IMF Concludes 2009 Article IV Consultation With New Zealand

by Mary Swire, Tax-News.com, Hong Kong

20 May 2009

In May 2009 the International Monetary Fund concluded an Article IV consultation with New Zealand. The fiscal position remains strong, but the outlook has weakened considerably and on balance, the IMF expects the economy to contract by about 2% in 2009.

After several years of strong growth, the New Zealand economy entered a recession in early 2008, triggered initially by the end of the housing boom and a severe drought, and later exacerbated by the global slowdown. Real GDP contracted throughout 2008. CPI inflation has eased since peaking in September 2008, driven by weak economic activity and a sharp decline in oil prices. The labour market remained relatively resilient, but also started to weaken in late 2008, with unemployment rising to 4.6%.

Monetary policy was loosened and the exchange rate depreciated significantly. The official cash rate (OCR) was cut by a total of 575 basis points since July 2008, to 2.5%. The inflation targeting regime has served New Zealand well providing a strong anchor for inflation expectations.

The fiscal position remained strong, but the outlook has weakened considerably. The budget balance is projected to reach a deficit of 1.5% of GDP in 2008/09 (July-June), compared to a surplus of 3% of GDP in 2007/08. The combined effect of the stimulus and the weaker outlook for commodity prices and growth is, however, resulting in a significant deterioration of the medium-term fiscal outlook. Given New Zealand’s considerable short-term external debt and large current account deficit, a rapid increase in public debt could lead to a higher country risk premium, which would reduce the benefits from the macroeconomic stimulus. Steps are already being taken to eliminate existing unfunded commitments and to stop the growth of employment in government administration.

The trade balance deteriorated, widening the current account deficit further to about 9% of GDP in 2008. Private capital inflows continued to finance the deficit, and net foreign liabilities increased to 94% of GDP.

The banks remain sound despite significant exposure to short-term external wholesale funding and vulnerability to a sharp increase in mortgage default rates.

The near-term outlook is weak, and the IMF expects the economy to contract by about 2% in 2009.

In its Executive Board Assessment the IMF noted the following:

The IMF 'commended the New Zealand authorities for their policy response, which will help support domestic demand in the short run and enhance financial stability. Moreover, the authorities’ strong track record of sound and transparent macroeconomic policies and structural reforms has allowed New Zealand to enter the downturn from a position of strength.'

' The authorities’ commitment to limit the increase in public debt, and to present in the upcoming 2009 budget a credible strategy to reduce the fiscal deficit over the medium term was welcomed. The authorities were encouraged to make contingency plans, given the unprecedented uncertainties in the global economic environment.'

'The significant easing of monetary policy since July 2008 has been appropriate. In light of the weak outlook for growth and inflation, further easing may be warranted, but cautiously. There has been a significant depreciation of the exchange rate but it is now broadly in line with fundamentals.'

'The financial sector has remained resilient in the global crisis, buttressed by prudent policies. The authorities were to be commended for monitoring the situation closely and taking timely measures to strengthen confidence and support bank access to funding. The IMF called for extreme stress tests for banks and increased bank capital if needed. The proposed prudential liquidity rules for the banking system should help reduce banks’ reliance on short-term external funding. The IMF welcomed the ongoing collaboration with the Australian authorities on banking supervision, regulation, and crisis preparedness.'

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