Opening Statement to the Finance and Expenditure Select Committee

Economic update#

I’ll start with the economic update.

In 2012 real GDP growth reached 2.5%, the strongest annual average rate since March 2008 and faster than many other developed countries. 

However, nominal GDP growth continued to be low, reflecting the moderation in the terms of trade we saw last year. Employment growth was also weak, although the latest Household Labour Force Survey saw employment up and unemployment down.  

Business indicators suggest solid growth in the first quarter of 2013.  The drought might cause some turbulence in the final figures, as farmers sending their stock to the works will serve to boost growth in the March quarter but at the expense of production later in the year.  

This overall pattern is one of the main reasons the exchange rate remains high, notwithstanding recent falls. There is a lot of cash in the global economy, and New Zealand is in good shape relative to many other countries.

While weather conditions have improved, we still expect growth to be hit this year. A lack of feed and animal conditioning will lower future dairy and meat production levels from what they would have been. 

Looking ahead, we forecast economic growth to average 2.5% per year over the five years to March 2017, with growth accelerating to 3% in the year to March 2015.

Domestic demand is the main driver, with private spending growth speeding up to over 6% in the year ahead, mainly as a result of higher investment.

There are a couple of substantial factors offsetting this growth; firstly a strong rise in imports associated with higher investment, and secondly the drought is expected to lower export growth in the year ended March 2014.

This growth outlook sees the unemployment rate drop to around 5%, and annual CPI inflation move back to the middle of the 1%-3% target band. 

Earlier on, committee members raised the question of the current account deficit, and I would like to comment briefly on this.  As at the Half Year Update in December, the current account deficit is forecast to increase as the Canterbury rebuild gets into full swing. Investment is forecast to increase by more than the increase that we expect in national saving. This marks it out as different to the period from 2005 to 2008 when national saving was falling. 

Our forecast of the deficit excluding Canterbury-related investment shows the underlying current account deficit tracking at similar levels relative to GDP to that of the recent past.  

On the basis of what we know now, we do not believe that the size of the current account deficit represents a threat to New Zealand’s economic stability or that the economy is on an unsustainable economic trajectory.  

The unique one-off nature of the rebuild, including how it is being financed, means it is inappropriate to simply extrapolate current account prospects over the next few years into the longer term. 

Our view is that the overall direction of policy should be to move back into surplus, reduce exposure to debt, make structural changes to promote economic growth, and maintain a prudent macroeconomic framework.

We assume the exchange rate will stay high for much of the forecast period. This will hold back activity in exporting and import-competing firms, especially those which do not experience the relatively strong export commodity prices we are expecting.

Household and business spending growth is expected to increase, though less than it did in the 2000s. Household saving as a share of income is forecast to track around recent levels, up around 10 percentage points from its low of the past decade.

The terms of trade are forecast to increase in the year ahead, leading to a rebound in nominal GDP growth and supporting faster growth in tax revenue.

Fiscal update#

This brings me to the fiscal update. 

Core crown tax revenue is forecast to increase by $14.6 billion over the next four years. These increases are expected to outpace the growth in the economy. It’s worth noting that tax revenue was higher than expected in the Half Year Update, which gave the Government more choices such as the signalled ACC levy reductions. 

The operating balance before gains and losses (OBEGAL) is forecast to move from a deficit of $6.3 billion this year to a surplus of $75 million in the year ending June 2015, after any ACC levy reductions.  And net crown debt is forecast to peak as a share of GDP at 28.7% in the year ending June 2015.

Risks and external validations of New Zealand’s approach...#

There are of course risks to our forecasts. 

From a global point of view, Europe is not out of the woods yet, and the turnaround in the US has some way to go. There is also a risk that growth for our major trading partners, including Australia and China, will slow. On the other hand there are upside risks – for example, China is seeking to rebalance its economy away from exports and investment-led growth towards consumption. Faster progress towards this goal would benefit New Zealand as a major supplier of commodities, including dairy products.

Overall, global risks have become more balanced as policy-makers have moved to reduce the likelihood of economic crises, or to boost growth.

Domestically, there is a mix of upside and downside risks, including:

• the size and pace of the Canterbury rebuild
• the exchange rate and how it is passed through the economy
• the impact of the drought, and
• the saving behaviour of households, particularly in light of current house price increases.

For now though the outlook remains relatively positive, and there have been some welcome external validations of New Zealand’s approach to economic and fiscal management. 

The IMF’s report, released on 14 May, considers New Zealand’s monetary policy stance to be appropriate, and notes the Reserve Bank is well placed to respond effectively should circumstances change. The report also notes the planned pace of deficit reduction strikes the right balance between sustaining aggregate demand and limiting public debt growth.

The OECD’s recent economic survey of New Zealand, released last week, also observes the economy is starting to gain some momentum, and notes that macroeconomic policies are striking the right balance to support the recovery.

Of course there remain challenges in terms of shifting where growth comes from over the long-term. Among other things, the OECD report supports the Treasury’s view that education is a key area we need to focus on if we’re to achieve a sustainable step-change in economic growth, and higher living standards for all New Zealanders. The report notes that standardised tests point to a long “tail” that the system is failing, despite high average scores. We can’t achieve higher levels of more inclusive growth without addressing this.

The Treasury’s Long-Term Fiscal Statement is due for release in July this year, where we will lay out the long-term challenges for New Zealand. We have deliberately engaged diverse experts from a range of economic and social disciplines in the development of the Statement, given that many of the challenges we need to address as a country are complex and intergenerational. The issues affect all New Zealanders and will need to be tackled by successive governments, and we hope it will stimulate broad, evidence-based public discussion and debate.

Key Treasury work streams#

I’d now like to touch briefly on two key work streams the Committee has expressed an interest in previously.

The first is our work to embed our Living Standards Framework, which informs the Treasury’s advice and analysis across a range of policy. We have used it as the basis for the analysis underpinning our Long-Term Fiscal Statement, and in doing so have ensured that we are able to reflect a broad set of perspectives and drivers of policy.

We have also started our joint project with Statistics NZ on measuring progress against the five dimensions of the framework – economic growth, sustainability, equity, risk and social infrastructure – over a time-series of over 50 years. This work is progressing well and we hope to have some results to share before the end of the year.

The second area I’d like to touch on briefly is the work programme around our monitoring function. 

The Treasury initiated a work programme last year to strengthen our monitoring of commercial assets owned by the Crown, as part of our commitment to continually improve our processes. This encompasses all of the commercial entities monitored by the Treasury. We are looking at:

• How we enable closer engagement and better alignment between Boards and Ministers.
• Processes for providing advice on governance, including director recruitment and performance evaluation.
• The tools and procedures we use, including the potential to make greater use of external experts to provide specialist advice in areas like strategic reviews.

All of this is part of a broader focus on how the Treasury manages the Crown’s balance sheet as a whole to ensure the best value for taxpayers. 

While this work programme is ongoing, we yesterday released a report on the monitoring of Solid Energy which forms part of the review, given the public interest in the company. 

The central finding of the review was that the failure of Solid Energy has not highlighted a material failure in Treasury’s monitoring processes. It did however provide a number of recommendations which we are taking forward into the wider monitoring work programme. 

Finally, I’d like to return briefly to the subject of forecasting, where I’m pleased to be able to advise the Committee that the latest review of the Treasury’s performance compared with the major private and public sector forecasters in New Zealand stacks up very well, with the Treasury among the top one or two forecasters of real GDP growth and CPI inflation over the last 10 years.

That concludes my opening statement – I look forward to your questions.