Finance

Navigating Economic Challenges: OECD's Advisory on New Zealand's Monetary Policy and Fiscal Strategy

In the latest report from the Organisation for Economic Cooperation and Development (OECD), a clear message is articulated for the financial future of New Zealand: monetary policy must closely follow data trends, and significant uncertainties remain as to when inflation rates will align with the central bank's goals.

The Reserve Bank of New Zealand (RBNZ) is experiencing constraints in its ability to reduce interest rates within this fiscal year. The OECD urges the bank to refrain from adopting a more lenient policy until there's a confirmed trajectory of inflation rates returning to the target window. This cautionary stance emerges from the OECD's Economic Surveys: New Zealand 2024 report, made public on Monday in Wellington.

Persistent Inflation: A Barrier to Monetary Relaxation

The OECD report articulates that "Inflation is likely to be persistent," setting limitations on the potential for reducing the Official Cash Rate (OCR) in 2024. It is recommended that the OCR be held steady at the current 5.5%, up until the point where there's incontrovertible proof that inflation will plummet to the median of RBNZ's target range.

With the headline inflation rate lingering at 4% during the first quarter, which notably overshoots the RBNZ's 1-3% target band as well as its 2% optimum target—coupled with a domestic price pressure indicator that remains high at 5.8%—there are heightened concerns. Numerous economists anticipated that the RBNZ would commence interest rate cuts towards the latter part of this year. Still, some now suggest that such a policy turn might be postponed until 2025.

According to the OECD, reiterating the necessity for a data-dependent approach to monetary policy, the forecast of when inflation will meet the central bank's targets remains ambiguous. It also highlights the role of the government in curbing expenditure to narrow the fiscal deficit, thereby supporting the RBNZ in its efforts to subdue inflation.

A Path to Financial Equilibrium

Nicola Willis, the Finance Minister, announced in March her aspirations to achieve a budget surplus by 2028—one year later than the earlier projections. This delay stems from subdued economic growth patterns and a diminution in revenue. Yet, Willis remains committed to executing income tax slashes in her fiscal budget proposal scheduled for May 30.

The OECD advises the government to implement fiscal guidelines and taxation policies that incrementally decrease the fiscal deficit until a balanced budget is attained. It notes that any potential tax deductions should be compensated for by corresponding revenue increase or cost-cutting measures.

Modest Growth Forecasts Amidst Housing Challenges

The Paris-based OECD envisions merely modest economic expansion for New Zealand, with projections of growth by just 0.8% for the year leading up to December 2024, with expectations for an increase to 1.9% in 2025.

The OECD predicts a surge in housing construction spurred by the intensifying housing shortage and climbing house prices and rents. Additionally, robust demand growth from trading partners and, notably, the revival of the tourism industry are likely to enhance export performance.

Fiscal Framework and Policy Recommendations

The OECD's comprehensive report also provided a broad spectrum of recommendations for the New Zealand government:

Instituting a Spending Growth Target

The suggestion posits that the government could reap benefits from a precise expenditure growth benchmark. It contends that an emphasis on fiscal targets centered on the operational balance and debt—sans expenditure—is inadequate.

Establishing an Independent Fiscal Institution

An independent fiscal body responsible for evaluating policies, and which reports directly to parliament, is another key recommendation, aiming for impartial assessment and enhanced fiscal transparency.

Introducing a Capital Gains Tax

The OECD argues for the launch of a capital gains tax, which could help in diminishing the unevenness of household asset allocation, encouraging more balanced and prudent investment decisions.

Prioritizing Macroeconomic Statistics

Given the pivotal importance of accurate data for policymaking, the OECD underscores the need for more weight to be put on macroeconomic statistics. It points to New Zealand's absence of monthly Consumer Price Index (CPI) and unemployment figures.

Addressing Productivity Concerns

The report notes that productivity in New Zealand trails considerably behind the OECD frontier, and this is partly attributed to insufficient market competition. Solutions proposed include making market entry easier, implementing efficient regulations, executing antitrust laws diligently, and, as a final option, considering company break-ups.

Liberalizing the Foreign Investment Regime

New Zealand's foreign direct investment regime is described as "one of the most restrictive in the OECD." Easing these restrictions could potentially encourage greater international investment, fostering economic growth.

Narrowing the Current Account Deficit

The current account deficit of New Zealand, which stands as one of the highest in the OECD, is projected to contract. However, given its structural nature, it is likely that it will continue to exceed the long-term average unless the government can further reduce its fiscal deficit.

Conclusion

The OECD's Economic Surveys present a clear delineation of the steps New Zealand must take to align its monetary policy with inflation targets, achieve economic stability, and stimulate growth in a pragmatic way. As the nation faces persistent inflationary pressures and fiscal challenges, the guidance offered by the OECD is both timely and forward-thinking.

The onus now lies on the nation's policymakers to take into account these recommendations, balancing immediate economic needs with long-term fiscal sustainability. It remains to be seen how these strategies will be translated into actionable policy and what their impact will be on New Zealand's economic trajectory in the coming years.

©2024 Bloomberg L.P. (Source: Bloomberg)