1.0 The Front Pages
“It’s the economy, stupid!”. The quote from Bill Clinton’s strategist James Carville in 1992 couldn’t be more appropriate as we look ahead to the election on 14 October. The rising cost of living is front and centre in the lead up to the election, with political parties campaigning on solutions for how they will save our economy in the next three years. Households remain deeply pessimistic about the economic landscape although the latest Westpac McDermott Miller Consumer Confidence Index rose by 5.4 points and the ANZ-Roy Morgan NZ Consumer Confidence index rose by one percentage point.
Cost of living dominates the election conversation
Household financial pressures remain high, with rising living costs and mortgage rates taking their toll. The Reserve Bank of New Zealand’s (RBNZ) interest rate hikes are having their intended effect, cooling the economy and bringing inflation down. Westpac expects an increasing number of households to windback their spending over the year ahead.
The election result, whichever way it goes, will provide a short-term boost for consumer confidence. However, the parties that form the next government will face a number of challenges in their first term. Inflation is expected to remain above the three percent upper bound of the target range until 2025, gross domestic product (GDP) growth is expected to slow, and unemployment is likely to increase above five percent by 2025.
The RBNZ kept the Official Cash Rate (OCR) at 5.5 percent in its August Monetary Policy Statement. The Bank noted that the current level of interest rates is having the desired effect of curbing spending and inflationary pressures. The RBNZ also said that the New Zealand economy is evolving as expected, with a slowdown in activity that is necessary to bring inflation back within target.
The RBNZ is forecasting inflation to fall to 3.9 percent in 2024, before returning to within the one to three percent target range at 2.2 percent in 2025, and two percent in 2026. However, it warned that “in the near term, there is a risk that activity and inflation measures do not slow as much as expected” and that “a prolonged period of subdued spending growth is still required to reduce inflationary pressures”.
The International Monetary Fund (IMF) concluded its 2023 Article IV Consultation with New Zealand and is more optimistic about New Zealand’s ability to fight inflation, expecting it to be just 2.6 percent in 2024. However, it was noted that New Zealand recovered faster from the pandemic induced economic slowdown than most other advanced economies. The return of economic activity, together with generous fiscal and monetary support, resulted in strong investment and consumption. This came, however, at the cost of overheating against capacity constraints, which was exacerbated by restrictions on labour movement due to border closures and disruptions in global supply chains. The IMF warned that if fiscal policy (government spending) does not consolidate as planned, and persistently high inflation and wage growth remain, it could compel the RBNZ to keep the OCR higher for longer. A not-so-subtle hint as we approach the election.
Increasing prices and lower tax income increases the budget deficit
Reducing government spending and returning to surplus are key priorities for the National and Act parties in the upcoming election. The Pre-election Economic and Fiscal Update (PREFU), released in early September, showed that the government’s operating balance before gains and losses (OBEGAL) deficit was $10 billion in the 2022/23 fiscal year. This is $3 billion larger than was expected at Budget 2023, predominantly due to weaker than expected tax revenue. These trends are expected to continue and even after taking into consideration the Government’s recently announced fiscal sustainability measures, higher expenses and other developments mean that, as we predicted in the Summer 2023 Birds Eye View, the OBEGAL return to surplus has once again been pushed out another year. This time to 2026/27.
GDP growth to remain below pre COVID-19 levels
The PREFU also provides the most recent outlook for the future of our economy. The Treasury remains optimistic, forecasting 3.1 percent GDP growth for 2023. Stats NZ’s June release of revised March 2023 GDP results showed that New Zealand did not have a technical recession. GDP grew by 0.9 percent over the quarter. The IMF and the RBNZ are more pessimistic than the Treasury about the economy’s short-term future. The IMF and the RBNZ forecast GDP growth of just 1.1 percent and 1.2 percent, respectively, in 2023. Looking longer-term, the Treasury is forecasting GDP growth to fall to 1.3 percent in 2024, before increasing to two percent in 2025 and 3.3 percent in 2026. The RBNZ also has growth returning above three percent in 2026 (3.2 percent). The IMF is less optimistic, not expecting GDP to grow by greater than three percent until at least 2028 at the earliest.
