Pre-election Economic and Fiscal Update 2020

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

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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#

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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 (Update) is part of a suite of documents we release as required by the Public Finance Act 1989.

This Update 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#

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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 wellbeing. Our framework builds on 30 years of New Zealand and international evidence on wellbeing and provides a high-level framework on intergenerational wellbeing.

Understanding our path#

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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, please go to our website.

Statement of Responsibility#

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I make this statement in accordance with section 26W of the Public Finance Act 1989.

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 September 2020 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 September 2020. 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.

 

Caralee McLiesh
Secretary to the Treasury

10 September 2020

 

To enable the Treasury to prepare this Economic and Fiscal Update I have ensured all government decisions and other circumstances as at 7 September 2020 of which I was aware and that had material economic or fiscal implications have been communicated to the Secretary to the Treasury, in accordance with the requirements of the Public Finance Act 1989.

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 the omission from the Update under section 26V of the Public Finance Act 1989 of any decisions, circumstances or statements not incorporated in it.

 

Hon Grant Robertson
Minister of Finance

9 September 2020

Executive Summary#

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Note:

1. The fiscal measures for the 2020 fiscal year represent the unaudited actual results.

Sources: Stats NZ, the Treasury

• The COVID-19 pandemic continues to cause widespread economic and social disruption around the world. Infection rates are still rising in many parts of the world and the timeline for the development of a vaccine or effective treatment is still very uncertain. Community transmission re-emerged in New Zealand in August following a 102-day period during which there was no evidence of transmission, and the country returned to higher alert levels. These developments highlight the continued uncertainty about New Zealand's economic outlook.
• In addition to our main forecast, this Update provides three alternative forecast scenarios for the economy to reflect the continued uncertainties about the outlook. These scenarios include an earlier recovery in exports of services than assumed in our main forecast, an extended period of border controls and a resurgence in community transmission. The scenarios help illustrate the nature of the economic challenges ahead and the potential range of outcomes against which the public finances can be assessed.
• When the country moved down to Alert Level 1 in June, spending picked up, providing a boost to the domestic economy; however, a return to higher alert levels following the re-emergence of community transmission in Auckland in mid-August has slowed the pace of economic recovery, and the country's borders look likely to remain closed to travellers for an extended period of time.
• Our main economic forecasts include $58.5 billion of discretionary COVID‑19 fiscal support over the forecast period, more than the $35 billion included in the main Budget Economic and Fiscal Update (Budget Update).[1] Border restrictions are assumed to be lifted on 1 January 2022, with all international travel allowed from then. This forecast also allows for limited international travel to resume in mid-2021, reflecting the possible emergence of safe travel zones or a resumption in international education.
• The initial economic impact of COVID-19, while still large, has been less severe than anticipated in the Budget Update, with a faster-than-expected move down alert levels, and high-frequency activity indicators suggesting activity has picked up sooner than expected. Annual average GDP growth is now expected to fall to -3.1% in the June 2020 quarter, compared to -4.6% forecast in the Budget Update. Despite this improvement, the forecast contraction in GDP of 16.0% in the June 2020 quarter will far exceed previous records.
• Despite a less negative near-term outlook, the medium-term outlook has deteriorated owing to a deterioration in the global economic outlook, and to the fact that the effects of the COVID-19 pandemic are now expected to be more persistent. Annual growth averages 2.8% over the forecast period compared to 3.9% in the Budget Update, with real GDP at the end of the forecast period 2.5% below the Budget Update.
• Weaker real activity is the main driver of lower nominal GDP, with cumulative nominal GDP over the five years to June 2024 forecast to be almost $13 billion lower than in the Budget Update.
• Government support, and a faster move to lower alert levels, has helped to cushion the initial impact on unemployment. However, unemployment is expected to rise over the coming quarters as border restrictions weigh on activity and fiscal support is eased. We expect the unemployment rate to peak at 7.8% in the March 2022 quarter, lower and later than the peak of 9.8% in the September 2020 quarter forecast in the Budget Update.
• A slower domestic recovery in the medium term, together with weaker commodity prices and a higher exchange rate, is expected to result in lower inflation compared to the Budget Update over much of the forecast period. However, continued accommodative monetary policy support measures are expected to contribute to raising inflation towards 2.0%, the midpoint of the Reserve Bank's inflation target, by the end of the forecast period.
• A more negative outlook for the global economy is expected to slow the pace of economic recovery through several channels. Border restrictions lower export earnings, particularly in the tourism and education export sectors. The resulting impact on incomes, together with lower confidence, ultimately drives weaker consumption and investment. The loss of services exports associated with border restrictions contributes to the widening of the current account deficit to 5.6% of GDP by the September 2021 quarter.
• The economic impact of COVID-19, together with the Government's response, has had a significant impact on the Government's fiscal position. The 2019/20 and 2020/21 fiscal years show the biggest deterioration as tax revenue falls and the impact of the Government's COVID-19 fiscal support measures takes effect. As economic activity picks up, the forecast shows an uplift in tax revenue and at the same time some of the temporary fiscal support measures start to unwind, leading to the operating balance before gains and losses (OBEGAL) deficits narrowing from $31.7 billion in 2020/21 to $12.4 billion by 2023/24.
• Total core Crown tax revenue fell in the 2019/20 fiscal year and this trend is expected to continue over the next two years, primarily owing to the economic slowdown. The tax revenue forecasts then start to recover as economic activity starts to pick up. Compared to the Budget Update, the fall in tax revenue in 2019/20 and 2020/21 is smaller, with core Crown tax revenue falling to $84.7 billion in 2020/21 (Budget Update: $80.1 billion), and the recovery is slower over the remainder of the forecast period.
• Core Crown expenses have significantly increased in the 2019/20 fiscal year as a result of the Government's COVID-19 fiscal support measures. It is expected that core Crown expenses will continue to increase in the 2020/21 fiscal year, reaching $119.5 billion, then reduce as the Government's COVID-19 temporary fiscal support measures fall away.
• In the 2019/20 fiscal year, the Government has recorded an OBEGAL deficit of $23.4 billion, while net core Crown debt increased by $25.7 billion to be $83.4 billion. The OBEGAL deficit is expected to worsen to $31.7 billion in 2020/21, then start to recover. Over the forecast period (2020/21 to 2023/24), the Government's cash shortfall averages around $28 billion per year.
• The Government's strong balance sheet position prior to the COVID-19 pandemic has enabled the Government to absorb the fiscal impact from COVID-19 by increasing debt and running down net worth. From the start of the 2019/20 fiscal year, net core Crown debt increases by around $143 billion by 2023/24 to be $201.1 billion. Over the same period, net worth decreases by around $100 billion to be $43.5 billion in 2023/24. As a share of GDP, net core Crown debt continues to rise and reaches 55.3% by 2023/24.
• The weaker outlook in the 2023/24 fiscal year will mean the fiscal outlook over the projection period (2024/25 to 2033/34) will also be weaker compared to the Budget Update.

Economic Outlook#

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Summary#

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• The COVID-19 pandemic continues to cause major disruption to life and economic activity around the world. The recent re-emergence of community transmission of COVID-19 in Auckland, which was placed under Alert Level 3 restrictions while the rest of the country moved to Alert Level 2 in mid-August, highlights the continued uncertainty about New Zealand's economic outlook. Intermittent restrictions on gatherings and activities here and in other parts of the world indicate that the path of the pandemic remains uncertain, but it is likely that the pandemic will continue to impact economic activity for some time. The continued pervasiveness of COVID-19 since May is a major factor in a weaker world economic outlook compared to the Budget Update.
• New Zealand experienced 102 days without evidence of community transmission of COVID-19 after successfully eliminating the disease in May. The swifter move to lower alert levels than had been assumed in the Budget Update has been associated with an earlier and stronger rebound in activity levels prior to the renewed restrictions in mid‑August. Early indicators of activity from higher-frequency data suggest the economy bounced back to, or near, pre-COVID-19 levels by July 2020. This could suggest that the economic impact of each alert level has been less than initially assumed. While the impacts remain uncertain, we have revised down the assumed impact of the alert levels relative to the assumptions used in the Budget Update.
• The impact of COVID-19 remains substantial, particularly for those industries dependent on international tourism and education, and the contraction in GDP in the June 2020 quarter will far exceed previous records. The return of Alert Level 3 restrictions in Auckland and Alert Level 2 for the rest of the country is expected to dampen the rebound in GDP in the September 2020 quarter.
• Overall, the near-term economic outlook is less negative than that contained in the Budget Update, while the medium-term outlook is weaker. We now anticipate that real GDP declined by 16% in the June 2020 quarter, a historically large decline, but smaller than the near 24% decline forecast in the Budget Update. Annual average growth now reaches -3.1% in the June 2020 quarter compared to -4.6% forecast in the Budget Update. GDP falls a further 0.5% in the year to June 2021, with annual growth then averaging 3.9% over the final three forecast years. Persistent impacts of the pandemic are expected to reduce New Zealand's potential output, slowing the pace of recovery.
• We have assumed the government provides $58.5 billion of fiscal support over the forecast period, higher than the $35 billion included in the main Budget Update forecast. Much of the support is expected to take place in the 2019/20 and 2020/21 years, and the level of expenditure is consistent with the fiscal forecasts.
• The bounce-back in activity since the Alert Level 4 and 3 restrictions were lifted in May, along with extended fiscal support, is expected to have promoted worker retention, and prevented a sharper rise in the unemployment rate in the near term. However, extended border restrictions together with weaker world growth compared to the Budget Update are expected to slow the economic recovery. Unemployment peaks at 7.8% in the March 2022 quarter before easing to 5.3% by June 2024.
• The Treasury's working assumption is that border restrictions are lifted on 1 January 2022, nine months later than in the Budget Update. Border restrictions reduce export earnings, particularly in the tourism and education sectors. Border restrictions are assumed to begin easing from the September 2021 quarter onwards, allowing for a partial resumption of some services exports, possibly as a result of safe travel zones. The extended border restrictions, combined with a judgement that international tourism will take time to recover, see lower services exports throughout the forecast period.
• Weaker world growth affects export demand more generally and has a negative impact on the terms of trade. The impact on incomes, together with lower confidence, ultimately drives weaker consumption and investment than in the Budget Update over the medium term. Lower export revenue also widens the current account deficit to 5.6% of GDP by the September 2021 quarter.
• Weaker commodity prices, a higher exchange rate and a slower domestic recovery are expected to keep inflation lower than forecast in the Budget Update in the medium term before rising towards 2.0%, the mid-point of the Reserve Bank's inflation target, by the end of the forecast period, supported by accommodative monetary policy.
• Weaker confidence levels are forecast to dampen residential and investment activity over the forecast period after rebounding when the country moved down from Alert Levels 4 and 3. With net migration only beginning to make a sustained contribution to population growth after border restrictions are eased, total investment is over 3% lower by June 2024 compared to the Budget Update.
• Cumulatively, nominal expenditure GDP is forecast to be around $13 billion lower over the forecast period compared to the main Budget Update forecast. Stronger near-term activity is more than offset by a weaker global and domestic recovery, leading to a lower level of real GDP, while overall price pressures are broadly similar. Lower aggregate income in the economy is a major contributor to the deterioration in the fiscal outlook presented in the Fiscal Outlook chapter.
• This chapter provides several alternative paths the economy may take to reflect the continued uncertainties around how the pandemic may evolve. The alternative forecast scenarios illustrate the possible impacts if several COVID-19-related assumptions were altered. In particular, the following three scenarios are explored:
  • an earlier recovery in exports of services, which might reflect more effective safe travel zones or a stronger resumption in international education
  • an extended period of border controls as a result of a delay in the development of a vaccine or another form of effective treatment, and continued global transmission of COVID-19, and
  • a resurgence in community transmission that would require a return to higher alert levels in New Zealand.

Sources: Stats NZ, the Treasury

Economic Outlook#

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Activity rebounded after Alert Level 4 and 3 restrictions were eased, but COVID-19 is expected to dampen September 2020 quarter growth and the economic recovery…

The New Zealand economy benefited from earlier than expected downward movements through the alert levels, following the successful elimination of COVID-19 in the community in the first half of the year. This has paved the way for a shallower contraction and an earlier resumption in economic activity than had been previously assumed in the near term. However, the move to higher alert levels in mid-August is expected to have dampened the rebound in domestic activity in the September 2020 quarter. Elsewhere around the world, the course of the virus since the Budget Update has meant the global economic outlook has deteriorated. We now forecast a slower economic recovery over the medium term with the effects of the pandemic more persistent than assumed in the Budget Update.

There was a sharp recovery in high-frequency indicators of economic activity (such as traffic movements, electricity use and the New Zealand Activity Index (NZAC)) after the country moved down from Alert Levels 4 and 3, which possibly reflects that the economic impact of higher alert levels has been lower than first anticipated. These factors have led to an upward revision to forecasts of near-term economic growth. GDP is now expected to contract by 3.1% on an annual average basis in the June 2020 quarter, compared with 4.6% in the Budget Update. Much of the expected contraction will have occurred in the June 2020 quarter, continuing the smaller fall in economic activity in the March 2020 quarter. However, the earlier reopening of the domestic economy and the aforementioned indicators of economic activity suggest a shallower quarterly fall of 16%, less of a decline than the near 24% fall forecast in the Budget Update. The near-term economic activity box below explores recent developments and impacts of COVID-19 in more detail.

COVID-19 infections continue to rise around the world, and a weaker global economic recovery is expected, once a vaccine or another effective form of treatment is found. As world incomes fall, so too does demand for our exports. Weaker global activity is expected to reduce commodity prices and border restrictions will curtail services exports earnings. Even when borders are reopened, the pace of the recovery in New Zealand is expected to be slower than forecast in the Budget Update. This reflects economic scarring and the greater degree of uncertainty in the world economy, which in New Zealand will be felt particularly in communities for which international tourism is an important source of jobs. However, as the effects of the pandemic dissipate and the domestic economy is able to begin recovering in earnest, annual average growth rises to a peak of 6.5% in the March 2022 quarter before easing to 4.1% by June 2024, supported by continued accommodative monetary policy. Nevertheless, real GDP is expected to remain 2.5% lower than forecast in the June 2024 quarter compared to the Budget Update (Figure 1.1).

Figure 1.1 - Real production GDP

Sources: Stats NZ, the Treasury

Text description of Figure 1.1 – Real production GDP.

Table 1.2 and the economic assumptions box provide additional detail on the main forecasts, consistent with the requirements of the Public Finance Act 1989.

Sources: Reserve Bank of New Zealand (RBNZ), Stats NZ, the Treasury

Economic forecasts are presented on a June year basis for consistency with the fiscal forecasts.

Notes:

1. Business investment is the total of all investment types. It includes public investment but excludes residential investment.
2. Percent of the labour force, June quarter, seasonally adjusted.
3. Trade-weighted index, average for the June quarter.
4. Average for the June quarter.

…with consumption activity likely to be lower over the forecast period

Consumption activity rebounded after Alert Levels 4 and 3 restrictions were eased in the first half of the year, with households possibly using involuntary savings accumulated during Alert Levels 4 and 3 to satisfy pent-up demand. Households that had international travel plans were likely to have re‑evaluated them, given the current international travel restrictions and advice from the Ministry of Foreign Affairs and Trade. Government support during and since the Alert Levels 4 and 3 restrictions period will also have assisted in cushioning the impact on household incomes during the initial phases of the economic recovery. The renewed restrictions in mid-August are expected to dampen the rebound in consumption in the September 2020 quarter and may put additional pressure on household balance sheets.

As fiscal support eases over this half of the year and into 2021 however, consumption growth is forecast to ease, with annual average consumption growth contracting 6.4% inthe March 2021 quarter. Some households will continue to experience reduced work hours or shift to Jobseeker Support once the Wage Subsidy Scheme and COVID-19 Income Relief Payment (CIRP) comes to an end, while others may decide to increase precautionary savings as a result of the heightened uncertainties about future finances. The increase in term deposits since March may in part be attributable to such behaviour (Figure 1.4).

Figure 1.4 - Consumer lending and household deposits

Source: RBNZ

Text description of Figure 1.4 – Consumer lending and household deposits.

Consumption activity remains softer than forecast in the Budget Update, reflecting the weaker medium-term economic outlook and lower household incomes. Annual average consumption growth peaks at 7.0% in the March 2022 quarter, rather than 13.1% as forecast in the Budget Update (Figure 1.5). More persistent scarring effects from Alert Levels 4 and 3 restrictions, extended border closures and a weaker world recovery lead to a slower overall economic recovery in New Zealand via lower growth in labour market participation, a higher rate of structural unemployment and a lower rate of capital accumulation, which are discussed in more detail in the box below. The effects of a slower economic recovery are expected to be particularly felt in regions that have been reliant on international tourism spending.

Figure 1.5 - Real private consumption

Sources: Stats NZ, the Treasury

Text description of Figure 1.5 – Real private consumption.

Rising house prices over the medium term support the recovery in consumption growth…

Household wealth is an important influence on the macro economy, particularly via its impacts on consumer spending as growth in private consumption in New Zealand follows house price growth quite closely.

Housing market activity has been more resilient than expected in the Budget Update, supported by pent-up demand, involuntary savings during Alert Levels 4 and 3 and looser monetary conditions. However, various competing forces make the outlook for house prices particularly uncertain.

Border restrictions are likely to constrain net migration in the short term and heightened uncertainty around the economic outlook constrain demand for housing. Low interest rates and the temporary removal of the Reserve Bank's loan to value ratio restrictions are expected to provide some offset. On balance, we forecast a period of weaker house prices over the year to June 2021, with prices falling 5.1% from their March 2020 levels, dampening consumption growth (Figure 1.7). House prices then recover as net-migration rises, economic confidence recovers and monetary policy remains accommodative throughout the forecast period. Rising housing wealth is then expected to support the recovery in consumption growth over the final three years of the forecast period. However, given the recent resilience in the housing market, there are upside risks to our forecasts if current sentiment is maintained.

Figure 1.7 - House prices

Sources: CoreLogic, the Treasury

Text description of Figure 1.7 – House prices.

…along with higher net migration when borders are reopened

Net migration is expected to be substantially lower in the year ahead given the continued border restrictions. While many New Zealanders and permanent residents have returned to the country in recent months, the departure of temporary visa holders is expected to broadly offset arrivals. Extended border restrictions raise the risk of labour shortages, particularly in sectors that have previously been reliant on temporary visa holders, such as accommodation and food services; agriculture, forestry and fishing; and construction. Growth in these sectors may be held back by limited labour supply.

As border restrictions partially ease from the September 2021 quarter, net migration flows gradually rise to reach 35,000 by June 2024, the same end-point as assumed in the Budget Update. Rising net migration increases population growth and stimulates demand, supporting overall economic growth.

The weaker economic outlook raises unemployment despite early fiscal support…

Unemployment unexpectedly fell from 4.2% in the March 2020 quarter to 4.0% in the June quarter, which was partly attributable to measurement challenges encountered by Stats NZ during Alert Levels 4 and 3 in the first half of the quarter. However, extensive fiscal support measures are also expected to have played a large role in supporting household incomes and labour market attachment. The impacts COVID-19 and fiscal support have had on the labour market to date are explored in more detail in the box below.

An experimental weekly breakdown of the unemployment rate released by Stats NZ showed a clear upward trend over the June quarter, which was more in line with expectations and rising income support (such as Jobseeker Support) recipient numbers. Renewed restrictions on gatherings and social activity as a result of the move to Alert Level 3 in Auckland and Alert Level 2 elsewhere are expected to put further strain on businesses and firm viability remains a key uncertainty for the outlook.

As fiscal support measures ease over the year ahead and extended border closures prolong a period of reduced tourism and international education activity, unemployment is forecast to rise, peaking at 7.8% in the March 2022 quarter. This is both lower and later than the forecast peak in the Budget Update of 9.8% in the September 2020 quarter (Figure 1.8). The stronger than expected rebound in near-term activity after Alert Level 4 and 3 restrictions were eased in the first half of the year has led to a smaller rise in income support recipients than had been forecast. A higher level of fiscal support than had been assumed in the Budget Update is also expected to have supported aggregate demand in the months after the earlier restrictions on activity were lifted.

Figure 1.8 - Unemployment

Sources: Stats NZ, the Treasury

Text description of Figure 1.8 – Unemployment.

Over the medium term, weaker domestic demand stemming from reduced earnings from goods exports, and a slower recovery in tourism spending lowers employment growth. Unemployment remains persistently higher than forecast in the Budget Update from the June 2021 quarter onwards, trending down to 5.3% by June 2024. Even when borders are reopened fully in early 2022, demand for labour remains subdued, particularly if travel behaviours and preferences change in the aftermath of the pandemic. The persistent effects of the COVID-19 pandemic are expected to lead to a degree of economic scarring, leading to structurally higher unemployment as discussed in the Revising Potential Output box on page 20. Elevated levels of unemployment are expected to result in reduced wage inflation pressures over the medium term and contribute to slightly weaker inflation compared to the Budget Update.

…and the slower recovery keeps inflation subdued for longer

Inflation was stronger than forecast in the Budget Update in the March and June 2020 quarters. However, weaker commodity prices, a higher exchange rate and weaker recovery in demand are expected to cause inflation to fall, with annual inflation reaching a trough of 0.5% in the March 2021 quarter. A weaker world recovery combined with extended border restrictions then keeps annual inflation below the main Budget Update forecast scenario from the December 2021 quarter onwards (Figure 1.14). However, as the economy recovers and monetary policy continues to provide support, inflation gradually rises towards the Reserve Bank's 2.0% target midpoint by the June 2024 quarter.

Figure 1.14 - Consumers Price Index

Sources: Stats NZ, the Treasury

Text description of Figure 1.14 – Consumers Price Index.

Weaker global activity is likely to constrain investment growth…

Construction activity has resumed since Alert Level 4 and 3 restrictions were eased and the number of consents issued over the past year to July has largely recovered to levels recorded prior to the pandemic, which should indicate a strong pipeline of activity lies ahead. However, lower aggregate demand as a result of lower household incomes and population growth may lead to an increase in the number of projects facing delays or cancellations, a view corroborated by our discussions with industry representatives in June, where concerns were raised about their forward order books beyond December 2020.

