ANZ NZ's economics team looks at key themes for 2015; Here's theme two: Is NZ a poster child in the post-GFC era?

ANZ NZ's economics team looks at key themes for 2015; Here's theme two: Is NZ a poster child in the post-GFC era?
There are no shortages of opportunity either at home or overseas for New Zealand. Cameron Bagrie assesses how we are placed as we start 2015.

Over six articles we're publishing a detailed outlook from ANZ NZ's economics team on six key themes for 2015.

Here is the second one. (The first one is here.)

By Cameron Bagrie*

The New Zealand economy has typically been “rolled” by one of two dynamics:

• A global event; or

• A build-up of internal imbalances and weaknesses that necessitate a purging process.

Mother Nature can play a role too but doesn’t usually dominate the overall economic cycle.

The first risk is very real, and is covered in Theme 5.

The second represents a group of indicators that don’t typically make mainstream media commentary, but which are critical in assessing the potential durability of an expansion and the probability of a pending correction.

Recall that the New Zealand economy entered recession prior to the GFC and the Asian Crisis. Drought and the RBNZ played a role during the latter but the seeds were sown by deteriorating structural metrics; the economy was “primed” for a crunch.

A quick glance through a few key indicators reveals:

• Household debt is still high but off historical peaks.

It stands at 156% of disposable income compared to 161% in 2007. Household debt servicing, at just over 9% of disposable income, is higher than it was a year ago, but still well below the circa 14% level evident during the GFC.

• Net external debt has fallen to 60% of GDP from 85% of GDP at the time of the GFC.

• The current account deficit has fallen to under 3% of GDP from close to 8% of GDP in 2006. The annual goods balance has moved from deficit into surplus, with lower credit growth and borrowing costs contributing to a narrowing in income deficits to GDP.

• Credit growth has generally tracked below the growth in nominal GDP. Deleveraging has dominated and the household sector in aggregate is no longer using the rising value of housing collateral as an ATM.

• The household savings rate has been in positive territory since the March 2009 year.

• The fiscal accounts are back on track for surplus after letting the automatic stabilisers work during the downturn and absorbing the up-front costs of rebuilding Christchurch. Net public debt – at less than 30% of GDP – is world class.  Inflation is low and productivity is rising. No need for the RBNZ to be heavy-handed.

• Banks have successfully lengthened the terms of a large proportion of their funding, making the New Zealand economy less sensitive to capital outflows and variation in global funding costs. Around 86% of loans and advances to the domestic financial system are being funded domestically or for terms longer than one year.

Some metrics remain at disconcerting levels – house prices and household debt levels are high in relation to incomes and nationwide household saving is low.

There are still some concerns on other levels.

The global scene is highly uncertain, and our dependence on trade and overseas capital leaves New Zealand vulnerable to adverse external events. Domestic twin risks dominate, namely house prices – particularly in Auckland and the concentration of debt in the dairy sector. House and land prices are high in relation to incomes, with the economy and financial system vulnerable to abrupt falls in asset values. Potential catalysts include a deteriorating outlook for incomes courtesy of an aggressive turn in the global scene (we are watching Asia and Australia), or a sharp move higher in (currently low) residential and rural interest rates for borrowing.

On the whole, though, one must conclude that the New Zealand economy is in better shape, structurally speaking, suggesting that the party can rock on a little longer. But equally there are aspects that require continued attention, and possibly active intervention if pre-2008 style behaviours resurface.

THE NZD – HARD TO GET TOO BEARISH ABSENT A GLOBAL EVENT

One “fundamental” matters in regard to the NZD; it is the general outlook for the economy, and it still looks okay.

While commentators can point to lower commodity prices as justification for the NZD moving down, that is only a necessary condition and not a sufficient one. Strong economies don’t tend to have weak currencies.

Strong net migration, high domestic confidence, an improving housing market, and increasing labour market utilisation are supporting the NZD.

Growth is slowing, but from an above-trend rate towards trend; 3% growth is not something to be sniffed at.

