IMF calls on Govt, Opposition to keep fiscal policy tight to help RBNZ withdraw stimulus from economy growing above trend; NZ$ 5-15% over-valued

By Bernard Hickey

The International Monetary Fund has delivered its annual verdict on the New Zealand economy, calling on whoever is in Government after the September 20 General Election to keep budget policy tight to help the Reserve Bank contain inflationary pressures in an economy growing faster than trend.

"If there are revenue surprises, they should be used to pay down debt," IMF Asia Pacific Division Chief Brian Aitken told reporters in Wellington as the IMF released its 'Article IV' consultation document on the New Zealand economy.

The IMF said the Government's plan to return to budget surplus by 2014/15 would help keep its favourable standing with foreign creditors "against the background of relatively high net foreign liabilities, and create space to cope with future economic shocks and deal with aging and health care costs that are expected to incrase over the long term."

"Deficit reduction also has an important role to play in supporting monetary policy through the current cycle by making room for increases in private sector and earthquake related reconstruction spending," the IMF said.

"The Government's ongoing deficit reduction plan should also ease pressure on the exchange rate by boosting national saving," it said.

Aitken said the New Zealand dollar was still "a bit stronger" than the IMF would like it to be, estimating it was between 5% and 15% over-valued. Aitken said during last year's visit the New Zealand dollar was around 15% over-valued.

China slowdown?

Aitken said a sharp slowdown in China was the main external threat to New Zealand's outlook, given around two thirds of New Zealand's goods exports were now sent to China, Australia and other parts of Asia. However, he said the IMF did not see evidence of an imminent slide in China's growth rate.

"As such, any adverse development would have a substantial impact of New Zealand's terms of trade," the IMF said, adding that the withdrawal of unconventional monetary stimulus by central banks such as the Federal Reserve could also create turmoil in emerging markets.

'Elevated' Auckland house prices

Aitken said New Zealand's house prices appeared elevated by historical and international comparisons of affordability.

"With house price inflaiton running high, there remains the risk that expectations-driven, self reinforcing demand dynamics and price over-shooting could take hold," the IMF said.

"The Government's steps to help eleviate supply bottlenecks, measures to tighten standards for mortgage lending, and an increase in mortgage rates should help ease price pressures," it said.

"But a sudden price correction--possibly triggered by a shock to household incomes or borrowing costs--could reduce consumer confidence, impact overall economic activity, and hurt banks' balance sheets."

It pointed to a scenario where a sharp Chinese slowdown shocked the New Zealand economy.

"For example, a sharp slowdown in CHina could weaken growth prospects in Australia, triggering a broad-based fall in demand for New Zealand's exports, and lead to a sudden decline in house, farm and commercial real estate prices," it said.

"This in turn could weaken consumer demand and negatively affect banks' balance sheets and their willingness to lend. The downside macroeconomic impact in a scenario where shocks compound each other could be large."

High LVR policy supported

The IMF said it supported the Reserve Bank's macro-prudential policies, including its 'speed limit' on high LVR lending.

"Some recent data suggest that the measures have had an impact, cooling mortgage lending," it said.

Finance Minister Bill English put out the following statement:

IMF backs NZ’s economic, fiscal policy approach

Confirmation from the International Monetary Fund that New Zealand’s growth prospects have improved and that its macro-economic framework remains sound is a welcome further endorsement of the Government’s economic programme, Finance Minister Bill English says.

As the IMF notes in its concluding statement issued today, New Zealand’s economic expansion is becoming increasingly embedded and broad-based. It forecasts annual economic growth will increase to about 3.5 per cent this year.

“It’s encouraging that the IMF has again noted that our macro-economic framework remains sound and provides policy space to respond to adverse shocks,” Mr English says

“In particular, it concludes the Government’s focus on returning to surplus next year will help to preserve its favourable standing with external creditors against New Zealand’s background of relatively high net foreign liabilities.

“I also agree with the IMF that New Zealand faces some risks, including globally from any downturn in the fortunes of China and the rest of Asia, and on the domestic front from issues around housing affordability.

“As the IMF notes, the Government’s steps to help alleviate housing supply bottlenecks and the Reserve Bank’s measures to tighten mortgage lending and to raise interest rates should help to ease house price pressures.

“The Government’s fiscal deficit reduction programme is also expected to take some pressure off the exchange rate, as the IMF acknowledges.

“So this latest report on New Zealand confirms we remain on the right track to build a faster-growing economy and to manage the global and domestic risks that might come our way,” Mr English says. “That’s important if we are to support more jobs and higher incomes for New Zealand families.”