A sharp slowdown in China's growth, financial market volatility, a sustained decline in commodity prices and a drop in house prices are the biggest potential risks facing the New Zealand economy, according to an assessment by the International Monetary Fund.
The IMF gives New Zealand a broadly favourable appraisal in its latest country report, noting that economic growth is "becoming increasingly embedded and broad-based" and headline inflation remaining below the mid-point of the central bank's target even while underlying pressures "may be building."
The global body of 188 member countries, set up to foster international monetary cooperation, expects the New Zealand economy to expand 3.5 per cent this year before moderating to a trend rate of 2.5 per cent over the medium term. The nation's terms of trade will continue to boost growth in national income while moderating from near-record levels, given a decline in global dairy prices.
Strong construction activity, driven by the rebuild of Christchurch and more broadly a shortage of housing, is expected "to remain an important driver for near-term growth," the IMF said.
The report includes a risk assessment matrix for New Zealand, which rates a probability and impact of key risks. A sharp slowdown in growth in China is rated a low/medium likelihood which would have a medium impact on the economy, affecting New Zealand directly through the terms of trade and indirectly through the impact on Australia, New Zealand's second-largest market. It noted New Zealand's flexible exchange rate would provide something of a buffer.
A surge in global financial market volatility is regarded as a high risk which could be triggered by a disorderly exit by the US Federal Reserve and other major central banks from unconventional monetary policies. This could have a medium impact on New Zealand, driving up offshore wholesale borrowing costs, the IMF says.
A sustained decline in commodity prices is deemed a medium risk but with a high impact on the economy, given the nation's dependence on commodity exports, though with the exchange rate providing a buffer.
A sharp fall in house prices is cited as the biggest potential domestic risk, with a medium likelihood and a medium-to-high impact on the economy.
"There are underlying supply and demand factors that contributed to the high and rising house prices in New Zealand, but the risk of house price overshooting remains," it said. "A deterioration in households' ability to service mortgage debt, possibly due to a sharp rise in unemployment, falling incomes, or very high domestic interest rates, could cause a sudden price correction, reducing consumer confidence as a large share of wealth is in housing, worsening banks' balance sheets and impact on overall economic activity," it said.