Budget 2016's debt repayment focus risks being lost opportunity to stoke economy

Friday 20th May 2016

The Treasury is likely to upgrade its forecasts for economic growth in Budget 2016 next week but Finance Minister Bill English has already signalled that more of his focus is on debt repayment than on fiscal stimulus or tax cuts.

English said last week that although government debt levels aren't high by international standards, "we could be stretched if another economic shock or natural disaster hit."

He's had plenty of evidence of the risks - net government debt soared from just 6 percent of gross domestic product in 2008 before the full impact of the global financial crisis hit, to reach 25.7 percent of GDP as at March 31 this year and the government's target is to bring that down to 20 percent of GDP by 2020. The Treasury's official forecast in December is for a more modest decline to 24 percent of GDP by then.

The budget cycle is designed as a no-surprises model and in the run-up to the May 26 announcement initiatives worth about $650 million have already been made public, ranging from cycle trail funding and health research to a tax package for small and medium-sized businesses worth $187 million over four years.

English says he can deliver on spending priorities even while reducing debt. But some economists question whether he risks missing an opportunity for the economy by not adopting a more stimulatory strategy.

"The ratings agencies would still be happy if fiscal policy was a little bit more stimulatory," said Nathan Penny, an economist at ASB Bank. "The National government has run a period of tight fiscal policy, putting aside Canterbury, to get back to surplus. Do we need to run surpluses out to the horizon? That's an open question."

Penny said debt at less than 30 percent of GDP is low by international standards.

One government agency that will be taking a strong interest in Budget 2016 is the Reserve Bank, which is currently projecting annual inflation will have remained below its target range for eight quarters in the three months ending Sept. 30, the longest undershoot since the target was introduced in 2002. In cutting the official cash rate a quarter point to 2.25 basis points on March 10, governor Graeme Wheeler said stimulus "is needed to support continued expansion in the New Zealand economy," which in turn would gradually nudge inflation back to the bank's 2 percent mid-point target.

"One argument we think has appeal is that with monetary policy there's only so much it can do in terms of generating growth, particularly when there is not much fiscal stimulus going into the economy," ASB's Penny said. "It would work better if it was working in tandem with fiscal policy."

Wheeler may not have much more lead in his pencil. The market is predicting a further OCR cut at the June 9 monetary policy statement or failing that the Aug. 11 MPS. But he has little real control over the biggest causes of weak inflation, from a tradable sector influenced by record low interest rates globally and a kiwi dollar driven by perceptions of Federal Reserve policy.

"While the fiscal stance looks set to be a little more expansionary in the near term, a greater focus on debt repayment will mean a modestly more contractionary fiscal stance over the forecast period," ANZ Bank New Zealand economists Cameron Bagrie and Philip Borkin said in their Budget 2016 preview. "All things being equal, this will keep pressure on monetary policy to remain more accommodative than would otherwise have been the case."

The government achieved a budget surplus of $414 million in 2015 on an operating balance before gains and losses (obegal) basis, a turnaround from 2011's $18.4 billion deficit. The Treasury is currently projecting a deficit of about $400 million for the current fiscal year before moving back into the black in coming years.

English said in last week's pre-Budget speech to the Wellington Chamber of Commerce that with a surplus delivered in 2015, the government is now "focusing more on repaying debt - and we’re less concerned with minor overs and unders in Treasury’s short-term obegal forecasts."

That doesn't mean the current fiscal year has no capacity for a positive surprise. The financial statements for the nine months ended March 31 showed an obegal surplus of $167 million, against a forecast of a deficit of $167 million in the Half Year Economic and Fiscal Update in December. Core Crown tax revenue was 1.4 percent ahead of forecast at $50.2 billion.

There is new spending - an allowance of $1 billion was made for Budget 2016 but this will now be increased to bring forward some of 2017's projected $2.5 billion allowance "in recognition of the additional spending pressures" as a result of migrant-driven population growth and "further opportunities to invest in better public services," English said.

A further chunk of 2017's allowance has been siphoned off to go on debt repayment, he said.

By contrast, the capital spending allowance, for one-off investments in infrastructure and other public assets, will undershoot the $1.7 billion previously flagged for Budget 2016 because some of the additional investment will be funded by reprioritising other areas of the Crown's balance sheet. All up the changes to allowances amount to a $1.2 billion reduction in spending over the nxt five years, "helping to further reduce debt and meet the government’s 2020 net debt target," English said.

One of his mantras is to spend money better rather than spend extra money.

ANZ's economists titled their preview "Rainy Day Coffers" and questioned whether debt repayment "should have such an overarching priority at this juncture". They say a small obegal surplus is possible this year. Health and education are likely to get the lion's share of extra funding in Budget 2016.

BusinessDesk.co.nz

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