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The Treasury takes a refreshed look at the nature of our external debt and its components

Posted in Opinion

Today's Monthly Economic Indicators published by The Treasury included a Special Topic: New Zealand’s external debt – an international comparison which is reprinted here.

By The Treasury*

A new breakdown of New Zealand’s external debt data, published by Statistics New Zealand as part of the September quarter Balance of Payments release, supplements the existing published data and allows us for the first time to directly compare our external debt position with international data compiled by the World Bank.

Taking stock of the new data

Chart 4 shows how the new external debt data fit in with the existing International Investment Position (IIP) statistics.

New Zealand’s total financial liabilities as reported by the existing IIP data at the end of the September 2012 quarter amounted to around 155% of GDP, with a fifth (33.5% of GDP) in the form of equity and the remainder comprising international borrowing.

To translate the international borrowing component into a measure consistent with the World Bank’s external debt tables requires subtracting the portion of the debt that relates to financial derivative contracts.

This returns a comparable external debt figure of 111% of GDP for New Zealand (the third column from the left in Chart 4), which is then broken down into the five categories as reported by the World Bank in the fourth column.

How does New Zealand compare?

Table 1 shows how the new, more granular data compare with a selection of OECD countries. New Zealand’s total level of external debt is slightly higher than the OECD average

New Zealand’s public sector external debt, in the form of the ‘General Government’ and ‘Monetary Authorities’ categories, is lower than the OECD average. Similarly, at 10.5% of GDP, the external debt of the corporate sector (the ‘Other sectors’ category) is also comparatively low.

There are, however, two notable areas where New Zealand’s external debt position stands out – the first of which is in the banking sector. At just over 50% of GDP, and comprising almost half of New Zealand’s total external debt, debt in the banking sector is comparatively high relative to the rest of the OECD.

What sets the New Zealand banking sector further apart is the high proportion of the sector’s external debt that is owed to related parties ie, Australian parent banks. We were aware of this before the publication of the new breakdown. However, the new statistics put a precise number on the extent of related-party debt in the banking sector, which amounts to just under 60% of its gross external debt (around 30% of GDP).

The World Bank’s external debt compilation does not require countries to break down their external debt statistics in terms of what is owed to related parties, so it is difficult to assess how this compares to the situation in other countries.

However, given the high degree of foreign ownership of the New Zealand banking sector compared to other advanced economies, corresponding data from the Bank of International Settlements (BIS) suggest that New Zealand is a pronounced outlier in this respect.

The second area in which New Zealand’s external debt position stands out is the comparatively high share that is in the form of ‘direct intercompany investment’ (ie, external debt, mainly in the corporate sector, owed to overseas companies that have equity interests in New Zealand – column 6 of Table 1).

At 26% of GDP, such debt accounts for around a quarter of New Zealand’s total external debt compared to an average share of around 12% for the OECD as a whole.

What does this mean?

Overall, external debt owed to related parties by the banking sector, as well as direct intercompany external borrowing, is equivalent to just over half of New Zealand’s gross external debt – estimated to be by far the highest proportion in the OECD. To the extent that these two forms of international borrowing are more stable and less flighty sources of funds than completely unrelated forms of borrowing – a reasonable assumption given the deeper relationships and more-aligned interests between the counterparties – this implies that the composition of our gross external liability position poses less direct roll-over funding risk than in similarly indebted countries.

Given that the vast majority of our external liabilities are either denominated in New Zealand dollars or hedged, all else equal, this is also a factor that should lend support to our credit rating (although such hedging does expose New Zealand borrowers to counterparty credit risk).

Shifting the focus to the asset side

Nonetheless, while New Zealand compares quite well in terms of the magnitude and composition of our gross external debt, our position as a net international debtor instead highlights our weak international asset position.

This is illustrated by our comparatively high leverage ratio (ie, ratio of gross external liabilities to gross external assets) which, at close to two, is amongst the highest in the OECD.

Implications for policy

Altogether, the recent publication of the new external debt series by Statistics New Zealand affords us a fresh and more precise look at the composition and nature of a key portion of our international liabilities.

However, in terms of policy advice, the issues raised are similar in nature to existing work looking at ways to reduce the economy’s exposure to external vulnerabilities. Treasury has published a range of work over recent years on this subject including a 2011 Working Paper as well as the 2011 Briefing to the Incoming Minister.

Further research along the same lines remains a key priority.

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This article was first published in January's Monthly Economic Indicators

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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14 Comments

Overall, external debt owed

Overall, external debt owed to related parties by the banking sector, as well as direct intercompany external borrowing, is equivalent to just over half of New Zealand’s gross external debt – estimated to be by far the highest proportion in the OECD. To the extent that these two forms of international borrowing are more stable and less flighty sources of funds than completely unrelated forms of borrowing – a reasonable assumption given the deeper relationships and more-aligned interests between the counterparties – this implies that the composition of our gross external liability position poses less direct roll-over funding risk than in similarly indebted countries.
 
Thin capitalisation issues?

   ''That's not the way the

 

 ''That's not the way the world really works anymore,'' he continued. ''We're an empire now, and when we act, we create our own reality. And while you're studying that reality -- judiciously, as you will -- we'll act again, creating other new realities, which you can study too, and that's how things will sort out. We're history's actors . . . and you, all of you, will be left to just study what we do.''
 
http://www.ablemesh.co.uk/historysactors.html

The IRD/Govt tightened up on

The IRD/Govt tightened up on the thin cap rules a couple of years ago by lowering the level of debt/assets that could be used to deduct interest for tax purposes...  I think the level is now a max of 60% debt to total assets before the thin cap rules kick in
In any case an offshore parent company loan to a local subsidiary is a quasi form of equity in any case and it will always be subordinate to any thrid party borrowings (which will likely backed by a parent co guarantee)...
 
