-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KRPaO1QjsyFbRjUZvoKDXAyd7W4l9KXaZWB73iHibK9aPTyc0AHdlDeZmUU9slbm WkbnwW8lYsT65qYGRpburg== 0001104659-05-031100.txt : 20050705 0001104659-05-031100.hdr.sgml : 20050704 20050705094308 ACCESSION NUMBER: 0001104659-05-031100 CONFORMED SUBMISSION TYPE: 18-K/A PUBLIC DOCUMENT COUNT: 70 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20050705 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HER MAJESTY THE QUEEN IN RIGHT OF NEW ZEALAND CENTRAL INDEX KEY: 0000216105 STANDARD INDUSTRIAL CLASSIFICATION: FOREIGN GOVERNMENTS [8888] IRS NUMBER: 000000000 FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 18-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 001-07700 FILM NUMBER: 05934749 BUSINESS ADDRESS: STREET 1: 1 THE TERRACE STREET 2: NATIONAL PROVIDENT BLDG CITY: WELLINGTON NEW ZEALAND STATE: Q2 ZIP: 6015 MAIL ADDRESS: STREET 1: C/O NEW ZEALAND DEBT MANAGEMENT OFFICE STREET 2: TREASURY 1 TERRACE PO BOX 3724 CITY: WELLINGTON NEW ZEALAND STATE: Q2 ZIP: 6015 18-K/A 1 a05-11198_118ka.htm 18-K/A

 

As filed with the Securities and Exchange Commission on July 5, 2005

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 18-K/A

 

AMENDMENT NO. 1

to

ANNUAL REPORT
of

 

HER MAJESTY THE QUEEN
IN RIGHT OF NEW ZEALAND

(Name of Registrant)

 

Date of end of last fiscal year: June 30, 2004

 

SECURITIES REGISTERED

(As of the close of the last fiscal period)

 

Title of Issue

 

Amounts as to which
registration is effective

 

Names of exchanges
on which registered

 

 

 

 

 

Twenty Year 10 5/8%
Bonds Due November 15, 2005

 

US$200,000,000

 

New York Stock Exchange

Twenty-five Year 9 7/8%
Bonds Due January 15, 2011

 

US$150,000,000

 

New York Stock Exchange

 

Name and address of person authorized to receive notices and communications from the Securities and Exchange Commission:

 

HER EXCELLENCY MS. ROSEMARY BANKS
Permanent Representative
of the New Zealand Permanent Mission
to the United Nations
One United Nations Plaza
25th Floor
New York, NY  10017

 


 

Copies to:
JEFFREY F. BROWNE
Sullivan & Cromwell
101 Collins Street

Melbourne, Victoria 3000
Australia

 

 



 

EXPLANATORY NOTE

 

The undersigned registrant hereby amends its Annual Report on Form 18-K for the fiscal year ended June 30, 2004 (the “Annual Report”) by filing the following additional exhibits.

 

Exhibit (e)(1) – 2005 Budget Speech

 

Exhibit (e)(2) – 2005 Fiscal Strategy Report

 

Exhibit (e)(3) – 2005 Budget Economic and Fiscal Update

 

Information contained in or otherwise accessible through the Internet sites mentioned in the exhibits to the Annual Report on Form 18-K, as amended, does not form a part of the Annual Report. All references to Internet sites are for informational purposes only.

 

2



 

SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Amendment to New Zealand’s Annual Report on Form 18-K/A to be signed on its behalf by the undersigned, thereunto duly authorized, at New York, New York on the 1st day of July, 2005.

 

 

 

HER MAJESTY THE QUEEN IN RIGHT OF NEW
ZEALAND

 

 

 

 

 

 

 

By

/s/ Rosemary Banks

 

 

 

HER EXCELLENCY MS. ROSEMARY BANKS

 

 

Permanent Representative

 

 

New Zealand Permanent Mission

 

 

to the United Nations

 

 

 

 

 

 

 

By

/s/ Timothy John McIvor

 

 

 

TIMOTHY JOHN MCIVOR

 

 

Deputy Permanent Representative

 

 

New Zealand Permanent Mission

 

 

to the United Nations

 

3



 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

HER MAJESTY THE QUEEN
IN RIGHT OF NEW ZEALAND

 

 

EXHIBITS
to

FORM 18-K

ANNUAL REPORT
UNDER THE
SECURITIES EXCHANGE ACT OF 1934
FILED AS PART OF THE

FORM 18-K/A

AMENDMENT NO. 1

to the

ANNUAL REPORT

 

 

EXHIBIT VOLUME

 

4



 

Exhibit Index to the Form 18-K/A Amendment No. 1

 

The undersigned hereby amends its Annual Report on Form 18-K for the fiscal year ended June 30, 2004 (the “Annual Report”) by filing the following additional exhibits.

 

Exhibit (e)(1) – 2005 Budget Speech

 

Exhibit (e)(2) – 2005 Fiscal Strategy Report

 

Exhibit (e)(3) – 2005 Budget Economic and Fiscal Update

 

5


EX-99.1 2 a05-11198_1ex99d1.htm EX-99.1

Exhibit 99.1

 

19 May 2005

 

 

Budget 2005

 

 

 

Speech

 

Fiscal Strategy Report

 

Economic and Fiscal Update

 



 

Guide to the Budget Documents

 

A number of documents are released on Budget day. The intent of these documents is to provide information about the Government’s spending intentions; its performance; and the wider fiscal and economic picture.

 

The budget documents, ordered from widest to most specific coverage, are as follows:

 

Executive Summary

 

The Executive Summary is the overview of all the Budget information and contains the key points for the media and general public. It summarises the Government’s spending decisions and generally focuses on issues raised in the Budget Speech, the Budget Economic and Fiscal Update and the Fiscal Strategy Report.

 

Budget Speech

 

The Budget Speech is the Minister of Finance’s speech at the start of Parliament’s debate about the Estimates. The Speech generally focuses on the overall fiscal and economic position, and how the Government will fund its policy priorities.

 

Fiscal Strategy Report

 

The Fiscal Strategy Report measures how the Government is going against its overall goals in areas such as achieving debt objectives.  It includes:

 

             fiscal trends covering at least the next ten years, and

 

             a comparison with the long term fiscal objectives set out in the Budget Policy Statement.

 

The Government must explain inconsistencies between the Fiscal Strategy Report, the Budget Policy Statement and the previous year’s Fiscal Strategy Report.

 

Budget Economic and Fiscal Update

 

This document includes the Treasury’s overall economic and fiscal forecasts. The Update includes the implications of government financial decisions and other information relevant to the fiscal and economic position.

 

The Estimates of Appropriations

 

The Estimates outline how much money the Government plans to spend on each specified area or “vote”.  The Supplementary Estimates outline the additional money required to cover the previous year’s spending.

 

Departmental Statements of Intent

 

The Statement of Intent provides information about how each government department intends to manage for outcomes over the next 3-5 years.  The Statement of Intent contains annual financial and output class information required under the Public Finance Act 1989.

 

Internet

 

These documents will be made available on the New Zealand Treasury’s Internet site.
The URL for this site is http://www.treasury.govt.nz.

 




 

Fiscal Outlook

 

 

 

Fiscal Forecasts – Finalisation Dates and Key Assumptions

 

 

 

Summary of Budget Update

 

 

 

Fiscal Indicators

 

 

 

Key Trends

 

 

 

Revenue and Expenses

 

 

 

Core Crown – Revenue

 

 

 

Effects of Tax Policy Changes on the Tax Forecasts

 

 

 

Core Crown – Expenses

 

 

 

2005 Budget Package

 

 

 

State-Owned Enterprises (SOEs) – Revenue and Expenses

 

 

 

Crown Entities – Revenue and Expenses

 

 

 

Net Worth

 

 

 

Comparison with December Update

 

 

 

 

 

Risks and Scenarios

 

 

 

Summary

 

 

 

Economic Risks

 

 

 

Economic Scenarios

 

 

 

Fiscal Scenarios

 

 

 

Fiscal Sensitivities

 

 

 

 

 

Specific Fiscal Risks

 

 

 

Introduction

 

 

 

Charges against Future Budgets

 

 

 

Statement of Fiscal Risks

 

 

 

Contingent Liabilities

 

 



 

Generally Accepted Accounting Practice (GAAP) Series Tables

 

 

 

Forecast Financial Statements

 

 

 

Statement of Accounting Policies and Forecast Assumptions

 

 

 

Reporting Entity as at 9 May 2005

 

 

 

Forecast Financial Statements

 

 

 

Notes to the Forecast Financial Statements

 

 

 

Glossary of Terms

 

 

Other Information

 

On the Treasury’s website is a series of additional information that contains:

 

             information previously disclosed as part of the Budget Update (references have been made to the link within the document)

 

             economic forecast tables

 

             financial information bringing together a comprehensive comparison of the fiscal forecasts to those contained in the 2004 December Update.

 



 

19 May 2005

 

 

Budget 2005

 

 

Budget Speech

 



 

Budget Speech

 

Madam Speaker,

 

I move, that the Appropriation (2005/06 Estimates) Bill be now read a second time.

 

Budget 2005 is about securing the future. Securing the future for the nation as a whole and securing the future for New Zealand families and New Zealanders individually.

 

The major features are:

 

             the creation of KiwiSaver, a new work-based savings scheme

 

             major changes to taxation, in particular tax cuts to encourage investment and savings and to assist small business, in part paid for by the new carbon charge

 

             significant additional spending to promote increased opportunities, particularly through education

 

             large increases in spending to enhance security, through health spending, additional Police staff, a long-term defence spending plan, funding for Working for Families and the Rates Rebates scheme and

 

             further increases in spending to support economic growth.

 

The unifying theme connecting these elements is the fact that they are focussed on improving the long-term economic and social health of New Zealand.

 

Madam Speaker,

 

Over the last five years New Zealand has experienced a period of sustained economic growth.  This has had major benefits.

 

The first has been significant employment and income growth.  Between the March 2000 quarter and the March 2005 quarter some 260,000 more people have found employment in net terms.  Of these 218,000 are full-time and 42,000 part-time.  This predominance of full-time job growth within the total picture contrasts markedly with the experience of the previous ten years.

 

Income growth has also been strong.  Real per capita incomes have risen 11 per cent since the March 2000 quarter.  New Zealand’s relative slide in relation to the OECD average has ceased and begun to reverse.  But there is still a long way to go before we can claim to be back in the top half of the OECD in that respect.

 

The second benefit has been that prudent fiscal management has led to a significant lowering of the debt to GDP ratios while enabling the rapid build up of assets in the New Zealand Superannuation Fund.   As a nation, we are far better placed to deal with the fiscal challenges of the coming demographic transition than we were five years ago.

 



 

In this respect, we are not merely in the top half of the OECD but in the top handful of countries.  Provided we remain prudent and sensible, and avoid unnecessary politically driven bidding wars, this will stand us in excellent stead over the next generation as many other rich nations struggle with high debt and unsustainable policies.

 

Gross sovereign-issued debt has fallen from 35 per cent of GDP in June 1999 to an estimated 22.6 per cent at the end of June this year.  Alongside this, accumulated assets in the New Zealand Superannuation Fund will stand at around $6.5 billion.

 

The New Zealand Government will, for the first time ever, move into a net positive financial asset position in 2006/07.

 

Despite this, the third benefit has been to allow for significant increases in investment in health and education, providing for lower primary healthcare costs, more surgical procedures, more modest tertiary fees, and a less onerous student loans system.  Along with this have gone rises in the level of New Zealand Superannuation after the cut of 1999 and the first stages of the Working for Families package, which is lifting substantially the incomes of hundreds of thousands of low to middle income families.

 

Madam Speaker,

 

It is the Labour-Progressive Government’s determination to maintain these gains into the long term while dealing with a new range of challenges and opportunities which have come to the fore over the last few years.

 

The expectation is that the economy will slow over the next two years to an annual growth rate of about 2½ per cent. This will be due to a combination of the effects of capacity constraints, slowing net migration, the dampening impact of higher interest rates on spending and a difficult external trading environment created, in particular, by the strong New Zealand dollar.

 

The capacity constraints have led to the tightening of monetary policy as the Reserve Bank seeks to dampen inflationary pressures.  This has had the effect of placing further pressure on an already strong New Zealand dollar, thus contributing to widening the current account deficit.

 

The primary reason for the strong Kiwi is, of course, the weak greenback.  Large current account deficits in the United States in combination with large and seemingly uncontrolled fiscal deficits have caused that.  For the second time in 25 years the United States has proved that tax cuts are not self-funding. If unaccompanied by expenditure cuts they simply lead to burgeoning deficits and debt.  There is a lesson for all of us in this.

 

Certainly this experience, and the tight capacity constraints in New Zealand, militate against large scale fiscal expansion, whether by revenue reduction or larger expenditure increases than those planned in this budget.  That is particularly so if such reductions or increases are structural in nature and therefore continue to resonate through the long-term fiscal forecasts.  As always, too much jam now is likely to lead to only crumbs later.

 

These facts are emphasised by the fiscal and economic forecasts. The current account deficit is forecast to stay well above 6 per cent of GDP over the next four years, though starting to contract towards the end of the period.

 



 

The fiscal position remains strong and gross debt is forecast to move to about 20 per cent of GDP by the end of the forecast period.  But then it remains around that figure over the ten year projection period beyond that.

 

The fiscal surpluses remain strong in the immediate term. The cash surplus for the current year is forecast to be $2.4 billion.  This reduces to a cash surplus of $30 million for 2005/06, but changes to an average cash deficit for the following three years of about $1.9 billion a year.

 

In operating balance terms, this translates into an OBERAC of $7.4 billion or 4.9 per cent of GDP this year, $6.7 billion or 4.3 per cent of GDP next year, and an average of $4.8 billion or 2.9 per cent of GDP in the following three years.

 

While in nominal terms this still sounds large, it is just sufficient to fund the contributions to the New Zealand Superannuation Fund and other capital needs without a trend increase in the gross debt to GDP ratio.

 

Moreover, this is subject to the assumption that the growth in expenditure during both the forecast and projection periods will be significantly less than it has been in both Budget 2004 and Budget 2005.

 

The fully implemented effect of both budgets averages about $3.1 billion a year (GST exclusive).  (Members should note that all figures in Budget 2005 are GST exclusive for the first time as a result of the new Public Finance Act provisions). Last year’s spend included over $1 billion alone on the Working for Families package.  This year there are substantial one-off effects in terms of tax cuts for the business sector and for savings and investment, as well as new policies such as KiwiSaver.

 

The message of Budget 2005 is that such large one-off packages will be rare over the foreseeable future unless accompanied by expenditure cuts or efficiency gains elsewhere within the state sector.

 

Over the next three budgets the allowance for new spending has been set at $1.9 billion a year, thereafter growing by inflation.

 

The government is aware that to achieve these targets will require careful prioritisation.  Already, I have warned Ministers and Departments, and the public, to moderate expectations in terms of expenditure increases next year.

 

Madam Speaker,

 

As I indicated earlier, we are forecasting substantial current account deficits over the next four years.  While a more realistic level of the New Zealand dollar will eventually bring that deficit back to more comfortable levels, the fact remains we have run significant current account deficits for nearly all our history as a nation.

 

That, and a range of other indices, point to a low level of household savings in New Zealand.  We are left highly dependent on foreign capital, which means a substantial proportion of our national income is reclaimed by foreigners as theirs.  Hence the fact that our Gross National Product is significantly less than our Gross Domestic Product.

 



 

New Zealanders often bemoan the consequences of low saving, such as high levels of foreign ownership.  But, if we are to own, literally, more of our future we must lift our level of savings.

 

Three areas are of particular interest: saving for retirement, saving for home ownership, and saving for the costs of one’s children’s tertiary education.

 

In approaching how best to lift, over time, our national performance with respect to these the Labour-Progressive Government is motivated by considerations of equity, simplicity, and practicality.  In addition, the government wishes to maintain a voluntary approach. Finally, we are determined not to swap the current situation of government saving and private dissaving into one of government dissaving and private saving.   In other words, the fiscal costs of any policy initiatives have to be moderate.

 

Consideration was given to whether an integrated savings scheme, combining all three elements, was possible.   In the end, it is considered that, while it is possible to combine retirement saving and first home deposit saving, it is not desirable to integrate savings for tertiary education.

 

Expressions of interest have been sought for a tertiary education savings scheme with broad design parameters.

 

With respect to retirement and first home deposit savings, the government has decided to begin with a broadly based work-based savings scheme akin to that proposed by the group chaired by Peter Harris, which reported last year.  While many of the recommendations of the Harris committee have been amended in some detail, the essential features of the proposal have survived intact.

