IMF: Savings the key if NZ is to join Asian bounce back

Faster-than-expected reconstruction in Canterbury could create bottlenecks and boost inflation. Photo / Simon Baker

Opinion

In Asia as a whole, the recovery has matured as both exports and domestic demand have fuelled rapid economic growth, which reached 8.25 per cent last year.

Exports have benefited from an upturn in the global investment cycle as well as strong demand from emerging economies in Asia as well as other regions.

Domestic demand has also been robust, reflecting expansionary fiscal policies as well as growing private investment and consumption.

Investment is being driven by the need in many Asian countries to overcome capacity constraints and to build infrastructure, while consumption is being propelled by rising employment, wages, and productivity.

New Zealand has benefited from increasing ties with fast-growing Asian countries such as China, but its pace of recovery has weakened considerably since mid-2010.

New Zealand's muted recovery reflects soft domestic demand as cautious households and businesses look to strengthen their balance sheets by slowing debt accumulation amid a weak housing market and an uncertain outlook.

Moreover, two large earthquakes in Canterbury resulted in terrible loss of life and substantial damage to property which hurt confidence.

Despite the earthquake-related tragedy in Japan in mid-March this year, near-term prospects for Asia are favourable.

Our recently released Asia-Pacific Economic Outlook forecasts that growth in the region will average nearly 7 per cent this year and next.

Regional growth is expected to be led by China and India, with important spillovers for other countries in the region and the world, particularly through demand for commodities and exports of other intermediate inputs in the context of the Asian supply chain.

For New Zealand, much uncertainty surrounds the economic outlook, particularly related to the size and timing of reconstruction from the earthquakes.

In the near term, the earthquakes will slow activity, with real GDP growth projected at 1 per cent this year. For next year, growth is projected to rise to 4 per cent, led by reconstruction.

Risks are tilted to the downside for New Zealand, including a faltering of emerging Asia's rapid growth and a possible rise in global long-term interest rates as a result of high funding requirements of banks and sovereigns in advanced economies.

The Japan earthquake, unrest in the Middle East and North Africa and volatile oil prices add uncertainty to the global outlook.

Upside risks stem from a faster-than-expected recovery in advanced economies pushing up commodity prices or stronger spillovers from Australia.

Also, faster-than-expected reconstruction in Canterbury could create bottlenecks and boost inflation.

Asia's rapid growth is accompanied by the emergence of pockets of overheating across the region in both goods and asset prices.

Asset price pressures are reflected in strong credit growth as well as property price increases in a few economies.

Headline inflation has accelerated since last October, mainly because of higher commodity prices, but core inflation has also picked up.

Inflation is expected to increase further this year, before decelerating modestly next year as global commodity prices stabilise and central banks across the region continue to normalise monetary conditions.

In addition to higher policy rates, exchange rate flexibility is a key line of defence against overheating pressures.

Exchange rate appreciation would result in a tightening of monetary conditions and reduce the burden to be borne by higher policy rates.

Several economies also have scope for more fiscal consolidation.

In New Zealand, after signs of recovery, the Reserve Bank lifted its policy rate from a record low of 2.5 per cent to 3 per cent in mid-2010.

In mid-March this year, however, the Reserve Bank reduced the policy rate by 50 basis points as insurance against downside risks as a result of the February earthquake.

The bank will need to tighten monetary policy once it becomes clear that the recovery is underway and should guard against a rise in medium-term inflation expectations as a result of higher food and oil prices, coupled with possible bottlenecks arising from earthquake reconstruction.

The earthquakes have worsened the fiscal deficit in the near term, but returning to fiscal surpluses by 2014-15 is feasible and desirable.

Fiscal consolidation would build a buffer against future shocks and relieve pressure on monetary policy and the exchange rate, thereby helping rebalance the economy and contain the current account deficit over the medium term.

It would also reduce the likelihood of a rise in the risk premium related to New Zealand's high net foreign liabilities.

Looking beyond the near-term macro-economic policy challenges, Asia faces a need to strengthen the platform for sustained strong growth over the medium term.

Such a platform would include measures to reduce inequality and raise employment prospects to guard against the risk of social instability, while pressing ahead with efforts to rebalance growth by strengthening private domestic demand.

For New Zealand, however, low household saving is a contributing factor to the large net foreign liabilities, which are a key external vulnerability.

Thus, unlike many other Asian economies, New Zealand needs to increase national saving over the medium term. Continued efforts to raise national saving and improve productivity, including through fiscal consolidation, tax and welfare reform, and streamlining regulation, would reduce external vulnerabilities.

* Anoop Singh is director of International Monetary Fund's Asia Pacific department.