IMF Completes 2024 Article IV Review for New Zealand

Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1] with New Zealand on May 8, 2024 and endorsed the staff appraisal without a meeting on a lapse-of-time basis.[2]

New Zealand's economic activity has slowed following monetary policy tightening and a decline in investment. After the Reserve Bank of New Zealand's (RBNZ) cumulative rate hikes of 525 bps between October 2021 and May 2023, GDP growth momentum fell substantially in 2023 and the slowdown is broad-based. Following border reopening, record net migration in 2023 helped address supply-side bottlenecks and labor shortages. Inflation has declined significantly from its 7.3 percent y/y peak in 2022Q2 to 4 percent y/y in 2024Q1 but is still well above the RBNZ target and higher than in peer economies. Inflation expectations remain anchored. Budget 2023's large operating and capital allowances in responses to rising costs and one-off outlays related to the North Island weather events put off consolidation in FY23/24. The current account deficit narrowed in 2023 but remains above its long-run average. Housing prices have stabilized following a 13 percent decline from 2022Q1 to 2023Q2, and financial stability risks remain contained.

Growth is expected to remain slow at 1 percent y/y in 2024 before picking up in 2025, as the lagged impact of monetary policy tightening suppresses domestic demand. Improving external conditions should help narrow the trade deficit, especially through tourism. Headline inflation is projected to fall below 3 percent y/y in 2024Q3 as global disinflation supports lower tradable inflation and slowing domestic demand reduces non-tradable inflation. The unemployment rate is expected to increase and level around 5½ percent as the output gap turns negative.

Risks to the outlook for growth and inflation are broadly balanced. Given considerable uncertainty, the risk of policy miscalibration remains. If domestic labor market pressures persist or if shocks fuel imported inflation, a premature loosening of monetary policy could de-anchor inflation expectations given the extended period of high prices. Conversely, a larger-than-anticipated impact of monetary tightening could cause a protracted downturn and drive inflation to undershoot the RBNZ target. High interest rates combined with low growth could create stress in financial markets, especially in mortgage lending. Upside risks to growth include stronger migration boosting labor supply and helping lower wage pressures, and a faster-than-expected decline in inflation, both of which can allow earlier monetary easing. New Zealand's global integration creates vulnerabilities to risks from geo-economic fragmentation. New Zealand is also vulnerable to natural disasters and climate shocks.

Executive Board Assessment

In concluding the 2024 Article IV consultation with New Zealand, Executive Directors endorsed the staff's appraisal, as follows:

New Zealand's policy-induced slowdown continues. In the near term, real GDP growth is expected remain below its long-term trend, as the lagged impact of monetary policy tightening suppresses domestic demand, although improving external conditions should provide some support to growth and narrow the trade deficit, especially through tourism. Headline inflation is projected to return below 3 percent in the second half of 2024, which would allow for some monetary easing, leading to a recovery of growth in 2025. Risks to the outlook are broadly balanced. The external position in 2023 remained weaker than implied by medium-term fundamentals and desirable policies.

Budget 2024 should deliver a tight fiscal stance in the near term and provide a comprehensive consolidation strategy for the medium term. To avoid any upside pressure to inflation, it is important to calibrate the funding, timing, and the parameters of tax relief measures to be fiscally neutral in 2024. While New Zealand's government debt is sustainable, substantial adjustment is needed over the medium term to halt the rapid increase of debt and preserve the fiscal space needed to respond to future shocks. To this end, the fiscal strategy should commit the government to containing operating expenses and using any upside surprises to revenues to reduce debt. Spending reforms should be based on a comprehensive cost-benefit analysis of government programs and address long-term aging-related fiscal pressures while preserving outlays on high-value infrastructure and support to the most vulnerable.

Monetary policy is appropriately tight and should remain restrictive to ensure a timely return of inflation to target. The OCR remains significantly above the RBNZ's neutral rate suite of indicators. While the economy is showing signs of slowing more rapidly than previously thought and unemployment is rising, continued vigilance is needed. The increase of financial resources in 2023 (through additional capital and an indemnity) and increased FX reserves support the RBNZ's capacity to safeguard stability. Exchange rate flexibility is important for supporting external adjustment.

Financial stability risks appear contained. Non-performing loans have ticked up but remain low and the banking system remains well-capitalized, liquid, and profitable. Yet, continued monitoring is needed, as a protracted downturn that raises unemployment could affect household incomes. Current proposals to revise the macroprudential settings are appropriate, and the introduction of the debt-to-income (DTI) restriction is in line with earlier IMF staff advice. Similarly, the Deposit Takers Act is a welcome step to harmonize regulation for bank and non-bank deposit takers and to introduce deposit insurance.

Structural reforms are needed to boost the housing supply, revive productivity growth, lower emissions, and address challenges from climate change. The ongoing housing affordability challenges cannot be solved without a significant increase in residential construction. Policy recommendations include reforming land use restrictions, addressing local infrastructure funding needs, and using land value and capital gains taxes to incentivize more efficient land use. To address slow productivity growth, public investment in R&D, new infrastructure, and maintenance of the existing public capital stock are critical. Immigration, together with efforts to improve education outcomes and skills matching, could address skills shortages and boost productivity. To prepare the economy for the impact of climate change, efforts are needed to invest in adaptation infrastructure, limit residential zoning in high-risk areas, address data gaps, and rebuild fiscal buffers. Additional reforms, including pricing agricultural emissions, are needed to achieve domestic and international emissions targets.

[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] The Executive Board takes decisions under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussions.