NZ current account deficit improves to 8.5% of GDP, but worse than expected (Update 4)

New Zealand's seasonally adjusted (s.a) current account deficit improved in the March quarter to 8.5% of GDP from a revised 9% of GDP in the December quarter, figures released be Statistics New Zealand (Stats NZ) show. But this was worse than expected as the median economist prediction for the deficit had been 8.4% of GDP. (Update 4 includes Westpac comments.) Imports fell more than exports, creating the first seasonally adjusted surplus in goods trade in six years, but New Zealand's net debt as a percentage of GDP continued to rise to 98.2% of GDP from 86.4% a year earlier because of heavy borrowing to pay the interest on previous debt.

The current account deficit (s.a) for the year ended March 2009 was NZ$15.2 billion, compared to NZ$16.1 billion in the year to December and NZ$14.2 billion (8% of GDP) in the year to March 2008. The deficit for the March quarter on its own was NZ$2.7 billion, from NZ$3.7 billion in December. The seasonally adjusted balance on goods saw its first quarterly surplus in six years at NZ$863 million, from a deficit of NZ$104 million in the December quarter. Imports of goods fell by NZ$1.3 billion from December, while exports only fell by NZ$0.38 billion, mainly due to falls in export prices, Stats NZ said. As reported earlier in June, New Zealand's merchandise export prices fell 8.2% in the March quarter from December, the biggest quarterly drop in over 50 years. Merchandise import prices fell 5.4% from December. Dairy export product prices fell 20.5% in the quarter from record high prices in December (the largest drop since 1950), although volumes of dairy exports rose. Unadjusted, the balance on goods had a surplus of NZ$1.3 billion, compared to NZ$0.3 billion in March 2008. New Zealand's investment income deficit rose NZ$35 million in the March quarter from December to NZ$3.3 billion. However the March deficit was down from NZ$3.5 billion the year before. "Foreign investors' earnings in New Zealand fell for the third consecutive quarter, but this was more than offset by a decrease in New Zealand investors' earnings from abroad," Government statistician Geoff Bascand said. "The seasonally adjusted balance on services also contributed to the smaller current account deficit in the latest quarter. Exports of travel services increased, while imports of transportation services fell, mainly due to lower expenditure on freight. This is linked to the drop in volumes of imported goods," Bascand said. Seasonally adjusted, the balance on services improved to a deficit of NZ$299 million in the March quarter from a NZ$500 million deficit in December. Unadjusted figures show a NZ$687 million surplus in the first quarter, down from NZ$933 million in March 2008.  Unadjusted, the current account deficit in the March quarter was NZ$1.2 billion, the smallest March quarter current account deficit since 2004. Of New Zealand's major banks, Westpac had forecast an 8.2% deficit; ASB forecast 8.4%; ANZ National 8.3%; and BNZ 8.2%. ASB economist Jane Turner said that this quarter's current account delivered no surprises, but that the gains seen in the goods balances were "likely to be limited going forward."

As already seen in the trade figures, the improvement in the goods balance comes from a sharp fall in imports (as domestic demand contracts) more than offsetting a milder fall in exports. These trade surpluses are unlikely to be sustained; a recovery in dairy production has temporarily masked underlying weakness in non-agricultural exports which will become more apparent in coming quarters. On the services side, a decline in imports of services (correcting from the previous quarter's spike in freight prices) also helped narrow the deficit this quarter. The Investment Income deficit saw a slight increase on the previous quarter (i.e. a larger outflow). Income earned on foreign-owned NZ investments and NZ investments abroad both fell. Against a back drop of a global economic recession, the decline in income earned (on both sides) comes from a fall in profitability, dividend payments and interest payments. A current account deficit needs to be financed and the financial account recorded net inflow of financial capital of $2,028 million, meeting these funding requirements. This mostly came from a $2,115 million foreign investment in NZ, in the form of direct investors increasing lending to overseas subsidiaries. The inflow of financial capital increases New Zealand's liabilities to overseas. Net international liabilities increased strongly, up to 98.2% of GDP, though much of the increase comes from changes in valuations. Main causes of the valuation effects over Q1 were the fall in global share prices (reducing the value of NZ owned foreign assets), changes in financial derivative contracts and exchange rates changes. This quarter's current account was very close to expectations, and delivered few surprises. The current account deficit turned a sharp corner over Q1, and we expect that these improvements will continue in the short term. Behind this shift has been a steady annual improvement in the goods balance and investment income (on the back of falling profitability of NZ firms). However, as mentioned above, the gains in the goods balance are likely to be limited going forward. The volatility in financial markets has caused some volatility in the financial accounts lately, mostly owing to valuation effects, these have since settled down as market volatility has abated somewhat.

Westpac economists Brendan O'Donovan and Michael Gordon said the big surprise for them was the investment income balance. They also noted that the rise in New Zealand's net international debt was not as bad as it first seemed.

The big surprise for us was in the investment income balance. The quarterly data suggests an increase in profits for overseas-owned firms in New Zealand, and a sharp rise in interest payments on debt instruments held offshore. Quite frankly we find both of these implausible in the current environment. Company profits have demonstrably fallen in recent times, and notwithstanding the higher premium paid for borrowing offshore, the absolute level of interest rates fell in Q1 as the RBNZ continued to slash the cash rate. However, we'll grant that these series are very difficult to measure from quarter to the next (they're no piece of cake to forecast either), and we remain of the view that they will trend lower over this year. Income from New Zealand's overseas investments fell from $664m to $472m, more in line with what we expected. Profits from overseas subsidiaries of New Zealand firms fell sharply, and interest earned on overseas loans was lower. New Zealand's net international debt position rose from $156bn to $162bn in the March quarter. But that's not as bad as it first seems: around $4bn of the increase in 'debt' was actually due to financial derivatives - that is, changes in the market value of hedges on existing debt. This item will fall over time as interest rates normalise. And there was one positive aspect of the overseas debt position: New Zealand firms were able to extend the duration of their debt, with the proportion maturing in more than a year rising from 47% to 52% - not an easy thing to do in a time of financial stress worldwide. While the deficit was slightly larger than expectations, there was no reaction in the currency or interest rates, with the market focused more on tomorrow's GDP figures. The annual deficit remains relatively high at 8.5% of GDP, but this reflects the record spike in oil prices in the first half of 2008; as this drops out of the equation, we expect the annual deficit to fall well below 6% of GDP by year-end.

The improvement in the deficit is welcome; the reasons for it, not so much. Weak import demand, lower company profits and low interest rates reflect the fact that New Zealand is at a particularly low point in the economic cycle. But without changes in behaviour, the risk is that future growth could be just as unbalanced as it was before the credit crunch. Certainly the incentives haven't changed: housing as an asset class has fared better than others such as equities, and record low interest rates for an extended period will do little to discourage debt-fuelled consumption or boost saving. So the question is whether New Zealanders have been sufficiently chastened by this recession to change their ways voluntarily. The RBNZ has given the benefit of the doubt so far, but they are sufficiently worried about a return to lopsided growth to highlight it as an alternative scenario in the March Monetary Policy Statement.