Pre-election Economic and Fiscal Update 2017

An introduction to the Pre-election Economic and Fiscal Update#

Print this section

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

Sharing what we do

As the government's lead economic and financial adviser we forecast the economic outlook for New Zealand and the Government's fiscal outlook. This Pre-election Economic and Fiscal Update (PREFU) is part of a suite of documents we release as required by the Public Finance Act 1989. With the announcement of an election date of 23 September 2017, the 2017 PREFU must be published between 20 and 30 working days prior to this date.

The PREFU is an opening of the Government's books ahead of the General Election. It primarily outlines what the Treasury observes in our current economic and fiscal climate, what we might see in the future, and what risks we may face over the next four years (our forecast period). This gives an indication of what the economy is most-likely to do to inform decision-making.

Making it New Zealander-centric

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

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

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

Understanding our path

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

Statement of Responsibility#

Print this section

On the basis of the economic and fiscal information available to it, the Treasury has used its best professional judgement in preparing, and supplying the Minister of Finance with this Economic and Fiscal Update. The Update incorporates the fiscal and economic implications of both government decisions and other circumstances as at 7 August 2017 that were communicated to me by the Minister of Finance in accordance with the requirements of the Public Finance Act 1989 and of other economic and fiscal information available to the Treasury as at 7 August 2017. This Update does not incorporate any decisions, circumstances or statements that the Minister of Finance has determined, in accordance with section 26V of the Public Finance Act 1989, should not be incorporated in this Update.

Gabriel Makhlouf
Secretary to the Treasury

16 August 2017

To enable the Treasury to prepare this Economic and Fiscal Update I have ensured the Secretary to the Treasury has been advised, in accordance with the requirements of the Public Finance Act 1989, of all government decisions and other circumstances as at 7 August 2017 of which I was aware and that had material economic or fiscal implications.

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

Hon Steven Joyce
Minister of Finance

16 August 2017

Executive Summary#

Print this section

Sources: Statistics New Zealand, the Treasury

New Zealand's economy and the Crown's books are in a sound state.

The economy is expected to continue its steady growth over the 4-year forecast period. Growth in real GDP is forecast to pick up to 3.7 percent in mid-2019 before easing to 2.3 percent in 2020/21.

The stronger period of economic growth over the next two years or so is expected to lead to a gradual decline in the unemployment rate and a pick-up in wages and prices that lifts inflation to 2.1 percent in 2019/20. Beyond 2019, slower population growth and reduced monetary policy stimulus are forecast to lead to slower economic growth. The forecast growth profile is a little lower than in the Budget Economic and Fiscal Update (Budget Update), mostly reflecting a smaller contribution to growth from residential investment. As a result, over the four years ending June 2021, nominal GDP is 0.2 percent ($2.6 billion) lower than in the Budget Update.

The 2016/17 fiscal result is anticipated to be stronger than expected while fiscal forecasts for the next 4 years remain fairly close to the Budget Update. The operating balance before gains and losses (OBEGAL) surplus is estimated to reach $3.7 billion in 2016/17, largely reflecting stronger tax revenue growth. Owing to the one-off nature of some of the factors behind the tax revenue growth in 2016/17, the rate of growth is not expected to continue. Budget allowances remain unchanged from those set out in the 2017 Fiscal Strategy Report (FSR).

Largely as a result of the expected improvement in the 2016/17 fiscal results, net debt is estimated to be $2.0 billion lower than anticipated in the Budget Update by 2020/21 to stand at 18.8 percent of GDP. Contributions to the New Zealand Superannuation Fund are forecast to resume that year. Projections show net debt as a share of GDP continuing to decline beyond 2020/21, based on the same assumptions for operating and capital allowances as in the FSR.

The economic and fiscal outlook is subject to a range of assumptions, risks and uncertainties. For the fiscal forecast, a judgement has been made that the current strength in tax revenue does not continue throughout the forecast period. For the economy, the terms of trade may be stronger if prices for key export commodities hold up for longer than expected, or domestic demand may be lower if households' expectations of future income and wealth are dampened by slow wage growth or weaker house price growth. More detail and discussion of assumptions, risks and uncertainties are included in the Fiscal Outlook, Specific Fiscal Risks, Economic Outlook, and Risks and Scenarios chapters.

 

1 Economic Outlook#

Print this section

Overview#

Print this section

• The New Zealand economy grew an estimated 2.8% in the 2016/17 fiscal year, a little lower than anticipated in the Budget Economic and Fiscal Update (Budget Update). Measured in current prices, the economy is estimated to have grown 6.2% in 2016/17, unchanged from the Budget Update.
• Growth is forecast to pick up to 3.7% in 2018/19 before easing to 2.3% in 2020/21. The outlook is underpinned by ongoing strength in population growth, the continued cyclical upturn in the international economy, the stimulus provided by Budget 2017 and supportive monetary policy.
• The pick-up in growth over the next two years or so is expected to lead to a gradual decline in the unemployment rate and a faster pace of increase in wages and prices. Headline inflation is expected to be variable this year and to increase gradually thereafter, rising to 2.1% in 2019/20. Net immigration is assumed to ease over the forecast period, although there is considerable uncertainty around its path. Beyond 2018/19, slower population growth and reduced monetary policy stimulus lead to slower economic growth.
• Residential investment declined in the March 2017 quarter, likely reflecting the impacts of higher mortgage rates, tighter bank lending standards and higher construction costs. Looking forward, strong population growth and still-low interest rates suggest that residential investment will pick up, although growth may be slower than previously forecast. Reflecting these developments, the outlook for economic growth is a little lower than in the Budget Update.
• Recent gains in the terms of trade lead to a modest upward revision to current price estimates of economic growth in 2017/18. Thereafter, nominal GDP growth is forecast to be a bit lower than in the Budget Update. Cumulatively, over the four years to 2020/21, nominal GDP is 0.2% ($2.6 billion) lower than in the Budget Update.
• As usual, the outlook is subject to a range of risks and uncertainties. The terms of trade may be stronger if prices for key export commodities hold up for longer than expected, providing a boost to national income. Growth in domestic demand may be lower than expected if households' expectations of future income or wealth are dampened by continuing slow wage growth or a weaker outlook for house price growth.

Economic forecasts are presented on a June year basis for consistency with the fiscal forecasts. Longer time series for these variables are provided on page 142.

Notes:

1. Business investment is the total of all investment types excluding residential building. Previous separations of market and non-market investment are no longer produced by Statistics New Zealand.
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, June quarter, seasonally adjusted.
5. Quarterly Employment Survey, average ordinary-time hourly earnings, annual percentage change.
6. Annual percentage change.
7. System of National Accounts (SNA) and merchandise basis.
8. Quotable Value New Zealand (QVNZ) House Price Index, annual percentage change.
9. Percent of household disposable income (HHDI), March years.
10. Average for the June quarter.

Recent Developments#

Print this section

Economic expansion has continued at a moderate pace…

This section discusses recent developments and their implications for the economic outlook.

The economy appears to have grown at a moderate pace, on average, so far this year. Economic growth slowed over the six months to March 2017, reflecting both temporary factors, including the Kaikōura earthquakes and bad weather, and more persistent factors, most noticeably in the housing market. Recent indicators point to a faster pace of growth over the June quarter (Figure 1.1). The Treasury estimates the economy grew 2.8% over the year ended June 2017.

Figure 1.1 - Economic growth (GDP, production measure)

Sources: Statistics New Zealand, the Treasury

…although the housing market has eased…

Long-term global bond yields rose late last year leading to a rise in the cost of funding for New Zealand banks and to an increase in two-year mortgage rates of around 45 basis points, although mortgage rates remain low in historical terms. Loan-to-value ratio restrictions were tightened late last year, particularly for investors, and bank lending criteria for residential property developers have also been tightened. These developments have contributed to slower growth in total new residential mortgage lending, fewer sales of existing dwellings and slower house price growth, particularly in Auckland.

Residential investment activity eased in the March quarter and growth in dwelling consents, which provide an indicator of future activity, has slowed (Figure 1.2). The slowdown in dwelling consents has been most pronounced in Canterbury, where earthquake rebuild activity is winding down. Nationally, activity in the industry is at a high level and there is some evidence from surveys and discussions with businesses that the supply of labour and other resources are tight and are constraining growth in activity, particularly in Auckland. The pressure on resources is being reflected in rising construction costs (Figure 1.2).

Figure 1.2 - Dwelling consents and costs

Source: Statistics New Zealand

Looking ahead, still-low interest rates and strong population growth will continue to support housing demand. However, tighter financial conditions and higher construction costs point to a slower pace of growth than previously forecast, although it is difficult to know how much of an impact these developments will have or how persistent they will be. The lower level of activity in Canterbury may release resources for use elsewhere and increased availability of public finance may hasten the pace of infrastructure investment. On the other hand, mortgage interest rates could increase further and/or high levels of household debt may have made household borrowing more sensitive to past interest rate increases than assumed.

...growth has been supported by higher export volumes and improved terms of trade…

Other recent indicators point to a stronger pace of growth in the second quarter of 2017 following a March outturn that was weaker than expected. In particular, export volumes rebounded following a period of weakness and export prices increased further over the June quarter. Goods import volumes also increased strongly, although part of the increase appears to be related to the timing of fuel imports, which can be lumpy, and is expected to be temporary. Services export activity will benefit from the British and Irish Lions rugby tour, although much of the impact is expected to be recorded in the September quarter when most of the supporting visitors departed. Import prices remained subdued as oil and fuel prices weakened, helping offset a fall in the exchange rate. These price movements are providing additional support for the terms of trade, which are expected to rise to their highest level in over 40 years in the June 2017 quarter, and are boosting national income.

Source: OECD

The improved international outlook evident earlier this year has been largely confirmed by recent data. Growth in the major advanced economies has strengthened and unemployment has fallen. In a number of countries, unemployment rates are low in historical terms, although most countries in the OECD are above New Zealand and it remains high in the euro area (Table 1.2). Wage growth remains weak and inflationary pressures are subdued.

Growth in Australia has slowed in recent quarters, partly because of temporary factors, but appears to have recovered in the June quarter. Business confidence has improved, employment growth has strengthened and retail sales have picked up. In China, growth has remained stronger than in 2016, buoyed by policy stimulus, particularly for property construction and infrastructure. Consumption growth has remained robust, supporting imports of food products, including from New Zealand, and stronger foreign demand has boosted exports. Stronger growth in China and increased global trade volumes are helping to sustain solid growth in trade-dependent Asian economies.

Stronger foreign demand, particularly from China, has supported prices for dairy, forestry and horticultural products, while meat prices have been underpinned by tight global supply (Figure 1.3). Export prices are expected to ease a little this year but to remain high and to add to domestic demand.

Figure 1.3 - Commodity export prices

Source: ANZ World Price Indexes

Growth in household spending seems to have continued at a solid pace, supported by past gains in employment, improved export returns, rising wealth and favourable consumer sentiment. Net migration inflows have remained high, propelling population growth to its fastest pace since 1974, and are adding to domestic demand.

…and business investment has picked up

Growth in business investment has picked up in recent quarters, driven by business equipment investment. Following a period of strong growth, non-residential building investment fell in the March 2017 quarter. This fall is expected to be temporary and forward looking indicators point to a solid pipeline of activity over the forecast period.

Unemployment is lower…

June quarter 2017 labour market data showed employment growth weakened in the quarter, although growth over the year grew at a robust pace, up 3.1% from a year ago (Figure 1.4). The decline in employment in June was driven by a fall in part-time employment, which tends to be highly variable from quarter-to-quarter. Full-time employment continued to expand, rising 0.7% in the quarter and 3.0% from the same quarter a year ago. The labour force participation rate declined 0.6 percentage points to 70.0 in the June quarter (Figure 1.4), and the unemployment rate fell 0.1 percentage point to 4.8%.

Figure 1.4 - Employment and labour force participation

Source: Statistics New Zealand

Annual growth in ordinary time hourly earnings of 1.6% in the year to June 2017 was driven by public sector wages, which rose 4.1% partly owing to collective pay settlements in the education sector, while private sector growth was more modest at 1.2% (Figure 1.5). However, private sector wages have recovered from a period of very weak growth over the second half of 2016, to an annualised rate of 2.0% over the first half of 2017. Although subdued wage growth is consistent with our view that some spare capacity remains in the labour market, wage growth is weaker than can be explained by excess capacity alone.

Figure 1.5 - Wage growth

Source: Statistics New Zealand

June quarter 2017 labour market data were received after the forecasts were finalised. Employment, participation and unemployment were lower than expected while wage growth was close to expectations. However, the differences were within the usual range of quarterly variation and do not materially alter our view of the labour market. Nonetheless, the lower unemployment rate and the decline in participation, alongside other indicators of labour market capacity, such as survey measures of the degree of difficulty finding labour, increase the risk that there is less spare capacity in the labour market than assumed[1]. In addition to uncertainty around the extent of spare capacity, it is difficult to determine the degree of inflationary pressure associated with reduced labour market slack. A number of countries with historically low unemployment rates are finding wage growth has not picked up to the same extent as in the past.

…and inflation has eased

Consumer price inflation eased to 1.7% in the year to June 2017 from 2.2% in March, partly reflecting lower fuel prices in the quarter (Figure 1.6). Non-tradables inflation was also a bit weaker and measures of core, or underlying inflation, also eased slightly. Overall, the lower inflation outturn appears to partly reflect some unusual reductions in some categories of prices, which will hold down annual inflation until they drop out of the calculation. The lower inflation reading also appears to reflect some factors that may be more long-lasting, including the rapid pace of technological improvement embodied in goods and services, which may delay progress in returning inflation to the 2.0% mid-point of the Reserve Bank's target range.

Figure 1.6 - CPI inflation

Source: Statistics New Zealand

 

Nominal GDP growth reflects higher terms of trade and inflation over the year

Although annual inflation eased in June it has increased from 0.4% in June 2016 as the effects of previous oil price declines have dropped out of the annual calculation. The terms of trade have also improved significantly over the past year.

Gains in the terms of trade and higher inflation have supported growth in nominal gross domestic product (GDP), which includes movements in both real activity and prices (Figure 1.7). The faster pace of nominal GDP growth has flowed through to tax revenue, which is expected to be 1.3% ($1.0 billion) higher in 2016/17 than forecast in the Budget Update.

Figure 1.7 - Nominal GDP and the terms of trade

Sources: Statistics New Zealand, the Treasury

Economic Outlook#

Print this section

This section discusses the outlook for the economy over the next four years.

The forecasts for the domestic outlook are conditioned on a number of judgements and assumptions (see box on page 7). The TWI exchange rate is assumed to remain around its current level (78.1), which is slightly higher than in the Budget Update, for most of the forecast period. Growth in potential output is assumed to average 2.9% over the forecast period, slightly lower than in the Budget Update, reflecting downward revisions to past growth and growing evidence of capacity constraints in the economy. Lower growth in potential output is reflected in lower average labour productivity growth over the forecasts.

As in the Budget Update, we assume the 12-month total net migration inflow remains over 70,000 for the remainder of 2017 and thereafter declines steadily to 20,000 in the June quarter 2021. Growth in the working-age population slows from 2.5% in 2016/17 to 2.1% in 2018/19 and to 1.4% in 2020/21.

Positive growth outlook…

The pace of economic growth is expected to increase over the next two years or so and to absorb remaining spare capacity in the economy (Figure 1.8). The outlook is underpinned by strong population growth, the cyclical upturn in the international economy, the stimulus provided in Budget 2017 and supportive monetary policy.

Figure 1.8 - Economic growth (production GDP)

Sources: Statistics New Zealand, the Treasury

Compared to the Budget Update growth is slightly weaker over the next two years, mostly because there appears to be less spare capacity in the economy than previously thought. The higher exchange rate is also contributing to a slower pick up in growth and inflation than might otherwise occur.

Growth in the 2017/18 year is forecast to pick up to 3.2% as exports rebound from a period of weakness. Growth in 2017/18 is forecast to be slightly lower than in the Budget Update, reflecting recent data, including housing market activity and house prices, that suggests there is a bit less momentum in residential investment and private consumption expenditure than previously thought. Nonetheless, private consumption growth is expected to remain solid.

Economic growth accelerates to 3.7% in 2018/19, well above potential growth, as ongoing employment growth supports household income growth and, therefore, consumer spending (Figure 1.9). Household income and consumption gets a further boost from the introduction of the Family Incomes Package on 1 April 2018, which reduces income tax and increases government transfers to households. Household saving also gets a boost, reflecting our assumption that 60% of the increase in income is spent. The assumptions around household behaviour are based on past experience, but the way households respond to an increase in income may be affected by a range of factors, including expectations around future income and wealth, that are difficult to predict.

Figure 1.9 - Private consumption and household income growth

Sources: Statistics New Zealand, the Treasury

Private consumption growth slows over 2019/20 and 2020/21 as rising interest rates and slower employment growth lead to slower growth in disposable income.

The forecast for public consumption expenditure is little changed from the Budget Update. Growth slows over the years ahead, consistent with announcements in Budget 2017. The Treasury's fiscal impulse measure, which captures the impact of fiscal policy changes on the economy, including the Family Incomes Package and capital spending, shows fiscal policy is expected to contribute around one percentage point to economic growth in 2018/19 and a bit less the following year. The decline in government operating expenses as a share of GDP results in negative impulses from 2019/20.[2]

Residential investment activity is expected to continue to contribute to growth over the forecast period given the strength of population growth and support from low interest rates. However, should tighter financial conditions and higher construction costs persist, the pace of growth in activity is likely to be lower than previously forecast (Figure 1.10).

Figure 1.10 - Residential investment

Sources: Statistics New Zealand, the Treasury

 

…provides broad-based support for business investment

Growth in business investment has picked up over the past year or so and, as a share of GDP, it is close to historical highs (Figure 1.11). The outlook over the next few years is positive, consistent with surveyed intentions of business investment and the Government's announcements of capital expenditure including Canterbury and Kaikōura earthquake related work and other public infrastructure works (eg, Auckland City Rail Link). Rising international visitor numbers, continued low global and domestic interest rates, population growth and the prospect of a sustained improvement in export prices provide support for business investment.

Figure 1.11 - Business investment

Sources: Statistics New Zealand, the Treasury

Improved external environment…

The outlook for growth in New Zealand's major trading partners is little changed from the Budget Update (Figure 1.12). The improvement in global conditions evident earlier this year has been maintained through the June quarter. Above-trend growth has contributed to declines in unemployment rates to historically low levels in some large economies, including the United States (US) and Japan. Above-trend growth is projected to continue in a number of advanced economies leading to further declines in unemployment and a pick up in wage and price inflation from current low rates.

Figure 1.12 - Trading partner growth 

Sources: Haver Analytics, the Treasury

The outlook for China is a little stronger than previously as the faster pace of growth in the first quarter has continued. Growth is expected to be only a little lower than last year, supported by increased spending on infrastructure and property construction. The possibility of policy change following the Chinese Communist Party's National Congress later this year is a source of uncertainty. Credit growth remains high and high levels of debt continue to pose a risk to the medium-term outlook. Growth is expected to slow modestly over the forecast horizon, from around 6.6% in 2017 to 5.8% in 2020, as the economy continues to rebalance towards more services-led growth. This rebalancing is expected to provide significant support for New Zealand's exports and the terms of trade. Growth in other Asian economies (excluding China and Japan) is being supported by the improved global outlook and by expansionary macroeconomic policies.

Growth in Australia has been variable in recent quarters, largely reflecting temporary factors, including weather-related disruptions to mining sector output. In recent months, employment growth has strengthened and the unemployment rate has decreased, although wage growth remains subdued. Household debt is high and growing faster than household incomes, raising medium-term risks to the growth outlook. Australia is expected to grow at a moderate pace, supported by low interest rates and higher export volumes, leading to a gradual decline in the unemployment rate.

The US has continued to grow at a moderate above-trend pace and, in the euro-area and Japan, growth momentum has strengthened further. Delays in reaching political agreement have increased uncertainty around the prospects of expansionary fiscal policy in the US, although we continue to project some fiscal stimulus in 2018. In the euro area, political uncertainty appears to have declined in recent months and business and consumer sentiment has improved. Euro area growth is projected to remain around trend over the forecast period leading to modest reductions in the unemployment rate. In the United Kingdom (UK), growth has weakened as the lower exchange rate has eroded consumer spending power. Economic growth is projected to slow as uncertainty around the implications of the UK's exit from the European Union undermines investment spending in particular. Household spending is also likely to remain subdued as the labour market weakens and real income growth slows.

Inflation remains below target in many advanced economies and core inflation has remained subdued (Figure 1.13). Monetary policy remains highly accommodative in advanced economies, although the risks of further easing have retreated. Monetary policy is expected to continue to support growth until economic slack is absorbed and inflation rises to its target, which is around 2019 or later in many economies. However, the outlook for monetary policy remains uncertain. If there is less spare capacity than assumed, or if growth is stronger than expected, inflation could rise more quickly than expected and monetary policy may be tighter. In these circumstances, the New Zealand dollar could depreciate, leading to some rebalancing of activity in New Zealand towards the external sector.

Figure 1.13 - Core inflation 

Source: Haver Analytics

 

…is supporting the terms of trade…

New Zealand's terms of trade are estimated to have increased further in the June quarter but are expected to decline later this year, partly reflecting recent falls in dairy auction prices (Figure 1.14). However, the terms of trade are assumed to remain a little higher than previously forecast largely reflecting improved prospects across a number of export commodities, and a weaker outlook for oil prices. Dairy, meat and forestry prices are all benefiting from stronger demand in China and from regulatory restrictions on alternative sources of supply. Oil prices have been weaker than anticipated in the Budget Update reflecting falling production costs, particularly of US shale oil, which is expected to persist.

Figure 1.14 - Terms of trade

Sources: Statistics New Zealand, the Treasury

There are both upside and downside risks to the terms of trade. The terms of trade may be stronger if oil production costs continue to fall or if production rises. Growth in China may hold up, further supporting commodity export prices. On the other hand, high levels of debt in China may lead to a tightening in financial conditions that leads to slower growth and lower demand for New Zealand's exports. In the oil market, past weakness in investment may lead to supply constraints, and higher prices, as global demand continues to expand.

…although import volumes grow strongly…

Export volume growth is forecast to strengthen to around 4.0% over the year ahead, although a large part of this strength reflects the rebound evident in goods exports over the June 2017 quarter (Figure 1.15). The Lions rugby tour, which concluded in July 2017, is also expected to provide a boost to exports. Beyond the initial quarters, the outlook is for exports to grow a little over 2% per year, somewhat below their long-run average as the relatively high exchange rate constrains profitability. High commodity export prices provide an offset to the high exchange rate for some sectors, but non-commodity and services exporters, including tourism services, are likely to find it challenging to maintain competitiveness.

Figure 1.15 - Exports and imports 

Sources: Statistics New Zealand, the Treasury

Ongoing domestic demand strength, the high exchange rate and the absorption of spare capacity are reflected in steady import demand growth of around 4.0% per year. With import growth outstripping export growth, net exports subtract from GDP growth over the forecast period. Goods import prices, which have been weakening, are projected to be broadly stable over the forecast period, reflecting expectations that commodity prices, including oil, will increase over time and that higher global inflation will support prices of non-commodity goods.

…leading to a gradual widening of the current account deficit

The annual goods deficit is expected to narrow over the year ahead, reflecting the rebound in June's trade data, the boost from the Lions rugby tour and the higher terms of trade (Figure 1.16). However, when these factors drop out of the annual calculation, the goods deficit is projected to widen. The deficit on primary income has narrowed over the past few years as growth in net external debt has slowed and global interest rates have fallen. Looking forward, global interest rates are projected to rise gradually and the income deficit is expected to stabilise as a share of GDP before increasing sightly in the later years as global interest rates continue to rise. Overall, the current account deficit is forecast to widen from around 3.1% of GDP in the year ended June 2017 to 3.9% of GDP in the year ended June 2021.

Figure 1.16 - Current account and components 

Sources: Statistics New Zealand, the Treasury

The net international liability position is expected to remain broadly stable at around 58% of GDP until late in the forecast period when it begins to increase as the current account deficit rises above 3% of GDP.

As the labour market tightens…

Employment growth has been strong over the past year, although it slowed in the June 2017 quarter. Survey indicators of employment intentions point to solid growth over the rest of the year. Further out, employment growth is expected to ease, although it is projected to be a little stronger than previously forecast.Labour force participation has been very high recently, and the starting point for the participation rate forecast is higher than in the Budget Update.

Partly a reflection of the strength of labour supply growth, the unemployment rate has declined only modestly over the past year, although it is a little lower than anticipated in the Budget Update. Over the year ahead, net immigration is projected to remain high, complementing further strong expansion in labour inputs and a pickup in business investment (capital inputs). Productivity growth is projected to remain weak (Figure 1.17).

Figure 1.17 - Contributions to GDP growth[3]

Sources: Statistics New Zealand, the Treasury

Over the remainder of the forecast period, slowing net migration and easing labour force participation lead to slower growth in labour inputs. Productivity growth is expected to pick up although the strength and timing of the pick up in productivity is uncertain, particularly in the context of subdued growth over recent years. Productivity growth may be slower than assumed if labour inputs grow more strongly than expected. Productivity growth may be faster than assumed if past investment decisions better enable firms to take advantage of opportunities for trade than expected.

Unemployment is expected to remain around its current rate over the year ahead, before easing gradually over the remainder of the forecast period. We expect participation to remain high, albeit easing gradually, over the forecast period as the proportion of the older working-age population, which has a relatively low participation rate, continues its secular increase. Similarly, average hours worked per employee are assumed to decline gradually over the forecast period ahead.

In aggregate, these trends result in a decline in average hours worked across the population as a whole (a measure of labour utilisation), although the declining unemployment rate provides some offset. As a consequence, real GDP per capita (output per person), which reflects the projected increase in labour productivity (output per hour worked) and the decline in labour utilisation (hours worked per person), is expected to grow at a similar rate over the forecast period to its average over the past few years (ie, around 1.2%) (Figure 1.18).

Figure 1.18 - Contributions to GDP per capita growth[3]

Sources: Statistics New Zealand, the Treasury

 

…wage growth picks up…

As the labour market tightens, annual wage growth is forecast to increase to 2.8% and to slow a little thereafter. Real wages have grown strongly over recent years despite weak productivity growth, and real unit labour costs, which are a measure of cost competitiveness, have increased (Figure 1.19). The projected lift in productivity growth, combined with a slower period of real wage growth, is forecast to restore competitiveness. However, the pace of adjustment in unit labour costs is uncertain. It could be faster if nominal wages grow more slowly than anticipated or if the terms of trade hold up at a higher level than assumed. Conversely, lower inflation or weaker productivity growth may prolong the adjustment.

Figure 1.19 - Unit labour costs and real wages[3]

Source: The Treasury

…and inflation rises…

Interest rates are expected to remain around their current levels until mid-2018, when we estimate the economy will be operating at, or close to, full capacity (Figure 1.20). With demand expected to continue to strengthen, wages and prices will come under greater pressure to increase. These conditions allow monetary policy support for growth to be gradually reduced from the middle of 2018.

Figure 1.20 - Inflation and 90-day rates

Sources: Statistics New Zealand, RBNZ, the Treasury

Inflation is expected to remain around 1.7% this year before declining temporarily early next year as higher oil prices in the March quarter this year drop out of the annual CPI calculation. The exchange rate, which is projected to remain around current levels, helps to keep tradables inflation well contained over 2018, while domestic wage and price pressures underpin a gradual rise in non-tradables inflation. By the end of 2018, headline inflation is forecast to be increasing at an annualised pace of 2.0%, and annual inflation rises to 2.0% by the end of 2019.

The Official Cash Rate is expected to begin rising in mid-2018 as the Reserve Bank seeks to achieve its objective of stabilising inflation at the 2.0% mid-point of its target range. From around 2.0% in June 2018, short-term interest rates are forecast to rise to around 3.8% in June 2021.

…supporting growth in nominal GDP

Nominal GDP growth eases over the forecast period from an expected peak of 6.2% in the year ended June 2017 to 4.1% in the year ending June 2021. Compared to Budget Update 2017, nominal GDP is expected to be a little higher in the year ended June 2018, mostly reflecting recent gains in the terms of trade (Fig 1.21).

Figure 1.21 - Nominal GDP

Sources: Statistics New Zealand, the Treasury

In subsequent years, nominal GDP is forecast to be a little lower than in the Budget Update, reflecting small downward revisions to both real GDP growth and inflation. In total, nominal GDP is lower by $2.6 billion (0.2%) over the four years to June 2021. Most of the lower GDP is accounted for by downward revisions to residential investment.

Risks

The judgements and assumptions underpinning these forecasts are, as usual, attended by considerable uncertainty. There is, for example, uncertainty surrounding estimates of spare capacity and when, and by how much, inflation will respond to increased capacity pressure. Possible changes in fiscal and other government policy both here and abroad are further sources of uncertainty. Prospects for the global economy have improved, but some of the major challenges facing a number of our key trading partners have yet to be resolved, and the risk of slower global growth remains high, particularly over the medium term.

