[This is the IMF's summary of its latest Review of New Zealand.]
On September 20, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with New Zealand, and considered and endorsed the staff appraisal without a meeting on a lapse-of-time basis.
Some key drivers of New Zealand’s strong growth through 2016—reconstruction spending after the 2011 earthquake, a sustained wave of high net migration, a housing boom, and strong terms of trade—weakened in 2017-18. Despite the long expansion, inflation has remained unusually weak, reflecting partly imported disinflation and partly the boost to labor supply from net migration.
Economic growth picked up in early 2019 after slowing in the second half of 2018. The pickup mostly reflected a rebound in private business investment growth. Residential investment also strengthened, notwithstanding cooling housing markets. The Reserve Bank of New Zealand (RBNZ)’s measures of underlying inflation remained between ½ and ¼ of a percentage point below the 2 percent midpoint of the target range. The unemployment rate declined below 4 percent in the second quarter of 2019. Wage inflation has picked up, partly reflecting the rise in the minimum wage in April 2018 and 2019.
The current account deficit widened to 3.8 percent of GDP in 2018, reflecting a decline in the terms of trade. The external position was weaker than implied by medium-term fundamentals and policy settings, while the New Zealand dollar was moderately overvalued.
Bank lending continued to slow across all sectors, growing now broadly in line with nominal GDP. Banks strengthened their lending standards, although the recent modest easing in the RBNZ’s loan-to-value ratio (LVR) restrictions in January 2018 and January 2019 has led to a renewed uptick in new high-LVR loans. The RBNZ has proposed an increase in capital requirements to lower the probability of bank failure. The ongoing Phase Two of the Review of the RBNZ Act focuses on updating its regulatory, supervisory, and macroprudential functions.
Housing markets cooled but affordability constraints remain. The cooling reflects a tightening in banks’ mortgage lending standards, the tightening of LVR restrictions by the RBNZ during 2016-17, and declining affordability. The government is refocusing elements of its multipronged approach to improve housing affordability.
Within the greater focus on wellbeing under the Living Standards Framework, the government has a roster of policies to foster productivity growth. These include introducing an R&D tax credit regime, continuing to increase education spending, creating a New Zealand Infrastructure Commission to enhance procurement and delivery and set up of an infrastructure pipeline, using wage increases to further more inclusive growth, and fostering regional development through the Provincial Growth Fund and greater focus on regional immigration to align immigration of skilled labor with employers’ needs in the regions.
Executive Board Assessment
In concluding the 2019 Article IV consultation with New Zealand, Executive Directors endorsed the staff’s appraisal, as follows:
New Zealand’s economic expansion is still solid. Despite the loss of momentum in economic activity and a cooling in housing markets, output has remained close to potential, and the unemployment rate has continued to decline. Broader price and wage pressures have not yet emerged even though the economy has operated close to capacity for some time. The external position was weaker than implied by medium-term fundamentals and policy settings.
Economic growth is expected to remain close to that of potential output, but risks to the growth outlook are tilted to the downside. After increasing in early 2019, growth is expected to strengthen further in 2019-20 on the back of monetary and fiscal policy support, eventually leading to a small positive output gap and a gradual acceleration of inflation towards the 2 percent midpoint of the RBNZ’s target range. Downside risks to the economic outlook in New Zealand have increased, however, reflecting higher downside risks to the global economic outlook.
The recent monetary policy easing fits the subdued inflation conditions and near-term risks to the outlook. Economic growth is only expected to remain close to potential on the back of a timely increase in macroeconomic policy support. Such support remains critical until underlying domestic demand and inflation have strengthened more durably. With downside risks to growth, employment, and inflation, insufficient monetary accommodation still is a bigger concern than the upside risk to inflation if the monetary policy stance were to turn out to be too expansionary.
Fiscal policy strikes an adequate balance between near-term demand support and maintaining prudent debt levels. The FY2019/20 budget supports new wellbeing initiatives and should provide modest near-term stimulus to aggregate demand. While New Zealand has substantial fiscal space, the continued emphasis on meeting the medium-term debt objectives highlights the government’s commitment to maintaining the fiscal buffers needed to respond to potential large economic downturns and other contingencies such as natural disasters. The planned move from time-bound point targets for net public debt to a target range of 15 to 25 percent of GDP as a medium-term debt anchor provides for a welcome increase in flexibility.
The New Zealand authorities should prepare contingent policy responses in the event of a severe economic downturn. With the policy rate approaching its effective lower bound, the RBNZ will likely have to resort to an unconventional monetary policy response. On the fiscal side, readiness for a timely, effective response, given long implementation lags, especially in capital spending, will be essential.
The scope for easing macroprudential restrictions is limited, given still-high macrofinancial vulnerabilities. The combined impact of the LVR settings and tighter bank lending standards has led to a decline in riskier mortgages in bank assets. While house price inflation and credit growth have moderated, any further easing of LVR restrictions should consider the possible impact on banks’ prudential lending standards, as well as the risks to financial stability from high household debt.
The proposed higher capital conservation buffers would provide for a welcome increase in banking system resilience. The new requirements would increase bank capital to levels that are commensurate with the systemic financial risks emanating from the banking system. Starting from a relatively strong position, there is scope for some flexibility when setting some parameters in the revised capital framework, including the length of the phase-in period and types of capital within the buffers. The new framework should also differentiate more between large and small banks. A stronger bank supervision regime would still be needed, to complement the higher capital requirements.
The main reforms envisaged in the ongoing Phase Two of the Review of the RBNZ Act should increase financial system resilience. The upgrades to the regulatory and supervisory framework would advance key areas of reform identified in the IMF’s 2017 Financial Sector Assessment Program, including enhancing the RBNZ’s resources and operational independence for its supervisory and regulatory functions, broadening the macroprudential toolkit, and introducing a deposit insurance framework.
Mitigating supply constraints is critical for housing affordability and requires further progress in the government’s comprehensive housing policy agenda. The reform of the institutional structure, including the establishment of the Ministry of Housing and Urban Development, should help in implementing housing policies. Further work is needed to complete the agenda, including enabling local councils to actively plan for and increase housing supply growth. Tax reform, such as a tax on all vacant land, should also be considered.
Addressing long-standing low productivity growth continues to be a central concern. In this respect, some important first steps have been taken, including the introduction of a new R&D tax credit regime; the creation of the New Zealand Infrastructure Commission to help in closing infrastructure gaps; and the reform of the vocational education and training sector.