Courtesy of best-in-class yields and a solid growth outlook, the NZD will remain supported during times where global drivers are on the back foot. However, yield and economic growth are a well-trodden path and a well-known story. As recent falls in the AUD and NZD illustrate, yield and growth are not always enough to stem currency declines when volatility and uncertainty is high.

Potential downside risks to the economy – and thus the NZD – continue to dominate global market thinking. The candidates are pretty clear; dairy prices have halved, the terms of trade are in retreat, and the RBNZ is repeatedly saying the NZD is unjustifiably and unsustainably high. And they have now stated that rates could move up or down.

But until the domestic economy rolls over, a default bid will remain for the NZD.

There is a glaring 300 basis point yield differential with countries accounting for 70% of global GDP.

Given the bond ladder (JGBs 0.25%, German Bunds 0.4%, US 10-year Treasuries 1.8% and NZGBs double that) and a world awash with liquidity, NZD dips will be bought.

Rock-solid economic credentials are the modern day rock-star. New Zealand looks stellar compared to peers.

New Zealand is showing signs of no longer being a hi-beta play on the global scene. Suddenly NZGBs have become defensive plays and the New Zealand equity market is holding up well vis-à-vis global peers and ructions.

Dairy prices are down but the terms of trade are still elevated. And when we eye the relative paths over the medium-term for the price of butter versus TVs, steak versus cars, and seafood versus clothing, we remain bullish on the trend for the terms of trade.

There is a secular story to be mindful of. As growth in China rotates from investment to consumption so too do capital flows. That’s NZD/AUD supportive.

Success comes with a catch. The NZD is overvalued but the economy has coped. New Zealand is starting to stand out as a poster child in the post-GFC era. The microeconomic platform is being put on a pedestal internationally. Amidst cyclical volatility in the NZD, capital will still be biased towards New Zealand.

And so we have a central scenario of elevation for the NZD.

It’ll move down against the USD courtesy of the USD heading up, but it’s difficult to get bearish against other currency pairs.

All this is subject to the huge caveat that the global scene remains stable.

That may seem like a heroic assumption but we’re not into picking black swan events. Previous shakeouts in the NZD have been linked to global events. Any big move over the coming years will be driven by the same.

All eyes are on China.

NO POST-CHRISTCHURCH REBUILD HOLE

The economy – and particularly the Canterbury region – is being supported by earthquake rebuild-related activity.

There is a growing perception that the economy is then set to fall into a hole as the rebuild stimulus fades. The argument is logical enough. While rebuild activity will last another decade, the peak in the profile is rapidly approaching, and as this fades, the incremental boost to growth becomes a drag.

While the latter fact is a mathematical truth, we disagree regarding the impact on the aggregate economy for a number of reasons.

• The stimulus peak from the rebuild is just under 2% of GDP, but this has been steadily building over four years, and the stimulus will similarly fade gradually from its forecast peak in 2017. We suspect the rebuild will take longer than forecast, but irrespective, people know it will peak in the coming years and this gives them time to adjust and plan accordingly.

• The Christchurch rebuild stimulus has been offset by contractionary fiscal policy. There are regional and sector facets to this. But fiscal policy will not remain contractionary indefinitely; politicians won’t keep their hands off the loot.  The scaling up in irrigation-related development across the Canterbury Plains will also provide a boost for the region. 

• A host of the Canterbury rebuild-related work is necessary for replacement demand impetus to occur: tourism, education and CBD activity being examples. As the city “recovers” (is rebuilt), activity in these areas should recover too.

• The rebuild is placing pressure on aggregate demand; the unemployment rate in Canterbury is a shade over 3%. Some fading in momentum is to be expected given supply-side constraints. Fading momentum is not a downturn.

• Christchurch is chewing up resources that could otherwise be devoted to other activities. These resources can be redeployed ex-post, boosting growth elsewhere.

• Various automatic stabilisers will adjust as appropriate. As activity from the rebuild fades, so too will (some) pressure on the OCR (and indirectly on the NZD).

