## _cr05152

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---

### Executive summary — macro performance and recent developments
- Growth averaged 4 percent a year over the past 6 years, versus an OECD average of 2½ percent.
- Employment rose by 18 percent over the same period; unemployment fell to 3.6 percent (lowest in the OECD).
- CPI inflation averaged 2¼ percent, consistent with the RBNZ’s 1 to 3 percent target range.
- Government debt declined steadily, supported by sizeable and growing current surpluses.
- 2004 specifics:
  - Real GDP growth: almost 5 percent in 2004.
  - House price inflation eased to 13½ percent y/y in February 2005 from 25 percent in 2004.
  - Current account deficit widened to 6.4 percent of GDP in 2004.
  - Net foreign liabilities: 84½ percent of GDP at end-2004.
  - Indicators of tight resource use: employment rose 4½ percent during 2004; unemployment 3.6 percent; capacity utilization at record levels (especially construction).

### Inflation, exchange rate, and monetary stance
- Headline CPI inflation: rose to 2¾ percent y/y by end-2004 from 1½ percent a year earlier; nontradable inflation 4¼ percent y/y.
- New Zealand dollar:
  - Appreciated by 7 percent on a trade-weighted basis since end-2003.
  - Estimated 16 percent above its post-float average at end-March 2005.
  - IMF staff estimate the NZD to be some 15 percent above medium-term equilibrium (macroeconomic balance methodology).
- RBNZ policy actions:
  - OCR raised six times between January and October 2004 to 6.5 percent; raised by a further 25 basis points in March 2005.
  - RBNZ judged further tightening might not be necessary in December MPS because full effects of 2004 increases had not yet worked through.
  - Staff judged further tightening would probably be required and emphasized retaining a tightening bias.

### Fiscal outcomes, projections, and constraints
- OBERAC:
  - Operating surplus before revaluations and accounting changes (OBERAC) rose to 4¾ percent of GDP in 2003/04.
  - DEFU projected 2004/05 OBERAC at 4.3 percent of GDP (budgeted 3.9 percent); OBERAC was ¾ percent of GDP above DEFU projections in the eight months to February 2005.
  - OBERAC projected to decline to 3 percent of GDP by 2007/08.
- Government debt:
  - Gross government debt declined to 25¼ percent of GDP (2003/04).
  - Gross debt projected to fall below 20 percent of GDP in 2008/09; net debt including the NZS Fund becoming negative in 2008/09.
- Budget plans:
  - Projected phased increase in operating spending by about 2 percentage points of GDP from 2004/05 level.
  - Working for Families (WFF) total cost rises to ¾ percent of GDP by 2006/07.
  - Staff estimate DEFU projections imply a cumulative fiscal impulse in 2005/06–2006/07 of about 1½ percent of GDP.
- Staff advice: limits exist on scope for expansionary fiscal policy; caution against using cyclical revenues to raise spending.

### Outlook and risks
- Short-term projection: real GDP growth expected to moderate to about 2¾ percent in 2005 and 2006.
  - Downside drivers: cooling housing market, expected fall in residential investment, deceleration in consumer durables, higher household debt service burdens from OCR increases.
  - Offsetting: business fixed investment expected to remain strong; export incomes supported by high commodity prices.
- Inflation: likely to remain at the top of the 1–3 percent band through 2005; staff judged inflation might edge above 3 percent in 2005 but could fall back within band fairly quickly.
- External: current account deficit may widen slightly in 2005–06 as a strong exchange rate weakens export growth.
- Medium-term: real GDP growth projected to average about 3¼ percent; inflation expected to decline to about 2 percent.
- Key medium-term constraint: with labor force participation at 67¾ percent, trend productivity growth must rise to sustain per capita income growth.
- Risks:
  - Upside: delayed or muted slowdown, continued high consumer confidence, strong commodity prices, stronger-than-expected business investment.
  - Downside: further exchange rate appreciation (especially via U.S. dollar weakness) hurting export incomes; rise in U.S. bond yields transmitting to NZ long-term rates.

### Vulnerability assessment and stress testing
- Standard external sustainability stress tests do not suggest major concerns, though large exchange rate depreciation mechanically raises external debt-to-GDP ratios.
- Mitigating factors (not fully captured in standard framework): foreign-currency debt predominantly hedged.
- Past flexibility and generally healthy balance sheets provide cushioning.

### Monetary policy and foreign exchange intervention stance (detailed)
- RBNZ:
  - Recognizes current monetary settings might not be sufficient to contain inflationary pressures.
  - December MPS: judged further tightening might not be necessary because lagged effects of 2004 increases were yet to work through.
  - March MPS: pushed out timing of expected slowdown to late 2005; little scope for easing in foreseeable future.
- FX intervention:
  - Authorities have not intervened since policy review; committed to freely floating ER.
  - Will contemplate intervention if (i) exchange rate exceptionally and unjustifiably high or low, and (ii) an opportunity exists ensuring effectiveness.
  - RBNZ considered currency strength largely due to high commodity prices and interest differentials and questioned intervention effectiveness under current dynamics.
  - Staff viewed intervention criteria as well-considered and likely to make intervention rare but potentially effective.

### Long-term fiscal pressures and policy responses
- Health and pensions:
  - Per capita health spending rose at an average annual rate of 5 percent in real terms in the last five years.
  - Current government spending on pensions and health care around 11 percent of GDP.
  - Demographic changes could push pension and health care spending to some 19 percent of GDP by 2051.
  - Under higher cost assumptions pension and health spending could rise to as much as 34 percent of GDP.
- NZS Fund intended to prefund a portion of future pension liabilities.
- Staff suggested consideration of parametric changes in pension and health care systems.
- Authorities committed to publishing long-run fiscal reports at least every four years.

### Growth, productivity, and labor market policies
- Per capita income: about 20 percent below the OECD median.
- Productivity:
  - Labor productivity growth averaged 1½ percent per annum in recent years.
  - RBNZ estimate: trend productivity growth needs to rise to about 2 percent to maintain recent per capita income growth.
  - Staff: sustain business investment; implement transportation and energy infrastructure improvements; reduce Resource Management Act uncertainties to encourage investment.
- Labor market measures:
  - Employment Relations Act amendments in 2005 introduce bargaining in good faith, limit free-riding of individual agreements, facilitate multi-employer collective agreements.
  - Significant minimum wage increases; Holidays Act extension from three to four weeks by 2007.
  - Staff recommended reviewing effects of these changes and adequacy of probationary arrangements.
- Participation and welfare-to-work:
  - Authorities expanding access to childcare; WFF designed to avoid adverse participation impacts.
  - Resources increased for case management to move beneficiaries into work; trial employment periods for persons on invalids benefit.
  - Over last three years a 21 percent increase in number receiving invalids and sickness benefits.
  - Staff suggested elements of Denmark’s “right and duty” welfare model could be considered.

### Household savings, indebtedness, and implications for monetary policy (Box 2 highlights)
- Historical and level indicators:
  - Household debt doubled to 100 percent by end of the 1990s.
  - Estimated household debt ratio 137 percent at end of 2004.
  - At end-2004, 85 percent of mortgage loans were fixed for less than two years or at floating rates.
  - Housing equity has risen by some 100 percentage points of income in recent years.
- Empirical results on interest-rate sensitivity of consumption:
  - With household debt at 50 percent of disposable income, a 1 percentage point rise in the interest rate estimated to reduce consumption by some ¾ percent after 2 years.
  - With household debt near 140 percent, the same interest rate increase estimated to lower consumption by 2¼ percent.
- Implications:
  - Higher indebtedness increases sensitivity of household spending to interest rates.
  - Higher housing equity may mitigate some interest-sensitivity through improved hedging capacity.

