Confidence boom won't become growth

FAIRFAX

AUSSIE HIGH: Were it not for the 6.5 per cent gain in Australian tourists during the past year, visitor numbers would have fallen by 9 per cent.

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OPINION: Our expectation and the expectation of most other forecasters is that the New Zealand economy is likely to grow in rather unspectacular fashion over the next couple of years by between 2.5 per cent and 3.5 per cent per annum, writes Tony Alexander this week.

After that, it is anyone's guess because of the huge uncertainty surrounding issues such as where the world economy will go, how successfully foreign central banks can get rid of emergency level interest rates, how governments can start to get their accounts back into order, how willing banks will be to lend, and how willing consumers and businesses will be to borrow.

But putting those uncertainties aside, the main reasons we see near average growth in the economy for the next couple of years are as follows:

Floating interest rates are at four-decade lows and each month household cashflow improves around $100 million as borrowers roll from high fixed to low floating rates. Improving cashflow will help underpin a recovery in retail spending, along with above-average net migration inflows, and the simple need to replace a lot of stuff that is now worn out – such as our cars and couches.

The civil construction sector will be busy with higher government infrastructure spending plus local authorities getting ready for the Rugby World Cup. Exporters will receive some growth assistance from improving commodity prices – up 20 per cent in the past seven months. Businesses in the housing materials, house construction, and household furnishings sectors will benefit from a rise in home building from four-decade lows.

But here are some of the reasons why one should not expect strong growth, or even necessarily sustained average growth beyond 2011. First, this is clearly not a traditional export-led upturn, given the exchange rate is now around 10 per cent above its trade weighted average level. At the same point in the cycle of recovery from the 1997/98 Asian Crisis, the currency was about 9 per cent below and didn't go above average until early 2003.

A domestic-led upturn has nasty implications for the current account balance, which could bring expressions of concern from credit rating agencies and investors by 2011-12. This will bring a currency correction, but potentially also an extra lift in interest rates and slap to confidence.

Farm debt levels are high – especially in dairying – the payout is low, costs keep rising, so a traditional dairy spending spree looks extremely unlikely this cycle.

Long-term fixed interest rates are now at above-average levels, and when the Reserve Bank starts tightening monetary policy by mid-2010, a lot of borrowers (now resetting from fixed to floating rates) will have their cash outflows affected quite quickly.

Our biggest export sector is tourism, and if it were not for the 6.5 per cent gain in visitors from Australia during the past year – courtesy of tax handouts across the ditch – visitor numbers would have fallen 9 per cent. Such a decline may, however, be revealed in the coming year as the Aussie fiscal stimulus has ended, other economies have shattered citizens, and our exchange rate is very high for a far-flung destination with an increasingly tarnished "clean green" image.

Finally, banks cannot access credit as easily offshore as was the case in the past, and it costs more than before. That means interest rates for savers will now be permanently more attractive, thus offering a disincentive to spend. Secondly, the need to increase the proportion of funding from domestic sources means reduced willingness to lend – along with extra cost increases soon as capital requirements get tightened.

The intensity of these negative factors cannot be ignored. That is why although we economists speak of a return to average growth we don't think the sometimes record business and consumer confidence readings are going to blindly translate into strong growth.

» Tony Alexander is the chief economist for the Bank of New Zealand.

- © Fairfax NZ News

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