real GDP and are calculated for each of the components of expenditure GDP, eg, consumption, investment, exports and imports. The aggregate GDP price deflator reflects movements in all those components and is a wider measure of price changes in the economy than the CPI. The ratio of the exports price deflator to the imports price deflator is referred to as the terms of trade and is part of the overall GDP price deflator and therefore affects nominal GDP. The terms of trade measure the volume of imports that can be purchased for a given volume of exports. The Treasury forecasts both real and nominal expenditure GDP (Figure 5). Nominal GDP is the measure of value added that is used to forecast tax revenue as taxes are paid on current dollar values.

Economic Outlook#

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Overview#

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• The outlook for the New Zealand economy has not changed significantly in the relatively short time since the Budget Update. Growth in real GDP in the year to March 2014 was slightly faster than expected in the Budget Update, but the outlook for the year ahead is slightly weaker. Thereafter, the outlook for growth in real GDP is largely unchanged.
• Growth in nominal GDP was also marginally higher in the past year than expected in the Budget Update, largely because of higher terms of trade, but is now forecast to be weaker over most of the forecast period as the terms of trade are expected to fall sooner and domestic prices have increased by less than previously expected. For an explanation of real and nominal GDP, see the box Real and Nominal GDP on page 7.
• Economic growth amongst our main trading partners in the first quarter of 2014 was close to forecast at the aggregate level and the outlook remains similar to previously. Risks remain in the outlook for the world economy, especially geopolitical risks, and they are discussed further in the Risks and Scenarios chapter.
• Dairy export prices are forecast to fall earlier than in the Budget Update, but to stabilise at around the same level later in 2014. If sustained, the latest auction prices would point to the risk of a larger fall in dairy prices and the terms of trade. A scenario based partly on lower terms of trade is discussed in the Risks and Scenarios chapter.
• The main factors supporting growth in the New Zealand economy over the forecast period are the same as in the Budget Update, in particular the surge in residential construction in Christchurch and Auckland, faster population growth as a result of higher net migration inflows, and historically high terms of trade despite a near-term adjustment.
• The factors that are expected to moderate growth in the economy include rising interest rates, the continuing high value of the New Zealand dollar and fiscal restraint.
• The capacity of the New Zealand economy to grow is marginally increased by faster population growth, but pressure on resources is expected to increase as the pace of expansion exceeds the economy's potential rate of growth, and this pressure will manifest itself in higher inflation.

Recent Developments and Near-term Outlook#

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Outlook for economic growth similar to Budget Update...

Figure 1.1 - Real GDP growth

Source:  Statistics New Zealand, the Treasur

Real production GDP grew 3.3% in the year to March 2014 from the previous year, slightly faster than the 3.0% forecast in the Budget Update (Figure 1.1). Growth in the March quarter was marginally higher than forecast at 1.0%, but most of the difference in annual average growth was accounted for by upward revisions to earlier quarters' previously published growth rates. The outlook for annual average growth in real GDP in the year ahead is 3.8% (slightly lower than the 4.0% in the Budget Update), easing to 3.0% in March 2016 and 2.1% in March 2018.

...but private consumption was lower than expected in the March quarter...

Although outturns at an aggregate level for the March quarter were only slightly higher than forecast, there were some significant differences within the components of economic activity. The level of real private consumption was unchanged from the previous quarter, which was well below the Budget Update forecast of 0.8% growth, with the demand for services down by 0.4% in the quarter. The reasons for the weakness are not yet clear but a strong recovery is expected in the June quarter, based on indicators released to date.

Growth in private consumption in current dollar terms was weaker than forecast by a slightly larger margin as consumption prices rose only 0.1% in the March quarter, compared to the Budget Update forecast of a 0.3% increase. Consumer price inflation was lower than expected in the June quarter for non-tradable goods and services, indicating a continuation of weak price pressures in the economy. The annual inflation rate in June 2014 was 1.6%, less than the Budget Update forecast of 1.8%, with non-tradables inflation of 2.7% compared with a forecast of 3.4%.

...offset by higher net exports in both real and nominal terms

Strong growth in exports offset the weak growth in private consumption in the March quarter in both real and nominal terms. Goods export volumes increased 3.9% in the March quarter against an expectation of a slight fall from the December quarter; services exports also increased more than expected, offsetting the weak private consumption outturn.

At the same time, goods import volumes increased by less than forecast, partially offset by higher than expected services imports. As a result, net exports made a larger contribution to GDP than expected. The terms of trade (the ratio of export prices to import prices) were close to forecast so net exports were also higher than forecast in nominal terms.

However, the near-term outlook is for slightly weaker growth...

Although real private consumption is expected to rebound strongly in June from its flat result in the March quarter, it is not expected to recover fully in nominal terms. Consumer price inflation of 0.3% in the June quarter was weaker than forecast in the Budget Update, pointing to weak price growth in the GDP measure of consumption. The level of nominal consumption is expected to remain lower than previously forecast in coming quarters despite ongoing growth in the consumption of goods and services in real terms.

Recent developments in the external sector of the economy reinforce the outlook for slightly weaker than earlier forecast GDP growth in the year ahead. The value of merchandise exports fell in the June quarter with both volumes and prices lower, and import volumes appear to have increased, supporting the forecast negative contribution from net goods exports to real GDP; similarly, although visitor arrivals were up slightly in the June quarter from March, resident departures increased by more, pointing to weak net services exports.

...as weaker terms of trade compound the impact of lower domestic prices

Dairy prices have declined sooner than expected in the Budget Update and these forecasts bring forward the fall in prices. The decline may be partly seasonal as supply increases in New Zealand and demand dips in China, but increasing global supply and high stock levels in China may also be contributing to the weaker prices. The forecast assumes that prices stabilise at around the same level as in the Budget Update by the end of 2014 as the seasonal factors reverse.

Dairy auction prices have fallen further since finalisation of the forecasts in mid-July, dropping 8.4% in US dollars in early August. Dairy auction prices tend to be volatile and the recent falls may overstate the weakness in demand. However, if the latest prices were sustained, they would pose a downside risk to the main forecast. The impact of a larger fall in the terms of trade is explored in the Risks and Scenarios chapter.

Forestry prices have also declined as demand from China has fallen with slower growth in housing construction. These export price declines have been only partly offset by higher meat prices as sheep meat prices were lifted by additional demand from China and meat supply remains constrained in the US. At the same time, oil prices have increased as geopolitical risks have intensified in the Middle East and Ukraine.

Figure 1.2 - Goods terms of trade (SNA)

Source:  Statistics New Zealand, the Treasury

The terms of trade are expected to decline sooner than forecast in the Budget Update, although to a similar level (Figure 1.2). There is normally a lag of one to two quarters from auction prices to export prices and the terms of trade, and on this basis the declines in market prices since the March quarter are expected to result in a larger fall in the goods terms of trade in the year to December 2014 of 9%, compared with a fall of 5% over the same period in the Budget Update.

Despite lower commodity export prices, the value of the New Zealand (NZ) dollar averaged 80.2 on the Trade Weighted Index (TWI) in the June quarter, 1.5% higher than the Budget Update assumption. It is assumed to decline only slowly from that level over the next couple of years and to remain higher than previously forecast, keeping tradables inflation lower than otherwise but constraining services and manufactured exports to some degree.

Rapid increase in household income points to strong growth in real consumption...

Other data released since the Budget Update was finalised also point to continuing robust growth in the economy in real terms. Firms' demand for labour grew strongly in the year to June, with total weekly paid hours up 3.6% and the number of people employed up 3.7% (Figure 1.3). The increase in labour input was spread across most industries.

Figure 1.3 - Employment and labour force growth

Source:  Statistics New Zealand

The supply of labour also increased rapidly over the past year, partly as a result of gains from external migration. The net inflow of migrants in the year to June 2014 was 38,300, an increase of 30,400 from the year before. The increase was largely a result of a fall in the number of departures of New Zealand citizens to Australia (16,500), but increased arrivals of non-New Zealand citizens (9,300) and of returning New Zealand citizens (3,300) also contributed. Net external migration added around 0.9 percentage points to total population growth in the past year.

In addition, the proportion of the working-age population participating in the labour market increased from 68.1% a year ago to 68.9% in the June quarter, resulting in a total increase in the labour force of 2.8% (Figure 1.3). With the faster growth in the number of people employed, the unemployment rate fell from 6.4% a year ago to 5.6% in June 2014. Average hourly wages increased 2.5% from a year before and, given the large increase in total weekly paid hours, total weekly gross earnings rose 6.3% from a year before. With low inflation recently, this result underpins the outlook for ongoing real consumption growth in the near term.

Figure 1.4 - Migration and house prices

Source:  Statistics New Zealand, REINZ

...but housing demand has eased

Despite rapid population growth as a result of elevated net inward migration, the demand for existing housing has eased since late 2013. House sales declined 14% from a year ago in the June quarter 2014 and the annual rate of increase in house prices slowed from just less than 10% in late 2013 to 6.2% in June (Figure 1.4). Loan-to-value ratio (LVR) restrictions introduced by the Reserve Bank in October 2013, and rising interest rates since earlier this year, may have cooled housing demand.

Notes:

1. Forecasts finalised 18 July 2014.
2. Contribution to GDP growth.
3. Estimated as the percentage difference between actual real GDP and potential real GDP.
4. Percent of the labour force, March quarter, seasonally adjusted.
5. Percent of the working-age population, March quarter, seasonally adjusted.
6. Quarterly Employment Survey, average ordinary-time hourly earnings, annual percentage change.
7. Annual percentage change.
8. System of National Accounts (SNA) and merchandise basis, annual average percentage change.
9. Quotable Value New Zealand (QVNZ) House Price Index, annual percentage change.
10. Average for the March quarter.

Longer time series for these variables are provided on page 130.

Positive outlook for residential investment...

Figure 1.5 - Dwelling consents and residential investment

Source:  Statistics New Zealand

Despite the slightly weaker demand for existing houses, residential investment is expected to continue to increase rapidly in the year ahead as the rebuilding of Christchurch gathers further pace and house-building in Auckland increases in response to the shortage of supply. Residential building consents, particularly for Canterbury and Auckland, point to ongoing growth in residential construction (Figure 1.5). Dwelling consents in Canterbury were 44% higher in the year to June 2014 than in the previous year.

...and business and consumer confidence remain elevated

The outlook for business investment is also positive. Business confidence and activity indicators have eased from elevated levels recently; investment intentions remain above historical averages, supply factors are increasing as the major constraint on the expansion of output, and capacity utilisation rates are high. In the next year or so, investment will be supported by the high value of the NZ dollar and relatively low interest rates, making imported capital goods cheaper and investment more profitable.

Figure 1.6 - Consumer confidence and private consumption

Source:  Statistics New Zealand, Westpac-McDermott Miller

Consumer confidence remains elevated, despite some easing in the June quarter, pointing to ongoing private consumption growth (Figure 1.6). Higher interest rates and a slowdown in the housing market may have made consumers more cautious, but the outlook for private consumption in real terms remains positive, thanks to rapid population growth from net migration inflows and increasing incomes from expanding employment. However, with relatively low inflation outturns expected to continue in the near term - even as inflation pressures build - the outlook for nominal consumption growth is weaker than in the Budget Update, as highlighted earlier.

Overall, the outlook for nominal GDP growth in the near term is weaker than in the Budget Update because of the sooner-than-expected fall in the terms of trade, the higher NZ dollar and lower domestic inflation. Nominal GDP increased 7.0% in the year to March 2014 from the previous year, 0.3 percentage points higher than expected in the Budget Update. However, it is forecast to grow by 5.2% in the year to March 2015, 0.5 percentage points less than in the Budget Update. The level of nominal GDP in the June 2015 year is forecast to be $900 million (0.4%) lower than in the Budget Update.

Recent Developments and Outlook for Main Trading Partners

In aggregate, New Zealand's main trading partners' economies grew much as expected in the first quarter of 2014, although there were some offsetting variances from forecast. The outlook for the forecast period has not changed significantly since the Budget Update.

China's annual growth picked up in the June quarter with some fiscal stimulus and monetary easing, but authorities face a trade-off between boosting growth in the short term and rebalancing the economy and reducing credit risk over the medium term. The Australian economy recorded above-trend growth in the first quarter as export volumes increased sooner than expected; however, domestic demand remains weak and growth is expected to be sub-trend for some time, albeit supported by continuing low interest rates.

The US economy contracted in the March quarter as a result of the harsh winter and a rundown in inventories, and is expected to record lower growth for the year as a whole. The euro area also recorded low growth in the first quarter and is expected to remain weak for some time as the area experiences a protracted recovery from its debt crisis.

The United Kingdom (UK) and Japanese economies both performed better than expected in the March quarter. The recovery in the UK is expected to continue for the rest of the year, supported by rapid employment growth. In Japan, private consumption was brought forward to avoid the 1 April sales tax increase and is expected to be lower in the rest of the year.

Forecasts for most other Asian economies were revised down on the weaker outlook for the major advanced economies (especially the US) and some specific factors such as the political unrest in Thailand. Downgrades for these economies account for most of the reduction in trading partner growth in 2014 (in addition to the weaker US result), but the outlook for subsequent years is unchanged at the aggregate level from the Budget Update.

Sources: IMF, Consensus Forecasts, the Treasury

Inflation is increasing in the US and UK. The Federal Reserve plans to conclude its asset purchases in October and is expected to raise its policy rate in the first half of 2015; the Bank of England may raise its policy rate earlier. Inflation is generally low elsewhere, especially in Europe where the European Central Bank loosened monetary conditions further in June.

The extended period of low interest rates has brought reduced volatility in financial markets, leading investors to seek higher yields, including in New Zealand. The tightening of monetary policy in the US may lead to deleveraging and a reversal of some of these capital flows. These risks are discussed further in the Risks and Scenarios chapter.