 

The new KiwiSaver scheme is intended to begin operation on 1 April 2007.

 

KiwiSaver’s basic features are:

 

             automatic enrolment in a savings scheme at the workplace for new employees aged 18-65, with the ability to opt out

 

             an upfront contribution by the government on joining, plus low management fees

 

             a basic contribution rate of 4 per cent of income deducted through the tax system and

 

             minimum compliance costs for employee and employer.

 

Apart from automatic enrolment, employees may become KiwiSavers at any time.

 

The new employee can opt out by notifying IRD between weeks two and four after starting a new job.  In this case IRD notifies the employer, otherwise deductions begin the next pay day after eight weeks with a new employer.

 

Contributions will be at one of two levels.  The standard rate will be set at 4 per cent of income, but the employee can opt for a higher deduction rate of 8 per cent.

 

The government will support KiwiSavers in three ways.

 

Firstly, it will meet the costs of the administration through IRD.

 



 

Secondly, a $1,000 upfront contribution will be provided to each new KiwiSaver.  This contribution will be available to a member of an existing registered superannuation scheme that fully converts to a KiwiSaver product.

 

Thirdly, the government will provide to savers in approved KiwiSaver products a fee subsidy at a capped level.  This level has yet to be finalised and will depend on consultation and negotiation with providers.

 

Normally, a KiwiSaver will have full access to their funds at age 65 or after five years in KiwiSaver, whichever is the later.  Hardship provisions allowing withdrawal are being developed and permanent emigration will also trigger the ability to withdraw.

 

A KiwiSaver can elect to take a contribution holiday for up to five years, with contributions resuming unless a further option to suspend is exercised.

 

The self-employed will be able to become KiwiSavers, selecting their own contribution rate and frequency of contributions.

 

Employers will be able to make contributions on behalf of their KiwiSaver employees via Inland Revenue.  This means they can be made at the same time as employee contributions with minimum compliance costs.  The actual rate of employer contribution will be a matter of negotiation between employer and employee.

 

Employers will also be able to apply to the Government Actuary for an exemption to the automatic enrolment provisions if they have a work-based superannuation scheme which meets a set of defined conditions.

 

There will be two types of KiwiSaver providers: default providers and other qualifying providers.  All qualifying providers will need to meet a set of minimum criteria.

 

If an employee does not pick a provider, he or she will be randomly allocated to a default provider.  In addition to having to meet the standard criteria, default providers will be selected through a competitive tender process designed in part to negotiate lower fees.

 

IRD will hold initial contributions for eight weeks to allow time for the contributors to choose a provider.  Small balances will also be held until they accumulate to a minimum level to avoid costs to the providers.  In both cases interest at the IRD’s use of money interest rate will be paid on the balances.

 

The operating costs of KiwiSaver, including an education campaign to improve financial literacy, are estimated at $90 million in 2006/07, $280 million in 2007/08, $143 million in 2008/09 and $154 million in 2009/10.  This is based on an assumption that the number of KiwiSavers will be around 265,000 by 1 July 2008 and around 415,000 by 1 July 2010.

 

KiwiSaver will be linked to a new scheme to assist modest to middle-income families with the deposit for a first home.  Those who are KiwiSavers for a minimum of three years will qualify for an additional subsidy of $1,000 a year up to a maximum of five years at the time of purchase of their first home.  They will be able to draw down all of their accumulated savings as KiwiSavers except for the initial $1,000 upfront contribution.  There will be conditions in relation to the total household income of the applicants and the value of the house being purchased.

 



 

The housing deposit subsidy will also be available to members of registered superannuation schemes if their employer is exempt from the automatic enrolment provisions or if their scheme converts to a KiwiSaver product.  Preliminary estimates are that around 3,000 households a year will take advantage of this opportunity.  The estimated annual cost is up to $35 million.

 

Other measures to support home ownership include expanding the Mortgage Insurance Scheme introduced in 2003.  Lenders other than Kiwibank will be able to participate. The eligibility caps on income will be increased by $20,000 a year.  By 2008/09 the Scheme is estimated to cost $22 million a year and the volume of loans covered is expected to rise from less than 1,000 a year at present to some 5,000 loans a year.

 

The government will also fund a new home ownership education programme.

 

The Minister of Housing will announce further details of these first home purchase initiatives today.

 

Madam Speaker,

 

The New Zealand Superannuation Fund, KiwiSaver, the encouragement for home ownership, and the proposed tertiary education savings scheme are all part of the effort to lift our national savings rate.

 

The nature of the taxation on savings and investment also has a role to play in this respect.  The government does not support large-scale tax incentives to support savings.  These are of dubious value and efficacy.

 

But the current tax regime for investments is very complex and can lead to perverse incentives.  It overtaxes those on the lower statutory rate of tax, tends to advantage certain forms of offshore investment, and distinguishes between various destinations for that investment.  Equally, any attempt at reform is likely to have controversial elements.

 

The changes I am foreshadowing this afternoon are designed to remove disincentives to save and invest, remove elements of overtaxation, and lead to an outcome where investment is guided more by the returns on the investment than by the tax opportunities presented.

 

With respect to the taxation of domestic investment two major changes will be legislated for.  Under the first, New Zealand-based collective investment vehicles will no longer be required to be taxed as entities.  Rather they will be able to elect to have the income earned by a fund regularly attributed to the individuals investing in it and taxed at their marginal statutory rates.

 

As with the current regime for taxation on interest-bearing accounts, the investor will advise the fund of their marginal rate.  When income is earned, it will be credited to the account of the individual and the fund will withhold tax from it at that marginal rate.  This will be a final withholding tax so no tax return will be required.  Equivalence to the tax regime on interest and direct investment of shares will be achieved.  And, as it is a final withholding tax, the investment income will have no impact on family assistance, child support or student loan repayments.

 

For those collective investment vehicles which elect into the new rules the overtaxation on those earning under $38,000 a year is removed.

 



 

The estimated cost of this tax cut is $25 million.

 

At this stage the new rules are not compulsory, recognising that some collective investment vehicles would find it hard to adopt the look-through rules.  However, as the new elective rules bed in this issue will be kept under review.

 

Under the new elective rules some taxpayers on the 39 cent marginal rate could pay more, depending on how their financial affairs are arranged. But for many this will be more than offset by the second change to the taxation rules on New Zealand domestic investment.

 

This involves the removal of the taxation on the gains made on the sale of domestic shares by collective investment vehicles.

 

The estimated cost of this tax cut is about $100 million a year.

 

Reform of the taxation of offshore investment is more difficult.  Under current rules, offshore share investment is taxed differently depending on the country in which the investment is made.  If direct investment is in what is called a “grey list” country, it is excluded from the foreign investment fund rules.  If it is not, then foreign investment fund rules which tax accrued capital gains apply.  The rules contain four methods for calculating investment for a foreign investment fund.

 

Consideration was given for some time to the use of a version of the risk-free rate of return method with respect to overseas investment by New Zealanders.

 

In the end this has not been adopted.  The main issue is the complexity involved in applying such a mechanism.

 

The method is conceptually simple but quickly becomes complex in application, particularly for individual investors where investments are made at different points in a year.

 

Moreover, the fundamental perception problem remains with respect to tax being applied even where losses had been incurred.

 

Instead, it is proposed to issue a discussion document within the next few weeks proposing to apply an income calculation method based on actual changes in value for investment funds, companies and individual investors.

 

Under the proposal, the grey list will be abolished for portfolio share investment.  Collective investment vehicles will be taxed on the basis of the change in their accrued value.  This would make for clearer rules, but in practical terms the results should be similar to the law as it currently applies for funds that are in the business of actively trading shares.

 

For individual and other investors it is even more difficult to find an approach that is reasonable without favouring direct offshore investment over investing in a fund.  The approach being proposed is that individual and other investors will also be taxed on the change in value of their overseas shares, but with an annual cap so that tax is spread over a number of years to better reflect cash flow.  The discussion document will propose a threshold so that those with small holdings of foreign shares continue to be taxed just on dividends received.

 



 

This will lead to accusations of extending the capital gains tax regime at present implicit in taxation on non-grey list investment.  It is clear, however, that any reform of the current regime that does not penalise investment into New Zealand shares will lead to some such outcome.

 

The choice then is between a complex regime which tends to favour investment going offshore or a simpler regime which is more favourable to investment in New Zealand.

 

It is proposed that the new tax rules on investment come into force on 1 April 2007.

 

In Budget 2004, I announced that the government was reviewing the tax depreciation rules to see if there were ways of reducing tax biases within the rules and to resolve practical problems with their operation.  The first series of changes resulting from that review have been introduced in a bill which is now before Parliament.  I am announcing the second set of proposed changes today.

 

Tax depreciation rates will be changed to reflect better how assets decline in value.  Current rates are likely to penalise investment in short-lived plant and equipment, which can create tax biases that distort the structure of capital investment away from the best investment opportunities.  To deal with these biases, depreciation rates for short-lived plant and equipment will increase and depreciation rates on buildings will reduce.

 

The method for calculating tax depreciation rates has been revised.  From the 2005/06 income year tax depreciation rates will be worked out in one of two ways.  For buildings the straight-line basis will be applied over their economic lives to determine their depreciation rate, and a diminishing value equivalent of this straight line rate will also be available.  For plant and equipment the double declining balance method will apply.  This means, for example, an asset with a ten year economic life can be written off at a rate of 20 per cent diminishing value.

 

For equipment such as laptop computers the changes will result in a 25 per cent increase in the allowable annual depreciation deduction, from 48 per cent to 60 per cent a year.

 

More neutral tax depreciation rules will mean that businesses have incentives to invest in assets that provide the best commercial returns.  The changes will help businesses make better decisions about capital investments.

 

Secondly, to reduce some of the compliance costs to business from having to maintain fixed asset registers, the low-value asset threshold will rise from $200 to $500.  This change should reduce the number of assets that a business must annually account for and will reduce the number of tax adjustments that it must make when the asset is sold.

 

The new depreciation rules will apply to plant and equipment purchased on or after 1 April 2005 and to buildings purchased from today.

 

The increase to the low-value asset write-off threshold takes effect from purchases made after today.

 

Budget 2005 also contains a number of tax measures to improve New Zealand’s access to worldwide labour, skills, and capital.

 

The first of these will reduce tax costs related to international recruitment to New Zealand.  A temporary tax exemption of five years on foreign income will be made available to

 



 

people who come to work here, whether they are foreigners or New Zealanders who have been non-resident for tax purposes for ten years.  People who are not in employment will receive the same exemption for three years.

 

Tax on offshore income is an important issue for highly skilled people who are in demand internationally and for the businesses that recruit them from overseas. The new exemption will thus remove a tax barrier to New Zealand gaining the skilled people it needs.

 

Updated tax rules for securities lending will make New Zealand more attractive for international investment.  Existing rules have acted as a barrier to the development of a securities lending market here.  Qualifying transactions will now be treated on their economic substance rather than legal form.

 

As I announced last week, Budget 2005 will also give companies that bring in new equity investors better access to tax deductions for R&D expenditure.  This will cater for the growth cycle of technology companies by allowing R&D deductions to be matched with income from that expenditure.

 

Proposals are also being developed to change the tax treatment of employee share options. The aim is to remove some of the obstacles created by the tax system to businesses which offer share options to their employees.  A paper setting out proposals will be released for public consultation later this year.

 

I have already announced other major changes with respect to taxation.  These related in particular to tax simplification and reforms to Fringe Benefit Tax.

 

The simplification proposals involve the alignment of payment dates for provisional tax and GST, allowing businesses to elect to base provisional tax payments on GST turnover, and a subsidy to payroll agents for meeting PAYE–related compliance costs imposed on small employers.

 

These measures will lead to an ongoing cost of about $115 million a year.

 

With respect to Fringe Benefit Tax, the valuation rate for motor vehicles will be cut. Taxpayers will also be able to elect to calculate motor vehicle FBT on a vehicle’s tax book value as an alternative to using the cost price.

 

At the same time, the thresholds applying to unclassified fringe benefits will be raised.  In the case of an employer the rise will be from $450 a quarter to $15,000 a year.

 

Similarly, the private use of employer owned or leased business tools will be exempted from FBT where provided primarily for business purposes and where they cost less than $5,000 each.

 

Other changes include resolving problems with foreign superannuation schemes, removing unintended tax consequences from unbundling payouts from cooperatives, and aligning the tax treatment of investments into foreign hybrid vehicles with the treatment of investment into other foreign companies.

 

Finally, a discussion document will be released later this year on the tax treatment of limited partnerships.

 



 

This tax package, with its focus on savings and investment, has an estimated cost of $466 million in its first full year.  These are only part of the tax cuts incorporated into this year’s budget.

 

Consideration has also been given to changes in the personal tax system.  As I have said many times, there is no evidence our rates are especially high by international standards once a comparison is made including all taxes and compulsory levies for social security and other purposes.

 

Moreover, even small changes in rates or thresholds have large revenue consequences.  But in one area a strong case has been made for change, not least by the United Future Party.

 

That is in relation to the movement of the three main personal tax thresholds to match inflation as is done with excise duty on petrol, tobacco, and alcohol.

 

The Labour-Progressive Government, therefore, has decided to adjust the thresholds every three years.  Because of the complexity of personal tax changes compared with excise duty, annual changes were rejected.  The gain to most individuals would be very small in relation to the administrative costs.

 

Also, because tax threshold changes need to be announced well in advance of implementation there would be a very significant lag between the last available CPI figure and the commencement of changes on the subsequent 1 April.

 

Therefore, it has been decided to adjust each three years by using the mid-point of the Reserve Bank’s Policy Targets Agreement inflation band.  This equates to a 6.12 per cent movement in the thresholds every three years.

 

This means that at the time of the first triennial adjustment, 1 April 2008, the $9,500 threshold will move to $10,081, the $38,000 threshold to $40,324 and the $60,000 threshold to $63,672.

 

Taken together, all the tax cuts I have announced today will cost $229 million in 2005/06, $319 million in 2006/07, $535 million in 2007/08, and $776 million in 2008/09, or about $1.86 billion over the forecast period.  Additionally, in delaying provisional tax payment dates in 2007/08 to 2008/09 there is a delay of $760 million in tax revenues.

 

These revenue losses will be partially offset by the revenue from the new carbon charge which will come into effect on 1 April 2007. As already announced this will be set at $15 per tonne of CO2 equivalent.  The gross revenue is estimated at $528 million in the first full year but this will be offset by rebates which will reduce the estimated net annual income to $322 million. Thus in the forecast period tax cuts of $1.86 billion will be offset by about $720 million of net carbon charge revenue.

 

Madam Speaker,

 

KiwiSaver and the very significant changes to business and investment taxation contained in this year’s budget are a key part of the government’s strategy to lift investment and make doing business easier.

 

Lifting our long-term rate of sustainable growth remains a key priority for action.  Budget 2005 contributes further to this key objective in a number of ways.

 



 

Further investment in the budget builds on the Growth and Innovation Framework.  Over the forecast period the following additional resources are being supplied:

 

             $31 million to increase the gains from international economic partnerships

 

             $49 million to implement the government’s digital strategy

 

             $72 million to increase support for business research and development

 

             $118 million to further increase capability in the public science system

 

             $24 million to strengthen the regulatory environment by providing additional funding to the Commerce Commission, Securities Commission and the Takeovers Panel

 

             $9 million to boost New Zealand as a tourist destination and

 

             $45 million to expand Modern Apprenticeships and Industry Training and provide foundation learning, specifically literacy and numeracy through the Industry Training Fund.

 

Infrastructure spending also receives a large boost in Budget 2005.  All the increase in excise duty that came into force on 1 April is going into the Land Transport Fund.

 

This means that the resources available to the Fund will rise from $1.54 billion in 2004/05 to $1.75 billion in 2005/06.

 

In addition, I am announcing today that in the three years to 30 June 2009, a further $100 million a year will be provided to the National Land Transport Fund.  This additional $300 million will enable planning to proceed for a higher rate of roading construction than would otherwise have occurred.

 

This means the total available to the Land Transport Fund over the coming four years is over $8.4 billion.

 

Madam Speaker,

 

The largest amount of support this or any New Zealand Government gives to the business sector is through Vote Education.

 

Budget 2005 is marked by two key features in that respect. The first is substantial further investment in both basic and high level skills.  The second is determination to drive towards a higher level of quality and relevance in our post-compulsory sector.

