## cr17111 ## Source details **Canonical URL:** [cr17111](https://www.imf.org/-/media/files/publications/cr/2017/cr17111.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17111.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17111.pdf.json) --- ### Context and recent developments - Since early 2011 expansion driven by reconstruction after the 2011 Canterbury earthquake, accommodative monetary policy, and a net migration wave boosting residential investment and services exports. - Macro-financial features and vulnerabilities: - Rapid housing credit expansion, strong residential investment, buoyant house prices, household debt ratios rising. - Net foreign liability ratio among the highest in advanced economies (Annex I). - Four biggest banks are subsidiaries of large Australian banks, contributing to external funding stability. - Growth and labor market (recent) - GDP growth accelerated to 4 percent — some 1½ percentage points above trend. - Employment growth averaged over 4½ percent in 2016, up from about 2¼ percent in 2015. - Net migration flows remained high in 2016 at 2¾ percent of the labor force. - Unemployment rate fluctuated around the NAIRU of about 5 percent in 2016. - Inflation and monetary policy (recent) - Headline inflation moved back into the bottom of the target range in 2016Q4, below the midpoint for five years. - RBNZ policy rate lowered in three 25 basis point steps to 1.75 percent in 2016. - External sector and exchange rate (recent) - Real exchange rate remained above its longer-term average—some 14 percent as of end-2016—but about 7 percent off its 2014 peak. - Terms of trade are only 10 percent below their 2014 peak. - Housing market and household sector (recent) - Real house prices increased by more than 10 percent in 2016. - Residential investment ratio increased further. - Household saving ratio estimated at around 1 percent of gross disposable income. - Household gross debt-to-income ratio across all households around 168 percent, exceeding its pre-GFC peak of around 160 percent. - Share of investor loans with DTI greater than 7: one third. ### Outlook (baseline) - Growth and inflation - Near-term growth to rebound after 2016Q4 weakness then moderate toward trend. - Near-term support: continued high net migration, reconstruction after the Kaikoura earthquake, stronger business investment, robust services export growth. - Medium term: net migration expected to moderate as Australian labor markets strengthen; rising interest rates expected to dampen residential investment and aggregate demand. - Inflation should strengthen as capacity constraints take hold over the next one to two years; wage pressure expected to remain muted with high migration. - Macro-financial baseline - Gradual moderation of house price inflation and stabilizing housing vulnerabilities in the medium term. - Main drivers: tighter macroprudential policies, higher interest rates, lower net migration, increasing supply. - As credit growth slows, banks’ international net wholesale funding will moderate. ### Risks (selected) - Near-term upside risks - Stronger net migration and stronger terms of trade could lead to faster debt reduction, increase likelihood of tax cuts, and encourage infrastructure spending. - Near-term downside risks - Tighter external financial conditions or macroprudential constraints could slow credit, investment, and growth more than expected. - A global dairy production pickup could lower global dairy prices, harming domestic dairy production and exports. - Macro-financial downside risks - Rising household debt amplifies high-impact external shocks through household deleveraging and a housing correction. - Feedback could include financial sector stress and possible bank balance sheet stress affecting New Zealand and Australian parent banks. ### Authorities’ views on outlook and risks - Authorities broadly shared staff’s views: spare capacity has shrunk; inflation expected to rise gradually to the middle of the target range near-to-medium term. - Drivers of growth identified: strong net migration, supporting consumption and construction; strong service exports. - External downside risks remain major concern (China slowdown; uncertainty on U.S. recovery and rate tightening; global trade policy shifts). - Authorities view domestic risks as more balanced; acknowledged high household debt could amplify a large negative shock. ### Monetary and fiscal policy discussion — staff views - Monetary policy - Current accommodative setting appropriate until inflation firmly within target range; RBNZ should stand ready for an unexpected upshift. - Near-term inflation risks asymmetric to the downside after long period below target, strong labor force growth, possible currency appreciation, temporary oil-price effects. - Macroprudential policies better placed to tackle housing-related financial stability risks than monetary policy. - Fiscal policy - Slightly contractionary fiscal stance will balance the macroeconomic policy mix in the near term. - Baseline expenditure path includes higher infrastructure spending and new growth-friendly measures, yielding a positive fiscal impulse in the current fiscal year. - Consolidation implied: increases of about ½ percent of GDP in the cyclically-adjusted primary balance consistent with growth moderating to trend. - Cyclical revenue windfalls should be used to reduce public debt. ### Monetary policy and inflation outlook (RBNZ perspectives) - Inflation expectations - Medium-term expectations anchored at around 2 percent; short-term expectations approaching 2 percent. - Wage and tradables dynamics - Wage pressures contained by positive labor supply shock. - Tradables inflation beginning to accelerate, mitigated by slow appreciation of free-floating exchange rate. - Policy stance - Current expectations: OCR need not be raised until late 2018 to prevent overshooting; RBNZ stands ready to move OCR in either direction. ### Macroprudential policy, household risk, and staff recommendations - Effectiveness and limitations - Exposure limits to high LVRs reduced potential bank losses but have not fully reined in housing credit growth or reduced banks’ vulnerabilities related to household debt. - Increasing DTI ratios imply higher household default probabilities. - Staff recommendation - Extend macroprudential toolkit to include a DTI or (stressed) DSTI instrument, in line with FSAP recommendations, to directly target household debt-service vulnerabilities. - Activate new instrument if October 2016 macroprudential package effects on credit growth or credit risk prove temporary. - Authorities’ position - Extension under review; any change must be agreed with the Minister of Finance per the Memorandum of Understanding. - RBNZ planned consultation document by mid-May; would not apply new instrument immediately upon availability. ### Macroprudential measures deployed and empirical evidence - LVR-related measures timeline and exposure limits - October 2013: 10 percent limit on share of residential mortgage loans with an LVR above 80 percent. - November 2015: - Auckland: 5 percent limit on investor loans with LVR above 70 percent. - Auckland: 10 percent limit on owner-occupier loans with LVR above 80 percent. - Rest of New Zealand: 15 percent limit on loans with LVR above 80 percent. - October 2016: - 5 percent limit on investor loans with LVR above 60 percent. - 10 percent limit on owner-occupier loans with LVR above 80 percent. - Complementary measures - Capital gains from re-sale of non-primary residences within two years taxable as of 2016. - Reporting and taxation rules for foreign buyers tightened. - Empirical findings - Moderation of housing credit growth after end-2013 measures and tentatively after October 2016 package. - Actual credit and house price growth remained below counterfactual without LVR restrictions; statistically significant difference only for house price developments in Auckland. - Share of loans with LVR above 80 percent in total new loans fell drastically and remained low. - Investor lending share in new loans fell only slightly and temporarily after November 2015; appears reduced more substantially after October 2016 tightening. - Household debt-serviceability risks - Most mortgage loans variable-interest or fixed for less than one year, creating debt serviceability risks when interest rates rise. - DTI increases across borrower categories increase vulnerability; one third of investor loans have a DTI greater than 7. - Policy implication - Because LVR caps can become less binding as prices rise, complementary DTI measures could provide a more permanent anchor to limit debt serviceability risks. ### Housing supply, local governments, and taxation (Box 1) - Local government revenue and incentives - Property taxes primary revenue source for local councils; taxes determined by local councils’ budget needs, potentially creating insider-outsider dynamics. - Development charges and infrastructure funding - Local councils rely on development charges or developer agreements; development charges often do not finance infrastructure upgrades in existing neighborhoods. - Zoning and supply constraints - Zoning rules differ across local councils; in Auckland rules simplified into 6 zones under the Auckland Unitary Plan (entered into force in part in November 2016). - Unitary Plan may facilitate faster correction of national housing demand-supply imbalances given Auckland’s role. - Local government borrowing and central support - Councils pool debt issuance under New Zealand Local Government Funding Agency (LGFA); central government is a 20 percent shareholder. - Central government introduced the NZ$ 1bn Housing Infrastructure Fund in FY2016/17, repayable without interest over 10 years; only Auckland, Christchurch, and eight other local councils qualify. ### External balance sheet and external sector assessment (Annex I) - Headline metrics - NIIP amounted to minus 63.3 percent of GDP at end-2016Q3. - Without valuation effects, cumulated current account deficits since 2000Q2 would imply net foreign liabilities close to 80 percent of GDP at end-2016Q3. - Returns and valuation effects (2000Q3-2016Q3) - Average total return on external assets: 2.2 percent. - Average total return on external liabilities: 1.8 percent. - Currency and maturity composition (mid-2016 / end-2016Q3) - Almost 98 percent of external liabilities effectively denominated in domestic currency. - About 58 percent of assets are foreign currency-denominated. - Net long foreign currency position close to 30 percent of GDP (if foreign assets unhedged). - 58% of non-equity liabilities were medium- to long-term debt instruments. - Share of short-term debt liabilities decreased by some 20 percentage points since early 2000s. - Sectoral composition and banks - Net external liabilities of government account for 18 percent of total at 2016Q3. - Banks responsible for about two-thirds of net external liabilities as of 2016Q3. - Some 70 percent of banks’ net foreign liabilities (and roughly 60 percent of gross foreign liabilities) traced to related parties; Australian parent banks main source. - External sector assessment - Historical current account deficit averaged around 3¾ of GDP. - Current account deficit narrowed to 2.7 percent of GDP in 2016 from 3.4 of GDP in 2015. - Cyclically-adjusted current account balance in 2016 estimated at minus 2.1 percent of GDP; exceeds estimated norm by 1.1 percent (norm standard deviation 0.7). - REER assessed as overvalued by 4 percent (EBA elasticity -0.25). - REER nearly 15 percent above long-run average as of December 2016. - External position in 2016 assessed as moderately weaker than implied by fundamentals and policy settings. ### Risk Assessment Matrix (selected external and domestic risks) - Domestic risks and policy responses (likelihood / time horizon / impact) - Stronger growth because of higher net migration or stronger terms of trade: Likelihood M; Time horizon Short term to medium term; Impact M; Policies: accelerated fiscal consolidation, monetary policy tightening and tighter macroprudential policies if needed. - Slower growth because of lower dairy price or tighter credit constraints: Likelihood M; Time horizon Short to medium term; Impact M; Policies: monetary policy easing, coupled with fiscal policy easing if zero lower bound. - Housing market downturn: Likelihood L; Time horizon Short to medium term; Impact H; Policies: monetary and selective macroprudential policy easing; fiscal stimulus; mortgage debt restructuring measures. - External risks (likelihood / time horizon / impact) - Significant China slowdown: Likelihood L/M; Time horizon Short to medium term; Impact H; Policies: combined monetary, selective macroprudential, and fiscal easing. - Tighter and more volatile global financial conditions: Likelihood M; Time horizon Short term; Impact M; Policies: monetary, selective macroprudential, and fiscal easing. ### Net migration, employment, investment, and productivity effects (selected empirical findings) - VAR results and interpretation - An unexpected increase in Australian unemployment tends to increase New Zealand unemployment and reduce wage growth. - Other shocks to net migration tend to drive unemployment lower with little impact on wage growth. - Cross-country regression (16 OECD countries, 1990–2014) - A net migration flow of 1 percent of total population associated with increase in output of nearly 1.5 – 2 percent, driven by employment and capital stock increases. - Key growth estimates (Column (1) OLS; Column (2) 2-SLS): - Output: 1.84** ; 1.54** - Employment: 2.01** ; 1.73** - Hours: 1.82** ; 1.72** - Capital: 1.82** ; 1.94** - Output per worker: -0.16 ; -0.16 - TFP: -0.10 ; -0.25 - ** and * indicate significance at 5% and 10% respectively. - Migration volatility effects - Interaction of migration size with high volatility shows negative and sizeable coefficients, suggesting volatility can dampen output and input responses; capital stock adjustment interaction significant at just above 10 percent. - Conclusions - Drivers of migration matter: current wave influenced by both weaker Australian labor markets and stronger local demand. - Output per worker remains unaffected by migration; investment adjusts quickly; no robust negative short-run TFP effects. - Volatility of migration flows can dampen rapid adjustment in factor inputs. ### Financial system resilience, bank capital, funding, and oversight - Capital and stress tests - Preliminary RBNZ estimates suggest CET-1 ratios on internationally comparable basis would be at least 1 to 2 percentage points above published headline figures. - FSAP stress tests indicate CET-1 ratio remaining above 7 percent in major shocks; total capital requirements including conservation buffers could be breached in stress scenarios. - Funding trends - Banks increasingly used wholesale funding in 2016; about 60 percent of that wholesale funding was foreign. - Newly introduced APRA funding exposure limits for Australian parents to New Zealand subsidiaries will create additional refinancing needs, with transition to end-2020. - Staff recommendation on capital - RBNZ capital review should recommend higher capital ratios for larger banks; benchmark: somewhat higher than APRA’s “unquestionably strong” targets for large Australian banks. - Options: surcharge for domestic systemically important institutions or generally higher minimum capital requirements. - Oversight, crisis resolution, AML/CFT - Recommendations: increase regulatory discipline weight in three-pillar framework; strengthen home-host cooperation with APRA; align financial market infrastructure regulation with international standards; broaden asset management regulatory perimeter; enhance Open Bank Resolution credibility (including higher de minimis exemptions). - AML/CFT: legislation to subject several DNFBPs to AML/CFT; new disclosure requirements for foreign trusts as of February 2017; RBNZ guidance on remittance corridor AML obligations. ### Supporting growth and productivity — policy priorities - Structural assessment - Policy settings close to best practice among OECD but per capita income and productivity gaps remain; income estimated 20 percent below predicted by policy settings. - Multifactor productivity growth slowed since early 2000s; capital intensity stagnated. - Policy measures recommended - Address housing supply bottlenecks broadly: urban planning reform; reform local-central fiscal relationships. - Consider additional local infrastructure revenue sources (e.g., ad-valorem component for property taxes for infrastructure). - Ramp up “Innovative New Zealand” spending: NZ$761 million over the next four years (pilot-dependent) and complementary tax incentives for R&D. - Tax reform to raise private saving incentives and discourage real estate as a saving vehicle. - Trade liberalization and reforms (including occupational licensing) to increase exports to 40 percent of GDP by 2025. - Authorities’ actions - Auckland Unitary Plan and Housing Infrastructure Fund viewed positively; pursuing further planning-system reforms. - Ongoing Business Growth Agenda aims to raise exports to 40 percent of GDP by 2025. ### Annex VI — External and Fiscal DSAs (selected figures and projections) - External debt baseline (percent of GDP) - 2011: 123.8; 2012: 120.8; 2013: 109.4; 2014: 109.4; 2015: 112.6; 2016: 110.7; 2017: 110.3; 2018: 110.7; 2019: 111.1; 2020: 111.6; 2021: 112.2. - Current account and trade (percent of GDP) - Current account deficit (excluding interest payments): 2016: 1.4; 2017: 0.1; 2018: 0.7; 2019: 0.9. - Deficit in balance of goods and services: 2016: -0.7; 2017: -0.3; 2018: 0.2. - Exports (percent of GDP): 2016: 26.8; 2017: 26.7; 2018: 26.6. - Imports (percent of GDP): 2016: 26.1; 2017: 26.4; 2018: 26.8. - Gross external financing need (US$ billions) - 2016: 70.7; 2017: 80.2; 2018: 87.7; 2019: 92.4; 2020: 97.4; 2021: 102.7. - Public sector debt projections (percent of GDP) - Nominal gross public debt: 2015: 28.1; 2016: 29.6; 2017: 28.9; 2018: 26.9; 2019: 24.1; 2020: 20.9; 2021: 17.2; 2022: 13.3. - Real GDP growth projections: 2017: 3.1; 2018: 2.9; 2019: 2.6; 2020: 2.6; 2021: 2.6; 2022: 2.5. - Primary balance (baseline, percent of GDP): 2017: 1.2; 2018: 2.2; 2019: 2.7; 2020: 3.2; 2021: 3.4; 2022: 3.4. - Effective interest rate projections (percent): 2017: 5.0; 2018: 4.9; 2019: 5.0; 2020: 5.2; 2021: 5.5; 2022: 5.9. - Change in gross public sector debt (annual, percent of GDP): 2015: 2.1; 2016: 0.1; 2017: -0.6; 2018: -2.0; cumulative: -19.5 through projection horizon. - Sovereign market indicators (as of January 30, 2017) - U.S. 10-yr (bp): 105. - 5Y CDS (bp): 87. - Fiscal policy intentions - Authorities’ objective: reduce net debt to around 20 percent of GDP in 2020, and to between 10 and 15 percent of GDP by 2025. - Government fiscal stance: short-term slightly expansionary; tighter stance forecast from 2018/19. - Policy intent: resume contributions to the New Zealand Superannuation Fund once net debt falls below 20 percent of GDP. *Source: IMF staff report excerpts — cr17111.* ### 1. Local Governments and the Housing Supply Constraints ______________________________________ 18 ### 1. Local Governments and the Housing Supply Constraints ______________________________________ 18 ### Context - Since early 2011, New Zealand experienced a solid expansion driven by reconstruction spending after the 2011 Canterbury earthquake, accommodative monetary policy, and a net migration wave that reinforced residential investment, improving services exports, and strong terms of trade by historical standards. - Containing macro-financial vulnerabilities related to a booming housing market has been challenging: - Rapid housing credit expansion accompanied strong residential investment and buoyant house prices, with household debt ratios rising again. - The current account deficit remained below average in the expansion. - The net foreign liability ratio is among the highest in advanced economies but broadly stable (Annex I—External Balance Sheet). - The four biggest banks are subsidiaries of large Australian banks, which contributes to stability in external funding. ### Recent developments - Growth and labor market - GDP growth accelerated to 4 percent — some 1½ percentage points above trend. - Employment growth averaged over 4½ percent in 2016, up from about 2¼ percent in 2015 and well above average. - Net migration flows remained high in 2016 at 2¾ percent of the labor force. - The unemployment rate fluctuated around the NAIRU of about 5 percent in 2016. - Inflation and monetary policy - Headline inflation moved back into the bottom of the target