Molesworth & Featherston (Budget) – May 19th 2006

Direct Link To This Week's Weekend Update Edition:
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Budget 2006
Jam tomorrow but not today

The economic idea behind Michael Cullen’s seventh budget is that the downturn we’re in is a temporary and inevitable part of an economic cycle; and that the best response is to keep a steady hand.

The government has identified two major constraints on its ambition to ‘transform’ our economy: fast Internet and roads, and these were the only blockbusters in the document - even if the messenger brought one early.

This government’s idea of economic transformation is ‘continuous change and adaptation.’ In other words, lots of little policies rather than big bold brush steps.

As Dr Cullen put it, “This Government does not subscribe to the theory that economic transformation consists of a period of actual intense pain followed by often hypothetical gains. This is particularly so when, on past experience, the pain seems always to be concentrated on ordinary Kiwis on low and middle incomes and the gains are made by a few.”

As a result Treasury has lowered its growth forecasts to 1 percent in the year to March 2007 but heroically sees a rebound to 3 per cent and then 3.5 per cent in subsequent years. (By comparison, economic growth for our top 14 trading partners is forecast at 3.6% this year and 3.5% from then on.)

The operating surplus is expected to reach $8.5 billion in the current year, although with almost two months still to run that could yet change.

Next year’s forecast is for a $5.7 billion surplus, which will continue to fall in the following years leading to a cash deficit of between $1.4 billion and $2.2 billion in the outyears.

For the first time there is a major divergence between Treasury and IRD’s revenue numbers - ironic given the urging by Ulf Shoefisch in a recent paper on forecasting that the two work more closely together. IRD is more positive about business tax revenue than Treasury, and the tax gatherers actually do surveys of taxpayers so may well be right.

If IRD is right there could be between $1 billion and $2 billion more a year from 2007, which Dr Cullen has clearly signalled would give him more room to make real business tax cuts - not just changes that are fiscally neutral.

The transport package worth $1.3 billion is paid for by transferring capital on the sale of Meridian Energy’s Southern Hydro in Australia to Transit and the launch of a longer-dated government bond to be labeled an infrastructure bond.

The bond will raise $1 billion which will over-fund the committed cash by more than $500 million, leaving room for the spending on roads to be expanded even more than announced last night.

A major surprise was the lack of new public transport funding to meet the cries coming from Auckland and Wellington commuters and local government.

The Government has changed its long term debt target. It is expecting gross debt to reach 20 percent of GDP by 2010 (net debt will switch to net assets by about $1 billion this year) and it will then hold it at that level. It is the first time the Government has clearly set a prudent debt level and means that a steady increase in nominal borrowing is envisaged - by as much as $6 billion a year from 2010 - to hold debt steady at that proportion of the economy.

Unemployment is expected to rise to 4.7 per cent next year, a lift of almost one percentage point from the current level. Wages won't keep growing as fast as they have. Treasury expects average house prices to fall 5 percent before mid-2007. Business investment will fall over the coming twelve months but then recover as exports pick up. Agricultural exports will have a better year. The lower dollar will increase demand for our exports after a lag of a year.

The current account deficit will fall but only to a still-ugly six percent of GDP and there is little commentary on the scale of the deficit or suggestions about how the current account might one day be balanced. (Treasury says the cause of the deficit's growth in the last two years was weak export performance from the agricultural sector as a result of poor and a rapid increase in imports and increase, together with an increase in the investment income deficit. There’s no examination of why these factors persist nor why the exchange rate is not adjusting to balance them, though.)

Treasury says the major risk ahead is the terms of trade - the quantity of overseas products we are able to buy for a given bunch of our exports. We had a slightly better than normal terms of trade since the nineties but it’s now below the level Treasury forecast back in December.

Treasury thinks the terms of trade will continue to fall, although they should stay above historical levels, helped by growing demand from China for our stuff and strong economic conditions in our other major trading partners. “The effect of the fall in the terms of trade is to reduce incomes in the economy as a whole, not only in the export sector. Lower export incomes flow through to households and increasing import prices reduce households’ disposable income and lead to lower consumption growth than otherwise,” Treasury says.

The budget politics would never satisfy critics nor will its announcements cause voters to switch in any direction - it was never designed to do that. Labour’s political calculation is that political results will be delivered by sustained increases in economic performance resulting from its small scale changes and policy stability.

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Direct Link To This Week's Weekend Update Edition:
http://molesworthandfeatherston.info/pdf/MandF19May06L.pdf

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