 

In this year’s budget we build on our commitment to deliver an education system that is founded on quality and relevance, and aimed at lifting education standards across the board. Our investment reflects our determination to increase participation in quality education, and to reduce the underachievement that characterises some sectors of New Zealand.

 

We are increasing our investment in early childhood education by $152 million over four years, as we continue to deliver on our commitment to make early childhood education more affordable, more accessible and of the best quality possible for all New Zealand families.

 



 

Research shows intensive and regular quality early childhood education has long-term educational benefits, and our government is determined to ensure these benefits are available to every single young New Zealander.

 

New Zealand’s schooling system is internationally respected. On average New Zealand students do very well by world standards and our top students are amongst the best in the world.

 

The government is working with teachers to ensure good teachers are rewarded for their excellent work through higher salaries, better conditions, professional development and clear career paths.

 

Our commitment to more and better paid teachers in our schools continues with a total investment of $1.43 billion since Budget 2004.  This includes $476 million in this year’s Budget for teacher pay settlements and $91.3 million to provide an estimated extra 421 teachers (FTTEs) for secondary, area and middle schools.

 

This brings a total of 3,040 extra teachers (FTTEs) over and above those required for roll growth, based on the recommendations of the School Staffing Review Group of 2001.

 

The government continues to adjust school operational funding each year.

 

Between 1999 and 2006 $241 million will have been added to schools’ operational funding.  That is a nominal increase of 39.6 per cent over seven years, or almost 15 per cent over and above the level of inflation.

 

This budget also focuses on student outcomes and progress through the provision of high quality assessment tools and professional development to help teachers and schools monitor their students’ progress.

 

We are investing $30.2 million over four years in ICT.  Specifically another 20 ICT professional development clusters will be added to the already 80 successful clusters throughout New Zealand.  The rollout of laptops to every teacher in New Zealand in a state or integrated school will be completed.

 

Developing an internet version of the Assessment Tools for Teaching and Learning (asTTle) means teachers and parents can get more detailed and up-to-date information about children’s learning.

 

Special education funding has increased from $245 million in 1999 to $413 million in this budget.

 

Additional funding this year will provide for:

 

             increasing the numbers of students eligible for Supplementary Learning Support from 1,000 to 1,500

 

             increased funding for teacher aides and

 

             more support for assessing learning needs.

 

The tertiary package announced today provides additional funding of $296.7 million over the next four years to support the ongoing development of quality and relevant tertiary education.

 



 

In previous budgets, we have focused on putting in place the tertiary education system reforms.  In Budget 2005 we are consolidating this work by investing in improvements to the quality and relevance of teaching, learning and research in New Zealand.

 

In addition to the industry training funding I have already referred to, the major areas of increase will be:

 

             an additional $75.5 million over four years to increase the Performance-Based Research Fund

 

             higher funding rates for technical and scientific subject areas including science, trades, technical subjects, agriculture and horticulture

 

             $57 million over four years for improved support for tertiary students, including increasing the medical trainee intern grant by $10,000 a year and establishing a Bonded Merit Scholarship programme.

 

Madam Speaker,

 

If education lies at the heart of the government’s aspirations for opportunity, spending on health represents both opportunity and security.

 

Budget 2005 commits additional resources to health which will total over $1.09 billion a year by 2008/09. A good part of this reflects meeting in full the costs of maintaining real, population-adjusted spending for the health and disability sector.

 

This year’s health package also provides for:

 

             funding for the establishment of the Cancer Control Council

 

             the roll out of the Primary Health Care Strategy to people aged 18-24, thus reducing first contact fees and pharmaceutical co-payments

 

             a standard national travel and accommodation policy for those who have high costs from travelling to treatment centres

 

             further funding for the National Immunisation Register

 

             the extension of free breast screening to women aged 45-49 and 65-69

 

             the changes that come into effect on 1 July as the first large step on the way to abolishing asset testing for those assessed as in need of older people’s long-term residential care

 

             contributing towards the cost of the nurses’ pay settlement

 

             increased funding for disability support and aged care services

 

             funding the increased uptake of the Primary Health Care Strategy

 

             continued progress on doubling the number of hip and major joint operations

 

             increasing cataract interventions by 50 per cent

 

             additional funding to continue the roll out of the Mental Health Blueprint and

 

             a range of Progressive Party initiatives which have already been announced.

 



 

Much of this increase in funding will be spent on New Zealand’s senior citizens.  They will also be the largest beneficiaries from the changes to the Rates Rebates scheme already announced by the Prime Minister which will see over 150,000 superannuitant households benefit by up to $500 a year from 1 July 2006.

 

Madam Speaker,

 

Security has many aspects, from health to law and order to defence.

 

Since 1999, this government has placed great importance on making communities safer and helping people feel more secure in their homes. To that end it has made proper resourcing of Police a priority.

 

The Police operational budget has increased substantially every year since 1999, with a consequential rise in Police numbers and resources. This in turn has seen the crime rate reduce by 12.4 per cent between the calendar years 1999 and 2004, the Police resolution rate rise from 38.9 per cent to 44.6 per cent and the road toll fall to levels not seen since the 1960s.

 

We will maintain this successful strategy for making our communities safer. The Police Vote will increase by $73.6 million to a record high of $1.03 billion.

 

The budget will provide for another around 245 sworn and non-sworn Police staff. For the first time in our history, Police staff in New Zealand will number over 10,000.

 

The government will add $156.5 million in new baseline funding to the Ministry of Justice over the next four years.  The additional budget will ensure the Ministry is well equipped to manage its growing workload and deliver more effective and efficient services to court users and the judiciary.

 

The increases follow a review of baseline funding which found the Ministry needed additional resources following several years of significant reform work and change within the justice area.

 

From the middle of 2006 we will, for the first time since 1987, lift the limits on income and capital which allow access to legal aid.  Furthermore, the eligibility tests will be adjusted from time to time meaning that in future access to legal aid will be protected from inflation.

 

The final key areas of security are border security and defence.

 

Over the next four years (2005-2009) the government will spend an additional $13.3 million on enhanced border and security measures to improve the integrity of New Zealand’s borders and immigration systems, and protect New Zealand staff overseas.

 

This enhanced border security will help protect New Zealand’s access to classified information from peer countries; and contribute to fairer labour market conditions for New Zealand workers by ensuring wages and conditions are not undercut by illegal workers.

 

The Defence Sustainability Initiative will provide an additional $4.6 billion over the next 10 years to restore and develop the resources of the New Zealand Defence Force and the

 



 

Ministry of Defence and will align long-term personnel recruitment, training, development and resources with the Defence capital acquisition programme.

 

This long-term strategic funding initiative follows a systematic approach by this government to restore the capability of our Defence Force, which was left to run down during the 1990s, resulting in ageing equipment and infrastructure and personnel shortages.

 

Budget 2005 reflects the aims of the government’s housing strategy, which promotes the importance of quality, sustainable housing for all New Zealanders.

 

State housing is central to meeting the housing needs of those requiring direct assistance and will remain at the core of government assistance. An additional $134 million over the next four years will be invested as we continue to build our stock of state houses.

 

The Rural Housing, Healthy Housing and Community Renewal programmes will receive a further $33 million over the next three years to continue their work of providing better and healthier homes in areas of greatest need.

 

Madam Speaker,

 

This year sees the continued roll-out of the Working for Families package, with over 260,000 low to middle income families becoming eligible for targeted assistance. In addition we are seeing progress on a major reform of the benefit system, with a drive towards a single core benefit and a more tailored service for beneficiaries.

 

An investment of $149 million over four years in this year’s budget complements the aims of these key platforms of the social development agenda.

 

To support the Working for Families package, programmes that give parents and children a better start will receive a $47 million boost.

 

To enhance the choices parents have to participate in the labour market, we will also invest $55 million over the next four years in Out of School Care and Recreation, childcare and related initiatives. These initiatives will help to meet the demands of a growing labour market, as well as boost the incomes of Kiwi families looking to build their stake in a growing economy.

 

Filling the jobs in a growing economy is also a key focus of our welfare reforms. The reforms take place in a context of record low unemployment and growing skill and labour shortages.

 

To provide opportunities for more people to enter the workforce an additional $47 million will be invested over the next four years in work-focussed programmes for beneficiaries. This includes a focus on long-term unemployed and a new service to support more sickness and invalids beneficiaries into work.

 

Madam Speaker,

 

New Zealanders responded magnificently to the needs of those affected by the Boxing Day tsunami.  The government responded in like manner.

 

The result was to see a temporary lift in our overseas aid budget to 0.27 per cent of Gross National Income.

 



 

Budget 2005 provides for the overseas aid allocation to increase by $59.4 million this coming year compared with Budget 2004’s initial estimates.

 

This will maintain spending at the 0.27 per cent level.  It will be maintained at that level in 2006/07 and increased to 0.28 per cent in 2007/08.

 

This adds up to the most significant increases in overseas development assistance in recent decades.  The primary focus will be on our Pacific backyard where the developmental needs are very large.  But bilateral programmes with Indonesia and Vietnam will also be significantly strengthened.

 

Madam Speaker,

 

Individual ministers will be making a range of statements on specific initiatives which include too much detail to be covered this afternoon.

 

As I said in introducing Budget 2005, its focus is on the long term, not the next four months or even the next four years.  That is shown by the key initiatives which:

 

             lock in funding for New Zealand Superannuation

 

             begin to address the task of lifting our savings rate as both individuals and a nation

 

             introduce significant business tax cuts and structural changes to drive stronger investment

 

             look to enhance our capacity to perform as good and responsible international citizens

 

             accelerate further support for business development

 

             strengthen our public health system

 

             enhance the capacity and effectiveness of our education system and

 

             support families in practical and effective ways rather than by mere rhetorical flourishes.

 

Madam Speaker,

 

Budget 2005 completes a second cycle of budgets that I have had the honour to present on behalf of two Labour-led Governments.  They have consciously been pragmatic documents designed to build a stronger fiscal position, lift economic growth and increase social cohesion.  On a base of stability and security, typified by the New Zealand Superannuation Fund, we are building a nation we can be proud of.

 

We also seek to build a superstructure on that base of innovation and responsiveness to change which makes it exciting to be a New Zealander.

 

We look to the future, both short and long term, with that pride and sense of excitement.  We have achieved much in terms of strong government finances, record low unemployment, and economic growth.  But the building of a better future is by definition, a task which is never completed.

 

We look forward with relish to continuing that never ending task.

 


EX-99.2 3 a05-11198_1ex99d2.htm EX-99.2

Exhibit 99.2

 

19 May 2005

 

 

Budget 2005

 

 

Fiscal Strategy Report

 



 

Fiscal Strategy Report

 

Introduction

 

Sustainable economic growth is a key focus for the Government

 

In our first Budget Policy Statement (BPS) in 2000 the Government committed itself to making real and sustainable improvements in the lives and living standards of all New Zealanders – at work, in their homes and communities, in education and in retirement. We recognised that a sound and growing economy requires prudent fiscal management coupled with policies that foster a society which generates innovative businesses, effective government and strong communities. To achieve this, our focus has been on improving skills, enhancing our environment, strengthening national identity and closing income gaps. Five years on, we are reaping the benefits of this strategy and remain committed to further increasing New Zealand’s long-term rate of economic growth for the benefit of all.

 

Our fiscal strategy remains focused on preparing for the future fiscal costs of ageing

 

In BPS 2000 we stressed that:

 

Our policy programme will only be sustainable if it is grounded in sound fiscal policy. Sound fiscal policy takes a longer view and recognises the emergence of spending pressures long before they impact.

 

Figure 1 – Dependency ratio(1)

 

 

Source:  The Treasury

 


(1)

Dependency ratio shows the proportion of dependent people per person of a working age.



 

This Government’s fiscal strategy, in place since the start of our first term, is to strengthen public finances to prepare for the future fiscal costs associated with an ageing population (see Figure 1). Given the uncertainties associated with the size of these pressures, our approach comprises two complementary elements (see Figure 2):

 

Figure 2 – Gross sovereign issued debt and NZS Fund assets

 

 

Source:  The Treasury

 

             The accumulation of financial assets through contributions to the New Zealand Superannuation (NZS) Fund.

 

             Managing debt at prudent levels with gross sovereign-issued debt as a percentage of GDP slowly reducing over the longer term.

 

Under current tax-to-GDP ratios, a sustained increase in spending would cause the Government’s operating balance to move into deficit and ultimately lead to a rise in the ratio of debt to GDP. Eventually this would require lower spending and/or higher taxes.

 

The NZS Fund helps smooth the effects of population ageing by increasing the net worth (via accumulated financial assets) of the Crown in order to partly finance the required extra spending in the future. Lowering debt also increases net worth and it allows funds that would otherwise pay debt servicing costs to be used for other spending. Both elements of the fiscal strategy allow time to assess the impact of demographic and other changes and to develop and implement policy responses.  Our long-term fiscal strategy requires us to limit growth in spending over the next decade or so – the so-called golden years (Figure 1) – so we can avoid entering the period of more marked demographic change in a poor fiscal position.

 

To give effect to this fiscal strategy, the Government runs operating surpluses over the economic cycle sufficient to meet the NZS Fund contributions and most of the Government’s other capital spending needs. The decision to fund capital spending largely through current revenue rather than through borrowing emerges from the need to balance the potential benefits of capital spending against the fiscal position and the wider impacts on the economy. For example, there is the need to consider the impact of certain rising gross debt and associated finance costs against the quite uncertain financial or growth returns from some capital spending (eg, defence spending, hospitals and schools).

 

Once capital spending is accounted for, there is very little cash available for initiatives above those already included in the forecasts or, as is the case in the forecast years, there is a need to borrow to make up the shortfall. Consequently it cannot be assumed that a large

 



 

operating surplus is indicative of substantial funds available for tax cuts or extra expenditure since it does not take account of certain areas of capital spending regarded as a priority by this Government, eg, contributions to the NZS Fund, student loans and defence and infrastructure (eg, roading, schools and hospitals).

 

Figure 3 – Net cash flows from core Crown operations and cash surplus/deficit

 

 

Source:  The Treasury

 

We have gone a long way towards meeting these fiscal objectives

 

Since we have been in office, gross sovereign-issued debt has fallen from 35% of GDP at 30 June 1999 to an estimated 23% by the end of June 2005. Alongside this, assets accumulated in the NZS Fund will stand at around $6.5 billion by June 2005. This progress has been more rapid than expected when we put together our first Budget in 2000. At that time long-term projections showed gross debt to GDP falling to just under 25% of GDP by 2009/10.

 

Figure 4 – An international comparison of government debt – calendar year 2004

 

 

Sources: OECD Economic Outlook 76, Treasury Crown Financial Statements, six months ended 31 December 2004.

 

Note: For New Zealand, gross debt is Gross sovereign-issued debt. Net debt is defined here to include NZS Fund assets.

 



 

The lower debt objective announced in the 2004 Fiscal Strategy Report (FSR) reinforced the importance of keeping debt at low levels by locking in this progress. By also putting a timeframe to this objective we provided greater transparency about the extent of improvement we want to see in the fiscal position in the period before ageing really begins to impact.

 

New Zealand’s government debt is now low in historical and also in international terms.  This is appropriate given future fiscal pressures together with the fact that we are a small, distant, open economy with comparatively high levels of external debt.  Lower levels of government debt have reduced the need to react sharply to shocks and lowered the risk premium in interest rates. In this way, sound public finances have made a significant contribution to improved economic growth.

 

… while taking account of the impact of fiscal policy on the economy

 

Faster than expected progress has allowed us to move the emphasis of fiscal policy over the short term from building up operating surpluses to consolidating operating surpluses at levels sufficient to make ongoing but more gradual progress on our long-term objectives.  This will see lower operating surpluses in the future than over the recent past.

 

The speed of this adjustment allows for the impact of spending and tax decisions on the wider economy. It also depends on our assessment of how much of the change in the fiscal position we think is structural and how much is due to cyclical factors.  We have been cautious not to spend what may have been cyclical increases in operating surpluses. This has enabled us to make faster progress on our debt and NZS Fund objectives over the past four years. However, the persistence of these surpluses and their composition have made us more confident that structural factors have been at work.

 

Budget 2004 and the Working for Families initiative was the first phase of this transition to lower operating surpluses.  Budget 2005 with its Business and KiwiSaver Packages completes this move, given our current assessment of the fiscal outlook.

 



 

Reviewing Economic and Fiscal Developments

 

The economy has been amongst the best performing in the OECD and this has flowed through to the fiscal position

 

The economy grew 4.8% in real terms over 2004 and by 8.4% in nominal terms. Employment growth has also been strong, helping unemployment rates to fall to record low levels.  This is reflected in the OBERAC – the operating balance adjusted for revaluation movements and accounting policy changes (Figure 5). Furthermore, after adjusting for the economic cycle the majority of the increase in the OBERAC remains pointing to a structural improvement in the fiscal position.

