## cr18202 — NEW ZEALAND ## Source details **Canonical URL:** [cr18202 — NEW ZEALAND](https://www.imf.org/-/media/files/publications/cr/2018/cr18202.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18202.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18202.pdf.json) --- ### CONTEXT - New Zealand’s economy has enjoyed a solid expansion, but inflation has been unusually weak. - Key growth drivers: reconstruction spending after the 2011 and 2016 earthquakes, a net migration wave, accommodative monetary policy, increasing terms of trade, and strong external demand from Asia. - With net migration and labor supply increases more persistent and stronger than expected, potential output has been revised upward, while the output gap has decreased more slowly. - Inflation has been either below or in the lower half of the 1 to 3 percent target range of the Reserve Bank of New Zealand (RBNZ). - Housing-related macro-financial vulnerabilities increased during the expansion; RBNZ used loan-to-value ratio (LVR) restrictions to curtail related risks. - Rising house prices led to rapid household credit growth through 2016 and household debt ratios rising from already high levels; affordability has been constrained for some potential buyers, notably first-time home buyers. - The New Zealand economy faces a productivity challenge despite favorable regulatory settings; growth in per capita income or GDP per hour has been relatively low. Remote location (“distance”) and a small market size have been identified as obstacles to higher productivity. ### RECENT DEVELOPMENTS - GDP growth rebounded in mid-2017 as weather-related and other temporary factors subsided; growth in 2017 was around 3 percent, close to trend but below earlier buoyant rates of around 4 percent in 2014-16 implied by revisions to national accounts data. - Export growth recovered as dairy and meat production picked up with higher prices. - Private consumption continued to grow robustly, supported by strong employment gains. - Business investment was strong, partly due to strong tourism demand; residential investment growth decelerated and its momentum remains softer, while import growth picked up. - Net migration remained at recent record high levels; employment continued to grow above trend and the unemployment rate declined slightly below recent NAIRU estimates through 2017. - Disinflation re-emerged in 2017 despite the economy operating close to capacity; headline inflation moderated while underlying inflation increased modestly to around 1½ percent and wage increases remained weak in 2017. - External position in 2017 was moderately weaker than implied by medium-term fundamentals and the New Zealand dollar was moderately overvalued; the New Zealand dollar depreciated by about 6 percent in real effective terms in the second half of 2017. - The housing market cooled and credit growth to households slowed: house price increases moderated since mid-2016 (led by Auckland), house sales declined, residential building approvals slowed; RBNZ tightened LVR restrictions in October 2016 and tightened bank lending standards. - Banks hold strong capital and liquidity buffers; profitability remained strong, underpinned by net interest margins. Slower credit growth and strong deposit growth reduced banks’ need to fund from market sources and lowered offshore market funding reliance while average maturity of such funding increased. Boxed findings: - Business fixed investment growth has remained relatively weak; much private fixed investment growth reflected residential rather than business investment; capital intensity broadly stagnated. - Revisions to GDP imply real GDP by expenditure was 2.0 percent higher by end-2016 than previously reported; potential output revised upward accordingly. ### OUTLOOK - Growth is expected to remain strong at around 3 percent in the medium term. - Inflation should edge towards the middle of the target range (1-3 percent). - The turn to a more expansionary fiscal policy stance should offset slowing residential investment and weaker agricultural exports in the near term. - KiwiBuild program should entail an increase in residential investment over time. - With potential output growth slowing due to the slowdown of net migration, the output gap should turn positive and upward pressures on domestic prices are expected to emerge. - Inflation is projected to rise gradually toward the mid-point of the 1-3 percent target range. - The current account deficit should remain below longer-term averages. Vulnerabilities and projections: - Vulnerabilities from household debt are expected to decline gradually but will remain high. - The soft landing in the housing market should continue, reflecting increasing supply over time from the KiwiBuild program and gradually rising domestic interest rates. - The interest burden on household debt should remain low, given relatively small expected increases in interest rates over the medium term, while the household debt ratio should start decreasing in 2018. - Potential output growth is projected to slow over a 5-year horizon, mostly because of lower labor supply growth (reflecting improving labor market conditions abroad and tighter visa requirements since August 2017). Capital deepening is expected to increase moderately. ### RISKS - Near-term risks to growth are broadly balanced; medium-term risks are tilted to the downside. - Upside risks: - Stronger-than-expected global and Australian economies. - Net migration could decrease more slowly than projected. - Downside domestic risks: - Fiscal stimulus might be less expansionary if policy implementation is more gradual than projected. - KiwiBuild could shift housing supply from private to public sector rather than catalyzing stronger residential investment overall. - Downside external risks: - Tighter global financial conditions. - Structurally weak growth in advanced economies. - A significant China slowdown. - Retreat from cross-border integration. - Household debt remains high under the baseline outlook and would amplify the impact of large downside shocks, notwithstanding recent improvements in banks’ credit portfolios and risk structure after macroprudential intervention. Such shocks could trigger a disruptive housing market correction. Authorities’ views: - Authorities broadly concurred with staff’s assessment of outlook and risks. They expect economic growth to pick up in the near term, capacity constraints to broaden, upward pressure on inflation to increase, and wage inflation to rise (buoyed by announced increases in the minimum wage over the next three years). - Authorities share staff’s concerns about external downside risks; growing concern that trade disputes could be settled outside the current multilateral system and result in new trade restrictions, likely harming smaller economies such as New Zealand more than larger economies. ### POLICY DISCUSSIONS — MACROECONOMIC AND FINANCIAL POLICIES Context and recent policy actions: - Low inflation remains a monetary policy challenge; tradable prices were the main source of renewed disinflation in 2017-18. - The solid expansion has maintained a strong fiscal position but increased infrastructure and other spending needs. - Central government’s spending plans for the next four years are more expansionary than in the previous budget and relative to the last Article IV consultation, driven by higher social, housing and regional spending. - Near term: this spending will result in smaller budget surpluses; in outer years, additional spending increases are financed by the cancellation of personal income tax cuts slated to start in FY2019/20. - Net debt is forecast to decrease below 20 percent of GDP by FY2022/23, two years later than previously anticipated. - Macroprudential policies have reduced risks to financial stability: after three rounds of tightening of LVR restrictions, the share of outstanding residential mortgages with LVRs above 80 percent declined to under 8 percent by September 2017, from 21 percent in September 2013. RBNZ relaxed LVR restrictions marginally as of January 1, 2018 and signaled possible further easing. Staff views on policy stance: - The current monetary policy stance is appropriately expansionary. Continued accommodative monetary policy has helped stabilize inflation expectations and will help the cyclical relationship between economic slack and prices reemerge. - A precautionary further easing would raise risks of a steeper tightening if inflationary pressures emerged sooner than expected, given the economy appears to have been operating close to capacity for some time. - A premature tightening could result in renewed currency appreciation and prolong price setting below the mid-point of the target range, given persistently low inflation in recent years, and lower the credibility of the flexible inflation targeting framework. - There is scope to tilt the balance from budget discipline to meeting increased spending needs from strong economic and population growth. - Compared to the time of the 2017 Article IV Consultation, the updated baseline expenditure path already incorporates new growth-friendly measures and higher infrastructure spending, although gaps likely remain for the latter. - Governments remain committed to budget discipline and the medium-term debt anchor; at a minimum, there is no need for faster debt reduction beyond that outlined in the FY2018/19 budget. ### New Zealand’s Infrastructure Gap and Fiscal Policy (Box 3) - Annual infrastructure shortfall: almost 0.3 percent of GDP on infrastructure investment in