VZCZCXRO5232
PP RUEHNZ
DE RUEHWL #0351/01 1240652
ZNR UUUUU ZZH
P 040652Z MAY 07
FM AMEMBASSY WELLINGTON
TO RUEHC/SECSTATE WASHDC PRIORITY 4222
INFO RUEHBY/AMEMBASSY CANBERRA PRIORITY 4827
RUEHNZ/AMCONSUL AUCKLAND PRIORITY 1305
RUEHRC/DEPT OF AGRICULTURE WASHDC PRIORITY
RUCPDOC/USDOC WASHDC PRIORITY 0130
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RHHMUNA/CDR USPACOM HONOLULU HI PRIORITY

UNCLAS SECTION 01 OF 03 WELLINGTON 000351 
 
SIPDIS 
 
SIPDIS 
 
STATE PASS TO USTR, STATE FOR EAP/ANP, EB, INR, PACOM FOR 
J01E/J2/J233/J5/SJFHQ 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD PGOV PREL NZ
SUBJECT: NEW ZEALAND'S MONETARY POLICY AT ODDS WITH FISCAL 
POLICY 
 
1) (U) SUMMARY: On April 26 the New Zealand Reserve Bank 
(NZRB) raised the Official Cash Rate (OCR) by 25 basis 
points, to 7.75 percent, citing inflationary pressures from 
increased government expenditures and a sustained housing 
boom. Financial experts believe this action is likely to push 
floating mortgage rates, already hovering around 9.8%, 
through the psychological double-digit barrier of 10%. Fixed 
rate mortgages have also edged higher in recent weeks, with 
benchmark two-year rates reaching 8.8%. The increase means 
that mortgage holders face the highest interest rates in 
nearly a decade.  The OCR rise has also created a 23-year 
high in the value of the Kiwi dollar, negatively affecting 
exports and leading a number of export manufacturers to 
announce they will leave New Zealand for cheaper destinations. 
 
2) (U) Meanwhile, the OECD's 2007 economic survey of New 
Zealand has rated the NZ economy well in the bottom half of 
the OECD tables, in large part because of the high value of 
the Kiwi dollar and high domestic interest rates.  The report 
also cites other weaknesses as New Zealand's large net 
foreign debt and current account deficit, as well as falling 
household savings levels. The report maintains that lower 
government spending would make it easier for the NZRB to curb 
inflation and stabilize the economy.  The economy is by and 
large still doing fairly well by global standards -- with GDP 
growth predicted to reach 2% and unemployment remaining at 
3.7%.  But manufacturers' and exporters' concerns about the 
high Kiwi dollar and interest rates are already being 
exploited by the opposition National Party, which blames 
Labour government's spending for the problems.  To help 
deflect criticism, Labour has asked Parliament to look into 
ways to control inflation other than just adjusting the OCR. 
Many analysts say such an inquiry will be a waste of time 
unless the Government looks at aligning fiscal and monetary 
policies. End Summary. 
 
------------------- 
Effect of OCR Hike 
------------------- 
 
3) (U) In announcing the interest rate hike, NZRB head Dr. 
Alan Bollard attributed his decision to increase the OCR rate 
to the robust housing market, increases in government 
spending, a rising gap between the value of imports and 
exports, ongoing high levels of immigration, and a strong 
labor market.  He also described the strength of the Kiwi 
dollar as both "exceptional" by historical standards (at a 23 
year high) and "unjustified" on medium-term economic data. 
This was seen as a shot across the bow for the currency 
markets but the warning was largely ignored, with the dollar 
closing that day at US74.81c. 
 
4) (U) Bollard's move prompted manufacturers, unions and 
political parties to call on the Government to develop other 
financial measures besides the OCR for controlling inflation. 
Last week, one of New Zealand,s largest manufacturers of 
consumer appliances, Fisher & Paykel said it would close its 
Auckland washing-machine manufacturing plant and shift 
production to Thailand, with the loss of some 350 jobs. Soon 
thereafter bed-maker Sleepyhead said it may shift its plant 
to China, putting another 400 jobs at risk. These lay-offs 
follow announcements this past month from three large (by NZ 
standards) Christchurch manufacturers, G. L. Bowron, Click 
Clack and Whisper Gen, all of which blamed the high NZ dollar 
for the need to downsize. 
 
5) (U) The interest rate hike comes just days after the OECD 
warned that GNZ's spending increases were likely to fuel 
inflation and increase the exchange rate of the Kiwi dollar, 
which would further exacerbate imbalances in the economy. All 
eyes are now on Finance Minister Michael Cullen, who is due 
to unveil the annual Budget in just three weeks time. In it 
he is expected to include another $1.9NZ billion in new 
expenditures, including $1bNZ worth of business tax cuts. 
Analysts expect that if these increases are made the NZRB 
will raise the OCR rate again at their next meeting in June, 
to 8 percent. 
 