Within this aggregate story, there will be regional-specific aspects to manage.

Waning rebuild activity is Christchurch-specific; less contractionary fiscal policy is a national phenomenon. Resources will therefore need to adjust. The onus is on local policy-makers and businesses to get alternate drivers of growth into place in a timely fashion.

For Christchurch to flourish post-rebuild, key microeconomic facets and sectors need to be firing.

The likes of the education sector, manufacturing, agriculture, tourism and the port (we note growing competition from Timaru) need to be performing well. Identifying and unlocking alternate drivers of growth need to be at front and centre, and we can see that on some levels.

It’ll be a failure to drive broader regional activity that will determine the post-rebuild bog for Christchurch (or not), not waning rebuild activity itself.

INFLATION – A FOOT IN EITHER CAMP

There is a strong likelihood annual headline CPI inflation will fall into negative territory over early 2015, and it will certainly be below the bottom of the RBNZ’s 1-3% band over the year.

Having such a low rate of inflation is not entirely surprising, as it is a global phenomenon.

Declines in oil prices feature heavily; falls in petrol prices alone are enough to knock around 1% off headline inflation. However, forecasters (including ourselves) have a track record of over-estimating inflation in recent years. Back in the December 2012 MPS, for example, the RBNZ has projected that CPI inflation would end 2014 at 1.8%, with the forecast consensus generally higher than that.

Annual CPI inflation has been below the midpoint of the inflation target for the past three years, with sub-2% core inflation for the last four.

With the New Zealand economy posting reasonable rates of growth in this period, the question remains whether the current spate of low inflation reflects transitory or more enduring features.

Of the deflationary factors we can identify, falling oil prices, the high NZD, euro and yen weakness (which should reduce capital goods and car prices), and net migration boosts to labour supply fall into the category of “temporary but sticky”.

There are some more enduring influences too, with higher productivity containing unit labour costs (at least in New Zealand), excess manufacturing capacity globally driving disinflationary forces, household restraint, low rates of credit growth relative to incomes, better-anchored inflation expectations, and rapid technological change. The latter is growing in significance. Witness Uber (competition in the taxi market), booking hotels over the internet, the prevalence of online shopping – price comparison has become significantly easier, and margins are shrinking as a result. See Theme 1: Change is the New Normal.

Surveyed measures of inflation expectations have eased and remain clustered around the midpoint of the inflation target; that’s helpful.

Pockets of pricing pressure remain, most notably in the construction sector, but to date they have not filtered through into more generalised price lifts – a welcome dynamic.

Our projections assume both transitory and enduring influences continue to go head-to-head; we’re taking the classic two-handed economist approach on this.

The proof, however, is in the pudding, and the longer inflation remains low, the more pressure will build for a rethink over the relationships between the real economy and inflation.

THINKING BEYOND CHINA

The speed of the increase in New Zealand’s trade connectivity with China has been staggering.

Merchandise exports have been compounding at 23% per year since the New Zealand-China free trade agreement was signed in 2008. China now takes half of our wool and forestry exports, and its share of our seafood, dairy, sheep-meat and beef exports have risen sharply. China is now our second-largest source of inbound tourists.

With opportunity and connectivity comes vulnerability – either through adverse internal market developments (eg. regulatory risk, such as recent changes in the infant formula arena) or wider macroeconomic forces (i.e. a material turn in the Chinese economy). The latter represents a significant source of risk over the coming years as nations that built up considerable leverage during the era of low interest rates adapt to higher US rates as the US Federal Reserve starts to normalise interest rates settings (refer Theme 5).

While China is now New Zealand’s largest merchandise export market – at around 20% of total exports – the concentration risk argument can be overplayed.

• China is a huge market; it represents 19% of the global population and 12% of global GDP. They should always be material as a trading partner.

• New Zealand is pursuing an aggressive free trade agreement (FTA) agenda, which is opening up new trade opportunities. In fact New Zealand already has FTAs in place with 28% of the global population and 18% of global GDP. Additional FTAs currently under negotiation cover a further 43% of global GDP and 30% of the globe’s population. That’s a big playground. Alternative opportunities abound.

• New Zealand has hardly been standing still in other markets. In fact, over the last five years double-digit growth in merchandise exports has occurred for 46 of the countries New Zealand trades with (22% of total). We export more than $100 million worth of goods and products to 43 countries each year. Exports into many of these countries, such as Bangladesh, Brazil, Turkey, UAE, Peru and Chile, have been growing in excess of 20% per annum.

• We believe many businesses have created, or are in the midst of creating, propositions that can be easily transferred to alternative markets if things go awry in China. While China is currently the largest market for many of these propositions, it doesn’t mean other markets won’t rise to match – or even out-compete – China in the future.

However, New Zealand can ill afford to be complacent.

One of the dangers of embracing huge opportunities in one market is that you become blinkered to wider developments and other opportunities that are fast developing in other parts of the Asian region (and further afield, such as in South America).

With this in mind, we took a deeper look at the wider Asian region.

Data availability is a constraint; nonetheless we’ve attempted to identify the key characteristics that might make countries attractive export markets for New Zealand-orientated products, and the key obstacles currently holding them back.

We selected six broad categories to assess the potential of different Asian export markets using a range of indicators for each. The key was the breadth of indicators we looked at; 29 in total. We didn’t focus on population or GDP alone.

The key categories were:

• Food market size and development;

• Consumer purchasing power and affluence;

• Alignment with New Zealand-orientated trade;

• Market access; 

• Regulatory and political risk; and

• Supply and cool chain development / infrastructure.

We collected data for 30 countries in the Asian region, reaching the following broad conclusions:

• For food market development and size, Japan was most attractive, followed by China, Korea, Hong Kong and Singapore. Beyond the top five, some of the more interesting up-and-comer rankings were for Malaysia, Kazakhstan, and Azerbaijan.

• The top five for consumer purchasing power and affluence were Singapore, China, Hong Kong, Japan, and – surprisingly – Mongolia.

• Looking at alignment with NZ-orientated trade (i.e. countries that consume large quantities of what we produce, and produce large quantities of what we import) revealed some surprises – the top five being Armenia, Mongolia, Japan, Korea, and Brunei Darussalam.

• Less surprisingly, Hong Kong, Brunei Darussalam and Singapore took out the top three spots in regard to market access, as no tariffs are applied to primary products. They were followed by Indonesia, the Philippines, Malaysia and China.

• In terms of supply and cool chain development Singapore and Hong Kong took the top spots, with Japan, Malaysia and Korea rounding out the top five.

Overall, the top 5 (of 28) ranked countries were Singapore, Hong Kong, Japan, Korea and China. Not surprisingly, these are already well-established export markets for many sectors.

The up-and-comers threw up a mix of a few less well-known nations and some more familiar names. They include Malaysia, Brunei Darussalam, Kazakhstan, Azerbaijan, Thailand, Armenia, Indonesia and Vietnam.

All up, while much of the focus has been on the Chinese market, New Zealand seems to have opportunities aplenty in the broader Asian theatre too.

But it doesn’t stop there with other areas, such as South America, likely to become more of a focal point over coming years. This will accentuate New Zealand’s time-old problem as espoused by the Chinese President Xi Jinping on his trip down-under late last year: “New Zealand will have to worry about the fact that there is more Chinese demand than you can possibly supply.”

Taking into account the long-term maths of emerging market demand, modernisation of the food chain in new markets, westernisation of emerging consumer taste preferences, opening up of new cultural segments, preferential access to a wide range of markets (including traditional ones), strong business relationships with key multinational foodservice and retailers – it all looks pretty impressive to us.

With the demand side taken care of (in trend terms at least – these countries do have business cycles), what will matter is the execution of chosen strategies by businesses to extract the maximum value from the opportunities available. There will also need to be strong support from government and the regulatory environment. There have been lots of encouraging signs from many sectors, with a number of success stories, but what is required is a continuous loop of strategy development, execution and refinement in a world that changes rapidly. We cover some encouraging developments in the tradable sector below.