transportation, telecommunications, electricity and water services. - Cumulative gap: 9.5 percent of GDP by 2040. - Real GDP gains from closing the gap (IMF DSGE model estimates): - Benchmark: 0.1-0.2 percent of GDP (2022) and 0.6-0.8 percent of GDP (2050). - Regional Focus, based on Population Share: 0.1-0.2 percent of GDP (2022) and 0.7-0.8 percent of GDP (2050). - Regional Focus, Population Share plus 25 percent: 0.1-0.2 percent of GDP (2022) and 0.7-0.9 percent of GDP (2050). - Financing and efficiency effects: - Gains are higher with deficit financing. - Tax financing (PIT and/or GST) would offset almost one quarter of the long-term gains. - Additional regional focus could yield an extra 0.1 percent of real GDP in the long term, despite potential efficiency losses in implementation. - Policy implication: - Stronger structural revenue should be used to increase spending on infrastructure and other measures that would strengthen the economy’s growth potential. ### FISCAL POLICY STANCE - Near term: - Higher spending expected to translate into a positive fiscal impulse. - The impulse is not expected to result in substantial upward price pressure since some higher spending will increase potential output. - This fiscal stance complements accommodative monetary policy but could potentially further weaken the external position. - Medium term: - A slightly contractionary fiscal stance is expected, involving increases of about ½ percent of GDP in the cyclically-adjusted primary balance. - This medium-term stance is consistent with growth moderating to trend under current baseline projections and would contribute to moderating upward pressure on the currency. ### MACROPRUDENTIAL POLICY AND HOUSING MARKET - Loan-to-value ratio (LVR) policy: - Further relaxation of LVR restrictions would not be helpful under the baseline outlook. - Household debt vulnerabilities remain high; modest housing market cooling does not call for easing macroprudential policies. - Further easing is unlikely to reignite a housing boom with new housing supply measures, but there is also no clear need for further easing to prevent a destabilizing market correction. - Authorities’ views: - Monetary policy will be accommodative for a considerable period; RBNZ officials expect inflation to increase gradually to the 2 percent midpoint of the target range. - Fiscal plans accommodate growing demands from rapid population growth; the FY2018/19 Budget increased spending on infrastructure, housing, health, regional development, and education. - Budget Responsibility Rules commit to reducing net public debt to around 20 percent of GDP by FY2021/2022, preserving fiscal space and keeping expenditures near its recent historical average of 30 percent of GDP. - Authorities see macroprudential policies as having contained financial stability risks from the housing market; further easing would be gradual and contingent on the outlook. ### RESERVE BANK ACT REVIEW - Phase One outcomes: - Updates add a “maximum sustainable employment” objective alongside price stability. - Establishes a monetary policy committee for decision-making. - Overarching objectives to be set by the Minister of Finance based on a regular review led by the RBNZ, replacing the Policy Targets Agreement (PTA) between the Minister and the RBNZ Governor. - The March 2018 PTA operationalizes the employment objective through a qualitative description. - Staff assessment of Phase One: - Welcome update of governance while maintaining flexible inflation targeting. - Formalization of an employment objective recognizes de facto employment stabilization in modern flexible inflation targeting. - Operationalization through a qualitative objective avoids undue risks to operational monetary policy independence and should be maintained. - Periodic reset of overarching objectives after an RBNZ-led review should enhance transparency and accountability. - Phase Two priorities: - Should clarify RBNZ’s financial policy mandate and objectives. - FSAP identified urgent need for strengthening the macroprudential framework, including broadening the toolkit to include a debt-to-income (DTI) or debt-service-to-income (DSTI) instrument, and strengthening the supervisory pillar of the three-pillar banking regulation approach. - Related reforms should be prioritized in deliberations, implementation, and resource allocation. - Authorities’ views on Review: - Phase One seen as an update preserving flexible inflation targeting; employment objective should be operationalized qualitatively. - Committee structure preferred for decision making under delegated authority. - Phase Two offers an opportunity to reconsider the financial policy mandate; possible development of a Risk Statement by the government to frame the RBNZ’s financial policy mandate. - A committee structure for financial policy decision making is under consideration. ### MANAGING HOUSING MARKET IMBALANCES - New government housing policy agenda components: - KiwiBuild: plans to build 100,000 affordable houses over 10 years (about one third of average annual residential building authorizations) for first-time homebuyers. After initial financing of NZ$2 billion, the program would be sustained through the sales of completed houses. - Addressing supply constraints: Urban Growth Agenda to increase availability of developable land and address regulatory, planning and other policy constraints, including the underfunding of locally-provided infrastructure. - Tax policy changes: Extension of the bright-line test from a two-year to a five-year holding period; residential properties other than main home acquired after March 29, 2018 will be subject to capital gain taxes if disposed of within five years of acquisition. Proposal to limit negative gearing such that deductibility of net losses from property investment (and interest costs) from other taxable income would be eliminated. - Restrictions on nonresidents: Proposed ban in a draft amendment to the Overseas Investment Act to re-classify all residential land as “sensitive land,” requiring approval for foreign buyers under tighter qualifying criteria; scheduled for parliamentary vote as early as late June 2018. - Staff views: - Housing policy appropriately focuses on closing supply and tax-system gaps. - KiwiBuild can redirect builders’ incentives toward lower-price housing and more cost-effective building technology but carries budget risks and risks of crowding out private supply and market distortions. - Tax Working Group should consider raising land taxes to increase recurrent cost of holding land and encourage (re)development. - A ban on residential real estate purchases by nonresidents is unlikely to improve affordability significantly; it would be a capital flow management measure (CFM) under the IMF’s Institutional View (IV) due to residency-based discrimination and would not align with the IV. - Available data suggest foreign buyers have played a minor role recently; the proposed CFM design is unlikely to be temporary or targeted. - The broader housing policy agenda, if fully implemented, would address most potential problems associated with foreign buyers on a non-discriminatory basis. - Authorities’ views: - Restoring affordability requires focus on strengthening supply and lowering tax distortions; direct intervention via KiwiBuild is considered required in addition to Urban Growth Agenda measures. - Extension of the bright-line test to five years is in place; further tax reforms (including ring-fencing negative gearing and possible capital gains or land taxes excluding family home and land under it) are being considered by the Tax Working Group. - Authorities disagree that the proposed ban on nonresident purchases is a CFM under the IV, arguing the ban must be assessed holistically given social, economic and political context. - The proposed screening regime would allow nonresidents to acquire residential land if they commit to reside and become tax residents, increase housing supply, or develop the land for other purposes. - Authorities argue the regime will help channel foreign direct investment into productive economy rather than unproductive speculation, and that it will have only limited effect on aggregate capital flows or the balance of payments. ### HOUSING AFFORDABILITY EVIDENCE AND IMPACTS (Box 4) - Home ownership: - Decline from more than 70 percent over 1990-97 to 63 percent in June 2017. - Housing cost indicators: - Housing costs remain below 20 percent of household income; the ratio in 2016 marginally exceeded the previous peak in 2011 but declined in 2017. - First-home buyers and renters: - Share of potential first home-buyer households with below average income after housing costs increased to 82 percent in 2016Q1 in Auckland, compared to 77 percent at the national level. - Rental market has acted as a safety valve for those who cannot afford home ownership. - Affordability for new labor market entrants: - At prevailing median house price and median household income, estimated debt-service-to-income ratio would exceed the affordable threshold of 30 percent. - It would take at least 4 years of saving one-third of household income for a 20 percent deposit to be eligible for a mortgage. ### SUPPORTING HIGHER AND MORE INCLUSIVE GROWTH - Structural weaknesses: - Strong expansion has not resulted in strong per capita income growth, highlighting structural weaknesses. - Lack of capital deepening in the current expansion is a concern; New Zealand risks missing out on new technologies embodied in capital. - Total factor productivity growth has been relatively low compared