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Treasury doubles central bank's forecast for drought impact

Monday 8th April 2013

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The Treasury forecasts the summer drought will knock 0.7 of a percentage point off annual economic growth, more than twice the 0.2 percent to 0.3 percent forecast by the Reserve Bank of New Zealand in its latest monetary policy statement, on March 14.

In commentary accompanying its monthly economic update, the Treasury says the spike in global dairy prices will help offset some of the drought's impact and that the rest of the national economy is feeling chipper, especially the two largest cities: Auckland and Christchurch.

With drought still not officially broken in many parts of the country, the Treasury assumes it gets no worse than it is now, "but that the impacts will continue to be felt for some time" and if dry, cold conditions were to set in, further downward revision would likely be required.

Most of the 0.7 percentage point impact on inflation-adjusted, or real, gross domestic product is likely to be contained in the current financial year. That means GDP growth in 2013 of about 2.0 percent, compared with the 2.7 percent forecast in last December's half year fiscal and economic update.

"However, we note that this estimate is more uncertain given the wide range of possible developments in agricultural prices and incomes," the Treasury said.

There would likely be offsets in the March quarter between lower milk production and earlier meat slaughter, with "the biggest negative impact" in the June quarter.

"Somewhat fortuitously, the domestic drought has coincided with tighter global dairy supply conditions that have contributed to a sharp increase in global prices (reflecting drought-induced supply fears) and also a potentially lower New Zealand dollar."

The new estimate also takes no account of the negative impact of GDP if hydro-electricity storage lakes remain below normal levels through winter, triggering electricity generation by more expensive gas-fired power stations.

There was also a possibility dry weather would produce upticks in some other sectors, including the wine industry, which expects a bumper vintage, and the hospitality and construction sectors.

The economic update included the impressions recorded from interviews by Treasury analysts of 40 firms nationwide in March, which found positive sentiment based on successful cost management by most firms rather than strong growth, and few firms reporting a profit squeeze in current conditions.

"In general, tax accountants expect 5 percent to 10 percent growth in profits this year" and there was an increase in mergers and acquisitions.

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