## _cr13117 — Risk Assessment Matrix and Key Findings ## Source details **Canonical URL:** [_cr13117 — Risk Assessment Matrix and Key Findings](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13117.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13117.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13117.pdf.json) --- ### Recent developments - Output - Growth estimated at 2½ percent for the year. - Subdued household consumption and business investment offset by strong agriculture production and continued expansion in construction. - Earthquake related reconstruction is gathering pace; overall cost of reconstruction from the 2010 and 2011 earthquakes is estimated at about 15 percent of GDP; about one-half of the damage was to housing stock; public sector will finance around one-third of reconstruction; bulk of remaining costs financed from abroad through reinsurance. - Inflation and labor market - Inflation remains subdued; exchange rate dampens tradable price inflation. - Wage pressures contained; labor market remains soft by a range of measures. - Housing pressures emerged in Auckland (supply bottlenecks) and Christchurch (construction cost inflation); these two cities account for more than half of housing wealth in New Zealand; prices outside these cities stable. - Monetary policy - Reserve Bank of New Zealand (RBNZ) policy rate kept at 2½ percent for two years. - Favorable offshore borrowing conditions reduced banks’ funding costs and lowered lending rates. - Fiscal developments - Net government debt rose from 5½ percent of GDP in 2008 to 20 percent in 2011 due to the crisis and two large earthquakes. - Government established medium term deficit reduction plan to reduce structural budget deficit by about 6 percent of GDP over four years, mainly through spending restraint. - External sector - Current account deficit in 2012 widened to 5 percent of GDP. - Net external liabilities at 72 percent of GDP at end-2012. ### Outlook and risks - Near-term outlook and projections - Growth forecast for this year currently at 2¼ percent; medium-term output growth should peak at 2¾-3 percent as reconstruction spending increases before converging to a trend rate of about 2½ percent. - Underlying inflation expected to increase but remain modest. - Severe drought noted as a downside risk with difficult-to-project impact on growth; recent severe drought is currently estimated to detract 0.7 percentage points from real GDP in calendar 2013. - External risks (main channels) - Declining export demand causing worse terms of trade; past commodity price declines often offset by exchange rate weakening. - Increased cost of external funding and rollover risks due to banks’ reliance on offshore wholesale funding; some total liabilities are short term external borrowings. - Banks less vulnerable than in late-2008: share of retail deposits and average maturity of bank liabilities have increased and funding sources are diversified. - Banks have been prefunding upcoming needs at relatively low rates, reducing likelihood and impact of offshore funding shutdown. - Housing sector risks - Household credit growth, housing market turnover, and house price inflation have picked up, particularly in Auckland. - Emerging risk of expectations-driven, self-reinforcing demand dynamics and price overshooting. - A shock to household incomes or borrowing costs could cause sudden price correction, reduce consumer confidence (large share of wealth in housing), worsen banks’ balance sheets, and impact overall activity. - Mitigating factors: declining ratio of household debt to disposable income and low concentration of debt among low-income households; conservative bank lending practices and high capital requirements for mortgages. - Possible outward spillovers - Small-size limits spillovers but potential effects on Australia due to Australian banks’ ownership of most of New Zealand banking system and economic similarities; direct credit exposure of Australian banks to New Zealand is fairly limited and stress tests suggest resilience. - Tail risks and downside scenarios - Compounding external shocks (international financial turmoil and slowdown in China and Australia) could trigger sudden declines in house and farm prices, weaken consumer demand, and negatively affect banks’ balance sheets; downside macroeconomic impact in such compounded scenario could be large. ### Risk Assessment Matrix — key risks, likelihood, and expected impact - Stalled or incomplete delivery of Euro area policy commitments - Overall level of concern: Medium - Likelihood: Medium - Expected impact: Declining export demand and drying up of European funding market; sustained decline in growth, higher unemployment, potential bank funding cost increases or threatened access; floating NZD would help buffer impact. - Fiscal policy shock in the US - Overall level of concern: Low - Likelihood: Low - Expected impact: Reduced world demand for New Zealand exports and commodity prices via similar transmission channels. - Deeper than expected slowdown in the EMs - Overall level of concern: Low - Likelihood: Low - Expected impact: Medium; growth shock to Asia, especially China, would affect growth in Australia and thereby New Zealand given export links. - Further buildup of house price inflation and subsequent sharp fall in house prices - Overall level of concern: Low to medium - Likelihood: Low to medium - Expected impact: Medium to High; rapid price growth could raise debt-financed consumption and pressure aggregate demand; sudden price correction could dampen private consumption, reduce investment, increase defaults, and hurt banks’ balance sheets. Risks mitigated by conservative lending, high mortgage capital requirements, and prudential policies under consideration. ### Authorities’ views - Authorities agree with staff’s outlook and risks; earthquake reconstruction a major long-term demand driver but timing and size uncertain. - Authorities expect drought to have sizeable negative effect on growth this year. - Authorities note increased housing market risks, low residential construction contributing to shortages, recent decline in mortgage rates, and easier credit conditions due to banks’ competition for market share. - RBNZ monitoring for reductions in household saving and increased vulnerability to interest rate or unemployment shocks. ### Near-term macroeconomic management — policy assessment and recommendations - Monetary policy stance - Current accommodative stance appropriate given below trend growth and low inflation. - Tension exists between maintaining inflation in target band in a soft economy and preventing housing price acceleration that could threaten financial stability. - Stance may need to change if house price and credit expansion fuel excessive consumption and inflationary pressures; RBNZ credibility and transmission mechanism should allow nimble response. - Fiscal policy - Deficit reduction plan would achieve a budget surplus by 2015; 2013 deficit expected to be about 2¾ percent of GDP. - Plan relies mainly on expenditure restraint, reprioritizing spending, reducing cost of existing policies, and efficiency gains. - Welfare reform expected to reduce spending by almost 2½ percent of GDP in the next two years. - Cuts broad based: almost 1 percent of GDP reduction in superannuation, social security and welfare; ¾ percent in health; 0.6 percent of GDP in education. - Revenue expected to increase by almost ½ percent of GDP from 2013 to 2015. - Under plan, net debt would peak at about 30 percent of GDP in 2015 and return to 20 percent of GDP by 2021. - Government plans to sell stakes in several state-owned enterprises over the next four years amounting to about 3 percent of GDP to fund capital spending. - Macroeconomic impact and policy space - Pace of deficit reduction seen as striking right balance: withdraws stimulus as private and reconstruction spending rise; reduces pressure on monetary policy; creates fiscal space for aging and health care costs and to cope with negative shocks or banking sector liabilities. - Policies could help raise national savings, reduce current account deficit, and limit increase in foreign liabilities. - Authorities have policy space: RBNZ can lower interest rates and loosen monetary conditions; free-floating NZD provides cushion; emergency liquidity support capacity exists; modest public debt allows option to delay deficit reduction if outlook worsens. - Macro-prudential tools under consideration could help limit housing market risks by guarding against loosening lending standards, though effectiveness is untested and evasion/arbitrage are concerns. ### Monetary policy stance and housing risks (Authorities’ views) - The RBNZ regards the currently accommodative monetary stance as consistent with keeping inflation in its targeted range of 1 to 3 percent. - The RBNZ agreed their flat interest rate outlook would need to be revisited if a housing-related credit boom added to underlying inflation pressures. - To address housing risks, the RBNZ is consulting on a potential increase in bank capital requirements against high loan-to-value lending. - The RBNZ expects the new macro-prudential policy framework could: - increase resilience in the banking system against a future housing downturn; - have a moderating influence on credit expansion to the housing sector. - The RBNZ pointed to longer-term measures to address housing supply constraints to help contain price pressures and increase affordability. ### Current account and exchange rate assessment (Authorities’ views and staff scenarios) - Persistently large current account deficits reflect structural savings – investment imbalances, with low household savings playing a key role. - Deficit is expected to widen this year despite relatively strong terms of trade as earthquake related reconstruction gathers pace. - Recommendations from the Savings Working Group (February 2011) suggest raising national saving by 2–3 percent of GDP primarily through an increase in public saving and tax policy changes, including: - a further switch from income to consumption taxation over the medium term while maintaining the broad base of the GST; - indexing interest income and expenses at a standard rate for tax purposes that reflects the rate of inflation. - Staff baseline scenario: if the exchange rate depreciates by 10 percent over the next two years, the current account deficit would gradually decline to around 6 percent of GDP when the earthquake reconstruction comes off its peak. - Stabilizing net foreign liabilities at around 80 percent of GDP would require a trade surplus of around 2 percent of GDP more than in the baseline scenario, achievable through further exchange rate adjustment and/or a shift in public and private savings behavior. - Model-based approaches suggest New Zealand’s real exchange rate is 10-15 percent above the level consistent with medium term fundamentals; the IMF’s amended real exchange rate regression yields an estimate of 10 percent overvaluation. - A second approach suggests stabilizing net external liabilities at the 2011 level of around 80 percent of GDP (excluding reinsurances) would require the current account deficit falling to about 3¾ percent of GDP, which would need the New Zealand dollar to be about 15 percent weaker than its current level. ### Financial sector stability: developments and vulnerabilities - Banking sector developments - Asset quality remains good; ratio of nonperforming loans to total assets is low and continues to decline from its peak. - Return-on-assets is in line with the pre-crisis average. - Capital adequacy has improved and is well above the Basel III capital requirements which the RBNZ began to put in place in January. - Banks have shifted toward more stable funding sources via strong deposit growth and slower credit growth. - Reliance on offshore wholesale funding has been reduced and is of longer maturity. - Deposits now meet around half of banks’ funding requirements. - Remaining vulnerabilities - The four major banks are systemic with broadly similar business models. - Reliance on wholesale offshore funding (as reflected in high loan-to-deposit ratios), although lower than pre-crisis levels, still represents a risk. - Residential mortgages and agricultural lending account for a large part of banks’ assets; these sectors are vulnerable to price fluctuations and where leverage is still high. - Capital requirements and macro-prudential framework - RBNZ’s conservative risk weights, capital eligibility, and deduction rules give New Zealand banks higher quality capital than their advanced country peers. - Expected new tools include countercyclical capital buffers; overlays to sectoral capital requirements; cyclical variation in the Core Funding Ratio; loan-to-value restrictions. - Framework expected to be in place by the second half of the year; RBNZ to apply measures after consultation with the Minister of Finance. - Stress tests and resilience - Recent stress tests based on single and combined shocks show the major banks would be able to withstand a sizeable shock to output, terms of trade, commodity prices, rising unemployment, and a fall in house, farm, and commercial property prices. - A severe combined shock would make major inroads into banks’ capital buffers, requiring recapitalization efforts; banks would likely require RBNZ help to withstand an extreme funding shock. ### Annex 1 — The Resilience of New Zealand's Banking Sector (selected findings) - Liability structure and liquidity - System-wide core funding ratio (CFR) rose from "a little under 70 percent in October 2008 to 85 percent at end 2012". - Banks fully compliant with new requirement that liquidity mismatch ratios "should not be less than zero." - Currency, market, and counterparty risk management - About half of bank borrowings are denominated in New Zealand dollars; remaining foreign-currency borrowings are "fully hedged against currency risk." - Asset quality and capital adequacy - Rise in non-performing loans "peaked at around 2 percent in 2011" and has since reversed. - Capital adequacy exceeds full Basel III requirements with a high proportion of equity capital. - Stress test design and outcomes - Most severe scenario components include: - 40 percent fall in the world price of New Zealand’s commodity exports; - six-month freeze on wholesale debt markets; - cumulative output loss of four percent; - rise in unemployment to "11½ percent"; - fall in house, farm and commercial property prices of "about 30 percent." - Under a combined severe scenario, Tier 1 capital ratios fell "from over 10 percent to around 6 percent." - Tests indicate banks "need to replenish capital buffers," primarily through raising new capital. ### Key to the imbalance — unusually low household savings rates - Household saving patterns and drivers - Investment levels comparable to peers; household savings rates unusually low. - Staff estimation: 50 percent rise in household’s perceived net wealth from 1990 to 2009 is associated with a 5 percentage point fall in the net private saving rate, controlling for public savings and terms of trade. - Household saving closely correlated with changes in household net wealth (dominated by house equity). - Structural and institutional factors - New Zealand and Ireland are the only two OECD countries that do not have a tier-2 pension scheme. - Limited access to tax-preferred saving vehicles other than property noted. - Prospective developments and implications - Return to budget surplus should increase national savings; 2012 Budget plans a return to surplus by fiscal year 2015. - KiwiSaver (launched 2007) likely to have strong take-up going forward. - Key question: whether post-2008 jump in household savings rate is a structural break. - Staff policy recommendations (condensed) - Fiscal policy: implement current deficit reduction plan if recovery proceeds as expected. - Monetary policy: support accommodative stance; tighten gradually if recovery strengthens and downside risks dissipate. - Financial sector policy: assess balance between vulnerability and efficiency; consider raising bank capital gradually above Basel III; encourage analysis of macroprudential measures. ### Annex 5 — External Debt Sustainability: Bound Tests (selected figures and scenarios) - Macroeconomic projections and facts - Growth for 2012 is estimated at 2½ percent; 2013 forecast at 2¼ percent. - RBNZ policy rate has been kept at 2½ percent for two years. - Earthquake-related reconstruction expected to require investment spending in excess of 15 percent of GDP and take at least ten more years to complete. - Current account deficit in 2012 = 5 percent of GDP. - Net external liabilities = 72 percent of GDP at end-2012. - Current unemployment rate (period average, 2012) = 6.9 percent. - Headline CPI inflation for 2012 = 