4.2.2 Private-sector debt and factors affecting it
New Zealand private-sector debt at 30 June 2010 was $315 billion and 166% of GDP. It was dominated by housing loans (54%), followed by business (23%) and agriculture (15%).
|% of GDP|
|Total private debt||315||166%|
|Net foreign liability||163||86%|
Source: Reserve Bank of NZ; Ministry of Education Student Loan Annual Report
Note: These figures do not include debt issued by directly by non-financial business organisations, e.g., corporate bonds.
Net Crown debt then was $20 billion (11% of GDP), although this had increased to $35 billion (18% of GDP) by the end of October 2010, and New Zealand's NFL (30 September 2010) was $162.5 billion – 85.2% of GDP.
The main contributors to New Zealand's NFL are housing, business and agricultural loans. If these were half their current totals, the net foreign liability would be just 8% of GDP, and New Zealand would have no vulnerability issue.
The history of the sectoral debt balances is shown in Figure 4.1 (data not available for business and agriculture before 2004).
- Figure 4.1: Private-sector debt 1988-2009 (% of GDP)
- Source: Reserve Bank of NZ
All sector debt, except consumer credit, has been rising as a percentage of GDP.
To identify sensible policy options, it is important to understand the drivers of these debt totals.
Housing loans are taken out mainly by people in their 20s and 30s and repaid over the next 25 to 30 years, with debt levels determined by purchase prices. The lenders are mainly older people and foreigners. An increase in property prices raises debt levels as young people take out much larger mortgages than older people are repaying. Ellis (2005) has demonstrated that rising property prices have had a major role in increasing debt levels in Australia and that this effect can occur even when all households can meet their mortgage repayments. The simple relationship between the Reserve Bank house price index and household debt shows that a 1% increase in real house prices leads to about a 0.5% increase in total real mortgage loans (Figure 4.2).
What determines house prices? Research indicates a reasonably long list including building costs, incomes and factors affecting the supply of land for building new houses. However, here we examine two other important influences: taxes and migration.
- Figure 4.2: Real housing loans vs. real house price index, 1990-2009 (% changes)
- Source: Reserve Bank of New Zealand
Taxes and house prices
A simple pricing model for property investment based on a required risk premium for after-tax returns relative to the after-tax returns on government bonds indicates that the favourable tax treatment of property investment relative to neutral treatment accounts for a good proportion, about 50%, of house price increases (Table 2).
|Residential property investor||Owner-occupier|
|Actual gain in real house prices||88%||88%|
|Gain in house prices under neutral tax treatment||47%||41%|
|Gain in prices due to tax concession||42%||47%|
|% of price growth due to concessionary tax||47%||53%|
Without a capital gains tax, the only way to reduce the tax distortion on property prices would be at the very least to reduce taxes on financial assets, the main investment alternative.
In short, a lower rate of tax on the returns from (especially) long-term savings would provide a higher after-tax return and thus a more attractive alternative to property investment. This would be likely to restrain house prices and therefore aggregate mortgage debt.
Options for lower taxes on income from savings are discussed in Section 7.2.
Migration and house prices
The history of house price increases and net migration flows in New Zealand is shown in Figure 4.3.
The relationship between migration flows and housing prices has been analysed by Coleman and Landon-Lane (2007). They found that a net immigration flow equal to 1% of the population (10 per 1000 inhabitants) is associated with an approximately 10% increase in house prices. This relationship has existed since the 1960s. Limiting immigration swings could therefore lead to a substantial reduction in future house prices and housing debt.
- Figure 4.3: Annual change in house prices and annual net migration
- Source: Coleman & Landon-Lane (2007); Reserve Bank of NZ; Statistics NZ