Depressed levels of business confidence and lower aggregate demand over the forecast period are expected to slow the pace of recovery in investment compared to the Budget Update. The weaker global outlook is likely to lower export volumes and prices, reducing incomes. We now forecast business investment will remain below pre-COVID-19 levels until the March 2023 quarter, a year longer than expected in the Budget Update.

…and while New Zealand's export prices have been supported recently, the goods balance is forecast to return to a deficit…

The goods balance of the current account is expected to improve in the near term as imports decline, reflecting weaker overall domestic demand. Meanwhile, New Zealand's exports of goods have been fairly resilient and prices have fared reasonably well so far, which is expected to keep the annual trade balance in surplus over the remainder of 2020 (Figure 1.15). However, as the world economy slows, lower global demand is expected to put downward pressure on commodity prices, lowering the terms of trade and exporter incomes in the second half of 2020. The goods balance is therefore forecast to return to deficit from the June 2021 quarter and remain there through to the end of the forecast period. The deficit in the goods balance is expected to widen over time from a combination of goods exports growth being constrained by the world outlook, and rising domestic demand for imports as household incomes rise.

Figure 1.15 - Current account balance and its components

Sources: Stats NZ, the Treasury

Text description of Figure 1.15 – Current account balance and its components.

…leading to a widening current account deficit as services exports will also be constrained by extended border restrictions

While New Zealand's goods balance deficit is usually at least partially offset by a positive services balance, extended border restrictions compared with the Budget Update mean that international tourism and education activities are reduced substantially in the year ahead. Some of the reduced international tourism activity will be offset by an increase in domestic tourism activity. However, increased domestic tourism will show up as increased consumption rather than services exports in the national accounts. The magnitude of the increase is also unlikely to fully offset the reduction in international spending.

The services balance is therefore forecast to fall into deficit for the first time since 1998, where it is forecast to remain until the June 2023 quarter, well after the borders restrictions are assumed to ease. This reflects negative impacts on household income globally and a possible change in traveller behaviours in the aftermath of the pandemic. Capacity on international air routes may also take some time to be fully re‑established. Global travel is therefore expected to require some time to return to previous levels.

Combined with the weaker outlook for the exports of goods, this services deficit means that the annual current account deficit is forecast to widen to a peak of 5.6% of GDP by the September 2021 quarter, which is narrower and later than the 5.7% deficit forecast in the June 2021 quarter in the Budget Update.

The global economy is expected to take longer to recover…

The COVID-19 pandemic continues to take a severe toll on human health around the world. Total COVID-19 cases exceeded 25 million and over 900,000 people had lost their lives as at mid-September 2020. The disruption to economic activity has been extremely severe, although there has been a wide range of economic outcomes in our trading partners in the June 2020 quarter. Quarterly GDP in China grew 11.5%, following a fall of 10.0% in the March quarter, but falls were recorded in our other main trading partners in the June 2020 quarter, ranging from 1.4% in Taiwan and 3.2% in South Korea to 20.4% in the United Kingdom and 25.6% in India. However, easing restrictions in many parts of the world has enabled a substantial recovery in activity to occur. Global indexes of manufacturing and services activity have strengthened from their lows in the June quarter, indicating global economic activity is recovering; however, renewed outbreaks of the virus in some parts of the world, including Europe and Australia, may temper the pace of the recovery.

The International Monetary Fund's (IMF) June 2020 World Economic Update forecasts global growth at -4.9% in 2020 and 5.4% in 2021, down from -3.0% and 5.8% respectively at the time of its April forecasts. The downward revisions reflected additional disruption to activity from social distancing measures persisting into the second half of 2020 and long lasting harm (scarring) occurring from the restrictions on activity in the first half of the year. The Organisation for Economic Cooperation and Development’s (OECD’s) June 2020 Economic Outlook suggests even weaker outcomes are possible. Both the IMF and OECD updates provide scenarios where a second wave of infection would create a more dire situation than a single wave scenario, and the OECD noted that either situation is equally likely to occur.

In light of recent events, we now expect a more gradual economic recovery for our trading partners than earlier assumed. Activity in the economies of our trading partners is assumed to contract 3.3% in the 2020 calendar year, before bouncing back 5.5% in 2021 (Figure 1.16). Compared with global growth overall, China's economic growth is relatively more important for growth in our main trading partners, accounting for almost one third of New Zealand's trade. China is expected to grow modestly in 2020 and to continue to provide support for New Zealand's exports. However, the outlook for trading partner growth is conditional on the pandemic being brought under control in coming months and public health restrictions being progressively eased. In some countries, the nascent recovery is being threatened by renewed outbreaks of the virus, increasing the risks that the recovery will be more gradual. The alternative scenarios consider the implications of slower growth in our main trading partners for the economic outlook.

Figure 1.16 - Trading partner growth

Source: The Treasury

Text description of Figure 1.16 – Trading partner growth.

…and our trading partners will have different impacts from COVID-19

Output in China returned to pre-COVID-19 levels in the June quarter following a 10.0% fall in the March quarter. The recovery in China is expected to help stabilise economic conditions across Asia, particularly in the industrial sector, and to underpin a broader recovery over 2021. Tourism, however, which is important to a number of economies in the region, has weakened considerably and is likely to continue to have a considerable dampening effect on activity. Weaker global demand more generally will also restrain the pace of recovery across the Asia-Pacific region.

In Australia, measures to contain the spread of the virus resulted in a 7.0% quarterly contraction in output in the June 2020 quarter, the largest fall since records began. Employment has fallen considerably and the unemployment rate has risen from 5.1% in February 2020 to 7.5% in July. Australia experienced a period of easing restrictions earlier in the year, before a renewed outbreak in Victoria resulted in a period of tighter containment measures. It is likely that the outbreak of the virus in Victoria will dampen the rebound in quarterly Australian GDP in the September 2020 quarter and slow the pace of recovery.

Very substantial monetary and fiscal policy support is helping to prevent a deeper recession in Australia. The Australian government's support measures, together with declines in revenue and increases in expenses, are expected to result in budget deficits equivalent to 4.3% of GDP in the year ending June 2020 and 9.7% of GDP in the year ending June 2021.

The human and economic costs of the pandemic have been especially severe in the United States. The number of confirmed cases and fatalities is the highest in the world, and rising. Measures to contain the virus led to output falling 9.6% in the June quarter, while the unemployment rate increased to 14.7% in April, from 3.5% in February. An easing of restrictions has enabled a recovery in activity to begin, and the unemployment rate declined to 8.4% in August. However, in some states, easing of restrictions has been associated with renewed COVID-19 outbreaks. This has led some states to partially reverse earlier easing measures or to postpone planned easing. Ongoing disruption to activity and heightened uncertainty are likely to restrain private sector spending and slow the pace of recovery.

Nominal GDP is weaker than forecast in the Budget Update

A weaker world outlook and the slower pace of domestic recovery mean that New Zealand's real GDP is cumulatively reduced by around 2.5% compared to the Budget Update. Weaker domestic prices and a lower terms of trade mean that nominal GDP is lower by a cumulative $13 billion (-0.9%) over the forecast period compared to the main Budget Update forecast. These changes in overall income in the economy have a significant negative impact on tax revenue and the government's fiscal position, as outlined in the Fiscal Outlook chapter.

Alternative Scenarios#

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The outlook for the economy continues to remain uncertain. This uncertainty stems from multiple factors including the evolution of the virus and the development of effective vaccines and treatments; the pace of the recovery; the extent of long-term reductions in output (‘scarring'); and the implications of persistently high unemployment that may arise from business failures and the necessary changes in business operations. These factors may be inter-related: earlier control of the pandemic is likely to facilitate a stronger recovery and reduce the risks of long-term damage to the economy. Alternatively, the longer the virus continues to spread and disrupt economic and social activity, the slower the pace of recovery and the greater the risks of long-lasting scarring.

The Government policy response has focused on measures to protect viable businesses, sustain employment and create new business opportunities. The level of fiscal support has been very considerable to date, but additional support may be provided if the virus proves difficult to contain. How businesses and households respond is also important to the outlook. Their behaviour will be affected by uncertainty and confidence around developments in health, income and wealth.

Reflecting this uncertainty, the Treasury has constructed three alternative scenarios to the main forecast described above. The approach here differs from the usual upside (or stronger) and downside (or weaker) growth scenarios presented in the past to highlight the sensitivity of the outlook to particular assumptions that are highly uncertain. Each scenario incorporates the same initial fall in real GDP expected in the June 2020 quarter and the same anticipated recovery in the September 2020 quarter but then incorporates different assumptions about the pace of the recovery, the course of the virus, the degree of long-term scarring and the extent of monetary and fiscal support.

Compared to the main forecast:

• In the earlier recovery in services exports scenario, the recovery in services exportscommences earlier, and is stronger than in the main forecast, and leads to stronger real GDP growth. This might be consistent with the development of policies and procedures that reduces the risks to public health associated with international travel and enables some easing of travel restrictions between selected countries. Business investment would be stronger and the unemployment rate would be lower. The difference in real GDP is modest at the end of the forecast period.
• In the extended border controls scenario, the recovery in services exports is weaker. This might be consistent with a world where no form of effective treatment is found, leading to strict border controls being maintained indefinitely. Global economic growth would be weaker and export returns would be lower. These conditions would result in increased business failure, weaker investment and persistently higher unemployment as the structure of the economy changes. Additional monetary policy support is likely to be required to meet the Reserve Bank’s policy targets. The deeper scarring effects contribute to a reduction in real GDP of about 3% at the end of the forecast period.

• In the resurgence in community transmission scenario, real GDP contracts sharply in the December 2020 quarter and, following a rebound in the subsequent quarter, thereafter grows at a similar pace to the main forecast. It is assumed the country would return to stricter control measures for some time if there is a resurgence in community transmission of COVID-19. Despite additional fiscal support, business failures would increase, household consumption would be lower and the unemployment rate would be persistently higher. Real GDP is 1% lower at the end of the forecast period.

Figure 1.17 - Real GDP

Sources: Stats NZ, the Treasury

Text description of Figure 1.17 – Real GDP.

Taken together, the scenarios help illustrate the nature of the economic challenges ahead and the potential range of outcomes against which the public finances can be assessed. However, we have no means of gauging which of these outcomes is more plausible, nor do we believe they cover the entire range of plausible outcomes.

Key assumptions and judgements in the scenarios 

As described above, the outlook in the main forecast is conditioned on several key assumptions around which there is great uncertainty. The three alternative scenarios - constructed from a range of many possibilities - help illustrate the sensitivity of the outlook to those assumptions. The changes we make to these assumptions are discussed below. In both the extended border controls scenario and the earlier recovery in services exports scenario, we proceed by changing our assumptions about the stringency of border controls and relate these to different possibilities regarding the course of the pandemic and behavioural responses, but the scenarios are open to a range of other possibilities. In contrast, the resurgence in community transmission scenario proceeds from an assumption regarding the course of the pandemic and the behavioural responses that may stem from that. In this way, the scenarios highlight both the sources of uncertainty stemming from judgements within the forecasting environment and those arising from the pandemic.

Key assumption 1: Restrictions on international travel are fully eased on 1 January 2022 

The timing, speed and extent of the recovery in domestic and global activity will be affected by measures that are taken around the world to contain the spread of the virus and to support economic activity. At present, restrictions on the movement of people within and between countries are an important part of the international response to the pandemic. In the main forecast, restrictions on inbound travel to New Zealand are assumed to ease partially from 1 July 2021 and to be removed completely from 1 January 2022. This might be consistent with the development and deployment of a vaccine or treatment within the next year, and with other means to manage the health risks of the pandemic such as enabling travel between countries with a low incidence of COVID-19 infection.

In the absence of such developments, stricter or longer-lasting restrictions on the movement of people are likely to lead to slower global growth and to dampen prospects for a recovery in New Zealand's goods and services exports. Alternatively, the extent to which border controls are eased on 1 July 2021 may be greater than assumed in the main forecast or, for a given set of easing measures, there may be greater capacity to accommodate travel to New Zealand than assumed in the main forecasts. This might be consistent with the introduction of protocols and procedures that enable restrictions to be eased on travel for some purposes, such as education and employment, or for a wider range of countries than assumed in the main forecast. In addition to uncertainty about when, and by how much, border restrictions might be eased, there is uncertainty surrounding the pace of recovery in both travel demand and travel industry capacity.

In the earlier recovery in services exports scenario, the partial easing of restrictions enables services exports to recover more strongly in the second half of 2021. A further pick-up is assumed when all restrictions are lifted on 1 January 2022. We assume that travel services subsequently grow at a similar rate to the main forecast. In this scenario, services exports are 4% below their pre-virus level at the end of the forecast period (Figure 1.18). In the extended border controls scenario, the recovery in services exports is more gradual and, at the end of the forecast period, services exports are 35% below their pre-virus level; this compares with a 14% decline in the main forecast (Figure 1.18).

Figure 1.18 - Services exports

Sources: Stats NZ, the Treasury

Text description of Figure 1.18 – Services exports.

Key assumption 2: Virus transmission control measures do not tighten significantly

The main forecasts assume the ongoing successful prevention of transmission from cases that might arrive in New Zealand once the outbreak of community transmission in mid‑August is contained. Nonetheless, there is a risk that widespread community transmission may reoccur. In this scenario, stricter transmission control measures are likely to be re-introduced, particularly in the absence of an effective vaccine, and economic activity considerably disrupted.

In the resurgence in community transmission scenario, we assume that public health measures are significantly tightened in the December 2020 quarter. We also assume that fiscal support to households increases by $5 billion, beginning in the December quarter and extending for the rest of the 2020/21 fiscal year. Despite additional fiscal support, December 2020 quarter GDP is around 4.5% lower than in the previous quarter. This might be consistent with a nationwide return to Alert Level 3 for a period followed by a period at Alert Level 2, and a subsequent easing to Alert Level 1. In this scenario, we assume Alert Level 3 restrictions are in place for three weeks and Alert Level 2 restrictions are in place for six weeks. The scenario might also be consistent with more stringent and/or prolonged restrictions only applying to some regions.

Key assumption 3: The degree of scarring in the economy

The extent of the recovery in GDP will also be affected by developments in the economy's productive capacity. As discussed in the box on page 20, the main forecast assumes output is permanently lower than it would be in the absence of the pandemic. Factors reducing output include lower investment, reduced on-the-job training and, particularly in sectors exposed to international travel, the scrapping of some assets that are unable to be redeployed elsewhere, including physical, human and intangible capital.

Figure 1.19 - Real business investment

Sources: Stats NZ, the Treasury

Text description of Figure 1.19 – Real business investment.

The scale of these effects is uncertain and it is possible that there could be a larger impact, particularly if uncertainty about future demand persists for longer than assumed and firms become less willing to innovate and invest. In the labour market, there is a risk unemployment is persistently higher than in the main forecast, increasing the loss of human capital and slowing the pace of skill acquisition and productivity growth in the economy.

More pronounced scarring impacts might be consistent with both the extended border controls scenario and the resurgence in community transmission scenario. In the extended border controls scenario, weaker travel demand and persistent uncertainty further depress business investment. The negative impacts on the economy's productive potential accumulate over time, reflecting the slower pace of capital accumulation. Persistent uncertainty might also make firms more cautious about expanding employment and unemployment may decline more gradually. In this scenario, potential output is 1% lower at the end of the forecast and the unemployment rate is 6.6%, compared to about 5.3% in the main forecast. This has implications for wage and price inflation: the lower level of potential output means that there is less spare capacity in the economy, which puts more upward pressure on prices relative to the main forecast, but in the labour market, spare capacity is greater, leading to weaker wage growth and relatively less inflationary pressure.

In the resurgence in community transmission scenario, the increased risk of business failure and heightened uncertainty are likely to weigh on business expansion and household spending. In this scenario, unemployment is likely to be higher, although additional fiscal support is assumed to mitigate the extent of the rise. The unemployment rate peaks at about 9.4% and potential output is about 0.6% lower at the end of the forecast period than in the main forecast. The NAIRU is assumed to be 5.1% at the end of the forecast period, higher than 4.8% in the main forecast, and the unemployment rate is about 5.8% at the end of the forecast period.

Alternatively, the unemployment rate might decline more quickly than in the main forecast if the negative effects of the pandemic are not as severe as anticipated. This might be consistent with the earlier recovery in services exports scenario.

Figure 1.20 - Unemployment rate

Sources: Stats NZ, the Treasury

Text description of Figure 1.20 – Unemployment rate.

Key assumption 4: The global economic outlook

Developments in the world economy are important to the nature of the domestic recovery. In the main forecast, the outlook for growth in New Zealand's main trading partners is conditional on continued easing in lockdown measures and no further significant disruption in activity. The need for more prolonged or stricter pandemic control measures in our main trading partners would likely slow the pace of recovery and dampen demand for New Zealand exports. Moreover, continued disruption to trading partner activity raises the risk of scarring impacts in the affected countries and in New Zealand. In the extended border controls scenario, we assume growth in our major trading partners is 0.5 percentage points weaker in each year than in the main forecast. This reduces export returns and contributes to weaker business investment, lower employment and more subdued household consumption spending. Persistent uncertainty is assumed to exacerbate these effects, although the scale of the impact is difficult to judge and even weaker outcomes are possible.

Key assumption 5: Fiscal and monetary policy support

Fiscal and monetary support for individuals, workers and firms is helping to alleviate the extent of disruption to economic activity and reduce the risk of further long-term damage. The effectiveness of these policies and decisions to cease, maintain or increase support will be important to the path of the economic recovery. As discussed above, the main forecast makes assumptions across each of these dimensions, all of which are highly uncertain.

Each of the three alternative scenarios is associated with a particular combination of monetary and fiscal responses that reflects the trajectory of key variables within the scenario, including inflation and unemployment. This helps to illustrate the conditional nature of policy responses to the economic outlook. For example, fiscal support might be further increased in response to developments that raise the risk of long-lasting damage to the economy. As discussed above, this might be consistent with the return of strict public health measures and the increased risk of firm failure and household hardship that would bring.

Importantly, the conditioning of the forecasts runs both ways. For example, the main forecast is conditioned on market expectations for interest rates, which imply a fall over the next year, and the trade-weighted exchange rate remaining around its June quarter level. However, there is no New Zealand precedent for the Reserve Bank's monetary policies and much uncertainty surrounds the outcomes of the policies and their implications for future policy choices.

In scenarios where increased uncertainty restrains the pace of the recovery, it might be necessary to ease monetary conditions further to achieve the Reserve Bank's inflation and employment objectives. In the extended border controls scenario, we assume that monetary conditions are eased by the equivalent of a two percentage point reduction in the policy interest rate (the OCR) by the end of December 2022. This might be consistent with an expansion of the Bank's Large Scale Asset Purchases programme. We also assume the exchange rate declines gradually, reflecting the weaker terms of trade, and is around 9% lower at the end of the forecast period (Figure 1.21). The path of the exchange rate has implications for inflation; in this case, it puts upward pressure on the price of imported goods relative to the main forecast.

Figure 1.21 - Trade-weighted exchange rate

Sources: Stats NZ, the Treasury

Text description of Figure 1.21 – Trade-weighted exchange rate.

In the resurgence in community transmission scenario, additional fiscal spending of around $5 billion in 2020/21 helps smooth the impacts of temporary income losses, and the lingering effects on consumption and investment are addressed through an easing in monetary conditions equivalent to a reduction in the policy interest rate of about one percentage point. The exchange rate is about 1.4% lower from the December 2020 quarter onwards (Figure 1.21).

Alternatively, an earlier recovery in domestic demand, which might be consistent with the earlier recovery in services exports scenario, is likely to be associated with reduced monetary policy accommodation and a higher exchange rate (Figure 1.21). The fiscal policy assumption is the same as in the main forecast.

Key assumption 6: The impact of the pandemic on inflation

Over the medium term, the paths of wages and prices are important drivers of government tax revenue. It is clear that the pandemic is creating significant spare capacity in the economy, particularly in those sectors of the economy dependent on travel and tourism. However, it is highly uncertain how domestic prices will respond to the pandemic. With movements across the border tightly controlled, lower prices in dependent sectors may have little impact on demand. If demand rises only modestly when prices are cut significantly, firms' profits may fall. Moreover, firms that have experienced large falls in cash flows may be reluctant to cut prices or to take on credit.

As discussed above, there is the potential for inflation to be affected by movements in the exchange rate and by the interaction of potential output and aggregate demand. In both the extended border controls and the resurgence in community transmission scenarios, the lower exchange rate puts upward pressure on inflation. At the same time, persistent weakness in activity results in downward pressure on inflation. However, scarring reduces the economy's potential output, which reduces excess capacity in the economy and partially attenuates the negative inflationary effects of weaker demand (Figure 1.22).

In the earlier recovery in services exports scenario, the faster recovery in domestic demand reduces spare capacity and puts upward pressure on inflation (Figure 1.22). However, firms might choose not to increase their prices as demand returns, in order to rebuild their customer base. In this case, inflation might be weaker than assumed. The higher exchange rate is a source of downward pressure on inflation. Firms may also choose to boost investment, perhaps to take advantage of changes in preferences and behaviours resulting from the pandemic experience, which could raise productivity and reduce inflationary pressures.

Figure 1.22 - Inflation (Consumers Price Index)

Sources: Stats NZ, the Treasury

Text description of Figure 1.22 – Inflation (Consumers Price Index).

In all these scenarios, the relationship between spare capacity and inflation is assumed to be as responsive as it is in normal times, despite historically high levels of spare capacity. In recent times, the historical relationship between inflation and spare capacity appears to have weakened, further adding to uncertainty around the outlook for inflation and for monetary policy.

Nominal GDP, the operating balance and net government debt under the scenarios

The combined effects of the alternative scenario assumptions for real GDP, the terms of trade, consumer price inflation and other prices in the economy are reflected in nominal GDP and in the fiscal aggregates. Cumulative nominal GDP is weakest in the resurgence in community transmission scenario, reflecting weaker real GDP and lower inflation, particularly over the first half of the forecast period (Figure 1.23). Compared to the main forecast, nominal GDP is weaker in each of the four fiscal years ending June 2024, and the cumulative reduction in GDP is slightly over $23 billion (or 1.8%). The loss in GDP is slightly under $23 billion (1.7%) in the extended border controls scenario. In contrast, real GDP and inflation are strongest in the earlier recovery in services exports scenario, which lifts the cumulative level of nominal GDP by about $22 billion (1.6%) compared with the main forecast.