Unemployment expected to grow above five percent
The RBNZ’s efforts to bring down inflation by reducing aggregate demand and increasing the supply of labour seem to be having the intended effect. Labour shortages are easing as the economy slows down, and a record level of migration in the year to July 2023 has added to the workforce. The unemployment rate increased to 3.6 percent in the June 2023 quarter. SEEK (a jobs website) reported in late August that applications per job advertisement had risen by 11 percent and were at a record high, while job advertisement volumes had declined 26 percent year-on-year. This decrease was experienced across all regions except for Hawkes Bay, which was unchanged, and the West Coast, where job advertisements grew by one percent. The national decline was driven by the main centres, with advertisements in Canterbury falling six percent, Wellington five percent, and Auckland four percent. The June quarter increase in unemployment might be the beginning of a trend. The Treasury is forecasting that unemployment will increase to 4.8 percent by June 2024, while the RBNZ and the IMF are both expecting the unemployment rate to be at, or above, five percent. Longer-term, the Treasury has unemployment peaking at 5.4 percent in 2025 and the RBNZ at 5.3 percent. Unemployment will then remain around five percent in 2026 before beginning to fall back towards the long-term trend of four percent. However, this is not expected to be achieved until at least 2028.
The incoming government is in for a difficult start
Whoever wins the election on 14 October is going to face a difficult start to their term with a slowing economy and growing unemployment. The next Finance Minister will be hoping that the economy is showing signs of improvement by the next election in 2026. If not, it will provide ammunition for the opposition to demand change. All eyes are now on 14 October.
2.0 Special feature: Infrastructure
New Zealand’s current and future infrastructure needs are a major focus of the upcoming election as the country faces a significant infrastructure deficit. The delivery and regulatory oversight of infrastructure is a critical role for central and local government. It is important to ensure that infrastructure is planned, built, and maintained in a way that is cost effective, efficient, and sustainable. High quality and resilient infrastructure, that is fit-for-purpose, is a necessary condition for continuous economic and social development. Infrastructure related issues are some of the most important concerns for New Zealanders, as evidenced by the Ipsos New Zealand Issues Monitor which regularly features issues such as the price of housing, healthcare and hospitals, climate change, public transport, and education.
How much does New Zealand currently spend on infrastructure?
At the household level, New Zealand households spend around $13,500 (or 16 percent of their after-tax income) on infrastructure services annually. The largest shares are spent on private transport (55 percent), electricity (15 percent), and telecommunications (10 percent). Unsurprisingly, households in large cites spend the smallest share of income on infrastructure services while those in rural areas spend the most. This is because the costs of infrastructure delivery in cities are able to be spread out over a larger number of people.
The OECD’s indicators on government investment spending include expenditure on infrastructure related to transport, housing, schools, office buildings, and research and development. New Zealand performs relatively well on these indicators. In 2021, government investment as a share of GDP equalled 4.8 percent, the sixth highest in the OECD. Government investment as a share of total government expenditure was also comparatively high at 10.7 percent in 2021 (equal fifth place with Norway). The largest investments are made in education, transport, and telecommunications infrastructure. Over 60 percent of total investment in New Zealand is made by central government, much higher than in the average OECD country (42.6 percent).
Despite the relatively high level of government spending on infrastructure New Zealand faces a number of serious challenges related to the state of water infrastructure, public transport, the quality of roads, traffic congestion in major cities, and planning for the needs of the future, including population growth and climate change. Indicators on spending do not reveal much about the quality of infrastructure, or how efficiently the money is being used. The Global Infrastructure Hub rated the quality of New Zealand’s infrastructure at 76 (on a scale of zero to 100, where 100 is best), compared to an average of 84 for all high-income countries. In addition, research by the New Zealand Infrastructure Commission has found that New Zealand is among the least efficient high-income countries at delivering infrastructure, ranking among the bottom 10 percent. In other words, the quality of our infrastructure does not match the level of spending.
New Zealand’s infrastructure deficit is estimated to be $210 billion, a consequence of historical underinvestment and lack of long term planning. This means that $104 billion worth of roads, schools, and hospitals that should exist today do not. On top of that, an additional $106 billion is required to meet the needs of the future.
Investment in infrastructure needs to be managed more efficiently to maximise value
The gap between what the government spends on infrastructure and the outcomes of those investments suggests that there may be governance issues. The OECD defines infrastructure governance as “the policies, frameworks, norms, processes, and tools used by public bodies to plan, make decisions, implement, and monitor the entire life cycle of public infrastructure”. The OECD’s Infrastructure Governance Indicators (IGI) show that New Zealand performs poorly on all three pillars: long-term strategic vision; fiscal sustainability, affordability, and value for money; and efficient and effective public procurement.
