New Zealand: 2018 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for New Zealand
Author: International Monetary Fund. Asia and Pacific Dept
Publication Date:
03 Jul 2018
eISBN:
9781484365816
Language:
English
Keywords:
ISCR; CR; government; stats NZ; financial asset; monetary policy; household debt; housing affordability; soft landing; policy agenda; net debt; Housing; Housing prices; Global
Download PDF (1.8 MB)

New Zealand's economy has enjoyed a solid expansion since 2011.

Abstract

New Zealand's economy has enjoyed a solid expansion since 2011.

Context

1. New Zealand’s economy has enjoyed a solid expansion, but, as elsewhere, inflation has been unusually weak. Reconstruction spending after the 2011 and 2016 earthquakes and a net migration wave, partly driven by external factors, have been important growth drivers, with support from accommodative monetary policy, increasing terms of trade, and strong external demand from Asia. With net migration and labor supply increases more persistent and stronger than expected, potential output has been revised upward, while the output gap has decreased more slowly. Inflation has been either below or in the lower half of the 1 to 3 percent target range of the Reserve Bank of New Zealand (RBNZ).

uA01fig01

Real GDP Growth

(%)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Haver Analytics and IMF staff calculations.
uA01fig02

Labor Force and Net Migration

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Source: Haver Analytics.

2. Housing-related macro-financial vulnerabilities have increased in the expansion, and macro-prudential policies have been deployed to contain the risks. Rising house prices have resulted in rapid household credit growth through 2016 and household debt ratios rising from already high levels. The RBNZ has used loan-to-value ratio (LVR) restrictions to curtail related risks. While the negative impact of high house prices on affordability has been offset by substantially lower interest costs, they have become an affordability constraint for some potential buyers, notably first-time home buyers.

uA01fig03

Price-to-Rent Ratio

(Nominal house prices over rent pricey 2010=100; Deviation from average, 2000 to 2017Q4 or latest available)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: OCED; and IMF staff calculations.
uA01fig04

House Price-to-Income Ratio

(Nominal house prices over nominal disposable income per head, 2010=100; Deviation from average, 2000 to 2017Q4 or latest available)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: OECD; and IMF staff calculations.

3. The New Zealand economy faces a productivity challenge despite favorable regulatory settings. Growth in per capita income or GDP per hour has been relatively low. Remote location (“distance”) and a small market size have been identified as obstacles to higher productivity.

Recent Developments, Outlook and Risks

A. Developments Over the Past 12 Months

4. GDP growth rebounded in mid-2017 as weather-related and other temporary factors subsided (Figure 1). Export growth recovered, as dairy and meat production picked up with higher prices. Private consumption continued to grow robustly, supported by strong employment gains. Business investment was also strong, partly due to the strong tourism demand (Box 1). Residential investment growth, in contrast, decelerated and its momentum remains softer, while import growth picked up. Overall, at around 3 percent, growth in 2017 was close to trend but below the buoyant rates of around 4 percent in 2014–16 implied by revisions to national accounts data late last year (Box 2).

Figure 1.
Figure 1.

Growth Starting to Pick Up Again

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Haver Analytics; Statistics New Zealand; and IMF staff calculations.
uA01fig05

Residential Investment

(%)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Haver Analytics; and IMF staff calculations.
uA01fig06

Employment Growth and Unemployment Rate

(%)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Haver Analytics and IMF staff calculations.

5. Net migration remained at recent record high levels. Strong immigration continued, while emigration did not increase, improving labor market conditions in Australia (the main destination country) notwithstanding. Employment continued to grow above trend, while the unemployment rate declined slightly below recent NAIRU estimates through 2017.

6. Disinflation re-emerged in 2017 even though the economy seems to have been operating close to capacity for the past two years. After a bounce in early 2017, mostly because of commodity price increases, headline inflation moderated in the remainder of the year, partly reflecting renewed downward pressures on prices for tradable goods and services. Underlying inflation increased modestly to around 1½ percent, while wage increases remained weak in 2017 even though many indicators point to the economy being broadly at full employment (Figure 2).

Figure 2.
Figure 2.

Monetary Policy Still Faces Weak Inflation, Despite Lower Unemployment

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Reserve Bank of New Zealand; Haver Analytics; CoreLogic; and IMF staff calculations.

Recent Developments in Business Fixed Investment

Business fixed investment growth has remained relatively weak. In general, private fixed investment growth in New Zealand has been stronger than in other advanced countries in recent years. But much of that growth has reflected residential rather than business investment. Outside fixed investment in tradable services, which have seen strong demand, especially in tourism-related services, business investment has remained relatively weak compared to (unexpectedly) rapid labor force and employment growth, notably in tradable goods production and in machinery and equipment. Capital intensity in the economy has thus broadly stagnated in New Zealand’s solid expansion.

uA01fig07

Real Private Fixed Investment

(Y/Y % change)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

uA01fig08

Investment in Machinery and Equipment

(% GDP)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: IMF, World Economic Outlook; OECD; Orbis and IMF staff Calculations.