2 Fiscal Outlook#

Print this section

Overview#

Print this section

• The 2016/17 fiscal results are estimated to be significantly improved from the previous financial year. The operating balance before gains and losses (OBEGAL) surplus is estimated to reach $3.7 billion with core Crown tax revenue expected to grow by 7.4% compared to an increase of around 4% in core Crown expenses. In addition net core Crown debt is expected to reduce by $1.3 billion compared to 2015/16, to be $60.6 billion.
• Growth in the nominal economy, partially offset by the introduction of the Family Incomes Package in April 2018, contribute to core Crown tax revenue increasing across the remainder of the forecast period.
• Core Crown expenses rise in nominal terms but continue to decline as a percentage of GDP to reach 27.7% by 2020/21. Budget allowances (both operating and capital) are as set out in the 2017 Fiscal Strategy Report (FSR).
• Residual cash is largely neutral over the forecast period with net core Crown debt at the end of the forecast period similar to current levels. As a percentage of GDP, it reduces across the forecast period and is forecast to be 18.8% of GDP by 2020/21.
• Net worth attributable to the Crown continues to grow across the forecast period, largely owing to rising operating balances.
• Contributions to the New Zealand Superannuation Fund (NZS Fund) are forecast to resume in 2020/21 when net debt is forecast to fall below 20% of GDP, with $2.2 billion assumed to be contributed in that year.
• Total assets are forecast to grow by $47.3 billion to stand at $340.0 billion by 2020/21 largely reflecting the increased capital spend and the upward valuation of property, plant and equipment at 30 June 2017. Liabilities fall in nominal terms, with borrowings decreasing in the later part of the forecast period. Total liabilities are expected to stand at $193.8 billion at the end of 2020/21, with borrowings making up $109.5 billion of that balance.
• While the 2016/17 fiscal results are estimated to be better than previously forecast, the OBEGAL forecasts for the next four years remain fairly close to the Budget Update. Net core Crown debt is estimated to be around $2.0 billion lower than the Budget Update across the forecast period, largely reflecting the 2016/17 outturn. Further discussion on the comparison to the Budget Update is on page 41.
• These forecasts are sensitive to a number of assumptions and should be read in conjunction with the Risks and Scenarios and Specific Fiscal Risks chapters. In particular, judgements have been made regarding the extent to which the current strength in tax revenue outturns continues throughout the forecast period.
• The Fiscal Outlook chapter also includes medium term projections that extend beyond the forecast period until 2030/31. These projections represent a potential future path based on historic averages. The assumptions for allowances in the projections remain unchanged from those used in the 2017 FSR.

Notes:

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

Source: The Treasury

Fiscal Forecasts#

Print this section

This section of the chapter focuses on the five-year forecast horizon, up to and including 2020/21.

The preparation of the pre-election fiscal forecasts has involved:

• reassessing tax revenue (in conjunction with Inland Revenue (IRD) and benefit expense forecasts in light of the revisions to the macroeconomic forecasts
• updating the operating results and expense forecasts using the 2016/17 pre-audited financial information from departments and significant other government reporting entities
• considering the impact of additional financial information that has occurred since the finalisation of the Budget Update forecasts on 3 May 2017, and
• incorporating the fiscal impact of significant Cabinet decisions made since the Budget Update, up to and including 7 August 2017.

This section discusses the following areas: core Crown tax revenue, core Crown expenses, the operating balance, core Crown capital spending, residual cash and net core Crown debt, the total Crown balance sheet and a comparison to the Budget Update.

Further information on the underlying economic assumptions used in these fiscal forecasts can be found on page 46.

Core Crown Tax Revenue#

Print this section

Tax revenue grows over the forecast period...

Core Crown tax revenue (Figure 2.1) is forecast to rise in each year of the forecast period in nominal terms while falling slightly as a percentage of nominal GDP. By 2020/21, core Crown tax revenue is expected to reach $89.8 billion, $19.4 billion higher than in 2015/16.

Figure 2.1 - Core Crown tax revenue

Source: The Treasury

…with a relatively strong 2016/17 outturn expected...

Based on preliminary data for June 2017, core Crown tax revenue grew 7.4% ($5.2 billion) in the 2016/17 financial year (Table 2.3), to 28.1% of nominal GDP.

Source: The Treasury

The strong corporate tax outturn was spread across most sectors of the economy, with a notable contribution from the finance and investment sectors. The box on page 28 provides further discussion on the impact the corporate tax outturn has had on the fiscal forecasts.

In nominal terms, source deduction revenue contributed the most ($1.7 billion) to tax revenue growth in 2016/17. This growth came mainly from growth in the number of people in employment, with a lesser contribution from growth in personal income rates.

With more people in employment, and those in employment earning more than in 2015/16, domestic consumer spending also grew strongly in 2016/17 (5.6%). This was the major component of the 8.2% growth in goods and services tax (GST) revenue, helped by continued growth in residential construction.

The extent to which the current 2016/17 strength is a permanent uplift in tax revenue is a key judgement in the tax forecasts. The volatility of corporate tax in particular creates some uncertainty. Page 55 of the Risks and Scenarios chapter demonstrates the range of tax revenue outturns under different scenarios.

… while tax revenue grows in line with nominal GDP for the remainder of the forecast period

Most of the growth in the tax revenue forecasts after 2016/17 can be attributed to growth in the nominal economy, with nominal GDP forecast to grow at 4.7% per year on average from 2016/17 to 2020/21.

Figure 2.2 - Core Crown tax revenue and nominal GDP growth

Source: The Treasury

Tax revenue growth remains below GDP growth in 2018/19, mainly owing to the effects of the Family Incomes Package that was included in the Budget Update. Tax revenue is then forecast to grow at a faster rate than GDP, owing to fiscal drag (ie, the effect whereby pay as you earn (PAYE) grows more quickly than underling salary and wage income owing to the progressive nature of the income tax scale), and the effect that increasing deposit interest rates have on resident withholding tax (RWT).

Comparison with IRD forecasts

IRD has also prepared a set of tax forecasts which, like the Treasury's tax forecasts, were based on the Treasury's macroeconomic forecasts. The Treasury's forecasts of core Crown tax revenue are, on average, 0.6% higher than IRD's forecasts. Most of the forecast differences arise from differing assumptions made around interest rates and the difference between wholesale and retail interest rates between the two agencies, and other judgements made in relation to RWT.

This comparison is included in the Additional Information on the Treasury website at http://www.treasury.govt.nz/budget/forecasts/prefu2017

Corporate tax forecasts

The outturn for corporate tax in 2016/17 is expected to be strong…

Corporate tax growth in the 2016/17 year is expected to have been particularly strong, currently estimated at 12.5% (Figure 2.3).

Figure 2.3 - Core Crown corporate tax

Source: The Treasury

This box outlines the key assumptions and judgements applied to the corporate tax forecasts, which is not expected to continue to grow at such a pace.

…but the rate of growth is not expected to continue at the same pace…

Although corporate tax is expected to rise across the forecast period, this rate of growth is unlikely to persist. There are two factors contributing to this: macroeconomic factors and the relatively high investment returns earned in the finance/investment sector in 2016/17 that are not assumed to continue.

Analysis of the latest corporate tax assessment data indicates that a large portion of the 2016/17 tax revenue growth was spread across most sectors of the economy, and across firms both large and small.

Since the increase in tax revenue is broad-based, we have made a judgement that it is likely some permanent effect will persist into later years of the forecast period.

The contribution to 2016/17 corporate tax growth from the finance and investment sectors may not be so permanent. The growth in finance/investment sector tax occurred in a year of relatively high investment market returns which, in our judgement, is unlikely to occur every year as this level of volatility un this sector is not unusual.

Overall, after taking account of these factors, total corporate tax revenue is expected to continue to rise in each year of the forecast period, reaching $16.2 billion (5.0% of GDP) by 2020/21.

... and corporate tax forecasts are higher than the Budget Update.

As a result, while the forecasts are $1.7 billion higher than at the Budget Update across the forecast period, $1.2 billion of this lift occurs in the 2016/17 and 2017/18 years. As there has been some downgrade to the macroeconomic outlook for operating surpluses relative to the Budget Update (see macroeconomic bars in Figure 2.4) by the last year of the forecast the corporate taxes are only $86 million higher in 2020/21 (Figure 2.4).

Figure 2.4 - Core Crown corporate tax compared to the Budget Update

Source: The Treasury

Core Crown Expenses#

Print this section

Core Crown expenses reduce as a percentage of GDP ...

Core Crown expenses are expected to grow more slowly than the nominal economy, which sees core Crown expenses declining across the forecast period from 29.2% in 2015/16 to 27.7% of GDP at the end of the forecast period (Figure 2.5).

Figure 2.5 - Core Crown expenses

Source: The Treasury

… despite nominal core Crown expenses increasing...

Core Crown expenses are expected to increase by $15.5 billion over the forecast period from $74.0 billion in 2015/16 to $89.5 billion in 2020/21, an increase of around $3 billion each year (Figure 2.5).

This nominal growth is largely as a result of past budget decisions and new spending set aside for future budgets via the operating allowances (Figure 2.6). Budget operating allowances are assumed to be the same as those included in the Budget Update.

Figure 2.6 - Increase in core Crown expenses relative to 2015/16 actuals

Source: The Treasury

Future operating allowances are currently set at $1.7 billion for Budget 2018, increasing by 2% each subsequent Budget.[4]

The forecasts assume that future cost increases, whether they be from increased demand for government services, inflation or additional services, can be met from these future allowances.

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

In addition to new budget spending, social assistance spending is forecast to increase by $5.2 billion across the forecast period while finance costs remain fairly static.

...with an increase in the number New Zealand superannuation recipients contributing to expenditure growth...

NZS payments account for $3.8 billion of the increase in core Crown expenses over the forecast period. The majority of this growth relates to growth in the number of NZS recipients. Recipient numbers are forecast to increase from almost 691,000 in 2015/16 to 823,000 by the end of the forecast horizon (an increase of 19.1%). The remaining increase is largely owing to indexation of entitlements to wage growth (Figure 2.7). By the end of the forecast period, NZS is around 55% of the total social assistance spending (compared to 50% in 2015/16) and 18% of core Crown expenditure.

Figure 2.7 - Growth of NZS expenses

Source: The Treasury

...while other forms of social assistance also increase

While New Zealand superannuation is around half of social assistance spending, other types of social assistance are also expected to increase by $1.3 billion over the same period (Figure 2.8).

Figure 2.8 - Social assistance spending

Source: The Treasury

The Family Incomes Package included in the Budget Update is expected to increase social assistance spending by $0.5 billion per year from 2019/20. In addition income-related rents and Kiwisaver subsidies are also expected to add $0.4 billion and $0.3 billion respectively.

Operating Balance#

Print this section

The 2016/17 operating performance is expected to be significantly improved…

The strong tax outturn is the key contributor to an expected OBEGAL surplus of $3.7 billion in 2016/17, just over double the $1.8 billion recorded in 2015/16 (Table 2.4).

Source: The Treasury

As discussed earlier, core Crown tax is expected to be $5.2 billion higher in 2016/17 compared with the previous year. However, core Crown expenses are only forecast to increase by $2.9 billion with the largest increases expected to be social assistance spending.

Partially offsetting the core Crown result, Crown entities (CEs) are expected to make an OBEGAL deficit in 2016/17 largely reflecting increased insurance expenses from the new costs associated with the Kaikōura earthquakes. In addition the OBEGAL deficits in ACC have also increased from the previous year. This is driven by several factors including a higher number of claims across all accounts, lower discount rates (used to calculate the present value of claims), and price increases.

Figure 2.9 - Components of OBEGAL by segment

Source: The Treasury

…before returning to steady growth over the next four years …

OBEGAL is expected to grow steadily in the remaining years of the forecasts rising to $6.4 billion by 2020/21.

Figure 2.9 shows the composition of OBEGAL from the different segments of the Government.

The core Crown segment is forecast to have an OBEGAL surplus that remains relatively constant in the next two years, albeit less than the current year, before continuing to rise over the remainder of the forecast period, largely reflecting growth in tax revenue outpacing growth in nominal spending.

CEs are expected to be largely neutral with relatively small deficits while State-owned Enterprises' (SOEs) contribution to OBEGAL remains fairly stable with operating surpluses forecast to average $0.7 billion throughout the forecast period.

See pages 97 to 98 for a list of CEs and SOEs.

...while investment returns contribute to the growth in net worth

The total Crown operating balance, inclusive of gains and losses, is forecast to be in surplus across all years of the forecast period with an initial peak in 2016/17 of $11.5 billion.

Gains and losses then return to long-term assumptions and the operating balance follows the OBEGAL trend growing to $10.1 billion in 2020/21 (Figure 2.10).

Figure 2.10 - Components of operating balance

Source: The Treasury

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

The NZS Fund had small investment losses in 2015/16 and is now forecasting gains on investments of around $5.5 billion in the current year. Beyond 2016/17, investment gains assume a long-term rate of return.

In addition to investment gains, actuarial gains on the Crown's significant long-term liabilities such as ACC and Government Superannuation Fund (GSF) are forecast to be $1.4 billion in 2016/17 (compared to actuarial losses of $7.1 billion in 2015/16). However, as future actuarial gains or losses resulting from discount rates and CPI changes are not forecast, they do not impact the operating balance beyond 2016/17.

Summary fiscal indicators

The Treasury calculates two summary fiscal indicators - the cyclically-adjusted balance and the fiscal impulse indicator - to help assess the Government's fiscal position. These indicators are subject to uncertainty as their calculation relies on estimated variables. Further detail on these indicators, including sensitivity analysis, can be found in the Additional Information on the Treasury website (www.treasury.govt.nz/budget/forecasts/prefu2017).

Source: The Treasury

Cyclically-adjusted balance

The cyclically-adjusted balance (CAB) is an estimate of the OBEGAL adjusted for the cyclical position of the economy. Cyclical factors (eg, higher tax receipts in an upturn or higher unemployment expenses in a downturn) are removed to assess the Government's underlying fiscal position.The CAB is in surplus across the entire forecast period, indicating the forecast OBEGAL surpluses are structural – that is, they are not owing to cyclical economic conditions. The profile of the CAB broadly reflects the profile of the OBEGAL across the forecast period. In 2016/17 the CAB peaks owing to high company tax revenue, timing of expenditure and the improved performance of CES and SOEs. The introduction of the Family Incomes Package sees the CAB decline over 2017/18 and 2018/19. Cyclically-adjusted surpluses are forecast to rise from 1.1% of GDP in 2018/19 to 2.0% of GDP by the end of the forecast period.