The sub-pillars that New Zealand ranks the lowest on include alignment with strategic objectives and budget allocations, independent assessments of value for money, effective and efficient use of the procurement workforce, and strategic use of public procurement to achieve key policy objectives. Inefficiencies in public investment in infrastructure mean that only a fraction of investments translate into productive infrastructure. This limits long-term gains, for example the multiplier effect of spending and the development of economy-wide productive capacity.
The widespread damage caused by weather events this year is a stark reminder of the urgency of planning for a climate-resilient infrastructure stock. One in seven people across the country live in areas prone to flooding, representing over $100 billion worth of residential buildings. The number of people vulnerable to the impacts of severe weather events will only continue to grow. The IGI on delivering environmentally sustainable and climate-resilient infrastructure again shows that New Zealand has one of the lowest scores in the OECD. New Zealand ranked fourth from the bottom on the composite indicator, behind comparable countries such as the United Kingdom (UK), Canada, and Ireland, and significantly lower than the OECD average.
How can we ensure better outcomes?
Designing and delivering projects that will meet the demands and conditions of the future requires a long-term perspective, and systems level thinking that needs to consider the interconnected and wide ranging nature of these issues. For example, New Zealand’s population is expected to increase by more than a million people over the next 20 years. Much of this growth will be concentrated in large population centres that already face serious infrastructure challenges such as traffic congestion and lack of quality housing. This means taking a proactive approach to planning for the infrastructure needs of a larger and more densely packed population, including public transport, roads, water and waste infrastructure, and affordable and quality housing for all.
The impacts of a changing climate must also be factored into decisions. The National Adaptation Plan (NAP) lists a number of critical actions to increase the resilience of homes, buildings, and places over the coming years. Some of these include plans to embed adaptation into funding models for housing and urban development, to reduce and manage the impacts of climate hazards on homes and buildings. Initial work on these actions is set to begin in 2024. However, the onus for adaptation in the case of homes and buildings is placed on the private sector. The Climate Change Commission will provide the first progress report on the implementation, progress, and effectiveness of the NAP in August 2024.
New Zealand’s Infrastructure Strategy lists five components that must be considered to deliver better infrastructure:
- Good decision-making: Prioritising projects that maximise well-being for all New Zealanders. This includes thinking about the right policy, regulations, institutions, governance, and ownership structures
- Funding and financing: Funding and financing structures should be project-specific and be effectively spread out over time. How costs are distributed is also important, as there are implications for equity, including intergenerational equity
- Enabling planning framework: The planning and consenting systems of today must be appropriately designed to enable the delivery of projects that meet the needs of the future
- Technology: Encouraging greater use of technology across the sector can help improve productivity, skill levels, and wages across the sector. It can also enable better planning and decision making
- Capable workforce: A credible and stable infrastructure pipeline is an important signal that can provide industry with the confidence to invest in the skills to improve delivery. This is essential if we are to compete with other countries for labour.
Meeting the country’s current and future infrastructure needs is a challenge that requires a collaborative approach from both the public and private sectors. Many countries have struggled to find innovative ways to finance solutions to this problem. This is particularly difficult in New Zealand, where much of our available capital is tied up in housing. This means that projects and programmes that might provide long-term results are starved of the resources that they need to make a real difference. The Infrastructure Strategy points to six core principles for infrastructure funding and financing. These include designing mechanisms where those who benefit pay, whole-of-life costing in funding requirements, the minimisation of administrative costs for providers and users, and ensuring intergenerational equity by making sure financing arrangements reflect the period over which assets deliver services.
Infrastructure planning and decision making is complex and requires a focus on the needs of the future. Additionally, more often than not, difficult trade-offs must be made. Infrastructure projects are expensive and have multigenerational life cycles. Coordination between central government, local government, and the private sector is key to ensuring we get the best value for our infrastructure spend. Through engagement with the community, local government understands the needs of the populations they serve. Therefore, they have the capacity to be more responsive and to offer tailored solutions. The strengths of central government lie in being able to develop consistent and robust regulatory frameworks, and in providing access to the level of resources required for large projects. The private sector offers efficiency, innovative solutions, and competition that can deliver cost savings.
Challenges are compounded by our current political system, which encourages a short-term focus. Reforms vital to a country’s financing needs and well-being must be determined objectively and be able to withstand a change in government. The Infrastructure Pipeline developed by the Infrastructure Commission is a step in the right direction. It brings together data and information from sector participants on major projects across sectors and regions that have been committed to over the next five years.