Figure 1.23 - Nominal GDP

Sources: Stats NZ, the Treasury

Text description of Figure 1.23 – Nominal GDP.

The weaker outlook for nominal GDP in the extended border controls and the resurgence in community transmission scenarios flows through to lower tax revenue and higher operating expenses, the latter partly driven by increased welfare expenses. In the resurgence in community transmission scenario, increased fiscal support further raises operating expenses, and the operating balance before gains and losses (OBEGAL) deficit is about $7 billion higher in 2020/21 and about $2 billion higher in subsequent years than in the main forecast (Figure 1.24). In this scenario, net core Crown debt rises to about $214 billion (59% of GDP) in 2023/24 (Figure 1.25), compared to $201 billion (55% of GDP) in the main scenario.

In the earlier recovery in services exports scenario, stronger nominal GDP growth supports tax revenue and lower unemployment contributes to reduced operating expenses. As a result, OBEGAL deficits are about $2.4 billion lower, on average, from 2021/22 onwards than in the main forecast (Figure 1.24). In 2023/24, the OBEGAL deficit narrows to about $10 billion (3% of GDP) and net core Crown debt is about $194 billion (52% of GDP). In the extended border controls scenario, weaker nominal GDP growth and higher operating expenses result in wider OBEGAL deficits than in the main scenario (Figure 1.24). Net core Crown debt is about $208 billion (59% of GDP) in 2023/24 (Figure 1.25).

Figure 1.24 - Total Crown OBEGAL deficits

Source: The Treasury

Text description of Figure 1.24 – Total Crown OBEGAL deficits.

Figure 1.25 - Net core Crown debt

Source: The Treasury

Text description of Figure 1.25 – Net core Crown debt.

Fiscal Outlook#

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Summary#

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• The economic impact of COVID-19, coupled with the resulting Government fiscal response, will have a significant impact on the Government's finances, with ongoing operating deficits and an increasing level of debt.
• In the 2019/20 fiscal year, the Government has recorded an operating balance before gains and losses (OBEGAL) deficit of $23.4 billion, while net core Crown debt increased by $25.7 billion to be $83.4 billion.
• Over the next four years significant OBEGAL deficits are expected and net core Crown debt continues to rise, reaching $201.1 billion by 2023/24.
• The impact from COVID-19 on the Government's finances are hardest felt in the 2019/20 and 2020/21 fiscal years as economic activity slows reducing tax revenue and the Government's support measures take effect. Beyond 2020/21, as economic activity picks up, the forecast shows an uplift in tax revenue. At the same time a majority of the Government's temporary fiscal support measures unwind, leading to a recovery in the Crown's operating balance indicators.
• In the 2019/20 fiscal year, there was an OBEGAL deficit of $23.4 billion. This deficit is forecast to increase to a deficit of $31.7 billion in 2020/21, before beginning to reduce in 2021/22. OBEGAL deficits average $16.2 billion over the last three years of the forecast.
• The Government's strong balance sheet position prior to the COVID-19 pandemic has enabled the Government to absorb the fiscal impact from COVID-19 by increasing borrowings and running down net worth.
• Beyond 2019/20, net core Crown debt is expected to increase on average by around $29.4 billion per year across the forecast and as operating deficits begin to reduce so too does the annual increase in net core Crown debt. Net core Crown debt is forecast to reach 55.3% of GDP by the end of the forecast period.
• In the Budget Update, the Government signalled funding of $62.1 billion to respond to and recover from COVID-19. This included the establishment of the $50 billion COVID‑19 Response and Recovery Fund (CRRF). To date, $35.9 billion of the CRRF has been applied by the Government, leaving $14.1 billion for the Government to allocate in the future. The estimated costs of some individual initiatives funded from the CRRF have been updated, resulting in an overall reduction in the fiscal impact of around $4 billion from the CRRF, compared to the Budget Update.
• In addition to the Government's fiscal support measures, the Reserve Bank is continuing to employ monetary policy measures such as the Large Scale Asset Purchases (LSAP). This programme has been expanded to $100 billion, up from the previous $33 billion limit reported in the Budget Update.
• In 2019/20, compared to the Budget Update, most key fiscal indicators have come in stronger on the back of the economy holding up better than expected and lower than forecast Government spending. Over the next three years the difference to the Budget Update is largely owing to the change in the profile of the Government's COVID-19 fiscal support measures.
• The OBEGAL deficit outlook by the end of the forecast period is expected to be weaker, reflecting a slower-paced economic recovery and an increase in expenditure from COVID-19 fiscal support measures. The weaker outlook in the 2023/24 fiscal year will mean the fiscal outlook over the projection period (2024/25 to 2033/34) will also be weaker compared to the Budget Update, with OBEGAL deficits continuing out to 2033/34.
• There is added uncertainty in these forecasts in relation to the size of the economic impact, and the pace of recovery. The Economic Outlook chapter discusses these uncertainties and provides some scenarios to illustrate the range of potential outcomes.
• These forecasts are sensitive to a number of judgements and assumptions and should be read in conjunction with the Risks to the Fiscal Forecasts chapter.

Note:

1. '2019 Actual' numbers have been restated to reflect updated accounting standards. For more details refer to the forecast financial statements note 17 on page 158.

Source: The Treasury

This chapter has three sections:

• 30 June 2020 actual results - this covers the fiscal results of the 2019/20 fiscal year, based on the unaudited financial statements of the Government for the year ended 30 June 2020
• Short-term outlook - this covers the fiscal forecasts for the period from 2020/21 to 2023/24, and
• Medium-term outlook - this covers the fiscal projections for the period from 2024/25 to 2033/34, based on assumptions that extrapolate the conditions existing in the final year of the forecast period.

30 June 2020 Actual Results#

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This section of the chapter focuses on the 30 June 2020 unaudited actual results. The timing of the 2020 Pre-election Update has meant the Treasury has prepared the Financial Statements of the Government for the year ended 30 June 2020, which are now subject to audit. The unaudited numbers for the 2019/20 fiscal year have been used throughout this document.

The Financial Statements of the Government for the year ended 30 June 2020 will not be finalised until the audit is completed; therefore the numbers discussed in this section are subject to change. It is difficult to determine whether there will be any material differences; however, recent history suggests audit changes have had a minimal impact on the Government's key fiscal indicators. In addition, the release of June 2020 quarter GDP data on 17 September 2020 will change the GDP ratios of key fiscal indicators for the 2019/20 fiscal year presented in the Fiscal Outlook chapter.

Similar to the forecasts, the 30 June 2020 unaudited actual results are underpinned by a number of judgements, estimates and assumptions. The COVID-19 pandemic has meant there is more uncertainty around the key judgements, estimates and assumptions used in asset and liability valuations, and in determining accrued revenues and expenses.

The Government's fiscal position has significantly deteriorated during the 2019/20 fiscal year…

COVID-19 has had a significant impact on the Government's results for the 2019/20 fiscal year, with large deficits, increasing debt levels and a fall in net worth.

In the 2019/20 fiscal year, there was an OBEGAL deficit of $23.4 billion compared to an OBEGAL surplus of $7.4 billion in 2018/19. Likewise, residual cash is in a deficit position of $23.7 billion, and as a result net core Crown debt has increased to $83.4 billion in the 2019/20 year from $57.7 billion in 2018/19.

…as a slowdown in the economy combined with one-off items last year has contributed to a decrease in core Crown tax revenue…

Overall, core Crown tax revenue is lower by $1.6 billion from last year to be $84.9 billion in the 2019/20 fiscal year. The slowdown in economic activity owing to the COVID-19 pandemic and the one-off increase to core Crown tax revenue recognised last year from the implementation of Inland Revenue's new system have contributed to a decrease in core Crown tax revenue.

A change in tax revenue estimation[12] using the Treasury's forecast of firms' net operating surplus for the 2020 and 2021 income tax years has reduced tax revenue by $0.5 billion. The calculation for the 2020 and 2021 income tax years differs from previous years (and other years in the forecast), in which income tax assessments were based on 105% of the prior year terminal tax. This change is to recognise the impact of COVID-19 on taxable income in 2020 and 2021, and in particular the impact from New Zealand entering the Alert Level 4 lockdown on 25 March 2020. As a result, the percentage applied to terminal tax is 102.8% for the 2020 income tax year and 96.45% for the 2021 income tax year, rather than the standard increase of 105%.

In addition to the change in tax revenue estimations, a significant part of the decrease in core Crown tax revenue from 2019/20 was owing to the 2018/19 tax revenue being higher primarily as a result of the implementation of Inland Revenue's Simplified Tax and Revenue Technology (START) system in the 2018/19 year, which impacted how tax revenue is calculated and resulted in a one-off increase in that year.

Across the main tax types, corporate tax fell by $3.3 billion (21.0%) in 2019/20, mainly reflecting this one-off boost in the 2018/19 year discussed above but also reflecting a $0.3 billion reduction owing to the change in estimation noted above. GST revenue decreased by $0.1 billion (0.5%) in 2019/20, mostly owing to weaker private consumption, residential investment and overseas tourist spending in New Zealand in the last part of 2019/20.

Partially offsetting these reductions in tax revenue, source deductions, which are mainly PAYE on wages and salaries, grew by $1.9 billion (5.9%) in 2019/20. Growth in 2019/20 came mainly from wage increases, but was also aided by the Wage Subsidy supporting employment through the June quarter. Other tax types were relatively static compared to 2018/19.

...while the Government's COVID-19 fiscal support measures have driven a significant increase in core Crown expenses...

In nominal terms, core Crown expenses increased by $21.8 billion (25.1%) to $108.8 billion. The largest driver of growth in nominal core Crown expenditure was the Government’s fiscal support measures in response to COVID-19, which made up around $16.7 billion of additional operating expenditure in the 2019/20 year. The Government’s Budget 2019 and Budget 2020 decisions also contributed to this growth. At the time of announcement, these decisions were forecast to increase core Crown expenses in 2019/20 by $3.8 billion in total.

Within core Crown expenses the most significant growth was in expenses related to social assistance spending which increased by $14.6 billion, from $29.0 billion in 2018/19 to $43.6 billion in 2019/20. This increase was largely owing to the Wage Subsidy Scheme that was put in place to support businesses and workers who are financially impacted by COVID-19. Payments from this scheme totalled $12.1 billion in the 2019/20 year.

However, the scheme was temporary and the Resurgence Wage Subsidy Scheme finished on 3 September 2020, so these subsidies are expected to have less of an impact beyond 2019/20.

…the net profits from SOEs and Crown entities have declined…

The combined operating results of State-owned enterprises and Crown entities have contributed around $5.0 billion to the OBEGAL deficit. A number of State-owned enterprises and Crown entities were impacted by reductions in revenue and increases in expenditure owing to the impacts of COVID-19 (eg, Air New Zealand and the New Zealand Transport Agency). Increases in insurance expenditure also adversely impact OBEGAL for Crown entities such as the Accident Compensation Corporation (ACC) and the Earthquake Commission (EQC).

…and net losses have increased the operating balance deficit

Overall, total net losses for the year were $8.1 billion, largely owing to $6.0 billion of losses in relation to the valuation of the long-term liability for ACC[13] outstanding claims largely as a result of a fall in discount rates, $3.3 billion of losses recognised relating to the LSAP programme owing to current market prices for these bonds being higher than when the bonds were issued (refer box on page 60), and $1.1 billion in relation to the Emissions Trading Scheme (ETS) (owing to an increase in the carbon price used to value the ETS liability). These valuation losses were partially offset by $1.9 billion in investment gains mostly from the New Zealand Superannuation Fund (NZS Fund) and ACC investment activities.

When these net losses are combined with the OBEGAL deficit (and including surpluses from associates and joint ventures), the operating balance for 2019/20 was a deficit of $30.3 billion.

The decline in the operating results also flow through to core Crown residual cash…

The net core Crown operating cash flow for the 2019/20 fiscal year is a deficit of $14.3 billion largely as a result of static tax receipts and an increase in cash payments in relation to the Government's fiscal support measures in response to COVID-19.

In addition, the Government has spent $9.4 billion on capital investments in 2019/20, which was $2.6 billion higher than 2018/19. The core Crown capital investment largely consisted of purchases of physical assets of $3.0 billion, investment in Crown entities of $3.2 billion and the Government's contributions to the NZS Fund of $1.5 billion. In addition, in 2019/20 advances issued were $1.7 billion higher than in the 2018/19 year largely as a result of the Small Business Cash Flow Scheme which was established as part of the Government's COVID-19 response.

…resulting in an increase to net core Crown debt

Taking into account both operating and capital activities of the Crown, the cash shortfall (residual cash deficit) this year has increased to $23.7 billion from $0.7 billion in 2018/19.

Net core Crown debt of $83.4 billion for 2019/20 has increased by $25.7 billion from $57.7 billion in 2018/19. The cash shortfall is the main driver of the increase in net core Crown debt. In addition, the LSAP programme has adversely impacted net core Crown debt by around $3 billion (refer to box on page 60).

As a percentage of GDP, net core Crown debt has also increased, from 19.0% in 2018/19 to 27.6% in 2019/20.

Similarly, both gross debt and total borrowings have increased since last year. The increase in gross debt of $17.1 billion is less than the increase in net core Crown debt owing to the LSAP programme (refer to page 60) that results in a switch between government-issued bonds to bank settlement accounts, meaning the impact on gross debt is lower than the impact on net core Crown debt.

In contrast, the increase in total borrowings of $42.5 billion is higher than the increase in core Crown net debt. Gross sovereign-issued debt (which will include the impact on borrowings from the LSAP programme) increased by $33.2 billion to help fund the cash shortfall, while SOE and Crown entity borrowings increased by around $7.6 billion largely owing to growth in Kiwibank deposits and lending undertaken by Kāinga Ora to fund capital expansion. NZS Fund also contributed around $1.8 billion mostly relating to losses on derivatives held as at 30 June 2020.

Operating deficits result in a significant decrease in net worth with an increase in liabilities exceeding the increase in assets

Although taxpayers' funds were positive in 2019/20, they have been significantly depleted since 2018/19, reducing from $34.0 billion to $3.1 billion as a result of the operating deficit of $30.3 billion.

Revaluation uplifts of physical assets increased by $5.1 billion while at the same time revaluations of long-term retirement plans (eg, the Government Superannuation Fund) and Veterans' Disability Entitlements resulted in $1.6 billion of losses which are taken directly to reserves. When these revaluations are combined with the operating balance deficit of $30.3 billion and minority interest transactions, net worth decreased by $27.6 billion to be $115.7 billion.

Total assets grew by $28.5 billion in the 2019/20 year to reach $393.2 billion, while at the same time liabilities increased by $56.2 billion to reach $277.5 billion. Of the increase in assets, financial assets grew the most increasing by $19.0 billion, while property, plant and equipment increased by $8.8 billion (including revaluation uplifts). Of the increase in liabilities, borrowings increased by $42.5 billion, while ACC's insurance liability increased by $8.3 billion. The increase in borrowings is largely a result of funding the Government's response to COVID-19. The increase in the ACC liability is largely owing to changes in discount rates which are used to present value the outstanding claims liability balance.

The 2019/20 actual outturn has come in more strongly than expected in the 2020 Budget Update

Most of the Government's key fiscal indicators have come in stronger than what was forecast at the Budget Update. The improvement is owing to economic activity holding up better than expected in the June quarter, and as a result core Crown tax revenue was $2.6 billion higher than expected. In addition, core Crown expenses have come in lower by $5.2 billion with the majority of this difference relating to spending in relation to the Government’s COVID-19 fiscal support measures being lower than forecast. Partially offsetting the variances in tax revenue and core Crown expenses, SOE and Crown entity results are weaker than expected. Overall the OBEGAL deficit was $4.9 billion lower than forecast at the Budget Update.

The variances in core Crown tax revenue and core Crown expenses also flow through to improve the cash position, with the core Crown residual cash deficit being lower than forecast by $8.3 billion. The improvement in the residual cash position also flows through to the net core Crown debt position; however, some of this improvement is partially offset by the expansion in the size of the LSAP programme since the Budget Update, meaning that overall net core Crown debt is $5.5 billion lower than forecast as at 30 June 2020.

Short-term Outlook#

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This section of the chapter focuses on the four-year forecast horizon, covering from 2020/21 up to and including the 2023/24 fiscal year. The preparation of the pre-election fiscal forecasts has involved:

• updating the operating results and expense forecasts from departments and significant other government reporting entities for the years 2020/21 to 2023/24
• considering the impact of additional financial information that has occurred since the finalisation of the Budget Update forecasts on 20 April 2020, and
• incorporating the fiscal impact of significant Cabinet decisions made since the Budget Update, up to and including 7 September 2020.

Core Crown Tax Revenue#

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Tax revenue is forecast to decrease in 2020/21 and 2021/22, before beginning to increase later in the forecast period

Core Crown tax revenue (Figure 2.2) is forecast to decrease in nominal terms in 2020/21 and 2021/22, before beginning to recover in 2022/23 and then continue to increase in the last year of the forecast period. As a percentage of GDP, core Crown tax revenue is forecast to decrease from 28.1% in 2019/20 to 26.3% in 2021/22, after which it is forecast to increase and remain stable at around 27% for the remainder of the forecast period.

Figure 2.2 – Core Crown tax revenue

Source: The Treasury

Text description of Figure 2.2 – Core Crown tax revenue.

By 2023/24, core Crown tax revenue is expected to reach $98.5 billion, $13.6 billion higher than in the 2019/20 year. Table 2.6 shows the breakdown of the movements across the major tax types over the four years to 2023/24.

Source: The Treasury

Overall core Crown tax revenue decreases in 2020/21 and 2021/22…

GST revenue is forecast to fall by $0.8 billion in 2020/21. This decline is mostly owing to a significant fall in overseas tourist spending in 2020/21. Private consumption recovers from 2021/22 onwards resulting in increased GST revenue.

Corporate tax revenue is expected to remain flat in 2020/21 and then fall in 2021/22. An expected decline in tax revenue, owing to lower operating profits expected as a result of the impact of COVID-19, is the main reason for flat corporate tax revenue in 2020/21. A fall of $1.3 billion in 2021/22 is mainly a result of changes to depreciation allowances and asset-expensing thresholds.

Resident withholding tax on interest is expected to fall by $0.4 billion in 2020/21, mainly owing to declining deposit interest rates.

Net other persons tax revenue is forecast to fall over 2020/21 and 2021/22 owing to a decline in taxable profits and changes to depreciation allowances and asset-expensing thresholds.

Source deductions, which are mainly PAYE on wages and salaries, are forecast to grow by $1.2 billion in 2020/21 and 2021/22, mainly owing to wage growth, as the level of employment is expected to decline, particularly in 2020/21.

…but then starts to recover from 2022/23...

Corporate tax revenue is forecast to increase through 2022/23 and 2023/24 owing to relatively strong forecasts for profit growth in those years.

Source deductions revenue is expected to grow more strongly, almost entirely owing to a recovery in employment and wage growth, with wage growth contributing to fiscal drag.[14]

GST revenue is forecast to increase by $3.7 billion from 2022/23 onwards, mainly owing to a lift in private consumption, residential investment and tourist spending in New Zealand.

Net other persons tax revenue growth is expected to resume in 2022/23, as taxable profits are expected to continue to increase, terminal tax rebounds, and the effects of the depreciation and asset-expensing changes are less negative than in 2021/22.

…broadly in line with expected economic growth

Figure 2.3 shows that core Crown tax revenue is forecast to grow at a slower rate than nominal GDP in both 2020/21 and 2021/22, mainly owing to:

• Major components of the GDP forecast that affect the tax forecasts, such as compensation of employees and overseas tourist spending in New Zealand, are forecast to grow at a slower rate than total nominal GDP.
• Deposit interest rates are expected to decline further, causing RWT on interest to fall.
• Policy changes introduced in response to the COVID-19 pandemic, mainly relating to depreciation allowances, asset-expensing thresholds and loss carry-back, are expected to reduce tax revenue.

In 2022/23, tax revenue growth exceeds nominal GDP growth as tax policy change effects are less negative than in 2021/22 and taxable profits are forecast to grow at a faster rate than GDP.

Figure 2.3 – Core Crown tax revenue and nominal GDP growth

Source: The Treasury

Text description of Figure 2.3 – Core Crown tax revenue and nominal GDP growth.

Core Crown Expenses#

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Core Crown expenses are expected to increase significantly in the near term primarily owing to the Government's COVID-19 response…

Core Crown expenses are forecast to increase by an additional $10.7 billion in 2020/21, peaking at $119.5 billion, and then decrease by $9.6 billion in 2021/22 billion before increasing again in 2022/23. In the last year of the forecast, core Crown expenses reach $116.1 billion. Core Crown expenses as a percentage of GDP are expected to peak at 39.4% in 2020/21 before declining to 31.9% by 2023/24 (Figure 2.4).

Figure 2.4 – Core Crown expenses

Source: The Treasury

Text description of Figure 2.4 – Core Crown expenses.

The impact of the Government's response to and recovery from COVID‑19 will mean core Crown expenses are forecast to remain at elevated levels for the next few years. However, it is expected that most of the Government's policy measures in relation to COVID-19 will be temporary, with a smaller ongoing impact to core Crown expenses by the end of the forecast period. Refer to Table 2.3 in the box on page 43 for the forecast profile of COVID‑19 related operating expenditure. Looking through the temporary nature of the Government's fiscal support measures, core Crown expenses are expected to increase by $19.7 billion by the end of the forecast.

…with previous Budget decisions and allowances for future Budget decisions being a key driver of the growth…

Around half of the nominal increase in expenses is attributable to previous budget decisions and new spending set aside for future budgets. At the time of announcement, Budget 2020 decisions were expected to increase expenditure by $3.2 billion. There has been no change to future budget operating allowances in these forecasts. Future budget operating allowances are currently set at $2.4 billion for Budgets 2021 and 2022, increasing to $2.6 billion in Budget 2023. The fiscal forecasts assume that any additional costs in relation to Government commitments and future costs pressures will be met from operating allowances. For forecasting purposes, budget operating allowances are assumed to be all operating expenditure. However, operating allowances may actually be used for a combination of revenue and operating or capital expenditure initiatives when allocated. Refer to the box on page 57 for more details on how Budget allowances operate and Table 2.17 on page 80 for some sensitivity analysis regarding allowance settings.

