Thursday, May 15, 2014

New Zealand Budget 2014

Overview
  • The 2014 Budget has the Crown’s finances moving into the black in 2014/15 with a surplus of 0.2% of GDP ($372 million) in 2014/15.  Surpluses rise to 1.3% of GDP ($3.5 billion) by 2017/18. 
  • The Government has allowed themselves some room for new initiatives.  The Budget includes new initiatives of $1.0 billion in 2014/15 with education and health the main winners.  They have allocated $1.5 billion for new initiatives in 2015/16, rising by 2% per annum from 2016/17.   
  • The Treasury is forecasting robust economic growth in the period ahead accompanied by a declining unemployment rate and rising inflationary pressures.  Their forecasts are broadly in line with our own.
  • In a smart political move the Government is leaving its options open as to how they will utilise future new initiative allocations.  Options include tax reductions, operational and/or capital spending and debt repayment.  Auto-enrolment for KiwiSaver is also an option.   We expect we will hear more about those options in the lead up to the General Election on 20 September.


Key policy initiatives
  • The cornerstone of the Budget is a $500 million package aimed at supporting children and families, including extending paid parental leave, free GP visits and prescriptions for children under 13 years, and an increase in the parental tax credit.
  • $858 million is allocated over four years for early childhood education and schools.  This includes $359 million for the previously announced programme to strengthen leadership and quality teaching across school.  Schools’ operational grants will increase by $85.3 million.
  • $199 million new investment in tertiary education, including an increase in tuition subsidies in some disciplines, a further 6000 apprentices in the Apprenticeship Reboot programme and the establishment of three new Centres of Research Excellence.
  • A $1.8 billion increase in health spending over four years.
  • Housing sees $30 million to help the community housing sector provide more homes for high needs families and the Ministry of Social Development receives extra funding to assist people find the right housing option.
  • There are a number of initiatives to support business innovation, including $69 million over four years for New Zealand Trade and Enterprise to expand its presence in China, South America and the Middle East, $56.8 million over four years in contestable science and innovation funding, and $58 million in increased tax deductions for Research & Development by start-up firms.
  • A further $1 billion of the $4.7 billion in the Future Investment Fund from asset sales is allocated to infrastructure investment.
  • ACC is on track for a reduction in levies of around $480 million in 2015/16 depending on the outcome of public consultation.

Assessment


It has been a long hard road to get the Crown’s books back into order.  Following a domestic recession that was followed closely by the Global Financial Crisis and the devastating Canterbury earthquakes, the Crown’s operating balance (OBEGAL) blew out to 9.2% of GDP in 2010/11.  A forecast surplus in 2014/15 is a creditable turnaround.
Repairing the Crown’s finances has been a significant drag on economic growth over the last few years.  Of course the upside of deeply contractionary fiscal policy is that has allowed the Reserve Bank to keep interest rates lower than would have otherwise been the case. 
The Government appears acutely aware of not providing extra pressure for the Reserve Bank to raise interest rates.  While this Budget includes higher spending and lower surpluses than previously forecast, it is not likely to lead the Reserve Bank to alter their views on the outlook for the economy or monetary policy settings.  The Government also appears aware of the risk of committing cyclical improvements in the Crown’s finances to new initiatives that may need to be unwound when the cycle turns.
A key feature of recent Budgets has been the tight control of expenditure.  While the Government has allowed themselves to spend more in this Budget, the ratio of spending to GDP is projected to decline to under 30% by 2017/18.  The decline of the Government as a proportion of the economy frees up resources for the private sector, the real wealth creators in the economy, to grow. 
Getting debt down is a critical part of ensuring financial stability and reducing vulnerabilities.  It provides a buffer to cope with the inevitable next downturn in the economic cycle and better prepares the Crown’s finances for the fiscal pressures that come with the aging of the population. 
That said, we continue to be disappointed in the Government’s continued commitment to current arrangements for New Zealand Superannuation.  We understand the politics but the significant opportunity cost of that commitment should be recognised.
The Government is leaving its options open as to how they will utilise future new initiative allocations.  Options include tax reductions, operational and/or capital spending and debt repayment.  Auto-enrolment for KiwiSaver is also an option.  We expect discussion of the options will be a key part of the election campaign for National.
Rising Budget surpluses is good for national savings.  However New Zealand’s biggest savings problem is poor household savings.  It is therefore not surprising that our vote for future policy initiatives is for those that focus on the building of private savings.

The fiscal numbers
The 2013/14 deficit (OBEGAL) is slightly worse than forecast in the Half Year Economic and Fiscal Update (HYEFU) on the back of recent weaker than expected tax revenues.  The Government is projecting a deficit of -1.1% of GDP in the current year compared with -1.0% in the HYEFU.   

However, this is made up on the back of stronger near-term GDP forecasts so that a surplus of 0.2% of GDP is expected in 2014/15, up from 0.0% in the HYEFU.   Surpluses continue to rise over the forecast horizon to 1.3% or $3.5 billion in 2017/18, although the surpluses are slightly lower in future years on the back of the allocations for new initiatives.

Core Crown expenditure declines as a percentage of GDP over the forecast period, reflecting tight control of expenditure and strong nominal GDP growth.  After peaking at 35.1% of GDP in 2010/11, the ratio is expected to decline to 29.9% of GDP in 2017/18. 

Core Crown revenue rises as a percentage of GDP over the forecast period reflecting stronger economic growth.  From a low of 28.6% of GDP in 2010/11, the ratio of revenue to GDP rises to 31.1% of GDP in 2017/18.

Net core Crown debt is expected to peak at 26.4% of GDP in 2014/15 before declining to 23.8% of GDP by 2017/18.  The Treasury expects net debt to be back to 20% of GDP in 2019/20, at which point the Government expects to resume contributions to the New Zealand Superannuation Fund.

The economic assumptions
The Treasury’s economic growth assumptions are broadly in line with our own.  Treasury is estimating growth of 3.0% for the year to March 2014 (AMP Capital 3.1%), rising to 4.0% (AMP Capital 3.8%) in the year to March 2015.  Growth then slows as monetary conditions tighten, the terms of trade decline and net migration slows.  Treasury is forecasting growth to come back to 3.0% (AMP Capital 2.8%) in the year to March 2016.

We have the unemployment rate falling a bit faster than Treasury: they expect an unemployment rate of 5.1% in March 2016, compared with our forecast of 4.8%.  The Treasury believes inflation will reach 2.5% in March 2016 which is a bit higher than our forecast peak of 2.3%.  We expect similar degrees of deterioration in the current account balance to a deficit of around 6.0% of GDP by March 2016.

On balance, the Treasury’s fiscal forecasts appear based on sound and reasonable economic assumptions.