Mission Concluding Statement 

New Zealand: Staff Concluding Statement of the 2024 Article IV Mission

March 19, 2024

• Real GDP growth is projected to slow to 1.1 percent in 2024 before recovering in 2025. Inflation has declined from its peak and is expected to fall below 3 percent in 2024Q3.
• Policy settings should remain restrictive. Budget 2024 should adopt a tight fiscal stance to help disinflation and address structural issues. Monetary policy is appropriately tight.
• Structural reforms are needed to boost the housing supply, revive productivity growth, lower emissions, and address challenges from climate change.

Wellington, New Zealand:

Tramping the narrow path to a soft landing

New Zealand’s economic activity has slowed following monetary policy tightening and a decline in investment. After the Reserve Bank of New Zealand’s (RBNZ) cumulative rate hikes of 525 bps between October 2021 and May 2023, GDP growth momentum fell substantially in 2023. The first three quarters of 2023 saw a contraction in private investment and government consumption and slow growth in household consumption, suggesting the slowdown is broad-based and likely reflects the lagged impact of policy tightening. Following border reopening, record net migration in 2023 helped address supply-side bottlenecks and labor shortages. High frequency indicators point to slow growth in the December quarter.

Despite tight monetary policy, inflation remains high. Inflation has declined significantly from its 7.3 percent y/y peak in 2022Q2 to 4.7 percent y/y in 2023Q4 but is still well above the RBNZ target, and is higher than peer economies. The slower progress in reducing inflation compared to other economies is due to delayed passthrough from pandemic era shocks, weather-related domestic food shortages, tight labor markets, persistent wage pressures, and the effects of migration on rental and housing costs. More recently, global disinflation helped reduce headline inflation, but trimmed-mean and non-tradable inflation are more persistent. Importantly however, inflation expectations remain anchored, and there is no indication of a wage-price spiral.

Current fiscal policy is more expansionary than in most other advanced economies. The government is running a structural fiscal deficit with its spending-to-GDP ratio higher in FY23/24 following Budget 2023’s sizable operating and capital allowances in responses to rising costs and one-off outlays related to the North Island weather events. This, together with weaker-than-expected revenue as economic activity slowed, put off consolidation and resulted in a larger-than-expected positive fiscal impulse.

The current account deficit narrowed in 2023 but remains above its long-run average. The goods trade deficit narrowed marginally, as weaker demand in export destinations was more than offset by a contraction in imports due to slower domestic economic activity and lower oil prices. Tourist and student arrivals continue recovering toward pre-pandemic levels. On the other hand, the primary income deficit increased due to higher interest rates on New Zealand’s net external liabilities. IMF staff assess that the external position in 2023 remained weaker than implied by medium-term fundamentals and desirable policies.

Housing prices are stabilizing on the back of strong population growth and residential property related tax policy changes. After a 13 percent decline from 2022Q1 to 2023Q2, housing prices have now stabilized but remained 25 percent above their 2020Q1 level in 2023Q3. Rents were up 7 percent y/y in September 2023, 13 percent higher than in January 2020. As lending conditions tightened, credit growth further slowed in 2023, though household debt remains high, at 165 percent of disposable income in 2023Q2.

Economic Activity is Likely to Pick Up from Next Year

Growth is expected to remain slow in 2024 before picking up in 2025. Real GDP growth is expected to expand by 1.1 percent y/y in 2024, below its long-term trend, as the lagged impact of monetary policy tightening suppresses domestic demand. By contrast, improving external conditions should provide some support to near-term growth and narrow the trade deficit, especially through tourism. New IMF staff research suggests that global disinflation will help lower inflation in the tradables sector and migration will ease labor market tightness. Slowing domestic demand will likely reduce non-tradable inflation. As a result, headline inflation is expected to fall below 3 percent y/y in 2024Q3. IMF staff expect a gradual easing of monetary policy starting toward the end of 2024, which should support growth to recover to over 2 percent y/y in 2025. The unemployment rate will probably continue to increase and will level around 5 percent in 2024 and 2025 as the output gap turns negative.

Risks to the outlook for growth and inflation are broadly balanced. Given considerable uncertainty, the risk of policy miscalibration remains. If domestic labor market pressures persist or if shocks fuel imported inflation, a premature loosening of monetary policy could de-anchor inflation expectations given the extended period of high prices. Conversely, a larger-than-anticipated impact of monetary tightening could cause a protracted downturn and drive inflation to undershoot the RBNZ target. High interest rates combined with low growth could create stress in financial markets, especially in mortgage lending. Upside risks to growth include stronger migration boosting labor supply and helping lower wage pressures, and a faster-than-expected decline in inflation, both of which can allow earlier monetary easing. New Zealand’s global integration creates vulnerabilities to risks from geo-economic fragmentation. New Zealand is also vulnerable to natural disasters and climate shocks.

Policies for Macroeconomic Stability and Growth

Budget 2024 should deliver a tight fiscal stance in FY24/25 to support disinflation. The details of the budget are still being formulated, but in its first 100 days the new government has announced plans for significant back-office spending cuts across public sector agencies and better targeted employment supports. Meanwhile, the planned personal income tax relief is targeted predominantly at low and middle income earners and families with children, which have a higher propensity to spend. To avoid any upside pressure to inflation it is important to calibrate the funding, timing, and the parameters of this tax relief to be fiscally neutral.

The government’s fiscal strategy should signal a strong commitment to consolidation by addressing structural fiscal challenges. With net general government debt at around 20 percent of GDP at end-2023, New Zealand’s government debt is sustainable. However, debt increased more rapidly than in many advanced economies in recent years and will continue its upward trajectory absent decisive consolidation. The authorities have emphasized the need to make New Zealand more fiscally sustainable in the medium term. In IMF staff’s view, restoring an operating surplus in the 4-year forecast period should remain the objective, underpinned by efficacious caps on operating allowances. This could strengthen credibility and preserve the policy space to respond to shocks. Spending reforms should be based on a comprehensive cost-benefit analysis of government programs and address long-term aging-related fiscal pressures. The focus should be on spending areas which have increased the most since the pandemic, such as the wage bill, transfers, and social benefits. Outlays on high-value infrastructure and support to the most vulnerable should be protected.

New Zealand would benefit from a more efficient, equitable, and sustainable tax system. New Zealand already has one of the most efficient goods and services tax systems globally. However, tax policy reforms are needed to promote investment, and productivity growth, increase the progressivity of income tax, and mobilize additional revenue in response to long-term fiscal challenges. To achieve these objectives, reforms should combine comprehensive capital gains tax, land value tax, and changes to corporate income tax.

Monetary policy is appropriately tight and should remain restrictive to ensure a timely return of inflation to target. The policy rate remains significantly above the RBNZ’s neutral rate suite of indicators. While the economy is showing signs of slowing more rapidly than previously thought and unemployment is rising, continued vigilance is needed. The increase of financial resources in 2023 (through additional capital and an indemnity) and increased FX reserves support the RBNZ’s capacity to safeguard stability. The recent change to the RBNZ's remit reinforces the price stability objective and is not expected to affect monetary policy.

Financial stability risks appear contained. Non-performing loans have ticked up but remain low and the banking system remains well-capitalized, liquid, and profitable. Yet, continued monitoring is needed, as a protracted downturn that raises unemployment could affect household incomes. The RBNZ’s proposal to activate debt-to-income restrictions and ease loan-to-value settings somewhat is appropriate. While not currently binding, the introduction of the debt-to-income (DTI) restriction would seek to protect against high-risk lending through the credit cycle. IMF staff suggest that location-based DTIs could also be considered at a later time to account for regional differences. The Deposit Takers Act is a welcome step to harmonize regulation for bank and non-bank deposit takers and to introduce deposit insurance. A proportionate approach to rule-making is needed to support competition and address concerns of smaller deposit takers.   

Policies to boost the housing supply are urgently needed. New Zealand has a relatively small housing stock that has not kept up with population growth. As a result, affordability issues are particularly severe, notwithstanding the price correction in 2021-23. Earlier efforts in New Zealand have shown that changes in zoning can be effective in boosting housing supply. Additional reforms of land use restrictions are essential for further construction. Moreover, investment in transport and water infrastructure is needed to support urban development. This requires local councils to address funding and capacity constraints.

Labor productivity growth has been slow for decades. Slow productivity growth has contributed to a rapid increase in unit labor costs, undermining New Zealand’s competitiveness. Public investment in R&D, new infrastructure, and maintenance of the existing public capital stock are critical. A more predictable infrastructure pipeline would encourage construction companies to expand implementation capacity. Immigrants have, on average, higher education levels and higher labor force participation rates. Further immigration together with efforts to improve education outcomes and skills matching, could address skills shortages and boost productivity. While the population is highly educated, New Zealand lags other advanced economies in terms of post-graduate degrees, partly due to emigration of skilled New Zealanders. Results from the 2022 PISA round show that New Zealand’s test scores continue to decline, underscoring the need to improve education outcomes. Test scores also reveal differences in education outcomes across socio-economic backgrounds.

Labor market policies should support inclusive growth. While unemployment is near historic lows, long-term unemployment rates and Māori unemployment rates remain high. Active labor market policies and expanded training opportunities can help the labor market be more inclusive. Despite recent growth moderation, the minimum wage relative to the median is among the highest in advanced economies, with potential employment headwinds for low-skilled workers. Minimum wage increases should be commensurate with productivity growth.

Additional adaptation policies are needed to meet the challenges of climate change. New Zealand is susceptible to climate shocks, rising temperatures, and natural disasters. The government has committed to new spending on flood protection works and has launched an inquiry into adaptation funding and managed retreat, and the RBNZ has conducted financial sector climate stress tests. Additional efforts are needed to invest in adaptation infrastructure, limit residential zoning in high-risk areas, address data gaps, and rebuild fiscal buffers.

New Zealand’s ambitious climate goals call for major reforms. The Emissions Trading Scheme (ETS) has helped limit net emissions by encouraging robust reductions and removals, particularly from afforestation. However, significant reforms will be necessary to meet domestic and international targets, including New Zealand's first Nationally Determined Contribution (NDC) under the Paris Agreement, and the 2050 Net Zero. These include reducing the number of available units in the scheme, pricing agricultural emissions, and strengthening the incentives for gross emissions reductions within the ETS. Given the ambition of New Zealand’s first NDC, the use of international mitigation is likely to be required. In taking policy decisions, environmental integrity risks and relative costs should be considered.

The mission would like to thank the authorities and counterparts in the private sector, civil society, think tanks, iwi, and other organizations for frank and engaging discussions.