…while benefit costs continue to grow, mainly owing to increasing recipient numbers…

Social assistance spending is forecast to fall by $4.0 billion by 2023/24. Expenditure in the 2019/20 year has been elevated by the Wage Subsidy Scheme, which totalled $12.1 billion. If we look through the Wage Subsidy Scheme, given its temporary nature, social assistance spending will grow by $8.1 billion mainly owing to growth in recipient numbers, the impact of indexation of most benefits to wage growth and the increase of $25 per week in main benefits from 1 April 2020.

The New Zealand Superannuation benefit is expected to grow by $3.5 billion between 2019/20 and 2023/24. New Zealand Superannuation recipient numbers are forecast to increase from an average of around 767,000 in 2018/19 to 905,000 by the end of the forecast period (an increase of 18.0%). By the end of the forecast period, New Zealand Superannuation equals just under half of core Crown social assistance spending and 16.4% of core Crown expenditure.

Growth in Jobseeker Support and Emergency Benefit and Accommodation Assistance benefits is expected to contribute $1.6 billion and $0.7 billion respectively to the growth in social assistance costs (excluding the Wage Subsidy impact).

Figure 2.5 – Social security welfare expense and recipient numbers of main benefits and NZS

Source: The Treasury

Text description of Figure 2.5 – Social security welfare expense and recipient numbers of main benefits and NZS.

The economic conditions over the forecast period are a significant factor in the expected growth in Jobseeker Support and Emergency Benefit recipients, with flow-on impacts to Accommodation Assistance, and the growth in overall benefit expenses:

• The number of Jobseeker Support and Emergency Benefit recipients is expected to increase by 89,000 by 2020/21 compared with 2019/20 and then increase further in 2021/22 to peak at 279,000, before reducing to 246,000 recipients by 2023/24, 84,000 (an increase of 52%) more recipients than 2019/20.
• The number of Accommodation Assistance recipients is expected to increase by 76,000 by 2020/21 compared with 2019/20 and then increase further in 2021/22, peaking at 420,000 recipients, before reducing to 405,000 recipients by 2023/24 an increase of 87,000 (a 27% increase) compared with 2019/20.

…and finance costs decrease owing to monetary policy interventions via the LSAP and lower interest rates

Core Crown finance costs are forecast to reduce by $0.9 billion by the end of the forecast period when compared to the 2019/20 fiscal year. While additional borrowings to fund the forecast residual cash deficits result in additional interest costs, this is more than offset by a lower effective interest rate of borrowings owing both to lower Government bond interest rates and to settlement cash liabilities having a lower interest rate than the repurchased Government bonds they have effectively replaced through the LSAP programme. Refer to the box on page 60 for further details of the LSAP programme.

Operating Balance before Gains and Losses and the Operating Balance#

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OBEGAL deficits are forecast across the period although some recovery is expected from 2022/23…

The unaudited OBEGAL was a $23.4 billion deficit in 2019/20 and this is forecast to increase sharply to reach a $31.7 billion deficit in 2020/21 before starting to reduce over the remainder of the forecast period. An OBEGAL deficit of $12.4 billion is forecast for the final year of the forecast (Figure 2.7).

Figure 2.7 – Components of OBEGAL by segment

Source: The Treasury

Text description of Figure 2.7 – Components of OBEGAL by segment.

In line with the expected economic impacts of COVID-19 and the Government's response, OBEGAL deficits are expected to be highest in the near term, before starting to recover in 2022/23.

State-owned enterprises (SOEs) had deficits in 2019/20 (compared to surpluses in 2018/19) and are forecasting deficits in the 2020/21 year. This reflects the expected decline in third-party revenue due to COVID-19 for some SOEs and increased expenditure (eg, asset impairments). The SOE segment as a whole is expected to recover and return small surpluses in the last two years of the forecast.

The Crown entities sector is forecasting deficits of $2.9 billion and $2.6 billion for 2020/21 and 2021/22 before reducing deficits to around $1.8 billion for the last two years of the forecast period. These deficits are mainly driven by ACC and District Health Boards (DHBs) averaging OBEGAL deficits of $1.6 billion and $0.6 billion respectively. ACC’s OBEGAL deficits largely arise from the increased future cost of its outstanding insurance claims liabilities while the DHBs’ deficits are owing to forecast growth in demand leading to rising costs. Other Crown entities, largely in the education and housing sectors, are also forecasting deficits across the period although on a much smaller scale.

…leading to operating balance deficits

The total Crown operating balance, which includes gains and losses on assets and liabilities, is also forecast to be in deficit across all years of the forecast period (Figure 2.8).

Figure 2.8 – Components of operating balance

Source: The Treasury

Text description of Figure 2.8 – Components of operating balance.

Operating balance deficits peak at $35.3 billion in 2020/21, reducing to $20.1 billion in 2021/22 and then reducing further to $7.8 billion in the last year of the forecast period. This trend reflects the OBEGAL trend, which flows directly through, with gains and losses having a smaller impact.

While gains and losses on the Crown's liabilities such as the ACC and ETS liabilities are not forecast beyond an actual year, they are forecast for the Crown's investment activities. The impact of the LSAP is forecast to result in $6.1 billion of losses in 2020/21 and $1.7 billion in 2021/22 (see box below). However, net gains on the Government's investment activities (largely the NZS Fund) of between $3.4 billion and $4.5 billion across the forecast period more than offset these losses.

Residual Cash and Net Core Crown Debt[16]#

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Significant cash shortfalls are now expected, reflecting the forecast deficits…

From 2019/20 up until 2023/24, a cash shortfall of $110.7 billion is expected (Figure 2.9). This cash shortfall is funded largely through additional borrowing.

Figure 2.9 – Core Crown residual cash

Source: The Treasury

Text description of Figure 2.9 – Core Crown residual cash.

The level of operating cash deficit is forecast to grow in 2020/21 from the deficit of $14.3 billion in 2019/20 to peak at $29.0 billion, before reducing over the remainder of the forecast period. The trend in these deficits broadly follows a similar trend to the OBEGAL forecast, with larger cash deficits in the near term as cash payments for COVID-19 related expenses are expected.

…while capital spending increases the cash deficits…

In addition to the $9.4 billion spent in 2019/20, the Government is expected to invest a net total of $44.4 billion in capital over the forecast years to 2023/24, a total of $53.8 billion including the 2019/20 year. Net capital spending (including the 2019/20 spend) includes:

• $14.9 billion on building and acquiring physical assets
• $3.1 billion on advances, and
• $18.8 billion on providing capital to Crown entities (eg, to Waka Kotahi NZ Transport Agency (NZTA) for state highways ($7.4 billion), to DHBs to build or develop hospitals ($3.7 billion) and to KiwiRail to invest in the rail network ($3.0 billion)).

In addition, the forecast capital spending includes $9.2 billion in contributions to the NZS Fund and future new capital spending of $10.7 billion including $8.4 billion in contingencies where funding has been set aside for specific initiatives, but additional report backs are required before funding is confirmed. Future new capital spending represents funding set aside to be allocated in the future.

Table 2.8 shows core Crown capital spending that has an impact on net core Crown debt. It excludes capital spending undertaken directly by Crown entities and SOEs funded from their own resources (including third-party financing).

Source: The Treasury

…and consequently, net core Crown debt is expected to increase significantly over the forecast period

In nominal terms, net core Crown debt is expected to grow substantially over the forecast period, reaching $201.1 billion in 2023/24. This is an increase of $117.7 billion from the unaudited position at the end of the 2019/20 year. The increase in net core Crown debt is mainly driven by the need to fund the residual cash deficits of around $110.7 billion expected beyond 2019/20 up to 2023/24.

As a percentage of GDP, net core Crown debt is expected to increase rapidly from 27.6% in 2019/20 to 43.0% in 2020/21 (Figure 2.10). It then gradually rises, to reach 55.3% in 2023/24.

Figure 2.10 – Net core Crown debt

Source: The Treasury

Text description of Figure 2.10 – Net core Crown debt.

Beyond 2021, gross debt rises rapidly…

Gross debt is expected to stay relatively static through 2020/21 and 2021/22 and then increase significantly in 2022/23 and continue rising in 2023/24, increasing by a total of $58.2 billion from 2019/20 (Figure 2.11).

Figure 2.11 – Gross debt

Source: The Treasury

Text description of Figure 2.11 – Gross Debt.

Forecast gross debt as a percentage of GDP rises significantly, before reaching 43.9% by the end of the forecast period.

While net core Crown debt increases in all years, gross debt is relatively static up until 2021/22 (Figure 2.11). This is largely owing to the LSAP programme, which provides for the Reserve Bank to purchase government-issued bonds and borrow through bank settlement accounts instead. As the gross debt indicator excludes Reserve Bank settlement cash, the switch from government-issued bonds to bank settlement accounts under the LSAP programme means gross debt has reduced. In contrast, net core Crown debt includes bank settlement accounts, so the switch in borrowings under the LSAP programme has a different impact. Refer to the box on page 60 for further details of the fiscal impacts of the LSAP on both gross debt and net core Crown debt indicators.

…and the core Crown borrowing programme will provide net funds of $120.5 billion

The core Crown borrowing programme includes the issuance of both New Zealand Government Bonds (NZGB) and short-term borrowings (eg, Treasury Bills and Euro-Commercial Paper).

Heightened uncertainty remains on the timing, and to a lesser extent the size, of cash requirements, alongside variability in economic activity. To mitigate this uncertainty, a sizeable cash buffer is forecast, which ensures the Government is better placed to manage funding and liquidity risks. Consistent with the profile of core Crown residual cash deficits, NZGB issuance is predominantly weighted towards the early part of the forecast.

Beyond 2019/20, the bond programme is expected to raise funds of $162.5 billion in total. Bond maturities and repurchases will result in repayments of $39.3 billion of existing debt. In addition, short-term borrowing is expected to be $2.7 billion lower at the end of the forecast period (Table 2.9). Overall, the core Crown borrowing programme will provide net funds of $120.5 billion to help meet residual cash deficits and to ensure cash is available for the upcoming bond maturities in 2025.

Source: The Treasury

Table 2.10 sets out how all forecast Government revenue, and operating and capital expenditure, impacts the key fiscal indicators.

Note:

1. State-owned enterprises (SOEs) and Crown entities (CEs)

Source: The Treasury

Total Crown Balance Sheet#

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Operating balance deficits drive a decline in the Crown's net worth…

Net worth is the difference between the Crown's total assets (what the government owns) and liabilities (what the government owes). Net worth primarily consists of the accumulation of operating surpluses and deficits (referred to as taxpayers' funds) and revaluation movements in physical assets.

In nominal terms, net worth declines by $72.2 billion from 2019/20, a decrease of 62.4%. As a percentage of GDP, net worth decreases to be 12.0% in 2023/24 (Figure 2.12). The impact of the operating balance deficit, which is largely owing to the COVID‑19 economic impact and the Government's fiscal response to date, flows through to the Crown's balance sheet. Refer to Table 2.11 for a composition of net worth.

Figure 2.12 – Net worth

Source: The Treasury

Text description of Figure 2.12 – Net worth.

Source: The Treasury

This table shows that taxpayers' funds is forecast to be in a negative position from the 2020/21 fiscal year[19]. A positive taxpayers' funds provides a buffer against adverse events. These forecasts reflect the use of that buffer in response to COVID-19. This reduction in taxpayers' funds arises largely as a result of the increase in borrowings - refer to Table 2.12 for further discussion on changes in assets and liabilities which drives the changes in taxpayers' funds.

…and there has also been a significant change in the value of the Crown's assets and liabilities…

The overall decrease in net worth can be analysed by the movements in the total assets and total liabilities. Over the forecast period, total assets are forecast to increase by $66.9 billion from the 2019/20 unaudited actual results; however, more than offsetting this, total liabilities are expected to increase by $139.1 billion as indicated in Table 2.12 below. Total assets are expected to grow to reach $460.2 billion in 2023/24 while liabilities are forecast to reach $416.6 billion by the end of the forecast period.

Source: The Treasury

…with liabilities growing at a faster pace than assets

The largest asset growth over the forecast period is in property, plant and equipment, which is expected to increase by $21.8 billion from 2019/20, and reach $208.1 billion in the 2023/24 fiscal year. Beyond 2019/20 this increase reflects investment in new property, plant and equipment (eg, schools, military assets, public housing and infrastructure) and reflects the additional core Crown capital spend discussed earlier (refer to page 63).

Marketable securities are held by the Government for the purpose of realising capital gains or interest revenue and funding future Government expenditure. The $11.6 billion growth in marketable securities across the forecast period primarily reflects changes in the current economic environment and the Government's use of the balance sheet to fund the response to and recovery from COVID-19. Up until 2021/22, marketable securities are still expected to increase; however, these will reduce in 2022/23 as they are utilised to fund the Government's COVID-19 response and only increase by a small amount in 2023/24.

Beyond 2019/20, share investments gradually grow by $10.5 billion to reach $44.3 billion by the 2023/24 fiscal year.

Crown advances are forecast to grow steadily across the forecast period, increasing by $5.3 billion, and finally reaching $42.9 billion in the 2023/24 fiscal year. Advances include loans (mortgages) held by Kiwibank and student loans. The growth in Kiwibank loan assets is generally offset by growth in Kiwibank's loan liabilities.

Future new capital spending represents funding set aside to be allocated in the future, a forecast increase of $10.7 billion by the 2023/24 fiscal year, while the top-down capital adjustment reduces total assets by $2.9 billion by the same point in time. As previously discussed (refer to page 62) the forecast for new capital spending includes $8.4 billion in contingencies where funding has been set aside for specific initiatives.

The increase in total liabilities is largely owing to the forecast borrowings increase of $133.9 billion, 88% higher than the level at 2019/20. Borrowings are forecast to increase sharply in 2020/21, before continuing to climb gradually, reaching $286.6 billion in the 2023/24 fiscal year.

Core Crown borrowings grow from around $110 billion in 2019/20 to reach just over $232 billion by the end of the forecast period. At the same time, Crown entity borrowings increase to reach just over $15 billion by 2023/24 (an increase of around $7 billion), while SOE borrowings increase by just under $5 billion to reach around $39 billion and increase more slowly across the forecast period (Figure 2.13).

Figure 2.13 – Third party borrowings by segment

Source: The Treasury

Text description of Figure 2.13 – Third party borrowings by segment.

The increase in core Crown borrowings is largely attributable to an increase in Government bonds issued (around a $60 billion increase from 2019/20) and an increase in settlement deposits with the Reserve Bank over the forecast period. Although relatively small in the near term (as a result of the LSAP programme) Government bonds are expected to increase by just over $60 billion in the last two years of the fiscal forecast. This increase and the settlement deposit increase are a direct result of the economic impacts of COVID-19 and the Government’s fiscal and monetary response to it. Refer to the box on page 60 for further details of the LSAP programme impacts.

A significant proportion of the increase in Crown entity borrowings is attributable to an increase in borrowing to fund Government decisions on housing, including the additional 8,000 new public housing and transitional housing places. SOE borrowings are largely attributable to Kiwibank deposits although growth in this is largely offset by the Kiwibank mortgage assets that it holds, as discussed earlier.

The remainder of the increase in total liabilities is mainly driven by a forecast increase in insurance liabilities, which grow by $8.9 billion beyond 2019/20. While ACC's liability increases by $9.7 billion, the Crown's earthquake-related insurance liabilities are expected to reduce by $0.8 billion over the same period.

Comparison to the Budget Update#

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While the fiscal outlook continues to show operating deficits and an increase in net core Crown debt, other key fiscal indicators show an improvement when compared to the Budget Update (Table 2.13).

Overall, OBEGAL deficits are now expected to be lower than previously forecast in the 2019/20 fiscal year. The unaudited OBEGAL deficit of $23.4 billion for the 2019/20 fiscal year is now forecast to be lower by $4.9 billion compared to the Budget Update. This improvement is mainly a result of stronger economic activity up to 30 June 2020 and lower government expenditure.

By the end of the forecast period, the OBEGAL deficit is now expected to be $7.5 billion higher than the Budget Update, a forecast deficit of $12.4 billion. The softer medium-term economic outlook and reforecast COVID-19 response and recovery expenditure are the key drivers for this.

Beyond 2019/20, over the forecast period residual cash deficits of $110.8 billion are expected, which is around $8.1 billion lower than the Budget Update. Although expected tax receipts have weakened and expected benefit payments have increased from those previously forecast, this is more than offset by lower-than-expected government spending, and a reduction in net interest payments mainly owing to the LSAP programme and lower interest rates.

The improvement in residual cash deficits also flows through to reduce net core Crown debt; however, the impact from losses in relation to LSAP means that overall net core Crown debt is relatively close to the Budget Update by the end of the forecast period.

The economic outlook directly impacts tax revenue, which is higher in the short term but lower from the 2021/22 fiscal year…

Most of the major tax types have followed the nominal GDP forecast revisions: higher than the Budget Update in the short term, but lower than the Budget Update later in the forecast period.

The tax data up to 30 June 2020 has been used as the starting point for the Pre-election Update tax forecasts, which shows that core Crown tax revenue for the 12 months to 30 June 2020 was $2.6 billion higher than the Budget Update. There were positive variances in GST, corporate tax and other persons tax largely as a result of economic activity holding up slightly better than expected in the June quarter.

The higher tax revenue starting point and stronger near-term nominal GDP growth forecast increased the tax revenue forecasts in the 2020/21 fiscal year ($4.6 billion higher than the Budget Update); but weaker nominal GDP growth expected later in the forecast period reduces expected tax revenue from the 2021/22 fiscal year onwards (on average $3.5 billion lower for each of the last three years of the forecast) (Figure 2.14).

Figure 2.14 – Core Crown tax revenue compared to the Budget Update

Source: The Treasury

Text description of Figure 2.14 – Core Crown tax revenue compared to the Budget Update.

…with core Crown expenses expected to increase significantly in the 2020/21 fiscal year as a result of underspends in 2019/20; beyond this, changes in timing of COVID-19 fiscal support are expected to be a key driver of the change…

Overall, core Crown expenses beyond 2019/20 are expected to be $7.7 billion lower than the Budget Update. Core Crown expenses are expected to be higher in 2020/21, largely as a result of expenses being transferred from the 2019/20 fiscal year, where they were originally forecast at the Budget Update (refer to page 48 for further discussion of 2019/20 variances from the Budget Update) (Figure 2.15).

Figure 2.15 – Core Crown expenses compared to the Budget Update

Source: The Treasury

Text description of Figure 2.15 – Core Crown expenses compared to the Budget Update.

The expected change in the remaining fiscal years of the forecast, when compared to the Budget Update, can be mostly attributed to the change in the expected timing of costs funded from the CRRF and the updated phasing of the unallocated portion of the CRRF. This has resulted in forecast increases in expenses in the 2020/21 and 2023/24 fiscal years and a forecast decrease in expenses in the 2021/22 and 2022/23 fiscal years (Table 2.14).

…while several other factors are expected to impact core Crown expenses…

As a result of the weaker economic outlook, beneficiary numbers and wage growth (to which most benefits are indexed) are forecast to increase, and by the end of the forecast period benefit expenses are higher by $5.8 billion compared to the Budget Update.

The top-down adjustment for the Pre-election Update has been increased since the Budget Update, particularly for the 2021/22 fiscal year. The increase reflects the Treasury's view that, given the sharp lift in Government spending, some of this may not eventuate. Refer to the box on page 73 for further discussion of the top-down adjustment.

The size of the LSAP programme has increased since the Budget Update. The LSAP results in a reduction in finance costs as the interest rate on the settlement account is lower than the coupon rate of the repurchased Government bonds. Overall finance costs are expected to be lower by around $0.9 billion in 2020/21, which widens to be lower by $2.3 billion in 2022/23 and $7.1 billion overall.

…feeding into OBEGAL deficits in 2020/21 that are higher than previously expected, before reducing for two years and then increasing again in 2023/24…

Although some of the strength seen in core Crown tax revenue for the 2019/20 fiscal year is expected to continue through into 2020/21, this is more than offset by higher expenditure, primarily relating to the Government's fiscal response in relation to COVID‑19 resulting in an OBEGAL deficit that is higher than previously forecast (Table 2.14).

Source: The Treasury

OBEGAL deficits are now expected to be lower than previously forecast for the 2021/22 and 2022/23 fiscal years largely because core Crown expenses are lower than previously forecast and this reduction being greater than both the decline in tax revenue and higher deficits expected by the SOE and Crown entity segments. However, by the end of the forecast period the expected OBEGAL deficit is $7.5 billion higher than the Budget Update.

…although SOE and Crown entity results are weaker

Overall SOE and Crown entity results are expected to be weaker in all years of the forecast period. From 2019/20 the operating results are expected to be $3.7 billion weaker than the Budget Update.

The expected results of ACC and Kāinga Ora are forecast to be on average $0.8 billion lower per annum compared to the Budget Update. For ACC this is mainly owing due to a drop in interest rates and updated information around claims costs which have increased expenses, while for Kāinga Ora this is primarily a result of the rent freeze announced by the Government and the expansion of its activities (eg, 8,000 additional housing places).

Residual cash deficits have reduced since the Budget Update…

In total, residual cash deficits of $110.8 billion are expected beyond 2019/20, which is a reduction of $8.1 billion from the Budget Update. The main drivers are tax revenue and core Crown expenses, as discussed above.

Additionally, net interest costs are expected to be lower by $8.7 billion largely owing to the increase in the size of the LSAP programme since the Budget Update. The estimated costs of COVID-19 initiatives funded from the CRRF have been revised down by around $4.0 billion, as the actual uptake from some initiatives has been less than expected. Contributions to the NZS Fund are expected to be lower by $1.2 billion in the last two years of the forecast owing to a weaker GDP track compared to the Budget Update.

Partially offsetting this, core Crown tax receipts beyond 2019/20 are expected to be lower overall by $3.8 billion, while benefit payments are expected to be higher by $6.3 billion. The overall weaker economic outlook is the main reason for these revisions.

…however, net core Crown debt remains broadly the same…

The above-mentioned improvements in residual cash also flow directly through to reduce net core Crown debt, compared to the Budget Update.

However, the significant expansion in the LSAP programme, announced by the Reserve Bank, which has increased from $33 billion to $100 billion, has adversely impacted net core Crown debt, as described in the LSAP box on page 60.

