Since 2011, New Zealand has enjoyed a solid expansion. Construction has been a major driver, while strong net migration and low interest rates have added momentum. Macro-financial vulnerabilities have increased with a booming housing market.

Abstract

Since 2011, New Zealand has enjoyed a solid expansion. Construction has been a major driver, while strong net migration and low interest rates have added momentum. Macro-financial vulnerabilities have increased with a booming housing market.

Context

1. Since early 2011, New Zealand has enjoyed a solid expansion. Reconstruction spending after the 2011 Canterbury earthquake was an important catalyst, but the expansion has also been supported by accommodative monetary policy and a net migration wave, which have reinforced momentum in residential investment, improving services exports, and continued strong terms of trade by historical standards.

uA01fig01

New Zealand: Real GDP Growth

(%)

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Source: Haver Analytics.

2. Containing macro-financial vulnerabilities related to a booming housing market has been challenging. Rapid housing credit expansion has been the flipside to the strong growth in residential investment and buoyant house prices, with already high household debt ratios rising again. As for other vulnerabilities, the current account deficit has remained below average in the expansion, and the net foreign liability ratio, which is among the highest in advanced economies, has been broadly stable (Annex I—External Balance Sheet). Commercial banks intermediate much of the foreign liabilities domestically. The fact that the four biggest banks are subsidiaries of large Australian banks contributes to stability in external funding.

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Labor Force and Net Migration

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Source: Haver Analytics.

Recent Developments, Outlook and Risks

A. Recent Developments

3. Economic activity picked up momentum through much of 2016, rather than weakening as expected earlier.

  • GDP growth has accelerated to 4 percent —some 1½ percentage points above trend. On the expenditure side, stronger growth has reflected upticks in private consumption, and residential and public investment. The momentum weakened in the fourth quarter, including because of a softening in private consumption and a sharp drop in exports. But this weakness is expected to be temporary, mainly reflecting weather- and earthquake-related disruptions.

  • Labor market conditions have improved. Employment growth averaged over 4½ percent in 2016, up from about 2¼ percent in 2015 and well above average.1 Net migration flows remained high in 2016 at 2¾ percent of the labor force, partly due to continued weakness in Australian labor markets. With the resulting increase in labor force growth, the unemployment rate fluctuated around the NAIRU of about 5 percent in 2016.

  • Headline inflation moved back into the bottom of the target range in 2016Q4 though it still remains below the midpoint, now for five years. Tradable price deflation has risen to near zero with the recent global oil price increase, notwithstanding further real currency appreciation in 2016. Non-tradable inflation has strengthened in the second half of 2016.

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Residential Investment

(%)

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Source: Haver Analytics.
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Employment Growth and Unemployment Rate

(%)

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Source: Haver Analytics.

4. Economic slack has largely been worked off. IMF staff and RBNZ estimates suggest that output was broadly back at capacity as of 2016Q4. General wage pressures have not yet emerged, given strong labor force growth. That said, conditions vary across sectors, and capacity constraints are emerging in some sectors, including in the construction sector.

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Output Gap

(% potential output)

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Note: Ygap1 and Ygap2 are 5-quarter centered moving averages estimated with an HP filter (lambda = 1600) run on output and expenditure on GDP data respectively. Ygap3 is estimated using a time-variant measure of NAIRU obtained by HP filtering unemployment data (lambda = 1600), and an estimated Okun coefficient of -0.3. Ygap4 is estimated assuming a constant NAIRU of 5% and an estimated Okun coefficient of -0.3.Sources: Haver Analytics; and IMF staff estimates.
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Wage Inflation

(Actual vs fitted, annual %)

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Note: The fitted wage inflation curve is derived from an estimated wage Phillips curve including lagged annual inflation, 3 lags of mean Marketscope Survey inflation expectations, and 1 lag of the estimated unemployment gap.Sources: Haver Analytics; and IMF staff estimates.

5. The RBNZ lowered the policy rate in three 25 basis point steps to 1.75 percent in 2016. In its Policy Statements, the RBNZ noted that the New Zealand dollar was too strong for balanced growth and contributed to deflation in domestic tradables prices.

6. The current account balance is moderately weaker than its fundamental level, and the exchange rate remains moderately overvalued (Annex II—External Sector Assessment).

