5  Future scenarios

5.1  Future prospects under business-as-usual

5.1.1  The income burden of external debt

New Zealand's decades of current account deficits (Figure 3.4) and external borrowing have left it with one of the highest NFL-to-GDP ratios in the OECD (Figure 5.1).

The consequence of financing investment using foreign funding over many years is that servicing the resulting liabilities forms a large part of the current account deficit. Since 2000, New Zealand has spent about 6% of GDP servicing its foreign obligations (Figure 3.4). This means that if New Zealand does not achieve trade surpluses that are sufficient to meet the cost of servicing foreign borrowing, the country's foreign liabilities will continue to increase. However, whether the ratio of NFL to GDP rises will depend on the strength of GDP growth.

Much of the recent improvement in the current account likely reflects the impact of the recession. With weaker growth propspects, investment has fallen and saving has increased as households and businesses have sought to pay off debts.

Figure 5.1: Composition of international liabilities

Source:  Statistics New Zealand

Note: 2000 to 2009 are December years, while 2010 is a September year.

5.1.2  Implications of no policy change

With economic recovery, NFL are predicted to deteriorate again. The IMF has estimated an increase to above 100% of GDP in the next five years, while Treasury's latest forecast is that it will increase to about 90% of GDP in the next five years.[11]

Either way, there is little confidence that most of the recent lift in saving is permanent – the latest data suggests only a very small part - which means that NFL will rise in relation to GDP with any significant economic recovery. Given the uncertainties involved and the serious implications of rising NFL, it would be wise to operate on this basis and take precautionary steps now.

5.1.3  Comparison with other countries

New Zealand's current position is near the limit for developed economies.[12] Other countries that have similarly large NFL (Portugal, Spain, Greece, Ireland) are showing many signs of serious difficulty. Figures 5.2 and 5.3 demonstrate one feature that differentiates New Zealand – its low government debt (both on a gross and net basis). Rating agencies and foreign investors have shown only moderate concern about New Zealand's external liabilities, in part because of the strong government position, but the continuing deterioration in the fiscal position sharply increases the risk. So too do external developments with the increasing concern about the US position and the heavily-indebted European economies, where borrowing needs are speculated to be beyond the capacity of markets.

Figure 5.2: General government gross financial liabilities (percent of nominal GDP) in 2009

Source:  Source: IMF, OECD, Statistics NZ

Figure 5.3: General government net financial liabilities (percent of nominal GDP) in 2009

Source:  Source: IMF, OECD, Statistics NZ

5.1.4  Reducing New Zealand's vulnerability

Further deterioration in New Zealand's NFL would be very risky and imprudent. Stabilising the position as a first step is important, and requires higher national savings to help fund more investment without higher foreign borrowing. The Treasury (2010b) estimates that stabilising the NFL at 90% of GDP would require national saving to be about 2% of GDP higher than otherwise would be the case.[13]

This would not eliminate New Zealand's vulnerability but stop it getting worse. To reduce New Zealand's vulnerability would mean reducing NFL to, say, 70% of GDP over some 10 years. This would require an increase in national saving of about 4% of GDP (The Treasury 2010b).

Significantly, improving net export performance and increasing saving relative to investment are consistent goals: the resources released by a lower investment-saving gap eventually flow to generate higher exports or greater production of import substitutes, shifting the economic activity from non-tradable to tradable goods and services.

The IMF (2010a) estimates that stabilising the NFL at 90% of GDP would involve a depreciation of the real exchange rate by around 20%. A reduction to 75% of GDP over 15 years would involve a real exchange rate depreciation of 25%.

Reducing New Zealand's vulnerability requires building a stock of precautionary savings. This will firstly reduce the risk of an external crisis occurring and, secondly, provide financial resources to buffer the economy if an adverse shock did occur. In their latest Article 4 New Zealand consultation, the IMF recommends that faster fiscal consolidation than is presently forecast is crucial to ensuring the country has sufficient fiscal capacity to respond effectively to future shocks.

Fiscal policy can also play a key role in shifting the economy towards tradables. The IMF (2010b) suggests that faster fiscal consolidation in New Zealand would lead to a depreciation of the currency, a lower sovereign risk premium and lower current account deficit. It predicts that a permanent increase of 1% of GDP in government saving will lead to an improvement in the current account by between 0.4% and 0.6% of GDP.