The New Zealand economy is experiencing a gradual deleveraging cycle which will weigh on real GDP growth over the coming years. While declining oil prices will provide some support to corporate profit margins and economic activity, these positives will likely be offset by the joint deterioration in the dairy and construction sectors, which remain the two key pillars of the economy.
While we believe that the New Zealand government's target for a fiscal surplus in Fiscal Year 2014/15 will not be achieve, the fiscal accounts remain in rude health compared with most developed market economies. We are forecasting a deficit equivalent to 0.2% of GDP in FY2014/15, before flipping to a surplus of 0.3% of GDP in FY2015/16, supported by continued spending restraint, which should keep government spending relative to GDP stable even as the welfare burden grows.
We are forecasting the Reserve Bank of New Zealand (RBNZ) to maintain its overnight cash rate at 3.50% throughout 2015 and 2016, but note that risks are weighted to the downside in light of collapsing inflation expectations. The RBNZ is keen to avoid lower interest rates putting further upside pressure on property prices, therefore any further property-specific tightening measures could be accompanied by an interest rate cut.
Despite the gradual improvement in recent years, New Zealand's external accounts remain the economy's weak link and a persistent current account deficit poses risks of large-scale capital outflow. In order to correct these imbalances, we will need to see domestic savings rise sharply, while investment growth cools, which will undermine economic growth to some extent.
The New Zealand dollar remains among the most overvalued currencies in the world, and although this is partially justified by high real interest rates, we expect the NZD to fall over the medium term, particularly as the RBNZ increasingly talks down the currency. We forecast the NZD to average USD0.7200/NZD in 2015 and USD0.6800/NZD in 2016.
New Zealand Prime Minister John Key's decision to deploy troops in Iraq has pitted the National Party against both the opposition and its own political supporters. While the move currently has the slim backing of New Zealand voters, this support could fall should the mission overrun its two-year plan, which could help support the popularity of the still-weak Labor Party.
Major Forecast Changes
We have made a slight downward revision to our inflation forecast since our previous Country Risk Report, and now expect consumer price inflation to average just 0.8% in 2015, compared with 1.2% in 2014. Collapsing global oil prices and ongoing domestic deleveraging also suggest outright deflation is a growing possibility, particularly if we begin to see domestic property price weakness.
Key Risks To Outlook
We believe there are two main risks facing the New Zealand economy:
Domestically, a continued surge in property prices could sow the seeds for an eventual sharp decline and associated financial instability owing to the large levels of household debt in the economy and the banking sector's exposure to the mortgage market. The property market is slightly overvalued from a nationwide perspective, but key cities such as Auckland are experiencing what appear to be bubble-like price advances, which left unchecked could create financial instability.
Externally, a sharper than expected decline in Chinese import demand could lead to further declines in dairy prices and export volumes, reversing the enormously beneficial upturn seen in New Zealand's terms of trade over recent years. So far, New Zealand's terms of trade have only deteriorated slightly, but a collapse in Chinese demand, possibly due to a devaluation of the Chinese yuan, could weigh further on New Zealand's dairy export prices.
|Real GDP growth, % y-o-y||2.3||3.2||2.4||2.5|
|Nominal GDP, USDbn||181.4||191.7||171.8||169.2|
|Consumer price inflation, % y-o-y, eop||1.6||0.8||0.8||2.5|
|Exchange rate NZD/USD, eop||1.22||1.28||1.43||1.43|
|Budget balance, % of GDP||-2.0||-1.3||-0.2||0.3|
|Current account balance, % of GDP||-3.4||-2.6||-1.1||-0.3|