Coronavirus: How Covid-19 will hit the Government's books

Sunday, 17 May 2020

Chinese eateries along the Dominion Rd strip are struggling as the economic toll of Covid Level 4 begins to bite.

Do you know your EFUs, or have I lost you already?

There's nothing quite like an EFU, short for Economic and Fiscal Update. They're a bible of economic forecasting and Government accounts produced by the Treasury twice a year, once at the budget and again at the end of the calendar year.

The Budget EFU is called BEFU (Budget Economic and Fiscal Update) and the end of year update is called HYEFU (Half Year Economic and Fiscal Update, usually pronounced Hi-ee-foo in case you were wondering). The half year bit refers to the financial year, which ends in the middle of the calendar year.

Every three years, we're treated to an extra EFU, the PREFU (Pre-election Economic and Fiscal Updade), which comes out just before the election.

* Budget 2020: A decade of economic pain, Robertson uses balance sheet to shield economy

* Fiscal and monetary response to better-case coronavirus scenario takes shape

The updates are an important part of New Zealand's economic and political landscape. Treasury is legally required to produce and publish them.

They're an essential part of government transparency, giving media, the opposition, and the general public a look at its books before important events.

Usually, each update builds upon the one before it. The changes are slight. Treasury will revise its forecasts, saying the economy will grow slightly faster or slower than it thought at the previous update. Forecast tax revenue will change slightly, maybe debt too, but the changes are usually nothing too dramatic.

The documents help us to look at the extent of the economic shock of Covid-19. We can do this by looking at BEFU, the set of forecasts released at the Budget last week and last December's HYEFU, Treasury's last set of pre-Covid-19 forecasts.

Putting them side-by-side shows the extent of the economic damage of Covid-19. HYEFU gives us a glimpse of an economy where things trucked on much as normal. The economy continued to grow and unemployment remained relatively low.

BEFU gives us a look into the future of the economy we're in right now, with high unemployment and an economy that shrinks, rather than grows.

The first chart to look at is the most important one. This is a comparison of nominal GDP, or Gross Domestic Product.

It measures the size of our economy. Ideally, the size of an economy grows as the population increases and invention and innovation make people wealthier and more productive.

A growing economy tends to mean unemployment is low as growing businesses take on more staff. It also means more tax revenue each year for the Government.

As you can see here, in HYEFU, the economy was expected to keep growing. Unfortunately, Covid-19 has undone this, meaning the economy will shrink.

The next chart to look at is unemployment. The unemployment rate is a measurement of all the people who want to find work who are unable to find it. People who aren't looking for work, people who are ill or superannuitants for example, aren't counted.

In normal times, the Government tries to keep unemployment below 4 per cent, which is roughly where it was before the crisis.

As the BEFU chart shows, Treasury expects unemployment to climb much higher than this in the near future, as Covid-19 batters the economy.

Māori and Pacific peoples also have much higher rates of unemployment than the population as a whole, although these are not forecast.

A battered economy yields less revenue for the Government. This is a combination of companies making less money and therefore paying less tax, people spending less, and people going from being employed taxpayers to becoming unemployed.

As you can see from this chart, the Crown's expected tax revenue has taken a sever battering from Covid-19.

This means the Government will either have to borrow more to pay for the spending it wants to do, or cut spending to adjust to its reduced revenue.

In a crisis, there's really only one option. Counterintuitively, it's to spend more. As businesses cut their cloth to fit, it's the job of governments to spend to keep money flowing through an economy until the private sector can get on its feet again.

This is called economic stimulus.

As you can see in this chart, spending will be ramped up considerably over the next few years. Spending will grow far in excess of what was expected at HYEFU, when the state spent roughly $87b a year, climbing to $109b.

Instead, the Government will open its coffers, spending $114b this year, and keeping spending high for the rest of the forecast period.

All of this has an effect on the Government's books.

If it spends more than it taxes, it creates a budget deficit. If it taxes more than it spends, there's a surplus.

This is recorded in the Government's books as OBEGAL, or Operating Balance Before Gains and Losses.

Recent governments have aimed for budget surpluses over the long term, although the economic shocks of the Global Financial Crisis and now Covid-19 have got in the way.

As you can se in the chart, lower taxes and increased spending will create massive deficits in the near term, although it's hoped the Government will return to surplus by the end of the year.

The Government is set to take on an enormous amount of debt over the next few years as it engages in successive rounds of economic stimulus.

It's not unprecedented — we've taken on large debt before to fight wars or stave off an economic depression. It's also not that much relative to the size of our economy.

Treasury thinks that at the end of the crisis we'll still have less debt relative to the size of our economy, than most of our international peers.

The comparison between HYEFU and BEFU shows how costly Covid-19 will be for the Government. In December, it was expecting borrowing to increase only slightly, and slowly decrease as a share of the economy.

But revised forecasts in BEFU tell a very different story, with debt now expected to rise each year before hitting $200b and stabilising.