1.1 percent; end of period CPI (2012) = 0.9 percent. - Representative external debt box figures (percent of GDP) - Historical: 81 - Baseline: 117 - CA shock: 123 - Growth shock: 122 - Combined shock: 124 - Combined shock + 30% depreciation: 128 - Stress scenarios include non-interest current account shock; growth shock (permanent 1/4 standard deviation); real depreciation shock (one-time real depreciation of 30 percent in 2013, with FX hedging assumed to cover 90 percent of foreign currency-denominated debt). - Selected balance of payments and public finance figures (percent of GDP, 2012) - Investment = 19.6; National saving = 14.5. - Revenue = 34.2; Expenditure = 36.7; Net lending (+)/borrowing (–) = -2.5. - Gross debt 2012 = 38.2; Net debt (financial assets excl. NZS Fund & Advances) 2012 = 24.3. - Insurance sector: earthquake claims of $13.4 billion have been paid to date, out of an expected total claims cost well in excess of $30 billion. ### Key indicators and projections (selected exact figures) - Nominal GDP (2012): US$169.7 billion - GDP per capita (2012): US$38,111 - Population (2012): 4.4 million - Quota: SDR 894.6 million - Real growth (percent change, GDP production basis): -0.8 (2008), -1.6 (2009), 1.8 (2010), 1.4 (2011), 2.5 (2012), 2.2 (2013 Proj). - Headline CPI inflation (period average): 4.0 (2008), 2.1 (2009), 2.3 (2010), 4.0 (2011), 1.1 (2012), 1.4 (2013 Proj). - Unemployment rate (period average, in percent): 4.2 (2008), 6.1 (2009), 6.5 (2010), 6.5 (2011), 6.9 (2012), 6.7 (2013 Proj). - Investment (percent of GDP): 22.9 (2008), 18.5 (2009), 19.3 (2010), 18.7 (2011), 19.6 (2012), 20.1 (2013 Proj). - National saving (percent of GDP): 14.5 (2008), 16.0 (2009), 16.1 (2010), 14.6 (2011), 14.5 (2012), 14.0 (2013 Proj). - Gross external debt (percent of GDP): 136.1 (2008), 129.2 (2009), 127.5 (2010), 125.5 (2011), 120.7 (2012). - Gross official reserves (NZ$ billions): 19.1 (2008), 21.6 (2009), 21.7 (2010), 22.1 (2011), 21.4 (2012). ### Policy messages, staff appraisal, and Executive Board priorities - Staff appraisal - Growth likely to remain modest; increased construction activity offset by headwinds from budget deficit reduction, strong dollar, and the severe drought. - Spare capacity and soft labor market will contain inflation pressures in near term. - Rising house prices are a growing concern; could lead to increased debt-financed household spending and higher risk of abrupt price correction. - Current accommodative monetary policy stance appropriate but may need to change if house price and credit expansion fuel excessive consumption and inflationary pressures. - Planned pace of deficit reduction strikes right balance: withdraws stimulus as private and reconstruction spending rise, reduces pressure on monetary policy, creates fiscal space, and could help raise national savings. - Reducing pressure on the exchange rate and limiting current account deficits in a lasting way requires addressing low household savings. - Executive Board assessment and priorities - Commended prudent macroeconomic management following the global downturn and earthquakes. - Main risks identified: persistent low national savings and large external liabilities; high and rising house prices and associated financial stability risks; external shocks from Europe, China, Australia, and other parts of Asia. - Monetary policy judged appropriate given subdued domestic demand and benign inflationary expectations; tightening may be warranted if house-price and credit expansion fuel inflationary pressures. - Macroprudential measures recommended as complements to monetary and fiscal policy to manage housing-related risks. - Structural reforms and policies to raise national saving and address the savings-investment imbalance remain important for medium-term resilience. - Staff recommendation - Staff recommends that the next Article IV consultation be held on the standard 12-month cycle. *Source: IMF staff report content in _cr13117 — Risk Assessment Matrix and related annexes.* ### 1. Risk Assessment Matrix ________________________________________________________________________7 ### _cr13117 - 1. Risk Assessment Matrix ________________________________________________________________________7 ### Recent developments - Output - Growth estimated at 2½ percent for the year; subdued household consumption and business investment offset by strong agriculture production and continued expansion in construction. - Earthquake related reconstruction is gathering pace. Footnote: overall cost of reconstruction from the 2010 and 2011 earthquakes is estimated at about 15 percent of GDP; about one-half of the damage was to housing stock; public sector will finance around one-third of reconstruction; bulk of remaining costs financed from abroad through reinsurance. - Inflation and labor market - Inflation remains subdued; exchange rate dampens tradable price inflation. - Wage pressures contained; labor market remains soft by a range of measures. - Housing pressures emerged in Auckland (supply bottlenecks) and Christchurch (construction cost inflation); these two cities account for more than half of housing wealth in New Zealand; prices outside these cities stable. - Monetary policy - Reserve Bank of New Zealand (RBNZ) policy rate kept at 2½ percent for two years. - Favorable offshore borrowing conditions reduced banks’ funding costs and lowered lending rates. - Fiscal developments - Net government debt rose from 5½ percent of GDP in 2008 to 20 percent in 2011 due to the crisis and two large earthquakes. - Government established medium term deficit reduction plan to reduce structural budget deficit by about 6 percent of GDP over four years, mainly through spending restraint. - External sector - Current account deficit in 2012 widened to 5 percent of GDP (well below the 8 percent level in 2005-08). - Net external liabilities at 72 percent of GDP at end-2012. ### Outlook and risks - Near-term outlook and projections - Growth forecast for this year currently at 2¼ percent; medium-term output growth should peak at 2¾-3 percent as reconstruction spending increases before converging to a trend rate of about 2½ percent. - Underlying inflation expected to increase but remain modest. - Severe drought noted as a downside risk with difficult-to-project impact on growth. - External risks (main channels) - Declining export demand causing worse terms of trade; past commodity price declines often offset by exchange rate weakening. - Increased cost of external funding and rollover risks due to banks’ reliance on offshore wholesale funding; some total liabilities are short term external borrowings. - Banks less vulnerable than in late-2008: share of retail deposits and average maturity of bank liabilities have increased and funding sources are diversified. - Banks have been prefunding upcoming needs at relatively low rates, reducing likelihood and impact of offshore funding shutdown. - Housing sector risks - Household credit growth, housing market turnover, and house price inflation have picked up, particularly in Auckland. - Emerging risk of expectations-driven, self-reinforcing demand dynamics and price overshooting. - A shock to household incomes or borrowing costs could cause sudden price correction, reduce consumer confidence (large share of wealth in housing), worsen banks’ balance sheets, and impact overall activity. - Mitigating factors: declining ratio of household debt to disposable income and low concentration of debt among low-income households; conservative bank lending practices and high capital requirements for mortgages. - Possible outward spillovers - Small-size limits spillovers but potential effects on Australia due to Australian banks’ ownership of most of New Zealand banking system and economic similarities; direct credit exposure of Australian banks to New Zealand is fairly limited and stress tests suggest resilience. - Tail risks and downside scenarios - Compounding external shocks (international financial turmoil and slowdown in China and Australia) could trigger sudden declines in house and farm prices, weaken consumer demand, and negatively affect banks’ balance sheets; downside macroeconomic impact in such compounded scenario could be large. ### Risk Assessment Matrix (Box 1) — key risks, likelihood, and expected impact - Stalled or incomplete delivery of Euro area policy commitments - Overall level of concern: Medium - Likelihood: Medium - Expected impact: Declining export demand and drying up of European funding market; sustained decline in growth, higher unemployment, potential bank funding cost increases or threatened access; floating NZD would help buffer impact. - Fiscal policy shock in the US - Overall level of concern: Low - Likelihood: Low - Expected impact: Reduced world demand for New Zealand exports and commodity prices via similar transmission channels. - Deeper than expected slowdown in the EMs - Overall level of concern: Low - Likelihood: Low - Expected impact: Medium; growth shock to Asia, especially China, would affect growth in Australia and thereby New Zealand given export links. - Further buildup of house price inflation and subsequent sharp fall in house prices - Overall level of concern: Low to medium - Likelihood: Low to medium - Expected impact: Medium to High; rapid price growth could raise debt-financed consumption and pressure aggregate demand; sudden price correction could dampen private consumption, reduce investment, increase defaults, and hurt banks’ balance sheets. Risks mitigated by conservative lending, high mortgage capital requirements, and prudential policies under consideration. ### Authorities’ views - Authorities agree with staff’s outlook and risks; earthquake reconstruction a major long-term demand driver but timing and size uncertain. - Authorities expect drought to have sizeable negative effect on growth this year. - Authorities note increased housing market risks, low residential construction contributing to shortages, recent decline in mortgage rates, and easier credit conditions due to banks’ competition for market share. - RBNZ monitoring for reductions in household saving and increased vulnerability to interest rate or unemployment shocks. ### Near-term macroeconomic management — policy assessment and recommendations - Monetary policy stance - Current accommodative stance appropriate given below trend growth and low inflation. - Tension exists between maintaining inflation in target band in a soft economy and preventing housing price acceleration that could threaten financial stability. - Stance may need to change if house price and credit expansion fuel excessive consumption and inflationary pressures; RBNZ credibility and transmission mechanism should allow nimble response. - Fiscal policy - Deficit reduction plan would achieve a budget surplus by 2015; 2013 deficit expected to be about 2¾ percent of GDP. - Plan relies mainly on expenditure restraint, reprioritizing spending, reducing cost of existing policies, and efficiency gains. - Welfare reform expected to reduce spending by almost 2½ percent of GDP in the next two years. - Cuts broad based: almost 1 percent of GDP reduction in superannuation, social security and welfare; ¾ percent in health; 0.6 percent of GDP in education. - Revenue expected to increase by almost ½ percent of GDP from 2013 to 2015. - Under plan, net debt would peak at about 30 percent of GDP in 2015 and return to 20 percent of GDP by 2021. - Government plans to sell stakes in several state-owned enterprises over the next four years amounting to about 3 percent of GDP to fund capital spending. - Macroeconomic impact and policy space - Pace of deficit reduction seen as striking right balance: withdraws stimulus as private and reconstruction spending rise; reduces pressure on monetary policy; creates fiscal space for aging and health care costs and to cope with negative shocks or banking sector liabilities. - Policies could help raise national savings, reduce current account deficit, and limit increase in foreign liabilities. - Authorities have policy space: RBNZ can lower interest rates and loosen monetary conditions; free-floating NZD provides cushion; emergency liquidity support capacity exists; modest public debt allows option to delay deficit reduction if outlook worsens. - Macro-prudential tools under consideration could help limit housing market risks by guarding against loosening lending standards, though effectiveness is untested and evasion/arbitrage are concerns. *Source: IMF staff report content in _cr13117 - 1. Risk Assessment Matrix ________________________________________________________________________7* ### 16. Authorities’ views. The RBNZ regards the currently accommodative monetary stance as ### _cr13117 - 16. Authorities’ views. The RBNZ regards the currently accommodative monetary stance as ### Monetary policy stance and housing risks - The RBNZ regards the currently accommodative monetary stance as consistent with keeping inflation in its targeted range of 1 to 3 percent. - The RBNZ agreed their flat interest rate outlook would need to be revisited if a housing-related credit boom added to underlying inflation pressures. - To address housing risks, the RBNZ is consulting on a potential increase in bank capital requirements against high loan-to-value lending. - The RBNZ expects the new macro-prudential policy framework could: - increase resilience in the banking system against a future housing downturn; - have a moderating influence on credit expansion to the housing sector. - The RBNZ pointed to longer-term measures to address housing supply constraints to help contain price pressures and increase affordability. ### Current account and external stability - New Zealand’s persistently large current account deficits appear to reflect structural savings – investment imbalances, with low household savings playing a key role. - The deficit is expected to widen this year despite relatively strong terms of trade as earthquake related reconstruction gathers pace. - Meeting the country’s investment needs given low savings has required capital inflows motivated by higher domestic interest rates, resulting in a strong exchange rate over an extended number of years and a buildup of the country’s stock of net external debt. - Reducing pressure on the exchange rate and limiting current account deficits in a lasting way requires addressing the reasons for low savings rather than short-term macroeconomic management. - The government’s Savings Working Group presented recommendations in February 2011, suggesting raising national saving by 2–3 percent of GDP primarily through an increase in public saving and tax policy changes. Recommendations include: - a further switch from income to consumption taxation over the medium term while maintaining the broad base of the GST; - indexing interest income and expenses at a standard rate for tax purposes that reflects the rate of inflation. - Budget deficit reduction and further household balance sheet repair would also contribute to raising national savings. - Much will depend on whether the post-crisis increase in the household savings rate represents a structural break from past behavior. ### Exchange rate assessment and scenarios - Short-term factors contributing to the currently overvalued exchange rate include: - a continuing gap between domestic and foreign interest rates; - more recently, increased portfolio flows into New Zealand. - Staff baseline scenario: if the exchange rate depreciates by 10 percent over the next two years, perhaps the result of lower capital inflows and a tighter fiscal policy stance, the current account deficit would gradually decline to around 6 percent of GDP when the earthquake reconstruction comes off its peak. - Stabilizing net foreign liabilities at around 80 percent of GDP would require a trade surplus of around 2 percent of GDP more than in the baseline scenario, achievable through further exchange rate adjustment and/or a shift in public and private savings behavior. - A worsening of the terms of trade would likely be accompanied by additional depreciation relative to the baseline scenario, helping buffer the impact on the current account. - Model-based approaches suggest New Zealand’s real exchange rate is 10-15 percent above the level consistent with medium term fundamentals; the IMF’s amended real exchange rate regression yields an estimate of 10 percent overvaluation. - A second approach suggests stabilizing net external liabilities at the 2011 level of around 80 percent of GDP (excluding reinsurances) would require the current account deficit falling to about 3¾ percent of GDP, which would need the New Zealand dollar to be about 15 percent weaker than its current level. ### Authorities’ views on external risks and exchange rate - The authorities agreed persistent strength of the New Zealand dollar