Revisions to New Zealand’s GDP and Their Implications, 2014–16

Revisions to historical GDP data suggest substantially higher economic growth in 2014–16. The revisions to GDP reflect additional survey and other data. First, the 2016 annual enterprise survey suggests higher business income. Second, the 2016 Household Expenditure Survey revised household consumption growth upwards since 2014. Third, residential investment was revised, using housing insurance data to account for building activity not requiring consent.

uA01fig09

Revisions to Aggregate Demand Components

(In constant prices, differences in percent of previous estimates)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Statistics New Zealand; and IMF staff calculations.

The higher real GDP growth mostly reflects stronger domestic demand. Levels of both private consumption and gross capital formation were strongly revised upwards, whereas that of government expenditure was slightly revised downwards. In sum, these revisions resulted in real GDP by expenditure being 2.0 percent higher by end-2016 than previously reported.

Potential output has been also revised upward. The higher GDP implies that labor productivity growth in 2014–16 has been higher than previously thought. With productivity growth closer to recent averages, the stronger aggregate demand is widely assessed to have been mirrored in strong potential output growth. This assessment is consistent with the view that strong labor force growth, supported in part by a net migration wave driven by external factors, and strong employment growth have resulted in a partly supply-driven expansion of the New Zealand economy. Interestingly, however, fixed private business investment has been revised upward in line with GDP, and the capital intensity of production is broadly unchanged.

uA01fig10

Output Gap

(% potential output)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Haver Analytics and IMF staff estimates.
uA01fig11

Wage Inflation

(Nominal vs real, annual %)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Haver Analytics and IMF staff estimates.1/ Defined as nominal wage inflation minus CPI inflation.

7. The external position in 2017 was moderately weaker than implied by medium-term fundamentals while the New Zealand dollar was moderately overvalued (Annex I). The expansion was mostly domestic demand-driven, which led to lower contributions to growth from net exports and lower trade surpluses (Figure 3). The trade balance impact was broadly offset by stronger terms of trade and by a lower primary income deficit, which narrowed with lower interest rates. The New Zealand dollar depreciated by about 6 percent in real effective terms in the second half of 2017, likely correcting some of the currency overvaluation.

Figure 3.
Figure 3.

External Sector Remains Stronger and Stable

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Reserve Bank of New Zealand; Haver Analytics; and IMF staff calculations.
uA01fig12

Goods Terms of Trade and REER

(Indices, in logs)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Source: Haver Analytics.

8. The housing market is cooling and credit growth to households slowed. House price increases moderated since mid-2016, led by Auckland, while house sales declined and increases in residential building approvals slowed. The cooling appeared to reflect macroprudential policy intervention as RBNZ further tightened LVR restrictions in October 2016, primarily affecting credit to property investors, as well as possibly weaker foreign demand and self-correction in response to declining affordability. Together with tightening in bank lending standards, growth in household credit moderated in turn, broadly in line with nominal income growth (Figures 5–7).

Figure 4.
Figure 4.

The Fiscal Position Remains Strong, Notwithstanding Higher Spending

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Treasury, Budget 2018 and 2017 Half-Year Economic and Fiscal Update; and IMF staff calculations.
Figure 5.
Figure 5.

Household Debt and Housing Remain a Concern, but with Signs of Improvement

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Reserve Bank of New Zealand; and Haver Analytics.
Figure 6.
Figure 6.

The Housing Market is Cooling

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Reserve Bank of New Zealand; OECD; QV via Corelogic; Haver Analytics; and IMF staff calculations.
Figure 7.
Figure 7.

Households’ Balance Sheets Risks Have Started to Improve

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Reserve Bank of New Zealand; Statistics New Zealand; Haver Analytics; and IMF staff calculations.1/ Some estimates are not publicly available for confidentiality and quality reasons.
uA01fig13

Private Banks’ Marginal Funding Costs

(In percent)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Source: RBNZ.

9. Banks continue to hold strong capital and liquidity buffers. Profitability remained strong, underpinned by net interest margins. Slower credit growth and strong deposit growth with stable interest rates, reduced banks’ needs to fund from market sources. This lowered offshore market funding reliance, while the average maturity of such funding also increased (Figure 8).

Figure 8.
Figure 8.

The Banking Sector Is Strong

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Source: Reserve Bank of New Zealand.

B. Outlook

10. Growth is expected to remain strong at around 3 percent in the medium term, while inflation should edge towards the middle of the target range. The turn to a more expansionary fiscal policy stance should offset slowing residential investment and weaker agricultural exports due to dry weather conditions in the near term. Over time, the KiwiBuild program should entail an increase in residential investment (see below). With potential output growth slowing due to the slowdown of net migration, the output gap should turn positive, and upward pressures on domestic prices are expected to emerge. Inflation is projected to rise gradually toward the mid-point of the 1–3 percent target range. The current account deficit should remain below longer-term averages.

