With the Reserve Bank’s move to cut the Official Cash Rate yesterday all eyes are now on next year’s Budget.
And the question will be whether the blowout in health expenditure and the drop in tax revenue means the return to surplus will have to be delayed again until 2028-29.
Labour’s 2023 Budget forecast the Government books returning to surplus in 2025-26; Finance Minister Nicola Willis extended that out by two years to 2027-28 and it now seems highly likely that it will be shifted out again by at least another year.
But keeping the Government books in deficit for that long risks prolonging inflation and causing the Reserve Bank to slow its rate at which it drops interest rates.
The theory is that too large a deficit risks pushing inflation up again.
This was highlighted by the OECD Chief Economist Clare Lombardelli, who earlier this year headed a 144-page OECD study of the New Zealand economy.
She told journalists in Wellington that the Government should set spending and tax policies to gradually reduce the fiscal deficit and reach a budget balance.
“This would, of course, be supportive of monetary policy, allowing interest rates to fall sooner than they otherwise would be able to,” she said.
Prime Minister Christopher Luxon backed up that theory yesterday, citing the government’s spending cuts as having made it easier for the Reserve Bank to make the interest rate cuts.
But next year’s Budget will not be so easy.
Already the deficit looks like beating the projections.
Nevertheless, Reserve Bank Governor Adrian Orr forecasts more OCR cuts early next year.
By then, however, he will have seen a revised deficit track for the Government, which may show a retreat from the targets he is currently working on which were unveiled in this year’s Budget.
It seems that Willis may be willing to abandon her 2027-28 target of returning the books to surplus.
“When the revenue forecasts come down, that does make the path to surplus more challenging,” she said referring to comments on revenue made by Treasury’s Chief Economist, Dominick Stephens in a speech last week.
But Stephens also said any real cuts to Government spending would need to involve substantial cutbacks at HealthNZ.
That will be difficult politically.
The choices Willis faces there thrown into sharp focus yesterday with the Health NZ announcement that it was shedding 1500 jobs.
Over the first three months of this year HealthNZ was already $401 million over Budget.
If it continues like that, it will be $1.6 billion in the red by the time the next Budget is presented.
Willis told Parliament back in August that she had less than one billion left in her Budget Operating Allowance for next year to direct to new expenditure.
A deficit of Health NZ’s size would have to be paid for from that allowance.
Given that yesterday’s proposed job losses would likely save less than $200 million, the scale of the challenge facing Health Commissioner Lester Levy and Willis would seem impossible. Thus, a delay in the return to surplus would seem inevitable.
When asked about this yesterday, Willis said she would say anything about the deficit until the Half-Yearly Economic and Fiscal Update on December 17.
And when she was asked whether she would be seeking more cuts from HealthNZ she said: “Every budget I deliver will include a significant increase in funding for Health New Zealand.”
But that is a given.
In August she told Parliament that the Government had already pre-committed $1.37 billion per annum against the Budget 2025 allowance to meet forecast demographic, volume, and price pressures for front-line health services delivered by Health New Zealand.
“We have done this to give the health sector confidence to plan for the future so New Zealanders can get the healthcare they need,” she said.
It is that allocation that has reduced her $2.4 billion operating allowance for next year to less than a billion.
The $1.37 billion is to cope with the demographic pressures of an ageing population.
In a major speech in September, Treasury’s Chief Economist, Dominick Stephens said managing healthcare spending was central to the long-term fiscal challenge because it was a large and growing part of total government spending.
Treasury modelling showed that reducing health expenditure growth would contribute to a more sustainable trajectory for debt.
“Some savings can be made from a greater preventative focus and reducing inefficiencies but making substantive savings is likely to require some tough choices around entitlements,” he said.
“This would come with trade-offs, particularly for groups of the population who already face challenges accessing health services.”
The Ipsos Issues Monitor shows that health this year has climbed past crime and housing to become the second biggest issue for New Zealanders after the economy.
Since February, it has jumped from being the most important concern for 27 percent of respondents to 41 percent in September.
That means the Government has little political space to make the kind of cuts Stephens was referring to.
And Luxon yesterday didn’t sound like a Prime Minister preparing to cut into Health NZ in any substantial way.
“Our Government will continue to prioritize health outcomes,” he said.
“We’ve put unprecedented amounts of investment into health, almost $17 billion over the last three budgets.”
At the same time, he was also talking up the Government’s pressure on spending and saying it had been a major factor in bringing down interest rates.
“We have been working our way rather assiduously through to make sure we have daily practice around good financial management so that we can be a good partner to monetary policy, to lower inflation and also obviously interest rates,” he said.
Reserve Bank Governor Adrian Orr was asked about Luxon’s comments.
“Success has thousands of parents so I’m very pleased to no longer be an orphan,” was his wry reply.
The former Reserve Bank economist and economic commentator, Michael Reddell, on “X” offered a simple read out.
“People less constrained (than Orr) can simply say that fiscal policy changes have made no material contribution. (to the reduction in inflation),” he posted.
That is because of the long lags between a fiscal contraction and a drop in inflation.
So, if the Government is now preparing for larger deficits, will that increase inflation?
That is the risk it faces.
Otherwise, it will need to do what Stephens suggests and make some tough choices around entitlements.
As Luxon essentially claimed victory over inflation yesterday he didn’t sound like a Prime Minister preparing the ground for an austerity Budget.
