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Opinion: Kiwi dollar may pay the price of our overspending

By Simon Louisson of NZPA

Thursday 24th March 2005

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Current account figures out this week revealed the extent to which we are living on borrowings.

New Zealand had a $9.4 billion current account deficit in 2004. That means that in all dealings with the outside world including trade, tourism investment and interest payments, kiwis overspent by $2346 per head.

The country has been running deficits uninterrupted since the first oil shock hit in 1974. Families or businesses certainly couldn't run their finances in such a way and it's questionable whether the country can.

The result of years of accumulated deficits is that the net international investment position - liabilities minus assets - stood at minus $123.5 billion on December 31. That's $30,875 each folks.

Can it continue? As long as foreigners keep lending, it can, although this is a vicious cycle - the more we borrow the worse the position gets. Foreign borrowers will demand higher and higher interest rates as fewer are prepared to take the risk of lending to us.

The net investment position equating to 84% of GDP was a the startling figure in the data, National Bank economist Sean Comber said.

Investors assess the United States' annual current account deficit at 6.3% of GDP has grown too big and have punished the US dollar accordingly. It has dropped 54% in value against the euro in three years and 68% against the kiwi dollar.

But our deficit now equates to 6.4% of GDP and BNZ economists predict it will be rise to nearly 8% by mid next year.

International standards normally judge a deficit above 5% of GDP as a warning flag.

The saving grace for New Zealand is that, unlike in the States, the Government is running a whopping budget surplus.

Infometrics economist Andrew Gawith said the domestic economy has been rampant for three years and that has spilled over into consumer spending on imports.

Part of the high import bill has came from very strong investment spending on capital equipment, partly to overcome labour shortages.

"The positive spin you could put on it is you are running a deficit to grow. But a fair chunk of the current account is a function of excess demand spilling over into imports of consumption goods which hasn't been matched by the value of exports despite the fact that we have bloody good commodity prices."

The unusual and worrying aspect of the deficit is that New Zealand's export commodity prices have been at their highest since that oil shock in 1974. Normally, high commodity prices mean high exports and a healthy trade balance.

The concern is that commodity prices will come off and the deficit will further deteriorate.

There are three common solutions to a structural current account deficit - boost exports, cut imports or increase savings to replace foreign borrowing.

With the currency up near post float highs, a boost to exports seems improbable. Containing demand for imports and boosting savings by hiking interest rates is more likely and is what Reserve Bank Governor Alan Bollard has been endeavouring with his seven rate hikes since the start of 2004.

The problem with that process is that higher interest rates make New Zealand dollar assets more attractive to foreigners and tend to push up the currency, exacerbating the current account problem.

Gawith says that financial markets have to weigh up whether Bollard is pushing rates up because there is real problem with the economy or if he is just attempting to slow an over-heated economy.

"I think it's the former - he's got a problem."

GDP figures out today showed economic growth in the December quarter slowed to 0.4% from 0.6% in the September quarter and 1.0% a year ago. That means investors may be confronting an unhealthy cocktail of high currency, high interest rates and slowing growth - hardly an attractive economic proposition for a foreign investor.

"Once he's clobbered the domestic economy, those rates will come off, so if you're investing in New Zealand dollars to collect those nice interest rates, you could be in for a nasty surprise," said Gawith.

And already some investors have worked that out. The New Zealand dollar has reacted to the current account data and a seventh hike in US interest rates that has closed the differential between US and New Zealand rates. The kiwi has dropped from a peak of US74.5c on Friday last week to US71.5c today - a fall which could be the start of a long slide if history is repeated..

The last such major "correction" in the currency began in December 1996 with the kiwi at US71.76c and continued until October 2000, when the currency had lost 46% of its value at US38.95c.

The sharemarket also fell with a thud with some foreign investors, who use Telecom as a proxy for the market, taking their currency profits in the market leader and selling.

Brendan Flynn, director of sovereign ratings at Standard & Poor's, said the influential international credit rating agency had been looking "in depth" at New Zealand's currency account problems.

"It's the thing that makes us most nervous about New Zealand," he said. "It is something that we look at, and it's not just the current account deficit, it's also the net external debt that goes along with that. And if you look at New Zealand, that is the thing that concerns us most."

He said there was no question of New Zealand's AA-plus rating (one below the top AAA level) being downgraded but concern would rise if export commodity prices came off without a fall in the currency.

At what point did the agency downgrade? "I'm reluctant to put any trigger point on it," he said.

Flynn also took comfort from the fact that most of the borrowing was being done by the private sector and the Government was running large budget surpluses.

"That buys the rating a bit of flexibility. It can withstand that higher level of external debt because the Government finances are in a very strong position."

So while a credit rating downgrade is not yet on the agenda, the current account chickens may shortly come home to roost in the form of a lower currency. It may be time to take that overseas holiday before it becomes too expensive.

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