Standard and Poor's puts NZ's sovereign credit rating on negative watch on weaker fiscal outlook

Ratings agency Standard and Poor's has put New Zealand's sovereign credit rating on negative outlook for the second time in two years after a deterioration in the government's budget outlook detailed last week by Finance Minister Bill English.

The New Zealand dollar fell more than a cent to 77.25 USc on the news. Credit default swaps on New Zealand sovereign debt rose 8 basis points to 62.5 basis points over benchmark rates.

BNZ economist Stephen Toplis said the move was shock that showed New Zealand's "Chickens coming home to roost."

Here is S&P's full statement below.

Standard & Poor’s Ratings Services said today that it has revised its outlook on the foreign currency sovereign credit ratings on New Zealand to negative from stable. The credit ratings were affirmed at ‘AA+/A-1+’.

There is no change to the stable outlook on the ‘AAA/A-1+’ local currency ratings.

“The outlook revision on the foreign currency ratings reflect our recognition of the risks stemming from New Zealand's projected widening external imbalances in the context of the country’s weakened fiscal flexibility,” said Sovereign Ratings credit analyst Kyran Curry.

“New Zealand’s vulnerability to external shocks, arising from its open and relatively undiversified economy, also raises risks to the country’s economic recovery and credit quality.” Standard & Poor’s stresses, however, that these weaknesses are mitigated by New Zealand’s fiscal and monetary policy flexibility, strong institutions, economic resilience, and its actively traded currency.

“The main risk to the ratings would be a significant weakening in the credit quality of New Zealand's banking sector, which is largely owned by the Australian banks, said Mr. Curry.

“That said, however, a range of factors ameliorates some of these risks, including a high degree of foreign-currency-debt hedging and an actively traded currency. New Zealand has independent and effective monetary policy settings with a highly traded and free-floating currency that allows external imbalances to adjust. A large portion of the nation's external debt is denominated in New Zealand dollars, while much of the remainder finances companies with revenues in foreign exchange or is hedged. In sum, we view New Zealand's financial and capital markets as supportive of the rating.”

The negative outlook on the New Zealand foreign currency ratings reflects the possibility of a ratings downgrade if New Zealand's external position does not improve. Rising public savings will be an important component of such an improvement.

The rating could fall, too, if New Zealand's current account weakens because of any higher real cross-border funding costs within its banks. On the other hand, the ratings could stabilize at the current levels upon a sharper-than-expected improvement in the external accounts, led by stronger export performance and higher public savings.

We have also revised to negative the outlooks on six government-related entities (GREs), given their relationship to the New Zealand government.

Those GREs and our rating actions are as follows:

· New Plymouth District Council — outlook on the ‘AA+/A-1+’ foreign and local currency credit ratings revised to negative from stable.

· Wellington City Council — outlook on the ‘AA+/A-1+’local currency credit rating revised to negative from stable.

· Auckland District Health Board — outlook on the ‘AA+/A-1+’ foreign currency credit ratings revised to negative from stable; no change to the AAA/Stable/A-1+ local currency credit ratings.

· Counties Manukau District Health Board — outlook on the ‘AA+/A-1+’ foreign currency credit ratings revised to negative from stable; no change to the AAA/Stable/A-1+ local currency credit ratings.

· Housing New Zealand Corp. — outlook on the ‘AA+/A-1+’ foreign currency credit ratings revised to negative from stable; no change to the AAA/Stable/A-1+ local currency credit ratings.

· Housing New Zealand Ltd. — outlook on the ‘AA+/A-1+’ foreign currency credit ratings revised to negative from stable; no change to the AAA/Stable/A-1+ local currency credit ratings.

Here are BNZ economist Stephen Toplis' comments:

With the New Zealand economy in a relatively good space, by global standards, this came as a significant surprise. A shock made that much greater by the fact that S&P representatives had seemed fairly relaxed about New Zealand’s lot when they were recently in the country. Financial markets expressed this surprise with the NZD falling over a cent against the USD immediately after the announcement and sovereign credit default swaps rising.

Standard & Poor’s points its finger firmly at New Zealand’s significant net international liabilities and prospect of a rising current account deficit as its reasons for concern. We think its worries in this regard are well justified and are at the heart of the current debate surrounding New Zealand’s savings shortfall. The fact that the fiscal outlook has deteriorated has added to this angst.

It’s one thing to have a current account deficit but it’s another to have twin deficits – and this is where New Zealand currently finds itself. That said, one questions the timing of the announcement and S&P’s understanding of the New Zealand economy. To start with the net international investment position has been steadily improving since March 2009 to levels lowerthan expected by most. While this does not mean that the recent trend will remain intact.

It is questionable that the international shortfall will grow more than previously thought by the rating agency. Indeed, just this morning we wrote a research note pointing to the fact that New Zealand’s savings ratio had improved over the last twelve months reducing the pressure on the external accounts. This information was released last week in the National Accounts data for the year ended March 2010.

Moreover, S&P points to New Zealand’s vulnerability “stemming from its open and relatively undiversified economy”.

Another truism but hardly news. The most bemusing aspect of today’s release, however, was that the rating agency believes the New Zealand economy (per capita growth) will grow only 1.6% in calendar 2011. This is miles below our own expectation of 3.5%, the Consensus view of 3.2% and the Reserve Bank’s miserable 2.5% projection.

Where this number came from is anyone’s guess. Of course, given the recent track record of the ratings agencies, one questions their views anyway but, alas, they have to be swallowed. In this light, it is interesting to note that New Zealand is seen as being vulnerable when the US and UK appear to be getting away with fiscal murder (at least in a relative sense given their AAA ratings as opposed to NZ’s AA+).

S&P notes that the sovereign’s rating would come under downward pressure if trend GDP growth falls materially and/or if “New Zealand’s current account weakens because of any higher real cross-border funding costs within its banks.”

Note the irony in the fact that today’s statement actually accelerates New Zealand in that very direction.

Nonetheless, one can’t help but wonder if today’s developments aren’t considered positive by many in authority:

– The Reserve Bank would much prefer to see the New Zealand dollar under downward pressure and if that has to come at the expense of modestly higher longer term interest rates so be it; – Treasury is mad keen on an economic rebalance so the same argument applies;

– An increase in the national savings rate appears to be a centre-piece of the upcoming policy process for Government so getting an agency such as Standard & Poor’s to promote the necessity of a hike in savings might be helpful in getting the public on side with any tough decisions that might have to be made;

– S&P notes that “longer-term fiscal consolidation will benefit from the continued build-up of assets to fund government pension obligations”.

One can only assume this is a direct reference to the New Zealand Superannuation Fund which has found itself in limbo since the Government cut its funding. Folk there must be happy to hear S&P justify its existence. Be that as it may, ratings are much like the currency.

One should really hope that both your ratings and currency are in the ascendancy as this would reflect economic strength. A drop in both, of course, highlights the complete opposite. A surprise it all may be, but, alas, the warnings are real. New Zealand and New Zealanders do have to face up to the fact that the chickens are finally coming home to roost. In these uncertain times countries’ weak points are being gone over with a microscope.

In New Zealand’s case that weak point has long been highlighted as its poor savings record and deteriorating external imbalances. S&P is giving us a timely warning that we must now front these issues. If we choose to do so ourselves it will mean a period of adjustment accompanied by lower-than-desired growth.

If we don’t the world may do it for us.

S&P amended its growth forecast to clarify that it was for per capita growth, rather than total growth.

(Updated to remove S&P report, which we should not have published in full. Our apologies to S&P.)