range in 2016Q4 though it still remains below the midpoint, now for five years. - Tradable price deflation rose to near zero with recent global oil price increases; non-tradable inflation strengthened in the second half of 2016. - The RBNZ lowered the policy rate in three 25 basis point steps to 1.75 percent in 2016. - External sector and exchange rate - The current account balance is moderately weaker than its fundamental level; the exchange rate remains moderately overvalued (Annex II—External Sector Assessment). - The real exchange rate remained above its longer-term average—some 14 percent as of end-2016—but came about 7 percent off its 2014 peak. - Terms of trade are only 10 percent below their 2014 peak. - Housing market and household sector - Real house prices increased by more than 10 percent in 2016. - Residential investment ratio increased further. - Standard metrics of house price overvaluation edged up; New Zealand ranks in the top range across OECD countries. - Recent housing indicators (sales and building approvals) suggest some cooling toward end-2016; a third round of tightening macroprudential measures in October 2016 likely drove much of the cooling. - Growth in real credit to households remained strong alongside booming house prices. - Share of loans with very high loan-to-value ratios (LVR) fell; share of investor lending fell due to tighter macroprudential policy. - Debt-to-income (DTI) ratios rose for all buyer categories. - Household saving ratio has decreased steadily since 2012 and is estimated at around 1 percent of gross disposable income. - Household net worth increased as the value of household assets rose faster than debt; leverage has trended slightly down. - The sector’s saving-investment balance is now negative, implying net lending by other sectors and highlighting feedback from credit to aggregate demand. - Consumption as a fraction of household net worth has decreased slightly. ### Outlook - Baseline growth and inflation - Near-term growth to rebound after 2016Q4 weakness and then moderate toward trend. - Near-term support from continued high net migration, reconstruction after the Kaikoura earthquake, and stronger business investment. - Services export growth expected to remain robust. - Over the medium term, net migration expected to moderate as Australian labor markets strengthen, and rising interest rates are expected to dampen residential investment and aggregate demand. - Inflation should strengthen as capacity constraints increasingly take hold over the next one to two years; wage pressure expected to remain muted with continued high migration in the near term. - Macro-financial baseline - Gradual moderation of house price inflation and stabilizing housing vulnerabilities in the medium term. - Main drivers of moderation: tighter macroprudential policies, higher interest rates, lower rates of net migration, and increasing supply. - As credit growth slows, banks’ international net wholesale funding will moderate. ### Risks - Near-term growth risks - Upside: stronger net migration and stronger terms of trade could lead to faster debt reduction, increase likelihood of tax cuts, and encourage infrastructure spending. - Downside: tighter external financial conditions or macroprudential constraints could slow credit, investment, and growth more than expected; lower external demand and commodity prices (including from increasing protectionism) would lower growth. - A global dairy production pickup could lower global dairy prices, harming domestic dairy production, exports, domestic demand, and strain the dairy sector financially. - Macro-financial downside risks - Rising household debt remains a risk to financial stability and would amplify a high-impact downside shock—likely external—through household deleveraging and a housing correction. - Feedback effects could include financial sector stress and possible bank balance sheet stress in a prolonged downturn, affecting both New Zealand and Australian parent banks and subsidiaries. ### Authorities’ views on outlook and risks - Authorities broadly shared staff’s views: spare capacity has shrunk; inflation expected to rise gradually to the middle of the target range near-to-medium term. - Drivers of growth identified: strong net migration, supporting consumption and construction; strong service exports. - Narrower current account in 2016 partly reflected very low global interest rates; some further depreciation of the exchange rate would help boost tradable sector growth. - Recovery in dairy prices would help restore farm incomes but translate into more spending with lag as farmers repay debt from loss financing. - External downside risks remain the major concern (slower trading partner growth, particularly China; uncertainty on U.S. recovery and rate tightening; global trade policy shifts). - Authorities view domestic risks as more balanced; elevated net migration supports growth; Kaikoura earthquake disruption expected to be minor. They acknowledged high household debt could amplify a large negative shock. ### Policy discussions — Monetary and fiscal - Context - The current net migration wave has posed fewer demand-management challenges because of its composition: fewer emigrants (including lower-skilled New Zealanders) and more immigrants who are students and younger cohorts (Annex IV—Migration). This likely explains weaker aggregate demand effects and helped keep wage pressures in check despite a construction boom. - Monetary policy must address low inflation and currency strength; currency overvaluation and return differentials pose risks to tradable sectors and could exacerbate external imbalances. - Output gap has closed and capacity constraints may be emerging. - Fiscal position expected to strengthen: strong revenue growth forecast across all sources; central government’s spending plans for the next four years are based on conservative inflation and real GDP forecasts (consistent with IMF staff); net debt should decrease below 20 percent of GDP by FY2020/21. - Staff views on policy mix - Monetary policy - The current accommodative monetary policy setting is appropriate until inflation is firmly within the target range, but the RBNZ should stand ready for an unexpected upshift in the inflation path. - Near-term inflation risks are asymmetric to the downside after a long period below target, strong labor force growth, possible renewed currency appreciation, and some temporary inflation uptick from higher oil prices. - If an unexpected upshift in inflation occurred, domestic financial conditions would tighten in expectation of a monetary response, reducing further upside risks to actual inflation. - While low interest rates have contributed to rising house prices, macroprudential policies are better placed to tackle housing-related financial stability risks. - A change in global environment or domestic conditions could require earlier policy tightening than implied by RBNZ forecasts; financial conditions are already less accommodative due to currency appreciation and upward pressure on banks’ lending and funding rates from widening gap between credit and deposit growth and deposit competition. - Fiscal policy - A slightly contractionary fiscal stance will balance the macroeconomic policy mix in the near term. - Baseline expenditure path includes higher infrastructure spending and new growth-friendly measures, resulting in a positive fiscal impulse in the current fiscal year; with the economy approaching capacity, this impulse is helpful while inflation remains low. - Current budget plans imply a slightly contractionary fiscal stance going forward: consolidation leading to increases of about ½ percent of GDP in the cyclically-adjusted primary balance is consistent with growth moderating to trend. - Consolidation would also help moderate upward pressure on the currency. - Stronger-than-expected momentum may produce revenue surprises, some structural (higher labor force growth) and accompanied by increased demand for infrastructure and services; New Zealand has fiscal space to accommodate needs from stronger population growth. - Cyclical revenue windfalls should be used to reduce public debt. *Source: IMF staff report excerpt — "1. Local Governments and the Housing Supply Constraints" (cr17111).* ### 20. The RBNZ feels that all the conditions are in place for a slow, orderly rise in inflation. ### 20. The RBNZ feels that all the conditions are in place for a slow, orderly rise in inflation. ### Monetary policy and inflation outlook - Inflation expectations: - Medium-term expectations remain very well anchored at around 2 percent. - Short-term expectations are now also approaching 2 percent. - Wage and tradables dynamics: - Wage pressures are contained by the ongoing positive labor supply shock. - Tradables inflation is beginning to accelerate because of broader international trends, mitigated by the ongoing, slow appreciation of the free-floating exchange rate. - Policy stance and reaction function: - Current expectations are that the overnight cash rate (OCR) need not be raised until late 2018 to prevent any overshooting of the target range for inflation. - The RBNZ stands ready to move the OCR in either direction if warranted by shocks. ### Fiscal policy and public finances - Authorities’ fiscal stance: - Fiscal plans are considered appropriate given the current upswing in migration and related demands on government services and capacity. - The government has increased spending on infrastructure nationally and created the Housing Infrastructure Fund to help address housing capacity constraints. - Fiscal anchor: - Authorities continue to focus on strengthening fiscal buffers by reducing net public debt to around 20 percent of GDP by 2020. ### Housing-related macro-financial vulnerabilities (context) - Near-term trajectory: - Housing-related macro-financial vulnerabilities could increase further in the short term. - Real house prices and household debt ratios will likely continue increasing in the near term, even as factors underpinning strong real house price gains are expected to ease in the medium term. - Supply-side and policy drivers: - Policy measures to enable more supply and a prospective turn in real interest rates expected to ease pressures in the medium term. ### Macroprudential policy and household risk - Effectiveness of existing tools: - Exposure limits to high LVRs have reduced potential bank losses in case of household defaults but have not fully succeeded in reining in housing credit growth or reducing banks’ vulnerabilities related to household debt. - Increasing debt-to-income ratios imply higher household default probabilities. - Staff recommendation: - The macroprudential toolkit should be extended to include a DTI or (stressed) debt service to income (DSTI) instrument, in line with FSAP recommendations, to directly target the most acute household vulnerability. - Other macroprudential instruments (LVRs) are approaching practical limits or address the problem only indirectly. - The new instrument should be activated if the effects of the October 2016 macroprudential package on credit growth or credit risk profile prove to be temporary. - Authorities’ position: - The extension with a debt-to-income instrument was under review; any change must be agreed with the Minister of Finance per the Memorandum of Understanding. - The RBNZ planned to publish a consultation document by mid-May and clarified it would not apply the new instrument immediately upon availability but only if the most recent tightening proved ineffective. ### Housing supply, taxation, and structural measures - Supply-side measures: - Orderly resolution of demand-supply imbalance, particularly in Auckland, requires policies to boost housing supply. - The Auckland Unitary Plan (came into effect in November 2016) and the Housing Infrastructure Fund support supply and infrastructure financing at local level. - Tax measures (staff view): - Broader taxation of capital gains in real estate and limitations to subtract negative gearing losses from other income sources would reduce incentives for leveraged real estate investments and redirect saving incentives to other investments. ### Bank resilience, capital, and funding - Capital and stress tests: - Preliminary RBNZ estimates suggest CET-1 ratios on an internationally comparable basis would be at least 1 to 2 percentage points above published headline figures (given relatively more conservative risk weights in New Zealand). - FSAP stress tests indicate banks have sufficient capital buffers to withstand major shocks, with the CET-1 ratio remaining above 7 percent; total capital requirements including conservation buffers could be breached in stress scenarios. - Funding trends: - After several years of meeting funding needs through domestic deposits, banks increasingly resorted to wholesale funding in 2016, of which about 60 percent was foreign. - Credit growth is expected to exceed deposit growth at least in the short term. - Newly introduced funding exposure limits for Australian parents to New Zealand subsidiaries (by APRA) will lead to additional refinancing needs for some banks, with a transition period to end-2020. - Staff recommendation on capital: - The ongoing RBNZ capital review should recommend higher capital ratios for the larger banks, given the systemic risk dimension. - A reasonable benchmark could be capital adequacy ratios for New Zealand’s large banks that are somewhat higher than APRA’s “unquestionably strong” capital targets for the large Australian banks. - Higher capital requirements could be instituted by a surcharge for domestic systemically important institutions or by generally higher minimum capital requirements. - Authorities’ view on capital and liquidity: - Authorities expect the forthcoming capital review would deliver conservative capital requirements relative to Basel III and international peers and noted their approach would tend to be more conservative than for Australian parent banks. - A review of regulatory requirements related to bank funding and liquidity was planned; post-GFC funding and liquidity ratio regime introduced ahead of Basel III had already resulted in substantial improvements. ### Oversight, crisis resolution, and AML/CFT - Oversight and crisis resolution upgrades recommended: - Increase the weight of regulatory discipline relative to self and market discipline in New Zealand's three-pillar bank regulation approach. - Foster stronger home-host supervisory cooperation with APRA. - Align regulatory and supervisory framework for financial market infrastructures with international standards. - Broaden the regulatory perimeter for the asset management industry. - Enhance the credibility of the Open Bank Resolution (OBR) framework, including by higher de minimis exemptions from freezing and haircutting deposits under the OBR in lieu of deposit insurance. - AML/CFT and remittances: - Authorities introduced legislation to subject several designated non-financial businesses and professions to AML/CFT requirements and, as of February 2017, introduced new disclosure requirements for foreign trusts on beneficial ownership. - The RBNZ issued a 2015 statement clarifying AML obligations for remittance corridors to Pacific Island States and advocated a measured risk management approach by banks towards money transfer operators (MTOs). - Authorities participate in international fora and provide technical assistance to Pacific Island States on AML/CFT compliance, payments infrastructure modernization, and remittance solutions. ### Supporting growth and productivity - Structural context: - Structural policy settings are close to or mark best practice among OECD economies, but persistent per capita income and productivity gaps remain; income is lower than predicted by these policy settings by an estimated 20 percent. - Multifactor productivity growth has slowed since the early 2000s; capital intensity has stagnated. - Policy measures to support growth: - Address housing supply bottlenecks more broadly (comprehensive reform of urban planning legislation; reform of local-central government fiscal relationships). - Consider additional local infrastructure revenue sources, such as an ad-valorem component for property taxes devoted to infrastructure maintenance, and mechanisms for central government redistribution to assist smaller communities. - Ramp up “Innovative New Zealand” spending if pilot successful; the program will spend NZ$761 million over the next four years and could be complemented by tax incentives for R&D spending. - Tax reform to raise incentives for private saving and discourage real estate investment as a saving vehicle could enhance domestic capital market depth and lower risk premiums. - Trade liberalization and reforms (including occupational licensing) to strengthen competition and productivity, with an aim to increase the share of exports in GDP to 40 percent by 2025. - Authorities’ actions: - Authorities view recent measures (Auckland Unitary Plan, Housing Infrastructure Fund) as positive and are pursuing further planning-system reforms. - Ongoing Business Growth Agenda (BGA) aims to deepen international connections, raise exports to 40 percent of GDP by 2025, diversify the export base, support innovation, and boost technical workforce capabilities. ### Staff appraisal, outlook, and policy priorities - Macroeconomic assessment: - New Zealand has enjoyed a solid expansion driven by high net migration and strong construction; the economy is now broadly at capacity and headline inflation has returned into the target range. - Macro-financial vulnerabilities in the household sector have increased: high house price inflation and a household debt to GDP ratio that is high and still rising. - With commodity prices off their peaks, the real effective exchange rate has depreciated somewhat but remains moderately overvalued relative to medium-term fundamentals. - Outlook and risks: - Economic growth should remain above trend into 2018 before moderating. - Inflation is projected to rise gradually toward the 2 percent midpoint of the RBNZ target range. - Tighter macroprudential policies, higher interest rates, moderating net migration, and easing housing supply constraints should result in lower house price increases and stabilization of household debt relative to income. - Upside risks: stronger net migration and terms of trade. - Downside risks: tighter external financial conditions and macroprudential constraints; high-impact downside shocks could pose risks to financial stability due to amplification effects and possible bank balance sheet stress from high household debt. - Policy recommendations: - Focus on managing risks and harnessing opportunities from strong economic and population growth. - Maintain broadly appropriate macroeconomic policy settings. - Contain household balance sheet vulnerabilities to protect financial sector stability while addressing housing demand-supply imbalances. - Provide infrastructure and services to promote human and knowledge-based capital to sustain growth opportunities. - Monetary policy assessment: - Current monetary settings appropriately address low inflation; inflation is expected to return gradually to the midpoint of the target range. - Downside risks to inflation remain a concern after a long period of inflation below target, strong labor force growth, and some temporary upticks (e.g., higher oil prices). *Source: IMF staff report (cr17111), chapter excerpts on New Zealand macroeconomic and financial sector assessment.