Grim forecast for New Zealand's finances

TRACY WATKINS

OPINION: After Treasury opened the books on yet another gloomy forecast, it is tempting to ask whether things could get any worse.

Well, yes, is the short answer.

In a case study presented by Treasury in today's Pre-election Fiscal Update (prefu) as one extreme scenario, we are caught in a downward spiral that ultimately results in the Government being so bust it can't pay its bills.

But even under less extreme scenarios, Treasury acknowledges that New Zealand's credit downgrade by international ratings agencies Fitch and Standard & Poor's - with potentially a third, Moody's, tipped to follow suit - has exacerbated some of the downside risks faced by the New Zealand economy.

When Finance Minister Bill English briefed media on the fiscal update today, he said the downgrades didn't appear to have affected mortgage interest rates.

But in its briefing papers, Treasury notes: "In the absence of a marked improvement in the external position, New Zealand may be more likely to be singled out in the funding markets in the future. All things being equal, any further deterioration in the ratings outlook could serve to raise debt servicing costs for the Crown as well as borrowing rates for households and businesses."

Mindful of an uncertain global outlook, Treasury has devoted a chapter in the prefu to things turning even uglier than it has forecast - and says there is a one in five risk of things getting even worse than that.

Under its downside scenario, a failure on the part of Governments to contain the Euro crisis, causes a severe disruption to global funding markets, and a prolonged period of "sub-potential growth" in the global economy.

For New Zealand this means a reduction demand for our exports and a sharp drop in incomes for agricultural producers flowing through into weaker domestic demand, less income for investment and debt repayment and a significantly wider current account deficit.

On the financial side, this drop in confidence and pick-up in global risk-aversion would be expected to reduce the availability - and raise the cost - of credit for New Zealand.

On the domestic side, private consumption growth is held back by weak house price growth and the desire of households to reduce debt to more comfortable levels.

"Given the wider potential for much tighter conditions in global funding markets, the risk is that the degree of household consolidation could be more intense than expected with households seeking to move to an even lower level of debt than we have forecast. While this might bring forward the rebalancing that the economy needs in the long run, such a scenario would involve weaker domestic activity in the near term," Treasury notes.

Meanwhile, there is ongoing uncertainty over the timing of the Canterbury rebuild and more seismic activity could push the costs above the current $20 billion estimate.

A slower rebuild will also mean lower economic activity in the short term.

Drought, flood and weather driven supply shocks,  bio-security breaches and one-off events such as the grounding of Rena were further risks.

In the "one in five" downside scenario painted by Treasury, a protracted global recession sparked by the euro zone crisis, coupled with the limited ability of countries to support their economies through fiscal and monetary policy as they did in 2008, affects exports and tourism, leading to a rapid deterioration in the current account deficit, lower tax revenue and a $14.5 billion hole in tax revenue by 2016.

Under this scenario, core crown debt also rises steeply, to 35 per cent of GDP in the year ending June 2016.

Treasury does not overstate the risk of this "downside to the downside" scenario occurring but notes: "Overall historic forecasting performance suggests that there is at least a one in five chance of an outcome worse than that captured in the downside scenario. Indeed there are a number of risks for the economy over and above those captured in the scenario."

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