New Zealand New Zealand at a Glance: 2004-05

Country Report

New Zealand New Zealand at a glance: 2004-05

OVERVIEW The centre-left coalition government led by the Labour Party is in danger of becoming bogged down by a number of issues, such as the row over Maori claims to the country’s foreshores and seabed. Meanwhile, relations between Labour and the parties on which it relies for support are becoming increasingly fractious. Yet Labour remains well ahead of the main opposition centre-right National Party in the polls, and its grip on power is secure. It remains to be seen whether National’s new leader, Don Brash, has the political skills needed to reunite the party and boost its popularity. The Economist Intelligence Unit expects continued fiscal operating surpluses over the forecast period, but substantial increases in government spending are unlikely as the government focuses on building up the new pension fund. Consumer price inflation will remain comfortably within the 1-3% target range of the Reserve Bank of New Zealand (RBNZ, the independent central bank). The current-account deficit will widen to 5% of GDP in 2003, but is forecast to narrow to 4.1% of GDP by 2005.

Key changes from last month Political outlook • A further slip in National’s opinion poll ratings in October saw Mr Brash, a former governor of the Reserve Bank and the then shadow finance minister, launch and win a snap leadership contest against the beleaguered Bill English, who had led the party since 2001. Mr Brash’s election is likely to signal an increased emphasis on welfare reform and tax cuts. Economic policy outlook • The Australian airline, Qantas, and the state-owned airline, Air New Zealand, are considering their options after their proposed alliance was rejected by New Zealand’s Commerce Commission in mid-October. Economic forecast • Latest data releases have led us to revise upwards our estimate for domestic demand growth, and revise downwards that for export growth, with the net result that overall growth in 2003 is estimated at 2.6% (previously 2.7%). Our projection for growth in 2004 has been revised upwards to 2.8% (from 2.5%), with growth in 2005 now forecast at 3.1% (previously 3%). November 2003

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Outlook for 2004-05

Political outlook

Domestic politics The centre-left coalition government led by the Labour Party is in danger of becoming bogged down by a number of peripheral issues, including a potentially damaging controversy with Maori over who owns the country’s foreshores and seabed. Relations between Labour and the parties on which it relies for support also appear to be growing more fractious. Although the Labour prime minister, Helen Clark, can count on the support of her party’s junior coalition partner, the left-wing Progressive Coalition, the centrist, pro- family United Future (with which the coalition has an informal support agreement) is growing increasingly frustrated with the government’s social and environmental policies, and its continued support is far from guaranteed. Meanwhile, relations with the Greens (on whom the government relies when support from United Future is not forthcoming) have deteriorated sharply over the lifting of the moratorium on genetic modification at the end of October. Wounds are, however, likely to heal, reflecting the recognition by the Greens that an antagonistic relationship with the government could increase the chance of a National Party victory in the next election, due in mid-2005. Indeed, there are already signs of a thaw, with the Greens ensuring the passage in October of the government’s controversial Supreme Court Bill, which removes the right to appeal to the UK-based Privy Council in legal disputes, after United Future decided not to back the legislation. Labour’s level of discomfort over the next two years will depend partly on the ability of Don Brash, the new leader of the main opposition, the centre-right National Party, to unify the party under his leadership. A further slip in already dismal opinion poll ratings in October saw Mr Brash, a former governor of the Reserve Bank of New Zealand (RBNZ, the independent central bank) and the then shadow finance minister, launch and win a snap leadership contest against the beleaguered Bill English, who had led the party since 2001. Labour’s occupation of the political middle ground has left National struggling to develop a policy platform that clearly differentiates it, and Mr Brash’s election is likely to signal an increased emphasis on tough welfare reform and tax cuts. Few doubt Mr Brash’s capabilities on the policy front, but whether he has the political skills necessary to reunite the party and boost its popularity remains to be seen. Winston Peters and his right-of-centre party, New Zealand First (which has the third largest number of parliamentary seats), currently seem to pose the greater threat to Labour. Mr Peters, a vocal anti-immigration campaigner, has persistently attacked the government’s immigration policies since the 2002 election. However, with the government having recently tightened immigration rules, Mr Peters has turned his attention to the debate on ownership of the foreshore and seabed, and his tough line on Maori appeasement is likely to strike a chord with many, including (ironically) Maori who feel let down by Labour’s Maori members of parliament (MPs).

