New Zealand: 2019 Article IV Consultation—Press Release and Staff Report

2019 Article IV Consultation-Press Release and Staff Report

Abstract

2019 Article IV Consultation-Press Release and Staff Report

Context

1. New Zealand’s expansion lost momentum in 2017–18. Some key drivers of the strong growth through 2016—reconstruction spending after the 2011 earthquake, a sustained wave of high net migration, a housing boom, and strong terms of trade—weakened. Despite the long expansion, inflation has remained unusually weak, reflecting partly imported disinflation and partly the boost to labor supply from net migration.

2. A housing boom has reduced housing affordability and engendered macrofinancial vulnerabilities. Rising house prices have coincided with rapid household credit growth, and the household debt ratio has risen to high levels in international comparison. Macroprudential tightening in 2014–17 served to mitigate vulnerabilities and house price overvaluation.

3. The New Zealand economy faces a longstanding productivity challenge. Labor productivity growth has remained low, and the level of productivity has been below the average of high-income OECD countries.

4. The government’s policy agenda aims at a fairer and more inclusive economy, and sustainable growth. Priorities are regional development, lower economic inequality, and improved housing affordability. The FY2019/20 budget has been framed as the first wellbeing budget under the Living Standards Framework (LSF) and encapsulates these priorities. The multi-year Review of the RBNZ Act has already resulted in an update of the monetary policy framework and is now in Phase Two, which will consider an update of the financial policy and regulatory framework.1

uA01fig01

Real GDP, Expenditure

(In logs)

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: Haver Analytics and IMF staff calculations.
uA01fig02

Inflation

(Deviation from Midpoint of Target Range in Percent)

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: Haver Analytics and IMF staff calculations.

Recent Developments, Outlook and Risks

A. Developments Over the Past 12 Months

5. Economic growth picked up in early 2019 after slowing in the second half of 2018. The pickup mostly reflected a rebound in private business investment growth, which had contracted at times in 2018 in the context of low business confidence (Figure 1). Residential investment also strengthened, notwithstanding cooling housing markets. Employment growth slowed markedly in late-2018 but has strengthened more recently. The unemployment rate declined below 4 percent in the second quarter of 2019.

Figure 1.
Figure 1.

Growth is Slowing

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: Haver Analytics; Statistics New Zealand; and IMF staff calculations.
uA01fig03

Labor Force and Net Migration

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Source: Haver Analytics and Statistics New Zealand.
uA01fig04

Employment Growth, Unemployment, Underemployment and Participation Rate

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: Haver Analytics and IMF staff calculations.

6. Inflation continued to fluctuate mostly below the midpoint of the target range. Headline inflation rose to 1.7 percent in 2019Q2, up from 1.5 percent in 2019Q1, mostly because the impact of declining fuel prices wore off. The RBNZ’s measures of underlying inflation remained between ½ and ¼ of a percentage point below the 2 percent midpoint of the target range. Wage inflation has picked up, partly reflecting the rise in the minimum wage in April 2018 and 2019.2

7. The economy is close to but likely still below internal balance. With the slowing growth, staff estimates suggest that output was broadly at potential in early 2019 (Figure 2), while unemployment was below the NAIRU.3 Nevertheless, general price and wage pressures have been contained, while underemployment remains at elevated levels. Cost pressure and capacity constraints have emerged at sectoral levels, notably in construction.

Figure 2.
Figure 2.

Monetary Policy Still Faces Weak Inflation, Despite Lower Unemployment

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: Reserve Bank of New Zealand; Haver Analytics; CoreLogic; and IMF staff calculations.
uA01fig05

Inflation Expectations

(%, annual change in CPI)

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: Haver Analytics and IMF staff calculations.
uA01fig06

Wage Inflation

(Nominal vs real, annual %)

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

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

8. The external position was weaker than implied by medium-term fundamentals and policy settings, while the New Zealand dollar was moderately overvalued. The backdrop to this assessment is a mostly domestic demand-driven current economic expansion, with generally negative contributions from net exports to growth, and broad terms-of-trade improvements. The current account deficit widened to 3.8 percent of GDP in 2018, reflecting a small decline in the terms of trade (Figure 3). The real effective exchange rate (REER) was around 10 percent above its long-term average in 2018 (Annex I).

Figure 3.
Figure 3.

