1985 sees rapid change in N.Z. economy

Press, 18 December 1985, Page 47

1985 sees rapid change in N.Z. economy

By

MARTIN FREETH

The year 1985 has seen rapid and radical change in the New Zealand economy. An energetic Government has acclelerated the pace of its reform to drive the country towards new economic “health.” Gone are most of the policies of an era of interventionalism and short-term adjustment In 1985, the new orthodoxy of a vigorous, more-market economy firmly took hold. New Zealanders have been learning the recovery of health involves the endurance of economic “pain” in the form of falling real incomes, soaring interest rates and a highly-inflated foreign exchange rate. The price has yet to be fully paid, but the time of promised recovery draws nearer.

Eighteen months after its election, the Government shows no signs of deviating from its avowed “medium term” strategy. The aim remains to see New Zealand restructured away from an unrealistic and wasteful use of its resources and towards an efficient and productive economy, living within its means.

The Government has pursued that end with conviction. The programmatic nature of its policies continues to attract the necessary political support. The pervasiveness of the ideas behind this programme is reflected in National’s “position” paper released towards the end of the year. The Government’s policy emphasis has now largely been adopted by its political opponents. Economic change in 1985 has been signposted by the most significant of the Government’s policy changes through the year. Financial sector deregulation has brought the swiftest impact on the country’s economic life. High interest rates, falling export returns, and some encroaches on consumer price inflation have followed new financial policies which included: ® The New Zealand dollar has been floating since March, allowing its value against other currencies to. fluctuate according to market forces. The dollar has not floated before, and its value is now supposed to reflect this economy’s performance in comparison with other economies. That has not happened yet, and the dollar’s value has been much stronger than exEjcted, largely because of gh capital inflows into New Zealand. The exchange rate peaked in October when the dollar hit 59 American cents. The dollar’s trade-weighted index was then 23 per cent higher than it was in March.

® The Government has been working a new system for controlling the level of funds in the financial system. This liquidity management, run since January mainly through weekly Treasury Bill tenders, has limited the level of funds at any one time, and put upward pressure on shortterm interest rates. These rates averaged round 27 per cent in the middle months of the year. • Financial institutions have seen much greater freedom. In February, the Government did away with requirements, which had existed since the early 19705.

• Banking is to be deregulated in line with new policies unveiled in November. Limited criteria have been set down to allow access for

new institutions into the banking industry. © The phases-out of import licensing is being speeded up under a programme announced in September. This controversial policy is the biggest step yet taken to dump the comprehensive system of protection that has existed since the 19305.

@ Tax incentives for exporters are being phased out. This financial year, tax credits for export sales performance are being cut in half, and will disappear altogether in 1988.

© Export assistance through suspensory loans was dropped by the Govern-, ment in May. The loans gave exporters up to 40 per cent of their costs in promoting their products on world markets. Taxation has been the other area of big policy change in 1985. The . thrust of Government reforms has been to make' the system more fair and bring.it into line with more-market economy. In particular, reforms have sought to broaden the tax base and remove the disincentive to productivity from the present personal income tax scale.

The goods and services tax has never been far from the headlines. The GST was moulder, through processes of public consultation and Parliamentary scrutiny, in 1985 and the rate has been set at 10 per cent. Legislation for the hew tax was passed in November, and a 33 million publicity campaign to promote GST before its introduction next October 1 is well under way. ' .■' Personal income tax reforms, also to come in on October 1, were unveiled in a Government package in August. The Government says the tax paid by almost everyone will be cut. Fringe Benefit Tax, the first main piece of tax reform, has been paid by companies since April. Company taxes have come under scrutiny. The Government’s August package lifted the company tax rate from 45 per cent to 48 per cent from next April 1. It also gave notice of fundamental change in the taxation of company dividends to shareholders from 198889.

As with industry, farmers have been learning to live without long-held systems of income support. The agricultural sector was told by the Government in 1985 that the time had come for greater adaptation to the conditions of the international market.

Fanners have been hit by the immediate impact ol economy-wide trends in interest rates and the strength of the dollar. Pastoral farm incomes are one sector predicted to be particularly hard hit in 1986.

Underlying a more market approach in the economy has been a new set ol financial imperatives for the Government. The strategy calls for a tightening of both fiscal and monetary policies. In June, the Government’s Budget estimated a spectacular cut in the size of the fiscal deficit to less than 3 per cent of the gross domestic product. High interest rates throughout the economy have reflected adherence to a tight monetary policy, run through regular tender sales of Government stock. The Government in 1985 maintained its commitment to an economic theory which links rising prices to rising’ money supply. The fundamental prescription

for Governments is tight control on money supply and the creation of an environment maximising the play of market forces. The economic change reflects an indigenous adaptation of those prescriptions but are the Government’s policies working? The short answer is that it is too soon to tell. Its medium term focus means the strategy followed since July, 1984, is not intended to produce a marked improvement in all the main economic indicators until 1987. By then, the Government hopes, inflation will be in single figures, the level of economic activity will have picked up. and unemployment will be oh a downward path. There are signs in early 1986 that the economy is heading in a direction consistent with policy goals. Inflation, having peaked at an annual rate of 16.6 per cent in the June quarter, is falling. Recent forecasts indicate annual rates of down to almost 10 per cent by the third quarter of next year, before a hiccup when GST adds an extra 5 per cent all at once.

Consumer price forecasts are clouded by the impact of wage settlements emerging out of the 1985 round. Settlements have been higher than the Government wanted and they will push inflation back up to more than 20 per cent by the end of 1986 on the assessment of some economists. •

The wage settlement will, however, bring welcome relief to thousands of income earners who have seen their spending power cut steadily for almost .two years now. They will have to wait until October, for other relief in the form of tax cuts. Hopes that the Government may ease tax rates before the big launch of GST have

been dashed by the outcome of the wage round. Interest rates are finally showing signs of coming down, although householders are unlikely to see lower mortgage and other consumer rates until at least the middle of 1986. Wholesale rates started to ease in October, but politicians and economists say it will take six to 12 months for a decline to set in for retail rates.

The Government has predicted interest rates will follow inflation down, or at least the expectation that the rise in prices will be slower in future.

The year will be marked by a slowing of general economic activity, falling •business profitability and the likelihood of some company failures. Slower growth has been a long anticipated impact of the Government’s policies, but in 1985 economic activity held up longer than was expected. The official outlook now for 1986 is for a “rough landing,” with activity falling relatively sharply in the second half.. One Reserve Bank forecast is for a 2 per cent contraction in the economy in the year to end in March, 1987.

A decline in company profits will reflect lower activity, the level of interest rates and reduced export earnings because of the strong dollar. The country’s largest company, Fletcher Challenge, has estimated annual profits for 1986 only at the level of 1985. Business failures are forecast as a result of relatively high.wage rises and a Government refusal not to provide accommodation through higher growth in money, supply.

Performance of the government sector in 1986 will be particularly significant.

The much-vaunted achievement of the Budget last June was a drastic cut in the Government’s estimated - fiscal deficit.

Half-way into the present financial year, the deficit was slightly ahead of the optimistic first estimate, but the prospect is still for achievement of a much tighter fiscal policy than of previous Governments. The maintenance of tight monetary policy remains central to the strategy, and statistics at the end of 1985 show the Government is slowing monetary growth. It insists that tight control will continue in. 1986 as the central plank in the Government’s fight against inflation.

The question of success is anyway one largely hinging on the performance of others outside the Government. As its three Finance Ministers have emphasised in dozens of speeches in 1985, the strategy throws more responsibility for New Zealand’s economic future on to businesses, farmers and trade unions.

A more market economy means the attainment of national economic goals will hinge on more decisions made by more people. Government’s role is to create the proper environment. Part of the Government’s strategy has been to implant a spirit of economic recovery. •

Opinion polls indicate the changes have not cost Labour its popular political support. Indeed, support for the Government mounted as 1985 progressed and one poll in November put voter support at its highest margin above the National Party since the election. The next election is not due until September, 1987, at the time when the Government hopes the “plain” will have paid off in a more prosperous economy.