### Financial sector soundness, supervision, and cross-border issues
- Banking sector metrics (2000–2004 series highlights):
  - Residential mortgage loans account around 40–43 percent of assets.
  - Return on average assets: 1.3 percent in 2004.
  - Total capital: more than 10 percent; Tier one around 8 percent of risk-weighted assets.
  - Impaired assets ratio about ¼ percent (historic low).
  - Five largest banks (90 percent of assets and deposits) rated AA-.
- External debt composition and hedging (end-March 2004):
  - Total gross external debt (end-March, $NZ billions, 1997–2004 series): 80.7, 85.6, 97.7, 107.3, 128.0, 138.1, 138.0, 142.1.
  - By sector (share of total gross external debt, end-March 2004): Official government 12.8; Corporate sector 87.2; Banks 57.0; Other corporate 30.2.
  - By currency (end-March 2004): New Zealand dollar 49.0; Foreign currency 51.1.
  - By (residual) maturity (end-March 2004): Short term (under 1 year) 50.9; Medium term (1-5 years) 19.0; Long term (over 5 years) 23.5.
  - Hedging: surveyed foreign-currency debt about 88 percent hedged via natural hedges or financial derivatives (1998–2004 series shows high coverage).
- Cross-border supervision:
  - Four large Australian-owned banks account for some 85 percent of banking assets.
  - RBNZ and APRA building enhanced home-host supervisory relationship; high-level council established.
  - Staff welcomed coordination but stressed final schemes must incorporate safeguards for New Zealand financial stability.
- Stress tests and vulnerabilities:
  - FSAP and RBNZ stress tests indicate banking system robust to shocks: major decline in agricultural export demand; large fall in housing prices with higher unemployment; substantial increase in cost of foreign capital inflows.
  - Household debt: household debt rose to 137 percent of disposable income; household interest payments projected to rise above previous highs in 2005–06.
  - RBNZ plans to use household-level data to analyze vulnerability endorsed by staff.

### External position — key indicators and narrative
- Current account (annual 1998–2004): -5.5, -4.2, -6.5, -4.1, -2.7, -3.4, -4.6.
- Net foreign liabilities (percent of GDP at end-March 1998–2004): 88.7, 85.1, 80.2, 76.8, 79.8, 78.1, 79.5.
- Gross external debt (percent of GDP at end-March 1998–2004): 85.0, 95.4, 98.8, 111.5, 111.6, 107.2, 104.0.
- Real effective exchange rate (1990=100) (1998–2004): 89.2, 88.0, 81.9, 83.1, 95.3, 106.5, 111.6.
- Narrative:
  - Net external liabilities broadly unchanged over last four years as assets kept pace with debt rise.
  - Banks' share of external debt rose from 25 percent of GDP at end-March 1997 to 59 percent at end-March 2004; banks account for about 57 percent of total gross external debt.
  - Foreign-currency component declined to 51 percent of total debt at end-March 2004 after peaking at 63 percent at end-March 2001.
  - For surveyed foreign-currency debt about 88 percent hedged via natural hedges or derivatives; use of derivatives increased sharply since end-March 1998.

### Box 1 — rapid employment expansion and productivity growth (key numeric points)
- 1992–2004:
  - GDP growth: 3.7
  - Labor productivity growth (output per hour worked): 1.2
  - Labor input growth (hours worked): 2.5
  - Working age population: 1.3
  - Participation rate: 0.4
  - Change in unemployment: 0.6
  - Total hours worked per person: 0.2
- 1999–2004:
  - GDP growth: 3.9
  - Labor productivity growth: 1.5
  - Labor input growth: 2.4
  - Working age population: 1.4
  - Participation rate: 0.5
  - Change in unemployment: 0.8
  - Total hours worked per person: -0.3
- Medium-term projections:
  - GDP growth: 3.3
  - Labor productivity growth: 2.0
  - Labor input growth: 1.3
  - Working age population: 1.3
  - Participation rate: 0.1
  - Change in unemployment: -0.1
  - Total hours worked per person: 0.0
- Additional points:
  - Labor input expected to rise by about 1¼ percent a year over the medium-term (vs 2½ percent over 1992-2004).
  - Productivity growth needs to increase to 2 percent a year (from about 1¼ per during 1992-2004) to achieve annual potential output growth of 3¼ percent.
  - Employment rate rose from 57 percent in 1992 to 64 percent in 2004.
  - Bélorgey et al. (2004) estimate a 1 percent increase in employment rate decreases average productivity by ½ percent; extrapolation suggests rapid employment growth may have lowered measured average labor productivity growth by as much as ½ percent a year.

### Executive Board assessment (selected points)
- Commended strong growth and low unemployment; praised sound monetary and fiscal policies and structural reforms.
- Supported RBNZ tightening and tightening bias given upside inflation risks.
- Fiscal recommendations:
  - Not to spend cyclical component of higher-than-expected surpluses.
  - Maintain operating surpluses over cycle, contributions to NZS Fund, and capital spending needs.
  - Urged continued prudence given rapid growth in health and education spending.
- Long-run fiscal: supported NZS Fund prefunding; recommended early adoption of parametric changes in pension and health care.
- Growth and productivity: increase labor productivity is key; support boosting business investment, R&D, and infrastructure upgrades.
- Labor market: preserve flexibility; review effects of recent measures; scope to raise participation (expand childcare, require benefit recipients to participate in training/work).
- Financial sector: strongly welcomed efforts to strengthen banking regulation and crisis management; encouraged safeguards in closer integration with Australian regulation.
- Trade and aid: noted remaining trade barriers in agriculture; welcomed Doha Round engagement and bilateral/region FTA work.

### Selected economic indicators (selected exact figures)
- Real economy (percent change):
  - GDP (production basis): 2000: 3.6, 2001: 2.6, 2002: 4.7, 2003: 3.4, 2004: 4.8, 2005 (Proj.): 2.8
  - Domestic demand: 2000: 1.9, 2001: 2.6, 2002: 5.6, 2003: 5.3, 2004: 8.0, 2005 (Proj.): 3.6
  - Exports of goods and services: 2000: 6.0, 2001: 2.5, 2002: 6.3, 2003: 1.7, 2004: 5.2, 2005 (Proj.): 2.6
  - Imports of goods and services: 2000: 0.3, 2001: 1.7, 2002: 9.6, 2003: 7.9, 2004: 15.8, 2005 (Proj.): 5.1
  - Headline CPI inflation (end of period): 2000: 4.0, 2001: 1.8, 2002: 2.7, 2003: 1.6, 2004: 2.7, 2005 (Proj.): 2.8
  - Unemployment rate (in percent): 2000: 6.0, 2001: 5.3, 2002: 5.2, 2003: 4.6, 2004: 3.9, 2005 (Proj.): 3.8
  - National saving (in percent of GDP) 1/: 2000: 14.9, 2001: 18.3, 2002: 18.3, 2003: 18.1, 2004: 17.6, 2005 (Proj.): 17.4
  - Investment (in percent of GDP): 2000: 21.2, 2001: 20.8, 2002: 22.0, 2003: 22.2, 2004: 24.0, 2005 (Proj.): 24.4
- Government budget (in percent of GDP) 2/:
  - Revenue: 2000: 33.2, 2001: 33.6, 2002: 31.8, 2003: 33.9, 2004: 33.4, 2005 (Proj.): 33.6
  - Expenditure: 2000: 32.9, 2001: 32.5, 2002: 30.3, 2003: 32.4, 2004: 29.6, 2005 (Proj.): 30.4
  - OBERAC 3/: 2000: 1.3, 2001: 1.2, 2002: 1.9, 2003: 1.5, 2004: 5.3, 2005 (Proj.): 3.7
  - Net public debt: 2000: 19.5, 2001: 17.0, 2002: 14.2, 2003: 13.7, 2004: 10.8, 2005 (Proj.): 8.7
- Interest rates and yields:
  - Interest rate (90-day, in percent) 4/: 2000: 6.7, 2001: 4.9, 2002: 5.9, 2003: 5.3, 2004: 6.8, 2005 (as of May 2): 7.0
  - Government bond yield (10-year, in percent) 4/: 2000: 6.1, 2001: 6.6, 2002: 6.1, 2003: 5.9, 2004: 6.0, 2005 (as of May 2): 5.9
- Balance of payments (in percent of GDP):
  - Current account balance: 2000: -4.8, 2001: -2.4, 2002: -3.7, 2003: -4.2, 2004: -6.4, 2005 (Proj.): -7.0
  - Trade balance: 2000: 1.3, 2001: 2.9, 2002: 0.3, 2003: -0.5, 2004: -1.4, 2005 (Proj.): -1.7
- External assets and liabilities (in percent of GDP):
  - Gross external debt: 2000: 85.6, 2001: 93.5, 2002: 103.7, 2003: 109.5, 2004: 105.5, 2005 (Proj.): 107.9
  - Net external liabilities: 2000: 81.5, 2001: 75.7, 2002: 78.4, 2003: 78.7, 2004: 84.5, 2005 (Proj.): 86.6
- Exchange rate (end of period):
  - US$/$NZ 4/: 2000: 0.44, 2001: 0.42, 2002: 0.52, 2003: 0.66, 2004: 0.72, 2005 (as of May 2): 0.73
  - Trade-weighted index (June 1979 = 100) 4/: 2000: 49.7, 2001: 49.9, 2002: 58.2, 2003: 65.1, 2004: 68.8, 2005 (as of May 2): 71.3
  - Real effective exchange rate 5/: 2000: 81.9, 2001: 83.1, 2002: 95.3, 2003: 106.5, 2004: 111.6

