The Treasury delivered a cheerful set of economic forecasts in its half-year update yesterday.
While it has shaved 0.3 percentage points off its estimate for economic growth in the year to March 2015, compared with its pre-election update (Prefu) in August, it has revised up its forecasts for the next two years.
The net effect is it now has the economy expanding by a cumulative 9 per cent over the three years to March 2017, up from a cumulative 8.2 per cent four months ago.
While that is higher than the consensus among nine forecasting operations polled by NZIER, it is marginally softer than the cumulative 9.3 per cent forecast by the Reserve Bank last week.
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Like the bank, the Treasury has also revised up its estimate of the potential or non-inflationary growth rate the economy can handle at this stage to just under 3 per cent a year, as a surge in net immigration swells the labour supply and strong business investment boosts productivity. It expects inflation not to reach 2 per cent until 2016 and to stay there or thereabouts for the following three years.
In terms of the drivers of growth, business investment is expected to be almost as important as private consumption over the next two or three years.
The Treasury expects the annual net inflow of migrants to peak at 52,500 in March next year, but acknowledges it may turn out to be higher. Even so it expects the unemployment rate, currently 5.4 per cent, to drop below 5 per cent in 2016, and wage growth to remain positive in real terms over the next five years.
A potential downside risk to its growth forecasts is that the recovery in dairy prices it expects to see next year may not eventuate.
On the other hand the forecasts, finalised just over a month ago, do not include the subsequent steep fall in oil prices. They assume that the oil price will fall from US$100 a barrel to US$83 over the next four years. Currently it is around US$57.
Finance Minister Bill English acknowledged the hit to incomes - and his tax base - from the halving of export dairy prices since February. But he pointed to the 53 per cent of ANZ's commodity price index which is not made up of dairy products and is up 14.5 per cent on a year ago. As well as the impact from lower dairy prices, the Government's tax revenue this year and in subsequent years will be reduced by lower inflation which is, English noted, a global phenomenon.
Despite the stronger outlook for real growth, compared with Prefu, nominal gross domestic product (a proxy for the tax base) is forecast to be a cumulative $13 billion lower over the next four years.
Tax revenue is accordingly expected to be a cumulative $2.4 billion lower over that period, and the Treasury is no longer forecasting a $300 million fiscal surplus for the current year but rather a deficit of $600 million.
But over the same four years the Government's operating expenses are expected to be $3.1 billion lower than in the Prefu. Lower inflation is expected to mean lower wage growth, to which New Zealand Superannuation is indexed, and lower interest rates, reducing the Government's interest bill.
Bank of New Zealand head of research Stephen Toplis sees some risk the Treasury's real GDP forecasts over the medium term could prove too optimistic as the flow-on impacts of lower dairy prices, the moderation in the marginal contribution from the Canterbury rebuilding, eventual lower net migration inflows and higher interest rates conspire to weaken growth.
"There are no financial market implications," Toplis said, "except to the extent that the fiscal accounts and forecasts continue to show New Zealand in a good light.
"This implies that the risk premium on New Zealand assets can fall further and the New Zealand dollar remains supported."
There were no changes to planned bond issuance.
ASB economist Nathan Penny said that in any case New Zealand long-term rates were likely to remain constrained by both the current low level of global bond yields and the long pause before any further official cash rate increases, which ASB expects to resume late next year.