New Zealand: IMF Staff Concluding Statement of the 2017 Article IV Mission
IMF News, March 6, 2017
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- Published: March 6, 2017
Context and recent developments
- New Zealand has enjoyed a solid economic expansion in recent years driven by record high net migration, strong construction activity, and accommodative monetary policy.
- Construction has been an important driver, with above average residential investment ratios.
- House prices have increased rapidly; household debt (as a percent of income) is high and rising.
- Inflation has mostly been below the Reserve Bank of New Zealand’s (RBNZ) 1-3 percent target range; the New Zealand dollar has stayed relatively strong.
- The terms of trade have remained above average, although dairy price declines in 2014-15 led to losses and some financial distress in the sector.
- Real GDP growth accelerated to about 4½ percent through 2016, with broad-based strength in demand and employment; the economy is now operating broadly at capacity.
- Headline inflation returned back into the target range in 2016Q4, reflecting the rebound in oil prices and a recovery in non-tradables inflation.
- Housing markets have remained buoyant, although house price growth in Auckland has slowed.
Outlook and risks
- Baseline projections:
- Economic growth is projected to remain strong and above trend into 2018, with subsequent moderation toward trend growth of around 2¾ percent.
- Near-term strength is underpinned by investment (including residential and infrastructure), the production impact of the recent recovery in dairy prices, and further, albeit moderating, net migration.
- Inflation is projected to rise gradually toward the 2 percent mid-point of the RBNZ target range.
- Household debt vulnerabilities:
- Household debt vulnerabilities are expected to stabilize in the medium term but will remain high.
- Tighter macroprudential policies, higher interest rates, moderating net migration, and easing housing supply constraints should result in lower house price increases.
- As credit growth slows, household debt will stabilize relative to income at high levels in international comparison.
- Banks’ international net wholesale funding needs will moderate, containing related vulnerabilities.
- Risk balance:
- Upside risks: stronger net migration and terms of trade could accelerate activity and house price increases.
- Downside risks: tighter external financial conditions and macroprudential constraints could slow credit, investment, and growth.
- A high-impact downside shock—likely external—could be amplified by rising household debt through household deleveraging and a housing correction; dairy price declines under such a shock could cause financial stress in the sector.
- Financial sector assessment (FSAP):
- The FSAP concluded the financial sector appears to be sound but recommended enhancing resilience by expanding the macroprudential toolkit, increasing capital buffer requirements to reflect concentration in the financial sector, and strengthening financial sector oversight and crisis resolution regimes.
Policy recommendations — Macroeconomic management
- Monetary policy:
- Current monetary policy settings appropriately address low inflation; inflation is expected to return gradually to the mid-point of the target range.
- Risks to inflation are broadly balanced, with downside risks still a bigger concern after a long period of inflation below target and strong labor force growth.
- If there was an unexpected upshift in the inflation path, domestic financial conditions would tighten in response, reducing further upside risks.
- Fiscal policy:
- The strong fiscal position provides room to accommodate needs from strong population growth.
- Compared to the previous budget, the updated baseline expenditure path already incorporates higher infrastructure spending and new growth-friendly measures; this is expected to result in a positive fiscal impulse in the current fiscal year.
- With the economy approaching full capacity, the fiscal impulse is helpful and current budget plans appropriately imply a counter-cyclical fiscal stance going forward.
- Stronger-than-expected revenue for cyclical reasons should be used to reduce public debt.
Policy recommendations — Strengthening macro-financial resilience
- Housing and household balance sheets:
- Housing-related macro-financial vulnerabilities are expected to increase in the near term and prospectively stabilize at a high level in the medium term.
- A root cause is a demand-supply imbalance in the housing market, especially in Auckland, producing a house price boom, overvaluation, and high household debt.
- The authorities have taken steps to enable more housing supply; even with these measures, resolution will take time and vulnerabilities should be contained with macroprudential policies in the meantime.
- Macroprudential toolkit:
- The RBNZ’s macroprudential toolkit needs broadening.
- Exposure limits to high loan-to-value ratios (LVRs) have reduced potential losses on bank balance sheets but do not protect against an increase in the number of households defaulting as rising debt-to-income (DTI) ratios on new loans increase default probability.
- Recommendation: extend the macroprudential toolkit to include a DTI or (stressed) DSTI instrument, in line with FSAP recommendations; activate the new instrument if effects of the most recent macroprudential package on credit growth prove temporary.
- Other macroprudential instruments are approaching practical limits (LVRs) or address the problem indirectly with limited effectiveness and higher risks of unintended consequences.
- Bank capital and supervision:
- Bank balance sheet resilience should be strengthened further through increases in bank capital requirements under the ongoing RBNZ capital review.
- New Zealand’s large banks have similar business models with high concentration in mortgage lending and the dairy sector and significant reliance on foreign funding; aiming for capital adequacy ratios somewhat higher than APRA’s “unquestionably strong” capital targets for large Australian banks could be a reasonable benchmark.
- Upgrades to oversight and crisis resolution regimes are encouraged, including:
- Increase the weight of regulatory discipline to reinforce self and market discipline.
- Foster stronger home-host supervisory cooperation with APRA.
- Adopt reform plans to align regulatory and supervisory framework for financial market infrastructure with international standards.
- Broaden the regulatory perimeter for the asset management industry.
- Clarify the operation of the Open Bank Resolution framework and strengthen the financial safety net.
Policy recommendations — Supporting growth opportunities
- Leverage benefits from high net migration, innovation, and interconnectedness to offset remoteness and small market size.
- Housing supply and urban planning:
- Target housing supply bottlenecks more broadly to safeguard attractiveness for high-skilled immigration and business.
- Complement measures such as the Auckland Unitary Plan and the Housing Infrastructure Fund with a comprehensive reform of urban planning legislation and measures to support local infrastructure financing.
- Local infrastructure financing measures could include some central government funding, more efficient property taxation, and user charges.
- Tax and saving incentives:
- Redirect saving incentives from housing to other investments.
- A broader capital gains tax on real estate would lower incentives for investment in housing.
- Limiting negative gearing for rental properties would work in a similar direction.
- Innovation and trade:
- Provide support for innovation beyond the current budget announcement of the “Innovative New Zealand” program, which increased financing for science and some R&D grants, and subsidies for tertiary education by 0.1 percent of total annual spending; if the pilot is successful, spending should be ramped up.
- Continue efforts toward further trade liberalization in regional and multilateral fora; expand access to service export markets and broader market access for agricultural products to raise incentives for diversification and innovation in the sector.
New Zealand: IMF Staff Concluding Statement of the 2017 Article IV Mission.