Cullen's new tack rattles economists

By Felicity Anderson, Nzoom.com Business News Editor

Friday 24th May 2002

Economists are nervous about two key elements of Budget 2002.

They are worried Treasury's forecasts of surpluses both the upside and downside projections are overly optimistic.

But they're potentially more jitttery about Finance Minister Michael Cullen's shift away from placing a fiscal cap on government spending over the next three years should Labour be re-elected.

Economists teams from major New Zealand's banks agree on one point if Cullen gets to keep his hand on the government's books, they'll be watching the quality of his future spending closely for effects on the economy.

The National Bank's team says the current spending cap meant the government had to prioritise spending.

Cullen gave the government $6.125 billion (after one slight addition) over three years and the operating books show it has spent all but $230 million of it. That's being kept in the larder for now in case a worthy, hungry visitor requires sustenance.

"The move to a very loose fiscal management tool centred around the government's long-term intentions has upped the ante on both fiscal slippage and lower quality expenditure," the National Bank team says.

"Meeting projections (operating surplus and bond tender program) will require strong fiscal discipline post election.

"According to the Treasury's projections the fiscal stance is expected to be contractionary for the next four years. The spending assumption built into the fiscal forecasts look light on reality."

ANZ's team says Cullen has acknowledged there are potential problems with the 'cap' system, such as the incentive to reclassify operating expenses as capital investment to avoid the restriction.

But it says his proposed new system of provisions based on broad long term objectives could prove "rubbery" and potentially reinforces the upside risks to expenditure projections.

Under Cullen's new proposal, a system of fiscal provisions will be introduced these will be determined by the amounts that can be spent while still maintaining longer term fiscal objectives (such as achieving and maintaining gross crown debt below 30% of GDP).

On the basis of current projections, the Government sees this providing scope for operating expense growth of around 2.5% per annum and capital investment of $500billion - $600 billion per annum.

Westpac's team says there is more to being prudent than achieving operating surpluses. The level and quality of spending, the type of taxation and the design of government policies are what matter most for economic growth.

It say despite the fact that the budget balance is expected to be around 2% of GDP in the current fiscal year and forecast to increase to 3% in 2006, it is important not to be complacent about the numbers.

A difficulty with the budget balances is that they do not account for the effect of the economic cycle, it says. During an economic expansion, tax revenues will increase and some expenditure (such as unemployment benefits) will fall.

"With the NZ economy currently in an expansion phase, some of the budget surplus will be the result of the economic cycle rather than a moderation in discretionary government spending. Once the impact of the economic cycle is taken account of, the budget surpluses are significantly reduced."

The Westpac team is also somewhat critical of the government's capital spending agenda.

"Over their first term in office the government is expected to have spent an additional $4.2 billion on major capital expenditures.

"Just over $1 billion of this is for private sector activity, which does not fill a public policy need and may, in fact, lead to higher interest rates and the 'crowding out' of private sector investment."

It also signals that the government's additional $3.5 billion spend on capital over the next three years is taking place outside of the operating accounts and isn't reflected in the budget balance.

Deutsche Bank's team made one other interesting observation, based on the Treasury's forecasts.

"Treasury's projections in the Budget assume the 90 Day bank bill rate peaking at around 6.1% some 90bps lower than projected by the RBNZ and then settling at around 6%," the bank's economists note.

"The Treasury clearly sees less pressure on inflation than does the RBNZ. The tension between the Treasury's view (which is likely to be shared by the Finance Minister) and the RBNZ's view could have a bearing on who is appointed to replace Dr Brash as Governor of the Bank.

"Comments made by the Minister's Economic Advisor suggested that a revised Policy Targets Agreement is not out of the question when a new Governor is appointed."

Deutsche Bank thinks the chances of this occurring will be heightened if the RBNZ hikes rates aggressively over coming months without strong evidence to justify such action.

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