"Defeat, or victory?" asks BERL

Business and Economic
Research Limited
MEDIA RELEASE
FRIDAY 08 SEPTEMBER 2000

"Defeat, or victory?" asks BERL

"Will we - again - snatch defeat from the jaws of victory?" asks independent economic forecasters BERL.

Having correctly predicted early last year that the NZ$ was set to fall significantly, BERL today warned of the consequences of any reversal over the near future.

Critical to the future outlook for the NZ economy, BERL argues, will be whether the NZ$ remains at its current competitive level for long enough to send the signal that investment in NZ industry will indeed be profitable again. Or, will the Kiwi re-appreciate in a re-run of the 1985, 1988, 1994/95 and late-1998 periods?

"The lower level of the Kiwi must be understood to be the medicine required to re-balance an unbalanced economy. These past periods have seen market players, commentators and/or policy-makers 'talk-up' the currency, as well as 'prop-up' the currency with higher interest rates. A repeat of any of those episodes will, as certain as night follows day, see NZ being forced to swallow even fouler-tasting medicine in future years", warned BERL Forecasts Editor Dr Ganesh Nana.

In releasing their latest quarterly assessment of the NZ economy, the researchers point to the damage caused by previous cycles in the value of the NZ$ over the past 15 years.

"In particular, despite the recent stimulus from the low NZ$, there is little sign of any 'import-replacement' activities re-emerging," noted Dr Nana.
"Past cycles and experience of re-appreciating exchange rates, and the near-certainty of highly volatile import prices to compete against, have sapped any business or industry desire to invest in NZ productive activity. As a consequence, the NZ economy continues to satisfy its ever-hungry appetite for an expanding range of goods from abroad - whether we can afford them, or not", explained Dr Nana.

BERL points to impressive export growth over the past year and expects this to continue, as a result of strong world demand and a competitive exchange rate. Nevertheless, continued import growth sees the balance of payments deficit stuck in the $7bn to $8bn region for the next three years.

BERL argues that significant improvement in the external deficit will need a long time to emerge. It will be helped immeasurably if - in contrast to recent experience - market players, commentators, and policy-makers indicate acceptance of the Kiwi continuing at its present competitive level. If this were to be convincingly signalled, then investment in NZ business and industry may accelerate and 'import-replacement' activities may re-emerge.

In the short term, BERL notes the economy as having stalled in the June and September quarters but expects quarterly growth averaging 0.5% to resume thereafter, based on solid export growth and modest household spending. Consumer price inflation is expected to peak near 2.7% in the December quarter.
Recent falls in unemployment numbers are expected to continue, but are overshadowed by a burgeoning migration net outflow which is forecast to reach 20,000 in the year to June 2002. It should not be forgotten that this also means a loss of skills and, hence, productive capacity.

"A worst-case scenario would arise if the authorities respond, as in the past, as though these capacity constraints are a reflection of inflationary pressures. Wage increases arising from (or, to alleviate) skill shortages are not a valid reason for higher interest rates. The Reserve Bank MUST distinguish between demand-induced inflation and a capacity-constrained economy. If they - again - respond to capacity constraints by increasing interest rates, they will - again - aggravate the skill and capacity shortages and NZ will continue its downward path", concluded Dr Nana.

Summary sheet (page 3) from September 2000 BERL Forecasts attached.

For further details and/or comment contact : Dr Ganesh Nana
Senior Economist
Editor, BERL Forecasts
email: ganesh.nana@berl.co.nz

THE PICTURE

September 2000
Will we, again, snatch defeat from the jaws of victory?

The critical question in assessing the prospects for the NZ economy is whether the NZ$ remains at a competitive level long enough to send the signal that investment in NZ industry will indeed be profitable again?
Or, will the Kiwi re-appreciate in a re-run of 1985, 1988, 1994/95 and late-1998?

Our expectation is that the rate will not go up in the foreseeable future for the simple reason that the balance of payments is forecast to remain heavily in deficit.

Given growth prospects elsewhere, NZ is clearly not an attractive destination for funds. We cannot see any reason for that situation to change in the near future. Hence, we expect the NZ$ to remain near US$0.44 and AU$0.75 in the short term.

As previously forecast we expect economic growth to have stalled during the June and September 2000 quarters, with quarterly growth of 0.5% resuming thereafter.

A solid export-led basis to growth is being established and is expected to continue. Export volumes are forecast to rise 8.4% in the March 2001 year contingent on the maintenance of a competitive exchange rate.
Growth in household spending in contrast, is expected to slow to under 2% in real terms over the forecast horizon.

A continued net migration outflow is forecast, with the exodus reaching 20,000 in the year to June 2002. The impact is to restrain the expansion of people-service industries, as well as contributing to a subdued outlook for house construction and house prices.

Reduced unemployment is also likely to result from this migration outflow. It should not be forgotten, though, that it also means a loss of skills which lowers productive capacity. A worst-case scenario would arise if the authorities responded to such capacity constraints as a reflection of inflationary pressures.

The absence of import-substitution industries sees stubbornly high import growth continuing and the balance of payments current account deficit stuck in the $7bn to $8bn region over the forecast horizon - representing 6.4% of GDP in the June 2003 year, down from an expected 7.9% in the year to June 2000.

ENDS

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