New Zealand: Staff Concluding Statement of Art IV Mission
New Zealand: Staff Concluding Statement of the 2019 Article IV Consultation Mission
June 25, 2019
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
• New Zealand’s economic expansion lost momentum recently. The near-term growth outlook is expected to improve on the back of a timely increase in macroeconomic policy support. Downside risks to the growth outlook have increased but New Zealand has the policy space to respond should such risks materialize.
• Macroeconomic policy settings are broadly appropriate, while macroprudential policy settings are attuned to macrofinancial vulnerabilities in the household sector, which have started to decline but remain elevated.
• Financial sector reform in the context of the Review of the Capital Adequacy Framework and the Review of the Reserve Bank of New Zealand Act should provide for a welcome further strengthening of the resilience of the financial system and regulatory framework.
• The government’s structural policy agenda appropriately focuses on reducing infrastructure gaps, increasing human capital, and lifting productivity, while seeking to make growth more inclusive and improve housing affordability.
New Zealand’s economic expansion is solid, but lost momentum recently. The slowing growth in the second half of 2018 primarily reflected weaker growth in gross fixed capital formation. Employment growth has slowed, but unemployment remains low. The Reserve Bank of New Zealand (RBNZ)’s measures of underlying inflation remained between ½ and ¼ of a percentage point below the 2 percent midpoint of the target range.
Housing markets have cooled but affordability constraints remain. The cooling reflected a tightening in banks’ mortgage lending standards, the tightening of loan-to-value ratio (LVR) restrictions by the RBNZ during 2016-17, and declining affordability. Bank lending has slowed across all sectors, growing now broadly in line with nominal GDP. The current account deficit widened to 3.8 percent of GDP in 2018, reflecting a decline in the terms of trade early in the year. The external position was weaker than implied by medium-term fundamentals and policy settings, while the New Zealand dollar was moderately overvalued.
Outlook and Risks
Economic growth is expected to strengthen in the near term and moderate to potential in the medium term. The strengthening in the second half of the year and in 2020 primarily reflects increased monetary and fiscal policy support, while the terms of trade are expected to continue supporting domestic demand. The near-term boost in growth should lead to a positive output gap and a gradual acceleration of inflation towards the 2 percent midpoint of the RBNZ’s target range. In the medium term, output growth is expected to moderate to that of potential, which itself will slow modestly, mostly because of labor supply growth decreasing with the expected gradual decline in net migration.
Risks to the outlook are increasingly tilted to the downside. On the domestic side, the fiscal stimulus could be less expansionary if policy implementation were to be more gradual than expected, and the domestic housing market cooling could morph into a downturn, either because of external shocks or diminished expectations. On the external side, global financial conditions could be tighter and dairy prices could be lower. Risks to global trade and growth from rising protectionism have increased, and this could have negative spillovers to the New Zealand economy, including through the impact on China and Australia, two key trading partners. High household debt remains a risk to economic growth and financial stability, and it could amplify the effects of large, adverse shocks. On the upside, in the near term, growth could be stronger if net migration were to decrease more slowly than expected or if the terms of trade were to be stronger.
Macroeconomic and Macroprudential Policy Settings Are Broadly Appropriate
The current monetary policy stance fits the subdued inflation conditions. The RBNZ lowered the cash rate from 1.75 to 1.5 percent in May 2019, reflecting a somewhat weaker inflation outlook. With renewed disinflation in internationally traded goods and services, a period of sustained growth above the economy’s full employment capacity is needed for underlying domestic inflation to rise further. With downside risks to growth, employment, and inflation, insufficient monetary accommodation still is a bigger concern than upside risks to inflation if the monetary policy stance turned out to be too expansionary.
The FY2019/20 budget strikes an appropriate balance between supporting policy priorities and maintaining prudent debt levels. The increase in operating and capital allowances compared to the Budget Policy Statement addresses cost and capacity pressure in the delivery of essential infrastructure and services with a rapidly growing population. It also supports new wellbeing initiatives, targeting mental health, child wellbeing, Māori and Pasifika aspirations, productivity, and digital transformation. The budget aims to meet the target for net debt of 20 percent of GDP by FY2021/22. While New Zealand has substantial fiscal space, the continued emphasis on meeting prudent medium-term debt objectives highlights the government’s commitment to budget discipline and to maintaining the fiscal buffers needed to respond to large economic downturns and other contingencies, which has served New Zealand well.
