Over the next six days we're publishing a detailed outlook from ANZ NZ's economics team on six key themes for 2015.
Here is the first one.
By Cameron Bagrie*
We’re moving from legacy to opportunity, amidst the demands of rebuilding our second-largest city, housing shortages in our largest city, demographic shifts, global wobbles and an overvalued currency.
We present six themes intertwined with this journey.
A common sub-theme is the heightened importance of the microeconomic story.
We’re optimistic about New Zealand’s medium-term prognosis, amidst a very elevated risk profile across the global economy.
THEME 1: CHANGE IS THE NEW NORMAL
There’s a wide array of cyclical and structural forces shaping the outlook for New Zealand, including the interplay of monetary policy and fiscal policy, altered consumer attitudes to spending, shifting demographics, altering trade patterns and heightened volatility and technological advancement. Secular forces are growing in relevance and speed of advance (i.e. technology). This creates frictions and tensions which need greater active management by both policymakers and businesses. There is higher performance variability across and within industries. A nimble and fast-adapting education sector will be critical. Leadership needs to trump populism. The microeconomic agenda – both at the firm and policymaker level – will be key. Microeconomics always matters; it matters more when the economy is navigating structural tensions.
The New Zealand economy looks okay on numerous levels.
The last technical recession was in the second half of 2010; the level of real GDP has risen 11% since then. The unemployment rate has dropped from over 7% to 5.4% in just two years. The economy is entering its fifth year of expansion. Productivity levels are up and inflation is low.
The economy still has its share of issues.
Real GDP per capita is only 6% above 2010 levels; wage growth is still subdued, and unemployment is high in some segments. It’s taking time for the “trickle down” to take hold. The household savings rate is now positive but is still low, and net external debt is still high – though both are better than they were five years ago. House prices are overvalued – and strongly so in Auckland. The potential for the market to scream away further had been nipped in the bud via the higher OCR and high-LVR lending restrictions, but borrowing rates are now nudging lower again on global nervousness, pouring petrol on to the fire. New Zealand may be hugely reliant on offshore savings, but regulatory changes like the core funding ratio regime and required lengthening of the term of bank funding have been brought in to mitigate vulnerability to changes in global credit markets. Credit growth is tracking below the rate of nominal GDP; that’s deleveraging, albeit slowly. It’s akin to managing some unruly children, as opposed to reining in someone who is completely off the rails.
We can point to both conventional elixirs of growth and challenges going forward:
The elevated terms of trade, the boost from migration, the construction boom, and supportive financial conditions. These are going head-to-head with restrictive fiscal policy, a high NZD, a national balance sheet that won’t allow a good old-fashioned spending free-for-all, and falls in dairy prices. growth remains in prospect.
That picture is clouded by changes that are manifesting on a number of levels.
• Demographic issues are coming more and more to the fore.
People are living longer. Male life expectancy at birth has risen from 74 in 1980 to 79.3 today. The current ratio of 5 workers per retiree is expected to decrease to just over 2.5 by 2061. This will increase the tax burden and lead to skill shortages. The medical sector will find both opportunity and challenge in this dynamic. We as a nation need to have a serious chat about that retirement age! But there are wider issues including succession for many businesses (and particularly regions) too.
• Trade patterns are evolving.
New Zealand was the first OECD country to sign a Free Trade Agreement with China (in 2008). Partly as a result, New Zealand’s China-bound exports have catapulted from between 2-5% of total merchandise exports over the previous two decades, to 20% of exports in the past 12 months. Growth in market share to the ASEAN group of nations and the Middle East has also lifted, while our traditional markets (the UK, Japan and the US) have tailed off. The next hotspot to watch, South America, is waiting in the wings. These are fundamentally different markets with different consumer preferences and tastes. China is now New Zealand’s largest inbound tourism market; their tastes differ from traditional markets.
• Economies’ speed limits have shifted,
With material implications for the composition of global growth, incomes, wage growth and expected investment returns; all will be lower. A leveraging tailwind has been replaced by a deleveraging headwind. That’s payback for prior largesse. Some economies are failing to embrace reform (i.e. parts of Europe) which only exacerbates challenges. New Zealand has fared better; our potential growth rate dipped post-GFC but has now recovered lost ground (refer Theme 3); that’s a positive signal for living standards going forward.
• Technology is advancing rapidly.
