The International Monetary Fund has given the thumbs-up to the Government's plans to curb spending and rein in debt.

Prime Minister John Key now says it is very likely this year's will be a zero Budget, with no allowance for new spending overall, and any increases in health and education funded by cuts elsewhere.

Dropping the $800 million allowance for new spending which had been pencilled in last year's Budget was driven by the Government's determination to return its books to surplus in 2014/15 in what are now more challenging circumstances, he said.

The IMF, which has been in the country for one of its regular check-ups, says the planned pace of deficit reduction, which entails an improvement of about 5 per cent of gross domestic product over the next five years, strikes the right balance between the need to limit increases in public debt while containing any adverse effect on economic growth during the recovery.


The head of the IMF mission, Brian Aitken, described the pace of the fiscal adjustment as ambitious but not dramatic by international standards.

"We wouldn't want to see dramatic."

It would withdraw stimulus in line with expected increases in private sector spending and earthquake-related reconstruction.

New Zealand is still in a better position than some other developed countries to cope with any further shocks, in that there is scope for the Reserve Bank to cut the official cash rate, and for the Government to slow the pace of fiscal consolidation.

The existing fiscal track would increase that fiscal buffer and make it easier to deal with an ageing population and rising healthcare costs. And it would take pressure off monetary policy and thereby the exchange rate.

"The outlook for New Zealand looks good, but not great," Aitken said.

The IMF sees the same risks as the Reserve Bank and Treasury.

While its level of concern about Europe has lessened compared with four months ago, it still sees the potential for a great deal of turmoil in European markets, which in turn could increase the chances of a hard landing in China, spilling over into Australia and hitting New Zealand's commodity prices as well.

Banks remain vulnerable to the state of wholesale markets overseas on the funding side and through their exposure to highly leveraged households and farmers on the lending side.

The fund is supportive of moves the Reserve Bank has already made, and will implement next year, to lessen those risks.