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Capital PLIGHT

Friday 25th August 2000

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Foreign investors have taken flight - and so have locals. NEVILLE BENNETT examines the parlous state of the financial markets

The Kiwi dollar has been undermined by a huge growth in overseas debt (NBR, Aug 11). It may also suffer from a withdrawal of overseas capital and from ordinary Kiwis investing abroad. This is a difficult problem to quantify but the evidence is robust for portfolio assets (especially bonds and treasuries) and equities.

Methodological issues and complications surround any analysis. Some include the removal of head offices of such companies as Brierley Investments, Lion Nathan and Nufarm to different overseas locations. It is also difficult to separate present trends from recent trends. For this reason the problem of foreign capital flows will be considered in a historical context to identify the trends confidently.

Valuable information on the historical context is endemic in Gordon Walker's Securities Regulation in Australia and New Zealand (LBC Information Services, 1998). Walker quantifies investment from 1990 and stresses the rise in foreign capital in equity - which rose over 248% in the 1989-98 period. Foreign direct investment (FDI) increased from $8.4 billion in 1989 to $32.4 billion (285%) in the same period. FDI meant considerable control (25% plus) over many New Zealand companies.

At the same time borrowing for overseas debt increased during 1990-95 from a total of $45 billion to $54 billion. Total foreign investment rose during 1990-95 from $60 billion to $96 billion. But, as New Zealand's investment overseas also grew dynamically from $14.8 billion to $23 billion from 1990-95, New Zealand's international investment position saw an increase in net debt from $45 billion in 1990 to $73 billion in 1995.

The burst of debt growth in the 1990-95 phase was associated with deregulation and privatisation, and especially the Employment Contracts Act, which attracted the attention of foreign investors. The Economist, for example, heaped praise on New Zealand's competitive outlook. It was the darling of the financial press, partly as a means of beating the US or the UK over the head.

But around 1995, a disturbing new trend became evident. Economic growth, immigration and a housing boom encouraged high interest rates and a high dollar. These conditions attracted a burst of euro-kiwi and samurai issues that diverted vast sums into the housing market.

The data on corporate borrowing, especially by banks (NBR, Aug 4) is instructive. Corporate overseas debt increased from $44 billion in 1993 to $46 billion in 1995 but then grew to $53.6 billion in 1996, $60 billion in 1997, $79.6 billion in 1998, $85 billion in 1999 and $92 billion today. Non-banking corporate debt is falling. A current account deficit of about 7% of GDP also encourages debt funding.

Statistics New Zealand's latest statement on international investment covers the period to March 31, 1999. This statement is quite optimistic. It notes increased borrowing by the banks but stresses an increase in New Zealand overseas assets.

FDI was steady at $60 billion. New Zealand's net position improved largely because foreign holders of New Zealand equities suffered from falling local share prices, while New Zealanders benefited from rising foreign stock exchanges. It appears the position has deteriorated since 1999 as foreigners are disconcerted by poor returns.

Capital mobility also implies the possibility of capital flight. Mobile international capital tends to take a critical stance on government policies, especially fiscal deficits. BusinessWeek pithily encaptured this sentiment: "What the market wants is simple: less debt or higher interest rates." And in the information age the globe is tied into a single electronic market that constantly, and instantly, reflects the value a market puts on a country's currency.

Capital flight is difficult to define and measure. But it involves private capital outflows. These can be foreigners withdrawing funds but also local investors expatriating money.

So far I have not identified good data on New Zealanders sending money overseas because of the imbalance between the risks associated with investing in the local market (poor performance of the sharemarket and a depreciating dollar) versus foreign market risks. The WestpacTrust household survey indicators show Kiwis have $38 billion in managed funds, which grew 5.63% in the last year. A high proportion of these funds is invested in international assets. As managed funds are the only growing asset category by value, there is evidence of local residents expatriating capital at a rate of $2 billion in funds. Private purchases of overseas assets are unquantified.

It is possible an exodus of capital is stimulated by electoral uncertainty. Since the adoption of MMP, government has been by coalitions which are inherently unstable. The present regime has attempted to build investor confidence but has not been entirely successful because it has raised personal tax rates and modified the Employment Contracts Act.

Be that as it may, foreign investors will probably be equally or more unsettled by a depreciating dollar, a huge current account deficit, slow economic growth and a paucity of high-tech exports. New Zealand remains an international anomaly in that it has first-world living standards based on third-world exports which are highly dependent on unprocessed commodities.

The attitude of foreign investors is crucial as about half of listed companies are foreign controlled (47% in 1996) and overseas owners held 57% of the top 40 shares in July 1998.

A study in progress by an international investment bank has produced some startling, though preliminary, results. It appears there has been a sell-down of equity holdings in the NZSE40. Offshore investors have reduced their holdings from 62% to about 50% in the last year. This is a severe fall. This finding is widely supported by anecdotal evidence from many brokers.

There has also been a sell-down in portfolio assets. The volumes held by foreigners has always been somewhat volatile but recent Reserve Bank data is worrying. Non-residents held 53.7% of New Zealand bonds and treasuries in June, 1998. In June 2000, the proportion had fallen to 37.8%. It is significant much of the fall has been recent. In January 2000, foreigners held 42.4% of government paper. By June it had fallen to 37.8%.

It would be too dramatic to say New Zealand is experiencing capital flight. Its present condition does not bear comparison to Mexico's plight in 1994 or much of Asia's in 1996. But there is an exodus of capital and evidence from managed funds, equities and portfolio investments that it has become quite substantial in this year.

This haemorrhage of productive capital is obscured by a continuing inflow of bank money destined for the housing market. The loss of productive foreign capital and its partial replacement by bank loans is a deteriorating situation of worrying magnitude.

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