Roger J Kerr looks at the likelihood the risk premium for New Zealand debt could change if we get either a change of Government or a different set of coalition partners

 By Roger J Kerr

"Political risk" has not been an issue for New Zealand’s financial markets for a good number of years until now as the two main parties have followed the well-established fiscal and monetary management policy settings and have not made wholesale changes to wider economic policy planks.

There has not been a risk premium added on to NZ Government bond yields for a very long time in respect to the political landscape changing abruptly and thus economic policies fundamentally changing.

There are plenty of other economic and financial/investment market reasons as to why New Zealand 10-year Government bonds are priced at a 1.78% margin above US 10-year Treasury bonds i.e. narrow commodity-based economy, tiny size of our bond market, high household debt levels partly owed to foreign lenders (via the banks), large Balance of Payments Current Account deficit and a volatile/floating exchange rate.

Over recent years with financial/economic turmoil in Europe and elsewhere NZ bonds have been in hot demand as an alternative investment destination, particularly from Asian-based sovereign wealth funds.

Our sovereign credit rating has remained stable in a sea of downgrades elsewhere in the world.

To date these foreign investors have not really viewed political risk in New Zealand as something they should be concerned about and have not required an additional margin to compensate for that risk.

The events over the next six weeks through the general election campaign may well highlight to foreign investors that the political risk should not be dismissed so lightly.

Cobbled together MMP governments in New Zealand demand policy trade-offs to be formed.

However, the fundamental policy prescriptions for monetary and fiscal policy have not been questioned or altered by this process over the last 20 years.

Will next month’s election result be any different in this respect?

So far the NZ bond market has not reflected any nervousness about risks and threats to economic policy from the election.

The Labour Party has been so far behind in the political opinion polls to date that the step to the left by leader David Cunliffe in respect to economic policy has not registered as a risk with investors.

Should the Labour/Green combined polling improve over coming weeks to the point they could form a government with other minor parties we may start to see some portfolio re-positioning by bond investors as they contemplate the potential fall-out from big changes to the Reserve Bank Act, increased fiscal risk and economic growth risks as business investment is parked.

Quantifying such political and event risk is always difficult; however foreign holders of our bonds would not be expecting any change of economic course that a Labour/Greens coalition may well ultimately deliver if they are elected.

Some political commentators are now seeing the possibility of PM John Key being forced to negotiate post-election with NZ First leader Winston Peters to form a government (or a minority government with supply support).

Given Winston’s attitude to foreign investors, we could be in for a few interesting weeks in the financial markets in September/October if this situation eventuates. 

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Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com