The era of historically low interest rates is over, fiscal deficits are running high, and governments’ capacity for borrowing is limited. At the same time, growing infrastructure issues cannot be ignored. Strengthening the efficiency of how infrastructure spending is managed and delivered will be the key to maximising the value of this spend.
3.0 BERL forecasts
Despite the better-than-expected GDP growth this quarter (0.9 percent), we anticipate a long, slow road to recovery. Economic activity is expected to remain muted over the next year, weighed down by the RBNZ’s persistent rate hikes. The impacts of the aggressive monetary tightening undertaken by the RBNZ, to bring inflation back within its target range of between one and three percent, are now visible in most sectors of the economy. Activity has mellowed in the service, good-producing, and primary sectors. The Performance of Services Index (PSI) and the Performance of Manufacturing Index (PMI) have both been in contractionary territory as new orders/business and activity/sales have fallen for firms in these sectors. Debt servicing costs as a share of income are increasing, and household appetite for spending is low. Retail sales volumes are trending downwards. Given that interest rates are expected to remain at their currently elevated levels over the next few years, we expect GDP growth to remain muted. Any gains over the next year will be largely driven by population growth. The IMF expects GDP growth in advanced economies to remain around 1.5 percent through to 2024. In a high interest environment, we expect low investment and consumption expenditure from the public and private sectors throughout 2024 and 2025. Moreover, weak economic conditions in our key trading partners will also have an impact on New Zealand’s growth prospects.
Inflation has peaked and is starting to ease, albeit slower than the RBNZ would like. However, there are still some risks on the horizon. After falling for most of 2023, oil prices are on the rise again, threatening to erase the gains made so far in terms of slowing inflation. Food price inflation is also proving to be stubborn. On the flip side, wage growth seems to be slowing down, eliminating the risk of a wage-price spiral. Inflation is expected to remain above target levels through 2024, according to our forecasts. We expect inflation to ease to the RBNZ’s target rate of two percent only in 2026. Thus, we anticipate that the current economic environment of low growth, combined with high inflation, will persist over the medium term.
Growth in FTE employment has been exceptionally strong over the past year, mainly driven by large net migration gains. The labour market is expected to gradually lose steam as demand for goods and services falls. Moreover, it is unlikely that current levels of migration will be sustained over the coming years. We expect FTE growth to be slower than usual over the next two years as unemployment rises, before ticking up again in 2026 as conditions begin to normalise.
The buoyant labour market has, so far, provided resilience to the domestic economy. However, there are clear signs that this period of historically low unemployment is coming to an end. Unemployment usually increases with a lag as employers reduce new hiring, and then make workforce cuts if economic conditions continue to deteriorate. Unemployment has already started to rise, and we expect it to peak at around five percent by 2025 as the RBNZ keeps interest rates at elevated levels. We also see unemployment remaining at around five percent through to 2026, in line with RBNZ and Treasury forecasts.
The recent surge in net migration has been a consequence of the international borders reopening to new workers after a long closure in an exceptionally tight labour market. Over the past year, net migration has climbed to levels not seen before. In the year to July 2023, the net migration gain was estimated to be 96,200 people. Net migration was around 50,000 people per year pre-pandemic, and we see it returning to these levels as demand for workers dissipates.
Growth in exports, which has largely been driven by high international prices for commodities, will come off recent highs. Low economic growth in key trading partners, such as China and the EU, does not bode well for New Zealand’s export market as demand for our goods and services will drop. Export growth is already starting to slow down as commodity prices return to pre-pandemic levels. As global inflation slows, export growth will depend more heavily on growth in volumes rather than being value-driven. Import growth is also expected to slow down as domestic demand, particularly for goods, is falling with households tightening their belts. There are risks to the upside as oil prices could spike again with oil producers Saudi Arabia and Russia reducing oil supply.
The focus of the next government will be to bring OBEGAL into the green. A sluggish economy will not help to meet this objective as the tax take from individuals and businesses falls. The Treasury only expects OBEGAL to return to surplus in the 2026/27 fiscal year.
|FTE employment growth||2||6.8||1.2||1.5||2.2|
|Unemployment rate (% of labour force)||3.3||3.6||4.7||5||4.9|
|OBEGAL ($ billions)||-9.7||-10||-11.8||-7.2||-4|
All % growth rates are annual June years.
We have simplified the contents of our forecast data tables, to focus on a selection of key variables. If you would like to obtain forecasts of other variables not shown, please email firstname.lastname@example.org or phone +64 21 868 190.