By Bernard Hickey and Alex Tarrant
Fitch Ratings has cut New Zealand's sovereign credit rating to AA from AA+, saying it saw New Zealand's net foreign debt as higher than others with AA credit ratings and that New Zealand's structural imbalances were continuing to widen.
"New Zealand's high level of net external debt is an outlier among rated peers - a key vulnerability that is likely to persist as the current account deficit is projected to widen again, reflecting a structural savings/investment imbalance," said Andrew Colquhoun, Fitch's Head of Asia-Pacific Sovereigns.
The New Zealand dollar dropped from 77.8 USc shortly before the news was announced at 5.30 am NZ time to 76.5 USc by 7.30 am.
Finance Minister Bill English, who had been in the US last week talking to ratings agencies, said although New Zealand's external debt had fallen a bit, markets had become much more sensitive to counties with high levels of external debt. One ratings agency executive had told him they had been caught out by not giving enough weight to Italy's external debt, and now every sovereign was under the microscope.
“They’re going through a cycle. There has been quite a number of countries downgraded. I wouldn’t say we knew it was coming, but we’ve always known what the issues are," English said.
"That’s why we’ve been working pretty hard for the last couple of years on getting the government’s debt under control, because that’s an important part of this, but also trying to pull some of the indirect levers to influence our household debt," he said.
Westpac chief economist Dominick Stephens said the move would likely raise the cost of government borrowing, and could also raise costs for corporates, including banks. A possible rise in bank funding costs due to the current global economic turmoil was flagged by Reserve Bank Governor Alan Bollard earlier in September, although Bollard noted the banks did not currently need to raise funds on global wholesale money markets, and it would be more of a '2012 story'.
The downgrade comes after the government yesterday raised NZ$1 billion of debt at near record low costs, as investors looked to diversify away from volatile European markets. See more here.
Stephens said the downgrade and warning from Fitch meant the Reserve Bank was certainly in "wait and see" mode with the Official Cash Rate, which economists generally expect to raised in either March or June next year.
ANZ economists said the Fitch move would increase speculation Standard & Poor's, which has New Zealand on negative outlook, might downgrade the government's credit rating as well. However, the upward revision to the government's earthquake costs might stay S&Ps hand until it sees the pre-election fiscal update, due toward the end of October, they said.
Christian Hawkesby, head of fixed income at Harbour Asset Management, said the 'real news' in today's announcement was it increased the likihood of an S&P downgrade.
"By focusing on net external debt, S&P follows a similar methodology to Fitch. But even then, this still leaves NZ in the major league, more closely linked to core countries like the US, UK and German than European periphery countries or emerging markets," Hawkesby said.
"Moody’s, who focus more narrowly on government debt, have reaffirmed the NZ government’s AAA rating. So while these are volatile times, we are expecting global investors to be able to put this news in context and continue to support the NZ government bond market,” he said.
ASB chief economist said subsequent to the Fitch move, Moody's had reaffirmed its stable outlook for New Zealand's Aaa rating.
Fitch more aggressive
Fitch is seen as the third ranked of the three global credit rating agencies, behind Standard and Poor's and Moody's, although it has been more aggressive and prescient with its downgrades of indebted European governments in the last three years.
Standard and Poor's currently has New Zealand on AA+, but put that on negative outlook in November last year, suggesting a one in three chance of a downgrade within two years. Moody's has New Zealand on a AAA rating with a stable outlook. Fitch's rating downgrade is the first New Zealand sovereign ratings downgrade for 13 years.
The last sovereign ratings cut was in September 1998 when Moody's cut New Zealand's rating from Aa1 to Aa2. Since then ratings agencies have been upgrading New Zealand's outlook. See the history of New Zealand's sovereign credit ratings here at NZDMO.
Fitch's Colquohoun said the outlook for the new AA rating was stable and New Zealand remained well placed among the world's highly-rated sovereign credits, with moderate public indebtedness, fiscal prudence, and strong public institutions.
New Zealand's net external debt of 83% of GDP on a USD basis (78% in NZD terms) by end-2010 was well above the 10% median for 'AA' range credits, but had reached 70% of GDP in NZD terms by June 2011, Fitch said.
