Anoop SIngh: Asia's strength lifts NZ economy

Asian markets and Australia's robust economy have helped New Zealand. Photo / Sarah Ivey

New Zealand has benefited as Asia has entered the second year of the global economic expansion still firmly in the lead of the global recovery.

Growth in the first half of this year proceeded well above trend in almost all regional economies, as global manufacturing continued to rebound, fuelling exports and investment.

Private consumption remained strong, as labour conditions continued to improve and confidence remained high despite higher market volatility as a result of global financial turbulence.

Strong demand from fast-growing Asian markets and the robust Australian economy helped New Zealand ride out the global crisis better than most.

During the second half of the year, economic activity in Asia has moderated towards a more sustainable pace, although it remains robust.

Retail sales growth has slowed across Asia, and industrial production and exports have started to moderate.

The moderation in part reflects the maturing of the global and regional inventory cycle, particularly for information technology products that are important for production and exports in many Asian economies.

SHORT-TERM OUTLOOK

The short-term outlook for Asia remains positive, with growth expected to continue moderating to more sustainable levels while remaining relatively strong.

The continuing, albeit sluggish, recovery in advanced economies during 2010-11 should support growth in Asia's exports although below the rates last year and early next year.

A gradual pace of withdrawal of policy stimulus, sustained improvements in labour market conditions and still accommodative financial conditions are expected to sustain private domestic demand.

Ample global liquidity, relatively robust regional growth and low public debt in Asia should continue to fuel capital flows.

Reflecting the slowing of export growth and strong domestic demand, Asia's current account surplus is projected to decrease modestly as a share of regional GDP to around 3 per cent this year and next.

The recovery in New Zealand is expected to continue, led by higher export commodity prices, although the outlook has weakened because of the earthquake, soft demand for credit and a slowing housing market.

Strong growth in Asia, especially Australia and China, will support demand for New Zealand exports and the New Zealand economy is projected by the IMF to grow by about 3 per cent this year and next.

Underlying inflation is expected to be within the target range of 1 to 3 per cent. However, headline inflation is forecast at above the target range in 2010-11 because of one-off measures such as increases in GST and levies on fuel and electricity prices.

The current account deficit is projected to widen to about 4 per cent of GDP next year as the income deficit is expected to worsen as interest rates and profits rise.

RISKS IN THE OUTLOOK

The main risks to the outlook for Asia and New Zealand stem from the external environment.

Underlying sovereign and banking vulnerabilities in advanced economies remain, and concerns linger over the global recovery.

Despite strong economic and policy fundamentals, important trade and financial linkages with advanced economies suggest a further deterioration in global financial conditions and a slowing of the global recovery would have important repercussions for the region.

A weaker than expected recovery of final demand in advanced economies and more volatile capital inflows could hurt private domestic demand by lowering consumer and business confidence and increasing the cost of capital.

Demand for New Zealand commodities could decline, impacting on commodity prices, and renewed turmoil in world capital markets could put pressure on New Zealand banks.

EXIT FROM POLICY STIMULUS

In view of the strong economic expansion under way, and emerging signs of inflationary pressure, the time has come to normalise policy stances across the region. New Zealand has taken steps with monetary policy. But many countries are still highly accommodative. With output gaps closing rapidly, inflation pressures could intensify next year.

In New Zealand, given that the output gap is not expected to close for some time, the RBNZ should return to a neutral stance gradually once the recovery is well established. For fiscal policy, faster than planned consolidation in New Zealand would relieve pressure on monetary policy and thereby the exchange rate, and limit the increase in the current account deficit.

Faster consolidation would create fiscal space to deal with future shocks, and reduce the likelihood of an increase in the risk premium related to New Zealand's high external debt.

MEDIUM-TERM CHALLENGES

Sustaining robust growth in Asia will require continued progress with rebalancing growth towards domestic demand. This year current account surpluses as a per cent of GDP in Emerging Asia have narrowed, although modestly.

With external demand from advanced economies unlikely to quickly return to pre-crisis trends, Asia will need stronger domestic demand to ensure robust growth.

Measures to reinforce private domestic consumption and investment will be needed.

For New Zealand high external debt remains a key vulnerability. Low household saving is a fundamental factor behind large current account deficits and rising external debt in recent years. Thus New Zealand needs to increase national saving over the medium term.

With this aim, the Government introduced several tax reforms to shift the tax burden from income to consumption to encourage saving. Vulnerabilities related to high external debt would also be reduced by reforms to raise productivity and labour force participation, thereby lifting export capacity.

Anoop Singh is director of the Asia and Pacific Department of the International Monetary Fund.