Treasury's view on the rosy side

By BRIAN FALLOW economics editor

The Treasury is taking a rosier view of the outlook both for economic growth and for interest rates than the Reserve Bank did last week.

It forecasts the economy to expand 3.1 per cent in the year to next March - up from the 1.9 per cent expected in December following the September 11 attacks. Growth then eases gently to 3 per cent the following year and 2.9 per cent the year after that.

The Reserve Bank has growth falling from 2.75 per cent to 2.25 per cent over the same period.

The Treasury forecasts may be underestimating the drag on the economy from monetary conditions.

They expect 90-day wholesale interest rates to remain around a "neutral" level of 6 per cent over the next three years, whereas the Reserve Bank last week foreshadowed rates of 6.5 to 7 per cent over the same period.

And the exchange rate has already risen, in the two weeks since Treasury economists finalised their forecasts, to the level they assumed it would reach three years from now.

For the coming fiscal year (to June 2003) an operating surplus of $2.3 billion is forecast - ample, Finance Minister Michael Cullen said, to cover the $1.2 billion to be set aside in the New Zealand Superannuation fund.

But in cash terms a deficit of $1.9 billion is forecast, in part because of a spike in forecast capital spending next year.

Some $1.5 billion in capital spending is allowed for next year in addition to the $1 billion needed to offset depreciation and maintain the Crown's existing physical assets.

That includes some lumpy items of defence hardware and refinancing of hospital debt (previously off the Crown's balance sheet) which matures next year.

In subsequent years capital spending drops to around $500 million, on top of the $1 billion a year needed to offset depreciation.

Covering the $1.9 billion cash deficit and existing debt which matures will require bond issuance of $3.4 billion in the coming year, well below market expectations of more than $4 billion.

Taking the current fiscal year and the next four all together, Treasury forecasts a cumulative $16.2 billion in operating surpluses.

But when allowance is made for spending on physical infrastructure ($7.8 billion), student loans ($6.1 billion), capital injections into State-owned enterprises ($2.4 billion) and contributions to the superannuation fund ($7.7 billion), there will be a cash shortfall which will require $8.3 billion of additional borrowing.

Even so net debt, which stood at more than 50 per cent of GDP 10 years ago and which has fallen to 16.8 per cent of GDP now, will drop to 9.3 per cent in the 2005-06 year if you count the burgeoning assets of the super fund, or 15.5 per cent if you do not. Bank of New Zealand head of market economics Stephen Toplis said the low level of debt substantially reduced New Zealand's vulnerability to shocks, including the coming demand on Government finances from the ageing population.

The Treasury's economic forecasts have domestic demand growing at better than 3 per cent for most of the next three years, offset by a deteriorating trade performance as exports grow more slowly than imports.

Employment growth, which has been strong over the past year, is expected to slow as firms concentrate on seeking productivity gains. But because labour force growth, swollen by net immigration to around 2.4 per cent, is forecast to moderate, the unemployment rate stays around 5.5 per cent year ahead and then improves to just over 5 per cent in the years that follow.

The net inflow of migration is thought to be near its peak now, with a gain of 30,000 in the year to June 2002, falling to 15,000 the following year and returning to its long-run average of 5000 thereafter.

Because just over half the net gain consists of people younger than 20, Treasury, like the Reserve Bank, sees migration as adding to demand.

Another key assumption in the forecasts is that households have recovered their appetite for debt, which waned over the past two years, though they do not expect borrowing to surge to the extent it did in the 1990s.

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