* ### 45. The strong fiscal position provides room to accommodate the needs from strong ### 45. The strong fiscal position provides room to accommodate the needs from strong ### Fiscal stance and fiscal space - The latest budget update already incorporates higher infrastructure and social spending in response to higher-than-expected population growth, while still providing for a slightly contractionary fiscal stance going forward that will balance the macroeconomic policy mix in an economy that is now operating broadly at capacity. - There is fiscal space to allow for higher structural spending if needed. - Stronger-than-expected revenue for cyclical reasons should be used to reduce public debt. ### Housing-related macro-financial vulnerabilities and macroprudential policy - To manage housing-related macro-financial vulnerabilities, the RBNZ’s macro-prudential toolkit should be broadened. - To reduce the probability of bank balance sheet distress from rising household debt defaults under downside shocks, the macroprudential toolkit should be extended to include a DTI or (stressed) DSTI instrument, in line with recommendations by the FSAP. - These instruments would directly target the most acute household vulnerability. - Other macroprudential instruments available to the RBNZ are approaching their practical limit or address the problem indirectly. - The new instrument should be activated in the event that effects of the most recent macroprudential package on credit growth prove to be temporary. ### Financial system resilience, bank capital, and oversight - Financial system resilience should be strengthened through higher bank capital requirements and upgrades to oversight and crisis resolution regimes. - The large banks feature a strong similarity in business models with a high-risk concentration and significant reliance on foreign funding, which adds a systemic risk dimension. - In staff’s view, the on-going RBNZ capital review should recommend capital adequacy ratios for New Zealand’s large banks that are somewhat higher than the Australian Prudential Regulation Authority’s (APRA’s) “unquestionably strong” capital targets for the large Australian banks could be a reasonable benchmark. - Implementation of pertinent FSAP recommendations would further strengthen the oversight and crisis resolution regimes. ### Measures to lift potential growth - Measures should focus on leveraging the benefits from high net migration, innovation, and interconnectedness. - These benefits could help compensate for New Zealand’s remoteness and small market size. - Targeting housing supply bottlenecks more broadly would safeguard the attractiveness for high-skilled immigration and business. - Redirecting saving incentives from housing to other investments would lower the incentives for investment in housing and contribute to deeper capital markets. - Providing additional support for innovation could provide a basis for diversification and lift productivity. - Continuing efforts toward further trade liberalization, in regional and multilateral fora, as intended, could also help in this respect. ### Other - It is expected that the next Article IV Consultation with New Zealand will be held on the standard 12-month cycle. *NEW ZEALAND 18 INTERNATIONAL MONETARY FUND* ### Box 1. Local Governments and the Housing Supply Constraints ### Box 1. Local Governments and the Housing Supply Constraints ### Role of local councils and revenue framework - Property taxes are the primary tax revenue source for local councils (along with user charges and other fees). - Property taxes are typically determined by the local councils’ budget needs. - This property tax–based revenue structure can promote insider-outsider dynamics: existing homeowners may be reluctant to pay for the infrastructure needed for new housing if they do not benefit directly. ### Development charges and infrastructure funding - Local councils rely on development charges, or agreements with developers, for provision of infrastructure services. - Development charges most often do not provide the revenue for the infrastructure upgrades needed in existing neighborhoods from new housing (e.g., to deal with congestion). ### Zoning rules and constraints on supply - Rules about zoning for housing (and development in general) differ across local councils. - Zoning rules are another avenue through which insiders may constrain outsiders from constructing new supply. - In Auckland, rules have been simplified into 6 zones under the Auckland Unitary Plan, entering into force (in part) in November 2016. - The Unitary Plan may facilitate faster correction of national housing demand-supply imbalances given Auckland’s significant role in those imbalances. - Note: The simplified zoning followed the unification of local authorities in the Auckland region in 2011 into one Council. ### Local government borrowing constraints and central government support - Many local councils face constraints on debt financing. - Local councils pool their debt issuance under the New Zealand Local Government Funding Agency (LGFA), implicitly guaranteed by the central government (as a 20 percent shareholder; the rest is held by 31 local councils). - The LGFA’s credit rating equals that of the central government, which it maintains by imposing relatively strict debt and deficit guidelines on members. - These guidelines have constrained some highly-indebted councils. - The central government introduced the NZ$ 1bn Housing Infrastructure Fund in the FY2016/17 Budget, available to finance high growth local councils’ infrastructure needs related to new housing (only Auckland, Christchurch, and eight other local councils qualify), repayable without interest over 10 years. *Source: IMF staff box: "Local Governments and the Housing Supply Constraints."* ### Annex I. New Zealand’s External Balance Sheet: Developments ### Annex I. New Zealand’s External Balance Sheet: Developments and Risk Profile ### Overview and headline metrics - New Zealand’s net international investment position (NIIP) amounted to minus 63.3 percent of GDP at the end of 2016Q3. - Without valuation effects, the cumulated current account deficits since 2000Q2 would have implied net foreign liabilities of close to 80 percent of GDP at the end of 2016Q3 (this difference also includes other, non-valuation factors). - The country has the largest net foreign liabilities relative to GDP among AAA-rated countries. ### Valuation effects and returns - Valuation effects mitigated the impact of persistent current account deficits; without them net foreign liabilities would have been larger. - Total returns (2000Q3-2016Q3): - Average total return on external assets: 2.2 percent. - Average total return on external liabilities: 1.8 percent. - Despite higher returns on assets, external liabilities are considerably larger, so the total return differential was not large enough to prevent a positive net payoff to nonresidents on the net liabilities, though the net payoff has been small compared to the average growth rate of nominal GDP. - If these trends in total returns continued, New Zealand’s net foreign liabilities would not increase if the current account deficit remained relatively small as a percent of GDP. Since the global financial crisis, the net foreign liability position has remained broadly stable for this reason. ### Structure of the external balance sheet and sources of resilience - Currency denomination: - As of mid-2016, almost 98 percent of the external liabilities were effectively denominated in domestic currency. - About 58 percent of assets are foreign currency-denominated. - Under the assumption that foreign assets in foreign currency are not hedged, New Zealand has a net long foreign currency position of close to 30 percent of GDP. - Implication: Currency depreciation leads to improvements in the external balance sheet; traditional adverse balance sheet effects from currency depreciation are less applicable. - Maturity and instrument composition (end-2016Q3 and comparisons to early 2000s): - 58% of non-equity liabilities were medium- to long-term debt instruments (maturities of more than 1 year). - The share of short-term debt liabilities decreased by some 20 percentage points since the early 2000s, reducing short-term refinancing risks. - 24% of assets were held in long-term debt instruments. - Net equity position has been broadly balanced at around zero; the net debt position closely matches the net foreign liability position in magnitude. - Sectors and the role of banks: - The net external liabilities of government account for 18 percent of the total at 2016Q3. - Non-residents hold close to two-thirds of outstanding government securities as of 2016Q3, with much of those holdings in long-term bonds. - Banks account for and are responsible for about two-thirds of net external liabilities as of 2016Q3. - Some 70 percent of banks’ net foreign liabilities (and roughly 60 percent of gross foreign liabilities) can be traced to related parties, with Australian parent banks being the main source. - Assessment: As long as Australian banks remain resilient, this related-party funding should be stable and likely associated with a better understanding of local market conditions than many unrelated external creditors. ### External sector assessment: current account, REER, and external sustainability - Historical current account and NIIP: - New Zealand has historically run a sizeable current account deficit, averaging around 3¾ of GDP. - These deficits reflect a long-standing structural savings-investment imbalance, particularly low savings, resulting in a sizeable net negative IIP. - Recent developments: - The current expansion has been mostly driven by domestic demand. The current account deficit initially widened but has since stabilized and remained below the long-run average throughout the expansion. - In 2015 the deficit widened temporarily with the sharp drop in dairy prices over 2014-2015. - The current account deficit narrowed to 2.7 percent of GDP in 2016 from 3.4 of GDP in 2015. - IMF model-based assessments: - The cyclically-adjusted current account balance in 2016 is estimated at minus 2.1 percent of GDP; this exceeds the estimated norm based on fundamentals and policy settings by 1.1 percent (the estimated norm has a standard deviation of 0.7). - The cyclical adjustment mainly reflects a positive output gap relative to the rest of the world; the New Zealand economy is estimated to be broadly at capacity. - Based on the estimated current account gap and assuming an EBA-estimated elasticity of the current account-to-GDP ratio and the REER of -0.25, the REER is assessed as overvalued by 4 percent (Table 1 reference in text). - The REER would need to depreciate by around 2 percent to be consistent with medium-term fundamentals (based on the external sustainability approach). - REER position and EBA assessments: - Except in 2009, the trade-weighted REER has run 5-20 percent above its long-run average (1989–2016). - With terms of trade below their 2014Q2 peak, the REER is some 7 percent below its peak reached around the same time; as of December 2016 the REER was still nearly 15 percent above the long run average. - IMF EBA approaches and estimates for 2014, 2015, 2016 (Text Table 1): - REER index regression: 14% (2014), 6% (2015), 8% (2016). - Current account regression: 2% (2014), 10% (2015), 4% (2016). - External