Michael Cullen

6 October, 2008
The Treasury's Pre-election Economic and Fiscal Update 2008

Good afternoon everyone.

Thank you for coming to the release of the Treasury's latest set of forecasts for the New Zealand economy and Crown accounts.

When I spoke at the release of the Treasury's Half Year Economic and Fiscal Update report last December, I cautioned that New Zealanders were entering a period of economic uncertainty.

That view was confirmed in the Budget Economic and Fiscal Update in late May.

But what we thought we knew, even five short months ago, has been overtaken by events.

Let us be clear.

The dramatic scale and speed with which international financial markets have moved in recent weeks have been extraordinary.

When added to the significant swings in international share, land, and commodity prices over the past 18 months, the cumulative effect on the international and domestic economy, and on people's level of confidence and sense of security, has been profound.

The fallout from the United States' mortgage crisis in recent weeks in particular has expressed itself in genuine stress in global credit markets of a magnitude perhaps unprecedented in living memory.

In 2008 we New Zealanders have been reminded that we are a small, trading nation heavily reliant on overseas capital.

We have been reminded also that our well-being is intimately tied up with the health of the global economy.

We have been reminded of how sensitive the Crown's accounts are to changes in the economic environment.

But while New Zealand is susceptible to periodic externally-generated shocks on our economy and society, we are not powerless.

This government has since the first day it entered office worked hard to build-up the economy's productive capacity and to at the same time significantly strengthen the Crown's balance sheet.

We did so as a conscious choice to empower the nation in preparation for the inevitable future rainy day. That rainy day has arrived.

We entered this period of challenge from a position of strength and, provided that we, as a nation, keep our nerve and maintain prudent policies, we will pull through this unpleasant period in global economic history in a better shape than many other developed countries.

The bailout announcement by the Federal Government in Washington has delivered some relief in financial markets and will help to restore some needed confidence into international credit markets.

It is the largest Federal Government financial bailout in the history of the United States of America.

The consensus expectation among economists here at home is for growth to return to the economy in this current December Quarter and for a period of very modest growth next year before the economy gets back to somewhere closer to 3 per cent growth in calendar 2010.

But all of these forecasts are based on the premise of first restoring confidence to America's financial markets.

We have to be honest and acknowledge these uncertainties.

The raw numbers contained in these Treasury documents may be the best professional advice of the Treasury when the forecasts were finalised between 28 August and 17 September.

But the Treasury would be the first to admit that there are risks around the numbers because we cannot know how the most recent financial market volatility will practically effect real output - either here or abroad.

But while there is still uncertainty about the full and precise impact on the global economy that remains to flow through from the financial markets' woes, we do know with some clarity what the impact on our economy has been from these overseas developments since late 2007 and so far in 2008.

The first three quarters of 2008 were weaker in New Zealand than anticipated in May.

Skyrocketing global oil and food prices over the past eighteen months, together with the relentless upward march of international credit costs as the effects of the sub-prime mortgage fiasco spread, had their negative fallout on New Zealand's housing market, on our business confidence and on household budgets.

* Economic slowdowns translate into a relative increase in some government expenses, such as on welfare.
* Economic slowdowns translate into less-than-anticipated revenue for the Crown.
* Economic slowdowns have a cumulative effect on the Crown's balance sheet as debt-servicing costs rise on the back of rising debt.

Around two thirds of the decline in the OBEGAL Operating Balance over the forecast period is driven by a weaker economy and associated higher debt-servicing costs.

Around one-third of the explanation for the lower forecast period OBEGAL is due to higher-than-expected expenses.

As you can see from the slide, the majority of the explanation for the weakening OBEGAL directly flow from a weaker economy: tax revenue is down, benefit expenses are up and this has to be financed by taking on additional debt.

Tax revenue is forecast to be $3.1 billion less over the forecast period than had been anticipated back in May. As you can see, this is made up from:

* $1.3 billion less from Goods and Services Tax
* $1.4 billion less from corporate taxes
* $609 million less from Other Persons tax
* $328 million less from Other

Most of the higher expenses in the "changes in policy costs" category are due to the popularity of KiwiSaver and free early childhood education being much greater than had been forecast by officials in May.

KiwiSaver which has increased in cost by $650 million over the forecast period; Free early childhood education has had an increase in costs of over $800 million over the forecast period.