*Italic: IMF staff appraisal excerpt from the provided content unit.*

### Executive Summary ......................................................................................................

### Executive Summary

### Economic background and recent performance
- Growth averaged 4 percent a year over the past 6 years, compared to an annual average of 2½ percent across the OECD.
- Employment rose by 18 percent over the same period, reducing the unemployment rate to 3.6 percent, the lowest in the OECD.
- CPI inflation has averaged 2¼ percent, consistent with the Reserve Bank of New Zealand’s 1 to 3 percent target range.
- Government debt has declined steadily, aided by sizeable and growing current surpluses.

### 2004 developments and resource utilization
- Real GDP growth rose to almost 5 percent in 2004, driven mainly by strong domestic demand.
- Household consumption was buoyant due to strong income growth and improved terms of trade; fixed investment accelerated as firms faced growing capacity constraints.
- House price inflation eased to 13½ percent y/y in February 2005 from 25 percent in 2004 following a fall in net inward migration; residential investment slowed from the pace set in 2002–03.
- The current account deficit widened to 6.4 percent of GDP in 2004.
- Net foreign liabilities rose to 84½ percent of GDP at end-2004.
- Indicators point to an economy operating at full stretch: employment rose 4½ percent during 2004, unemployment fell to 3.6 percent, labor scarcity indicators reached historical highs, and capacity utilization was at record levels (especially in construction).

### Inflation, exchange rate, and monetary stance
- Headline CPI inflation rose to 2¾ percent y/y by end-2004, from 1½ percent a year earlier; nontradable inflation was 4¼ percent y/y.
- The New Zealand dollar appreciated by 7 percent on a trade-weighted basis since end-2003 and was estimated to be 16 percent above its post-float average at end-March 2005.
- The Reserve Bank of New Zealand raised the official cash rate (OCR) six times between January and October 2004, bringing the OCR to 6.5 percent; the OCR was raised by a further 25 basis points in March 2005.

### Fiscal outcomes
- The operating surplus before revaluations and accounting changes (OBERAC) rose to 4¾ percent of GDP in 2003/04.
- Gross government debt declined to 25¼ percent of GDP.
- The December Economic and Fiscal Update (DEFU) projected the 2004/05 OBERAC at 4.3 percent of GDP (budgeted 3.9 percent); in the eight months to February 2005 the OBERAC was ¾ percent of GDP above DEFU projections owing to spending delays and higher state-owned enterprise surpluses.

### Outlook and risks
- Short-term projection: real GDP growth is expected to moderate to about 2¾ percent in 2005 and 2006.
  - Drivers of slowdown: cooling housing market, expected fall in residential investment, deceleration in consumer durables, and higher household debt service burdens from OCR increases.
  - Offsetting factors: business fixed investment expected to remain strong; export incomes supported by high commodity prices.
- CPI inflation likely to remain at the top of the 1–3 percent target band through 2005.
- External current account deficit may widen slightly further in 2005–06 as a strong exchange rate weakens export growth.
- Medium-term projection: real GDP growth projected to average about 3¼ percent; inflation expected to decline to about 2 percent.
- Key medium-term constraint: given high labor force participation at 67¾ percent, a rise in trend productivity growth is required to sustain strong per capita income growth.
- Risks:
  - Upside: delayed or muted slowdown, continued high consumer confidence and strong commodity prices, and stronger-than-expected business investment.
  - Downside: further appreciation of the exchange rate (especially via U.S. dollar weakness) that could more rapidly hurt export incomes; a rise in U.S. bond yields transmitting to New Zealand long-term rates.

### Vulnerability assessment
- Stress tests using the standard external sustainability framework do not suggest major concerns, though a large exchange rate depreciation mechanically raises external debt to GDP ratios.
- The mitigating role of foreign-currency debt being predominantly hedged is not captured in the standard framework.
- The country’s past flexibility and generally healthy balance sheets provide cushioning against shocks.

### Policy discussions and recommendations
- Monetary policy
  - Staff and authorities broadly agree on the macro stance: the RBNZ’s tightening and retention of a tightening bias was appropriate given upward inflationary risks amid strong resource utilization.
  - Monetary policy faces a difficult balancing act: further tightening could aggravate a nascent slowdown; insufficient tightening could allow inflation to rise.
- Fiscal policy
  - New Zealand’s fiscal position is very strong, but scope for expansionary fiscal policy is limited without exacerbating resource strains.
  - The government plans phased spending increases for health, education, and support to low-income families while meeting a prudent medium-term target for reducing the debt-to-GDP ratio.
  - Long-term fiscal pressures from rising health care costs and population aging remain significant; reforms of pension and health care systems need consideration.
- Growth and structural policies
  - Raising productivity growth (and to a lesser extent labor participation) is key to closing the gap with OECD average per capita incomes.
  - Priorities: implement infrastructure improvements on schedule; continue upgrading education and training; employ measures to facilitate movement from welfare to work.
- Financial sector
  - New Zealand’s banking system remains sound; authorities have used the period of calm to strengthen the crisis management framework.
  - Discussions on potential integration of banking regulation with Australia are underway; outcomes are uncertain, and adequate safeguards for financial stability in New Zealand must remain in place.

*Source: Executive Summary (IMF country report content).*

### 14.      With the economy continuing to show considerable momentum, the RBNZ

### _cr05152 - 14.      With the economy continuing to show considerable momentum, the RBNZ

### Monetary policy and inflation outlook
- RBNZ recognized current monetary settings might not be sufficient to contain inflationary pressures.
- At the December MPS the RBNZ judged a further tightening might not be necessary because full effects of interest rate increases in 2004 had yet to work through the economy.
  - Increased competition between mortgage lenders in late 2004 likely extended usual interest-rate transmission lags.
  - Foreign exchange hedges rolling off in 2005 would expose exporters to the appreciated exchange rate, creating additional drag.
- Inflation was already at the top of the band; RBNZ considered there was little headroom to absorb additional upside surprises.
- IMF staff agreed further monetary tightening would probably be required.
  - Staff noted the high exchange rate was already appearing to affect export industries like forestry and seafood.
  - Staff judged inflation might edge above the 3 percent band in 2005, but that this could be consistent with the medium-term inflation objective if inflation fell back within the band fairly quickly.
  - Staff emphasized the importance of monetary policy retaining a tightening bias.
- Continued strong data led to another OCR increase in March 2005.
  - In the March MPS the RBNZ pushed out the timing of the expected slowdown to late 2005.
  - Authorities judged there was little scope for easing monetary policy in the foreseeable future; staff concurred.

