Keeping Their Powder Dry

Acomparatively recent addition to the Treasury list is entitled “New Zealand’s Current Account Deficit: Analysis based on the Intertemporal Optimisation Approach”. This paper is preoccupied with the balance of payments current account, which has been persistently in deficit since the early 1970s and increased markedly during the late 1990s. Is this cause for significant concern?
The paper tackles that question, according to an abstract, “by evaluating New Zealand’s external solvency, the degree of optimality of the intertemporal consumption smoothing through its current account, and whether its international financial capital flows have been used in an optimal (consumption-smoothing) fashion…”
Having whetted readers’ appetite in Treasury research, I run the obvious risk of driving them from this column to plug into www.treasury.govt.nz to find out more about the current account. But while the Treasury can drench its driest working papers with data, its Budget-day analysis of the drought was numerically arid for anyone wanting rough idea of the GDP impact.
The economic outlook report devoted page to the report, reminding readers that New Zealand experiences significant variability in its climate and each season there are likely to be at least some areas with extremes. These extremes become important for the macro economy if they are widespread and sustained, as were the droughts in 1997/98 and 1998/99.
At the time the Treasury finalised its Budget forecasts, parts of the South Island and lower North Island again were experiencing drought. Agricultural production in those areas had been affected by the impact of dry conditions on farm production and there would be more serious implications for next season’s production from poor stock condition, lower lambing percentages and lack of water for irrigation if unfavourable weather continued through winter into spring.
But it was “highly uncertain how much impact the drought will have on next season” and there were offsetting factors, because growing conditions had been average or better than average in other parts of the country. This meant there might be regional impacts from reduced production and income to farmers, but at the macro level there was “a significant offset from above-average production and income in other areas, particularly North Island dairy country”.
The Reserve Bank recognised the drought, too, in its May monetary policy statement. It recalled that the previous two droughts had coincided with the Asian financial crisis and asked if the coincidence of drought and negative external shock again threatened to have significant negative impact on the New Zealand economy.
“The short answer is that it is still too early to say,” was its answer. The connections between climatic conditions, output and inflation are not straightforward, the Reserve Bank pointed out, because the short-term impacts can be quite different from the longer-term effects.
Moreover, while parts of the country indeed were experiencing extreme drought, much of the North Island had enjoyed average to above-average rainfall and exceptionally good growing conditions. significant proportion of New Zealand’s dairy herd is located in this area and in parts of the Waikato, compared with last year, late-season milkfat production volumes were 300-400 percent higher.
Even in the dry South Island, milk production was up more than 10 percent for the season. Most of the impact of drought normally falls on the following year’s production, for various reasons. Among them, grass growth in the winter and spring sets the scene for lambing and calving percentages, and the early season’s milk output. The economic effect would depend considerably on the timing and scale of winter rains.
Measured GDP would be affected both directly through pastoral sector output, and indirectly, through related sectors such as primary food manufacturing and transportation. The Reserve Bank noted less obvious impact of droughts: they reduce measured electricity production. As drought conditions intensify, lake levels fall, diminishing the amount of potential hydro electricity generation. Electricity companies are forced to substitute thermal generation for hydro generation and thermal energy inputs are more expensive than the inputs used for hydro generation. The total measured value added in electricity production therefore tends to fall, having noticeably adverse impact on production GDP in the same year as the drought.
Bank economists agreed it was too early to count the economic damage. Government economists, while forecasting host of economic happenings, were keeping their powder dry on the drought and at the end of May the Ministry of Agriculture and Forestry had yet to finalise its report on the drought impact. Not for public consumption, anyway.

Bob Edlin is Wellington-based economic commentator and journalist.

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