We’ve mastered the health response, now for the economy

Firstly, the good news: the public health results of New Zealand’s COVID-19 lockdown have been exceptional, despite some issues at the border that saw some people get out of isolation early without being tested. The return to Alert Level 1, less than 2½ months after the country went into lockdown, was far quicker than anyone dared to hope for as the global pandemic escalated so quickly back in March.

The series of scenarios published by Treasury in mid-April, based around a range of different lockdown lengths, showed a drop in GDP in the year to March 2021 of between 11% and 34%. Although Treasury’s estimates of the short-term hit to economic activity seemed unduly pessimistic alongside our 8.0% contraction, Treasury’s larger declines could not be ruled out if the country had remained at Alert Levels 3 and 4 for longer.

The relatively short period of time (3½ weeks) at Alert Level 2 and the fact that this Alert Level was less restrictive than had initially been indicated, particularly regarding domestic travel, also point towards a faster bounce back in the domestic economy than was previously expected.

However, we have also refined our estimates of how much economic activity was restricted during Alert Levels 3 and 4. We now estimate that seasonally adjusted quarterly GDP in June will be 18% smaller than in the December quarter (compared with a 13% drop in our previous forecasts). Although the ensuing bounce in the September quarter will also be larger (revised up from a 5.8% rebound to a 14% lift in activity), the maths of the short-term hit in the June quarter means our forecasts of annual GDP growth end up slightly lower through until March 2021.

Beyond those short-term adjustments, the economic outlook remains bleak. We remain of the view that the most important question is about how the economy’s recovery shapes up during 2021 and 2022. We continue to expect a U-shaped recovery (see Graph 1) – one where economic activity remains lower for longer, which is considerably less optimistic than the V-shaped pick-ups forecast by Treasury, Westpac, and the Reserve Bank.

Graph 1

For the economy to turn around and genuinely regain momentum, the following criteria need to be met.

• More certainty is needed about the international economic outlook.
• The tourism sector needs greater clarity about border restrictions and the likely timeline for them being partially or wholly removed.
• The rate of job losses needs to slow.
• People need time to see new opportunities for growth and start investing and hiring accordingly.

Looking through this list, it is clear that a rapid economic recovery will be difficult to achieve. The remainder of our Forecast Story details our thinking about the key aspects of the economic outlook and touches on the ongoing areas of uncertainty mentioned above.

With day-to-day life in New Zealand largely back to normal, it’s easy to forget that the COVID-19 pandemic continues to rage around much of the rest of the globe. Parts of the US, South America, and Africa are under severe pressure, and infection numbers have been picking up again in many European countries. However, the appetite for ongoing or renewed restrictions on people’s movements and economic activity appears limited.

The ongoing pandemic is raising substantial concerns about the global economic outlook. With New Zealand’s status as a small trading nation, our economic fortunes are inextricably linked to the global economy. Even though New Zealand’s domestic activity is showing signs of a rebound, this rebound will be limited by weak global activity.

From a global economic perspective, then, the world faces the worst mix of outcomes: short-term economic pain caused by lockdown conditions, and longer-term problems generated by a mix of official incompetence in containment measures and ongoing public fear of the virus. Graph 2 shows that global growth projections have continued to be revised down since our last forecasts were published in April.

Graph 2

Chinese economic activity rebounded in the June quarter but remains subdued. After a 6.8%pa reduction in GDP in the March quarter, Chinese growth lifted to 3.2%pa in the June quarter on the back of rising industrial production. However, retail spending over the first half of 2020 in China was down by 12%pa and is struggling to show a post-lockdown surge. In general, we expect slower Chinese economic growth to persist, particularly if the COVID-19 pandemic continues to suppress global demand. Weak global GDP outcomes will continue to hit trade, with a 3.2%pa fall in New Zealand’s goods exports to China in the June quarter symptomatic of the trade slowdown.

Prospects for goods exports volumes and prices are highly dependent on global demand. We have not revised down our export forecasts over the next two years, because the continued deterioration in Consensus forecasts for global growth is consistent with our April view that the numbers at that stage had not fully incorporated the effects of the pandemic.