AUCKLAND’S HOUSING WOES

Auckland house prices have risen by more than 40% over the last three years – compared to around 25% in Canterbury and less than 10% elsewhere. Auckland median house prices are around eight times median household incomes as compared to under six for other New Zealand centres.

A combination of factors look to be behind Auckland house price growth:

Large cities globally have seen surging price growth; witness London, New York, Sydney, etc.

Urbanisation and higher population growth – Auckland’s urban population has increased by roughly 50% since 1991, as opposed to 17.5% for the rest of the country. Subnational population projections suggest Auckland’s population growth will continue to outstrip other regions, approaching 2 million people by 2031. Auckland is likely to account for around half of the 20,000 additional households in New Zealand per annum over the next 20 years. This cumulates to big numbers – remember the close to 400,000 additional housing units required over the next 30 years cited in the Unitary Plan for Auckland.

A concerted period of underbuilding. Building consents per head of population decreased markedly in Auckland following the building boom years of the mid-2000s. The number of building consents issued for new dwellings in Auckland has more than doubled since its early 2009 trough, but is still only a shade higher than historical averages. Our regional housing demand and supply estimates are approximate, but they continue to pinpoint a housing shortfall in the Auckland and Canterbury regions. Within the existing dwelling market, inventory levels are very low in relation to sales (around 2 months on average compared to historical norms of closer to 7) – a key factor underpinning prices.

Poor planning and execution. You don’t get sustained periods of underbuilding for no reason. If there is not much land available, the price goes up. And high-priced land means it can become uneconomic to build affordable houses. It isn’t just about zoning. It’s also about putting time limits on development to stymie land banking by investors.

Regulation. Bring on the reform of the Resource Management Act (RMA).

Tastes. You can’t just blame the market for not addressing shortages. Many people now want and expect bigger houses, rather than starting with a smaller one in a cheaper suburb. It’s not exactly reasonable to complain it is harder to buy a first house if that first house is twice the size our parents’ was.

Attitudes. Auckland needs to go both up (highrise and more intensive housing) and out (i.e. more land). This brings us to the NIMBYs, where self-interest interferes with group interest.

The investor market. The fact that the rents in Auckland have not yet moved up sharply (though admittedly anecdotes are turning) tells us to be wary of the supply-shortage theory as dominating too far.

The Asian and global factor. Forget the xenophobic hysteria. Auckland has a diverse ethnic mix and it’s impossible to disentangle offshore from residents’ purchases. But anecdotally, the demand is strong from offshore. And why shouldn’t it be? Property here looks cheap by global comparison, and New Zealand looks a nice place to be amidst global challenges and woes.

Costs. Costs for consenting, land, or construction; all have moved up rapidly. Poor productivity growth across the construction sector hasn’t helped either.

The situation is now problematic on a number of levels.

The more you binge, the greater the odds of a correction – a risk the RBNZ is alert to, as are we. Housing cycles have been historically closely linked with economic ones, given more than two thirds of measured household wealth is in housing. Recent council valuations placed the value of the Auckland residential housing stock at approximately $475bn, more than twice our nationwide annual GDP.

It’s driving tensions between Auckland and regional New Zealand; regions see the Government pouring billions into Auckland (and Christchurch) and ask, what about me? That sort of resentment is not good for stability.

• The more internalised Auckland becomes with its housing challenges, the greater the risk that the connections between Auckland and the rest of the nation play second fiddle. The broader economy needs a strong Auckland just as Auckland needs the rest of New Zealand; it’s the dominant gateway into the New Zealand story. But that’s a catch-22, because for Auckland to flourish and act as the gateway, housing woes need to be addressed.

