Tight Budget May Do Some of RBNZ's Work, Says HSBC

Sailing a course between supporting a quake-stricken economy and concerns about sovereign rating was always going to be tough. Today's budget manoeuvres through those obstacles well, with a more expansionary fiscal stance in 2011 and tightening delayed a year due to the quake, but plans to return a surplus a year earlier than previously (by 2014/15) and to keep net debt under 30% of GDP. These goals are reached by reallocation of spending priorities and asset sales. We still expect the RBNZ to hike rates before year-end, though the tight budget is a downside risk to hikes later in the horizon.

Facts

- The government projects the budget balances to be -$NZ16.7b (-8.4% of GDP) in 2010/11, -$NZ9.7b (-4.7% of GDP) in 2012/13. The budget is expected to return to surplus by 2014/15 of +$NZ1.3b (0.5% of GDP).

- Net crown debt is expected to peak at 29.6% of GDP in 2014/15 and to fall thereafter.

- The government is forecasting GDP to grow by 1.0% in 2010/11, 1.8% in 2011/12, 4.0% in 2012/13.

- CPI inflation is expected to be 4.5% in 2010/11, 3.1% in 2011/12 and 2.4% in 2012/13.

- The unemployment rate is expected to fall to 4.8% by 2012/13 and 4.6% by 2014/15.

Implications

The enormity of the effect of the Canterbury earthquakes on New Zealand was always expected to have a large impact on the government's fiscal position. Government estimates suggest that GDP is expected to be 1.5% lower in 2011 as a result of the quakes and the working assumption is that the government will spend $NZ15 billion (8% of GDP) to repair Canterbury.

At the same time the government also faced the threat of a sovereign downgrade, given concerns about rising government debt levels and New Zealand's foreign borrowing requirement.

A combination of asset sales - of energy generation companies and some of the government's Air New Zealand holding – and redirection of spending priorities have allowed the government to pull forward its plans of getting to a budget surplus by one year, to 2014/15, and keep net government debt to under 30%, with plans to get net debt back down under 20% of GDP by the 2020s.

In the short run the government is expecting to support the economy significantly more than previously planned, as a result of the quake, but in the medium-term the unwind of the government's deficits is fairly aggressive. The quake has seen the budget deficit for the current year blowout from an estimated 5.5% of GDP to 8.4% of GDP, reflecting a weaker economy on the revenue side and spending by the government to support the quake stricken parts of the economy. This will be unwound with significant fiscal contractions planned for 2013 and 2014.

The government is forecasting the economy to grow by 1.0% in 2010/11, 1.8% in 2011/12 and 4.0% in 2012/13, which we view as adequately conservative given our forecasts are for stronger growth over each of the forecast years: 1.2%, 2.5% and 4.3%.

Bottom line

Reprioritising of spending and asset sales have helped to keep the planned peak in net debt under 30% which is a clear positive for the sovereign outlook. S&P have left the ratings unchanged subsequent to the budget release.

The planned rapid tightening of the fiscal position in the out years may help do some of the RBNZ's work for it next year.

However, we still think that given the outlook for the economy, the current emergency settings of the cash rate will begin to be removed from Q4 this year.

ENDS

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