Figure 2.17 – Net core Crown debt compared to the Budget Update

Source: The Treasury

Text description of Figure 2.17 – Net core Crown debt compared to the Budget Update.

Figure 2.18 – Net worth compared to the Budget Update

Source: The Treasury

Text description of Figure 2.18 – Net worth compared to the Budget Update.

…while the change in the operating results flows directly into net worth

In the 2019/20 fiscal year, some physical assets have been revalued, which has resulted in an overall increase in net worth of around $5.1 billion.

When the asset revaluations are combined with the changes in the operating balance this flows through to improve the net worth position. The gains and losses which are included in the operating balance are broadly in line with what was expected in the Budget Update.

Key Economic Assumptions Used in the Forecast Financial Statements#

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The Forecast Financial Statements 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 to forecast tax revenue
• a forecast of CPI inflation is needed because social assistance benefits are generally indexed to inflation, and
• 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 Forecast Financial Statements is provided in Table 2.16.

Notes:

1. Production measure.
2. Expenditure measure.

Sources: The Treasury, Stats NZ

Medium-term Outlook#

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The previous sections of this chapter have concentrated on the 2019/20 actual results (unaudited) and the four-year forecast horizon, up to and including 2023/24. The focus now switches to the decade beyond the last forecast year, extending to 2033/34, referred to as the medium-term projections. Projections differ from forecasts in several 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 is growing on trend, and contain no unplanned future policy responses that might be enacted.

The fiscal projections presented in this section are based on the main Pre-election Update forecast.

The medium-term economic outlook has deteriorated compared to the Budget Update...

The Treasury's Pre-election Update economic forecasts show that the medium-term outlook has deteriorated compared to the Budget Update. Annual growth of nominal GDP gradually slows over the projection period, from 6.8% in the year ending June 2024 to 3.9% by the year ending June 2034.

While projected nominal GDP growth rates are similar to those produced for the 2020 Fiscal Strategy, they arise from an end-of-forecast GDP base which is $10.3 billion (2.8%) lower compared to Budget 2020. By the end of the projection decade, nominal GDP in the Pre-election Updateis 1.4% lower than Budget 2020. Table 2.19 shows the paths of the other main economic projections.

…with increased fiscal pressure due to ongoing CRRF spending assumed in the projection period

The projections presented at Budget 2020 assumed that spending decisions related to the CRRF did not have any ongoing expenses in the projection period.

For the Pre-election Update, we assume approximately $1 billion of COVID-related spending to be ongoing in the projection period. This means that excluding the impacts of other changes to the expenditure forecasts, the starting base of core Crown expenses for our projections in the Pre-election Update is higher by about $1 billion compared to Budget 2020.

Assuming that operating and capital allowances are the same as in the 2020 Fiscal Strategy…

The assumptions for operating and capital allowance drive the projections of many of the fiscal indicators. The operating allowances fund the growth of functional spending areas such as health, education, and law and order, while capital allowances fund infrastructure projects.

The Pre-election Update fiscal projections assume the same operating and capital allowances as at Budget 2020. From 2024/25, operating allowances are assumed to be $2.1 billion, growing at 2% per budget and capital allowances are assumed to be $3.0 billion per annum also growing at 2% per budget. These were set at Budget 2020 as a feasible path that met the Government's long-term fiscal objectives at the time.

...core Crown revenue and expenses stabilise at 31% of GDP by 2033/34

Core Crown revenue as a percentage of GDP rises gradually over the projection period and stabilises at 31% of GDP by 2033/34, around the long-run average level. The increase in the early years of the projection period is a result of core Crown revenue falling to a relatively low share of GDP by the end of the forecast period, from which it is assumed to recover through the projection period. The path of core Crown revenue as a percentage of nominal GDP is similar to Budget 2020.

However, core Crown expenses as a percentage of nominal GDP are higher in the projection period in the Pre-election Update relative to Budget 2020. This is due to higher transfer payments and subsidies and ongoing CRRF spending in the projection period. It also reflects that, unlike revenue, expenditure is assumed to be largely unaffected by the weaker nominal GDP compared to Budget 2020, resulting in an increase in core Crown expenses as a share of the economy.

Weaker nominal GDP does result in core Crown expenses declining slightly as a percentage of nominal GDP due to slower growth in operating expenses, relative to nominal GDP. By the end of the projection period, core Crown expenses stabilise at 30% of GDP.

Figure 2.19 illustrates the paths of core Crown revenue and expenses, as percentages of nominal GDP, in recent history, Budget 2020 and the Pre-election Update forecasts and projections.

Figure 2.19 – Core Crown revenue and expenses

Source: The Treasury

Text description of Figure 2.19 – Core Crown revenue and expenses.

Net core Crown debt declines over the projection period to 48% of GDP and the OBEGAL deficit is projected to be 0.5% of GDP by 2033/34

The change in the economic and fiscal forecasts, particularly the weaker medium-term outlook, and the fact that allowances have remained unchanged from the Budget 2020 means that total Crown OBEGAL in the Pre-election Update is weaker in each year compared to the projections in Budget 2020 (Figure 2.20). By the end of the projection period, the OBEGAL deficit is projected to be 0.5% of GDP.

Figure 2.20 – Total Crown OBEGAL

Source: The Treasury

Text description of Figure 2.20 – Total Crown OBEGAL.

Net core Crown debt increases to peak at 56% of GDP in 2025/26 and gradually declines over the projection period to 48% of GDP by 2033/34. This is illustrated in Figure 2.21 in the projection period compared to Budget 2020.

Figure 2.21 – Net core Crown debt (excluding NZS Fund and advances)

Source: The Treasury

Text description of Figure 2.21 – Net core Crown debt (excluding NZS Fund and advances).

The projections are sensitive to assumptions about future spending growth

In addition to the economic uncertainty discussed in the Economic Outlook chapter, the medium-term fiscal position is sensitive to both short and medium term fiscal policy choices. We illustrate this sensitivity by adjusting the spending assumptions used to produce the projections in two alternative projections:

• High short-term spending - assumes operating allowances are $1.0 billion higher than set at Budget 2020 in each of next three Budgets (Budgets 2021 to 2023). From Budget 2024 operating spending increases at the same rate assumed in the main projection. This reflects the risk that operating spending in the forecast period grows faster than currently planned due to cost pressures in public services.
• Low long-term spending - assumes operating allowances for the next three Budgets are unchanged from the level set at Budget 2020. Beginning in Budget 2024, operating a lower annual operating allowance of $1.8 billion, growing in line with inflation thereafter. These assumptions are selected to demonstrate the level of spending growth required to achieve an OBEGAL surplus within a decade.

In both projections, assumptions around economic variables, capital spending, and tax remain unchanged from the main projection. The results of these projections compared to the main assumptions are shown in Table 2.17 and Figures 2.22 to 2.24 below.

These projections are not intended to demonstrate specific fiscal policy options, but indicate how sensitive medium-term fiscal variables are to higher or lower rates of spending growth across different time horizons.

Note that operating allowance assumed in the 'low long-term spending' variant ($1.8 billion from Budget 2024) represents a lower level of growth in government spending than the recent historical average. While this would still represent a nominal increase in government expenditure in each year, the amount of money spent on the government services usually funded from operating allowances [21] would be declining as a share of the economy at a faster rate than in the central projection (Figure 2.24).

Figure 2.22 – Net core Crown debt under different expenditure scenarios

Source: The Treasury

Text description of Figure 2.22 – Net core Crown debt under different expenditure scenarios.

Figure 2.23 - Total Crown OBEGAL under different expenditure scenarios

Text description of Figure 2.23 – Total Crown OBEGAL under different expenditure scenarios.

Figure 2.24 - Core Crown expenses (excluding NZS Fund, welfare and interest payments)

Text description of Figure 2.24 – Core Crown expenses (excluding NZS Fund, welfare and interest payments).

Notes:

1. Operating balance before gains/(losses).
2. Excludes minority interests.
3. Gross Sovereign Issued Debt.
4. Excludes financial assets of the NZS Fund and core Crown advances.
5. Excludes assets and liabilities belonging to minority interests.

Source: The Treasury

Key Assumptions for Medium-term Fiscal Projections#

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The assumptions for the medium-term economic and fiscal projections are outlined in this section. The full assumptions can be found at https://treasury.govt.nz/publications/fsm/fiscal-strategy-model-prefu-2020

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, Stats NZ

The assumptions for the economic variables remain unchanged from the 2020 Fiscal Strategy. While many economic variables are at, or very close to, their assumed long-run trend growth rates or levels at the end of the forecast period, a few may require transition in the early years of the projections and some for even longer periods into the projections. In such cases the annual convergence rate assumed is based on recent actual and forecast performance.

In the early years of the projections, several economic variables that are still influenced by the impacts of the COVID-19 pandemic, like the unemployment rate and average weekly hours worked are transitioned back to long-run stable assumptions. Once these are attained the economy is assumed to grow at trend growth rates with no economic cycles in the projections.

Other economic variables reach their long-run assumed rates or levels within the first three projected years, such as CPI growth, annual labour productivity growth, and nominal average hourly wage growth.

The government 10-year bond annual rate of return rises gradually over the entire decade of projections reaching 3.6% by 2033/34. This is driven by assumed movement towards the current long-run stable projection assumption of 5.0%. However, as the annual rate of return in the final forecast year is only 1.8%, the rate does not reach the long-run level within the projection period. The long-run assumption of 5% will be reviewed in the near future, as both actual and forecast interest rates have reduced in recent years.

Projected real GDP grows from its forecast base via the annual combined change in the size of the employed labour force, the average hours they work and their productivity.

Growth in nominal GDP in each projected year is achieved by adding CPI-based inflation to the real GDP growth. The long-run stable assumption for CPI inflation is 2 per cent per year, which matches the midpoint of the band set in remit for the Monetary Policy Committee. Nominal GDP growth is used to project many fiscal variables, including tax revenue. It is also the denominator for most major fiscal indicators, such as net core Crown debt to GDP.

Risks to the Fiscal Forecasts#

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Overview#

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The Treasury's fiscal forecasts are based on a number of assumptions and key judgements using the best information available and our best professional judgement. As with any kind of forecast, there is a risk that actual events will differ from expectations. This chapter outlines the key risks to the fiscal forecasts.

Risks to the fiscal forecasts can be either positive or negative, and can affect revenue and spending or assets and liabilities. The key risks to the fiscal forecasts can be broadly classified into the following categories:

This chapter provides a discussion of the following risks to the fiscal forecasts:

• COVID-19 (risk type 1, with consequences for all risk types) - there is a significant risk that the fiscal forecasts will be impacted from the continued effects of COVID-19, particularly on the economy, and from the Government's response. This section outlines the key risks to the fiscal forecasts resulting from COVID-19, including the possibility of a resurgence in community transmission of COVID-19 in New Zealand.
• Fiscal Sensitivities (risk type 2) - the fiscal forecasts are sensitive to particular economic indicators (eg, nominal GDP). This section outlines how changes in these economic indicators impact key fiscal indicators.
• Balance Sheet Risks (risk types 2 and 3) - the Government's balance sheet is exposed to a number of risks. This section outlines the risks that assets and liabilities will not be able to provide public services, finance or prefund future government expenditure and obligations, or achieve commercial objectives.
• Specific Fiscal Risks (risk types 4 and 5) - the fiscal forecasts will be impacted from future policy decisions and changes in demand for government services. This section covers all government decisions and other circumstances known to the Government, as at 7 September 2020, that may have a material effect on the fiscal outlook, but are not certain enough in timing or quantum to include in the fiscal forecasts.
• Contingent Liabilities and Assets (risk type 3) - the fiscal forecasts will be impacted if any of the Government's current contingent liabilities or assets crystallise. This section outlines the Government's (unaudited actual) contingent liabilities and assets as at 30 June 2020.

In Economic and Fiscal Updates prior to this year's Budget Update, information on Fiscal Sensitivities and Balance Sheet Risks was disclosed separately in a Risks and Scenarios chapter. However, we believe it is more useful in the current environment to include this information in this chapter with the other discussions of risks to the fiscal forecasts.

COVID-19#

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The COVID-19 pandemic is a major public health shock, which has already had a significant fiscal impact on the Government's finances. This chapter identifies the following specific fiscal risks directly affected by COVID-19:

Policy changes

• Business Finance Guarantee Scheme (Finance)
• COVID-19 Vaccine Strategy (Health)
• Further COVID-19 Business Support (Finance)
• Potential Tax Policy Changes (Revenue)

Cost pressures

• Change in Demand for Tertiary Education and Training (Education)
• Managed Isolation and Quarantine (Housing)
• Small Business Cashflow Scheme (Revenue)

Cross-portfolio risks

• Services Funded by Third Parties

In addition, other specific fiscal risks identified in this chapter are more generally affected by the economic downturn brought about by COVID-19. Despite the identification of these specific fiscal risks, the true fiscal impact of COVID-19 is still highly uncertain. This uncertainty presents significant risks to some of the assumptions used in preparing the fiscal forecasts. The key risks to the fiscal forecasts are:

• The impact on the economy - while several months have passed since the initial onset of the pandemic, the duration of the economic downturn and subsequent pace of the recovery depend on many unknown factors. Forecasts for tax revenue and benefit expenses are particularly sensitive to economic conditions. To illustrate this uncertainty the Economic Outlook chapter, from page 11, includes scenarios that model the fiscal impact of how the economy might evolve if some of the key judgements around COVID-19 in the main forecast were to be altered.
• The Government's response - the Government has already implemented policies to respond to COVID-19. Policies announced and communicated up to 7 September 2020 have been included in the fiscal forecasts based on the best information available. However, given the degree of uncertainty, there is a risk that actual costs and/or timing of these policies may differ, for example in estimating future calls on the Business Finance Guarantee Scheme or Small Business Cashflow Scheme.
• The Government's role in recovery - COVID-19 has impacted a number of sectors in the economy. The Government's response was initially focused on fighting the virus and cushioning the blow and, while still directed towards fighting further outbreaks of the virus, is now becoming increasingly focused on recovery from the impacts of COVID-19. Funding set aside to manage the fiscal costs of the response to, and recovery from, COVID-19 has been included in the fiscal forecasts.
• The COVID-19 Response and Recovery Fund - the Government has established the $50 billion COVID-19 Response and Recovery Fund (CRRF) as a budget management tool for managing the fiscal impacts of COVID-19. These forecasts assume that the CRRF will be fully allocated by the end of the forecast period. At the date the fiscal forecasts were finalised, 7 September 2020, $14.1 billion was still available in this budget envelope. To include this remaining budget envelope in the forecasts, the Treasury has had to make judgements about the nature (eg, operating or capital) and timing of the costs. There is a risk that actual costs will differ from the judgements and assumptions used to prepare the fiscal forecasts. There is also a risk that the fiscal costs of the Government's response and recovery may be more or less than what has been reflected in the fiscal forecasts.
• The impact on valuations of assets and liabilities - a number of assets and liabilities on the Crown balance sheet are valued using market information (eg, land and buildings, share investments and ACC outstanding claims liability). The impact of COVID-19 is likely to cause some ongoing volatility in the market that will affect the future value of assets and liabilities on the Government’s balance sheet.
• Contingent liabilities - the effects from COVID-19 may result in costs from some of the Government’s existing contingent liabilities converting into expenses during the forecast period. In particular, there is a risk that there may be calls on some uncalled capital facilities and some Crown guarantees and indemnities may crystallise (see pages 122 to 132).
• The risk of a resurgence in community transmission of COVID-19 or extended border controls - the key fiscal risks associated with COVID-19, which are outlined above, all apply under the main forecast. The main forecast reflects key assumptions that COVID-19 Alert Level 1 is in place from the September 2020 quarter (with approximately four weeks at Alert Levels 2 and 3) through to the end of 2021, that border restrictions are in place through to 1 January 2022, and that fiscal support measures are around $58.5 billion over the forecast period.

In addition to the key fiscal risks associated with the main forecast, there are further fiscal risks associated with two of the alternative scenarios outlined in the Economic Outlook chapter: (i) a scenario where there is a resurgence in community transmission of COVID‑19 in New Zealand, and (ii) a scenario where there are extended border controls. Under a scenario with a resurgence in community transmission, fiscal impacts would be highly dependent on the extent of infection and the nature, timing and effectiveness of the public health response (eg, whether there were to be a small number of cases in a community, a larger number of cases in a region, or multiple clusters spread nationally). Under a scenario with a resurgence in community transmission of COVID-19 or extended border controls, potential fiscal impacts include:

• costs to deliver any public health response to a resurgence in community transmission of COVID-19
• negative impacts on tax forecasts and benefit expenses (from economic conditions and/or COVID-19 alert level restrictions)
• costs of any Government policy decisions to support households and firms
• the impact on valuations of assets and liabilities, and
• costs from some of the Government's existing contingent liabilities converting into expenses.

Fiscal Sensitivities#

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Table 3.1 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 2024, tax revenue would be around $4.1 billion higher than forecast in the June 2024 year. The sensitivities are broadly symmetric: if nominal GDP growth is one percentage point lower than expected each year, tax revenue would be around $4.0 billion lower than forecast in the June 2024 year. The figures are indicative and can be influenced by the composition of growth as different types of activity have different effective tax rates.

Note:

1. Funds managed by the Treasury.

Source: The Treasury

The forecast financial position is based on judgements and assumptions about the future. To inform these judgements and assumptions we rely on market information. Some additional assumptions include those related to foreign exchange rates, share prices, the carbon price and property prices. For example, foreign-currency-denominated financial assets and liabilities are converted into New Zealand dollars, the Government's listed share investments are reported on market prices, and property owned by the Crown is valued using market information. These values are based on information prevailing at 30 June 2020. Where the actual outcome differs from our assumptions, the Crown's actual financial position is likely to differ from the forecasts. In addition, changes in these variables can also have flow-on effects for 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#

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The Government's balance sheet is absorbing a significant shock because of COVID-19, deploying the resilience built up over several economic cycles of responsible fiscal management. In addition, the COVID-19 response has seen some further risks added to the Government's balance sheet, for instance in relation to guarantees provided to businesses.

The Government's balance sheet can be usefully categorised by function or purpose as illustrated in Table 3.2 below.

Balance sheet risks are therefore risks that assets and liabilities will not be able to provide public services, finance or prefund future government expenditure and obligations, or achieve commercial objectives. The resilience of the balance sheet refers to its ability to absorb and adapt to shocks and stresses that might otherwise hinder these objectives being achieved.

Sources of (Social) balance sheet risk to public services

Physical assets such as land, buildings, state highways and military equipment are susceptible to external natural hazards and the quality of asset management in delivering services. The government generally relies on asset management, including built-in redundancies (eg, in network capacities), and its ability to re-allocate or repurpose assets (eg, in responding to a crisis) rather than risk transfer instruments such as insurance in managing these risks.

The replacement costs of physical assets are also susceptible to valuation movements through changes in property market conditions, changes in demand and changes in the costs of construction. The Pre-election Update forecasts have incorporated valuations up to 30 June 2020. A number of valuers have identified that while prices have not been significantly impacted by COVID-19, only limited market evidence is available from the time COVID-19 restrictions were first implemented. They have warned that illiquidity in property markets may be a short-term issue or a longer-term concern. Consequently, the property valuations in the balance sheet may be an unreliable guide to future property prices.

Social insurance and retirement liabilities (eg, Accident Compensation, Veterans' Disability and the Government Superannuation Fund) are prone to volatility through their actuarial valuations, including changes to expectations of future interest rates and inflation rates. These forecasts reflect a significant crystallisation of this risk as a consequence of the recent reduction of interest rates to unprecedented low levels.

These forecasts show significant concessionary lending available to achieve public policy purposes. This lending includes student loans and the Small Business Cashflow Scheme, while the forecasts also provide for Progressive Home Ownership Loans. This lending brings counter-party risk, and also exposes the Crown to risks associated with changes in assumptions about the future value of money, affecting how these future repayments are discounted. Expected credit losses from this lending are closely monitored.

The Crown faces contingent liabilities, for example, indemnities of activities in the public interest, environmental claims, and legal proceedings. The government indemnities associated with the Business Finance Guarantee Scheme to support viable businesses represent a significant increase in balance sheet risk. Contingent liabilities are discussed more fully on pages 122 to 132 at the end of this chapter.

Sources of (Financial) balance sheet risk to finance or prefund future government expenditure and obligations

The New Zealand Government remains among the highest-rated sovereigns globally, with the top Aaa foreign-currency rating from Moody's (reaffirmed on 2 April 2020) and AA foreign-currency ratings from Standard & Poor's and Fitch. Moody's has reported: “While the global coronavirus outbreak presents unprecedented challenges to New Zealand's economy, the Government has promptly deployed its fiscal capacity to buffer the impact of the shock. Institutional effectiveness mitigates vulnerabilities related to reliance on external financing and elevated household debt.”

The deployment of the Government's fiscal capacity has meant that the balance sheet is now more highly leveraged than previously. In addition, monetary policy activities including a Large Scale Asset Purchases (LSAP) programme, foreign-exchange swaps to manage short‑term interest rate pressures, and lending to the finance sector by the Reserve Bank have increased interest-rate risk.

Financial assets held by ACC and the New Zealand Superannuation Fund are sensitive to financial market volatility, such as movements in interest rates, exchange rates and equity prices. Crown financial institutions set long-term investment strategies based on underlying policy objectives. These strategies aim to look through short-term volatility and take exposures that would offset the impact of long-term social insurance or retirement liabilities.

Liquidity risk: the Crown incurs liquidity risk with respect to its ability to raise cash to meet its obligations. Each agency manages its own specific liquidity risk while the Treasury manages the Crown's liquidity requirements. The LSAP programme instituted by the Reserve Bank provides additional assurance that this risk is managed in the current environment.

Sources of (Commercial) balance sheet risk to meet commercial objectives

A number of commercial entities owned by the Crown have their financial performance and valuations impacted by the commercial environment in which they operate. These forecasts include support packages for state-controlled commercial businesses where COVID-19 has significantly impacted their commercial environment.

Managing risk into the future

The Crown's exposure to balance sheet risks is unavoidable if it is to pursue its objectives. The general approach that has been taken to identify, measure and treat these risks where practicable, to maintain debt at prudent levels and to hold a healthy level of net worth has enabled the Government to effectively absorb much of the shock of COVID‑19.

