Battling the slowdown: Find a balance in tending economy

Think of the economy as a twin-engine plane.

For several years one engine - the domestic economy, dominated by consumer spending - has been running unsustainably hot while the other, the export sector, has coughed and spluttered as it struggles with an overvalued dollar.

The June quarter gross domestic product figures released yesterday show signs of the long-anticipated - and necessary - "rebalancing" of the two engines.

Domestic demand is unambiguously weaker while exports show at least fragile and tentative signs of recovery.

The figures are likely to give Reserve Bank governor Alan Bollard some comfort.

The financial markets interpreted it that way, scaling back the odds of another interest rate hike and sending the kiwi dollar lower.

Rebalancing is needed because if domestic demand is too strong for too long it oustrips the economy's capacity to meet that demand. It does not deliver any more output and jobs, just higher prices and a blowout in imports, which we have to borrow to pay for.

It means the central bank has to push up interest rates to quench the excess demand, and that keeps the dollar high, hammering those parts of the economy which earn the country's living as a trading nation.

Three of the four kinds of spending which make up internal demand shrank during the June quarter: private consumption (down 0.4 per cent), business investment (down 5.6 per cent) and residential construction (down 7.2 per cent). Only Government spending made a positive contribution to growth.

The Reserve Bank is counting on the growth in consumer spending slowing to a standstill over the next year or two. So far so good?

Perhaps not, says Bank of New Zealand economist Craig Ebert. The quarter's weak result may have more to do with high petrol prices, which have since fallen, than a genuine stalling.

Overall the domestic economy contracted by 1.7 per cent in the June quarter. On an annual average basis it posted its the weakest growth for nearly five years.

And less of that enfeebled internal demand was met by imports. They fell 1.3 per cent in volume terms. Exports rose a healthy 4.7 per cent.

But there is a fly in the butter.

The surge in exports was heavily concentrated in the pastoral farming sector, with a 20 per cent rise in the volume of dairy products shipped (much of it a run-down in inventories) and a 13 per cent increase in meat accounting for over 90 per cent of the increase in exports.

Exports of manufactured goods and forest products, by contrast, fell.

Looking forward, the pastoral sector is of course hostage to the weather. And these figures will not show any impact from the bungy-like rebound in the exchange rate since the June quarter.

Overall the quarter's 0.5 per cent economic growth, following 0.8 per cent in the March quarter, represents a "respectable rebound" after the flat patch in the second half of 2005, says ANZ National Bank chief economist Cameron Bagrie.

But it does not mean the bottom of the economic cycle is behind us and growth is accelerating again.

Monetary conditions - interest rates and the exchange rate - are still restrictive. A lot of mortgage debt has yet to be rolled over into higher interest rates and corporate profits are under pressure.

The decline in business investment, when the economy still faces capacity bottlenecks and poor productivity, will not help its growth potential, Bagrie says.

The quarter's overall growth rate of 0.5 per cent masks a wide variation between different sectors. Agriculture and manufacturing between them account for two-fifths of that growth.

But Statistics New Zealand said the increase in manufacturing value-added was heavily concentrated in the food-processing sector, which includes dairy factories and meat works.

The Government sector accounted for a further fifth of the overall growth, and was up a hefty 11 per cent.

The utilities sector jumped 6 per cent, showing electricity generators could use more water, which nature provides free, and less natural gas, which they have to pay for, so boosting their value-added.

Among the sectors which declined in the quarter, construction stands out with 6.5 per cent fall in output. But fishing, forestry and mining, wholesale and retail trade and even transport and communications also went backwards.

While the June quarter GDP figures show a contraction in residential building, the forward-looking indicator of building consents tell a more encouraging story. Statistics New Zealand said building consents for August continued a rising trend evident since March.

First NZ Capital economist Jason Wong thinks the figures show the Reserve Bank has got it wrong.

"The data defy the bank's recent statement that domestic demand is slowing more gradually than expected," he says.

Domestic demand did not grow at all in the June quarter. In fact it shrank. "To be sure, inflation has been slower to fall this cycle than expected, but we think a period of weaker inflation pressures is ahead and the bank should certainly not be contemplating tightening."

The usual focus on GDP overlooks the fact that the population is growing and that a substantial chunk of what New Zealanders produce does not belong to them but to foreign suppliers of capital.

Arcus chief economist Rozanna Wozniak says population growth is exceeding growth in output and incomes.

While GDP, adjusted for inflation, was up 1.4 per cent on a year ago - the lowest for five years - in per capita terms it was only 0.4 per cent higher.

And when statisticians calculate real gross national income, taking account of the international investment income deficit and a fall in the buying power of NZ exports, the annual growth shrinks to 0.1 per cent, or minus 2 per cent per capita - the biggest fall since 1992.

"Suddenly the soft landing doesn't seem so soft." she says.