Consider a few examples. Uber removes the need for staff in central booking offices. Self-driving trucks and cars are a challenge to the transport workforce. Alibaba allows small businesses to connect with manufacturers the world over (even for smaller order runs), cutting out the “middle-man”. The rise of 3D printers looks to revolutionise local and customised manufacturing – an example being custom prosthetics. Internet shopping and the technological revolution have challenged the CD store, is threatening bookstores, and is now moving further into the retail chain. It’s not just blue collar jobs under threat. IBM’s Watson (the artificial intelligence “computer” of Jeopardy fame) is on its way to becoming the best medical diagnostician in the US. The big data revolution is putting an army of consultants out of business, as it is possible to analyse the entire data set (not just a sample), making targeted productivity improvements and real-time feedback possible. Generally, technology is increasing the productivity of the most skilled in their respective professions, while reducing the need for the “bottom 50%”. Other jobs will no doubt arise that are currently unthinkable at present. Who would have thought ten years ago that mobile game development was a not only a viable career, but a lucrative one; that all big companies would need social media teams; or that bloggers would often control the news? Parents need to be thinking long and hard about how technology, artificial intelligence and robotics will impact the employment opportunities for their children.
• Global inflation trends are subdued.
Deflation risks abound.
• People are more cautious.
Borrow-and-spend style growth is being replaced by living within one’s means. You can see subtle shifts across the economy; formal measures of saving have lifted, but also partial indicators of the same. KiwiSaver appears more embedded than ever. The economy can now have a more rational debate about lifting the retirement age (it’s not about to happen soon but there is at least more debate and call for it). We’re seeing similar nuances globally and the ramifications are immense. Globally, a lot relies on the US consumer. The US consumer’s ability to drag the global economy along is diluted if they are experiencing structural change too, as we suspect.
• House prices are surging, but retailing is not.
Retailing remains a tough gig across the country despite falls in the unemployment rate, rising incomes, elevated consumer confidence and rising asset prices. A restrained consumer is essential if New Zealand’s building boom is to be accommodated without blowing out the external accounts or lifting inflation.
• Some regions and nations get it, and some don’t.
Micro is the new macro. Central bank intervention can only take you so far. Witness Europe, which is in desperate need of an accident to drive an appetite for change and reform. We suspect they’ll get one.
• 2015 will bring a lot more volatility to contend with.
The VIX index (which measures S&P equity volatility and is a proxy for global risk) has risen sharply in the last two months; that’s telling us something about the conviction (or lack of it) around the global scene. Pick your economic challenge. Ukraine, Russia, Middle East, Europe, emerging markets including China, US, leverage in the oil sector, and so on. It’s typical for the global scene to be buffeted by an array of forces but this array is now a swarm. We seem to be jumping from hot spot to hot spot, all amidst the belief that central bank policymakers offer indefinite salvation in the form of interest rates being lower for longer. What happens when that steroid loses its efficacy, which is what we are seeing semblances of now.
• Despite recent falls, the NZD is still trading above conventional estimates of fair value and we expect it to continue to do so.
The yield differential is wide, QE is suppressing the euro and yen, and New Zealand’s rock-solid credentials look “rock star-like” compared to others.
• Interest rates are lower than usual and are set to remain so.
Pre the 1970s there was little inflation and interest rates were low. The inflationary burst and battle to tame the beast is looking at present like the historical exception, as opposed to the rule. That has huge implications not just for borrowers but for savers too.
• Asset bubbles are more relevant.
Prudential policy is the new realm for central banks. Market forces alone can fail. Soft commodity prices have gone up, down, and sideways but are still generally very elevated. The same applies for New Zealand’s goods terms of trade. However, there is more volatility to contend with and that has major implications for stabilisers such as currencies and monetary policy, which typically act as offsets. And some other commodity bellwethers are showing clear signs of mean reversion. Where are the peak oil theorists?
• Locally, there are some extraordinary oneoffs to contend with,
In the form of a city rebuild and Auckland’s housing shortages. Neither have quick fixes, and they offer both cyclical boosts to the economy (and strains) and longer-term secular challenges. That’s putting huge pressure on resource allocation. Climate change and biosecurity issues have not disappeared. Indeed, if anything, the sensitivities and their significance are rising. We can’t afford a larger repeat of the Psa crisis in our agriculture sector, when market sentiment is nervous and capital flows are mobile.
• The Government is being more proactive and surgical with its interventions;
It’s neither the ambulance at the bottom of the cliff nor willy-nilly throwing money at issues. Money is being targeted and spent, but with accountability parameters around it.
