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Tunnel at the end of the light never came for NZ economy in 2004

By Simon Louisson of NZPA

Wednesday 29th December 2004

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2004 fitted the quip that economists will keep forecasting the downturn until the economy gets its right.

The tunnel at the end of the light never came for the economy in 2004 and there appears a reasonable prospect that may be repeated in 2005.

However, when the economists finally get it right, the landing may come with more of a thud.

For over two years they have been predicting a slowdown from the buoyant growth enjoyed virtually uninterrupted through the 2000s.

Not only did it not come this year, but growth accelerated.

Both the Reserve Bank and Treasury now expect growth in calendar 2004 to be 5.2% - near the top of the 30 member OECD class - although the September quarter's growth of 0.6% was below the RB's expectations.

Each is forecasting the rate to slow to around 2-2.5% by the second half of next year.

But don't fall over if they are wrong again and you hear mutterings of "upside surprises".

The National Bank's December survey of business confidence, which tends to be a good indicator of future growth, showed improving confidence, particularly in respect to businesses' own prospects.

The bank's chief economist John McDermott expressed surprise. He had expected the effects of the New Zealand dollar nudging post-float highs combined with the Reserve Bank's six interest rate hikes this year and surging oil prices would dampen enthusiasm.

So how has the expansionary period continued apace in the face of the Reserve Bank's best efforts to cool things for fear inflation will get out of control?

There have been two main drivers.

Firstly, commodity prices have soared so much that New Zealand's terms of trade (how many imports can be bought with a fixed quantity of exports) have hit a 30-year high. A very high correlation exists between New Zealand's terms of trade and economic growth.

Export prices have been underpinned by the global recovery and China's economic boom. Fonterra's recent announced lift in its forecast payout to dairy farmers is one factor that could give the expansion phase fresh legs.

Secondly, the domestic economy has been fuelled by a domestic consumption splurge, which in turn was driven by a hugely buoyant housing market which shows few signs of abating and the liveliest labour market in 20 years. High house prices encourage people to spend and more people in jobs helps virtually every indicator except inflation.

The Reserve Bank argues exporters will soon feel the pinch from the higher currency and domestic consumers will rein in spending because of very high household debt levels and as their fixed mortgages are rolled over into new loans at the higher rates.

However, the fact Governor Alan Bollard on December 9 signalled another rate rise, rather than a fall, suggests the Reserve Bank thinks the growth phase has not run its course.

One thing that has allowed the boom in the housing market and the economy in general to run and run has been the huge amount - over $10 billion this year - raised by foreign retail investors in New Zealand dollar-denominated bonds.

Japanese housewives and Belgian dentists attracted by New Zealand's high interest rates have bought the bonds at yields of 5-6%. That has been a relatively cheap source of finance for local banks that has allowed them to offer two-year mortgages not far above the Official Cash Rate.

Despite New Zealand's great growth spurt, Finance Minister Michael Cullen said the prospect of climbing to the top half of the OECD ladder in terms of per capita wealth remain dim. That is because Italy, the next country above, is a long way ahead. In fact Spain, which has had outstanding growth recently, may have overtaken New Zealand and the Czech Republic is snapping at our heels.

McDermott said the Government's goal of rising to top half of the OECD is "an aspiration we should have".

But he notes a lot of New Zealand's strong performance in the 200s was the result of "adding more inputs" - i.e. migrants coming to live here.

"On pure growth, we have been doing spectacularly well compared with the OECD but on a per capita growth basis not so flash -- just better than average. Certainly we've stopped falling down the ladder."

To climb, New Zealand's needs to maintain the progress it has had plus taste a little fortune, such as a further lift in terms of trade.

But the latter may not be luck. McDermott suggests New Zealand may be experiencing a jump shift in its terms of trade. The century-long fall in the real price of primary commodities such as meat and butter may be reversing.

New Zealand's share of households' spending through much of the twentieth century had been losing out to manufactured goods.

But greater wealth coupled with the September 11 terrorist attacks has seen the emphasis in Western eating habits shift towards quality and safety - something New Zealand has been able to cash in on. Further processing, better access to wealthy markets and the rising wealth of countries such as China and India has helped this process.

Parallel to this, there is a world glut in electronic goods which are becoming cheaper and cheaper.

"There has been a very subtle paradigm shift that has occurred over the last five years," McDermott said.

This has been disguised by the cyclical rise in commodity prices.

While New Zealand's commodity prices may still retreat they are likely to trend up.

"New Zealand has shifted into the positive side of that balance sheet so we have the potential to climb back up that OECD ladder," McDermott said.

In the meantime, he said the economy could easily run through 2005 at a brisk pace despite the strong currency and the cash rate being hiked 150 basis points. And even if it slows to the predicted 2 to 2.5%, that rate would have been seen as very respectable in the 1980s and 1990s.

McDermott warned the longer growth cycle continued beyond what is considered the sustainable rate, the more chance of a "hard landing".

"The reality is economies don't soft land - it's not how things unravel. You know that running at a pace of 4.5 to 5% economic growth is unsustainable.

"As we go forward, a nasty drought or another Asian-type crisis would be harder for us to bypass. The debt levels have increased, so debt servicing has increased accordingly, a lot of the foreign exchange cover corporates have been putting on is now running out."

A collapse in commodity prices and the terms of trade could knock the economy for six.

"Instead of having a gentle slowdown, it would be a bit of a thud."

If that happens, those from that discipline known as the "dismal science" will finally be able to congratulate themselves on being right.

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