"The economy's high net external indebtedness reflects a persistent current account deficit, peaking at 8.9% of GDP in 2008. The deficit corrected sharply amid recession in 2009-2010, but Fitch projects it will widen again to 4.9% in 2012 and 5.5% in 2013 as domestic demand recovers," it said.
High household debt
Fitch said it viewed New Zealand's high net external indebtedness as a key vulnerability, particularly in a global environment that had remained volatile since the ratings were assigned a Negative Outlook in 2009.
"The downgrade partly reflects Fitch's view that the sustained shift in the domestic savings/investment ratio required to narrow the deficit sustainably is unlikely within the forecast period."
New Zealand remained in the club of advanced economies with high household indebtedness - around 150% of household disposable income, similar to levels in Australia (157%) and the UK (159%), and above the US (116%), Fitch said.
"Unlike the UK and US, New Zealand has seen no meaningful reduction in this ratio since 2008. Fitch acknowledges that the government has implemented policies designed to facilitate a shift in savings, including raising KiwiSaver contribution rates, but the agency cautions that changing deep-seated behaviour is likely to be difficult," it said.
"While a sustained strengthening in household savings could address New Zealand's external indebtedness, such a development - even if it emerged - could make for a period of weaker growth, unless accompanied by renewed structural reforms. Historical experience shows that private consumption growth in New Zealand has been well-correlated with house price moves."
Fitch said New Zealand's five-year-average real GDP growth rate of 0.7% compared unfavourably with median average growth rates of 1.1% and 1.4% for 'AA' and 'AAA' range countries.
"Adding to risks over the medium-term outlook, official data indicates that the productivity performance of New Zealand's economy weakened over the 2000s. Average incomes remain moderate by 'AA' standards and even further below the 'AAA' median," it said.
Public finances deteriorated in last three years
"Public finances have traditionally been a rating strength for New Zealand relative to 'AA' rated peers but the deterioration experienced over the past three years has eroded that strength. The debt/GDP ratio of 46% in 2011, although below the 'AAA' median of 57%, is similar to the 'AA' median of 43% and the ratio of debt-to-revenues has risen in line with the 'AA' rating median to 122%. "
Fitch also pointed out foreigners held more than half of New Zealand's marketable government debt.
"The sovereign's own funding conditions may not be isolated from any materialisation of risks in external finances, although Fitch stresses that the risk of such a downside scenario remains remote despite the downgrade," it said.
"A sharper than expected rebalancing of New Zealand's economy leading to a reduction in the current account deficit and sustained falls in net external indebtedness nearer the norms for highly-rated sovereigns would benefit the ratings. New Zealand's ratings remain supported by fiscal prudence, with the government hoping to return to budget surplus in FY2014/15. However, upwards revisions to damage estimates from the Christchurch earthquake and consequent additional fiscal costs, or fiscal slippage driven by other causes, could set back this timetable."
Fitch downgraded New Zealand's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'AA' from 'AA+', and Long-Term Local-Currency IDR to 'AA+' from 'AAA'. The Outlook on both ratings is Stable. The Country Ceiling has been affirmed at 'AAA', and the Short-Term Foreign-Currency IDR at 'F1+'.
'It's happening all over the world'
Finance Minister Bill English said the downgrade was part of "what's going on in a world that's pretty volatile, where much worse things than that are happening".
“We’ve made considerable progress over the last couple of years. This agency, [which] had us on what’s called negative watch two years ago, are focussed on our high external debt. Now since then our external debt has reduced a bit, but the financial markets – the people who lend to us – have become much more sensitive to the amount of debt any country has," English said on Newstalk ZB.
"In our case it’s largely private sector debt held by households. Households are saving more, they are getting their debt down, they’re getting into a better position than they were when we had the last financial crisis in 2008. But in a sense the goal posts have shifted, because they [the markets] are more sensitive, even though our levels of debt are lower than they were two years ago," he said.
English met with Fitch executives on his trip to the US last week, although the ratings agency was tight-lipped on their views on New Zealand as they were considering New Zealand’s position.
