New Zealand
2012 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice

The New Zealand economy continues to grow at a modest pace. The 2012 Article IV Consultation reports that domestic demand has remained soft as households and businesses continue to deleverage amid a weak housing market and an uncertain outlook. Executive Directors endorse that output growth should pick up somewhat in 2012 as earthquake reconstruction spending is expected to gain pace. High household debt is likely to weigh on the growth of private consumption as households will need to save to strengthen their balance sheets.

Abstract

The New Zealand economy continues to grow at a modest pace. The 2012 Article IV Consultation reports that domestic demand has remained soft as households and businesses continue to deleverage amid a weak housing market and an uncertain outlook. Executive Directors endorse that output growth should pick up somewhat in 2012 as earthquake reconstruction spending is expected to gain pace. High household debt is likely to weigh on the growth of private consumption as households will need to save to strengthen their balance sheets.

THE RECOVERY REMAINS MODEST

1. Growth. The New Zealand economy continues to grow at a modest pace. Output grew by 1½ percent in 2011, as elevated export commodity prices and favorable agricultural conditions helped offset the adverse impact of large earthquakes in Canterbury in late 2010 and early 2011 (Figure 1). Continued aftershocks have delayed earthquake-related reconstruction. Domestic demand has remained soft as households and businesses continue to deleverage amid a weak housing market and an uncertain outlook.

Figure 1.
Figure 1.

A Modest Recovery from Recession

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Sources: Statistics New Zealand; Reserve Bank of New Zealand; UNIDO database; Haver Analytics database; World Economic Outlook; and Fund staff estimates.

2. Inflation. Elevated rates of unemployment, currently above 6 percent, and spare capacity have helped contain inflation. Annual inflation has been falling and is currently in the middle of the Reserve Bank of New Zealand’s (RBNZ) 1–3 percent target band (Figure 2). The strong New Zealand dollar has helped dampen imported inflation.

Figure 2.
Figure 2.

An Accommodative Monetary Stance

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Sources: Reserve Bank of New Zealand; Statistics New Zealand; New Zealand Institute of Economic Research; Bloomberg; International Financial Statistics database.

3. Monetary policy. The RBNZ lowered the policy rate in March 2011 by 50 basis points to cushion the impact of the February earthquake. Since then, it has kept the policy rate on hold given the deterioration in the global economic position, subdued domestic activity, and the expected impact on future domestic activity of the strong exchange rate.

uA01fig02

Policy Rate

(In percent)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

4. The exchange rate. The nominal effective exchange rate has appreciated by around 30 percent since its trough in early 2009. The appreciation reflects the effects of higher export prices, positive interest rate differentials, and, although currently volatile, some increase in global risk appetite since end-2011.

5. Fiscal developments. Reflecting the slow recovery, past revenue and spending decisions, and accrued earthquake-related spending (which will largely be funded by the government-run Earthquake Commission and sizable reinsurance offshore), the fiscal deficit (total Crown) in 2010/11 reached a record high of 9¼ percent of GDP on an accrual basis. Net government debt increased to 20 percent of GDP by mid-2011 from a low of 5½ percent in 2008.

6. External sector. The current account deficit in 2011 remained low at 4 percent of GDP, well below the 8 percent level in 2005-08, reflecting terms of trade gains, weak domestic demand, and low world interest rates. Net external liabilities have declined, in part due to accrued reinsurance payments related to the earthquakes, but remain high at 72 percent of GDP at end-2011.

uA01fig03

Net External Liabilities

(In percent of annual GDP)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Source: Statistics New Zealand.

7. The banking sector is dominated by four large subsidiaries of Australian banks that have proved resilient to the recent turbulence in the global financial markets. Bank profits are strong and nonperforming loans have fallen to less than 2 percent of total loans (Figure 3). Capital adequacy has improved since 2007, with the Tier 1 capital ratio reaching 10 percent in September 2011. All banks are well positioned to meet the Basel III capital requirements, which the RBNZ plans to implement from January 2013. The RBNZ has continued to strengthen regulation and supervision of nonbanks.

Figure 3.
Figure 3.

Banking Sector Developments

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Sources: Reserve Bank of New Zealand; Bankscope; APRA; Haver Analytics database; and IMF staff estimates.

