NZ Debt Management Office to monitor Moody's review of bank credit ratings, but any downgrade should have little effect on govt borrowing

It is too early to guess what effect a credit ratings downgrade for New Zealand’s major banks might have on the Government’s cost of borrowing, although the situation will be monitored, the head of the New Zealand Treasury’s Debt Management Office says.

Credit rating agency Moody’s this week put New Zealand’s major banks on review for a possible ratings downgrade, due to a review of their Australian parents. Moody’s will also look at New Zealand banks’ sensitivities to wholesale funding markets, where they borrow up to 40% of their funding.

The announcement of the bank review comes after Moody’s indicated in January it was comfortable with the Government’s debt levels, although the rating agency did note potential risks from its reliance on offshore funding.

'Depends on whether concerns for banks flow on to govt'

NZDMO Treasurer Philip Combes told interest.co.nz any effects on the country’s sovereign rating from the bank review would ultimately depend on whether any particular action on the banks flowed through to the sovereign rating.

“I think it’s certainly far too early to say whether there are any implications. I’d have to say at this stage it is most unlikely,” Combes said.

“As we found over the last several years, there’s been more volatility in bank funding rates by quite a margin than there has been in sovereign funding levels. What’s happening in the banking sector doesn’t have any great impact on the sovereign, unless you were talking about factors that were affecting the country as a whole,” he said.

However, if a downgrade of the banks led to a rise in borrowing costs, and that flowed through into economic activity, it was a possible there could be some small effect on the sovereign borrowing costs.

“The issue is, unless that’s significant, you’d just take that in the mix along with a whole lot of other factors that potentially impact on GDP growth, and therefore on tax revenue and the state of the Government’s finances,” Combes said.

“The fundamental point I’d make is there was a lot more of that sort of an issue during the Global Financial Crisis and that did have a more marked impact on GDP growth and the like. You’d expect anything now to be much, much less significant than anything we experienced back then,” he said.

Sensitivities to offshore borrowing had been around for quite some time, Combes added. What was new was the way the rating agencies assessed those sensitivities.

“It was exactly the same issue around Standard and Poor’s move to negative outlook for the sovereign [in November 2010].”

“In New Zealand, if anything, our external imbalances have been reducing over the last twelve months. But there’s no doubt there’s a heightened sensitivity by rating agencies to external vulnerabilities,” Combes said.

Happy to accelerate govt borrowing

Meanwhile, strong demand for New Zealand government debt, and historically low interest rates, meant the NZDMO had been happy to accelerate the government’s borrowing programme.

In the last two and a half months the NZDMO had three of its biggest tenders it had had for a long time, culminating in a NZ$950 million tender a few weeks ago, Combes said.

The Government says it needs to borrow on average NZ$300 million a week for its budget requirements.

“Our sense is that international demand - not just for Australian and New Zealand sovereigns, but also the banks as well – has been pretty strong,” Combes said.

“In that sense, we think that there’s some methodological issues that rating agencies are looking at, rather than economic conditions per se, because they [the conditions] are clearly better now than they were one to two years ago,” he said.

The recent large debt issues were “absolutely” due to increased demand rather than the NZDMO trying to get them in before markets possibly fell away again, although some risks did remain in Europe.

“We’ve done quite a lot of marketing mid to late last year, particularly into the Asian region, but also to London and the US. As a result of that activity there’s no doubt there’s been heightened interest in New Zealand government securities,” Combes said.

“We’re really keen to meet that demand with supply when there is strong interest from offshore,” he said.

Yields were also better.

“Historically yields have been around 6% for ten year bonds in New Zealand for most of the last decade,” Combes said.

That had got down to almost 5%. “Certainly we’ve been able to issue significantly below 6% for quite some time now,” he said.

“The combination of demand, plus historically low interest rates for borrowing out to ten years, has meant that we’ve been quite happy to accelerate our programme while conditions are good.”

Still risks in Europe

As the Government’s fiscal position improved as it moved toward surplus, the NZDMO would have progressively less to do over the next three years.

“From our point of view, while demand is there, it’s important to borrow, because there are risks – much more around what happens in Europe. There are still risks in the sovereign debt arena, and our view is that, while things have settled recently in Europe, there are still risks going forward,” Combes said.

“And there is still a lot of talk about the state of the US finances as well. So our view is in this sort of environment, it’s always good to borrow when yields are low and when you can, but there is no doubt that we’ll have less to do, progressively, over the next three years than we’ve had to do in the last couple,” he said.