-------------------------- 
OECD Adds Fuel to the Fire 
-------------------------- 
 
6) (U) NZ's high interest rates have been given the thumbs 
 
WELLINGTON 00000351  002 OF 003 
 
 
down by the OECD as well. In a widely publicized report 
released on 23rd April, the OECD ranked New Zealand,s 
economy at 22 out of 30 OECD member countries. "What really 
matters is that living standards are quite a lot below the 
OECD median and they don't seem to be catching up," reported 
Deborah Roseveare, who heads the OECD's New Zealand desk. 
Despite ranking near the top for its policy and regulatory 
framework, New Zealand's productivity and saving rates are 
near the bottom. Roseveare added that the reforms of the 
1980s and 90s were essential and had contributed to 
productivity growth in the past but the OECD is puzzled as to 
why New Zealand hasn't performed better.  Part of the 
explanation could be the huge swings in the Kiwi dollar's 
exchange rate, which hinders exports, along with persistently 
high interest rates, which discourage investment. "It's not 
obvious what policy makers can do about it," maintained 
Roseveare. 
 
7) (U) The OECD Economic Survey of New Zealand further 
indicates that NZ faces the dual challenge of raising 
national income levels and providing superannuation payments 
for an aging population. The report says New Zealand needs 
stronger and deeper financial markets as an alternative to 
investment in housing, as well as a tax regime that 
encourages people to work, save and invest. The OECD suggests 
this goal could be achieved by flatter, more broadly based 
tax system with lower private income and corporate tax rates 
and a higher GST level. Or, there could be a dual system 
which taxes capital gains along with private income. (NB: NZ 
does not currently have a capital gains tax.)  The survey 
also recommends New Zealand cut the top private tax rate 
(currently 39% for incomes of NZ$60,000 (US$45,000) and 
above), raise the GST rate by 1% to 13.5%,  raise the age of 
superannuation entitlement (now 65 years) and find new ways 
to control inflation other than raising the OCR. The OECD 
survey concludes that the Reserve Bank will not be able to 
lower the interest rates that are pushing up exchange rates 
and household and business costs until the economy slows or 
foreign investors suddenly lose confidence in New Zealand. 
 
------------------------------ 
Political and Business Fallout 
------------------------------ 
 
8) (U) One of the most politically sensitive remarks in the 
OECD report claims that, "New Zealand's living standards, 
whether measured by GDP or net national income per person, 
lag well behind the OECD mean and median," but more 
importantly well behind Australia (ranked 9) against whom NZ 
constantly compares its standard of living. National Party's 
finance spokesman, Bill English says that the OECD Survey 
identifies, "Labour's spending binge in the lead-up to the 
next election as one of the main causes of the high interest 
rates, inflation, and high exchange rate bedeviling the 
economy." Not surprisingly, Finance Minister Cullen says the 
report proves that Labour's economic policies have given New 
Zealand one of the most flexible and resilient economy in the 
OECD. 
 
9) (U) Economic Development Minister Trevor Mallard said 
giving the Reserve Bank new tools to fight inflation, beyond 
its use of interest rates, would at a minimum require a 
multi-party accord on monetary policy. He said such an 
agreement is unlikely, however, given that the last time 
Labour attempted to involve National in talks over another 
option - the proposed tax on mortgage rates to slow the 
housing market - the National Party swiftly condemned it. 
Mallard also indicated that the Reserve Bank and the Treasury 
were continuing to look at other ways to supplement the OCR 
tool.  Meanwhile, National's Finance Spokesman Bill English 
has said he is not convinced other measures would work. 
National blames high Government spending for NZ's 
inflationary pressures. 
 
10) (U) The political sniping has drawn Prime Minister Helen 
Clark into the debate, and on May 2 she endorsed an inquiry 
by the all-party Finance and Select Committee, chaired by 
Labour's Shane Jones. The committee may examine capital gains 
tax or a mortgage rate levy as an alternate means to further 
NZRB rate hikes. Some pundits believe that neither of the two 
main parties are likely to adopt these measures but are more 
likely to focus on tightening tax rules on investment 
properties and apply more vigilant policing of laws covering 
 
WELLINGTON 00000351  003 OF 003 
 
 
property speculation. 
 
¶11. (U) Prominent business leaders also reacted to the 
government's response by saying that any inquiry by a 
parliamentary select committee into the pressures on 
inflation and the export sector will be a waste of time if 
the focus is only on monetary policy. They believe the 
government needs to focus more on productivity-raising 
measures such as staged tax reductions, freer employment law, 
less regulation of the business sector, and more private 
sector involvement in infrastructure and government business 
enterprises. They maintain that inflation needs to be 
controlled by reducing the growth in government spending to 
below the growth rate of the economy so that more resources 
are available to the productive sector. 
McCormick