Medium-term Outlook#

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Fundamental drivers of outlook unchanged

The medium-term growth outlook is largely unchanged from the Budget Update. The drivers of growth are expected to be a surge in residential construction in Auckland and Christchurch, higher net migration and historically high terms of trade despite some near-term adjustment. These factors are expected to be reinforced by continuing strong labour income growth, leading to increasing private consumption.

The initial above-trend growth will place further pressure on labour and capital resources, leading to increased inflationary pressures and higher interest rates. Growth will also be moderated by a continuing high value of the NZ dollar and fiscal restraint. The current account deficit is forecast to increase from its current low level as import values grow faster than exports.

Figure 1.7 - Nominal GDP

Source:  Statistics New Zealand, the Treasury

While growth in real GDP in the March 2015 year is forecast to be slightly lower than in the Budget Update, the outlook is very similar over the rest of the forecast period. In terms of nominal GDP, growth is expected to be slightly lower in the March 2015 year and similar thereafter (Figure 1.7). The level of nominal GDP is forecast to be approximately 0.5% lower than in the Budget Update over the forecast period as a whole.

Terms of trade to stabilise above historical average...

Although the goods terms of trade are expected to fall 10% in the year to March 2015, they are forecast to stabilise at around that level and to be 9% higher over the forecast period than their average over the past decade. They are expected to be chiefly supported by continuing robust demand from China for dairy and meat products. Demand for forestry products will pick up again with an increase in construction activity in China and residential construction in the US and Australia. Demand for New Zealand's other primary commodities, and for manufactured products, is expected to be sustained by the gradual recovery in the world economy.

...but NZ dollar to decline, making some exports more competitive

The value of the NZ dollar is assumed to remain close to its record level on the TWI in the near term, supported by relatively high commodity prices and positive interest rate differentials. It is expected to begin to decline as the economic recovery becomes more established in the US and the Federal Reserve starts to increase its policy rate, gradually reducing the interest rate differential. The impact of an earlier and more rapid decline in the NZ dollar as a result of a faster recovery in the US economy is discussed in the Risks and Scenarios chapter.

The fall in the NZ dollar is expected to boost tourism earnings and manufactured exports as NZ dollar-priced goods and services become more competitive. The TWI is assumed to decline from an average of 81.2 in the current quarter to 73.3 in the June quarter of 2018, a fall of 9.7% over four years.

Residential investment a major driver of growth in the economy...

The rebuilding of residential housing in Christchurch is forecast to be a major driver of growth in real GDP at the start of the forecast period and then to help sustain the level of activity. Annual growth in residential investment is forecast to peak in the December quarter 2014, but the level of activity is forecast to continue to increase throughout the rest of the forecast period.

The assumptions concerning the rebuilding of Christchurch are unchanged from the Budget Update. The total amount of rebuild-related investment is estimated to be $40 billion (in 2011 prices), with around half of this total assumed to take place by mid-2018. Most of this investment will be funded by insurance payments and government investment. Residential investment is expected to provide the greatest contribution over the forecast period, followed by investment in infrastructure and social assets, and commercial assets.

...along with business investment

Businesses are also expected to continue to expand their investment as aggregate demand in the economy increases. As noted above, business confidence and investment intentions are at high levels, although they have eased from earlier in the year. Reduced spare capacity in the economy, continuing high terms of trade and a tighter labour market are expected to lead firms to invest more. Annual average growth in business investment is forecast to remain high until mid-2015, and then to decline to be similar to GDP growth by the end of the forecast period.

Higher net migration boosts population growth...

Figure 1.8 - Net external migration

Source:  Statistics New Zealand, the Treasury

The net external migration inflow has been running ahead of the Budget Update forecast as departures declined. The forecast peak annual gain in September 2014 has been increased from 38,100 in the Budget Update to 42,500 in these forecasts (Figure 1.8); the turn-around in net migration inflows in 2015 is now assumed to be slightly sharper than previously as departures start to increase again with a pick-up in the Australian economy and arrivals begin to fall as the demand for labour eases. The small change in the profile of migration results in an additional 3,500 people in the total population compared with the Budget Update. Higher net migration inflows would pose an upside risk to the outlook.

...and increased demand for workers results in a fall in unemployment...

Figure 1.9 - Participation and unemployment

Source:  Statistics New Zealand, the Treasury

The demand for labour is expected to continue to grow with the expansion in the economy. Employment growth is forecast to remain strong over the remainder of 2014, but to ease as the pace of growth in output slows. Growth in the working-age population will be boosted by higher net migration and the proportion of the working-age population participating in the labour market is forecast to decline only slightly from its March quarter peak. As a result, the unemployment rate is forecast to fall to 4.5% in the first half of 2018 (Figure 1.9).

...but muted wage growth

Wage growth has been relatively subdued recently with an increase in average hourly earnings of 2.5% in the year to June 2014, as public sector wage growth of 1.3% offset private sector wage growth of 3.1%. Wage growth is expected to accelerate gradually as a result of increased growth in labour supply from net migration, initially low inflation and continuing public sector wage restraint. Growth in hourly wages is forecast to increase to 3.0% by March quarter 2015 and to 3.4% by the end of the forecast period, the same as in the Budget Update. Moderate employment growth, combined with rising wage growth, will increase total compensation of employees by more than 1% per quarter throughout most of the forecast period.

Household income growth will support private consumption...

Steady growth in household incomes is forecast to support ongoing growth in private consumption over the forecast period. Private consumption growth is slightly higher over the period than in the Budget Update in real terms, but from a marginally lower base in the March 2014 year; at the end of the forecast period the level of real private consumption is expected to be practically the same as in the Budget Update. However, the level of nominal private consumption is expected to be lower throughout the period chiefly because of the lower starting point as a result of recent weak inflation outturns.

...but the Government will continue to exercise spending restraint

It is assumed that the current fiscal strategy of limiting the growth in public consumption and non-market investment is maintained. Growth in public consumption is forecast to be low in the March 2015 year at 0.1%, but to increase slightly thereafter with the larger increment in the annual operating allowance announced in Budget 2014, but remains below the rate of growth in the economy as a whole. As is outlined in the Fiscal Outlook chapter, the operating allowance has been added to expenditure as a working assumption, but in practice would be available for a mixture of expenditure and revenue initiatives.

Nevertheless, inflationary pressures will increase...

The economy's growth rate is forecast initially to outstrip its ability to expand without placing additional pressure on prices. It is estimated that actual output was slightly higher than potential output in the March 2014 quarter and that it will exceed the economy's sustainable or non-inflationary level by 1.3% in the second half of 2015. The economy's potential growth rate is estimated to be marginally higher than in the Budget Update because of the faster population growth from net migration inflows. The annual average potential growth rate is estimated to increase from 2.2% in the March quarter 2014 to a peak of 2.8% before declining to around 2.5% in the long run.

Figure 1.10 - CPI inflation

Source:  Statistics New Zealand, the Treasury

As actual output is expected to exceed the economy's level of potential output, non-tradables inflation is forecast to rise to around 4% in the second half of 2016. Tradables inflation will increase gradually over the forecast period as the value of the NZ dollar falls, but continue to offset the higher non-tradables inflation. Annual inflation is forecast to peak in the third quarter of 2016 at 2.5%, but to decline towards the mid-point of the Reserve Bank's target band by the end of the forecast period (Figure 1.10).

...leading to interest rate increases

The Reserve Bank is expected to continue to raise the OCR as inflationary pressures strengthen. Ninety-day interest rates are assumed in these forecasts to rise from 3.4% in the June quarter 2014 to 4.8% by the fourth quarter of 2015 and to 5.3% by late 2017. Higher interest rates will moderate growth in private consumption and investment apart from the Christchurch rebuild, so that the economy grows more slowly and inflationary pressures are reduced. Longer-term interest rates are expected to increase in line with international rates as global monetary conditions are normalised.

Value of imports will increase faster than exports...

With rapid growth in private consumption and both residential and business investment in the March 2015 year, real gross national expenditure (GNE) is forecast to increase 6.1%, up from 4.7% growth in the March 2014 year. The robust expansion in domestic demand is expected to lead to continuing rapid growth in import volumes of 7.0% in the March 2015 year, down only slightly from 7.9% growth in the previous year. As growth in GNE slows over the forecast period, import volume growth will ease, but import values will increase more rapidly later in the forecast period as the value of the NZ dollar falls.

Export volumes are forecast to grow by around 2.5% to 3.0% per year from 2016 onwards as production expands in response to increased international demand. Export values are forecast to decline initially with lower export volumes and the expected fall in commodity prices, although an assumed fall in the value of the NZ dollar later in the period will bring an increase in total export values.

...and the current account deficit will widen but stabilise by the end of the forecasts

Figure 1.11 - Current Account

Source:  Statistics New Zealand, the Treasury

Lower export volumes in the near term, combined with a fall in the terms of trade, are expected to lead to an increase in the annual current account deficit from around 2.6% of GDP in mid-2014 to 4.8% of GDP in March 2015. The annual figures have been enhanced recently by the high terms of trade, but the annual goods balance is forecast to become negative as the terms of trade fall. The current account deficit is forecast to stabilise at 6.4% of GDP in the final couple of years of the forecast period.

Economic Forecast Assumptions

• Net permanent and long-term migration inflows rose to 38,300 in the year ended June 2014, although only data up to May 2014 (36,400) were available when the Pre-election Update was finalised. Net migrant inflows are forecast to rise to 42,500 in the September 2014 year before returning to the long-run assumption of 12,000 per year in March 2017.
• The annual average potential growth rate is estimated to increase from 2.2% in the March quarter 2014 to a peak of 2.8% before declining to around 2.5% in the long run.
• The non-accelerating inflation rate of unemployment (NAIRU) is estimated to be around 4.5% by 2018.
• Average hours worked per week are estimated to decline from their current level of 33.7 to 33.1.
• Economy-wide labour productivity growth is estimated to average 1.1% per year between the years ending March 2014 and March 2018.
• Investment associated with the rebuild following the Canterbury earthquakes is assumed to be around $40 billion in 2011 prices (rounded to the nearest $5 billion), spread across residential property ($18 billion), commercial property ($9 billion) and infrastructure and social assets ($11 billion). Around half of the total is forecast to be undertaken within the forecast period to June 2018.
• West Texas Intermediate (WTI) oil prices are assumed to fall from US$103.30 per barrel in the June 2014 quarter to around US$89 in the March 2018 quarter, in line with oil futures prices.
• Ninety-day interest rates are assumed to increase from 3.4% in the June 2014 quarter to 5.3% in the June 2018 quarter and 10-year interest rates to rise from 4.4% in the June 2014 quarter to 5.2% in the June 2018 quarter.
• The TWI is assumed to fall slightly from an average of 81.2 in the current quarter to just below 80.0 in mid-2016, when it will begin to decline to 73.3 in the June 2018 quarter.
• Tobacco excise tax increases add 0.2 percentage points to annual inflation in each of the March 2015 and 2016 quarters.
• Reduced Accident Compensation Corporation (ACC) levy rates will reduce contributions by households and employers by about $400 million in the 2014/15 levy year and around $480 million in the 2015/16 levy year. The reduction in ACC vehicle levies is estimated to reduce CPI inflation by 0.25 percentage points in the September 2015 quarter.

Fiscal Outlook#

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Overview#

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Notes:

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

Source: The Treasury

• The Treasury forecasts an OBEGAL surplus of $297 million in the 2014/15 fiscal year. Beyond 2014/15, annual surpluses are expected to increase by between $500 million and $1.1 billion each year of the forecast and, by 2017/18, the OBEGAL surplus is expected to reach $3.0 billion.
• Core Crown tax revenue continues to grow across the forecast period and is expected to reach $77.1 billion by 2017/18.
• Beyond 2013/14, core Crown expenses are expected to rise by $10.2 billion by the end of the forecast period. This rise is largely owing to operating allowances[1] (which contribute $6.0 billion) and increases in social assistance spending of $3.7 billion. This forecast growth in core Crown expenses is slower than growth in the nominal economy so by the end of the forecast period core Crown expenses are expected to fall to 30.0% of GDP.
• In nominal terms, net core Crown debt is forecast to increase, reaching $67.9 billion in 2017/18 while the residual cash position remains in deficit across the forecast period. As a share of GDP, net core Crown debt is expected to decline, falling to 25.0% by June 2018 (Table 2.2).
• The Crown's balance sheet strengthens across the forecast period with net worth attributable to the Crown reaching $92.0 billion by 2017/18 (compared to $74.4 billion in 2013/14).
• Compared to the Budget Update, core Crown tax revenue forecasts have been revised downwards owing to the changes in macroeconomic conditions. Weaker tax forecasts, both revenue and receipts, result in surpluses that are expected to be smaller than the Budget Update in each of the four years across the forecast period and a larger cash shortfall. As a result, debt repayments now commence a year later (the first year outside the forecast period) once residual cash surpluses are achieved.
• In preparing these fiscal forecasts, key assumptions have been made on the performance of the economy as well as new operating allowances. As with all assumptions, there is inherent uncertainty and a change in any one assumption could negatively or positively impact forecasts for the Crown's fiscal indicators. The Risks and Scenarios and the Specific Fiscal Risks chapters outline the key risks to the Crown achieving these forecasts.

 

Source: The Treasury

• This chapter also includes medium-term projections to 2027/28. These projections represent a potential future path based on historical averages. The weaker OBEGAL outlook compared to the Budget Update would mean there would be a delay by one year to the re-commencement of the Crown's NZS Fund contributions (to 2020/21).

 

Core Crown Tax Revenue#

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Core Crown tax revenue is weaker than at the Budget Update...

Figure 2.1 - Movement in core Crown tax revenue since the Budget Update

Source:  The Treasury

Overall, tax revenue is forecast to be $2.1 billion less than the Budget Update across the forecast period with tax revenue between $0.3 billion and $0.5 billion lower each year.

