Tuesday, December 14, 2010

NZ Half-Year Fiscal Update

The New Zealand Treasury has, not unexpectedly, taken an axe to their New Zealand economic growth forecasts. The implication is that operating balance expectations are commensurately lower and public debt forecasts higher.

Economic growth forecasts are significantly weaker in the short-term. Treasury is now expecting 2.2% (annual average % change) growth for the year to March 2011, down from the May forecast of 3.2%. This is broadly in line with our forecast of 2.1%. Weak household spending is the main difference between the May and December forecasts.

The March 2012 forecast of 3.4% is stronger than the May forecast of 3.1%, but this is due to the generally weaker growth environment being offset by the rebuilding activity following the devastating Christchurch earthquake. This is slightly stronger than our forecast of 3.1% for the March 2012 year.

Further out, Treasury is expecting 2.9% growth in the year to March 2013, again slightly stronger than our 2.6%, but in line with our expectations of a modest economic recovery that will take some considerable time to build any significant momentum.

The fiscal implications are significant. Treasury expects an operating deficit (OBEGAL) of 5.5% of GDP in FY2011. This compares with a forecast deficit of 4.2% of GDP in May. This deterioration had been well flagged in recent monthly out-turn data.

As in the Budget, this is expected to be the low point in the cycle, with deficits gradually reducing in size in the out-years with a surplus being projected in FY2016. Despite the lower starting point, this is a year earlier than expected at the time of the May Budget.

Net public debt is higher through-out the forecast track by just over 1 percentage point of GDP. Net debt is expected to be 27.8% of GDP in 2014, compared with the earlier forecast of 26.5% of GDP.

Even though the Treasury’s view of the near-term economic outlook is now broadly in line with our own, I can’t help but worry that the expected improvement in the key fiscal indicators is going to be somewhat more difficult to achieve. The recession was structural, the recovery is proving to be hard work, and by the Treasury’s own admission, the budget deficit is largely structural.

That doesn’t sound like an easy fix. We need to take a hard look at spending and start to deal with some of our longer-term structural fiscal issues like entitlement to New Zealand Superannuation. Pressures to spend will only grow over the next few years, with healthcare, education and infrastructure springing immediately to mind. We need to make sure we spend in the right places, especially if the Government is serious about building the capacity of the economy to grow.