Figures in a comprehensive review, known as the December Economic and Fiscal Update (DEFU) showed the treasury expected the economy to shrink by 0.9 per cent in the year ended to March 1999 before recovering to grow by 1.6 per cent and 2.4 per cent in the following two years.

That was sharply lower than the GDP figures in May's 1998-99 budget, which saw growth of 2.7 per cent this year, rising to 3.9 per cent and 3.5 per cent in the two subsequent years.

The forecasts are close to a ``worse case'' slower world growth scenario prepared by treasury in September in response to the combined impact of the Asian crisis and a domestic drought.

In response to the latest data, treasurer Bill Birch said the fiscal policies announced in May's budget were no longer sufficiently sustainable in the longterm.

``Since the budget, our top ten trading partners growth forecast is down from 2.7 per cent to 0.8 per cent,'' he told a news conference.

He said the conservative National Party government had attacked the problem through a reduction in taxes, policies that increased household disposable incomes, micro-economic reform and cuts to spending since May.

It now plans to spend an extra New Zealand $4.25 billion ( $2.2 billion) over its full three-year term to 2000, against an extra New Zealand $5 billion originally planned under a now-defunct coalition deal struck in 1996.

Even with a lower spending track, Birch expected to run a small budget deficit of New Zealand $52 million in the year to June 1999, then deficits of New Zealand $1.3 billion and New Zealand $1 billion thereafter.

One significant impact of the growth slowdown, and the return to deficits after six years of surpluses, has been to stall the government's ambitious debt repayment programme that had been intended to cut net debt as aproportion of GDP to 20 per cent.

The latest forecasts show that ratio rising from 24.4 per cent at June 1998 to 27.8 per cent by June 2001, instead of falling.

Birch said the risk of a world recession had receded significantly since October, ``but there are still substantial risks out there.''

He said the planned privatisation of large energy generator Contact Energy should completed before mid-1999. If analysts' predictions of a value of New Zealand $1.4 to New Zealand $1.5 billion were realised, that could well leave the government with a substantial surplus, as treasury forecasts always exclude gains from privatisations, he said.

Contact has a book value of New Zealand $880 million and any surplus or deficit on sale would go straight to the budget balance.

Birch said the centrist MPs and minor parties that support the minority government on key votes in parliament backed the careful fiscal approach.

``They are familiar with it (the DEFU) and I think they see it, as we do, as a pretty positiveresponse to what has been a pretty traumatic change to our export markets,'' he said.

Some financial market economists said the DEFU seemed to have been overly cautious in forecasting fiscal pressure, however, and they saw better recovery prospects than Birch during 1999.

Mark Benseman economist at Merrill Lynch said it was possible that Birch was looking to make some political capital from an expected pick-up during 1999 -- which is certain to be an election year -- to help the National Party's election prospects.

``To some extent I believe that the next Budget will paint a slightly rosier picture than what's here, and they will use that as perhaps a springboard to an election at that point.'' The budget is due around the middle of 1999 while the latest date for a general election is November.