Most of the lower tax revenue is owing to changes in macroeconomic conditions that have been reflected in the economic forecasts. In particular, reductions in forecasts of nominal private consumption resulting in decreases in the goods and services tax (GST) forecasts across each year of the forecast, and a lower deposit rate track resulting in reduced forecasts of residents' withholding tax (RWT) (included in Other taxes in Figure 2.1). Partially offsetting these influences, a higher forecast for corporate profits is expected to deliver higher-than-previously anticipated corporate tax revenue. As the reductions in overall tax forecasts mirror macroeconomic conditions, the tax-to-GDP profile is very similar to the Budget Update. Refer Table 2.3 for a summary of the key drivers of the changes in tax forecasts from the Budget Update.

The 2013/14 forecast, which is based on preliminary, unaudited results for the 2013/14 year, is $0.4 billion lower than the Budget Update. This change comprises $0.2 billion for GST, $0.1 billion for corporate tax and $0.1 billion for other taxes (Figure 2.1). Refer to the box on page 28 for further discussion of the 2013/14 forecast tax revenue result.

...but continues to grow by 5.6% per year on average over the forecast period

Figure 2.2 - Core Crown tax revenue

Source:  The Treasury

Core Crown tax revenue is forecast to rise in each year of the forecast period. While tax is weaker than previously forecast, growth of 5.6% per year across the forecast period is still expected and, by 2017/18, core Crown tax revenue is expected to reach $77.1 billion.

Figure 2.3 - Core Crown tax revenue growth

Source:  The Treasury

Forecast tax revenue increases relative to nominal GDP, reaching 28.4% by the end of the forecast period compared to 27.5% in 2012/13 (Figure 2.2) mainly owing to the progressive nature of the personal tax scale.

Most of the growth in nominal tax revenue forecasts can be attributed to growth in the nominal economy, with nominal GDP forecast to grow at 5.0% per year on average over the forecast period. Tax revenue growth increases in 2014/15 before slowing over the remainder of the forecast period as the growth in nominal GDP slows (Figure 2.3).

All tax types are expected to increase across the forecast period as shown in Table 2.4.

Note: These numbers may not add due to rounding.

Source: The Treasury

Growth in employees' compensation and the progressive nature of the personal tax scale (fiscal drag) see source deductions increase by $7.3 billion over the forecast period while growth in corporate profits sees corporate tax increasing by $2.2 billion over the forecast period. Private consumption is expected to grow, contributing to a forecast $5.3 billion increase in GST.

Forecast increases in deposit interest rates and growth in the interest-bearing deposit base are expected to result in growth in tax on interest earned on residents' savings (RWT) of about $1.6 billion across the forecast period.

The Risks and Scenarios chapter provides further discussion of the risks around tax revenue.

IRD has also prepared a set of tax forecasts based on the Treasury's macroeconomic forecasts (Table 2.5).[2]

Source: The Treasury, IRD

Unaudited 2013/14 Tax Revenue Outturn

The Financial Statements of Government for the full 2013/14 year have not yet been completed. They are due for release in October 2014.

Preliminary, unaudited data indicate that core Crown tax revenue for the year was approximately $381 million (0.6%) below the Budget Update forecast.

Source: The Treasury

The largest variances from forecast occurred in GST and corporate tax.

The main economic driver of GST is private domestic consumption. The latest Statistics NZ GDP data indicated that nominal private consumption grew by 0.1% in the March 2014 quarter, whereas the Budget Update had forecast an increase of 1.1%. We estimate that this shortfall versus forecast in domestic consumption through the first half of the 2014 calendar year has decreased GST by about $150 million relative to the Budget Update forecast. The remaining $30 million is mainly the result of earthquake-related refunds being higher than was previously assumed.

The lower-than-forecast private consumption in the March quarter has led to a reduction in the level of the private consumption forecast across the forecast period, with a corresponding reduction in the level of the GST forecasts.

The reasons for the corporate tax shortfall are not as clear-cut as for GST. This is because returns for corporate income tax are filed annually and the 2014 returns are not due until next year, whereas the vast majority of GST returns are filed every one or two months. However, based on the currently-available data, it appears that June quarter terminal tax assessments, ie, end-of-year square-ups for the 2013 tax year, were slightly below expectations. Since terminal tax is effectively ‘backward-looking', this is not expected to have implications for future years. The corporate tax forecasts have been increased by around $100 million each year from 2015 onwards, owing to a slight increase in the forecast of the underlying macroeconomic driver.

Core Crown Expenses#

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Figure 2.4 - Changes in core Crown expenses since the Budget Update

Source:  The Treasury

Core Crown expenses have decreased marginally since the Budget Update...

Core Crown expense forecasts are slightly lower than forecast at the Budget Update across all years with the exception of 2015/16. Expenses by the end of the 2017/18 year are expected to be a cumulative $0.8 billion lower than previously expected (Figure 2.4).

These lower expenses include $0.2 billion of tax impairments that were forecast in 2013/14 at Budget Update that have not eventuated, as well as around $0.4 billion related to phasing changes resulting in expenses now falling outside the current forecast period.

Figure 2.5 - Core Crown expenses

Source:  The Treasury

...but continue to grow across the forecast period...

Core Crown expenses are expected to increase in nominal terms by around $11.1 billion by 2017/18 compared with 2012/13, with $10.2 billion of this beyond 2013/14 (Figure 2.5). However, as core Crown expenses are forecast to grow at a slower rate than growth in the nominal economy, they are expected to ease from 33.0% of GDP in 2012/13 to 30.0% of GDP by the end of the forecast period.

Figure 2.6 - Increase in core Crown expenses (compared to 2012/13)

Source:  The Treasury

Nominal growth in core Crown expenses is largely attributable to 2013/14 and future operating allowances, coupled with increasing social assistance spending as shown in Figure 2.6.

In these forecasts, finance costs also increase over the forecast period to reflect increasing gross debt and rising interest rates.

Other increases in expenses include core Crown expenses for the Canterbury rebuild (refer to pages 34 to 35 for details of the profile and phasing of earthquake expenses).

Figure 2.7 - Components of social assistance spending

Source:  The Treasury

Social assistance spending is expected toincrease by $3.7 billion between 2012/13 and 2017/18. Of this, New Zealand Superannuation payments (around half of social assistance costs), grow by $3.4 billion as payments are linked to wage growth and recipient numbers increase (Figure 2.7). Other benefit expenses, largely income-related rent, are also expected to increase marginally over the forecast.

Operating Balance#

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The Crown is forecast to return to surplus this financial year…

Figure 2.8 - Components of OBEGAL by segment

Source:  The Treasury

The OBEGAL is expected to return to surplus in the current 2014/15 year with a surplus of $297 million forecast. Beyond 2014/15, surpluses are expected to increase by between $0.5 billion and $1.1 billion per year.

Figure 2.8 shows the composition of OBEGAL from the different segments of the total Crown.

The core Crown segment moves from a forecast OBEGAL deficit of $4.0 billion in 2013/14 to a forecast $2.7 billion surplus in 2017/18, largely reflecting growth in tax revenue.

The State-owned Enterprise (SOE) and Crown entity (CE) segments together positively impact the OBEGAL balance by $2.0 billion in 2013/14, easing back to $0.9 billion in the final year of the forecast period largely reflecting ACC levy rate reductions announced in Budget 2013.

These forecast surpluses are expected to assist in strengthening the Crown's balance sheet and contribute to the Crown's ability to repay debt in the future.

...although OBEGAL is lower compared to the Budget Update

These forecasts indicate the annual OBEGAL surpluses are forecast to be smaller in all years relative to the Budget Update. The surplus in 2017/18 is forecast, for example, to be $3.0 billion, half a billion lower than previously forecast (Table 2.7).

Source: The Treasury

Material changes to OBEGAL forecasts since the Budget Update include:

• Tax revenue is weaker across the forecast period than the Budget Update as discussed earlier (refer page 25).
• IRD's tax impairments were forecast to be higher than eventuated in 2013/14.
• The Office of Treaty Settlements (OTS) has updated its Treaty settlement expenditure forecasts for the timing of forthcoming Deeds of Settlement. The timing for Deeds is determined by milestones earlier in the settlement process such as claimant groups achieving a mandate for negotiations and agreements being reached on redress packages with the Crown. As settlements get closer to being finalised, the OTS has a greater amount of certainty about when they will occur and impact on Crown expenses.
• Earthquake Commission (EQC) forecasts in the first two years have changed following an updated valuation of EQC's insurance liabilities at 30 June 2014.
• ACC's results in the later years of the forecast largely reflect increases in investment income from investments outweighing changes in insurance costs.
• Social assistance expenses are slightly higher than previous forecasts and are expected to be higher by $0.1 billion in the final 2017/18 year.

 

Figure 2.9 - Components of operating balance

Source:  The Treasury

...with increases in OBEGAL lifting the operating balance

The total Crown operating balance, inclusive of gains and losses, is forecast to be in surplus across all years of the forecast period. Figure 2.9 shows the growth in the operating balance and its components. The 2013/14 year's forecast surplus of $2.8 billion includes $5.2 billion of gains made by Crown financial institutions (CFIs), largely ACC and NZS Fund. While the 2013/14 year reflects the current strong market growth, lower long-term rates of returns are assumed in future years, resulting in lower growth in these years. These gains result in increased financial assets which lead to increases in the Crown's share of net worth (refer page 38 for discussion).

In addition, updated long-term liability valuations for ACC and the Government Superannuation Fund (GSF) at 30 June 2014 have led to $1.1 billion of actuarial gains in the 2013/14 year (compared to $3.6 billion in 2012/13).

When compared to the Budget Update, the operating surplus is forecast to be lower in all years. In 2017/18 the operating balance is forecast to be a $6.1 billion surplus, $0.6 billion lower than previously forecast.

Cyclically-adjusted Balance and Fiscal Impulse

In addition to OBEGAL and the operating balance (both of which are total Crown indicators), the cyclically-adjusted balance and the fiscal impulse are useful indicators in assessing the relationship between fiscal policy and the economy. These indicators are summarised in Table 2.8.

Source: The Treasury

Cyclically-adjusted Balance (CAB)[3]

CAB is an estimate of the fiscal balance (OBEGAL) adjusted for fluctuations of actual GDP around trend GDP. Adjustments are also made for significant one-off expenses in order to provide a picture of the underlying fiscal position and the effects of policy decisions.

Figure 2.10 shows CAB tracking close to OBEGAL in recent years, indicating that the operating deficits between 2009 and 2013 have been largely structural. OBEGAL is expected to reach a surplus of 0.1% of GDP in the year ending June 2015. However, because the economy is assumed to be operating a little above capacity over much of the forecast period, the CAB is expected to reach surplus two years later in the year ending June 2017.

Fiscal impulse

The fiscal impulse is a summary measure of how changes in the fiscal position impacts aggregate demand. The fiscal impulse is calculated on a cyclically-adjusted basis and excludes net interest payments. To better capture the role of capital spending, this indicator uses the change in a cash-based version of the fiscal balance (CAB supplemented by capital expenditure). Figure 2.10 shows fiscal policy is expected to withdraw from aggregate demand over the forecast period.

Figure 2.10 - Operating balance indicators and fiscal impulse

Source:  The Treasury

 

Cost to the Crown of the Canterbury Rebuild

As reported previously, the Canterbury earthquakes were unprecedented events. Early estimates of costs were very challenging. Over time, as agreements are reached and decisions are made, the costs of the rebuild become clearer and are re-estimated and published.

Estimates of the cost to the Crown of the Canterbury rebuild have increased significantly since 2011. At the time the 2011 Budget Update was prepared, only months after the February earthquake, the initial estimate of total costs was $8.8 billion (including $3.1 billion of claims costs to EQC). All expenses were assumed to be operating, in the absence of information regarding the Crown's contribution to capital expenditure. In these early estimates the Treasury emphasised the high levels of uncertainty.

Three and a half years after the 2011 Budget Update, these forecasts estimate operating costs have increased to $12.6 billion (including $7.4 billion in relation to EQC) reflecting updated estimates and agreements reached. In addition, capital expenditure of asset rebuilds, such as the new Canterbury hospitals, is estimated to be $3.2 billion. The Treasury is a long way from determining the final costs to the Crown arising out of the Canterbury rebuild because uncertainty remains around the likely final costs to the Crown of a number of items (eg, Christchurch central city anchor projects) have not yet been determined.

The Treasury uses the same approach for forecasting the costs of the Canterbury rebuild that are used in the Financial Statements of the Government, which are subject to audit by the Auditor-General.

Costs associated with water infrastructure are recognised up-front while the costs of road repairs are recognised in the year of repair. This is consistent with the way the Crown treats repairs to local roadways across New Zealand, where there is a spreading of costs to reflect that the first call for funding these future expenses will be from dedicated ring-fenced revenue sources.

Operating expenditure will have an impact on the Crown's OBEGAL while capital expenditure does not. Instead capital expenditure results in growth in the Crown's balance sheet.

The current forecasts reflect the Treasury's best professional judgement of the known costs under current government policy. They do not include future decisions the Government may or may not take regarding the rebuild.

Table 2.9 outlines the latest estimates of the net impact of the earthquakes included in these forecasts and future years. As the rebuild progresses the composition of expenditure shifts more towards capital spending as Crown assets are replaced.

Latest estimates for the total cost to the Crown are $15.8 billion and are expected to extend beyond the forecast period. This compares to an estimate of $15.4 billion to 2018 in the Budget Update. These latest estimates include updates from entities with significant earthquake costs (primarily CERA, EQC and Southern Response). A full update of all entities with earthquake-related expenses will be undertaken in the next Half Year Update. Refer to page ii which discusses the Treasury's process for this forecast update.