New Zealand’s sound fiscal framework has been strengthened further. The introduction of a target band for net public debt beyond FY2021/22 will provide a transparent medium-term public debt anchor for budget decisions, while avoiding the drawbacks of a narrow, time-bound debt target. The target range of 15 to 25 percent of GDP is prudent and maintains the fiscal buffer needed for the potentially large-scale fiscal policy response that might be required, given New Zealand’s vulnerabilities. At the same time, the range also provides the flexibility to let automatic stabilizers operate over the cycle and accommodate productive spending when appropriate. The new wellbeing budget framework allows the government to establish spending priorities that will further living standards. The prioritization of spending in the context of broader socio-economic and environmental indicators should also facilitate setting program objectives to ensure and monitor effectiveness.
The scope for easing macroprudential restrictions is limited, given still-high macrofinancial vulnerabilities. The shares of riskier home loans in bank assets (those with very high LVRs, high debt-to-income, and investor loans) has moderated due to the combined impact of the LVR settings and tighter bank lending standards. However, with the RBNZ’s recent easing of the LVR restrictions, improvements in some macroprudential risk factors such as credit growth have recently stalled or started to reverse. Further easing of LVR restrictions should consider the possible impact on banks’ prudential lending standards, as well as the risks to financial stability from elevated household debt.
Reforms to Strengthen Financial Sector Resilience
The proposed increase in bank capital adequacy requirements would provide for a welcome increase in the resilience of the banking system. The new requirements would increase bank capital to levels that are commensurate with the systemic financial risks emanating from the dominance of the four large banks with similar concentrated exposure to mortgages, business models and funding structures. The new buffer for domestic systemically important banks (D-SIB buffer) could be higher, with a corresponding decrease in the capital conservation buffer for all banks. The phase-in period should be sufficiently flexible to ease the transition. A stronger bank supervision regime would still be needed, to complement the higher capital requirements.
The ongoing Phase Two of the Review of the RBNZ Act is expected to advance key areas of reform identified in the IMF’s 2017 Financial Sector Assessment Program. Reforms should include enhancing the RBNZ’s resources and operational independence for the supervisory and regulatory functions, broadening the macroprudential toolkit, and introducing a deposit insurance framework and clarifying responsibilities and the overall framework for crisis management.
Fostering Housing Affordability
Mitigating supply constraints is critical for improving housing affordability. House prices are expected to continue rising under the baseline economic outlook. Demand for housing is likely to remain strong, given population growth and low interest rates, while the supply response is constrained, by land use and other restrictions, and construction costs are high. Improving housing affordability would reduce inequality and contribute to lower macrofinancial risks, and, in the longer term, make growth more sustainable. Supply-side reforms are central for broad improvements in affordability, although additional direct support might be required for some lower-income households.
The government has advanced in its comprehensive housing policy agenda. The establishment of the Ministry of Housing and Urban Development should help in implementing housing policies. The government entity Kāinga OraHomes and Communities is intended to become the lead developer for affordable homes and public housing. Steps have also been taken to support local governments’ infrastructure funding and financing to facilitate timely infrastructure provision. Further work is needed to complete the agenda, including enabling local councils to actively plan for and enable housing supply growth and planning reforms. The IMF team welcomes the government’s intention to consider adding elements of tax reform, such as a vacant land tax, to the agenda. A broad land tax would offer additional benefits. This comprehensive agenda should foster housing affordability on a non-discriminatory basis.
Supporting Wellbeing and More Inclusive Growth
Addressing low productivity growth will be central from a wellbeing perspective. New Zealand risks missing out on new technologies embodied in capital, as capital deepening has stalled in the current expansion. Within the greater focus on wellbeing using the Treasury’s Living Standards Framework, the government seeks to build on key recommendations, by the Productivity Commission and international organizations, to foster productivity growth, primarily by encouraging physical and human capital formation, but also by increasing the focus on complementary social objectives and housing affordability. In this respect, the IMF team welcomes the introduction of a new R&D tax credit regime, with a broad definition of R&D and focus on younger firms; the creation of the New Zealand Infrastructure Commission (NZIC) to help in closing infrastructure gaps; and the reform of the vocational education and training (VET) sector. It also welcomes the government’s commitment to achieving its emissions targets under the Paris Agreement and the intention to set up a framework for climate change policies.
The IMF team would like to thank the authorities and counterparts in the private sector, think tanks, and other organizations for frank and engaging discussions.