### Foreign exchange intervention stance
- Authorities have not intervened in the foreign exchange market since the recent review of intervention policy.
- RBNZ remains committed to a freely floating exchange rate but announced in March 2004 it would contemplate intervention if:
  - the exchange rate was exceptionally and unjustifiably high or low, and
  - an opportunity existed that would ensure such intervention would be effective.
- IMF staff estimate the New Zealand dollar to be some 15 percent above medium-term equilibrium levels according to a macroeconomic balance methodology.
- RBNZ considered currency strength largely attributable to relatively high commodity prices and interest differentials and questioned whether intervention would be effective under current market dynamics.
- Staff viewed the intervention criteria as well-considered and likely to make intervention an effective, but rare, occurrence.

### Fiscal policy: positions, projections, and constraints
- Authorities’ medium-term fiscal objectives (May 2004 Fiscal Strategy Report):
  - (i) maintain government debt at prudent levels, with gross debt to be brought below 20 percent of GDP before 2015;
  - (ii) run operating surpluses on average over the economic cycle sufficient to meet contributions to the NZS Fund; and
  - (iii) meet capital spending pressures and priorities.
- Debt target revised to be more stringent than prior 30 percent of GDP target and given a specific timeframe.
- Current fiscal projections and budget plans:
  - Projected phased increase in operating spending over the budget horizon by about 2 percentage points of GDP from its 2004/05 level.
  - Revenues projected to remain broadly stable relative to GDP.
  - OBERAC surplus projected to decline to 3 percent of GDP by 2007/08.
  - Gross debt projected to fall below 20 percent of GDP in 2008/09.
  - Net debt including the NZS Fund becoming negative in 2008/09.
- Working for Families (WFF) package:
  - The total cost of the package rises to ¾ percent of GDP by 2006/07.
- Staff assessment and advice:
  - Staff agreed limits exist on the scope for expansionary fiscal policy despite the strong fiscal position.
  - Staff estimate the DEFU fiscal projections imply a cumulative fiscal impulse in 2005/06 to 2006/07 of about 1½ percent of GDP.
  - Staff cautioned that a more expansionary path (additional spending or tax cuts) could aggravate short-term resource strains and undermine the debt-to-GDP declining path.
  - Staff endorsed authorities’ intentions in the Budget Policy Statement 2005 to avoid fiscal expansion that would unduly pressure interest and exchange rates and to avoid spending cyclical revenue increases.

### Long-term fiscal pressures and policy responses
- Rising health care costs and population aging pose significant long-term spending pressures:
  - Per capita health spending has risen at an average annual rate of 5 percent in real terms in the last five years.
  - Current government spending on pensions and health care is around 11 percent of GDP.
  - Demographic changes could push pension and health care spending to some 19 percent of GDP by 2051.
  - Allowing for higher cost assumptions, pension and health spending could rise to as much as 34 percent of GDP.
- NZS Fund intended to prefund a portion of future pension liabilities to partially smooth pension-related pressures.
- Staff noted substantial challenges remain to keep public spending on a sustainable path and suggested consideration of parametric changes in pension and health care systems.
- Authorities committed to publishing long-run fiscal reports at least every four years.

### Growth, productivity, and labor market policies
- Objective: sustain strong growth to raise living standards and better manage population aging; per capita income remains some 20 percent below the OECD median.
- Productivity and investment:
  - Labor productivity is at the lower end of the OECD range.
  - Labor productivity growth has averaged 1½ percent per annum in recent years.
  - RBNZ estimate: trend productivity growth needs to rise to about 2 percent to maintain recent per capita income growth.
  - Staff highlighted the importance of sustaining business investment and implementing planned improvements in transportation and energy infrastructure.
  - Reducing uncertainties in the resource consent process (Resource Management Act amendments) seen as beneficial for investment.
- Labor market flexibility and reforms:
  - Employment Relations Act amendments in 2005 include requirements to bargain in good faith, limit “free-riding” of individual agreements on collective negotiations, and facilitate increased use of multi-employer collective agreements.
  - Significant minimum wage increases and Holidays Act extension from three to four weeks by 2007 adopted.
  - Staff recommended reviewing the effects of these labor market changes after a suitable period and encouraged reviewing adequacy of arrangements for probationary periods.
- Labor participation and welfare-to-work measures:
  - Authorities pursuing reforms to expand labor participation, including expanding access to childcare and the WFF package designed to avoid adverse impacts on participation.
  - Authorities increasing resources for case management to help move people from benefits back into work and introducing trial employment periods for persons on the invalids benefit.
  - Over the last three years a 21 percent increase occurred in the number of people receiving invalids and sickness benefits.
  - Staff suggested elements of Denmark’s “right and duty” welfare model could reinforce efforts to raise participation.

### Household savings and international openness
- Authorities developing a program to facilitate household savings; proposal for employers to offer access to a savings plan with voluntary employee participation via an ‘opt-out’ system.
  - Authorities aim to reduce costs of saving, especially for lower-income workers.
  - Staff suggested any budgetary incentives for saving should be time limited and income targeted.
  - Staff noted that such a program may not increase saving for many employees and unlikely to much affect investment and growth given access to international capital.
- Trade policy:
  - New Zealand active in multilateral Doha Round negotiations; sensitive to agricultural export trade barriers.
  - Bilateral progress: closer economic partnership with Thailand (November 2004); positive studies on FTAs with China and Malaysia.
  - Negotiations ongoing for a four-way partnership with Brunei Darussalam, Chile, and Singapore; ASEAN-Australia and New Zealand FTA negotiations to commence in 2005.
- Official development assistance:
  - New Zealand provided 0.23 percent of Gross National Income for ODA in 2003.

### Financial sector and supervision
- Banking sector sound: strong capital, low nonperforming assets, well-managed risks.
- RBNZ regulatory initiatives:
  - Adopted a framework for independent reviews of banks’ systems and controls; first use already made.
  - Reviewing the disclosure regime, particularly in light of Basel II.
  - Enhancing capacity to manage financial stresses: operationalizing lender of last resort role and finalizing options for responding to bank failures.
  - Policy to limit outsourcing of key functions so banks can operate on a stand-alone basis in a crisis.
- Cross-border supervisory cooperation:
  - Four large Australian-owned banks account for some 85 percent of banking assets.
  - RBNZ and the Australian Prudential Regulation Authority (APRA) have undertaken to build an enhanced home-host supervisory relationship.
  - Australian and New Zealand authorities established a high-level council on banking supervision to coordinate trans-Tasman regulatory issues.
  - Staff welcomed coordination but stressed final regulatory schemes must incorporate safeguards for New Zealand’s financial stability in a crisis.
- Financial Stability Report and household vulnerability:
  - First Financial Stability Report (October 2004) noted a slowing housing market could pose difficulties for nonbank financial institutions exposed to speculative developments.
  - Household debt has risen to 137 percent of disposable income, double its level 12 years ago.
  - Household interest payments projected to rise above previous highs in 2005–06.
  - FSSA stress-tests found banking system robust to household-sector shocks, including a substantial decline in housing prices.
  - Staff endorsed RBNZ plans to use household-level data to analyze household vulnerability to higher interest rates or other shocks.

_Italic: IMF staff appraisal excerpt from the provided content unit._

### 33.      New Zealand has maintained its recent record of outperforming other advanced

### New Zealand has maintained its recent record of outperforming other advanced

### Recent growth and labor market outcomes
- Over the last 6 years, growth has averaged 4 percent a year, compared to an annual average of 2½ percent across the OECD.
- Job creation has continued at a rapid pace, reducing unemployment to the lowest in the OECD.
- These outcomes are underpinned by sustained implementation of sound monetary and fiscal policies and wide-ranging structural reforms undertaken in the past.