External Sector Remains Stable

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

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

The Fiscal Position Remains Strong, Notwithstanding Higher Spending

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: Treasury, Budget 2018 and 2017 Half-Year Economic and Fiscal Update; and IMF staff calculations.
uA01fig07

Goods Terms of Trade and REER

(200202=100, in logs)

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: Haver Analytics and IMF staff calculations.

9. Housing markets cooled but affordability constraints remain. House sales have declined by about 30 percent from their peak in mid-2016. House price inflation stabilized at 1.5 percent y/y nationally by 2019Q1, while prices have declined in Auckland since mid-2018. The cooling reflects a tightening in banks’ mortgage lending standards, the tightening of loan-to-value ratio (LVR) restrictions by the Reserve Bank of New Zealand (RBNZ) during 2016–17, and declining affordability. In Auckland, improved supply prospects because of zoning reforms and weaker foreign demand also played a role (Figures 57). Growth in residential investment has picked up, however, consistent with still robust underlying demand and some supply constraints.

Figure 5.
Figure 5.

The Housing Market Has Cooled

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: Reserve Bank of New Zealand; OECD; QV via Corelogic; Haver Analytics; and IMF staff calculations.
Figure 6.
Figure 6.

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

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: Reserve Bank of New Zealand; Statistics New Zealand; and Haver Analytics.
Figure 7.
Figure 7.

Households’ Balance Sheets Risks Have Started to Improve

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: Reserve Bank of New Zealand; Statistics New Zealand; Haver Analytics; and IMF staff calculations.
uA01fig08

House Prices

(Y/Y % change )

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Source: REINZ.
uA01fig09

Volume Sold

(3-month moving average)

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: REINZ and IMF staff calculations.

10. Key financial soundness indicators have improved further. Bank lending continued to slow across all sectors, growing now broadly in line with nominal GDP. Banks strengthened their lending standards, although the recent modest easing in the RBNZ’s LVR restrictions in January 2018 and January 2019 has led to a renewed uptick in new high LVR loans (Figures 7 and 8). While shorter-term U.S. dollar interest rates increased over the past year, the funding costs of New Zealand banks remained broadly stable (Figure 8).

Figure 8.
Figure 8.

The Banking Sector Is Strong

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Source: Reserve Bank of New Zealand.

B. Outlook

11. After the recent pickup, growth is expected to remain close to trend on the back of increased policy support. It is forecast to weaken somewhat in mid-2019 given external headwinds, but the recent monetary policy easing and increased government spending are expected to lift domestic demand. With this boost, a small positive output gap is expected to emerge, and inflation should move towards the 2 percent midpoint of the RBNZ’s target range. In the medium term, output growth is expected to moderate to that of potential, which itself will slow modestly, mostly because of labor supply growth decreasing with the expected further gradual decline in net migration from recent highs.4

uA01fig10

Growth Accounting

(Percentor Percentage Points)

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: Statistics New Zealand; Authorities’ data; and IMF staff calculations

12. Potential output growth is projected to slow over a 5-year horizon, mostly because of lower labor supply growth. This reflects lower working age population growth because of the expected gradual decline in net migration. Total factor productivity is expected to strengthen, reflecting cost control and efficiency gains, as broader capacity constraints, primarily related to construction and public infrastructure provision, are expected to emerge under the baseline outlook.

13. Household macrofinancial vulnerabilities are forecast to decline under the baseline scenario. House price inflation is expected to stabilize at rates slightly above consumer inflation. Residential investment is expected to rise at recent rates, consistent with continued strong housing approvals data and underlying housing supply shortfalls. With prices slowing relative to incomes, the household debt to disposable income ratio is expected to decline from 164 percent in 2018 to 149 percent in 2024.

C. Risks

14. Risks to the outlook are increasingly tilted to the downside. On the domestic side, the fiscal policy stance could be less expansionary if policy implementation were to be more gradual than expected, a risk given recent patterns. The domestic housing market cooling could morph into a downturn, either because of external shocks or diminished expectations. On the external side, global financial conditions could be tighter and dairy prices could be lower. Risks to global trade and growth from rising protectionism have increased, and this could have negative spillovers to the New Zealand economy, including through the impact on China and Australia, two key trading partners. High household debt remains a risk to economic growth and financial stability, and it could amplify the effects of large, adverse shocks. On the upside, in the near term, growth could be stronger if net migration were to decrease more slowly than expected or if the terms of trade were to be stronger (Annex II).

