FEU Special Topic: The current account and New Zealand’s external balances

FEU Special Topic: The current account and New Zealand’s external balances

The New Zealand economy has been through a tumultuous period across the pandemic, and this is apparent in the GDP data, which has seen record quarterly changes. The balance of payments have also experienced some sharp swings and this Special Topic outlines some of these impacts.

The current account…

The current account of the balance of payments records whether the value of NZ’s exports of goods and services is greater or less than the value of imports of goods and services. The current account also records whether the income earned from overseas assets, such as interest and dividends, exceeds or falls shorts of the income paid to foreign owners of NZ assets. When the current account is in deficit it means that some portion of national spending is being financed by foreign funds or capital inflows as measured by the financial account balance. In turn, these capital inflows add to the stock of liabilities recorded in New Zealand’s net international investment position (NIIP).

The current account can also be expressed as the difference between national saving (both public and private) and investment. When the current account is in deficit, national saving falls short of investment and foreign capital inflows are required to make up the shortfall. This view is consistent with role of the current account in smoothing consumption spending over time. This means that current borrowing from overseas can be met by higher future income, at which time the borrowing is repaid. We look at the impact of government and private sector spending and saving decisions on the current account balance.

The current account is not the only factor driving the NIIP, capital gains and losses on both assets and liabilities also have an important role to play. In this Special Topic we focus on the impacts of the pandemic on the current account and show how capital gains have helped to limit the impact on the NIIP.

…narrowed over the past decade…

Measured on an annual basis, New Zealand’s current account has been continuously in deficit since 1973, mostly attributable to deficits in the balance of income. Foreign capital is used to finance the difference between saving and investment.  By the mid-2000’s the accumulated deficits resulted in New Zealand’s net foreign liability position reaching almost 85% of GDP. This was very high by international standards and led to fears that foreigners might be unwilling to continue to finance current account deficits resulting in a sharp and disruptive adjustment.[1] Ultimately, the global financial crisis (GFC) of 2007/08 was the trigger for a sharp and sustained correction in the current account deficit and in the net liability position. In the decade following the GFC the deficit has averaged less than 3% of GDP, well below the average of over 4% in the preceding four decades, and the net liability position declined 55% of GDP.

…but has widened during the pandemic

The widening deficit is a result of a confluence of factors, most notably the reversal of the services balance from surplus to deficit as New Zealand’s international border closed in response to COVID-19. In addition, deficits in both the goods and income balances have widened (Figure 1). 

Figure 1: Annual current account balance

Source: Stats NZ

Border restrictions stopped international tourism…

Restrictions on people movements across the border led to a halt in international travel that has driven a reversal in the balance on services from a $4 billion (1.2% of GDP) surplus in the year ending March 2020 to a $6 billion (1.8% of GDP) deficit in the year ending March 2022 (Figure 2). Travel restrictions have not been the only driver of the deterioration, global supply-chain disruption has contributed to a surge in the price of transporting goods, while domestic demand for online services has increased as the pandemic changed spending behaviour. Net spending on other imports, especially software and online streaming services, has increased by around $1.5 billion per year compared to pre-pandemic levels.

Figure 2: Annual services balance

Source: Stats NZ

…while demand switched toward goods…

The goods deficit has also deteriorated across the pandemic as public health restrictions and behavioural changes led to a switch in spending away from services and towards goods. This switch was reinforced by stimulatory monetary and fiscal policies. Globally, the impact of disruption to goods and services production, including from the Russia-Ukraine conflict, combined with policy stimulus has led to a rapid rise in prices. Following a slump in imports in the June 2020 quarter when pandemic restriction in New Zealand and many other countries were at their peak, the result has been a surge in import values (Figure 3). New Zealand’s export prices also benefited from the boost to goods demand and the terms of trade rose to record highs. However, disruptions to supply in New Zealand have limited the rise in export values and the goods trade deficit, according to the most recent overseas merchandise trade data, rose to a record $11.4 billion in the year to July 2022.

Figure 3: Quarterly goods balance

Source: Stats NZ

…and New Zealand firms returned profits to overseas investors

In the period since the GFC, reduced external borrowing and declining global interest rates have reduced debt-servicing costs. This helped to drive the income deficit to a trough of 1.6% of GDP in early 2020 from over 7% in 2009 (Figure 4). However, the income deficit has subsequently increased, to 2.2% of GDP, as dividend payments by New Zealand businesses to overseas investors has increased.

Figure 4: Annual primary income balance

Source: Stats NZ

The widening deficit reflects policy support during the pandemic...

The current account can also be viewed as the difference between national savings and investment, where a deficit indicates the requirement for external borrowing to make up the shortfall in national savings. This view also reflects the consumption smoothing role that current account deficits can play. For instance, if a country is struck by a shock—such as the current pandemic or a natural disaster—that temporarily depresses its ability to access productive capacity, rather than take the full brunt of the shock immediately, the country can spread out the pain over time by running a current account deficit. 

During the pandemic the Government has acted to smooth household and business income by significantly increasing borrowing. In addition, monetary policy stimulus has lowered the cost of borrowing for households and businesses. Early in the pandemic this support, combined with restrictions that limited the ability to spend, contributed to a rise in household and business saving (Figure 5). Coupled with a slowdown in investment, the current account deficit narrowed. Subsequently, as the worst effects of the pandemic have subsided, private sector saving has fallen and investment has picked up, leading to a wider current account deficit.

Figure 5: Sectoral contributions to current account

Source: Stats NZ
[1] Institutional sectoral data for March 2022 and March 2021 years are provisional from the experimental quarterly income GDP accounts and my not sum to the current account

Over the medium-term, we expect the deficit to return towards pre-pandemic levels. The Government’s fiscal position is expected improve as pandemic related spending is withdrawn and tighter monetary policy is expected to slow growth in private sector investment and encourage increased private saving.

New Zealand’s net liability position has improved

The capital inflows associated with current account deficits are recorded in the financial account. New Zealand’s long history of deficits is reflected in the net liability position (Figure 6). However, the net position is also affected by changes in the underlying value of assets and liabilities, that is, by capital gains and losses. These capital gains have become more significant as the stock of assets and liabilities has grown.

Figure 6: Net international investment position

Source: Stats NZ

New Zealand’s net international liabilities have fallen significantly since the GFC…

Figure 7 shows how these capital gains have almost fully offset the cumulative value of current account deficits since 2009. Since the peak in New Zealand’s net international liability position, the financial account, the sum of the current and capital accounts, has contributed roughly $50 billion to net international liabilities. Net capital gains arising from the exchange rate, market prices and valuation changes have almost fully offset the impacts of capital inflows on the value of net liabilities. In addition, GDP growth across the period explains most of the lower NIIP to GDP ratio.

NZ’s improved net liability position has allayed many of the concerns about sustainability that were to the fore prior to the GFC. Despite the increase in public debt during the pandemic, New Zealand’s international credit ratings were upgraded by S&P in February 2021, reflecting confidence in the economy’s ability to weather external shocks.

Figure 7: Changes to the NIIP since March 2009

Source: Stats NZ