Thomas Coughlan: Government books in great shape - but the economy about to hit the wall

OPINION

The Government’s books are in rude health: debt is forecast to track down, expenses and revenue are stabilising as a percentage of GDP and, defying expectations, a surplus is forecast for 2025.

Numbers released today in the Treasury’s half-year forecasts - known as the HYEFU - show a mixed picture: healthy Government books but an economy in pain.

And there’s one very important detail for Finance Minister Grant Robertson in the forecasts: Treasury thinks the Government’s management of the economy is not contributing to inflation. In fact, the Government’s relative restraint is forecast to help the Reserve Bank put the brakes on inflation by sucking demand out of the economy.

It even went so far as to say that the Government’s fiscal policy “reduces the need for the Reserve Bank to raise rates” in the future - translation: the Government’s tax take might be reducing pressure on mortgage-holders struggling with higher interest rates. A political win.

Oh and net debt - a number once thought so important it might have been the headline of this story - will peak at 21.4 per cent of GDP in 2024, before tracking down to 14.1 per cent in 2027 - that’s $68.2 billion in nominal terms.

But that’s where the good news ends, because while the news is good for the Government, everyone else is struggling.

Treasury has joined the Reserve Bank in forecasting a minor recession next year (at three quarters, Treasury’s forecast is one quarter shorter than the Reserve Bank’s), unemployment is expected to rise to 5.5 per cent in 2024 (the highest rate in a decade) with 51,000 more Kiwis not in work.

House prices are expected to plummet. Treasury has updated its forecasts, and assumed prices will fall a further 15 per cent between September 2022 and December 2024, and only begin to recover in 2025.

With house prices goes the economy and lower house prices translate into lower household wealth resulting in much weaker consumption. Real household wealth will fall by 5 per cent this year on 2021.

Pity our exporters who kept the economy alive during the pandemic.

Global dairy prices have declined 33 per cent from their peak this year. Export prices are expected to take a beating in the coming years.

There are two rays of sunshine in these forecasts: Treasury thinks inflation has peaked and is on the way down. Across the road at the Reserve Bank, they believe inflation is going to peak at 7.5 per cent in the current quarter before beginning a slow decline.

The second piece of good news is that hourly wages are forecast to rise significantly above inflation for every year of the forecasts (not this year, obviously). Wages will grow at 6.8 per cent next year, above inflation of 6.4 per cent, the year after, wages will grow at 6.1 per cent, but inflation will grow at 3.5 per cent; by 2025, inflation will be 2.5 per cent, but wages will be 2.5 per cent, and in 2026, hourly wages will grow by 4 per cent, while CPI will be 2 per cent.

Those hourly wage forecasts represent a fairly significant revision on Treasury’s May forecasts.

The picture painted by these numbers is a strange one.

The Government’s books are in curiously good shape. There’s enough revenue to pay for expenses, a surplus is forecast and debt is low. Cast an eye to the United Kingdom, which is facing the grim choice between hiking already high taxes or cutting essential spending, and you’ll see how lucky we are. Robertson isn’t wrong when he said New Zealand is in a good starting position on the fiscal side of things.

But my lord - if the books are in good shape, spare a thought for the wider economy. Have an extra helping of pav this Christmas folks, because next year will be tough.

Recessions are never nice, and spare a thought for the people who are forecast to lose their jobs next year.

Who will win the election?

Ah - the question everyone wants answered. Pollsters will tell you that how people feel about the economy is one of the key indicators of how a party will do in an election.

Based on that, you’d have to say these numbers aren’t good for Labour: a recession, rising unemployment, and falling house prices are not a great backdrop for an election campaign (even if house prices are already too high - the infinite wisdom of the median voter would have houses consistently rise until they became cheaper).

One thing in Labour’s favour is the books are in good shape, giving it plenty of room to move should it wish to take action to blunt the impact of the tough economic times next year.

It won’t want to spend too much, lest it overstimulate the economy, but it has the fiscal space to roll out additional support if it needs to.

Prime Minister Jacinda Ardern has said the Government will take a rolling approach to the economic challenges next year, Robertson and Transport Minister Michael Wood suggested the same today.

Keep an eye on tax cuts. One of the problems for the Government is that one of the reasons for the books being so healthy is that the tax take is particularly high, even in relative terms.

Robertson will come under increased pressure to offer tax cuts, particularly in election year.

He’ll be mindful of the timing, however, noting that tax cuts exacerbate inflation.

How much money?

Robertson left the operating allowance - the amount of new money in the budget - unchanged this year. It is his first time as finance minister that he has not topped up the allowance.

It’s a strong signal to ministers and the wider economy that Labour is taking a more restrained approach to public spending than it did during the pandemic.

Ministers have been told to reprioritise spending in their portfolios if they want additional money in the Budget.

What this means in reality is that Robertson will be able to dish out more new money in the Budget (more than the $4.5b allocated today) without adding to the net level of Crown spending - this is because that funding will have come from reallocating spending that was already happening.

One thing to keep an eye on is a massive increase of $9.1b to the capital allowance - this is the pot of money used to build assets like schools and hospitals.

This can be spent over many years, not necessarily just next year. Keep an eye out for big projects that might require a lot of spending: light rail in Auckland or the Lake Onslow project.

Nuggets!

The HYEFU is also where Treasury has to look at risks the Government faces in the foreseeable future.

This year’s HYEFU included a few doozies. Unluckily for the Government, many of these risks come from policies going awry.

The Government’s Three Waters reforms need an estimated $582 million in operating expenditure to cover the cost of a new ICT system. The Crown is estimated to recover those costs once the new entities start charging households.

The new health system, which received multi-year funding in the last Budget, may require even more money. Treasury warns that the existing funding was made on assumptions about DHB deficits and the scope for efficiencies. If those pressures turn out to be wrong, Treasury warns, more money will be required.

The TVNZ-RNZ merger, which already appears threatened, came under further pressure in the forecasts.

Since the Budget, “cost pressures and risks” have emerged around the merger relating to market conditions, content cost and the necessary investment in technology.

It has also been discovered that TVNZ-RNZ will need to pay tax, meaning it will have less income than expected to run its operations. That might mean the Government would need to stump up yet more cash to get the outcomes it wants.

The Government’s unemployment insurance scheme is also a risk. The scheme works like ACC, where employers and employees pay into a fund that pays out if they are laid off.

The problem, Treasury notes, is that the Government, which employs a significant number of people, will have to pay into the scheme meaning that rolling it out will cost a fair chunk of change.

The NZ Upgrade transport programme is under pressure. The $6.8b of transport projects have come under pressure from inflation, which means there is a chance - a very high chance - that more money will be needed to top up the kitty.

And lastly, spare a thought for Wellington’s Let’s Get Wellington Moving Transport Package: for years Treasury has warned that councils might struggle to come up with their 40 per cent share of the funding for the programme.

Now, Treasury is worried Waka Kotahi-NZTA will struggle to come up with its share, which comes from petrol taxes and road user charges. If that is the case, the Crown will have to front up with extra cash.

This risk was foreshadowed in May, but has been elevated since then.