### Growth drivers and near-term developments
- Activity was expected to slow in 2004 due to:
  - appreciation of the New Zealand dollar, and
  - a substantial fall in net migration inflows expected to reduce housing market pressures and slow durable consumption as residential investment declined.
- Actual outcomes:
  - Exporters’ incomes have held up, aided by strong commodity prices and widespread foreign exchange hedging.
  - Strong labor market supported consumption and promoted strong business investment to overcome capacity pressures and labor shortages.
- Growth has continued to surprise on the upside.

### Inflation, resource utilization, and monetary policy
- Since the beginning of 2004, domestic demand has been consistently stronger than envisaged.
- The RBNZ has raised rates seven times.
- Resource utilization has risen to record high levels, yet inflation has remained inside the target range because strong upward pressures on nontraded goods prices have been offset by low inflation in non-oil traded goods prices.
- Labor markets are now exceptionally tight and inflation, already near the top of the band, may rise above 3 percent in 2005.
- Policy assessment:
  - Upside risks to inflation predominate.
  - A further tightening could exacerbate a slowdown that may already be underway.
  - Expected easing of resource pressures once lower net migration cools the housing market and lags from higher interest rates and a more appreciated exchange rate materialize.
  - Given underlying momentum in household consumption and business investment, staff agree with the RBNZ that monetary policy should retain a tightening bias.

### Fiscal performance and near-term fiscal stance
- Policy objectives:
  - Achieve operating surpluses over the economic cycle sufficient to cover contributions to the NZS Fund,
  - Meet capital spending requirements,
  - Bring gross government debt down below 20 percent of GDP by 2015.
- Treasury’s December 2004 forecasts show operating surpluses over the next few years that are larger than previously anticipated.
- Higher-than-expected fiscal surpluses reflect buoyant revenues.
- Staff strongly endorse the authorities’ intention not to use the cyclical component of these revenues to raise spending.
- The new projections imply a small stimulus over the next few years; a more expansionary policy would risk adding to current resource pressures and complicating medium-term fiscal objectives.
- Recent rapid growth in spending categories, including health and education, is unlikely to be sustainable; continued prudence and discipline in expenditure decisions should be maintained.

### Long-term fiscal challenges: demographics, pensions, and health care
- Treasury estimates suggest demographic changes over the next half century are likely to double or triple government spending on pensions and health care from the current level of 11 percent of GDP, depending on cost assumptions.
- Creation of the NZS Fund to prefund part of future pension liabilities is an important step to smooth budget effects of expected pension increases.
- To keep public spending on a sustainable path, parametric changes in the pension and health care systems will need to be considered.
- Staff welcome the decision to start publishing long-run fiscal reports at least every four years to inform public debate about reform needs.

### Productivity, medium-term growth prospects, and required adjustments
- Despite strong recent performance, per capita income remains some 20 percent below the OECD median.
- The challenge is to sustain high growth and narrow the gap while managing population aging.
- Labor productivity growth is key because there is no longer scope for substantial gains in labor utilization.
- Projections and targets:
  - Labor input expected to rise by about 1¼ percent a year over the medium-term, compared to 2½ percent over 1992-2004.
  - To achieve annual growth in potential output of 3¼ percent, productivity growth needs to increase to 2 percent a year (from about 1¼ per during 1992-2004).
  - Productivity growth has been higher in recent years at about 1½ percent.
- Policy actions to support higher productivity growth:
  - Maintain high business investment to deepen capital per worker and introduce new technology.
  - Upgrade transportation and energy infrastructure.
  - Ensure the education system equips the workforce with requisite skills.
  - Improve the Resource Management Act to reduce investor uncertainties.

### Labor market policies and participation
- Recent measures affecting the labor market include the Holidays Act, amendments to the Employment Relations Act, and increases in the minimum wage; these are generally not expected to impair labor market flexibility but effects should be kept under close review.
- Given tight labor markets, the risk of poor employment matches may deter hiring; adequacy of arrangements for probationary periods should be reviewed.
- Active case management to help transition people from welfare to work is promising to expand participation.
  - Participation is relatively high but scope exists to increase participation among certain groups to meet labor needs and cushion slowing net immigration.
  - Recent measures: expanding access to childcare to increase opportunity for women; the Working for Families package provides a foundation for further reforms.
  - New initiatives include trial employment periods for recipients of invalids benefit and case-by-case approaches to health problems of those receiving sickness benefit.
  - Recommendation: reinforce efforts by strengthening requirements for those on benefits to participate in training or work programs.

### Household savings, financial reforms, and regulatory adjustments
- Schemes to promote savings likely yield benefits in improving household resilience and economic opportunities.
  - Even if aggregate savings rise, effects on investment and growth are unlikely to be large because New Zealand already has easy access to international capital.
  - Workplace savings systems can help households build financial assets to buffer shocks and expand opportunities to invest in education, housing, small business, and retirement.
  - Design of such schemes should account for administrative costs and carefully design incentives to limit budgetary impact.
- Banking regulation reforms are underway:
  - Financial sector fundamentally sound: strong capital, low nonperforming assets, well-managed risks.
  - Authorities are strengthening regulatory and crisis management capacity.
  - Planned review of regulation and disclosure of nonbank financial institutions is important.
  - Discussions with Australia on closer integration of banking regulation are underway; priority should be ensuring adequate safeguards for financial stability in New Zealand remain.

### Box 1 — Rapid Employment Expansion and Productivity Growth (key quantitative points)
- Over 1992 to 2004:
  - GDP growth: 3.7
  - Labor productivity growth (output per hour worked): 1.2
  - Labor input growth (hours worked): 2.5
  - Working age population: 1.3
  - Participation rate: 0.4
  - Change in unemployment: 0.6
  - Total hours worked per person: 0.2
- Over 1999 to 2004:
  - GDP growth: 3.9
  - Labor productivity growth: 1.5
  - Labor input growth: 2.4
  - Working age population: 1.4
  - Participation rate: 0.5
  - Change in unemployment: 0.8
  - Total hours worked per person: -0.3
- Medium term projections:
  - GDP growth: 3.3
  - Labor productivity growth: 2.0
  - Labor input growth: 1.3
  - Working age population: 1.3
  - Participation rate: 0.1
  - Change in unemployment: -0.1
  - Total hours worked per person: 0.0
- Additional quantitative points from Box 1:
  - Labor input expected to rise by only about 1¼ percent a year over the medium-term, compared to 2½ percent over 1992-2004.
  - Productivity growth needs to increase to 2 percent a year (from about 1¼ per during 1992-2004) for the economy to achieve annual growth in potential output of 3¼ percent.
  - Employment rate rose from 57 percent in 1992 to 64 percent in 2004, implying an average increase in the rate of about 1 percent a year.
  - Bélorgey et al. (2004) estimate that a 1 percent increase in the employment rate decreases average productivity by ½ percent; extrapolation suggests rapid employment growth may have lowered measured average labor productivity growth by as much as ½ percent a year.

### Conclusions and procedural note
- Staff view:
  - Monetary policy should retain a tightening bias given predominantly upside risks to inflation.
  - Fiscal prudence should be maintained; avoid using cyclical revenues to raise spending.
  - Structural reforms to boost productivity, preserve labor market flexibility, and prepare fiscal policy for demographic pressures are priorities.
- It is proposed that the next Article IV consultation with New Zealand take place on the standard 12-month cycle.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05152.pdf*

### Box 2. Rising Household Indebtedness and Monetary Policy

### Box 2. Rising Household Indebtedness and Monetary Policy

### Overview of recent household indebtedness in New Zealand
- Following financial deregulation in the mid-1980s, and aided by the decline in nominal interest rates permitted by disinflation, the ratio of household debt to income in New Zealand doubled to 100 percent by the end of the 1990s.
- Borrowing accelerated in 2002-04, primarily due to the rise in housing prices, lifting the debt ratio to an estimated 137 percent at the end of 2004, a level broadly similar to the U.S., U.K., and Australia.