11. Vulnerabilities from household debt are expected to decline gradually but will remain high. While housing demand fundamentals remain robust under the baseline outlook, the soft landing in the housing market should continue, reflecting increasing supply over time from the KiwiBuild program (see paragraphs 31 and 32) and gradually rising domestic interest rates. The interest burden on household debt should remain low, given relatively small expected increases in interest rates over the medium term, while the household debt ratio should start decreasing in 2018.

Impact of Interest Rate Changes on Housing Loans

article image
Sources: RBNZ and IMF staff calculations.

12. Potential output growth is projected to slow over a 5-year horizon, mostly because of lower labor supply growth. The latter reflects improving labor market conditions abroad and tighter visa requirements since August 2017. Capital deepening is expected to increase moderately, reflecting higher infrastructure investment in the near term, adjustment to a higher labor supply path after recent upward surprises, and incentives for cost control and adapting new technologies as capacity constraints broaden.

uA01fig14

Growth Accounting

(Percent or Percentage Paints)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Stats NZ, Authorities’ data, IMF staff calculations

C. Risks

13. Risks to growth are broadly balanced in the near term but tilted to the downside in the medium term (Annex II). New Zealand has monetary and fiscal policy space to respond to shocks. On the upside, a stronger-than-expected performance of the global and the Australian economies would benefit New Zealand, and net migration could decrease more slowly than projected. On the downside, on the domestic side, the fiscal stimulus might be less expansionary if policy implementation is more gradual than projected. Furthermore, KiwiBuild could lead to shifts in housing supply from the private construction sector to the public sector rather than being a catalyst for stronger residential investment overall. On the external side, New Zealand is exposed to risks from tighter global financial conditions, structurally weak growth in advanced economies, a significant China slowdown, and a retreat from cross-border integration. Household debt remains high under the baseline outlook and would amplify the impact of large downside shocks, notwithstanding recent improvements in bank’s credit portfolio and risk structure after macroprudential policy intervention. Such shocks could also trigger a disruptive housing market correction.

Authorities’ Views

14. The authorities broadly concurred with staff’s assessment of the outlook and risks. They expect economic growth to pick up in the near term, reflecting the expansionary fiscal policy and robust population growth. Capacity constraints will broaden from construction to other sectors, and upward pressure on inflation will increase. Wage inflation will also rise, buoyed by the announced increases in the minimum wage over the next three years. In the medium term, growth is expected to moderate toward its potential output growth rate, which itself will moderate because of the expected slowdown of net migration. The recovery from the recent adverse weather conditions will increase agricultural export growth in the short term. The authorities share staff’s concerns about external downside risks. A growing concern in this regard is that trade disputes could increasingly be settled outside of the current multilateral system and result in new trade restrictions, which is likely to harm smaller economies such as New Zealand more than larger economies.

Policy Discussions

A. Macroeconomic and Financial Policies

Context

15. Low inflation remains a monetary policy challenge. Tradable prices have been the main source of the renewed disinflation in 2017–18, suggesting that the low inflation problem is, in part, imported, including through greater competitive pressures. But the low inflation challenge is broader. Wage and price pressures remain weak across the economy even though it is broadly at full employment according to several indicators and the output gap has been closed for some time.

16. The solid expansion has helped to maintain a strong fiscal position but has also come with rapidly increasing infrastructure and other spending needs (Figure 4). Revenue growth has again surprised on the upside in the current fiscal year. The central government’s spending plans for the next four years are more expansionary than in the previous budget and relative to the last Article IV consultation, driven by higher social, housing and regional spending (Annex III). In the near term, this spending will result in smaller budget surpluses, but in the outer years, the additional spending increases are financed by the cancellation of personal income tax cuts that had been slated to start in FY2019/20. Net debt is forecast to decrease below 20 percent of GDP by FY2022/23, two years later than previously anticipated.

17. Macroprudential policies have contributed to reducing risks to financial stability. After three rounds of tightening of LVR restrictions (Annex IV), the share of outstanding residential mortgages with LVRs above 80 percent declined to under 8 percent by September 2017, from 21 percent in September 2013 prior to the imposition of LVR restrictions. Bank and household balance sheets have become more resilient with this decline. The RBNZ relaxed the LVR restrictions marginally as of January 1, 2018 and signaled possible further easing.