 

Figure 5 – Historical and forecast OBERAC and cyclically adjusted balance

 

 

Source:  The Treasury

 

A significant structural increase in the fiscal position has enabled us to deliver on our key policy priorities in Budgets 2004 and 2005…

 

Budget 2005 covers decisions around core Crown expenses that amount to $48.2 billion for 2005/06 together with capital spending of $2.1 billion. It will deliver $2.0 billion of new funding in 2005/06 (net of initiatives to increase revenue, such as Thin Capitalisation Rules for Banks), rising to $2.7 billion in 2008/09. This includes significant new operating funding in health, education, justice, defence and social development.

 

This new funding is larger than was indicated in the 2005 BPS although the BPS signalled there may be scope for additional spending to advance initiatives around savings and business. In designing the KiwiSaver and Business Packages we have been mindful of the current economic position and sought to contribute to economic growth over the longer term. The KiwiSaver Package will provide mechanisms to encourage saving for retirement and home ownership.  The Business Package introduces changes to the tax system to improve the efficiency of business investment, reduce compliance costs and boost business performance and economic growth. The aim of each of these packages is to provide an economic environment that encourages businesses and households to plan and invest.  In addition, from 1 April 2008 personal income tax thresholds will be indexed every three years in line with the mid-point of the Reserve Bank’s inflation target band. The composition of new operating initiatives in Budget 2005 is presented in Figure 6.

 



 

Figure 6 – Spending and revenue initiatives in Budget 2005 – final year impact

 

 

Source:  The Treasury

 

In addition to this operating spending, Budget 2005 will deliver a further $1.3 billion of capital spending in excess of what was signalled in the BPS, taking total capital spending over the forecast horizon to $4.2 billion.  The composition of new capital spending over the forecast period is presented in Figure 7.

 

Figure 7 – The cumulative composition of allocated new capital spending for the forecast period

 

 

Source:  The Treasury

 

Note: $2.2 billion forecast capital spending remains unallocated.

 

But future Budget packages will be smaller in order to remain on track to meet our fiscal objectives…

 

As indicated in the 2005 BPS, the increased spending on future Budget initiatives will be smaller than in the last two Budgets. These Budgets included specific one-off initiatives such as the Working for Families and Business Package.  Our current plans are for an additional funding $1.9 billion over existing baselines in Budget 2006 rising by 2% (the mid-point of the CPI inflation target range) in Budgets 2007 and 2008. In addition we are intending to spend $2.2 billion on new capital initiatives over Budgets 2006 to 2008. In accordance with our stated fiscal management approach, we will review the operating and

 



 

capital amounts as we get closer to each Budget to ensure they remain consistent with maintaining progress toward our fiscal objectives and policy goals and with economic conditions.

 

… requiring the growth of government spending to slow from recent rates

 

The ability to meet our fiscal objectives will ultimately depend on the pace of growth in government spending. Structural increases in revenue combined with lower finance, social security and welfare costs provided us with the extra fiscal headroom to implement the new initiatives contained in this and previous Budgets, as well as deliver funding in key areas such as health, education, defence and transport. In our second term, the nominal average annual growth rate for health increased to 7.8%, education rose to 7.6% and defence to 4.4%.

 

Figure 8 – Final forecast year impact of net Budget packages

 

 

Source:  The Treasury

 

Current forecasts do not see the increases in revenue or reductions in finance and welfare costs being replicated. As a result, maintaining recent growth rates in expenditure would compromise our ability to achieve our fiscal objectives and reduce future policy options particularly as population ageing begins to impact. Unless new initiatives are growth enhancing, they may also fuel inflationary pressures.

 

Although additional expenditure in future Budgets cannot be as large as that of Budgets 2004 and 2005, it will remain sizeable compared with pre-2004 Budgets (as seen in Figure 8). Consequently, the level of spending in future Budgets will enable us to continue to deliver on our key economic and social objectives. Furthermore, it will build on a solid base of spending.

 

This Government has implemented a large number of policy changes during its last two terms in office. It is now time to consolidate on what we have done and continue to test the effectiveness of the spending that has been implemented. It may also be the case that new programmes have made other spending less relevant.

 

We will be looking for opportunities to address total expenditure across all sectors to ensure that it is delivering value for money. To the extent that we can identify low-priority spending across various areas we will be in a position to free up funds and hence implement new initiatives in future Budgets.

 



 

The Long-Term Fiscal Outlook

 

The Government remains committed to achieving its long-term fiscal objectives

 

Figure 9 shows gross debt falling to 20% of GDP by 2006/07 and remaining close to but slightly above this objective thereafter. This result is a consequence of a number of factors. First, there has been an increase in new operating and capital spending from the levels indicated a year ago and in the 2005 BPS. As noted earlier, this spending enabled us to deliver on a number of key policy areas and completes the transition to lower operating surpluses. Beyond 2008/09, the projections assume operating and capital allowances of $1.9 billion and $750 million respectively (compared with $1.4 billion and $550 million in the 2004 FSR). However, although operating and capital spending allowances have increased, they now rise with assumed inflation (rather than nominal GDP). Third, the Treasury has reviewed the rate of return assumption used to calculate the NZS Fund contributions, details of which are included in the accompanying box.

 

Figure 9 – Gross sovereign-issued debt

 

 

Source:  The Treasury

 

Review of the Rate of Return on Crown Financial Institutions

 

To ensure a consistent approach is taken in preparing projections for financial asset portfolios of Crown financial institutions (CFIs), the Treasury has reviewed the assumptions and methodology around the rate of return earned on investments for the purpose of long-term fiscal projections.  The review took account of historical evidence, an assessment of the longer-term economic outlook and the current portfolio mix.

 

The CFI that has the biggest impact on the forecasts and projections of gross debt is the NZS Fund. The Treasury’s work results in a decline in the expected gross annual return for the NZS Fund. The work also suggests a fall in the tax rate applied to NZS Fund investment returns that provides a partial offset to the lower gross return.  The net result is a decrease in the after-tax expected annual rate of return from 6.8% to 6.1%. This is currently the Treasury’s best estimate given the current state of capital markets and the research around them.

 

Changing the rate of return on the NZS Fund affects capital contributions in every year because under the legislation they are set using a 40-year rolling horizon. Over the forecast period the contributions are required to increase by around $760 million as a result of changing the assumed rate of return.  Higher contributions, all else equal, result in lower cash flow balances and higher debt than otherwise.  By 2015 it results in gross debt to GDP being approximately 2% of GDP higher.

 



 

Our ability to meet the objective is very sensitive to any changes in the short term or in the assumptions underlying the projections. A number of changes can take place in the economic environment between now and the projection period which could have a significant influence on the debt track. This includes drivers of both spending and revenue.  For example, on the revenue side the projections assume that taxes grow with nominal GDP beyond 2008/09 (ie, they assume no fiscal drag). While our decision to inflation index personal income tax thresholds will remove one component of fiscal drag there will still be some drag associated with remaining increases in personal incomes as a consequence of other factors (eg, productivity movements, job turnover). As a result, the projections of tax revenue are somewhat conservative and hence the debt track would look more favourable than is assumed for projection purposes.

 

Nevertheless, the impacts of these changes on the projected debt track reinforce the need to control expenditure growth in order to deliver on the Budgets built into the projections.

 

Figure 10 presents the core Crown expenditure as a percentage of GDP. Consistent with our objectives, this remains around current levels for the projection period.

 

Figure 10 – Core Crown expenses excluding finance costs

 

 

Source:  The Treasury

 

Our long-term fiscal objectives remain unchanged but we intend to take stock of them in advance of the 2006 FSR

 

Following the lowering of the gross debt objective and introduction of a specific timeframe last year, the Government is leaving its long-term fiscal objectives unchanged (see Annex 1).

 

Over the next parliamentary term the Government will continue its fiscal strategy of running structural operating surpluses sufficient to meet the required contributions to the NZS Fund. In addition, we will continue to balance capital and operating expenditure to ensure we continue to maintain debt at prudent levels.

 

Looking forward, a number of factors suggest it may be timely to refresh the objectives in advance of the 2006 FSR.  These include taking stock of our achievements at the start of a new government and clarifying the preferred movement in debt beyond 2015. This will ensure ongoing consistency with the Public Finance Act 1989 (PFA) requirement for a timeframe of at least 10 years in relation to the long-term fiscal objectives.  In addition, the Government will adopt the New Zealand International Financial Reporting Standards (NZ IFRS) in 2007, which may result in greater volatility for some fiscal aggregates.

 



 

The Treasury will also be releasing the first statement of the long-term fiscal position required under the PFA.  This will provide us with an updated assessment of the impact of ageing and other drivers on the fiscal position over the long term.

 

Conclusion

 

Prudent fiscal management, coupled with solid economic growth and a structural improvement in the fiscal position over recent years, has provided a platform from which to implement the Government’s flagship priorities. These included the Working for Families package in 2004 and the Business package and KiwiSaver in 2005. The nature of the structural improvement enabled us to fund these priorities on a scale that reflects their importance in progressing our overarching economic and social goals. Furthermore, the significant level of funding directed towards these key areas ensures their future successful implementation.

 

This Government has built a reputation for prudent fiscal management. It has advanced a significant policy programme in the short and medium term while at the same time being fiscally responsible over the longer term. The current Government’s fiscal strategy – running operating surpluses sufficient to meet contributions to the NZS Fund and cover other capital spending while also reducing Crown debt to prudent levels – has put future governments in a better position to manage the demographic and other costs that New Zealand will face. Looking forward we remain committed to ensuring that the opportunities we take in the short term remain consistent with a stable future for New Zealand.

 

 

Hon Dr Michael Cullen
Minister of Finance

 

12 May 2005

 



 

Annex 1

 

Long-Term Fiscal Objectives

 

Table A1.1Long-term fiscal objectives

 

Long-term fiscal objectives

 

To achieve the objectives, the Government’s high-level focus is on:

 

 

 

 

 

Operating balance

 

Operating surplus on average over the economic cycle sufficient to meet the requirements for contributions to the NZS Fund and ensure consistency with the debt objective.

 

Revenue

 

Ensure sufficient revenue to meet the operating balance objective.

 

Expenses

 

Ensure expenses are consistent with the operating balance objective.

 

             Operating surpluses (measured by the OBERAC) during the build-up phase of the NZS Fund.  The focus is on core Crown revenues and expenses, with tax to GDP and core Crown expenses to GDP around current levels.

 

             Because the OBERAC surplus includes the net (after-tax) return on the NZS Fund, which the NZS Fund will retain, the Government is effectively targeting OBERAC surpluses excluding the NZS Fund’s retained investment returns.

 

             A robust, broad-based tax system that raises revenue in a fair and efficient way.

 

             SOEs and Crown entities contributing to surpluses, consistent with their legislation and Government policy.

 

 

 

 

 

Debt

 

Manage total debt at prudent levels.  Gross sovereign-issued debt as a percentage of GDP slowly reducing over the longer term and passing through 20% of GDP before 2015.

 

             SOEs will have debt structures that reflect best commercial practice.  Changes in the level of debt will reflect specific circumstances.

 

             Gross sovereign-issued debt to GDP will be reducing during the period ahead of the major demographic changes associated with population ageing.

 

             Net debt, with NZS Fund assets, is expected to fall towards minus 15% of GDP by 2015 (ie, a net financial asset position).

 

 

 

 

 

Net worth

 

Increase net worth consistent with the operating balance objective.

 

             Increasing net worth consistent with the operating balance objective will see net worth at above 50% of GDP by 2015.

 

             The NZS Fund is expected to be 21% of GDP by 2015.

 

             Consistent with the net worth objective, there will also be a focus on quality investment.

 

 



 

Annex 2

 

Short-Term Fiscal Intentions

 

Table A2.1 Short-term fiscal intentions

 

2005 Fiscal Strategy Report

 

2005 Budget Policy Statement

 

 

 

 

 

Operating balance

 

Based on operating amounts for the 2005 Budget, and indicative amounts for the next two Budgets, the operating surplus on an OBERAC basis and excluding net returns on the NZS Fund will be around 3% of GDP, remaining consistent with the long-term objective for the operating balance.

 

Operating balance

 

Based on operating amounts for the 2005 Budget, and indicative amounts for the next two Budgets, the operating surplus on an OBERAC basis and excluding net returns on the NZS Fund will be around 3% of GDP, remaining consistent with the long-term objective for the operating balance.

 

 

 

 

 

Debt

 

Gross sovereign-issued debt is forecast to be 20.2% of GDP in 2008/09.

 

The Government will set forecast new capital spending amounts that ensure progress is made toward the long-term objective for debt.  The Government’s bias is towards debt to GDP trending down over time.

 

Debt

 

Gross sovereign-issued debt is forecast to be 19.6% of GDP in 2008/09.

 

 

The Government will set forecast new capital spending amounts that ensure progress is made toward the long-term objective for debt.  The Government’s bias is towards debt to GDP trending down over time.

 

 

 

 

 

Expenses

 

Total Crown expenses are forecast to be 41.0% of GDP in 2008/09.

 

Core Crown expenses are forecast to average 31.4% over the forecast period and be 32.1% of GDP in 2008/09.

 

This assumes new operating expense amounts of $2.7 billion for the 2005 Budget and $1.9 billion for the 2006, 2007 and 2008 Budgets (GST exclusive).

 

Expenses

 

Total Crown expenses are forecast to be 41.0% of GDP in 2008/09.

 

 

Core Crown expenses are forecast to average 31.5% over the forecast period and be 32.3% of GDP in 2008/09.

 

 

This assumes new operating expense amounts of $2.1 billion; $1.9 billion; $2.0 billion; and $2.0 billion for the 2005, 2006, 2007 and 2008 Budgets respectively (GST exclusive).

 

 

 

 

 

Revenues

 

Total Crown revenues are forecast to be 43.9% of GDP in 2008/09.  Within this, core Crown revenues are forecast to be 34.1% of GDP in 2008/09.

 

The Government will set revenue plans that ensure progress is made towards the long-term revenue objective.

 

Revenues

 

Total Crown revenues are forecast to be 44.0% of GDP in 2008/09.  Within this, core Crown revenues are forecast to be 34.3% of GDP in 2008/09.

 

 

 

The Government will set revenue plans that ensure progress is made towards the long-term revenue objective.

 

 

 

 

 

Net worth

 

Net worth is forecast to be 35.4% of GDP in 2008/09, including NZS Fund assets of 10.9% of GDP.

 

Net worth

 

Net worth is forecast to be 35.4% of GDP in 2008/09, including NZS Fund assets of 10.6% of GDP.

 

 



 

The differences between short-term intentions set out in the 2005 BPS and those in the 2005 FSR are discussed in the text. The Budget Economic and Fiscal Update fiscal forecasts are consistent with our short-term fiscal intentions. For example, as seen in Table A2.2 gross sovereign-issued debt trends down over time from 22.6% of GDP in 2005 to 20.2% in 2009. The operating surplus, on an OBERAC basis, for 2006 to 2009 averages 2.8% of GDP and hence is consistent with our intentions set out in the 2005 BPS.

