Recent forecasts from The Treasury point towards New Zealand avoiding a technical recession and getting on top of inflation before the end of 2024. The Reserve Bank’s forecasts still see a recession, but a relatively mild one, with inflation also getting back within the 1-3%pa target band by the end of next year. The economy’s resilience so far appears remarkable, which begs the question – dare we dream of the soft landing that we’d been hoping for, but didn’t think was feasible given the imbalances in the economy? Or will excessive demand and price pressures still force a tougher period than official forecasts are indicating?
Although forecasts of no recession and a swift moderation in inflation are possible, we remain somewhat sceptical. In our view, there are risks that economic activity needs to be hit harder because inflation remains more persistent. Regardless of whether New Zealand experiences a technical recession or not, economic conditions in 2023 and 2024 will feel recessionary, as we pay the price for our earlier supports during the pandemic. All this economic pain is necessary to get the economy onto a more sustainable path for the future.
Recession fears diminish, but haven’t disappeared
In recent weeks, economic indicators and forecasts have created a feeling that a soft landing might well be possible. Treasury’s forecasts published at the 2023 Budget showed New Zealand avoiding a recession within its forecast horizon. Instead, Treasury now expects the economy to be 1.1% larger at the end of 2023 compared to 2022. Back in December, Treasury’s Half Year Economic and Fiscal Update had forecast a 0.8% fall in activity over the same period.
The Reserve Bank still has a recession forecast in the May 2023 Monetary Policy Statement, but of the mildest kind, with a 0.3% total decline in activity over two quarters in mid-2023.
Both views see better tourism activity, cyclone recovery spending and investment, and higher net migration as adding to the economy into the future.
Our own estimates also show a remarkable level of recent economic activity, with our preliminary assessment of economic activity over the start of 2023 being flat to ever so slightly higher.
Budget 2023 includes many smaller policy changes
Budget 2023 included several smaller policy changes that all add to an overall increase in spending. Key among the announcements was the 20 hours of free early childhood education being extended to two-year-olds from March 2024, removing the $5 co-payment for many prescriptions, free or half-price public transport for young people depending on age, and more funding for insulation.
Additional funding to support the cyclone recovery was also announced, with a direct $1b package announced pre-Budget, and a substantial boost in infrastructure investment also confirmed. A total of $71b in infrastructure investment was announced as part of the Infrastructure Action Plan – although with 74% of identified actions already underway, the additional value of the “plan” seems limited for now. Concerningly, one of the important actions is that the Infrastructure Commission and Treasury will take until 2025 to develop an infrastructure priority list. That list is critical but taking until 2025 is too slow given the scale of investment that is required.
An additional $6b was allocated to be invested as part of the National Resilience Plan, although details are still sparce at present.
The government also announced a $160m subsidy over four years for the electronic gaming industry, seeking to compete with Australian subsidies and providing direct industrial support after heavy lobbying. Economists take a dim view of such subsidies, given the creation of winners and losers when it comes to government’s favouring some areas and not others. The amount of funding, at $40m per year for a sector worth $400m per year, is a substantial subsidy that many other private businesses would also be keen to enjoy. It also sets the wrong tone about priorities, in our view, with only $130m allocated over the same period for community and business support post-cyclone.
An encouraging piece of news in the Budget was the continuation of funding for the Apprenticeship Boost scheme until the end of 2024, enabling an “estimated 30,000 apprentices to start or continue” in the scheme.
However, all this additional spending, as well as a tax take that is set to be weaker than previously forecast, saw a deterioration in the outlook for the fiscal position. Core Crown expenses are set to be $9.4b higher over the 2024-2027 forecast period than expected in December, and revenue is set to be $10.7b lower. Net debt will rise and remain higher for longer, pushing the move back to a budget surplus out at least another year.
Concerns raised over ability to deliver infrastructure
Buried deeper in the Budget were two “specific fiscal risks” that raise concerns about future infrastructure funding and delivery. The following bullet points are direct quotes from Treasury’s document.
- National Land Transport Fund (Cost Pressure or Variance – Expenses, Capital and Revenue): There is insufficient funding within the National Land Transport Fund (NLTF) to carry out expected activities in line with the National Land Transport Programme. There is a risk additional Crown funding may be required to top up the NLTF to address these pressures until the gap between revenue and expenditure can be resolved in a sustainable way.
- Transport Local Government Share (Cost Pressure or Variance – Expenses): Local government has been signalling that it is unable to afford its share of continuing programmes and investments. Without this share of funding, there is a risk that planned activities may not be able to be carried out to expected levels of service.
Both risks reaffirm our concerns that, although official forecasts of infrastructure investment are tracking higher, the actual ability to deliver these projects is more challenging. Expectations remain for a rephasing, re-costing, or other form of rescoping of parts of the New Zealand Upgrade Programme.
Wider than just transport investment, problems with the planning and delivery of infrastructure investment risks undermining economic development and standing in the way of productivity improvements. The Wairarapa provides a recent example, where a lack of further wastewater capacity has forced a halt in new sewage connections and risks stymieing future developments.
The end of OCR raises?
Despite mounting market concerns that the higher levels of migration and forecast government spending provide upside risks to inflationary pressures, the Reserve Bank took a more restrained view. The Bank now sees evidence of both inflation and inflation expectations moderating, and more economic indicators showing that this disinflationary pathway will continue.
In the Bank’s view, which is in alignment with Treasury’s forecasts, inflation is expected to be back below the top of the Reserve Bank’s 3% target band by the end of 2024, as higher interest rates work their way through the system. Both Treasury and the Reserve Bank expect household spending to fall throughout 2023, leading to less demand-side inflationary pressure.
As a result, the Reserve Bank thinks that prior increases to the official cash rate will be enough to achieve its inflation goal, and it doesn’t currently see a case for further interest rate raises. To be clear – further official cash rate raises would have increased the depth and length of a recession, and so no further rates rises provides a pathway for New Zealand skirting recession, at least technically.
Still a feverish dream no matter what
The dream of a soft landing might well see New Zealand avoid a recession. Economic news has continued to be considerably cheerier than economists might have imagined last year, given the challenges thrown at the economy. The rapid increase in interest rates, a deliberately engineered slowdown, and frequent destructive weather events have tested current economic momentum.
But even if New Zealand does avoid a technical recession, the overall slowdown in economic momentum will still feel like a recession, and some areas such as residential construction and retailing will go through a tougher period of activity. Let us be clear – 2023 and into 2024 will bring economic pain – the unknown is how deep it will be and how long it might persist. An emerging view is that it might be shorter and less sharp than first feared.