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War Uncertainty

War Uncertainty

This Wednesday the NZ Treasury released a seven page briefing to the Finance Minister on the impact on the New Zealand economy of the Iraqi conflict. Unsurprisingly given the massive uncertainties involved they reached no firm conclusions beyond a simple one that because of the sheer uncertainty the outlook for world growth this year is not as good as when they put their last Economic and Fiscal Update together back in December. All they could do – and all we could do in a similar exercise – is note the range of possible scenarios, the means by which the NZ economy would be affected by the scenarios, and possible Reserve Bank responses.

They noted that specialist analysts in the field have decided there are four most probable scenarios

Full Iraqi capitulation to UN demands with no war. A short war with US/UN victory similar to the 1991 Gulf War. A drawn out conflict with terrorist/war attacks in the US and Europe. Something in between the short and long war scenarios.

The way in which each of these scenarios affected NZ would be via the following routes.

Lower demand for NZ exports, especially tourism. Lower prices for NZ exports. Higher oil import prices. Reduced business and consumer confidence. Weak and volatile sharemarkets. Exchange rate changes.

Under the no war scenario we are likely to see positives all around by and large with the widely expected rebound in US growth later this year happening early, rallying sharemarkets, falling oil prices and rebounding confidence. But Treasury note that there are some fundamental concerns about the US economy – such as the large current account deficit – and these could still leave the US economy weak if not headed for another recession even if the war scenario is confirmed as avoided and Iraq fully disarms as demanded in the next few months.

Under the quick conflict scenario export prices may not drop much, but a volume effect would eat into returns from manufactured exports. Tourist numbers would fall away as they did after the September 2001 terrorist attacks but then recover quickly. A short-lived sharp jump in oil prices would have little impact in NZ as firms would probably absorb the cost rise long enough for a short war to be concluded. Business and consumer confidence levels would fall sharply, but Treasury (and we) feel there is sufficient momentum in the domestic economy to prevent a large economic impact. Share prices would weaken but not have much impact on spending decisions in New Zealand, while the exchange rate would jump about – with Treasury not taking a punt on which way it would go. Given we would expect a weak greenback under any war scenario we see the short-lived conflict scenario producing a quick rise in the NZD.

All up, a short conflict is seen as having only a brief negative impact on the NZ economy, though this impact may be greater than what happened after September 2001 because of the absence of the low currency which still prevailed back then and lower commodity prices now.

It is of course the long drawn out war of the fourth scenario which is most worrying, and here while Treasury refrain from saying we would have a recession, the longer the conflict the greater the chance this happens. To whit, under the long war scenario they see the following.

A prolonged drop in tourist numbers, especially with airlines reacting to sustained high oil prices by lifting airfares. A potential negative impact on the international education market as families keep children at home while the conflict continues. More severe weakness in manufactured goods exports, especially if the destination for most of them – Australia – suffers badly. Lower commodity export prices due to actual and expected sustained weak world growth. Sustained high oil prices which would drive global inflation up, generate second round inflation effects in NZ, and potentially lead to tighter monetary policy in New Zealand. High oil prices would also cut household expenditure available for other items. Possibly falling job numbers.

Effectively, all we have from Treasury and all we have been able to discuss with interested parties ourselves is a list of the transmission mechanism by which a conflict in Iraq would affect us here. Of importance is the fact that our economy is in less robust shape than after September 2001 with a negative currency effect now feeding through, farm incomes falling rather than rising to record levels assisted by good weather versus dry conditions now, and a housing upturn starting whereas it will peak naturally later this year. Our central expectation is of a short conflict, but like everyone else all we can is wait and see with the knowledge that whatever happens there are sure to be some big surprises which generate substantial volatility in the financial markets.

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