Delay in economic recovery has led to ‘small deterioration in the fiscal forecasts’, Treasury says in its Half Year Economic and Fiscal Update as it expects a widening fiscal deficit and forecasts surplus to return in 2029/2030

Although there’s signs of emerging economic recovery, Treasury says a widening fiscal deficit is expected in 2025/2026 driven in part by the weak economy.

Released on Tuesday, the Half Year Economic and Fiscal Update 2025 (HYEFU) provides a statement on the Government’s fiscal position when it comes to economic and fiscal forecasts, analysis of the country’s fiscal position and some potential fiscal risks.

HYEFU is published alongside Finance Minister Nicola Willis’ Budget Policy Statement which looks ahead to Budget 2026.

In 2024, the Government adopted a new fiscal indicator called OBEGALx - this excludes the Accident Compensation Corporation (which is supposed to be a self-funding entity in the long-run).

OBEGAL (Operating Balance Before Gains and Losses) has been the standard measure of the Government’s annual spending since 2008. It excludes valuation changes which can impact the overall operating balance.

Treasury’s HYEFU, shared on Tuesday, also said the OBEGALx is forecast to return to surplus in 2029/2030.

Treasury said OBEGALx was forecast to deteriorate to a deficit of $13.9 billion in 2025/2026.

In Treasury's Financial Statements of the Government for the year ended June 30, OBEGALx was $9.3 billion. 

“As a share of Gross Domestic Product (GDP), it falls from -2.1% in 2024/2025 to -3.0% in 2025/2026. This will be the largest OBEGALx deficit as a share of GDP since the 2019/2020 year.”

Core Crown tax revenue was forecasted to decline as a share of GDP – to 27.3% in 2025/2026 from 27.9% in 2024/2025.

“We estimate around half of this decline is a result of the economic cycle and roughly one half is due to policy changes, in particular the impact of Investment Boost.”

Core Crown expenses – which the Government, as part of its fiscal strategy, wants to get towards 30% of GDP over time – is forecast to rise to 32.8% from 32.5%.

Treasury said this was due to a range of “cyclical, structural and one-off factors” including “higher unemployment benefits, increased superannuation payments, Budget decisions, the rephasing of expenditure and one-off impairments”.

Treasury said its estimate of the cyclically adjusted OBEGALx in 2025/2026 is -1.9% of GDP.

“This is the part of the deficit that will not resolve as the economy recovers. It suggests that only approximately one-third of the OBEGALx deficit will close as a direct result of the economic recovery."

“Correcting the other two-thirds is primarily delivered by actions to limit expenditure growth and improve Crown entity performance.”

When it came to OBEGALx and surplus, Treasury said it expected it to return to surplus in 2029/2030 as “a result of a rise in core Crown tax revenue as a share of GDP, a reduction in core Crown expenses as a share of GDP and improved Crown entity performance over the forecast period.”

Changes to the Emissions Trading Scheme revenue, New Zealand Superannuation Fund revenue and the timing of expenses has impacted OBEGALx over the forecast period.

“Overall, this is a relatively small deterioration compared with previous forecast changes.”

But the small OBEGALx surplus in May’s Budget Update in the 2029/2029 forecast has become a small deficit, and the return to OBEGALx surplus is now forecast in 2029/2030, Treasury said.

Treasury said there would be larger deficits driving an increase in net core Crown debt to GDP and a decline in net worth to GDP.

“Net core Crown debt is forecast to increase as a share of GDP until it reaches 46.9% in 2027/2028, due to additional borrowings to finance operating deficits and investments.”

In Treasury's Financial Statements of the Government for the year ended June 30, Net core Crown debt was at $182.2 billion. 

Treasury said this was then forecast to decline by the end of the forecast period and the forecast assumes capital allowances for new investments of $3.5 billion per Budget.

“Operating balance deficits are the main drivers of the deterioration in net worth attributable to the Crown, which is forecast to decline from 41.1% of GDP in 2024/2025 to 32.2% of GDP in 2029/2030. 

“Once the operating balance returns to surplus, net worth attributable to the Crown as a share of GDP is forecast to stabilise.”

Treasury said in the near term, the economic cycle is deeper and there is greater spare capacity. “The forecast economic recovery is delayed.”

When it came to risks to the forecasts, Treasury said there could be a more rapid cyclical upturn flowing from monetary policy easing together with strong terms of trade its projecting.

On the downside, Treasury said prolonged caution from firms and households could slow recovery more than forecasted.

Budget Policy Statement

In the Budget Policy Statement (BPS), which looks ahead to next year’s Budget, it said the Government would be focusing on health, education, defence, law and order.

“Spending restraint is realised by setting Budget operating and capital allowances,” the BPS said.

The Treasury described the operating allowance as: “The pool of net new operating funding available at each Budget for new policy initiatives or cost increases in existing policies.”

“The operating allowance can be allocated either to expenditure or revenue policy changes.

“Because most of the operating allowance is usually allocated to expenditure, it is often referred to as an allowance for new spending. However, Budget allowances are net concepts, where additional expenditure can be offset by savings, reprioritisation or additional revenue.”

And capital allowance was an indication of future capital expenditure, Treasury said. “The ultimate financial constraint is the fiscal strategy.”

Last Monday, Finance Minister Nicola Willis told Newstalk ZB that she did not intend to cut her operating allowances further than what they had published at the Budget.

And on Tuesday, the operating allowances for Budgets 2026, 2027 and 2028 remained at $2.4 billion.

Budget 2029 has been set at $2.4 billion.

The BPS said: “Any future adjustments would have to be consistent with the overarching objective to get the government’s books back in order and restore discipline to public spending.”

“Existing pre-commitments mean there is only $1 billion per year, on average, left to be allocated from the operating allowance for Budget 2026.

“Most agencies and Ministers will need to plan to manage service pressures and other commitments with little or no additional funding.”

When it came to capital allowance for Budgets 2026, 2027 and 2028 – this would remain at $3.5 billion. Budget 2029 has been set at $3.5 billion.

The Government’s fiscal strategy

In the previous BPS, the Government’s fiscal strategy was outlined as:

• Reducing core Crown expenses towards 30% of Gross Domestic Product (GDP) over time
• Returning OBEGAL to surplus by 2027/2028
• Putting net core Crown debt as a percentage of GDP on a downward trajectory towards 40% and in the longer term, keeping it below this percentage

While its fiscal strategy for 2025, as set out in this year’s Fiscal Strategy Report, is the same when it comes to core Crown expenses and net core Crown debt - there was a change to how it mentioned surplus, with it saying: “Return the headline operating balance measure to surplus.”

‘2026 is going to be better than 2025’

On Tuesday, Willis said the Government was sticking to its strategy of taking “a deliberate, medium-term approach to fiscal consolidation, and not over-reacting to movements in the forecasts”.

Willis said the Government is targeting an OBEGALx surplus in 2028/2029.

“Achieving these fiscal goals will require ongoing restraint and tight control of discretionary spending,” Willis said.

“As such, we have confirmed our operating allowances will not exceed $2.4 billion in next year’s Budget.”

Willis said: “2026 is going to be better than 2025.”