Staff’s Views

18. The current monetary policy stance is appropriately expansionary. A continued accomodative monetary policy stance has already contributed to stabilizing inflation expectations, and it will help the cyclical relationship between economic slack and prices to reemerge after a long period of downward pressure on prices from tradables deflation and strong labor supply growth. It will also lower risks to demand from currency overvaluation. The policy setting is robust to current uncertainties. A precautionary further easing would raise risks of a steeper tightening if inflationary pressures emerged sooner than expected, given that the economy appears to have been operating close to capacity for some time. On the other hand, a premature tightening could result in renewed currency appreciation and prolong price setting below the mid-point of the target range, given persistently low inflation in recent years, and lower the credibility of the flexible inflation targeting framework.

uA01fig15

Inflation Expectations

(%, annual change in CPI)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Haver Analytics and IMF staff calculations.

19. There is scope to tilt the balance from budget discipline to meeting increased spending needs from strong economic and population growth. Compared to the time of the 2017 Article IV Consultation, the updated baseline expenditure path already incorporates new growth-friendly measures (Annex III) and higher infrastructure spending (see Box 3), although gaps likely remain for the latter. At the same time, governments have been committed to budget discipline and the medium-term debt anchor. The balance between budget discipline and meeting spending needs reflects strong domestic preferences for maintaining low net debt ratios. While the authorities’ prudent fiscal management is commendable, there is, at a minimum, no need for faster debt reduction beyond that outlined in the FY2018/19 budget (consistent with the fiscal DSA in Annex V). Stronger structural revenue, such as that from higher-than-expected population growth, should thus be used to increase spending on infrastructure and other measures that would strengthen the economy’s growth potential.

New Zealand’s Infrastructure Gap and Fiscal Policy1

New Zealand has increased spending on infrastructure, but gaps remain. The concerted effort aims to address the infrastructure gaps that the government perceives in New Zealand. According to analysis published by the Global Infrastructure Hub, New Zealand is facing an annual shortfall of almost 0.3 percent of GDP on infrastructure investment in transportation, telecommunications, electricity and water services, translating into a cumulative gap of 9.5 percent of GDP by 2040.2

uA01fig16

New Zealand versus Comparators

(Percent of GDP, per year)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Source: Global Infrastructure Outlook, Oxford Economics.
uA01fig17

Infrastructure Components for New Zealand

(Percent of GDP, per year)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Source: Global Infrastructure Outlook, Oxford Economics.

Real GDP Gains from Closing the Gap

(Percent of GDP, deviation from baseline)

article image
Note: Ranges of outcomes result from different types of deficit and tax financing.Source: IMF staff calculations.

There are benefits to closing New Zealand’s infrastructure investment gap. Estimated long-term gains (from an IMF DSGE model) range from 0.6 to 0.8 percent of real GDP. Gains are higher with deficit financing. Tax financing (PIT and/or GST) would offset almost one quarter of the long-term gains.

Additional focus of infrastructure spending in the regions outside of the main urban areas would have added benefits. Regions in need of development usually have higher output elasticities of public capital, although they also experience less efficient implementation of public investment. Under an illustrative set of assumptions, real GDP could be an additional 0.1 percent higher in the long term, as the regions benefit more from new unique local facilities and better connectivity with the rest of the country, even with an efficiency loss.3 This additional focus is consistent with the increased emphasis on regional development because of the new Provincial Growth Fund.

1 See the accompanying Selected Issues Paper, Muir, 2018, “Infrastructure Investment in New Zealand: Gaps and Multiplier Effects.”2 The Global Infrastructure Hub is a new initiative of the G-20. Its prime output is the quantification of infrastructure investment gaps for over 50 countries, including New Zealand.3 These estimates are based on literature for Italy and Spain that correlates infrastructure investment undertaken in underdeveloped regions with better returns (up to 30 percent higher) but weaker efficiency (up to 10 percent lower). See, for example, for Italy, Bonaglia and others (2000) and Percoco (2004), or Marquez and others (2011) for Spain.

20. The expected fiscal policy stance balances the macroeconomic policy mix in the near and medium term. The higher spending is expected to translate into a positive fiscal impulse in the near term. This impulse is not expected to result in substantial upward price pressure since some of the higher spending will also increase potential output. While this will complement the accommodative monetary policy stance, which might be less effective on the domestic spending side, given the cooling housing market, it could potentially further weaken the external position. At the same, the slightly contractionary fiscal stance in the medium term—involving expected 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.

21. Further relaxation of LVR restrictions would not be helpful under the baseline outlook. With household debt vulnerabilities remaining high, the modest cooling of the housing market under the baseline projection does not call for an easing of macroprudential policies. While further easing is unlikely to reignite a housing boom with the new housing supply measures, there is also no clear need for further easing to prevent, together with other macroeconomic policies, a destabilizing market correction under the baseline.

Authorities’ Views

22. The authorities noted that monetary policy will be accommodative for a considerable period of time. Inflation expectations remain well anchored, and RBNZ officials are confident that, under current monetary conditions, inflation will increase gradually to the 2 percent midpoint of the target range. With such a stance, monetary policy would also contribute to maximize sustainable employment at this moment.

