Budget likely to fall short

By ULF SCHOEFISCH*

Budget 2000: Will the Government rise to the occasion?

The business community has given the Government a clear thumbs down over the past month, as illustrated by the drop in business confidence to a level last seen during the 1998 recession. Policy changes announced and implemented by the Labour-Alliance Coalition are seen as focusing mainly on wealth redistribution rather than wealth creation.

So far the Government has been busy undoing some of the key economic policies of the 1990s. It is now time for revealing in detail what policies are on offer for pushing the economy forward.

Thursday's Budget provides a major opportunity for demonstrating that there is a more business-friendly side to this Government.

The Coalition has had the good fortune of inheriting a well-running economy that has been producing higher-than-expected fiscal revenue. As a result, the operating surplus for this year is expected to be around $400 million higher than forecast by the National administration before the last election.

Downward revisions to the valuation of liabilities of the Government Superannuation Fund and the ACC tail will add further to the surplus estimate for the current fiscal year, leading to a figure of around $800 million.

Gradually rising surpluses are likely to be projected for the following years, reaching $2.5 billion by 2003. That corresponds to around 2.1 per cent of gross domestic product and will be presented by the Minister of Finance as proof of this Government's fiscal prudence.

Michael Cullen is likely to repeat his intention of using those surpluses for establishing a retirement fund that will assist in meeting future superannuation entitlements. Unfortunately, little extra information will emerge, given that Dr Cullen appears to have met some resistance to his plans from within the Coalition.

The rise in budget surpluses will be projected despite the Coalition's comprehensive new spending initiatives. Compared to the previous fiscal baseline, an extra $6 billion will be spent over the next three years.

Most will be spent on social policy, health and education. The key initiatives have already been well publicised or even been implemented. That includes the April increase in superannuation payments, the reduction in student loan costs, and the return to subsidised rents for state house tenants. Other small-scale initiatives have been announced by cabinet ministers during a pre-Budget campaign.

The significant extra expenditure and increasing fiscal surpluses can be reconciled through the assumption of strong revenue growth, driven by solid economic growth projections over coming years and boosted by the lift in the top marginal income tax rate. The Treasury's growth forecasts are likely to be more optimistic than those published in the previous update presented in March.

Following growth of 4.1 per cent over the past year, the official forecasts are likely to show only a modest slowdown to 3.6 per cent over the year to March 2001. Lower growth of between 2.5 per cent and 3.0 per cent is likely to be projected for the two final years of the forecast period, due to a continued tightening in monetary policy and less rapid growth of New Zealand's trading partners.

The sharp downturn in business confidence and activity indicators over the past month are likely to trigger an immediate debate about the credibility of the near-term growth projections, which are the backbone of the fiscal outlook.

The recent downturn in indicators of economic activity will also lead to a particular focus on the Government's business policy initiatives, which will be evaluated in the light of their ability to strengthen New Zealand's medium-term growth performance. Relatively little information has emerged regarding industry policy, apart from statements of broad goals such as doubling the state's investment in industry development, with a focus on exports.

The Budget is expected to contain an increase in funding for Trade NZ and details on additional venture capital initiatives. Announcements on tax simplification will primarily be relevant for small businesses.

In light of low business confidence, it is unfortunate that the Government seems to have changed its mind on two high-profile policy initiatives. The export guarantee scheme, supposed to help small exporters in particular, appears to be off the agenda, and the proposal for tax deductibility for R&D spending has also been rejected. Instead, Government support for R&D will be distributed via a grants scheme, which the business community considers a second-best solution.

It is advisable to retain a healthy scepticism about the likely impact of the Budget on business confidence. While some initiatives will be considered steps in the right direction, the agenda is likely to fall well short of what is required to convince the business community that the Government fully appreciates the economic challenges ahead.

* Ulf Schoefisch is chief economist of Deutsche Bank New Zealand.