 

HtG, you are so right to

HtG, you are so right to assert the government attended to restricting acts of transfer pricing undertaken by foreign firms with the help of their accountants.
 
But I guess foreign corporations can revalue asset values upwards just as the local power companies did, if we are to believe Geoff Bertram's assertion.  
 
Bertram said that for several years, power companies were revaluing their assets on paper and using that as a basis to increase their prices.
 
A profitability analysis of Meridian, Genesis and Mighty River conducted by Ernst and Young in 2011 estimated that economic profit totalled $3.8 billion between 2002 and 2011, on total revenues of $42 billion.
 
Their invested capital rose from $4 billion in 2002 to nearly $12 billion in 2011 but most of this increase - $6.2 billion, according to the companies' annual reports - was asset revaluations, with less than $2 billion representing the historic cost of net actual investment.
 
Those increases in asset values went untaxed but made their returns on investment look low, which justified price hikes, he said. Genesis did not want to comment on the revaluations and Mighty River said it was a question for the Electricity Authority.

Assets to liabilities: So are

Assets to liabilities: So are we approaching the point where there is not much more to sell off (and what there is meats steadily greater resistance), what I shall call "Peak flogging off"

The problem is with these

The problem is with these assets, what are they really worth?  At the moment if the property bubble is  x2  then really our assets are worth far less....add in who would buy them (say a school) in a depressed economy?  
The only assets worth anything are the ones where the Govn grants a monopoly to the owners, so the power companies....that means in order to get the maximum price the Govn has to sell us the consumer and poor consumers in particular (electricity price is in effect a regressive tax)  down the river.
and these bozos we voted for, rinse and repeat for Labour of course.
regards

The ration quoted is of

The ration quoted is of external assets to external liabilities ( ie what New Zealanders including the Government own off shore compared with what we owe offshore ). Nothing to do do with the value of schools unless they are in another country.
 
I imagine that ratio has been like that forever for little old NZ. One way to fix it would be for the government to sell everything it owns here to foreigners and invest the money overseas.

DH Plenty left to sell off.

DH
Plenty left to sell off. We still own more than 90% of our land. It's true that most of our large private companies (as opposed to cooperatives) have been sold off. But there's still a heap of large government owned companies left. And most of our houses are still locally owned, albeit mortgaged to the hilt.
If foreign investors thought we had nothing left to sell they would already have pushed the currency down and put up our interest rates. Hasn't happened yet.
Foreign investors judge we have plenty left to sell and room to borrow. That's why they're letting us run a current account deficit of around 5% of GDP.
Here's the RBNZ chart showing our housing stock is still worth NZ$700 billion or around 300% of GDP. That's around 50 years worth of continuing to run current deficits of around 5% a year. http://www.rbnz.govt.nz/keygraphs/Fig4.html
We just need to start selling off our houses to foreign investors...
Oh wait... we just started doing that.
I just did it. ;)
cheers
Bernard

That's it Bernard - work that

That's it Bernard - work that line publicly and hard and the identity of the real bandits will be revealed.

Wouldn't you have to subtract

Wouldn't you have to subtract out net overseas liability from that $700m? I mean three quarters of the debt is against housing isn't it?

You know all I can see is a

You know all I can see is a total mess. I do not see any ppoint in a comparison. Just let's deal with our debts, with our financial situation without looking at what others are going through now. They say that however, in terms of policy advice, the issues raised are similar in nature to existing work looking at ways to reduce the economy’s exposure to external vulnerabilities. What can I say, I am keeping my fingers crossed, because when the economy is vulnerable, it is diffiucult to talk about the finacial growth. Hopefully the external debt is going to be fixed as soon as possible.

What sets the New Zealand

What sets the New Zealand banking sector further apart is the high proportion of the sector’s external debt that is owed to related parties ie, Australian parent banks. We were aware of this before the publication of the new breakdown. However, the new statistics put a precise number on the extent of related-party debt in the banking sector, which amounts to just under 60% of its gross external debt (around 30% of GDP).
This is probably the heart of the matter. Our Australian  banks borow the money they lend to us from Australia- this is most probably an accounting fiction. Where would the Australian Parent Banks  get all those NZ dollars from?
 

This is probably the heart of

This is probably the heart of the matter. Our Australian  banks borow the money they lend to us from Australia- this is most probably an accounting fiction. Where would the Australian Parent Banks  get all those NZ dollars from?
 
This has worked in the past and various iterations do today. 

the rbnz made a call about 5

the rbnz made a call about 5 years ago to wipe out the nbdt sector, apart from bank controlled UDC, and Marac which has just incidentally become a bank. Ireland did a similar thing a decade ago. talk is they are questioning that decision. nz has become extremely top heavy, most inductries are dominated by a very few large players (banking and finance included) practices border on monopolistic. nz the nation of small businesses is fast becoming a myth. furthermore because we have such large monopolistic industries price control is a problem. the government, monopolies commission and regulators are unusually quiet on this front. take the academic report out this week criticising the electricity market and high prices we pay. similar could be said about our banking industry whos margins have become bloated. The indebtedness to australia has lead to nz inc. losing control of our destiny. the rbnz needs to ensure real competition or regulation is imposed to wrestle some of this power back.