with peers. - Evidence of a persistent infrastructure gap after rapid population growth. - Growth has been concentrated in Auckland, Wellington and Christchurch, with less progress in regions. - Structural policy settings: - New Zealand’s structural policy settings are close to or mark best practice among OECD economies and it remains an attractive destination for skilled migrants. Policy priorities: - Minimum wages: - Proposed minimum wage increases out to 2020 could help ease income inequality. - New Zealand will have the second-highest minimum-to-median wage ratio in the OECD if proposals proceed. - In the current strong growth environment, negative impacts on employment, competitiveness, and productivity are likely to be minimal, but risks rise in a downturn. - Human capital and tertiary education: - Free tertiary-level education and training for at least one year could boost human capital; program design could include targeting given fiscal cost considerations. - Research & development (R&D): - Objective: lift R&D spending to 2 percent of GDP. - Instrument: an R&D tax credit, in addition to existing grant systems, would be an efficient support to business R&D. - Tax reform and investment incentives: - Tax reform could shift incentives toward broader business investment; evidence suggests residential real estate is effectively tax-favored compared to other investment. - Introducing progressive corporate income taxation is unlikely to be helpful; alternatives such as R&D tax credits or grants better support new companies and startups. - Maintaining broad tax bases will support corporate investment and productivity. - Regional development: - Provincial Growth Fund should ensure project selection benefits regions and can relieve pressures on major urban areas by encouraging population movement to regions. - Trade and FDI: - Continued support for open trade and the multilateral framework is welcome. - CP-TPP membership will provide increased market access. - FDI policy could be improved by clarifying restrictions under the Overseas Investment Act and reducing administrative burdens associated with direct investment approvals. ### QUANTITATIVE HIGHLIGHTS AND PROJECTIONS (selected figures preserved) - Growth in 2017: around 3 percent. - Earlier buoyant rates implied for 2014-16: around 4 percent. - Underlying inflation increased modestly to around 1½ percent in 2017. - New Zealand dollar real effective depreciation in H2 2017: about 6 percent. - Share of outstanding residential mortgages with LVRs above 80 percent: under 8 percent by September 2017 (down from 21 percent in September 2013). - Net debt forecast to decrease below 20 percent of GDP by FY2022/23. - Potential output growth projection horizon: 5-year horizon. Key time series (selected from tables and annexes): - Real GDP (production) (annual percent change, 2013–2023): 2.2, 3.6, 3.5, 4.0, 2.9, 3.1, 3.2, 3.1, 2.9, 2.7, 2.6. - Consumer prices (avg, % change, 2013–2023): 1.1, 1.2, 0.3, 0.6, 1.9, 1.4, 1.7, 1.9, 2.0, 2.0, 2.0. - Official cash rate (avg, percent, 2013–2023): 2.5, 3.1, 3.2, 2.2, 1.8, 1.8, 1.8, 2.1, 2.4, 2.9, 3.0. - Household debt (percent of nominal disposable income, 2013–2023): 151, 155, 161, 167, 168, 166, 165, 163, 161, 160, 159. - Current account (percent of GDP, 2013–2023): -3.2, -3.2, -3.1, -2.3, -2.7, -2.6, -2.9, -3.0, -3.0, -3.0, -3.0. - Net international investment position (percent of GDP, 2013–2023): -64.4, -65.3, -61.3, -59.3, -54.8, -54.3, -54.5, -54.8, -55.2, -55.7, -56.2. ### ANNEX HIGHLIGHTS - Annex I (External Sector Assessment): - External position in 2017 moderately weaker than fundamentals; REER some 10 percent above long-term average in 2017. - EBA REER index regression implies the dollar was overvalued by 15 percent in 2017; staff-adjusted estimates point to a currency overvaluation in the range of around 4½ percent (mid-point translation) or slightly less than 1 percent under the ES approach, depending on method. - NIIP was minus 55 percent of GDP at end-2017Q3; structure of external balance sheet reduces vulnerability (liabilities mainly in NZD; net FX asset position). - Annex II (Risk Assessment Matrix): Domestic and external risks enumerated with likelihoods, time horizons, impacts, and policy responses (monetary, macroprudential, fiscal, structural). - Annex III (Fiscal and Structural Policy Measures): Selected measures and dates (e.g., KiwiBuild NZ$2bn funding; minimum wage increases; Provincial Growth Fund NZ$1bn per year; carbon emissions net zero by 2050). - Annex IV (Macroprudential Measures timeline): LVR limits in October 2013, November 2015, October 2016, and January 2018 with exact percentage limits specified for owner occupiers and investors. - Annex V (DSA highlights and macro projections): Baseline external debt and selected projections (e.g., baseline external debt 2017 = 95.5; 2018 = 95.2; 2019 = 95.3; gross external financing need 2017 = 84.6 bn US$; 2018 = 80.0 bn US$). - Annex VI (2017 FSAP follow-up): Detailed recommendations and implementation updates across supervision, macroprudential framework, crisis readiness, and resolution; time‑frame legend provided (C, I, ST, MT). *International Monetary Fund staff report (2018), staff team comprised Thomas Helbling (head), Dirk Muir, Ryota Nakatani, Yu Ching Wong (all APD), and Zoltan Jakab (RES); Grant Johnston (OED) joined discussions; Ioana Hussiada and Nadine Dubost assisted from HQ.* ### 2018. The staff team comprised Thomas Helbling (head), Dirk Muir, ### NEW ZEALAND ### CONTEXT - New Zealand’s economy has enjoyed a solid expansion, but inflation has been unusually weak. - Key growth drivers: reconstruction spending after the 2011 and 2016 earthquakes, a net migration wave, accommodative monetary policy, increasing terms of trade, and strong external demand from Asia. - With net migration and labor supply increases more persistent and stronger than expected, potential output has been revised upward, while the output gap has decreased more slowly. - Inflation has been either below or in the lower half of the 1 to 3 percent target range of the Reserve Bank of New Zealand (RBNZ). - Housing-related macro-financial vulnerabilities increased during the expansion; RBNZ used loan-to-value ratio (LVR) restrictions to curtail related risks. - Rising house prices led to rapid household credit growth through 2016 and household debt ratios rising from already high levels; affordability has been constrained for some potential buyers, notably first-time home buyers. - The New Zealand economy faces a productivity challenge despite favorable regulatory settings; growth in per capita income or GDP per hour has been relatively low. Remote location (“distance”) and a small market size have been identified as obstacles to higher productivity. ### RECENT DEVELOPMENTS - GDP growth rebounded in mid-2017 as weather-related and other temporary factors subsided; at around 3 percent, growth in 2017 was close to trend but below the buoyant rates of around 4 percent in 2014-16 implied by revisions to national accounts data. - Export growth recovered as dairy and meat production picked up with higher prices. - Private consumption continued to grow robustly, supported by strong employment gains. - Business investment was strong, partly due to strong tourism demand; residential investment growth decelerated and its momentum remains softer, while import growth picked up. - Net migration remained at recent record high levels; employment continued to grow above trend and the unemployment rate declined slightly below recent NAIRU estimates through 2017. - Disinflation re-emerged in 2017 despite the economy operating close to capacity; headline inflation moderated while underlying inflation increased modestly to around 1½ percent and wage increases remained weak in 2017. - External position in 2017 was moderately weaker than implied by medium-term fundamentals and the New Zealand dollar was moderately overvalued (Annex I); the New Zealand dollar depreciated by about 6 percent in real effective terms in the second half of 2017. - The housing market cooled and credit growth to households slowed: house price increases moderated since mid-2016 (led by Auckland), house sales declined, residential building approvals slowed; RBNZ tightened LVR restrictions in October 2016 and tightened bank lending standards. - Banks hold strong capital and liquidity buffers; profitability remained strong, underpinned by net interest margins. Slower credit growth and strong deposit growth reduced banks’ need to fund from market sources and lowered offshore market funding reliance while average maturity of such funding increased. Boxed findings: - Business fixed investment growth has remained relatively weak; much private fixed investment growth reflected residential rather than business investment; capital intensity broadly stagnated. - Revisions to GDP imply real GDP by expenditure was 2.0 percent higher by end-2016 than previously reported; potential output revised upward accordingly. ### OUTLOOK - Growth is expected to remain strong at around 3 percent in the medium term. - Inflation should edge towards the middle of the target range (1-3 percent). - The turn to a more expansionary fiscal policy stance should offset slowing residential investment and weaker agricultural exports in the near term. - KiwiBuild program should entail an increase in residential investment over time. - With potential output growth slowing due to the slowdown of net migration, the output gap should turn positive and upward pressures on domestic prices are expected to emerge. - Inflation