That’s a non-exhaustive list, but it’s still long and is testament to the vast array of influences.
This interplay of cyclical and secular forces has major implications for the years ahead.
• The performance curve within sectors is still shifting; performance is becoming more dispersed.
Retailing is tough, but some manage to flourish while others do not. A string of construction companies folded last year in Christchurch; you can still go bust in a booming industry. Structural changes at the economy-wide level necessitate change at the core business level if firms are going to survive, let alone thrive, no matter what the industry. Microeconomic foundations need to be strengthened, with continued emphasis on doing the basics well, but also greater willingness to adapt to suit the changing environment. Firms need to get more strategic with their future direction. “She’ll be right” no longer applies in an increasingly connected and competitive global marketplace. An average business can look very good in a strong performing economy, but they are exposed in an environment where secular and cyclical forces collide. A larger gap between strong and weak businesses within sectors portends a lot more consolidation to come across and within industries.
• The same applies within regions.
Witness Queenstown and Wanaka versus Taupo and Rotorua a decade ago and compare them now. The combined guest nights for Taupo and Rotorua for the latest 12 months have dropped 6% from a decade earlier, while the figure for the Queenstown Lakes district has lifted 30%. The wider macroeconomic picture can only take a region (or business so far); ultimately it is the ability to execute around unique points of difference and comparative advantages that determines performance. That requires looking within as opposed to out. Regional development needs to be driven from within regions and not from central government. Central government can be the supporting actor but not the lead one.
• Leadership needs to trump populism.
That’s a tough call when game theory tells us that self-interest dominates group interest. As an investment thematic we favour nations that show more leadership than populism. It’s a short list. Leadership drives microeconomic reform, better growth and improving investment returns.
• Central government needs to be proactive in utilising some of its comparative advantages, including scale and balance sheet.
We aren’t talking about swinging right or left, letting the free market prevail or the Government becoming a bigger piece of the economic pie. We’re talking about the Government acting more and more in a facilitation role, working proactively with the business sector and community groups. The flow (and accessibility) of information and research will be critical in an environment of change. Governments have more scale than businesses (especially SMEs) here.
• Heavyweights across New Zealand industry will be important as leaders and some consideration should be given to actively incentivising such businesses to assist “trickle down” dynamics.
Auckland International Airport’s investment in tourism, promoting New Zealand and driving international connectivity, supports the airport but also the downstream tourism industry. Any industry needs the heavyweights to be investing strongly on their behalf; they open gates and doors. But particularly small open economies.
• The policy agenda needs to be proactive as opposed to reactive.
Proactivity will bring the potential for mistakes but that’s better than being behind the curve and playing catch-up.
• Firms need to do the same.
For firms it’s the same old story discussed above; the divergence between the winners and losers will continue to widen, with the winners being those that embrace the constant change that technology brings us, amid heightened tensions across the business cycle. Where once you could cash the “rent check” from your intellectual capital, there is now a clear trend of disruptive innovation that creates new wealth at the expense of rent-seeking behaviour. Ergo, examine how bloggers and social media have disrupted the once powerful news media, and ask the question of how an Uber could disrupt your guild. As Kodak, Nokia and Dell have learned, it’s better to be the one doing the disrupting.
• Tension points need to be managed to prevent steering the economy off course.
Addressing Auckland’s housing woes and Christchurch’s rebuild stresses top the list. This is occurring, and the growth story is broader than them alone. A nimble education sector is critical. If the demand picture is evolving quickly so too must the supply-side building blocks of an economy.
• Have a culture of continued tweaking rather than try to slug the home run.
As the Oakland Athletics proved, it’s the team of unlikely athletes that always gets on base that wins the game, rather than a few superstars.
*This report was written by the ANZ New Zealand economics team which consists of chief economist Cameron Bagrie, senior rates strategist David Croy, senior economists Sharon Zollner and Mark Smith, economist Peter Gardiner, senior FX strategist Sam Tuck, and rural economist Con Williams. It is used with permission.
A link to Theme 1 - Change is the new normal, is here.
A link to Theme 2 - Localised focal points, is here.
A link to Theme 3 - The trend is your friend, is here.
A link to Theme 4 - Our key downside risk, is here.
A link to Theme 5 - Liquidity vs fundamentals, is here.
A link to Theme 6 - Addressing income inequality, is here.