Thu, 28 Sep 2000, 7:15pm EDT

N.Z. Economy Shrank 0.7% in 2nd Quarter as Construction Slumped

By Victoria Batchelor

Wellington, Sept. 29 (Bloomberg) -- New Zealand's economy went into reverse in the second quarter, shrinking 0.7 percent and leaving the central bank with the dilemma of how to combat faster inflation and a sliding currency.

The decline was greater than expectations that gross domestic product would fall 0.5 percent after growing a revised 0.6 percent in the first three months of the year. First-quarter growth was revised down from 0.8 percent. In the year ended June 30, the economy grew 4.8 percent, Statistics New Zealand said.

``The economy is having a miserable time,'' said Geoff Mason, senior economist at Bank of New Zealand Ltd., before the figures were released. ``It's more than just payback from the extra-strong growth of last year.''

The shrinking economy has the central bank in a bind, because inflation is expected to breach its 3 percent ceiling later this year. Raising rates to tame inflation poses the risk of a second recession in two years. Reserve Bank Governor Don Brash has already been criticized for raising rates too high, too fast.

It was the biggest decline in GDP since the first quarter of 1998, when the economy last sank into recession. Fourth-quarter growth was also revised down to 2 percent from 2.3 percent.

All eight economists surveyed by Bloomberg News expect the central bank to leave interest rates at 6.5 percent at its six- weekly policy review next Wednesday, though four of the eight expect a quarter-point increase later this year.

The bank raised borrowing costs five times, by a total 2 percentage points, between November and May.

Alone in OECD

The contraction isn't completely out of the blue -- Brash warned last month the economy probably shrank last quarter. It does show, though, how poorly New Zealand is performing.

This year, world growth will touch 4.7 percent, its fastest rate in more than a decade, according to the International Monetary Fund. New Zealand is the only nation in the 29-member Organization for Economic Co-Operation and Development on the brink of recession.

The problems don't stop there. The New Zealand dollar has shed 20 percent this year, making it the world's fourth-worst performing currency, and the main Top 40 stock index has lost 27.4 percent in U.S. dollar terms, ranking it the 10th worst index in the world.

Reports earlier this week showed consumer confidence at a two- year low, while business confidence also declined this month.

``The economy is likely to remain unfriendly from an investor perspective,'' said Adrian Orr, chief economist at WestpacTrust, before the figures were released.

Still, the economy should avoid sliding back into recession, as the weak dollar underpins exports and woos tourists, economists said. The economy is expected to grow 0.5 percent this quarter, according to a Bloomberg survey.

``New Zealand should just avoid a technical recession by recording very slight growth in the third quarter and will likely bounce back a little more strongly in the final quarter,'' Goldman Sachs said in its latest Asia-Pacific economics outlook.

A recession is defined as two straight quarters of economic contraction.

Worst Offender

Contributing most to the decline in activity in the quarter, was a 23.1 percent drop in spending on houses and apartments.

In production terms, activity in the retail industry declined 0.2 percent and construction activity dropped 13.2 percent. Statistics New Zealand said spending on durable goods decreased in the quarter, largely reflecting a slump in spending on cars, clothing and footwear.

``Consumers are suffering from weak incomes, higher petrol prices, tax hikes and falling employment,'' BNZ's Mason said.

The economy has shed 10,000 jobs this year, out of a working population of 1.5 million, and gasoline pump-prices have risen as oil prices hover near a 10-year high.

``In this environment, the Reserve Bank shouldn't raise rates for the rest of the year,'' even amid signs of faster inflation, Mason said.

As the housing industry slumps, companies reliant on the construction industry are having a tough time. One of the first reactions is to cut back staffing.

``There's no point having 20 staff in a shop when customers aren't there,'' said Mike Spraggon, chief executive of Mitre-10 New Zealand Ltd., the nation's largest hardware store chain. ``It's very evident things aren't as buoyant as they have been.''

Meantime, the report showed, government spending declined 1.9 percent.

In production terms, manufacturing activity slipped 0.7 percent and agricultural activity dropped 3.2 percent.

SNZ said the early end to the dairy season, the nation's largest export industry, saw the fall in farm production. And even though manufactured exports were buoyant, weak demand from domestic consumers saw manufacturing production fall.

Offsetting the declines, exports of goods and services rose 0.7 percent, adding 0.2 percentage points to growth.

There are also signs inflation is under control. The GDP price deflator, a measure of overall price changes for goods and services purchased in New Zealand, rose 0.4 percent in the quarter, after rising 0.5 percent in the first three months of the year.

Still, expectations are consumer price inflation will speed in the third quarter as the weak dollar boosts the cost of food prices and other imported goods.

A separate report showed the current account deficit widened to 7.2 percent of GDP in the year ended June 30.

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-- Carl Jenkins (Somewherepress@aol.com), September 28, 2000