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International relations Concern that New Zealand will be disadvantaged by a recently signed free- trade agreement (FTA) between Australia and Thailand, and a possible future FTA between China and Australia, will result in a renewed focus on bilateral trade negotiations. Trade talks between New Zealand and Thailand could progress quite rapidly, although the prospect of some form of trade agreement with China, first mooted during the visit to New Zealand in October of China’s president, Hu Jintao, is a long way off. Hopes of a bilateral free-trade agreement (FTA) with the US have already been dashed, although the US government had in any case indicated that trade talks were a low priority.

Economic policy outlook

Policy trends A major shift in economic policy is unlikely in the next two years, with the government continuing to focus on increasing investment in health and education. Despite the recent announcement of measures to help to boost the development of the biotechnology and film sectors, a lack of new initiatives in other areas suggests that progress towards boosting the country’s sustainable rate of economic growth (one of the government’s central goals) will be limited. The government will continue to run operating surpluses during the Economist Intelligence Unit’s forecast period, although substantial increases in spending are unlikely as the government focuses on building up the new superannuation (pension) fund. The government is likely to loosen the purse strings in fiscal year 2004/05 (July-June), ahead of the next general election (due by mid-2005). The first priority is likely to be greater financial support for poorer families. Tax cuts are unlikely, but there may be some if budget surpluses exceed target, if only to outflank opposition calls for surpluses to be returned to the taxpayer. The Australian airline, Qantas, and the state-owned airline, Air New Zealand, are considering their options after their proposed alliance was rejected as anti- competitive by New Zealand’s Commerce Commission in mid-October. The ruling follows a similar rejection of the deal by the Australian competition authority in September.

Fiscal policy According to the Treasury, the operating surplus in 2002/03, excluding revaluations and accounting changes, was well ahead of target at NZ$5.6bn (US$3.2bn at 2003 average exchange rate), owing to strong revenue growth. If revaluations and accounting changes are taken into account, the operating surplus for the year was NZ$2bn, but this was still well ahead of target. The Treasury’s projected operating surplus for 2003/04 is NZ$3.8bn, or 2.8% of GDP. However, we are cautious about the government’s ability to stay within its spending limits, given its commitments on health and education. Using OECD measures of government expenditure and revenue, which are wider than those used by the Treasury, we forecast fiscal surpluses equivalent to 1.7% of GDP in 2003 and 1.5% of GDP in 2004, falling to 1.3% in 2005 owing to likely spending increases around the time of the next election.

Monetary policy The RBNZ reduced the overnight cash rate (OCR) by 25 basis points to 5% on July 24th, the third such cut since April, but has since left rates unchanged. The cut reflected the improvement in the medium-term outlook for inflation, as

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well as the risks to growth posed by the stronger currency and power shortages earlier in the year. However, a resurgence in consumer spending, strong growth in house prices and signs of a recovery in external demand mean that the next movement in interest rates is upwards. The resumption in the New Zealand dollar’s rally against the US currency and concern about the sustainability of the global economic recovery suggest that the RBNZ will hold fire until the first half of 2004. From this point, we expect to see the OCR gradually returned to a more neutral level, although the stronger currency and indebted households’ sensitivity to interest rate rises means that the OCR is unlikely to rise above 5.75% by the end of 2005.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2002 2003 2004 2005 Real GDP growth World 2.9 3.3 3.9 4.1 OECD 1.8 1.8 2.4 2.6 EU 1.0 0.6 1.9 2.3 Exchange rates ¥:US$ 125.3 115.7 109.8 114.8 US$:€ 0.945 1.132 1.230 1.185 SDR:US$ 0.772 0.714 0.683 0.698 Financial indicators ¥ 2-month private bill rate 0.10 0.05 0.10 0.10 US$ 3-month commercial paper rate 1.70 1.08 1.38 3.56 Commodity prices Oil (Brent; US$/b) 25.0 27.6 19.6 18.9 Gold (US$/troy oz) 310.3 354.0 323.8 307.5 Food, feedstuffs & beverages (% change in US$ terms) 12.7 5.6 1.7 5.8 Industrial raw materials (% change in US$ terms) 2.2 8.9 3.0 4.3 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. Having rebounded to an estimated 2.6% in 2003, growth in Japan is forecast to slow again to 1.6% and 1.2% in 2004 and 2005, respectively. Although at an annual average GDP growth rate of 5.9%, Asia and Australasia (excluding Japan) will enjoy the fastest rate of expansion of any world region in 2004-05. US GDP growth is forecast to pick up from an estimated 2.6% in 2003 to 3.4% in 2004 and 3.1% in 2005, lifting global growth (weighted using purchasing power parity exchange rates) from an estimated 3.3% in 2003 to 3.9% in 2004 and 4.1% in 2005. Meanwhile, world trade growth is forecast to recover from a subdued 3.4% in 2003 to 5.3% in 2004 and 6.1% in 2005. Crude oil prices have remained high owing to the slower than expected resumption of Iraqi oil production and the low level of US oil stocks, although world oil prices will fall sharply from an average of US$27.6/barrel in 2003 to US$19.6/b in 2004, a decline of 29%. Oil prices are forecast to average US$18.91/b in 2005.

Economic growth Gross domestic product by expenditure (NZ$ m at constant 1995/96 prices; % change year on year in brackets unless otherwise indicated) 2002a 2003b 2004c 2005c Private consumption 66,508.0 68,830.8 70,557.0 72,226.3 (3.8) (3.5) (2.5) (2.4) Public consumption 20,034.0 20,675.1 21,295.3 22,019.4 (4.7) (3.2) (3.0) (3.4) Gross fixed investment 23,756.0 25,807.0 26,701.2 27,889.9 (7.7) (8.6) (3.5) (4.5) Final domestic demand 110,298.0 115,312.9 118,553.6 122,135.6 (4.8) (4.5) (2.8) (3.0) Stockbuilding 1,274.0 1,100.0 1,100.0 1,100.0 (0.1)d (-0.2)d (0.0)d (0.0)d Total domestic demand 111,572.0 116,412.9 119,653.6 123,235.6 (4.8) (4.3) (2.8) (3.0) Exports of goods & services 37,076.0 37,823.4 40,030.1 42,429.4 (5.8) (2.0) (5.8) (6.0) Imports of goods & services -35,909.0 -38,470.3 -40,620.9 -42,875.8 (8.8) (7.1) (5.6) (5.6) Foreign balance 1,167.0 -646.9 -590.9 -446.4 (-0.8)d (-1.6)d (0.0)d (0.1)d GDP 112,884.0 115,766.0 119,062.7 122,789.1 (4.2) (2.6) (2.8) (3.1) a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. d Contribution to real GDP growth. Despite the continued strength of domestic demand, real GDP growth (on an expenditure, calendar-year basis) will slow to 2.6% in 2003, as much weaker export growth and strong import growth turn net exports sharply negative, reducing growth by up to 1.6 percentage points. Domestic demand growth will weaken in 2004, owing to more moderate private consumption growth and a downturn in the residential construction sector. Growth will nevertheless pick up to 2.8% that year, as net exports turn positive, the result of stronger export growth and weaker import growth. Real GDP growth will strengthen further to around 3.1% in 2005, as stronger world trade supports firmer export expansion and stronger growth in non-residential investment. Private consumption has remained surprisingly robust in the past few months, supported by strong inward migration and solid job creation. However, slower employment growth, along with an expected easing in net migration and a rise in interest rates, will see growth in private consumption slow from 3.5% in 2003 to 2.5% in 2004 and 2.4% in 2005. Residential construction has held up more strongly than expected in 2003, although demand for new housing will weaken in 2004-05 as interest rates rise and inward migration slows. Other investment spending, which has suffered in 2003 from the impact on exporters of the appreciating currency and the fall in agricultural output, is likely to strengthen modestly in 2004, as external demand picks up and companies take advantage of the stronger currency and, consequently, cheaper imported capital goods to address capacity constraints. However, the expected downturn in housing means that total investment growth will still slow to an annual average of 4% in 2004-05, compared with an estimated 8.6% in 2003.

The stronger currency, falling agricultural output and the sluggish global economy have depressed export growth in 2003. Real growth in goods and services exports (in national accounts terms) is forecast to accelerate to an annual average of 5.9% in 2004-05 as world trade growth recovers, although the impact of the stronger currency on New Zealand’s price competitiveness will prevent a greater rebound. Import growth is forecast to slow in 2004-05, in line with more moderate domestic demand growth.

