Recession nearly over, says BNZ economist who called recession first (Update 4)

BNZ economist Stephen Toplis said New Zealand's economic recession was in its "death throes" as business and consumer confidence had climbed "significantly" off their lows. Toplis, head of research at BNZ, was the first bank economist to predict that New Zealand would enter recession back in March last year. (Update 4 includes comments on economic imbalances remaining.) New Zealand was the first Western economy to enter recession in the March quarter last year, and has so far had five consecutive quarters of negative Gross Domestic Product (GDP) growth, with the June quarter of 2009 expected to be the sixth. "The vast majority of leading indicators that we monitor now point to an improvement in the economy starting either late this year or early next," Toplis said. "Formally, we forecast that Q3 will be the first quarter in the next period of expansion but, realistically, it won't be until next year that the quarterly growth profile does anything but oscillate around zero," he said.

"Even then, it is notable that, despite the relatively optimistic outlook that we have, the level of activity in the economy does not get back to its December quarter 2007 peak until Q4 2010 or, possibly, early 2011." "Whatever the case, it's hard to see the substantive negative quarters for the six months ended March; meaning that, come what may, the cyclical trough in growth is now behind us." Housing market to lead the way Toplis said that the housing market was expected, perhaps ironically, to drive the first stages of the expansion in the economy after an apparent correction over the last few months. However, he pointed out that if house price inflation took off again, then this would put the recovery in danger. "In saying this, we are more focused on the potential for an uptick in construction activity than we are promoting a resurgence in house price inflation," Toplis said. "Indeed, if house price inflation takes off again, particularly if it is debt led, this would be a very bad sign for the economy implying that few had learnt anything from recent lessons and, in turn, condemning the household sector to a further relatively near term correction. Hopefully, the diminished supply of credit will keep inflation in check but it is not a given, particularly if our expected supply response does not eventuate," he said. Private consumption to follow housing Toplis said that an upturn in private consumption would follow on from housing activity, as seen in previous economic cycles. However, he noted this would be dependant on unemployment, which BNZ is forecasting to peak at 8% in 2010. This unemployment rate would be no worse than in the 1998 downturn, and much better than that in 1991/92, he said. "Household spending will be supported too by falling interest rates and the recent tax cuts. In addition, low or negative inflation across a number of goods and services will help prop up effective disposable income," Toplis said. "Spending should thus start to creep up by the end of this year, aided by net immigration," he said. "While this is our central view, the actual outcome will be heavily dependant on the offset to the positives that comes by way of falling employment and a rising unemployment rate which, in turn, will encourage a heightened savings rate for the household sector." "If the unemployment rate can be contained at the sort of level we are anticipating then we can feel comfortable with our household sector prognosis but if things turn nasty on us on this front then all bets are off." Dairy in for a tough year though Although there were "clear signs that commodity prices are up off their lows", Toplis argued that New Zealand's dairy sector may still face tough times over the next year in the face of increased protectionism in America and the European Union. "This, combined with falling land prices, will make life very difficult for the dairy sector over the next twelve months," he said. "Nonetheless, talk of ongoing disaster for the sector is misplaced. Already low global returns are resulting in major destocking in the dairy sectors of those nations who are less production-efficient than New Zealand. Eventually, this will result in diminished supply of product at the same time as global demand begins to pick up. Accordingly, in a cash flow sense, we believe the next twelve months will be the low in this cycle for dairy producers." Toplis said tourism was expected to lag the initial pick up in New Zealand, being a reflection of global growth. He added that the swine flu virus was an "added encumbrance" to a lift in tourism. But will NZ be fixed? "The major concern with the prognosis we are delivering is that it doesn't significantly correct the major imbalances that remain in the New Zealand economy. Namely: a significant current account deficit; a huge external debt position; insufficient household saving; widening fiscal imbalances," Toplis said. "New Zealand's external debt levels as a percentage of GDP are amongst the highest in the world "“ and not just the developed world. This leaves us perpetually vulnerable to the actions of the rest of the world particularly in terms of how this debt is funded," he said. "We see no short term solution to this problem. Indeed, with the current account deficit expected to stay relatively high as a percentage of GDP for the foreseeable future, it appears likely that foreign debt will rise further." Toplis said that the best that could be done to mitigate these future vulnerabilities was to ensure New Zealand's banking sector had secure funding lines and adequate protection in the event of funding disruption. This was what the RBNZ was currently focussing on, he said, with New Zealand banks required to maintain higher capital ratios, increase funds from New Zealand depositors, and lengthen funding. "What would be in the best interests of the economy, however, is that the household sector savings ratio improves over time as this would address all of the imbalances noted above while, at the same time, potentially alleviating some of the banking sector concerns that remain." "There is strong evidence currently that saving is rising. In part it is a precautionary objective due to the fear of potential unemployment; in part it is because households are throwing less speculative money around "“ especially that directed at the housing sector; and, in part because plummeting mortgage rates have allowed households to reduce the term and magnitude of their debt obligations more quickly than expected." With those imbalances it'll be a slow grind up from here Toplis said BNZ expected GDP growth would most likely average between 2% and 2.5% over the next decade, as opposed to the 3.5% over the previous decade. "What we can say with some certainty, however, is that the imbalances that remain will play a major part in constraining New Zealand's expansion for the foreseeable future. We think it imperative that all players in the economy recognise that growth in the years ahead will thus be lower than we have become accustomed to over the previous decade and that there will be greater vulnerability to the growth path," Toplis said. "The household sector will have to face up to an ongoing rebalancing of its balance sheet, which will see lower speculative investment activity and a higher level of saving. Higher saving, by definition, means a lower level of spending, which will eat into future retailing activity." "This process will be exacerbated by Government's own need to get its books into order. The deficits that are currently being run will result in a sharply rising debt profile." "In the first instance, the rising demand for funds will force interest rates, particularly at the longer end of the curve, higher and will crowd out business investment. This in turn means a lower level of economic activity." "More importantly, though, over the medium term Government will have to repay the debt build up currently under way. It has only four options: increase taxes; widen the tax base; reduce spending; and create an environment where productivity is boosted substantially. The focus will, clearly, go on the last option but, realistically, the most likely solutions are via a combination of the first three. This will, again, be growth limiting." "And for businesses, not only will they feel the fall out from the Government and household sector rebalancing but they will also have to face up to tougher access to credit, and higher costs for the privilege for borrowing. Both of which will limit future investment activity."