Mission Concluding Statement 

New Zealand: Staff Concluding Statement of the 2022 Article IV Mission

March 23, 2022

Washington, DC:

• New Zealand’s economy has reached a strong cyclical position, enabled by sound management of the COVID-19 crisis despite intermittent setbacks. The current Omicron outbreak and high and volatile commodity prices in the wake of the war in Ukraine introduce new uncertainty, with adverse near-term impacts on economic activity and consumer price inflation.
• The normalization of macroeconomic policies has started, as fiscal COVID-19 support measures have been scaled down and monetary policy stimulus is being withdrawn to address inflation. Policy tightening should continue, with the pace calibrated to evolving domestic and external economic conditions.
• While the housing market has begun to turn, housing affordability remains a concern, requiring continued focus on boosting supply and expanding social housing. Macroprudential measures introduced to address financial stability risks from elevated house prices appear to be working and should be maintained.
• Beyond the pandemic, structural policies should aim at improving productivity and promoting inclusive and sustainable growth. Strengthening price-based mechanisms will be important to achieve New Zealand’s greenhouse gas emissions targets.

New Zealand’s management of the COVID-19 crisis has been successful . Strong public health policies and tight border controls allowed for effective containment of infection waves in 2020 and 2021. After a slow start to the vaccination campaign, New Zealand has managed to achieve very high vaccination rates, prompting a shift towards risk-based mitigation and a living-with-COVID strategy. The current Omicron wave may have peaked, and gradual border reopening is underway.

After sizeable economic stimulus during the initial COVID-19 waves, the normalization of macroeconomic policies has started. The authorities deployed contingency fiscal support measures in response to the pandemic’s resurgence in 2021. They included the Wage Subsidy Scheme and Resurgence Support Payments, which played a pivotal role in cushioning the impact on households and firms and have since been downsized. The Reserve Bank of New Zealand (RBNZ) was among the first advanced economy central banks to start tightening monetary policy in response to New Zealand’s faster economic recovery and inflationary pressures. The Monetary Policy Committee (MPC) discontinued asset purchases under the Large-Scale Asset Purchase (LSAP) program in July 2021 and raised the policy rate by 75 bps cumulatively since October 2021.

With strong economic and health policies, the economy rebounded strongly in 2021. Economic activity expanded by 5.6 percent in 2021, as firms and households adapted to live with the pandemic. Despite heterogeneity across sectors, the unemployment rate fell to very low levels, with labor force participation fully recovered from the initial COVID-19 shock. Businesses struggled to hire suitable workers, putting upward pressure on wages, which increased by 3.8 percent y/y at the end of 2021. A spike in food and fuel costs, supply chain disruptions, surging house prices, and higher wages pushed inflation to 5.9 percent y/y at end-2021, significantly above the RBNZ’s 1-3 percent target. The banking system has remained resilient. Banks report strong capitalization, ample liquidity, and rising profitability. After the initial recovery, credit growth slowed in recent months, reflecting a slowdown in mortgage lending amid rising mortgage rates, macroprudential tightening, tax changes, and a stricter consumer protection regime. New Zealand's external position has remained broadly consistent with economic fundamentals and desirable policy settings.

Economic growth is expected to moderate, reflecting the ongoing COVID wave, global spillovers, and policy tightening. Lost hours worked due to the Omicron wave are weighing on growth in the near term, while the weakening global economy is likely to affect exports. In addition, the withdrawal of fiscal and monetary policy support and the slowdown in the housing market are contributing to a moderation of economic growth, which is expected at 2.7 percent in 2022. With a tight labor market, commodity price pressures related to the war in Ukraine, and continued supply chain disruptions, inflation is expected to further rise in the near term and stay well above the RBNZ’s target range this year.

Downside risks dominate in the near and medium term. In the near term, the most immediate risks are further outbreaks of COVID-19 variants, either globally or within New Zealand, and further intensification of geopolitical tensions, which could adversely affect economic activity and inflation in New Zealand through weaker external demand and higher commodity prices. Extended global supply chain disruptions could impact growth and inflation. Slower growth in China could have a significant impact on New Zealand’s economy given China’s importance as a trading partner. Apart from COVID-19, domestic risks are centered around financial stability and growth implications of developments in the housing market due to high household debt, borrowers’ vulnerability to rising interest rates, and banks’ high exposure to housing. De-anchoring of inflation expectations and natural disasters are other potential sources of risk.