is projected to rise gradually toward the mid-point of the 1-3 percent target range. - The current account deficit should remain below longer-term averages. Vulnerabilities and projections: - Vulnerabilities from household debt are expected to decline gradually but will remain high. - The soft landing in the housing market should continue, reflecting increasing supply over time from the KiwiBuild program and gradually rising domestic interest rates. - The interest burden on household debt should remain low, given relatively small expected increases in interest rates over the medium term, while the household debt ratio should start decreasing in 2018. - Potential output growth is projected to slow over a 5-year horizon, mostly because of lower labor supply growth (reflecting improving labor market conditions abroad and tighter visa requirements since August 2017). Capital deepening is expected to increase moderately. ### RISKS - Near-term risks to growth are broadly balanced; medium-term risks are tilted to the downside (Annex II). - Upside risks: stronger-than-expected global and Australian economies; net migration could decrease more slowly than projected. - Downside domestic risks: fiscal stimulus might be less expansionary if policy implementation is more gradual than projected; KiwiBuild could shift housing supply from private to public sector rather than catalyzing stronger residential investment overall. - Downside external risks: tighter global financial conditions; structurally weak growth in advanced economies; a significant China slowdown; retreat from cross-border integration. - Household debt remains high under the baseline outlook and would amplify the impact of large downside shocks, notwithstanding recent improvements in banks’ credit portfolios and risk structure after macroprudential intervention. Such shocks could trigger a disruptive housing market correction. Authorities’ views: - Authorities broadly concurred with staff’s assessment of outlook and risks. They expect economic growth to pick up in the near term, capacity constraints to broaden, upward pressure on inflation to increase, and wage inflation to rise (buoyed by announced increases in the minimum wage over the next three years). - Authorities share staff’s concerns about external downside risks; growing concern that trade disputes could be settled outside the current multilateral system and result in new trade restrictions, likely harming smaller economies such as New Zealand more than larger economies. ### POLICY DISCUSSIONS — MACROECONOMIC AND FINANCIAL POLICIES Context and recent policy actions: - Low inflation remains a monetary policy challenge; tradable prices were the main source of renewed disinflation in 2017-18. - The solid expansion has maintained a strong fiscal position but increased infrastructure and other spending needs. - Central government’s spending plans for the next four years are more expansionary than in the previous budget and relative to the last Article IV consultation, driven by higher social, housing and regional spending (Annex III). - Near term: this spending will result in smaller budget surpluses; in outer years, additional spending increases are financed by the cancellation of personal income tax cuts slated to start in FY2019/20. - Net debt is forecast to decrease below 20 percent of GDP by FY2022/23, two years later than previously anticipated. - Macroprudential policies have reduced risks to financial stability: after three rounds of tightening of LVR restrictions (Annex IV), the share of outstanding residential mortgages with LVRs above 80 percent declined to under 8 percent by September 2017, from 21 percent in September 2013. RBNZ relaxed LVR restrictions marginally as of January 1, 2018 and signaled possible further easing. Staff views on policy stance: - The current monetary policy stance is appropriately expansionary. Continued accommodative monetary policy has helped stabilize inflation expectations and will help the cyclical relationship between economic slack and prices reemerge. - A precautionary further easing would raise risks of a steeper tightening if inflationary pressures emerged sooner than expected, given the economy appears to have been operating close to capacity for some time. - A premature tightening could result in renewed currency appreciation and prolong price setting below the mid-point of the target range, given persistently low inflation in recent years, and lower the credibility of the flexible inflation targeting framework. - There is scope to tilt the balance from budget discipline to meeting increased spending needs from strong economic and population growth. - Compared to the time of the 2017 Article IV Consultation, the updated baseline expenditure path already incorporates new growth-friendly measures and higher infrastructure spending (see Box 3), although gaps likely remain for the latter. - Governments remain committed to budget discipline and the medium-term debt anchor; at a minimum, there is no need for faster debt reduction beyond that outlined in the FY2018/19 budget. Key numeric/statistical points preserved from the source: - Growth in 2017: around 3 percent. - Earlier buoyant rates implied for 2014-16: around 4 percent. - Underlying inflation increased modestly to around 1½ percent in 2017. - New Zealand dollar real effective depreciation in H2 2017: about 6 percent. - Share of outstanding residential mortgages with LVRs above 80 percent: under 8 percent by September 2017 (down from 21 percent in September 2013). - Net debt forecast to decrease below 20 percent of GDP by FY2022/23. - Potential output growth projection horizon: 5-year horizon. _International Monetary Fund staff report (2018), staff team comprised Thomas Helbling (head), Dirk Muir, Ryota Nakatani, Yu Ching Wong (all APD), and Zoltan Jakab (RES); Grant Johnston (OED) joined discussions; Ioana Hussiada and Nadine Dubost assisted from HQ._ ### Annex V). Stronger structural revenue, such as that from higher-than-expected population growth, ### Annex V). Stronger structural revenue, such as that from higher-than-expected population growth, ### New Zealand’s Infrastructure Gap and Fiscal Policy (Box 3) - New Zealand faces an annual shortfall of almost 0.3 percent of GDP on infrastructure investment in transportation, telecommunications, electricity and water services, translating into a cumulative gap of 9.5 percent of GDP by 2040. - Real GDP gains from closing the gap (IMF DSGE model estimates): - Benchmark: 0.1-0.2 percent of GDP (2022) and 0.6-0.8 percent of GDP (2050). - Regional Focus, based on Population Share: 0.1-0.2 percent of GDP (2022) and 0.7-0.8 percent of GDP (2050). - Regional Focus, Population Share plus 25 percent: 0.1-0.2 percent of GDP (2022) and 0.7-0.9 percent of GDP (2050). - Note: Ranges result from different types of deficit and tax financing. - Financing and efficiency effects: - Gains are higher with deficit financing. - Tax financing (PIT and/or GST) would offset almost one quarter of the long-term gains. - Additional regional focus could yield an extra 0.1 percent of real GDP in the long term, despite potential efficiency losses in implementation. - Policy implication: - Stronger structural revenue should be used to increase spending on infrastructure and other measures that would strengthen the economy’s growth potential. ### Fiscal policy stance and near- to medium-term outlook - Near term: - Higher spending expected to translate into a positive fiscal impulse. - The impulse is not expected to result in substantial upward price pressure since some higher spending will increase potential output. - This fiscal stance complements accommodative monetary policy but could potentially further weaken the external position. - Medium term: - A slightly contractionary fiscal stance is expected, involving increases of about ½ percent of GDP in the cyclically-adjusted primary balance. - This medium-term stance is consistent with growth moderating to trend under current baseline projections and would contribute to moderating upward pressure on the currency. ### Macroprudential policy and housing market - Loan-to-value ratio (LVR) policy: - Further relaxation of LVR restrictions would not be helpful under the baseline outlook. - Household debt vulnerabilities remain high; modest housing market cooling does not call for easing macroprudential policies. - Further easing is unlikely to reignite a housing boom with new housing supply measures, but there is also no clear need for further easing to prevent a destabilizing market correction. - Authorities’ views: - Monetary policy will be accommodative for a considerable period; RBNZ officials expect inflation to increase gradually to the 2 percent midpoint of the target range. - Fiscal plans accommodate growing demands from rapid population growth; the FY2018/19 Budget increased spending on infrastructure, housing, health, regional development, and education. - Budget Responsibility Rules commit to reducing net public debt to around 20 percent of GDP by FY2021/2022, preserving fiscal space and keeping expenditures near its recent historical average of 30 percent of GDP. - Authorities see macroprudential policies as having contained financial stability risks from the housing market; further easing would be gradual and contingent on the outlook. ### Review of the Reserve Bank Act (Phase One and Phase Two) - Phase One outcomes: - Updates add a “maximum sustainable employment” objective alongside price stability. - Establishes a monetary policy committee for decision-making. - Overarching objectives to be set by the Minister of Finance based on a regular review led by the RBNZ, replacing the Policy Targets Agreement (PTA) between the Minister and the RBNZ Governor. - The March 2018 PTA operationalizes the employment objective through a qualitative description. - Staff assessment of Phase One: - Welcome update of governance while maintaining flexible inflation targeting. - Formalization of an employment objective recognizes de facto employment stabilization in modern flexible inflation targeting. - Operationalization through a qualitative objective avoids undue risks to operational monetary policy independence and should be maintained. - Periodic reset of overarching objectives after an RBNZ-led review should enhance transparency and accountability. - Phase Two priorities: - Should clarify RBNZ’s financial policy mandate and objectives. - FSAP identified urgent need for strengthening the macroprudential framework, including broadening the toolkit to include a debt-to-income (DTI) or debt-service-to-income (DSTI) instrument, and strengthening the supervisory pillar of the three-pillar banking regulation approach. - Related reforms should be prioritized in deliberations, implementation, and resource allocation. - Authorities’ views on Review: - Phase One seen as an update preserving flexible inflation targeting; employment objective should be operationalized qualitatively. - Committee structure preferred for decision making under delegated authority. - Phase Two offers an opportunity to reconsider the financial policy mandate; possible development of a Risk Statement by the government to frame the RBNZ’s financial policy mandate. - A committee structure for financial policy decision making is under consideration. ### Managing Housing Market Imbalances - New government housing policy agenda components: - Supply initiatives: KiwiBuild plans to build 100,000 affordable houses over 10 years (about one third of average annual residential building authorizations) for first-time homebuyers. After initial financing of NZ$2 billion, the program would be sustained through the sales of completed houses. - Addressing supply constraints: Urban Growth Agenda to increase availability of developable land and address regulatory, planning and other policy constraints, including the underfunding of locally-provided infrastructure. - Tax policy changes: Extension of the bright-line test from a two-year to a five-year holding period; residential properties other than main home acquired after March 29, 2018 will be subject to capital gain taxes if disposed of within five years of acquisition. Proposal to limit negative gearing such that deductibility of net losses from property investment (and interest costs) from other taxable income would be eliminated. - Restrictions on nonresidents: Proposed ban in a draft amendment to the Overseas Investment Act to re-classify all residential land as “sensitive land,” requiring approval for foreign buyers under tighter qualifying criteria; scheduled for parliamentary vote as early as late June 2018. - Staff views: - Housing policy appropriately focuses on closing supply and tax-system gaps. - KiwiBuild can redirect builders’ incentives toward lower-price housing and more cost-effective building technology but carries budget risks and risks of crowding out private supply and market distortions. - Tax Working Group should consider raising land taxes to increase recurrent cost of holding land and encourage (re)development. - A ban on residential real estate purchases by nonresidents is unlikely to improve affordability significantly; it would be a capital flow management measure (CFM) under the IMF’s Institutional View (IV) due to residency-based discrimination and would not align with the IV. - Available data suggest foreign buyers have played a minor role recently; the proposed CFM design is unlikely to be temporary or targeted. - The broader housing policy agenda, if fully implemented, would address most potential problems associated with foreign buyers on a non-discriminatory basis. - Authorities’ views: - Restoring affordability requires focus on strengthening supply and lowering tax distortions; direct intervention via KiwiBuild is considered required in addition to Urban Growth Agenda measures. - Extension of the bright-line test to five years is in place; further tax reforms (including ring-fencing negative gearing and possible capital gains or land taxes excluding family home and land under it) are being considered by the Tax Working Group. - Authorities disagree that the proposed ban on nonresident purchases is a CFM under the IV, arguing the ban must be assessed holistically given social, economic and political context. - The proposed screening regime would allow nonresidents to acquire residential land if they commit to reside and become tax residents, increase housing supply, or develop the land for other purposes. - Authorities argue the regime will help channel foreign direct investment into productive economy rather than unproductive speculation, and that it will have only limited effect on aggregate capital flows or the balance of payments. ### Housing affordability evidence and impacts (Box 4) - Home ownership: - Decline from more than 70 percent over 1990-97 to 63 percent in June 2017. - Housing cost indicators: - Housing costs remain below 20 percent of household income; the ratio in 2016 marginally exceeded the previous peak in 2011 but declined in 2017. - First-home buyers and renters: - Share of potential first home-buyer households with below average income after housing costs increased to 82 percent in 2016Q1 in Auckland, compared to 77 percent at the national level. - Rental market has acted as a safety valve for those who cannot afford home ownership. - Affordability for new labor market entrants: - At prevailing median house price and median household income, estimated debt-service-to-income ratio would exceed the affordable threshold of 30 percent. - It would take at least 4 years of saving one-third of household income for a 20 percent deposit to be eligible for a mortgage. ### Supporting Higher and More Inclusive Growth - Growth and productivity concerns: - Strong expansion has not resulted in strong per capita income growth, highlighting structural weaknesses. - Lack of capital deepening in the current expansion is a concern; New Zealand risks missing out on new technologies embodied in capital. - Total factor productivity growth has been relatively low compared with peers. - Evidence of a persistent infrastructure gap after rapid population growth. - Growth has been concentrated in Auckland, Wellington and Christchurch, with less progress in regions. - Structural policy stance: - New Zealand’s structural policy settings are close to or mark best practice among OECD economies and it remains an attractive destination for skilled migrants. *IMF staff summary based on the provided content unit.* ### 37. The government’s structural policy agenda seeks to support productive, sustainable, ### 37. The government’s structural policy agenda seeks to support productive, sustainable, ### Structural policy objectives and initial emphases - Aim: support productive, sustainable, and inclusive growth. - Initial emphasis areas: - Minimum wages. - Productivity, including research and development (R&D) and education. - Tax reform. - Regional development. - Trade policy. - Status: While the FY2018/19 budget has provided clarity on many elements of the agenda, parts are still under development. ### Minimum wage policy and distributional effects - Proposed minimum wage increases out to 2020 could help ease income inequality. - Resulting positioning: New Zealand will have the second-highest minimum-to-median wage ratio in the OECD. - Near-term macro effects: In the current strong growth environment, the negative impact of higher minimum wages on employment growth, international competitiveness, and labor productivity are likely to be minimal. - Risk: These impacts might turn out to be larger in a downturn. ### Human capital and tertiary education - Policy: Free tertiary-level education and training for at least one year could boost human capital. - Fiscal consideration: Given its potential fiscal cost, the program could include greater targeting based on needs, possibly beyond the current time horizon. ### Research & development (R&D) - Objective: Lift R&D spending in New Zealand to 2 percent of GDP. - Instrument: An R&D tax credit, if well designed, would be an efficient instrument to support R&D spending in the business sector. - Complement: The tax incentive is intended in addition to the current grant system. ### Tax reform and investment incentives - Role: Tax reform could play an important role in shifting incentives toward broader business investment. - Evidence: Estimates of marginal effective tax rates published by the Tax Working Group suggest that investment in residential real estate is effectively tax-favored compared to other investment. - Corporate taxation: Introducing progressive corporate income taxation is unlikely to be helpful, considering the relatively small size of businesses in New Zealand. - Alternatives to progressive corporate tax: New companies and startups can be supported more effectively through other instruments, such as R&D tax credits or grants. - Principle: Maintaining broad tax bases will support corporate investment and productivity more generally. ### Regional development: Provincial Growth Fund - Objective: Ensure project selection that helps regions to benefit from income gains more in line