Rising house prices have lifted housing costs in the Auckland region relative to elsewhere. According to the 2013 Census, Auckland homeowners spent more than 15% of their income on housing, higher than other regions. Close to 60% of Auckland owner-occupied dwellings still had an outstanding mortgage, as opposed to around 50% elsewhere. In 2013 almost half of crowded households in New Zealand were in Auckland. The number of persons per dwelling in Auckland (around 3) is above those of other centres (closer to 2.5).

Deteriorating housing affordability in Auckland has coincided with falling home ownership. In 1986 home ownership rates in Auckland were similar to the rest of New Zealand at (73.9% versus 73.6%). Since then home ownership rates in Auckland have fallen relative to the rest of New Zealand (61.5% vs 66.5% of households owned their home or held it in a family trust by 2013).

• It’s one factor exacerbating income inequality given the proportion of income now being spent on housing.

The array of challenges and reasons for Auckland’s woes mean you can forget about a quick fix, but we are seeing movement.

In response to the 2011 Productivity Commission enquiry into housing affordability, a number of workstreams examining land supply restrictions, paying for infrastructure development, productivity in the construction sector, and costs and delays in the regulatory process have been undertaken. Under the Special Housing Areas Act (2013), development can be fast-tracked (3 months for brownfield and 6 months for greenfield applications), with the council taking a more flexible approach to granting the resource consents necessary for subdivision and development. Recent proposed changes to the RMA are designed to further improve the supply and address the rising cost of building.

Until the Auckland Unitary Plan becomes operative in 2016, the Auckland Housing Accord targeted the creation of 39,000 new residential sections and dwelling consents to the end of September 2016, with targets of 9,000, 13,000 and 17,000 each year respectively. Progress is being made, with close to 8,000 consents lodged and 11,060 new dwellings and sections created in the September 2014 year. More than 80 Special Housing Areas (SHAs) have been created during the first year of the Accord, which are expected to accommodate 43,000 new dwellings, with about the same number of other dwellings already in the pipeline according to MBIE estimates.

This is a good start, but the lags are long. We are at the early stages of what is likely to be a long road ahead. Dwellings still need to be built, and work on infrastructure (including roads, sewage and schooling) completed. The challenge will be doing this while avoiding the economy blowing an inflationary gasket, and simultaneously ensuring that crucial investment flows toward the productive sectors of the economy are not impeded. Already annual residential construction cost inflation in Auckland is running at 7%, higher than in Canterbury, and the rest of the country.

Putting in place more affordable housing will entail a different construction sector response than has been seen in the past, where new dwelling supply has tended to come in the form of large, expensive dwellings. The demand side will also have to reflect new realities, given that the ageing of the population structure is likely to lead to smaller household sizes. Auckland’s housing stock is changing as the city reacts to its growing population and high costs for residential land, with more multi-storey homes and apartments, greater density, and fewer unoccupied homes making the dwelling stock different to the rest of the country. These trends need to continue. New ways could also be found to utilise current shelter in Auckland more effectively. According to 2013 Census figures over half of four-bedroom dwellings in Auckland had 2+ bedrooms spare.

Beyond the obvious policymaker desire to lift the supply of houses, we’re mindful of other facets that will need to come together.

• Market mechanisms are also influential in matching the demand and supply for dwellings, and shouldn’t be overlooked. Census estimates point to a small internal migration outflow from Auckland to other centres (NB: this is distinct from external migration, which does benefit Auckland). Auckland is not a big sucking vortex pulling in the rest of New Zealand at all. Waikato and the Bay of Plenty have benefitted; this tells us that market forces still have a role to play.

• The proposed reform of the RMA has to have real teeth. We’ve seen encouraging broad principles so far but no substance.

• The construction sector needs to lift its game in regard to productivity growth. The finger can’t solely be pointed at regulations and costs. Incremental improvements such as reusable concrete boxing and more use of pre-fabricated units all help. Perhaps in the future we’ll be pouring our houses out of a tube. The technology already exists. In the meantime it would certainly help with construction costs if the average kiwi didn’t feel the need to play architect and make their house design unique. But it seems to be in our DNA.

• Political capital is going to need to be burned taking on the likes of the NIMBYs.