OUTLOOK AND RISKS

8. Near-term outlook. The pace of New Zealand’s economic recovery is likely to remain modest. Output growth should pick up somewhat to 2⅓ percent in 2012 as earthquake reconstruction spending gains pace, although the size and timing of this spending is still uncertain. Other sources of demand will remain soft, however, as global growth prospects are uncertain and households are still highly leveraged and will need to save to strengthen their balance sheets. The spare capacity and elevated unemployment will contain wage and inflation pressures in the near term.

uA01fig04

Assumed Timing of Rebuilding (2012-17)

(In percent of GDP)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

9. Medium-term outlook. Assuming that the bulk of reconstruction takes place during 2013–17, staff projects growth to rise to 3¼ percent in 2013 and converge to the potential rate of 2⅓ percent in outer years. High household debt and an expected increase in interest rates are likely to continue to weigh on the growth of private consumption and investment. Moreover, the government’s fiscal deficit reduction plan will limit increases in government consumption and investment. Under the baseline assumption of a constant real effective exchange rate, the contribution of net exports to growth would be muted, and the current account deficit is projected to widen as the income deficit worsens with the expected rise in global interest rates.

10. External risks. The key risks to the outlook are largely on the external front and on the downside, related to emerging weaknesses in the global economy and a possible upheaval in the global financial system (Box 1). The main channels are:

  • Lower export demand. One-third of New Zealand exports go to China and Australia, leaving growth prospects vulnerable to their economic outlook.

  • Worsened terms of trade. Likewise, about three-quarters of New Zealand exports are commodities and agricultural products whose prices are highly dependent on demand from global markets. Falling demand could significantly weaken the terms of trade from recent historically high levels. However, declines in commodity prices in the past have been accompanied to some extent by a weakening of the exchange rate, helping to buffer the impact on the domestic economy.

  • Increased cost of external funding. While New Zealand banks have little direct asset exposure to European borrowers, they do rely heavily on offshore wholesale funding. A worsening of global financial conditions could raise the cost of this funding, putting upward pressure on interest rates for domestic firms and households.

  • Rollover risks. Banks’ persistent reliance on offshore wholesale funding leaves them vulnerable to the tail risk of a temporary shutdown of global funding markets. While the probability of this event is difficult to determine, banks are less vulnerable than during the market disruption in late 2008, as the share of retail deposits and the average maturity of bank liabilities have been steadily increasing over the last three years and the source of funding is diversified across different regions and products. Nevertheless a sizeable share of offshore funding—almost 30 percent—still needs to be rolled over within 3 months.

uA01fig05

Dairy Price Index and TWI

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

New Zealand: Risk Assessment Matrix

article image
uA01fig06

Sources of New Zealand Bank Funding 1/

(In percent of total loans)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Source: RBNZ1/ Weighted average of seven locally incorporated banks.2/ Includes retail and longer-dated wholesale funding as well as Tier 1 capital.

11. Housing sector risks. Although affordability ratios and debt servicing ratios have recently improved, house prices still remain elevated at about 10-20 percent above an estimated norm based on observed fundamentals. A sudden price correction, possibly triggered by higher borrowing costs or a shock to household incomes, could shake consumer confidence, worsen banks’ balance sheets, and impair the economic recovery. The likelihood of this risk materializing in the near term, however, is low. 1

uA01fig07

Household Debt and Servicing Costs

(In percent)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Source: RBNZ: Financial Stability Report, 2011.
uA01fig08

House Prices Relative to Fundamental Indicators

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Source: Quotable Value Ltd, RBNZ, Statistics New Zealand, Ministry of Housing

12. Tail risks and downside scenarios. Many of the above risks are closely linked—for example, a hard landing in China, which would negatively affect Australia, would consequently reduce demand for New Zealand exports, worsen terms of trade, reduce household income, and could trigger a sudden decline in house prices. This could in turn weaken consumer demand and growth, and negatively affect banks’ balance sheets.

13. New Zealand’s exposure. While difficult to model, the downside macroeconomic impact of such a scenario could be substantial. The Treasury explored an illustrative downside scenario based on financial turmoil in Europe leading to a spike in global risk aversion. The resulting protracted global recession (with a contraction in U.S. output of 1½ percent in 2012) impacts New Zealand through a variety of channels, including deteriorating terms of trade, a loss of business confidence, and a disruption of wholesale funding markets. Based on this, the scenario speculates that growth in New Zealand would be reduced by ½ percent in 2012 and nearly 1 percent in 2013 relative to the baseline scenario, with recovery beginning in 2014. These results are broadly in line with those estimated by a basic Global Projection Model, which shows a comparable correlation of the New Zealand economy to growth abroad.