is mainly the result of structural savings – investment imbalances, and not short-term monetary policy management. - They recognize the long-standing risk posed by the country’s relatively large external debt position, and view the planned increase in public savings as the most effective policy action to reduce this risk. - They noted the increase in household saving in the past few years but agreed there is uncertainty about how much represents a structural shift. - They emphasized the key role of the integrity and credibility of the RBNZ’s monetary policy framework, including the free floating exchange rate, in delivering macroeconomic stability and enhancing resilience. - They agreed part of the currency’s current strength may dissipate with eventual tightening by major central banks, but expressed concern that weak global growth and persistent European financial turmoil could delay tightening and add to future current account deficits. ### Financial sector stability: developments and vulnerabilities - Banking sector developments: - Asset quality remains good; the ratio of nonperforming loans to total assets is low and continues to decline from its peak. - Return-on-assets is in line with the pre-crisis average. - Capital adequacy has improved and is well above the Basel III capital requirements which the RBNZ began to put in place in January. - Banks have shifted toward more stable funding sources via strong deposit growth and slower credit growth. - Reliance on offshore wholesale funding has been reduced and is of longer maturity. - Deposits now meet around half of banks’ funding requirements. - Remaining vulnerabilities: - The four major banks are systemic with broadly similar business models. - Reliance on wholesale offshore funding (as reflected in high loan-to-deposit ratios), although lower than pre-crisis levels, still represents a risk. - Residential mortgages and agricultural lending account for a large part of banks’ assets; these sectors are vulnerable to price fluctuations and where leverage is still high. ### Capital requirements and macro-prudential framework - The RBNZ’s conservative risk weights, capital eligibility, and deduction rules give New Zealand banks higher quality capital than their advanced country peers. - Banking sector vulnerabilities should be assessed on an ongoing basis to minimize the systemic risk posed by large banks, taking into account evolving international standards. - The announced macro-prudential tools (available to use in circumstances such as periods of excessive credit growth) send a strong signal of intent to safeguard financial stability. - Expected new tools include: - countercyclical capital buffers; - overlays to sectoral capital requirements; - cyclical variation in the Core Funding Ratio; - loan-to-value restrictions. - The intention is for the RBNZ to apply these measures after consultation with the Minister of Finance, with a memorandum of understanding outlining the process to be signed soon. - The framework is expected to be in place by the second half of the year. - The new measures could help dampen credit cycles, strengthen macroeconomic management, and guard against an acceleration of house price inflation. ### Stress tests and resilience - Recent stress tests based on single and combined shocks show the major banks would be able to withstand a sizeable shock to output, terms of trade, commodity prices, rising unemployment, and a fall in house, farm, and commercial property prices. - A severe shock combining an adverse global scenario with sectoral downturns would make major inroads into banks’ capital buffers, requiring recapitalization efforts. - Banks would likely require RBNZ help to withstand an extreme funding shock. ### Authorities’ stance on regulation and AML/CFT - Authorities emphasized a conservative approach to bank regulation and supervision. - Given high capital quality, they did not see a need at present to raise minimum capital requirements for the four systemically important banks above the Basel III requirements. - Authorities agreed the new macro-prudential tools should complement, not substitute for, macroeconomic and micro-prudential measures. - They intend to use these tools judiciously and with caution, using them infrequently, with the primary objective of limiting the periodic buildup of system-wide risk. - Measures have been taken to further strengthen the AML/CFT regime, particularly to ensure adequate transparency of legal persons and arrangements. ### Staff appraisal: outlook, policy assessments, and risks - Outlook and risks: - Growth this year is likely to remain modest, with increased construction activity offset by headwinds from budget deficit reduction, the strong dollar, and the recent severe drought. - Spare capacity and a soft labor market will contain inflation pressures in the near term. - Rising house prices, already elevated by standard metrics, are a growing concern because they could lead to increased debt-financed household spending, putting pressure on aggregate demand and increasing the risk of an abrupt price correction. - Other threats include an intensification of European sovereign debt problems and a slowdown in China, Australia, and other parts of Asia. - Monetary policy: - The current accommodative monetary policy stance is appropriate but may need to change if house price and credit expansion begin to fuel excessive consumption spending and inflationary pressures. - The RBNZ’s credibility and the effective monetary transmission mechanism should allow for a nimble response should circumstances change. - Fiscal policy: - The planned pace of deficit reduction strikes the right balance between sustaining aggregate demand and limiting public debt growth. - It withdraws fiscal stimulus at the right time by making room for expected increases in private sector and earthquake-related reconstruction spending. - It has improved the macroeconomic policy mix by reducing pressure on monetary policy, creates fiscal space to deal with future spending pressures and shocks, and could help raise national savings. - New Zealand’s relatively modest public debt gives the authorities some scope to delay the planned deficit reduction path in the event of a sharp deterioration in the economic outlook. - External vulnerabilities and exchange rate: - New Zealand’s large net liabilities are a longstanding source of external risk and reflect historically low household savings rates. - Reducing pressure on the exchange rate and limiting current account deficits in a lasting way will require addressing the reasons for low savings. - Short-term contributors to the currently overvalued exchange rate include the gap between domestic and foreign interest rates and increased portfolio flows into New Zealand. - If global monetary conditions become less stimulatory, the exchange rate would likely depreciate over time, reducing the current account deficit over the medium term. - Financial sector issues: - Banks remain sound, and recent stress tests show the major banks could withstand a sizeable shock to output, terms of trade, rising unemployment, and falls in property prices. - Banks remain exposed to highly leveraged households and farmers and rollover risks from large short-term offshore funding needs. - The new macro-prudential tools under consideration could improve the RBNZ’s ability to guard against loosened bank lending standards that would contribute to an unsustainable acceleration in house price inflation. - These tools should complement macroeconomic and micro-prudential measures, be used infrequently, and be applied with caution given limited experience, with the primary objective of limiting periodic buildup of system-wide risk. *Source: IMF staff report content provided in the supplied document excerpt.