The build-up and subsequent deployment of that fiscal resilience in response to COVID‑19 has underscored the importance of the principles of responsible fiscal management in the Public Finance Act 1989. That deployment is reflected in the reduction of net worth from $143.3 billion at 30 June 2019 to a forecast $43.5 billion as at 30 June 2024.

The forthcoming risk management challenge is to move from absorption to adaptation, as the Government moves from fighting the virus and cushioning the blow towards kickstarting the economy, resetting the Crown's balance sheet objectives and rebuilding its capacity to absorb shocks in the future.

Specific Fiscal Risks#

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This statement of specific fiscal risks is required by the Public Finance Act 1989. In addition to the discussion of other types of risks to the economic and fiscal forecasts outlined in this chapter, 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 outlook, but are not certain enough in timing or quantum to include in the fiscal forecasts. This section covers:

• how specific fiscal risks are managed
• criteria for inclusion and exclusion of specific fiscal risks, and
• the statement of specific fiscal risks.

The risks disclosed in this chapter reflect those that are known at the date of the finalisation of the fiscal forecasts, 7 September 2020. Although the process for disclosure of specific fiscal risks involves a number of entities, including government departments, the Treasury and the Minister of Finance, there remains a possibility that not every significant risk is identified.

How Specific Fiscal Risks are Managed

A key principle guiding the disclosure of risks is transparency. This means that material risks are disclosed in this section regardless of whether they can be managed through existing funding sources (eg, through prioritisation of funding already available to departments) or the Budget operating and capital allowances (the future new spending built into the fiscal forecasts). This ensures a prudent approach to the disclosure of risks, to improve transparency and to avoid prejudging future decisions by governments about what may or may not be funded from allowances.

The Government has a number of options to manage risks. The risks disclosed in this section therefore may not arise in a way that affects the fiscal forecasts presented in this Pre-election Update.

1 Reprioritisation

The unaudited actual result for core Crown expenses for the year ended 30 June 2020 is $108.8 billion, while capital spending for the same period totalled $9.4 billion. Some of this expenditure is temporary in nature. Looking beyond this, however, the base of non-temporary expenditure creates significant scope for reprioritisation. Agencies are expected to fund cost pressures and new activities from funding already allocated to them. This could include repurposing low-value expenditure or generating efficiency savings.

2 Budget allowances

The following allowances for new expenditure in future Budgets have been included in the Treasury's fiscal forecasts (Fiscal Outlook chapter) and are the same as those in the Budget Update. These may be reviewed at a later date when the fiscal impact of COVID‑19 is clearer.

These allowances are included in the fiscal forecasts to reflect future new spending by the Government and better link the forecasts to the Government's fiscal strategy. The effect of including the allowances in the forecasts is that new spending decisions in future Budgets should not impact the Government's fiscal targets.

The allowances are the main mechanism for the Government to allocate new expenditure for each Budget. The allowances have been set at a level that allows the Government to achieve its broader fiscal and policy objectives, and in accordance with the expectation that any new policy initiatives and cost pressures can be managed within these parameters. A self-imposed limit on expenditure also helps to ensure any new spending is targeted to areas of high priority.

For more information about Budget allowances, refer to pages 57 to 58 in the Fiscal Outlook chapter.

3 Policy choices

For some risks, the Government has choices around future funding, including how much is funded and the timing of when that funding is provided.

4 COVID-19 Response and Recovery Fund (CRRF)

For risks that materialise in full or in part owing to the impacts of COVID-19, drawing down on the remaining balance of the CRRF is an additional option for the Government.

Criteria for Inclusion either in the Fiscal Forecasts or as a Specific Fiscal Risk

Specific criteria based on section 26U of the Public Finance Act 1989 determine what is included in the fiscal forecasts as opposed to what is disclosed as a specific fiscal risk.

General Risks not Included as Specific Fiscal Risks

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

• risks from changes to economic assumptions, including as a result of COVID-19, and the most significant of these have been recognised elsewhere in this chapter and Pre‑election Update
• business risks and volatility in the returns from, and valuation of, the Government's investments relating to the broader economic and commercial environment, and
• the costs of future individual natural disasters, individual events resulting from climate change, and other major events (including biosecurity incursions), as their occurrence, nature and timing cannot be predicted.

New Zealand will continue to experience natural disasters and for some of these the frequency and/or severity is likely to increase with climate change, for example increased coastal flooding because of sea level rise and extreme weather events. Once such an event does occur, various choices arise about how to respond, and when to recognise potential liabilities. Specific risks are disclosed at that point based on the range of possible responses.

In addition, the fiscal forecasts do not include a liability for New Zealand's international climate change obligations because these are not yet measurable. Policy decisions already made and yet to be made aimed at securing New Zealand's commitments resulting from the Paris Agreement, as well as those designed to mitigate the wide‑ranging consequences of climate change in New Zealand, are expected to have a fiscal impact; however, any specific impact is unquantifiable at this stage.

Exclusions to Disclosure

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

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

Section 26V requires the Minister of Finance, if possible, to avoid withholding the matter, either by making a decision on it before the forecasts are finalised or by disclosing it without quantifying the risk.

Summary Table#

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The matters listed below are disclosed as specific fiscal risks because, in the Treasury's judgement, they meet the criteria for disclosure. Full descriptions are set out in the next section.

The table below is categorised based on the nature of the risk: policy changes, cost pressures and cross-portfolio risks. Within these categories, the risks have been ordered by portfolio and include the title of the risk, its status and whether it has an impact on revenue, expenses and/or capital expenditure. The status of the risk describes whether the risk reflects a new matter or is changed or unchanged since the Budget Update.

Statement of Specific Fiscal Risks as at 7 September 2020

Policy change risks

Cost pressure risks

Cross-portfolio risks

Policy Change Risks by Portfolio#

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ACC

Impacts of Changes to Accident Compensation Policy Settings (Unchanged)

The Government has signalled it will review a number of Accident Compensation scheme policy settings. Some of the policy issues identified would require either legislative or regulatory change. These changes could result in a significant 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 $1.5 billion to $2.0 billion would need to be reported if such an amendment were to be enacted.

Biosecurity

Mycoplasma Bovis Biosecurity Response (Unchanged)

The Government and the farming sector have agreed to attempt to eradicate the cattle disease Mycoplasma bovis. Crown funding has been appropriated and included in the forecasts for response activities in 2020/21 only. The timing of farming sector contributions may differ from what is in the fiscal forecasts. The need for Crown funding to be appropriated for 2021/22 and subsequent years will be considered depending on progress in eradicating the disease.

Broadcasting, Communications and Digital Media

Delivery of the Government's Public Media Outcomes (Unchanged)

The media sector, including both public and privately-owned organisations, is under increasing pressure from international competition, declining revenue shares and changes to the way people access content. The Government has committed to strengthening New Zealand's public media and has commissioned a detailed business case on the viability of a preferred approach. Once business case outcomes are agreed, significant additional investment may be required to deliver on the Government's public media outcomes.

Defence

Defence Funding Requirements to Deliver New Zealand's Defence Strategy (Unchanged)

In 2018, the Government updated Defence policy settings in the Strategic Defence Policy Statement 2018. These policy settings, and the Defence Capability Plan 2019 subsequently agreed by the Government in 2019, provide an indication of future Defence capital and operating funding requirements. However, the precise quantum and timing of actual Defence spending will depend on the approval of future business cases and Budget initiatives.

Disposal of New Zealand Defence Force Assets (Unchanged)

The Government continues to consider the potential to dispose of a number of New Zealand Defence Force assets. Depending on market conditions, the timing of disposal and the sale price received could have either a positive or a negative impact on the Government's overall financial position.

Education

Early Learning Action Plan (Unchanged)

Following public consultation between November 2018 and March 2019 and subsequent Cabinet approval, the Government released He Taonga te Tamaiti - Every Child a Taonga: Early Learning Action Plan 2019-2029 in December 2019. The estimated cost of the Early Learning Action Plan (ELAP) in the forecast period is approximately $1.2 billion. This estimated cost relates to actions that are indicated in the ELAP as likely to begin within the forecast period, such as improving adult-to-child ratios. To the extent that costs cannot be managed within baselines, further funding may be required.

Education Workforce Strategy (Unchanged)

The Ministry of Education is working in partnership with the Education Workforce Strategy Governance Group to develop a comprehensive Education Workforce Strategy (EWS) for the full education workforce. Cabinet will consider the draft EWS in early 2021. Post‑Cabinet consultation and engagement with the education workforce and the New Zealand public will follow. An action plan will likely be finalised in late 2021. Initial estimates are that unconstrained implementation, delivering on the full intent of the EWS, will cost more than $100 million.

Extension of the Fees-free Tertiary Education Policy (Unchanged)

The Government has a stated intention to extend its first-year fees-free tertiary education and training policy to make the first three years of tertiary education fees-free in future parliamentary terms. The behavioural changes from extending the policy, and therefore the impact on future costs, are unquantifiable at this stage.

Free and Healthy Lunch Programme (New)

The Free and Healthy Lunch Programme was a prototype to test different models of delivery to students in selected schools. The programme was expanded to provide lunches to the 25% most disadvantaged students in the country as part of the Government's COVID-19 response. The programme funding (both the prototype and expansion) ends in December 2021. If the Government decides to extend or expand the programme, additional ongoing funding beyond that currently provided for will be required.

Reform of Vocational Education (RoVE) (Changed)

The New Zealand Institute of Skills and Technology (NZIST) has been established, bringing into one organisation the 16 former Institutes of Technology and Polytechnics. The NZIST may seek significant additional Crown funding in the future for the transformation and management of its national network of education providers, including integrating support for work-based training such as apprenticeships. Design of, and implementation planning for, the vocational education Unified Funding System (UFS) is continuing. The Government has stated an intention to implement the UFS from 1 January 2023, but this and any additional investment is subject to Cabinet decisions.

Replacing Deciles with the Equity Index (New)

The Government has made an in-principle decision to replace school deciles with the Equity Index. The index provides a more refined measure to understand whether there are socio-economic factors present in the lives of children that can impact educational outcomes. This will inform how the education system can be resourced to provide all children with an equitable chance of success. Additional funding for schools and implementation will be required in the future to transition to the new system.

Response to the Tomorrow's Schools Review (Unchanged)

The Government's response to the Tomorrow's Schools Review has been publicly released. Continued policy development and relevant service and implementation design have begun. Accordingly, future decisions are required on almost all changes, including decisions on changes in investment. The Government has indicated it will consider these changes and new investments over the next three to four Budgets. This is a policy choice of the Government and the costs will be material but unquantifiable at this point for specific financial years. The impact of COVID-19 will lead to continued development work over the long term, with a short-term focus on supporting schools and front-line services.

Finance

Alternative Monetary Policy Tools (New)

The Reserve Bank of New Zealand (RBNZ) is considering a range of options to expand its Alternative Monetary Policy tools (AMPs). These tools may be supported by an indemnity from the Minister of Finance for potential losses for the RBNZ. The potential risk and costs to the Crown are material but unquantified at this stage.

Business Finance Guarantee Scheme (New)

As reported under contingent liabilities, the Crown has established a Business Finance Guarantee Scheme (BFGS) with a number of banks to support New Zealand businesses facing hardship as a consequence of COVID-19. The currently assessed fair value of these contracts, and the expense arising, has been quantified and incorporated into the forecasts. Changes to the BFGS currently being implemented will increase take-up of the scheme, and may impact on credit losses that will be incurred. This is a variance risk to the extent that the actual take-up of the scheme and credit losses incurred, which may also be affected by any future changes to the scheme's settings, may differ from what is included in the fiscal forecasts.

Deposit Insurance Scheme (Unchanged)

The Government has announced that by 2023 it plans to introduce a deposit insurance scheme, of $50,000 per depositor per institution, and is consulting on the details. The scheme would have an impact on both expenses and revenue over the forecast period, but is not yet reflected in the fiscal forecasts.

Further COVID-19 Business Support (New)

Through various policy decisions, the Government has committed to supporting businesses in response to COVID-19. Were the Government to provide additional support to businesses at various COVID-19 alert levels, this would represent a fiscal risk to the extent that the timing, extent and/or nature of COVID-19 business support may differ from that included in the fiscal forecasts.

Foreign Affairs

Official Development Assistance (Unchanged)

Each year, New Zealand's Official Development Assistance (ODA) expenditure is measured as a proportion of Gross National Income (GNI). In Budget 2020, Cabinet agreed to increase ODA by $55.589 million in 2020/21, lifting it to 0.31% of GNI from 0.28% of GNI. If Government wants to maintain the ratio at or around 0.31% beyond June 2021, a different level of funding may be required, depending on the scale of the economic impact of COVID-19.

Health

COVID-19 Vaccine Strategy (New)

The New Zealand Government will need to obtain or facilitate the development of a vaccine for COVID-19. There is a fiscal risk related to the cost of purchasing a vaccine if one becomes available, as well as the cost of vaccinating the population to prevent further outbreaks of COVID-19.

Health and Disability System Review (Changed)

The review of the New Zealand Health and Disability System has identified opportunities to improve the performance, structure and sustainability of the system with a goal of achieving equity of outcomes, and contributing to wellness for all, particularly Māori and Pacific peoples. Until the Government has considered the recommendations and decided which to implement, the costs of implementation will not be known. No decisions will be taken until after a government is formed following the General Election in October 2020.

Primary Care Services (Unchanged)

The Government has signalled the intention to further increase funding for Primary Care services beyond the increase provided in Budget 2020 and in response to COVID-19. The associated implementation details and arrangements for any further funding are yet to be finalised.

Local Government

Three Waters Infrastructure Investment and Reform Programme (New)

The Three Waters Review highlighted systemic challenges facing the three waters sector including infrastructure deficiencies, asset management, service delivery, capacity and capability issues, and funding and affordability constraints. In July 2020, the Government made funds available to territorial authorities to support their planned investment programme and large-scale asset replacements. This funding will be available only to territorial authorities that opt in to the proposed three waters service delivery reform programme over the next three years. It is possible that further funding is required in the future to incentivise territorial authorities to support and deliver the reform programme.

Māori Development

Government Response to WAI262 (Unchanged)

The Waitangi Tribunal's report on the WAI262 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. In April 2019, the Government initiated a whole-of-government approach to addressing issues raised in the WAI262 claim and the Tribunal's subsequent report.

Research, Science and Innovation

Research and Development Spending Target (Unchanged)

The Government has a target to increase economy-wide research and development (R&D) expenditure to 2% of GDP over 10 years. While the effect of COVID-19 is likely to decrease GDP, it is also likely to decrease private sector R&D expenditure. It is too soon to assess whether the combined effect of these two factors will further increase the cost to the Crown of achieving the 2% of GDP target.

Revenue

Potential Tax Policy Changes (Unchanged)

The Government has initiated a work programme to progress certain tax measures. These can be viewed on the tax policy website www.taxpolicy.ird.govt.nz. Given the effect of the COVID-19 pandemic on the economy, the focus of the work programme will be on supporting businesses and New Zealanders through this crisis and facilitating the recovery. The fiscal implications of these potential policy changes are unquantified at this stage.

Taxation of Digital Services (Unchanged)

The Government is currently considering options for reform of the international tax framework in light of the challenges posed by digitalisation and globalisation. The Government's preference is to continue working with the Organisation for Economic Co‑operation and Development (OECD) to find a multilaterally agreed solution to these challenges, but the Government will seriously consider a digital service tax if the OECD does not make sufficient progress on a multilateral solution. The revenue impact of any change will depend on the design of the preferred option.

Social Development

Changes to the Welfare System (Unchanged)

The Government has agreed that its vision for the welfare system is to ensure that people have an adequate income and standard of living, are treated with respect and can live in dignity, and are able to participate meaningfully in their communities. Cabinet has agreed to a multi-year policy work programme to deliver on this vision. Any changes agreed to in future will likely have legislative, operational, ICT and fiscal implications. Detailed information on the scale of change, implications and associated costs will be provided to Cabinet as part of future decisions.

Transport

Auckland City Rail Link Ownership Issues (Unchanged)

The Government has committed to fund 50% of the costs associated with the City Rail Link project, along with Auckland Council, which has also committed to fund 50% of the project. Both the Crown and Auckland Council have treated the investment for the City Rail Link project as capital expenditure. Depending on the final ownership structure of the City Rail Link, the Crown may need to write off some value from the Crown's books. Any write-off is likely to be in the range of +/- 20% of the Crown's investment (ie, there may be a write-up of value), but this depends on several factors including allocation of assets and valuation basis once allocation has been determined. The timeframe for decisions on future ownership has yet to be finalised. The current work plan is for such a decision to be made in late 2020, although the agreement between Sponsors and City Rail Link Limited allows for a decision to be made as late as 2022.

Light Rail in Auckland (Unchanged)

Cabinet has decided to terminate the parallel process for the Auckland Light Rail project and for any further decisions to be taken after a government is formed following the General Election in October 2020. The Government is still committed to addressing congestion on the city centre to Mangere corridor and, depending on future decisions, Crown funding may be required to support any rapid transit project.

Support for KiwiRail (Changed)

Budget 2020 provided an appropriation of $246 million for below rail network investment, $421 million to replace ageing rolling stock, and $400 million to support replacement of the ageing interisland ferry fleet and associated landside infrastructure. Further Crown funding is likely to be sought to progress these projects as part of the implementation of the Future of Rail programme.

Upper North Island Supply Chain Strategy (UNISCS) - Independent Working Group Recommendations (Unchanged)

Sapere Research Group has completed its report analysing the Working Group's options for moving freight from the Ports of Auckland. All of the five options analysed had economic costs that outweighed the economic benefits. Cabinet has deferred any decisions on the future location of Auckland's port until 2021, when officials are expected to give their advice on the Sapere and Working Group reports.

Wellington Transport Investment Programme (Unchanged)

The Government Policy Statement on land transport 2021 has been developed in a way that ensures that Let's Get Wellington Moving (LGWM), along with the Government's other priorities, can be funded from the National Land Transport Fund (NLTF) to the expected level. However, the ability to deliver LGWM in full relies on local government providing its own share. If the local government share is at risk of not being met, heightened by COVID‑19, there could be requests for greater funding from central government, putting further pressure on the NLTF.

Cost Pressure and Cost Variance Risks by Portfolio#

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ACC

ACC Levies (Unchanged)

ACC levies will remain unchanged until at least 2022, with indicative future levy rates for the Work, Earners' and Motor Vehicle accounts included in the forecasts. 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 that required to cover the cost of claims. If factors such as claims experience, ACC performance, and economic assumptions (particularly discount rates and unemployment rates) differ from the forecasts, ACC's levy revenue, claims costs, and liability may also differ from the forecasts. 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 future 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.

Climate Change

Emissions Trading Scheme - Fixed Price Option (Unchanged)

The Emissions Trading Scheme (ETS) earns revenue and incurs expenses for the Crown, both of which are uncertain. The uncertainty is partly owing to the future market price of New Zealand Units (NZUs), and the extent to which participants elect to use the Fixed Price Option (FPO). For the latest fiscal forecasts, both revenue and expenses assume a carbon price value based on the market price at 30 June 2020 of $32.10. Under the FPO, participants and eligible persons have an option to meet their obligations by purchasing units directly from the Crown at a fixed price. Should the secondary market price of NZUs exceed the fixed price near the time the surrender obligations are due in May 2021, it is likely that participants and eligible persons would use the FPO. As a result, the Crown would recognise an expense from selling units at below market price and receive cash that would reduce net core Crown debt. Conversely, if the market price of NZUs remains less than the $35 FPO for 2020 emissions it is likely that participants will use the secondary market to fulfil their surrender obligations rather than the FPO. The Climate Change Response (Emissions Trading Reform) Amendment Act 2020 enables the auctioning of units to begin in 2021. Auctioning NZUs will result in cash being paid to the Crown, also reducing net core Crown debt. The extent of this depends on the future price realised for auctioned units, which is inherently uncertain.

Conservation

Department of Conservation Compliance with Drinking Water Supply Infrastructure Requirements (New)

Three waters reforms (see Three Waters Infrastructure Investment and Reform Programme on page 105) will introduce new requirements for providers of drinking water and limit the definition of 'self-supplier' to individual domestic self-suppliers. The Department of Conservation manages drinking water supply infrastructure assets at over 2,000 sites including campsites, huts, visitor centres and town supplies, many of which are exempt from drinking water standards under the current definition of 'self-supplier'. The new requirement that all drinking water suppliers must provide safe drinking water and comply with drinking water standards on a consistent basis, and the proposed change to the definition of 'self-supplier' resulting from the Water Services Bill, may have significant fiscal implications for the Department of Conservation.

Corrections

Waikeria Mental Health Unit Operating Funding (New)

The Waikeria Prison Development, including a 500-bed High Security Facility and a 100‑bed Mental Health and Addiction Service, is currently under construction. The operational costs of running these facilities were not sought at the time Cabinet approved the projects. These operational costs, including the intensive model of care required by the Government as part of the Mental Health and Addiction Service, may require further Crown funding as there is a risk that these costs cannot be met within existing baselines.

Economic Development

New Zealand Screen Production Grant - International (Unchanged)

The New Zealand Screen Production Grant is an uncapped, on-demand grant that incentivises international studios to locate production work in New Zealand by offering them a rebate on their qualifying expenditure. Although potential delays to productions as a result of COVID-19 may offset some of this risk in the near term, there remains a high level of international interest in New Zealand as a place to do screen business over the forecast period. The fiscal forecasts include an estimate of expenditure based on known productions. There nevertheless remains a risk that demand for the Screen Production Grant will exceed what is included in the fiscal forecasts if more large-budget productions choose to locate in New Zealand (in addition to the two existing large-scale productions of the Avatar sequels and The Lord of the Rings television series).

Education

Change in Demand for Tertiary Education and Training (New)

There is significant uncertainty about the impact of COVID-19 on unemployment, the reduced net migration of New Zealand residents, and the scale of the increased enrolments in tertiary education that result. More people aged 18-24 years, and more people unable to find work who enter study instead to upskill or retrain, can lead to more enrolments in tertiary education. In Budget 2020, the COVID-19 Response and Recovery Fund provided an additional $334 million over 2021 to 2023 to meet increased learner demand. Due to the uncertainty around the impact of COVID-19, learner demand could be higher, or lower, than the available number of funded places for learners. Updated forecasts and initial enrolments in 2021 will provide an indication of any potential additional financial costs.

