Constant Bay, Charleston
From the beach 2024

The New Zealand economy has entered the new year with questions about whether the worst of the post-Covid hangover is behind us, or whether there’s more of a slowdown to come in 2024. We have collected our thoughts on three issues that will play a key role in determining New Zealand’s economic performance this year. Record high migration has been fuelling demand, as well as reducing skill shortages in the labour market, but has shown no signs of slowing yet. China’s economy continues to struggle, which could weigh on export incomes throughout the next 18 months. And the change of government has come with a promise of different priorities, but with little fiscal headroom for National and its coalition partners to achieve all they might like to.

Migration, like, WTF?

In just the first nine months of 2023, migrant arrivals totalled 188,689. This massive inflow exceeded the previous 12-month record of 184,884 in the year to March 2020, and the pre-Covid record of 144,358 in the year to July 2016. The latest data, up to November, has seen the annual inflow now reach 249,506. Put simply, immigrants are entering the country almost twice as fast as at any time in history (see Chart 1).

From a labour market perspective, the influx has been welcome as the pressure in the jobs market moves from overheated back towards more usual levels. The working-age population expanded 2.6% over the year to September 2023, the unemployment rate has pushed up from 3.4% to 3.9% since March last year, and firms are reporting that it is much less difficult to find both skilled and unskilled workers (see Chart 2).

But the possible demand implications for the economy are less welcome. An additional 127,400 people in the country means a lot more purchasing of goods and services as those people go about the process of setting themselves up in a new country, as well as the day-to-day demands associated with simply living. At its most recent Monetary Policy Statement in November, the Reserve Bank suddenly expressed concern about the demand and inflationary implications of stronger net migration. It was a point that we’d raised earlier in 2023 but had been dismissed at the time by the Bank. The Bank’s about-face saw these risks become the key contributor to its more hawkish stance on interest rates – even if September quarter GDP data subsequently failed to show any real signs of intensifying demand pressures yet.

The area where demand pressures would be expected to show through most quickly and obviously is the housing market. Simply put, at an average of 2.65 people per household, the new arrivals will need 48,075 homes to accommodate them all. And throughout 2023, we saw a pick-up across several housing-related series: rental inflation (substantially for new rentals), house sales volumes, house prices, and the average length of time on the market for properties. Additional demand for housing is clearly evident.

In trying to forecast migration throughout the last year, we have consistently assumed that the surge in arrivals as the borders reopened and businesses filled longstanding vacancies would be reasonably short-lived. A key part of this reasoning was that migration was jobs-driven, and that as employment pressure pulled back, so would migration, Yet despite job ads now being well below pre-pandemic levels, the trend in work visa numbers falling, and less intense growth in employment, migration continues to soar. Annual net migration estimates have repeatedly surpassed our forecast peak, and there is little sign yet that it will pull back below 100,000pa, let alone get anywhere near the prediction from our October forecasts of 27,200pa by the end of 2024.

We remain cautious about the implications for house prices to rise, given debt-servicing costs are already high due to elevated interest rates and property prices. In our view, these affordability issues will limit the scope for house prices to increase substantially during 2024 or 2025. Chart 3 shows the spread of house price predictions from various forecasters over the next two years. Stronger migration than previously forecast raises the risk of house price growth being towards the top end or above the range of forecasts shown. Faster house price inflation and more housing turnover has its own implications for demand across the economy, in terms of hardware, appliances, furniture and furnishings, construction activity, and potential wealth effects that could boost household spending as well.

In summary, migration presents considerable upside risks to the housing market, economic activity, and inflation during 2024. Even if consumer price inflation continues to moderate in line with the Reserve Bank’s expectations, there is a mounting chance that more stringent loan-to-value ratio restrictions could be implemented or, for the first time, debt-to-income borrowing limits be introduced to prevent a significant further deterioration in housing affordability. The Reserve Bank has this week begun consultation on the latter, with an announcement on the possible implementation of debt-to-income limits likely about the middle of this year.

Goodbye to the easy Chinese growth story

Back in 2021, China was the destination for a record 33% of New Zealand’s exports. That figure has since retreated to 28%, but as 2024 gets underway, China’s economy presents dual challenges for New Zealand.

First and foremost, China’s economy is struggling in the face of weak global demand, sluggish domestic activity, and a moribund housing and construction sector. After sustained growth in construction activity between 2009 and 2017, residential building completions have declined by 48% in the last 6½ years (see Chart 4).

The sector’s downturn has been epitomised by the ongoing Evergrande saga, which began to really negatively affect financial markets back in September 2021. The Chinese construction sector’s woes have resulted in significant downward pressure on New Zealand’s forestry export prices and volumes.

