NZ current account deficit widens less than expected to 4.9% of GDP in year to June; Nears 5% tipping point into ‘danger zone’

By Alex Tarrant

New Zealand’s current account deficit widened in the three months to June from March, but not to the proportion of the economy expected by economists as revisions to previous quarters worked in its favour, figures released by Statistics New Zealand show.

It is still just below the 5% mark for ‘the danger zone’, a point at which ANZ economists say international creditors will take much more notice of the economy’s external liabilities.

The current account deficit came in at 4.9% of GDP in the year to June from a revised 4.5% (down from 4.8%) in the year to March.

The median market expectation had been for a current account deficit reading of 5.2% of GDP. 

The New Zealand dollar rose slightly after the 10:45 am release, by about 25 basis points to 82.8 US cents at 11:20 am. 

The deficit widened during the June quarter primarily because foreign-owned companies in New Zealand – namely the big four banks – earned, and paid out, more in profits via dividends to their parents than in the March quarter.

Following the figures, ASB economists said they expected the current account deficit to widen over the next year to 6.5% if GDP before narrowing from 2014 as New Zealand's trade of goods and services started to strengthen. They didn't expect credit rating agencies would be any more worried about New Zealand's external vulnerabilities after the release than before it.

ANZ economists noted the actual, unadjusted, current account deficit in the June quarter of NZ$1.8 billion was higher than market expectations of NZ$1.6 billion. However, revisions to previous quarters meant the headline figure of the annual deficit being 4.9% of GDP was lower than the 5.2% expected.

ANZ economists said they expected future annual deficits would be capped below 6% of GDP.

Westpac economists said they expect the investment income deficit - which makes up for the majority of the current account deficit - to widen further over the next couple of years as the domestic economy improved, boosting the profitability of both New Zealand and foreign-owned firms.

Westpac economists said they expected the current account deficit to head back to the 6.5% region by late 2013.

Deficit requires foreign funds

The current account balance represents a net of New Zealand’s exports and imports of goods and services, as well as income flows like dividends, and other transfers with the rest of the world. A deficit represents a shortfall in New Zealand savings to fund its investment needs, which is made up for with overseas borrowing.

In June, while commenting on the March quarter current account figures, ANZ economists said a deficit of 5% of GDP was a level regarded as a tipping point into the “danger zone” for a country’s external accounts. ASB economists said in June that the March quarter figures showed New Zealand was “still vulnerable to the whims of its creditors.”

The Reserve Bank’s latest projections, in its September quarter Monetary Policy Statement, show it expects the current account deficit to widen to 5.7% of GDP in the year to March 2014, before narrowing again to 5.2% of GDP by March 2015 as both the household savings rate and terms of trade turn positive.

Treasury’s latest public projections, in its May Budget, show it expects the current account deficit to continue widening to 6.7% of GDP by March 2016.

Credit ratings agency Standard and Poor’s warned in August that pressure on New Zealand’s credit rating would emerge if its external accounts kept deteriorating. In September last year, after downgrading NZ’s credit rating a notch to AA, S&P said New Zealand would need sustained current account surpluses for there to be upward pressure on the rating.

And just this week, JBWere economist Bernard Doyle warned New Zealand’s widening current account deficit would not be as readily accepted by the rest of the world as before the global financial crisis.

The current account deficit grew during the 2000s to over 8% of GDP between December 2005 and March 2009, peaking at 8.9% of GDP in December 2008, before falling away to as small as 1.8% of  GDP in March 2010 as the global financial crisis hit the income outflows of foreign-owned New Zealand companies.

Keeping out of the danger zone

Figures released by Statistics New Zealand on Wednesday morning showed New Zealand recorded a seasonally adjusted current account deficit of NZ$2.9 billion in the June quarter. This was NZ$0.3 billion larger than the March quarter deficit, Stats NZ said.

The larger quarterly deficit was due to higher profits earned by foreign-owned banks.

“Overall, when compared with the latest quarter, more profits were paid out as dividends instead of being reinvested in New Zealand,” Stats NZ balance of payments manager John Morris said.

This was captured in New Zealand’s income deficit, which widened by NZ$511 million in the June quarter from March to NZ$2.8 billion as foreign investors earned more from their New Zealand investments.