14. Authorities’ views. The authorities shared staff’s assessment of the economic outlook and risks. They noted that earthquake reconstruction would be a major driver of demand for many years but the precise timing and size of spending is still uncertain.

POLICIES TO SUPPORT NEAR-TERM RECOVERY

15. Monetary policy stance. Staff supported the current accommodative monetary policy stance. The output gap will likely remain negative through 2013. Inflation has declined to below 2 percent and inflation expectations are in the middle of the RBNZ’s target band of 1-3 percent. Moreover, credit and asset price growth remain subdued. With the shift toward floating rate mortgages in recent years, household consumption should be more sensitive to interest rate changes, allowing the RBNZ to remove the monetary stimulus fairly quickly when required.

uA01fig09

Average Mortgage Duration

(In months)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

16. Managing risks. If international financial markets are disrupted or growth falters, staff noted that the authorities have policy space to respond to near-term shocks, with monetary policy serving as the first line of defense. The RBNZ has the scope to lower interest rates and loosen monetary conditions to help buffer against a downside scenario. As evident during the crisis, the free-floating New Zealand dollar provides an additional cushion against external shocks, including disruptions to offshore funding and a negative terms of trade shock. The authorities would also be able to provide emergency liquidity support to banks, a measure which proved effective when wholesale markets shut down in the wake of the 2008 crisis. Moreover, New Zealand’s relatively modest public debt gives the authorities scope to delay their planned deficit reduction path (discussed below) in the event of a sharp deterioration in the economic outlook.

17. Authorities’ views. The RBNZ regards a gradual unwinding of the currently accommodative monetary stance as consistent with keeping inflation in its targeted range of 1 to 3 percent. They noted that their most recent revision downwards in the projected future interest rate track related both to a weaker starting point for the economy and to the strength of the exchange rate—the easing in global monetary policy and recovery in global risk appetite had caused the New Zealand dollar to appreciate by 7 percent in trade-weighted terms since December, which (all else equal) will dampen the outlook for domestic economic activity. They expected that some tightening pressure could come from international funding markets if expected increases in average bank funding costs lead to upward pressure on retail interest rates relative to a given policy rate. They agreed that monetary policy should be the first line of defense against shocks.

REDUCING EXTERNAL VULNERABILITY

18. Current account. Reflecting low national saving relative to investment, New Zealand has run persistent current account deficits, resulting in large net external liabilities. With the recovery and as earthquake reconstruction activity gathers pace, and absent a depreciation of the real exchange rate, staff projects that the current account deficit will widen to around 7 percent of GDP over the medium term. The widening deficits would raise net external liabilities to around 90 percent of GDP by 2017.

19. Increasing national saving would be an important part of reducing the projected rise in current account deficits and net external liabilities, and reducing banks’ reliance on offshore wholesale funding. Staff noted that much will depend on whether the recent increase in the household saving rate—the measured rate recently became positive for the first time since 2000—represents a structural break from the past or is related to the business cycle and will eventually unwind. To boost household saving, staff supported the recommendations of the government’s Savings Working Group on further shifts from income to consumption taxation over the medium term and indexation of interest income and expenses to inflation for tax purposes.2

20. Fiscal deficit reduction (discussed below) would also contribute to raising national saving and reducing future net external liabilities. Staff analysis indicates that orderly reductions in net external liabilities in other advanced and emerging market countries have been mostly associated with improvements in public saving, to which fiscal deficit reduction has contributed (Box 2).

21. Exchange rate regime. New Zealand’s free floating exchange rate regime is expected to continue to play a key role in containing external vulnerabilities, as evident during the recent global crisis when depreciation provided a useful buffer against shocks. Widespread hedging mitigates the impact of exchange rate movements on banks’ balance sheets.

22. Exchange rate assessment. Staff analysis suggests that the New Zealand dollar is currently stronger than would be needed to bring the current account deficit to a level that is sustainable over the longer term (Box 3). Part of the current strength of the New Zealand dollar reflects the positive interest rate differentials with major currencies, which may dissipate with eventual tightening by the central banks.