Figure 2.11 - Operating balance indicators

Source: The Treasury

Fiscal impulse

The fiscal impulse is an estimate of discretionary changes in the fiscal position that have an impact on aggregate demand pressures in the economy. The fiscal impulse indicates that fiscal policy is forecast to have a contractionary impact on aggregate demand in 2016/17. This stance turns stimulatory in 2017/18 and 2018/19, and returns to a contractionary stance in the last two years of the forecast period. The positive impulses in 2017/18 and 2018/19 reflect the stimulatory impact of the Family Incomes Package, timing effects of company tax receipts and elevated capital spending. This is somewhat offset by the ongoing decline in operating expenditure as a percentage of GDP across the forecast period, which also drives the negative impulses from 2019/20.Movements in the timing of operating and capital expenditure, and higher company tax receipts have resulted in a contractionary impulse in 2016/17 and a more stimulatory impulse in 2017/18 relative to the Budget Update.

Core Crown Capital Spending#

Print this section

While capital spending is expected to be similar in 2016/17 to the previous year at $4.3 billion, the Government is forecast to spend around $6.0 billion a year (excluding contributions to the NZS Fund) over the next four years. Recommencing contributions to the NZS Fund in 2020/21 will add a further $2.2 billion in 2020/21. Including the current year's spending of $4.3 billion raises the total spend on capital items over the forecast period to $30.5 billion (Table 2.6).

Source: The Treasury

Net capital spending is expected to increase significantly in 2017/18 and 2018/19, with the largest capital spend in a number of years. The size of the forecast spend increases the risk that spending may be pushed into future periods as capacity constraints are tested.

Some capital payments in relation to City Rail Link and the Housing Infrastructure Fund are expected to fall outside the forecast period.

Table 2.6 outlines the capital spending by the core Crown that impacts cash flows. It excludes capital spending undertaken by CEs and SOEs directly that is funded from their own resources. As such, they will differ from the total Crown infrastructure spending announced by the Government, which focuses on this broader (and therefore larger) investment by the Crown[6].

In addition to the capital spending in Table 2.6 above, a number of capital projects have been undertaken through Public Private Partnerships (PPPs) (eg, Transmission Gully).

Unlike capital spending where cash payments are made as the asset is being constructed, cash flows in relation to PPPs do not typically commence until the completion of the project. Instead, borrowings are accumulated across the period reflecting the progress towards completion. Payments are then spread over a number of subsequent years as the assets become operational. Table 2.7 below summarises the expected amount of borrowings accrued over the forecast period in relation to PPPs.

Source: The Treasury

PPPs managed by the Department of Corrections and the Ministry of Education will be included in the net core Crown debt calculation. However the transport projects managed by the New Zealand Transport Agency (NZTA) are not included in net core Crown debt to the extent that funding will be obtained from existing sources (eg, the National Land Transport Fund in the case of Transmission Gully).

Residual Cash and Net Core Crown Debt#

Print this section

[7]

A residual cash surplus is expected in 2016/17…

Net operating cash flows of $5.8 billion in 2016/17 are forecast to exceed capital spending of $4.3 billion, resulting in a residual cash surplus of $1.5 billion. This surplus compares to a residual cash deficit of $1.3 billion in 2015/16. Overall, capital payments are slightly less than the previous year while operating cash flows have increased by $2.5 billion reflecting higher receipts and lower payments.

Figure 2.12 - Core Crown residual cash

Source: The Treasury

…leading to a reduction of net core Crown debt in 2016/17…

As a result of the expected residual cash surplus in 2016/17, net core Crown debt is expected to reduce in nominal terms from $61.9 billion (24.5% of GDP) in 2015/16 to $60.6 billion (22.5% of GDP) in 2016/17.

…before capital spending picks up pace...

Net operating cash flows are forecast to be in surplus across the forecast period, rising in a similar trend to the OBEGAL forecast. By 2020/21, net operating cash flows are forecast to be $9.1 billion. The increasing operating cash flows largely represent growth in tax receipts exceeding the growth in operating payments.

While operating cash flows are positive across the forecasts, capital spending is forecast to increase over the next four years as some of the large infrastructure projects such as the City Rail Link get underway.

As a result, capital payments are expected to exceed operating cash flows over the next two years before core Crown residual cash returns to surplus in 2019/20. Core Crown residual cash is broadly neutral in the last four years of the forecast period, with cash deficits in the next two years mostly offset by cash surpluses at the end of the forecast period.

Figure 2.13 - Net core Crown debt

Source: The Treasury

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

In dollar terms, net core Crown debt is forecast to increase over the next two years as cash flows from operating activities are not expected to be sufficient to meet capital spending before starting to decline once residual cash returns to surplus in 2019/20.

However, as a percentage of GDP, net core Crown debt continues to reduce across the forecast period, reaching 18.8% of GDP by 2020/21.

The bond programme remains relatively stable …

While nominal net core Crown debt increases in the short term the bond programme is forecast to remain unchanged over the forecast period.

The issuance profile is relatively flat in order to reduce the year-to-year volatility of bond programmes and ensure consistency of supply over this time.

The bond programme[8] is expected to raise funds of $34.6 billion over the forecast period, while $41.2 billion of existing debt will be repaid, providing net repayments of $7.4 billion (Table 2.8).

Source: The Treasury

…and gross debt falls as a percentage of GDP

Gross debt is expected to decline across the forecast period as a percentage of GDP. By 2020/21 gross debt is expected to decrease to 24.6% of GDP from 32.6% at the end of 2016/17.

In nominal terms gross debt also declines, primarily as forecast maturities are then expected to exceed new debt being issued. Gross debt is forecast to be $79.4 billion in 2020/21, $8.3 billion lower than current levels (Figure 2.14).

Figure 2.14 - Gross debt

Source: The Treasury

Total Crown Balance Sheet#

Print this section

Increasing operating balance surpluses result in a stronger balance sheet...

Net worth attributable to the Crown is forecast to grow in nominal terms across the forecast period largely owing to forecast operating balance surpluses to stand at $140.6 billion by 2020/21. In addition an upward valuation of property, plant and equipment of $8.0 billion in 2016/17 also caused some of the uplift.

As a share of nominal GDP, net worth attributable to the Crown is expected to increase across the forecast period as operating surpluses outpace GDP growth. Net worth attributable to the Crown reaches 43.5% by 2020/21 (Figure 2.15), up from 40.5% in 2016/17.

Figure 2.15 - Net worth attributable to the Crown

Source: The Treasury

...with assets increasing by $47.4 billion over the forecast period while liabilities reduce

Total assets are forecast to grow by $47.3 billion over the forecast period to $340.0 billion in 2020/21, made up of additional investments in assets, both physical and financial (Figure 2.16). At the same time, the Crown's liabilities are expected to decrease $3.4 billion and are estimated to be $193.8 billion in 2020/21.

Figure 2.16 - Total Crown assets

Source: The Treasury

The largest asset growth over the forecast period is in the social assets portfolio (just over 50% of the total Crown balance sheet). Social assets (eg, schools, hospitals and social housing) are expected to increase by $30.6 billion over the forecast period to be $180.1 billion in 2020/21 (Figure 2.17). This increase largely reflects growing capital spending.

Figure 2.17 - Social balance sheet

Source: The Treasury

Liabilities in relation to the social segment (eg, tax refunds, Emissions Trading Scheme (ETS) provision) remain fairly static. As a result, social net worth is expected to increase.

The financial asset portfolio (around 30% of the total Crown balance sheet) is expected to increase by $12.0 billion to be $99.9 billion in 2020/21, primarily reflecting investment growth in the large investment portfolios (NZS Fund and ACC).

On the liability side, borrowings in the financial sector are forecast to decrease by $9.0 billion by 2020/21, mostly as a result of the reduction in gross debt discussed earlier (page 38).

ACC's insurance liability is expected to continue to increase from $39.1 billion at the end of 2015/16 to $47.3 billion in 2020/21. By contrast, the GSF liability is forecast to fall to $8.8 billion by 2020/21, as pensions are paid out.

Overall, net worth in the financial sector increases by $20.9 billion across the forecast period (Figure 2.18).

Figure 2.18 - Financial balance sheet

Source: The Treasury

The commercial asset portfolio (representing nearly 20% of the Crown's balance sheet) is expected to increase by $4.7 billion over the forecast period to be $60.0 billion in 2020/21, with growth mostly coming from growth in the Kiwibank loan book (with a corresponding increase in liabilities as deposit balances are also forecast to rise). Commercial net worth remains fairly static (Figure 2.19).

Figure 2.19 - Commercial balance sheet

Source: The Treasury

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 show current estimates of what the Crown owns and owes. While the measurement at fair value is intended to reflect the value of these items, it can be volatile, resulting in fluctuations in the value of the assets and liabilities reflecting changes in the market and underlying assumptions.

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

Comparison to the Budget Update#

Print this section

The Budget Update was published on 25 May 2017. Since then, there have been a number of developments that have impacted the fiscal outlook, in particular the 2016/17 outturn which was stronger than estimated. Subsequent to that, the forecasts for the next four years remain fairly close to the Budget Update forecasts.

Table 2.9 below summarises the changes in the key fiscal indicators.

Source: The Treasury

2016/17 Core Crown tax revenue is expected to be $1.0 billion higher than the Budget Update...

Core Crown tax revenue for the 2016/17 financial year is forecast to be $1.0 billion (1.3%) higher than the Budget Update forecast.

Corporate tax, GST and source deductions were the tax types that varied most from the Budget Update (Figure 2.20).

Figure 2.20 - Movement in core Crown tax revenue since the Budget Update

Source: The Treasury

The higher-than-expected corporate tax revenue was spread around most sectors of the economy, but with a notable contribution from firms operating in the finance and investment sectors. Included in this, Portfolio Investment Entity (PIE) tax contributed around $80 million to the corporate tax variance. Such profits are inherently volatile and therefore difficult to forecast accurately.

At the time of the Budget Update, employment levels were running above forecast, but this had not translated into above-forecast source deductions. Since that time, the strength in employment became evident in the PAYE data, which moved steadily ahead of forecast.

Although 2016/17 GST revenue was above the Budget Update forecast, underlying GST strength may actually be timing in nature, as indicated by the GST receipts outturn, which was 0.5% below forecast. There is more support in the macroeconomic data for the 2016/17 GST receipts position than for the revenue position, with most of the major indicators of GST (eg, domestic consumption, residential investment and net tourist spending) being either close to or a little below their Budget Update forecasts.

As discussed earlier in the Core Crown tax revenue section, not all of the 2016/17 tax revenue strength has been assumed to continue through the remainder of the forecast period.

The net effect of these temporary and permanent factors was that, before considering the effect of changes in the macroeconomic forecast, the tax forecasts were increased by around $0.4 billion each year from 2017/18 onwards.

…but when combined with a lower outlook for GDP growth…

The outlook for nominal GDP growth has been revised downwards since the Budget Update, as shown in Figure 2.21.

Figure 2.21 - Nominal GDP growth forecast, Budget Update and Pre-election Update

Source: The Treasury

In addition to the overall decrease, individual components of GDP have also been revised as follows:

• Forecasts of aggregate employees' compensation have been increased, mainly as a result of a higher forecast for growth in wage rates.
• The forecast for growth in operating surpluses are now lower than in the Budget Update (the box on page 33 provides further discussion on the impact of the corporate tax fiscal forecasts).
• As mentioned in the Economic Outlook chapter, the forecast for residential investment growth has been reduced.

In total, changes in the macroeconomic forecast were slightly positive ($0.2 billion) for the tax revenue forecast in 2017/18, but slightly negative ($0.2 to $0.4 billion per year) thereafter.

…resulted in core Crown tax revenue forecast being similar to the Budget Update in the last few years of the forecast

The sum total of all of these factors has increased the total core Crown tax revenue forecast by $0.8 billion in 2017/18, but with very little net effect through 2018/19, 2019/20 and 2020/21. The largest forecast movements were in:

• source deductions, which is $1.6 billion higher in total than in the Budget Update, mainly owing to the higher starting position and a higher forecast for growth in wage rates
• corporate tax, which is expected to be higher than in the Budget Update in 2017/18, mainly owing to the higher 2017 starting position, but is expected to be similar to the Budget Update forecast by 2020/21, and
• GST, in which the forecasts are lower than in the Budget Update, mainly owing to the reduced outlook for residential investment growth.

Source: The Treasury

OBEGAL is higher in the short term …

The 2016/17 OBEGAL is likely to be significantly higher than the Budget Update while subsequent years are similar to the previous forecast. The major movements since the Budget Update are outlined in Table 2.11 below.

Source: The Treasury

In addition to the tax revenue forecast changes discussed above, other changes to OBEGAL forecasts include:

• ACC's OBEGAL results are forecast to decline in the last four years of the forecast period as a result of updating assumptions following the completion of the outstanding claims liability valuation at 30 June 2017. This resulting increase in expenditure is largely owing to two impacts since the Budget Update, a reduction in the discount rate (meaning the forecast cost of new claims in today's dollars is higher than estimated at the Budget Update) and a change in the assumptions relating to the in-between travel settlement with care providers.
• Other SOE and CE results are forecast to have a positive impact on OBEGAL in the 2016/17 fiscal year. These improved results are not expected to continue across the forecast period, with a slight deterioration from previous forecasts expected in the later years.
• Transport operating expenditure has increased, largely owing to the reclassification of capital spending in relation to the re-instatement of the Picton to Kaikōura state highway to operating spending.
• Net finance costs have reduced in the later years of the forecast owing to lower interest rates than previously forecast.
• Other changes include the re-phasing of expenditure in the current year until later in the forecast period along with expected increases in social assistance expenses (mainly owing to the upward revision of the wage growth increasing New Zealand Superannuation expenditure, partially offset by other benefit types as a result of a mix of lower inflation and a lower starting point in regards to recipients).

...while net core Crown debt is consistently lower across the forecast period compared to the Budget Update

Net core Crown debt is expected to be around $2 billion lower than the Budget Update in all years of the forecast (Table 2.12). This is largely owing to the expected 2016/17 result flowing through to the change in net core Crown debt in 2020/21, residual cash is neutral 2017/18 to 2020/21, leading to net core Crown debt being broadly in balance also.

Overall, tax receipts have a positive cash impact on net debt totalling $1.9 billion by the end of the forecast period. Changes to the timing and amount of operating and capital spending have reduced net core Crown debt since the Budget Update, particularly in the current year.

Source: The Treasury

The Transport spending changes are a mix of changes from capital to operating, timing of expected cash flows and an increase in capital spending subsequent to the Budget Update, including improvements being made to State Highway 1 (in the Kaikōura area), increasing the overall spending on roading projects.

Some re-phasing of expenditure has been forecast reflecting the latest information on when costs are going to be incurred, particularly around the timing of capital expenditure.

Key Economic Assumptions Used in the Fiscal Forecasts#

Print this section

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 2.13 below.

