5 Assessing New Zealand's resilience

This part of the paper makes an on-balance overall judgement about New Zealand's on-going resilience. It is important to understand whether New Zealand can avoid the difficulties from economic imbalances that beset some countries from the GFC. The assessment is achieved by weighting the relative importance of the factors that contribute to and detract from resilience in Section 4.

The impact of the GFC across countries has not been uniform. The extreme outcomes generated by the GFC for some countries show how crisis can manifest. Lane and Milesi-Ferretti (2010) look at the impact of the GFC across the world economy and examine factors that may have led to differential impacts. They conclude that large current account deficits and domestic credit booms are important factors in explaining the severity of crisis outcomes. In addition, institutions and industrial structure matter. Countries with fixed exchange rates tended to fare more poorly, as did countries with greater trade openness and a greater reliance on the manufacturing sectors.[30]

To date, New Zealand debtors have maintained the confidence of creditors in spite of high structural private debts that may have been encouraged by policy settings, and deterioration in the fiscal position. While this can be partly attributed to a relatively low gross national debt position (Section 3.2.2), the quality of New Zealand’s institutions and its economic structure have played a significant role. Together they appear to have created robust buffers that can absorb shocks, and thus shelter debtors from income and asset price volatility that would otherwise have affected their ability to meet obligations (Section 4.2.1). Moreover, over the short term, more cautious private saving and lending behaviours since the GFC may have further reduced the risks associated with large private debts. However, absent policy change, a transition to higher private saving could signal a sustained period of slow growth as the economy unwinds the past build-up of debt.

Nevertheless, irrespective of cause or rationality, the risks associated with large structural private debts remain. There is considerable uncertainty around the long-term behaviour of debtors and attitudes of creditors, in combination with a less robust fiscal position to manage inevitable future shocks. International experience over time shows that New Zealand's international investment position is at the upper end of the risk spectrum and is now at a level that has previously proved unsustainable. Therefore, it is conceivable that a New Zealand specific shock, or wider global disruption, could expose New Zealand's high debt level and lead to sharp adjustment (Section 4.2.2).

This intuition about the balance of risk is supported by external assessments from commentators and credit rating agencies like Standard & Poors.They recognise New Zealand’s debt risks, but are generally sanguine about New Zealand’s immediate prospects despite increasing global-wariness of risk (i.e. risks are considered material but not acute). For example, in UBS’s cross-country risk assessment, New Zealand ranks amongst the middle of its country balance sheet risk index (UBS, 2010). Using an array of financial statistical metrics, this level of risk was similar to Germany and Canada. The riskiest countries are the European countries currently under financial stress (Portugal and Greece), while the least risky tend to be the East Asian economies with high national saving rates (Taiwan and China).

Edwards (2006) estimated that New Zealand faced a 0.6% probability of a significant current account adjustment (defined as a reversal in the current deficit of 5% of GDP representing a difficult economic adjustment process) with a current account deficit of 3% of GDP. This probability rose to 5% at a current account deficit of 9% of GDP. These estimates were done at a time when offshore indebtedness was at similar levels as at present, but do not account for New Zealand's more stable Australian funding, which would likely reduce the risk. However, this assessment does predate the GFC and the adverse changes to the government's fiscal position, so is subject to some extra uncertainty.

Taken all together, these converging views suggest that New Zealand's private debt imbalances are significant, but not extreme. They do not point to an imminent crisis of confidence, particularly given that private debt positions have been generally showing some improvement since 2008. However, this rebalancing may not last if changes in private saving behaviours are not sustained. Moreover, the world is generally more fragile than it was, and New Zealand's high debts may mean it is disproportionately affected by future global shocks. Investor sentiment can change quickly as clearly illustrated in Europe over the past year. Such changes in sentiment can quickly become very costly and ultimately lead to forced economic adjustment.

Accordingly, it is desirable and prudent not to be complacent, and to build on the improving imbalance position in the near term, especially given the weaker fiscal position. To this end, it would be desirable for the government and individuals to take actions, to the extent they can, to further reduce the risk of financial crisis through reducing debt. However, the desired speed for the reduction in imbalances, and what constitutes an upper bound that needs to be avoided, is not clear.[31]