sustainability: 12% (2014), 7% (2015), 2% (2016). - The REER overvaluation range narrowed recently; the range around the estimated degree of overvaluation declined from around 0-15 percent in 2014 to around 0-10 percent in the latest assessment. - Overall assessment: - Given the REER remains above the long-run average, the estimated current account gap, and IMF EBA estimates of the REER gap, the external position in 2016 is assessed to be moderately weaker than implied by fundamentals and policy settings. ### Risk Assessment Matrix — selected external and domestic risks, likelihood, horizon, impact, and policies - Domestic risks (likelihood L/M/H; time horizon; impact L/M/H; policy responses): - Stronger growth because of higher net migration or stronger terms of trade - Likelihood: M - Time horizon: Short term to medium term - Impact: M - Policies: Accelerated fiscal consolidation, monetary policy tightening and tighter macroprudential policies if needed. - Slower growth because of lower dairy price or tighter credit constraints - Likelihood: M - Time horizon: Short to medium term - Impact: M - Policies: Monetary policy easing, coupled with fiscal policy easing if economy hits the zero lower bound. - Housing market downturn - Likelihood: L - Time horizon: Short to medium term - Impact: H - Policies: Monetary and selective macroprudential policy easing; fiscal policy stimulus; measures to facilitate mortgage debt restructuring, including selected fiscal intervention. - External risks: - Significant China slowdown (or other potential dairy price shock) - Likelihood: L/M - Time horizon: Short to medium term - Impact: H - Policies: Combined monetary, selective macroprudential, and fiscal policy easing as economy could reach the zero lower bound quickly. - Structurally weak growth in major advanced and emerging economies - Likelihood: H/M - Time horizon: Medium term - Impact: M - Policies: Temporary monetary and fiscal policy easing (especially if economy hits the zero lower bound). Structural reforms, including fiscal ones, to raise productivity. - Tighter and more volatile global financial conditions - Likelihood: M - Time horizon: Short term - Impact: M - Policies: Monetary, selective macroprudential policy, and fiscal policy easing (especially if economy hits the zero lower bound). - Economic fallout from political fragmentation and protectionism - Likelihood: H - Time horizon: Short to medium term - Impact: M - Policies: Temporary monetary and fiscal policy easing (especially if economy hits the zero lower bound). Continued pursuit of open market policies. ### Key implications and vulnerabilities - Large net foreign liabilities expose New Zealand to external funding shocks, but the external balance sheet structure (currency denomination, maturity profile, sectoral composition) has reduced some common vulnerabilities. - Banks’ reliance on related-party funding (notably Australian parent banks) concentrates counterparty and interconnectedness risks; stability of this funding depends on resilience of Australian banks. - A moderate overvaluation of the REER and a cyclically-adjusted current account below its estimated norm point to some external rebalancing needs over the medium term. _Italic: Source: Annex I. New Zealand’s External Balance Sheet: Developments and Risk Profile (cr17111)._ ### 5. The educational attainments of New Zealand’s migrant population suggest that ### 5. The educational attainments of New Zealand’s migrant population suggest that migration policy has contributed to raising human capital (Figure IV.1, panel 3) ### B. The Cyclical Effects of Net Migration - Positive net migration raises both actual and potential output; the balance depends on the composition of migration and labor market rigidities. - Migrants increase domestic demand upon arrival and, as they integrate, raise potential output; rapid labor market absorption leads to demand and supply broadly balancing, while slow supply adjustment can cause actual output to rise ahead of potential and generate inflationary pressures. - The macroeconomic impact depends on underlying drivers: - If driven by push factors in source countries, an unexpected increase in net migration is a labor supply shock that can cause a period of slack with weak wages and higher unemployment; magnitude and persistence depend on capital-labor ratios and nominal/real rigidities. - If migration reflects an elastic labor supply response to stronger local demand, it can dampen upward wage pressure and leave unemployment little changed. - Business cycle fluctuations in Australia are an important driver of net migration given high trans-Tasman mobility. - VAR analysis uses quarterly data 1994Q4 – 2016Q3 for: de-trended Australian unemployment rate; net migration (as a percent of the working age population in the previous quarter); de-trended New Zealand unemployment rate; and annual private wage growth. - Identification assumes fluctuations in Australian unemployment are exogenous; the identification scheme is recursive (Cholesky decomposition) with ordering: Australian unemployment rate; net migration into New Zealand; the New Zealand unemployment rate (or output/employment in variants); and annual wage inflation. - VAR impulse response findings: - An unexpected increase in the Australian unemployment rate tends to be associated with an increase in New Zealand unemployment and a decline in wage growth. - Other shocks to net migration tend to drive unemployment lower with little impact on wage growth. - VARs including de-trended output and de-trended employment produce qualitatively similar results: output and employment decline quickly below trend following an unexpected increase in Australian unemployment, whereas they rise above trend with other shocks. - Recent labor market developments suggest Australian conditions have not been the main driver of the current net migration wave: - The closing output gap, the decline in unemployment, and broadly stable wage growth point to demand effects being larger. - Composition of migration in the current wave features more student inflows who are likely to consume fewer durable goods such as housing in the near term, muting demand impact relative to previous waves (Vehbi 2016). - Outlook: - Slowing net migration to below historic high levels will partly depend on strengthening Australian labor markets; absent rapid improvement, upward pressure from that source may remain. - Decline in construction activity as major earthquake reconstruction unwinds should help ease migration gradually. ### C. Employment, Investment, and Productivity Effects - Cross-country framework: - Sample: 16 OECD countries over 1990 – 2014 (Australia, Belgium, Canada, Germany, Denmark, Finland, Hungary, Japan, Luxembourg, Netherlands, Norway, New Zealand, Sweden, Switzerland, the U.K., and the U.S.). - Data: OECD on inflows and outflows of foreign born population and employment; IMF on output and capital stock (public and private). - Method: regression based on Ortega and Peri (2009) examining effect of migration flows (percent of population) on components of a Cobb-Douglas production function. Dependent variables include growth rates of output, employment, hours worked, average hours per worker, aggregate capital stock, and TFP. TFP estimated as a residual assuming a labor income share of 0.66. - Specification: difference form with time dummies; estimation by OLS and 2-stage least squares (migration instrumented by its own lags). - Key short-run empirical results (Table IV.1): - A net migration flow of 1 percent of total population is associated with an increase in output of nearly 1.5 – 2 percent, driven by increases in both employment and the capital stock. - Growth rate estimates (Column (1) OLS; Column (2) 2-SLS): - Output: 1.84** ; 1.54** - Employment: 2.01** ; 1.73** - Hours: 1.82** ; 1.72** - Hours per worker: 0.13 ; 0.18 - Capital: 1.82** ; 1.94** - Output per worker: -0.16 ; -0.16 - TFP: -0.10 ; -0.25 - Capital deepening: -0.22 ; 0.20 - Private capital: -0.21 ; 0.18 - Public capital: -0.38 ; 0.15 - Notes: **, * significant at 5%, 10%. Migration measured as net flow of foreign born population in a year. - Interpretations and caveats: - No evidence of crowding out of domestic labor: hours worked and employment respond positively with no decline in average hours per worker. - Capital stock adjusts quickly in response to migration; predictable and not-too-large migration can be accommodated by modest investment adjustments. - Effect on capital deepening is inconclusive: OLS suggests decline in capital intensity (not significant); 2-SLS suggests increase in capital deepening (not significant). - Negative short-term effects on TFP growth appear but are not significant; output per worker is unaffected. - Ortega and Peri find a one-for-one short-run increase in output; this study finds a larger effect but cautions that effect size may be over-estimated if lag instruments do not fully account for persistent factors raising both migration and output. - Migration volatility: - New Zealand migration tends to occur in waves, implying greater volatility that could weaken short-run employment and investment responses if high inflows are later reversed by high outflows. - Regression using 5-year averages across five sub-periods (1990–2014) includes interaction between average migration level and a dummy for migration standard deviation exceeding the sample average. - Table IV.2 results (effects of migration volatility): - Coefficients (dependent variables: Output, Employment, Capital): - Migration: 1.765 ; 1.885* ; 2.295** - D.Migvolatility: 0.178 ; 0.230 ; 0.594 - Migration X D.Migvolatility: -1.021 ; -0.682 ; -1.217 - Constant: 0.945* ; -0.752 ; 1.07** - R2: 0.41 ; 0.30 ; 0.42 - N: 79 ; 79 ; 79 - Notes: **,* significant at 5%, 10%, t-statistics in italics. Fixed effects included. - Findings: - Interaction coefficients for output and input growth are negative and sizeable, suggesting volatility could dampen output and input responses to migration. - Coefficients are not significant at conventional levels except the interaction term in the capital stock equation which is significant at just above 10 percent, lending some support to the idea that size and volatility of migration may impair capital stock adjustment. - In New Zealand, concentration of migration in a single major city (Auckland) with constrained capacity to expand infrastructure quickly could further slow short-run capital adjustment. ### D. Conclusions - From a cyclical perspective, drivers of migration matter: currently, both weaker Australian labor markets and stronger local conditions are influencing low emigration and high immigration. - Economic conditions in New Zealand suggest demand effects have played a more dominant role in the current wave, although these demand effects may be more muted than in past waves owing to composition (e.g., student inflows). - The decline of net migration to more normal levels is expected to be gradual, partly due to the anticipated gradual improvement in Australian labor market conditions. - Evidence indicates: - Output per worker remains unaffected by migration. - Investment adjusts quickly in response to migration. - No robust negative effects on TFP in the short run. - Volatility of migration flows can dampen rapid adjustment in factor inputs; effects of volatility are statistically significant at near-conventional levels primarily for capital stock adjustment. *International Monetary Fund, “The educational attainments of New Zealand’s migrant population suggest that migration policy has contributed to raising human capital,” CR17111, excerpts.