Patches of blue sky show now not right time to hit fiscal panic button

Friday, 6 September 2019

What does the official cash rate mean?

OPINION: Finance Minister Grant Robertson has been steering a careful line by gently paving the political path for a possible 'cave-in' on the Government's debt reduction target while at the same time signalling he does not intend to jump the gun.

There have been growing calls for the Government to get out its cheque book since the Reserve Bank slashed the official cash rate to 1 per cent in August, drawing attention to the risk of a strong economic downturn and negative interest rates.

Robertson has responded by repeating the message that the Government's promise to operate at a surplus and its goal of reducing core government debt to no more than 20 per cent of GDP during the 2021-22 financial year was always subject to a get-out clause.

That caveat includes there being no 'major economic shock or crisis'.

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Each time Robertson voluntarily reminds people of that, as he did during a speech last week, it will inevitably be seen as signalling an increased expectation that he thinks the escape clause may need to be triggered.

But at the moment, the Government seems a fair way from assuming that.

Robertson wants to see more of the 'whites of the eyes' of an economic shock before ripping up the Budget responsibility rules, and that's understandable.

The main troubles facing the global economy are politically self-inflicted, stemming from concerns about the US-China trade war, Brexit, and the fear of further instability in Hong Kong.

But last week showed just how quickly patches of blue sky can appear from the gloom.

First Hong Kong chief executive Carrie Lam provided an opportunity to change the trajectory in Hong Kong by withdrawing its extradition bill and beefing up an inquiry into police conduct during the city's civil protests.

Then British MPs took some edge off 'hard Brexit' concerns by seizing control of the parliamentary agenda, initiating a bill to require a Brexit delay over 'no deal', and rejecting a call by Prime Minister Boris Johnson for an immediate election.

Finance Minister Grant Robertson says a negative OCR would not 'in itself' be what the Government looked at in determining whether there was an economic shock of the kind referred to in the Budget responsibility rules.

The situation in the United States will remain inherently unpredictable while President Trump remains in office.

But growing evidence that sanctions against China are harming the domestic US economy – such as a contraction in US manufacturing data on Thursday – and the proximity of the next presidential election in November next year, point to the possibility of sharp policy turns in the event that logic does in fact play a part.

Meanwhile, New Zealand's Reserve Bank still has the option of perhaps another six quarter-percentage points reductions to take the OCR down to -0.5 per cent before there would be a big risk of negative rates being something anyone would experience in the normal course of their lives, as opposed to something they might read about in the newspapers.

ANZ thinks there may only be five rounds left because OCR cuts below -0.25 per cent would not be passed through to some corporate borrowers due to 'zero floor' clauses in their contracts.

It sees the OCR falling to 0.25 per cent by May, listing seven reasons to worry about the economy.

But really all but two of ANZ's concerns – worries about dairy prices and new rules for bank capital requirements – could be traced back to the same root cause which is confidence about the global economy.

Would negative interest rates necessary imply 'a major economic shock or crisis' sufficient to trigger the get-out clause in the Budget responsibility rules?

Robertson responds 'decisions on monetary policy are not themselves what we are looking at in this context'.

'We are keeping a close eye on what is happening in the global economy and the flow on effects to New Zealand. As I have been saying for some time, if there is further deterioration in economic conditions the Government will respond accordingly.'

So the Reserve Bank has its decision to make, and he has his, even if they might be responding to essentially the same events.

There are ways the Government could deliver a modest fiscal stimulus without impinging on the Budget responsibility rules.

Increasing income equality, for example by raising the top income tax threshold and the top rate of tax is one option.

Shifting the burden of tax would deliver a stimulus because people on lower incomes tend to spend more of their money and save less.

And there are a variety of techniques that could be seen as 'cheats', even if dodging Budget responsibility rules may not be their primary purpose.

ANZ bank says the economy has stalled, but all but two of its seven concerns could be traced back to the geo-political malaise.

One getting some attention as part of the Government's tax programme is to offer investors a 'special' tax rate on profits from long-term infrastructure projects.

The NZ Super fund is pushing that idea, suggesting investors in infrastructure projects that pass a 'public utility test' – and we are talking about projects such as the proposed Auckland airport light rail scheme – could be offered a discount of 50 per cent or more on the tax on their profits from such investments.

'Investors have choices about where they invest and value certainty of the regulatory and tax environment, particularly as these tend to be very long duration assets,' NZ Super fund tax head John Payne says.

'Other countries have been active in looking to provide that environment to attract long-term investors, and New Zealand needs to make sure it is at least as attractive as those countries to attract the investment in infrastructure that we need.'

Similar arguments have been used to justify subsidies for the film industry on which 'Wellywood' is arguably addicted.

Ultimately, tax breaks for long-term infrastructure investments need to be seen for what they are – a disguised form of borrowing against the future, for which future generations will pick up the tab.

If they remained contained to a narrow range of infrastructure projects and didn't travel down a slippery slope, there might be no huge harm done.

But there appears no theoretical reason why providing subsidies for infrastructure investments in the form of discounted tax rates would be more economically efficient than any other more transparent type of subsidy – other than that it wouldn't show up as an accounting item in the Government's books.

At a stretch, you might argue infrastructure investors would value the 'certainty' a discounted tax rate provided over and above the actual monetary value of the discount itself.

But that would come at the corresponding cost of extra uncertainty for businesses that didn't enjoy the discount and which would therefore face the prospect of picking up a disproportionate share of the future company tax base.