* ### 30. Staff recommends that the next Article IV consultation be held on the standard 12-month ### _cr13117 - 30. Staff recommends that the next Article IV consultation be held on the standard 12-month cycle. ### Growth and External Sector - Modest growth continued in 2012; real GDP growth (production basis) series shown for 1999–2012. - Main export destinations: AUS, CHN, US, JPN, KOR, UK, MY S, GM (Figure indicates Australia and China as main export destinations). - Export Commodity Price Index trends (2002–2013) highlight Dairy, Forestry, Meat, skin & wool. - Reconstruction investment will support growth in the next few years. - Current account and external balances: - Current account (percent of GDP): -8.7 (2008), -2.5 (2009), -3.2 (2010), -4.1 (2011), -5.0 (2012). - Current account (in billions of New Zealand dollars): -16.3 (2008), -4.6 (2009), -6.3 (2010), -8.3 (2011), -10.5 (2012). - Net international investment position (US$ billion): -152.8 (2008), -151.8 (2009), -146.9 (2010), -147.9 (2011), -150.0 (2012). - Net international investment position (percent of GDP): -82.1 (2008), -81.1 (2009), -74.6 (2010), -72.3 (2011), -71.7 (2012). ### Monetary Policy and Inflation - Inflation subdued mainly due to falling tradable prices; CPI inflation (percent change, y/y) series shown. - Inflation expectations: - Expected annual inflation (1-year) and (2-year) series lie in the 1 to 3 percent target band. - Policy rate remains low: - Policy Rate (Official cash rate) series shown (2004–2013). - Interest rate (90-day, in percent) historical: 8.0 (2008), 3.0 (2009), 3.0 (2010), 2.8 (2011), 2.7 (2012). - Government bond yield (10-year, in percent): 6.1 (2008), 5.5 (2009), 5.6 (2010), 4.9 (2011), 3.7 (2012). - Unemployment elevated: - Unemployment rate (period average, in percent): 4.2 (2008), 6.1 (2009), 6.5 (2010), 6.5 (2011), 6.9 (2012). - Output gap: 0.7 (2008), -1.8 (2009), -1.0 (2010), -0.9 (2011), -0.1 (2012). ### Fiscal Policy and Public Debt - Authorities’ deficit reduction plan aims to achieve operating surplus by 2015. - Fiscal impulse and fiscal balances series (2009–2017) indicate ongoing expenditure restraint. - Key fiscal figures (percent of GDP, fiscal years ending June 30): - Revenue: 37.0 (2008/09), 36.8 (2009/10), 34.2 (2010/11), 36.0 (2011/12), 34.2 (2012/13), 34.6 (2013/14 Proj). - Expenditure: 33.8 (2008/09), 37.0 (2009/10), 37.0 (2010/11), 38.0 (2011/12), 36.7 (2012/13), 37.4 (2013/14 Proj). - Net lending (+)/borrowing (–): 3.2 (2008), -0.2 (2009), -2.8 (2010), -7.4 (2011), -2.5 (2012), -2.8 (2013 Proj). - Operating balance before gains and losses: 3.0 (2008), -2.1 (2009), -3.3 (2010), -9.2 (2011), -4.4 (2012), -3.5 (2013 Proj). - Debt metrics: - Gross sovereign-issued debt (in percent of GDP, June year): 32 (2008), 34 (2009), 36 (2010), 38 (2011), 37 (2012), 39 (2013 Proj) shown in tables. - Net Core Crown debt (excluding NZSF): 5.5 (2008), 9.2 (2009), 13.9 (2010), 20.0 (2011), 24.3 (2012), 28.2 (2013 Proj). - Net debt will peak at about 30 percent of GDP per figures and projections. ### Financial Sector and Banking - Capital adequacy has increased since 2007: - Tier 1 capital to RWA and total capital to RWA series (1999–2012) showing improvement. - Regulatory capital to risk-weighted assets: 10.5 (average 2001–11), 11.4 (2010), 12.6 (2011), 13.2 (2012), 13.1 (2013 Proj). - Tier I capital to risk-weighted assets: 8.5 (average 2001–11), 9.5 (2010), 9.8 (2011), 9.8 (2012), 11.1 (2013 Proj). - Asset quality improved; nonperforming loans low by advanced-country standards: - Nonperforming loans to total loans (percent): 0.9 (2008 average), 1.7 (2010), 2.1 (2011), 1.7 (2012), 1.6 (2013 Proj). - Provisions to impaired assets: 29.8 (2008), 31.4 (2010), 30.3 (2011), 31.5 (2012), 32.9 (2013 Proj). - Credit and balance-sheet composition: - Credit growth picked up in late 2012; year-on-year credit growth series shown (2004–2013). - Loan-to-deposit ratios high in the region; New Zealand compared to regional peers (2007–Feb 2013 averages). - Bank asset composition (in billions of New Zealand dollars) shows large share of residential mortgages. ### Key Indicators and Projections (selected exact figures) - Nominal GDP (2012): US$169.7 billion - GDP per capita (2012): US$38,111 - Population (2012): 4.4 million - Quota: SDR 894.6 million - Real growth (percent change, GDP production basis): -0.8 (2008), -1.6 (2009), 1.8 (2010), 1.4 (2011), 2.5 (2012), 2.2 (2013 Proj). - Headline CPI inflation (period average): 4.0 (2008), 2.1 (2009), 2.3 (2010), 4.0 (2011), 1.1 (2012), 1.4 (2013 Proj). - Unemployment rate (period average, in percent): 4.2 (2008), 6.1 (2009), 6.5 (2010), 6.5 (2011), 6.9 (2012), 6.7 (2013 Proj). - Investment (percent of GDP): 22.9 (2008), 18.5 (2009), 19.3 (2010), 18.7 (2011), 19.6 (2012), 20.1 (2013 Proj). - National saving (percent of GDP): 14.5 (2008), 16.0 (2009), 16.1 (2010), 14.6 (2011), 14.5 (2012), 14.0 (2013 Proj). - Gross external debt (percent of GDP): 136.1 (2008), 129.2 (2009), 127.5 (2010), 125.5 (2011), 120.7 (2012). - Gross official reserves (NZ$ billions): 19.1 (2008), 21.6 (2009), 21.7 (2010), 22.1 (2011), 21.4 (2012). ### Policy Messages and Staff Recommendation - Staff notes a modest growth outlook supported by external demand (Australia and China) and reconstruction investment. - Monetary stance characterized as accommodative given subdued inflation, spare capacity, elevated unemployment, and low policy rates. - Fiscal consolidation is under way with expenditure restraint expected to return operating surplus by 2015 and keep gross debt among the lowest in advanced economies. - Banking sector resilient: rising capital ratios, low nonperforming loans, and improving asset quality. - Staff recommends that the next Article IV consultation be held on the standard 12-month cycle. *Source: _cr13117 — IMF staff estimates and projections.* ### Annex 1. The Resilience of New Zealand's Banking Sector ### Annex 1. The Resilience of New Zealand's Banking Sector ### Overview and key resilience findings - The banking sector in New Zealand "weathered the global financial crisis well" and "has emerged in a stronger position and better placed to withstand another possible global banking shock." - Pre-crisis structural vulnerabilities identified: - limited deposit mobilization; - high reliance on short term foreign borrowing; - consequences of sustained credit expansion with high exposures to highly indebted household and dairy sectors; - notable expansion in mortgage lending. - The core institutions—the top four banks that are subsidiaries of leading Australian banks—did not need sustained access to temporary government and RBNZ support mechanisms and were unscathed by the shakeout of peripheral non bank financial institutions (NBFIs). ### Liability structure and liquidity - Liability and funding improvements: - System-wide core funding ratio (CFR)—which includes customer deposits, longer-term wholesale borrowing, and bank capital—rose from "a little under 70 percent in October 2008 to 85 percent at end 2012". - Banks have higher CFRs than required by the RBNZ and than under similar Basel III standards. - Banks are fully compliant with the new requirement that liquidity mismatch ratios "should not be less than zero." - Funding behavior: - Banks are borrowing less in international wholesale markets and at longer maturities. - Proportion of funding from the local deposit base has increased. - Banks have prefunded needs during calm markets and low rates and have started to use covered bonds to borrow at lower rates. ### Currency, market, and counterparty risk management - Banks generally do not borrow directly from parent institutions; borrowing occurs in international wholesale markets. - About half of bank borrowings are denominated in New Zealand dollars; therefore there is "no exchange rate risk" for that portion. - Remaining foreign-currency borrowings are "fully hedged against currency risk," typically through exchange rate swaps with nonresident investors who have New Zealand dollar denominated liabilities. - Counterparty risk is limited because counterparties are mainly "globally systemic institutions." - Credit risks are minimized because banks generally do not lend in foreign exchange and households do not typically borrow internationally but via domestic banks. - Fonterra, the largest dairy exporter, also hedges export proceeds, limiting volatility in farmers' incomes—important since loans to farmers "represent a significant share of the banks’ loan books." ### Asset quality and credit provision - Non-performing loans: - The rise in non-performing loans "peaked at around 2 percent in 2011" and has since reversed. - The increase in non-performing loans was "low in international terms." - Credit growth and lending capacity: - Although the rate of credit growth fell during the global crisis, "credit growth still remained positive" and banks "are in stronger position to provide credit to support the recovery." ### Capital adequacy and accounting conservatism - Capital metrics: - Capital adequacy has "remained strong