Promising outlook blurred by interest, confidence

Business and Economic

Research Limited

WEDNESDAY 14 JUNE 2000

"Promising outlook blurred by interest rates and confidence jitters" says BERL

The latest analysis of prospects for NZ from independent economists BERL contain a cautiously optimistic message.

"With the Kiwi dollar at the most competitive level for years, NZ should be set to experience a prolonged period of robust and sustained economic and income growth", BERL Forecasts Editor Dr Ganesh Nana commented.

Blurring the promising prospects however, and so responsible for BERL's caution, are the continued hawkish stance implicit in the RB's monetary policy profile and business confidence jitters. While confidence has seemed particularly fickle over the past year or so, the recent downturn in confidence is undoubtedly worrying - especially as such sentiment can indeed become prophetically self-fulfilling.

"It would not be difficult for NZ industry to 'talk itself' into a downturn - a so-called 'confidence recession'. We are not forecasting such an outcome - but we do view it as a significant downside-risk to our analysis. The task of the powers that be in both the government and the RB is to ensure such an unpalatable scenario does not transpire. A strong message (from both, if need be) that interest rate rises have indeed reached their peak would be a major contribution," urged Dr Nana.

On the other hand, a solid foundation for a cautiously promising outlook is being set by clear evidence of strong export growth.

"With the benefits from the depreciation of the exchange rate over the past 18 months or so now being reaped by exporters, we forecast that the necessary shift away from the consumption-led spending binge towards a more robust export-bias growth scene will continue," explained Dr Nana.

Although the BERL economists retain an optimistic tone over NZ's export prospects - forecasting an expansion of nearly 8% in the volume of exports in the year to March 2001 - they do not expect a quick turnaround in the trade deficit.

"The export performance is undoubtedly a bright star, but we remain concerned at the continuing growth in imports despite the weaker currency," noted Dr Nana.

The persistent failure of the trade balance to move into positive territory points to a deep structural malaise in the New Zealand economy. When the dollar depreciates we expect local production to expand to replace imports. But, much of our capacity to produce has been lost during the 1990s.

So, now, when the demand is there to support expansion, local production is not able to satisfy that demand. Furthermore, investment in renewing or expanding capacity is discouraged by higher interest rates. The higher interest rates result from our collective fixation with controlling short-term demand to ward-off fears of inflation.

"It is a sobering picture indeed to see that NZ's interest rates now rank amongst the highest in the OECD community," noted Dr Nana.

Meanwhile, we continue to ignore the critical need to encourage the longer-term expansion of supply through investment in new and improved capacity in New Zealand.

"The doctrine of the pre-emptive strike against inflation becomes self-defeating in the long-run, as it works against the incentive to invest in equipment, technology, infrastructure or in people."

Consequently, the Balance of Payments current account deficit is forecast to remain near 5.5% of GDP over the next two to three years - reinforcing the need for policy-makers to take a longer-term view when assessing the state and performance of the NZ economy.

Following a small 'confidence-crisis-induced' stalling of the recovery over the first two quarters of 2000 (where quarterly growth of 0.2% is expected) BERL forecast a return to a more respectable and sustainable growth path in the range of 0.5% to 0.6% per quarter. As a result, GDP growth for the March 2000 year, is set to average 4.4% - with rates of 2.7%, 2.1% and 2.3% in each of the following three March years.

The migration exodus is forecast to only slowly turnaround - a net inflow is not expected until 2002/03. With steady but unspectacular employment growth, the unemployment rate is forecast to drift from its present 6.7% to be below 6% by June 2001.

Excerpts (pages 3-5) from June 2000 BERL Forecasts attached.

For further details and/or comment contact : Dr Ganesh Nana
email: ganesh.nana@berl.co.nz

PAINTING THE PICTURE

June 2000

Benefits from the depreciation of the exchange rate over the past 18 months or so are now being reaped by exporters. Total merchandise export receipts for the March quarter were recorded at nearly 18% up on year-earlier levels. Particularly promising growth is occurring in manufacturing exports. For example, export volumes in the bell-weather machinery and transport equipment category in the December quarter were 12.5% up on those of a year ago. With this heartening evidence we continue to base our short-to-medium term forecast scenario around a shift of growth towards a more robust export bias.

On the other hand, the impact of yet another tightening of monetary policy - with little sign from the authorities that the peak has been reached - continues to cast a pall over our forecast picture. It is indeed a sobering thought to see that NZ's interest rates currently rank amongst the highest in the OECD community. Additionally, and clearly not unrelated to the aggressive interest rate posture of the RB, there seems to be a gathering crisis of confidence amongst the business community.

It would not be difficult for NZ industry to 'talk itself' into a downturn. We could term such an outcome a 'confidence recession'. This is not our forecast - but we do view such a possibility as a significant downside risk to our forecast. The task of policy-makers (central government and monetary authorities) is to ensure such an unpalatable scenario does not transpire. A strong message (from both, if need be) that interest rate rises have indeed reached their peak would be a major contribution.

Following a small 'confidence-crisis-induced' stalling of the recovery over the first two quarters of 2000 (where we expect quarterly growth of 0.2%) we forecast a return to a more respectable and sustainable growth path in the range of 0.5% to 0.6% per quarter. Consequently, GDP growth for the March 2000 year is set to average 4.4% - with rates of 2.7%, 2.1% and 2.3% in each of the following three March years.

That the exchange rate depreciation is now providing the positive impetus to exports is indeed heartening. That there seems little sign of the weaker currency curbing import growth is equally disheartening. Our forecast, despite strong export growth and a significant easing of import growth, is for a deficit on merchandise trade to remain over the forecast horizon. Consequently, the current account deficit is forecast to again be over $6bn in the year to June 2000 - or 5.7% of GDP and remaining near 5.5% of GDP over the forecast horizon.

The migration exodus is forecast to only slowly turnaround - a net inflow is not expected until 2002/03. With steady but unspectacular employment growth, the unemployment rate is forecast to drift from its present 6.7% to be below 6% by June 2001.

FEATURE

Structural adjustment : choices ?

Economics is simple. Invariably, it is concerned with the what happens (ie the adjustment) when demand and supply are "out of balance". That's it, really! The mantra ingrained into every budding economist during their first year or so of training is also simple : "if demand does not equal supply, price will adjust".

Unfortunately, the mechanics of how price will adjust, how quickly it will adjust and - most importantly - the consequences (or the side-effects) experienced by the economy during the process the price adjustment process remain the subject of critical debate amongst economic analysts. What has this got to do with the here and now? At the economy-wide level NZ has, more often than not, consistently been in a position where demand has exceeded supply.

During the 1970s and early 1980s, this was reflected in the traditional (but continual) adjustment of prices (ie inflation). Few will argue with the need to avert the rampant price inflation experience of this period. But if demand consistently exceeds supply, what are our other options ?

Two come to mind :  reduce demand

 increase supply

Simple, really.

Earlier in NZ's economic history, the excess of demand over supply has been reflected by the need to regulate or control demand (usually in the form of punitive restrictions on the level of allowable imports).

During the 1990s, demand has been controlled through implementing (when appropriate) tight monetary conditions. In so doing however, the gap between demand and supply has been exacerbated. This occurs because our chosen adjustment mechanism (monetary policy) has repercussions during the very process of adjustment. In particular, raising interest rates discourages investment, thereby harming capacity and ultimately our ability to supply. Thence the gap between demand and supply grows larger. Nevertheless, the excess of demand over supply continues to be reflected in the need to import increasing quantities to fill the gap between demand and supply.

The common element in both the pre-1970s and the 1990s examples are their focus on the reduction (or at least control) of demand. Thus we continually 'live in fear of full employment' and move to dampen demand when capacity constraints arise (ie when demand looks like exceeding our ability to supply).

The doctrine of the pre-emptive strike against inflation, becomes self-immolating as the fixation with reducing demand will ultimately work against the desire to rectify the gap between demand and supply.

Of course, there is the other option - increasing supply. Or to use the correct jargon, enhance and increase capacity to improve our ability to satisfactorily meet demand.

Become cleverer; adopt and/or adapt new technology; work harder; et cetera.

Of course, the incentives have got to be in place for these virtuous events to occur. The principal incentive undoubtedly is the prospect of good rewards in the form of being able to profit from one's endeavours.

None of this is new, despite many observing the US experience of the 1990s and giving it a new name.

The critical aspect is investment - in equipment (technology, machines, buildings, infrastructure) as well as people. For that has implications on both the demand and supply sides of the equation. Thus both the demand and supply sides of the equation are unambiguously inter-twined. If this is accepted, then both demand and supply issues should surely be addressed in a co-ordinated manner.

By assigning control of demand to monetary authorities (with little incentive for it to address the supply side), while hiving-off supply or capacity-enhancing aims to an economic development agency (or such like) misses the central point of the inter-relatedness of supply and demand.

ENDS

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