Authorities’ Views

15. The authorities broadly agreed with staff’s assessment of the outlook and risks. They anticipated a pick-up in growth in mid-2019 and through 2020, supported by accommodative monetary policy and the near-term fiscal impulse. Unemployment was seen as being close to the natural rate. The pickup in growth should put further pressure on wages and prices, bringing inflation to the mid-point of the target range. Net migration flows should also continue to support growth in the near term. In the medium-term, growth will slow to potential, as policy stimulus fades and net migration declines to levels that are closer to longer-term averages. The authorities were concerned about risks from trade tensions and other global downside risks. These could result in slower global growth and adverse spillovers into the New Zealand economy via their impact on business confidence and investment, resulting in a scenario in which inflation remains below the mid-point of the target range. Another concern was uncertainty about the potentially disruptive effects of digital and other technologies in product and labor markets.

Policy Discussions

16. The policy discussions focused on four issues: (i) macroeconomic policies to reach internal and external balance; (ii) policies to manage macrofinancial risks and reforms to strengthen financial regulation; (iii) policies to strengthen housing affordability; and (iv) policies to foster stronger and more inclusive growth.

A. Macroeconomic Policies for Internal and External Balance

Context

17. With recent rate cuts, monetary policy is more accommodative. The RBNZ reduced the policy rate—the overnight cash rate (OCR)—by 25 basis points in May 2019 and by 50 basis points in August responding to the weaker growth and inflation outlook. With the OCR at 1.0 percent, the two-step easing has lowered the real policy rate from around 0 to -¾ of a percent compared to an estimated neutral rate of 1–2 percent.

18. The FY2019/20 budget strikes a balance between supporting policy priorities and maintaining prudent debt levels. A small increase in operating and capital allowances compared to the December 2018 Budget Policy Statement addresses cost and capacity pressure in the delivery of essential infrastructure and services with a rapidly growing population.5 The 2019 Budget is the first Wellbeing Budget, using Treasury’s Living Standard’s Framework (Annex III). The Wellbeing Budget targets five priorities through new and repurposed spending programs, including mental health, child wellbeing and poverty, Māori and Pasifika aspirations, productivity, and digital transformation of the economy.

Staff’s Views

19. The accommodative monetary policy stance fits the subdued inflation conditions. Even though the economy appears close to internal balance, monetary policy still faces asymmetric risks. Downside risks to growth, employment, and inflation because of insufficient accommodation remain a bigger concern than upside risks to inflation if the monetary policy stance turns out to be too expansionary. Further cuts would be appropriate if further downside risks with impacts on New Zealand are realized.

20. The expected fiscal policy stance under the FY2019/20 budget strikes an adequate balance between a near-term boost to demand and maintaining prudent debt levels. At a projected 1.5 percent of GDP, the fiscal impulse expected in 2019 is helpful, given the recent slowing in economic growth and the current cyclical position. Subsequently, the fiscal policy stance is expected to turn mildly contractionary from mid-2020, as the government follows its Budget Responsibility Rules, which aim for a reduction in net debt to 20 percent of GDP by FY2021/22. Given the low level of debt, and good access to credit coupled with a strong sovereign rating, New Zealand has substantial fiscal space and is at low risk of public debt distress (Annex IV).

21. The expected rebalancing of the macroeconomic policy mix is appropriate under the baseline scenario. The expected balance of the policy mix toward moderate fiscal consolidation and accommodative monetary policy under the baseline is well suited for restoring internal and external balance, given current indications of exchange rate overvaluation and excess external imbalances. If the fiscal stance continued to be expansionary, it would require earlier monetary policy tightening, likely amplifying the currency overvaluation.

uA01fig11

Fiscal Impulse

(% nominal potential GDP)

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

22. New Zealand could face the effective lower bound on nominal policy rates should downside risks materialize but it has the space for a macroeconomic policy response. In the discussions, the authorities noted that they were discussing their choice of fiscal and monetary policy responses in the event of a severe economic downturn. Staff observed that the impact of a slowdown could be mitigated through expansionary fiscal policy given limited conventional monetary policy space (Annex V). The main concern is the readiness for a timely, effective response, given long implementation lags, especially in capital spending. The RBNZ has several options for unconventional monetary policy, including forward guidance and negative interest rates on its liquidity facilities to asset purchases, with the choice of instruments likely to depend on the underlying shocks and the extent of stress in the banking system.