The better than expected progress in settling historic Treaty grievances over the last 12 months, has also had an impact.

I think many of the senior journalists and analysts in this room will remember well what it was like for me as the Finance Minister appearing before you in sunnier international economic conditions in recent years.

In recent years, I would appear here to answer your questions as to why we were experiencing the regular occurrence of the Crown's OBEGAL surpluses coming in significantly above the Treasury's earlier official set of forecasts and to answer your questions as to how come the Treasury's forecast cash deficits just a few short months earlier had evaporated to become cash surpluses.

The answer was that Crown accounts are very sensitive to what is happening in the real economy.

The remarkable period of economic growth kept on coming in above not only the Treasury's forecasts but, to be fair to the Treasury, they came in above what many private sector economists were forecasting as well.

In the fullness of time it may be that we will look back at the early 21st Century with a clearer view of the role that plentiful credit from emerging economies played in prolonging economic expansion in New Zealand and elsewhere.

But it is fair to say that the best brains in the Treasury and in the private sector were in recent years regularly surprised by how long and strong economic activity continued to be sustained.

From a political point of view that was not always comfortable.

With economists not quite sure why the economy kept over-performing, and why surpluses kept coming in above forecast, the Labour-led government's approach was to be cautious.

We utilised the good international economic times to halve Crown debt as a ratio to GDP, to substantially build-up the financial assets of the Crown and we also used a higher than normal share of operating income for capital investment.

These were all deliberately conservative measures to build up our strength for any future rainy day.

We worked hard over many years to significantly strengthen the Crown's balance sheet because we knew that any undue fiscal easing - be it in the form of much more generous tax cuts or more generous social spending - would be structural, that is to say it would be on-going in its effects as it would come out of baselines.

It is a very good thing for New Zealand that we adopted that prudent approach.

What it means today is that there is no need for us, reading the Treasury's latest set of forecasts, to today over-react with a knee-jerk cut-back in social services and critical infrastructure investment.

The Government's strong infrastructure investment programme is critical to assisting to raise our economy's productivity over time.

The Government's strong infrastructure investment programme is vital to assisting to progressively raising living standards in New Zealand over time.

The Government's ambitious infrastructure investment programme, which includes inter-linked components from investment in the skills of our people to building an integrated First World transport system, is an absolutely fundamental ingredient to raising our potential or non-inflationary growth rate over time.

And the Government's social spending in public health, education, in superannuation entitlements, early childhood and tertiary education, and in encouraging a stronger personal savings culture, these are all critical also to making New Zealand a fairer and happier society, as well as a more competitive place in terms of attracting and retaining labour.

So a very important message that comes out of today's Treasury release is that, thanks to the prudent approach we have taken in recent years, we will not have to descend into any slash and burn response to the current slowdown, as we have so often tragically done in our nation's history during previous economic downturns.

The Government's strong investment in skills, in training, in tertiary education, in roads and rail, in public transport and in security of energy supply - these are all critical to raising our economy's productivity over time and this investment is secure in the years ahead because of the prudent approach to fiscal management adopted since the start of the new century.

The government's social spending programmes in health and education, in maintaining the level of New Zealand Superannuation, in promoting the transformation of our personal savings culture - The funding for these programmes is secure because of the prudent approach to fiscal management adopted since the start of the new century.

I want to reassure every New Zealander that the advice the government has from the Reserve Bank and the Treasury is that the banking system of Australia and New Zealand is very strong.

The Reserve Bank of New Zealand is working closely with the Australian Reserve Bank in monitoring Australasian financial markets during these challenging times for international credit markets.

The New Zealand Treasury is in regular contact with their colleagues at the Australian Treasury.

While the developments of recent weeks in international financial markets have been perhaps unprecedented in living memory, there is no question that New Zealanders can feel a very high degree of confidence that New Zealand and Australia will emerge through these challenging times in better shape than many other developed nations.

Today's Treasury release makes it clear that the Government's strong investment programme is happening at an appropriate time of economic slowdown and that the government's investment and social programmes are secure over the next few years.

What is also clear, however, is that now is not the time for promises of any additional tax bonuses over and above what is already legislated for by Parliament.

And today's release also indicates that, once we get through this troubled period for the international economy, then the prudent and wise approach will be to utilise a strengthening economy to once again build-up the Crown balance sheet into a stronger position through fiscal restraint.

ENDS

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