Education Operating Cost Pressures (Unchanged)

The education sector faces significant cost pressures from increasing demand in early childhood education (ECE) and schooling, largely as a result of population growth. Demographic change has an impact on expenditure on ECE subsidies, especially for the 20 hours' fully subsidised entitlement for three- to five-year-olds; the per-pupil component of schools' operational funding; and schools' full-time teaching equivalent entitlement, which is based on staff-to-student ratios. In addition, the Ministry of Education faces compounding departmental operating expenditure pressures due to the increasing demand for and price of education services, and other cost pressures experienced by its work programmes. These pressures, which include difficult-to-control inflationary pressures, represent risks to the extent that they cannot be managed through reprioritisation or new spending set aside in the forecasts. The Government's stated intention is that all pressures are managed through these mechanisms.

Learning Support (Changed)

The Government's Learning Support Action Plan 2019-2025 (the Action Plan) notes the need to provide better support for disabled children and young people, and those with additional learning needs. Some Action Plan priorities may need further funding, such as strengthening support for neurodiverse learners and those who require alternatives to mainstream schooling and/or are at risk of disengaging from education. In addition, some existing learning support services provided and/or funded by the Ministry of Education face volume and price pressures. There is a risk that these pressures cannot be met within existing baselines and further funding may be required.

School Transport Services (Unchanged)

The cost of Daily School Bus Services makes up approximately half of the total budget for School Transport Services. The Ministry of Education will be going to market for the tender for provision of these services, which could impact the annual expenditure under the new contracts. In addition, the combination of a demand increase of 14% in Specialised School Transport Assistance (prior to COVID-19) and indexation increases will likely lead to further cost increases. To the extent that these pressures cannot be managed within existing baselines, additional funding is likely to be required.

Finance

Closure of Tiwai Point Aluminium Smelter (New)

On 9 July 2020, Rio Tinto Limited announced the closure on or before August 2021 of New Zealand Aluminium Smelters (NZAS), which operates the Tiwai Point Aluminium Smelter in Southland, with the wind-down of operations expected to be completed by August 2021. The impacts on electricity generation and transmission companies, which are majority or wholly owned by the Crown, and the need for transitional assistance for the Southland regional economy and workforce are unknown at this stage but could be significant.

Earthquake Commission (Unchanged)

The Earthquake Commission's (EQC's) independent actuary undertakes half-yearly valuations of the total earthquake liability to the Crown. This includes settled and yet to settle claims (including those in litigation), an estimation of future claims not yet received, insurer finalisation and any associated reinsurance recoveries. Based on these valuations, a profile of the claims yet to settle is included in the fiscal forecasts. There remain risks that EQC's remaining settlement expenditure relating to the Canterbury and Kaikōura earthquakes will differ from (be higher or lower than) forecast. This is because EQC's remaining settlement expenditure relating to the Canterbury earthquakes does not incorporate any liability recognition or provision for costs relating to the over-cap portion of any building claims, whether they are on-sold remedial building claims or otherwise. EQC only recognises expected future costs where it is liable for such costs under the Earthquake Commission Act 1993. The risks include litigation and the resolution of liability with insurers and reinsurers, in addition to the level of future remedial claims. It is not possible at this stage to fully quantify the potential financial impact or the timing of these risks owing to the uncertainty associated with them, and variation could be material.

Goodwill on Acquisition (Unchanged)

As at 30 June 2020, the Government had goodwill on acquisition of a number of sub‑entities totalling $483 million (unaudited actual). Under New Zealand accounting standards (PBE IPSAS 26), 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. The fiscal forecasts currently make no allowance for further such impairment losses.

Foreign Affairs

Antarctica New Zealand - Redevelopment of Scott Base (Unchanged)

The infrastructure at Scott Base is approaching the end of its functional life. The indicative cost of redeveloping the base ranges from $200 million to $290 million over an approximately eight-year period. Budget 2019 provided $19.7 million to Antarctica New Zealand to undertake further design and market testing to confirm costs ahead of seeking full redevelopment costs. In June 2019, Cabinet agreed in principle to the redevelopment of Scott Base and to a specific design option, subject to approval of the final costs, to be sought in a future Budget.

Greater Christchurch Regeneration

Southern Response Earthquake Services Support (Changed)

The ultimate cost to the Crown of settling earthquake claims remains subject to uncertainty. Forecasts currently 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 be higher than this estimate, which is sensitive to its underlying assumptions such as damage estimates, recent and future court decisions, claims emerging in the future and the forecast profile of claims settlement.

Health

DHB Sustainability (Unchanged)

In recent years, the District Health Board (DHB) sector has been running operating deficits. As a result, a number of DHBs have required additional equity injections from the Government in order to remain solvent. This trend is expected to continue, with the fiscal forecasts reflecting deficits from DHBs of, on average, $600 million per year over the forecast period. The fiscal forecasts assume that future expenditure growth will be met from future Budget allowances.

There is a significant risk that DHBs' deficits may be higher than what has been included in the fiscal forecasts, which would adversely impact the Government's operating balance and net core Crown debt. In particular, the DHB sector is likely to face significant cost pressures in the future to maintain the delivery of existing services. These cost pressures may increase as a result of the COVID-19 response. DHB expenditure growth is likely to be driven by demographic changes, price inflation of inputs, and wage costs (both pay negotiation and progression through pay scales). The Government does have choices for meeting future cost pressures if they eventuate. However, given current policy settings, constraining or reducing expenditure over the forecast period while maintaining existing services would be very difficult. DHBs will be likely to require additional revenue to manage growing deficits. Decisions on the Health and Disability System Review recommendations will not be taken until after a government has been formed following the General Election in October 2020.

Health Capital Pressure (Unchanged)

These capital pressures mainly relate to DHBs, but also to the Ministry of Health and other parts of the health system. DHBs have submitted updated capital intentions, identifying the indicative need for Crown funding over the next four years. Budget 2020 provided $750 million for DHBs and Budget 2019 provided $1.7 billion, with a further $300 million being provided through the New Zealand Upgrade Programme. However, the pressures remain significant over the forecast period. These pressures are largely driven by asset condition issues and demographic change (population growth and an ageing population), placing pressure on infrastructure capacity. Information technology capability in the Ministry of Health and other parts of the sector also needs to be addressed because of ageing legacy systems and an inability to leverage new technology. The magnitude of the risk will depend in part on whether the capital expenditure can be incurred at the time forecast in the fiscal forecasts.

Health Operating Pressure (Unchanged)

The health sector is likely to face significant operating pressures within its existing baselines to maintain the delivery of existing health services. The main pressure drivers include demographic changes (both growth and an ageing population), wage costs (both pay negotiations and progression through pay scale), price inflation of inputs and increased operating costs from investment in information and communications technology (ICT).

Housing

Divestment and Development of Kāinga Ora - Homes and Communities' Housing (Unchanged)

Kāinga Ora's financial forecasts include business-as-usual divestments, acquisitions and the redevelopment of land and housing as part of its asset management strategy. Revenue from land and property divestments is used to help finance new public housing stock. The COVID-19 crisis is expected to disrupt the property market, potentially reducing Kāinga Ora's revenue from divestments, thereby increasing its borrowing and/or Crown funding requirements. Kāinga Ora also faces commercial and financial risks inherent in large-scale build and urban development programmes, the magnitude of which has increased as a result of the adverse impact of COVID-19 on Kāinga Ora's pipeline, international supply chains and the financial viability of its build partners.

Emergency Housing Special Needs Grants (Unchanged)

Emergency Housing Special Needs Grants help individuals and families with the cost of staying in short-term accommodation if they are unable to access a transitional or public housing place. If demand increases and/or the number of transitional or public housing places does not increase as forecast, this would increase demand for the grants, with associated fiscal costs.

Increases to Market Rent (Unchanged)

Over $1 billion of payments per annum for housing assistance, such as income-related rent subsidies and accommodation payments for transitional housing, are linked to market-based rent levels. Should market rents increase above what is assumed for the forecasts, further funding may be required to maintain current levels of support.

KiwiBuild - Fiscal and Delivery Risks (Unchanged)

Changes in the housing market and economy may have an impact on the costs of delivering homes and associated revenue recycling. If the prices of underwritten houses fall, Crown underwrites may be called, thereby increasing debt, and the value of the portfolio may fall, impacting the operating balance. To achieve programme goals, there may be a need to change policy settings or provide support to developers and/or homebuyers. The Crown also faces general commercial risks associated with development and with implementing a large and evolving programme, which pose fiscal and delivery risks.

Large-scale Housing and Urban Development Projects (New)

Kāinga Ora is currently carrying out a number of large-scale housing redevelopment projects. While a portion of these costs will be met from Kāinga Ora's balance sheet, funding for the additional infrastructure and works needed to support these developments is yet to be agreed between central and local governments.

Managed Isolation and Quarantine (New)

Given the changing global situation and uncertainty with respect to COVID-19, demand for Managed Isolation and Quarantine (MIQ), and the number of places, length of time, and type of accommodation, health and security arrangements required, may change rapidly. Any changes in demand may create cost volatility and could outstrip current MIQ supply and appropriated funding. Current expectations are that facilities may be required for some time, giving rise to a need to seek funding additional to that already included in the forecasts.

Tāmaki Regeneration Project (Changed)

The Tāmaki Regeneration Project involves the replacement of 2,500 existing public houses with between 7,500 and 10,500 new public, affordable and market houses (around one-third of which will be public houses). Development involves writing off existing public housing assets. If land sale proceeds are less than the value of write-offs in a given year, there will be a negative impact on the operating balance. The likelihood of this occurring has increased, given the expected impact of COVID-19 on land prices.

Internal Affairs

Archives New Zealand Storage Capacity (Unchanged)

There are capacity and condition issues with the current property portfolio for the storage of New Zealand's documentary heritage. Budget 2019 provided funding to complete the design work and initial shift activities associated with the proposed upgrade and expansion of the physical infrastructure. Budget 2020 provided funding for the development and subsequent lease of the new Wellington Archives New Zealand facility and the land purchase and design for a new Regional Shared Repository (RSR). Further funding will be sought in Budget 2022 for the construction of the new RSR to respond to forecast storage growth to 2030.

Royal Commission of Inquiry into Abuse in State Care (New)

The Royal Commission of Inquiry into Historical Abuse in State Care and in the Care of Faith-based Institutions was formally established in November 2018 and was funded only for the first phase of its work. Additional funding may be required through Budget 2021 to enable the Royal Commission to complete the second phase of work, following submission of its interim report in late 2020.

Justice

Legal Aid Demand Pressures (New)

Entitlement to legal aid is legislatively mandated and costs are driven by the volume and complexity of cases. The average cost per case has increased as a result of growth in more serious cases. Volumes can be affected, either positively or negatively, by changes to justice sector policy settings or trends in crime. There is a risk that additional funding will be required if volumes are higher or cases more complex than assumed in the forecasts.

Police

Firearms Reform Programme (Unchanged)

The Arms Legislation Act 2020 was assented to on 24 June 2020. The Act amends the Arms Act 1983 to provide for the establishment of a firearms registry and for other changes including amendments to the licensing regime, increased regulatory oversight, and the development of new offences and penalties. To the extent that the implementation of the changes cannot be managed within baselines, additional funding will be required.

Racing

Financial Viability of TAB NZ (New)

The Government made up to $50 million available for the Racing Industry Transition Agency (now TAB NZ) to support its operations through to 31 July 2020. The work to determine the level of the industry support package revealed that TAB NZ was undercapitalised, and additional support may be needed. In the post-COVID environment, TAB NZ revenue may also be depressed for several years, which could have downstream implications for the industry and communities that depend on it. Work is underway to confirm and size this and identify options for addressing any funding requirements.

Regional Economic Development

Provincial Growth Fund (Unchanged)

The Government has committed to a Provincial Growth Fund of $3.0 billion over a three-year period. The capital and operating split and timing of this funding, as set out in the fiscal forecasts, are likely to change, and final capital and operating expense amounts in any year may vary from those forecast.

Revenue

Cash Held in Tax Pools (Changed)

Funds held in tax pools are recognised as a Crown asset. There is a risk that funds held in these pools may be withdrawn by that taxpayer, resulting in a reduction in the Crown's available cash reserves. The risk of withdrawal is larger in economic downturn as taxpayers are more likely to withdraw deposits. Conversely, there is also a risk that tax pool deposits will increase if Inland Revenue's use of money interest rates remains unchanged and the Reserve Bank moves to negative interest rates.

Research and Development Tax Incentive (Unchanged)

The Government has implemented a Research and Development (R&D) Tax Incentive, which allows eligible firms to deduct a percentage of their expenditure on R&D against their tax liability to the Crown. Under certain circumstances, eligible firms may receive a cash payment in place of a tax credit. There is a risk that costs may differ from forecasts owing to the limited availability of data for forecasting purposes on future R&D expenditure, including how firms' R&D expenditure will respond to the subsidy. Additionally, international experience shows that costs of R&D tax credits can be significantly higher than expected if firms recategorise other types of expenditure as R&D in order to claim the credit. Costs may also differ from forecasts as the investment environment can change quickly.

Small Business Cashflow Scheme (New)

The Small Business Cashflow Scheme was introduced to support small-to-medium businesses affected by COVID-19. There is a variance risk that the value of the lending may differ from what is currently forecast, either positively or negatively, as the lending under the scheme is dependent on demand until the application closing date of 31 December 2020. As new lending occurs, an initial write-down to fair value is made. This reflects the cost the Crown incurs in making a loan at below-market terms and the risk that borrowers will not repay their loans. The fair value of the scheme will depend on the amount of loans and the assumptions around borrower repayments and defaults over the life of the scheme. The fair value assumptions made to project borrower repayments and discount them to today's dollars rely on volatile factors that are subject to change.

Student Loans - Valuation (Unchanged)

The value of student loans is sensitive to assumptions such as borrowers' future incomes and general economic factors such as interest rates, unemployment levels, salary inflation and the Consumers Price Index. As new lending occurs, an initial write-down to fair value is made, and an expense is 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 rely on volatile factors that are subject to change.

Transformation and Technology Renewal (Unchanged)

The Business Transformation programme agreed by the previous Government in 2015 is reflected in the fiscal forecasts. There are risks that the remaining implementation costs, revenue gains and operating costs savings may differ from forecasts. In addition, changes in government policies could materially affect the programme's costs and benefits.

Social Development

Quarterly Employment Survey Redevelopment (Changed)

Stats NZ is redeveloping the Quarterly Employment Survey, which will change the way average wages are calculated from the current approach. There are several ways in which the new survey will differ, and the exact impact of this is uncertain. New Zealand Superannuation and Veteran's Pension rates are linked to the level of the net average wage, while other main benefit rates (such as Jobseeker Support, Sole Parent Support and the Supported Living Payment) are indexed to annual movements in net wages. Current estimates indicate redevelopment would likely increase costs to the Crown; however, this is unable to be quantified owing to ongoing uncertainty.

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 $4.4 billion. Based on this estimate, the Government's contribution to the project will be around $2.2 billion. There is a risk that the timing, scope and amount of the Government's contribution to the project could be different from what is included in the fiscal forecasts.

Treaty of Waitangi Negotiations

Relativity Clause (Unchanged)

The Deeds of Settlement negotiated with Waikato-Tainui and Ngāi Tahu include a relativity mechanism. Now that the total redress amount for all historical Treaty settlements exceeds $1.0 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 17.0% for Waikato-Tainui and 16.1% for Ngāi Tahu. There is a risk that the timing and amount of the expense for the relativity payments may differ from 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 that 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.

Veterans

Veterans' Disability Entitlements (New)

The fiscal forecasts include a liability for payments to veterans deemed to be in relation to their service rendered. On 28 July 2020, the Minister for Veterans announced new declarations of qualifying operational service, which may result in an increase in the liability. The fiscal impacts of this announcement have not been reflected in the fiscal forecasts, as they could not be quantified prior to the forecast finalisation date.

Cross-portfolio Specific Fiscal Risks#

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Addressing the Gender Pay Gap in the State Sector (Changed)

The Government has made a commitment to addressing the gender pay gap in the core public service. The Eliminating the Public Service Gender Pay Gap 2018-20 Action Plan Progress Report was released in July 2020 and highlights that good progress has been made towards closing this gap. Fulfilling the remainder of this commitment will involve costs to the Crown.

Budget 2020 Priority Packages (Unchanged)

In the Budget Policy Statement 2020, the Government signalled its intention to focus on five wellbeing priority areas in Budget 2020. As a result of COVID-19, however, packages to address these priority areas were not included in Budget 2020, which focused on funding existing cost pressures and responding to COVID-19. It remains the Government's intention to progress parts of these priority packages, but the timing for doing this is yet to be determined.

Changes to Institutional Form of Government Agencies (Unchanged)

The Government has announced a number of policy commitments that involve changes to the machinery of government. These commitments are likely to involve changes to the composition and structure of existing government departments. Where the additional resourcing and other costs of these changes cannot be met through baseline expenditure, further Crown funding may be required.

Increasing the Minimum Wage (Unchanged)

Government policy decisions to increase the minimum wage to $20 by April 2021 will mean increased costs to State sector employers to the extent that their employees receive a direct increase in wages. Where costs cannot be absorbed within baselines without compromising service delivery, funding may be sought.

Information and Communications Technology Operating and Capital Pressures (New)

A number of agencies are facing increasing operating and capital pressures related to ageing information and communications technology (ICT) assets and capability that are no longer fit for purpose. In addition, COVID-19 has highlighted the need for some agencies, particularly in the Education sector, to expand existing digital services, in line with increased demand and changed circumstances. This risk is aligned with the need for agencies to transition to cloud based solutions in line with the Government's Cloud-First policy. These pressures are fiscal risks to the extent that they cannot be managed through agencies' existing balance sheets and/or other funding mechanisms as outlined in this chapter.

New Zealand Upgrade Programme (Unchanged)

The New Zealand Upgrade Programme was announced in December 2019. The programme provides funding for significant capital investments. Operating expenses still need to be provided for some projects and there remains a risk regarding the timing of the capital projects that have been reflected in the fiscal forecasts.

Non-government Providers Receiving Funding from the Crown (Unchanged)

The Government is facing ongoing pressure from non-government providers of Crown‑funded services to fund a greater proportion of their costs, or to fund cost pressures. This includes providers in the health, disability, welfare, justice, and child protection sectors.

Other Capital Cost Pressures (Changed)

Agencies are likely to face capital expenditure pressures related to replacing ageing infrastructure and other capital requirements driven by demand pressures. These pressures are risks to the fiscal forecasts to the extent that they cannot be managed through agencies' existing balance sheets and baselines, new capital spending set aside in forecasts from the multi-year capital allowance, or other funding mechanisms (eg, Crown Infrastructure Partners). The Government's stated intention is that all pressures are managed through these mechanisms.

Other Operating Cost Pressures (Changed)

As in previous years, agencies are likely to face operating expenditure pressures in the future as a result of changes in the demand for and price of the services they provide or because some of their funding is time limited. The majority of spending by agencies is not automatically adjusted for increases driven by demand or price pressures. These pressures and those arising from time-limited funding are risks to the fiscal forecasts to the extent that they cannot be managed through reprioritisation or new spending set aside in the forecasts. The Government's stated intention is that all pressures are managed through these mechanisms.

Outcomes from Other Government Inquiries and Reviews (Unchanged)

A number of inquiries and reviews across government (not specifically mentioned elsewhere in this chapter) are underway or have recently released findings. At this point it is uncertain what the fiscal impact from the outcomes of these reviews may be.

Pay Equity Claims Following the Care and Support Worker Settlement (Unchanged)

A number of claims have been raised, mainly from workers in the social sectors (including health, education and welfare), in relation to the Equal Pay Act 1972 providing for pay equity (equal pay for work of equal value). The forecasts include an estimate of the expected cost to settle current and future claims; however, there is a risk that the costs may differ depending on the number of further claims that are raised and the outcomes reached from applying the pay equity principles to each particular claim.

Policy Responses to the 15 March 2019 Terror Attacks (Unchanged)

The Government has made several responses to the 15 March 2019 terror attacks. Further responses may be needed including policy and legislative amendments. In addition, there are likely to be further costs associated with responding to the Royal Commission of Inquiry into the Attack on Christchurch Mosques on 15 March 2019, which are unable to be quantified at this point.

Possible Responses to the 2020 Referendums on Cannabis Law Reform and End of Life Choice (Unchanged)

The Government has committed to holding referendums, at the General Election in October 2020, on legalising the use of cannabis and on end of life choice. The cost of conducting the referendums has been provided for in the forecasts. However, there could be associated impacts on the Government's operating balance should current legal frameworks change as an outcome of the referendums.

Services Funded by Third Parties (Changed)

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. If revenue collected is lower than the total costs of providing the service, there is a risk that the Government may need to provide additional funding or that changes will be required to the way government services are delivered, which could result in costs to the Crown. As a result of COVID-19 the Government has, through the COVID-19 Response and Recovery Fund, provided additional funding, particularly, but not exclusively, to New Zealand's border agencies. If the ongoing impacts of COVID-19 on revenue received from third parties are worse than forecast or last for longer, further additional government funding may be required.

State Sector Employment Agreements (Unchanged)

All collective agreements in the State sector are due to be renegotiated over the forecast period. As well as direct fiscal implications for the employers of workforces covered by any changes to remuneration, the renegotiation of agreements can have flow-on effects for remuneration in other employers across the sector.

Transitioning to an Electric Vehicle Fleet in the State Sector (New)

The Government has set a target of having all light vehicles in the government fleet emissions-free, where practicable, by 2025/26. The costs associated with transitioning to an electric vehicle fleet have not been included in the fiscal forecasts. To the extent that agencies are unable to meet such costs from within baselines, further funding may be required.

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. Examples include earthquake strengthening for some of the buildings that do not meet modern building standards and maintenance for buildings with weather-tightness issues. The likelihood, timing and fiscal impact of any repairs are uncertain.

Risks Removed Since the Budget Update#

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Contingent Liabilities and Contingent Assets#

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

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 guarantee or indemnity qualifies as a financial guarantee contract, or the amount becomes sufficiently reliable to record as a liability, it would reduce the operating balance and net worth. When a contingent liability crystallises, and is settled, there is an increase in 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 an asset.