23. New Zealand’s sound fiscal framework has been strengthened further. The introduction of a target band for net public debt beyond FY2021/22 will provide a transparent medium-term public debt anchor for budget decisions, while avoiding the drawbacks of a narrow, time-bound debt target. The target range of 15 to 25 percent of GDP is prudent and maintains the fiscal buffer needed for the potentially large-scale fiscal policy response that might be required, given New Zealand’s vulnerabilities. At the same time, the range also provides the flexibility to let automatic stabilizers operate over the cycle and accommodate productive spending when appropriate. The new wellbeing budget framework allows the government to establish spending priorities that will further living standards. The prioritization of spending in the context of broader socio-economic and environmental indicators should also facilitate setting program objectives to ensure and monitor effectiveness. There should be decisions made on how to evaluate the outcomes of those objectives in relation to wellbeing to provide guidance to government spending.6

Authorities’ Views

24. A sustained lift in the inflation path toward the mid-point of the inflation target range will require a period of sustained above-trend growth. RBNZ officials noted that core inflation measures had increased to rates close to 2 percent—the mid-point of the target range, consistent with the economy operating broadly at capacity and labor markets tightening gradually. Nevertheless, with global growth slowing, additional easing might be required for growth to remain strong enough to generate the desired upward pressure on prices and wages. In the RBNZ’s assessment, the exchange rate is broadly in line with fundamentals, taking into account the wide range of uncertainty around fair value assessments. Nevertheless, with major central banks expected to ease policy again, unhelpful downward pressure on inflation from renewed appreciation of the New Zealand dollar was a concern.

25. The conduct of fiscal policy will remain prudent even with greater focus on fostering wellbeing and related spending increases. The Wellbeing Budget is a framework to ensure improved targeting of government spending with a multi-year horizon. However, the new spending priorities have not replaced earlier ones. In particular, higher spending for infrastructure and the Provincial Growth Fund for regional development continues. The authorities also underscored the government’s continued commitment to the Budget Responsibility Rules, including the aim to reduce net public debt to 20 percent of GDP by FY2021/2022. While recognizing that New Zealand had substantial fiscal space, the authorities did not see a need for modifying the Budget Responsibility Rules, as they allow for deviations subject to any significant shocks to the economy. Cyclical conditions did not call for such an increase, and they also doubted the capacity to increase productive spending further, given the higher spending already in train. Beyond the net debt target for FY2021/22 under the current rules, the government is looking to move to a medium-term net debt anchor, with a range between 15 and 25 percent of GDP. This will provide more flexibility over the cycle, while still allowing for a large debt buffer for use in emergencies, such as another extensive natural disaster or a large economic downturn.

26. Preparations for a policy response in the event of a severe economic downturn are underway. The RBNZ is considering how to use its balance sheet most effectively, given the small amount of government debt outstanding. On the fiscal side, the main concern is readiness for a timely, effective response, given implementation lags, especially in capital spending.

B. Managing Macrofinancial Risks and Strengthening Financial Regulation

Context

27. The RBNZ relaxed macroprudential policy further as macrofinancial risks continued to ease. The LVR restrictions on banks’ new mortgage loans were relaxed on the assessment that both mortgage credit growth and house price inflation had eased to more sustainable rates, reducing the riskiness of banks’ new housing lending (Text Table).

28. The RBNZ has proposed an increase in capital requirements to lower the probability of bank failure. The proposed increase would entail a rise in the required capital conservation buffer from 2½ to 7½ percent of risk-weighted assets (RWA) and increases for other buffers, raising Tier 1 minimum capital adequacy requirements from 8½ percent of RWA currently to 16 percent for domestic systemically important banks (D-SIBs) and 15 percent for smaller banks Annex VI). These new minimum requirements for high-quality capital would put New Zealand’s locally incorporated banks near the top of international peers. The RBNZ is currently reviewing the proposed changes to the capital framework after a public consultation. A decision is expected in November 2019.

uA01fig12

Proposed Capital Requirements

(In percent of risk-weighted assets)

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Source; RBNZ.
uA01fig13

Capital Ratios

(% of RWAs, March 2019)

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Source: RBNZ.

29. The ongoing Phase Two of the Review of the RBNZ Act focuses on updating its regulatory, supervisory, and macroprudential functions. The government has announced its in-principle decision after Phase 2A of the public consultation to introduce a deposit insurance framework as part of the overhaul of the crisis-management framework, a break from the past when such a framework was rejected on moral hazard grounds. The proposed limited deposit protection of up to NZ$50,000 per account per institution, would fully cover 90 percent of individual bank depositors, but only about 40 percent of the total bank deposits value. Other in-principle decisions and options considered in Phase 2B are discussed in Annex VII.

Macro prudential Measures on New Residential Mortgage Lending of Each Bank

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Staff’s Views

30. The scope for further easing macroprudential restrictions is limited, given still-high macrofinancial vulnerabilities. The share of riskier home loans in bank assets (those with very high LVRs, high debt-to-income, investor loans, and interest-only loans) have moderated due to the combined impact of the LVR settings and tighter bank lending standards. Nonetheless, despite the positive effects of the LVR restrictions implemented over 2013–17, household debt—at 164 percent of household disposable income—continues to be a high-risk structural vulnerability as many borrowers remain highly leveraged. With the recent easing of the LVR restrictions, improvements in some macroprudential risk factors have stalled or started to reverse. Further easing of LVR restrictions should, therefore, consider the possible impact on banks’ prudential lending standards, as well as on risks to financial stability from elevated household debt. Avoiding a further build-up of household balance sheet vulnerabilities would allow for the easing of LVRs in a market downturn.

uA01fig14

Risk Characteristics of New Residential Mortgage Lending

(Percent of new mortgage lending)

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Source: RBNZ.
uA01fig15

DTI and LVR of New Mortgages

(% of total lending in the year to September 20IS)

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Source: RBNZ.

31. The proposed increase in banks’ capital conservation buffer would result in a welcome reduction in systemic financial risks. The material increase in the requirements is consistent with the 2017 FSAP recommendation to raise capital buffers in view of the systemic financial risks emanating from the dominance of the four large banks in the financial system, with similar concentrated exposure to residential mortgages, business models and funding structures. With the increases, capital adequacy requirements in New Zealand would be broadly at the lower end of the range of requirements that, according to recent studies, would have been sufficient to absorb losses in the majority of past banking crisis without undue costs to economic activity. The RBNZ estimated that, overall, the expected capital increases would amount to 20–60 percent of current CET1 capital (an additional NZ$13.7 billion), equivalent to 70 percent of bank profits over the proposed 5-year transition period.

32. There is scope for some flexibility in the final settings for key parameters in the new bank capital framework. In staff’s view, there is a strong case to double the new buffer for domestic systemically important banks (D-SIB buffer) to 2 percent (with a corresponding decrease in the capital conservation buffer for all banks) since much of the structural systemic financial risks identified in the FSAP arise from the D-SIBs. There would also be scope for a somewhat smaller increase of the general conservation buffer, given that other regulatory changes since the global financial crisis likely also lowered the probability of bank failure (e.g., higher liquidity requirements). Alternatively, the RBNZ could also evaluate whether a mix of Tier 1 and Tier 2 capital could provide for a similar strengthening of the loss absorbency provided by banks’ capital buffer. Finally, the phase-in period could be set flexibly to ease the transition. In the discussions, staff also noted that a stronger bank supervision regime would still be needed, to complement the higher capital requirements.

33. The ongoing Phase Two of the Review of the RBNZ Act is expected to advance key areas of reform identified in the IMF’s 2017 Financial Sector Assessment Program (FSAP). Staff welcomes the in-principle decision to adopt a deposit insurance framework, a move recommended by the 2017 FSAP (Annex VIII), and also emphasizes the importance of continued operational independence and additional resources to strengthen the supervisory and regulatory functions of the RBNZ.7

Authorities’ Views

34. The authorities noted that, while household debt remains high, macrofinancial risks have moderated. House prices have moderately declined in Auckland while increases have slowed elsewhere in the country. Banks have steadily strengthened their lending standards since 2016. Further easing in LVRs by the RBNZ is possible if macrofinancial risks decline further, which would require continuing slow growth in credit and house prices, close to or below income growth, and banks maintaining prudent lending standards.

35. The RBNZ noted that the goal of the proposed gradual increase in the bank capital conservation buffer was to make the banking system safer. The proposal was based on evidence that the costs of systemic banking crises are higher than previously understood. The cost from higher capital requirements in terms of lending and economic growth were often overstated, while the benefits were understated. Increasing the amount and quality of capital ensures that banks can survive all but the most exceptional shocks. Officials also noted that the RBNZ is reviewing public submissions in the consultation process, in particular feedback on the risk appetite framework, the related calibration of capital requirements, instruments, and the implementation timeline.

36. Phase Two of the Review of the RBNZ will take into consideration the key reform recommendations of the 2017 FSAP. The in-principle decision to adopt a deposit insurance framework was consistent with the FSAP’s recommendation on the need to have deposit protection to complete the financial safety net. The proposed insurance limit range, albeit comparatively low, would cover about 90 percent of depositors. The deposit insurance would complement the existing options for the orderly resolution of an insolvent bank. The broader crisis management and resolution framework was still under review.

C. Policies to Improve Housing Affordability

Context

37. The government is refocusing elements of its multi-pronged approach to improve housing affordability.

  • On the demand side, the policy measures so far have included an increase in the accommodation supplement—a cash subsidy linked to low-income recipients’ actual rents or home ownership costs; the extension from two to five years of the period during which capital gains on residential investment property are taxed (“bright line test”); a change in the tax treatment of residential rental losses, which can only be deducted from future taxable income from rental properties rather than taxable income in general; and a ban on the purchase of residential property by nonresidents under the Overseas Investment Amendment Act.8

  • On the supply side, the implementation of the KiwiBuild program—where the government plans to build 100,000 affordable homes for first-time home buyers over ten years from 2018—is lagging. The government is currently considering a reset of the program, which is likely to be smaller in scale and more regional needs-based, while at the same time prioritizing social housing, and rent support for low-income households. The Urban Growth Agenda is the umbrella for other measures on the supply side, including related to planning, zoning, and the provision of housing-related infrastructure.

  • On the institutional side, the government established the Ministry of Housing and Urban Development, consolidating responsibilities for the housing agenda. The government agency Kāinga OraHomes and Communities was established as the lead developer for affordable homes and social housing.

Staff’s Views

38. Improving housing affordability would lower macrofinancial risks and contribute to more sustainable growth. Housing affordability has barely improved, notwithstanding the housing market cooling. House prices are expected to continue rising under the baseline economic outlook. Demand for housing is likely to remain strong, given population growth and low interest rates, while the supply response is constrained by land use and other restrictions. Construction costs are high. Improving housing affordability would reduce inequality and contribute to lower macrofinancial risks, and, in the longer term, make growth more sustainable, including by supporting productivity through agglomeration externalities. Supply-side reforms are central for broad improvements in affordability, although additional direct support might be required for some lower-income households.

uA01fig16

House Price-to-income Ratios

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

Sources: RENZ; Statistics New Zealand; and Interest.co.nz.

39. The government’s continued focus on advancing its comprehensive housing policy agenda is welcome. The consolidation for housing-related policies in one Ministry should help in policy implementation. Steps taken to support local governments’ infrastructure funding and financing to facilitate timely infrastructure provision are welcome developments.

40. Nonetheless, the housing policy agenda could benefit from some further measures. The objectives of the KiwiBuild program could, at lower risk to the budget, be achieved through other means, including, for example, temporary tax credits for the construction sector to adopt new technology, rather than the government taking on the role of a developer. Staff welcomes the government’s intention to consider adding elements of tax reform, such as a tax on all vacant land, to the agenda. A broad land tax, for example, would support more efficient land use. Since the comprehensive agenda should foster housing affordability on a non-discriminatory basis, the ban on purchases of residential property by nonresidents should be removed, given its use is not in line with the IMF’s Institutional View (IV) on capital flows. At the local level, there should be reforms to simplify and standardize zoning and permit local councils to actively plan for and enable housing supply growth and planning reforms.

Authorities’ Views

41. The implementation of the government’s multi-pronged approach to improve housing affordability is advancing. A more comprehensive housing policy agenda is taking shape, including increased focus on making housing for lower income households more affordable through a better accommodation supplement. The authorities highlighted that, in addition to the housing related measures already put in place, the new Ministry of Housing and Urban Development has reinforced institutional capacity to deliver the full breadth of the housing plan, including on the legislative changes needed to ensure more affordable houses and the related infrastructure development. The ministry will be supported by a new government entity for affordable housing development, Kāinga OraHomes and Communities, to strengthen delivery.