“But they did focus on their concerns in Europe, which were on those countries that owed a lot of debt to foreigners, some of the countries that we’ve talked about here in New Zealand, where New Zealand is at similar levels,” English said.
“They’re going through a cycle. There has been quite a number of countries downgraded. I wouldn’t say we knew it was coming, but we’ve always known what the issues are. That’s why we’ve been working pretty hard for the last couple of years on getting the government’s debt under control, because that’s an important part of this, but also trying to pull some of the indirect levers to influence our household debt," he said.
Moody’s and Standard & Poor’s would be considering the same issues, going through a cycle of assessing their ratings.
“The mood in Washington at this meeting was very much that every sovereign was under the microscope," English said.
“They’ve got particularly negative about debt. They’re all trying to grapple with a very large economy like Italy which has high external debt. As one of them said to me, ‘we got caught out on Italy, not giving enough weight to their high external debt,'" he said.
'It's National's fault'
Labour Party leader Phil Goff said the downgrade was evidence of the National-led government's economic mismanagement and the failure of National's policy to borrow for tax cuts.
"National has failed to make the hard decisions needed to fix the imbalances in the economy. The downgrade is a clear judgement on National's failure to get the economy growing and to deal with New Zealand's long-term problems,” Goff said in a media statement.
"It's simply not good enough for John Key and Bill English to talk about just "muddling through". That kind of statement exposes their short-term thinking and lack of ambition when it comes to getting our economy going," he said.
"The downgrade shows why Labour's plan to introduce a capital gains tax to redirect investment into the productive economy and to pay back debt without selling our assets is so important. We also need to make bold decisions when it comes to lifting our national savings," he said.
Phil Goff has previously waved off questions about the fact Labour's policies would require the government to take on more debt in the short-term, saying ratings agencies were more concerned about a nation's debt track further out. See: Labour's Goff unfazed about need to borrow more than National in short-term, says ratings agencies would look at better long-term debt track.
'It's why we need ACT'
ACT leader, and former Reserve Bank governor, Don Brash said the downgrade was avoidable. The government had not done enough to grow domestic incomes and increase exports, he said.
“Low growth in incomes means low growth in savings, and the weak growth in export volumes reflects the big growth in Government spending,” Brash said.
“The Government has dropped the ball here. The fiscal deficit has increased from NZ$4 billion in the year to June 2009, to NZ$6 billion in the year to June 2010, and to NZ$18 billion in the year to June 2011. Only about one third of the NZ$18 billion is related to the Christchurch earthquakes,” he said.
“This is precisely the reason I decided to get back into politics. The current Government acknowledges the issues and is generally moving in the right direction, and often under trying circumstances, but they need a strong ACT Party in Government with them to help make more effective policy decisions that will avoid these kind of seriously negative economic outcomes.”
'Don't sell the SOEs'
Green Party co-leader Russel Norman said the move by Fitch was a thumbs-down to National, for failing to address the structural savings and investment imbalances within the economy. The primary reason for the downgrade was a worsening outlook for New Zealand's current account deficit due largely to high levels of foreign ownership in the New Zealand economy, he said.
“As the economy slowly recovers, increasing flows of money are going offshore in the form of dividends and profits to overseas owners of New Zealand companies and farms,” Norman said.
“Privatising our state-owned enterprises, which will inevitably lead to significant overseas ownership of them, will worsen the current account deficit as even greater levels of profits will flow offshore to their new owners. High levels of foreign ownership create a fundamental vulnerability in our economy to capital drain. We can solve this by retaining ownership of our state-owned enterprises and through higher foreign ownership tests, including an outright ban on the sale of land to non-citizen, non-resident owners," he said.
“On the fiscal side of the ledger, National must accept responsibility for their poorly-timed and poorly designed tax cuts — cuts which fuelled record levels of Government borrowing and failed to effectively stimulate an economy in recession," Norman said.
“The Government’s failure to consider revenue-raising options in the form of an earthquake levy to help pay for the rebuilding of Christchurch or the introduction of a capital gains tax (excluding the family home) to address the tax incentive to speculate in property, is now being shown up as short-sighted and will result in the cost of borrowing for all of us going up as a result of the downgrade.”