23. The authorities emphasized that their fiscal plans accommodate the growing demands for government services and infrastructure from rapid population growth. The FY2018/19 Budget increased spending on infrastructure, housing, health, regional development, and education. Going forward, the authorities are focused on the Budget Responsibility Rules, which commit to reducing net public debt to around 20 percent of GDP by FY2021/2022 – two years later than in the previous (FY2017/18) budget, but still preserving fiscal space and keeping expenditures near its recent historical average of 30 percent of GDP.

24. The authorities concurred that macroprudential policies have contained risks to financial stability from a booming housing market. While they noted staff’s view that high household debt ratios argued against further easing of LVRs, on balance the Reserve Bank considered tighter credit standards and a calmer housing market justified the small easing they enacted recently. They noted, however, that the macroprudential framework would be reconsidered in Phase Two of the Review of the Reserve Bank Act and that, in the meantime, any further easing would be gradual and contingent on the outlook.

B. Review of Reserve Bank Act

Context

25. Phase One of the Review of the Reserve Bank Act has resulted in updates of the monetary policy framework. The updates add a “maximum sustainable employment” objective alongside price stability to the main monetary policy objectives and put a monetary policy committee in charge of decision-making. Once the committee is established, overarching monetary policy objectives would be established by the Minister of Finance, based on a (regular) review of the monetary policy goals led by the RBNZ, instead of being agreed upon in a Policy Targets Agreement (PTA) between the Minister and the RBNZ Governor. In the March 2018 PTA, the employment objective has already been operationalized through a qualitative description.

26. The forthcoming Phase Two of the Review will consider financial stability and other policies. The backdrop to this phase is the perception that the RBNZ’s current regulatory and supervisory powers, including on the macro-prudential side, are far-reaching but without sufficiently clear overarching objectives set by elected officials. The powers are primarily based on the RBNZ’s responsibility for keeping the financial system sound and efficient under the Reserve Bank Act.

Staff’s Views

27. The revisions to the monetary policy framework under Phase One of the Review represents a welcome, useful update of governance elements, while maintaining the successful flexible inflation targeting regime. The formalization of an employment objective recognizes the fact that, de facto, modern flexible inflation targeting already involves employment stabilization.1 The operationalization through a qualitative objective avoids undue risks to operational monetary policy independence and should be maintained in the forthcoming legislative changes. The periodic reset of overarching monetary policy objectives upon recommendations after a review led by the RBNZ should further enhance the transparency and accountability of the framework.

28. Phase Two of the Review should give priority to key areas in need of reform. The clarification of the RBNZ’s financial policy mandate and objectives will be ambitious in scope. Last year’s Financial Sector Assessment Program (FSAP) identified an urgent need for strengthening the macroprudential framework, including by broadening the toolkit to include a debt-to-income (DTI) or debt-service-to-income (DSTI) instrument, and the supervisory pillar of New Zealand’s three-pillar approach to banking regulation (Annex VI). Related reforms should be prioritized in the deliberations, implementation, and addition of resources.

Authorities’ Views

29. The authorities considered Phase One of the Review of the Reserve Bank Act to be an update of the governance framework for the successful flexible inflation targeting regime. The employment objective recognizes that monetary policy has some role to play in macroeconomic stabilization. The authorities agreed that the employment objective should be operationalized through a qualitative description, following the style in the current PTA. The authorities noted that a committee structure was their preferred structured for decision making under delegated authority, instead of having all statutory responsibility falling on the governor.

30. Phase Two of the Review of the Reserve Bank Act is an opportunity to reconsider the financial policy mandate of the RBNZ. While the Reserve Bank Act assigns the RBNZ responsibility for promoting the maintenance of a sound and efficient financial system, the authorities are of the view that these objectives may not be sufficiently specific to provide for robust accountability under a delegated mandate. Among the possible options to be considered was the development of a Risk Statement by the government, which, akin to the overarching monetary policy objectives, could frame the RBNZ’s financial policy mandate. A committee structure for decision making in financial policy is also under consideration.

C. Managing Housing Market Imbalances Context

31. The new government’s housing policy agenda focuses on direct supply initiatives, tax policy changes, and restrictions on home ownership by nonresidents. Addressing declining housing affordability has become a policy priority (Box 4).

  • Supply initiatives. Under the KiwiBuild program, the government plans to build 100,000 affordable houses over 10 years (about one third of average annual residential building authorizations) for first-time homebuyers. After initial financing of NZ$2 billion, the program would be sustained through the sales of completed houses.

  • Addressing other supply constraints. Besides the KiwiBuild program, the Urban Growth Agenda aims to increase the availability of developable land and the supply response to higher house prices by addressing regulatory, planning and other policy constraints, including the underfunding of locally-provided infrastructure.

