Dialogue: No sign of boost to standard of living in Budget

By DARREN GIBBS*

Nowadays New Zealand budgets tend not to be a focus for financial markets. This year's Budget proved to be of marginally greater interest. Although Michael Cullen had signalled the broad economic and fiscal outlook well in advance, the level of bond issuance especially beyond the coming year was greater than the market had expected.

As a result, while there was little reaction in the equity and foreign exchange markets, the debt market was sold lower as the market contemplated how it would absorb the unanticipated supply.

From a Macroeconomic perspective, the Budget appears reasonably sound. The central outlook is for steadily rising operating surpluses. Oberac - the operating balance excluding revaluation and accounting adjustments - is expected to rise from an estimated $1.7 billion this year to $3.7 billion by 2004-05. Net public debt is expected to rise in nominal terms but remain broadly constant as a proportion of GDP. The short-term economic impact of the Budget is mildly contractionary, allowing slightly greater room for lower interest rates than would otherwise be the case.

The economic outlook that underpins the fiscal projections seems plausible. The central scenario is subject to significant uncertainty, however, with the global outlook constituting the key source of risk. Although the American economy appears to have stabilised, evidence of a rapid recovery of the sort now being priced by global debt, commodity and equity markets is yet to emerge. And the effect of the US slowdown is now weighing on the economies of Europe and Asia. Only in Australia has data tended to point on the strong side of expectations in recent weeks.

Calculations by the Treasury suggest that the forecast 2001-02 operating surplus of $1.4 billion could turn out to be as little as $0.5 billion if the global economy slows more substantially. It is not difficult to construct further plausible alternatives that would see the operating surplus fall even lower, although a return to large deficits seems unlikely at this stage.

Next year's election, however, adds a further dimension of risk. Dr Cullen's decision to raise his self-imposed spending cap by $270 million did not amount to much in macroeconomic terms. But it does raise questions about Dr Cullen's ability to resist the demands of his ministerial colleagues, especially if the Government's lead in the opinion polls narrows.

It is not difficult to imagine a further, more significant, relaxation of the cap next year.

To summarise, from the perspective of short-term fiscal management, Dr Cullen's Budget rates a B. The central outlook appears sound and there is room for the automatic stabilisers to operate in the event of a more significant global slowdown without leading to a return to chronic fiscal deficits. However, Dr Cullen will have his work cut out to achieve this grade next year.

From the point of view of contributing to the prospects for sustainable economic growth, sadly the Budget scores a D. Again there was little in the Budget, apart from rhetoric, to suggest that the seemingly inexorable decline in New Zealanders relative standard of living will be arrested.

Trend labour productivity remains disappointing. To achieve higher productivity requires greater and smarter use of human and physical capital and that in turn requires that the providers of capital stand to reward from the risks that they take. There is no silver bullet. But as the Australian and British Governments have concluded, a reduction in corporate tax rates is likely to be part of the solution.

Financial markets will share the business community's disappointment that growth-friendly policies continue to languish on the Government's agenda. It is this failing that will be the focus of long-term investors and which will have the greatest impact on our markets over time.

* Darren Gibbs is a senior economist at Deutsche Bank NZ.

www.nzherald.co.nz/budget

Charts: