Tuesday, October 7, 2008

Government Fiscal Blues - Deficits & Debt to Rise

Budget Balance as percent of GDP
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The Government expects a sharp deterioration in its fiscal position in both the short and medium term, reflecting the impact of global recession on a slowing domestic economy.

The Treasury in its pre-election fiscal update (read all the nitty-gritty details here) forecasts the budget surplus of NZ$5.6 billion in the year ending June 2008 to slump to a deficit of $64 million next year, widening to a deficit of $1.7 billion by 2010 and remaining in a deficit for 10 years.

A rapid deterioration in the cash balance is also expected, the NZ$2 billion cash surplus in the year ended June 2008 turning into a $5.9 billion cash deficit in 2008/09. In the following four years, deficits are expected to widen to $7.3 billion by 2012.

National Debt (GSID) as percent of GDP
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The accumulation of budget deficits is expected to result in the gross national debt as a percentage of GDP increasing from 17.4 percent to 24.3 percent by 2013, pushing the debt above the Government's average target of 20 percent. By comparison, US gross national debt is around 70 percent of GDP. Close neighbour Australia has a better debt management record than New Zealand's but has no doubt been assisted by a faster growing economy propelled by a booming mineral export sector.

International Comparison - National Debt as percent of GDP - OECD Factbook, 2008
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The room to fund new policies or to offer election year "bribes" to voters is closing rapidly. Of the $1.75 billion earmarked for new spending next year, $1.25 billion is already committed in areas such as health, education, and funding the recently re-nationalised KiwiRail.

There is just $496 million left to spend in next year's Budget and only $614 million in each of the next three years.

While the Labour Government has funded its recent tax cuts introduced in stages since 1 October, conveniently on the eve of the election, the opposition National Party has pledged that its tax cut policy scheduled to be released shortly would not be funded by new borrowing.

Both major parties are avoiding telling voters the unpalatable truth: tax increases, further asset sales, and/or significant expenditure cuts will be necessary if these deficits are to be trimmed. Nonetheless, the government's balance sheet is sound thanks to prudent fiscal management generating accumulated cash surpluses over the past decade or so. The same could not be said for the United States.

While interest rates are predicted to fall, the exchange rate is expected to drop by 22 percent by 2013.

If anything, these forecasts may be too rosy: the forecasts were prepared based on information available at the end of August but the global economy has slumped by a greater magnitude than anticipated then and it is much more fragile and unstable. Treasury Secretary, John Whitehead, has acknowledged as much, continuing that the world economic crisis "is developing by the day and, by any measure, is very serious."

The New Zealand Institute of Economic Research, an independent think tank, reports that its latest Quarterly Survey of Business Opinion indicated that New Zealand's recession will run through the end of the December quarter at least.

Meantime, the Kiwi dollar has taken a
battering as offshore investors abandon the currency for safe haven investments. In mid year the currency was trading as high as 82 US cents per Kiwi dollar but in the financial market turmoil of this week's response to the US government's rescue or bailout plan passage into law the Kiwi has dropped as low as 61.7 US cents. The Bank of New Zealand, a commercial bank, has been forecasting the rate will drop to 62 US cents by year end.

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