Budget 2018

What tradeoffs have we seen in this Budget?

There isn’t a strong trade-off story to tell on the back of the 2018 Budget. Most of the significant trade-offs were signalled prior to Budget day. The reversal of the previous Government’s tax cuts provide around a third of the funding for the higher allowances, but a majority of the additional spend is driven by the higher revenues from a growing economy and adopting a ‘responsible debt reduction track’.

While Health, Education and Conservation have benefited from this Budget, there has been less of a focus on Agriculture, Defence and Tourism. There has been re-phasing of some of the large infrastructure spending plans, such as Kiwibuild, but this only stretches the time frames over which expected investment is to be made, rather than a reduction in overall spend.

What is the outlook for the next four years?

The New Zealand economy is forecast to track strongly. The Treasury forecasts economic growth of approximately 3% per annum on average over the next four years. Its expectation is that growth will peak at the end of 2019 at 3.6%, before falling to 2.5% in 2022. This is relatively consistent with the RBNZ’s estimate, which projects economic growth to hover near 3% per annum over the next four years.

Factors supporting growth include low interest rates, continued population growth, a positive international outlook, and a high terms of trade. These factors, in addition to expansionary fiscal policy coming in the form of Kiwibuild, the family incomes package, and higher government spending, are key drivers of economic growth in the next few years.

The steady growth is expected to lead to further declines in the unemployment rate, which is expected to drop to 4.1% in late 2019. Given the tight state of the labour market, coupled with the Coalitions promise to increase the minimum wage to $20 an hour by April 2021, we would expect wage inflation to increase in the near term. The Treasury’s projections align with this, with the hourly wage growth set to gradually rise to 3.4% by June 2022.

Is the 20% debt cap looking too prudent? 

The Government reemphasized its strict adherence to its budget responsibility rules that will see it reduce core Crown debt to below 20% of GDP by 2020. Core Crown debt is projected to grow from $60.4 billion in FY18 to $67.0 billion by FY21. As a percentage of GDP this will decrease from 21.7% in FY18 to 19.1% in FY22.

This is driven by Treasury’s largely positive outlook for the economy over the next five years resulting in positive movements in the OBEGAL surplus, growing from a forecast $3.1 billion surplus in FY18 to $7.3 billion in FY22.

Not accounting for cost pressures or potential future spending initiatives, the projected 19.1% debt target gives the Government some room to move to absorb potential future fiscal surprises. A large fiscal shock like the Canterbury earthquakes might require new debt of 10% of GDP, and 20% for two such shocks in short succession. This could suggest that a revised debt target of 30% of GDP would still leave significant room to manage two large shocks. 

Has the Labour-led government delivered on its election promises? 

The Coalition Government appears to have largely delivered on its election promises, with a focus on rebuilding critical public services, improving child poverty and housing, promoting economic growth in regional New Zealand and protecting our natural resources.

Unsurprisingly, Health and Education saw significant increases in additional operating spending over the next four years - $3.2 billion and $1.6 billion respectively. Health funding increases will focus on improving DHBs core services as well as primary care initiatives. Education spend is aimed at addressing increased demand through 1,500 new teachers and additional early childcare funding. Both have seen a boost in capital expenditure - $850 million to improve and expand hospitals, and $334 million to build more classrooms and improve the existing classroom stock.

Economic development will be promoted through the previously signalled Provincial Growth Fund and a $1.0 billion R&D tax incentive to encourage business expenditure on innovation that will see eligible businesses get 12.5 cents back for every dollar they spend on R&D. This should enable a transition away from government driven Growth Grants, and open up wider opportunities for businesses. 

The Government will invest in building 6,400 more public houses over the next four years, and invest in the underlying water and roading infrastructure to increase wider housing supply. There are no clear signals on how the Government will support and encourage the much larger 100,000 houses in 10 years promise.

Natural resources and conservation will see an additional spend in strengthening DoC’s capability, and $100 million in a Green Investment Fund to stimulate investment in low carbon industries.

What inflation signals are we seeing from Treasury? 

Treasury forecasts CPI inflation to remain around 1.5% in the near term, but rising to 2% by 2022. This gradual increase in consumer price inflation reflects the emerging capacity constraints in our economy, given the ever-tightening labour market and high terms of trade. These estimates track relatively consistently with the RBNZ’s consumer price inflation estimates in its latest monetary policy statement, albeit marginally lower than the RBNZ projections. This follows the usual trend of Treasury inflation estimates tracking slightly lower than the RBNZ’.

Growth is expected to lower unemployment and add to the capacity pressures in the economy; contributing to rising inflationary pressures and inflation forecasted to reach the middle of the monetary policy target band (2%). Given this expectation, interest rates are also projected to rise with the neutral nominal 90-day rate to reach 4.25% in June 2022.

What has the government not addressed?

The biggest question that needs to be asked of this Budget is whether it addresses New Zealand’s public infrastructure needs. This Budget addressed spending in some key areas such as Health, Education and Housing but Treasury’s 2014 and 2018 Investment Statements both highlighted that these assets, plus the Defence Estate, are old, in poor condition, and nearing the end of their useful economic lives.

The additional capital funding is likely to be welcomed across the sector, but it remains to be seen whether this spend will be sufficient to truly address the underlying concerns surrounding the bricks and mortar assets.