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High current account deficits

The persistent saving-investment gap is reflected in New Zealand's on-going current account deficits

Low rates of national saving relative to domestic investment are reflected in New Zealand's persistent current account deficits (Figure 8).

Figure 8 - Gross saving and investment flows
Figure 8 - Gross saving and investment flows.
Source: Statistics NZ, Treasury

Over many years New Zealand has borrowed a significant amount from overseas

A long period of current account deficits has led to a significant deterioration in New Zealand's net foreign asset position (the difference between what New Zealanders owe and what they own overseas), to about negative 90 percent of GDP. The Treasury’sforecast is for New Zealand's net foreign asset position to widen to around 100 per cent of GDP by 2014 (Figure 9). New Zealand has tended to attract foreign capital in the form of debt and direct equity investment. However, the net foreign asset position is predominantly made up of net debt rather than net equity, which is indicative of New Zealanders owing a lot, rather than being owned.

Figure 9 - Net foreign assets
Figure 9 - Net foreign assets.
Source: Statistics NZ, Treasury

* Figures prior to June 2000 quarter interpolated from annual series.

This resulting stock of foreign funds must be serviced. The cost of this servicing has averaged around 6 percent of GDP but of late has dropped to 4 percent with falling interest rates and lower returns to foreign investment in New Zealand.

The cost of servicing offshore debt would be more manageable if New Zealand had faster growth and higher investment

For a given level of current account deficit, a faster growing economy can service its obligations more easily than a slower growing economy. This is because, on average and over time, investment can be expected to more than cover its funding costs and help increase growth. Current account deficits in New Zealand are associated with average levels of investment (relative to other OECD countries) but low saving.

The current account deficit has improved as investment has fallen with the recession and economic uncertainty has increased household saving rates. However, most forecasts show these trends to be temporary.

An increase in national saving would be required to stabilise New Zealand's net foreign asset position

Stabilising the net foreign asset position

It is possible to estimate the increase in national saving that is required to stabilise New Zealand's external imbalances. To stabilise the net foreign asset position at current levels (around negative 90 percent of GDP), requires a 1.3 percent of GDP surplus on the trade balance (Figure 10). The associated increase in national saving (on forecast levels - refer to Figure 3) would need to be around 2 percent of GDP.[7] If GDP growth were to be higher, this would allow New Zealand to stabilise vulnerabilities at a lower saving rate. For example, a higher nominal GDP growth rate of 6 percent would require a smaller trade surplus and as a result, a smaller increase in national saving on forecast levels.

Figure 10 - Trade balance
Figure 10 - Trade balance.
Source: Treasury

Key assumption: Interest rate = 7%, Transfer balance = 0.4%

To reduce New Zealand's external imbalances, would require an even larger increase in national saving. To reduce the net foreign asset position to negative 70 percent of GDP (over 10 years) would require a trade surplus of around 3 percent of GDP. This is significantly above average historic levels (since 1989) and would likely be associated with a lower exchange rate on average. The associated increase in national saving (on forecast levels - refer to Figure 3) would need to be around 4 percent of GDP.

Now that government debt levels are rising, New Zealand is at greater risk of falling foreign-investor confidence, with potentially harmful effects on the economy

Overall, New Zealand has robust macroeconomic and financial institutional arrangements that individually and collectively provide significant financial and economic resilience, despite New Zealand's sizable imbalances. Effects of the recent global financial crisis were lessened because:

  • Public debt was low, by international standards, which allowed for accommodative fiscal policy when GDP was contracting.
  • A credible monetary policy framework allowed for looser monetary policy. Lower interest rates eased the burden on debtors.
  • The lower exchange rate acted as a buffer for exporters when commodity prices dropped. This is evidence of the advantages of a floating exchange rate regime. Floating exchange rates automatically adjust, which enable a country to dampen the impact of shocks and foreign business cycles.
  • Financial institutions are sound. Major financial institutions were characterised by little foreign currency exposure, strong credit ratings and funding lines from strong parent owners, and balance sheet strength and transparency.

However, given that current forecasts show that government debt levels are again rising quickly, it may be a risky strategy going forward to rely solely on offshore investors' confidence in macroeconomic and financial institutions.

The Treasury's view is that action should be taken now to reduce national debt levels

There are two key concerns: whether these imbalances continue to build to a level at which New Zealand is perceived by creditors as being too risky; and the degree to which the economy can weather another significant shock given the current state of imbalances. Financial confidence is at risk to any event that would trigger:

  • a material decline in property prices, commodity prices, or increase in unemployment, given the fragility of household and farm balance sheets, or
  • fresh attention on the overall extent of net foreign indebtedness.

The Treasury considers it desirable to reduce imbalances through policy reform, rather than risk the inevitable forced adjustment that would occur if New Zealand were to continue down the current path of spending and debt accumulation. Policy reform would help the prospects for an orderly and controlled adjustment, reducing the welfare costs that would occur if the adjustment was forced upon the economy.[8]

A rebalancing economy would see a reversal of long-term trends. That would mean lower debt, an improvement in New Zealand's net foreign asset position, and incomes and rents catching up with house prices and debt servicing requirements. The box on Stabilising the net foreign asset position shows what is required to control and reduce international liabilities.

Questions

  • Do you agree that New Zealand’s level of national saving is too low?
  • Why is the national saving rate in New Zealand comparatively low?
  • Is New Zealand households’ relatively low stock of financial assets a reflection of an ‘over investment’ in housing or a reflection of the low rate of household saving more generally?
  • How exposed is the New Zealand economy given its internal and external imbalances, and how could higher national saving help to ease these vulnerabilities?
  • To what extent could increased national saving increase economic growth?

 

Notes

  • [7]Modelling is based on an assumed nominal GDP growth of 5 percent (3 percent real GDP growth and 2 percent inflation). It also assumes 7 percent interest rates on net liabilities, which results in a net investment income deficit of 6 percent of GDP. This would be consistent with an on-going current account deficit of around 4.3 percent of GDP (assuming a 0.4 percent of GDP transfer surplus).
  • [8]This judgement rests on a “least-regrets” approach in light of data uncertainties, persistent macroeconomic imbalances and the possibility that individuals are basing saving decisions on long-run expectations where the environment could change.
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