Big promises, Big bucks.
- An additional $50bn will be thrown into the Covid-recovery fund. These are large numbers, designed to alleviate the largest economic contraction on record.
- The Budget outlined sobering forecasts, huge deficits, ballooning debt, and a massive fiscal impulse. And there’s a lot more to be thrown into the fight.
- All of the increased DMO issuance, of +50bn this year, will be matched by RBNZ LSAP buying.
The widely anticipated “rebuilding together” Budget delivered broadly on what was expected. Importantly, there’s still plenty of room to deliver more, as and when needed. The Budget outlined sobering economic and fiscal forecasts, huge deficits, ballooning debt (net debt peaking at 53.6% of GDP by fiscal 2023), and a massive fiscal impulse. And the Government is planning to throw a lot more in to fight the fallout of Covid-19. On top of the $12.1bn announced in March, there’s an additional $50bn of spending – called the Covid-19 Response and Recovery Fund (CRRF). A total of $10.7bn of CRRF planned spending had already been announced, and this leaves just under $40bn left to allocate. Around $16bn of this was allocated today, with the highlights including:
- A targeted extension to the wage subsidy scheme of $3.2bn by a total of 12 weeks for businesses facing a massive 50% fall in revenue;
- Additional $3bn of infrastructure spending, which includes the construction of 8,000 social housing homes;
- $1.6bn targeted at trades and apprenticeships training package; and
- A $1.1bn environmental jobs package.
There’s a little over $20bn of unallocated cash left in the Covid war chest.
Fiscal accounts were mauled
The economic and fiscal forecasts were as expected, splashed in red ink. The tax take will fall this year and next. At the same time, the fiscal response to cushion the blow to the economy sees deficits blowout. Operating deficits (OBEGAL) quickly mount, hitting a peak of $29bn in the 2021 June year, which is equivalent to 10% of GDP. The deficits far exceed the previous deficits recorded following the GFC and Canterbury quakes. Net debt builds rapidly over the four-year forecast horizon, jumping to 30% of GDP by the end of June this year, and then hitting a peak of 53.6% in 2023. The resulting cash deficits generated need to be filled, and debt issuance is set to soar.
The DMO’s planned issuance has been expanded dramatically. On top of the $42bn of new gross issuance projected in HYEFU19, the DMO is planning an additional $148bn of issuance through to the 2024 fiscal year. That’s a total of $190bn over the next four years, including $69bn for the 2021 June year.
Treasury’s forecasts
Like other forecasts the economy will take a massive blow in the June quarter, and the Treasury is picking a 25%qoq fall. The economy is expected to be 10% smaller this year compared to 2019 – similar in magnitude to our view. Underlying these forecasts were assumptions around the length of time that NZ remains in the different alert-levels, with an ongoing de-escalation of restrictions this year. And an assumption on when the border is re-opened (from March next year). Economic output is expected to get back to pre-covid trends in a few years. We think the sharp recover feels a little too punchy, given the likely impact to NZ’s potential growth rate. Population growth is substantially weaker with the closure of borders, and business investment will likely be curtailed for some time. The unemployment rate is expected to peak at just under 10% in the September quarter before a rapid descent to 4.2% in two-years’ time. The peak is similar to most other forecasters (we have a 10.5% peak), but the rate of decline in the unemployment rate feels overly optimistic given the scale of the impact to the global economy. The Treasury expects further policy stimulus from the RBNZ, by didn’t explicitly state how much.
Given the pressure and tight timeframe of producing the Budget the Treasury effectively had two central economic forecasts. One that included all Covid-related policy initiatives up to April 20, and then another that assumed the entire $62bn of policy ammunition is spent.
The Treasury pointed to the heightened uncertainty in these forecasts using scenario analysis. Two scenarios were highlighted, which included a downside (slower recovery) and upside (moderate impact from Covid-19 ahead). The downside scenario assumes the economic shock from Covid-19 is more persistent than in the main forecast, and the CRRF is completely exhausted in order to support the economy. More business failures and more job losses set the scene for slower productivity growth and ultimately a slower economic recovery. And weaker demand means inflation remains lower for longer. Underpinning the upside scenario is the assumption that the tourism sector begins its recovery as early as the end of 2020. Reviving the tourism sector ASAP would surely encourage business activity and improve sentiment. Unemployment falls back to 5% by late 2021, and stronger demand sees inflation reach 2.0% by the end of 2024. Net core Crown debt also reaches a relatively lower peak given higher tax revenues and lower welfare expenses in this scenario.
Planned fiscal policy leads to a significant boost to the economy in the near-term according to Treasury’s fiscal impulse analysis. The rapid fiscal response seen since March contributes to an over 6% shot to output. The massive injection dwarfs the peak fiscal boost delivered during the GFC. From 2022 Fiscal policy will provide a net drag on growth as the temporary support provided to fight the fallout of Covid is withdrawn. By then, other parts of the economy will be well into their recovery (hopefully).
The DMO (and RBNZ) are busy
The DMO has a very busy schedule in the coming years. The NZDMO will issue $60bn in 2020/21, up from $10bn in HYEFU 2019 (+50bn). The forecast bond programmes for the 2021/2022, 2022/2023 and 2023/2024 years have also been revised higher, to NZ$40 billion, NZ$35 billion and NZ$30 billion respectively. At the same time, the RBNZ will purchase $60bn ($50bn on top of the already purchased $10bn) in nominal and inflation linked NZGBs (plus $3bn of LGFA debt). The symmetry in numbers is not to be ignored. The Government will issue an extra $50bn, the RBNZ will purchase an extra $50bn. Of course, they came up with these needs independently… But NZGB buyers will be comforted by the central bank’s takedown of the (extra) debt.
In total, the NZDMO is planning for $190bn of gross issuance over the next four years (see table 1 below).
The debt expansion comes in response to the large fiscal package planned, on top of ongoing increases to core departmental operating allowances, and a weaker tax take as nominal GDP falls.
Do not fear a significant blow out in interest rates. Expectations of growth and inflation, and risk premia drive interest rates. We are in a recession, and even the most optimistic forecasts don’t have a return to trend until 2022. Recessions kill inflation. And inflation expectations have been hammered by oversupplied oil markets, and expected discounting out of lockdown. Rising unemployment rates will likely cause a fall in house prices of ~9%, and wages growth will weaken as a result. Term premia is negative in New Zealand, and the Sovereign’s credit rating remains as high as it gets. Government bonds rates will remain lower for even longer in the new world. The RBNZ will make sure of it. Interest rates will only rise when we are truly comfortable the economy has been reflated. And that’s what we will want to see.
Market reaction
The NZD never really recovered from its steep descent against the USD yesterday (-1.4%). The RBNZ’s May MPS made for a sobering read, placing downward pressure on the Kiwi. And Fed chairman Jerome Powell’s rather vocal aversion toward negative rates didn’t help. The USD strengthened overnight, sending the pair below the 0.60 mark – a break in a month-long uptrend. The objectively dismal Australian April jobless rate of 6.2% further strengthened the USD, sending the Kiwi down deeper. So, a bruised and battered Kiwi was trading at 0.5973 (and falling) heading into this afternoon’s Budget announcement.
But with a new announcement comes a new direction. Kind of. The Kiwi popped to 0.5994 (+23pts) then dropped and settled at around 0.5989 at time of press. Against the Aussie dollar, the Kiwi has since bounced off yesterday’s lows to 0.9308 (+25pts), albeit the Kiwi began its climb ahead of the announcement due to AUD weakness following the Aussie job report.
The initial market reaction shows that participants took the Budget as a welcome positive. But it seems that most of the action took place before the announcement. Had the Government disappointed, today’s commentary would’ve been a cut and paste of yesterday’s, only with the numbers pointing to lower on the axes.