Dialogue: Looking beyond forecasts to global economy

By DARREN GIBBS*

It would be a stretch to say that financial markets have looked forward to the Budget.

In fact, if our dealing room is representative, over recent weeks the likely content of the Budget has barely figured in discussion at all. Rather, the focus has remained on global economic and political issues as well as the activities of our Reserve Bank.

Dr Cullen had indicated the broad economic and fiscal direction of this Budget well in advance.

Predictably, the Treasury has revised up its forecast of economic growth for the year to next March compared with that made in the December Economic and Fiscal Update when pessimism about the health of the global economy - and its implications for New Zealand - was at its greatest.

The new forecast is broadly in line with the consensus view. With one eye on New Zealand's appreciating exchange rate, most analysts will likely conclude that it provides a reasonable baseline for the Government's fiscal planning.

The improved growth outlook has translated into a stronger fiscal operating surplus for the current year and beyond.

Consequently, the 2002-03 borrowing programme has been scaled back considerably compared with that implied in the December update. Moreover, the final $350 million tender in the current year's programme has also been cancelled.

The 2002-03 programme ($3.4 billion of issuance) was lower than market expectations and, after refinancing the maturing April 2003 bond, implies that the value of bonds in the market will rise by around $500 million.

Beyond next year, the implied bond programme is little changed. Given current yields compared with their global counterparts, and a much more solid New Zealand dollar, these bonds should be absorbed readily. Indeed, most of our research has shown that, within reasonable bounds, the supply of debt has only a limited impact on yield spreads. Indeed, there was little, if any, immediate financial market reaction to the Budget, with both interest rates and the exchange rate unchanged.

Given the Reserve Bank's concern about the level of demand pressure in the economy, the bank will be pleased that the Budget implies that fiscal policy will have a mild contractionary impact on aggregate demand.

This continues the previously indicated fiscal policy stance and accords with the assumption underpinning the economic projections contained in the bank's May monetary policy statement.

Interestingly, the Treasury appears to see somewhat less inflation pressure than the bank. The key 90-day bank bill is expected to peak at a little over 6 per cent next year rather than the 7 per cent envisaged by the bank.

How should the Budget be judged? This was a sound and steady Budget, and that's what financial markets like to see from Governments.

Does the lack of substantial surprise make this a good Budget? Not necessarily. While sound and stable public finances undoubtedly make a contribution to the country's wellbeing, having got the macroeconomics broadly right, it is important to structure tax and spending policies in a way that maximises sustainable growth prospects.

On that score, many people may again have been left disappointed.

* Darren Gibbs is senior economist at Deutsche Bank.

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