23. Authorities’ views. The authorities agreed that fiscal deficit reduction would help increase national saving. They stressed that the high New Zealand dollar is working against a rebalancing of growth and shared staff’s assessment that without depreciation, the projected current account deficit would lead to a further buildup of external liabilities. The authorities agreed that part of the currency’s current strength may dissipate with eventual tightening by major central banks, but underscored their concern that weak global growth and persistent European financial turmoil could delay this tightening for some time, inhibiting growth in New Zealand’s tradable sector.

Cross-Country Experiences in Reducing Net Foreign Liabilities 1/

New Zealand’s net foreign liabilities, at over 70 percent of GDP, are high by advanced country standards. Unlike many other similar countries, most of this debt is owed by the private sector, particularly by banks borrowing offshore to fund their domestic operations. This private debt could potentially become a fiscal liability in the event of large negative shocks to systemically important banks’ balance sheets.

This raises the question, are there experiences where countries have reduced large net foreign liabilities in an orderly way, and if so, how? As a first step in providing answers, we have identified some 22 episodes over the period of 1970-2010 where advanced and emerging market economies have reduced net foreign liabilities. These episodes exclude short-lived reductions that may reflect cyclical rather than structural and policy factors (an episode of “sustained” reduction is defined as a period of 8 years or more during which a country’s net liability-to-GDP ratio displays a clear downward trend). In most of these cases, however, major economic and financial crises are a prominent feature in early years, suggesting that crises may have played a role in prompting adjustments. Excluding these crisis-related cases, just seven episodes of orderly reduction remain.2/ In all seven cases, an improved trade balance has been a major factor in reducing foreign liabilities on a sustained basis.

uA01fig10

Contribution to Decreases in NFLs

(In percent of total)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Source: author’s calculation.

We consider the link between fiscal deficit reduction, private sector deleveraging, and reduction in net foreign liabilities in the seven episodes. The main finding is that orderly reductions in liabilities have mostly occurred when there have been improvements in gross public savings instead of private savings, and that in most cases the decline has occurred alongside successful fiscal deficit reduction. This would suggest that deficit reduction should help in reducing New Zealand’s foreign liabilities. Earlier staff analysis suggests that a 1 percent of GDP increase in public saving would raise national saving by about ½–⅔ percent of GDP.3/ New Zealand is unique however in that most of its liabilities are private rather than public, raising the question whether this would limit the ability of budget deficit reduction in the case of New Zealand to bring about a reduction in foreign liabilities more broadly.

1/ Preliminary findings based on a forthcoming paper by Y. Sun and W. Schule.2/ Austria (2001–09), Belgium (1985–2000), Canada (1993–2006), France (1993–2000), Ireland (1985–1999), Netherlands (2002–10), and Peru (1999–2006).3/ New Zealand: Selected Issues Paper, Chapter I (2011), IMF Country Report No. 11/103.

New Zealand’s Real Effective Exchange Rate

Real effective exchange rates based on both consumer prices and unit labor costs remain elevated, reflecting strengthening of the nominal effective exchange rate. The REER has appreciated by almost 35 percent from its trough in early 2009 and is currently 13 percent above the 1982-2011 average. The appreciation reflects the effects of higher commodity prices (which pushed the terms of trade to 20 percent above the average of the past two decades), positive interest rate differentials, and, although currently volatile, some increase in global risk appetite since end-2011. The strong exchange rate may inhibit the growth of the non-commodity tradable sector.

uA01fig11

Effective Exchange Rates

(2005=100)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Despite recent improvements, the current account deficit is projected to increase over the medium term. Under the baseline assumption of a constant real effective exchange rate, the current account deficit is projected to widen to about 7 percent of GDP over the medium term as earthquake reconstruction activity gains pace and global interest rates normalize. The widening deficits would increase net external liabilities from 72 percent of GDP in 2011 to around 90 percent of GDP by 2017.

uA01fig12

Real Effective Exchange Rate and Terms of Trade

(2000=100)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Staff analysis suggests that the New Zealand dollar is currently stronger than is consistent with a level of the current account deficit that is more sustainable over the longer term. To stabilize net external liabilities at the 2009 level of 80 percent of GDP, the current account deficit needs to be reduced to -3¾ percent of GDP, implying that, given the staff’s estimated trade elasticities, the New Zealand dollar would need to be about 15 percent weaker than its current level. Although subject to much uncertainty, model-based cross-country econometric approaches estimated with respect to a medium-term current account norm—in line with the IMF’s CGER exercise—show the exchange rate to be in the range of 10-20 percent above its equilibrium.

uA01fig13

Current Account

(In percent of GDP)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

INCREASING PUBLIC SAVING

24. Fiscal deficit reduction plan. The government’s medium-term deficit reduction plan is aimed at limiting the increase in public debt to preserve the fiscal space to guard against future economic risks and at contributing to lower external debt. To this end, the 2011/12 budget plans to reduce the fiscal deficit (total Crown) to about 6 percent of GDP, and return to budget surplus by 2014/15, mainly through spending control (Figure 4). According to this plan, net government debt would peak at about 30 percent of GDP in 2015, and decline to 20 percent of GDP by 2021.

Figure 4.
Figure 4.

The Government’s Deficit Reduction Plan 1/

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

1/ Core Crown only.Sources: The New Zealand Treasury; Statistics New Zealand; and IMF staff calculations and projections.

25. Benefits of this plan. The pace of deficit reduction entails an improvement of about 5 percent of GDP in the structural balance over the next five years. In staff view, this strikes the right balance between the need to limit public debt increases while containing any adverse impact on economic growth during the recovery. Specifically:

  • It contains the aggregate demand impact by withdrawing fiscal stimulus in line with expected increases in private sector and earthquake-related reconstruction spending. This spending will be a strong driver of growth over the next several years, allowing deficit reduction to proceed without jeopardizing output growth.

  • It creates fiscal space to help the country cope with a possible sharp reduction in domestic economic activity or the assumption of potential liabilities associated with future adverse shocks. Over the longer term, it will create space to deal with aging and rising health care costs.

  • It will facilitate a shift towards a more optimal macroeconomic policy mix, with a tighter fiscal policy easing pressure on monetary policy and therefore the exchange rate. This would help reduce the current account deficit, limit the increase in foreign liabilities, and reduce reliance on offshore wholesale funding.

uA01fig14

Public Health Spending: Projected Increases Over 2010-30

(In percent of GDP)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Source: IMF Fiscal Monitor database.
uA01fig15

Pension: Projected Increases Over 2010-30

(In percent of GDP)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Source: IMF Fiscal Monitor database.

26. Spending measures. The fiscal deficit reduction plan focuses on controlling spending, and the 2011/12 budget introduced measures to contain transfers to middle-income households. The government also plans to shift spending to higher-priority areas such as education and health by requiring government departments to find savings elsewhere. Capital spending will be funded by the proceeds of selling a stake in state-owned enterprises amounting to about 3 percent of 2011 GDP over the next four years, and thereby reduce borrowing. The government plans to reform the welfare system to reduce long-term welfare dependency, addressing major deficiencies identified by the Welfare Working Group.

27. Authorities’ views. The authorities emphasized that returning to budget surplus by 2014/15 is a core commitment of the government. They argued that although public debt is still low by international standards, its rate of increase has been rapid and needs to be arrested. The authorities agreed that deficit reduction would help to rebuild fiscal space to help the country cope with future economic and fiscal shocks, and would reduce pressure on monetary policy and therefore the exchange rate, as earthquake reconstruction gathers pace.

MAINTAINING FINANCIAL STABILITY

28. Balance sheet risks. New Zealand banks face a number of unique risks. On the asset side, banks’ large exposure to highly indebted households and to the agriculture sector is a key vulnerability. Household debt remains high at about 150 percent of disposable income, and a rise in mortgage rates together with an increase in unemployment could lead to an increase in nonperforming loans. A large fall in dairy and meat prices would reduce the quality of agricultural loans, but the capital requirements for these loans have been strengthened since mid-2011. On the liability side, banks have made steady progress in lengthening the maturity profile of their wholesale funding since 2008 and increasing the share of retail deposits, but the total stock of banks’ gross external liabilities remains above 70 percent of GDP and loan-to-deposit ratios remain high.

uA01fig16

Agricultural Debt to Agricultural Export Earnings

(In ratio)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Sources: RBNZ SSR, Statistics New Zealand.
uA01fig17

Loan-to-Deposit Ratios in Asian Countries

(In percent; 2006-11 averages)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Source: IMF staff calculations.

