New Zealand: Staff Concluding Statement of the 2015 Article IV Mission
IMF News, November 10, 2015
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- Published: November 10, 2015
Recent Developments
- Mission period: October 28–November 10, 2015; mission led by Mr. Chikahisa Sumi; meetings in Wellington, Auckland, and Christchurch.
- Economic slowdown drivers:
- Dairy prices have fallen sharply from historic highs.
- Investment associated with the Canterbury rebuild is plateauing.
- Output growth has slowed and unemployment edged up.
- Inflation has declined, partly due to the drop in oil prices.
- House prices in Auckland have continued to rise rapidly.
- Policy responses to date:
- Reserve Bank of New Zealand (RBNZ) has cut its policy rate by a cumulative 75 bps to 2.75 percent since June.
- Authorities introduced a package of tighter macroprudential regulations and tax measures aimed at containing risks from the Auckland housing market.
- 2014/15 government operating balance in surplus; fiscal consolidation progressing broadly in line with plans to reduce net debt to no higher than 20 percent of GDP by 2020.
Outlook
- Short-term: challenging; decline in dairy prices still feeding through the economy; main trading partners China and Australia are slowing.
- Growth and inflation projections and dynamics:
- Output growth is expected to slow in 2015 and remain somewhat below potential in 2016.
- Inflation is projected to rise to within the RBNZ’s target range of 1–3 percent in 2016 as oil price effects drop out and NZ dollar depreciation passes through.
- Resilience factors:
- Flexible exchange rate has depreciated over the past year, though it still remains somewhat overvalued.
- Farmers are adapting to lower prices; banks continue to support the agricultural sector.
- Banks remain well-capitalized; stress tests indicate the sector can withstand a sizeable shock to house prices, the terms of trade, and economic activity; banks have reduced reliance on foreign funding.
- Business and consumer confidence have recently picked up; net immigration remains strong.
- Medium-term prospects supported by exports (dairy, tourism, education services) benefitting from China’s shift to consumption-oriented growth and growing consumer demand in other Asian countries.
Risks (tilted to the downside)
- Dairy prices: renewed decline could threaten higher-cost dairy producers; impact on financial stability likely limited.
- China spillovers: sharper-than-expected slowdown in China could reduce New Zealand’s exports and also adversely affect Australia.
- El Niño: entrenched El Niño could cause drought and significantly affect agricultural output in rainfall-reliant areas.
- House prices: Auckland market may be driven by self-reinforcing demand dynamics leading to a sudden sharp correction; high household debt implies a rise in interest rates could strain debt servicing, squeeze disposable income and consumption, and possibly trigger house price declines.
- Financial market volatility: U.S. monetary policy normalization may lead to unexpected bouts of higher global financial market volatility, causing abrupt depreciation, higher financing costs, and/or periods of very poor liquidity in international financial markets.
- Upside scenarios: stronger housing supply response could smooth house price inflation and support growth; recovery in dairy prices would boost incomes and investment; continued high net immigration could boost longer-run growth (but pose short-term management challenges).
Macroeconomic Management (findings and recommendations)
- Fiscal policy:
- Strong public sector balance sheet underpins confidence.
- Planned medium-term fiscal consolidation is broadly appropriate.
- In the short term, automatic stabilizers should be allowed to operate fully.
- Accelerate investment in infrastructure and housing (in high-quality projects) where possible to support higher housing supply in Auckland and infrastructure improvements.
- Monetary policy:
- Should focus on price stability while paying due regard to economic growth.
- With weak growth and core inflation in the lower half of the target band, the RBNZ’s easing bias is appropriate.
- Monetary policy should be freed to focus on the real cycle by managing house price inflation through other measures.
- Housing supply and coordination:
- Underlying issue is a supply/demand mismatch.
- Intensify efforts to boost higher-density housing, increase supply of land and infrastructure, improve local/central government coordination, and discourage land hoarding.
- Supply response will be slow; interim measures needed to buy time.
- Interim measures to manage housing/financial stability risks:
- Prudential measures: evaluate impact of new measures; be prepared for further steps such as targeted higher risk weights on housing loans, higher down payments, and a formal debt serviceability test.
- Tax measures: newly introduced measures to deter speculative investment are welcome; further steps envisaged. Consider comprehensive reform to reduce tax advantage of housing over other investments, including reducing the scope for negative gearing.
Responses to Risks (policy space and conditional actions)
- Authorities have ample monetary and fiscal policy space; flexible exchange rate expected to act as a buffer.
- If a sharp slowdown driven by key export markets occurs:
- Monetary policy and, if severe, coordinated fiscal policy response could be warranted.
- If severe housing downturn occurs:
- Supportive demand policies may be needed.
- Financial system resilience:
- Stress tests suggest ability to withstand—at least in the short term—adverse developments related to China spillovers, dairy prices, and the housing market.
- However, periods of extremely low liquidity or an excessive risk premium could call for both monetary and fiscal support.
- Use of monetary policy relative to financial stability:
- Monetary policy has focused on price stability.
- Only if financial stability risks become broad based and prudential policy is insufficient should using monetary policy to “lean against the wind” be considered; benefits must be weighed against output costs and risk of policy reversals.
- Banking sector structural issues:
- Continued reliance on offshore funding and large share of mortgage lending persist.
- Important to continue strengthening capital buffers and move toward more stable sources of funding.
Medium-Term Policies
- External vulnerability:
- Long-standing dependence on borrowings from abroad (albeit mostly hedged or in domestic currency).
- Chronically low national saving; savings-investment balance persistently negative; accumulation of a large net negative international investment position financed to a significant extent by bank borrowing from abroad; may have raised capital costs.
- Raising saving is key:
- Higher private and household saving would improve the international investment position, reduce susceptibility to external developments, lower capital costs for businesses, incentivize productive investment, and lead to capital deepening.
- Consider comprehensive measures to encourage private long-term financial saving, including reform of retirement income policies.
- Options include changing parameters of the Kiwisaver scheme—e.g., default settings, access to funds, and taxation—to increase coverage and contributions while containing fiscal costs, and adjustment of parameters of the public pension system.
- Deepening capital markets and broadening retirement planning options are expected benefits.
- Productivity:
- Despite successful structural reforms in the 1980s, productivity remains low compared to OECD peers.
- Services sector accounts for 70 percent of the economy; Productivity Commission highlights need to raise productivity in services.
- Measures include boosting competition in key sectors such as finance, real estate, retail, and business and other professional services; and leveraging ICT technology more intensively, including by enhancing skills.
Source: New Zealand: Staff Concluding Statement of the 2015 Article IV Mission (November 10, 2015).