Speech to ANZ’s Capital Markets ConferenceFinance Earthquake Recovery
Good afternoon. We’re all familiar with the events in Christchurch last month. Few words come close to conveying the scale and impact of that disaster.
Can I also acknowledge the horrific events in Japan last week - they show there is always someone worse off than ourselves. More than most, we understand what the Japanese people are going through.
Here at home, helping support and rebuild Christchurch is among the most important things the Government will do this year and into the future.
The Government intends to continue implementing its wider economic policy programme, which I will come back to later. But first, let me cover the Government’s immediate response to the earthquake.
Our first priority was the rescue operation. We declared a national state of emergency so we could throw every available resource – both nationally and internationally – into trying to save the lives of people trapped in the rubble.
Getting power, water and sewerage, and roads up and running was a critical priority. Huge progress has been made – almost all households outside the CBD now have power. About 95 per cent have running water and over 80 per cent can use their toilets.
But due to severe damage in parts of Christchurch, some households might be without water or a flushing toilet for some time.
We provided immediate financial relief to the people of Christchurch, including a $120 million six-week wage subsidy and job loss package. This will probably be extended in some form.
Civil Defence is overseeing the demolition of dangerous buildings. About a quarter of the buildings in the central city have been red-stickered, so this will take some time. We expect the central city to be partly closed for several months.
Rebuilding will be a massive job, taking several years. Here are some examples, which illustrate the scale of the challenge:
- Advice from EQC's engineers suggests thousands of houses may need to be rebuilt and another 100,000 may need repairs.
- The Christchurch earthquake assistance package has so far supported more than 56,000 employees, sole traders and individuals.
- Many schools were disrupted. However we expect 95 per cent to have reopened by next Monday.
- Hospitals coped well with earthquake trauma patients. While many patients were moved around the country, some elective surgery has now resumed in Christchurch.
- About 400 construction personnel are still working on silt removal and making roads safe. The cost of repairs to local roads will likely be several hundred million dollars.
We expect the Government to play a role in funding and co-ordinating building work. We'll work our way through these issues in the coming weeks – including what structures might be necessary to make this happen as quickly as possible.
Due to aftershocks and the need for inspections and demolitions, building in the CBD may not begin for several months.
The Prime Minister this week announced a Royal Commission of Inquiry into the Christchurch earthquake, including why some buildings collapsed in central Christchurch – resulting in a huge loss of life, while others didn't. It will include a look at the building code and whether that needs to be changed.
And there will be a memorial service in Christchurch tomorrow to mourn the great loss of life in the earthquake.
Treasury's preliminary estimate is that the combined cost of the two earthquakes is around $15 billion.
To put this in context, the cost is about 7 per cent of GDP. By contrast damage from the Kobe earthquake in Japan was just over 2 per cent of Japan’s GDP, and Hurricane Katrina about 1 per cent of US GDP. The cost of last week’s disaster in Japan will be large, though we have no reliable figures yet.
The cost of the Christchurch earthquakes will be funded from four main sources:
- EQC covers most private homes up to $100,000 and contents up to $20,000 excluding GST. EQC can comfortably fund payouts from both the February quake and outstanding payments from September. Damage over $100,000 or demolition of private homes will be covered by private insurance.
- Commercial buildings are covered by private insurers, most of which have global reinsurance. This is a major event in the global reinsurance market; until last week it was the largest cost since Hurricane Katrina more than five years ago.
- Local government is partially insured for rebuilding its local infrastructure. The remaining cost is normally a shared expense between central and local Government, but we recognise that Christchurch ratepayers now have less capacity to pay their share.
• In addition, central Government faces damage to a number of its own properties, with schools being the hardest hit.
One consequence of reinsurance is that most of the direct cost of both quakes will be borne overseas. Ironically, in the short term this will actually help the balance of payments, producing a small surplus this year.
Effect on the economy
The wider economic impact of the earthquake, combined with already slower economic growth, will dampen the economy in the near term.
