Written By: - Date published: 7:15 am, August 26th, 2015 - 54 comments
Categories: auckland supercity, bill english, debt / deficit, Economy, housing, john key, tax, treasury - Tags: dairy, demographics, reserve bank
By Simon Louisson
John Key says New Zealand has options in the face of a share market meltdown.
The Prime Minister says that New Zealand is not like Greece (well that’s a relief).
The question is how real are those options?
Enormous debt built up by six successive Budget deficits has limited options.
Government debt under the stewardship of Finance Minister Bill English has soared to $63 billion – some 26.5% of GDP – from just $17 billion, or 9.1% of GDP, in 2009 when National tool office.
And while the economy temporarily revived due to a spike in dairy prices and the stimulus of the Christchurch rebuild, Bill English discarded the concept of the “automatic stabilizer’, where you save in good times so you can spend in bad times.
Remember it is only
three four years ago that international rating agencies Fitch and Standard and Poor’s downgraded New Zealand’s credit rating, citing concern over our high external debt.
S&P’s sovereign credit analyst Kyran Curry said then: “the lowering of the foreign and local currency long-term ratings follows our assessment of the likelihood that New Zealand’s external position will deteriorate further”.
Our economic strengths were “moderated by New Zealand’s very high external imbalances, which are accompanied by high household and agriculture sector debt, dependence on commodity income, and emerging fiscal pressures associated with its aging population”.
Downward pressure on New Zealand’s ratings could re-emerge if the external position deteriorated, added Mr Curry.
Shortly after the ratings downgrade, New Zealand’s external position improved, thanks to dairy prices, but that situation has drastically reversed in the last 18 months with the Global Dairy Trade Index down 62 percent from a peak in 2013.
As well, debt in the household and agricultural sectors has increased sharply, and the latter it is about to increase drastically with most dairy farms now being unprofitable.
And now, our economy is tracking on what Treasury euphemistically called “Scenario One” – ie a negative outlook.
Under Treasury’s Budget Scenario One economic forecast, where world prices for New Zealand’s commodity exports fall below the central forecast, New Zealand’s current account deficit jumps to 7.7% of GDP by the end of 2016, far worse than the 3.6% deficit in the year to March 31, 2015.
Such an ugly deficit will certainly make the rating agencies sit bolt upright.
The central forecast had wholemilk powder prices moving back by 2016 to US$3900/MT, far north of their current level of US$1856.
Mr Key told Radio NZ that fears about China’s outlook mainly revolved around the construction and investment sectors while New Zealand was happily exposed to the consumer sector. Well go look at the fall in milk powder prices Mr Key.
The effect of a credit rating cut is to make borrowing by the government or New Zealanders more expensive. It is a detrimental and serious event that has long-term negative economic implications.
So essentially, the option of stimulating the economy via increased spending, or tax cuts, which would each significantly add to debt, is seriously limited.
A second option cited by Mr Key is a potential sharper cut in interest rates than already contemplated by the central bank.
Unlike many of the world’s leading economies, New Zealand has not yet had to cut its interest rates to zero, so with the Official Cash Rate at 2.5% there is theoretically a degree of wriggle room.
However, even there, the rating agencies are poised like Jerome Keino ready to wack us as a sharp cut to interest rates would puff up the Auckland property market further.
S&P just this month cut the ratings of the New Zealand arms of the four big Australian banks, citing concern about the over-valued Auckland market.
It said that most financial institutions would be adversely affected if house prices in Auckland fell sharply, even if they didn’t lend much in that region. The agency said that was because of Auckland’s importance to the New Zealand economy, accounting for about 35% of national output.
Then on Monday, Reserve Bank Deputy Governor Grant Spencer said the potential for a bursting of the Auckland property bubble was a serious danger to both banks, the banking system as well as the economy as a whole.
A sharp cut in interest rates will therefore be problematic without further inflating the Auckland property bubble, thereby risking destabilizing the financial system, something the Reserve Bank has a statutory requirement to protect.
So while New Zealand may have more options than Greece, thanks to this Government’s profligate past spending, including irresponsible tax cuts, our options have narrowed drastically.
Simon Louisson is a former journalist who worked for NZPA, Reuters, AP Dow Jones and The Wall Street Journal, The Press, The Jerusalem Post and as a media and political adviser to the Green Party.