However, the second half of this year will prove important as prospects for global growth in 2021 start to become clearer. To date, ongoing downward revisions in growth expectations for 2020 have been accompanied by similar upward revisions for global growth in 2021. If COVID-19 problems hang around and global optimism about 2021 starts to fade, then we will be forced to reconsider the speed of our forecast recovery in exports. Indeed, we have already knocked the peak off our forecasts for export growth later in 2022/23.

Services exports are obviously heavily influenced by the effects of the border restrictions on tourism and international education. There has been much discussion about a trans-Tasman or Pacific bubble – a possibility that, from December this year, we incorporated into our modelling of the regional economic effects of COVID-19. Better outcomes for services exports are the primary driver of our improved export forecasts during 2021 (see Graph 3), but the amount of political and media vacillation on the topic makes it difficult to predict the services outlook with any confidence.

Graph 3

Finally, in the trade space, we note that the disruption of COVID-19 to the international economy, including supply chains, has created discussion about the need to produce and source more goods locally. However, we are sceptical of the scope for investment in domestic manufacturing given New Zealand’s lack of scale and relatively high-cost operating environment. There might be a window of 2-3 years where firms are able to take advantage of global disruption and a public desire to support local business. But over the long-run, manufacturers are likely to keep being squeezed by low-cost Chinese producers as trends in international trade return to something more “normal”. Instead, a focus on niche manufacturing opportunities and the continued development of “weightless” services exports are better long-term prospects for the economy.

Apart from continuing global economic uncertainty, exporters are also having to grapple with a sharp rebound in the exchange rate from its March lows. By the end of June, the New Zealand dollar had rallied from US56c to US64c, recovering about 70% of the ground it lost between the start of January and mid-March. The lift reflects several factors.

• The greenback has fallen from favour as the US has become one of the countries that has been worst affected by COVID-19, with no signs of improvement.
• Investors’ risk appetite has improved after the big decline in financial markets during March.
• Australasia’s COVID-19 health outcomes have been viewed favourably by the rest of the world.
• Australia’s immediate economic outlook appears to be relatively good, with less reliance on tourism than New Zealand, and strong export commodity prices given disruptions to production in competing nations such as Brazil. The Australian dollar’s rise has, in part, dragged the New Zealand dollar higher as well.

The de facto tightening in monetary conditions implied by the rebound in the dollar is increasing the pressure on the Reserve Bank to ease other monetary settings. We expect the Bank to expand its Large Scale Asset Purchases (LSAP) from $60b to as much as $100b by early next year. Such a move will probably be accompanied by a moderation in the Bank’s forecast speed of recovery in economic activity and employment, given that the Bank’s outlook is currently among the most optimistic projections.

Just as importantly, the Bank will soon need to signal what is coming in 2021 when the current LSAP spending is completed. It is unlikely that the Bank will suddenly cease its programme of monetary stimulus and financial market support. Thus additional purchasing headspace will need to be announced in early 2021 to give the market certainty of accommodative monetary policy conditions being continued.

We have used a combination of wage subsidy recipient numbers and jobseeker benefit numbers to model the likely track in the unemployment rate through the middle part of this year. Other forecasters estimate the unemployment rate spiked from 4.2% in the March quarter to between 5.9% and 8.3% in the June quarter, and that it will climb to between 7.4% and 10% in the September quarter. However, we struggle to see the unemployment rate climbing quite so rapidly, and we estimate that it will be at 5.8% in June and 7.6% in September.

In our view, the wage subsidy and its extension have effectively delayed the inevitable job losses and associated rise in unemployment sparked by the pandemic and lockdown. Around 20,000 jobs have been lost since June, and we expect job losses will mount further during the final months of 2020 after the wage subsidy extension runs out. There is then likely to be a continuing stream of redundancies throughout much of 2021 as businesses struggle with persistently weaker demand conditions.

We also note that many of the job losses we have seen to date are difficult to directly attribute to COVID-19. Although job cuts in the tourism sector are an obvious effect of the collapse in international visitor numbers, redundancies across many other firms and industries reflect businesses using COVID-19 as a catalyst for rationalisation or consolidation that they were looking to implement anyway. Other businesses were already in difficult financial situations, with the lockdown hastening their demise, rather than being the primary cause of it.

