By Lucy Craymer and Alasdair Pal

WELLINGTON (Reuters) – New Zealand’s government on Wednesday forecast the country would enter a recession in 2023, even as the budget remained on target to move into surplus for the 2024/25 financial year.

Spending constraints and the forecast recession will add to challenges facing Prime Minister Jacinda Ardern’s Labour party as it approaches a general election next year.

The economy will shrink in the second, third and fourth quarters of 2023, according to Wednesday’s economic and fiscal update from the Treasury.

The Reserve Bank of New Zealand is even more pessimistic than the Treasury, having forecast a year-long recession beginning in the second quarter of next year, a result of steep interest rate rises it has implemented to control inflation.

“2023 is a challenging year for many New Zealand households,” Finance Minister Grant Robertson told a press conference after issuing the regular mid-financial-year update.

Getting back to surplus would demand tough budgetary choices, he said in a statement.

Ministries would be told to find money within existing budgets for new initiatives next year, Robertson said.

In May, the government announced heavy spending on infrastructure, including new schools, and on the health system, which got more funding for drugs and facilities.

Opposition parties have crticised Labour’s spending as contributing to inflation, which is running at just below three-decade highs.

Robertson said a careful approach to the budget was needed if the country wanted to get inflation down.

Nonetheless, the fiscal outlook has already improved. The government predicted a budget deficit of NZ$3.63 billion ($2.34 billion), or 0.9% of gross domestic product (GDP), for the financial year ending June 2023. That was narrower than the NZ$6.6 billion forecast in the budget issued in May.

Public finances would produce another deficit in 2023/24 but shift to a surplus of NZ$1.6 billion in 2024/25, according to the Treasury’s update document.

It forecast that net debt under an old method of calculation would peak at 41.8% of GDP in 2023/24, compared with the May forecast for a peak in 2023/24 at 41.2% of GDP.

Westpac economists said in a note that the relatively benign fiscal outlook hinted at some wiggle room for government spending. “For now, though, the Government is keeping its powder dry,” the note added.

The government said it would extend transport subsidies, with the expiry of a cut on petrol excise duty deferred to February and half-price public transport remaining until March.

Despite economic weakness, inflation will not return to the government’s target band of 1% to 3% until December 2024, according to the Treasury’s update. In the third quarter of 2022, consumer prices were 7.2% higher than a year earlier.

($1 = 1.5485 New Zealand dollars)

(Reporting by Lucy Craymer; Editing by Lincoln Feast and Bradley Perrett)

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