Changyong Rhee: Strong links with Asia lift NZ prospects

The main external risk for New Zealand remains a sharper-than-expected slowdown in growth in China. Photo / AP

The outlook for New Zealand's economy and the region is positive, says IMF director Changyong Rhee.

New Zealand is well positioned to capitalise on the largely favourable global trends and enjoy steady growth in 2014-15, buoyed by its strong links with fast growing Asia that absorbs about two-thirds of its exports. Strong Asian demand for dairy products reflecting the preference of the growing middle class for higher quality food products has led to high global dairy prices and this has boosted incomes in New Zealand and supported domestic demand.

Our latest Regional Economic Outlook sets out a number of positives on Asian prospects which is good news for New Zealand. The region should remain resilient to global risks especially as recent policy actions taken to address vulnerabilities have started to bear fruit.

Our analysis also suggests that global activity is picking up in the United States and the euro area, thanks to a reduction in fiscal tightening and still accommodative monetary conditions. While some large emerging market economies have been slowing, overall growth in emerging markets has picked up. Stock markets across most of the globe have reflected those trends and many have reached all-time highs.

The largest economies in the region are also doing relatively well. In China, the unveiling of the government's reform agenda has boosted sentiment, and growth should moderate only slightly to 7.5 per cent this year. Meanwhile, in Japan Abenomics is lifting confidence and inflation, and growth there should remain above trend at 1.4 per cent this year. The overall outlook for Asia is one of steady, robust growth of about 5.5 per cent in 2014-15. No longer as stellar as a few years ago, but still a very positive backdrop for New Zealand.

This outlook assumes that risk factors remain dormant. An unexpected tightening of global liquidity would affect the region. Domestic vulnerabilities could magnify the impact: as interest rates rise, vulnerabilities stemming from pockets of high corporate leverage and household indebtedness would come to the fore.

In addition, economies with weaker fundamentals would be hard hit. Asia is also facing various risks from within the region. These include a sharper-than-envisaged slowdown and financial vulnerabilities in China, a waning impact of Abenomics, and political uncertainty. Decisive progress on structural reforms is critical.

The agenda varies across the region, involving vigorous implementation of the government's reform blueprint to put growth on a more sustainable path in China; further product and labour market reforms to prevent deflation and low growth from returning in Japan; deregulation, boosting infrastructure and continuing to promote trade and financial integration in many emerging and developing economies.

In New Zealand, growth prospects have improved for the near term as business and consumer confidence is strong and commodity prices for key exports remain high. The economic expansion is increasingly embedded and broad-based, and growth is forecast to increase to about 3 per cent this year. The drivers include supportive financial conditions, high commodity prices, construction activity related to the Canterbury rebuild and general housing shortages, and a substantial increase in net immigration.

With excess capacity largely exhausted, pressures on core inflation will rise and the Reserve Bank of New Zealand has already begun tightening monetary policy. The government's priority to return to budget surplus has an important role by making room for increases in private sector and earthquake-related reconstruction spending, and thereby allowing for lower interest rates than would otherwise be the case and reducing pressure on the exchange rate. Deficit reduction also will create fiscal space to cope with future economic shocks.

The main external risk for New Zealand remains a sharper-than-expected slowdown in growth in China, compounded by indirect effects on its other trading partners. Financial contagion from negative developments in the rest of the world is also a possibility. Domestically, rapid house price inflation remains a concern. However, steps to help alleviate supply bottlenecks, imposition of measures to tighten mortgage lending, and an increase in mortgage rates should help ease price pressures. Finally, the authorities' macroeconomic framework remains sound and provides policy space to respond to adverse shocks and the flexible exchange rate continues to serve as an important buffer.

Changyong Rhee is director of the International Monetary Fund's Asia and Pacific Department.