with the major urban centers. - Additional role: Can be an appropriate tool to relieve pressures on the major urban areas by encouraging movement of population into the regions. ### Trade policy and foreign direct investment - Stance: Continued support of open trade and the multilateral trade framework is welcome. - CP-TPP: As one of the initial signatories of Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CP-TPP), New Zealand will benefit from increased market access and new growth opportunities. - FDI policy: Foreign direct investment complements productivity benefits from international trade; New Zealand would benefit from an improvement of the current policy regime. - Specific recommendation: Restrictions under the Overseas Investment Act could be clarified, and the administrative burden associated with direct investment approvals could be reduced. ### Authorities’ views - Focus: Structural policy agenda aimed at making the economy and economic growth productive, sustainable and inclusive. - Motivation for measures: Reducing income and geographical inequality motivated the increase in the minimum wage, the equivalent of a free year of tertiary education (university or vocational), and establishment of the three-year Provincial Growth Fund. - R&D commitment: Commitment to increase R&D spending to 2 percent of GDP, including a new tax incentive in addition to the grant system. - Trade: Government continues to pursue deeper economic integration through international trade, with the signing of the CP-TPP noted as an important step. ### Staff appraisal — context, outlook, and policy assessment - Context: - New Zealand’s economic expansion remains solid. - Growth moderated toward trend recently after buoyant rates in 2014-16. - Demand fundamentals: financial conditions are supportive, the terms of trade are close to historic highs, and net migration is still high. - External position in 2017: assessed to be moderately weaker than implied by fundamentals and policy settings. - Internal imbalances: narrowed, although progress on the inflation front remains tentative. - Outlook and risks: - Outlook: Growth is expected to remain at around 3 percent in the near term. - Housing: Housing demand fundamentals remain robust; soft landing should continue given gradually increasing supply. - Near-term risks: Broadly balanced, with upside from stronger-than-expected net migration or global growth, and downside from more gradual government spending and weaker demand stimulus. - External downside risks: tighter global financial conditions, structurally low growth in advanced economies, a significant slowdown in China, and more protectionist/inward-looking policies. - Household debt: Remains high under the baseline outlook and would amplify the impact of large downside shocks and possibly trigger a disruptive housing market correction. - Macroeconomic policy settings: - Monetary policy: Stance is sufficiently expansionary to address current, below-target inflation and lowers risks to demand from currency overvaluation. - Fiscal position: Strong fiscal position provides space to accommodate needs from strong economic and population growth; no need for faster debt reduction beyond that outlined in the FY2018/19 budget. - Recommendation for stronger structural revenues: Use for increased spending on infrastructure and other measures that would raise potential output. - Macroprudential policy: - Contribution: Policies have reduced risks to financial stability and should continue to mitigate risks from high household debt. - Observed improvements: Bank and household balance sheets more resilient with a lower share of loans with high LVRs. - Recommendation: With household debt still elevated, further relaxation of LVR restrictions would not be appropriate under the baseline outlook. - Reserve Bank Act Review: - Status: Review is timely; Phase One well advanced and has led to an update of the governance framework. - Policy Targets Agreement: Employment objective operationalized through a qualitative description consistent with operational monetary policy independence and should be maintained. - Phase Two: Focused on financial stability and other policies; should emphasize priority reforms suggested in the 2017 FSAP, such as the macroprudential toolkit and the supervisory pillar. - Housing policy assessment: - Focus: Strengthening supply and lowering tax distortions to restore broad-based housing affordability. - Complementarity: KiwiBuild program and the Urban Growth Agenda are complementary; success depends on well-coordinated public sector progress. - Nonresident purchase ban: A ban of residential real estate purchases by nonresidents is unlikely to have a significant impact on housing affordability. - CFM: The proposed CFM should be reconsidered. - Overall: The broad housing policy agenda, if fully implemented, would address most potential problems associated with foreign buyers on a non-discriminatory basis. *Source: cr18202 - 37. The government’s structural policy agenda seeks to support productive, sustainable, (cr18202 - 37. The government’s structural policy agenda seeks to support productive, sustainable,)* ### 47. It is expected that the next Article IV Consultation with New Zealand will be held on ### cr18202 - 47. It is expected that the next Article IV Consultation with New Zealand will be held on ### Growth and Domestic Demand - Economic growth is "starting to pick up again" and "continues to strengthen" supported by buoyant domestic demand and relatively strong agricultural commodity prices. - Real GDP (production) (annual percent change): 2.2, 3.6, 3.5, 4.0, 2.9, 3.1, 3.2, 3.1, 2.9, 2.7, 2.6 (2013–2023, Table 1). - Real GDP (expenditure) (annual percent change): 2.2, 3.2, 4.2, 4.2, 3.0, 3.2, 3.2, 3.1, 2.9, 2.7, 2.6 (2013–2023, Table 1). - Domestic demand (annual percent change): 3.7, 4.5, 3.2, 4.7, 4.0, 4.9, 3.1, 3.1, 2.8, 2.6, 2.4 (2013–2023, Table 1). - Net exports contributed negatively in several years (e.g., net exports contribution to growth: -1.6, -1.6, 0.8, -0.6, -1.4, -1.5, -0.1, -0.2, -0.1, -0.1, 0.0 as shown in figure captions). ### Labor Market and Income - Labor force and migration: rising labor participation and historically strong net immigration are noted contributors to labor market strength (figures). - Employment (annual percent change): 1.5, 3.5, 2.2, 4.6, 4.1, 2.8, 1.8, 1.4, 1.3, 1.3, 1.4 (2013–2023, Table 1). - Unemployment (percent of labor force): 5.8, 5.4, 5.4, 5.1, 4.7, 4.5, 4.5, 4.4, 4.3, 4.3, 4.4 (2013–2023, Table 1). - Real gross national disposable income per capita (NZ$): 46,491; 47,896; 48,204; 49,851; 50,560; 51,808; 52,176; 52,741; 53,365; 53,916; 54,538 (2013–2023, Table 1). ### Inflation, Monetary Policy, and Credit - Core inflation remains in the lower half of the RBNZ target band, with weak tradables inflation identified as a primary factor (Figure 2). - Consumer prices (avg, % change): 1.1, 1.2, 0.3, 0.6, 1.9, 1.4, 1.7, 1.9, 2.0, 2.0, 2.0 (2013–2023, Table 1). - Official cash rate (policy rate, percent, avg): 2.5, 3.1, 3.2, 2.2, 1.8, 1.8, 1.8, 2.1, 2.4, 2.9, 3.0 (2013–2023, Table 1). - Credit to the private sector (percent change): 5.1, 4.5, 8.4, 7.3, 4.9, 5.1, 5.3, 5.1, 5.0, 5.0, 4.7 (2013–2023, Table 1). - Housing credit growth has softened and business credit growth is still firm (Figure 2). ### External Sector - Terms of trade and real exchange rate remain stronger and the current account balance is broadly stable (Figure 3). - Current account (percent of GDP): -3.2, -3.2, -3.1, -2.3, -2.7, -2.6, -2.9, -3.0, -3.0, -3.0, -3.0 (2013–2023, Table 1 / Table 3). - Exports of goods and services (percent of GDP): 28.4, 28.2, 27.8, 26.2, 27.0, 26.9, 26.5, 26.2, 26.1, 26.2, 26.4 (2013–2023, Table 3). - Services contribution to export growth remains strong; China has become the largest export destination (Figure 3). ### Fiscal Position - Fiscal metrics point to a relatively small government and low public debt, with expenditure restraint and strong revenues enabling a short-term positive fiscal impulse while maintaining consolidation over time (Figure 4). - General government revenue (percent of GDP): 37.3, 37.2, 37.7, 37.6, 37.2, 37.0, 37.1, 37.1, 37.2, 37.3, 37.3 (2013–2023, Table 1 / Table 2). - General government expenditure (percent of GDP): 38.5, 37.7, 37.3, 36.4, 35.8, 36.2, 36.1, 35.9, 35.6, 35.3, 35.3 (2013–2023, Table 1 / Table 2). - Net lending/borrowing (percent of GDP): -1.3, -0.5, 0.3, 1.2, 1.4, 0.8, 0.9, 1.3, 1.6, 2.0, 2.0 (2013–2023, Table 1). - Gross debt (percent of GDP): 34.6, 34.2, 34.3, 33.5, 31.7, 30.0, 29.0, 28.1, 27.6, 26.2, 23.0 (2013–2023, Table 1). - Net debt (percent of GDP): 11.0, 10.4, 9.8, 9.1, 8.6, 10.0, 11.0, 10.8, 10.2, 8.1, 4.9 (2013–2023, Table 1). ### Housing Market, Household Debt, and Macroprudential Measures - House prices and household indebtedness rose with low interest rates, but there are signs of cooling and improvement following policy measures (Figures 5–7). - Household debt (percent of nominal disposable income): 151, 155, 161, 167, 168, 166, 165, 163, 161, 160, 159 (2013–2023, Table 1). - House prices (percent change, avg): 9.0, 6.5, 11.6, 13.0, 6.4, 4.5, 4.5, 4.2, 4.0, 4.0, 4.0 (2013–2023, Table 1). - Share of outstanding mortgages by high LVR and share of high DTI loans have declined following tighter LVR caps and tightened lending standards; interest-only loans and investor loans have declined substantially (Figures 5 and 7). - Residential investment has been subdued: Residential Investment (% of nominal GDP) series and weak pipeline of new construction noted (Figure 6). ### Banking