### Implications for monetary policy
- Higher indebtedness could increase the sensitivity of household spending to interest rates, potentially allowing monetary policy to achieve its goals with smaller interest rate adjustments.
- The negative impact of interest rates on the incomes of households that are debtors will be greater at higher debt levels (see Debelle, 2004).
- New Zealand households are relatively exposed to interest rate effects on their disposable income; at the end of 2004, some 85 percent of mortgage loans were at interest rates fixed for less than two years, or were at floating rates.

### Empirical findings on interest-rate sensitivity of consumption
- Real interest rates on housing mortgages are found to have a negative impact on consumption.
- A model allowing this effect to depend on the level of household indebtedness has greater explanatory power.
- Estimated impacts (model results reported):
  - With household debt at 50 percent of disposable income, a 1 percentage point rise in the interest rate is estimated to reduce consumption by some ¾ percent after 2 years.
  - With the household debt ratio near 140 percent, as at the end of 2004, the same interest rate increase is estimated to lower consumption by 2¼ percent.

### Housing equity and potential mitigation of interest sensitivity
- Recent U.S. research finds that households can better hedge income shocks when collateral for borrowing is more abundant (Lustig et al, 2004).
- Housing equity has risen by some 100 percentage points of income in recent years in New Zealand, so the scope for households to smooth income shocks from interest rate changes may have risen significantly.

### Key numeric points and indicators cited in the box
- Household debt to income:
  - Doubled to 100 percent by end of the 1990s.
  - Estimated 137 percent at end of 2004.
- Mortgage rate exposure:
  - 85 percent of mortgage loans fixed for less than two years, or at floating rates (end-2004).
- Consumption responses to a 1 percentage point interest rate rise:
  - At 50 percent household debt: reduce consumption by some ¾ percent after 2 years.
  - At ~140 percent household debt: reduce consumption by 2¼ percent.
- Housing equity:
  - Has risen by some 100 percentage points of income in recent years in New Zealand.

*Box 2. Rising Household Indebtedness and Monetary Policy (excerpt).*

### 1.      New Zealand does not appear to face major economic vulnerabilities.

### 1.      New Zealand does not appear to face major economic vulnerabilities.

### Overall assessment
- The economy "remains well placed to manage adverse economic shocks."
- Net foreign liabilities "remain high, they have declined from their peak."
- "Foreign debt has become more concentrated in the banking sector and its maturity has shortened."
- "About half of the debt remains denominated in foreign currency, but exchange rate risk is mitigated through substantial hedging."
- "Corporate and banking sector balance sheets continue to look strong."
- "Household balance sheets and finances also look reasonably sound."
- Main household asset and liability:
  - Housing is the main household asset.
  - Mortgage debt is the major household liability and a major asset of the banking system.
- Downside risks:
  - "Higher leverage has recently increased debt servicing costs of households, and a substantial increase in interest rates or unemployment or a correction in housing prices could potentially strain the finances of some households."

### A. External position — key findings and statistics
- Current account (annual) (1998–2004): -5.5, -4.2, -6.5, -4.1, -2.7, -3.4, -4.6 (annual series shown).
- Net foreign liabilities (percent of GDP at end-March) (1998–2004): 88.7, 85.1, 80.2, 76.8, 79.8, 78.1, 79.5.
- Gross external debt (percent of GDP at end-March) (1998–2004): 85.0, 95.4, 98.8, 111.5, 111.6, 107.2, 104.0.
- Components of gross external debt (selected shares, end-March 2004):
  - Local currency denominated: 50.7 (percent of GDP table).
  - Short-term (residual maturity): 52.7 (percent of GDP table).
  - Official government: 13.3 (percent of GDP table).
- Foreign-currency denominated external debt (percent of GDP, 1998–2004): 39.6, 50.4, 56.1, 70.7, 64.1, 53.8, 53.3.
- Share of foreign-currency debt hedged (in percent) (1998–2004): 94.9, 97.2, 96.6, 99.8, 94.4, 89.0, 87.9.
- Financial derivatives (in billions or percent as in table): 54.1, 50.3, 52.8, 50.8, 57.7, 61.5, 62.2 (series shown).
- Naturally hedged (series): 40.7, 25.5, 25.5, 30.1, 27.6, 27.5, 25.8.
- Unhedged (series): 5.1, 24.2, 21.6, 19.1, 14.6, 11.1, 12.2.
- Trade flows (exports/imports volumes, y-o-y) (selected): Exports: 1.8, 8.1, 6.0, 2.5, 6.3, 1.7, 5.2. Imports: 1.3, 11.8, 0.3, 1.7, 9.6, 7.9, 15.8.
- Real effective exchange rate (1990=100) (1998–2004): 89.2, 88.0, 81.9, 83.1, 95.3, 106.5, 111.6.

Notes from narrative:
- "Net external liabilities have remained broadly unchanged over the last four years, as assets have kept pace with the rise in debt."
- Gross external debt rose from "85 percent of GDP at end-March 1998 to 111 percent at end-March 2001, and has since declined to 104 percent at end-March 2004."
- "Banks account for a growing proportion of external debt": banks' external debt rose from "25 percent of GDP at end-March 1997 to 59 percent at end-March 2004," and banks now account for "some 57 percent of total gross external debt."
- Foreign creditors composition shift: "foreigners’ holdings of New Zealand government debt have declined, representing only some 13 percent of total debt at end-March 2004."

Maturity and hedging observations:
- "The maturity profile of the external debt has been shortening."
- Foreign currency component declined to "51 percent of total debt at end-March 2004" after rising to "63 percent at end-March 2001."
- Hedging: for surveyed debt "some 88 percent has been hedged either through natural hedges or using financial derivatives."
- Dependence on financial derivatives for hedging "has increased sharply since end-March 1998."
- Market depth: "The market for these instruments appears to be reasonably deep and has proven to be rather resilient."

### B. Sectoral balance sheets — banks
- Banks' assets (share of total) (year series 2000–2004):
  - Financial investments: 11.6, 15.1, 13.0, 12.8, 10.2.
  - Residential mortgage loans: 42.0, 39.0, 41.4, 40.2, 42.9.
  - Other lending: 40.6, 37.1, 40.7, 41.3, 39.3.
  - Other assets: 5.8, 8.8, 4.9, 5.6, 7.7.
- Profitability indicators (year average):
  - Lending Margin (2000–2004): 2.4, 2.3, 2.3, 2.5, 2.6.
  - Return on Average Assets (2000–2004): 1.1, 1.1, 1.1, 1.4, 1.3.
- Capital adequacy ratios:
  - Total capital (2000–2004): 10.3, 10.6, 10.9, 11.5, 10.4.
  - Tier one (2000–2004): 7.0, 7.2, 7.8, 8.4, 7.9.
- Impaired assets (as a percentage of total lending): 0.4, 0.6, 0.4, 0.3, 0.2.
- Narrative summary:
  - "Banking sector performance remains very strong."
  - "Return on assets was 1.3 percent" in 2004.
  - Banks maintain "total capital of more than 10 percent and tier-one capital of about 8 percent of risk-weighted assets."
  - Asset quality high: ratio of impaired assets to total assets "about ¼ percent" (historic low).
  - Major banks' ratings: "the five largest banks, which account for 90 percent of total assets and deposits, have credit ratings of AA-."
  - Stress tests (FSAP 2004) indicate banks would be resilient to significant market and credit risk shocks, including scenarios: major decline in demand for agricultural exports; large fall in housing prices coupled with rise in unemployment; substantial increase in cost of foreign capital inflows.