Notes:

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

Source: The Treasury

Forecasts have been updated to take account of the latest information available. Overall, updated forecasts have led to rephasing of both operating and capital net costs with some costs now falling outside the forecast period. Updated valuations of both EQC and Southern Response Earthquake Services Limited's earthquake liabilities at 30 June 2014 have resulted in an increase of $0.2 billion in operating costs being recognised in these forecasts. Additional operating costs in relation to anchor projects (including write-downs and impairments of property) also add $0.1 billion, while re-estimations of insurance recoveries, demolition costs and red zone property management costs result in $0.1 billion of additional net operating costs.

The full cost of EQC's earthquake claims liability is captured in the table above. It outlines the costs of the Canterbury rebuild to the total Crown (which includes all Crown entities, such as EQC, State-owned Enterprises and core Crown departments).

Under the Earthquake Commission Act, if the assets of the EQC are not sufficient to meet its liabilities, the Crown is responsible for funding the deficiency by way of a grant or advance. EQC continues to expect its National Disaster Fund (NDF) will be depleted during the current fiscal year. Whether these claims are funded by the NDF, or directly by the Crown, however, will have no bearing on the overall costs to the total Crown because that funding will represent a transfer within the total Crown reporting group.

The Specific Fiscal Risks chapter discusses the fiscal risks associated with the Canterbury earthquake forecast net expenses. Key risks include the timing of expenditure and escalating costs as well as the independent review of infrastructure costs shared by the Christchurch City Council and the Crown (due to be completed by 1 December 2014).

Net Core Crown Debt#

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Net core Crown debt peaks as a share of GDP in 2014/15...

Figure 2.11 - Net core Crown debt

Source:  The Treasury

Net core Crown debt as a share of GDP is expected to peak in 2014/15 at 26.8% (Figure 2.11). By 2017/18 net core Crown debt is expected to have fallen to 25.0% of GDP.

While operating cash flows are expected to return to surplus in 2014/15, net capital spending is expected to exceed operating cash flows resulting in core Crown residual cash[4] deficits across the forecast period. Cash deficits are funded by increases in net core Crown debt⁴ (either through additional borrowing or a reduction in financial assets).

Over the forecast period, the Crown is expected to generate cash flows from core Crown operations of $8.6 billion and will receive the last of the proceeds from the Meridian share offer ($0.6 billion)[5]. The core Crown is forecast to spend $24.0 billion on capital items such as purchasing of physical assets (eg, school buildings), advances (eg, student loans) and future new capital spending. Overall, this results in a cash shortfall across the forecast of $12.4 billion. As a result of this cash shortfall, net core Crown debt is expected to increase in nominal terms and to peak on an annual basis in 2017/18 at $67.9 billion (one year later than previously forecast), and then fall after residual cash surpluses are achieved.

Figure 2.12 - Core Crown residual cash

Source:  The Treasury

...but is higher than the Budget Update...

Core Crown residual cash is expected to remain in deficit across the forecast period and is higher than the Budget Update largely owing to lower tax receipts than previously forecast (Figure 2.12). As a result, net core Crown debt (in both nominal terms and as a share of GDP) is forecast to be higher in each of the forecast years when compared to the Budget Update.

...with the bond maturities funding residual cash deficits

Figure 2.13 - Gross debt vs net debt

Source:  The Treasury

There has been no change in the bond programme to 2017/18 from the Budget Update. The bond programme is expected to raise funds of $36.6 billion over the forecast period, while $25.4 billion of existing debt will be repaid, providing net cash proceeds of $11.2 billion (Table 2.10). While there is a greater cash shortfall over the forecast period ($12.4 billion compared to $9.4 billion forecast at the Budget Update), this additional shortfall is expected to be managed through reductions in financial assets.

The movement in gross debt generally reflects the timing of the bond programme and maturities. As a percentage of GDP it is forecast to decrease from 36.6% in 2012/13 to 32.5% in 2017/18 (Figure 2.13) consistent with the decrease in net debt as a share of national income.

Source: The Treasury

Total Crown Balance Sheet#

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Figure 2.14 - Size of the Crown's balance sheet

Source:  The Treasury

Operating balance surpluses strengthen the balance sheet...

Net worth attributable to the Crown is forecast to grow steadily in nominal terms across the forecast period largely owing to forecast operating balance surpluses. Beyond June 2014, net worth attributable to the Crown is expected to grow by $17.6 billion to stand at $92.0 billion or 33.9% of GDP by 2017/18 (Figure 2.14).

...with assets increasing by $41 billion over the forecast period...

Figure 2.15 - Total Crown assets

Source:  The Treasury

Total assets are forecast to grow by $41.1 billion over the forecast period with the largest asset growth in the financial assets portfolio (Figure 2.15). This growth reflects investments by CFIs, with much of this growth recognised as gains in the Crown's operating balance.

The commercial asset portfolio is expected to increase by $9.6 billion over the forecast period, with growth in Kiwibank's mortgage book comprising $7.2 billion of this increase. (This growth is also reflected in the Crown's liabilities as Kiwibank deposits grow in line with these mortgages.)

Social assets (eg, schools, hospitals and social housing) are expected to increase by $16.8 billion by the end of the forecast period, primarily as a result of new capital investments via the Future Investment Fund.[6]

At the Budget Update, $1.7 billion remained in the fund to be allocated to future capital spending ($3.0 billion had already been allocated). Subsequent to Budget 2014, $0.1 billion has been allocated to regional roading packages. This is a pre-commitment against Budget 2015, leaving $1.6 billion yet to be allocated across Budget 2015 and Budget 2016.

Figure 2.16 - Total Crown liabilities

Source:  The Treasury

...and liabilities begin to fall in 2017/18

The Crown's liabilities are expected to increase by $13.5 billion (Figure 2.16) over much of the forecast period, largely driven by increased borrowing ($16.4 billion over the forecast period) before beginning to fall in 2017/18. Borrowings are forecast to peak at $119.9 billion in 2016/17 before decreasing slightly to stand at $116.4 billion by 2017/18.

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

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

Financial assets have increased significantly in recent years. CFIs (eg, NZS Fund and ACC) hold investments to make financial returns, and those asset values are dependent on market prices, interest rates and exchange rates, which can all be volatile. For example, a 10% change in the NZ dollar exchange rate or share prices can impact the Crown's operating balance by $1 billion to $2 billion.

In addition, the Crown has a number of significant long-term liabilities (eg, ACC claims and GSF retirement liability) that are actuarially valued based on estimated future cash flows 50 years into the future. As part of the actuarial valuation, inflation rates are used to help estimate future cash flows, while discount rates are used to obtain the value of those future cash flows in today's dollars (their present value). Even small changes in these assumptions can have significant impacts on the valuation because the cash flows are so large and over such long periods.

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

Outside of market factors, valuations are subject to a number of judgements and estimates. In general, as time goes on, better information becomes available and initial estimates are updated to reflect current information. Some examples of this include ACC rehabilitation costs, earthquake-related insurance liabilities and student wage growth.

...while other risks still remain

In addition to those items on the balance sheet there are a number of liabilities (and assets) that may arise in the future but are not yet included in our forecasts, either because they are contingent on an uncertain future event occurring (eg, outcome of litigation) or the liability cannot be measured reliably. If these liabilities crystallise, there will be associated costs with a negative impact (or positive in the case of contingent assets) on the operating balance or net debt. Refer to page 75 for a list of the contingent liabilities that the Crown was exposed to at 31 May 2014. The Risks and Scenarios chapter also includes further discussion on risks to the Crown's balance sheet.

Fiscal Forecast Assumptions#

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The fiscal forecasts are based on assumptions and judgements developed from the best information available on 5 August 2014, when the forecasts were finalised. Actual events may differ from these assumptions and judgements. Furthermore, uncertainty around the forecast assumptions and judgements increases over the forecast period. The impact of the Canterbury earthquakes adds further uncertainty to the economic and fiscal forecasts.

The fiscal forecasts are prepared on the basis of underlying economic forecasts. Such forecasts are critical for determining revenue and expense estimates. For example:

• A nominal GDP forecast is needed in order to forecast tax revenue.
• A forecast of CPI inflation is needed because social assistance benefits are generally indexed to inflation.
• Forecasts of interest rates are needed to forecast finance costs, interest income and discount rates.

A summary of the key economic forecasts that are particularly relevant to the fiscal forecasts is provided in Table 2.11 (on a June-year-end basis to align with the Government's balance date).

 

Notes:

1. Production measure.
2. Expenditure measure.

Source: The Treasury

In addition, a number of other key assumptions are critical in the preparation of the fiscal forecasts.

 

Medium-term Projections

The previous sections of this chapter have concentrated on the five-year forecast horizon, up to and including 2017/18. The focus now switches to the decade beyond the last forecast year, extending to 2027/28, referred to as the medium-term projections. The different names reflect different levels of precision.

Forecasts are based on comprehensive modelling of, and expert opinion on, economic and fiscal conditions. They take into account the relationships and interactions between variables, and make allowance for the impacts of existing policies. Based on the information available, they represent the best attempt to predict future outcomes.

Projections represent potential future paths of variables. They are usually based on historical averages of the levels or growth rates, and depend greatly on both the forecast base from which they arise and the assumptions used to generate them. Projections should not be viewed as accurate predictions, but rather as indicators of potential outcomes under a given set of assumptions. The projections assume an economy that is free of cycles and growing on trend, and contain no unplanned policy responses that might, in actuality, be enacted to address unfavourable trends or encourage positive outcomes.

Projected nominal GDP growth slows...

The two economic variables that most significantly influence the fiscal projections are nominal GDP and the CPI inflation measure. A table in the annex to this section shows the paths of the other main economic projections.

Annual growth of nominal GDP gradually slows over the projections, from a peak of 4.5% in the year ending June 2021 to 4.2% by the year ending June 2028. This is mainly owing to the labour force contribution, where an ageing population slowly reduces overall participation rates.

While projected nominal GDP growth rates are virtually identical to those produced for the 2014 Fiscal Strategy Report (FSR), they arise from an end-of-forecast GDP base which is $1.4 billion (0.5%) lower. This wedge is maintained over the projection decade. Because tax revenue is brought to a stable ratio of nominal GDP in projections, based both on history and current tax parameters, this results in reduced tax, in dollar terms, relative to the 2014 FSR.

Figure 2.17 - Core Crown revenue and expenses

Source:  The Treasury

Figure 2.17 illustrates the paths of core Crown revenue and expenses, as percentages of nominal GDP, in recent history and the Pre-election Update forecasts and projections.

Lower tax revenue is the main reason why the fiscal projections are not quite as strong as those of the 2014 FSR. As depicted in Figure 2.18 the total Crown operating balance before gains/(losses) tracks slightly below the previous projection.

Figure 2.18 - Total Crown operating balance before gains/(losses) or OBEGAL

Source:  The Treasury

The Pre-election Update projection of expenses, in dollar terms, is only slightly higher than the previous projection. The majority of the small difference is owing to higher interest costs, which arise from debt not reducing as quickly.

...with OBEGAL surpluses projected to continue...

Figure 2.19 - Net core Crown debt (excluding NZS Fund and advances) assuming no policy intervention

Source:  The Treasury

The projection of OBEGAL continues the rising profile exhibited in the forecast years. Surpluses increase, not just in dollar terms but also as percentages of GDP, principally because revenue growth outstrips that of expenses. Allowances for new operating spending grow more slowly than nominal GDP. By contrast, most revenue types, and in particular tax revenue, grow in line with nominal GDP. The track also receives a boost in the initial years of projections as some tax types lift to their long-run stable ratios of nominal GDP.

...resulting in net core Crown debt reaching 20% of GDP in 2020/21

Weaker revenue projections also result in a projection of net core Crown debt to GDP that is marginally higher than in the 2014 FSR, as shown in Figure 2.19. The narrowing of the gap between the two net debt tracks in 2019/20, before moving apart again, reflects the assumed resumption of capital contributions to the NZS Fund shifting out one further year.

The current policy relating to resumption of capital contributions to the NZS Fund is that these will restart once net core Crown debt is no higher than 20% of GDP. This was projected to occur in 2019/20 in the 2014 FSR. However, the reduction in both forecast and projected tax revenue means that net core Crown debt is projected to fall below 20% of GDP one year later. As a result, capital contributions are now projected to also resume one year further out, in 2020/21.

Further long term projections are available in the Treasury's latest Statement on New Zealand's Long-Term Fiscal Position, which was published in July 2013. It outlines how, in common with many advanced economies, New Zealand faces an ageing population structure which will bring with it both challenges and opportunities.

Assumptions for Medium-term Fiscal Projections#

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The assumptions for the medium-term economic and fiscal projections are outlined in this section. The full assumptions can be found in the 2014 FSR, at http://www.treasury.govt.nz/budget/2014/fsr

* Annual average % change unless otherwise stated.

** Level of unemployment (average for year ending June).

*** Hours worked measure.

**** Average over public and private sector.

***** Total hours worked ÷ total number employed.

Sources: The Treasury, Statistics New Zealand

No economic variables have had their medium-term, stable assumptions changed since the 2014 FSR. As average hours worked per week is assumed to grow at the rate of average hours paid per week, it has stabilised at a slightly higher level, but in the same projected year. This does not affect projected GDP as it depends on the unchanged growth rate, not the level, of average hours worked per week.

Economic projections display the potential paths that some key economic indicators take beyond their forecast bases, while simultaneously providing inputs to projecting many fiscal variables. For example, the modelling of many future benefit expenses uses inflation to annually index payment rates. Nominal GDP acts as the denominator in fiscal indicators to make them more comparable over periods of a decade or more.

The stable projection assumption for annual growth in CPI is 2%, which is the midpoint of the 1% to 3% target in the Reserve Bank's Policy Targets Agreement. With annual growth in CPI at 2.1% by the end of the forecasts, the stable assumption is attained in the first projected year and maintained in all later ones.

Nominal GDP is projected using a growth rate produced by combining those of real GDP and CPI. Projected real GDP growth is itself derived from the growth rates of several economic variables, particularly that of the labour force and annual labour productivity growth.

Notes:

1. Operating balance before gains/(losses).
2. Gross sovereign-issued debt.
3. Excludes financial assets of the NZS Fund and core Crown advances.
4. Excludes assets and liabilities belonging to minority interests.

Source: The Treasury

Source: The Treasury

Risks and Scenarios#

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Overview#

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• This chapter outlines the main economic and fiscal risks associated with the central forecast. Risks to the economic outlook are evenly balanced over the forecast period as a whole, while being tilted to the downside in the near-term. In addition to risks associated with the economy, the Crown is also exposed to expenditure and balance sheet risks. In particular, volatility in market prices can have a significant impact on the Crown’s fiscal position.
• Internationally, the risks with potentially the largest impact on the New Zealand economy relate to the level of demand for New Zealand's commodity exports, particularly from China, as well as the timing and magnitude of interest rate increases in the US and the sensitivity of energy prices to geopolitical developments.
• Domestically, the risks with potentially the largest impact on the New Zealand economy relate to the pace of the Canterbury rebuild and its interaction with the wider economy, the sensitivity of households to higher debt servicing costs, along with net migration’s impact on domestic demand.
• Two scenarios are presented that represent two possible ways in which the New Zealand economy could deviate from the central forecast. Scenario one is based on weaker short-term domestic demand combined with a larger decline in the terms of trade, which lowers nominal GDP over the forecast period. Scenario two is based on stronger growth in the US, which leads to exchange rate depreciation and a more competitive export sector, increasing nominal GDP over the forecast period.
• The first part of this chapter outlines the key risks to the economic outlook. The second part of the chapter presents the two alternative scenarios for the economy. The remainder of the chapter focuses on general fiscal risks that can impact the Crown's fiscal position.

Economic Risks#

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Uncertain global outlook...

Global developments can impact New Zealand through migration, trade, confidence and financial channels. Risks posed to the outlook for key trading partners, and global financial settings in general, are all factors that can lead to rapid changes in the economic outlook for New Zealand.

…as risks to New Zealand's key trading partners remain...

Risks to the growth outlook for China remain, even with June quarter growth strengthening after a weaker March quarter. The property investment and construction boom that stimulated Chinese growth following the global financial crisis was fuelled by rapid credit growth. Concerns around the high level of local government debt, the quality of lending in the shadow banking sector and exposure of financial institutions to housing market vulnerabilities persist. China's growth could slow more quickly than in the central forecasts if financial market disruption resulted in significantly tighter credit conditions; however, their impact is likely to be limited by room for further policy adjustment, sustained urbanisation and solid income growth.

Commodity prices have fallen recently, led by declines in export dairy and forestry prices. While the weaker outturn in the GlobalDiaryTrade auction held in early August poses a downside risk if sustained, commodity prices tend to be volatile and the latest prices may overstate the weakness in demand. There have also been some positive offsets: sheep meat prices have strengthened as demand from China has increased, while meat supply remains constrained in the US. The extent to which these trends continue is uncertain. A continuation of recent dairy auction price falls would pose a downside risk to the main forecast, which the first scenario explores in combination with further weakness in household consumption in New Zealand.

...and the US economy starts to gain momentum...

Recent strong growth in investment, consumption and construction, combined with the lowest market volatility since 2007, give the US economy significant potential to outperform current forecasts. Recent speeches by Federal Reserve Chair Janet Yellen indicate that if future data releases are stronger than expected, normalisation of monetary policy would happen earlier. However, a stronger US economy could further exacerbate the risks to emerging economies if expectations of a faster withdrawal of monetary stimulus were to develop. The impact of an earlier tightening in US monetary policy on the New Zealand economy is explored in more detail as part of the second scenario.

...while geopolitical developments could contribute to price volatility...

Recent geopolitical developments in Ukraine and the Middle East have been watched closely by markets for any possible impacts on energy supplies, with much of the focus on oil. While long-term implications of the recent geopolitical developments remain uncertain, further deterioration that impacts energy supplies may further increase prices. Similarly, improvements that enhance the stability of energy supplies could reduce energy prices. The impact on New Zealand of Russia's recent ban on food imports from selected countries (not including New Zealand) is uncertain at this stage.

Domestic outlook is also uncertain...

Key areas of uncertainty remain, including the speed of the Canterbury rebuild and its wider economic implications, the reaction of households to higher debt servicing costs, and the scale of the current migration cycle and its impact on domestic demand.

...with the timing and extent of the Canterbury rebuild an area of uncertainty…

There is still uncertainty around the overall timing and magnitude of the Canterbury rebuild. Key determinants continue to be the pace of the settlement of remaining insurance claims and the evolution of resource pressures in the construction sector. While the resolution of insurance claims has continued to progress, there are risks that the greater complexity of remaining claims could slow the rate of settlement. The availability and mobility of skilled labour will also impact on the pace of reconstruction if specific skill shortages act as bottlenecks in the construction industry. If the rebuild were to progress more slowly, residential and non-residential investment and employment growth could all be weaker than reflected in the central forecast.

The Canterbury region will account for a greater share of GDP than in previous construction booms and regional resource pressures will act to crowd out activity in other parts of the economy. The extent to which prices and wages rise to facilitate the transfer of resources remains heavily influenced by competing demand pressures elsewhere, especially in Auckland.

...as is the sensitivity of households to increasing interest rates…

Household debt levels have increased recently after falling since the global financial crisis. Households are relatively exposed to interest rate increases as the majority of mortgage rate debt will quickly reflect increases in the OCR. Households are, however, increasingly shifting to fixed rate mortgages which have not increased as much as floating rates so far. If households exercise more restraint, debt levels would be lower than otherwise but consumption growth would be weaker, which scenario one explores in more detail. On the other hand, if households are less sensitive to interest rate increases, consumption growth would be higher than otherwise, and in the absence of stronger income growth this would lead to higher debt than otherwise.

...while the housing market weakens in spite of strong net migration

House price growth and house sales have slowed as loan-to-value restrictions have impacted mortgage lending. Mortgage rates have also begun to rise, with the expectation of future increases as the tightening cycle continues. This weakness in the housing market has been in contrast to the near-record net migration gains, which historically have increased the demand for housing, contributing to both house price inflation and construction activity. While higher net migration flows would pose an upside risk, there could also be a delayed response to the recent increases in net migration, leading to stronger demand for housing and possibly higher private consumption growth. The second scenario incorporates a larger effect from the central forecast's net migration gain.

Other risks around key judgements

Economic relationships are complex and judgements need to be made about key economic variables such as the exchange rate. If, for any reason, key factors such as those outlined above play out differently than assumed in the central forecast and impact on the inflation outlook, then the Reserve Bank's setting of monetary policy would be responsive to those different conditions. Interest rates could rise by more or less and the pace of tightening could be faster or slower depending on the direction of change.

Alternative Scenarios#

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The following scenarios show how the economy might evolve if some of the key judgements in the central forecast are altered (Table 3.1). The scenarios represent two of a number of ways that the economy could deviate from the central forecast. Scenario one represents the economic impacts of weaker short-term domestic demand combined with a larger decline in the terms of trade. Scenario two represents the economic impacts of stronger growth in the US.

Notes:

1. March quarter, seasonally adjusted
2. March quarter average

Sources: Reserve Bank, Statistics New Zealand, the Treasury

Scenario one - Softer household demand with weaker export prices

Softer than expected household demand...

Figure 3.1 - Real consumption

Source: The Treasury

In the first scenario, households are more responsive to increasing interest rates than in the central forecasts, and the weakness in private consumption seen in the March quarter of 2014 continues throughout the year, as shown in Figure 3.1. Households that are exposed to elevated debt levels reduce consumption by more than expected in the central forecast to offset increased debt-servicing costs, which reduces private consumption over the remainder of 2014.

...and lower dairy prices lead to a weaker housing market...

In this scenario, export dairy prices continue to fall, weighing on commodity exports. The merchandise terms of trade consequently decline, while the exchange rate depreciates sharply to help buffer the shock from lower dairy prices. The lower terms of trade flow through to slower income growth, which further lowers private consumption once the initial spike owing to increasing interest rates has subsided.

Figure 3.2 - Residential investment

Source: The Treasury

Figure 3.3 - 90-day interest rate

Source: The Treasury

The near-term weakness in consumption will dampen housing demand and lead to weaker house price growth. This leads to lower residential investment (Figure 3.2) compared to the central forecast, which is another factor which lowers nominal GDP growth as households and firms react to the income shock.

...and lower interest rates...

Weaker domestic demand helps contain inflation expectations, which results in a slower monetary tightening cycle. Under this scenario, the Reserve Bank does not raise the OCR again until the end of 2015, which keeps the 90-day rate lower than in the central forecast (Figure 3.3). However, as the exchange rate depreciates and New Zealand's goods and services become more competitive, net exports begin to contribute positively to growth and import volumes shrink. Together with the stabilisation of the terms of trade, strong growth near the end of the forecast period requires more aggressive monetary policy tightening. This causes interest rates to increase faster near the end of the forecast period, although to a lower peak than in the central forecast.

…as well as lower tax revenue and operating balance

Weaker domestic activity, combined with the lower terms of trade, reduces nominal GDP by a cumulative $20 billion relative to the central forecasts over the forecast period.

Core Crown tax revenue is a cumulative $7.0 billion lower over the forecast period in this scenario, owing to the weaker nominal GDP. The weaker labour market and lower labour incomes reduce source deductions revenue by $1.4 billion over the forecast period. The economy's weaker nominal activity means that business profitability is reduced, resulting in corporate taxes being a cumulative $1.9 billion lower. Resident withholding tax is $1.3 billion lower over the forecast period with interest rates increasing by less than in the central forecast. Weaker nominal consumption and residential investment reduce GST revenue by a cumulative $1.3 billion over the forecast period.

Figure 3.4 - Operating balance (before gains and losses)

Source: The Treasury

Core Crown expenses are higher than in the central forecast, driven by an increase in debt servicing costs. The softer labour market also results in an increase in the number of recipients of unemployment-related benefits compared to the central forecasts. In this scenario, the return to surplus in OBEGAL is delayed until June 2018 (Figure 3.4). As a consequence, net core Crown debt peaks at 28.4% of GDP in the June 2016 year, compared to 26.8% in the June 2015 year in the central forecast (Figure 3.8). By the end of the forecast period, net core Crown debt is 28.2% of GDP in this scenario compared to 25.0% of GDP in the central forecast.

Since the economic forecasts were finalised in mid-July, dairy prices at the early August GlobalDairyTrade auction were weaker than the central forecast had anticipated. It is important to note that scenario one reflects a combination of other factors in addition to lower dairy prices. Therefore, while the probability of this scenario has increased as a consequence of weaker dairy prices, it remains more likely that the overall economy will evolve in a manner that is more similar to the central forecast.

Scenario two - Stronger US growth with more domestic momentum

The US economy grows faster and, combined with stronger domestic inflation...

Figure 3.5 - Exchange rate (TWI)

Source: The Treasury

In the second scenario both the US economy and domestic price pressures are stronger than expected. As the US economy strengthens, the Federal Reserve reacts by beginning the tightening cycle earlier than currently expected. As interest rates begin to rise in the US, lowering the difference in rates between New Zealand and the US, the exchange rate depreciates (Figure 3.5). In this scenario the TWI falls from 79.0 in the December quarter of 2014 to 77.4 in the December quarter of 2015, while over the forecast period the TWI is on average 1.5% lower than assumed in the central forecast.

Figure 3.6 - Consumers price index

Source: The Treasury

While net migration remains the same in this scenario, the pressure from the recent gains in net migration increase domestic demand more than in the central forecast. The increase in domestic demand, combined with exchange rate depreciation, leads to increased inflationary pressures. The Reserve Bank responds by tightening monetary policy more aggressively to contain inflation expectations over the medium term, which brings inflation back towards 2% by the end of the forecast period. Inflation remains higher over the forecast period in this scenario, averaging 2.5% per year compared to 2.1% per year in the central forecast (Figure 3.6).

...leads to exchange rate depreciation and lower current account deficits

As the exchange rate falls, the price of imported goods increases, which makes exporters and import-competing domestic businesses becoming more competitive, boosting manufacturing and service exports and the production of import substitutes. Through this channel the lower exchange rate helps to rebalance the economy, lowering the annual current account deficit in June quarter 2018 from 6.4% of GDP in the central forecast to 6.0% of GDP (Figure 3.7). Furthermore, net exports of goods and services contribute an additional 0.2% to GDP growth in the year to March 2016 compared to the central forecast.

Nominal GDP growth and tax revenue higher

Figure 3.7 - Current account

Source: The Treasury

Stronger US growth and the lower exchange rate, combined with greater price pressures, increase nominal GDP by a cumulative $13 billion above the central forecasts over the forecast period. Core Crown tax revenue is a cumulative $3.9 billion higher over the forecast period. Higher nominal consumption and residential investment boost GST revenue by $0.5 billion over the forecast period. The stronger labour market and increased competition for workers push up wages and salaries, boosting source deductions revenue by a cumulative $1.3 billion. The stronger economic activity allows firms to increase their margins, boosting profitability and increasing corporate tax by $1.2 billion. Higher short-term interest rates, needed to control rising inflation, boost tax on interest by $0.4 billion.

Figure 3.8 - Net core Crown debt

Source: The Treasury

Core Crown expenses are slightly lower than in the central forecast owing to a fall in debt servicing costs. The stronger labour market also results in a decrease in the number of recipients of unemployment-related benefits compared to the central forecasts. In this scenario, OBEGAL records a larger surplus of 0.3% of GDP ($0.6 billion) in the June 2015 year (Figure 3.4). Net core Crown debt declines to 23.3% of GDP in the June 2018 year compared to 25.0% of GDP in the central forecast (Figure 3.8).

General Fiscal Risks#

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The remainder of this chapter focuses on the links between the risks to the performance of the economy and the Crown's fiscal position. For more on fiscal risks, see the Specific Fiscal Risks chapter on page 61.