 

Table A2.2 – Budget Update fiscal forecasts (% of GDP)

 

Year end June

 

2002

 

2003

 

2004

 

2005

 

2006

 

2007

 

2008

 

2009

 

 

 

 

 

Actual

 

 

 

 

 

 

 

Forecast

 

 

 

 

 

Financial Performance

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Crown revenue

 

39.9

 

43.6

 

43.0

 

43.3

 

44.1

 

44.1

 

43.6

 

43.9

 

Core Crown revenue

 

31.8

 

33.4

 

33.4

 

33.9

 

34.2

 

34.0

 

33.7

 

34.1

 

Total Crown expenses

 

38.0

 

42.3

 

37.8

 

39.5

 

39.9

 

40.9

 

41.4

 

41.0

 

Core Crown expenses

 

30.3

 

31.9

 

29.6

 

30.1

 

30.9

 

31.8

 

32.3

 

32.1

 

OBERAC

 

2.2

 

4.3

 

4.7

 

4.9

 

4.3

 

3.3

 

2.3

 

3.0

 

Core Crown operating expenses + contributions to NZS Fund

 

30.8

 

32.9

 

30.9

 

31.5

 

32.4

 

33.2

 

33.8

 

33.6

 

OBERAC ex Fund returns

 

2.2

 

4.2

 

4.6

 

4.7

 

4.0

 

2.9

 

1.8

 

2.4

 

Financial Position

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net worth

 

15.0

 

18.2

 

25.2

 

27.8

 

31.2

 

33.4

 

34.1

 

35.4

 

Total Crown gross debt

 

29.3

 

29.7

 

26.2

 

23.7

 

23.2

 

21.9

 

21.8

 

21.2

 

Gross sovereign-issued debt

 

28.9

 

27.6

 

25.3

 

22.6

 

21.3

 

20.2

 

20.4

 

20.2

 

Core Crown net debt

 

15.4

 

13.4

 

10.8

 

7.7

 

6.6

 

6.6

 

7.4

 

7.5

 

Net debt with NZS Fund assets

 

14.9

 

12.0

 

8.0

 

3.4

 

0.6

 

(1.0

)

(1.8

)

(3.4

)

Cash

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash flows from core Crown operations

 

3.0

 

3.7

 

3.9

 

5.5

 

4.1

 

2.7

 

1.6

 

2.1

 

Available to pay debt/(required to be financed)

 

(0.3

)

0.9

 

0.4

 

1.6

 

 

(1.0

)

(1.6

)

(0.8

)

NZS Fund

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contributions

 

0.5

 

0.9

 

1.3

 

1.4

 

1.5

 

1.5

 

1.5

 

1.5

 

NZS Fund returns (after tax)

 

 

0.1

 

0.1

 

0.3

 

0.3

 

0.4

 

0.5

 

0.6

 

Accumulated assets

 

0.5

 

1.4

 

2.8

 

4.3

 

5.9

 

7.6

 

9.2

 

10.9

 

 



 

Annex 3

 

Fiscal Projections

 

Projections for revenue, expenses, the operating balance, net worth and debt are shown below.

 

Figure A3.1 – Revenue

 

 

Figure A3.2 – Expenses

 

 

Figure A3.3 – Operating balance

 

 



 

Figure A3.4 – Net worth

 

 

Figure A3.5 – Total Crown gross debt

 

 

Source:  The Treasury

 



 

Economic, demographic and fiscal assumptions

 

From 2005/06 to 2008/09, the fiscal projections incorporate the economic and fiscal forecasts detailed in the Budget Update.  Beyond 2008/09, the fiscal projections are based on long-run technical and policy assumptions and are not forecasts.  The following assumptions apply beyond 2008/09:

 

             Nominal GDP grows with assumed labour productivity growth (average annual rate of 1.5%), projected changes in the labour force and inflation (average annual rate of 2%).

 

             Demographic and labour force trends are based on Statistics New Zealand (SNZ) population projections with medium fertility, medium mortality and long-term net migration of 10,000 a year.  These projections are based on SNZ 2004 (base) National Population Projections, updated with the Treasury’s short-term migration and population estimates to ensure consistency with the Budget Update forecasts.

 

As a result, the projections beyond 2008/09 are the result of assumptions about the long-run economic drivers of growth.  For example, a stronger labour productivity growth assumption will, keeping other factors constant, lead to a higher projection of real GDP growth.

 

Table A3.1 – Summary of economic assumptions*

 

June Year(2)

 

2006

 

2007

 

2008

 

2009

 

2010

 

2011

 

2012

 

2013

 

2014

 

2020

 

 

 

Forecasts

 

Projections

 

Labour force growth

 

1.3

 

1.2

 

1.2

 

1.3

 

1.2

 

1.0

 

0.7

 

0.7

 

0.6

 

0.4

 

Unemployment rate

 

3.7

 

4.1

 

4.3

 

4.5

 

4.5

 

4.5

 

4.5

 

4.5

 

4.5

 

4.5

 

Employment growth

 

1.1

 

0.7

 

1.0

 

1.2

 

1.2

 

1.0

 

0.7

 

0.7

 

0.6

 

0.4

 

Labour productivity growth**

 

1.4

 

2.1

 

2.3

 

1.8

 

1.5

 

1.5

 

1.5

 

1.5

 

1.5

 

1.5

 

Real GDP

 

2.2

 

2.8

 

3.4

 

3.0

 

2.7

 

2.5

 

2.3

 

2.2

 

2.1

 

2.0

 

Consumer price index (annual % change)

 

2.6

 

2.7

 

2.3

 

2.0

 

2.0

 

2.0

 

2.0

 

2.0

 

2.0

 

2.0

 

Government 10-year bonds (quarterly avg %)

 

6.4

 

6.3

 

6.0

 

6.0

 

6.0

 

6.0

 

6.0

 

6.0

 

6.0

 

6.0

 

Nominal average hourly wage growth

 

4.6

 

3.8

 

3.5

 

3.5

 

3.5

 

3.5

 

3.5

 

3.5

 

3.5

 

3.5

 

 


*

Annual average % change unless otherwise stated.

**

Full-time equivalent employed measure

 

Sources:  The Treasury, Statistics New Zealand

 


(2)

Note that the economic forecasts in the Budget Update are based on a March year.

 



 

Table A3.2 – Summary of fiscal assumptions beyond 2008/09

 

Tax revenue

 

GDP linked, with assumptions of constant tax rate boundaries.

NZS

 

Demographically adjusted and linked to nominal wages after reaching 65% wage floor.

Other benefits

 

Demographically adjusted and linked to inflation.

Health and education

 

Demographically adjusted.

Finance costs

 

A function of debt levels and interest rates.

Other

 

Not demographically adjusted.

Operating allowance

 

$1.8 billion (GST exclusive) in 2009/10, increasing at the rate of 2% per annum.

Capital allowance

 

$750 million in 2009/10, increasing at the rate of 2% per annum.

NZS Fund

 

Contributions to the Fund are assumed to be consistent with the New Zealand Superannuation Fund Act 2001(3).

 

Source:  The Treasury

 

For the FSR projections, expenses are modelled using a “top-down” approach (with the exception of NZS, which is always modelled so as to capture demographics and wage adjustments). The demographic adjustments in health and education mean that nominal spending will be affected by population changes (both total and composition).  In the case of “other benefits”, there is both demographic and inflation adjustment (to reflect benefit indexation to the CPI). Other expenses (eg, core government) are not demographically or inflation adjusted. On an ex post basis, the ”operating allowance” will be allocated across expense areas to reflect choices about non-demographic factors such as wages and new initiatives. This modelling approach provides a sense of the top-down aggregate expenditure control inherent in a particular fiscal strategy.

 

An alternative approach is to model expenses on a “bottom-up” basis.  In this case there is no operating allowance. Rather, expense areas are modelled so as to capture demographics, inflation and a real growth factor (typically in per capita or per recipient terms).  The growth factor can be varied to reflect different views about cost and policy drivers. This modelling approach provides a sense of spending trends, aggregate and by sector, under alternative assumptions. It is often used in long-term fiscal sustainability analysis. Examples of the bottom-up approach can be found in the 2005 BPS (Figure 4, page 7) and Treasury Working Papers(4).

 

Further details of the modelling approach can be found in Treasury Working Paper 00/02 “Manual for the Long-term Fiscal Model”, available at www.treasury.govt.nz.

 


(3)

A more detailed review of the assumptions involved in projecting the NZS Fund contributions and earnings can be found on page 59 of the Budget Update. Further details can be found in “Financing New Zealand Superannuation”, a Treasury Working Paper by McCulloch and Frances, available at www.treasury.govt.nz.

 

 

(4)

See “Long Term Fiscal Projections and their Relationship with the Intertemporal Budget Constraint: An Application to New Zealand”, Treasury Working Paper 02/04 and “Population Ageing and Government Health Expenditures in New Zealand, 1951-2051”, Treasury Working Paper 04/14.

 



 

In addition to the effect of revised short-term fiscal forecasts, the fiscal projections differ from the 2004 FSR for four main reasons:

 

             The operating allowance has been increased from $1.4 billion to $1.8 billion (excluding demographics).  This new assumption approximates the $2.0 billion new forecast spending amount in the first year of the projections. (The operating allowance is lower because it does not cover demographic expense increases.  These are incorporated in the relevant expense areas.) The capital allowance has also been increased from $550 million to $750 million.

 

             The 2004 FSR had the operating and capital allowances growing with the rate of GDP in the projected years.  The operating and capital allowances are now assumed to grow with the rate of inflation to smooth the transition period between forecast and projection years.

 

             There has been a change in the rate of return assumption used to calculate the NZS Fund contribution rate. This is detailed in the “Long-Term Fiscal Outlook” section.

 

             Statistics New Zealand has changed its long-term medium net migration assumption from 5,000 to 10,000 (the average net migration over the past 15 years) per year, to reflect changes in immigration policy during the past 20 years. This has been incorporated into the fiscal projections.

 


EX-99.3 4 a05-11198_1ex99d3.htm EX-99.3

Exhibit 99.3

 

B.2 & B.3

 

 

19 May 2005

 

 

Budget 2005

 

 

Economic and Fiscal Update

 



 

Statement of Responsibility

 

On the basis of the economic and fiscal information available to it, the Treasury has used its best professional judgement in supplying the Minister of Finance with this Economic and Fiscal Update.  The Update incorporates the fiscal and economic implications both of Government decisions and circumstances as at 9 May 2005 that were communicated to me, and of other economic and fiscal information available to the Treasury in accordance with the provisions of the Public Finance Act 1989.

 

 

John Whitehead
Secretary to the Treasury

 

12 May 2005

 

 

This Economic and Fiscal Update has been prepared in accordance with the Public Finance Act 1989.  I accept overall responsibility for the integrity of the disclosures contained in this Update, and the consistency and completeness of the Update information in accordance with the requirements of the Public Finance Act 1989.

 

To enable the Treasury to prepare this Update, I have ensured that the Secretary to the Treasury has been advised of all Government decisions and other circumstances as at 9 May 2005 of which I was aware and that had material economic or fiscal implications.

 

 

Hon Dr Michael Cullen
Minister of Finance

 

12 May 2005

 



 

1

Economic Outlook

 

Summary

 

             The New Zealand economy has averaged 4.0% annual growth in the past six years, well above the OECD average of 2.6%.  The drivers of this growth have included both cyclical and structural factors.

 

Figure 1.1 – Growth in real GDP

 

 

Source: Statistics New Zealand, OECD

 

             Growth in 2004 was sustained by continuing income growth and rising household wealth stemming from the strong labour and housing markets and high international commodity prices.  Consumption expenditure remained strong but residential investment fell in the second half of 2004.

 

             Growth slowed in the second half of 2004 partly as a result of temporary factors and we expect some rebound in the first quarter of 2005.  However, the economy appears to be at a turning point and we are forecasting slower growth for the next two years, with a recovery in the year to March 2008.

 

             High exchange and interest rates, declining net migration inflows, slower trading partner growth and a forecast decline in the terms of trade are the main drivers of lower growth.  Further out, a projected fall in exchange and interest rates and a return to trend growth in the global economy are expected to lead to stronger growth.

 

             Employment growth is forecast to slow from its recent record rate and the unemployment rate to rise slightly.  Wage growth is expected to pick up as a result of pressures in the labour market and as the mix of employment rebalances.

 

             We expect lower net migration inflows to have a negative effect on growth in consumption and residential investment.  Higher interest rates and cyclical factors are expected to compound the slowdown in residential investment.

 



 

             Business investment growth is expected to remain robust in the near term but to decline as demand and profitability decline, labour shortages ease and the price of capital goods increases with the projected fall in the exchange rate.

 

             Government consumption and investment are expected to make a positive contribution to growth in the economy throughout the forecast period.  Increased transfers are also expected to sustain private consumption.

 

             The global economy is strengthening again after a period of weaker growth, but growth is assumed to be lower (on an annual average basis) in calendar year 2005 than in 2004.  Areas of concern in the global economy are the growth differential between the United States and other advanced economies and the resulting financial imbalances.

 

             We expect export volume growth to decline in the March 2006 year as a result of the delayed impact of the high exchange rate and slower world growth.  A recovery is forecast for the following two years as the projected lower exchange rate has a positive impact.

 

             Import volume growth is expected to decline as the domestic economy cools and the exchange rate falls.  Growth in imports is expected to strengthen again later in the forecast period as the domestic economy recovers.

 

             We expect annual CPI inflation to remain just below the top of the Reserve Bank’s target band for the next year as tradables inflation increases but non-tradables inflation pressures ease.  Short-term interest rates are forecast to remain at current levels until the end of 2005 and then to revert to their assumed neutral level of 5.8% by March 2009 in line with forecast inflation.

 

             Growth in nominal GDP is forecast to decline from 8.4% in calendar year 2004 to 4.3% in the year to March 2006.  In the near term, the higher growth in nominal GDP is expected to be reflected in higher corporate profits, but this component is likely to decline as the economy slows.

 

Figure 1.2 – Growth in real and nominal GDP

 

 

Sources: Statistics New Zealand, The Treasury

 

             The deficit on the current account is expected to increase further, peaking at around 7.0% of GDP in late 2006 – early 2007, driven by an increase in the deficit on goods as a result of high import growth, while export growth slows as a result of the high exchange rate and slower global growth.  The deficit is expected to decline slightly over the remainder of the forecast period, but to remain at 6.1% of GDP in March 2009.

 



 

             There are both upside and downside risks to this central scenario, including a more cyclical path for real and nominal GDP growth.  Some of the risks on the downside, while of low probability, could have a greater impact on the economy than the upside risks, if they were to eventuate.  (See chapter 3 page 87 for a discussion of some of the risks associated with the forecasts and the elaboration of two other scenarios.)

 

Table 1.1 – Economic outlook: central forecast(1)

 

(Annual average % change,
March years)

 

2004
Actual

 

2005
Estimate

 

2006
Forecast

 

2007
Forecast

 

2008
Forecast

 

2009
Forecast

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Private consumption

 

5.6

 

5.3

 

2.8

 

2.2

 

3.0

 

2.7

 

Public consumption(2)

 

3.1

 

7.1

 

6.3

 

4.4

 

3.8

 

3.3

 

Total Consumption

 

5.1

 

5.7

 

3.6

 

2.7

 

3.2

 

2.8

 

Residential investment

 

15.9

 

0.7

 

-8.6

 

-4.1

 

0.8

 

1.2

 

Central Government Investment

 

0.5

 

4.1

 

6.6

 

4.3

 

7.0

 

1.5

 

Other Investment

 

14.3

 

12.9

 

4.3

 

0.3

 

2.1

 

3.4

 

Total Investment

 

13.7

 

8.8

 

1.4

 

-0.4

 

2.1

 

2.8

 

Stock change(3)

 

0.2

 

0.5

 

-0.5

 

0.0

 

0.0

 

0.0

 

Gross National Expenditure

 

7.0

 

7.1

 

2.4

 

1.9

 

2.9

 

2.8

 

Exports

 

1.0

 

4.5

 

3.3

 

4.1

 

4.0

 

3.3

 

Imports

 

11.9

 

12.8

 

4.1

 

2.4

 

2.5

 

2.6

 

GDP (Production Measure)

 

3.6

 

4.2

 

2.3

 

2.5

 

3.5

 

3.0

 

- annual % change

 

5.0

 

2.8

 

2.0

 

3.0

 

3.3

 

2.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Real GDP per capita

 

1.9

 

3.0

 

1.3

 

1.6

 

2.6

 

2.1

 

Nominal GDP (expenditure basis)

 

6.3

 

8.2

 

4.3

 

3.0

 

4.8

 

5.0

 

GDP deflator

 

2.8

 

4.1

 

2.0

 

0.5

 

1.3

 

1.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Employment(4)

 

2.9

 

3.6

 

1.5

 

0.6

 

1.1

 

1.2

 

Unemployment(5)

 

4.3

 

3.4

 

3.8

 

4.2

 

4.3

 

4.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Wages(6)

 

3.4

 

3.3

 

4.2

 

4.0

 

3.5

 

3.5

 

CPI inflation

 

1.5

 

2.8

 

2.8

 

2.7

 

2.4

 

2.0

 

Export prices(7)

 

-8.2

 

3.6

 

0.3

 

3.7

 

1.3

 

1.1

 

Import prices(7)

 

-11.6

 

-1.9

 

2.0

 

7.1

 

3.0

 

1.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current account balance

 

 

 

 

 

 

 

 

 

 

 

 

 

  - $ million

 

-6,326

 

-9,881

 

-10,316

 

-10,952

 

-11,011

 

-10,731

 

  - % of GDP

 

-4.6

 

-6.6

 

-6.7

 

-6.9

 

-6.6

 

-6.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TWI(8)

 

66.9

 

69.6

 

66.2

 

62.1

 

59.9

 

58.8

 

90-day bank bill rate(8)

 

5.5

 

6.9

 

6.8

 

6.3

 

5.8

 

5.8

 

10-year bond rate(8)

 

5.8

 

6.0

 

6.4

 

6.4

 

6.0

 

6.0

 

 

Sources:  Statistics New Zealand, Reserve Bank of New Zealand, The Treasury

 


NOTES:

(1)

Forecasts finalised on 18 April 2005. Text finalised on 12 May 2005.

