by Geoff Mason
There is little doubt that New Zealand had an excellent year in 2001, managing to outperform most of its major trading partners. The first half, in particular, saw annualised growth of near 5% and although growth slowed in the second half of the year it was still a remarkable performance in the face of a hostile global trading environment.
It was also a good year for the New Zealand share market with the NZSE40 up 8% compared to a 10% fall in global equities.
That said, this is one of the most serious global downturns New Zealand has had to face for some years. Latest data suggests that world output contracted in the second half of last year and, although there have been times when output has contracted by more (last time was in 1980), two consecutive negative quarters in global terms is anything but typical.
Indeed we need to go back to the first oil shock in 1974 for the global economy to contract for as long as it has in 2001.
What distinguishes this downturn is the unprecedented degree of synchronicity between the major economies with virtually all regions of the globe (excluding China) weakening simultaneously.
Japan in particular is looking very weak with the International Monetary Fund (IMF) forecasting output to contract by 1% in 2001 and 1.3% in 2002. This would be the first time in the post-war period that Japan has experienced two consecutive years of contraction.
While a string of upbeat economic reports suggests that the worst of the US earnings and economic performance is over, we are cautious about the robustness of a recovery.
Indeed there is a very real risk the US economy will experience a "double-dip" recession if consumer spending falls in the face of increasing job losses, threatening a new round of confidence declines.
The high degree of synchronicity and trade dependence in the world economy also raises the risk of further negative feedback, particularly if the US economy stays weak for longer than expected. That is why the IMF is picking the global economy in 2001 and 2002 to be weaker than at any time in the past two decades.
The bleak (but improving) outlook for the global economy suggests that exports are unlikely to be a significant driver of domestic growth in 2002.
Last year most of New Zealand’s economic resilience was the result of healthy gains in export incomes, owing to high international prices for key export commodities, a weak currency and rising export volumes.
However many of these positive influences are unlikely to continue in 2002. Indeed already there are signs the export growth momentum has started to fade with net exports subtracting 0.3 percentage points from growth in the third quarter of last year. As a result gross domestic product only managed a 0.2% rise after surging 1.8% the previous quarter.
Exporters have also been adversely affected by falling commodity prices and an appreciating currency in recent months.
Commodity prices have fallen near 11% since their May peak in New Zealand dollar terms, while the currency has risen around 5% from September lows. This export weakness will inevitably feed into retail spending that, until recently, has been growing at a healthy pace.
A softening labour market will also likely weigh on household spending going forward as firms move to contain costs.
Over the past year there has been a tendency by firms to take on more staff than justified by growth in output. This has lead to a decline in labour productivity and corporate profits.
The best way for firms to restore margins is to boost productivity by shedding excess labour. We expect employment growth to slow sharply and the jobless rate to rise in 2002. This in turn will curb household spending and depress confidence further over coming quarters.
As a consequence we believe the most likely economic scenario in 2002 is a prolonged period of below potential growth with the New Zealand dollar likely to come under downward pressure in the second half of 2002. Under-performance of the New Zealand economy is also likely to limit any upside in the share market.
One positive aspect of the outlook is that inflation looks set to slow to below the mid-point of the Reserve Bank's 1.5% target range, opening the way for further rate cuts.
Although in its most recent statement the RBNZ set a high hurdle for more rate cuts, we believe short-term interest rates could end the year close to post-Asian crisis lows of between 3½-4%.
Geoff Mason is the manager of investment strategy at BNZ Investment Management.
Geoff Mason is Manager - Investment Strategy BNZ Investment Management.
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