Westpac chief economist Dominick Stephens said the downgrade should raise the government's cost of borrowing, while it could also widen corporate and bank funding costs. However he said it was difficult to know what "new" information Fitch had based its decion on.
"There has been speculation that the trigger was the recent weaker than expected GDP print for the June quarter, combined with increased cost estimates for the Christchurch earthquake," Stephens said.
"While Fitch's news release didn't point to this specifically, it did note that while New Zealand's ratings remain supported by "fiscal prudence", and public finances were typically a point of strength for New Zealand relative to its peers, upward revisions to the damage estimates from the Christchurch earthquake and consequent fiscal costs, or fiscal slippage driven by other causes, could set back the Government's current forecast of returning to budget surplus by 2014/15," he said.
"Fitch focused on risks generated by New Zealand's relative high level of external debt, noting that while New Zealand's current account deficit had corrected sharply amid the recession in 2009/10 as consumer demand fell, Fitch expects it to widen again in the coming years as consumer demand recovers (on their forecasts the current account deficit is expected to grow to 4.9% in 2012 and 5.5% in 2013). This high net external indebtedness, in part due to low household savings, was viewed as the key vulnerability, particularly in the volatile global environment. "
This had long been a theme of Fitch's. In its 2009 report which downgraded NZ's credit outlook to negative, it warned that net debt would be likely to rise above 100% by 2011.
"However New Zealand's net international investment position has improved substantially in recent years and is now at 70% of GDP, down from a revised peak of 85% (although reinsurance funds from offshore have provided something of a temporary boost). Fitch is presumably sceptical about the extent of structural improvement in this outlook noting that "changing deep-seated behaviour is likely to be difficult" (in relation to domestic savings behaviour)," Stephens said.
The market reacted to the news with the NZD falling 80pips against the Australian dollar
"Theoretically a lower credit rating will increase the cost of funds for the New Zealand economy and the New Zealand government. Typically you would expect to see higher government bond rates, further widening of corporate funding spreads, a lower NZD, and lower short term swap rates potentially combined with higher long-term swap rates leading to a steeper yield curve.," Stephens said.
"Even apart from today's downgrade, we've flagged the possibility of rising borrowing costs independent of changes in the OCR, as a result of heightened global financial market volatility. That possibility reinforces our view that the RBNZ remains firmly in wait and see mode for now," he said.
Meanwhile ANZ economists said the move was not entirely unexpected, as the possibility of a downgrade had been widely talked about.
"In terms of how we got here, it is worth reiterating that Fitch has had NZ on negative outlook since July 2009, so in a sense this removes that “threat” that had been hanging over the market (noting that the outlook is now stable). But what we are really talking about here are degrees of excellence – recall that Uncle Sam has also just been downgraded too," ANZ economists said.
"It will of course increase speculation in markets that Standard & Poor’s (S&P) might follow suit – recall that they too have New Zealand on negative outlook. Picking the timing of this is pure speculation, but we would expect them to either follow suit quickly, or wait for the Pre-Election and Fiscal Update (PREFU), which by law, must be published between 20 and 30 days before the general election (on November 26th)," they said.
"Given the circa NZ$4bn upward revision to the EQC’s earthquake liabilities, some deterioration of the Crown’s position is on the cards, and in that sense, it would make sense for S&P to wait for the PREFU before announcing a downgrade, if they are intent on doing so," they said.
ASB chief economist Nick Tuffley said the move raised the chance of a downgrade from S&P.
"Historically the immediate reaction to past downgrades has been modest. Much of the market movement around a ratings downgrade tends to be in response to the underlying economic environment, rather than the ratings change itself," Tuffley said.
"We expect that will largely be the case following the Fitch downgrade: the European debt crisis and consequent concerns about the global economy will continue to dominate the trends in the NZD and interest rates," he said.
"Even at AA from one agency, NZ appears more stable than many other countries receiving downgrades. Nevertheless, the global backdrop is one of nervousness, and it is still possible another rating agency also cuts NZ’s rating."
(Updated with details from Fitch statement, NZ dollar fall, background, Comment from Bill English, Westpac comment, Goff comment, ANZ comment, Habour asset management comment, ACT, Greens, ASB)
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