Banks and households need to change their ways: Bollard

Monday 14th June 2010

More household belt-tightening and a stronger switch by banks away from unproductive personal credit growth are necessary if New Zealand's ongoing risk of economic shocks caused by the country's high foreign indebtedness is to improve, Reserve Bank of New Zealand Governor Alan Bollard said today.

In speech notes for a closed address to the Wellington Regional Chamber of Commerce, Bollard said the government's books were in good order, leading to the UBS investment bank ranking New Zealand "in the middle of the pack" for financial fragility.

However, when only the external accounts were taken into account, New Zealand shifts dramatically to the risky end of the spectrum, sitting seventh most fragile, with Australia - also a high current account deficit economy - at sixth.

"New Zealand has taken action to address some of its imbalances, but households and banks can do more to reduce risks inherent in the external imbalance," said Bollard, who produced a simple depiction of reasons for the country's high current account deficit, and highlights the impact of most New Zealand borrowing being funded by foreign-owned, mainly Australian, banks.

“Some of this is largely outside our control, like the relative valuations of major currencies," Bollard said. "But there is a lot that can be and is being done: designing fiscal and tax policy to reduce vulnerabilities, putting in place cautious bank regulation, and improving access to a range of investment opportunities.

"Ultimately, however, it is up to New Zealanders to improve the quantity and quality of household savings," he said. "In addition much will depend on how these extra savings are invested, and whether this is domestically or internationally."

"Financial markets do not judge our savings balance directly, but rather through its funding implications and its contributions to the external balance."

Bollard said the facts about New Zealand's foreign debt position are:

relatively high foreign investment here, but we do not do much investment overseas;
high levels of private debt, predominantly overseas funded, short-term, but hedged against foreign exchange movements;
almost all this debt is channelled through bank lending;
low savings rates, with very limited financial savings and stocks and shares.
overwhelmingly, household assets are invested in housing and other property.

“We believe New Zealanders have decided they are over-exposed to property assets and to high debt, and they are prepared to constrain consumption to improve their savings," he said. "The question is how much rebalancing they contemplate, and for how long.”

"Our calculations suggest that reducing current account deficits to no more than about 5 percent of GDP on average is necessary to stabilise the Net Investment Position as a share of GDP, while reducing that share over time would require lower deficits to be run," he said.

On the external account, the trade balance has improved with strong export prices and less demand for imports from consumers, farmers and businesses. But a large deficit on the investment income balance is showing no signs of enduring improvement, and the strong New Zealand dollar has not helped, Bollard said.

“Indeed it will be difficult to improve this metric as it will require us to get our net external debt position on to a downward trend," he said. The financing consequences of years of running external deficits mean that foreigners have more than twice as much invested in New Zealand as we have invested overseas. “Our net external liabilities cannot keep increasing with impunity."

Ultimately either the markets will penalise us by requiring a larger premium for its continued funding, and/or the sheer size of servicing our obligations will become an intolerable burden to the country, he said.

"Rather than await such painful punishments, we should be looking to improve the situation," Bollard said.

Businesswire.co.nz

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