by both historic and international standards" and banks "already exceed the full Basel III requirements with a high proportion of equity capital." - Staff research suggests that if banks followed more standard approaches used by comparator countries, the capital adequacy ratio in New Zealand would be "about 100 to 200 basis points higher than presently measured." - Conservatism: - Banks are required to use conservative accounting guidelines that ensure higher risk weights on potentially risky assets. - Profitability has returned to the pre-crisis average, "boosting own funds." ### Regulatory reforms and resolution framework - Structural and supervisory reforms: - The top banks now conduct mainstream operations through subsidiaries rather than branches of Australian parents. - Directors have a fiduciary duty to safeguard the interests of New Zealand-based depositors. - An Open Bank Resolution framework is being introduced to provide an alternative to taxpayer bailout or liquidation by maintaining access to a bank’s core transactional functions while enabling losses to be borne by creditors once shareholders’ funds have been extinguished. - The regulatory perimeter has been widened to include deposit-taking NBFIs to limit contagion and regulatory arbitrage. - Several stronger NBFIs have converted into banks, increasing system-wide stability and competition. ### Stress tests and capital buffer needs - Stress test design (conducted with APRA): - Most severe scenario components: - 40 percent fall in the world price of New Zealand’s commodity exports; - six-month freeze on wholesale debt markets; - cumulative output loss of four percent; - rise in unemployment to "11½ percent"; - fall in house, farm and commercial property prices of "about 30 percent." - Estimates of default rates and LGDs used APRA standardized estimates: "exposures at default averaged 4 percent for the banks, with a range of 3.1 to 5 percent." - Overall, impaired asset expenses over the three-year scenario rose to "5.5 percent of total loans." - Stress test outcomes: - Capital adequacy ratios fell sharply as banks reported losses, but banks "complied with the minimum Tier 1 capital adequacy ratio that was in place at that time (at 4 percent)," although two banks "fall by 1 percentage point below the minimum total capital ratio of 8 percent." - RBNZ intends to conduct such tests more frequently, widen scope to include all domestic banks, and include a broader range of risks to the financial system. - Additional Fund staff stress-test findings: - Tests based on substantial falls in asset quality (especially residential mortgages) showed probability of default rose sharply and estimated losses exceeded provisions; banks’ Tier 1 capital ratio "fell by about 1 percentage point." - A combined severe scenario "looked at combined shocks including adverse international developments," under which Tier 1 capital ratios fell "from over 10 percent to around 6 percent." - Capital replenishment need: - Tests indicated that banks "need to replenish capital buffers," which would need to be done "primarily through the raising of new capital" because scope for internally generated funds is limited during recession. *Prepared by Neil Saker.* ### 4. Key to the imbalance is unusually low ### 4. Key to the imbalance is unusually low household savings rates in New Zealand ### Household saving patterns and drivers - Investment levels in New Zealand have been comparable to those of its peers; public savings rates have been relatively strong; business savings remain positive over much of the last three decades. - Household savings rates in New Zealand have been unusually low and, until the 2008 global crisis, the gap between New Zealand’s household savings rate and those in other countries had widened. - Previous staff analysis suggests that house price inflation has been a significant driver of falling household savings rates. - Staff estimation suggests that the 50 percent rise in household’s perceived net wealth in New Zealand from 1990 to 2009 is associated with a 5 percentage point fall in the net private saving rate, controlling for public savings and terms of trade. - Household saving rates appear closely correlated with changes in household net wealth (dominated by house equity in New Zealand), making savings more sensitive to house prices. - There are uncertainties in measures of household savings in New Zealand related to difficulties in distinguishing it from business savings; nevertheless, overall private saving is low. ### Cross-country comparison and regression evidence - Cross-country panel regression of household savings on observed fundamentals shows persistent one-sided residuals similar to those of the current account regressions, indicating observed fundamentals fail to fully explain the persistently low household savings rate. - The regression evidence implies a common set of structural factors may explain both the low household savings and current account balances in New Zealand. - By contrast, cross-country regressions fit Australia better for household savings, suggesting Australia’s unexplained current account deficit may be associated with unusually high investment rather than low savings. ### Structural and institutional factors possibly reducing savings - New Zealand stands out as one of the only OECD countries where individuals do not have access to any significantly tax-preferred saving vehicles other than property. - New Zealand and Ireland are the only two OECD countries that do not have a tier-2 pension scheme—a compulsory private saving account or a mixture of defined benefit and defined contribution schemes and funding by social security taxes. - Compared to some OECD countries, New Zealand relied more heavily on direct taxes (based on the IMF Fiscal Affairs Department’s Tax Revenue Structure database for 2003-2007), which may have had a role in reducing private savings. - Other less-quantitative factors and unique structural features may reduce households’ incentive to save. ### Prospective developments and implications for national savings - Not-well-understood structurally low household saving is likely a major reason for the persistently strong exchange rate, current account deficits, and resulting stock of net external debt. - Factors that could increase national savings going forward: - Return to budget surplus should increase national savings; the 2012 Budget plans a return to surplus by fiscal year 2015. - KiwiSaver, an incentivized retirement savings scheme launched in 2007 with automatic enrollment for new employees, based on the past five years, future take-up is likely to be strong. - A key question: whether the jump in the household savings rate post-2008 is a structural break or whether rates will return to pre-crisis levels. - Further household balance sheet repair could face an offsetting force of rising house prices in the coming years. - Reddell of RBNZ argues that the persistent current account deficits (and high interest and exchange rate) could be related to high housing investment needs associated with markedly increased and relatively rapid population growth since around 1990. ### Policy recommendations (condensed main recommendations from 2012 Article IV Consultation) - Fiscal policy: - Implement the current deficit reduction plan if the economic recovery proceeds as expected; the planned fiscal consolidation balances containing public and external debt while limiting adverse growth impact. - Fiscal consolidation would relieve pressure on monetary policy and the exchange rate, helping contain the current account deficit over the medium term. - Monetary policy: - Support accommodative monetary stance; recommend the RBNZ tighten gradually to contain inflationary pressures if the recovery remains on track and downside risks dissipate. - The RBNZ kept its policy rate unchanged at 2.5 percent given uncertainty over the global outlook, soft domestic demand, benign inflationary expectations and the strong exchange rate. - Financial sector policy: - Assess on an ongoing basis the balance between banking sector vulnerability versus efficiency. - Recommend future stress tests include funding risks and that the core funding ratio be increased more than planned over time. - Consider merits of raising bank capital gradually to levels well above the Basel III requirements. - Encourage analysis of the cost and benefit of macroprudential measures. - Authorities have conducted stress tests including funding shocks; capital adequacy has improved and is well above Basel III requirements; banks have shifted toward more stable funding sources. - Authorities are revising the macroprudential framework; new tools will include countercyclical capital buffers, overlays to sectoral capital requirements, and loan-to-value restrictions. *Source: _cr13117 - 4. Key to the imbalance is unusually low household savings rates in New Zealand (IMF).