  • Tax policy changes. To dampen property speculation, more residential property sales will be subject to capital gains taxes, as the related bright-line test has been extended from a two-year to a five-year holding period. Residential properties other than main home acquired after March 29, 2018 will be subject to capital gain taxes if disposed of within five years of acquisition. The government also proposed to limit negative gearing from rental properties, such that the deductibility of net losses from property investment (and interest costs) from other taxable income would be eliminated. A Tax Working Group is considering possible additional reform, including a broader capital gains tax on real estate investment and land tax reform.

  • Restrictions on nonresidents’ real estate purchases. A proposed ban in a draft amendment to the Overseas Investment Act is scheduled for a parliamentary vote as early as late June 2018. Under the amendment, all residential land would be re-classified as “sensitive land,” which would require approval for foreign buyers under tighter qualifying criteria.

Tracking Housing Affordability in New Zealand1

Housing affordability is a pressing concern in major cities. The house-price-to-income ratio has risen more rapidly in Auckland, resulting in a widening wedge with the rest of the nation. The decline in home ownership from more than 70 percent over 1990–97 to 63 percent in June 2017 suggests a deterioration in affordability.

uA01fig18

House Price-to-income

(Ratio)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Source: RBNZ, Financial Stability Review(November 2016).

Housing cost indicators suggest that affordability in general may not have worsened considerably. Housing costs remain below 20 percent of household income. The ratio in 2016 marginally exceeded the previous peak in 2011 but has since declined in 2017. Historically low interest rate levels have largely offset the higher cost from the higher required principal repayments for larger housing loans.

uA01fig19

Housing Costs to Total Household Income

(Percent mid-year)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Source: NZ Statistics.
uA01fig20

Component of Housing Costs

(In percent of total housing costs expenditure)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: NZ Statistics; and IMF staff calculation.

Affordability has worsened for Auckland first-home buyers and is better for renters. A new housing affordability measure compiled by the government examines household incomes, subtracting the cost of buying or renting and compares that to a 2013 benchmark to track affordability over time. The share of potential first home-buyer households with below average income after housing costs increased to 82 percent in 2016Q1 in Auckland, compared to 77 percent at the national level. In contrast, the housing rental market has so far acted as a safety valve for those cannot afford home ownership.

uA01fig21

Housing Affordability Measure: National vs Auckland

(Percent share of households with below average income after housing costs)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: Ministry of Business, Innovation & Employment; NZ Statistics, and OECD.Note: Housing affordability measure (HAM) compares the income after housing costs of renters and potential first home buyers to income after housing costs for the average Mew Zealand) household in June 2013.

The central group subject to the housing affordability problem is new entrants to the labor market with little of the savings needed for home ownership. Our analysis suggests that at the prevailing median house price level and median household income, the estimated debt-service-to-income ratio would exceed the affordable threshold of 30 percent. It would also take at least 4 years of saving one-third of household income for a 20 percent deposit in order to be eligible for a mortgage.

1 See the accompanying Selected Issues Paper, Wong, 2018, “Housing Affordability in New Zealand and Policy Response.”

Staff’s Views

32. The housing policy agenda appropriately focuses on closing key gaps on the supply side and in the tax system. While demand-side drivers have stabilized, they remain robust, and improved housing affordability ultimately requires a stronger housing supply response. These measures are complementary, and the success of the housing policy agenda will depend on well-coordinated progress on all fronts. While the large scale of the KiwiBuild program can provide the certainty needed to redirect builders’ incentives toward lower-price housing and adopt new, more cost-effective building technology, the direct market intervention by the government also comes with risks to the budget and risks of crowding out private housing supply and market distortions more broadly. The Tax Working Group should also consider raising land taxes, which are efficient and would increase the recurrent cost of holding land, thereby encouraging its (re)development.

33. A ban of residential real estate purchases by nonresidents is unlikely to improve housing affordability significantly. The proposed draft amendment to the Overseas Investment Act would be a capital flow management measure (CFM) under the IMF’s Institutional View (IV) on capital flows, as it would introduce discrimination based on residency and thus limit capital flows by its design. Its use would not be in line with the IV. While macroeconomic and macroprudential policy settings are broadly appropriate, available data suggest that foreign buyers appear to have played a minor role in New Zealand’s residential real estate markets recently. And in its current design, the CFM is unlikely to be temporary or targeted. The broad housing policy agenda above, if fully implemented, would address most of the potential problems associated with foreign buyers on a non-discriminatory basis.

Authorities’ Views

34. The authorities concurred that restoring housing affordability required a focus on strengthening supply and lowering tax distortions. They noted that measures to intensify competition in land markets via the Urban Growth Agenda would not be sufficient. Direct intervention, through the KiwiBuild program, was also required. On tax policy, while the extension of the bright-line test to five years for capital gains taxation on non-primary residences is now in place, a wider set of reforms are being considered to the tax treatment of residential real estate investment. This includes ring-fencing negative gearing on investment properties. The Tax Working Group has been directed to consider whether a system of taxing capital gains or land (not applying to the family home or the land under it), or other housing tax measures, would improve the tax system.

