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Opinion: NZ trips over deficit

By Simon Louisson of NZPA

Friday 24th March 2006

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Former prime minister Rob Muldoon reckoned the average Kiwi wouldn't know what a fiscal deficit was if he or she tripped over it.

People may also not understand what the current account deficit is, but they are certain to feel its side-effects after yesterday's announcement it ballooned in 2005 to a staggering $13.7 billion - 8.9% of GDP.

Instead of near parity to the aussie dollar, the kiwi dollar may soon be down around two-thirds, and we may soon be lucky to get half a US dollar for a kiwi compared to three-quarters a few months ago.

As well as more expensive jaunts overseas, the pain will come via much higher petrol prices, and import prices generally, and probably higher interest rates.

For the uninitiated, the current account, aka the balance of payments, measures New Zealand's financial dealings with the outside world. It mainly comprises the trade balance (exports minus imports) and the investment balance (foreign debt and dividends minus New Zealanders' foreign interest payments and dividends).

New Zealand has a structural problem. We have to go back to 1973 to find an annual current account surplus. The deficit has most been manageable - below 5% of GDP - with at least the trade balance in surplus, until 2003.

However, the trade deficit has swung from a $3.4 billion annual surplus in 2001 to a $3.9 billion deficit in 2005.

And the traditional current account curse - the deficit on investment income - has widened from $7 billion three years ago to $10.8 billion.

To break it down, the current account deficit amounts to every man, woman and child spending $3314 more than was earned last year.

Our net foreign debt rose by $10.5 billion to $136.5 billion last year - equal to $27,293 per person.

The deficit was equally dire in 1986 when the kiwi dollar was also at insanely high levels as it was last year. Only in 1975 in the aftermath of the oil shock it has it been worse.

New Zealand's economy has been buoyant for the last five years, but essentially that growth, now coming to an end, has been underpinned by massive borrowing. The money has mostly been spent on houses and consumer goods. House prices have zoomed ahead as everyone plays the property game. People felt richer as their equity in the house rose, so they borrowed more and spent up large.

"A big current account deficit doesn't have to be a problem if it's funding good quality investment, that you can service in future," Westpac chief economist Brendan O'Donovan told Radio NZ.

"But what we have been doing collectively as a country is getting heavily into the hock, but effectively just bid up existing asset prices.

"Most of the borrowing that we are doing is just to bid up property prices and there is not a lot of additional cashflow generation from them."

While property investment made a lot of sense from an individual's perspective, from a country's perspective it has been a poor investment.

O'Donovan expects the deficit to get worse before it finally responds to the lower currency.

The kiwi dollar has fallen 13% already this year, tumbling over a cent today on unexpectedly weak growth figures.

Funding a $13.7 billion deficit is no easy task and it is likely to get much trickier. Much of the funding for the last few years has come from the so called Japanese housewife. Japanese investors, dissatisfied with the zero interest rate offering at home, have bought tens of billions of uridashi bonds - New Zealand dollar bonds offering much more attractive rates, although lower than local rates.

That has largely funded the spree on housing. Banks have been able to offer loans close to the Official Cash Rate of 7.25%.

However, it could all end in tears, not just for the Japanese housewives who may have got a healthy interest rate, but could see bonds reconverted at 65 yen per dollar instead of the 80-plus they paid for them.

Next year, there will be $2 billion to $3.8 billion of uridashi bonds maturing every month. That debt will have to be refunded in addition to the current account deficit running at over a billion dollars a month.

ANZ National Bank acting chief economist Cameron Bagrie said New Zealand can't keep relying on the rest of the world to fund its spending.

He estimates the country will need $14 billion from overseas to fund the deficit.

Local interest rates are projected to fall due to the sharply slowing economy while overseas rates are picked to rise.

"We are probably not going to attract that capital through the interest rate market, so it probably means we need to attract it by foreign direct investment."

With very little "greenfield" industries around, attracting foreign direct investment will mostly mean selling off the family silver. Only trouble is, we sold off most of the silver in the 1980s to clear the Government's foreign debt. Now, the cupboard is nearly bare.

"When you look around New Zealand at the moment, there doesn't look to be too much family silver to sell," he told Radio NZ.

One third of the $12.2 billion capital inflow in 2005 came from selling New Zealand foreign investments. These now total just $52 billion while foreigners already own $165 billion of New Zealand assets.

The trouble with flogging the silver is that it exacerbates the problem of paying all those dividends and interest payments to foreigners.

Translate the position to a household level and it would be clear budget advisers need to called in.

But because the Government's own books are so healthily in surplus, international credit rating agencies, quasi advisers, say there is as yet no threat to New Zealand's high sovereign rating.

The solution to the problem is for everyone to save more, spend less on consumables, invest savings in productive enterprise and export more. It sounds easy but of course is far harder to execute. It may even take a crisis for changes to be forced on us.

And Bagrie says because of the precarious current account position, the country is very susceptible to an economic shock that could be triggered by something such as bird flu.

"If we get hit by another shock in 2006, it really will be game-on for the New Zealand economy."

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