Talking Points: Time to revisit the plan

SLOW DOWN: Economic indicators show a slowing in the economy as FX, interest rates, labour and housing costs atart to impact.

The year ahead will see an increasingly challenging economic environment for small businesses. All indications are that New Zealand's prolonged growth of the last few years is slowing down.  The simple response to these changing economic times is to focus on business and financial planning.

Times will get a little tougher all round: companies reliant on domestic spending will see reduced growth after the "spend up" of the past few years. Small exporters will still feel the crunch of the strong NZD, though the pressure should start to recede toward the end of the year.

Even with a slowing economy the labour market is going to remain tight. Retaining key employees is a real challenge for small business. This puts pressure on wages and forces business to consider contingencies should employees shift jobs. The unemployment rate also blipped from its 20-year low, now at 3.9% - but even so labour shortages will persist and remain a major issue for New Zealand.
These issues are exacerbated by increasing fuel costs and the uncertainty of creeping inflation or higher interest rates.

The high exchange rate is still pinching export earnings, as FX hedges progressively roll off and expose exporters to the stronger NZD.  Though we do expect the NZD to weaken, the threat of further interest rate increases in the short term is holding it up.

Part of the slowing of the economy stems from the Reserve Bank's mandated duty to keep inflation low and stable. The run of strong growth has stretched the economy's ability to supply, resulting in chronic capacity constraints and rising inflation, particularly in the construction sector. In response the RB has pushed interest rates up sharply since early 2004. We think it has done more than enough to quell inflation, but interest rate cuts are unlikely until 2006.

Typically at the economic crossroads, the signals are mixed.

Notwithstanding a rebound in early 2005, recent forward economic indicators have taken on a mixed look. Is the inevitable turning point, after such a prolonged expansion, now upon us?

One recent positive is a strong rebound in retail sales in the first quarter of the year after a soft finish to 2004, up 1.3 per cent (adjusting for inflation). The housing market has been harder to read after the mortgage rate `war' at the end of 2004: prices have been robust since then but turnover has started to drift down again.  More recently, the issuance of council consents to build houses has also softened.

Elsewhere in the world, 2004 marked the most rapid acceleration the global economy made out of the slowdown that hit at the start of the millennium. The mainstay of the globe, the US, continues to grow at a healthy pace.  But the next biggest economic bloc, Europe, is going from bad to worse - much in need of economic reform but not yet prepared to take serious action. Japan, too, is cooling after an export-driven surge, and has yet to shake off over a decade of malaise. The Australian building sector has cooled relative to a couple of years ago. China is one of the brighter patches in our neck of woods, even if the expected eight per cent growth for this year is actually a slight slowdown! China will provide a long-term growth opportunity for New Zealand.

All these factors are reflected in a drop in business confidence that has crumbled dramatically to levels more akin with recession or a shock reaction to a development such as the SARS outbreak a couple of years ago. 

In good times the focus on working tightly towards business and financial plans tends to wane. But with a slowdown indicated, the clear signal is that small business needs to be cautious and focus on getting the business basics right.

As costs escalate and growth slows, a disciplined commitment to planning will provide the best chance of weathering this economic storm.

*David Cunningham is Westpac's head of small business.