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Towards the end of November, both the Prime Minister and the Finance Minister warned that the budget surplus that was projected to be achieved in the current financial year might not now happen until financial year 2015/16.
In its Pre-election Economic and Fiscal Update, released in August, the Treasury projected a surplus of $297 million in the year ending 30 June 2015. This was lower than the $372 million surplus projected at the time of the May Budget.
Now, however, there are concerns that the $297 million surplus projected in August may turn into a projected deficit when the Treasury publishes its Half-year Economic and Fiscal Update on 16 December.
The question is: why? After all, the economy is growing at above its long-term average rate, and this should result in good growth in tax revenues. Equally, falling unemployment and a relatively thrifty public sector management ought to constrain expenditure growth.
The problem, though, is that tax revenues have not been growing as rapidly as anticipated, and it seems that low inflation and commodity prices (especially milk) are to blame.
A low rate of inflation is often a sign of economic health. But, if the rate is lower than expected, it can be problematic in terms of government revenue.
Taxes are levied on actual income and expenditure. So, for any given level of activity (production or employment) in the economy, a 2% rate of inflation will result in more tax revenues than a 1% rate of inflation. A higher rate of inflation will also tend to cause personal incomes, and hence PAYE revenues, to creep into higher tax brackets.
The Reserve Bank of New Zealand has the target of keeping inflation at between 1% and 3% of the medium term, with a focus on keeping future average inflation near the 2% target midpoint. Broadly speaking, the Treasury’s tax projections assume that inflation will hit the 2% target in the medium term, so the projections start to go awry when inflation falls below the target.
And this is exactly what has happened of late. As the chart illustrates, inflation has been below the 2% target midpoint since late 2011. The rate fell below the bottom of the target range between mid-2012 and mid-2013, and the latest figure suggests that this could soon happen again.
Sharply lower prices for milk powder on international markets are also likely to be having a depressing effect on the rural economy and tax revenues.
The chart below implies that the price of whole milk powder fell by more than half between mid-January and mid-November this year. This largely explains why Fonterra have cut their forecast milk pay-out from $8.65/kg milk solids in 2013/14 to $5.30/kg milk solids in 2014/15. Based on current production levels, this reduction will cut total dairy farm incomes in New Zealand by around $5.5 billion.
New Zealand’s merchandise trade deficit in October was $908 million. This compares with a deficit of $169 million in October 2013.
Underlying this increased trade deficit was a 5.1% decrease in exports (from $4,241 million in October 2013, to $4,026 million in October 2014) and an 11.9% increase in imports (from $4,410 million in October 2013, to $4,935 million in October 2014).
Exports to New Zealand’s largest trading partner, China, fell by 40.4% (from $1,071 million in October 2013, to $638 million in October 2014), while imports from China increased by 18.1% (from $796 million in October 2013, to $940 million in October 2014).
Reflecting the whole milk powder price collapse, referred to above, the value of milk powder, butter and cheese exports were down 24% (from $1,501 million in October 2013, to $1,140 million in October 2014). The largest growth in the value of imports was related to aircraft and other vehicles and parts, which saw imports rise by 33%, to $777 million over the same period.
The value of exports and imports can vary greatly from month to month. This is especially true of imports, where exceptional items, like an aircraft, can distort the figures. But, there were no exceptional items in the October 2014 trade figures, and this implies that the deterioration in New Zealand’s trade performance was genuine.
However, the longer-term trend in the balance of trade is unclear. The annual trade balance in October 2014 (at $107 million surplus) is noticeably improved from the deficits of the pre-2008 period. Data over recent months suggest ongoing improvements may not be sustained.
The results from the Household Labour Force Survey for September 2014 showed that, compared to a year earlier, the total number of people in employment had increased by 70,400 (or by 3.2%), to a total of 2,332,200. Over the same period, the total number of unemployed people had decreased by 14,000, to a total of 134,300, and the unemployment rate had fallen to 5.4%.
The number of people in employment was the highest on record, and was 189,000 (or 8.8%) more than the number at the time of the previous trough in the September 2009 quarter.
The graph below indicates that employment growth has accelerated significantly since pausing between 2011 and 2012.
Another feature of the growth in employment is that it appears to be spreading to include more regions of the country. Employment is still growing most in Canterbury and Auckland, but all regions, apart from Wellington and the Bay of Plenty, experienced some employment growth between September 2013 and September 2014.
Employment growth has also occurred in more sectors of the economy during the latest four quarters than previously. However, building and construction still dominates, accounting for around half the employment growth during the last year.
The number of unemployed people and the unemployment rate in the latest quarter were both around the same as in late-2008/early-2009, before the full force of the Global Financial Crisis was felt.
However, one of the most interesting features of the figures is that the decline in the number of unemployed people has been much smaller than the increase in the number of people in employment.
During the last year, for example, the growth in the number of people in employment has been five times the reduction in the number of unemployed people. This implies that the large majority of jobs that created have been filled by people who are new to the labour force. It also raises the question of whether the effective minimum level of unemployment is now greater than it has been in the past.
It is probably too early to answer the question definitively, but the emerging evidence suggests that it might be true. In the mid-2000s, for example, the unemployment rate varied around 3.5%-4.0%, but most forecasters appear to think that the rate will not drop much below 5.0% in the foreseeable future, even with continued steady economic growth.
In the year to October 2014, New Zealand experienced its highest-ever net gain of 47,700 migrants. Until the August 2014 year (43,500), the high was 42,500 in the May 2003. Over the last 20 years (December 1994–2013 years), New Zealand's annual net inflow of migrants averaged 11,700.
The record was driven by both more arrivals and fewer departures of permanent and long-term migrants. Migrant arrivals reached a new high of 107,200 in the year to October, while migrant departures numbered 59,500.
Just less than a third of the arriving migrants were New Zealand and Australian citizens. And roughly another one third were arrivals with work visas. Many of those in these two groups will have come, or returned, to New Zealand to take advantage of the relatively favourable labour market conditions.
The size of these two groups in part explains why the number of unemployed people in New Zealand did not fall by more than it did, although there were other factors in play.
Around one fifth of the permanent and long term arrivals were on student visas, and more than half of these were from India or China.
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