  • The trade surplus and the current account deficit have remained broadly stable as a percent of GDP even though the expansion has been mostly domestic-demand driven. The steady decline in import prices since mid-2012, continued relatively strong exports prices, and lower world interest rates have helped to offset a small deterioration in real net exports.

  • The real exchange rate has remained above its longer-term average—some 14 percent as of end-2016—but has come some 7 percent off its 2014 peak. Currency strength mirrors terms of trade that are still high in historical perspective; the latter are only 10 percent below their 2014 peak. It has also been supported by the relatively favorable return differentials on domestic assets.

uA01fig07

Goods Terms of Trade and REER

(Indices, in logs)

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Source: Haver Analytics.

7. Housing markets have remained buoyant. Demand for housing has remained strong. Real house prices increased by more than 10 percent in 2016, a further increase in the residential investment ratio notwithstanding. Standard metrics of house price overvaluation have thus edged up further and position New Zealand in the top range across OECD countries. Recent readings in housing market indicators, including sales and building approvals, suggest some cooling in market conditions toward the end of 2016. A third round of tightening macroprudential measures in October 2016 has likely been the main driver.

8. Macro-financial vulnerabilities related to households have increased despite improvements along some margins.

  • Growth in real credit to households has remained strong with booming house prices. While surveys suggest that banks have followed an increasingly conservative approach to lending, the risk profile of new loans has not improved in all dimensions. The share of loans with very high loan-to-value ratios (LVR) has fallen, as has the share of investor lending, which reflects the tightening of macroprudential policy instruments. Some debt serviceability indicators, however, have deteriorated. Debt-to-income (DTI) ratios in particular have risen for all buyer categories.

  • Household saving has decreased with rising housing wealth. The value of household assets has risen faster than their debt, and their net worth has thus increased and leverage has trended slightly down. The household saving ratio has decreased steadily since 2012 and is estimated at around 1 percent of gross disposable income. The sector’s saving-investment balance is now negative, implying net lending by other sectors and highlighting the feedback from credit to aggregate demand. That said, consumption as a fraction of household net worth has decreased slightly, suggesting that not all wealth increases are seen as permanent.

uA01fig08

Growth in Real Credit By Sector

(%)

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Source: Haver Analytics.
uA01fig09

Household Credit and House Prices

(Indices, 1998Q4=1, in logs)

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Source: Haver Analytics.
uA01fig10

Ratios of Consumption to Income and Wealth

(%)

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Source: Haver Analytics.

B. Outlook

9. The outlook is for continued strong growth and inflation gravitating toward the midpoint of the target range, with macro-financial vulnerabilities stabilizing in the medium term.

  • After temporary weakness in 2016Q4, growth is expected to rebound and then moderate toward trend. Near-term growth in the baseline outlook will be supported by continued high net migration, reconstruction following the Kaikoura earthquake, and stronger business investment. Services export growth is expected to remain robust. Over the medium term, net migration is expected to moderate as Australian labor markets strengthen. This moderation, together with rising interest rates, also dampens growth in residential investment and in aggregate demand.

  • Inflation should strengthen. While wage pressure should remain muted with continued high migration in the near term, other cost and price pressures are likely to emerge as capacity constraints increasingly take hold over the next one to two years.

  • The macro-financial baseline outlook is for gradual moderation of house price inflation and stabilizing housing vulnerabilities in the medium term. Tighter macroprudential policies, higher interest rates, lower rates of net migration, and increasing supply are the main drivers of the moderation in house price increases. As credit growth slows, banks’ international net wholesale funding will moderate, containing related vulnerabilities.

C. Risks

10. Risks to the near-term growth outlook have become more balanced. There are upside risks from both stronger net migration and terms of trade (Annex III—Risk Assessment Matrix). This could result in faster debt reduction, which in turn could increase the likelihood of tax cuts and encourage further spending on infrastructure. On the downside, tighter external financial conditions or macroprudential constraints could slow credit, investment, and growth more than expected. Lower external demand and commodity prices, including potentially because of increasing protectionism, would also result in lower growth. A stronger pickup in dairy production in the rest of the world could lead to lower global dairy prices and setbacks to domestic dairy production, exports, and, ultimately, domestic demand, as well as financial stress in the diary sector.