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 in this chapter. Quantifiable contingencies of 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 unquantifiable contingent liabilities and unquantifiable contingent assets that potentially could have an impact of more than $20 million and are not expected to be remote.[28]

The contingencies have been stated as at 30 June 2020, being the unaudited actuals.

Quantifiable Contingent Liabilities and Contingent Assets

Contingent liabilities

Contingent assets

The 'Air New Zealand Partnership' contingent liability reported in the Budget Update is now less than $100 million as at 30 June 2020, and has been aggregated into the 'other quantifiable contingent liabilities' total above.

Unquantifiable Contingent Liabilities and Contingent Assets

Contingent liabilities

The 'Remediation of per- and poly-fluoroalkyl substances contamination' contingent liability reported in the Budget Update has been removed as it is considered to be remote.

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 the organisations listed below, contributes capital by subscribing to shares in certain institutions. The capital (when called) is typically used to raise additional funding for loans to member countries, or in the case of the quota contributions to directly finance lending to members. For New Zealand and other donor countries, capital contributions comprise both 'paid-in' capital and 'callable capital or promissory notes'.

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

Guarantees and indemnities

Guarantees are legally binding promises made by the Crown to assume responsibility for a debt, or the 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 services.

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).

Business Finance Guarantee Scheme

The Crown has established a Business Finance Guarantee Scheme with a number of banks to support New Zealand businesses facing hardship as a consequence of COVID-19. Under this scheme, the Crown has indemnified approved banks for an amount equal to 80% of the shortfall that arises in relation to a supported loan in default. As these indemnities are financial guarantee contracts, the fair value of the contract, and the expense arising, has been quantified and incorporated into the forecasts.

New Zealand Export Credit Office guarantees

The New Zealand Export Credit Office provides a range of guarantee products to assist New Zealand exporters to 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.

$127 million at 30 June 2020 ($109 million at 30 June 2019)

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.

$189 million at 30 June 2020 ($134 million at 30 June 2019)

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.

$183 million at 30 June 2020 ($174 million at 30 June 2019)

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 for Primary Industries has been notified compensation will be sought following its responses for incursions including pea weevil, Bonamia ostreae, kauri dieback and other minor incursions, as well as claims for losses incurred following the destruction of bud-stock, known as the post-entry quarantine response. Infectious bursal disease virus claims are also expected based on discussions with industry. These claims can be quantified but do not meet the tests for recognising a provision.

$132 million at 30 June 2020 ($138 million at 30 June 2019)

Unquantifiable contingent liabilities

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

The indemnities and claims that are disclosed individually, while they cannot be quantified, have the potential to exceed $20 million in costs and are not considered to be remote.

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

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

Accident Compensation Corporation (ACC) litigation

Litigation involving ACC arises mainly 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 and therefore are not material for the Crown.

Aquaculture settlements

Under the Māori Commercial Aquaculture Claims Settlement Act 2004, the Crown is obligated to provide regional Iwi with 20% of future aquaculture growth. This settlement is unusual because it is an ongoing and prospective settlement. As aquaculture in New Zealand grows, settlement obligations arise. Iwi may choose to accept settlement as either cash, marine rights, or a combination following the negotiation process. The amount and timing of settlements are therefore uncertain, as they are dependent on sector growth, as well as the preferred nature of settlement. This results in challenges with regard to reliably estimating the Crown's potential obligations. The contingency is therefore unquantified.

Canterbury insurance disputes

Southern Response Earthquake Services Limited (SRES) from time to time receives notification of legal claims and disputes in relation to claim settlements as a commercial outcome of conducting its business.

A representative action proceeding was filed against SRES on 29 May 2018. The financial statements make no allowance for the outcome of these proceedings, as the range of possible outcomes cannot be reliably quantified at this time. These claims are being defended because there is a wide range of potential outcomes, and any estimate of a possible obligation resulting from this proceeding would be unreliable.

Kiwifruit vine disease Psa-V

Approximately 210 growers, represented by Strathboss Kiwifruit Limited, filed a claim against the Ministry for Primary Industries alleging it is legally liable for damages they have suffered from a biosecurity incursion of the kiwifruit vine disease Psa-V in New Zealand. On 27 June 2018, the High Court found that the Ministry owed a duty of care to Strathboss and claimants. The Court of Appeal overturned the High Court's decision, finding that the Ministry for Primary Industries did not owe a duty of care to Strathboss and claimants. Strathboss is appealing the decision to the Supreme Court and the Supreme Court has given leave to appeal. The Ministry for Primary Industries is still unable to quantify Strathboss's claim because the extent of any loss will be decided at a second trial in the High Court. Unless the Supreme Court finds the Crown is liable, this trial will not occur, and the claim will not be quantified.

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 for Primary Industries has been notified that compensation will be sought following its response to the Mycoplasma bovis incursion. The contingent liability resulting from the Mycoplasma bovis outbreak is unquantified because the Ministry for Primary Industries is unable to reliably estimate the period of time losses will be incurred as a result of its actions under the Biosecurity Act 1993. To the extent that an obligation can be quantified, an amount is recognised in the Financial Statements of the Government. As at 30 June 2020, a quantified contingent liability of $132 million has been recognised.

Treaty of Waitangi claims

Under the Treaty of Waitangi Act 1975, any Māori may lodge with the Waitangi Tribunal certain claims relating to land or actions counter to the principles of the Treaty. 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 a State-owned enterprise (SOE), universities, wānanga or New Zealand Institute of Skills and Technology, 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.

Wakatu

Crown Law is acting for the Attorney-General on behalf of the Crown in right of New Zealand in Proprietors of Wakatu v Attorney-General (CIV 2010-485-181), in which it is claimed that the Crown breached trust, fiduciary and other equitable obligations relating to land transactions in the top of the South Island in the 1840s. The plaintiff seeks the return of land they say the Crown holds on trust for the successors of the original owners and compensation, or other relief, for alleged breach of trust, fiduciary and other equitable obligations. In February 2017, the Supreme Court held that the Crown owed a fiduciary duty in relation to the land transactions concerned, but remitted matters of breach, defences and remedy to the High Court for a further hearing or hearings. The matter is large and complex and could take up to a further 10 years to resolve.

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 a 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. Where costs cannot be reliably measured, they are disclosed as an unquantified contingent liability.

Holidays Act compliance

A number of entities have commenced or completed a review of calculations in recent years to ensure compliance with the Holidays Act 2003. Where possible, a provision has been made in these financial statements for obligations arising from those reviews that have been made in the current year or previous years. To the extent that an obligation cannot reasonably be quantified, there is an unquantified contingency. Further work continues to be undertaken by entities to calculate the potential liability. For some entities, there are complexities and this issue is taking longer to resolve (eg, District Health Boards and schools).

Treaty of Waitangi claims - settlement relativity payments - see page 117

Description of Contingent Assets

There are no material quantifiable or unquantifiable contingent assets at 30 June 2020.

Forecast Financial Statements#

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

They are based on the accounting policies and assumptions that follow. As with all such assumptions, there is a degree of uncertainty surrounding them. This uncertainty increases as the forecast horizon extends. There are risks to the fiscal forecasts which are discussed further in the Risks to the Fiscal Forecasts chapter.

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 September 2020.

The finalisation dates and key assumptions that underpin the preparation of the Forecast Financial Statements are outlined in the Fiscal Outlook chapter (pages 39 to 83).

Statement of Accounting Policies#

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Significant Accounting Policies

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

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

The Forecast Financial Statements reflect the accounting standards in place in the year that they are prepared. Adoption of new accounting standards in future financial years are consequently not reflected in these Forecast Financial Statements. Where accounting standards are to be adopted within the fiscal forecasts period, this has been signalled in the note disclosures where impacts may be significant.

The specific accounting policies are included on the Treasury's website at https://treasury.govt.nz/information-and-services/state-sector-leadership/guidance/financial-reporting-policies-and-guidance/accounting-policies

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 Risks to the Fiscal Forecasts chapter on pages 85 to 132. Key forecast assumptions are set out on pages 49 to 50.

Reporting and Forecast Period

The reporting periods for these Forecast Financial Statements are the years ended 30 June 2020 to 30 June 2024. The “2020 Previous Budget” figures are the original forecasts to 30 June 2020 as presented in the 2019 Budget Update and the “2020 Unaudited Actual” figures are the actual results for the year ended 30 June 2020 that are currently subject to audit. The “2019 Actual” figures are the audited results reported in the Financial Statements of the Government (FSG) for the year ended 30 June 2019, except where balances have been restated to reflect the adoption of the following accounting standards from 1 July 2019:

• PBE IPSAS 35: Consolidated Financial Statements, and
• PBE IPSAS 39: Employee Benefits (updated).

A reconciliation between the key indicators published in the FSG for the year ended 30 June 2019 and the comparative numbers published in this document as a result of these changes is included in note 17.

Government Reporting Entity as at 7 September 2020#

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These forecast financial statements are for the Government Reporting entity as specified in Part 3 of the Public Finance Act 1989. This comprises Ministers of the Crown and the following entities (classified in the three institutional components used for segmental reporting). The following tables list the Entities within each institutional Component. (Subsidiaries are consolidated by their parents and not listed separately).

Core Crown Segment

Departments

1. Crown Law Office
2. Department of Conservation
3. Department of Corrections
4. Department of Internal Affairs
5. Department of the Prime Minister and Cabinet - (includes National Emergency Management Agency as departmental agency)
6. Education Review Office
7. Government Communications Security Bureau
8. Inland Revenue Department
9. Land Information New Zealand
10. Ministry for Culture and Heritage
11. Ministry for Pacific Peoples
12. Ministry for Primary Industries
13. Ministry for the Environment
14. Ministry for Women
15. Ministry of Business, Innovation, and Employment
16. Ministry of Defence
17. Ministry of Education
18. Ministry of Foreign Affairs and Trade
19. Ministry of Health - (includes Cancer Control Agency as departmental agency)
20. Ministry of Housing and Urban Development
21. Ministry of Justice - (includes Te Arawhiti – Office for Māori Crown Relations as departmental agency)
22. Ministry of Māori Development
23. Ministry of Social Development
24. Ministry of Transport
25. New Zealand Customs Service
26. New Zealand Defence Force
27. New Zealand Police
28. New Zealand Security Intelligence Service
29. Office of the Clerk of the House of Representatives
30. Oranga Tamariki, Ministry for Children
31. Parliamentary Counsel Office
32. Parliamentary Service
33. Public Service Commission - (includes Social Wellbeing Agency as a departmental agency)
34. Serious Fraud Office
35. Statistics New Zealand
36. Te Kāhui Whakamana Rua Tekau mā Iwa - Pike River Recovery Agency
37. The Treasury

Offices of Parliament

1. Controller and Auditor-General
2. Office of the Ombudsman
3. Parliamentary Commissioner for the Environment

Others

1. New Zealand Superannuation Fund
2. Reserve Bank of New Zealand

State-owned Enterprises Segment

State-owned Enterprises

1. Airways Corporation of New Zealand Limited
2. Animal Control Products Limited
3. AsureQuality Limited
4. Electricity Corporation of New Zealand Limited
5. KiwiRail Holdings Limited
6. Kordia Group Limited
7. Landcorp Farming Limited
8. Meteorological Service of New Zealand Limited
9. New Zealand Post Limited
10. New Zealand Railways Corporation
11. Quotable Value Limited
12. Transpower New Zealand Limited

Mixed ownership model companies (Public Finance Act Schedule 5) 

1. Genesis Energy Limited
2. Mercury NZ Limited
3. Meridian Energy Limited

Other

1. Air New Zealand Limited
2. Kiwi Group Holdings Limited (including Kiwibank)

Crown Entities Segment

Crown Entities

1. Accident Compensation Corporation
2. Accreditation Council
3. Arts Council of New Zealand Toi Aotearoa
4. Broadcasting Commission
5. Broadcasting Standards Authority
6. Callaghan Innovation
7. Children's Commissioner
8. Civil Aviation Authority of New Zealand
9. Climate Change Commission
10. Commerce Commission
11. Criminal Cases Review Commission
12. Crown Irrigation Investments Limited
13. Crown Research Institutes (7)
14. District Health Boards (20)
15. Drug Free Sport New Zealand
16. Earthquake Commission
17. Education New Zealand
18. Electoral Commission
19. Electricity Authority
20. Energy Efficiency and Conservation Authority
21. Environmental Protection Authority
22. External Reporting Board
23. Financial Markets Authority
24. Fire and Emergency New Zealand
25. Government Superannuation Fund Authority
26. Guardians of New Zealand Superannuation
27. Health and Disability Commissioner
28. Health Promotion Agency
29. Health Quality and Safety Commission
30. Health Research Council of New Zealand
31. Heritage New Zealand Pouhere Taonga
32. Human Rights Commission
33. Independent Police Conduct Authority
34. Kāinga Ora - Homes and Communities
35. Law Commission
36. Maritime New Zealand
37. Museum of New Zealand Te Papa Tongarewa Board
38. New Zealand Antarctic Institute
39. New Zealand Artificial Limb Service
40. New Zealand Blood Service
41. New Zealand Film Commission
42. New Zealand Growth Capital Partners (previously New Zealand Venture Investment Fund)
43. New Zealand Infrastructure Commission/Te Waihanga
44. New Zealand Institute of Skills and Technology
45. New Zealand Lotteries Commission
46. New Zealand Productivity Commission
47. New Zealand Qualifications Authority
48. New Zealand Symphony Orchestra
49. New Zealand Tourism Board
50. New Zealand Trade and Enterprise
51. New Zealand Transport Agency
52. New Zealand Walking Access Commission
53. Office of Film and Literature Classification
54. Pharmaceutical Management Agency
55. Privacy Commissioner
56. Public Trust
57. Radio New Zealand Limited
58. Real Estate Agents Authority
59. Retirement Commissioner
60. School Boards of Trustees (2,420)
61. Social Workers Registration Board
62. Sport and Recreation New Zealand
63. Takeovers Panel
64. Te Reo Whakapuaki Irirangi (Māori Broadcasting Funding Agency)
65. Te Taura Whiri i te Reo Māori (Māori Language Commission)
66. Television New Zealand Limited
67. Tertiary Education Commission
68. Transport Accident Investigation Commission
69. WorkSafe New Zealand

Organisations listed in schedule 4 of the Public Finance Act 1989

1. Agricultural and Marketing Research and Development Trust
2. Asia New Zealand Foundation
3. Fish and Game Councils (12)
4. Game Animal Council
5. Māori Trustee
6. National Pacific Radio Trust
7. New Zealand Fish and Game Council
8. New Zealand Game Bird Habitat Trust Board
9. New Zealand Government Property Corporation
10. New Zealand Lottery Grants Board
11. Ngāi Tahu Ancillary Claims Trust
12. Pacific Co-operation Foundation
13. Pacific Island Business Development Trust
14. Reserves Boards (21)
15. Te Ariki Trust

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

1. Crown Asset Management Limited
2. Crown Infrastructure Partners Limited
3. Education Payroll Limited
4. New Zealand Green Investment Finance Limited
5. Ōtākaro Limited
6. Predator Free 2050 Limited
7. Provincial Growth Fund Limited
8. Research and Education Advanced Network New Zealand Limited
9. Southern Response Earthquake Services Limited
10. Tāmaki Redevelopment Company Limited
11. The Network for Learning Limited

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

1. Te Urewera

Others

1. Christ Church Cathedral Reinstatement Trust
2. Venture Capital Fund

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

Crown entities

1. Tertiary Education Institutions (11)
   (8 Universities and 3 Wānanga)

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

1. City Rail Link Limited

Forecast Financial Statements#

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Forecast Statement of Financial Performance
for the years ending 30 June

1. The '2019 Actual' and '2020 Previous Budget' numbers were restated to reflect the adoption of new accounting standards from 1 July 2019. Refer to note 17 for details of the impact of these changes.

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

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

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 '2019 Actual' and '2020 Previous Budget' numbers were restated to reflect the adoption of new accounting standards from 1 July 2019. Refer to note 17 for details of the impact of these changes.
2. The classifications of the functions of the Government reflect current approved 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 Revenue and Expense
for the years ending 30 June

1. The '2019 Actual' and '2020 Previous Budget' numbers were restated to reflect the adoption of new accounting standards from 1 July 2019. Refer to note 17 for details of the impact of these changes.

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

1. The '2019 Actual' and '2020 Previous Budget' numbers were restated to reflect the adoption of new accounting standards from 1 July 2019. Refer to note 17 for details of the impact of these changes.

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. The '2019 Actual' and '2020 Previous Budget' numbers were restated to reflect the adoption of new accounting standards from 1 July 2019. Refer to note 17 for details of the impact of these changes.
2. Further information on the proceeds and repayments of government bonds is available in note 16.
3. Excludes transactions with ACC and NZS Fund.

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

Forecast Statement of Cash Flows (continued)
for the years ending 30 June

1. The '2019 Actual' and '2020 Previous Budget' numbers were restated to reflect the adoption of new accounting standards from 1 July 2019. Refer to note 17 for details of the impact of these changes.

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

Forecast Statement of Financial Position
as at 30 June

1. The '2019 Actual' and '2020 Previous Budget' numbers were restated to reflect the adoption of new accounting standards from 1 July 2019. Refer to note 17 for details of the impact of these changes.
2. Equity accounted investments include tertiary education institutions and City Rail Link Limited.

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

Forecast Statement of Borrowings
as at 30 June

Monetary liabilities facilitate payments to be effected in New Zealand dollars, thereby ensuring the smooth functioning of the economy.

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. The '2019 Actual' and '2020 Previous Budget' numbers were restated to reflect the adoption of new accounting standards from 1 July 2019. Refer to note 17 for details of the impact of these changes.
2. Core Crown borrowings in this instance include unsettled purchases of securities (classified as accounts payable in the Statement of Financial Position).
3. 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.
4. Core Crown financial assets exclude receivables, except for unsettled sales of securities.
5. 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.
6. 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.
7. Net core Crown debt (excluding NZS Fund and advances) excludes financial assets which are held for public policy rather than treasury management purposes.
8. The Reserve Bank has used $1.6 billion of settlement cash to purchase reserves that were to have been funded by the government borrowing programme. Therefore, the impact of settlement cash on GSID is adjusted by this amount.

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

Statement of Actual Commitments
as at 30 June

1. The 30 June 2019 commitments were restated to reflect the adoption of the new accounting standard PBE IPSAS 35: Consolidated Financial Statements. The impact of this is to increase total commitments by $39 million. Refer note 17 for further details of this new standard.

Statement of Actual Contingent Liabilities and Assets
as at 30 June

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

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

Notes to the Forecast Financial Statements#

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NOTE 1: Sovereign Revenue (Accrual)

1. Customs excise-equivalent duty.

NOTE 1 (continued):  Sovereign Receipts (Cash)

NOTE 2:  Investment Revenue/(Expenditure)

NOTE 3:  Transfer Payments and Subsidies

NOTE 4:  Other Operating Expenses

NOTE 5:  Insurance

ACC liability

Calculation information

Taylor Fry has prepared an independent actuarial estimate of the ACC outstanding claims liability as at 30 June 2020. 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 estimate also includes a risk margin to provide for a higher degree of certainty that the liability for outstanding claims, at balance date, will be adequate to cover possible adverse developments. 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 (AWE) and the discount rate. Discount rates were derived from the yield curve for New Zealand Government bonds. For these forecast statements, the claims liability has been updated for the latest discount rates as at 30 June 2020. The equivalent single effective discount rate, taking into account ACC's projected future cash flow patterns, is 1.86% and allows for a long-term discount rate of 4.30% from 2083.

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.

NOTE 6:  Forecast New Spending and Top-down Expense Adjustment

Unallocated contingencies represent expenses included in Budget 2020 and previous Budgets that have yet to be allocated to departments. Forecast new spending indicates the expected spending increases from future Budgets.

The forecast for new operating spending for Budget 2021 is $2.4 billion. Some of this allowance has been pre-committed as at the forecast finalisation date of 7 September 2020, with only the unallocated portion of the allowance included in this note.

Unallocated contingencies represent capital spending from Budget 2020 and previous Budgets that has yet to be allocated to departments. Forecast new spending indicates the expected capital spending increases from future Budgets.

NOTE 7:  Net Gains and Losses on Non-Financial Instruments

NOTE 8:  Financial Assets (including receivables)

NOTE 9:  Student Loans

NOTE 10:  Property, Plant and Equipment

1. Using a revaluation methodology unless otherwise stated.
2. The rail freight network was valued on a commercial basis for the previous budget and is now valued on a public benefit basis.

1. 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).
2. Other mainly relates to the establishment of NZIST and transfers to/from other asset categories.

NOTE 11:  NZ Superannuation Fund

Under the new accounting standard, PBE IPSAS 35 (effective from 1 July 2019), any controlling interests the New Zealand Superannuation Fund has invested in are reported on a fair value basis and shown as a single line item 'Investments in controlled enterprises' in the statement of financial position (rather than on the previous line-by-line basis). Consequently, there have been material reclassifications between the NZ Superannuation Fund's different asset and liability classes, but with a smaller net impact on the overall value of the Fund. Refer to Note 17 for further details.

NOTE 12:  Payables

NOTE 13:  Retirement Plan Liabilities

The net liability of the Government Superannuation Fund (GSF) was calculated by GSF's actuary as at 30 June 2020. 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 2020, 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 2020.

Other principal long-term financial assumptions were an inflation rate, as measured by the Consumers Price Index (CPI), of 0.83% p.a. gradually increasing to 1.58% p.a. to 30 June 2025, then gradually increasing from 1.58% p.a in the year ended 30 June 2037 to 2.0% p.a. in the year ended 30 June 2083 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% p.a. (2.5% p.a. at 30 June 2019).

The 2019/20 projected increase in the net GSF liability is $810 million, reflecting a increase in the GSF liability of $545 million and an decrease in the GSF net assets of $265 million.

The changes in the projected net GSF liability from 2019/20 onwards reflect the net of the expected current service cost, interest cost, investment returns and contributions.

The amended accounting standard PBE IPSAS 39: Employee Benefits is effective for these forecasts across all years. The value of the net GSF liability has not changed with this change in accounting standard but there have been changes to the presentation of the annual movements in the net liability in the Statement of Financial Performance. Refer to note 17 for further details of the impact of this change on the comparative numbers published in these forecast financial statements.

NOTE 14:  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 last week of June 2020.

The movement in the ETS provision is as follows: