Mission Concluding Statement 

New Zealand: Staff Concluding Statement of the 2021 Article IV Discussions

March 11, 2021

• New Zealand’s sound management of the COVID-19 crisis has been effective in suppressing infections and enabling a faster-than-expected economic recovery. Decisive and unprecedented fiscal and monetary policy responses cushioned the economic impact and supported a swift recovery of activity to above its pre-crisis level. However, the recovery has been uneven, with some sectors and workers disproportionately affected.
• While no additional stimulus is needed at the current juncture, fiscal and monetary support should not be withdrawn prematurely given the still-uneven recovery and continued high uncertainty. The authorities should stand ready to deploy additional monetary and fiscal stimulus should downside risks materialize.
• The rapid rise in house prices raises concerns around affordability and financial vulnerabilities. A comprehensive policy response is needed, including measures to unlock supply, dampen speculative demand, and buttress financial stability.
• Beyond the pandemic, the authorities should continue to strengthen structural reforms to increase the productive capacity of the economy and promote durable, inclusive, and green growth.

Washington, DC – The authorities took timely, decisive, and well-coordinated policy actions in response to the pandemic. Following an initial wave in March-April 2020, infections were quickly brought under control and, notwit­hstanding small regional clusters in August 2020 and February-March 2021, have stayed exceptionally low. The health policy response, with strict layered quarantine requirements, a focus on testing, contact tracing, and social distancing, and the ongoing border closure, has proven very effective.

The size and scope of economic policy support have been unprecedented and helped avert a much larger decline in economic activity and employment. Making use of substantial fiscal space, direct fiscal support measures of about 19.2 percent of GDP (through fiscal year 2024/25) were put in train. These measures, among the largest internationally (as a share of GDP), have included wage subsidies, infrastructure investment, and tax measures to support business cashflow and investment. Monetary policy has been very accommodative, with the policy rate cut to 0.25 percent, the Large-Scale Asset Purchase Program, and the Funding for Lending Program. The authorities also deployed an array of other support policies, including the Small Business Cashflow and Business Finance Guarantee schemes, to support affected firms’ access to finance.

Economic activity fell sharply initially but then recovered faster than expected. Following a sharp contraction in the first half of 2020, real GDP began to recover quickly and had already returned to above its pre-COVID level by the latter part of the year, ahead of most other advanced economies. However, while most COVID-related restrictions have been removed, tourism and education exports lag other sectors in the recovery because of the closed border. Inflation remained subdued at 1.4 percent in 2020Q4, below the target range mid-point of the Reserve Bank of New Zealand (RBNZ). Employment and labor incomes have held up better than expected, with hourly wages growing modestly in 2020Q4. However, job losses have been unevenly distributed and concentrated in contact-intensive service sectors. They have been impacting disproportionally low-skilled workers, youth, women, and some ethnic groups, highlighting concerns about increasing inequality.

The economy is expected to continue recovering in the near term, though at a more moderate pace. Activity is expected to expand at a slower pace in coming quarters given the impact of the continued border closure and still-high uncertainty. Wage growth is expected to remain modest. While some spikes—driven by higher commodity prices and temporary supply chain disruptions—are likely in the near term, inflation is only expected to durably reach 2 percent in 2023.

Vulnerabilities in business and household balance sheets should be monitored. Household and non-financial corporate balance sheets have held up relatively well during the crisis, and banks remain adequately capitalized and liquid. However, business insolvency, especially in disproportionately affected sectors, will likely increase with the expiry of COVID-19 support. Surging house prices have supported household balance sheets but amplify affordability concerns for first home buyers and financial stability risks.

Despite the improved economic outlook, significant risks remain .

· Renewed domestic outbreaks and the potential for health risks to delay the opening of the international border constitute important downside risks to growth, highlighted by the recent lockdown in Auckland, as does COVID-19’s impact on New Zealand’s trading partners and export commodity prices. In contrast, faster-than-expected global containment of the virus could prompt a faster reopening of borders, jumpstarting tourism and international education, and lead to a more rapid recovery.

· Rising speculative demand for housing, along with historically low interest rates and structural housing supply shortages, is amplifying the housing cycle and heightens financial stability and affordability concerns. Unsustainable house prices relative to income, a tightening of credit standards, or a sharp rise in mortgage rates could trigger an eventual, pronounced correction.

While additional stimulus is not currently needed, fiscal and monetary support should not be withdrawn prematurely , as output remains below potential and the recovery is still uneven and subject to heightened risks.

• Fiscal policy should remain sufficiently accommodative in the near term, as envisaged by current policy plans, to ensure a successful transition from public to private demand and limit scarring. While the successful, large-scale wage subsidy scheme instituted in March 2020 has expired, several measures are supporting the recovery, including business tax measures and infrastructure spending. Going forward, the pace of fiscal normalization needs to be carefully calibrated to support employment and minimize bankruptcies of distressed but viable firms. The authorities should stand ready to deploy additional fiscal support, including public investment and fiscal lifelines such as liquidity and targeted income support measures, if the recovery falters. In this respect, the recent introduction of contingency measures to manage resurgence events is welcome and will help mitigate uncertainty related to the pandemic.
• Monetary policy should continue to be data dependent and will likely need to remain accommodative for an extended period. Tightening should be avoided until inflation and employment objectives are sustainably achieved. The RBNZ has additional room for monetary easing, potentially including negative policy rates, in case downside risks to the recovery materialize. Conversely, should the recovery proceed at a stronger-than-expected pace, a gradual withdrawal of monetary stimulus can be carefully considered. Surging house prices should be addressed primarily through fiscal, regulatory, and macroprudential measures, though monetary policy may have a role if house prices pose risks to the inflation objective.

The authorities’ shift from job retention to active labor market policies is appropriate. The shift from wage subsidies to active labor market policies, including the expansion of training and Flexi-wage subsidies, will facilitate the reallocation of workers. The permanent increase in unemployment benefits from a relatively low level is welcome and will strengthen automatic stabilizers.

Financial sector policies should maintain resilience against financial risks. Financial vulnerabilities are rising from the unwinding of relief measures, banks’ concentrated exposure to residential mortgage lending, and elevated household debt. The increased resource allocation for the RBNZ to strengthen supervisory and regulatory functions is welcome. The ongoing Phase Two Review of the RBNZ Act is an opportunity to ensure that the RBNZ has adequate operational autonomy and a sufficient degree of flexibility to respond to financial stability risks by having the full macroprudential policy toolkit at its disposal. The extension of the implementation of the 2019 Capital Review, raising banks’ required capitalization starting in July 2022, mitigates risks of a premature tightening of lending conditions while maintaining the commitment to further increase banks’ capital buffers over the medium term.

The deployment of macroprudential tools to address housing-related risks is welcome. The reinstatement of loan-to-value ratio (LVR) restrictions in March and further tightening for investors from May 2021 will help mitigate stability risks. Additional tools, including debt-to-income ratio limits, caps on investor interest-only loans, and higher bank capital risk weights on mortgage lending, are under consideration and could play a useful role in addressing housing-related risks.

Tackling supply-demand imbalances in the housing sector requires a comprehensive approach.

· Achieving long-term housing affordability depends critically on freeing up land supply, improving planning and zoning, and fostering infrastructure investments to enable fast-track housing developments. Steps taken to support local councils’ infrastructure funding and financing would facilitate a timely supply of land and infrastructure provision. The reform of the Resource Management Act is expected to reduce current complexities in land use that restrict infrastructure and housing development and contribute to efficiency in strategic planning. Increasing the stock of social housing also remains important, and the Residential Development Response Fund’s plans to deliver 18,000 public houses and transitional housing space, undertake rental housing reforms, and provide assistance to low-income households are welcome.

· Mitigating near-term housing demand, particularly from investors, would help moderate price pressures. Introduction of stamp duties or an expansion of capital gains taxation could reduce the attractiveness of residential property investment. The authorities should differentiate in these approaches between first home buyers and investors, while continuing to provide selective grant and loan assistance to first-time buyers.

Structural policies should aim at fostering durable, inclusive, and green growth. Expanding research and development spending and product market reforms can help accelerate productivity growth. The ongoing reform of the Overseas Investment Act is an opportunity to streamline the foreign direct investment approval process and deepen connectivity with global markets. In this context, the government’s intention to use the new national interest test sparingly is welcome. Infrastructure spending should aim to reduce the existing infrastructure gap, and the post-COVID-19 recovery offers opportunities for a re-orientation of investment towards low-emissions infrastructure and technology. Labor market policies should focus on supporting displaced workers and disadvantaged groups, while promoting reallocation of resources and long-term human capital accumulation.

The mission would like to thank the authorities and counterparts in the private sector, think tanks, and other organizations for frank and engaging discussions.