11. Macro-financial downside risks remain a concern. Rising household debt in particular remains a risk to financial stability. It would amplify a high-impact downside shock—which would likely be external— through household deleveraging and a housing correction. There would be feedback effects to the financial sector and, possibly, bank balance sheet stress in a drawn-out downturn, including through the impact on other borrowers as aggregate demand falls. The shock in such a scenario is likely to be common to both Australia and New Zealand and could negatively affect parent banks in the former, with spillovers to subsidiaries in the latter.

D. Authorities’ Views on Outlook and Risks

12. Authorities broadly shared staff’s views on the outlook. They agreed that spare capacity in the economy had shrunk, and inflation is expected to rise gradually to the middle of the target range over the near-to-medium term. Drivers of growth would include strong net migration, which would continue to support consumption and construction activity, and strong service exports. The narrower current account in 2016 partly reflected very low global interest rates; some further depreciation of the exchange rate, which remained stronger than consistent with medium-term fundamentals, would also help boost tradable sector growth. The recovery in dairy prices would help restore farm incomes, but would translate into more spending with some lag, as farmers must first repay debt from loss financing during the decline in dairy prices.

13. External downside risks continue to be the major concern. These include slower trading partner growth, particularly China; uncertainties around the timing and extent of the recovery in the United States and rate tightening; and around global trade policy shifts towards increasing protectionism. The authorities see domestic risks are more balanced, with elevated net migration supporting growth, and economic disruption from the Kaikoura earthquake is expected to be minor. They acknowledged that high household debt could play an amplifying role in the event of a large negative shock.

Policy Discussions

14. Discussions focused on three broad issues: (i) the appropriate macroeconomic policy mix; (ii} policies to contain macro-financial vulnerabilities and strengthening financial sector resilience, building on the FSAP recommendations2; and (iii) policies to manage opportunities from strong economic and population growth.

A. Monetary and Fiscal Policy

Context

15. The current net migration wave has posed fewer challenges to demand management because of its unusual composition (Annex IV—Migration). Fewer, including lower-skilled, New Zealanders are emigrating, while more immigrants arriving are students and members of younger age cohorts relative to past waves. The latter likely explains weaker aggregate demand effects in this wave, while the former has helped to keep wage pressures in check despite the current construction boom.

16. The current monetary policy setting addresses low inflation and currency strength. Currency overvaluation and upward pressure from return differentials pose risks. They could exacerbate external imbalances, prolong low inflation, and be an obstacle to higher productivity in tradables sectors, a concern considering New Zealand’s remote location and small market size. However, the output gap has closed and broader capacity constraints could be emerging.

17. The fiscal position is expected to strengthen further. Strong revenue growth is forecast across all revenue sources. The central government’s spending plans for the next four years are based on conservative forecasts for inflation and real GDP (consistent with those of IMF staff). Net debt should decrease below 20 percent of GDP by FY2020/21.

Staff Views

18. The current accommodative monetary policy setting is appropriate until inflation is firmly within the target range, but the RBNZ should stand ready for an unexpected upshift in the inflation path.

  • Costs of inflation risks will remain asymmetric in the near term. Downside risks to inflation still are a bigger concern after a long period of inflation below target, strong labor force growth, the possibility of a renewed currency appreciation, and the fact that some of the recent uptick in inflation was temporary because of higher oil prices. If there was an unexpected upshift in the inflation path, domestic financial conditions would tighten in expectation of a monetary policy response, thereby reducing further upside risks to actual inflation. While low interest rates have contributed to rising house prices, macroprudential policies are better placed to tackle risks to financial stability from housing-related vulnerabilities (see below).

  • A change in the global environment or domestic conditions could require an earlier policy tightening than it is implied by the RBNZ’s current forecasts. Financial conditions are already less accommodative with recent currency appreciation and the upward pressure on banks’ lending and funding rates from a widening gap between credit and deposit growth as well as deposit competition. Nevertheless, in the improving global environment, and with the economy already at capacity, there could be an unexpected upshift in the inflation path in New Zealand with the current policy setting.

19. A slightly contractionary fiscal policy stance will balance the macroeconomic policy mix in the near term.

  • The baseline expenditure path incorporates higher infrastructure spending and new growth-friendly measures, compared to the previous budget and Article IV consultation. This is expected to result in a positive fiscal impulse in the current fiscal year. With the economy approaching capacity, this impulse is helpful in the current macroeconomic context with still low inflation.

