Thursday, May 16, 2013

New Zealand Budget 2013

Budget 2013 marks another milestone of the pathway back to fiscal sustainability.  Solid economic growth continues to underpin a return to surplus in the 2014/15 fiscal year.  This is one year earlier than Australia (not that we’re at all competitive). Net debt is projected to peak at 28.7% of GDP in fiscal 2014/15, confirming New Zealand as having one of the strongest fiscal positions in the developed world.

Fiscal projections in the 2013 Budget are underpinned by average growth of 2.5% over the forecast period.  Growth is forecast at 2.4% in the year to March 2014, lower than the 2.9% expected in the Half-Year Economic and Fiscal Update (HYEFU).  The drought is the primary reason for the downward revision, taking an estimated 0.7% off growth this year.  Growth is then expected to rebound to 3.0% in 2015.  These forecasts are slightly lower than ours (2.8% and 3.2% respectively) and are therefore on the moderately conservative side in our view. Growth is expected to drift lower in the years following.

Other economic forecasts are broadly in line with our view.  Inflation is expected to be lower than previously forecast in the near term on the back of the high exchange rate.  Treasury is also forecasting a gradual decline in the unemployment rate (which will now be from a lower starting point following the release of March quarter HLFS data).  They are also forecasting deterioration in the current account deficit which is also in line with our own view.

Crown revenues are forecast to rise over the projection period on the back of solid economic growth.  And after two “zero” new spending budgets the improved fiscal outlook has allowed the Government a bit more latitude on spending.  They have allowed themselves $900m in new spending in Budget 2013, which along with continued reprioritisation of existing spending and higher revenue has enabled new initiatives in health, education and social services. 

A further boost to investment in innovation is welcome via increased funding to Callaghan Innovation for R&D grants.  That’s important support for the innovation system and I continue to favour the use of targeted grants to support our aspiring innovators.

Other significant initiatives include a reduction in ACC levies and a further commitment of $2.1 billion to the Canterbury rebuild.

Operating balance (excluding gains and losses or OBEGAL) is estimated at -2.9% of GDP in the current fiscal year (-3.4% of GDP in the HYEFU), a deficit of -0.9% in 2013/14 (-0.9%) and a surplus of 0.0% ($75 million) in 2014/15 (0.0%, $66 million).  Net core crown debt continues to rise to a peak of 28.7% of GDP in 2014/15, and then begins to decline.  Gross debt peaks at 38.5% of GDP in 2013/14.

Historical efforts to reduce New Zealand’s debt levels have stood us in good stead.  Our low level of debt combined with a credible plan to get back to fiscal sustainability after the Global Financial Crisis (and in our unique case the Canterbury earthquakes) is the key difference between us and much of the rest of the developed world.  By comparison gross debt as a percentage of GDP is 95% in Europe, 108% in America and 245% in Japan.  In the Australian Budget yesterday we saw the benefit of low and prudent debt levels when the market took the deterioration in the Australian crown accounts in their stride.

The fiscal impulse is expected to be somewhat less of a headwind than estimated in the last Budget.  Fiscal drag is now expected to be at its worst in 2015 at -1.2% of GDP.  That compares with a previous “peak” of -2.0% in 2014.  Further out fiscal drag is now forecast to be slightly greater than previously forecast.  That being the case it remains a critical reason why we expect only a moderate increase in interest rates over the next tightening cycle.

Concerns about fiscal drag also need to be tempered by the fact the government is also running a significant investment program.  Following the partial sale of Mighty River Power the Government has boosted the Future Investment Fund by $1.5 billion, taking the Fund to $2.1 billion.  This will be used to fund investment in schools, hospital, rail and irrigation.  The Government announced today that Meridian Energy will be the next asset up for partial sale, market conditions permitting.

The housing market was a key focus in the Budget.  Housing represents one of the biggest risks to New Zealand’s financial stability.  Improvements in household debt levels since 2006 have already started to turn for the worse again.  The most significant issues facing the housing market in New Zealand are supply-side in nature.  The Government announced today they will be introducing legislation to enable a streamlining of new housing developments in areas where housing is least affordable.  That’s a positive and helpful step in the right direction.

However it’s inevitable that demand management will also have to play a role.  The Minister of Finance announced today that he and the Reserve Bank Governor have signed a Memorandum of Understanding defining the operating guidelines for the use of macro-prudential tools to assist in the management of the credit cycle.  The tools are as proposed in the Reserve Banks’ recent consultation process and will be a welcome addition to their tool box.  However, it remains to be seen what impact they will have, especially given the housing cycle upturn is well advanced.  International evidence on the efficacy of such tools is, at best, mixed.  We continue to see them as complementary to the traditional demand management tool of interest rates and therefore continue to see the Reserve Bank embarking on a tightening cycle from later this year.

New Zealand is in good fiscal shape.  To be fair there are things I’d like to see the Government do differently, but they are mostly at the margin.  In general, the Government is managing a credible pathway to fiscal sustainability that looks increasingly robust.  At the same time they are managing to invest in growth enhancing infrastructure, public services and the rebuild of Canterbury. Rating agencies should be well pleased.