Notes:

1. Production measure.
2. Expenditure measure.

Source: The Treasury

10-Year Medium-term Projections#

Print this section

The previous sections of this chapter have concentrated on the five-year forecast horizon, up to and including 2020/21. The focus now switches to the decade beyond the last forecast year, extending to 2030/31, referred to as the medium-term projections. Projections differ from forecasts in a number of ways.

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. Forecasts represent the best attempt to predict future outcomes based on the information available.

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 future policy responses that might be enacted.

Projected nominal GDP growth slows...

The two most important economic variables that 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 projection period, from a peak of 4.4% in the year ending June 2025 to 4.1% by the year ending June 2031. This is owing to the labour force contribution, where an ageing population slowly reduces overall participation rates.

While projected nominal GDP growth rates are almost identical to those produced for the 2017 FSR, they arise from an end-of-forecast GDP base which is $1.7 billion (0.5%) lower. This difference is maintained over the projection decade.

…revenue rises faster than expenses…

Revenue and expenses are projected to increase in nominal terms but revenue rises faster than expenses, which is fairly flat as a share of GDP across the medium-term horizon.

Most revenue types grow in line with nominal GDP once they have reached an assumed steady-state level of GDP. Some tax types take several years into the projections to reach their stable percentages of GDP. This strengthens the revenue projections because some tax types grow faster than nominal GDP for some of the projected years. Growth in expenses is mainly driven by growth in transfer payments (including NZS) each year, along with allowances for new expenditure.

Figure 2.22 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.

Figure 2.22 - Core Crown revenue and expenses

Source: The Treasury

...and OBEGAL surpluses are projected to continue...

The OBEGAL is projected to increase across the projection period.

Surpluses increase, not just in dollar terms, but also as a percentage of nominal GDP.

The projected OBEGAL in the Pre-election Update is slightly weaker in each year compared to the projections in the 2017 FSR (Figure 2.23). The majority of the difference is owing to higher transfer payment costs and other operating expenses in the Pre-election Update.

Figure 2.23 - Total Crown operating balance before gains/(losses) or OBEGAL

Source: The Treasury

...resulting in net core Crown debt falling below 15% of GDP in 2022/23…

In the 2017 FSR, the Government announced a new long-term objective to reduce net debt to within a range of 10% and 15% and to be within that range by 2025. In the Pre-election Update, net core Crown debt is expected to be within this range approximately two years earlier than target (14.9% of GDP by 2023) and will steadily decline as a percentage of GDP for the remaining projection years. This is illustrated in Figure 2.24.

Figure 2.24 - Net core Crown debt (excluding NZS Fund and advances) assuming no policy intervention

Source: The Treasury

…assuming that operating and capital allowances are the same as the allowances in the 2017 FSR.

The projections assume the same operating and capital allowances as at the FSR 2017. From 2021/22, operating allowances are assumed to be $2 billion, growing at 4% per budget and capital allowances are assumed to be $4 billion growing at 20% per budget. These were set at the 2017 FSR so as to meet the Government's net debt objective. They reflect the headroom the Government has to invest in capital and public services or to alter tax and transfer settings. The updated forecast base, and the fact that allowances have remained unchanged from the 2017 FSR, result in a net core Crown debt to GDP that is lower in the Pre-election Update compared to the 2017 FSR (Figure 2.24).

Key Assumptions for Medium-term Fiscal Projections#

Print this section

The assumptions for the medium-term economic and fiscal projections are outlined in this section. The full assumptions can be found in the 2017 Pre-election Update, at http://www.treasury.govt.nz/government/fiscalstrategy/model

Notes:

1. Annual average percentage change unless otherwise stated
2. Note that the economic forecasts in the Pre-election Update are based on a June year.
3. Total unemployed as a percentage of the labour force (annual average)
4. Hours worked measure
5. Production measure, 2009/10 base
6. Expenditure measure

Sources: The Treasury, Statistics New Zealand

The assumptions for the economic variables remain unchanged from the 2017 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 one year earlier (in the first projected year). This affects projected GDP in 2022/23 and results in higher GDP growth rate in that year compared to the 2017 FSR.

Economic projections display the potential path that some key economic indicators take beyond their forecast bases, and provide 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 time.

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 2.09% 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. Excludes minority interests
3. Excludes financial assets of the NZS Fund and core Crown advances.
4. Excludes assets and liabilities belonging to minority interests.

Source: The Treasury

3 Risks and Scenarios#

Print this section

Overview#

Print this section

• In this chapter we discuss the risks and uncertainties surrounding the economic and fiscal forecasts. Fan charts are used to help illustrate forecast uncertainty and two alternative scenarios are presented to show how the economic and fiscal outlook might evolve under different assumptions and judgements. Specific Fiscal Risks are discussed in Chapter 4.
• Key risks to the international economy include: high levels of debt in China; uncertainty around fiscal stimulus and monetary policy normalisation in the US; the ability to achieve sustainably higher growth rates in Europe and Japan remains unclear; and high household debt and housing market risks in Australia. Should these risks materialise, global growth could deviate from that presented in the main forecast and, with it, key forecast judgements such as the terms of trade, exchange rate and migration flows.Other risks include the impact of the UK’s exit from the European Union and ongoing political debate about the merits of trade liberalisation.
• There are risks to domestic activity around household and investor behaviour and how high household debt levels and slowing house price growth will impact demand. There are also risks around the technical assumptions underpinning these forecasts, such as estimates of spare capacity in the economy which, if altered, would impact how the economy is expected to evolve.
• Scenario One illustrates how a higher terms of trade could support a faster pace of economic expansion and a stronger fiscal position. Scenario Two shows how weaker momentum in domestic activity could lead to weaker fiscal outcomes.
• The Crown's balance sheet is exposed to a number of risks beyond those associated with the operating balance. The Crown's financial position is exposed to risk through changes in the value of the Crown's assets or liabilities, and also through the potential impact of the Crown's fiscal obligations that arise from policy choices.

Risks and Uncertainties Around the Economic and Fiscal Outlook#

Print this section

The main forecasts are based on a set of assumptions (such as the evolution of the exchange rate, the terms of trade and population growth) and judgements around how developments in one part of the economy impact the rest of the economy[9]. Should these assumptions and judgements prove incorrect, the economic and fiscal outlook would deviate from that presented in Chapters 1 and 2. As shown in Figures 3.1 and 3.2, fan charts based on past forecast errors provide one way to illustrate the degree of uncertainty surrounding the outlook. Alternative scenarios are also useful as they provide an assessment of how the economy and fiscal position may deviate from the main forecast when key assumptions and judgements are altered[10].

Risks to the economic outlook add uncertainty to government revenue forecasts…

The amount of tax revenue that the Government receives in a given year is closely linked to the performance of the economy. For example, a fall in dairy export prices reduces farm incomes, which impacts on investment and consumption spending. Government tax revenue is affected through a number of channels including taxes on wages and salaries, corporate profits, and sales of goods and services.

Figure 3.1 shows a fan chart of nominal expenditure on GDP[11]. The width of the fan increases further into the forecast period, meaning the further away from the present the more uncertainty there is around the main forecast. The area within the outermost edges of the fan shows where nominal GDP is expected to be 90% of the time. At the end of the forecast period, this is within +/-7% ($22.6 billion) of the main forecast. The boundaries of the darker fan show where nominal GDP is expected to be 70% of the time. At the end of the forecast period, this is within +/-4.4% ($14.2 billion) of the main forecast. In the two scenarios considered in this chapter, nominal GDP forecasts remain within the darker fan (70th percentile).

Figure 3.1 - Nominal GDP fan chart

Sources: Statistics New Zealand, the Treasury

Figure 3.2 shows the uncertainty surrounding the main tax revenue forecast[12]. At the end of the forecast period, the outermost shaded area captures a range of approximately +/-$10.4 billion, within which actual tax outturns are expected to fall 90% of the time[13].

Figure 3.2 - Tax revenue fan chart

Source: The Treasury

…and uncertainty around fiscal expenditure pressures

Government expenses may also be impacted by economic developments. One channel is through changes in labour market conditions that affect the demand for working-age benefits. Another channel is through the indexation of a range of welfare benefits to wage and price movements. Government tax expenditures, including Working for Families, may also be affected by labour market conditions. Changes in net migration flows may also impact on the demand for central government services, particularly health, education and publicly funded infrastructure. Over the longer term, current policies imply population growth and population ageing will place increasing pressure on public expenditure, particularly in the areas of health and superannuation[14].

Changes in the valuation of long-term liabilities, such as the ACC claims liability and the GSF retirement plan, caused by changes in inflation and long-term interest rates, may also affect the Crown operating balance.

One-off and unexpected expenditures can also have a large impact on the Crown's fiscal position. In recent years, earthquakes have demonstrated the inherent exposure of the Crown’s fiscal position to unexpected events. More generally, uncertainty is inherent in forecasting the fiscal impacts of new policy initiatives.

Key Risks to the Economic and Fiscal Outlook#

Print this section

A range of risks to global economic, financial and political stability exist that could have a significant impact on the New Zealand economy should they materialise. In China, high levels of debt present a risk to growth. There is considerable uncertainty regarding the extent and timing of fiscal stimulus in the US. In Europe and Japan, the ability to achieve sustainably higher growth rates remains unclear. The UK’s exit negotiations with the European Union will remain a key source of uncertainty and a risk to growth for some time. Other global risks include heightened geopolitical tensions and ongoing political debate about the merits of trade liberalisation. While international risks are skewed towards weaker growth outcomes than incorporated in the main forecasts, upside risks to New Zealand’s terms of trade remain. For example, despite slowing aggregate GDP growth in China, demand for consumption goods could be stronger than assumed, leading to higher export prices. Lower oil production costs could support lower import prices.

In addition to the above, there are a number of key risks to the domestic economy. Households could be more sensitive to tighter financial conditions than assumed, particularly given record-high debt levels relative to incomes. There are risks to the main forecast assumptions around the impact of net migration inflows and how migration flows may evolve in the future. Capacity constraints in the construction sector may prove more binding than assumed, while estimates of economy-wide capacity pressures are uncertain.

High debt levels in China are a risk to trading partner growth…

Growth in China has been supported by significant policy stimulus, strong credit growth and rapidly rising debt. This has been particularly apparent in the housing market, where residential investment has accelerated strongly. As authorities turn their attention towards tightening financial market regulations to reduce debt risks, the impact on the real economy could be stronger than expected. A sharper-than-anticipated slowdown in growth could negatively impact commodity prices, trade and capital flows, which could slow growth in China's trading partners, including New Zealand and other key trading partners in the Asia-Pacific region.

…along with uncertainty around fiscal settings in the US

In the US, challenges in reaching political agreement have increased uncertainty around the extent and timing of future fiscal stimulus. While the main forecasts continue to reflect expectations of an easing in fiscal policy settings over the next two years, it is possible that stimulus is more modest and less stimulatory for growth than assumed. That said, the size and impact could also be larger than incorporated into the main forecasts. Meanwhile, the US labour market has continued to strengthen and monetary policy is expected to tighten further. Higher-than-expected US interest rates present a risk to governments and businesses holding US dollar debt, particularly in China and other emerging market economies.

Exporters face uncertainty around the terms of trade…

As a commodity exporter, New Zealand's terms of trade are exposed to a raft of risks. Changes to regulatory settings in key overseas markets can have significant impacts on global supply and the price of goods New Zealand produces and exports. On the other hand, a stronger international outlook would likely increase demand for exports resulting in a higher terms of trade. The impact of increased global competition owing to shale oil production could be greater than assumed, supporting lower import prices and a higher terms of trade, particularly over the medium term.

The terms of trade have been trending upwards since the early 2000s. Until 2013, this was driven mostly by rising export prices. However, more recently falling import prices have driven the increase. For New Zealand's terms of trade to continue rising, global demand for exports would need to outpace global supply or the inverse would need to occur on the imports side. Developments in China have been a key determinant of the terms of trade in recent years. Chinese urbanisation and ongoing transition towards consumption-led growth has supported demand for New Zealand's exports, while China's ability to produce manufactured products cheaply and at scale has kept import prices low. Stronger demand from Chinese consumers and/or tighter supply restrictions in China on the goods New Zealand produces, including from environmental policies, presents an upside risk to New Zealand's export prices.

…and the future of global trade policy

Political debate about the merits of trade liberalisation has intensified in recent years. A shift in trade policy towards protectionism, particularly in the US, is a key risk to the outlook for global trade volumes and global GDP. In addition, uncertainty surrounding the future of trade has the potential to negatively impact investment and productivity growth.

Developments in the Australian economy could affect net inward migration

In Australia, low interest rates are supporting the transition of growth towards non-mining sectors. They are also encouraging household borrowing and contributing to rising house prices. Household debt relative to incomes has reached record highs, making households more vulnerable to rising interest rates. In the housing market, investment in medium-to-high density housing has increased rapidly, raising the risk that the market is oversupplied, which could lead to a slowdown in construction, a fall in house prices, slower growth and higher unemployment. Conditions in the Australian labour market are a major determinant of the strength and direction of trans-Tasman migration flows. To the extent that the labour market in Australia is weaker than expected, net trans-Tasman flows are likely to continue to support higher net migration inflows than assumed in the main forecast.

Overall, net migration inflows may prove to be higher than assumed in the main forecast if the relative attractiveness of living, working and studying in New Zealand is stronger than expected. However, stronger growth internationally or shifts in domestic factors may lead to lower migration and softer GDP growth. There are also risks around the assumed impacts of migration on the economy, particularly the degree to which the current net migration cycle contributes to demand for consumption, housing and non-residential investment, including public infrastructure, as well as supply though the labour market.

High household debt relative to incomes could lead to softer domestic demand

Low interest rates and strong demand for housing have contributed to rising house prices and record-high household debt relative to incomes. In recent months, tighter lending standards and increased mortgage interest rates have caused credit growth to slow. Availability of credit is a key determinant of consumption and investment growth. Further increases in lending standards, or a decrease in the availability of credit, could slow economic growth by imposing tougher constraints on housing activity, which could spill over to the wider economy. In this environment, house price growth, and therefore household wealth, could be weaker as fewer households will be in a position to bid up prices. This could also contribute to slower growth.

An unexpected rise in interest rates or softer income growth may also prompt households to reduce their exposure to future interest rate rises by prioritising debt repayment over consumption, leading to softer growth. Renewed concerns around global financial market stability or a faster pace of monetary policy normalisation in the US are possible examples where unexpectedly higher offshore funding costs could drive interest rates higher. That said, there is headroom for domestic monetary policy settings to provide an offset.

There are also risks around assumptions of potential output and capacity constraints. The following box discusses these in further detail.

Uncertainty surrounding estimates of the output gap

The output gap is a measure of spare capacity in the economy. It is used to help forecasters determine inflationary pressures. However, the output gap is an unobservable variable so forecasters must estimate the output gap in order to understand the underlying state of the economy. Estimates of the output gap are, by their nature, highly uncertain and depend on different methodologies and assumptions. It is therefore useful to compare our estimate with those of other forecasters.