Inflation The year-on-year rate of consumer price inflation was unchanged at 1.5% in the third quarter of 2003, below the mid-point of the central bank’s 1-3% target range, although underlying inflation has begun to creep up. The rising cost of housing and the tight labour market may exert some upward pressure on prices in the labour-intensive services sector and, in the short term, the construction sector. Both sectors are shielded to a degree from international competition. However, inflationary pressures will remain under control in 2004. As domestic demand moderates, the stronger currency will continue to weigh down import prices, and low producer price inflation will help to keep a lid on retail prices. Annual average inflation is therefore forecast at 2% in 2004, rising slightly to 2.3% in 2005 as the currency eases, but still well within the central bank’s target range.

Exchange rates The New Zealand dollar lost some ground against the US currency between mid-July and early September, owing to a firmer US dollar and speculation about further interest rate cuts. However, it has since rebounded, reaching a fresh six-year high of NZ$1.64:US$1 at end-October, as the US dollar weakened again and it became clear that the next movement in local interest rates would be upwards. We expect the New Zealand dollar to continue to firm in the short term, as the US dollar softens further. However, a strong rally is unlikely, and the currency is set to average NZ$1.73:US$1 in 2003. The positive interest rate differential with the US will continue to support the New Zealand dollar at around NZ$1.65:US$1 in 2004, easing back slightly to NZ$1.69:US$1 in 2005. Our central exchange-rate forecast notwithstanding, the thinly traded nature of the currency and its vulnerability to investor risk aversion mean that the value of the New Zealand dollar against the US currency could prove volatile in the short term.

External sector The stronger currency, sluggish external demand and the continued expansion in domestic demand will see the trade balance (on a balance-of-payments basis) slip into deficit to the tune of 0.1% of GDP in 2003, the first deficit since 1999. The gradual recovery in the global economy and higher commodity (including dairy) prices will, however, underpin a return to surplus on the trade account in 2004, with a stronger trade surplus forecast for 2005. Reluctance to travel owing to fears of terrorism and concern about the outbreak of Severe Acute Respiratory Syndrome (SARS) in Asia depressed tourism revenue in the first half of this year and will result in a smaller services surplus as a proportion of GDP, although we expect a recovery in 2004 and 2005 as confidence returns. However, the main imbalance will remain the shortfall on the income account, pushed up in recent years by the cost of servicing rising levels of debt, as well as by the repatriation of profits by foreign-owned

companies. A reduction is unlikely in the medium term owing to the low domestic savings rate. The net effect of this will be to push up the current- account deficit to 5% of GDP in 2003, before the increasing merchandise trade surplus pulls it down again slightly to around 4% of GDP by 2005.

Forecast summary (% unless otherwise indicated) 2002a 2003b 2004c 2005c Real GDP growth 4.2 2.6 2.8 3.1 Unemployment rate (av) 5.2 5.1 5.2 5.2 Consumer price inflation (av) 2.7 1.8 2.0 2.3 Consumer price inflation (year-end) 2.7 1.9 2.2 2.1 Short-term interbank rate 9.8 9.7 9.8 10.0 Government balance (% of GDP) 1.3 1.7 1.5 1.3 Exports of goods fob (US$ bn) 14.5 15.5 17.1 18.9 Imports of goods fob (US$ bn) 14.0 15.6 16.8 18.1 Current-account balance (US$ bn) -1.9 -3.8 -4.0 -3.5 Current-account balance (% of GDP) -3.4 -5.0 -4.8 -4.1 External debt (year-end; US$ bn) 32.6 38.1 41.0 42.9 Exchange rate NZ$:US$ (av) 2.16 1.73 1.65 1.69 Exchange rate NZ$:¥100 (av) 1.72 1.50 1.50 1.47 Exchange rate NZ$:€ (year-end) 1.99 1.99 1.98 2.02 Exchange rate NZ$:SDR (year-end) 2.58 2.39 2.38 2.46 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

Editors: Kate Allard (editor); Graham Richardson (consulting editor) Editorial closing date: November 3rd 2003 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule