RBNZ calls for fiscal restraint

Reserve Bank says NZ credit rating downgrades reinforce need for govt fiscal consolidation; Supports bid for surplus

10th Nov 11, 9:09am by Alex Tarrant

The government’s credit rating downgrades in September reinforced the need for fiscal consolidation from the government, as the scope for fiscal policy to respond to weakening economic activity is considerably more constrained than at the start of the financial crisis in 2008, the Reserve Bank says.

Releasing its six-monthly Fiscal Stability Report, the Reserve Bank said due to the deterioration in the Crown’s balance sheet and elevated risks of further disruption to global financial markets, it was supportive of the government’s intention to return the books to surplus over coming years.

Both the incumbent National, and opposition Labour parties are promising to return the government’s books to surplus in 2014/15. The current election campaign is being dominated by promises from the two major parties that they would be the more fiscally responsible. See their claims in our Election 2011 coverage here.

The Reserve Bank said fiscal consolidation over the medium-to-long-term would help put the Crown in a position to respond to any future sharp contractions in economic growth.

“The scope for fiscal policy to respond to a sharp decline in domestic activity is considerably more constrained than at the onset of the global financial crisis,” the RBNZ said in the November Financial Stability Report.

The recent downgrades – Fitch and Standard & Poor’s both cut the Crown’s credit rating to AA from AA+ in September - underscored the importance of making progress on both external and fiscal rebalancing.

“The Crown’s financial position has deteriorated in recent years reflecting higher levels of expenditure and a reduced tax take. Along with additional fiscal costs associated with the earthquakes, this has led to a substantial widening in the operating balance in the year to June 2011,” the RBNZ said.

“In light of the elevated risks of further disruption to global financial markets, the Reserve Bank is supportive of the Government’s stated intention to return the fiscal position to surplus in coming years.

“A stabilisations of government debt levels would help to further moderate New Zealand’s external vulnerabilities, providing some offset if the private sector’s current cautions attitude to debt accumulation turns out to be temporary. Stabilisation over the medium-to-long-term would also help to increase fiscal headroom to respond to any future sharp contractions in economic growth,” the RBNZ said.

(Updates with video of RBNZ deputy governor Grant Spencer)

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20 Comments

by Nicholas Arrand | 10th Nov 11, 9:49am 1320871757

Oooo...they're coming thick and fast today! And all in the theme of 'take cover; get ready; prepare'...'they' see that things ahead are going to get rough....

by Wolly | 10th Nov 11, 10:29am 1320874178

Let's turn to consider MR and Mrs Quake in chch....they finally receive the insurance payout and it is not enough to build an outside dunny because building costs are still at bubble levels because wages never came down and gst went up.

Will they

a. Bite the bullet and borrow the massive amount and rebuild what they had far away from where they were on the outskirts of chch....or

b. Will they pack what's left and shoot south to buy an existing place in Ashburton or go north to Rangiora...or

c. Will they leave chch and rent somewhere while investing their capital across the Tasman in a bank deposit where it will be guaranteed by the aussie taxpayer!

by scarfie | 10th Nov 11, 3:26pm 1320891996

I am sure I could design them a pretty flash dunny at a modest construction cost Wolly, as a bonus I could even make it liquifaction proof.......ahhh..... hang on there is something wrong with that picture.

by Andrewj | 10th Nov 11, 11:03am 1320876210

But the governments stated intention to return to surplus is just another lie. You reach for the bottom of the bucket in an election year.The coming years will strech to coming decades and default. I dont even think the Polies believe the lie anymore.

I found this article somewhere, I thinks it relevant even though its about the UK.

>>>>>>>>

The purpose of deficit reduction is not to stimulate growth but to avoid default. It is obvious that a contraction of government spending is going to reduce GDP because government spending is one of the four components of GDP, along with consumption, investment and net exports.

It is also obviously true that as GDP declines then so do tax revenues. No argument on that one either.

But what you fail to grasp is that once a country gets into severe debt difficulties - ie when the debt to GDP ratio is very high and the deficit on the public accounts is also high - then its choices are (a) to cut the deficit sharply and accept declining living standards as a result; or (b) to keep borrowing and spending and run a very serious risk of default.

Default in the case of a country too large to be bailed out (like the UK) means the closure of hospitals and schools, the collapse of public services and serious civil unrest. It is catastrophic, absolutely unthinkable.

You share with the economic illiterates of the Labour front bench a belief that there is a soft landing to be had, where growth can be stimulated with a bit more borrowing and GDP growth kicks in to solve our debt problems. You can do that when you have a debt to GDP ratio of say 40% and a deficit of say 4% but to argue for more borrowing when debt is 80% of GDP and the deficit is 9% is, forgive me for saying so, chronically stupid.

First, you are confusing the debt and the deficit. They are not the same thing.

The debt is a balance sheet number and the deficit is the rate at which we add to it each year. If you want to talk about cutting the debt you have to swing the public accounts into surplus so that there is surplus cash to pay down the stock of debt. That is not possible in the medium term.

But to answer your first question directly, it's just arithmetic: as long as government spending falls by more than the reduction in the tax take as the economy contracts the deficit will decline.

Yes, this means everyone will get poorer, the economy will shrink and there will be higher unemployment, but it's the best that's on offer to a country facing default. There is no soft landing when your debt spirals out of control.

As to your second point, the debt to GDP ratio in previous years was manageable only because the deficit was small (or non existent) and because there was a long period of sustained economic growth. The three components of 'debt dynamics' - the stock of debt, the deficit and economic growth are all interlinked and arguably a country can manage quite well if any one of them is in good shape, even if the other two are not.

It's when you have three red lights flashing that you are in real trouble because default is inevitable. That's exactly where the UK is today. We have never been in this situation before, so in that sense Gordon Brown really has made economic history.

Lastly, the yields on gilts reflect not the market's resounding vote of confidence in the UK economy but the jaw-dropping risk profiles of almost every other investment imaginable. Pension fund managers, sovereign wealth funds and banks have no idea where to invest their funds now because there is such a high risk of losses. This is true of gold, equities and many sovereign bond issues.

The UK and the US have been favoured only because they have their own central banks and can print money if needed (which of course both have done and are doing), which is an easier form of default to swallow than the one on offer for, say, holders of Greek government debt, where 50% write downs are on the table.

Which raises a paradox because if the Eurozone sorts out its woes and the equities markets start to surge the yield on gilts will rocket. It's the last thing George Osborne needs.

by Wolly | 10th Nov 11, 11:09am 1320876570

That's way too much for a Labour voter to absorb AJ....one line is their limit mate...

by Colin Riden | 10th Nov 11, 11:58am 1320879499

Andrew, here is another lie for you. John Key has been telling us the Crown's balance sheet is healthy. I have been questioning that. Today the RBNZ states in its Fiscal Stability Report:

due to the deterioration in the Crown’s balance sheet

and

The Crown’s financial position has deteriorated in recent years reflecting higher levels of expenditure and a reduced tax take.

by scarfie | 10th Nov 11, 3:42pm 1320892960

Good we have people like you here to cut through the crap Colin.

by Ralph | 10th Nov 11, 12:07pm 1320880035

Nice post, but "But the governments stated intention to return to surplus is just another lie." seems a bit strong given you don't directly support that assertion anywhere later in the post.

by Anarkist | 10th Nov 11, 1:56pm 1320886589

Ralph it is a lie, though perhaps the politicians are actually too stupid to be able to tell the truth. Its fundamentally an impossible goal for a government to pay back the national debt in the long run. There are just massive economic and financial implications for them to do so. Back in 2000 when the United States under Bill Clinton actually managed to run a government surplus, his Economic Advisory Council outline what they were in a report that up until recently was classified, because its conclusions were just that politically sensitive, but its recently been released to the media under the Official Information Act.

"Planet Money has obtained a secret government report outlining what once looked like a potential crisis: The possibility that the U.S. government might pay off its entire debt.

It sounds ridiculous today. But not so long ago, the prospect of a debt-free U.S. was seen as a real possibility with the potential to upset the global financial system."

http://www.npr.org/blogs/money/2011/10/21/141510617/what-if-we-paid-off-the-debt-the-secret-government-report

by Roelof | 10th Nov 11, 12:58pm 1320883110

All good points AJ....

I'll to that by unfolding the story to the next level..

At some point the yield on gilts will go up because the Markets no longer value "money".

This is a Central Banks Nightmare... They call it the "unmooring" of inflation.. AND once unmoored it is very hard to undo.

There is a fine line between having confidence in currencey and Not..

oops... got visitors...

by Alex Tarrant | 10th Nov 11, 11:24am 1320877480

Have updated with video of RBNZ's Grant Spencer talking about govt debt.

by Andrewj | 10th Nov 11, 12:05pm 1320879935

thank Ostrich, heres the link

http://uk.reuters.com/article/2011/11/09/idUKWLA879220111109

In the recent years there has been some private-sector deleveraging, and an orderly wind-down in the real estate prices, factors that in our view should limit the risk of a sharp correction. Nevertheless, we believe that the external imbalances, evidenced in persistent current account deficits and high external debt, could affect the economy.

In our view, credit risks in the New Zealand economy are reflected in a high level of private sector debt, at about 150% of GDP, and the concentration of lending to the agricultural sector, including the dairy sector. Nevertheless, we consider that these risks are partly offset by: conservative lending and underwriting standards, a legal framework that supports creditors, and a strong track record of low level of nonperforming assets and credit losses compared with other systems for the past several years.

by Andrewj | 10th Nov 11, 12:10pm 1320880209

and this is why we need ' open bank resolution' its the government supporting the banking system at the expense of depositors. We have frigging geniusis amongst us..

>>>>>>

We consider that high dependence on net offshore borrowings--which fund about 42% of domestic customer loans--and limited support from core customer deposits--which fund only about 44% of domestic customer loans--weaken New Zealand's banking system. We consider that these weaknesses are partly offset by potential funding support from the Australian parents of the major banks and the government and regulator. We regard the government and regulator as responsive and flexible to the changing needs of the banking industry.

We classify the New Zealand government as being "supportive" of the banking system, reflecting our expectation that the government is likely to organize or facilitate market-led solution to support systemically important financial institutions should it be needed.

by Ralph | 10th Nov 11, 12:14pm 1320880448

I'm not so certain of the threat to depositors.

John Hussman points out that in almost all bank failures the bond holders and shareholders funds cover the losses and depositors don't get the losses. Therefore the concept of the bank bailout is foremost a bailout of the bondholders, who are first in the gun for losses.

by Andrewj | 10th Nov 11, 12:25pm 1320881146

So why do we need the 'OBR'?

by Ralph | 10th Nov 11, 12:39pm 1320881967

Well, firstly the people with the most experience in these matters are Americans. We do not allow an open market in finance so competition cannot destroy a bank here.

But if we accept their experience would hold true here, which it by and large probably would, the pupose of such government moves seem to be twofold. For market confidence and to ensure orderly restructuring should a disaster materialise.

by Colin Riden | 10th Nov 11, 12:26pm 1320881218

I believe that OBR puts depositors on an equal basis with bond holders, both of whom rank behind covered bond holders for claims on the covered assets.

by Andrewj | 10th Nov 11, 1:01pm 1320883264

todays must watch

http://www.youtube.com/watch?v=ZR6wok7g7do

by Bernard Hickey | 10th Nov 11, 6:38pm 1320903486

Cheers Andrewj

Just what I needed on a day like today

Bernard

by Hamish | 10th Nov 11, 4:42pm 1320896540

And the current headlines in the msm here about Italy at risk of default because they might not be able to repay their debts....well....how many nations at the moment literally wouldn't be able to repay their debts if tomorrow they were all called in?