The New Zealand economy is experiencing a gradual deleveraging cycle, which will weigh on real GDP growth over the coming years. While still depressed 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.
New Zealand's fiscal accounts remain in better health compared with most developed market economies. The New Zealand government has a strong commitment in keeping expenditures in check amid weak revenue collection, and we believe that it will continue to maintain its budget surplus, which is positive for the business environment as the private sector will be less crowded out by the government. Following a better than expected outcome in FY2015/16 (July-June), we are upgrading our FY2016/17 budget surplus forecast to 0.9% of GDP, from 0.4% previously.
Following a sixth 25bps cut in 14 months at its August 11 monetary policy meeting to a record low of 2.00%, we are forecasting the Reserve Bank of New Zealand (RBNZ) to cut its official cash rate (OCR) by another 25bps to 1.75% by Q117. We believe that the RBNZ will remain pressured to reduce interest rates over the coming months as it attempts to meet its medium-term inflation objective of 1.0-3.0% while also providing continued support to the domestic economy, which is still suffering from weak investment from depressed dairy prices.
Despite the gradual improvement since 2008, 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.
Although the New Zealand dollar is likely to range trade against the US dollar in the short term, we maintain our negative view on the currency over the medium term. New Zealand's high level of external indebtedness leaves the currency exposed to capital outflows as the dairy sector remains weak while the overvalued property market is looking increasingly precarious.
Major Forecast Changes
We have upgraded our FY2016/17 budget surplus forecast to 0.9% of GDP, from 0.4% previously, as the New Zealand government will continue to committed to reining expenditures in check amid weak revenue collection.
We have upgraded our 2016 average forecast for the New Zealand dollar to USD0.6700/NZD (versus USD0.6500/NZD previously) given its strength since the start of 2016, but we remain bearish against its trade-weighted partners over the medium-term.
We believe that 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 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, significantly 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 could weigh further on New Zealand's dairy export prices.
|e/f=BMI estimate/ forecast. Source: National Sources, BMI|
|Real GDP growth, % y-o-y||3.0||3.0||2.3||2.5|
|Nominal GDP, USDbn||197.3||171.7||168.8||168.6|
|Consumer price inflation, % y-o-y, eop||0.8||0.1||0.0||1.0|
|Exchange rate NZD/USD, eop||1.28||1.46||1.49||1.59|
|Budget balance, % of GDP||-1.1||0.3||1.0||0.9|
|Current account balance, % of GDP||-3.1||-3.1||-3.0||-2.7|
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