Sector and Financial Soundness - The banking sector is strong: banks remain well capitalized, highly profitable, with improving liquidity and core funding ratios (Figure 8; Table 5). - Regulatory capital to risk-weighted assets: 13.3, 13.1, 12.5, 12.4, 13.5, 13.7, 14.7 (2011–2017, Table 5). - Return on equity (percent): 16.1, 11.4, 13.9, 14.1, 12.0, 12.6, 14.0 (2011–2017, Table 5). - Non-performing loans to total loans (percent): 1.7, 1.4, 1.0, 0.8, 0.5, 0.5, 0.5 (2011–2017, Table 5). - Over one-half of loans are exposed to the housing sector; housing loans (Table 4) and banking-sector balance sheet metrics show large housing exposures. ### Macro-structural Issues and Productivity - New Zealand has registered the lowest productivity growth rates among its peers with deterioration post-GFC; R&D spending lags peers and investment gaps in basic infrastructure are identified as areas to augment productivity growth (Figure 9). - The trade and regulatory environment is favorable; tourism and education services exports are expanding and increasingly directed to China and India (Figure 9). ### Key Balance of Payments and Monetary Indicators (selected) - Net international investment position (percent of GDP): -64.4, -65.3, -61.3, -59.3, -54.8, -54.3, -54.5, -54.8, -55.2, -55.7, -56.2 (2013–2023, Table 3). - Gross official reserves (bn US$): 16.5, 15.8, 14.3, 18.2, 20.3 (Table 1 / Table 3 entries). - Nominal GDP (bn NZ$): 228, 241, 251, 266, 283, 300, 316, 332, 349, 366, 383 (2013–2023, Table 1). *Source: IMF staff report and accompanying figures and tables in the provided content.* ### Annex I. External Sector Assessment ### Annex I. External Sector Assessment ### External position assessment and valuation - The external position in 2017 was assessed to be moderately weaker than implied by fundamentals and policy settings, while the New Zealand dollar is moderately overvalued. - New Zealand’s NIIP amounted minus 55 percent of GDP at the end of 2017Q3. - New Zealand has historically run a current account deficit, averaging around 3 percent of GDP over the past decade. - New Zealand’s REER was some 10 percent above its long-term average in 2017. - During 2017, the merchandise terms of trade rose strongly and reached a new high in 2017Q4 for the lifetime of the series. - The REER depreciated in the second half of 2017, consistent with a steadily narrowing interest rate differential and RBNZ signaling. ### EBA assessments (2015–2017) - EBA Exchange Rate Assessments (REER and current account regressions, External sustainability): - REER index regression: 2015 = 6%, 2016 = 7%, 2017 = 15% - Current account regression: 2015 = 10%, 2016 = 3%, 2017 = 4% - External sustainability: 2015 = 7%, 2016 = 5%, 2017 = 1% - The EBA REER index regression implies that, in real effective terms, the dollar was overvalued by 15 percent in 2017. - The EBA current account regression: estimated cyclically-adjusted current account norm for 2017 was -0.6 percent of GDP, compared to an actual cyclically-adjusted balance of -2.3 percent. - Staff view adjusts CA norm closer to -1.2 percent of GDP. With this adjustment, the estimated current account gap is in the range of -0.3 to -1.9 percent of GDP. - With an EBA-estimated elasticity of the current account-to -GDP ratio with respect to the REER of -0.25, the mid-point of the range translates into a currency overvaluation of around 4½. ### External sustainability and NIIP dynamics - The NIIP level and trajectory are sustainable. - The External Stability (ES) approach suggests NIIP would be stabilized at current levels with a CA deficit of between 2.7 percent of GDP, while the adjusted medium-term CA deficit recorded is projected at 2.9 percent. - This implies the currency is overvalued by slightly less than 1 percent. - The structure of New Zealand’s external balance sheet reduces vulnerability: - External NIIP liabilities are mainly in New Zealand dollars and there is a net foreign currency asset position; a nominal depreciation tends to strengthen the external balance sheet, all else equal. - The banking sector has a net foreign currency liability position but it is fully hedged. - The New Zealand dollar has been freely floating since 1985; authorities are strongly committed to a floating regime. ### Policy implications - Policy gaps in New Zealand currently contribute to lowering the current account gap, everything else equal, and, therefore, currency overvaluation. - In the longer term, the government’s planned gradual fiscal consolidation should help to narrow the current account deficit by boosting national savings. ### Other considerations - The central bank undertook a brief but large intervention in 2007–08 when the market became illiquid following banking sector disruptions in the United States. - The floating regime reduces the need for reserve holding. --- ### Annex II — Key Risks and Policy Responses (Risk Assessment Matrix) - Domestic risks: - Stronger growth because of higher dairy prices — Likelihood: L; Time horizon: Short term; Impact: L. Policy: Automatic adjustment through commodity currency mechanism. - Stronger growth because of slower decrease in net migration — Likelihood: M; Time horizon: Short to medium term; Impact: M. Policy: Monetary policy tightening to dampen short-term positive aggregate demand effects. - Housing market downturn — Likelihood: M; Time horizon: Short to medium term; Impact: H. Policy: Monetary and selective macroprudential policy easing; fiscal policy stimulus; measures to facilitate mortgage debt restructuring. - External risks: - Lower energy prices — Likelihood: L; Time horizon: Short to medium term; Impact: L. Policy: Temporary monetary easing if lower inflation expectations become embedded. - Significant China slowdown — Likelihood: L/M; Time horizon: Short to medium term; Impact: H. Policy: Combined monetary, fiscal policy easing; selective macroprudential easing if housing market correction is severe. - Structurally weak growth in key advanced economies — Likelihood: H; Time horizon: Medium term; Impact: M. Policy: Temporary monetary and fiscal policy easing; structural reforms to raise productivity. - Tighter global financial conditions — Likelihood: H; Time horizon: Short to medium term; Impact: M. Policy: Monetary, selective macroprudential policy, and fiscal policy easing. - Retreat from cross-border integration — Likelihood: M; Time horizon: Short to medium term; Impact: M. Policy: Combined monetary and fiscal policy easing; selective macroprudential easing if housing market correction is severe. --- ### Annex III — Recent Fiscal and Structural Policy Measures (selected) - Fiscal policy changes in 100-Day Plan, HYEFU 2017, and Budget 2018: - New Zealand Superannuation Fund: Resume funding immediately at NZ$500mn, and increase to prior announced path that was to start in FY2020/21. Status: Effective December 14, 2017. - Families Package: Extend parental leave; Winter Energy Payment for low-income families; increase Student Benefit; Best Start for under-1-year-olds; reinstate Independent Earner Tax Credit. Status: Passed December 14, 2017. - Tax Working Group (TWG): Wide mandate to look at the whole tax system but directed to look at investor housing. Status: TWG has been meeting regularly since February 2018. - Managing housing market imbalances: - KiwiBuild: Government to fund NZ$2bn over 4 years to build 100,000 affordable housing units over 10 years. Status: Temporary unit in MBIE, until Housing Commission established; updated funding profile from Budget 2018. - Ban foreign house ownership: Reclassify housing as sensitive property under Overseas Investment Act to prevent foreigners from purchasing. Status: Legislation in Parliament; may be passed by June 2018. - State-owned homes: Government to stop sell-off, maintain ownership; additional funding to build 6,400 new social housing units over 4 years. Status: Stoppage announced December, 2017; additional funding part of Budget 2018. - Healthy Homes Guarantee Bill: Set comprehensive minimum standards for rental housing. Status: Passed December 2017. - Supporting higher and more inclusive growth: - Minimum wage increases: NZ$15.75 to NZ$16.50 per hour on April 1, 2018; to NZ$20.00 April 1, 2021. Status: Announced December 22, 2017. - Tertiary education subsidy: Funding for 1 year of tertiary education or 2 years of vocational training up to NZ$12,000 for any New Zealand citizen with less than 6 months of tertiary education or 1 year of vocational training. Status: Effective January 1, 2018. - Regional development: Minister of Regional Development to oversee 3-year NZ$1bn per year Provincial Growth Fund (PGF). Status: PGF began disbursing funds on February 23, 2018. - Carbon emissions: Reduce to net zero emissions by 2050. Set up Interim Climate Change Committee in December, 2017. --- ### Annex IV — Macroprudential Measures on Residential Loans (timeline and limits) - October 2013: - Owner occupiers: No more than 10 percent of the new commitments for new residential mortgage lending at LVRs above 80 percent. - November 2015: - Auckland owner occupiers: 10 percent limit on total new residential mortgage loans at LVRs above 80 percent. - Auckland investors: 5 percent limit on total new residential mortgage loans at LVRs above 70 percent. - Outside Auckland owner occupiers: 15 percent limit on total new residential mortgage loans at LVRs above 80 percent. - October 2016: - 10 percent limit on each bank’s new residential mortgage lending to owner occupiers at LVRs above 80 percent. - 5 percent limit on each bank’s new residential mortgage lending to property investors at LVRs above 60 percent. - January 2018: - 15 percent limit on each bank’s new residential mortgage lending to owner occupiers at LVRs above 80 percent. - 5 percent limit on each bank’s new residential mortgage lending to property investors at LVRs above 65 percent. --- ### Annex V — Selected DSA highlights and key macroeconomic projections - Baseline external debt (in percent of GDP): 2017 = 95.5; 2018 = 95.2; 2019 = 95.3; 2020 = 95.5; 2021 = 95.8; 2022 = 96.1; 2023 = 96.4. - Change in external debt (selected): 2017 = -3.3; 2018 = -0.3; 2019 = 0.1; 2020 = 0.2. - Identified external debt-creating flows (aggregate, selected): 2017 = -8.2; 2018 = -1.3; 2019 = -0.9. - Current account deficit, excluding interest payments (selected): 2017 = 1.4; 2018 = 0.0; 2019 = 0.2; 2020 = 0.3; 2021 = 0.4; 2022 = 0.5; 2023 = 0.5. - Exports (percent of GDP, selected): 2017 = 27.0; 2018 = 26.9; 2019 = 26.5; 2020 = 26.2. - Imports (percent of GDP, selected): 2017 = 26.2; 2018 = 26.1; 2019 = 25.6; 2020 = 25.3. - Net non-debt creating capital inflows (negative) (selected): 2017 = -4.2; 2018 = -1.3; 2019 = -0.9. - Gross external financing need (in billions of US dollars): 2017 = 84.6; 2018 = 80.0; 2019 = 87.2; 2020 = 93.1; 2021 = 99.2; 2022 = 105.7; 2023 = 112.2. - Key macroeconomic assumptions (selected): - Nominal GDP (US dollars): 2017 = 201.5; 2018 = 220.3; 2019 = 234.0; 2020 = 248.9; 2021 = 264.5; 2022 = 280.5; 2023 = 295.8. - Real GDP growth (in percent): 2017 = 2.9; 2018 = 2.1; 2019 = 1.7; 2020 = 3.1; 2021 = 3.2; 2022 = 3.1; 2023 = 2.9. - Exchange rate appreciation (US dollar value of local currency, change in percent): 2017 = 2.0; 2018 = 0.0; 2019 = 8.7; 2020 = 3.2. - GDP deflator (change in domestic currency): 2017 = 3.6; 2018 = 2.3; 2019 = 1.3; 2020 = 2.7. - Nominal external interest rate (in percent): 2017 = 1.5; 2018 = 1.8; 2019 = 0.4; 2020 = 3.0. - Growth of exports (US dollar terms, in percent): 2017 = 11.8; 2018 = 4.1; 2019 = 12.5; 2020 = 8.7. - Growth of imports (US dollar terms, in percent): 2017 = 11.2; 2018 = 4.0; 2019 = 14.2; 2020 = 9.2. - Current account balance, excluding interest payments (percent of GDP): 2017 = -1.4; 2018 = -1.5. - DSA scenario shocks illustrated in figures include: interest rate shock, historical scenarios, CA shock, combined shock, real depreciation shock (one-time real depreciation of 30 percent occurs in 2018). *Source: IMF staff estimates and IMF EBA estimates as presented in Annex I. External Sector Assessment.* ### Annex VI. New Zealand 2017 FSAP: Follow-Up on Key ### Annex VI. New Zealand 2017 FSAP: Follow-Up on Key Recommendations ### Financial Stability and Financial Sector Resilience - Recommendation: Increase RBNZ resources for the supervision and regulation of banks, insurance companies, and FMIs. - Time Frame: ST - Update: In process. RBNZ is working on bringing on board four additional staff. - Recommendation: Strengthen cooperation and collaboration arrangements with Australian authorities. - Time Frame: ST - Update: In process. Ongoing work especially on insurance side. Completed a hypothetical bank crisis simulation exercise. - Recommendation: Clarify responsibilities of the Treasury and RBNZ on financial sector issues to reinforce the role of RBNZ as prudential regulator and supervisor. - Time Frame: ST - Update: Terms of reference for Phase Two of the Review of the Reserve Bank Act include this item. - Recommendation: Issue enforceable standards on key risks, governance, risk management, and controls to make RBNZ’s supervisory expectations more transparent and support supervisory preventive action. - Time Frame: ST - Update: No progress yet. - Recommendation: Review and extend the enforcement regime to promote preventive action and enhance sanctions powers, including by eliminating ministerial consent for directions, and making compliance with RBNZ policy documents evidence of prudent practice. - Time Frame: MT - Update: Included in the Review of the Reserve Bank Act. - Recommendation: Initiate on-site programs to test the foundation of the three-pillar approach and directors’ attestations, and increase supervisory engagement with institutions in order to require appropriate action. - Time Frame: ST - Update: In process. A team has been formed to undertake cross-cutting review. - Recommendation: Refine FMA supervision by a) direct monitoring of aspects of asset management relevant to financial stability; b) ensuring quality of Financial Markets Supervisors; and c) enhancing insurance intermediary and conduct regulation and supervision. - Time Frame: I - Update: In process. A review of New Zealand’s insurance contract law has been initiated. MBIE is preparing an issues paper which is planned for release and public consultation in mid-2018. - Recommendation: Expand the FMA's regulatory perimeter to include licensing and supervision of custodians and appropriate oversight of wholesale asset managers. - Time Frame: ST - Update: In preparation. Need further work to understand and complete a thematic review on licensed firm management and custody management. - Recommendation: Adopt and implement proposed FMI legislation on regulation, oversight, and enforcement powers. - Time Frame: I - Update: In process. The drafting of the Financial Services Legislation Amendment Bill is almost completed. - Recommendation: Adopt the PFMI through detailed requirements in secondary legislation; change the frequency of FMI self-assessments in the proposed regime from three to two years; and enhance compliance of the designated FMIs with PFMI requirements. - Time Frame: ST - Update: No progress yet. - Recommendation: Ensure that designated nonfinancial businesses and professions are subject to AML/CFT requirements, particularly company service providers, lawyers, and accountants. - Time Frame: MT - Update: In process. The AML/CFT Amendment Act 2017 puts in place Phase 2 of AML/CFT laws which extend the current AML/CFT Act to cover more businesses. The law will come into effect in stages for different sectors, including for lawyers, conveyancers; and business that provide trust and company services from July 1, 2018; accountants from October 1, 2018; and real estate agents from January 1, 2019. - Recommendation: Expand data collection and modeling efforts to develop structural models for credit risk in commercial real estate (CRE) and corporate portfolios. - Time Frame: MT - Update: No progress yet. ### Macroprudential Framework - Recommendation: Strengthen arrangements for macroprudential policy by increasing communication efforts; by increasing the transparency of the process to adjust the framework; and by maintaining an accountability framework that does not jeopardize the integrity and independence of the macroprudential decision-making process. - Time Frame: C - Update: Will be considered in Phase Two of the Review of the Reserve Bank of New Zealand Act. - Recommendation: Introduce DTI measures in the macroprudential toolkit. - Time Frame: I - Update: In process. The RBNZ conducted a public consultation in June-August 2017 on the possible addition of serviceability restrictions to the macroprudential toolkit. Likely be considered in Phase Two of the Review of the Reserve Bank of New Zealand Act. - Recommendation: Implement DTI measures if the changes to the LVR do not reduce the risks in the housing sector. - Time Frame: I - Update: The authorities do not need to pursue this recommendation as housing risks have currently receded somewhat. - Recommendation: Increase capital buffer requirements to reflect the concentration of the financial sector in four banks. - Time Frame: I - Update: No progress yet. A review of the capital adequacy requirement for locally incorporated registered banks is underway. To be completed in the second or third quarter of 2018. ### Crisis Readiness, Management, and Resolution - Recommendation: Strengthen domestic crisis management arrangements by reaching ex ante agreement on roles, responsibilities, and processes; prepositioning, mobilization, logistics, and communications plans; and testing through simulation exercises. - Time Frame: MT - Update: Terms of Reference for Phase Two of the Review of the Reserve Bank of New Zealand Act include this recommendation. - Recommendation: Reconsider the merits of deposit insurance, or in the absence of policy support, introduce a limited depositor preference to provide legal certainty for the de minimis exemption in OBR. - Time Frame: MT - Update: Terms of Reference for Phase Two of the Review of the Reserve Bank of New Zealand Act include this recommendation. - Recommendation: Revise the RBNZ Act to provide greater clarity and certainty in resolution, by inserting objectives in resolution including protection of depositors and the public interest and requiring accountability reporting against these objectives; by clarifying that the RBNZ is the sole resolution authority, and inserting an express requirement for ministerial consent for resolutions with fiscal or systemic implications only. - Time Frame: MT - Update: Terms of Reference for Phase Two of the Review of the Reserve Bank of New Zealand Act includes this recommendation. ### Time‑frame legend and sources - C = continuous; I (immediate) = within one year; ST (short-term) = 1–3 years; MT (medium-term) = 3–5 years. - Sources: IMF (2017), New Zealand, Financial Sector Assessment Program—Financial System Stability Assessment; and New Zealand authorities. *Annex VI. New Zealand 2017 FSAP: Follow-Up on Key Recommendations (as provided in the source content).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18202.pdf_