  • Current budget plans appropriately imply a slightly contractionary fiscal stance going forward. Consolidation leading to increases of about ½ percent of GDP in the cyclically-adjusted primary balance is consistent with growth moderating to trend under current baseline projections. It would also contribute to moderating the upward pressure on the currency.

  • With a stronger-than-expected economic momentum, revenue is likely to continue to surprise on the upside. Some of the surprise will, however be structural, given higher-than-expected recent labor force growth, and be accompanied by increased demand for infrastructure and other essential government services. New Zealand has the fiscal space to accommodate the needs from stronger-than-expected population growth. Cyclical revenue windfalls, however, should be used to reduce public debt.

Authorities’ Views

20. The RBNZ feels that all the conditions are in place for a slow, orderly rise in inflation. Because of its past record, inflation expectations remain very well anchored at around 2 percent in the medium term, while short-term expectations are now also approaching 2 percent. Wage pressures are contained by the ongoing positive labor supply shock. Officials acknowledge that tradables inflation is beginning to accelerate because of the broader international trends, with mitigating influences from the ongoing, slow appreciation of the free-floating exchange rate. Against this backdrop, current expectations are that the overnight cash rate (OCR) need not be raised until late 2018 to prevent any overshooting of the target range for inflation. The RBNZ stands ready, though, to move the OCR in either direction if warranted by shocks.

21. The authorities consider that their fiscal plans are appropriate, given the current upswing in migration and related demands on government services and capacity. The government has increased spending on infrastructure nationally, and created the Housing Infrastructure Fund to help address housing capacity constraints. Going forward, the authorities continue to focus on strengthening fiscal buffers while the economy is in an upturn by reducing net public debt to around 20 percent of GDP by 2020.

B. Strengthening Macro-Financial Resilience

Context

22. Housing-related macro-financial vulnerabilities could increase further in the short term. The factors underpinning the strong real house price gains of the past years are expected to ease in the medium term, given policy measures to enable more supply and a prospective turn in real interest rates. In the near term, however, real house prices and household debt ratios will likely continue increasing.

23. The major commercial banks have resilient capital and liquidity buffers but their wholesale funding needs are rising again. Preliminary RBNZ estimates suggest that, given in particular relatively more conservative risk weights in New Zealand, common equity tier 1 (CET-1) ratios on an internationally comparable basis would be at least 1 to 2 percentage points above published headline figures. This would still leave them below the upper quartile of international peers. In addition, while recent FSAP stress tests indicate that banks have sufficient capital buffers to withstand major shocks, with the CET-1 ratio remaining above 7 percent, total capital requirements including conservation buffers could be breached. And after several years during which funding needs could largely be met though domestic deposits, banks increasingly had to resort to wholesale funding in 2016, of which about 60 percent was foreign.

Staff Views

24. With the housing boom, the RBNZ’s macroprudential toolkit needs broadening to manage related vulnerabilities effectively, as recommended by the FSAP.

  • Policies other than macroprudential are unlikely to slow the housing boom in the near term. The authorities have been proactive in applying the available macroprudential policies. Exposure limits to high LVRs have reduced the potential bank losses in case of household defaults. But they have not been fully successful in reining in housing credit growth or reducing banks’ vulnerabilities related to household debt (Annex V—Macroprudential Measures), as reflected in increasing debt-to-income ratios that imply higher household default probabilities.

  • To strengthen household balance sheet resilience and reduce the probability of household defaults under downside shocks, the macroprudential toolkit should be extended to include a DTI or (stressed) debt service to income (DSTI) instrument, in line with FSAP recommendations. Such an instrument would directly target the most acute household vulnerability. Other macroprudential instruments available to the RBNZ are approaching their practical limit (LVRs) or are addressing the problem only indirectly, with lower effectiveness and higher risks of unintended consequences.

  • The new instrument should be activated in the event that the effects of the October 2016 macroprudential package on credit growth or credit risk profile prove to be temporary.

25. Housing supply and tax measures could further dampen house price pressures. An orderly resolution of the demand-supply imbalance in housing, particularly in Auckland, will require policies to boost housing supply (discussed below). Tax measures, such as a broader taxation of capital gains in real estate and limitations to subtract negative gearing losses from other income sources, would reduce incentives for leveraged real estate investments by households and help redirect saving incentives to other, potentially more productive investments.

26. Bank balance sheet resilience should be strengthened further through increases in bank capital requirements under the ongoing RBNZ capital review.

