Writing about the environment likely to face small and medium-sized NZ businesses over the next two years may seem like quite a difficult exercise when one considers the recent renewed volatility and weakness in financial markets around the world. However, while we are of the firm opinion that the problems of high Western government debt levels and weak US and European growth will dog the markets with periodic bursts of pessimism for at least the next two years, it is still possible to paint a broad picture of where things are likely to go here taking into account some factors specific to the New Zealand economy.

First, there is a clear stimulus to many sectors coming from the rebuilding of Christchurch. So far over 6,000 houses have been officially designated as Red Zone permanent casualties, 9,000 more are in the Orange Zone and awaiting determination, and in total over 100,000 houses have been damaged. Replacing the bulk of those properties, developing new subdivisions, demolishing some 1,000 buildings in the CBD and then replacing (some) of them will give a construction sector boost which will extend for the next decade, though likely be concentrated over calendar years 2012 and 2013.

This activity will provide business for many companies stretching from architectural services to earthworks, building materials fabrication, furnishings sales and so on. Interestingly, the surge in construction – which is expected to lead rapidly to severe labour shortages and higher labour costs – will occur at the same time as an expected period of catch-up construction in Auckland where housing shortages are getting worse and worse.

Second, the regions will receive good support for the next two years as farmers slowly become comfortable with their debt levels and loosen the purse strings for more than just extra fertilizer applications and some upgraded fencing. There is already evidence of dairy conversions picking up again, farm sales are lifting (assisted by buyer interest from offshore) and in the sheep and beef sectors there is substantial maintenance and capital spending to catch up on after many years of poor returns.

Third, the NZ economy entered recession officially in 2008, though some sectors such as retailing hit a brick wall in the middle of 2007 when mortgage rates exceeded 10%. Even though the recession ended in 2009 people and businesses have continued to exercise considerable spending constraint. But as debt levels fall and confidence about the sustainability of growth improves we expect economic growth to receive a substantial boost from traditional cyclical activities.

These include businesses increasing orders for raw materials in order to boost inventories back to more normal levels, businesses catching up on capital spending, and consumers catching up on spending on durable items such as cars, couches, and household appliances.

Fourth, assisting the third factor, we expect a fairly rapid tightening up of the labour market in the coming year as an aging population slows workforce growth to near one-third of what it was in the previous 15 years, young people find themselves with low training, and businesses simply rebuild workforces back toward more normal levels. The effect will be accelerating wages growth, pressure for increased spending on workplace training, and a good jump in job confidence that will encourage householders to increase their spending.

Fifth, there are some sectors enjoying good long term underlying growth such as film and game production, information technology, fashion and energy.

There are of course also some sectors which we expect will struggle over the next two years. These include tourism and wine, Kiwifruit due to the PSA vine disease, and many exporters affected by the high NZ dollar. Plus the government will be actively slowing growth as they tighten fiscal policy to remove budget deficits.

Overall we see good potential for the economy to grow around 4% over 2012 and 3% over 2013 with reasonable prospects for most parts of the country for one reason or another.

As growth picks up we expect to see the Reserve Bank removing the currently strong level of monetary stimulus with the official cash rate likely to rise from 2.5% currently to 5% come 2013. That means borrowers should budget for floating rate costs rising 2.5% with far smaller rises in fixed interest rates. But as we have already seen, the period of rising interest rates will not be smooth and just recently the promise by the United States Federal Reserve to not raise their cash rate for at least two years has caused falls in US long term interest rates to levels not seen in almost half a century and this will tend to cap how high our long term rates go.

As NZ interest rates rise at a time when they sit unchanged in the likes of the UK, US and Japan while rising only minimally in Europe, the attractiveness of the NZ dollar will increase. Throwing in our expectation of firm commodity prices and long-term structural investment in the food industry, we think it highly likely that the Kiwi dollar will rise against almost all currencies except the Chinese Yuan over the coming year to a year and a half.

As growth accelerates the labour market will tighten up and businesses should budget for increasing difficulties in getting staff and rising wage and non-wage labour costs. Some allowance should also be made for rising input costs generally in a world where resource availability is becoming more and more constrained and legislative changes push many costs upward. Candidates for this latter effect include increasing earthquake standards for NZ buildings, rising emissions standards for vehicles imported from overseas, plus obviously higher insurance premiums for everyone.

We think for most businesses it is valid to run on the expectation that next year will be better than this one. The problem however is that although we see strong NZ-specific factors, the downside risks facing the world economy should not be ignored. Perhaps the way in which this can be best handled by most businesses is to act as if generally tough times will continue and only switch into generalised expansion mode once good results have been seen over an extended period of time. Many times we have in fact specifically suggested that retailers would be best advised to plan to miss the first three months of the upturn in household spending through running low inventories, rather than stocking up for a forecast recovery which could easily yet again be delayed.

It pays to remember that not all businesses are or have been feeling pain, and many are cashed up and in a position to make some well-priced asset purchases. Getting into that position and keeping an eye out for canny asset acquisitions may be a better long-term strategy than simply trying to pick exactly when to gear up to the ride the next cyclical upturn in the economy – whenever it arrives.

(Written by Tony Alexander)

(Any views expressed in this publication are the views of Tony Alexander and do not necessarily represent those of Bank of New Zealand, or its related entities)