The Government says it will still invest in infrastructure despite dire Treasury forecasts, although KiwiRail will lose out because it will not get the capital investment promised by the previous Government.
In the December economic and fiscal forecasts, Treasury is predicting bigger deficits and a substantial rise in Government debt, as the economy struggles to come out of recession.
It expects the Government cash deficit will rise to $6 billion this financial year, and peak at more than $11 billion in 2013.
Finance Minister Bill English said to rein in spending the government will, where possible, drop unfunded commitments made by the previous Government, which includes capital investment in KiwiRail.
He said housing, education and smaller roading projects will get attention in the New Year, and after that there will be a strong focus on roading.
Labour Transport spokesman Darren Hughes said it was a deliberate move by National to undermine KiwiRail, so it can then say buying back the asset was a mistake.
In the half-yearly economic and fiscal update released on Thursday, the Treasury also forecast 52,000 more people would be unemployed by mid-2010.
The situation has worsened since the gloomy pre-election economic and fiscal update in October.
The Government will have to borrow more, as its gross debt is forecast to rise to $71 billion in 2013, which is 33% of gross domestic product.
However, Finance Minister Bill English has promised the National-led Government will not let debt get that bad.
"We are not going to let this happen," he said. "It would be too big a burden for future workers to be dealing with a persistently rising burden of debt.
"It's absolutely vital that we focus on quality long-term policies that are going to deal with the quality of Government spending."
Mr English says the Government will not go back on any of its election promises despite the public finances going deeper into debt.
The gloomy fiscal forecasts come off the back of predictions that the economy - which has been in recession this year - will remain flat next year. The Treasury forecasts the economy will start to recover in the year to March 2011.
Labour's finance spokesperson David Cunliffe said the Government should not have approved a further round of tax cuts to take effect in April next year.
He said increased spending on infrastructure would be a better approach, as that would create new jobs.
Earlier in the week, Treasury secretary John Whitehead said New Zealand was in a good position to cope with the world recession, as its public debt was low compared with other developed countries.
Forecast too optimistic - economists
Economists criticised the Treasury's forecasts for the economy and government debt position as being too optimistic.
They say the forecasts do not take into account the deterioration in the outlook for the world's economies since the forecasts were compiled almost a month ago.
BNZ economists say forecasts for New Zealand's trading partners have been slashed since the Treasury completed its forecasts on 20 November and its view is now out of date.
They say the Treasury's worst-case scenario - which includes two more years of recession and unemployment peaking at 7.2% - is most likely to happen.
However, ANZ National chief economist Cameron Bagrie says even this may be too optimistic, given the rate at which the outlook for the world economy is worsening.
Finance Minister Bill English says if the world economy continues to worsen, the Treasury's worst-case scenario will eventuate, but says this will not be clear until March 2009.
Government 'needs new plan'
Opposition parties say the Government needs a new plan to deal with worsening public finances.
Mr English says the Government will drop unfunded commitments made by the previous Labour Government and reduce growth in government administration.
But Labour Party finance spokesperson David Cunliffe says the unfunded commitments would make no difference to the latest Treasury forecast, which he says is a serious situation, demanding a serious response.
Mr Cunliffe says next year's Budget is too late to start putting a plan in place, because maintaining public confidence requires more immediate action.
Green Party co-leader Russel Norman says the Government lacks clear direction about how it is going to deal with the recession.