  • The large banks feature a strong similarity in business models with a high risk concentration in mortgage lending and the dairy sector and significant reliance on foreign funding, which all imply significant negative externalities in a stress situation.

  • The RBNZ is currently undertaking a bank capital review to determine adjustments to the overall level of required capital, its definition, and risk weights, including in light of international regulatory developments. Consultations will take place in 2017.

  • In staff’s view, the review should recommend higher capital ratios for the larger banks, given the systemic risk dimension. A reasonable benchmark could be capital adequacy ratios for New Zealand’s large banks that are somewhat higher than the Australian Prudential Regulation Authority’s (APRA’s) “unquestionably strong” capital targets for the large Australian banks, as systemic risks relative to peers seem somewhat more pronounced. Higher capital requirements could be instituted by a surcharge for domestic systemically important institutions or, given likely moral hazard concerns of the authorities, by generally higher minimum capital requirements.

27. With an upward trend in wholesale funding needs, banks may need to further improve their funding structure. Credit growth is expected to exceed deposit growth at least in the short term. In addition, the newly introduced funding exposure limits for Australian parents to their New Zealand subsidiaries introduced by APRA will lead to additional re-financing needs for some banks, although the transition period is relatively long (end-2020).

28. Upgrades to oversight and crisis resolution regimes would add to financial system resilience. The FSAP has identified several areas in which structural upgrades would help, including to: (i) increase the weight of regulatory discipline relative to self and market discipline in New Zealand’s three-pillar approach to bank regulation; (ii) foster even stronger home-host supervisory cooperation with APRA; (iii) adopt current reform plans to align the regulatory and supervisory framework for financial market infrastructures with international standards; (iv) broaden the regulatory perimeter for the asset management industry; and (v) enhance the credibility of the Open Bank Resolution (OBR) framework, including by higher de minimis exemptions from freezing and haircutting deposits under the OBR in lieu of the first-best solution of a deposit insurance.

29. The authorities have taken steps to meet outstanding AML/CFT standards. They have introduced legislation to Parliament, which would subject several designated non-financial businesses and professions, such as lawyers and real estate agents, to AML/CFT requirements. As of February 2017, they also introduced new disclosure requirements for foreign trusts, designed to provide for accurate and up-to-date on beneficial ownership.

30. The authorities have adopted a supportive approach toward the remittance corridors to Pacific Island States and are exploring further policy options. The RBNZ issued a statement in 2015 clarifying AML obligations and regulatory expectations and advocating a measured risk management approach by banks towards money transfer operators (MTOs). In addition, authorities participate in international fora, and government agencies are providing technical assistance to Pacific Island States, including on improving AML/CFT compliance, modernizing payments infrastructure, and supporting innovative remittance transfer solutions.

Authorities’ Views

31. The authorities noted that the extension of the RBNZ’s toolkit with a debt-to-income instrument was under review. The rationale for the extension was well understood, but any change in the toolkit must be agreed with the Minister of Finance, as outlined in the Memorandum of Understanding on macroprudential policy between the Minister of Finance and the RBNZ Governor. The next step would be the publication of a consultation document by the RBNZ by mid-May. The RBNZ also clarified that it would not apply the new instrument immediately upon availability but only if the most recent round of macroprudential tightening proved to be ineffective. There was strong agreement about the necessity of measures to strengthen housing supply, but the authorities were not convinced that additional housing-related tax changes are warranted, particularly as changes to the tax rules for property transactions were implemented in October 2015.

32. The authorities concurred on the need for strong bank capital positions. They expected that, based on their supervisory approach and banks’ risk profile, the forthcoming capital review would deliver conservative capital requirements relative to the Basel III standards and international peers. They also indicated that their approach would tend to be more conservative than the one for Australian parent banks, which would at least indirectly imply a benchmarking against the upper quartile of international peers. On bank funding and liquidity, the RBNZ informed that they were planning a review of related regulatory requirements. They noted that their post-GFC funding and liquidity ratio regime, which had been introduced ahead of the Basel III regime, had already resulted in substantial improvements in banks’ funding structure.