* ### Annex 5. New Zealand: External Debt Sustainability: Bound Tests 1/ 2/ ### Annex 5. New Zealand: External Debt Sustainability: Bound Tests ### Macroeconomic outlook and key projections - Growth for 2012 is estimated at 2½ percent. - Growth forecast for 2013 is currently at 2¼ percent. - Over the medium term, output growth should peak at 2¾-3 percent before converging to a trend rate of about 2½ percent. - The RBNZ policy rate has been kept at 2½ percent for two years. - Authorities expect to keep the Official Cash Rate unchanged through the end of this year, with eventual increases as recovery progresses. - The recent severe drought is currently estimated to detract 0.7 percentage points from real GDP in calendar 2013. - Earthquake-related reconstruction is expected to require investment spending in excess of 15 percent of GDP and reconstruction is expected to take at least ten more years to complete. - The current account deficit in 2012 widened to 5 percent of GDP. - Net external liabilities remain high at 72 percent of GDP at end-2012. - The current unemployment rate (period average, 2012) is 6.9 percent. - Headline CPI inflation for 2012 was 1.1 percent; end of period CPI (2012) was 0.9 percent. - Growth and price statistics (selected): - GDP (production basis): 2012 = 2.5; 2013 (Proj.) = 2.2 (percent change). - Final domestic demand: 2012 = 2.7; 2013 (Proj.) = 2.3 (percent change). - Private consumption: 2012 = 2.1; 2013 (Proj.) = 1.7 (percent change). - Fixed investment: 2012 = 6.6; 2013 (Proj.) = 5.9 (percent change). - Output gap: 2012 = -0.1; 2013 (Proj.) = -0.2 (percent of potential GDP). - Investment and saving (percent of GDP): - Investment 2012 = 19.6; 2013 (Proj.) = 20.1. - National saving 2012 = 14.5; 2013 (Proj.) = 14.0. - Public finance (percent of GDP) 2012: - Revenue = 34.2; Expenditure = 36.7; Net lending (+)/borrowing (–) = -2.5. - Gross debt 2012 = 38.2; Net debt (financial assets excl. NZS Fund & Advances) 2012 = 24.3. - Balance of payments (percent of GDP) 2012: - Current account = -5.0. - Trade balance (goods) = 0.5. - Terms of trade (percent change) 2012 = -6.8. - Net international investment position (NZ$ billion): 2012 = -150.0; (in percent of GDP) 2012 = -71.7. - Nominal GDP (2012): US$169.7 billion; GDP per capita (2012): US$38,111; Population (2012): 4.4 million. ### External debt and stress scenarios (bound tests) - The annex presents external debt in percent of GDP and several stress scenarios including: - Non-interest current account shock. - Growth shock (permanent 1/4 standard deviation shocks applied to growth rate as noted). - Real depreciation shock (one-time real depreciation of 30 percent occurs in 2013, with FX hedging assumed to cover 90 percent of foreign currency-denominated debt). - Combined shock (combinations of the above shocks). - Charts indicate baseline and scenario paths for external debt (baseline shown at 117 percent of GDP in box figures). - Representative scenario box figures (as presented in the charts): - Historical box: 81 (External debt in percent of GDP). - Baseline box: 117 (External debt in percent of GDP). - CA shock box: 123 (External debt in percent of GDP). - Combined shock box: 124 (External debt in percent of GDP). - Combined shock + 30% depreciation box: 128 (External debt in percent of GDP). - Growth shock box: 122 (External debt in percent of GDP). - Gross financing need under baseline and scenario components are shown alongside non-interest current account shocks and growth shock magnitudes; illustrative numeric labels in the annex charts include: - Baseline: 4.9; Scenario: 5.5; Historical: 4.4 (presumably percent or percent of GDP as displayed). - Baseline: 2.5; Scenario: 1.6; Historical: 2.2 (growth shock in percent per year as displayed). - Baseline: 0.1; Scenario: -1.0; Historical: -1.0 (non-interest current account shock in percent of GDP as displayed). ### Financial sector and vulnerabilities - Banks remain sound: asset quality remains good; ratio of nonperforming loans to total assets is low and declining; return-on-assets is in line with the pre-crisis average. - Capital adequacy has improved and is well above the Basel III capital requirements which the RBNZ began to put in place in January. - Banks have shifted toward more stable funding sources: deposits now meet around half of banks’ funding requirements; reliance on offshore wholesale funding has been reduced and is of longer maturity; banks’ balance sheets are fully hedged against exchange rate risk. - Household leverage and rising house prices are key vulnerabilities: - House price inflation for the March quarter: Auckland = 13 percent (annual), Canterbury = 10 percent (annual), nationwide = 8.6 percent (annual). - Rising house prices could lead to increased debt-financed household spending and raise risk of an abrupt price correction. - Stress tests indicate the major banks could withstand a variety of sizeable shocks, but banks remain exposed to highly leveraged borrowers and rollover risks associated with large short-term offshore funding needs. - Insurance sector: earthquake claims of $13.4 billion have been paid to date, out of an expected total claims cost well in excess of $30 billion. ### Fiscal strategy and policy recommendations - Directors welcomed the medium-term consolidation plan aiming to reduce the structural budget deficit by about 6 percent of GDP over four years, mainly through spending restraint. - The government aims to reduce net core Crown debt to 20 percent of GDP by 2020, from an expected peak just below 30 percent. - Expenditure-control measures include reprioritizing spending, reducing Budget operating allowances, reducing the cost of existing policies, and driving efficiency gains in the public sector. - Directors viewed the planned pace of deficit reduction as striking the right balance between sustaining aggregate demand and limiting public debt growth, while providing scope to delay planned deficit reduction in the event of a sharp deterioration in the outlook. - Directors emphasized addressing low household savings to reduce pressure on the exchange rate and limit current account deficits; they welcomed the shift in taxation from income to consumption taxes and follow-up on the Savings Working Group. - Directors supported judicious use of macroprudential tools by the RBNZ to limit risks in the housing market, complementing macroeconomic and microprudential measures; possible tools include a countercyclical capital buffer, adjustments to the core funding ratio, sectoral capital requirements, and restrictions on high LVR lending. - Authorities’ fiscal stance: Government is on track to return the operating balance to surplus in 2014/15 and rebuild fiscal buffers; public sector capital spending over the next four years will be funded from the Crown’s balance sheet and proceeds of the Government’s share offer program. ### Executive Board assessment and priorities - Executive Directors commended prudent macroeconomic management following the global downturn and earthquakes. - Main risks identified: - Persistent low national savings and large external liabilities. - High and rising house prices and associated financial stability risks. - External shocks from Europe, China, Australia, and other parts of Asia. - Monetary policy is judged appropriate given subdued domestic demand and benign inflationary expectations; a tightening may be warranted if house-price and credit expansion fuel inflationary pressures. - Macroprudential measures are recommended as complements to monetary and fiscal policy to manage housing-related risks. - Structural reforms and policies to raise national saving and address the savings-investment imbalance remain important for medium-term resilience. *Prepared by IMF staff (Asia and Pacific Department) — informational annex to the 2013 Article IV consultation with New Zealand.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13117.pdf_