Low levels of public debt relative to other developed countries means New Zealand's Government has room to delay its planned return to surplus if there is a sharp deterioration in the economy, the International Monetary Fund (IMF) says.
In a note endorsing its fact-finding mission to New Zealand in April, the IMF's Executive Board said while the Government's self-set 2014/15 surplus track would put it in a better position to handle future shocks and the costs of an ageing population, the target was not a be-all-and-end-all.
Prime Minister John Key and Finance Minister Bill English have said they would consider delaying the surplus track if they thought measures required to attain it would lead to a sharp contraction in demand in the New Zealand economy.
The IMF warned that risks facing the New Zealand economy were largely external, although New Zealand's free-floating exchange rate should help mitigate any global economic shocks. New Zealand's international debt position was a risk, especially given the current account was forecast to widen again, the IMF said.
Based on its April mission, the IMF forecast New Zealand's current account deficit widening to 7% of GDP over the "medium-term," and its net external liabilities widening to 90% of GDP in 2017. At the end of December 2011, New Zealand's net external liability position was NZ$147 billion, or the equivalent of 72% of GDP, according to Stats NZ.
The New Zealand dollar would need to be weaker than its current level to contain this increase and limit a further buildup of foreign liabilities over the longer term, the IMF said.
"Staff analysis suggests that the New Zealand dollar is currently stronger than is consistent with a level of the current account deficit that is more sustainable over the longer term," the IMF said.
"To stabilize net external liabilities at the 2009 level of 80 percent of GDP, the current account deficit needs to be reduced to -3¾ percent of GDP, implying that, given the staff’s estimated trade elasticities, the New Zealand dollar would need to be about 15 percent weaker than its current level," it said.
"Although subject to much uncertainty, model-based cross-country econometric approaches estimated with respect to a medium-term current account norm—in line with the IMF’s CGER exercise—show the exchange rate to be in the range of 10-20 percent above its equilibrium."
New Zealand's banks were still exposed to highly indebted households and farmers, as well as risks associated with large short-term offshore funding needs. The IMF said the Reserve Bank could consider tightening its core funding ratio for banks more than the planned 75% to reduce reliance on short-term external debt. For more on the core funding ratio see here.
The IMF welcomed the Reserve Bank's work on introducing more macro-prudential measures to its tool kit, as well as its intention to implement key features of Basel III in early 2013.
What the Treasury forecasts say
While the IMF's April mission came before Budget 2012 was released in May, Treasury's latest forecasts still pointed to a slim surplus in 2014/15 of NZ$197 million. That's down from forecasts released in October showing a NZ$1.45 billion surplus expected in 2014/15.
Treasury warned earlier this week that risks pushing the Government's position to its Budget 2012 downside scenario were increasing. That scenario does not show a surplus reached in the period to 2015/16.
Budget 2012 forecasts also show New Zealand's current account deficit widening from 3.6% of GDP in 2011 to 6.7% in 2016. Between 2006-2009 the current account balance was 8% of GDP or above. Finance Minister Bill English has recently defended these forecasts, saying the main driver of the worsening deficit was due to investment intentions, rather than consumption.
New Zealand's net international investment position is also forecast by Treasury in Budget 2012 to worsen in coming years from -67.5% of GDP in March 2011 to -80.8% in 2016. Net government debt is tipped to peak at 28.7% of GDP in 2013/14.
Nominally though, net core crown debt is forecast to keep rising through Treasury's forecast period, from just over NZ$40 billion in 2010/11 to NZ$70.7 billion (27.7% of GDP) in 2015/16.
The reason for it peaking before then as a proportion of GDP is down to Treasury's growth forecasts, which pick GDP growth rising from 1.2% in the year to March 2011 to 3.4% in 2014 on the back of the Christchurch rebuild, before falling back slightly to 2.9% in 2016.
Gross government debt is tipped to peak nominally at NZ$88.1 billion (38% of GDP) in 2013/14 before falling back to NZ$84.8 billion by 2015/16.
Over the same period the trade-weighted index, a measure of the level of the New Zealand dollar against a basket of currencies, is expected to fall to 63.0 in 2016. On Friday morning the TWI sat at 70.0.
What the IMF said
In concluding the 2012 Article IV consultation with New Zealand, Executive Directors endorsed staff’s appraisal as follows:
Outlook and risks. The pace of New Zealand’s economic recovery is likely to remain modest. Output growth should pick up somewhat in 2012 as earthquake reconstruction spending is expected to gain pace, but the size and timing of this spending is still uncertain. High household debt is likely to weigh on the growth of private consumption as households will need to save to strengthen their balance sheets. The spare capacity and elevated unemployment will contain wage and inflation pressures in the near term. The risks to this outlook are on the downside and largely external, stemming mainly from emerging weaknesses in the global economy and a possible upheaval in the global financial system. The flexible exchange rate would provide an important buffer against shocks.
Monetary policy. The current accommodative monetary stance is appropriate. If the recovery remains on track and downside risks dissipate, monetary policy will need to tighten gradually to contain inflationary pressures. However, if the global recovery stalls or international capital markets are disrupted, the RBNZ has scope to cut the policy rate and provide liquidity support for banks.
Fiscal policy. The planned deficit reduction path strikes a balance between the need to contain both public and external debt increases while limiting any adverse impact on economic growth during the recovery. The authorities’ plan to return to budget surplus by 2014/15 should put New Zealand in a better position to deal with future shocks and the long-term costs of aging. Moreover, it will relieve pressure on monetary policy and thereby the exchange rate, helping contain the current account deficit over the medium term. New Zealand’s relatively modest public debt gives the authorities some scope to delay their planned deficit reduction path in the event of a sharp deterioration in the economic outlook.
External vulnerabilities and the exchange rate. New Zealand’s large net liabilities present a risk. Despite recent improvements, the current account deficit is projected to increase over the medium term as earthquake reconstruction activity gains pace and global interest rates normalize. To contain this increase and limit a further buildup of foreign liabilities over the longer term, the New Zealand dollar would need to be weaker than its current level. However, part of its current strength may dissipate over time with the eventual tightening of policy rates by major central banks. Increasing national saving, including through the planned fiscal deficit reduction, would reduce external vulnerability.
Financial sector issues. Banks remain sound, but they are exposed to highly leveraged households and farmers and rollover risks associated with large short-term offshore funding needs. While New Zealand’s bank regulatory norms are more conservative than in many other countries, the authorities should assess on an ongoing basis the balance between banking sector vulnerability versus efficiency to minimize the risk that systemically important banks pose to the economy. Options to strengthen prudential norms if needed could include setting banks’ capital requirements above the Basel III minimum or raising the core funding ratio more than the planned 75 percent to reduce short term external debt further. The RBNZ’s continued work on the costs and benefits of macroprudential measures is welcome, as is the authorities’ intention to implement key features of Basel III in early 2013.