33. The authorities took the view that New Zealand’s supervisory approach to bank oversight has performed relatively well, but were in the process of examining the merits of some re-balancing. Their approach aimed to ensure that risk is well understood by market participants and the primary responsibility for management and investment decisions rested with them, not least to avoid moral hazard. They noted, however, that an increased weight of regulatory discipline was already in train, pointing to the forthcoming capital review as an example. They also agreed on the benefits of an even stronger home-host supervisory cooperation with APRA and a more pro-active role during on-site visits by APRA, while seeing less value in initiating stand-alone visits. Regulatory reforms of the current oversight regime for financial market infrastructures are under discussion. On other FSAP recommendations, the authorities indicated that they would keep the regulatory perimeter of securities markets under review and consider an adequate de minimis exemption from freezing and haircutting deposits under the OBR policy in lieu of a deposit insurance scheme. They also confirmed their pro-active approach on issues related to correspondent banking with Pacific Island States and AML/CFT issues.

C. Supporting Growth Opportunities

Context

34. New Zealand’s structural policy settings are close to or mark best practice among OECD economies, but persistent per capita income and productivity gaps remain.3 Income is lower than predicted by these policy settings, by an estimated 20 percent. Growth in labor productivity has declined, with multifactor productivity growth slowing from the early 2000s, and capital intensity has stagnated recently. Structural features can explain income and productivity gaps—a remote location and small size of domestic markets, lack of interconnectedness, and gaps in technology diffusion. New Zealand remains an attractive destination for skilled migrants.

35. The authorities have taken steps to alleviate housing supply bottlenecks. The Auckland Unitary Plan, which came into effect in November 2016, provides a uniform set of zoning rules for Auckland, where housing demand-supply imbalances remain large. The Housing Infrastructure Fund supports infrastructure development by local councils, thereby alleviating financing constraints encountered at this level of government (see Box 1).

Staff Views

36. Targeting housing supply bottlenecks more broadly would safeguard the attractiveness for high-skilled immigration and business. Recent measures, such as the Housing Infrastructure Fund, should be complemented by other reforms, including a comprehensive reform of urban planning legislation and reform of the relationship between the local and central governments in the fiscal framework. Much of the financing required for local infrastructure falls on local councils. Additional sources of revenues, such as an ad-valorem component for property taxes devoted to infrastructure maintenance, could be useful. Such a system of taxation could also be applied more generally by the central government, and distributed more equally across all local governments, allowing smaller communities to manage larger infrastructure needs in this time of more rapid population growth.

37. There is scope for productivity-enhancing fiscal reforms. The 2016/17 budget announced the “Innovative New Zealand” program, which appropriately focuses on increased financing for science and some R&D subsidies and increased subsidies for tertiary education. However, the program will only spend NZ$761 million over the next four years. Spending could be ramped up if the pilot proves to be successful, including by adding tax incentives for R&D spending.4 As discussed during the last Article IV mission, there is also scope for tax reform to raise incentives for private saving and discourage real estate investment as a saving vehicle.5 This could also contribute to enhance the depth of domestic capital markets and lower risk premiums.

38. Trade liberalization could help to strengthen competition and productivity, including in the services sectors. New Zealand firms in the services sector tend to be furthest from the international productivity frontier in relative to firms in goods producing sectors. While product market restrictions are generally low, there is room for reform in some areas, including occupational licensing and similar regulations restraining competition. The government’s agenda for continuing efforts toward further trade liberalization may also be helpful, by raising competition including in the services sector, and increasing production interconnectedness thereby unlocking productivity gains. Broader market access for agricultural products would also help, including by raising incentives for diversification and innovation in the sector.

Authorities’ Views

39. The authorities agreed that alleviating housing supply constraints would support growth in the long run. They expected the recently implemented measures to ease housing supply constraints (the Auckland Unitary Plan, and the Housing Infrastructure Fund) to produce positive results over time. The authorities consider that further measures to increase housing supply responsiveness are desirable and they are pursuing reforms to the planning system.

40. Authorities drew attention to steps taken to boost productivity and innovation in New Zealand. The government’s ongoing Business Growth Agenda (BGA) aims to help overcome the disadvantages of distance and small market size, in particular by deepening international connections, with a focus on increasing the share of exports in GDP to 40 percent by 2025, and diversifying the export base. A central part of the recently updated trade strategy is to pursue deeper economic integration – notwithstanding recent setbacks to the TPP – on a broad range of fronts, including, for example, by deepening existing free trade agreements (FTAs) and working to reduce non-tariff barriers to trade. The BGA also aims to support innovation through establishing technology incubators, strengthening communications networks, and boosting technical capabilities in the workforce, supplemented by measures in “Innovative New Zealand”.

