Drop deficits faster, IMF tells government

Drop deficits faster, IMF tells government

By Pattrick Smellie

May 27 (BusinessWire) - New Zealand has weathered the global financial crisis well, but needs to cut government spending and projected deficits faster than currently planned to give the country an adequate cushion, given the risks that the global economy will sour again, says the International Monetary Fund.

In its annual country review, published overnight, the IMF says part of the reason New Zealand was able to ride out the global financial crisis as well as it did was the accumulation of Budget surpluses prior to the 2008-09 recession. This allowed tax cuts and one-off new spending on infrastructure without threatening the country's relatively strong public debt position.

However, while net public debt to Gross Domestic Product is forecast to peak at below 30%, New Zealand's levels of foreign, mainly private debt remained very high by OECD standards, at a net 90% of GDP, with prospects of going above 100% of GDP.

The return to fiscal deficits until at least 2016 was also contributing to medium term over-valuation of the New Zealand dollar by between 10% and 25%, which in turn would slow the pace of export-led recovery.

The IMF also expects the impact of higher interest rates, expected later this year, to pass through quickly to household borrowers, because many people had refinanced their mortgages at variable interest rates.

House prices still appeared "over-valued," the IMF said. However, the medium trend for interest rates was likely to be lower than in the past because of the "rising wedge between the policy rate and bank funding costs."

The IMF says its advice to the New Zealand government that it cut government spending more quickly than is proposed had been rejected.

New Zealand "authorities decided that their planned pace of consolidation was appropriate," the IMF report says. It notes that "fiscal drag" is an explicit part of the government's fiscal consolidation plan, indicating that although personal income tax rates may be cut, there is no plan to change the incomes at which different rates take effect, even as incomes rise.

The IMF is also more pessimistic than the Treasury about the economic growth outlook, which it expects to settle at a long term sustainable rate of 2.3% a year. It stresses that New Zealand's strong public debt profile is offset by the weakness in its external position and low household savings rates, both of which drive a likely a return to unsustainably large balance of payments deficits.

"Assuming the exchange rate remains at present levels, (IMF) staff projects the current account deficit to widen to over 8% of GDP by 2015," the IMF report says. "The deficit may not widen as much if the present over-valuation of the real effective exchange rate proves to be temporary."

Nonetheless, New zealand would to be running a much lower than average current account deficit of 3% of GDP over the next 15 years to return to net foreign liabilities of 75% of GDP, last seen in 2001-03 before the recent rise in external and household debt.

The fact some 44% of the external debt in question has maturity dates of less than 12 months represents a "key vulnerability" for New Zealand, the IMF says.

Meanwhile, the OECD has issued its own brief survey of the New Zealand economy, making many of the same warnings as the IMF, and predicting that the economic recovery "may be weaker than in past recoveries...because of the overhang of private sector indebtedness, sticky unemployment and lingering uncertainty that may hold back investment."

"Though inflation remains subdued, long lags in monetary policy transmission call for the extreme policy stimulus to start to be withdrawn soon."

The IMF notes that the combined effect of tax cuts announced before the global financial crisis hit, and the infrastructure spending announced by the government to counter the crisis last year, New Zealand experienced one of the largest fiscal stimulus packages in the western world.

(BusinessWire)

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