“Profits earned by foreign-owned companies increased, mostly in the banking sector. While a similar amount was reinvested in New Zealand when compared with the March 2012 quarter, a greater proportion of dividends was paid out overall,” Stats NZ said.

In the year to June 2012, New Zealand’s unadjusted current account deficit was NZ$10.1 billion, or 4.9% of GDP. This compared to a deficit of NZ$7.4 billion (3.8% of GDP) in the year to June 2011.

“The larger annual deficit was mainly due to increased imports of goods over the year, as prices for petroleum and petroleum products rose. Foreign-owned banks also made higher profits over the year,” Stats NZ said.

The quarterly deficit was funded by a net inflow of foreign investment as foreign investors continued to purchase New Zealand government bonds, and banks received deposits from overseas, Stats NZ said.

“The net inflow of foreign investment was the main reason for the increase in New Zealand’s net international liability position, which was NZ$148.6 billion (72.6% of GDP) at 30 June 2012, up from NZ$145.6 billion (71.9% of GDP) at 31 March 2012,” Stats NZ said.

Economist reaction:

ASB:

The annual deficit, at 4.9%, of GDP, was smaller than our and market forecasts of 5.2% of GDP.  The unadjusted quarterly deficit of $1.8 billion was slightly larger than the $1.6 billion we and the consensus expected.  However, Q1 was revised to a smaller deficit, leaving the overall annual deficit lower.

More comprehensive coverage of services trade has lifted both exports and imports of services, but exports more so.  These revisions were the main reason for the change to the Q1 deficit.  They will also make for a slightly higher services balance going forward on a sustained basis, relative to prior expectations (all other things equal).

The larger than expected Q2 deficit was due to a greater than expected outflow of investment income.  In particular, StatsNZ noted higher profits earned on foreign owned NZ companies.  Over the first half of 2012 the NZ domestic economy has shown signs of improvement, reflected in the pick-up in housing demand and retail spending.  As this gradual improvement in domestic activity continues, we can expect profit outflows are likely to continue to underpin NZ’s current account deficit.

The seasonally-adjusted traded goods balance was in surplus as expected following the released of detailed trade data earlier this month (see release here).  However, over the coming year these surpluses will ease as New Zealand’s export commodity prices decline and import demand continues to recover.  However, a recovery in global food prices over 2013 is likely to see some recovery in NZ’s Terms of Trade and will limit the extent of future trade deficits.

The seasonally-adjusted services deficit remained unchanged over the quarter.  Over the quarter spending by overseas visitors declined due to lower average spend per visitor reflecting shorter stays over Q2.  Meanwhile, Stats NZ noted that over the past year the production of a number of films in NZ (including the Hobbit) have contributed to an increase in exports of services.  

The net international debt position increased to 72.6% of GDP over the quarter, up from 71.6% of GDP.   The increase in the net debt position largely came from the government sector, while the banking sector saw a small decline in its net debt position.  

The outstanding earthquake reinsurance claims still mask the extent of our net debt position.   External earthquake reinsurance claims have been revised up by $2.2 billion to a total of $17.9 billion.  Of these, $12.8 billion of these are yet to be settled.   Excluding outstanding reinsurance claims, New Zealand’s net debt position would be 78.9% of GDP.

Implications

Overall the current account outcome was a mild positive through the smaller than expected annual deficit, as Q1 revisions more than offset the slightly larger than expected Q2 deficit.  However, we do expect the deficit will widen further over the next year to 6.5% of GDP.  The impact of the past decline in commodity prices is starting to work its way through the trade balance and ongoing recovery in the economy will lift the outflow of investment come.  Heading into 2014, we expect goods and services trade to strengthen and start reducing the deficit.

A wider deficit over the next year will highlight NZ’s vulnerability to external financing.  However, gradual rebalancing of the economy is taking place.  The private sector (via the financial system) is gradually reducing its net foreign debt.  The Government is still increasing its use of foreign debt, but that will also change in the long term once budget surpluses are eventually restored.  We don’t expect rating agencies to be any more worried about NZ’s vulnerabilities after the current account release.

ANZ:

IMPLICATIONS 

Today’s quarterly current account deficit was higher than market expectations, although upward statistical revisions to the services balance helped keep the annual deficit below 5 percent of GDP.

