IMF Wraps Up 2023 Article IV New Zealand Consultation

Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1] with New Zealand.

New Zealand's economy is in the midst of a necessary, policy-induced slowdown following the strong post-pandemic recovery. With exemplary management of the pandemic, New Zealand recovered faster than most other advanced economies. This supported activity and, together with generous fiscal and monetary support, resulted in strong investment and consumption. But this came at the cost of overheating against capacity constraints exacerbated by restrictions on labor movement due to border closures, and disruptions in global supply chains. The external balance has also deteriorated significantly. Policies have adjusted meaningfully in response. The Reserve Bank of New Zealand (RBNZ) tighten monetary policy since October 2021, increasing the policy rate by 525 bps to 5.50 percent. Following an expansionary fiscal policy in FY2021/22, spending moderated slightly in FY2022/23 due to winding down of COVID-related expenditures. The economy is now slowing, but significant and persistent labor market constraints that has put upward pressure on wages, and the large positive output gap have kept inflation high. House prices have corrected significantly, but affordability remains an issue. Financial stability risks however appear contained.

The economy is expected to continue on its slow growth as monetary tightening takes hold. The bulk of the impact of the rate hikes will be felt in 2023 and 2024 given the usual lags in transmission. Growth is expected to slow to around 1 percent y/y in 2023 and 2024, with the possibility of a technical recession, despite some short-term boost from higher spending to address the North Island weather events and funding to meet central government cost pressures. Inflation is likely to decline gradually to the 1–3 percent target range only in 2025 given the pick-up in non-tradable inflation. With the border reopening, net migration has picked up sharply and should further alleviate labor market tightness, though the effect on net demand is unclear.

Risks to the outlook stem from the external environment and a potential need for stronger tightening of monetary and financial conditions. Global developments relating to growth, deepening geo-economic fragmentation, and financial stability shocks can significantly alter the baseline assumptions for New Zealand. Persistently high inflation and wage growth could compel the RBNZ to tighten monetary policy further or keep rates high for longer, especially if fiscal policy does not consolidate as planned in the forecast period. This will have consequences for growth, household consumption, and house prices, and even financial stability implications under severe stress.

Executive Board Assessment[2]

Executive Directors noted that following a strong post-pandemic recovery New Zealand's economy has slowed substantially due to policy tightening to contain overheating pressures, but inflation remains well above the target range of the Reserve Bank of New Zealand (RBNZ). Against this background, Directors underscored the importance of careful calibration of the fiscal and monetary policy mix to rebalance the economy and help address long-term structural needs.

Directors welcomed the RBNZ's commitment to reduce inflation to target levels in a data-dependent manner. They saw little scope to lower policy rates currently given the tight labor market and stubborn core inflation, and emphasized that a reignition of inflationary pressures would call for additional monetary policy tightening. Compiling a monthly inflation index would enhance the effectiveness of monetary policy.

Directors agreed that reconstruction spending should be prioritized in the aftermath of the North Island weather events, but also emphasized the need for medium-term fiscal consolidation to support rebalancing efforts and create space for addressing longer-term challenges related to population aging and climate change. They supported calls for increasing the efficiency of discretionary spending and welcomed the reinstatement of fiscal rules and the authorities' commitment to fiscal sustainability.

Directors noted that financial stability indicators show few signs of stress, but household and financial balance sheets should continue to be monitored closely. They welcomed the addition of debt-to-income restrictions to the macroprudential toolkit. They noted that the RBNZ should stand ready to provide liquidity if funding markets come under stress, including from spillovers from global financial markets. Directors pointed to housing shortages, noting a strong need to improve affordability and expand housing supply including for social housing. Directors welcomed efforts to further enhance the AML/CFT framework.

Directors commended the authorities' efforts to foster durable, inclusive, and green growth, noting challenges from large infrastructure deficits, climate change, low productivity, aging, and inequality. They welcomed the 2022 Digital Strategy for New Zealand which aims to grow the digital workforce, address labor shortages and skills mismatches, and increase the digital inclusion of under-represented groups. Directors were encouraged by the decoupling of greenhouse gas emissions and economic growth and noted strong policy initiatives under the Emissions Reduction and National Adaptation Plans, including the review of the Emissions Trading Scheme.

[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

[2] At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.IMF.org/external/np/sec/misc/qualifiers.htm.