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Monthly Economic Indicators

Special Topic: Current account adjustment

The net outflow of investment income is the major component of New Zealand’s current account deficit and has accounted for around half of the growth in the deficit over the past five years.  This special topic examines the main drivers of the investment income balance and the outlook for this component of the current account.

Investment income a major component of the current account deficit

The investment income section of the current account includes all income from New Zealand investment abroad and income from overseas investment in New Zealand, whether that income is actually repatriated or merely accrued to its owners.  Since investment in New Zealand far exceeds our investment overseas, the outflow of earnings on investment in New Zealand exceeds the inflow of earnings on our investment overseas.

The net outflow of investment income in the year to December 2008 was $13.6 billion, with a gross outflow of $16.5 billion and a gross inflow of $2.9 billion.  The deficit on investment income was equivalent to 7.6% of nominal GDP in the year to December 2008 and accounted for 85% of the total current account deficit of $16.1 billion (8.9% of GDP).  The deficit on investment income has increased from $7.25 billion (5.3% of GDP) in 2003, while the total current account deficit has increased from $5.8 billion (4.3% of GDP) over the same period (Figure 6). 

Figure 6 – Annual current account balance
Figure 6 – Annual current account balance.
Source: Statistics NZ

The increase in the deficit on investment income in this period accounts for more than half of the increase in the total current account deficit over this period.  The rest of the increase is accounted for by an increase in the goods deficit (which fell from a surplus of $0.4 billion in 2003 to a deficit of $2.4 billion of GDP in 2008) and a fall in the services balance from a surplus of $1.4 billion in 2003 to a deficit of $1.0 billion in 2008, offset by a slight increase in the transfers surplus from $0.15 billion to $0.9 billion. 

Growth in net liabilities the major determinant of net investment income outflow …

The major determinants of the investment income balance are growth in the stock of investments and changes in the earnings on those investments.  New Zealand investment abroad increased from $70.5 billion at 30 June 2000 to $125.5 billion at 31 December 2008, while foreign investment in New Zealand increased from $161.6 billion in mid 2000 to $293.2 billion at the end of 2008.  This resulted in a net international debtor position of $91.2 billion in 2000 increasing to $167.7 billion in 2008, equivalent to 93% of GDP in the year to December 2008 (Figure 7).

Figure 7 – International investments
Figure 7 – International investments.
Source: Statistics NZ

… along with the earnings on investments

Investment income flows are also influenced by the return on the underlying investments.  In the case of equity investment this is the return on capital and in the case of financial assets and liabilities it is the interest payable.  Historically, the return on foreign investments in New Zealand has been higher than the return on New Zealand investments overseas; this may be because of the different composition of investment in each case (more direct equity investment in New Zealand versus more portfolio investment overseas) or it may be due to measurement issues.  The higher implicit rate of return on foreign investment in New Zealand compounds the deficit on investment income (even for a zero net debt position, the outflow would be larger than the inflow).

Debt-servicing cost reflects interest rates …

The cost of servicing New Zealand’s net external liabilities shows a broad similarity to New Zealand interest rates.  Ninety-three percent of total net liabilities are debt (not equity) and of those net financial liabilities one third had a residual maturity of less than 90 days at 31 December 2008 and slightly more than half had a residual maturity of greater than 2 years.  The net cost of debt-servicing shows a relationship with New Zealand interest rates, especially with 90-day rates recently (Figure 8), but longer-term interest rates are also relevant because of the maturity profile of the net liabilities.

Figure 8 – Debt-servicing and interest rates
Figure 8 – Debt-servicing and interest rates.
Sources: Statistics NZ, Treasury December 2008 Forecasts

We expect the net cost of servicing New Zealand’s external debt to decline following the fall in domestic (and international) interest rates.  The fall is not expected to occur immediately as the transmission will depend on the residual maturity of the borrowings and rate reset dates.  In addition, borrowing costs may not fall as much as local rates because of spreads and higher charges for offshore borrowing.  There was a marked narrowing of the investment income deficit during the previous recession in the New Zealand economy in 1998-1999 when interest rates also fell sharply (Figure 8).

… and profits

Profits on equity investments are also an important determinant of the investment income flows.  As with financial assets and liabilities, equity investments in New Zealand exceed our investments overseas and so there is an outflow of net profits.  Profits are likely to fall in a recession and so the investment income deficit is likely to narrow for this reason as well.

Narrowing of deficit expected

Even allowing for a partial transmission of falls in interest rates to investment income flows, we expect a narrowing in the investment income deficit to be more rapid than in our December Economic Forecasts (Figure 9). 

Figure 9 – Current account forecasts (Dec 08)
Sources: Statistics NZ, Treasury December 2008 Forecasts

In addition, we expect a narrowing of the goods deficit as the greater weakness in domestic demand and fall in the value of the New Zealand dollar lead to lower imports, but some offset is likely from lower exports (especially tourism) as a result of the weaker world economy.  On the basis of the March quarter merchandise trade data, we now expect the current account deficit to narrow from 8.9% of GDP in December 2008 to 8.6% in March 2009, less than our forecast of 9.4% in December 2008.

 

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