Cablegate: New Zealand's Monetary Policy at Odds with Fiscal

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P 040652Z MAY 07





E.O. 12958: N/A

1) (U) SUMMARY: On April 26 the New Zealand Reserve Bank
(NZRB) raised the Official Cash Rate (OCR) by 25 basis
points, to 7.75 percent, citing inflationary pressures from
increased government expenditures and a sustained housing
boom. Financial experts believe this action is likely to push
floating mortgage rates, already hovering around 9.8%,
through the psychological double-digit barrier of 10%. Fixed
rate mortgages have also edged higher in recent weeks, with
benchmark two-year rates reaching 8.8%. The increase means
that mortgage holders face the highest interest rates in
nearly a decade. The OCR rise has also created a 23-year
high in the value of the Kiwi dollar, negatively affecting
exports and leading a number of export manufacturers to
announce they will leave New Zealand for cheaper destinations.

2) (U) Meanwhile, the OECD's 2007 economic survey of New
Zealand has rated the NZ economy well in the bottom half of
the OECD tables, in large part because of the high value of
the Kiwi dollar and high domestic interest rates. The report
also cites other weaknesses as New Zealand's large net
foreign debt and current account deficit, as well as falling
household savings levels. The report maintains that lower
government spending would make it easier for the NZRB to curb
inflation and stabilize the economy. The economy is by and
large still doing fairly well by global standards -- with GDP
growth predicted to reach 2% and unemployment remaining at
3.7%. But manufacturers' and exporters' concerns about the
high Kiwi dollar and interest rates are already being
exploited by the opposition National Party, which blames
Labour government's spending for the problems. To help
deflect criticism, Labour has asked Parliament to look into
ways to control inflation other than just adjusting the OCR.
Many analysts say such an inquiry will be a waste of time
unless the Government looks at aligning fiscal and monetary
policies. End Summary.

Effect of OCR Hike

3) (U) In announcing the interest rate hike, NZRB head Dr.
Alan Bollard attributed his decision to increase the OCR rate
to the robust housing market, increases in government
spending, a rising gap between the value of imports and
exports, ongoing high levels of immigration, and a strong
labor market. He also described the strength of the Kiwi
dollar as both "exceptional" by historical standards (at a 23
year high) and "unjustified" on medium-term economic data.
This was seen as a shot across the bow for the currency
markets but the warning was largely ignored, with the dollar
closing that day at US74.81c.

4) (U) Bollard's move prompted manufacturers, unions and
political parties to call on the Government to develop other
financial measures besides the OCR for controlling inflation.
Last week, one of New Zealand,s largest manufacturers of
consumer appliances, Fisher & Paykel said it would close its
Auckland washing-machine manufacturing plant and shift
production to Thailand, with the loss of some 350 jobs. Soon
thereafter bed-maker Sleepyhead said it may shift its plant
to China, putting another 400 jobs at risk. These lay-offs
follow announcements this past month from three large (by NZ
standards) Christchurch manufacturers, G. L. Bowron, Click
Clack and Whisper Gen, all of which blamed the high NZ dollar
for the need to downsize.

5) (U) The interest rate hike comes just days after the OECD
warned that GNZ's spending increases were likely to fuel
inflation and increase the exchange rate of the Kiwi dollar,
which would further exacerbate imbalances in the economy. All
eyes are now on Finance Minister Michael Cullen, who is due
to unveil the annual Budget in just three weeks time. In it
he is expected to include another $1.9NZ billion in new
expenditures, including $1bNZ worth of business tax cuts.
Analysts expect that if these increases are made the NZRB
will raise the OCR rate again at their next meeting in June,
to 8 percent.

OECD Adds Fuel to the Fire

6) (U) NZ's high interest rates have been given the thumbs

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down by the OECD as well. In a widely publicized report
released on 23rd April, the OECD ranked New Zealand,s
economy at 22 out of 30 OECD member countries. "What really
matters is that living standards are quite a lot below the
OECD median and they don't seem to be catching up," reported
Deborah Roseveare, who heads the OECD's New Zealand desk.
Despite ranking near the top for its policy and regulatory
framework, New Zealand's productivity and saving rates are
near the bottom. Roseveare added that the reforms of the
1980s and 90s were essential and had contributed to
productivity growth in the past but the OECD is puzzled as to
why New Zealand hasn't performed better. Part of the
explanation could be the huge swings in the Kiwi dollar's
exchange rate, which hinders exports, along with persistently
high interest rates, which discourage investment. "It's not
obvious what policy makers can do about it," maintained

7) (U) The OECD Economic Survey of New Zealand further
indicates that NZ faces the dual challenge of raising
national income levels and providing superannuation payments
for an aging population. The report says New Zealand needs
stronger and deeper financial markets as an alternative to
investment in housing, as well as a tax regime that
encourages people to work, save and invest. The OECD suggests
this goal could be achieved by flatter, more broadly based
tax system with lower private income and corporate tax rates
and a higher GST level. Or, there could be a dual system
which taxes capital gains along with private income. (NB: NZ
does not currently have a capital gains tax.) The survey
also recommends New Zealand cut the top private tax rate
(currently 39% for incomes of NZ$60,000 (US$45,000) and
above), raise the GST rate by 1% to 13.5%, raise the age of
superannuation entitlement (now 65 years) and find new ways
to control inflation other than raising the OCR. The OECD
survey concludes that the Reserve Bank will not be able to
lower the interest rates that are pushing up exchange rates
and household and business costs until the economy slows or
foreign investors suddenly lose confidence in New Zealand.

Political and Business Fallout

8) (U) One of the most politically sensitive remarks in the
OECD report claims that, "New Zealand's living standards,
whether measured by GDP or net national income per person,
lag well behind the OECD mean and median," but more
importantly well behind Australia (ranked 9) against whom NZ
constantly compares its standard of living. National Party's
finance spokesman, Bill English says that the OECD Survey
identifies, "Labour's spending binge in the lead-up to the
next election as one of the main causes of the high interest
rates, inflation, and high exchange rate bedeviling the
economy." Not surprisingly, Finance Minister Cullen says the
report proves that Labour's economic policies have given New
Zealand one of the most flexible and resilient economy in the

9) (U) Economic Development Minister Trevor Mallard said
giving the Reserve Bank new tools to fight inflation, beyond
its use of interest rates, would at a minimum require a
multi-party accord on monetary policy. He said such an
agreement is unlikely, however, given that the last time
Labour attempted to involve National in talks over another
option - the proposed tax on mortgage rates to slow the
housing market - the National Party swiftly condemned it.
Mallard also indicated that the Reserve Bank and the Treasury
were continuing to look at other ways to supplement the OCR
tool. Meanwhile, National's Finance Spokesman Bill English
has said he is not convinced other measures would work.
National blames high Government spending for NZ's
inflationary pressures.

10) (U) The political sniping has drawn Prime Minister Helen
Clark into the debate, and on May 2 she endorsed an inquiry
by the all-party Finance and Select Committee, chaired by
Labour's Shane Jones. The committee may examine capital gains
tax or a mortgage rate levy as an alternate means to further
NZRB rate hikes. Some pundits believe that neither of the two
main parties are likely to adopt these measures but are more
likely to focus on tightening tax rules on investment
properties and apply more vigilant policing of laws covering

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property speculation.

11. (U) Prominent business leaders also reacted to the
government's response by saying that any inquiry by a
parliamentary select committee into the pressures on
inflation and the export sector will be a waste of time if
the focus is only on monetary policy. They believe the
government needs to focus more on productivity-raising
measures such as staged tax reductions, freer employment law,
less regulation of the business sector, and more private
sector involvement in infrastructure and government business
enterprises. They maintain that inflation needs to be
controlled by reducing the growth in government spending to
below the growth rate of the economy so that more resources
are available to the productive sector.

© Scoop Media

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