I see that ANZ’s estimates of the impact on growth, government finances and interest rates have been pretty close to the Government’s. Well done Cameron and team.
Treasury has estimated that the direct impact of the quake will be to lower GDP by about 1.5 per cent in the year to June 2011.
While there will be a substantial lift as reconstruction commences, which is likely to see growth exceed 4 per cent within the next two years, the quake - combined with other factors - is still expected to leave nominal GDP a cumulative $15 billion lower over the five years to 2015.
The resulting loss of tax revenue could be between $3 billion to $5 billion over the five years, based on Treasury’s preliminary assessment.
Direct costs to the Crown
This indirect cost is in addition to the direct costs the Government will face for the rebuild of Christchurch.
These are many and varied, and are likely to include:
- At least $3 billion of claims to EQC before reinsurance cover applies;
- Substantial central Government contributions to repairing local infrastructure, including roads, water, storm water, sewerage and stop banks;
- An unknown cost for land remediation;
- Significant costs of temporary housing assistance; and
- ACC's preliminary estimate of $370 million for claims arising from the quake.
There will doubtless be others. So a reasonable ballpark estimate of the total cost to the Government from both quakes - and including direct and indirect expenses - is around $10 billion.
This figure needs to be placed in context. It sounds a lot. But New Zealand’s annual GDP is around $200 billion a year; the Government spends around $70 billion a year; and it has assets of over $220 billion. So we can fund the reconstruction.
And we must fund it. Christchurch is not only our second largest city, it is a major industrial, tourism and regional hub. It is essential for the wider economy.
The economic benefits of rebuilding the infrastructure are very high. Private sector reconstruction depends on us replacing the basic infrastructure the city needs.
So the major question is not whether we can afford to rebuild Christchurch, or whether we should. Rather, it is: What is the most appropriate mix of funding?
The Government’s fiscal response
The Government’s immediate response will be to issue more debt. On one level, this is out of necessity. We started paying the recovery and reconstruction bills immediately, whereas changes to spending and tax programmes take time.
Taking a longer view, debt is the appropriate response to a one-off cost. It allows the burden to borne over time, just as the benefits to rebuilding Christchurch will be permanent.
However, the quake comes at a time when the Government’s ability to absorb such shocks was already falling and its debt level rising.
The Crown has already borne a large share of the burden of the Global Financial Crisis. In the three years to June 2011, it will have run cumulative operating deficits of over $20 billion, and weakened its balance sheet by a similar amount. The negative credit outlook from S&P and Fitch reflects this.
While the pressure on households and businesses has been severe, it would have been much greater without the Government providing a buffer.
This was the appropriate response at the time. However, it results in both higher levels of public debt and finance costs. These impinge on our ability to fund public services and weather any future shocks.
More shocks will inevitably happen in future. For example, over the past two years, New Zealand has experienced the two earthquakes, the collapse of its finance company sector, blizzards in Southland, drought in Northland, PSA in the Kiwifruit industry, the costs of leaky homes and schools, and loss of life in the Pike River mine.
Such a sequence within two years is almost unprecedented.
You’ll perhaps forgive me if I ask “what’s next?”
Before the earthquake, the Government was looking carefully at its spending priorities so we could return to budget surplus sooner - and we will continue with that work.
Quake impact on Government’s books
Officials are still working through their updated forecasts as we prepare for the Budget, but two things are already clear:
First, the earthquake is likely to slightly delay our return to budget surplus.
Second, meeting the Government’s share of the immediate earthquake costs will require a quite substantial front loading of Crown debt in the next year or two.
In terms of our fiscal track, we intended to get back to a meaningful surplus in 2014/15 – a year earlier than forecast at the Half-Year Update in December. It now seems more likely that we will return to surplus in 2015/16, but we will have a better idea when we have completed Budget forecasts.
Due to the earthquake and other factors, this year’s operating deficit before gains and losses could be more than 8 per cent of GDP, or more than $16 billion – up from the $11.1 billion forecast in the December update.
