S&P affirms NZ's AA credit rating citing our 'resilient economy' but sees downside with high household and diary farm debt

OVERVIEW

•

New Zealand has monetary and fiscal flexibility, a resilient economy, and 
institutions conducive to swift and decisive policy actions. Offsetting 
these strengths is its high external debt. 

•

We are affirming our 'AA/A-1+' foreign currency long-term and short-term 
ratings and 'AA+/A-1+' local currency long-term and short-term ratings on 
New Zealand. 

•

The rating outlook remains stable, reflecting our expectation that New 
Zealand's fiscal performance will improve over the medium term, 
offsetting vulnerabilities associated with its high external debt.

RATING ACTION
On March 22, 2016, Standard & Poor's Ratings Services affirmed its 'AA' 
foreign currency long-term rating and 'AA+' local currency long-term rating on 
New Zealand. We also affirmed the 'A-1+' short-term ratings and maintained our 
transfer and convertibility risk assessment on New Zealand at 'AAA'. The 
rating outlook remains stable.

RATIONALE
The rating affirmation on New Zealand reflects the country's monetary and 
fiscal policy flexibility, economic resilience, and public policy stability. 
Moderating these strengths are New Zealand's very high external imbalances; 
its high household and agriculture sector debt; its dependence on commodity 
income; and risks to its financial system stability.

Underpinning the ratings on New Zealand are its strong institutions. We 
believe that the checks and balances in government are effective, and New 
Zealand ranks near the top of many surveys on governance, government 
efficiency, and business promotion. The Reserve Bank of New Zealand has strong 
credibility regarding its inflation mandate and its supervisory role. 

New Zealand benefits from a high-income and resilient economy, which we 
believe draws from decades of structural reforms and wage restraint. In the 
year ending June 30, 2016, we expect the country's GDP per capita to be 
US$34,000. 

Economic growth has been solid over the past few years, despite global and 
domestic challenges. We forecast growth to be 2.7% in fiscal year 2016, a 
little slower than the 3.3% posted in fiscal year 2015. Weakness in dairy 
export prices is dampening growth in the rural sector, and the tailwind from 
earthquake reconstruction activity in Canterbury appears to have dissipated. 
But strong net migration is supporting growth, through household consumption 
and residential investment. Ongoing strong residential investment may 
alleviate housing supply pressures over time, but in the meantime home prices 
in Auckland, the largest city, have spiked over the past few years, creating 
some concern. 

New Zealand's free-floating exchange rate, which has depreciated sharply since 
mid-2014, is helping the economy adjust. Services exports—especially tourism 
and education—have become an important contributor to growth. Despite this, we 
continue to expect widening current account deficits over coming years, with 
the country's falling terms of trade likely to drag down its trade balance. We 
forecast the current account deficit to widen to about 5% of GDP in fiscal 
year 2017 from its cyclical low of about 2.5% of GDP in fiscal year 2014, and 
to remain above 10% of current account receipts over the next few years. We 
see these deficits as high and thus limiting the scope for an accommodative 
fiscal policy.  

Weakening external performance will further increase the economy's already 
high external debt—net of official reserves and financial sector external 
assets—from an estimated 160% of current account receipts in fiscal year 2015 
to more than 200% in the near term. In addition, there is a large market for 
nonresident onshore and offshore issuance in New Zealand dollars (the Kauri, 
Eurokiwi, and Uridashi markets), which affects the demand for New Zealand 
dollars. This market totaled about NZ$62 billion, or 80% of New Zealand's 
annual current account receipts, at September 2015. It contributes to the 
liquidity of the New Zealand-dollar foreign exchange market, but by the same 
token could exacerbate a currency correction if offshore demand falls.

We also forecast New Zealand's gross external financing needs to remain high 
(at more than double its current account receipts and reserves). However, 
somewhat mitigating these risks are the depth of the New Zealand dollar 
foreign exchange market and its exchange rate flexibility (the 'Kiwi' is 
ranked 10th of actively traded currencies in the 2013 Bank for International 
Settlements' triennial survey of foreign exchange trading). 

New Zealand's current account deficits are traditionally associated with 
external borrowings by its banks to fund its growth. The parent companies of 
the four major banks in New Zealand are headquartered in Australia, and our 
ratings on them are equalized with those on their Australian parents given our 
view that they are core parts of their parents' groups. Should, contrary to 
our current expectation, the Australian authorities move to a senior creditor 
bail-in framework for its banking system, this would negatively affect the 
ratings of the Australian major banks and have a flow-on impact on the ratings 
on their New Zealand subsidiaries, and possibly their cost of funding. 

The possibility that foreign investors become less willing to fund banks at 
reasonable interest rates poses a risk to the banking system, the broader 
economy and, in turn, government finances. However, we believe that New 
Zealand's banks will retain ready access to external markets. Low dairy prices 
and the possibility of a disruptive housing market correction pose risks to 
the banking sector, but we currently believe that these risks are manageable 
(see "Will Home And Dairy Prices Sour The Performance Of New Zealand Banks In 
2016?", published Feb. 21, 2016).

Our rating affirmation with a stable outlook is premised on our expectation 
that the central government will improve its budget performance over coming 
years. We see rising public sector savings as a necessary response to 
declining private sector savings. The New Zealand government has made 
substantial headway in improving its fiscal performance following the negative 
impacts of the 2008 global recession and 2010–2011 Canterbury earthquakes. The 
general government cash deficit peaked at 6.8% of GDP in fiscal year 2011, and 
improved to a deficit of 1.1% of GDP in fiscal year 2015. The government's 
latest budget update indicates that weak export commodity prices and low 
inflation are contributing to softer revenues than it previously expected, and 
that fiscal deficits will be larger than previously thought. We have reduced 
our own projections for budget balances too, but more modestly, since we 
previously anticipated this weakness. As a result, we now expect net general 
government debt will peak at about 25% of GDP (in fiscal year 2018), higher 
than our earlier forecast of a peak of 24% of GDP, and project the 
debt-servicing burden to remain moderate.

We have maintained a one-notch distinction between the long-term foreign 
currency and local currency ratings in light of the credibility of the 
country's monetary policy, the freely floating currency, and the depth of 
domestic debt markets. Monetary flexibility can underpin a sovereign's greater 
debt-servicing flexibility in its own currency.

OUTLOOK
The stable outlook balances the stabilization in the government's debt profile 
and the risks associated with the country's high and likely rising external 
debt. The outlook is premised on our expectation that New Zealand's financial 
system will remain sound and its government finances robust. 

We could lower our ratings on New Zealand if its fiscal, external, or banking 
metrics turn out weaker than our current expectations. On the other hand, 
upward pressure on the ratings could eventually emerge if stronger export 
performance and higher public savings markedly reduced external debt and the 
government's debt burden.