Reading the tea leaves

The greatest risk to New Zealand's economic future - and the extent to which credible interpretations might be derived from this week's Pre-election Fiscal Update - is the volatile world economy. In this respect, the news from the other side of the world is not good. On Wednesday, fears of a global slump intensified as hopes of a "grand bargain" to solve Europe's sovereign debt crisis dissolved amid more of the bickering that has cast an economic pall over the continent.

Talks between the European Union finance ministers planned for mid-week failed to get off the ground; German chancellor, Angela Merkel, doubtless spurred on by domestic political alignments, pushed hard against French President Nicolas Sarkozy as they wrestled with the precise shape of a rescue package; and Silvio Berlusconi, sent packing at the weekend to sort out his country's own faltering economy, was rumoured to be having trouble keeping a government together.

That news, notwithstanding the distance it has travelled, has the potential indeed to undermine the economic forecasts delivered this week by the New Zealand Treasury. The Prefu, as it is colloquially known, was introduced as a statutory measure to reveal the state of the country's finances prior to each election. In theory, it is an excellent idea; in practice, while certainly much preferable to incoming governments staggering blindfolded to the Treasury benches, or to opposition parties firing blind into the unknown, still leaves a good deal of room for partisan readings.

Therein lies the rub. The situation in Europe, worsening by the day, threatens to provide the Treasury's Prefu with more than a vigorous massage. For reading between the lines of this influential triennial report - one which is typically used by the incumbent administration to bolster its own policies, and by the opposition to decry it in typical tit-for-tat rhetoric - is the assumption nothing truly seismic will occur in Europe, and thus throughout the world. The odds on that eventuality are shortening.

According to the Prefu's own risk analysis, if Europe is something of a cloud, it is not the only one on the horizon. Another is the boost for economic growth expected to be provided by the Canterbury rebuild. The cost of that was this week estimated to have risen to about $20 billion with some analysts suggesting it might eventually reach $30 billion.

That, of course, will be repaid in the additional boost for the economy - when it eventually gets under way in earnest. For the moment, however, uncertainty and delay are causing jitters in the market: the plunge in Fletcher Building's share price is one such manifestation, contingent as it is said to be on the rebuild.

A third fly in the ointment is the outlook for New Zealand's export prices. Fonterra's forecast this week also fell, reflecting a softening in demand, which in turn might be seen to be an indication of confidence in the general world economic outlook. The reality is that, should Europe be unable to sort out its fiscal differences and address its sovereign debt issues - and the contagion of default and lost confidence spread from Greece to much larger economies such as Italy and Spain - the result could well be a world recession at least as harsh and damaging as that experienced in 2008. This would play havoc with demand for New Zealand's exports, and make the cost of borrowing prohibitive in this country.

Such a gloom-laden trifecta would turn the glass-half-full scenarios presented in the Prefu - an average growth rate of 2.9% for the years ending 2012 to 2016, a fall in unemployment from 6.5% in this year to 4.7% in March 2016, and a return to surplus in 2015 - on their head. In the face of this, it must be hoped Europe comes to its senses (and it is receiving no end of advice on that score from other world leaders); that the seismic contortions beneath the Canterbury plains settle down sooner rather than later; and that the price of milk does not fall any further.

On such outcomes this country's future prosperity at present resides. Much of this is in the lap of the gods. We must hold on tight and hope for the best.


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