Staff Appraisal

41. Context. New Zealand has enjoyed a solid economic expansion, driven by high net migration and strong construction, and helped by accommodative monetary policy. The economy is now broadly at capacity, and headline inflation has returned into the target range. Macro-financial vulnerabilities in the household sector have increased, with high house price inflation, and the household debt to GDP ratio high and still rising. The trade surplus and current account deficit have remained broadly stable. With commodity prices off their peaks, the real effective exchange rate has depreciated somewhat, but remains moderately overvalued relative to medium-term fundamentals.

42. Outlook and risks. Economic growth should remain above trend into 2018, before moderating. Inflation is projected to rise gradually toward the 2 percent midpoint of the RBNZ target range. Tighter macroprudential policies, higher interest rates, moderating net migration, and easing housing supply constraints should result in lower house price increases and, as credit growth slows, the stabilization of household debt relative to income. Risks to the near-term growth outlook have become more balanced. There are upside risks from both stronger net migration and terms of trade. On the downside, there are risks from tighter external financial conditions and macroprudential constraints. Nevertheless, high-impact downside shocks which would result in a drawn-out downturn could pose risks to financial stability because of the amplification effects and possible bank balance sheet stress from high household debt.

43. Economic policies should focus on managing risks and harnessing opportunities from strong economic and population growth. Macroeconomic policy settings are broadly appropriate. Containing household balance sheet vulnerabilities will be critical for financial sector stability while underlying demand-supply imbalances in the housing market are being addressed. Providing infrastructure and the services needed to promote human and knowledge-based capital will be essential for maintaining growth opportunities.

44. Current monetary policy settings appropriately address low inflation. Inflation is expected to return gradually to the midpoint of the target range. While risks to inflation are broadly balanced, downside risks still are a bigger concern after a long period of inflation below target, strong labor force growth, and the fact that some of the recent uptick in inflation was temporary because of higher oil prices.

45. The strong fiscal position provides room to accommodate the needs from strong population growth. The latest budget update already incorporates higher infrastructure and social spending in response to higher-than-expected population growth, while still providing for a slightly contractionary fiscal stance going forward that will balance the macroeconomic policy mix in an economy that is now operating broadly at capacity. There is fiscal space to allow for higher structural spending if needed. Stronger-than-expected revenue for cyclical reasons should be used to reduce public debt.

46. To manage housing-related macro-financial vulnerabilities, the RBNZ’s macro-prudential toolkit should be broadened. To reduce the probability of bank balance sheet distress from rising household debt defaults under downside shocks, the macroprudential toolkit should be extended to include a DTI or (stressed) DSTI instrument, in line with recommendations by the FSAP. These would directly target the most acute household vulnerability. Other macroprudential instruments available to the RBNZ are approaching their practical limit or address the problem indirectly. The new instrument should be activated in the event that effects of the most recent macroprudential package on credit growth prove to be temporary.

47. Financial system resilience should also be strengthened through higher bank capital requirements and upgrades to oversight and crisis resolution regimes. The large banks feature a strong similarity in business models with a high-risk concentration and significant reliance on foreign funding, which adds a systemic risk dimension. In staff’s view, the on-going RBNZ capital review should recommend capital adequacy ratios for New Zealand’s large banks that are somewhat higher than the Australian Prudential Regulation Authority’s (APRA’s) “unquestionably strong” capital targets for the large Australian banks could be a reasonable benchmark. Implementation of pertinent FSAP recommendations would further strengthen the oversight and crisis resolution regimes.

48. Measures to lift potential growth should focus on leveraging the benefits from high net migration, innovation, and interconnectedness. These benefits could help compensate for New Zealand’s remoteness and small market size. Targeting housing supply bottlenecks more broadly would safeguard the attractiveness for high-skilled immigration and business. Redirecting saving incentives from housing to other investments would lower the incentives for investment in housing and contribute to deeper capital markets. Providing additional support for innovation could provide a basis for diversification and lift productivity. Continuing efforts toward further trade liberalization, in regional and multilateral fora, as intended, could also help in this respect.

