While most of you probably didn’t bother to sit through the entire presentation of this year’s budget, it does have wider implications for the New Zealand economy and the finance industry.
The governments budget on May 23 didn’t contain any surprises and as a consequence, both interest rates and the New Zealand Dollar (NZD) remained unchanged. Interestingly though, the Treasury interest rate expectation of 6.1% is modestly below what is projected by the RBNZ.
With the appointment of a new governor to be made in the near future and indications that the Policy Targets Agreement will be reviewed, the differing expectations implies that Treasury doesn’t see the same level of inflationary pressure as the RBNZ. The RBNZ has been aggressively raising the Official Cash Rate (OCR) in an effort to contain inflation.
The Treasury projected growth to average 3% over the next few years and the government’s plan of increasing operating surpluses will likely have a slight contraction in aggregate demand. This will help reduce inflationary pressures, along with the strengthening of the NZD, and thus may slow the pace of monetary policy tightening.
Inflation or growth? – A political tussle
A big concern is that the interest rate hikes are muting New Zealand’s potential for economic growth. As the government invests the budget surplus into the new Super Fund, economic growth will again be constrained and the current trend of reducing government debt (as a percentage of GDP) will likely ease.
The restriction on New Zealand’s growth was the major consideration when suggesting a revision of the Policy Targets agreement, to increase its sensitivity to factors other than inflation. The budget cited a focus that included growth prospects, among innovation, health and education for New Zealand. Government spending is high (as a percentage of GDP) compared to the countries with which we compete for investment, and this is also a hindrance to growth. These are seen as major areas where the government could help New Zealand reach its growth potential.
The Securities Commission received a small increase in funding while the Retirement Commission received slightly less funding than last year, when their funding was cut. This is possibly the biggest disappointment as the industry was hoping that the funding could be used to raise the financial awareness of New Zealanders. A plus though was news that the risk free return method (RFRM) would not be implemented before 2004, albeit still under consideration. Controversy has surrounded this recommendation by the McLeod Tax Review and the government is extremely unwilling to further discuss the issue before the election. For more information on RFRM please click here.
Where to for Bonds?
One result of the continuing budget surpluses is a reduction in the government’s need to borrow in the debt markets. At the same time, there has been an increase of offshore interest in New Zealand bonds due to the attractive interest rate differential. The effects of this increased offshore interest and reduced supply of government bonds is that domestic investors have added higher yielding corporate issues to their portfolios. This has the benefit of reducing overall portfolio risk by diversifying the assets of the fund across sectors with low correlation to each other. Also because of the higher yielding feature, corporate bonds offer the prospect of attractive returns.
Performances
Above is a summary of some of the funds in both the international and domestic fixed interest sectors. However, it is difficult to compare the averages of the two sectors. The difficulty arises from the return on international portfolios being dependent on both the performance of the underlying asset and whether it is hedged against currency risk or not. Overseas interest rates are comparatively low at present and this return would be eroded by the cost of the hedge and in the current environment of an increasing exchange rate, hedging is also very expensive. Another feature further complicating comparison is the differing degree of corporate bond issue allowed by each funds mandate.
Summary
The budget is particularly interesting given the short-run macroeconomic outlook of the Treasury and the forthcoming appointment of a new RBNZ Governor. With economic growth a focus of the budget and the widespread concerns that the RBNZ are restricting growth with their aggressive interest rate hikes, the government is expected to look outside the RBNZ for someone who is a little more sensitive to the growth of the economy.
