Reserve Bank of New Zealand (RBNZ) deputy governor Grant Spencer said in an interview he thinks New Zealand banks were in "pretty good shape" and that further reductions in the Official Cash Rate, if they were to take place, would not be expected to be of the same scale seen recently. Spencer made some refreshingly direct comments about changes in New Zealand's foreign-funded consumption habits and the risks of foreign investors turning off that funding tap.

"Alan (Bollard) indicated in January that there is potentially scope for more easing, but we wouldn't expect to see OCR reductions of the scale that we've had recently," Spencer told Isabelle Oderberg at the Business Spectator.

On when the New Zealand economy may exit the current recession, Spencer said that the RBNZ would come out with its forecast in its March Monetary Policy Statement, but that "the consensus at this point is for the bottom to be somewhere probably in the second half of this year and then starting to pull out through 2010. That's just a general picture globally and it's probably the general picture here in New Zealand, but we will be more specific on that with our March projections," he said.

Spencer also said that there were risks recent tax cuts would not have as strong an effect as expected in restarting consumer spending and that infrastructure spending would probably be more effective.

"The risk of straight tax cuts or increases in transfers is, of course, that they just get saved. Confidence is so low and people are so cautious in New Zealand at present that there is a risk that straight transfers have a minimal impact; they could be saved rather than spent in other words. So, I think actions that involve spending on domestic goods and services, for example in the infrastructure area, are probably going to have somewhat greater multiplier effects," he said.

On the issue of New Zealand's banks, Spencer said he thought they might have more success in refinancing using the government's wholesale guarantee in the next month or two, following the successes of Australian banks in raising funds. Spencer said a roadshow delivered in recent weeks by Treasury and the Reserve Bank had received a positive reception.

Elsewhere, he reiterated concerns about the vulnerability of New Zealand's financial system to a freeze on foreign funding. These are the strongest comments we've seen so far from a Reserve Bank official on these risks.

"The other area (of risk to watch as well as dairy prices) is the whole funding side of the economy, where New Zealand is a debtor country, as is Australia, and if anything we're probably a bit more dependent than Australia on the foreign markets and foreign investors," Spencer said. He is the Reserve Bank's Head of Financial Stability as well as its Deputy Governor.

"So that's a key risk for us in terms of the willingness of foreign investors to continue to fund the economy and fund the current account deficit," Spencer said.

"Now, that deficit is shrinking. Over the medium term we certainly expect that to improve and the household sector "“ saving "“ has turned right around and is now very conservative. It's improving its saving and consumption levels are very flat. So, the correction is underway, but it still has to be funded. The risk is that if some foreign finance was withdrawn or made a lot more expensive, then that could make the adjustment more painful."

Spencer also said the Reserve Bank was concerned about a potential downgrade in New Zealand's sovereign credit rating by Standard and Poor's.

"I think the government has every intention of maintaining responsible and suitably conservative policies so that would not happen," Spencer said.

"The two key things that S&P have cited have been the external deficit, which of course has been there for some time, but they're concerned that that will tend to improve rather than deteriorate. The other key thing is the government's finances which have been in a very strong position, but as we have a degree of fiscal easing, as we're seeing in every country in response to the crisis," Spencer said.

"We have to be careful that it doesn't get out of hand. If we had the prospect of a significant deterioration in the fiscal position then that would be the main risk for a potential downgrade. The government has made it very clear that it will not allow that to happen."

On the New Zealand dollar, Spencer said it was "certainly possible" that it could weaken further given the risk aversion seen from international investors in recent months.

Spencer also made some unusually direct comments about a long term shift in New Zealand and other economies away from consumption funded by foreign borrowing to production funded by local savings.

"The macro implications of all this mainly relate to the reduced willingness of investors in net saving countries to continually finance the current account deficits of net dis-saving countries," Spencer said.

"For New Zealand and Australia this implies higher levels of domestic saving relative to spending and a shift of resources towards the traded goods sectors of the economy. So yes, the landscape's going to be very different."

Here is a link to the full interview.