29. Bank supervision and regulation. To address these risks the RBNZ has in place a conservative approach to bank supervision and regulation, requiring that capital ratios be determined using more conservative risk weights and loss-given-default standards than in many other countries.3 Banks have also limited their exposure to low-income earners and high-risk mortgages, and the full recourse nature of mortgage lending also helps limit strategic loan defaults by households. The authorities are in close collaboration with the Australian authorities on crisis management, including undertaking a Trans-Tasman crisis management exercise in 2011.

30. Prudential measures. While recognizing this conservative approach, staff encouraged the authorities to assess on an ongoing basis the balance between banking sector vulnerability versus efficiency to ensure that the systemically important banks’ large wholesale funding needs and their exposure to highly leveraged households and farmers do not pose a sizable potential fiscal liability.4 Options to strengthen prudential norms could include setting the four large banks’ capital requirements above the Basel III minimum or raising the core funding ratio more than the planned 75 percent. Staff also noted that future stress tests of bank balance sheets could be more stringent than in the past to include a disruption to bank funding, a large increase in longer-term interest rates, and a longer time horizon to take into account the impact of sustained high unemployment.

uA01fig18

Assets of Four Major Banks for Selected Countries, 2010

(In percent of these banks’ home country banking sector assets)

Citation: IMF Staff Country Reports 2012, 132; 10.5089/9781475504125.002.A001

Sources: Bankscope; Banks’ Annual Reports; and IMF staff calculations.

31. Macroprudential measures. The RBNZ is examining the potential for various macroprudential measures to limit a build-up of systemic risk during periods of rapid credit growth. The core funding ratio for banks, for example, introduced in April 2010 with the aim of reducing banks’ dependence on short-term wholesale funding, may also help constrain excessive credit growth during upswings. The RBNZ’s recent study has been centered on the effectiveness of four instruments: the counter-cyclical capital buffer, adjustments to the core funding ratio, overlays to sectoral risk weights, and loan-to-value restrictions. Staff noted that the measures under consideration may be useful to manage risks from excessive bank credit growth during upswings.

32. Authorities’ views. The authorities emphasized their conservative approach to bank regulation and supervision. Given this together with New Zealand banks’ high capital quality, the banking system is well positioned to meet the Basel III capital requirements at an early date. The authorities envisaged that macroprudential tools are best reserved for periods of exceptional credit growth rather than being deployed frequently, and also noted possible regulatory arbitrage issues. They agreed that many of the issues related to prudential norms and stress testing could be informed by the results of the upcoming review of the Australian financial sector (FSAP), which will also cover New Zealand banking subsidiaries.

STAFF APPRAISAL

33. Outlook and risks. The pace of New Zealand’s economic recovery is likely to remain modest. Output growth should pick up somewhat in 2012 as earthquake reconstruction spending is expected to gain pace, but the size and timing of this spending is still uncertain. High household debt is likely to weigh on the growth of private consumption as households will need to save to strengthen their balance sheets. The spare capacity and elevated unemployment will contain wage and inflation pressures in the near term. The risks to this outlook are on the downside and largely external, stemming mainly from emerging weaknesses in the global economy and a possible upheaval in the global financial system. The flexible exchange rate would provide an important buffer against shocks.

34. Monetary policy. The current accommodative monetary stance is appropriate. If the recovery remains on track and downside risks dissipate, monetary policy will need to tighten gradually to contain inflationary pressures. However, if the global recovery stalls or international capital markets are disrupted, the RBNZ has scope to cut the policy rate and provide liquidity support for banks.

35. Fiscal policy. The planned deficit reduction path strikes a balance between the need to contain both public and external debt increases while limiting any adverse impact on economic growth during the recovery. The authorities’ plan to return to budget surplus by 2014/15 should put New Zealand in a better position to deal with future shocks and the long-term costs of aging. Moreover, it will relieve pressure on monetary policy and thereby the exchange rate, helping contain the current account deficit over the medium term. New Zealand’s relatively modest public debt gives the authorities some scope to delay their planned deficit reduction path in the event of a sharp deterioration in the economic outlook.