Although the cyclical downturn in China’s broader economy could persist throughout most or all of 2024, the nature of economic cycles means that China will enter another upturn in growth at some stage. Perhaps the more concerning aspect of China’s economic outlook, from New Zealand’s perspective, is that the rapid growth that characterised the 1990-2020 period looks unlikely to be repeated going forward.

Most critically, China’s population is now shrinking as a result of the country’s low birth rate. China’s one-child policy, in place between 1979 and 2016, has fast-forwarded the age profile of the country’s population to match the likes of Japan and Europe, with their post-war baby booms and lower fertility rates in recent years. Weaker population growth reduces the baseline potential for overall economic growth.

Chinese government policy is also shying away from the model of almost unrestrained economic growth of previous years. Increasing emphasis is being placed on domestically sourced products, with the aim of making the Chinese economy more self-sustaining than it has been in the past. Environmental considerations are also starting to play an increasing role, with the government clamping down on the more carbon-intensive steel producers, for example. Despite calls for government policy support for higher consumption, we expect for now that the Chinese government will stick to its focus on supply-side supports to further increase investment and production. However, this focus won’t be enough to stimulate activity and boost current growth expectations.

Consensus forecasts see China’s GDP growth slowing from 5.2%pa in 2023 to 4.6% this year and 4.3%pa in 2025. Aside from the Covid-affected years of 2020 and 2022, growth in all three years between 2023 and 2025 is expected to be the weakest since 1990.

Against this backdrop, New Zealand’s export sector is likely to find the going tough over the next 12-18 months. Our dependence on China to achieve export growth over the last 15 years needs to be replaced with a renewed focus on diversification and opening up new market opportunities, including better using our multilateral trade deals and reducing non-tariff barriers.

Government delivery in a fiscal straitjacket

There was a sense around last year’s election that the change of government was as much about dissatisfaction with Labour as it was about confidence in the alternative that National was offering. That perception was reinforced by the relatively strong performance of minor parties at the election, as well as a lack of vision from National about how to take the country forward, beyond undoing almost everything that Labour had tried to achieve over the previous six years.

Apart from the ideological and paternalistic tone adopted by Labour that alienated some voters, one of the biggest areas of dissatisfaction with the previous government was its inability to deliver on most of the flagship projects or major promises it had campaigned on. National has talked a lot about improved fiscal discipline and actual delivery on projects, so a jaded electorate will need to see evidence of both objectives starting to materialise this year, or the government is likely to lose people’s confidence pretty quickly.

The fiscal discipline has already begun to show through in some instances. The denial of additional funding for KiwiRail’s iReX project was a clear line in the sand, communicating that the government would not keep writing cheques for cost blowouts. The lack of detail around spending plans for infrastructure in the Half-Year Fiscal and Economic Update was also a reflection of the pressure on the government’s accounts, and an unwillingness to promise more projects when there was no clear ability to pay for them.

The shortfalls in some of New Zealand’s “public good” outcomes have become painfully apparent over recent years. Substandard and failing infrastructure has been reflected in hospitals that are past their use-by date, major issues with water and wastewater provision in some parts of the country, and concerns about the quality of road maintenance. Shortages of nurses and doctors also imply that some of the issues relate to ongoing operational funding, rather than major capital expenditure that hasn’t been adequately budgeted or prepared for. Although many voters will understand the fiscal limitations confronting the government, there are still clear needs to be addressed, despite the budgetary constraints. Failure to begin achieving real improvements is unlikely to be tolerated for long.

Overlaying these challenges for the government are the social divisions apparent in New Zealand. There is a worry that environmental, equity, or Māori issues are taking a back seat and could be detrimentally affected under the new government. The Covid pandemic has been a catalyst for more disagreement and polarisation on several issues than we have seen in New Zealand for several decades. On election night, Christopher Luxon talked about delivering “for every New Zealander.” It’s important that pledge is fulfilled, to avoid the country’s social cohesion breaking down further at the same time as economic outcomes continue to be challenging.

Even this year’s best possible outcomes will have their challenges

We will publish an updated set of forecasts for clients on 2 February, which will include a revised outlook for economic growth as well as other key variables such as migration and interest rates. The Goldilocks scenario for New Zealand would see above-average population growth continue to buoy up aggregate demand, with the labour market still easing and inflation maintaining its moderating trend, enabling interest rates to start to be reduced from their recent highs. But even this “ideal” result would still pose considerable challenges in terms of provincial economic outcomes and urban infrastructure provision. It looks like the legacy of the Covid pandemic and the resulting policy responses will continue to haunt the New Zealand economy throughout 2024.

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