First View - The “No Frills” Budget Must Balance A Massive Rebuild And Weaker Revenue

• The Kiwi economy is softening, and that means less inflation. Inflation expectations have fallen back, and are more inline with the RBNZ target mandate. Expectations of inflation should fall further.
• The Government’s “no frills” budget must tackle a massive cyclone rebuild, as tax revenues weaken, without new taxes (as promised). There will have to be a redirection of spending and a lift in debt.
• Finance Minister Grant Robertson has already announced $4bn in “savings” and reshuffling to reprioritise the Government’s spending. The focus will be on the rebuild and the cost-of-living crisis.

Here’s our take on current events

The Government will deliver the 2023 Budget on Thursday. It’s been labelled the “no frills” budget, implying restraint, no new taxes (or cyclone levy), and a lot of reshuffling. In order to pay for cyclone damage, the Government must divert monies from elsewhere and increase debt. At the same time, the Government wants to help out with the cost-of-living crisis. That too, will come at a cost.

The Treasury’s revised economic outlook is expected to provide a sobering read. For one, the Treasury goes back to the drawing board with a much weaker starting point. There was a telling release from the Treasury last week. And it went without much notice. Government revenues are failing to reach forecasts. Because the economy is simply weaker than expected. According to the Treasury, the Government’s coffers are not as heavy as they should be. In the nine months ended March 2023, tax revenue was $2.3bn short of forecast. And the forecast came from the HYEFU in December 2022 (not that long ago). It seems corporates have overestimated their revenues, with tax receipts $0.9bn below estimate. That’s not a good sign. And perhaps more importantly, GST receipts are also shy of estimates. The recent slowing in tax revenues point to an economy that is shifting, quickly. Corporate concerns have shifted from supply constraints (with labour hard to find) to demand concerns. Revenue growth is slowing, and the outlook is worsening. It’s the shortfall of GST receipts that has us sitting up and paying attention. “GST revenue ($0.8 billion) was also below forecast which indicates that the economy is tracking weaker than forecast.” Partially offsetting some of this bad news, was an underspend across “a number of government agencies.” That’s not good news either. Delays were a big part.

Given what we know, and what we’ve seen in recent data, Treasury must incorporate weaker economic activity and Government revenues throughout their projections. The RBNZ’s abrasive monetary tightening is working. In the HYEFU, a cumulative 0.8% three-quarter contraction was pencilled in. We’d expect to see that rubbed out and a deeper contraction drawn instead. Weaker economic activity means a lower tax take. Although, inflation will help to prop up tax revenue. Nonetheless, the return of the Crown’s operating balance to surplus will likely be pushed out as a consequence.

Not only are high interest rates constraining the economy, they’re lifting the interest the Government must pay on its debt. The weaker economy not only means revenue projections must be cut, but (forecast) higher unemployment will cost the taxpayer. And all of this comes at a time of significant expense. The Government must step in to help clean up and rebuild from atmospheric rivers of rain and a nasty cyclone. Guesstimates range from $9 to $15bn, and climbing. And the Government will be required to fund about half – the rest is insured.

In terms of the Government’s shopping list, Finance Minister Grant Robertson has already indicated that resources will be directed toward: addressing cost-of-living pressures, the continuation of key services, recovery and resilience, and lastly, fiscal sustainability. However, any lift to operating/capital allowances looked to be capped by the $4bn of savings. In a pre-Budget speech, Robertson announced that Budget 2023 will include $4bn of savings over the four-year forecast horizon due to reprioritisation of spending. How exactly that number was found will be revealed on Thursday.

For markets, changes to the debt programme will be of keen interest. The delay in the return to surplus, a smaller expected tax take, and the additional cyclone-related spending means Government debt will likely rise. And more debt means more issuance. A lift in the debt programme is expected. Markets traders will be on the lookout for any “warnings” from the major ratings agencies (S&P). New Zealand has a hefty current account deficit, a massive rebuilding task, rising interest costs and a weaker outlook.

The good news, however, is the decline in inflation.

Charts of the week: Moving in the right direction.

Last week, the RBNZ released the latest round of inflation expectations and near-term measures fell materially. The critical 2-year ahead measure dropped 51bp to 2.79%. For the first time since December 2021, the 2-year ahead print is back within the RBNZ’s 1-3% target band. The 1-year ahead recorded a deeper plunge, down 83bp to 4.28%. That’s the largest drop recorded since June 2020. It’s no surprise to see the downshift in expectations. The survey follows the drop in annual headline CPI inflation to 6.7% from 7.2%. It’s further evidence confirming that Kiwi inflation has indeed peaked. And as inflation continues to decelerate, expectations too should fall back to target.

The one blemish of the report was the little movement in longer-term expectations. The 5-year ahead fell just 1bp and remains elevated at 2.35%. While the 10-year ahead measure went the other way and lifted 9bp to 2.28%. The lift is indicative of more expected persistence in price pressure. The RBNZ’s assertive action is no doubt cooling expectations. The RBNZ has gained significant traction in its rate hikes to date. And we believe the RBNZ has done enough already to tame the inflation beast. That said, we expect the RBNZ to stick to their predetermined path, and we expect another 25bp hike to 5.5% next week. And that should be the last.

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