 

(2)

The forecast profile for public consumption is influenced by government defence spending.

 

(3)

Contribution to GDP growth.

 

(4)

Household Labour Force Survey, full-time equivalent employment.

 

(5)

Household Labour Force Survey, percentage of the labour force, March quarter, seasonally adjusted.

 

(6)

Quarterly Employment Survey, average hourly ordinary time earnings.

 

(7)

Overseas Trade Index basis, annual average percentage change, March quarter.

 

(8)

Average for the March quarter.

 



 

Assumptions Underlying the Central Forecast

 

Global economic activity – global economic growth, inflation and interest rate forecasts are assumed to conform to those presented in the March 2005 Consensus Forecasts and Asia Pacific Consensus Forecasts.  Economic growth for New Zealand’s top 14 trading partners is forecast at 3.2% for calendar 2005, a fall from the estimate of 4.1% for 2004.  Growth then returns to trend of around 3.5% from 2006 onwards.  The forecast for 2005 has been revised down since the December Economic and Fiscal Update 2004 (December Update) as a result of a weaker outlook for Australia and Japan.

 

             In Australia recent quarterly growth has been slow and the central bank has raised interest rates to forestall inflation pressures.  This has been translated into forecasts of a lower annual growth rate over the next year.

 

             In Japan downward revisions to historical data have led to an adjustment of forecasts.  Private consumption has again become the main source of weakness, following evidence of a long-awaited recovery over the three quarters to mid-2004.

 

See The Global Economic Outlook box on page 53 for further discussion.

 

Oil prices – Brent crude oil prices have increased since the December Update and are assumed to rise from their estimated level of US$47.80 per barrel in the March quarter 2005 to US$56 per barrel in the third quarter of 2005 before declining gradually over the remainder of the forecast period to US$47 per barrel in the March quarter 2009.  This outlook is based on futures pricing at the time the forecasts were finalised.

 

Net migration – net migrant inflows have continued to decline and are assumed to fall to 5,000 in calendar year 2005, before increasing again to their assumed long-term average of 10,000 per annum in calendar year 2006.

 

Monetary conditions – the New Zealand dollar exchange rate as measured by the Trade Weighted Index (TWI) is assumed to remain at around 70 until the third quarter of 2005, before declining steadily to its estimated equilibrium level of around 59.  A neutral short-term interest rate of 5.8% is assumed.

 

Climate – agricultural growing conditions and the level of hydro electricity storage lakes are assumed to be normal over the forecast period.

 


 


 

Recent Economic Environment

 

The economy has enjoyed a period of sustained expansion…

 

The New Zealand economy has grown strongly in the past six years after emerging from the 1997/98 recession.  Annual GDP growth averaged 4.0% in the period from 1999 to 2004, well above the average for OECD member countries of 2.6%.  The drivers of this strong performance have been well canvassed in the past (see December Update, pages 17-20) and include a range of cyclical and structural factors.

 

… but growth eased in the second half of 2004…

 

The rate of growth in the economy slowed sharply in the second half of 2004 to 2.2% (annual rate) from 5.2% in the first half.  The first half-year’s growth was broad-based, with robust domestic and external demand.  Strong consumption and investment led to rapid growth in imports, detracting from the positive contribution of exports.  In the second half of the year all of the components of final domestic demand made a smaller contribution to growth, with a decline in residential investment.  Exports fell in the third quarter and were negative for the second half as a whole.  An increase in inventory levels and a smaller negative contribution from imports provided only a partial offset.

 

Figure 1.3 – Contributions to GDP growth 2004 (six-month annualised)

 

Sources: Statistics New Zealand, The Treasury

 

… and will slow further

 

The slower growth in real GDP in the final quarter of 2004 was partly due to temporary factors, such as poor weather affecting consumer spending.  Although we expect a rebound in this component in the first quarter of 2005, the economy appears to be at a turning point, with many of the drivers of slower growth already apparent.  We are forecasting growth to be weaker for the next two years before a recovery begins in the year to March 2008.

 

Recent growth sustained by robust employment growth…

 

Final domestic demand sustained growth in the economy in 2004 despite making a smaller contribution to overall growth in the second half of the year.  The main factors supporting the domestic economy in 2004 were continuing household and corporate

 



 

income growth and rising household wealth stemming from the strength of the labour and housing markets and international commodity prices.

 

Robust growth in employment in 2004 and continuing wage growth combined to boost household incomes and sustain private consumption growth.  Total gross earnings increased by 7.0% in 2004, while real private consumption expenditure increased by 6.1%.  (See the Labour Market Performance box on page 46.)

 

… a buoyant housing market…

 

Rapid population growth (arising from high net migration inflows since late 2001) and relatively low interest rates (especially in 2003) led to a buoyant housing market and accompanying strong growth in residential investment in the past three years.  Although the housing market peaked in late 2003 in terms of the number of sales, it has remained strong, with prices continuing to show gains (but at a slower rate) and the number of sales remaining high.  Growth in residential investment was just under 20% in both 2002 and 2003, but it declined in the final two quarters of 2004.  Residential building consents fell 17.5% in the year to November 2004 (on a trend basis), but the rate of decline eased to 6.2% in the year to March 2005.

 

Figure 1.4 – Housing market indicators

 

 

Sources: Statistics New Zealand, REINZ

 

Increasing house prices have seen household wealth continue to rise over the past few years, fuelling some of the growth in consumer expenditure.  Household debt as a percentage of current income has increased rapidly in the past three years and the savings rate has become more negative (ie, in aggregate households are spending more than they are earning).  However, rising asset prices have more than offset this increase, leading to significant increases in household net wealth over the same period.  The increase in residential investment also led to an increase in consumption, particularly of durables to complement the new investment in housing.

 

… and external factors

 

Favourable terms of trade and strong trading partner growth also contributed to growth in the second half of 2004, especially growth in nominal GDP.  Prices for New Zealand’s main export commodities remained at high levels in this period, as a result of strong demand and – in the case of dairy, beef and lamb – supply factors.  High prices for these products, which together account for nearly 50% of commodity exports, sustained the terms of trade.  The strong growth in some of our trading partner economies, particularly

 



 

China, has also lifted prices for a number of raw materials, including oil, over the past year.

 

Figure 1.5 – Commodity prices

 

 

Source: ANZ Banking Group

 

Strong growth has resulted in spare capacity being used up…

 

Capacity utilisation in the manufacturing and construction industries reached a 43-year high of 92.6% in the December 2004 quarter according to the Quarterly Survey of Business Opinion (QSBO) and remained just below this level in the March 2005 quarter.  More than half of the respondents to the QSBO in recent quarters identified supply factors as the main constraint on the expansion of their output.  In the March 2005 survey, more than a quarter stated that labour was the main constraint on expansion of their business.

 

… emerging inflation pressures…

 

High capacity utilisation, strong employment growth and low unemployment have led to increased inflation pressures.  In the March 2005 QSBO, a net 40% of firms reported facing higher costs in the quarter, up from a net 35% in the previous quarter.  A net 23% of firms raised their prices in the March quarter and 31% intended to do so in the following quarter.  These figures point to increasing inflation pressure and declining profit margins as firms are squeezed by increased input costs, and competitive markets, the strong exchange rate and lower manufacturing costs in Asia restrict their ability to raise prices to final consumers.

 

… higher non-tradables inflation…

 

The rate of inflation, measured by the Consumers’ Price Index (CPI), has remained within the Reserve Bank’s target band of 1% to 3% in the recent period, despite increasing inflation pressures.  The annual increase in the CPI in the year to March 2005 was 2.8%, up from 1.5% the year before.  There has been a wide disparity between tradables and non-tradables inflation, with the high exchange rate holding down tradables inflation but the strong domestic economy leading to higher non-tradables inflation.

 



 

Figure 1.6 – Consumer price inflation

 

 

Source: Statistics New Zealand

 

… and an increase in the current account deficit

 

The continuing strong growth in the economy has also resulted in an increase in the current account deficit from 4.2% of GDP in 2003 to 6.4% in 2004.  This is mainly due to the increased deficit on investment income resulting from the high profits of foreign-owned companies in New Zealand, and a decline in the balance on goods and services as imports increased with the rapid growth in domestic demand and the high exchange rate.  (See Current Account Adjustment box on page 57.)

 



 

Labour Market Performance

 

Recent developments

 

The labour market has performed well in the recent period, reflecting strong growth in the economy as a whole.  The number of people employed has grown by an average of 2.8% per annum in the past six years and by 4.4% in 2004, lifting the labour force participation rate to 67.7% of the working age population and lowering the unemployment rate to 3.6%.  Both these results were a record for the Household Labour Force Survey (which began in 1986) and the unemployment rate was the lowest amongst the OECD member countries that calculate a comparable rate.(5)

 

Figure 1.7 – Participation and unemployment rates

 

 

Sources: Statistics New Zealand, The Treasury

 

The rapid expansion in employment and fall in unemployment have increased the difficulty of finding both skilled and unskilled staff to record levels, according to the QSBO.  In the March 2005 quarter, a net 60% of firms reported increased difficulty finding skilled staff and a net 49% reported increased difficulty finding unskilled staff, the second highest and highest levels (respectively) in the 30-year series.

 

Figure 1.8 – Wage growth

 

 

Sources: Statistics New Zealand, The Treasury

 


(5)

Employment increased slightly in the March 2005 quarter but the participation rate dipped to 67.6% and the unemployment rate increased to 3.9%.

 



 

Wage growth has also increased as spare labour resources have reduced.  The broadest measure of wage growth, the unadjusted Labour Cost Index (LCI), which captures merit increases but holds the composition of employment constant, rose by 4.6% in the year to March 2005, its highest year-on-year increase since the start of the series in 1996.  The adjusted LCI, which excludes merit increases while holding the composition of employment constant, increased by 2.4% in the same period, and average hourly earnings, measured by the Quarterly Employment Survey (QES) which includes changes in the composition of employment, increased by 3.4% in the year to March 2005 from the previous March year.

 

Total gross earnings have increased by an average of 6.1% per annum in the past six years, driven equally by growth in employment and growth in average hourly earnings, and indicating that the benefit of the strong labour market has been evenly split between more people working and higher earnings for those in employment.  Compensation of employees increased at a similar rate to total gross earnings (5.0% per annum over the six years to March 2004) and labour’s share of national income over this period has been relatively steady at an average of 42.5% of GDP.

 

Outlook

 

We expect employment growth to ease in the forecast period as the economy slows, but because labour supply growth will also be low (as a result of the assumed easing in net migration inflows), the unemployment rate is expected to remain below 4.0% until the third quarter of 2006, before rising to around 4.5% by the end of the forecast period.  Wage growth, as measured by the QES, is projected to increase because of the increased difficulty finding labour and as it recovers from its recent dip (which reflects changes in the composition of employment as more low-paid jobs were added).  Further out, firms’ ability to pay higher wages will be limited by declining profitability as economic growth slows.  Growth in non-farm net operating surplus (a measure of business profits) is forecast to decline from an estimated 12.6% in the year to March 2005 to average less than 3.0% per annum in the next four years.

 

We expect the strong business investment of the past two years to lead to further growth in labour productivity as the benefits of new plant and equipment are realised and the effects of the recent rapid expansion in employment pass.  (There is some evidence that the addition of more low-skill and low-paid jobs recently has lowered productivity growth.)  Slower employment growth also implies that growth in labour input makes a smaller contribution to real GDP growth than in recent years.

 

Figure 1.9 Labour productivity and real wage growth

 

Sources: Statistics New Zealand, The Treasury

 



 

Over the forecast period, we expect labour productivity to increase to around 2% per annum in the year to March 2007 as recent entrants to the labour force become more productive and as continuing business investment leads to an increase in the capital-to-labour ratio.  By the end of the forecast period, labour productivity growth is expected to be around our assessment of trend productivity growth of 1.5%.  Real wage growth (measured by the unadjusted Labour Cost Index deflated by the Consumers’ Price Index) has been positive over the past six years and has broadly reflected productivity growth.

 

The Outlook for 2005/06 and Beyond

 

We expect growth to ease further…

 

The easing in growth in the second half of 2004 was mainly due to a reversal of some of the factors which sustained growth over the previous six years.  In our central forecast, we expect the rate of year-on-year growth in the New Zealand economy to slow in the next two years as the effects of these cyclical factors – most of which are already in place – flow through.  The chief amongst them are high exchange and interest rates, the continuing slowdown in net migration inflows, slower trading partner growth in 2005 and a forecast decline in the terms of trade.  We estimate that growth in real GDP peaked at 4.8% in calendar year 2004 and will slow to 2.3% in the March 2006 year and 2.5% in the March 2007 year, but will then pick up to 3.5% in the following year and 3.0% in the year to March 2009.

 

Figure 1.10 – Growth in real GDP

 

 

Sources: Statistics New Zealand, The Treasury

 

… with some renewed strength possible in the first half of 2005…

 

We estimate that growth was stronger in the first quarter of 2005 as the economy recovered from the temporary factors which slowed growth in the final quarter of 2004.  Some recovery in private consumption is expected to have occurred in the first quarter of 2005 as part of a pick-up from weak retail sales in the final quarter of 2004 (sales volumes were affected by poor weather pre-Christmas), although the timing of Easter may have affected the seasonal pattern of sales in the first quarter of 2005.

 

Meat production and exports recovered in the March 2005 quarter after farmers held stock over for slaughter at the end of 2004; dairy exports also increased in the March 2005 quarter.  We estimate that a recovery in business investment occurred in early 2005 as investment intentions remained high; non-residential construction is estimated to have grown strongly with increased business investment and infrastructure projects, while residential investment continued to fall.

 



 

... but signs of the slowdown are becoming more apparent

 

Signs of the slower growth have become more apparent recently with falls in consumer and business confidence in the latest monthly surveys.  Although these are only single observations, they point to weaker growth in private consumption and business investment in the period ahead.  As always, there is a wide distribution of possible outcomes around our central forecast, with different probabilities associated with different risks.  (See chapter 3 page 87 for a full discussion of the risks associated with our forecasts and the development of two other scenarios.)

 

Private consumption growth expected to ease…

 

We expect slower employment growth, falling net migration and the effects of higher interest rates to lead to a fall in private consumption growth from an estimated 5.3% in the year to March 2005 to 2.8% in the year to March 2006 and 2.2% in the following year.  Increasing labour and export incomes and a projected fall in interest rates will lead to a recovery in private consumption growth to just under 3.0% by the end of the forecast period.

 

… as the labour market slows…

 

We forecast employment growth to slow in the next two years as the economy slows, but there will be some offset to total labour income from increased wage growth.  Growth in full-time equivalent employment is forecast to fall to a low of 0.5% in the year to June 2006, but to recover to 1.2% by the end of 2007.  Some recovery from the recent weakness in the QES wage growth measure is likely in the near term as the mix of employment rebalances and employers pay higher wages because of the increased difficulty of finding labour.  Wage growth is forecast to peak in late 2006 at 4.7% on an annual average basis and then to ease back to around 3.5%.

 

Annual growth in compensation of employees is forecast to peak at 7.8% in mid-2005 and to fall below 4.0% in 2006, leading to slower private consumption growth.  In the short term, the risks are skewed to employment growth holding up for longer and the participation rate increasing further than forecast, lending more support to consumption.

 

… and net migration declines

 

Net migration gains have been declining from a peak in mid-2003.  This is the result of an increasing number of New Zealanders travelling overseas for a year or more, declining numbers of young people coming to New Zealand to study, and increased outflows of young people who have completed courses in New Zealand.  Departures of New Zealanders have increased as safety concerns have subsided and employment conditions have become more attractive in the main destination countries (Australia and the United Kingdom).  These trends are expected to continue, with net migration inflows falling from 10,000 in the year to March 2005 to 5,000 in calendar year 2005.  Net inflows are expected to recover again to 10,000 by the end of 2006.