The output gap is the difference between actual GDP and potential GDP (the level of GDP that will stimulate excess inflation if exceeded). In this way the output gap is an estimate of the cyclical position of the economy and a measure of the degree of spare capacity. A positive output gap suggests the economy is operating above its potential level and capacity constraints are beginning to affect the economy. This would typically suggest that the economy has less room to grow, prices are likely to rise and, all else unchanged, less of the operating balance is structural (see box Summary fiscal indicators on page 33 for more details). We estimate the output gap is below zero at -0.5% on average in 2016/17.

Figure 3.3 shows the Treasury's estimate of the output gap relative to a range of other estimates[15]. For most of the sample period our estimate of the output gap is near the centre of the range of forecasts (the blue area) and close to the average (the green line). However, from 2011 onwards our estimate diverges somewhat and has been the lowest in the sample over the past few years.

Figure 3.3 - Output gap estimates

Sources: IMF, OECD, the Treasury and others

Given that the output gap is unobservable, forecasters look at a range of observable data to help inform estimates of the output gap. Some key indicators include non-tradable inflation, labour market data and businesses surveyed opinions of capacity.

The Treasury's current lower output gap estimate implies a more optimistic view of potential GDP; that is, we believe the economy has more room to grow than other forecasters. In part, this view reflects the persistent weakness in non-tradable inflation over the past four years, and the degree of spare capacity that we see in the labour market, particularly in light of recent strong migration. However, this view is becoming increasingly challenged by persistently strong survey measures of capacity (such as the Quarterly Survey of Business Opinions) which have been showing that businesses are facing significant capacity constraints. In light of this and other evidence we have revised up our view of the output gap from the Budget Update. Given the high degree of uncertainty surrounding the output gap and its importance for understanding the underlying state of the economy and subsequent inflationary pressure, it is crucial that we review our estimation and interpretation of the output gap regularly.

Alternative Scenarios#

Print this section

The following scenarios show how the economy might evolve if some of the assumptions in the main forecast are altered. They illustrate two of the many ways that the economy may deviate from the main forecast. Scenario One illustrates the economic and fiscal impacts of a higher terms of trade and stronger inflation. In this scenario, stronger export prices hold the terms of trade higher throughout the forecast horizon and inflationary pressures are stronger. Higher nominal GDP and tax revenues generate larger fiscal surpluses and lower net debt. Scenario Two illustrates the impact of weaker underlying momentum in the domestic economy. Specifically, tighter global credit conditions lead to a higher degree of credit rationing, dampening investment and private consumption growth. Weaker demand leads to lower inflationary pressure and softer nominal GDP growth, resulting in a weaker fiscal position.

Scenario One - Higher Terms of Trade and Inflation

This scenario illustrates the impact of a higher terms of trade and stronger inflation on the economic and fiscal outlook. Export prices are assumed to rise slightly above the main forecast in 2017 and remain higher throughout the forecast period. Higher export prices are achieved through stronger demand for New Zealand's goods exports, particularly stronger demand in China for dairy, meat and forestry products. As a result, the terms of trade are around 7% above the main forecast by June 2021 (Figure 3.4).

Figure 3.4 - Higher goods terms of trade (SNA)

Sources: Statistics New Zealand, the Treasury

The impact on domestic demand from the higher terms of trade is positive. Sustained higher exporter earnings support investment and consumption demand, which contributes to stronger employment growth and a lower unemployment rate. Wages increase at a faster pace than in the main forecast and real GDP per capita is higher.

The higher terms of trade also contributes to a stronger New Zealand dollar, which redistributes some of the higher export earnings to non-exporting households. However, exporters who do not benefit from a higher world price for their goods will have profits eroded by the stronger dollar.

While the stronger dollar has a dampening effect on tradables inflation, this scenario also assumes tighter capacity constraints and stronger non-tradables inflationary pressures than in the main forecast. As a result, the rate of CPI inflation is higher from the onset. The boost to domestic demand from higher export earnings also causes capacity constraints to bind sooner than assumed in the main forecast. In response to the stronger inflation outlook, the Reserve Bank lifts the Official Cash Rate earlier (Figure 3.5).

Figure 3.5 - Higher inflation and interest rates

Sources: Statistics New Zealand, Reserve Bank, the Treasury

Overall, higher export prices, stronger inflation and faster real GDP growth increase nominal GDP by a cumulative $22 billion over the forecast period to June 2021. This additional income generates $6.6 billion extra core Crown tax revenue than in the main forecast (Figure 3.7), with source deductions and GST $1.5 billion and $1.2 billion higher respectively.

In this scenario we assume that the Government's operating and capital allowances are unchanged from those in the main forecast (see Chapter 2 for details). Under these assumptions, OBEGAL surpluses are larger in each year, reaching $8.9 billion (2.7% of GDP) in 2021. This is $2.5 billion above that in the main forecast. The Government's debt position also improves, with the level of net core Crown debt $6.9 billion lower by June 2021 (Table 3.1).

Scenario Two - Softer Growth in the Domestic Economy

This scenario illustrates the possible implications for the economic and fiscal outlook when underlying momentum in the domestic economy is weaker than the main forecast. Tighter global financial market conditions - a decrease in the availability of credit in particular -are assumed to drive an increase in domestic lending standards and a higher degree of credit rationing than in the main forecast. As a result, activity in the housing market slows with less residential investment (Figure 3.6) and softer growth in house prices. Consumption expenditure on durables, such as household furnishings, is weaker as a result of fewer residential dwellings. We also assume households and investors have a lower appetite for risk in this environment, leading to lower domestic demand.

Figure 3.6 - Real residential investment

Sources: Statistics New Zealand, the Treasury

In the labour market, weaker activity translates into lower employment growth, a higher unemployment rate and slower wage growth. Annual CPI inflation is weaker across the forecast horizon and the Reserve Bank is assumed to remain on hold for longer.

Compared to the main forecast, real GDP growth peaks 0.4 percentage points lower (at 3.3% vs 3.7%) and six months later. However, with interest rates on hold for longer, the interest rate sensitive components of growth, such as residential investment, support an acceleration of growth later in the forecast period (Figure 3.6, Table 3.1).

Overall, nominal GDP is around $21 billion lower over the forecast period. Core Crown tax revenue is $8.1 billion lower (Figure 3.7), with lower source deductions (-$2.9 billion) and GST (-$2.3 billion).

Figure 3.7 - Core Crown tax revenue

Source: The Treasury

As in Scenario One, we assume that the Government's operating and capital allowances are unchanged from those in the main forecast (see Chapter 2 for details). Under these assumptions, OBEGAL surpluses are smaller but increase to $3.3 billion (1.0% of GDP) in 2021, and net debt is higher (Table 3.1).

*annual average % change

Source: The Treasury

Fiscal Sensitivities#

Print this section

Table 3.2 sets out some rules of thumb on the sensitivities of the fiscal position to small changes in specific variables. For example, if nominal GDP growth is one percentage point higher than forecast in each year up to June 2021, tax revenue would be around $3.7 billion higher than forecast in the June 2021 year as a result. The sensitivities are broadly symmetric and if nominal GDP growth is one percentage point lower than expected each year, tax revenue would be around $3.6 billion lower than forecast in the June 2021 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 the forecast would also impact the fiscal position owing to the effect on the portfolios of various government reporting entities, such as the NZS Fund, ACC and the Treasury's New Zealand Debt Management Office (NZDMO). For example, at 30 June 2016, a 1.0% increase in NZ interest rates would have reduced the total Crown operating balance by $896 million while a 1.0% decrease would have increased the total Crown operating balance by $926 million. The majority of the Government's borrowings and a large number of financial assets are managed by NZDMO. To illustrate the interest rate sensitivities on the NZDMO portfolio, Table 3.2 provides the estimated impact of lower interest rates on those assets and liabilities. A one percentage point lower interest rate would result in interest income on funds managed by the NZDMO being $100 million lower in the June 2021 year. This would be more than offset by interest expenses $298 million lower in the June 2021 year. As above, the sensitivities are broadly symmetric.

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

Source: The Treasury

The forecast financial position is based on a number of judgements and assumptions about the future. To inform these judgements and assumptions we rely on market information. Some additional assumptions include those around foreign exchange rates, share prices, the carbon price and property prices. Where the actual outcome differs from our assumptions, the Crown's actual financial position is likely to differ from the forecasts. For example, foreign currency-denominated financial assets and liabilities are converted into New Zealand dollars at the reporting date, the Government's listed share investments are reported on market prices and property owned by the Crown is valued using market information. Changes in these variables can also have flow-on effects on the Crown's operating balance. For example, a strengthening of share prices may result in higher returns from the Government's direct share investments.

Balance Sheet Risks#

Print this section

The Crown's balance sheet is exposed to a number of risks beyond those associated with the operating balance. The Crown's financial position is exposed to risk through changes in the value of its assets or liabilities, and also through the potential impact of the Crown's explicit and implicit obligations (including a strong expectation that the Crown would respond to an event) as a result of policy settings.

Main sources of balance sheet risk

A large source of balance sheet risk can be attributed to changes in the value of the Crown's assets and liabilities owing to movements in market variables such as interest rates, exchange rates and equity prices. As noted above, these changes can also have an impact on the Crown's operating balance.

Three areas of the balance sheet are particularly susceptible to market risk:

• Financial assets held by the Crown financial institutions (CFIs) are sensitive to financial-market volatility. CFIs tend to diversify their portfolios across a range of financial assets to manage exposures to specific types of market risks.
• Insurance and retirement liabilities and provisions are prone to market volatility through their actuarial valuations, which are sensitive to assumptions about variables such as interest and inflation rates.
• Physical assets such as land, buildings, state highways and military equipment are susceptible to valuation movements through changes in property market conditions, interest rates and changes in the costs of construction.

Other sources of balance sheet risk[16]

• Business risk: A number of entities owned by the Crown, including commercial and social entities, have their financial performance and valuations impacted by the broader commercial environment.
• Funding risk: The New Zealand Government remains amongst the highest-rated sovereigns globally, with the top Aaa foreign-currency rating from Moody's and AA foreign-currency ratings from Standard & Poor's and Fitch. Ratings outlooks are stable from all three agencies.
• In the case of an increase in global risk aversion New Zealand could face increased funding pressure in the future. All else being equal, deterioration in the ratings outlook could raise debt-servicing costs and lessen the funding capability for the Crown.
• Liquidity risk: with respect to its ability to raise cash to meet its obligations. This risk is relatively small and managed by each agency to meet its specific liquidity risk requirements and by the Treasury's NZDMO to manage the Crown's liquidity requirements.
• Contingent liabilities: relating to natural disasters and financial system stress. The Specific Fiscal Risks chapter discusses contingent assets and liabilities in greater detail.

4 Specific Fiscal Risks#

Print this section

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

Overview#

Print this section

Specific fiscal risks can be positive or negative and can affect revenue or spending or assets and liabilities. 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 operating and capital allowances for future Budgets to manage uncertainty and cost pressures. These allowances are included in the fiscal forecasts. Future policy decisions affecting operating expenses or capital expenditure are met either from within these allowances or through reprioritisation.

Future policy decisions are risks to the fiscal forecasts only to the extent that they cannot be managed from within:

• for operating expenditure, existing baselines or the allowance in the fiscal forecasts for forecast new operating expenses, or
• for capital, the existing Crown balance sheet or the allowance in the fiscal forecasts, for forecast new capital expenditure.

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 by ministerial portfolio. The summary table also classifies each risk 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 the Budget operating allowance): 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 the Budget operating allowances.
• Potential capital decisions (expected to be funded from the existing Crown balance sheet or the Budget 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 or the Budget capital allowance.

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

• Risks from changes to economic assumptions; the most significant economic risks have been identified in Chapter 3.
• Business risks and volatility in the returns from and valuation of the Crown's investments relating to the broader economic and commercial environment.
• 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, biosecurity incursions and other major events, as they usually occur infrequently and their occurrence, nature and timing cannot be predicted. Once a disaster does occur, a number of choices arise about how to respond and when potential liabilities are recognised (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.

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.

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[17] 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[18] (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[19] 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.

Charges against Future Budgets

This section provides transparency around amounts that are available in future Budget allowances to help mitigate risks noted in the Statement of Specific Fiscal Risks.

As noted, future government decisions and other circumstances are only a risk to the fiscal forecasts if they cannot be managed within existing baselines or future Budget allowances. In the Fiscal Strategy Report 2017 the Government set operating allowances for Budget 2018 of $1.7 billion, growing at 2% each Budget until Budget 2020. An allowance for Budget 2018 of $2.0 billion was set for capital, growing to $2.5 billion for Budget 2019 and Budget 2020.

The table below outlines decisions taken by the Government since Budget 2017 that have been charged against future Budget allowances. The decisions below have been incorporated into the fiscal forecasts and result in a corresponding reduction in funding available from future Budget capital allowances.

Statement of Specific Fiscal Risks#

Print this section

Summary Table

The matters listed below are disclosed as specific fiscal risks because they meet the rules for disclosure outlined before 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.

The table below is ordered by portfolio and includes the title of the risk, its status and the type of risk. The status of the risk describes whether the risk is changed or unchanged since the 2017Budget Economic and Fiscal Update or reflects a new matter. The type of risk highlights whether the risk impacts on revenue, operating expenses or capital expenditure. Cross-portfolio risks to the fiscal forecasts are outlined in a separate table.

Specific Fiscal Risks by Portfolio#

Print this section

ACC

ACC Levies (Unchanged)

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

Non-earners' Account (Unchanged)

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

Work-related Gradual Process Disease and Infection (Unchanged)

Under current legislation, the Government incurs an obligation for Work-related Gradual Process Disease and Infection claims when the claim is made, and an expense is recognised at this point. The liability for commercial accident and sickness insurance contracts would usually be recognised when exposure to conditions that will give rise to a claim occurs. An amendment to legislation would be required to recognise claims at the same time as for commercial contracts. An initial adjustment to the liability and an expense of about $1.0 billion to $1.5 billion would need to be reported if such an amendment were to be enacted.

Building and Construction

Housing Infrastructure Fund (Unchanged)

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

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

Children

Investing in Children Transformation (Unchanged)

The new Ministry for Vulnerable Children, Oranga Tamariki was established on 1 April 2017 with a new operating model to be implemented over the next few years and an expanded focus and target group, and new obligations from associated legislation. To the extent that the costs associated with the new Ministry cannot be funded from an amount the Government has set aside in a tagged contingency or from reprioritisation, additional funding is likely to be required.