Fiscal Sensitivities

Table 3.2 provides some rules of thumb on the sensitivities of the fiscal position to small changes in specific variables. For example, if nominal GDP growth is one percentage point faster than forecast in each year up to June 2018, tax revenue would be around $3.2 billion higher than forecast in the June 2018 year as a result. The sensitivities are broadly symmetric and if nominal GDP growth is one percentage point slower each year than expected, tax revenue would be around $3.1 billion lower than forecast in the June 2018 year. The figures are indicative and can be influenced by the composition of growth as different types of activity have different effective tax rates.

A different interest rate path from that forecast would also impact on the fiscal position. A one percentage point lower interest rate would result in interest income on funds managed by the Treasury's New Zealand Debt Management Office (NZDMO) being $145 million lower in the June 2018 year. This would be more than offset by interest expenses being $338 million lower in the June 2018 year.

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

Source: The Treasury

Revenue Risks

One of the major sources of risk to the fiscal position arises from the inherent uncertainty about future tax revenue. The amount of tax revenue that the Government receives in a given year is closely linked to the performance of the economy.

Figure 3.9 plots the central tax revenue forecast, along with confidence intervals around these forecasts based on the Treasury's historical tax forecast errors and the assumption of an even balance of risks around the central forecast.[8] The outermost shaded area captures the range ± $6.4 billion in the June 2018 year, within which actual tax outturns should be expected to fall 80% of the time.

The tax revenue forecasts from the two scenarios are also shown in Figure 3.9. The 2008/09 global financial crisis showed that exogenous shocks can have severe impacts on government revenue. Should any of the uncertainties outlined in the Economic Riskssection eventuate, government revenue would be different from forecast, with scenarios one and two being examples of possible outcomes.

Figure 3.9 - Core Crown tax revenue uncertainty

Source: The Treasury

Expenditure Risks

One-off and unexpected expenditure shocks can have a large impact on the Crown's operating balance in the year that they occur. Persistent over-forecasting of expenditure can also have substantial ongoing effects on the fiscal position, along with the uncertainty inherent in forecasting the cost of new policy initiatives.

There is also considerable uncertainty regarding the effect of the performance of the economy on Crown expenditures. This uncertainty relates largely to the operation of the so-called automatic stabilisers. For example, if the economy performs better (worse) than expected in a given year, official expenditures on social programmes may be lower (higher) than planned.

Balance Sheet Risks

In addition to risks around revenue and expenditure, which appear in the balance sheet through their impact on the operating balance, the Crown's financial position is also exposed to asset and liability risks. The largest source of balance sheet risk is volatility in asset and liability values owing to movements in market variables such as interest rates, exchange rates and equity prices.

For additional detail, refer to the 2014 Investment Statement which provides information on the shape and health of the Crown's portfolio of assets and liabilities at the end of the previous financial year.[9] It outlines how the balance sheet has changed in recent years and includes forecasts of its anticipated composition and size through to 30 June 2018.

Funding Risks

The New Zealand Crown remains in the top-20 rated sovereigns globally, with the top Aaa foreign-currency rating from Moody's and AA foreign-currency ratings from Standard & Poor's and Fitch. Ratings outlooks are stable for Standard & Poor's and Moody's, and the rating outlook from Fitch is positive.

In the case of an increase in global risk aversion and in the absence of a marked improvement in the external position, New Zealand may be more likely to face a degree of funding pressure in the future. All else being equal, any improvement in the ratings outlook could serve to lower debt-servicing costs for the Crown.

The Crown is also susceptible to “liquidity risk” with respect to its ability to raise cash to meet its obligations. This risk is relatively small, however, given ongoing management of the core Crown's liquidity position by the Treasury's NZDMO.

Specific Fiscal Risks#

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The Statement of Specific Fiscal Risks is required by the Public Finance Act 1989 to set out, to the fullest extent possible, all government decisions and other circumstances known to the Government at the date of the finalisation of the fiscal forecasts that may have a material effect on the fiscal and economic outlook, but are not certain enough in timing or amount to include in the fiscal forecasts. Although the process for disclosure of specific fiscal risks involves a number of parties, including government departments, the Treasury and the Minister of Finance, there remains a possibility that not every significant risk is identified. Disclosure of known risks is also subject to specific requirements and materiality thresholds, which are described after the Statement of Specific Fiscal Risks.

Overview#

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Specific fiscal risks can be positive or negative and can affect revenue or spending or the balance sheet. The links between external events and spending are indirect because new policies that change spending and revenue usually require a decision by the Government and approval from Parliament. The approach taken in this chapter is to disclose those potential policy decisions and key areas of uncertainty that may have a material effect on the fiscal outlook.

Established practice is that the Government sets aside allowances of new funding for future Budgets to manage uncertainty and cost pressures. These allowances are included in the fiscal forecasts. Current fiscal management policy is for future policy decisions affecting expenses or capital expenditure to be met through reprioritisation or from within existing provisions included in the fiscal forecasts. Future policy decisions are risks to the fiscal forecasts only to the extent that they cannot be managed from within:

• existing baselines or Budget allowances for operating expenditure, or
• the existing Crown balance sheet for capital expenditure, including the Future Investment Fund (FIF)/capital allowance.

Notwithstanding this, known material policy risks are identified as specific fiscal risks, even though the Government has more control in managing such risks through reprioritisation, the existing Crown balance sheet and the Budget allowances. This is done to ensure a prudent approach to the disclosure of risks, improve transparency and not pre-judge future decisions by governments.

The specific fiscal risks are categorised into:

• Potential policy decisions affecting revenue: For example, changes to tax policy or ACC levies could reduce or increase government income.
• Potential policy decisions affecting expenses (expected to be funded from reprioritisation or Budget allowances): Costs of policy proposals could increase or decrease expenses depending on decisions taken, and they are risks to the fiscal forecasts only to the extent that they cannot be managed within existing baselines or Budget allowances.
• Potential capital decisions (expected to be funded from the Crown balance sheet, including the FIF/capital allowance): Capital investment decisions are risks to the fiscal forecasts only to the extent that they cannot be managed within the existing Crown balance sheet, including the FIF/capital allowance.
• Matters dependent on external factors: The Crown's liability for costs is sometimes dependent on external factors such as the outcome of negotiations or international obligations.

A range of generic risks to the fiscal forecasts are not recognised as specific fiscal risks:

• Risks from changes to economic assumptions; the most significant economic risks have been identified in Chapter 3.
• Business risks and volatility in the returns from the Crown's investments relating to the broader economic and commercial environment.
• General cost pressures, such as those associated with demographic changes (eg, an ageing population).
• Potential risks from changes in demand for government services or transfer payments owing to underlying structural factors (such as changes in demand for Jobseeker Support).
• The costs of future individual natural disasters, and other major events, as they usually occur infrequently and their occurrence, nature and timing cannot be predicted. Once a disaster does occur, a number of choices arise about how to respond and when potential liabilities are recognised (eg, through setting aside an allocation of funding). Specific risks are disclosed at this point based on the range of possible responses.

The final part of the chapter contains a current list of contingent liabilities and contingent assets. Contingent liabilities are costs that the Crown will have to face if a particular event occurs or are present liabilities that are unable to be measured. Typically, contingent liabilities consist of guarantees and indemnities, legal disputes and claims on uncalled capital. The largest quantified contingent liabilities are to international financial organisations and mostly relate to uncalled capital and promissory notes. Contingent assets are possible assets that have arisen from past events but the value of the asset, or whether it will eventuate, will not be confirmed until a particular event occurs.

Statement of Specific Fiscal Risks#

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Summary Table

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

 

Potential Policy Decisions Affecting Revenue

ACC - Funding Policy Review (Changed)

The Government has been reviewing ACC's funding policy and intends that there be further levy reductions across all accounts but decisions have not yet been taken on the nature and timing of those reductions.  Such reductions would reduce Crown revenue and Crown assets, with a flow-on impact to the operating balance and net worth.

Revenue - Income-sharing Tax Credits (Unchanged)

The Government has introduced legislation to establish an income-sharing tax credit. If passed as introduced, the legislation will allow couples with children under the age of 18 to pool their earnings for income tax purposes if they meet certain criteria. If implemented, the changes could reduce tax revenue by around $500 million a year once the scheme is fully operational. The Finance and Expenditure Committee has recommended that the significant fiscal cost of the package be addressed before the Bill proceeds further.

Services Funded by Third Parties (Unchanged)

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

Potential Policy Decisions Affecting Expenses (Expected to be Funded from Reprioritisation or Budget Allowances)

ACC - Work-related Gradual Process Disease and Infection (Changed)

Under current legislation, the Government incurs an obligation for Work-related Gradual Process Disease and Infection claims when the claim is made, and an expense is recognised at this point. The liability for commercial accident and sickness insurance contracts would usually be recognised when exposure to conditions that will give rise to a claim occurs. An amendment to legislation would be required to recognise claims at the same time as for commercial contracts. An initial adjustment to the liability and an expense of about $1 billion would need to be reported if such an amendment were to be enacted.

Budget Operating Initiatives (Unchanged)

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

Canterbury Earthquake Recovery - Christchurch Central Recovery Plan - Anchor Projects (Changed)

The Crown is partially funding the construction of Anchor Projects as part of the Christchurch Central Recovery Plan as set out in the cost-sharing agreement with the Christchurch City Council. The extent of funding will vary from project to project, dependent on final project costs, and will to some extent eventually be recovered. Business cases are progressing through the decision-making process and construction costs will become increasingly clear during the business case process and the subsequent procurement phase. The Crown's contribution may differ from that included in the fiscal forecasts.

Christchurch City/Crown Cost Sharing - Horizontal Infrastructure (Unchanged)

The Crown is partially funding the recovery of local infrastructure in Canterbury as set out in the cost-sharing agreement with the Christchurch City Council. The agreement includes a review clause. The review is to be completed by 1 December 2014. Any additional costs or savings to the Crown that may arise from the review will have a corresponding fiscal impact.

Communications - Ultra-Fast Broadband Initiative (Changed)

The Government's expectation is that the current funding envelope for the roll out of Ultra-Fast Broadband (UFB) will not be breached and that the objective of rolling out UFB to 75% of New Zealanders by the end of 2019 will be met. Until the Commerce Commission issues a final decision, the largest partner in the roll out, Chorus, will face some degree of uncertainty which could give rise to a fiscal risk in achieving these targets.

Defence Force - Operating and Capital Costs (Changed)

In 2013, the Government reconsidered New Zealand Defence Force (NZDF) funding, output requirements and capability intentions, through the Defence Mid-Point Rebalancing Review.  The review has resulted in a baseline increase for NZDF in Budget 2014.  There is a likelihood that further operating and capital decisions may be required to achieve Defence White Paper (2010) policy and enable NZDF to manage additional cost pressures over the forecast period.

Finance - Concessionary Loans (Unchanged)

The Crown has provided loans to local government and iwi-based organisations on a concessionary basis to achieve public policy purposes. To reflect the concession, these loans have been written down and have a current carrying value of $382 million. There is, however, a risk that the adjustments made may be insufficient to cover the credit risk involved in these non-commercial loans.

Government Response to Wai 262 (Unchanged)

The Waitangi Tribunal's report on the Wai 262 claim focuses on the protection of Māori culture and identity, with a particular focus on mātauranga Māori and associated taonga. The Tribunal's recommendations are directed towards a number of government agencies individually, as groups and across sectors. The Government has yet to respond to the Tribunal's report and recommendations.

Housing/Social Development - Housing Assistance (Changed)

The Government has changed the policy settings for social housing and is considering a number of aspects of housing assistance. The changes and the matters the Government is considering include growing third party providers of social housing, increasing the effectiveness of financial assistance, and Housing New Zealand Corporation focusing on providing social housing to those with the greatest housing need. Increasing the scale or speed of change may require reprioritisation or additional funding.

Internal Affairs - All-of-Government Common Capabilities Sustainable Funding (New)

A central component of the Department of Internal Affairs' responsibilities as functional lead for All-of-Government ICT and the ICT Strategy and Action Plan is the development and delivery of All-of-Government common capabilities. The Government has agreed that departments and some Crown entities should migrate to common ICT capabilities, including RealMe. Many of these common capabilities have been developed and are being used and some are still in development. To the extent that these costs cannot be met within agencies' baselines, they may require new funding.

Revenue - KiwiSaver One-Off Enrolment (Unchanged)

The Government has announced its intention to consult on the design of a one-off KiwiSaver auto-enrolment exercise to increase the number of KiwiSaver members. The Government will proceed with a one-off KiwiSaver enrolment exercise only when it is confident that such a step poses no significant risks to returning to, and maintaining, an operating surplus and debt repayment is on track. An auto-enrolment exercise is likely to entail a one-off cost for kick-start payments to new members and ongoing additional costs for the Member Tax Credit. Depending on the timing, design features and take-up rate, these costs could be in the order of $100 million to $290 million over the first four years after auto-enrolment takes place, and are expected to be funded out of the operating allowance.

Revenue - Transformation and Technology Renewal (Unchanged)

The Government is exploring options that will change the way IRD manages its processes and data. Any changes could impact tax revenue collections and may have material costs to implement. IRD has commenced the development of a detailed business case(s) for Stage 1: Enabling secure digital services. The business case(s) will inform the Government's decision-making for the first stage of transformation and may require significant reprioritisation or new funding.

Social Development - Welfare Reform Costs (Unchanged)

The Welfare Reform package of changes to the benefit system was introduced from July 2013, following amendments to the Social Security Act 1964. The current phase is to review programmes with a view to reducing future benefit dependency and long-term liability. Additional funding was appropriated at Budget 2014. The extent of any further costs associated with the ongoing implementation of the Investment Approach is uncertain.