There are limited immediate market implications from today’s release. Over the past few years, a positive goods balance has tended to counteract the large invisibles deficit, but the camouflage appears to be wearing thin.

The terms of trade are now past their peaks, the higher import intensity of (recovering) investment and there is limited margin to boost primary production in the short-term.  

Although the annual deficit has remained below the 5 percent plus “watch zone”, the focus remains the trajectory of the current account deficit. We (and the RBNZ) expect future deficits to be capped at around 6 percent of GDP by structural public and private sector deleveraging and a lift in export commodity prices from early next year.

However, this depends crucially on borrowers showing ongoing restraint, with consumer spending making way to facilitate the Canterbury rebuild.

Considerable tensions lie ahead given the fickle global scene, the high NZD and the higher import intensity of the foreshadowed lift in investment activity. The recent lift in the GlobalDairyTrade auction has been encouraging, suggesting demand may provide more of a floor to export prices and a ceiling in the current account deficit. This will help, but improving export sector performance will depend on trading partner demand holding up, and the lower NZD acting as a safety valve.

Historically low interest rates are likely to help mitigate our debt servicing burden and help at the margin.

Westpac

New Zealand’s annual current account deficit widened to 4.9%, less than expected, in part thanks to upward revisions to previous quarters. The detail of the release was broadly as anticipated. The goods balance improved slightly in the quarter (in seasonally adjusted terms) but remains much lower than a year ago, as deteriorating external conditions weigh on exporters and imports continue to pick up. While the services deficit narrowed marginally, it remains stuck firmly in negative territory. The biggest surprise relative to our forecast was a larger investment income balance. Instead of remaining relatively flat it widened significantly, driven by increased earnings by foreign owned firms.

New Zealand’s current account deficit has now widened significantly from a recent low of 1.8% of GDP in March 2010 and we expect the gap to widen further yet. Despite the emergence of more positive signs for key New Zealand dairy export prices of late (we had the fourth consecutive rise in international dairy prices in last night’s GlobalDairyTrade auction), for now external conditions remain challenging for exporters. In addition the high NZD dollar is depressing exporters’ returns while at the same time making imported goods and services an attractive option. Lastly, the investment income balance is set to widen further over the next couple of years as the domestic economy improves and boosts profitability of both New Zealand and foreign-owned firm. That should see the current account deficit to be heading back into the region of 6.5% late next year. While this would still be well short of the 8.9% peak we saw in 2008, it would still be relatively high by international standards.

But even with such an outlook, and against an international backdrop where imbalances in some countries are coming under intense scrutiny from markets, there are no signs yet that New Zealand’s growing imbalances are facing the same harsh glare. That said, the simple fact is that the larger the current account, the more reliant New Zealand is on foreign savings. A long period of low interest rates risks exacerbating these imbalances.

Detail 
Both exports and imports of good (in seasonally adjusted terms) fell in the June quarter. Once again a feature was softer prices and volumes for dairy exports. On the imports side of the ledger, lumpiness in oil import volumes helped push imports lower. While the goods balance remains in positive territory for now, it is well down on levels of a year ago.

The services balance remains firmly entrenched in deficit territory (though it was upwardly revised following the incorporation of additional data from the Census of International Trade in Services and Royalties). The high exchange rate continues to weigh on spending by overseas visitors, while at the same time making holidays abroad attractive for New Zealanders. On a more positive note, New Zealand’s film industry is providing a boost to exports of services with a number of movies produced in the country over the last year, including the big budget film, The Hobbit.

The income deficit grew in the June quarter as profits of overseas-owned firms increased. As we noted above, we would expect further widening in the investment income balance over the coming years as stronger growth in New Zealand’s domestic economy is eventually reflected in improved profitability of both foreign- and domestically owned firms.

In today’s release, Stats NZ revised up its estimates of reinsurance claims relating to the Canterbury earthquakes after capturing more firms in its surveys. It now estimates total international reinsurance claims from the quakes at $17.9bn ($2.2bn higher than their previous estimate) of total claims. $5.1bn of claims with reinsurers had been settled by the end of June.  The remaining $12.8bn of outstanding claims continues to flatter New Zealand’s Net International Investment Position. Excluding these reinsurance claims, New Zealand’s Net International Investment Position was 78.9% of GDP in the June quarter, compared to 72.6% of GDP when outstanding reinsurance claims are included.