In other words, the downturn offers an opportunity for some of the dead wood across the economy to be removed and for resources to be shifted towards more productive uses. This process is an uncomfortable one and has significant human costs and consequences along the way. However, it should ultimately place New Zealand on a better trajectory for productivity and economic growth over the longer term.

Our forecast for a peak in the unemployment rate of 9.7% in the second half of next year is little changed from the 9.5% high we were predicting in our April forecasts (see Graph 4). However, our predicted unemployment rate is slightly lower than previously forecast during 2022 and the first half of 2023. This small shift reflects slightly better economic outcomes than we were anticipating in April, as well as the additional support the government is providing to the broader economy.

Graph 4

Our current forecasts reinforce our view from April that the rise in unemployment is still coming but will not arrive as fast as other forecasters had predicted. Equally, we sound a note of caution about views that there have been significantly fewer job losses to date than expected. There have still been more than 63,000 jobs lost over the past 3½ months, with over 400,000 workers whose firms have experienced a revenue decline of 40% or more even under Alert Levels 2 and 1. In short, many workers remain in a vulnerable position with a significant lack of job security. 

Household spending has been more heavily affected by the lockdown than we had initially anticipated. An estimated 16% drop in private consumption spending in the June quarter will create a bigger hole in annual spending, which we now forecast will be down 7.4% over the year to March 2021.

This sharper near-term drop in spending will lead to a commensurately bigger bounce in activity during 2021/22. The government’s various methods of support for household incomes, which include increases to welfare benefits, a temporary doubling of the winter energy payment, wage subsidy payments, and the COVID-19 Income Relief Payment, will all help shore up household spending over the next year.

Nevertheless, data to date suggests there has not been much of a post-lockdown spike in household spending. Spending appears to be sitting at similar levels to a year ago, meaning that households are not catching up on the lack of spending that occurred during April and early May. This outcome reflects caution from consumers in the face of job losses, income cuts, and uncertainty about future economic conditions.

With unemployment expected to continue pushing higher throughout the next 12 months, it could be late 2022 before private consumption surpasses its pre-COVID peak. As with GDP, perhaps the most important question lies around the longer-term outlook for spending. We are adopting a more conservative view about potential spending growth over the medium term, revising average growth for the three years to June 2025 down from 4.5% to 3.5%pa (see Graph 5). Put simply, the scars of the COVID-19 pandemic on spending behaviour will remain visible for many years to come.

Graph 5

The government’s response to the pandemic has been rapid and substantial. Spending associated with the government’s $50b COVID-19 Response and Recovery Fund (CRFF), coming on top of the $12b originally allocated for the wage subsidy, is expected to push net debt up from $58b to $201b by 2024 (or from 20% to 54% of GDP).

Much of the government’s fiscal stimulus will come via increased transfer payments to individuals and businesses and will lead to less negative outcomes for private consumption and investment spending. However, we have also revised up our forecasts of government consumption spending over the next year, with more money being channelled into the likes of health and education. This faster growth in public sector spending is likely to give way to a more austere approach by 2022 (see Graph 6) as the economy regains a more even keel and private sector spending gathers momentum. After peaking at 5.4%pa this year, government consumption is forecast to grow by an average of just 1.6%pa over the four years to June 2025.

Graph 6

Although we have revised up our forecasts of government consumption spending in the near term, we are less confident about the government’s ability to deliver on its investment plans. Putting aside the temporary hole that the lockdown will have created in government investment, we have moderated our growth projections for activity throughout the remainder of the forecast period. Over the four years to June 2025, we now predict that government investment will grow at an average of 3.3%pa, well short of the 4.5%pa growth we had pencilled in back in April.

Failures around major initiatives such as KiwiBuild, light rail in Auckland, and the Provincial Growth Fund mean we are cautious about the government’s ability to deliver on its promises. These doubts are reinforced by loose use of the term “shovel-ready”, although the government expects work on the projects contained in its $3b infrastructure package to start within the next 12 months.

New Zealand still faces significant economic headwinds. Although current economic activity appears, on the surface, to be upbeat, outcomes to date have been propped up by sizable but temporary support measures. The government has confirmed that it does not plan to make any further significant announcements of support, keeping $14b of the CRRF in reserve in case of another outbreak of COVID-19. As the various supports are removed from the economy in coming months, we expect more sobering, but realistic, economic outcomes will start to show through.