Statement by Grant Johnston, Alternate Executive Director for New Zealand June 25, 2018

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


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

The authorities broadly agree with the outlook presented in the staff report.

Economic growth in New Zealand has generally been in the range of 3 to 4 percent over the last three years, with key drivers including strong migration inflows, low interest rates and historically-high terms of trade. Employment growth has been strong and labor force participation is near a record-high 71 percent. However, wage and price pressures remain subdued and consumer price inflation is low. Low interest rates and high net inward migration have helped fuel demand for housing, with price-to-income ratios among the highest in the world.

The authorities’ forecasts are for growth to average around 3 percent over the next few years, with the economy operating broadly at, or above, capacity. While some of the recent growth drivers will moderate, a lift in government spending and robust trading-partner growth are expected to provide support to the economy. The pace of employment growth is expected to be more than sufficient to employ new entrants to the labor market, despite high population growth, and unemployment is forecast to decline further towards 4 percent. Growth is expected to add to capacity pressures in the economy, contributing to inflation rising to the target mid-point of 2 percent. The current account deficit is forecast to widen slightly, to around 3 percent of GDP, but consistent with a stable net international investment position. These forecasts are subject to a number of upside and downside risks, with growing trade protectionism an important downside risk.

Fiscal policy

A key anchor for fiscal policy is the Government’s intention to reduce net core Crown debt to 20 percent of GDP by 2021/22, subject to any significant shocks to the economy. Successive governments have considered a low level of public debt to be an important buffer given New Zealand’s exposure to external shocks and natural disasters, and its relatively high private and external indebtedness. The Government has also committed to keeping core expenditure within the recent historical range of spending—around 30 percent of GDP.

The fiscal outlook remains strong. The new Government’s first Budget, in May, increased operating and capital expenditure above their previous tracks but also showed a lift in expected tax revenue. Forecasts for the next four years show increasing operating and cash balances, and a declining debt ratio, consistent with the Government’s net debt objective. Fiscal policy is forecast to be stimulatory in the current fiscal year and the next, but contractionary after that. Increased spending has been directed to priority areas including meeting the needs of a growing population—particularly through the health and education systems—promoting economic development, taking action on child poverty and protecting New Zealand’s natural resources. The Government is increasing investment in social and transport infrastructure, and is gradually resuming contributions to the New Zealand Superannuation Fund, which prefunds a portion of future public pension costs. A Tax Working Group of external experts is looking at the structure, fairness and balance of New Zealand’s tax system and will make its final recommendations early next year.

Monetary and financial sector policies

Consumer price inflation remains below the 2 percent mid-point target, due in part to recent low food and import price inflation, and subdued wage pressures. The RBNZ has signalled that its policy rate will remain at 1.75 percent for some time to come. Ongoing stimulatory monetary policy is expected to result in increasing capacity pressures and consumer price inflation rising gradually to the 2 percent target. The RBNZ has also stated that the direction of its next move is equally balanced, up or down.

The monetary policy framework in New Zealand is being amended to add employment outcomes alongside price stability as a dual mandate for the RBNZ, and to create a formal committee to take monetary policy decisions. Legislation to effect these changes has yet to be introduced. In the interim, however, the Policy Targets Agreement with the Minister of Finance directs the Governor to “contribute to supporting maximum sustainable employment within the economy,” which builds on the flexibility the RBNZ has been using for some time.

A broader review of the RBNZ’s almost 30-year-old legislation is also underway. Key topics include: the institutional arrangements for prudential regulation and supervision; objectives, objective setting processes, and alignment with government policy and risk appetite; and role clarity for the Minister of Finance, Board and Governor, including the allocation and co-ordination of powers, functions, and tools. This review is likely to consider a number of the recommendations made in last year’s FSSA, which the authorities are continuing to work through.

Structural policy

The Government has embarked on a broad program of structural reforms with an overall theme of building a productive, sustainable and inclusive economy. This includes initiatives to support skills, innovation, regional development and trade, alongside policies to improve family income support, raise the minimum wage and transition to a low-emission economy.

In the skills area, the Government has begun to remove financial barriers to post-school education and training. The first year of study at a university, polytechnic or other tertiary provider is now fees-free, as is the first two years of industry training. The intention is to extend this to further years of study and training in the future. In the innovation space, the recent Budget contained a proposal for a new R&D tax incentive that would give eligible businesses 12.5 cents back for every dollar they spend on R&D. This is a contribution to the Government’s goal of lifting national investment in R&D from 1.3 percent to 2 percent of GDP within 10 years.

The Budget also formally established the $1 billion per year Provincial Growth Fund to support growth in regional New Zealand. The Fund aims to enhance economic development opportunities, create sustainable jobs, lift the productivity potential of regions, and help meet New Zealand’s climate change targets. Investments are already planned in tree-planting and regional rail projects. New Zealand is a CPTPP member and is involved in several free trade negotiations, including those with the Pacific Alliance and as part of RCEP. Negotiations on a free trade agreement are due to begin soon with the EU—collectively New Zealand’s third-largest trade partner.

Housing market

New Zealand maintains a high degree of capital account openness and welcomes productive foreign investment that adds to the economy. However, it also faces challenges from declining home ownership and rapidly-increasing house prices. Home ownership plays an important role in New Zealanders’ sense of wellbeing and security, and high house prices have fuelled concerns about globalization and increasing inequality around the world.

Addressing these challenges involves both supply-side and demand-side policies. In particular, the KiwiBuild program aims to deliver 100,000 affordable homes over 10 years for first home buyers through a combination of building on underutilized public land, purchasing or underwriting private developments off plan, and large-scale developments. A variety of housing-related tax measures have been introduced or are under consideration.

The Government has also introduced legislation to generally prevent most overseas persons from acquiring residential land, except where that investment boosts New Zealand’s housing supply, will result in a conversion of the use of that land (such as setting up a business), or the buyer is committed to living, and paying taxes, in New Zealand. This measure will ensure that house prices are shaped by New Zealanders and those that are committed to living in New Zealand, as they cannot be outbid by non-residents. As a demand-side policy—to complement supply-side measures—it will make some homes more affordable for buyers at some points in the property-market cycle. It will also help ensure that a greater proportion of foreign investment flows into the productive economy—where the benefits of free capital flows are greatest—rather than housing speculation. Furthermore, the Government considers foreign capital will be better harnessed to reduce New Zealand’s housing shortage through the incentives included in the new policy to support the supply of new housing, particularly large scale residential developments of at least twenty dwellings.

The Government is committed to maintaining New Zealand as an open, outward-looking trading nation, with public support for liberal policy settings not just around trade but also more broadly across society. Its view is that, without the introduction of the proposed screening regime for residential land, public support for trade agreements like the recently-signed CPTPP would not be forthcoming and New Zealand would be unable to commit to the types of bilateral and multilateral trade deals that underpin a significant portion of the domestic economy. Such agreements are much more important to the long-term strength and resilience of New Zealand’s economy and the wellbeing of its citizens than the introduction of a screening regime for residential property. The Government considers that incorporating this broader perspective would improve the Fund’s advice.

Finally, as there is no intention to manage aggregate capital flows, and it will have no material impact on the balance of payments, the authorities do not consider the policy on overseas purchases to be a capital flow management measure. The authorities also note that while foreign buyers may have played a smaller role in the housing market in 2017 (as noted in the staff report) their impact was likely to have been higher in the preceding years and, if this measure was not brought in, could be significant again in the future.