PM Key says NZ Government would delay move to surplus beyond 2014/15 and borrow more if Euro crisis worsens considerably

Prime Minister John Key has acknowledged the European debt crisis may prove worse than Treasury's Budget 2012 forecasts and the government would then choose to borrow more and delay its return to surplus from 2014/15 if the crisis worsened considerably.

Treasury told the government its economic forecasts in Budget 2012 were still their best judgement on where the New Zealand and world economies were headed, although the risk of a worsening situation in Europe had increased since the forecasts were finalised, Key told a post cabinet news conference in Wellington.

The economic forecasts for the May 24 Budget would have been finalised near the end of April, before a failed Greek election on May 6, and an anti-austerity vote in France's Presidential election.

Spain's borrowing costs have risen to unsustainable levels during May, and local data here has come in on the sluggish side. Unemployment unexpectedly jumped to 6.7% in early May, and the prices of dairy commodities sold at Fonterra's on-line auctions have hit a three-year low.

Speaking at his post-Cabinet press conference on Monday afternoon, Key said it was still too early to tell whether the latest concerns about Europe were just a temporary negative blip like those Treasury was incorporating into its forecasts. This happened at the end of 2011, before markets recovered again in the new year.

The forecasts already factored in a sharp recession across Europe.

However the risk of something worse happening in Europe had been increased by events during May, he said.

Key said the government would consider pushing its 2014/15 surplus track back if the European situation deteriorated considerably.

Asked whether the government would look to cut spending further if the crisis intensified, or whether the government would be prepared to borrow more if it had to extend the surplus track, Key said the government would likely borrow to bridge deterioration in tax revenue, rather than cutting schemes like Working for Families.

He said the Budget's main forecasts would show a small surplus in 2014/15. The size of the deficit in 2013/14 could be a positive surprise to Budget watchers, he said.

Greek elections, Spanish banks

Key noted developments over recent weeks in Europe had increased uncertainty in global markets.

“Anti-austerity parties are expected to do well in the second Greek elections in June, and the Greek banking system is under considerable pressure. Concerns are also growing around the Spanish banks, which were downgraded last week, and the Spanish government bond yields have been rising very sharply," Key said.

However it would be unwise to rush to judgement in terms of Treasury's forecasts, and whether they would now be out of date due to the events during May.

“We always knew that Europe would have its ups and downs. It’s important to differentiate whether these events are one of the downs we all expected, or whether they constitute something more fundamental," Key said.

“Volatility is of itself nothing new. You might recall that there was a real sense of crisis in Europe late last year, but this settled down in the new year as European government’s responded. So we have to see how things play out over a slightly longer period of time," he said.

“The advice we’ve had from Treasury is that the main Budget forecasts which you will see on Thursday remain its best judgement in the face of uncertainty about where the New Zealand economy is going. Those forecasts already factor in a good deal of weakness and volatility in Europe, including a sharp recession across the Euro area. However, it’s true to say that the risk of something worse happening in Europe has increased, even if the central scenario remains the same. So we are closely monitoring developments.”

If financial markets did tighten up, it was hugely important New Zealand was seen as a 'good risk,' Key said. The government was taking a responsible path of fiscal management by committing to a 2014/15 surplus.

If the crisis does worsen.....

Asked how the government would react if the European crisis worsened to a point where it had to either cut spending further or take on more debt, Key said the government had proven it could alter its course depending on the circumstances it faced.

“I think New Zealand certainly is in a vastly stronger position than it was back in 2008 when we became the government. But ultimately I don’t think we would, if we were required, tremendously change our spending patterns. What is more likely is that we’ll have less revenue – that will be the impact of an economic slowdown,” he said.

Asked whether the government would make cuts to policies like Working for Families, interest-free student loans or KiwiSaver, Key said, “that wouldn’t be my intention as I stand here today.”

“What would be more than likely to happen would be, there would be an economic slowdown, which would slow down the tax revenue we’ve got, and we might bridge that for a bit longer," he said.

“Overall, we’ve been very reluctant to aggressively go after those areas because we think New Zealanders rely on them. We think we’ve done the right thing."

Pushing the surplus back

While he wouldn’t be happy to push back the 2014/15 surplus target, Key said that might be beyond the government’s control if it resulted from a significant global slowdown. The government would not just cut spending for the sheer sake of reaching that target.

“But equally, the government’s been very focussed on trying to get back to surplus. And I think for very good reason. If there is further weakness in Europe, following the prescription the National-led government has is absolutely the right one," he said.

“We want to be on that list of countries that is seen as a good risk. That’s exactly the position that we’re in at the moment – our bond yields are coming down, it’s cheaper for New Zealand to raise money, and it’s cheaper for our companies and individuals to raise money. The last thing we’d want to do is abandon that target unless we really had to.”

Asked why the government was not borrowing more now seeing as its bond yields were so low, Key replied noted New Zealand’s high levels of private sector debt.

“We’ve made considerable assurances to the rating agencies that we intend to get back to surplus by 2014/15, and I don’t think it’s in New Zealand’s best interests to be borrowing money unless we absolutely need to,” he said.

Key noted his comments made in January that if the government needed to delay return to surplus, then it would be prepared to do so.

“But I don’t think that’s the situation we’re facing at the moment. I can’t be sure the way things unfold in Europe. But I will say we’ve been at this sort of situation before. We had it with the inability to renegotiate the new debt ceiling in the United States. We had it in Europe late last year," he said.

“Of course things could get a lot worse. But equally, this may be yet another storm that blows over.”

The government had not seen anything in its forecasts that showed the economy heading back into recession. Commodity prices were still relatively high, and the falling exchange rate was helping in that regard. Asia and Australia were still strong markets for New Zealand, and there was domestic stimulus from the Christchurch rebuild.

“So it’s always possible, but we’re in much better shape than most others.”

(Updates with quotes from Key)