On February 5, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with New Zealand. In the report, they examine a number of issues, including high house prices in Auckland, trade exposures, low GDP per capita and chronic low household savings. “From the 2000s, New Zealand has lagged behind top OECD countries in output per worker by 20–25 percent. This gap can be explained by both substantial productivity gaps and lower levels of capital. While the latter may be partly influenced by the low savings rate (and higher interest rates), the productivity gap is striking, particularly when taking into account New Zealand’s sound institutional and policy settings: New Zealand’s per capita should be 20 percent above the OECD average based on structural policy settings, not 20 percent below”.
The economy’s strong growth after the global financial crisis has been supported by rising terms of trade and reconstruction activity after the 2010–11 Canterbury earthquakes, as well as high net immigration. Growth peaked at 3.5 percent year-on-year (y/y) in Q4 2014, bringing output slightly above potential. However, the tailwinds have recently waned. In 2014, dairy prices began to fall from historic highs, leading to a sharp drop in income growth after the positive effect of declining oil prices had worn off, and investment activity related to the Canterbury rebuild has reached a plateau. As a result, output growth is estimated to have slowed to 2.3 percent in 2015, despite resilient consumption. Meanwhile, unemployment has been edging up reaching 6 percent in Q3 2015. Due largely to the decline in oil prices, inflation has dropped to 0.3 percent (y/y) in Q3 2015. House price inflation in Auckland has remained high, driven fundamentally by supply shortages.
The exchange rate depreciation has cushioned some of the impact of the decline in dairy prices. The bilateral exchange rate against the U.S. dollar has depreciated as dairy prices fell and the Reserve Bank of New Zealand (RBNZ) eased monetary policy. The depreciation has mitigated the impact of the international dairy price decline on farmers’ incomes, and supported exports of travel and education services.
With growth below potential, measures of core inflation around the lower half of the target band, and a still strong exchange rate, monetary policy has been eased since June and the Reserve Bank stands ready to reduce rates further if warranted.
To manage risks arising from house price inflation in Auckland, macroprudential measures were introduced in 2013, leading to a temporary slowdown in price hike. A package of additional macroprudential regulations and tax measures was announced in May 2015, but having become fully effective only in November. The banking sector has increased capital and liquidity buffers, but reliance on offshore funding and a large share of mortgage lending remain sources of vulnerability.
Fiscal policy is also supportive of the economy in the short term, while consolidation is projected to resume in the medium-term. Automatic stabilizers have been allowed to work and public investment is being increased. Net debt is projected to decline further to around 5 percent of GDP in the medium term.
With chronically low national saving, New Zealand’s economy is dependent on borrowing from abroad. Its persistently negative savings-investment balance has led to the accumulation of a large net negative international investment position (IIP) which reached65 percent of GDP in 2014.
The short-term outlook is challenging with both external and domestic risks, the latter arising from rapid house price inflation in Auckland. However, New Zealand’s flexible economy is resilient, and medium-term prospects remain positive. New Zealand’s main exports—agricultural consumer products and tourism—should benefit from the ongoing shift to a more consumption-oriented growth model in China. Consumer demand in other Asian countries is also expected to grow. Overall, output growth is projected to recover to its estimated potential rate of 2.5 percent. With measures of core inflation around the lower end of the target range and expectations consistent with the band’s midpoint, inflation is forecast to rise to within the RBNZ’s target range of 1–3 percent in 2016.
Executive Directors welcomed that New Zealand’s economy continues to perform well despite the slowdown imposed by the fall in dairy prices, plateaued investment associated with the Canterbury rebuild, and slower growth in trading partners. Directors agreed that New Zealand’s sound and flexible policy frameworks, including the important buffer provided by the flexible exchange rate, position the country well to weather the recent slowdown. Medium-term prospects remain positive, and Directors were encouraged by the authorities’ alertness to the downside risks and challenges arising from real estate market pressures, a persistently low savings rate, and relatively low productivity.
Directors considered the current accommodative monetary stance to be appropriate and agreed that, if needed, the authorities should stand ready for further easing given low inflationary pressures and below potential output. With regard to fiscal policy, they agreed that the planned easing this year and next, including through an acceleration of public investment in infrastructure, combined with a resumption of gradual fiscal consolidation thereafter, is appropriate. These measures should support the economy in the short term and bolster the public sector balance sheet in the longer term.
Directors noted that the banking system is resilient and well-supervised. They commended the proactive prudential and tax measures being taken to address the risks stemming from the housing market. Noting that the underlying cause of the housing market boom in Auckland is a supply/demand mismatch, they encouraged the authorities to be ready to use additional prudential measures and consider steps to reduce the tax advantage of housing over other forms of investments, while continuing to address supply-side bottlenecks.
Directors agreed that raising national and in particular private saving is critical to reducing external vulnerabilities from the still heavy reliance on offshore funding. They noted that higher saving may also reduce capital costs by lowering the risk premium and thereby support productive investment and long-term growth. They encouraged the authorities to consider comprehensive policy measures to boost long-term financial savings, including through reform of retirement income policies, as this could also help deepen New Zealand’s capital markets and broaden options for retirement planning.
Directors observed that, notwithstanding high living standards, New Zealand incomes lag those of other advanced economies, due to relatively low capital intensity and productivity. Acknowledging that the economy’s small size and distance from markets likely limit gains from trade, they encouraged the authorities to build on the country’s business-friendly environment to take steps to boost competition in key service sectors, leverage ICT more intensively, and address key infrastructure bottlenecks. They welcomed the focus of the government’s Business Growth Agenda on these issues.