42. The authorities do not consider the restrictions on purchases of residential property by nonresidents to be a CFM measure. The restrictions do not aim to affect capital flows or resolve a balance of payments issue. They are a demand-side measure to ban overseas speculators against the backdrop of the government’s comprehensive housing agenda. The goal is to create a housing market with prices shaped by New Zealanders, and to make homes more affordable. They also pointed out that the Phase I review of the Overseas Investment Act (OIA) not only brought residential land into the category of sensitive land but also simplified the rules for investment in forestry by overseas persons.

D. Supporting Wellbeing and More Inclusive Growth

Context

43. Addressing low productivity growth will be central from a wellbeing perspective. New Zealand risks missing out on new technologies embodied in capital, as capital deepening has stalled in the current expansion, while total factor productivity growth has been relatively low in comparison with peers (Figure 9). While structural features seem to explain much of New Zealand’s low productivity growth—a remote location, a small domestic market, and lack of interconnectedness, domestically and internationally—there is scope for policies to mitigate some of the implications, including for example, gaps in technology diffusion.

Figure 9.
Figure 9.

There Are Some Gaps in the Macro-Structural Position

Citation: IMF Staff Country Reports 2019, 303; 10.5089/9781513514758.002.A001

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

44. Within the greater focus on wellbeing under the Living Standards Framework, the government has a roster of policies to foster productivity growth. While major budget initiatives have a large social capital component – for example, child poverty and mental health – the authorities are also incorporating measures to lift productivity as identified in recent assessments of New Zealand’s structural settings by the Productivity Commission and international organizations. The measures have included:

  • Introducing an R&D tax credit regime, now at an advanced stage, with a broad definition of R&D, including new digital technologies. It focuses on younger firms and follows many suggested best practices.

  • Continuing to increase education spending. This includes reform of the vocational education training (VET) sector to ensure more efficient delivery and reduce the scope of duplication among the different VET institutions in the country, in addition to improving and building schools at all levels.

  • Creating a New Zealand Infrastructure Commission, Te Waihanga (NZIC), to be established in October 2019.9 The NZIC aims to enhance procurement and delivery and set up an infrastructure pipeline.

  • Using wage increases to further more inclusive growth, by establishing a Fair Pay Agreement Working Group, which recently recommended reintroducing sector-wide collective bargaining. This is in addition to the planned minimum wage increases outlined in 2018.

  • Fostering regional development through the Provincial Growth Fund (PGF) and greater focus on regional immigration to align immigration of skilled labor with employers’ needs in the regions.

Other elements of the structural reform agenda are still being prepared, with many of them (e.g., climate change policies) still at an early stage.

Staff’s Views

45. The thrust of the structural reform program underway is adequate. General economic productivity should benefit from the R&D tax credit regime. VET reform is key to strengthening human capital. The new NZIC should ensure better targeting and implementation of publicly-provided physical capital, particularly with the identification of a pipeline of projects which should reduce uncertainty on how government policies (especially on transport) interact with private investment plans.

46. Overreach of binding sectoral wage agreements should be avoided. The government has not yet responded to the recommendations of the working group, but the expectation is that it will support binding, sector-wide wage agreements for a small number of low-pay, low-skill occupations. It will be important to consider the trade-offs involved. While such agreements can help in reducing inequality, they may also impede economic and labor market adjustment after large shocks and, depending on reach and design, they could also lower demand for low-skilled labor.

47. The authorities’ continued pursuit of an open, multilateral trade regime is commendable. New Zealand remains a central player in the Regional Comprehensive Economic Partnership (RCEP) negotiation process and has implemented the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CP-TPP). Given that foreign direct investment complements the productivity benefits of international trade, the current work on reducing the administrative burdens associated with the OIA is welcome.

Authorities’ Views

48. The government is continuing its multi-pronged approach to boosting productivity as part of its broader focus on wellbeing. It is completing previously-announced initiatives, including: an R&D tax credit to foster innovation by young firms and increase R&D spending to 2 percent of GDP; the provision by NZIC of market information on a pipeline of infrastructure projects and considering the introduction of new reserve powers to ensure that investment is in New Zealand’s national interest; further reforming the OIA by streamlining processes for foreign direct investment; and reforming the VET sector to strengthen human capital. The government remains committed to deeper economic integration through international trade, with continued involvement in the negotiations for the RCEP, an upgraded free trade agreement (FTA) with China and a new FTA with the European Union.

Staff Appraisal

49. New Zealand’s economic expansion is still solid. Despite the loss of momentum in economic activity and a cooling in housing markets, output has remained close to potential, and the unemployment rate has continued to decline. Broader price and wage pressures have not yet emerged even though the economy has operated close to capacity for some time. The external position was weaker than implied by medium-term fundamentals and policy settings.

50. Economic growth is expected to remain close to that of potential output, but risks to the growth outlook are tilted to the downside. After increasing in early 2019, growth is expected to strengthen further in 2019–20 on the back of monetary and fiscal policy support, eventually leading to a small positive output gap and a gradual acceleration of inflation towards the 2 percent midpoint of the RBNZ’s target range. Downside risks to the economic outlook in New Zealand have increased, however, reflecting higher downside risks to the global economic outlook.

51. The recent monetary policy easing fits the subdued inflation conditions and near-term risks to the outlook. Economic growth is only expected to remain close to potential on the back of a timely increase in macroeconomic policy support. Such support remains critical until underlying domestic demand and inflation have strengthened more durably. With downside risks to growth, employment, and inflation, insufficient monetary accommodation still is a bigger concern than the upside risk to inflation if the monetary policy stance were to turn out to be too expansionary.

52. Fiscal policy strikes an adequate balance between near-term demand support and maintaining prudent debt levels. The FY2019/20 budget supports new wellbeing initiatives and should provide modest near-term stimulus to aggregate demand. While New Zealand has substantial fiscal space, the continued emphasis on meeting the medium-term debt objectives highlights the government’s commitment to maintaining the fiscal buffers needed to respond to potential large economic downturns and other contingencies such as natural disasters. The planned move from time-bound point targets for net public debt to a target range of 15 to 25 percent of GDP as a medium-term debt anchor provides for a welcome increase in flexibility.

53. The New Zealand authorities should prepare contingent policy responses in the event of a severe economic downturn. With the policy rate approaching its effective lower bound, the RBNZ will likely have to resort to an unconventional monetary policy response. On the fiscal side, readiness for a timely, effective response, given long implementation lags, especially in capital spending, will be essential.

54. The scope for easing macroprudential restrictions is limited, given still-high macrofinancial vulnerabilities. The combined impact of the LVR settings and tighter bank lending standards has led to a decline in riskier mortgages in bank assets. While house price inflation and credit growth have moderated, any further easing of LVR restrictions should consider the possible impact on banks’ prudential lending standards, as well as the risks to financial stability from high household debt.

55. The proposed higher capital conservation buffers would provide for a welcome increase in banking system resilience. The new requirements would increase bank capital to levels that are commensurate with the systemic financial risks emanating from the banking system. Starting from a relatively strong position, there is scope for some flexibility when setting some parameters in the revised capital framework, including the length of the phase-in period and types of capital within the buffers. The new framework should also differentiate more between large and small banks. A stronger bank supervision regime would still be needed, to complement the higher capital requirements.

56. The main reforms envisaged in the ongoing Phase Two of the Review of the RBNZ Act should increase financial system resilience. The upgrades to the regulatory and supervisory framework would advance key areas of reform identified in the IMF’s 2017 Financial Sector Assessment Program, including enhancing the RBNZ’s resources and operational independence for its supervisory and regulatory functions, broadening the macroprudential toolkit, and introducing a deposit insurance framework.

57. Mitigating supply constraints is critical for housing affordability and requires further progress in the government’s comprehensive housing policy agenda. The reform of the institutional structure, including the establishment of the Ministry of Housing and Urban Development, should help in implementing housing policies. Further work is needed to complete the agenda, including enabling local councils to actively plan for and increase housing supply growth. Tax reform, such as a tax on all vacant land, should also be considered.

58. Addressing long-standing low productivity growth continues to be a central concern. In this respect, some important first steps have been taken, including the introduction of a new R&D tax credit regime; the creation of the New Zealand Infrastructure Commission to help in closing infrastructure gaps; and the reform of the vocational education and training sector.

59. 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, 2014–2024

(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, 2013/14–2023/24

(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, 2014–2024

(In percent of GDP, unless otherwise indicated)

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