35. The authorities disagreed with the assessment that a ban on residential real estate purchases by nonresidents, if implemented, would be a CFM under the IV. They emphasized that the ban must be assessed holistically, taking into account the broader social, economic and political context. Declining housing affordability and greater inequality have become a major concern, which has lowered approval of globalization and immigration in New Zealand. Given the central role that home ownership plays in New Zealanders’ sense of wellbeing, the government has taken steps to ensure that housing prices will be shaped by domestic market forces. If the government had not committed to extend its domestic screening regime for sensitive New Zealand assets to residential land, it would not have been able to secure the public’s support for additional international trade agreements. The authorities noted that the proposed screening regime will allow nonresidents to obtain consent to acquire residential land where they are committed to reside and become tax residents, in New Zealand; where their investment will increase housing supply; or where they will develop the land for other purposes (such as commercial premises). They also think that the new regime will help ensure that foreign direct investment flows into the productive economy rather than unproductive speculation. Finally, the authorities do not consider this measure to be a CFM; it will only have a limited effect on aggregate capital flows or the balance of payments, and it will have no material impact on the broader direction of or the openness of New Zealand’s economy.

D. Supporting Higher and More Inclusive Growth

Context

36. New Zealand’s strong expansion has not resulted in strong per capita income growth, highlighting long-standing structural weaknesses.2 The lack of capital deepening in the current expansion has been of concern, as New Zealand risks missing out on new technologies embodied in capital. Total factor productivity growth, while steady, has been relatively low in comparison with peers. Moreover, after a period of rapid population growth, there is evidence of a persistent infrastructure gap. Regionally, much of the growth has been centered in the large urban areas—Auckland, Wellington and Christchurch— with less progress in the regions. However, New Zealand’s structural policy settings are close to or mark best practice among OECD economies and it remains an attractive destination for skilled migrants (see Figure 9).

Figure 9.
Figure 9.

There Are Some Gaps in the Macro-Structural Position

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: OECD.Stat; World Economic Forum, The Global Competitiveness Report 2017–2018; OECD Main Science and Technology Indicators; Oxford Economics and G-20 Global Infrastructure Hub, Global Infrastructure Outlook; OECD Trade Facilitation Indicators, StatsNZ; and IMF staff calculations.
uA01fig22

Compound Annual Growth Rate – Average Annual Household Income, 2007–2017

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Source: Ministry of Business, Innovation and Employment.

Staff’s Views

37. The government’s structural policy agenda seeks to support productive, sustainable, and inclusive growth. The initial emphasis has been on minimum wages; productivity, including research and development (R&D) and education; tax reform; regional development; and trade policy. While the FY2018/19 budget has provided clarity on many elements of the agenda, parts are still under development.

  • The proposed minimum wage increases out to 2020 could help ease income inequality. But, as a result, New Zealand will have the second-highest minimum-to-median wage ratio in the OECD. In the current strong growth environment, the negative impact of higher minimum wages on employment growth, international competitiveness, and labor productivity are likely to be minimal, although there are risks that these impacts might turn out to be larger in a downturn.

  • Free tertiary-level education and training for at least one year could boost human capital. Given its potential fiscal cost, the program could include greater targeting based on needs, possibly beyond the current time horizon.

  • The agenda appropriately focuses on lifting R&D spending in New Zealand to 2 percent of GDP. An R&D tax credit, if well designed, would be an efficient instrument to support R&D spending in the business sector.

  • Tax reform could play an important role in shifting incentives toward broader business investment. Estimates of marginal effective tax rates published by the Tax Working Group suggest that investment in residential real estate is effectively tax-favored compared to other investment. In contrast, introducing progressive corporate income taxation is unlikely to be helpful, considering the relatively small size of businesses in New Zealand. New companies and startups can be supported more effectively through other instruments, such as R&D tax credits or grants. Maintaining broad tax bases will support corporate investment and productivity more generally.

  • The new Provincial Growth Fund should ensure project selection that helps regions to benefit from income gains more in line with the major urban centers. It can also be an appropriate tool to relieve pressures on the major urban areas by encouraging movement of population into the regions (see Box 3).

uA01fig23

OECD Ratios of Minimum to Median Wages

(1 if minimum = median wage)

Citation: IMF Staff Country Reports 2018, 202; 10.5089/9781484365816.002.A001

Sources: OECD.Stat; IMF staff estimates

38. New Zealand’s continued support of open trade and the multilateral trade framework is welcome. As one of the initial signatories of Comprehensive and Progressive Agreement for Trans Pacific Partnership (CP-TPP), New Zealand will benefit from increased market access and new growth opportunities. Foreign direct investment complements the productivity benefits of international trade, and New Zealand would benefit from an improvement of the current policy regime. Restrictions under the Overseas Investment Act could be clarified, while the administrative burden associated with direct investment approvals could be reduced.

Authorities’ Views

39. The authorities emphasized that the structural policy agenda focused on making the economy and economic growth productive, sustainable and inclusive. The agenda is still under development. Nonetheless, important first steps had been made. Reducing income and geographical inequality has been the motivation for the increase in the minimum wage, the equivalent of a free year of tertiary education (university or vocational), and the establishment of the three-year Provincial Growth Fund for regional development. The commitment to increase R&D spending to 2 percent of GDP, which includes a new tax incentive in addition to the current grant system was a first step in a broader agenda to support higher productivity. Finally, the government continues to pursue deeper economic integration through international trade, with the signing of the CP-TPP an important step in this agenda.

Staff Appraisal

40. Context. New Zealand’s economic expansion remains solid. Growth moderated toward trend recently after buoyant rates in 2014–16, and demand fundamentals continue to be strong: financial conditions are supportive, the terms of trade are close to historic highs, and net migration is still high. The external position in 2017 was assessed to be moderately weaker than implied by fundamentals and policy settings, while internal macroeconomic imbalances narrowed, although progress on the inflation front remains tentative.

41. Outlook and risks. The economic outlook is favorable, as growth is expected to remain at around 3 percent in the near term. While housing demand fundamentals remain robust, the soft landing in the housing market should continue, given gradually increasing supply. Risks to growth are broadly balanced in the near term, although some downside risks remain a concern in the medium term. Near-term upside risks are stronger-than-expected net migration or global growth, while more gradual government spending and a weaker demand stimulus is a downside risk. There are external downside risks in both the near and medium term of tighter global financial conditions, structurally low growth in advanced economies, a significant slowdown in China, and more protectionist and inward-looking policies. Household debt remains high under the baseline outlook and would amplify the impact of large downside shocks, notwithstanding recent improvements in its risk structure, and, possibly, also trigger a disruptive housing market correction.

42. Current macroeconomic policy settings are broadly appropriate. The monetary policy stance is sufficiently expansionary to address current, below-target inflation and lowers risks to demand from currency overvaluation. The strong fiscal position provides space to accommodate the needs from strong economic and population growth. With the country’s strong fiscal position, there is no need for faster debt reduction beyond that outlined in the FY2018/19 budget. Stronger structural revenues, such as from higher-than-expected population growth, should be used to increase spending on infrastructure and other measures that would raise potential output.

43. Macroprudential policies have contributed to reducing risks to financial stability and should continue to mitigate risks from high household debt. Bank and household balance sheets have become more resilient with a lower share of loans with high LVRs. With household debt still elevated, further relaxation of LVR restrictions would not be appropriate under the baseline outlook.

44. The Review of the Reserve Bank Act is timely and has already led to an update of the governance framework after substantial evolution of New Zealand’s flexible inflation targeting monetary policy regime. Phase One of the review is well advanced. In the latest Policy Targets Agreement, the employment objective has already been operationalized through a qualitative description, which is consistent with operational monetary policy independence and should be maintained as the updated framework is legislated and fully implemented. Phase Two of the Review, focused on financial stability and other policies, is expected to be ambitious in scope. While this phase is an opportunity to better define the mandate and objectives for the RBNZ in this domain, emphasis should be given to priority areas in need of reform, especially those suggested in the 2017 FSAP, such as the macroprudential toolkit and the supervisory pillar.

45. The ambitious housing policy agenda appropriately focuses on strengthening supply and lowering tax distortions. This focus will help in restoring broad-based housing affordability. The different workstreams under the agenda, including the KiwiBuild program and the Urban Growth Agenda are complementary, and the success of the agenda will depend on well-coordinated progress across the public sector. A ban of residential real estate purchases by nonresidents is unlikely to have a significant impact on housing affordability and the proposed CFM should be reconsidered. The broad housing policy agenda above, if fully implemented, would address most of the potential problems associated with foreign buyers on a non-discriminatory basis.

46. The government’s structural policy agenda seeks to support productive, sustainable, and inclusive growth. Many elements of the agenda are still under development, and decisive reform progress would yield faster benefits. In particular, an R&D tax credit, if well designed, could be an efficient instrument to support innovation in the business sector, while tax reform could play an important role in shifting incentives toward broader business investment. New Zealand’s continued support of open trade and the multilateral trade framework is welcome. Foreign direct investment complements the productivity benefits of international trade and it would benefit from a clarification of the restrictions in New Zealand’s Overseas Investment Act and a reduction in the related administrative burden.

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

Table 1.

New Zealand: Main Economic Indicators, 2013–2023

(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, 2012/13–2022/23 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 (excludes RBNZ), Crown entities, and local governments. 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, 2013–2023

(In percent of GDP, unless otherwise indicated)

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