IS TREASURY'S OPTIMISM ABOUT THE ECONOMY JUSTIFIED

From a political point of view three different big numbers stand out from yesterday’s half yearly economic and fiscal update.

They are:

• The lower tax take
• The $1 billion for extra capital expenditure next year and substantial amounts from then on.
• The return to 3% + growth in the 2017/18 year.

THE TAX TAKE

The reduction in the tax forecast tax take is tiny — peaking at just over two percent in 2017/18 but set against inflation which is not expected to reach two per cent till 2016/17 and then stay around there for another year, the net effect will be a real reduction in Government tax revenue of nearly $5.8 billion over the next four years.

The net effect of this though is to lower the Budget surplus/deficit (OBEGAL) forecasts. That means a forecast deficit for the 2016 Budget of $400 million.

Finance Minister Bill English has been warning about the lower tax for much of the year now which means that the Cabinet has had ample time to consider it and as a result – possibly of political pressures from his colleagues – Mr English is saying that the Government will not change the spending plans it announced in the last Budget.

“We don’t intend to make any spending changes in an attempt to move the small forecast deficit in 1015/16 back to surplus,” he said.

“The 14/15 surplus target was very important as a way of turning around a large deficit.

“Now that has been achieved and the books are broadly in balance and in the immediate future we don’t intend to alter our spending plans in response to small positive or negative OBEGAL balances.”

Those spending plans include tax cuts promised for 2017.

And Mr English gave a clear hint that those could be brought forward to next year.

“That’s an option,” he said.

But he said the Government would not go outside the spending projections set out at the last Budget of new expenditure of one billion dollars in 2016 and $2.5 billion in 2017.

However he said “rephasing” of that spending between the two Budgets was possible.

But he warned that after seven or eight years of virtually frozen spending, the Government was coming under increasing spending pressure from some departments.

Though Mr English has relaxed some of the debt targets over the immediate future he says the Government is still on track to achieve a debt target of 20% of GDP by 2020.

The big ticket Government spending items are:

CAPITAL SPENDING

Mr English is setting aside an extra one billion dollars for capital spending next year.

This will be the beginning of an overall increase in capital expenditure intended to carry on through the forecast period. 

The increases come as  the Government has exhausted  the money set aside in the Future Investment Fund which was the proceeds of the power company privatisations and which was reserved for capital infrastructure projects.

All up it is proposing to invest $24.7 billion dollars on capital items by 2020.

Transport tops the list but there is also significant spending planned on new schools, defence equipment and the ongoing Canterbury rebuild.

Mr English also pointed to two big Government IT projects — at Inland Revenue and at the GCSB (though the budget for that is secret) — as being part of the projected spending. 

But of course it begged the question as to whether this was the Government’s response to the call last Thursday from the Reserve Governor,Graeme Wheeler,  for more infrastructure spending in Auckland to try and kick-start some economic activity and thus move inflation up from its current ultra-low levels.

Mr English said that the Government had “noted” the Governor’s comments.

“I think matching the Governor’s comments and the increase in the capital allowance are to some extent coincidental,” he said.

As far as Auckland was concerned he said the biggest immediate capital commitment there would be on the supply of housing.

Meanwhile he said the Government was getting much closer to the Auckland Council through the Transport Alignment Project which is essentially a Government led second look at Auckland’s road and rail transport priorities.

This was clearly intended to be an investigation of Mayor Len Brown’s favourite project, the Central Rail Loop (CRL).

“So as the future of the CRL becomes a  bit clearer, we’ve got to pay attention to all the other issues — traffic congestion and the impact of the CRL on the KiwiRail network so that out in front of us is considerable infrastructure investment,” said Mr English.

“It’s not easy to pull it forward and we don’t see an economic case for taking too big a risk by trying to pull things forward.

“But on the other hand we are working very hard with the Auckland Council so that we can get a solid foundation of a common understanding and larger clearer pipeline of the very significant infrastructure investment that needs to go there.”

THE OVERALL ECONOMIC OUTLOOK.

In a nutshell the forecasts are optimistic as far as the overall economy goes — they are picking growth to pick up in the second half of next year and then to increase to a very healthy 3.6% in the 2017/18 year.

That will delight the Beehive because it means the Government will go into the 2017 election with a growing economy.

However unemployment is picked to remain above 6% until 2018.

That optimism is shared by the Ministry of primary Industries who yesterday published their annual Situation and Outlook Report for primary industries.

They are forecasting a 5.3% increase in primary industries export revenue in the year to June 2016 despite a 7% fall in dairy production.

And then in the year to June 2017 they are forecasting a 16.1% increase in revenue buoyed up a by a three per cent increase in dairy production.

Treasury has warned that a more severe El Nino than they are expecting could change their growth forecasts. The Reserve Bank said the same thing in their Monetary Policy statement last week.

But MPI says that the dryer conditions brought on by an El Nino are likely to adversely affect only 35% of the national dairy herd and the other side of the El Nino, the heavier rain the west could actually increase production in large parts of the country.

Otherwise it says farmers are well placed to manage their way through the El Nino because of:

• Better productivity per animal and improved farming practices;
• Increased areas of land under irrigation (although irrigation restrictions are already in place in Canterbury, which remains in drought);
• Significant cow culling which has already occurred in response to high beef prices and a low dairy price forecast. 

“An El Niño event also affects global supply and demand, as other countries are also expected to experience drought conditions,” says the Ministry.

“Lower dairy production volumes in other countries could lead to higher prices, partly offsetting any projected falls in production.

“At the same time, increased animal culling in our competitor countries (like Australia that could also face an extended drought) could push meat prices down.”

But it is the Treasury’s 3.6% gdp growth forecast for 2017/2018 that will raise most eyebrows.

That’s higher than any yearly rate achieved since National was elected in 2008 even during the dairy boom.

(Growth peaked at 3.3% in the year to December last year).

Westpac economists, Anne Bonniface and Michael Gordon, in a commentary on the forecasts questioned the growth figures.

They questioned Treasury’s dairy price assumption which was that prices were expected to improve from mid-2016, returning to around $3,500/tonne by the end of 2017 – “a notably more optimistic view than our own assessment.”

“Consequently, we think there is scope for growth to disappoint relative to Treasury forecasts at this

horizon, especially once you factor in the scaling down of reconstruction activity in Canterbury.” 

On the other hand, the Ministry of Primary Industries is confident about dairy prices bouncing back by the fourth quarter of 2016. 

Westpac also questions Treasury’s inflation projections.

“The Treasury is projecting CPI inflation to rise to 1.4% by March next year (notably higher than the RBNZ’s 1.2% forecast and our own 1.1% pick) with inflation expected to return to the 2% midpoint of the RBNZ’s target band by the end of 2016. 

“In contrast, even the RBNZ doesn’t expect inflation to get back to this level until a full year later.”

The impact of a lower inflation track would be to further lower tax revenue and thus place greater pressure on Government spending if Mr English is to maintain his 20%-of-gdp-by=2020 target for debt. 

What all this suggests is that the next few months are going to be critical as the full impact of El Nino becomes clearer and to see whether or not growth – and with it, inflation — starts to pick up.

In the meantime though, Ministers can go to their summer break mildly optimistic about the economic future and therefore their own political futures.