* ### 3. In response to the acceleration of house price and credit growth, the authorities have ### cr17111 - 3. In response to the acceleration of house price and credit growth, the authorities have ### Macroprudential measures deployed - Main tools: LVR-related measures (caps on the share of loans with high LVRs in banks’ loan portfolios, “speed limits”). - Timeline and specific exposure limits: - October 2013: 10 percent limit on the share of residential mortgage loans with an LVR above 80 percent. - November 2015: - Auckland: 5 percent limit on the share of residential mortgage loans to property investors with an LVR above 70 percent. - Auckland: 10 percent limit on the share of residential mortgage loans to owner occupiers with an LVR above 80 percent. - Rest of New Zealand: 15 percent limit on the share for residential mortgage loans with an LVR above 80 percent. - October 2016: - 5 percent limit on the share of residential mortgage loans to property investors with an LVR above 60 percent. - 10 percent limit on the share of residential mortgage loans to owner occupiers with an LVR above 80 percent. - Additional prudential actions: - Increased capital requirements for loans with high LVRs and for investor loans via higher risk weights under the standardized approach or minimum parameter requirements for banks’ internal-ratings-based approach. ### Complementary fiscal, tax, and supply measures - Tax measures: - Capital gains from the re-sale of non-primary residences within two years became income-taxable as of 2016. - Reporting and taxation rules for foreign buyers have been tightened. - Housing supply measures: - Measures under way to strengthen housing supply in Auckland with a focus on promoting high-density housing; these measures will likely take a while to have a significant impact on housing market dynamics. ### Channels of impact and limitations of LVR measures - Mechanisms: - LVR restrictions act as borrowing constraints, primarily through the credit demand channel. - By lowering housing credit growth, LVR limits can rein in housing demand, dampen house price growth, and moderate expectations about future house price increases. - Bank exposure limits to high LVR loans increase the number of loans subject to LVR caps, improving the risk composition of banks’ loan portfolios. - Drawbacks and limitations: - LVR restrictions tend to be less restrictive for overall credit growth because rising housing values make LVRs less binding, allowing larger borrowing by existing homeowners. - Such measures may have only temporary effects on credit growth and house prices if housing values continue to rise. ### Empirical evidence on credit and house prices - Observed developments: - Moderation of housing credit growth after end-2013 measures and tentatively after October 2016 package. - House price expectations appear to have been contained. - Counterfactual VAR analysis (IMF (2017a) building on Price (2014)): - Actual credit and house price growth remained below a counterfactual without LVR restrictions after both the 2013 and the 2015 measures. - The difference is statistically significant only for house price developments in Auckland. - Regional differentiation introduced in November 2015 led to inter-regional spillovers: house price growth trended down in Auckland but rose in the rest of the country until the October 2016 country-wide tightening. ### Loan composition and borrower risk profile - High-LVR loans: - The share of loans with an LVR above 80 percent in total new loans fell drastically after the first macroprudential package and has remained low since. - Investor lending: - Investor lending share in new loans fell only slightly and temporarily after November 2015; it appears to have been reduced more substantially after October 2016 tightening. - Other risk features: - Most mortgage loans are either variable-interest or have interest fixed for less than one year, creating debt serviceability risks when interest rates rise. - Debt-to-income ratios (DTI) have increased across the board, in particular for residential property investor loans: one third of investor loans have a DTI greater than 7. ### Household balance sheets and leverage - Aggregate leverage: - Household leverage, measured by household debt in percent of net worth, has slightly trended downward since the GFC because asset values (mainly real estate) increased faster than gross debt. - This trend could be reversed by a correction in house prices. - Household leverage seems higher in upper income quintiles. - Debt-to-income levels: - The gross debt-to-income ratio across all households stands now at around 168 percent, thus exceeding its pre-GFC peak of around 160 percent. - New-loan flow data indicate that debt-to-income ratios associated with new loans have increased across all borrower categories. - These flow increases imply that debt-to-income ratios in the sub-group of borrowing households with mortgage debt are much higher and increasing, given frequent refinancing patterns. - Risk implications: - Increased DTI and short interest-rate fixation periods expose borrowing households to debt serviceability risks from interest rate increases or income shocks. - Even absent defaults, households under stress may cut consumption, with adverse spillovers to the broader economy and bank loan books. ### International experience and lessons - Empirical literature (summarized in Box 1 and IMF (2014)): - Limits on LVRs and DTI ratios have been associated with declines in mortgage lending growth and reduced house price appreciation in multiple studies. - Evidence suggests LVR and DTI measures enhance resilience and reduce fire-sale dynamics when housing markets turn downwards. - LVR limits tend to lose impact over time as rising house prices make them less binding, while DTI measures provide a more permanent anchor. - LVR and DTI measures are complementary: - LVR caps contain household leverage and limit bank losses given default (reducing loss given default). - DTI limits focus on household liquidity and debt servicing capacity, reducing default probabilities. ### Conclusions and policy implications - Overall assessment: - New Zealand’s mainly LVR-related macroprudential measures appear to have had some moderating influence on mortgage lending, expected and actual house price growth, and the quality of loan composition. - They have also helped contain household leverage. - However, these measures have not prevented a continuous deterioration in borrower households’ vulnerability with respect to debt servicing capacity risks (e.g., higher interest rates or income shocks). - Implicit policy considerations: - Because LVR caps can become less binding as prices rise, complementary use of DTI measures could provide a more permanent anchor to limit debt serviceability risks and reduce default probabilities. - Continued monitoring of loan flow characteristics and borrower DTI is important given rapid transmission of flow characteristics into stocks. *Source: International Monetary Fund.* ### Annex VI. New Zealand: External and Fiscal DSAs ### Annex VI. New Zealand: External and Fiscal DSAs ### External Debt Sustainability: Baseline and Stress Tests - Baseline external debt (in percent of GDP): 2011: 123.8; 2012: 120.8; 2013: 109.4; 2014: 109.4; 2015: 112.6; 2016: 110.7; 2017: 110.3; 2018: 110.7; 2019: 111.1; 2020: 111.6; 2021: 112.2. - Change in external debt (in percent of GDP): 2011: -3.1; 2012: -3.0; 2013: -11.5; 2014: 0.0; 2015: 3.2; 2016: -1.9; 2017: -0.4; 2018: 0.3; 2019: 0.4; 2020: 0.5; 2021: 0.5. - Identified external debt-creating flows (in percent of GDP): 2011: -13.8; 2012: -6.8; 2013: -12.5; 2014: -14.3; 2015: -5.0; 2016: -15.3; 2017: -15.4; 2018: -14.7; 2019: -14.2; 2020: -14.2; 2021: -14.2. - Current account deficit, excluding interest payments (in percent of GDP): 2011: 0.7; 2012: 2.1; 2013: 1.5; 2014: 1.6; 2015: 1.8; 2016: 1.4; 2017: 0.1; 2018: 0.7; 2019: 0.9; 2020: 1.0; 2021: 1.1. - Deficit in balance of goods and services (in percent of GDP): 2011: -2.1; 2012: -0.5; 2013: -1.0; 2014: -1.1; 2015: -0.6; 2016: -0.7; 2017: -0.3; 2018: 0.2; 2019: 0.3; 2020: 0.5; 2021: 0.5. - Exports (in percent of GDP): 2011: 30.8; 2012: 29.0; 2013: 28.5; 2014: 28.3; 2015: 28.2; 2016: 26.8; 2017: 26.7; 2018: 26.6; 2019: 26.8; 2020: 26.8; 2021: 26.7. - Imports (in percent of GDP): 2011–2021 row entries include 28.7, 28.6, 27.5, 27.3, 27.6, 26.1, 26.4, 26.8, 27.1, 27.3, 27.2 (preserved as in source). - Net non-debt creating capital inflows (negative, in percent of GDP): 2011: -5.4; 2012: -6.6; 2013: -8.9; 2014: -11.6; 2015: -13.5; 2016: -14.8; 2017: -14.7; 2018: -14.8; 2019: -14.8; 2020: -14.9; 2021: -15.0. - Automatic debt dynamics (in percent of GDP): 2011: -9.1; 2012: -2.3; 2013: -5.1; 2014: -4.3; 2015: 6.7; 2016: -2.0; 2017: -0.7; 2018: -0.7; 2019: -0.3; 2020: -0.3; 2021: -0.3. - Contribution from nominal interest rate (in percent of GDP): 2011: 2.1; 2012: 1.8; 2013: 1.7; 2014: 1.7; 2015: 1.5; 2016: 1.3; 2017: 2.4; 2018: 2.4; 2019: 2.5; 2020: 2.5; 