Corrections

Additional Capacity to Address Prison Population (Unchanged)

The fiscal forecasts include provision for the Government's agreed investment to create additional prison capacity to accommodate prison population growth over the next 10 years. It is likely that the Department of Corrections will require additional funding relating to the direct costs of accommodating prison population increases, as they arise, which would impact on operating and capital expenditure. There is also a risk that growth in the prison population is different from what is included in the forecasts and additional funding is required.

Defence

Disposal of NZDF Assets (Unchanged)

The Government is considering the potential to dispose of a number of New Zealand Defence Force (NZDF) assets. Depending on market conditions, the timing of disposal and sale price received could have either a positive or negative impact on the Government's overall financial position. NZDF is also completing an 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.

NZDF Operating and Capital Costs (Unchanged)

In 2016, the Government reconsidered NZDF capability and funding requirements through the Defence White Paper 2016. It is expected that changes to NZDF operating and capital funding will be made over the forecast period to achieve the Defence White Paper settings. However, the precise quantum and timing of these changes will be dependent on a range of business cases that will be considered by Cabinet in the future. In particular, significant asset purchases may be sought earlier than previously planned.

Earthquake Commission

EQC (Unchanged)

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

Economic Development

New Zealand Screen Production Grant (Unchanged)

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

Education

School and ECE Funding Review (Changed)

The Government has made its first decisions on the Review of Education Funding Systems across schooling and Early Childhood Education (ECE), agreeing that for state and state integrated schools and ECE services and ngā kōhanga reo the decile system will be replaced by a predictive risk index to allocate funding to overcome educational disadvantage. Decisions are yet to be taken on the system-wide level of funding required to mitigate disadvantage and other components of the funding model which may also have expenditure implications.

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. Should a decision be taken to refurbish the property, a rough-order cost estimate for this upgrade is $100 million over the forecast period.

Goodwill on Acquisition (Unchanged)

As at 30 June 2016, the Government had goodwill on acquisition of a number of sub-entities totalling $602 million. Under New Zealand accounting standards (PBE IPSAS 26), such goodwill items are required to be assessed annually for impairment. If there is any indication that the goodwill may be impaired, the recoverable amount of the cash generating units to which the goodwill is allocated is required to be estimated. If the recoverable amount is less than the carrying amount of those units, the units and the goodwill allocated to them are regarded as impaired and the Government is required to recognise impairment losses in the operating statement. Such assessments will be conducted at the end of the financial year, and the fiscal forecasts currently make no allowance for such impairment losses.

Greater Christchurch Regeneration

Christchurch Central Recovery Plan - Anchor Projects (Unchanged)

The Crown is partially funding the construction of Anchor Projects as part of the Christchurch Central Recovery Plan. The funding for the construction of Anchor Projects will vary from project to project, dependent on final scope, ownership decisions, implementation and project costs, and will to some extent eventually be recovered. Projects are progressing through the decision-making process and construction costs will become increasingly clear during the procurement phase. The quantum and timing of Crown contribution may differ from that included in the fiscal forecasts.

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 or potential revenues or recoveries associated with the future use of residential red zone are uncertain. The future value may change depending on any future alternate uses of the land. The fiscal impact of this is not yet certain.

Southern Response Earthquake Services Support (Unchanged)

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

Infrastructure

Crown Infrastructure Partners (New)

In July 2017, Cabinet agreed to task Crown Fibre Holdings with negotiating and, where viable, funding Crown investment to accelerate growth enabling infrastructure development in a manner that attracts immediate or future external investment. The initial task will be the design of the commercial model for investing in water and transport infrastructure to enable housing supply in growth areas and determining where this model can be successfully applied. Cabinet agreed to provide up to $600 million of uncalled capital to Crown Fibre Holdings for the delivery of Crown Infrastructure Partners to be pre-committed evenly between the Budget 2018 and 2019 capital allowances, but the funding has been reflected as capital expenditure in the forecasts. As the commercial model and funding arrangements for specific projects have not yet been developed, there is a high level of uncertainty in the areas noted below, which may have additional fiscal impacts that need to be managed:

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

Internal Affairs

Fire Services Levy (Unchanged)

The unification of New Zealand's Fire Services into Fire and Emergency New Zealand, which occurred on 1 July 2017, is expected to cost approximately $303 million and is being funded through a Crown contribution, a repayable capital loan and levy increases. The increase in levies required to meet the increased expenditure on Fire Services, and to contribute to repaying the repayable capital injection, has been approved for the year 2017/18 only. Any future levy changes beyond 2017/18 are still uncertain and not yet included in the fiscal forecasts.

North Island Property Review (New)

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

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

Māori Development

Proposed Māori Land Service (New)

The Te Ture Whenua Māori Bill is currently before the House. The Bill envisages services for Māori land owners which are not currently provided by the Crown at scale, including a Māori land register, owner decision-making service and dispute resolution service. Decisions are yet to be made on how these services will be delivered, and these decisions will determine their cost. If and when the Bill is passed, it provides for an 18-month period to develop and deliver the services. Funding has been set aside to design the proposed services, but there is currently no appropriated funding to implement or operate the service once the design process has been completed.

Parliamentary Service

Parliamentary Office Accommodation (New)

The Parliamentary Service is considering options for the provision of accommodation for future Parliaments following the expiry of the lease on Bowen House. Construction and some demolition costs have yet to be finalised or funded but are currently assessed to exceed $100 million.

Primary Industries

Investment in Water Infrastructure (Unchanged)

To date, a total of $183 million has been appropriated for the Crown-owned company, Crown Irrigation Investments Limited, to manage the Crown's investment in irrigation infrastructure. The Government will consider providing further capital up to $217 million in future Budgets as schemes reach the “investment-ready” stage.

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.

Potential Tax Policy Changes (Changed)

Some of the items on the tax policy work programme could have a significant positive impact on operating revenue. A summary of the Government's tax policy work programme can be viewed on Inland Revenue's tax policy website http://taxpolicy.ird.govt.nz/work-programme. The government will consult on any policy changes as part of the Generic Tax Policy Process before making any final decisions.

Student Loans - Valuation (Unchanged)

The value of student loans is sensitive to assumptions such as the borrower's future income, and general economic factors such as interest rates, unemployment levels, salary inflation and the CPI. As new lending occurs, an initial write-down to fair value will be made, and an expense will be incurred, reflecting the cost the Crown incurs in making an interest free loan and the risk that borrowers may not repay their loans. However, the assumptions made at the time of lending are volatile and are subject to change.

Tax and Transfer Settings (New)

The Government's Fiscal Strategy Report 2017 indicated that one of its short-term priorities is to consider further changes to tax and transfer settings, if fiscal conditions allow. A decision to implement any changes could have an impact on the operating balance.

Transformation and Technology Renewal (Unchanged)

The Business Transformation programme agreed by Cabinet is reflected in forecasts. There are risks that the expected implementation costs, revenue gains and operating costs savings may differ from forecasts. This includes a risk that, during the transition between systems, Inland Revenue discovers historic procedural issues. In addition, the Government is considering possible policy changes affecting the way Inland Revenue manages its processes and data. Any changes to procedures or policy could materially impact the programme's cost, and the additional revenue collected.

Social Housing

Divestment and Development of Housing (Unchanged)

The forecasts include divestments and redevelopments of housing property as part of Housing New Zealand Corporation's (HNZC's) asset management strategy. Proceeds from property divestments will be used to help fund investment in redeveloping and growing HNZC's stock. Market conditions impact on the proceeds of sale and the cost of acquisitions and development. Given these uncertainties, there is a risk that there will be variations from the fiscal forecasts.

Social Housing Reform (Unchanged)

The Government is progressing the Social Housing Reform Programme (SHRP). The SHRP aims to improve the housing and associated services provided to those in housing need, to build the social housing market and to fully recognise the costs of social housing. Specific fiscal risks associated with the SHRP are as follows:

• Existing and additional social housing places may require funding above the current Income Related Rent Subsidy (IRRS) appropriation cap.
• The development of a more diverse and competitive social housing market may adversely affect HNZC's financial position.
• Proceeds from social housing transfers are likely to differ from book value.

Tamaki Regeneration Project (Unchanged)

Proceeds from housing sales in Tamaki over the next 10 to 15 years may be less than the forecasted loss on houses sold. Over this period 7,500 new houses are planned to be built in Tamaki in place of about 2,500 existing houses.

Tertiary Education

Possible University of Waikato Medical School (New)

The University of Waikato and Waikato District Health Board have jointly developed a proposal to establish a third medical school based in Hamilton, with enhanced rural clinical training. The school would run a four-year graduate-entry medical programme from 2021.

Advice for Ministers on the proposal is being developed. The proposal represents a fiscal risk insofar as no funding has been set aside if Ministers decide to progress it.

Transport

Auckland City Rail Link (Unchanged)

The Government has committed to fund 50% of the costs associated with the City Rail Link project, which is estimated to cost $3.4 billion. Based on this estimate, the Government's contribution to this project will be around $1.7 billion, of which the first $436 million has been appropriated. There is a risk that the timing and amount of the government contribution towards the project could be different from what is included in the forecasts.

Auckland Transport Alignment Plan (Unchanged)

The Government and Auckland Council released the final report for the Auckland Transport Alignment Project (ATAP) in August 2016. The ATAP process has identified a funding gap of $4 billion to $6 billion over the next 30 years. The Government and Auckland Council are considering options to address this funding gap.

Rail Network Valuation Approach (Unchanged)

KiwiRail operates both freight and passenger transport services. The valuation approach for the assets used for these different activities is outlined in Pre-election 2017 Additional Information - Accounting Policies.

The freight business of KiwiRail is predominantly commercially focused and therefore for financial reporting purposes, assets relating to the freight business are fair valued on a net realisable value basis.

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

The impact of this change would increase the value of assets by around $4 billion, with an estimated $1 billion to $2 billion impacting OBEGAL reflecting the reversal of previous impairments of freight infrastructure assets recorded through the Statement of Financial Performance.

South Island Transport Corridor Reinstatement (Unchanged)

There is a risk that the costs of reinstating the South Island Transport Corridor (Picton-Christchurch) will cost more than what is currently included in the fiscal forecasts. It is also possible that the capital and operating classification of costs may change as the project progresses, which would have a corresponding impact on the operating balance. The classification between capital and operating expenditure has no impact on net core Crown debt.

Support for KiwiRail (Unchanged)

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

Treaty Negotiations

Government Response to Wai 262 (Unchanged)

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

Relativity Clause (Unchanged)

The Deeds of Settlement negotiated with Waikato-Tainui and Ngāi Tahu include a relativity mechanism. Now that the total redress amount for all historical Treaty settlements exceeds $1.0 billion in 1994 present-value terms, the mechanism provides that the Crown is liable to make payments to maintain the real value of Ngāi Tahu's and Waikato-Tainui's settlements as a proportion of all Treaty settlements. The agreed relativity proportions are 17% for Waikato-Tainui and approximately 16% for Ngāi Tahu. There is a risk that the timing and amount of the expense for the relativity payments may differ from that included in the fiscal forecasts. There is also uncertainty on how various disputes concerning the interpretation of the mechanism will be resolved.

Treaty Settlement Forecasts (Unchanged)

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

Cross-portfolio Specific Fiscal Risks

Agency Capital Intentions (Unchanged)

Future Budgets may well include new capital investments other than those identified in other specific fiscal risks. Such investments are most likely to be developed by the 25 investment-intensive agencies 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, improvements in asset performance, alternative methods of service delivery and changes to policy settings. New investments are risks to the fiscal forecasts only to the extent they cannot be managed through existing balance sheets, or the provision in the fiscal forecasts for forecast new capital spending.

Budget Operating Initiatives (Unchanged)

Future Budgets may well include new operating initiatives for new policies or to address cost pressures 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.

Changes in the Accounting Standard for Financial Instruments (New)

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

Pay Equity and Caregiver Employment Conditions (Changed)

There are several cases and funding claims mainly from workers in the social sectors (including health, education and welfare) relating to the interpretation, and application, of the Equal Pay Act 1972, the Minimum Wage Act 1983 and the Government's policy of paying certain family members through its Funded Care Policy.

A pay equity claim for Care and Support workers in the aged care, disability support and home and community services sector has already been resolved, but there are a number of outstanding claims and it is expected that further claims will be raised.Current claims include:

• social workers employed by the Ministry for Vulnerable Children, Oranga Tamariki
• education support workers employed by the Ministry of Education
• school support workers employed by school boards of trustees
• mental health support workers employed by non-government organisations (funded by Government), and
• clerical/administration workers employed by five DHBs in the South Island.

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

Services Funded by Third Parties (Unchanged)

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

State Sector Employment Agreements (Unchanged)

A number of large collective agreements are due to be renegotiated over the forecast period. 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.

Unexpected Maintenance for Crown-owned Buildings (Unchanged)

There is a possibility that the Crown will incur costs when unexpected maintenance is required for the buildings it owns; for example, earthquake strengthening some of the buildings that do not meet modern building standards, and maintenance for buildings with weathertight issues. The likelihood, timing and fiscal impact of any repairs are uncertain.

Risks Removed Since the 2017 Budget Update

No risks have been expired since the Budget Economic and Fiscal Update 2017.

Contingent Liabilities and Contingent Assets#

Print this section

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 net core Crown debt. In the case of some contingencies (eg, uncalled capital) the negative impact would be restricted to net core Crown debt because the cost would be offset by the acquisition of capital.

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

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

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

Some contingencies of the Crown are not able to be quantified. We have disclosed all unquantifiable contingent liabilities and unquantifiable contingent assets that are not expected to be remote.[21]

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

Quantifiable Contingent Liabilities and Contingent Assets

Unquantifiable Contingent Liabilities and Contingent Assets

The following unquantifiable contingent liability was removed: Maui Contracts, as the possibility of realisation is now considered to be remote.

Kiwifruit Vine Disease legal claim from Ministry for Primary Industries has been incorporated into Ministry for Primary Industries - Biosecurity Act compensation new contingent liability.

Description of Contingent Liabilities

Quantifiable contingent liabilities over $100 million

Uncalled capital

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

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

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

In addition to the uncalled capital detailed above, the Crown has agreed to provide an uncalled capital facility of $230 million to Southern Response Earthquake Services Limited (SRES) to support the Christchurch earthquake recovery process.

The above capital support will increase core Crown net debt when called; however, as Southern Response is part of the Crown there would be no impact on the total Crown operating balance.

Guarantees and indemnities

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

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

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

New Zealand Export Credit Office guarantees

The New Zealand Export Credit Office provides a range of guarantee products to assist New Zealand exporters manage risk and capitalise on trade opportunities around the globe. The obligations to third parties are guaranteed by the Crown and are intended to extend the capacity of facilities in the private sector.