Social Development - Welfare Reform Forecast Benefit Savings (Unchanged)

A conservative estimate of the likely benefits from Welfare Reform has been included in the fiscal forecasts. The actual impact may differ owing to behavioural factors and the complexity in implementing the reforms, with a corresponding impact on benefit expenditure.

State Sector Employment Agreements (Unchanged)

A number of large collective agreements are due to be negotiated in the short-to-medium term. As well as direct fiscal implications from any changes to remuneration, the renegotiation of these agreements can have flow-on effects to remuneration in other sectors. The Government has signalled an expectation of restraint given its current fiscal stance and that agreements will be managed within the current fiscal forecasts.

Vulnerable Children White Paper (Unchanged)

The Government has begun to implement proposals to better identify and provide assistance to vulnerable children. While funding for 2014/15 has been included in the fiscal forecasts, future costs of the proposal are still being developed. To the extent that these cannot be funded from reprioritisation, additional funding from the operating allowance may be required.

Potential Capital Decisions (Expected to be Funded from the Crown Balance Sheet, Including the FIF/capital allowance)

Arts, Culture and Heritage - Review of Military History Museum Arrangements (New)

In June 2014, the Government agreed to review the current arrangements around the recording, collecting and exhibiting of New Zealand's military history with a focus on the national level. At this stage it is unclear what the outcome of this business case will be, but this could result in further provision of military history exhibitions. This could require substantial Crown investment.

Agency Capital Intentions (Unchanged)

Future Budgets may well include new capital initiatives other than those identified in other specific fiscal risks. Such initiatives are likely to be primarily from the 16 capital-intensive agencies or sectors that are required to identify their capital spending intentions over the next 10 years based on current policy settings and certain demographic and inflation assumptions. The Government expects that these intentions will be managed back through a range of measures such as prioritisation, changes to asset utilisation, alternative methods of service delivery and changes to policy settings. New capital initiatives and agency capital intentions are risks to the fiscal forecasts only to the extent they cannot be managed through existing balance sheets, including the FIF, and the provision in the fiscal forecasts for forecast new capital spending.

Earthquake Strengthening for Crown-owned Buildings (Unchanged)

There is a possibility that the Crown will incur costs for earthquake strengthening some of its buildings that do not meet modern building standards. The Government is currently undertaking a stocktake of Crown-owned earthquake-prone buildings. The likelihood, timing and fiscal impact of any earthquake strengthening are uncertain.

Finance - Crown Overseas Properties (Unchanged)

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

Parliamentary Service - Parliamentary Accommodation (New)

With the expiry of the lease on Bowen House in December 2018, the Parliamentary Service is identifying and assessing options for future office accommodation which may require capital expenditure with estimates ranging from $40 million to $130 million.

Primary Industries - Investment in Water Infrastructure (Unchanged)

In addition to $80 million provided in Budget 2013 and $40 million provided in Budget 2014, the Government will consider providing up to $280 million in future Budgets to Crown Irrigation Investments Limited as schemes reach the “investment-ready” stage.

Transport - Auckland Transport Projects (Unchanged)

The Government has signalled its intention to accelerate transport projects in the Auckland Council's Auckland Plan, including Auckland Manukau Eastern Transport Initiatives, the East-West Link and support for the City Rail Link and a second Waitemata Harbour Crossing. Decisions on further Crown financial assistance for Auckland Manukau Eastern Transport Initiatives and the East-West Link will be made as part of future Budgets.

Transport - Regional State Highways (New)

A regional state highway acceleration package of $212 million was announced by the Government in June 2014. $115 million of this is subject to the outcome of further investigations. Further funding decisions will be considered as part of Budget 2015.

Transport - Support for KiwiRail (Unchanged)

The Government in Budgets 2010 to 2014 supported KiwiRail Holdings Limited (KiwiRail) with around $1 billion invested in its plan to become a commercially viable network. Further funding is being sought by KiwiRail in support of this objective. A major review of the business has commenced and will be assessed to inform Budget 2015 and any further investment.

Transport - Cycleways (New)

At the date these specific fiscal risks were finalised (5 August), a proposal relating to cycleways was under active consideration by the Government. If such a proposal is approved and is not to be funded entirely from within existing baselines, it may impact on the FIF or the Budget allowances.

Matters Dependent on External Factors

ACC - Levies (Unchanged)

Revenue from the levies set for the Work, Earners' and Motor Vehicle accounts may be more or less than is required to cover the cost of claims, if factors such as claims experience, ACC performance and economic assumptions (particularly discount rates) turn out differently from what has been forecast. Any such variance will have a corresponding impact on the operating balance.

ACC - Non-earners' Account (Unchanged)

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

Canterbury Earthquake Recovery - Residential Red Zone (Unchanged)

Some recoveries from EQC and private insurers remain outstanding and there is a risk that final recoveries may be greater or less than forecast. In addition, potential costs associated with the future use of residential red zone are uncertain. The future value of the land may change depending on any future alternative uses for it. The fiscal impact of this is not yet certain.

Caregiver Employment Conditions (Unchanged)

Several cases and funding claims in the disability support and aged care sectors relating to interpretation of the Minimum Wage Act 1983, the Equal Pay Act 1972 and the Government's policy of paying certain family members through its Funded Care Policy may involve significant costs to the Crown. Changes to the existing policy could require additional funding. Successful litigation may have implications for agencies that target assistance based on family circumstances and/or employ workers under similar contracts.

Communications - Impairment in Value of Broadband Investment (Unchanged)

The Government has set aside $1.345 billion to progressively capitalise Crown Fibre Holdings so that it can invest with private partners in a new network delivering “ultra-fast” broadband services. Given the contracts entered into, the extent of the recovery of this investment is somewhat dependent on the number of connections made to the network. The fiscal forecasts include a provision for impairing this investment, but the final amount of the impairment may vary from this provision.

Defence Force - Potential Rationalisation, Revaluation and Disposal of NZDF Assets (Unchanged)

The Government is considering the potential to dispose of a number of NZDF assets, including the Seasprite helicopters and Unimog trucks. Depending on market conditions, the timing of disposal and sale price received could have an impact on the Government's overall financial position. NZDF is also completing analysis of inventory that is surplus to requirements and is over and above the existing provision for obsolescence. The existing provision is also being reviewed to ensure that all items comprising the provision are still relevant.

Energy - Crown Revenue from Petroleum Royalties (Unchanged)

Crown revenue from petroleum royalties is very dependent upon extraction rates, the US dollar value per barrel and the US dollar/NZ dollar exchange rate. Movements up or down in any of these variables could result in a significant decrease or increase in Crown revenue. The overall impact for the Crown could be positive or negative.

Finance - EQC (Unchanged)

EQC is forecasting a cash deficiency in the National Disaster Fund (NDF) arising in the 2014/15 financial year. Under Section 16 of the Earthquake Commission Act 1993 the Crown shall provide funding to meet a deficiency in the NDF. Such funding will impact on net debt but not the operating balance or OBEGAL. The financial position of EQC and the amount of any Crown funding carry a high level of uncertainty owing to the nature of EQC's claims liability. An actuarial estimate of the net claims liability and its rate of settlement is included in the forecasts; however, the estimates are sensitive to underlying assumptions such as damage estimates, legal challenges, reinsurance recoveries and the forecast profile of settlements. The Crown's financial position may be adversely impacted if these assumptions are modified over time. Because the net claims liability is large, small percentage changes in the liability can have a material impact on costs and forecasts.

Finance - Goodwill on Acquisition (Unchanged)

As at 30 June 2013, the Government had goodwill on acquisition of a number of sub-entities totalling $655 million. Under New Zealand accounting standards (NZIAS 36), such goodwill items are required to be assessed annually for impairment. If there is any indication that the goodwill may be impaired, the recoverable amount of the cash generating units to which the goodwill is allocated is required to be estimated. If the recoverable amount is less than the carrying amount of those units, the units and the goodwill allocated to them are regarded as impaired and the Government is required to recognise impairment losses in the operating statement. Such assessments will be conducted at the end of the financial year, and the fiscal forecasts currently make no allowance for such impairment losses.

Finance - Solid Energy (Unchanged)

Since Solid Energy's financial restructure in October 2013 the company's export prices have deteriorated significantly driven mainly by a decrease in US dollar coal price. The company continues to develop and implement a business strategy to adapt to these challenging market conditions and continue operating. Any changes to the restructure arrangements or further deterioration in market conditions or the company’s financial position may adversely impact the Crown.

Finance - Southern Response Earthquake Services Support (Unchanged)

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

Housing - Divestment of Housing (Unchanged)

The forecasts reflect related divestments and redevelopments of some housing property. Property sales are subject to market conditions and therefore there is an inherent level of uncertainty about the return to the Crown associated with forecast divestments and to the proposed funding of the related developments.

Revenue - Cash Held in Tax Pools (Unchanged)

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

Revenue - Student Loans (Changed)

The value of student loans is sensitive to assumptions such as the borrower's future income, and general economic factors such as interest rates, unemployment levels, salary inflation and the CPI. As new lending occurs, an initial write-down to fair value will be made, and an expense will be incurred, reflecting the cost the Crown incurs in making an interest free loan. The forecasts for this initial write-down assume that loans issued after 1 January 2015 with similar repayment characteristics to student loans would attract an effective interest rate of 6.73%. The effective interest rate actually applied for these loans will be updated early in 2015.

Treaty Negotiations - Treaty Settlement Forecasts (Unchanged)

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

Treaty Negotiations - Relativity Clause (Unchanged)

The Deeds of Settlement negotiated with Waikato-Tainui and Ngāi Tahu include a relativity mechanism. Now that the total redress amount for all historical Treaty settlements exceeds $1 billion in 1994 present-value terms, the mechanism provides that the Crown is liable to make payments to maintain the real value of Ngāi Tahu and Waikato-Tainui's settlements as a proportion of all Treaty settlements. The agreed relativity proportions are 17% for Waikato-Tainui and approximately 16% for Ngāi Tahu. There is a risk that the timing and amount of the expense for the relativity payments may differ from that included in the fiscal forecasts. There is also uncertainty on how various disputes concerning the interpretation of the mechanism will be resolved.

Risks Removed Since the 2014 Budget Update

There have been no risks removed since the 2014 Budget Update.

Criteria and Rules for Inclusion in the Fiscal Forecasts or Disclosure as Specific Fiscal Risks

The Public Finance Act 1989 requires that the Statement of Specific Fiscal Risks sets out all government decisions, contingent liabilities or contractual obligations known to the Government and subject to specific requirements that may have a material effect on the economic or fiscal outlook.[11]

The criteria and rules set out below are used to determine if government decisions or other circumstances should be incorporated into the fiscal forecasts, disclosed as specific fiscal risks or, in some circumstances, excluded from disclosure.

Criteria for Including Matters in the Fiscal Forecasts

Matters are incorporated into the fiscal forecasts provided they meet the following criteria:

• The matter can be quantified for particular years with reasonable certainty.
• A decision has been taken, or a decision has not yet been taken but it is reasonably probable[12] the matter will be approved, or it is reasonably probable the situation will occur.

Additionally, any other matters may be incorporated into the forecasts if the Secretary to the Treasury considers, using best professional judgement, that the matters may have a material effect on the fiscal and economic outlook and are certain enough to include in the fiscal forecasts.

Rules for the Disclosure of Specific Fiscal Risks 

Matters are disclosed as specific fiscal risks if:

• the likely impact is more than $100 million over five years, and either
• a decision has not yet been taken but it is reasonably possible[13] (but not probable) that the matter will be approved or the situation will occur, or
• it is reasonably probable that the matter will be approved or the situation will occur, but the matter cannot be quantified or assigned to particular years with reasonable certainty.

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

Exclusions from Disclosure

Matters are excluded from disclosure as specific fiscal risks if they fail to meet the materiality criterion (ie, are less than $100 million over five years), or if they are unlikely[14] to be approved or occur within the forecasting period.

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

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

If possible, the Minister of Finance should avoid withholding the matter, either by making a decision on it before the forecasts are finalised, or by disclosing it without quantifying the risk.

Contingent Liabilities and Contingent Assets#

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

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

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

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

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

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

Some contingencies of the Crown are not able to be quantified. We have disclosed all unquantifiable contingent liabilities and unquantifiable contingent assets that are not expected to be remote.[15]

Contingent liabilities have been stated as at 31 May 2014, being the latest set of reported contingent liabilities.

Quantifiable Contingent Liabilities and Contingent Assets

 

Unquantifiable Contingent Liabilities and Contingent Assets

Description of Contingent Liabilities

Quantifiable contingent liabilities over $100 million

Uncalled capital

As part of the Crown's commitment to a multilateral approach to ensure global financial and economic stability, New Zealand, as a member country of these organisations, contributes capital by subscribing to shares in certain institutions.

The capital (when called) is typically used to raise additional funding for loans to member countries or, in the case of the quota contributions, to directly finance lending to members. For New Zealand and other donor countries, capital contributions comprise both “paid in” capital and “callable capital or promissory notes”.

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

Legal proceedings and disputes

Tax in dispute

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

$592 million at 31 May 2014 ($641 million at 30 June 2013)

Otherquantifiable contingent liabilities

Unclaimed monies

Under the Unclaimed Money Act 1971, entities (eg, financial institutions, insurance companies) hand over money not claimed after six years to IRD. The funds are repaid to the entitled owner on proof of identification.

$112 million at 31 May 2014 ($101 million at 30 June 2013)

Transpower New Zealand Limited

Transpower has a contingent liability relating to excess capital expenditure on the North Island Grid Upgrade Project (NIGU). The NIGU spend exceeds the amount initially approved in 2006. If the excess expenditure is not approved by the Commerce Commission it cannot be recovered from customers. NIGU is operational and a submission for the excess expenditure has been made.

