NZ Budget preview: more than a feeling

There’s nothing in the starting position to suggest urgent and drastic change is required to steer the books towards where the Government wants them to be but a weaker economic and fiscal outlook could have made for a few tough choices.

" ANZ Research wouldn’t be surprised if the Treasury’s economic outlook proves a little more optimistic than their own.”

An upbeat exterior

ANZ Research wouldn’t be surprised if the Treasury’s economic outlook proves a little more upbeat than the Government’s - that’s at least been the recent experience. However, the Government knows the starting point will be weaker and will suspect the near-term outlook will have been downgraded too.

Treasury’s Half-Year Economic and Fiscal Update included quarterly growth forecasts of 0.7 per cent for both Q3 and Q4 2018. Actual data printed was 0.3 per cent and 0.6 per cent respectively. And now, near-term indicators suggest the earlier forecast for quarterly growth of 0.8 per cent quarter-on-quarter over 2019 is on the optimistic side.

So far, indicators for first quarter gross domestic product (GDP) point to growth closer to 0.5 per cent quarter-on-quarter – ANZ Research would be surprised if Treasury haven’t at least downgraded this one. Thereafter, the indicators are less certain.

It’s likely Treasury is expecting growth to pick up from mid-2019 (ANZ Research is too, albeit gradually) but the question is how strong will be? And that’s a tricky one. Because the Treasury’s forecasts are finalised well before the Budget publication date (in order to accommodate the Budget decision-making process), it is possible the economic outlook doesn’t include the impact from the official cash rate cut delivered on May 8.

The impact may be in the tables but the additional stimulus may not be baked fully into the GDP and inflation outlooks.

What really matters for tax revenue is nominal GDP. And on that front things are also probably looking a little softer than at the Half-Year Update.

As outlined above, real GDP is due for a downgrade (at least in the near term) and, on the prices side, the recent loss of economic momentum and waning capacity indicators suggest inflation pressures are a little softer.

From a trade perspective, despite prices for New Zealand’s key exports holding up remarkably well in the face of slowing global growth (for dairy a lot of the explanation here lies with softening global supply), it would be hard to justify an upgrade to the terms of trade outlook.

Slightly downgraded

Fiscal policy decisions (which are guided by Government’s Budget Responsibility Rules and, at a more detailed level, the Wellbeing Budget priorities) together with the Treasury’s economic outlook (which informs the revenue and expenses forecasts) will determine where the fiscal forecasts land.

From the slightly higher starting point, delayed and reprioritised spending, alongside a slightly softer tax revenue outlook, will likely see the forecast operating balance before gains and losses surplus downgraded a touch. However, lifting surpluses across the forecast horizon are still expected.

Given the likelihood of a small downgrade in tax revenues, ANZ Research doesn’t see much upside in terms of higher discretionary spending. However, a downgrade to the labour market outlook could see forecast spending on social assistance payments rise, but this has actually been tracking below forecast to date.

As at the Half-Year Update, operating allowances for Budget 2019 to Budget 2022 were confirmed at $NZ2.4 billion per Budget, with some pre-commitments leaving a little less than that in the kitty for 2019 and 2020. ANZ Research expects operating allowances to remain unchanged but, if anything, the risk is skewed towards these being lowered slightly to keep the debt projection on course towards 20 per cent of GDP.

Capital spending, set by the multi-year capital envelope, is also expected to remain unchanged. No change to allowances implies all new spending decisions will either be made against what is yet to be allocated or from reprioritised spending. Minister Robertson has said the Government has found cost savings of $NZ1 billion over the forecast period.

Overall, the Government appears quite adamant about achieving its fiscal targets with the Minister of Finance recently stating “fiscal sustainability is an inherent part of a wellbeing approach”. Of these targets, reducing the level of net core Crown debt to 20 per cent of GDP within five years of taking office is perhaps the most focused on and therefore binding.

Wriggle room

“Within five years of taking office” implies the net debt forecasts will land at or below 20 per cent of GDP in the 2022 fiscal year. And indeed the Half-Year Update forecasts showed the Government overachieving on this front, with net debt reaching 19 per cent of GDP in June 2022. This implies there was always a little wriggle room for a slightly softer economy and/or unplanned expenses such as the one-off cost of the Government’s recent firearm buyback scheme.

Provided discretionary spending remains contained, a slightly softer revenue forecast shouldn’t derail the projected return of net debt to 20 per cent by 2022.

All things considered, ANZ Research is not expecting large changes to Debt Management’s bond issuance guidance. At the Half-Year Update the face value of gross NZGB issuance was forecast at $NZ8 billion from fiscal years 2019 to 2021, followed by $NZ7 billion in 2022 and $NZ6 billion in 2023.

This didn’t test the 20 per cent of GDP lower limit and with nominal GDP expected to come in a little softer, it shouldn’t test it now. However, there could be a little more funding pressure at the margin, so a small increase (of around $NZ1 billion) somewhere in the forecast wouldn’t surprise ANZ Research.

With the large nominal bond maturity this year and similarly sized maturities due over the next two years, New Zealand is probably due for a new bond syndication to be announced. A replacement 10-year benchmark nominal bond is a strong contender here but a 15-year or 20-year also wouldn’t surprise. Debt Management will want to set up lines where demand is highest and that’s the tricky part as demand can vary significantly from investor to investor.

Treasury bills outstanding were at $NZ4.6 billion as at 30 April 2019. This is a bit higher than earlier guidance but that likely reflects greater short-term funding requirements associated with the maturity and repurchase of March 2019 nominal bonds. It should unwind.

Strict adherence

In terms of the macroeconomic impacts of fiscal policy (pressure on GDP, inflation and interest rates), ANZ Research expects only small changes from the Half-Year Update. Delayed spending will likely see the positive fiscal impulse previously forecast for the year to June 2019 revised lower but with some of that strength pushed into the later years.

At the end of the day, the ability for the Government to use fiscal policy to stimulate the economy will remain constrained so long as strict adherence to the debt target continues.

Miles Workman is a Senior NZ Economist for ANZ