As I’ve mentioned, these earthquake costs are likely to include at least $3 billion of EQC claims, costs for temporary housing and emergency welfare assistance, and substantial contributions to repairing local infrastructure.
These costs will be accrued in the current year, even though the actual expenditure will be spread over several years into the future.
The 2010/11 deficit will also include the Government’s share of paying for leaky homes, a problem that had built up over a decade. As these temporary factors drop out, the deficit is likely to roughly halve in 2011/12.
In terms of net Crown debt, preliminary Budget forecasts suggest that on current policy net Crown debt could now exceed 30 per cent of GDP by June 2014, up from around 28 per cent in the December update. That’s a rapid increase from around 14 per cent in June 2010.
It’s important that we get net Crown debt back to pre-earthquake levels so we can absorb future economic shocks when they come along – as they surely will.
The other reason we are concerned about the rise in Government debt – from levels that were quite modest by world standards - is that it pushes up New Zealand’s total net foreign liabilities. By world standards they are extremely high at about 85 per cent of GDP, and are being closely watched by foreign lenders and credit ratings agencies.
So over the next few years – and for all the reasons we have outlined over the past year – we are not keen to increase debt more than we have to. This was the case before the quake, and remains true today.
It will require some careful decisions about where we prioritise spending, which we will do in a considered and balanced way.
These changes will be long-term spending decisions made on their own merits - not short-term decisions to meet the immediate bill from the earthquake.
In terms of spending priorities, l would like to make these general points:
- The cost of the quake will essentially be borne by the Government balance sheet, rather than by cutting operating spending or increasing taxes. In practice, this means we will both take on more debt and redirect some of our projected capital allocation towards Christchurch. That’s what any private business would do.
- Any changes we make will ensure that the Government’s commitment to protecting the most vulnerable and maintaining public services continues.
- And finally, as I’ve said already, the Government will press on with its broader economic programme to reduce our vulnerability to foreign lenders, get the Government’s finances in order and build faster growth based on higher national savings and exports.
It is likely that EQC levies, now a maximum $60 a year, will rise significantly. That’s because the cost to EQC of reinsurance is certain to increase, and the cover offered by the Natural Disaster Fund needs to be rebuilt.
Impact on infrastructure projects
I’ve also noted concerns from other regions that major infrastructure projects could be deferred to pay for Christchurch reconstruction. Their fears are exaggerated for three reasons.
First, major projects the Government has already committed to will not be deferred – they have proved their economic worth and they can’t simply be switched on and off.
Second, which projects we undertake ultimately depends on their costs and benefits. These will not have changed much due to the quake.
And finally, our economy has the capacity to absorb the impact of the quake and I am optimistic about its potential once the recovery starts to kick in.
The Reserve Bank last week forecast GDP growth to peak at over 5 per cent in 2012 and unemployment to fall below 5 per cent.
This is expected to be accompanied by a lift in 90-day interest rates to only 4.6 per cent, a low peak compared with the last cycle when interest rates reached almost double that figure.
That forecast combination of high growth and moderate inflation would be good for the economy and our export industries. Provided we keep debt and finance costs under control, we should still be able to fund worthwhile projects in future.
I can reassure the people of Canterbury that the Government remains absolutely committed to providing the resources needed to help rebuild your city and your economy.
It’s also important that we don’t allow the quake to become the sole focus of policy.
As the Prime Minister said, the basic issues New Zealand faces and the imbalances we’ve identified in the economy are as relevant today as they were last month.
We need to become a more export-orientated economy. We need to have higher savings, and we need to be more productive as a country.
The need for major construction in the next few years will make it more challenging in the short term to tilt the economy towards exporting. So the Government needs to be even more careful about not crowding out exports, savings and productive investment.
Building a stronger national economy, more jobs and higher incomes is the best way we can help the people of Christchurch.
So we will be pressing on with our programme to build the faster-growing economy we need to achieve those things.