By Lucy Craymer

WELLINGTON (Reuters) -New Zealand on Thursday announced a worse-than-forecast budget deficit as a slowing economy and a lower tax take hit its coffers, leaving the Labour government walking a tight rope as its spending plan is expected to fan inflationary pressures.

In his last budget ahead of what is set to be a close-run election in October, finance minister Grant Robertson announced billions towards rebuilding infrastructure following severe weather events at the start of the year and towards helping those struggling with increased living costs.

That has heaped pressure on New Zealand’s finances, as the government has had to navigate many challenges including three-decade high inflation, sharply rising borrowing costs, a stuttering economy and falling tax revenue.

Surveys show the high cost-of-living as a key concern for voters, as Prime Minister Chris Hipkins has reiterated the government’s plans to return to “bread and butter issues”, as his Labour party braces for what many expect to be a closely fought election.

“We’re focused on how we reduce the pressure of cost of living, delivering public services, cyclone recovery and increasing economic resilience,” Robertson told media.

Even so the government’s accounts are looking worse than they did last December. The country is projected to record a NZ$6.96 billion deficit for the year to June 2023 versus previous expectations for a deficit of NZ$3.63 billion, and will not return to surplus until 2025-26, a year later than previously forecast.

INFLATIONARY BOND PLAN

The government raised its bond programme with gross issuance up NZ$20 billion in the four years to June 2027 to NZ$120 billion.

Economists said they were surprised at the size of the new spending and that the fiscal forecasts are more expansionary than they had anticipated.

“We believe the Budget will add to inflationary pressure at the margin. This being the case, it does add weight to the argument that the cash rate eventually peaks at a level that is higher than the 5.5% the Reserve Bank has picked,” Bank of New Zealand economists said.

The New Zealand rose 0.25% to $0.6261, while two year swaps jumped 11 basis points after the budget.

The Reserve Bank of New Zealand has warned that a boost in government spending could add to red-hot inflation, which it has aggressively tried to temper by increasing the official cash rate by 500 basis points since October 2021.

However, Treasury sees inflation slowing to 3.3% by mid-2024, from the current blistering 6.7% pace, levels not seen since the early 1990s.

Another bright spot is that Treasury now expects the economy to grow 1% in the 12 months to June rather than moving into recession in the second half of this year. It noted that the cyclone rebuild and the return of tourists was boosting activity. In December, Treasury had forecast the economy to contract by 0.3%.

Much of the worsening in the accounts is due to falling tax revenue as the economy slows.

Adding to the strain on finances were two significant weather events at the start of the year that caused an estimated damage as high as NZ$14.5 billion.

S&P Global Ratings retained New Zealand’s AAA ratings, but warned of pressure ahead.

“Recession risks and reconstruction costs from Cyclone Gabrielle are delaying New Zealand’s post-COVID fiscal repair,” said Martin Foo, analyst at the ratings agency.

“If a somewhat expansionary fiscal stance adds to the import bill, this could further weaken external accounts and erode headroom for the sovereign ratings on New Zealand.”

(Reporting by Lucy CraymerEditing by Shri Navaratnam)

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