GROSS DOMESTIC PRODUCT

Following recession in the first half of 1998, the New Zealand economy has recovered to grow at a robust rate. The second half of 1999 saw a particularly strong performance with growth running at an annual rate of around 10 percent. In 1999 as a whole, the economy expanded by 3.4 percent in annual average terms.

Monetary conditions eased considerably from early 1997, setting the stage for recovery. In 1999, growth was bolstered by the pick up in global economic conditions as well as favourable growing conditions for the agricultural sector.

Growth in 1999 was broad-based. Household spending was supported by lower interest rates and an improving labor market. Consumer spending rose by nearly 4 percent in the year and spending on residential investment rose by around 20 percent. While business investment made little contribution to growth over 1999, inventory changes accounted for about a third of the growth in 1999, some of which could have been related to Y2K.

Exports were up by 5.0 percent in 1999, the strongest annual growth rate since the mid-1990s. Primary exports (around a third of New Zealand¡¯s exports) have been recovering from the effects of two years of drought and the impact of the Asian crisis. As a whole, primary exports were up around 4 percent, but growth was concentrated in the second half of the year, which saw growth in primary exports reaching nearly 20 percent. In the second half of the year, the agricultural sector bounced back from the effects of the 1998-1999 drought and was also buoyed by very favourable weather conditions. Manufactured exports and tourism both posted solid growth in 1999 benefiting from a lower exchange rate as well as improving global growth. A rebound in visitors from the Asian region as well as one-off events such as the millennium celebrations added impetus to the tourism sector.

On the production side, the primary sector, the goods-producing sector and the services industries all made solid contributions to growth in 1999. The year was, however, one of contrasting halves. In the first half of 1999, growth in the service industries well exceeded the negative growth in the primary sector and the flat production in the goods-producing sector. In contrast, the second half of the year saw the opposite, with a marked pick up in primary and manufacturing production. Again, this reflects the turnaround in the fortunes of the agricultural sector. Strong agricultural production in the final two quarters of the year had flown on effects to the primary food processing industry and the transport sector. Within the service sector, the communications industry recorded the strongest growth in 1999, posting an annual growth of 15 percent. This sector has been a strong performer for several years now.

The latest quarterly data showed real production GDP fell by 0.7 percent over the June 2000 quarter, with the annual GDP 4.5 percent higher. On the production side, only a couple of services sector showed any growth ¨C notably wholesaling activity and the communications industry. Construction activity detracted significantly from growth following the surge of the last quarter, while manufacturing was adversely affected by weak agricultural production and soft domestic demand.

The latest quarterly GDP outturn reinforces the picture of a soft domestic economy as painted by other indicators as such confidence and employment. However, conditions remain conductive for strong growth in the tradeables sector, with the latest indicators continuing to suggest a rebalancing in activity away from domestic to external sector growth. Ultimately this should filter through to the domestic economy making for solid economic growth.

INFLATION

Inflationary pressures were surprisingly weak over the second half of 1999. The effect of higher petrol prices, as a result of the sharp rise in international oil prices, was broadly offset by the effect of a substantial decline in fresh fruit and vegetable prices (due to a return to more favourable growing conditions). After stripping out these effects, "core" inflationary pressures were rather muted. All told, the consumer price index rose by 0.6 percent over the second half of 1999, so that, when measured on a consistent basis, annual inflation stood at 0.5 percent.

The first quarter of 2000 saw a lift in general inflationary pressures. The consumer price index rose by 0.7 percent in the quarter, and annual inflation (when measured on a consistent basis) rose to 1.7 percent. Higher petrol prices again made their mark, while there was some evidence to suggest that the incidence of price rises had become more widespread in the first quarter.

More recently, second quarter of 2000 CPI rose by 0.7 percent. However, the rise in quarterly inflation was narrowly concentrated in petrol price rises and tobacco products (reflecting an increase in excise taxes). These two factors are also expected to make a significant contribution to the September quarter inflation outturn. Looking towards the end of this year, these twin effects may to lead to a sharp spike in inflation, with the annual consumer price index likely to peak above the top of the RBNZ¡¯s 0-3 percent inflation target range.

EMPLOYMENT

Stronger growth in the economy in 1999 was reflected in an improving labour market. In December 1999, employment growth was up 2.7 percent over a year ago with full-time employment growth accounting for most of the job growth. The unemployment rate fell from 7.7 percent in December 1998 to 6.3 percent by the end of 1999. Furthermore, the latest labour market data showed the unemployment rate edging down further to 6.1 percent in the June 2000 quarter. However, this quarterly fall reflects an unusually sharp decline in the labour force participation rate, which is likely to be reversed in the quarters ahead. Over the first half of 2000, employment growth has remained reasonably soft, consistent with the projected slowing in activity growth.

In New Zealand¡¯s previous economic cycle, the unemployment rate troughed at around 6 percent. This, together with some signs of emerging skill shortages, suggests a reasonable degree of tightness in the labor market for this stage of the cycle. Net migration which helped boost labor force growth in the mid-1990s period was negative during 1999 and is not expected to turn around quickly.

As yet wage growth has remained subdued with annual wage growth running at 2 percent in 1999, a slowdown on the 3-percent growth is seen at the end of 1998. However, wage growth tends to lag employment trends, and some wage pressure is expected to emerge.

CURRENT ACCOUNT

The current account balance for the year to June 2000 recorded a deficit of 7.2 percent of GDP. While this was up from the 7.1 percent of GDP deficit recorded in the March quarter, the trend current account has been improving since December 1999. In particular, the trend current account was 5.9 percent of GDP using annualised rates in the June quarter, down from the deficit of 7.4 percent of GDP recorded for the December 1999 quarter. On the whole, the latest outturn supports the current forecast for an improving current account deficit as a result of the projected turnaround in the goods and services balance from deficit to surplus.

Looking further ahead, a projected increase in the trade balance is expected to drive the improvement in the overall current account deficit. A continuation of strong growth in the world economy and the stimulatory level of the NZ dollar is expected to assist exporters to expand markets. Strong growth in tourist arrivals is expected to lead to some improvement in the balance on services over the coming year.

EXCHANGE RATE

The exchange rate generally remained weak in 1999. On a trade weighted basis, the exchange rate ended the year at around the 55.5 mark, down slightly from where it stood at the start of the year, but down significantly from its peak of around 69 in early 1997. Against the US dollar, the NZ dollar lost about ? US cent in 1999 to stand at just over 52 US cents at the end of 1999 (this compares with a peak of just under 70 US cents in early 1997).

Since the start of 2000, the exchange rate has come under significant downward pressure. By early October, the exchange rate, on a trade-weighted basis, had fallen by around 13 percent, and was trading around the 47 level. Over the same time period, the NZ dollar has lost around 11 US cents, to be just over the 40 US cents mark.

GROSS EXTERNAL DEBT

New Zealand¡¯s total gross external debt remained unchanged at $87 billion in the year to March 2000 compared with the year to March 1999. After generally increasing since the beginning of the series in 1989, the net liability position has remained relatively steady in levels terms more recently, falling slightly from $89 billion in March 1998, to stay steady at $87 billion for the last two years. The steady net liability level combined with strong economic growth over 1999 has lead to the fall in New Zealand¡¯s net liabilities as a proportion of GDP.

FISCAL POLICY

Following a prolonged period of fiscal deficits New Zealand has consistently achieved operating surpluses since the fiscal year ending June 1994. The initial improvement in the fiscal balance over the mid-1990s period reflected a growing economy and firm control over expenditure. Government operating expenses have been reduced as a percentage of GDP from 41.6 percent in 1992-1993 to 34.6 percent in 1999-2000.

Over recent years the fiscal surplus has fallen back from above 3 percent of GDP in fiscal years 1995 and 1996 to 1.4 percent of GDP in 2000. Slower economic growth as well as tax reduction packages help explain the reduction in the fiscal surplus. This reduction, however, was moderated by state asset sales.

Net government debt has fallen from 49 percent of GDP in 1992 to 1993 to 21 percent in 1999 to 2000. Debt repayments have been financed from operating surpluses and asset sales proceeds. From 2001 to 2002 onwards, it is assumed that surpluses will contribute to building up financial assets to begin pre-funding future superannuation costs as well as paying off debt.

MONETARY POLICY

The Reserve Bank of New Zealand is an independent central bank and by the Reserve Bank Act 1989 is charged with maintaining price stability in New Zealand. The Act requires that there be a Policy Targets Agreement between the Minister of Finance and the Governor of the Reserve Bank. Initially, the Policy Targets Agreement required the Bank to maintain inflation in the range of 0 percent to 2 percent over any 12-month period. The range was increased to 0 percent to 3 percent in December 1996. The current Policy Targets Agreement, signed with the new Labour/Alliance Coalition Government in December 1999, also clarifies that in pursuing its price stability objective, the Bank shall seek to avoid unnecessary instability in output, interest rates and the exchange rate.

When it comes to implementing monetary policy the Reserve Bank uses an official cash rate target. This was introduced in March 1999 and was set at 4.5 percent. In 1998, interest rates fell with short-term interest rates falling from a peak of 10 per cent in mid-1998 to around 4.5 percent in early 1999. In contrast, short-term interest rates rose in 1999 and early 2000 in the face of a strengthening economy. The official cash rate currently stands at 6.5 percent. Despite the rise in short-term interest rates, overall monetary conditions in New Zealand remain quite stimulatory due to weakness in the exchange rate.

OUTLOOK

Conditions remain conducive for continued growth in the New Zealand economy. The world backdrop is positive and the current low exchange rate will provide a source of stimulus.

The economy has, however, slowed from the exceptionally strong growth rates seen in the latter part of 1999. Growth in the second half of 1999 was boosted by some one-off factors such as the rebound in agricultural production and Y2K effects that have unwound over the first half of 2000. Moreover, the recent observed sharp declines in both consumer and business confidence further highlights the risk of a slowing in activity going forward.

On the pricing front, the impact of higher imported inflation on the back of the weaker NZ dollar, together with the sharp rise in the cost of crude oil, are expected underlie a rise in consumer prices. In order to ward off such inflationary pressures, monetary conditions are expected to tighten further. Interest rates, already up 200 basis points since the beginning of 1999, are expected to rise further over the next year. Following annual average growth of around 4 percent in 2000, the economy is expected to slow to around 3 percent in 2001 and 2 percent in 2002.

Over the coming year, annual consumer price inflation is expected to push above the Bank¡¯s 0-3 percent inflation target. Nevertheless, abstracting from one-off influences on the price level, the forecast tightening in monetary conditions is expected to keep inflation under control over the next few years. Inflation is expected to settle back down to around 2 percent per annum.

The export sector is expected to be a key driver of growth over the next few years. Solid volume growth for both goods exports and tourism along with rising commodity prices are behind an expected reduction in the current account deficit. The current account deficit, currently equivalent to 7 percent of GDP, is expected to fall to around 5 percent of GDP over the next two years.

NEW ZEALAND: OVERALL ECONOMIC PERFORMANCE