During the exit from exceptional, crisis-related policy support, the pace of policy normalization needs to be calibrated carefully. With the recovery well-entrenched, tight labor market conditions, and elevated inflation, it is appropriate to withdraw fiscal and monetary support as envisaged. But in light of continued uncertainty, the speed of policy tightening should be under continuous review and dependent on evolving macroeconomic conditions.

• Fiscal policy should remain agile. While the scheduled tightening of fiscal policy is appropriate, the authorities should calibrate the fiscal stance to the evolution of the pandemic and economic conditions, providing additional, targeted support where needed. In this respect, the recent introduction of the temporary COVID Support Payment is welcome, providing limited and targeted support to firms in need without adding materially to aggregate demand pressures. The temporary reduction of the fuel excise duty and road user charges provides relief to consumers but should be replaced with measures that are better targeted to vulnerable households in case continued support is needed after the announced period. Public debt sustainability remains robust and substantial fiscal space is available to address downside risks.
• Monetary policy should remain data dependent, and continued, swift policy normalization will be appropriate under baseline conditions. Given New Zealand’s strong cyclical position and inflationary pressures, significant increases in the Official Cash Rate in the near term are appropriate, signaling the RBNZ’s commitment to addressing inflation as a priority.

Long-term fiscal challenges from population aging underscore the case for a credible fiscal anchor. As the pandemic-related uncertainty subsides, the authorities should set a medium-term fiscal anchor that would replace the suspended pre-pandemic debt target range. The strategy should be calibrated carefully to secure growth-enhancing investment and reduce procyclicality of fiscal policy, and it should be aligned with New Zealand’s existing long-term fiscal framework.

The RBNZ’s focus on strengthening banks’ resilience is timely. The scheduled increase in capital requirements will further strengthen banks’ resilience. The Deposit Takers Bill is a step forward in adopting international good practices to strengthen financial regulation and supervision and enhance depositor protection. Opportunities for further strengthening the proposed law should be seized, including by reinforcing the robustness of the crisis resolution framework and clarifying some aspects of the governance framework for the depositor compensation scheme. The careful approach toward a central bank digital currency (CBDC) is welcome, distilling options, needs, and challenges through public discussion amid declining use of physical cash.

Tackling housing market imbalances requires a comprehensive approach, and recent initiatives will help address these imbalances. Achieving long-term housing sustainability and affordability depends critically on freeing up land supply, improving planning and zoning, and fostering infrastructure investments to enable fast-track housing developments and lower construction costs. Financial incentives for local councils and iwi (Māori tribal organizations) to step up the provision of basic infrastructure for new developments will be helpful in this regard. Increasing the stock of social housing also remains important. Steps taken to mitigate investors’ demand for existing housing have helped moderate near-term price pressures. Loan-to-value ratio restrictions to address financial stability risks should be maintained, and work to expand the macroprudential policy toolkit to include debt-to-income limits and minimum standards for serviceability assessments is welcome.

Stronger efforts are needed to meet greenhouse gas emissions goals. The recent rise in carbon prices is welcome, although addressing agricultural emissions—the largest single emissions source—will require the successful implementation of planned agricultural emissions pricing. The forthcoming Emissions Reduction Plan is an opportunity to strengthen the price-based system, which would incentivize the adoption of new technologies and methods needed to achieve the targeted reductions. Parts of the proceeds of higher emissions prices should be used to further mitigate adverse social consequences. Complementary policies to address emissions, including through stepping up public investment and encouraging innovation, can help accelerate the transition to a low-emission economy.

Structural policies should promote durable and inclusive growth . The authorities should continue to promote innovative investment and digitalization, thereby supporting medium-term growth. Infrastructure spending should aim at reducing the infrastructure gap and supporting the transition to a net zero carbon growth path. Transitioning from relatively high corporate income tax to other sources, such as capital gains and possibly land taxes, would improve efficiency without reducing aggregate revenues. The planned introduction of the Income Insurance Scheme is welcome as it closes an important gap in social protection. Its parameters should be calibrated carefully to address trade-offs between insurance and disincentives. As the minimum wage has become increasingly binding after the rapid increase in recent years, further increases should be aligned with underlying labor productivity growth to avoid unintended impact on employment.

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