$150 million at 31 May 2014 ($156 million at 30 June 2013)

Unquantifiable contingent liabilities

This part of the Statement provides details of those contingent liabilities of the Crown that are not quantified, excluding those that are considered remote, reported by the following categories:

1. Indemnities
2. Legal disputes
3. Other contingent liabilities.

a Indemnities

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

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

 #

b Legal claims and proceedings

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

Accident Compensation Corporation (ACC) litigation   

There are a number of actions involving ACC in existence, arising from the statutory review and appeal process, and in the main coming from challenges to operational decisions made by ACC. Given the nature of these proceedings and uncertainty as to their outcomes, attempting to quantify the financial effect would be unrealistic, so no estimate has been made.

Air New Zealand litigation

Air New Zealand is currently named in two class actions in the US. One makes allegations against more than 30 airlines, of anti-competitive conduct in relation to pricing in the air cargo business. A second alleges that Air New Zealand together with many other airlines conspired in respect of fares and surcharges on trans-Pacific routes. Both class actions are being defended. The allegations made in relation to the air cargo business are also the subject of proceedings by the Australian Competition and Consumer Commission. A defended hearing in the Federal Court concluded in May 2013 and a decision is awaited. In the event that the Court determines that Air New Zealand had breached Australian laws, the company would have potential liability for pecuniary penalties.

Television New Zealand Limited (TVNZ)

In the normal course of business various legal claims have been made against TVNZ. Given the stage of proceedings and uncertainty as to the outcomes of the claims, no estimate of the financial effect can be made and no provision for any potential liability has been made in the financial statements.

Treaty of Waitangi claims

Under the Treaty of Waitangi Act 1975, any Māori may lodge certain claims relating to land or actions counter to the principles of the Treaty with the Waitangi Tribunal. Where the Tribunal finds a claim is well founded, it may recommend to the Crown that action be taken to compensate those affected. The Tribunal can make recommendations that are binding on the Crown with respect to land which has been transferred by the Crown to an SOE or tertiary institution, or is subject to the Crown Forest Assets Act 1989.

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

Ministry of Education litigation

Post Primary Teachers Association and several teachers have lodged a claim in the High Court alleging breach of statutory duty, and compensation, in respect of the Novopay system failures. The Ministry is defending this claim.

c  Other unquantifiable contingent liabilities

Criminal Proceeds (Recovery) Act 2009

The Ministry of Justice is responsible for administering the Criminal Proceeds (Recovery) Act 2009. The Act requires the Crown to give an undertaking as to damages or costs in relation to asset restraining orders. In the event that the Crown is found liable, payment may be required. The timing and amount of any possible payments required are not able to be estimated.

Environmental liabilities

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

Any contaminated sites for which costs can be reliably measured have been included in the Statement of Financial Position as provisions.

Treaty of Waitangi claims - Settlement Relativity Payments - see page 72.

Description of Contingent Assets

Quantifiable contingent assets over $100 million

Tax disputes - non-assessed

A contingent asset is recognised when IRD has advised, or was about to advise, a taxpayer of a proposed adjustment to their tax assessment. The taxpayer has the right to dispute this adjustment and a disputes resolution process can be entered into. The contingent asset is based on the likely outcome of the disputes process based on experience and similar prior cases.

$118 million at 31 May 2014 ($169 million at 30 June 2013)

Forecast Financial Statements#

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

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

The forecasts have been prepared in accordance with the Statement of Responsibility and reflect the judgements and information known at the time they were prepared. They reflect all government decisions and circumstances communicated to 5 August 2014.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined in the Fiscal Outlook chapter (pages 23 to 47).

Statement of Accounting Policies #

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Significant Accounting Policies

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

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

The specific accounting policies are included within the 2014 Pre-election Economic and Fiscal Update Additional Information document which can be found on the Treasury's website at www.treasury.govt.nz/budget/forecasts/prefu2014

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

The Forecast Financial Statements have been prepared on the basis of the Treasury's best professional judgement. Actual financial results for the periods covered are likely to vary from the information presented in these forecasts. Factors that may lead to a material difference between information in these Forecast Financial Statements and the actual reported results in future years are set out in the Specific Fiscal Riskschapter on pages 61 to 82.

Key forecast assumptions are set out on pages 40 to 42.

Government Reporting Entity as at 5 August 2014#

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

Core Crown segment

Departments

• Canterbury Earthquake Recovery Authority
• Crown Law Office
• Department of Conservation
• Department of Corrections
• Department of Internal Affairs
• Department of the Prime Minister and Cabinet
• Education Review Office
• Government Communications Security Bureau
• Inland Revenue Department
• Land Information New Zealand
• Ministry for Culture and Heritage
• Ministry for Primary Industries
• Ministry for the Environment
• Ministry of Business, Innovation and Employment
• Ministry of Defence
• Ministry of Education
• Ministry of Foreign Affairs and Trade
• Ministry of Health
• Ministry of Justice
• Ministry of Māori Development
• Ministry of Pacific Island Affairs
• Ministry of Social Development
• Ministry of Transport
• Ministry of Women's Affairs
• New Zealand Customs Service
• New Zealand Defence Force
• New Zealand Police
• New Zealand Security Intelligence Service
• Office of the Clerk of the House of Representatives
• Parliamentary Counsel Office
• Parliamentary Service
• Serious Fraud Office
• State Services Commission
• Statistics New Zealand
• The Treasury

Offices of Parliament

• Controller and Auditor-General
• The Ombudsmen
• Parliamentary Commissioner for the Environment

Others

• New Zealand Superannuation Fund
• Reserve Bank of New Zealand

State-owned enterprises segment

• Airways Corporation of New Zealand Limited
• Animal Control Products Limited
• AsureQuality Limited
• Electricity Corporation of New Zealand Limited
• Kiwirail Holdings Limited
• Kordia Group Limited
• Landcorp Farming Limited
• Learning Media Limited (in liquidation)
• Meteorological Service of New Zealand Limited
• New Zealand Post Limited
• New Zealand Railways Corporation
• Quotable Value Limited
• Solid Energy New Zealand Limited
• Transpower New Zealand Limited

Mixed ownership model companies (Public Finance Act schedule 5 companies)

• Genesis Energy Limited
• Meridian Energy Limited
• Mighty River Power Limited

Others

• Air New Zealand Limited

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

Forecast Financial Statements#

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Forecast Statement of Financial Performance for the years ending 30 June

 

1. Minority interests include those who recently purchased shares in the Government Share Offer Programme as well as the pre-existing minority interests.

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

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

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

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

Forecast Statement of Comprehensive Income for the years ending 30 June

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

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

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

Forecast Statement of Cash Flows for the years ending 30 June

 

1. Represents proceeds from the Government Share Offer net of purchases by ACC and NZSF.
2. Further information on the proceeds and repayments of government stock ("domestic bonds") is available in note 22.
3. Minority interests include those who recently purchased shares in the Government Share Offer Programme as well as the pre-existing minority interests.

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

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

Forecast Statement of Financial Position as at 30 June

 

1. Tertiary education institutions constitute most equity accounted investments.

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

Forecast Statement of Borrowings as at 30 June

Notes on borrowings

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

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

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

Statement of Actual Commitments as at 31 May 2014

Statement of Actual Contingent Liabilities and Assets as at 31 May 2014

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

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

Notes to the Forecast Financial Statements #

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1. Customs excise-equivalent duty.

NOTE 2: Interest revenue and dividends

NOTE 3: Transfer payments and subsidies

From 15 July 2013 the benefit categories Domestic Purposes Benefit, Invalid's Benefit, Unemployment and Emergency Benefit and Sickness Benefit, as well as Widow's Benefit, were replaced by new benefit categories.  These categories are Jobseeker Support and Emergency Benefit, Supported Living Payment and Sole Parent Support.

 

NOTE 4: Personnel expenses

NOTE 5: Depreciation, amortisation and other operating expenses

NOTE 6: Interest expenses

NOTE 7: Insurance expenses

NOTE 8: Forecast new spending and top-down expense adjustment

Unallocated contingencies represent expenses included in Budget 2014 and previous Budgets that has yet to be allocated. Forecast new spending indicates the expected spending increases from future Budgets.

Unallocated contingencies represent capital spending from Budget 2014 and previous Budgets that has yet to be allocated. Forecast new spending indicates the expected capital spending increases from future Budgets, which will be mostly funded from the Future Investment Fund.

NOTE 9: Gains and losses on financial instruments

NOTE 10: Gains and losses on non-financial instruments

NOTE 11: Operating balance

NOTE 12: Financial assets

NOTE 13: Student loans

NOTE 14: Property, plant and equipment

 

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

 

2. These additions do not include any purchases which may result from the allocation of the forecast for new capital spending (separately disclosed in the Forecast Statement of Financial Position).

NOTE 15: Intangible assets and goodwill

Net Kyoto position

The New Zealand Government has committed under the Kyoto Protocol to ensuring that New Zealand's average net emissions of greenhouse gases from 2008 to 2012 (the first commitment period of the Kyoto Protocol, or CP1) are reduced to gross 1990 emission levels, or to take responsibility for the difference. New Zealand can meet its commitment through emissions reductions and use of the Kyoto Protocol flexibility mechanisms such as Joint Implementation, the Clean Development Mechanism, and offsetting increased emissions against carbon removed by forests.

To assist New Zealand in meeting its Kyoto Protocol commitments, an Emissions Trading Scheme (ETS) was established (refer note 20). These two initiatives should be looked at together when understanding New Zealand's international climate change obligations.

The latest Net Position estimate can be found on the Ministry for the Environment's website: www.mfe.govt.nz/issues/climate/greenhouse-gas-emissions/net-position

NOTE 16: NZS Fund

NOTE 17: Payables

NOTE 18: Insurance liabilities

ACC liability

Calculation information

PwC NZ has prepared an independent actuarial estimate of the ACC outstanding claims liability as at 30 June 2014. This estimate includes the expected future payments relating to accidents that occurred prior to balance date (whether or not the associated claims have been reported to, or accepted by, ACC) and also the expected future administrative expenses of managing these claims. The assumptions underpinning this valuation form the basis of the five-year forecast of the outstanding claims liability.

The key economic variables that impact on changes to the valuation are the long-term Labour Cost Index (LCI), average weekly earnings and the discount rate. Discount rates were derived from the yield curve for New Zealand Government bonds. For these forecast statements, the claims liability has been updated for the latest discount rates as at 30 June 2014. The equivalent single effective discount rate, taking into account ACC's projected future cash flow patterns, is 5.01% and allows for a long-term discount rate of 5.5% from 2035.

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

Presentation approach

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

EQC liability

Calculation information

Melville Jessup Weaver prepared an independent actuarial estimate of the EQC outstanding claims liability at 30 June 2014 by estimating the projected ultimate claims costs then deducting the payments made in relation to those claims on or before that date. Each component of the claims liability was split into separate groups depending upon the Canterbury earthquake event grouping or other “business as usual” claims. These event groups were further split into sub-claim valuation groups being land claims, building claims or contents claims. The assumptions underpinning the 30 June 2014 valuation form the basis of the five-year forecast of the outstanding claims liability.

Critical assumptions used in projecting the ultimate costs include apportionment of costs across earthquake events, the profile of claims settlement, claims inflation rate per annum, risk margins and claims handling costs.

There is a high level of uncertainty associated with the valuation of the outstanding claims liability, reinsurance recoveries and unexpired risk liability. Some of the key uncertainties are: cost apportionment across events; the potential for construction cost to exceed expectations; land damage estimates; reinsurance recoveries and profile of claims settlement.

The actual claims outcome may differ from the one currently forecast.

Presentation approach

EQC reinsurance recoveries are included in receivables in the Statement of Financial Position.

NOTE 19: Retirement plan liabilities

The net liability of the Government Superannuation Fund (GSF) was calculated by GSF's actuary as at 30 June 2014. The liability arises from closed schemes for past and present public sector employees as set out in the Government Superannuation Fund Act 1956. A Projected Unit Credit method was used to calculate the liability as at 30 June 2014, based on membership data as at 30 June 2014.

The funding method requires the benefits payable from GSF in respect of past service to be calculated and then discounted back to the valuation date.

For these Forecast Financial Statements, the net GSF liability was updated for the latest discount rates derived from the market yield curve for New Zealand Government bonds as at 30 June 2014.

Other principal long-term financial assumptions were an inflation rate, as measured by the Consumers Price Index (CPI), of 2.1% p.a for the years to 30 June 2023, increasing yearly to reach 2.5% p.a. in 2033 where it remains for all years after that. In addition an annual salary growth rate, before any promotional effects, of 3% p.a. (unchanged from 30 June 2013).

The 2013/14 projected decrease in the net GSF liability is $1,022 million, reflecting a decrease in the GSF liability of $730 million and an increase in the GSF net assets of $292 million.

The decrease in the GSF liability of $730 million includes an actuarial gain between 1 July 2013 and 30 June 2014, of $366 million, owing to movements in the discount rates ($57 million) and changes in CPI ($377 million). The remaining $364 million reduction is owing to lower than expected benefits paid to members (reduces the liability), offset by current service cost and interest unwind (increases the liability).

The increase in the value of the net assets of GSF of $292 million includes a gain of $212 million reflecting the updated market value of assets at 30 June 2014. The balance of $79 million is the total of the expected investment returns and contributions received, offset by the benefits paid to members.

The changes in the projected net GSF liability from 2013/14 onwards reflect the net of the expected current service cost, interest cost, investment returns and contributions.

NOTE 20: Provisions

Provision for ETS credits

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

The allocation of NZUs creates a provision if allocated for free; the provision is reduced, and revenue recognised, as NZUs and Kyoto compliant units are surrendered to the Crown by emitters. The Kyoto compliant units collected through the ETS are recognised as revenue and as part of the net Kyoto Protocol position.

The prices for NZUs and Kyoto compliant units used to calculate the ETS provision are assumed to remain constant over the forecast period and are based on market prices during June 2014.

The ETS impact on the fiscal forecast is as follows:

NOTE 21: Net worth

NOTE 22: Core Crown residual cash

 

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

Forecast Statement of Segments #

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