$139 million at 31 May 2017 ($211 million at 30 June 2016)

The Body Laid Bare Exhibition indemnity

The Auckland Art Gallery Toi o Tāmaki is hosting the exhibition The Body Laid Bare: Masterpieces from the Tate Gallery. The exhibition is indemnified under the Government Indemnity of Touring Exhibition Scheme from 7 February 2017 to 28 July 2017 to cover the period of transit and display of these valuable works of art. This contingent liability therefore expired on 28 July 2017.

$438 million at 31 May 2017 (Nil at 30 June 2016)

Legal proceedings and disputes

Legal tax proceedings

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

$146 million at 31 May 2017 ($172 million at 30 June 2016)

Other quantifiable contingent liabilities

Unclaimed monies

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

$149 million at 31 May ($133 million at 30 June 2016)

Christchurch Engine Centre (CEC) Partnership Agreement

The Air New Zealand Group has a partnership agreement with Pratt and Whitney in which it holds a 49% interest in the CEC. By the nature of the agreement, joint and several liability exists between the two parties.

$111 million at 31 May 2017 ($68 million at 30 June 2016)

Unquantifiable contingent liabilities

This part of the Statement provides details of those contingent liabilities of the Crown that are not quantified, excluding those that are considered remote, reported by indemnities, legal claims and proceedings, and other contingent liabilities.

Indemnities

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

 

Legal claims and proceedings

There are numerous legal actions that have been brought against the Crown. However, in the majority of these actions it is considered a remote possibility that the Crown would lose the case. 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 and not considered to be remote.

Accident Compensation Corporation (ACC) litigation

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

Ministry for Primary Industries - Biosecurity Act compensation

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

In regards to the Psa-V incursion, in November 2014, 42 growers filed a claim against the Ministry for Primary Industries (MPI) alleging MPI is legally liable for damages they have suffered from a biosecurity incursion of the kiwifruit vine disease Psa-V in New Zealand. Included in the proceedings are approximately 210 grower claims represented by the first plaintiff, Strathboss Kiwifruit Limited. As Strathboss Kiwifruit Limited is required to prove MPI owes a duty of care to the growers before losses will be assessed, MPI is unable to quantify the first plaintiff's claim. The Ministry is defending the claim.

Treaty of Waitangi claims

Under the Treaty of Waitangi Act 1975, any Māori may lodge certain claims relating to land or actions counter to the principles of the Treaty with the Waitangi Tribunal. Where the Tribunal finds a claim is well founded, it may recommend to the Crown that action be taken to compensate those affected. The Tribunal can make recommendations that are binding on the Crown with respect to land 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.

Other unquantifiable contingent liabilities

Criminal Proceeds (Recovery) Act 2009

The Ministry of Justice is responsible for administering the Criminal Proceeds (Recovery) Act 2009. The Act requires the Crown to give an undertaking as to damages or costs in relation to asset restraining orders. In the event that the Crown is found liable, payment may be required.

Environmental liabilities

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

In accordance with PBE IPSAS 19: Provisions, Contingent Liabilities and Contingent Assets any contaminated sites for which costs can be reliably measured have been included in the statement of financial position as provisions.

Treaty of Waitangi claims - Settlement Relativity Payments - see page 82

Holidays Act 2003 and other relevant legislation

A number of entities have commenced a review of payroll calculations over the past six years in order to ensure compliance with the Holidays Act 2003 and other relevant legislation. Where possible, provision has been made in these financial statements for obligations arising from that review. To the extent that an obligation cannot reasonably be quantified at 31 May 2017, a contingent liability exists.

Description of Contingent Assets

Quantifiable contingent assets over $100 million

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

5 Forecast Financial Statements#

Print this section

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 7 August 2017.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined in the Fiscal Outlook chapter (pages 21 to 51).

Statement of Accounting Policies#

Print this section

Significant Accounting Policies

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

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

The specific accounting policies are included within the 2017 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/prefu2017

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 67 to 92.

Key forecast assumptions are set out on pages 24 to 25.

Reporting and Forecast Period

The reporting periods for these Forecast Financial Statements are the years ended 30 June 2017 to 30 June 2021. The “2016 Actual” figures reported in the statements are the audited results reported in the Financial Statements of the Government for the year ended 30 June 2016. The “2017 Previous Budget” figures are the original forecasts to 30 June 2017 as presented in the 2016 Budget.

Government Reporting Entity as at 7 August 2017#

Print this section

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

Core Crown Segment

Departments

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

Offices of Parliament

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

Others

• New Zealand Superannuation Fund
• Reserve Bank of New Zealand

State-owned Enterprises Segment

State-owned Enterprises

• Airways Corporation of New Zealand Limited
• Animal Control Products Limited
• AsureQuality Limited
• Electricity Corporation of New Zealand Limited
• KiwiRail Holdings Limited
• Kordia Group Limited
• Landcorp Farming Limited
• Meteorological Service of New Zealand Limited
• New Zealand Post Limited
• New Zealand Railways Corporation
• Quotable Value Limited
• Solid Energy New Zealand Limited
• Transpower New Zealand Limited

Mixed ownership model companies (Public Finance Act Schedule 5)

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

Other

• Air New Zealand Limited

Crown entities Segment

Crown entities

• Accident Compensation Corporation
• Accreditation Council
• Arts Council of New Zealand Toi Aotearoa
• Broadcasting Commission
• Broadcasting Standards Authority
• Callaghan Innovation
• Careers New Zealand
• Children's Commissioner
• Civil Aviation Authority of New Zealand
• Commerce Commission
• Crown Irrigation Investments Limited
• Crown Research Institutes (7)
• District Health Boards (20)
• Drug Free Sport New Zealand
• Earthquake Commission
• Education New Zealand
• Electoral Commission
• Electricity Authority
• Energy Efficiency and Conservation Authority
• Environmental Protection Authority
• External Reporting Board
• Families Commission
• Financial Markets Authority
• Fire and Emergency New Zealand
• Government Superannuation Fund Authority
• Guardians of New Zealand Superannuation
• Health and Disability Commissioner
• Health Promotion Agency
• Health Quality and Safety Commission
• Health Research Council of New Zealand
• Heritage New Zealand Pouhere Taonga
• Housing New Zealand Corporation
• Human Rights Commission
• Independent Police Conduct Authority
• Law Commission
• Maritime New Zealand
• Museum of New Zealand Te Papa Tongarewa Board
• New Zealand Antarctic Institute
• New Zealand Artificial Limb Service
• New Zealand Blood Service
• New Zealand Film Commission
• New Zealand Lotteries Commission
• New Zealand Productivity Commission
• New Zealand Qualifications Authority
• New Zealand Symphony Orchestra
• New Zealand Tourism Board
• New Zealand Trade and Enterprise
• New Zealand Transport Agency
• New Zealand Venture Investment Fund Limited
• New Zealand Walking Access Commission
• Office of Film and Literature Classification
• Pharmaceutical Management Agency
• Privacy Commissioner
• Public Trust
• Radio New Zealand Limited
• Real Estate Agents Authority
• Retirement Commissioner
• School Boards of Trustees (2,487)
• Social Workers Registration Board
• Sport and Recreation New Zealand
• Takeovers Panel
• Te Reo Whakapuaki Irirangi (Maori Broadcasting Funding Agency)
• Te Taura Whiri i te Reo Maori (Maori Language Commission)
• Television New Zealand Limited
• Tertiary Education Commission
• Transport Accident Investigation Commission
• WorkSafe New Zealand

Organisations listed in schedule 4 of the Public Finance Act 1989

• Agricultural and Marketing Research and Development Trust
• Asia New Zealand Foundation
• Fish and Game Councils (12)
• Game Animal Council
• Leadership Development Centre Trust
• Maori Trustee
• National Pacific Radio Trust
• New Zealand Fish and Game Council
• New Zealand Game Bird Habitat Trust Board
• New Zealand Government Property Corporation
• New Zealand Lottery Grants Board
• Ngai Tahu Ancillary Claims Trust
• Pacific Co-operation Foundation
• Pacific Island Business Development Trust
• Reserves Boards (22)
• Te Ariki Trust

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

• Crown Asset Management Limited
• Crown Fibre Holdings Limited
• Education Payroll Limited
• Health Benefits Limited (ceased operating)
• Otakaro Limited
• Predator Free 2050 Limited
• Research and Education Advanced Network New Zealand Limited
• Southern Response Earthquake Services Limited
• Tamaki Redevelopment Company Limited
• The Network for Learning Limited

Legal entities created by Treaty of Waitangi settlement Acts (Public Finance Act Schedule 6)

• Te Urewera

Others

• Education Council of Aotearoa New Zealand
• Regenerate Christchurch

Other entities

Crown entities

• Tertiary Education Institutions (28)

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

• City Rail Link Limited

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

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

Forecast Financial Statements#

Print this section

Forecast Statement of Financial Performance for the years ending 30 June

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

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

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

1. The classifications of the functions of the Government reflect current baselines. Forecast new operating spending is shown as a separate line item in the above analysis and will be allocated to functions of the Government once decisions are made in future Budgets.

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

 

Forecast Statement of Comprehensive Income Revenue and Expense for the years ending 30 June

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

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

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

Forecast Statement of Cash Flows for the years ending 30 June

1. Excludes transactions with ACC and NZS Fund.
2. Further information on the proceeds and repayments of government bonds is available in note 23.

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 of the 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

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

Statement of Actual Contingent Liabilities and Assets

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

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

Notes to the Forecast Financial Statements#

Print this section

NOTE 1: Sovereign Revenue (Accrual)

1. Customs excise-equivalent duty.

 

NOTE 2: Interest Revenue and Dividends

NOTE 3: Transfer Payments and Subsidies

NOTE 4: Personnel Expenses

NOTE 5: Depreciation and Amortisation

NOTE 6: Other Operating Expenses

NOTE 7: Finance Costs

NOTE 8: Insurance Expenses

NOTE 9: Forecast New Spending and Top-down Expense Adjustment

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

The forecast for new operating spending for Budget 2018 is $1.7 billion. It has been assumed that some of the allowances will be used to fund current commitments. Therefore the spending above represents the remaining allowances as at the forecast finalisation date of 7 August 2017, with only the unallocated portion of the allowance included in this note.

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

The forecast for new capital spending for Budget 2018 is $2.0 billion. Budgets 2019 to 2021 are $2.5 billion. It has been assumed that some of these allowances will be used to fund current Government commitments. Therefore the spending above represents the remaining allowances as at the forecast finalisation date of 7 August 2017, with only the unallocated portion of the allowance included in this note.

 

NOTE 10: Net Gains and Losses on Financial Instruments

NOTE 11: Net Gains and Losses on Non-Financial Instruments

NOTE 12: Operating Balance (excluding Minority Interests)

NOTE 13: Financial Assets (including receivables)

 

NOTE 14: Student Loans

NOTE 15: Property, Plant and Equipment

1. Using a revaluation methodology unless otherwise stated.
2. Includes the Crown's share of the costs in the Auckland City Rail Link.

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

NOTE 16: Intangible Assets and Goodwill

NOTE 17: New Zealand Superannuation Fund

NOTE 18: Payables

1. At 30 June 2017 accounts payable is expected to be higher due to unsettled trades.

 

NOTE 19: Insurance Liabilities

ACC liability

Calculation information

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

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

The key economic variables that impact on changes to the valuation are the long-term Labour Cost Index (LCI), average weekly earnings and the discount rate. Discount rates were derived from the yield curve for New Zealand Government bonds. For these forecast statements, the claims liability is based on the discount rates as at 30 June 2017. The equivalent single effective discount rate, taking into account ACC's projected future cash flow patterns, is 3.80% and allows for a long-term discount rate of 4.75% from 2048.

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

Presentation approach

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

EQC liability

Calculation information

Melville Jessup Weaver prepared an independent actuarial estimate of the EQC outstanding claims liability at 30 June 2017 by estimating the projected ultimate claims costs then deducting the payments made in relation to those claims on or before that date. Each component of the claims liability was split into separate groups depending upon the Canterbury earthquake event group in, Kaikōura earthquake or other "business as usual" claims. These event groups were further split into sub-claim valuation groups being land claims, building claims or contents claims. The assumptions underpinning the 30 June 2017 valuation form the basis of the five-year forecast of the outstanding claims liability.

There is a high level of uncertainty associated with the valuation of the outstanding claims liability, reinsurance recoveries and unexpired risk liability. Some of the key uncertainties are

• outstanding litigation, particularly in respect of ILV land settlements
• the level of remedial activity required on repairs completed under the Canterbury Home Repair Programme, and
• the need to reach an agreed financial settlement position with 3rd parties such as insurers and reinsurers as the Commission seeks to finalise its liability

Presentation approach

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

NOTE 20: Retirement Plan Liabilities

The net liability of the Government Superannuation Fund (GSF) was calculated by GSF's actuary as at 30 June 2017. The liability arises from closed schemes for past and present public sector employees as set out in the Government Superannuation Fund Act 1956.

A Projected Unit Credit method was used to calculate the liability as at 30 June 2017, based on membership data at that date.

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 2017.

Other principal long-term financial assumptions were an inflation rate, as measured by the Consumers Price Index (CPI), of 1.67% for the 20 years to 30 June 2037, then increasing gradually each year to 2.0% in the year ended 30 June 2048 and remaining at 2.0% p.a. for all years after that. In addition an annual salary growth rate, before any promotional effects, of 2.5% (unchanged from 31 January 2017).

The 2016/17 projected decrease in the net GSF liability is $1,437 million, reflecting a decrease in the GSF liability of $1,134 million and an increase in the GSF net assets of $303 million.

The decrease in the GSF liability of $1,134 million includes an actuarial gain between 1 July 2016 and 30 June 2017, of $766 million, owing to movements in the discount rates partly offset by the impact of movements in CPI rates. The remaining $368 million reduction is owing to the current service cost, interest unwind and membership changes (increases the liability) offset by the lower than expected benefits to members (reduced the liability).

The increase in the value of the net assets of GSF of $303 million includes a gain of $289 million reflecting the updated market value of assets at 30 June 2017. The balance of $14 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 2016/17 onwards reflect the net of the expected current service cost, interest cost, investment returns and contributions.

NOTE 21: Provisions

Provision for ETS credits

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

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

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

The ETS impact on the fiscal forecast is as follows:

NOTE 22: Changes in Net Worth

NOTE 23: Core Crown Residual Cash

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

NOTE 24: Net Canterbury earthquake expenses (operating and capital)

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

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

Notes:

1. Some expenses are non-cash (eg, asset write-offs and impairments) and therefore do not have a cash element to them.

Forecast Statement of Segments#

Print this section

Forecast Statement of Segments (2017)

Forecast Statement of Segments (2018)

Forecast Statement of Segments (2019)

 

Forecast Statement of Segments (2020)

Forecast Statement of Segments (2021)