36. External vulnerabilities and the exchange rate. New Zealand’s large net liabilities present a risk. Despite recent improvements, the current account deficit is projected to increase over the medium term as earthquake reconstruction activity gains pace and global interest rates normalize. To contain this increase and limit a further buildup of foreign liabilities over the longer term, the New Zealand dollar would need to be weaker than its current level. However, part of its current strength may dissipate over time with the eventual tightening of policy rates by major central banks. Increasing national saving, including through the planned fiscal deficit reduction, would reduce external vulnerability.

37. Financial sector issues. Banks remain sound, but they are exposed to highly leveraged households and farmers and rollover risks associated with large short-term offshore funding needs. While New Zealand’s bank regulatory norms are more conservative than in many other countries, the authorities should assess on an ongoing basis the balance between banking sector vulnerability versus efficiency to minimize the risk that systemically important banks pose to the economy. Options to strengthen prudential norms if needed could include setting banks’ capital requirements above the Basel III minimum or raising the core funding ratio more than the planned 75 percent to reduce short term external debt further. The RBNZ’s continued work on the costs and benefits of macroprudential measures is welcome, as is the authorities’ intention to implement key features of Basel III in early 2013.

38. Staff recommends that the next Article IV consultation be held on the standard 12-month cycle.

Table 1.

New Zealand: Selected Economic and Financial Indicators, 2008–13

article image
Sources: Data provided by the New Zealand authorities; and IMF staff estimates and projections.

Contribution in percent of GDP.

Based on national accounts data.

Fiscal years ending June 30.

Data for 2012 are for March.

IMF Information Notice System index (2000 = 100).

Table 2a.

New Zealand: Statement of Operations of Budgetary Central Government, 2007/08-2012/13 1/

(In billions of New Zealand dollars)

article image
Source: New Zealand Treasury

Fiscal year ending June 30. Includes core Crown (excluding RBNZ) and Crown entities.

Includes use of goods and services.

Includes currency, deposits and equities.

Excluding Reserve Bank Settlement cash.

Excluding NZ Superannuation Fund and advances.

Includes financial assets of NZ Superannuation Fund.

Table 2b.

New Zealand: Statement of Operations of Budgetary Central Government, 2007/08-2012/13 1/

(In percentage of GDP)

article image
Source: New Zealand Treasury

Fiscal year ending June 30. Includes core Crown (excluding RBNZ) and Crown entities.

Includes use of goods and services.

Includes currency, deposits and equities.

Excluding Reserve Bank Settlement cash.

Excluding NZ Superannuation Fund and advances.

Includes financial assets of NZ Superannuation Fund.

Table 2c.

New Zealand: Central Government Balance Sheet, 2007/08-2012/13

(In billions of New Zealand dollars)

article image
Source: New Zealand Treasury.
Table 3.

New Zealand: Balance of Payments and External Debt, 2006–11

(In percent of GDP)

article image
Sources: Data provided by the New Zealand authorities; and IMF staff estimates and projections.

The large net errors and omissions in 2008 and 2009 mainly reflect financial account data issues, as extreme volatility in exchange rates and market prices during that period made it difficult to separate out valuation effects from financial account transaction.

IIP balance sheet positions arise from transactions and valuation changes. The large net errors and omissions in 2008-09 do not lead to large under-estimation of net foreign liabilities.

Table 4.

New Zealand: Balance of Payments and External Debt, 2006–11

(In billions of U.S. dollars)

article image
Sources: Data provided by the New Zealand authorities; and IMF staff estimates and projections.

The large net errors and omissions in 2008 and 2009 mainly reflect financial account data issues, as extreme volatility in exchange rates and market prices during that period made it difficult to separate out valuation effects from financial account transaction.

IIP balance sheet positions arise from transactions and valuation changes. The large net errors and omissions in 2008-09 do not lead to large under-estimation of net foreign liabilities.

Table 5.

New Zealand: Medium-Term Scenario, 2009–17

article image
Sources: Data provided by the New Zealand authorities; and IMF staff estimates and projections.

Contribution in percent of GDP.

Converted from March year basis for historical data. Public saving covers general government.

Fiscal years ending June 30.

Excluding Reserve Bank Settlement cash.

Data for end-December.