2021: 2.5. - Contribution from real GDP growth (in percent of GDP): 2011: -2.0; 2012: -3.0; 2013: -2.4; 2014: -3.5; 2015: -3.1; 2016: -3.3; 2017: -3.2; 2018: -3.1; 2019: -2.7; 2020: -2.7; 2021: -2.7. - Contribution from price and exchange rate changes 2/: 2011: -9.2; 2012: -1.1; 2013: -4.3; 2014: -2.4; 2015: 8.3; 2016: (dots in source). - Residual, including change in gross foreign assets (2-3) 3/ (in percent of GDP): 2011: 10.8; 2012: 3.8; 2013: 1.0; 2014: 14.3; 2015: 8.2; 2016: 13.4; 2017: 15.0; 2018: 15.0; 2019: 14.7; 2020: 14.7; 2021: 14.7. - External debt-to-exports ratio (in percent): 2011: 402.0; 2012: 416.3; 2013: 384.2; 2014: 385.9; 2015: 399.8; 2016: 413.4; 2017: 412.4; 2018: 415.4; 2019: 415.1; 2020: 416.0; 2021: 419.8. - Gross external financing need (in billions of US dollars): 2011: 84.0; 2012: 94.5; 2013: 95.8; 2014: 87.6; 2015: 82.2; 2016: 70.7; 2017: 80.2; 2018: 87.7; 2019: 92.4; 2020: 97.4; 2021: 102.7. - Gross external financing need (in percent of GDP): 2011: 50.3; 2012: 54.0; 2013: 51.3; 2014: 44.0; 2015: 47.5; 2016: 10-Year; 2017: 10-Year; 2018: 38.8; 2019: 40.5; 2020: 42.4; 2021: 42.6; 2022: 42.9; 2023: 43.2 (table includes mixed formatting preserved as in source). - Scenario with key variables at their historical averages: values shown in source include 110.7, 122.9, 130.4, 138.1, 145.5, 152.7 (preserved verbatim). Key macroeconomic assumptions underlying baseline (selected): - Real GDP growth (in percent): historical/average/deviation row contains: 1.8, 2.5, 2.2, 3.4, 2.5, 1.9, 1.5, 3.1, 3.1, 3.0, 2.6, 2.6, 2.6 (preserved as in table). - GDP deflator in US dollars (change in percent): 13.0, 2.2, 4.4, 3.1, -15.1, 3.0, 11.2, 1.9, 5.5, 1.5, 2.2, 2.1, 2.2. - Nominal external interest rate (in percent): 1.9, 1.5, 1.5, 1.6, 1.2, 1.9, 0.6, 1.2, 2.4, 2.3, 2.3, 2.3, 2.3. - Growth of exports (US dollar terms, in percent): 18.9, -1.3, 4.7, 6.1, -13.5, 5.0, 13.3, -0.1, 8.7, 4.0, 5.3, 5.0, 4.3. - Growth of imports (US dollar terms, in percent): 20.3, 4.2, 2.8, 5.7, -12.0, 4.6, 14.7, -0.7, 10.5, 6.0, 5.8, 5.5, 4.4. - Current account balance, excluding interest payments (in percent of GDP): -0.7, -2.1, -1.5, -1.6, -1.8, -2.1, 1.7, -1.4, -0.1, -0.7, -0.9, -1.0, -1.1. - Net non-debt creating capital inflows (in percent of GDP): 5.4, 6.6, 8.9, 11.6, 13.5, 8.3, 2.8, 14.8, 14.7, 14.8, 14.8, 14.9, 15.0. Stress test notes (preserved labels and shocks as in figures): - Individual shocks are permanent one-half standard deviation shocks. - Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance. - One-time real depreciation of 30 percent occurs in 2010 (noted as a shock in figure captions). ### Public Sector Debt Sustainability: Baseline Scenario and Composition - Nominal gross public debt (in percent of GDP, selected years): 2015: 28.1; 2016: 29.6; 2017: 28.9; 2018: 26.9; 2019: 24.1; 2020: 20.9; 2021: 17.2; 2022: 13.3; later year: 9.4 (table preserves sequence). - Net public debt (in percent of GDP): reported same row as nominal gross public debt entries above. - Public gross financing needs (in percent of GDP, projection row in figures): charted historically and in projection; source shows values and trend lines (preserved as “projection”). - Real GDP growth (in percent) projections: 2017: 3.1; 2018: 2.9; 2019: 2.6; 2020: 2.6; 2021: 2.6; 2022: 2.5. - Inflation (GDP deflator, in percent) projections: 2017: 2.1; 2018: 1.7; 2019: 2.1; 2020: 2.0; 2021: 2.2; 2022: 2.3. - Primary balance (in percent of GDP) projections (baseline): 2017: 1.2; 2018: 2.2; 2019: 2.7; 2020: 3.2; 2021: 3.4; 2022: 3.4. - Effective interest rate (in percent) projections: 2017: 5.0; 2018: 4.9; 2019: 5.0; 2020: 5.2; 2021: 5.5; 2022: 5.9. - Change in gross public sector debt (in percent of GDP, annual and cumulative): 2015: 2.1; 2016: 0.1; 2017: -0.6; 2018: -2.0; 2019: -2.8; 2020: -3.2; 2021: -3.7; 2022: -3.9; cumulative: -19.5. - Identified debt-creating flows (in percent of GDP): 2015: 1.1; 2016: -2.2; 2017: -2.9; 2018: -1.3; 2019: -2.1; 2020: -2.6; 2021: -3.0; 2022: -3.3; cumulative: -15.6. - Primary deficit (in percent of GDP): 2015: 2.2; 2016: -1.1; 2017: -1.2; 2018: -1.2; 2019: -2.2; 2020: -2.7; 2021: -3.2; 2022: -3.4; cumulative: -16.0. - Primary (noninterest) revenue and grants (in percent of GDP): series includes 33.1, 33.9, 33.9, 33.5, 33.4, 33.4, 33.5, 33.5, 33.4, cumulative 200.7. - Primary (noninterest) expenditure (in percent of GDP): 35.2, 32.8, 32.8, 32.3, 31.2, 30.7, 30.3, 30.0, 30.0, cumulative 184.6. - Automatic debt dynamics (in percent of GDP): 2015: -1.0; 2016: -1.1; 2017: -1.8; 2018: -0.1; 2019: 0.1; 2020: 0.1; 2021: 0.1; 2022: 0.1; cumulative: 0.4. - Interest rate/growth differential (in percent of GDP): same series as automatic debt dynamics. - Of which: real interest rate contribution (in percent of GDP): 2015: -0.5; 2016: -0.2; 2017: -0.7; 2018: 0.8; 2019: 0.8; 2020: 0.7; 2021: 0.6; 2022: 0.5; cumulative 3.9. - Of which: real GDP growth contribution (in percent of GDP): 2015: -0.5; 2016: -0.9; 2017: -1.1; 2018: -0.8; 2019: -0.8; 2020: -0.6; 2021: -0.5; 2022: -0.4; cumulative -3.4. - Exchange rate depreciation contribution: 0.0 across the historical/projection rows in the table (preserved). - Other identified debt-creating flows: 0.0 across table. - Net privatization proceeds (negative): 0.0 across table. - Contingent liabilities: 0.0 across table. - Residual, including asset changes (in percent of GDP): 2015: 0.9; 2016: 2.3; 2017: 2.3; 2018: -0.7; 2019: -0.7; 2020: -0.6; 2021: -0.6; 2022: -0.6; cumulative -3.9. Public DSA alternative scenarios and composition (as presented): - Alternative scenarios include Baseline, Historical, and Constant Primary Balance scenarios with underlying assumptions preserved: - Constant Primary Balance scenario: Primary Balance = 1.2 (in percent of GDP) across projection years; Real GDP growth and Inflation same as baseline; Effective interest rate = 5.0 (in percent) consistently in projection. Sovereign market indicators and spreads (estimate as of January 30, 2017): - U.S. 10-yr (bp): 105. - 5Y CDS (bp): 87. - Ratings: Moody's Aaa/Aaa (Foreign/Local); S&P A A A A+ (source shows S&PsAAAA+); Fitch A A A A+ (source shows FitchAAAA+). - Effective interest rate (in percent, defined as interest payments divided by debt stock): series includes 6.2, 5.1, 5.0, 5.0, 4.9, 5.0, 5.2, 5.5, 5.9 (years preserved in table). ### Fiscal Outlook and Policy - Authorities’ fiscal objective: reduce net debt to around 20 percent of GDP in 2020, and to between 10 and 15 percent of GDP by 2025. - Government fiscal stance: short-term slightly expansionary; tighter stance forecast from 2018/19. - Policy intent: resume contributions to the New Zealand Superannuation Fund once net debt falls below 20 percent of GDP. - Fiscal priorities: rebuild fiscal buffers, invest in infrastructure and growth-friendly initiatives, fund cost pressures on public services, meet fiscal costs of the Kaikoura earthquake, and consider lowering income taxes when conditions permit. ### Monetary Policy and Financial Sector - Inflation and RBNZ stance: - Annual consumer inflation returned to midpoint of 1 to 3 percent target band in March quarter 2017. - Future inflation expected to stabilize at around 2 percent. - RBNZ signaled monetary policy will remain accommodative for a considerable period and stands ready to adjust policy in either direction. - Financial sector developments and supervision: - 2016 FSAP mission (first since 2004) found financial system sound and resilient to severe shocks. - Prudential regime introduced for insurance sector; Financial Markets Authority created in 2011; Financial Markets Conduct Act 2013 passed. - RBNZ reviewing bank capital requirements; reviews of legislation governing prudential supervision of insurers and regulatory regime for financial advice underway. - Consideration being given to debt-to-income limits as a macroprudential tool, with cost-benefit analysis and public consultation planned. - Proposal under consideration: enhanced de minimis in Open Bank Resolution regime as alternative to full deposit insurance. - RBNZ reviewing enforcement strategy and attestation regime, considering FSAP recommendations. ### Structural Reforms and Housing - Business Growth Agenda focuses on six inputs: exports, investment, innovation, skills, natural resources, and infrastructure. - Policy measures: - Attract more high-quality foreign business investment. - Raise public R&D investment to 0.8 percent of GDP. - Pursue modern free trade agreements and reduce regulatory red tape. - Capital spending substantially higher over next five years on transport, schools, hospitals, defense, and housing. - Housing policy and supply: - Focus on increasing supply: Resource Management Act reform legislated; work with Auckland Council on unitary plan implementation; more underutilized public land to support residential building. - New Housing Infrastructure Fund established. - Government considering Productivity Commission recommendations on urban planning. - Tax changes to identify capital gains from property sales introduced 18 months ago; effects still being monitored. - Public sector productivity: public sector is around one quarter of GDP; Government targets include reducing long-term welfare dependence and improving education, crime reduction, and government interactions. ### Data, Surveillance, and Technical Notes - Data provision adequate for surveillance; authorities progressing toward subscribing to IMF SDDS. - Table of Common Indicators Required for Surveillance (as of April 5, 2017) lists latest observations and reporting frequencies for Exchange Rates (4/5/17), Reserve items (2/17, received 3/30/17), Interest Rates (4/5/17), Consumer Price Index Q4 2016 (3/16/17), Central Government fiscal data 2015/16 (received 12/8/16), External Current Account Balance Q4 2016 (3/15/17), GDP/GNP Q4 2016 (3/16/17), Gross External Debt Q4 2016 (3/15/17), and International Investment Position Q4 2016 (3/15/17). - FSAP participation: FSSA from 2003 FSAP mission and subsequent assessments published; additional FSAP missions in August 2016 and November 2017; FSSA to be discussed with the Executive Board at the 2017 Article IV consultation. *Source: Annex VI. New Zealand: External and Fiscal DSAs — IMF staff report materials provided in the supplied content.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17111.pdf_