 

The housing market is also expected to cool

 

A weaker labour market and continued slowing in net migration inflows are expected to lead to a fall in residential investment in the next two years.  The impact of higher

 



 

mortgage interest rates (albeit delayed because of the high proportion of home loans which are at fixed rates) will also contribute to the fall.  In addition, residential rents have not kept pace with construction costs and house prices, reducing the returns from investment in housing;  and rapid growth in the number of apartments, combined with a downturn in the numbers of foreign students, has increased the risk of an over-supply in that part of the market.

 

Figure 1.11 – Net migration and house sales

 

 

Sources: Statistics New Zealand, REINZ

 

Residential investment growth is estimated to have fallen to zero in the March 2005 year and is forecast to be negative in the 2006 and 2007 March years before stabilising.  The fall in residential investment will also contribute to slower consumption growth, especially for consumer durables which are associated with residential investment.

 

Residential investment in the second half of 2004 was weaker than we expected in the December Update and there may be a catch-up in the first half of 2005.  The continued buoyancy in house sales (a leading indicator of residential investment) may also portend a short-term resurgence in residential investment, although the increase in house sales may merely reflect the mortgage rate war in late 2004.  The anecdotes of a backlog of work which has built up in the housing construction industry (chiefly because of the shortage of skilled trades people) provides a further risk of higher than forecast residential investment for a period.  For these reasons, residential investment in the first half of 2005 may be higher than envisaged in the central scenario, although if this is the case there would be lower activity later.

 

Business investment is expected to hold up in the near term

 

Business investment strengthened considerably from annual average growth between 1999 and 2003 of 7.7% to 17.9% in 2004 as a result of a combination of continuing robust demand, rising firm profitability, increased difficulty finding labour and lower prices for imported capital goods resulting from the high exchange rate.  Investment intentions remain positive, and so we expect business investment to hold up in the near term.  Thereafter, however, we expect growth in business investment to slow as the supportive factors just mentioned are reversed.  We forecast investment growth to fall to 0.3% in the March 2007 year, and then to recover to 3.4% in the year to March 2009 as the determinants of investment stabilise.

 



 

Figure 1.12 – Plant and machinery investment

 

 

Sources: Statistics New Zealand, NZIER

 

Government spending and transfers will add to demand

 

Increased government transfers as part of the Working for Families package (announced in the 2004 Budget) have previously been incorporated in the consumption forecasts.  As these transfers go to households with a higher propensity to consume (because they spend a high proportion of their total income), the package is likely to have a positive effect on consumption.

 

Sustained growth over the forecast period in government spending on goods and services, particularly in the areas of health and education, will also provide some offset to easing private consumption.  Government defence spending, much of which is counted as current expenditure, is also set to continue to grow in the forecast period.  On current plans, public consumption growth is forecast to decline from an estimated 7.1% in the year to March 2005 to 3.3% per annum at the end of the forecast period, but is above the growth rate in total GDP throughout that period.

 

Central government investment growth is forecast to increase from an estimated 4.1% in the March 2005 year to 6.6% in the March 2006 year and will make a positive contribution to growth in the forecast period.  This item includes budgeted investment in non-weapons military equipment and other capital spending in the health and housing areas.

 

The contribution from exports is forecast to decline

 

December 2004 quarter export volumes remained below December Update forecasts, despite their recovery from a weak September quarter.  Unseasonal patterns in dairy export volumes as a result of climatic factors and changes in stock-holding policies were the main causes of the variability in exports in the second half of 2004.  We are forecasting export volume growth of 4.5% in the year to March 2005 to slow to 3.3% in the following year due to the delayed impact of the high exchange rate and slower world growth.  The lower exchange rate and strengthening world growth in subsequent years are expected to lead to export growth of around 4.0% in the March 2007 and 2008 years.

 



 

There is uncertainty about the track for the exchange rate…

 

Our forecasts assume that the New Zealand dollar (TWI basis) will remain at its March 2005 quarter average for the June and September quarters, before declining to our estimate of its long-run equilibrium value by the end of the forecast period.  Factors that could contribute to a fall in the exchange rate from its current level include a slowing in economic growth, the growing current account deficit and forecast decline in the terms of trade.  The forecast narrowing of the positive differential between New Zealand and global interest rates may also reduce the attractiveness of the New Zealand dollar.  However, there is considerable uncertainty surrounding the timing and extent of any depreciation in the exchange rate.  This is particularly the case at the present time given uncertainties about the path of global currencies, especially the United States dollar.  Indeed, some further exchange rate appreciation in the short term cannot be ruled out.

 

Figure 1.13 – New Zealand dollar exchange rate (TWI)

 

 

Sources: Reserve Bank of New Zealand, The Treasury

 

… and its impact on exports

 

There is also uncertainty about how negatively the high exchange rate will impact on export receipts in the near term.  For some commodity exports, notably dairy, beef and lamb, the exchange rate has been offset by historically high international prices, leaving prices above their decade average in New Zealand dollar terms.  Forestry products are a notable exception to this commodity picture.  For manufactured product exporters, the effect of the exchange rate depends on the markets they export to; while the New Zealand dollar has appreciated strongly against the United States dollar, it has not posted such large gains against other currencies.  Some manufacturing exporters have a natural hedge in imported raw materials or componentry and some took out long-term forward contracts to protect their returns.  However, many of these forward contracts are about to expire, leaving firms to face a potentially abrupt transition to current exchange rates.

 

In the services sector, especially inbound tourism, the appreciation of the New Zealand dollar has only limited impact on the number of visitors in the short term, but it does reduce the amount travellers are prepared to spend once they arrive in New Zealand.  In the longer term the high exchange rate begins to affect the number of visitor arrivals as New Zealand loses competitiveness as a holiday destination.  The strong exchange rate also encourages more New Zealanders to travel overseas for holidays, detracting from services export receipts.  (For the development of alternative scenarios associated with the exchange rate and weaker demand for New Zealand’s exports, see chapter 3 page 90.)

 



 

Import volume growth is expected to decline

 

Strong consumption and investment growth led to an acceleration in import volume growth from 8.1% in calendar year 2003 to 15.7% in 2004.  The forecast falls in these major components of domestic demand will lead to a decline in import growth from an estimated 12.8% in the year to March 2005, to 4.1% in the year to March 2006, and then to average 2.5% growth in the following three years.  March 2005 quarter trade data suggest that import volume growth may be stronger than in our central forecast as a result of the stronger domestic economy and high exchange rate.  However, we consider that this strength in the domestic economy is a rebound from temporary weakness in late 2004 and is unlikely to be sustained.

 

We expect the net contribution of the export sector to GDP growth to be positive in the March 2006 year as export growth exceeds import growth, and this pattern will continue in subsequent years as export growth outpaces import growth as the exchange rate depreciates.  (See The Global Economic Outlook box on the following two pages for more discussion.)

 



 

The Global Economic Outlook

 

Recent and current developments

 

Global economic growth slowed steadily between September 2003 and September 2004, but quickened slightly in the December quarter of 2004.  The quarterly growth rate (New Zealand-export weighted) was most influenced – up until the December quarter of 2004 – by a sharp slowing of Australian growth, but growth rates were in fact declining in most of New Zealand’s major export markets.

 

Figure 1.14 – New Zealand trading partner growth, export weighted

 

Sources: Datastream, IMF, The Treasury

 

Consensus Forecasts point to quarterly growth recovering over the remainder of 2005, building on the rebound seen in the final quarter of 2004.  Nevertheless, annual average growth rates for 2005 will remain below those recorded in late 2003 and early 2004.  In subsequent years, steady growth of about 3½% per year is expected.  However, there is considerable uncertainty about these predictions, largely stemming from large growth and current account imbalances and high oil prices.  There have also been commentaries suggesting a more rapid increase in global interest rates than forecast as the United States Federal Reserve moves to control inflationary pressures.  Another source of uncertainty is slower GDP growth in Australia.

 

Global GDP growth (annual average % change)

 

Calendar year

 

2003

 

2004

 

2005

 

2006

 

2007

 

2008

 

2009

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consensus Forecasts (March 2005, October 2004 for 2007-2009)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Australia

 

3.4

 

3.2

 

2.6

 

3.2

 

3.4

 

3.7

 

3.4

 

United States

 

3.0

 

4.4

 

3.7

 

3.4

 

3.3

 

3.2

 

3.2

 

Europe

 

1.1

 

2.3

 

1.8

 

2.0

 

1.9

 

1.7

 

1.8

 

Japan

 

1.4

 

2.6

 

1.0

 

1.7

 

1.5

 

1.7

 

1.7

 

Non-Japan Asia

 

5.1

 

7.3

 

5.8

 

5.8

 

6.0

 

6.2

 

5.9

 

Trading partner average

 

3.0

 

4.1

 

3.2

 

3.4

 

3.4

 

3.5

 

3.4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IMF (April 2005)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Advanced Economies

 

2.0

 

3.4

 

2.6

 

3.0

 

 

 

 

 

 

 

World

 

4.0

 

5.1

 

4.3

 

4.4

 

 

 

 

 

 

 

 

Sources:  Consensus Economics, IMF, The Treasury

 



 

Weight of risks points to weaker outlook

 

In considering the uncertainties which affect the Consensus Forecasts, it is notable that the most widely discussed alternative scenarios all imply slower global growth.

 

A major concern is the large growth differential and increasing imbalances between countries.  Although the US current account deficit is similar to New Zealand’s as a percentage of GDP, such a large deficit in dollar terms places much higher demands on the supply of world investment funds.  While there is currently a plentiful supply of global capital, it is possible that this will not be sustained.  Either a reduction in supply or withdrawal of investor support for US assets could lead to an unruly decline in the US dollar and a turbulent growth adjustment.  In turn, any decline in the value of US dollar assets has the potential to put pressure on official balance sheets in Asian countries, possibly transmitting financial difficulties.

 

Figure 1.15 – US current account deficit

 

 

Source: Datastream

 

Oil prices are another source of uncertainty in global economic forecasts.  Based on futures data, spot prices are expected to decline from current levels of about US$50 per barrel over the next five years, but to remain considerably higher than the long-term average of US$20.  Should oil prices not decline as expected, the potential would increase for more widespread inflation or for oil-intensive industries to cut output in order to contain costs.

 

Both the global imbalances and oil price uncertainty raise the prospect of problems for monetary policy makers.  In the former case, high current account surpluses in Asia are increasing liquidity in the region and making it more difficult to contain domestic demand.  As a result, price movements in Asia have typically moved from deflation to inflation.  Keeping this inflation under control without exchange rate adjustment will be difficult and there is a possibility that inflation will spread, through higher commodity prices, to other countries.

 

Finally, forecasts of GDP growth in the economy of New Zealand’s main export destination, Australia, show a quick return to annual growth rates of about 3½% following the recent quarterly slowing.  Certainly, growth rates in excess of 3% per year have been typical in Australia, at least for non-farm GDP, for the past decade.  But some commentators have raised the possibility that recent official interest rate increases at a time of apparently slowing domestic demand growth could prolong the period of slow GDP growth.

 



 

Terms of trade are forecast to decline from recent high levels

 

We forecast the terms of trade (measured as the ratio of export to import prices) to decline from their recent record levels as a result of adverse developments in both export and import prices.  The terms of trade continued to increase in the second half of 2004 on the back of strong export prices, offset to some degree by higher oil prices.  Export commodity prices are forecast to decline in the second half of 2005 as positive supply factors are reversed and demand eases with slower trading partner growth.  Import prices, on the other hand, are forecast to increase in world price terms until the September quarter 2005, largely because of further projected increases in oil prices in the second and third quarters of 2005.  Thereafter, oil prices are assumed to decline, but to remain approximately one third higher than in the December Update.

 

Figure 1.16 – Terms of trade

 

 

Sources: Statistics New Zealand, The Treasury

 

Inflation pressures are expected to be moderate but persistent

 

We expect annual CPI inflation to remain within the Reserve Bank’s target zone of 1% to 3% “on average over the medium term” in the next year despite the current high capacity utilisation and economic activity only just coming back to its potential level.  Aggregate inflation has been suppressed by low tradables inflation (as a result of the appreciation of the exchange rate) and contributions from temporary factors such as declines in international airfares.  Non-tradables inflation has been boosted by high rates of growth in construction costs, price increases in transportation (largely as a result of oil price increases) and rising costs of household operations (chiefly energy costs).  We expect the first two of these to ease over the forecast period, but there will be a degree of persistence as the economy slows only gradually.  Tradables inflation will increase as the fall in the exchange rate translates into increasing import prices.

 



 

Figure 1.17 – Consumer price inflation

Sources: Statistics New Zealand, The Treasury

 

Short-term interest rates are expected to remain around current levels of 7.0% until the first quarter of 2006 in order to lean against current inflation pressures.  Interest rates are then forecast to decline towards their assumed neutral level of around 5.8% by the end of the period in line with forecast inflation.

 

Nominal GDP is expected to be higher in the near term

 

We expect nominal GDP to increase by more than forecast in the December Update in the year to March 2006 because of the high terms of trade in the current period and slightly higher inflation, reflecting the strength of the economy.  In income terms, much of the additional nominal GDP appears as operating surplus, or profits.  Corporates are currently performing well and profit growth has been strong, boosting corporate tax revenue.  However, as the economy slows we expect profit growth to slow markedly as cost pressures remain (particularly in the labour market) and competition limits price increases.  Nominal GDP growth is forecast to decline from an estimated 8.2% in the March 2005 year to 4.3% in the March 2006 year and 3.0% in the March 2007 year, but then to recover to 5.0% growth in the March 2009 year.

 

The current account deficit increases further

 

We expect the current account deficit to continue to increase, peaking at 7.0% of nominal GDP in late 2006 – early 2007.  After that, it will decline gradually to 6.1% of GDP in March quarter 2009.  The increase in the deficit is initially driven by an increase in the deficit on goods as a result of the continuing momentum in the domestic economy maintaining import growth, while export growth slows as a result of the high exchange rate and slower trading partner growth.

 



 

Figure 1.18 – Current account deficit

 

 

Sources: Statistics New Zealand, The Treasury

 

Subsequently, import prices are expected to increase more than export prices as the terms of trade deteriorate, further contributing to the deficit on goods.  The balance on investment income remains negative throughout the forecast period, as the profits that accrue to foreign investors in New Zealand continue to exceed returns from New Zealand’s overseas investments, but this component of the current account deficit decreases in the forecast period as business profitability declines.  (See the Current Account Adjustment box on the following pages for further discussion.)

 



 

Current Account Adjustment

 

International experience

 

The widening of a current account deficit may be associated with either cyclical – and therefore temporary – changes in the economy or changes in the underlying, fundamental determinants of the current account balance.  Examples of the former include changes in demand relative to supply in response to interest rate and exchange rate movements.  Examples of the latter include improvements in an economy’s growth potential, and thus its attractiveness as an investment destination, and improvements in global financial intermediation that facilitate investment across borders.

 

When cyclical factors drive the widening deficit, at some point the deficit will be unwound; in contrast, where the drivers are structural, higher deficits may persist for much longer periods. Recent international research confirms the importance of different cyclical drivers in determining the economic outcomes associated with a narrowing of the current account balance.

 

Output growth is an important determinant of cyclical movements in the current account.  As an economy booms, domestic demand may exceed domestic output growth.  This will be reflected in a rise in domestic investment relative to national saving, that is, an increased reliance on foreign saving, and an increase in imports and thereby a deterioration in the current account deficit.  If the boom leads to a rise in inflation, monetary policy will tighten to slow the growth in domestic demand and to counter the rise in inflation.  The combination of a slowing economy and the expected easing in monetary policy will tend to reduce the attractiveness of the domestic economy as an investment destination and to depreciate the exchange rate, which helps restore the trade balance, and thereby narrows the deficit.

 

The exchange rate is another important determinant of fluctuations in the current account deficit.  An exchange rate appreciation that is not supported by underlying economic conditions will tend to slow overall economic growth through a reduction in export growth and a rise in imports, which also causes the trade balance and the current account balance to deteriorate.  Monetary policy will respond to weaker price pressures through reduced interest rates and (as above) the exchange rate will tend to depreciate and the current account balance will improve.  The expected tightening of monetary policy limits the extent of depreciation and helps restrain the growth in demand, but in contrast to the previous scenario, the growth rate improves.

 

New Zealand experience

 

New Zealand’s experience in two recent episodes appears to confirm the importance of the drivers of the deficit to the outcomes associated with adjustment.  (In each of the accompanying charts, period 0 corresponds to the peak in the current account deficit in March 1986 and March 2000 respectively.)

 

Figure 1.19 maps the widening and subsequent narrowing of the deficit from its peaks in March 1986 and March 2000 respectively.

 



 

Figure 1.19 – Current account deficit reductions

 

 

Source: The Treasury

 

Figure 1.20 illustrates the markedly different growth experiences associated with each episode.  In 1986, real GDP growth was weak following the peak in the current account deficit, whereas in 2000 growth was strong.

 

Figure 1.20 – Real GDP growth

 

 

Sources: Statistics New Zealand, The Treasury

 

Figure 1.21 shows how the real exchange rate depreciated in the lead-up to, and after, the 2000 peak. In contrast the real exchange rate appreciated after 1986, a reflection of New Zealand’s high inflation rate and other structural rigidities at that time.

 

Figure 1.21 – Real exchange rate

 

 

Sources: Statistics New Zealand, The Treasury

 



 

Figure 1.22 uses the output gap, or the difference between current output and the hypothetical potential output, as a measure of general excess demand in the economy.  In contrast to 1986, when the economy was characterised by excess demand, there was a lack of demand in the period around the 2000 peak, which provided room for a period of non-inflationary growth.

 

Figure 1.22 – Output gap

 

 

Sources: Statistics New Zealand, The Treasury

 

Future prospects

 

Today’s growing current account deficit may reflect some fundamental changes in New Zealand’s growth prospects and in international financial flows, but it also reflects some temporary and cyclical phenomena. These include a degree of excess demand in the economy and an exchange rate above that expected to prevail over the medium term.

 

While we expect these cyclical factors to unwind in coming years, the current account deficit is projected to remain elevated over the forecast horizon.  This reflects the assumption that the exchange rate will decline only gradually, limiting the extent of growth in the export and import-competing sectors, and a view that New Zealand’s sound macroeconomic policy-setting will continue to underpin investor confidence.

 

Clearly, a different path is possible.  A more rapid exchange rate depreciation would likely see the deficit return toward historical levels (around 4½% of GDP) more quickly.  Experience both in New Zealand and elsewhere confirms the importance of real exchange rate adjustment and the maintenance of sustainable growth rates to the smooth adjustment of the current account.  How benign the adjustment path turns out to be depends on the mix of economic conditions at the time.

 



 

Fiscal Forecasts – Finalisation Dates and Key Assumptions

 

Finalisation Dates

 

Economic outlook (refer Chapter 1)

 

18 April

 

Tax revenue forecasts

 

29 April

 

Fiscal forecasts

 

9 May

 

Government decisions and circumstances

 

9 May

 

Actual asset revaluations

 

31 March

 

Foreign exchange rates

 

28 February

 

Specific fiscal risks (refer Chapter 4)

 

9 May

 

Contingent liabilities and commitments (refer Chapter 4)

 

31 March

 

 

Key assumptions

 

The fiscal forecasts have been prepared in accordance with the Public Finance Act 1989.  They are based on the Crown’s accounting policies and assumptions (refer page 120 of the GAAP tables). As with all assumptions, there is a degree of uncertainty surrounding them.  This uncertainty increases as the forecast horizon extends.  A summary of the key economic assumptions that are particularly relevant to the fiscal forecasts is provided below (on a June-year-end basis to align with the Crown’s balance date of 30 June):

 

 

 

2004/05

 

2005/06

 

2006/07

 

2007/08

 

2008/09

 

June years

 

BEFU 04

 

BEFU

 

BEFU

 

BEFU

 

BEFU

 

BEFU

 

Real GDP (P) (ann avg % chg)

 

2.4

 

3.4

 

2.2

 

2.8

 

3.4

 

3.0

 

Nominal GDP (E) ($m)

 

144,441

 

150,714

 

156,065

 

161,582

 

169,470

 

178,172

 

CPI (annual % change)

 

2.5

 

2.8

 

2.6

 

2.7

 

2.3

 

2.0

 

Govt 10-year bonds (qty avg %)

 

6.3

 

6.4

 

6.4

 

6.3

 

6.0

 

6.0

 

90-day bill rate (qty avg %)

 

5.8

 

7.0

 

6.5

 

6.0

 

5.8

 

5.8

 

Unemployment rate ((HLFS) basis ann avg %)

 

4.7

 

3.5

 

3.7

 

4.1

 

4.3

 

4.5

 

Full-time equivalent employment (ann avg %)

 

1.0

 

3.5

 

0.9

 

0.7

 

1.1

 

1.2

 

Current account (% of GDP)

 

-5.9

 

-6.8

 

-6.7

 

-6.9

 

-6.4

 

-6.0

 

 

Source:  The Treasury

 

New Zealand Superannuation (NZS) Fund

 

The contribution to the NZS Fund for the year ending 30 June 2006 is $2.337 billion.  The contribution to the NZS Fund is calculated over a 40-year rolling horizon to ensure that superannuation entitlements over the next 40 years can be met if the contribution rate were to be held constant at that level.  The Government is making the required minimum annual contribution for 2004/05 as calculated by the formula set out in the NZS Act.

 

$ billion (June year end)

 

2003

 

2004

 

2005

 

2006

 

2007

 

2008

 

2009

 

Required contribution

 

N/A

 

1.879

 

2.107

 

2.337

 

2.375

 

2.533

 

2.744

 

Actual/Budgeted contribution

 

1.200

 

1.879

 

2.107

 

2.337

 

2.375

 

2.533

 

2.744

 

 

Source:  The Treasury

 

The underlying assumptions in calculating the contributions are the nominal GDP series to 2046, the NZS expense series to 2046 and the expected long-term, net after-tax annual return of the NZS Fund (6.1%) (6.8% December Update).  The forecast rate of return is based on the Treasury’s assumptions for the rate of return on financial portfolios of Crown financial institutions.  The GDP and NZS expense series were projected using the assumptions stated on page 33 of the 2005 Fiscal Strategy Report.

 

The Treasury website contains further information on the NZS Fund, as well as a copy of the NZS Fund model.

 



 

2

Fiscal Outlook

 

Summary of the Budget Update

 

The fiscal position remains strong with the Government continuing to make progress towards its long-term objectives.

 

As stated in the Fiscal Strategy Report (FSR) “the Government’s fiscal strategy is to strengthen public finances to prepare for future fiscal costs associated with an ageing population”.

 

The Government has focused on two complementary elements to reach its objective, being:

 

             the accumulation of financial assets through contributions to the New Zealand Superannuation (NZS) Fund

 

             managing debt at prudent levels with gross sovereign-issued debt as a percentage of GDP slowly reducing over time.

 

The forecast fiscal outlook for the Budget Update shows:

 

             revenue sufficient to meet operating expenses with the residual (operating balance/OBERAC) forecast to be on average around 3.6% of GDP over the forecast period

 

             net worth increasing by around $27.7 billion over the forecast period, largely resulting from the accumulation of assets

 

             the cash equivalent of the OBERAC being applied to the Government’s investment strategy (such as contributions to the NZS Fund and purchasing physical assets).  Over the forecast period the cash generated is not sufficient to fund all of the Government’s investing activity, leaving an expected cash shortfall

 

             gross sovereign-issued debt as a percentage of GDP slowly reducing over the forecast period, while in nominal terms gross debt rises near the end of the forecast period.

 



 

Fiscal Indicators

 

There are a number of indicators that are important in understanding the state of the Government’s fiscal position.  No single indicator provides an all-purpose measure of the financial performance of the Crown and its impact on the economy.  For example:

 

             the total Crown operating balance reflects the difference between current revenues (tax revenue, investment income etc) and current expenses (salaries, benefit payments etc).  The operating balance shows whether the Government has generated enough revenue to cover expenses

 

             the total Crown OBERAC reflects the difference between current revenues and current expenses adjusted for valuation movements and accounting policy changes.  The OBERAC provides a measure of the Government’s underlying stewardship

 

             the total Crown net worth reflects the difference between total assets and total liabilities.  The change in net worth in any given forecast year is primarily driven by the operating balance

 

             the cash available/(shortfall to be funded) reflects the net effect of the Government’s core Crown operating (cash equivalent of the OBERAC) and investing activities (such as contributions to the NZS Fund and purchases of physical assets).  It shows whether the cash generated is sufficient to meet all government spending (both operating and investing)

 

             gross sovereign-issued debt reflects the debt burden of the core Crown (excluding the activity of the NZS Fund and GSF).  The movement over the forecast period is primarily driven by the cash available/(shortfall to be funded)

 

             net core Crown debt reflects borrowings (financial liabilities) less cash and bank balances, marketable securities and deposits, and advances (financial assets).  Net debt excludes the financial assets of the NZS Fund and GSF as these assets are restricted in nature.

 

Table 2.1 – Summary fiscal indicators(6)

 

 

 

Year ended 30 June

 

($ million)

 

2004
Actual

 

2005
Forecast

 

2006
Forecast

 

2007
Forecast

 

2008
Forecast

 

2009
Forecast

 

Total revenue

 

60,387

 

65,265

 

68,770

 

71,238

 

73,856

 

78,156

 

% of GDP

 

43.0

 

43.3

 

44.1

 

44.1

 

43.6

 

43.9

 

Total expenses

 

53,057

 

59,513

 

62,244

 

66,047

 

70,101

 

73,020

 

% of GDP

 

37.8

 

39.5

 

39.9

 

40.9

 

41.4

 

41.0

 

Operating balance

 

7,424

 

5,891

 

6,665

 

5,330

 

3,894

 

5,275

 

% of GDP

 

5.3

 

3.9

 

4.3

 

3.3

 

2.3

 

3.0

 

OBERAC

 

6,629

 

7,445

 

6,665

 

5,330

 

3,894

 

5,275

 

% of GDP

 

4.7

 

4.9

 

4.3

 

3.3

 

2.3

 

3.0

 

Net worth

 

35,463

 

41,972

 

48,637

 

53,967

 

57,861

 

63,136

 

% of GDP

 

25.2

 

27.8

 

31.2

 

33.4

 

34.1

 

35.4

 

Cash available/(shortfall to be funded)

 

520

 

2,413

 

30

 

(1,606

)

(2,776

)

(1,391

)

% of GDP

 

0.4

 

1.6

 

0.0

 

(1.0

)

(1.6

)

(0.8

)

Gross sovereign-issued debt

 

35,527

 

34,111

 

33,284

 

32,583

 

34,629

 

35,925

 

% of GDP

 

25.3

 

22.6

 

21.3

 

20.2

 

20.4

 

20.2

 

Net core Crown debt

 

15,204

 

11,533

 

10,257

 

10,640

 

12,527

 

13,439

 

% of GDP

 

10.8

 

7.7

 

6.6

 

6.6

 

7.4

 

7.5

 

 

Source: The Treasury

 


(6)

Detailed tables of the key indicators for the Budget Update and December Update are located on pages 80 and 81.

 



 

Key Trends

 

Revenues are forecast to exceed operating expenses…

 

In each of the forecast years the revenue generated is expected to be more than sufficient to meet the Government’s operating expenses (salaries, benefit payments, depreciation costs etc).  This translates into an operating balance of $5.9 billion in 2004/05 reducing to $5.3 billion by 2008/09.

 

Figure 2.1 – Core Crown revenue and expense growth (excluding GSF valuation)

 

 

Source: The Treasury

 

Figure 2.2 – Final forecast year impact of net Budget packages

 

 

Source: The Treasury

 

In recent years revenue growth has exceeded expense growth, largely due to strong economic growth.  This trend is expected to reverse over the initial stage of the forecast period, before both expense and revenue growth converge towards the end of the forecast period.  This reflects:

 

             the impact of the 2004 and 2005 Budgets.  The allowance for new initiatives in future Budgets is expected to be smaller than the previous two Budgets, so forecast expense growth decreases from 2006/07 onwards

 

             the impact of the forecast economic cycle on tax revenue.  Tax revenue growth decreases due to an expected slowdown in economic growth in the early part of the forecasts, before rebounding by 2008/09.

 



 

This translates into an OBERAC that is forecast to fall from $7.4 billion (4.9% of GDP) in the current year to $3.9 billion (2.3% of GDP) by 2007/08(7), before rising to $5.3 billion (3% of GDP) by 2008/09.

 

… as a result the Government is expected to strengthen its fiscal position…

 

Net worth is forecast at $42 billion (27.8% of GDP) in the current year and is expected to rise to $63.1 billion (35.4% of GDP) by 2008/09.  The forecast increase in net worth is driven by the operating surpluses the Government is expected to run over the forecast horizon.

 

Figure 2.3 – Core Crown investments on a year-by-year basis

 

 

Source: The Treasury

 

… by accumulating assets…

 

In line with the Government’s fiscal objectives the OBERAC has been applied to fund the Government’s investments.  Over the forecast period total assets are expected to increase by around $35.8 billion.

 

The OBERAC cannot be fully used by the Government to help finance its capital programme.  This is because some components of the OBERAC are non-cash (ie, depreciation) or retained by entities within the Crown (ie, SOE/Crown entity surpluses and NZS Fund returns) for the purpose of achieving their long-term objectives.  Adjusting for these items gives the core Crown operating cash flows.  Figure 2.3 shows how these cash flows are applied across the forecast years.  Table 2.2 shows the cumulated balance sheet impact.

 


(7)

The decrease in 2007/08 is due to the change in provisional tax dates as part of the Business package having a one-off impact of $760 million.

 



 

Table 2.2 – Impact of Crown operating surpluses on the balance sheet from 2004/05 to 2008/09 inclusive

 

 

Source: The Treasury

 

As outlined in Table 2.2, the accumulated operating balance is expected to be $27.1 billion over the forecast period.  Adjusting for non-cash items ($8.3 billion) and returns retained by entities within the Crown ($10 billion) gives a cash flow from operations which generates around $25.4 billion over the forecast horizon.

 

Figure 2.4 – Gross sovereign-issued debt

 

 

Source: The Treasury

 

This will be invested primarily in NZS Fund contributions of $12.1 billion, advances of $4 billion (mainly student loans and refinancing existing private sector debt of the health and housing sectors), purchases of physical assets of $9.1 billion (for example, schools and defence equipment), injections into Crown entities for hospitals and housing of $1.6 billion and the purchase of foreign exchange reserves of $1.9 billion.

 

There is a residual financing requirement of around $3.3 billion, which will be partially met by reducing the holdings of marketable securities and deposits which have accumulated from 2003/04 and 2004/05, and by raising some debt.

 



 

… while gross debt as a percentage of GDP slowly reduces over the forecast period

 

As a percentage of GDP, gross debt is expected to fall from 25.3% in 2003/04 to 20.2% by 2008/09.  In nominal terms, gross debt is also forecast to fall to $32.6 billion by 2006/07 and then rise to $35.9 billion by the end of the forecast horizon.

 

The initial decrease in debt in nominal terms reflects residual assets from the strong results in 2003/04 and 2004/05.  Gross debt is then expected to slowly rise, reflecting the fact that capital spending will be greater than the funding available due to the OBERAC as shown in Table 2.2.

 

The increased asset position expected in 2004/05 has led to a change in the Government’s 2005/06 bond programme which has been reduced to $2.2 billion, compared with $2.5 billion at the December Update.  The domestic bond programme is set at $2.8 billion per annum for the remainder of the forecast period.

 

Net debt is also expected to fall before flattening by the end of the forecast horizon

 

Net debt(8) in nominal terms and as a percentage of GDP is forecast to fall in the current year, reflecting the strong asset position achieved in 2004/05.  Net debt is expected to remain relatively flat as a percentage of GDP between 2005/06 and 2008/09.  The difference in the trend of gross debt arises because some of the expected borrowing will be used to fund financial assets including student loans and reserves.

 

Figure 2.5 – Net debt

 

 

Source: The Treasury

 

Net core Crown debt with the financial assets of the NZS Fund is forecast to be below zero by 2006/07.

 


(8)

Net debt excludes the assets of the NZS Fund and GSF.

 



 

Revenue and Expenses

 

Table 2.3 – Revenue and expenses comparison with December Update

 

 

 

Year ended 30 June

 

(% of GDP)

 

2004
Actual

 

2005
Forecast

 

2006
Forecast

 

2007
Forecast

 

2008
Forecast

 

2009
Forecast

 

Total Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

Budget Update

 

43.0

 

43.3

 

44.1

 

44.1

 

43.6

 

43.9

 

December Update

 

 

 

43.0

 

43.7

 

43.9

 

43.9

 

44.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

Budget Update

 

37.8

 

39.5

 

39.9

 

40.9

 

41.4

 

41.0

 

December Update

 

 

 

39.3

 

39.8

 

40.7

 

41.1

 

41.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Core Crown Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

Budget Update

 

33.4

 

33.9

 

34.2

 

34.0

 

33.7

 

34.1

 

December Update

 

 

 

33.6

 

33.9

 

34.0