### B. Sectoral balance sheets — corporations
- Corporate indicators (median of non-financial companies, percent) (1998–2003):
  - Debt to assets: 28.1, 29.4, 27.9, 21.4, 22.3, 24.1.
  - Debt to sales: 32.1, 38.6, 33.4, 22.2, 20.3, 19.9.
  - Interest coverage ratio (EBITDA / interest) (1998–2003): 5.1, 3.9, 4.1, 3.4, 5.4, 5.6.
  - Return on equity: 10.7, 13.3, 10.4, 8.7, 10.7, 12.4.
  - Return on assets: 7.6, 7.3, 7.1, 6.5, 6.6, 8.0.
- Narrative summary:
  - "Overall financial indicators for the corporate sector ... remain sound."
  - "Rates of return on assets and on equity rose in 2003."
  - "Leverage ratios remain in line with Australia’s and interest coverage remains healthy, although it may decline as the effect of higher interest rates kick in."

### B. Sectoral balance sheets — households
- Household balance sheet indicators (1998–2003) (in percent of annual disposable income, and wealth figures):
  - Net Wealth (levels shown): 373, 377, 361, 352, 373, 431.
  - Net financial wealth: 161.6, 165.5, 160.2, 155.5, 147.5, 153.0.
    - Assets: 178.0, 184.0, 179.0, 175.0, 170.0, 176.0.
    - Liabilities: 16.4, 18.5, 18.8, 19.5, 22.5, 23.0.
  - Net housing wealth: 212.4, 211.5, 199.8, 196.5, 225.5, 278.0.
    - Housing value: 296.0, 300.0, 291.0, 289.0, 323.0, 387.0.
    - Housing loan: 83.6, 88.5, 91.2, 92.5, 97.5, 109.0.
  - Debt Servicing Costs: 8.5, 8.0, 9.3, 8.5, 9.3, 9.5.
  - Savings Rate (year ending in March): -4.0, -4.8, -0.8, -4.4, -3.1, -8.2.
- Narrative points:
  - "The strong real estate market contributed to a significant increase in household net worth in 2002–04."
  - "Mortgage debt has gradually risen from 84 percent of disposable income in 1998 to 109 percent in 2003."
  - "Net financial wealth rose slightly in 2003 relative to disposable income, as the equity market rebounded."
- Sensitivity to shocks:
  - Interest cost increase: interest costs rose "from 8 percent of disposable income in 1999 to 10¼ percent in 2004."
  - Reserve Bank sensitivity: "an increase by 1 percentage point in the residential mortgage rate would increase these interest costs to 11.5 percent of disposable income."
  - Rental property ownership: rental properties rose from "less than 20 percent of urban privately-owned dwellings in 1991 to over 25 percent in 2004."
  - Risk channel: "If interest rates rise relative to rental returns, some households who borrowed to invest in rental properties could find themselves under some financial strain."

### Hedging, maturity, and composition of external debt (tables summary)
- Total gross external debt (end-March, in $NZ billions, 1997–2004): 80.7, 85.6, 97.7, 107.3, 128.0, 138.1, 138.0, 142.1 (table values).
- By sector (share of total gross external debt, end-March 2004): Official government 12.8 (percent of total gross external debt table), Corporate sector 87.2; within corporate, Banks 57.0 and Other corporate 30.2.
- By currency (percent of total gross external debt, end-March 2004): New Zealand dollar 49.0; Foreign currency 51.1.
- By (residual) maturity (percent of total gross external debt, end-March 2004): Short term (under 1 year) 50.9; Medium term (1-5 years) 19.0; Long term (over 5 years) 23.5.
- Hedging details (foreign currency external debt and hedging, end-March series 1998–2004):
  - Foreign currency external debt (1/) (1998–2004): 43.2, 48.7, 57.9, 69.7, 68.4, 62.4, 67.2.
  - Coverage of supplement (percent) (1998–2004): 75.1, 78.0, 81.2, 81.1, 90.5, 81.5, 81.6.
  - Type of hedge — Financial derivatives (1998–2004): 17.6, 24.5, 30.6, 35.4, 39.5, 38.4, 41.8.
  - Naturally hedged (1998–2004): 13.2, 12.4, 14.8, 21.0, 18.9, 17.2, 17.3.
  - Unhedged (1998–2004): 12.4, 11.8, 12.5, 13.3, 10.0, 6.9, 8.2.
- By sector hedging (end-March 2004, in billions or percent as in table):
  - Banks — foreign currency exposure: 43.3; financial derivatives: 32.3; naturally hedged and unhedged portions noted in table.
  - Corporate and official — foreign currency exposure: 23.9; financial derivatives: 9.5.

### Policy-relevant implications and scenarios
- Resilience indicators:
  - Strong bank capitalization and profitability (total capital >10 percent; tier-one ≈8 percent; return on assets 1.3 percent).
  - Low impaired assets ratio (about ¼ percent).
  - High degree of hedging: "some 88 percent ... hedged either through natural hedges or using financial derivatives" for surveyed foreign currency debt.
- Sources of vulnerability to monitor:
  - High, though declining, net foreign liabilities (examples: 79.5 percent of GDP at end-March 2004).
  - Increasing concentration of external debt in banks and shortening maturities (short-term share 50.9 percent of total gross external debt in 2004).
  - Household leverage and debt servicing (mortgage debt 109.0 relative to disposable income in 2003; debt servicing costs 10¼ percent in 2004).
- Stress scenarios highlighted by prior analysis (FSAP and RBNZ stress tests):
  - Major decline in demand for agricultural exports.
  - Large fall in housing prices coupled with a rise in unemployment.
  - Substantial increase in the cost of foreign capital inflows.
  - An increase of 1 percentage point in the residential mortgage rate (RBNZ analysis) raises household interest costs to 11.5 percent of disposable income.

*Source: IMF staff report annex titled "New Zealand does not appear to face major economic vulnerabilities."*

### 2005. Estimates of external debt by original maturity—as required by SDDS, rather than by

### _cr05152 - 2005. Estimates of external debt by original maturity—as required by SDDS, rather than by

### Background and data issues
- Estimates of external debt by original maturity—as required by SDDS, rather than by remaining maturity as measured by official data—are being prepared.
- Remaining data issues:
  - Timeliness of local government data: authorities are exploring the feasibility of earlier publication.
  - Requirement for publication of an industrial production index.

### Recent economic performance (summary)
- Real GDP growth:
  - Average since 1999: 4 percent.
  - 2004: 4.8 percent.
- Domestic demand drivers in 2004:
  - Private consumption growth: 6 percent.
  - Business investment: increased rapidly.
- Labor market and public finances:
  - Unemployment: lowest rate in the OECD (no numeric OECD comparison beyond statement).
  - OBERAC (2003/04): 4¾ percent of GDP.
  - Gross government debt (2003/04): 25¼ percent of GDP.
- External position and exchange rate:
  - Current account deficit (2004): 6.4 percent of GDP.
  - Import volumes (2004): jumped by 16 percent.
  - Export volumes (2004): grew by 5¼ percent.
  - Net foreign liabilities (end-2004): 84½ percent of GDP.
  - New Zealand dollar: appreciated 7 percent on a trade-weighted basis since end-2003; about 16 percent above its twenty year average on a real effective basis.
  - Terms of trade: at a 30 year high due to rising international commodity prices.
- Inflation and monetary policy:
  - Inflation: rose to near the top of the 1 to 3 percent target range.
  - RBNZ OCR increases: six times between January and October 2004 to 6.5 percent; a further 25 basis points in March 2005.

### Near-term outlook and projections
- Growth projections:
  - 2005-06: about 2¾ percent.
  - Medium-term average: about 3¼ percent.
- Factors affecting 2005-06:
  - Consumer spending expected to moderate due to a cooling housing market and higher interest rates.
  - Export growth likely dampened as hedges roll off amid a high exchange rate.
  - Upside domestic demand risks: high job security.
  - Monetary policy: little scope for easing in the foreseeable future per RBNZ.
- External and inflation outlook:
  - As the cyclical position unwinds, external current account deficit and inflation expected to decline.