49. It is expected that the next Article IV Consultation with New Zealand will be held on the standard 12-month cycle.

Local Governments and the Housing Supply Constraints

Local councils play a key role in alleviating current housing demand-supply imbalances. This box discusses how some features of the current framework for local governments can result in constraints on housing supply.

The property tax-based revenue structure of local councils can lead to constraints on new housing supply. Property taxes are the primary tax revenue source for local councils (along with user charges and other fees). They are typically determined by the local councils’ budget needs. This can promote insider-outsider dynamics in local communities, as existing homeowners may be reluctant to pay for the infrastructure needed for new housing if they do not benefit directly.

Development charges reduce the need for property taxes to cover infrastructure needs. Local councils rely on development charges, or agreements with developers for provision of these services. But development charges most often do not provide the revenue for the infrastructure upgrades needed in existing neighborhoods from new housing (e.g., to deal with congestion).

Rules about zoning for housing (and development in general) differ across local councils. Zoning rules are another avenue through which insiders may constrain outsiders from constructing new supply. However, rules in Auckland have been simplified into 6 zones under the Auckland Unitary Plan, entering into force (in part) in November 2016.1 As Auckland accounts for much of the national housing demand-supply imbalances, the Unitary Plan may now provide for their faster correction.

Many local councils face constraints on debt financing. They can issue debt to meet infrastructure needs. Local councils pool their debt issuance under the New Zealand Local Government Funding Agency (LGFA), implicitly guaranteed by the central government (as a 20 percent shareholder; the rest is held by 31 local councils). Consequently, the LGFA’s credit rating equals that of the central government, which it maintains by imposing relatively strict debt and deficit guidelines on members. The latter have constrained some highly-indebted councils.

The central government has stepped in to relax local financing constraints. It introduced the NZ$ 1bn Housing Infrastructure Fund in the FY2016/17 Budget, available to finance high growth local councils’ infrastructure needs related to new housing (only Auckland, Christchurch, and eight other local councils qualify), repayable without interest over 10 years.

1 The simplified zoning followed the unification of local authorities in the Auckland region in 2011 into one Council.
Figure 1.
Figure 1.

Output and Prices

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Source: Haver Analytics.
Figure 2.
Figure 2.

Considerations for Monetary Policy

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Sources: Reserve Bank of New Zealand; Haver Analytics; CoreLogic; and IMF staff estimates.
Figure 3.
Figure 3.

External Developments

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Sources: The Reserve Bank of New Zealand; Haver Analytics; and IMF staff calculations and projections.
Figure 4.
Figure 4.

Fiscal Developments

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Sources: The Treasury, Budget 2016; and IMF staff estimates.
Figure 5.
Figure 5.

Housing Market

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Sources: Reserve Bank of New Zealand; OECD; QV via CoreLogic; and Haver Analytics.
Figure 6.
Figure 6.

Banking Sector

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Source: Reserve Bank of New Zealand.
Figure 7.
Figure 7.

Key Macro-Financial Trends

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Sources: Reserve Bank of New Zealand; and Haver Analytics.1/ Floating first mortgage new customer housing rate.2/ M3 institutions prior to Nov 2004 and registered banks afterwards.
Figure 8.
Figure 8.

Residential Housing Loans: Risk Profile

Citation: IMF Staff Country Reports 2017, 111; 10.5089/9781475599091.002.A001

Source: Reserve Bank of New Zealand.
Table 1.

New Zealand: Main Economic Indicators, 2010-2022

(Annual percent change, unless otherwise indicated)

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Sources: Authorities’ data and IMF staff estimates and projections.

Calendar year.

Table 2.

New Zealand: Fiscal Accounts, 2011/12-2021/22 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Authorities’ data and IMF staff estimates and projections.

The fiscal year runs from July to June.

Accrual basis; GFS. Comprises Core Crown (excl. Reserve Bank of New Zealand) and Crown entities. Includes New Zealand Superannuation Fund.

“Other liabilities” include government pension liabilities, and the Accident Compensation Corporation (ACC) liabilities (roughly 85 percent funded by assets, and projected to be fully funded by 2019/2020).

“Net debt” is gross debt less debt-relevant financial assets - cash and equivalents, marketable securities, etc. (often held to cover pension liabilities).

Table 3.

New Zealand: Balance of Payments, 2010-2022

(In percent of GDP, unless otherwise indicated)

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Sources: Authorities’ data and IMF staff estimates and projections.