### Executive Board assessment — key findings and recommendations
- Commendations:
  - Welcomed strong economic growth and low unemployment.
  - Praised sustained and skilful implementation of sound monetary and fiscal policies and structural reforms.
- Monetary policy:
  - Supported authorities’ tightening of monetary policy.
  - Noted difficult trade-off: respond to inflationary pressures while avoiding an unduly sharp slowing of activity.
  - On balance, risks to inflation judged predominantly on the upside; supported maintaining a tightening bias.
  - Supported approach of limiting FX intervention to exceptional cases meeting clearly specified conditions.
- Fiscal policy:
  - Commended transparent, predictable medium-term fiscal framework and strong fiscal performance.
  - Welcomed 2004/05 budget decision to lower the debt target from 30 to 20 percent of GDP to be achieved before 2015.
  - Endorsed objectives: operating surpluses over the cycle, contributions to the NZS Fund, meet capital spending, maintain prudent debt levels.
  - Recommended not spending the cyclical component of higher-than-expected surpluses.
  - Urged continued prudence given rapid growth in spending categories (health, education).
- Long-run fiscal challenges:
  - Supported NZS Fund prefunding step; highlighted need for further parametric changes in pension and health care systems.
  - Recommended adoption of such measures early and welcomed planned publication of long-run fiscal reports at least every four years.
- Growth and productivity:
  - Identified increase in labor productivity as the key policy challenge to raise per capita income (currently about four-fifths of OECD median levels).
  - Supported policies to boost business investment, adopt new technologies, increase R&D, and upgrade transportation and energy infrastructure.
  - Endorsed steps to enhance tertiary education quality and relevance; supported improving the Resource Management Act to facilitate investment.
- Labor market and participation:
  - Valued flexible labor market; recommended preserving flexibility.
  - Suggested review of effects of recent labor market measures (including the Holidays Act and minimum wage increases) and adequacy of probationary employment arrangements.
  - Saw scope to increase participation among certain groups; welcomed plans to expand child care and stronger requirements for benefit recipients to participate in training or work programs.
- Household savings and financial resilience:
  - Endorsed emphasis on minimizing administrative costs of workplace savings schemes and recommended designing savings incentives to contain budgetary impact.
- Financial sector and regulation:
  - Strongly welcomed efforts to strengthen banking regulation and crisis management.
  - Supported planned review of regulation and disclosure of nonbank financial institutions.
  - Encouraged ensuring adequate safeguards for New Zealand financial stability in closer regulatory integration discussions with Australia.
- Trade and aid:
  - Noted substantial trade barriers remain in key areas including agricultural products.
  - Welcomed authorities’ commitment to promoting an open international trading system (bilateral, regional, multilateral/Doha round).
  - Commended generous response to the recent tsunami and encouraged progress toward raising overseas development assistance.

### Selected economic indicators (selected exact figures)
- Real economy (percent change):
  - GDP (production basis): 2000: 3.6, 2001: 2.6, 2002: 4.7, 2003: 3.4, 2004: 4.8, 2005 (Proj.): 2.8
  - Domestic demand: 2000: 1.9, 2001: 2.6, 2002: 5.6, 2003: 5.3, 2004: 8.0, 2005 (Proj.): 3.6
  - Exports of goods and services: 2000: 6.0, 2001: 2.5, 2002: 6.3, 2003: 1.7, 2004: 5.2, 2005 (Proj.): 2.6
  - Imports of goods and services: 2000: 0.3, 2001: 1.7, 2002: 9.6, 2003: 7.9, 2004: 15.8, 2005 (Proj.): 5.1
  - Headline CPI inflation (end of period): 2000: 4.0, 2001: 1.8, 2002: 2.7, 2003: 1.6, 2004: 2.7, 2005 (Proj.): 2.8
  - Unemployment rate (in percent): 2000: 6.0, 2001: 5.3, 2002: 5.2, 2003: 4.6, 2004: 3.9, 2005 (Proj.): 3.8
  - National saving (in percent of GDP) 1/: 2000: 14.9, 2001: 18.3, 2002: 18.3, 2003: 18.1, 2004: 17.6, 2005 (Proj.): 17.4
  - Investment (in percent of GDP): 2000: 21.2, 2001: 20.8, 2002: 22.0, 2003: 22.2, 2004: 24.0, 2005 (Proj.): 24.4
- Government budget (in percent of GDP) 2/:
  - Revenue: 2000: 33.2, 2001: 33.6, 2002: 31.8, 2003: 33.9, 2004: 33.4, 2005 (Proj.): 33.6
  - Expenditure: 2000: 32.9, 2001: 32.5, 2002: 30.3, 2003: 32.4, 2004: 29.6, 2005 (Proj.): 30.4
  - OBERAC 3/: 2000: 1.3, 2001: 1.2, 2002: 1.9, 2003: 1.5, 2004: 5.3, 2005 (Proj.): 3.7
  - Net public debt: 2000: 19.5, 2001: 17.0, 2002: 14.2, 2003: 13.7, 2004: 10.8, 2005 (Proj.): 8.7
- Money and credit (end of period):
  - M3, resident (change in percent): 2000: 2.3, 2001: 7.0, 2002: 11.5, 2003: 9.5, 2004: 3.4, 2005: ...
  - Private domestic credit (change in percent): 2000: 6.8, 2001: 8.9, 2002: 9.0, 2003: 8.2, 2004: 12.1, 2005: ...
  - Interest rate (90-day, in percent) 4/: 2000: 6.7, 2001: 4.9, 2002: 5.9, 2003: 5.3, 2004: 6.8, 2005 (as of May 2): 7.0
  - Government bond yield (10-year, in percent) 4/: 2000: 6.1, 2001: 6.6, 2002: 6.1, 2003: 5.9, 2004: 6.0, 2005 (as of May 2): 5.9
- Balance of payments (in percent of GDP):
  - Current account balance: 2000: -4.8, 2001: -2.4, 2002: -3.7, 2003: -4.2, 2004: -6.4, 2005 (Proj.): -7.0
  - Trade balance: 2000: 1.3, 2001: 2.9, 2002: 0.3, 2003: -0.5, 2004: -1.4, 2005 (Proj.): -1.7
- External assets and liabilities (in percent of GDP):
  - Official reserves: 2000: 9.0, 2001: 8.6, 2002: 9.4, 2003: 9.3, 2004: 9.7, 2005: ...
  - Gross external debt: 2000: 85.6, 2001: 93.5, 2002: 103.7, 2003: 109.5, 2004: 105.5, 2005 (Proj.): 107.9
  - Net external liabilities: 2000: 81.5, 2001: 75.7, 2002: 78.4, 2003: 78.7, 2004: 84.5, 2005 (Proj.): 86.6
- Exchange rate (end of period):
  - US$/$NZ 4/: 2000: 0.44, 2001: 0.42, 2002: 0.52, 2003: 0.66, 2004: 0.72, 2005 (as of May 2): 0.73
  - Trade-weighted index (June 1979 = 100) 4/: 2000: 49.7, 2001: 49.9, 2002: 58.2, 2003: 65.1, 2004: 68.8, 2005 (as of May 2): 71.3
  - Nominal effective exchange rate 5/: 2000: 85.9, 2001: 86.5, 2002: 98.5, 2003: 110.1, 2004: 114.6, 2005: ...
  - Real effective exchange rate 5/: 2000: 81.9, 2001: 83.1, 2002: 95.3, 2003: 106.5, 2004: 111.6, 2005: ...

*IMF Executive Board conclusion of the 2005 Article IV consultation with New Zealand (Public Information Notice No. 05/60, May 5, 2005).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05152.pdf_