• Auckland’s challenges are also opportunities for some regions. There is an opportunity for regions to proactively target Auckland businesses that are aligned to strengths in their regions. We’re for more co-ordination in terms of regional development, though the key elixirs of regional growth and opportunities need to come from within regions themselves.

• It’s looking increasingly likely we’ll see another prudential response targeting the property investor market this year.

• Political rhetoric will be strong in regard to offshore buyers too, though it is very unlikely that this Government will take any measures that would substantially impede the flow of foreign capital.

Solving Auckland’s housing challenges is far from simple. You can’t point the finger at one catalyst (i.e. shortages) and building more as a response. The challenges are immense.

We’re just pointing out that a multi-pronged approach is going to be necessary to at least keep the magnitude of the issues in the orange zone as opposed to the red hot one.

NET IMMIGRATION

Migration has been a key supporting factor for the economy.

Net permanent and long-term (PLT) immigration inflows are expected to peak below 55,000 persons by mid-2015. This is equivalent to around 1.2% of the resident population, the highest inflow since at least the early 1960s.

In contrast to flows in Australia, net immigration inflows are highly cyclical in the New Zealand context, and are generally viewed to be a major driver of New Zealand business cycles – although we note that the current strong net migration episode in New Zealand is both a cause and a reflection of relative domestic strength. Migration flows depend on a range of economic, social and legal considerations, both here and abroad.

Net immigration is the difference between two large and volatile numbers. At present, PLT arrivals currently outnumber departures by roughly two to one. The high quality of life on offer in New Zealand remains a magnet, with PLT arrivals approaching 2003 and early 1970s peaks as a share of population. However, the major swing variable behind the recent pick-up in PLT immigration has been low PLT departures, with the strong domestic outlook in relation to our trading partners keeping would-be emigrants off the plane. Traditionally New Zealand has tended to act as a spring board for migration inflows into Australia, but net departures across the Tasman have slowed from a flood to a trickle.

The traditional view is that net immigration inflows tend to add more to demand than supply, mostly via their impact on the demand for dwellings. In the current episode, however, close to two-thirds of the increase in net immigration has come via reduced PLT departures, which are generally more geographically widespread and represent people who are closely integrated into the supply of labour. More than one-quarter of PLT arrivals are also returning New Zealand citizens. Along with high numbers of arrivals from elsewhere, this will help address capacity bottlenecks. This suggests less of an impact on capacity pressure than would otherwise be the case. High rates of labour force participation, low rates of wage inflation and a reasonably modest response from the nationwide housing market to strong net immigration support this view, although pressures on the housing stock in some parts of the country (eg. Auckland) remain acute.

While the global scene is fickle, our expectation is that improving prospects for our trading partner economies, most notably Australia, will trigger a lift in PLT departures by the end of the year. Despite this, New Zealand is expected to remain a highly attractive destination for incoming migrants and we expect this to prevent a return to negative rates of net immigration that typically follow large net inflows.

We expect annual net PLT inflows will slow to around 25,000 persons by the end of 2017, the fabled soft landing, although risks and uncertainties remain.

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*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. Theme 1 is here.

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.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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65 Comments

The economy may be fine from a macro GDP point of view, however the actual participation by most workers, households, & those living outside of Auckland/Wellington may be something quite different.  

Nothing personal Cameron, your bank is exposed to China, exposed to Dairy and exposed to housing, all are facing head winds. Who the hell let AKL houses double in value since 2008, what a cock up. Where is the production backing this debt? It looks like China is rapidly becoming self sufficient in dairy, thats leaves us with ???
 
 

This is a typical report, unbalanced and proves that we have learnt nothing from previous boom bust cycles in our exports.  Yes NZ can develop export markets, but we always get blindsided by competition.  No mention of which countries are ramping up their dairy production, who have the capability to squeeze us out of markets that we have developed.  We are not the only country in the world capable of exporting milk, far from it, nor is the marginal producer in NZ still competitive globally.  We are loosing market share in our exports, somehow this is getting overlooked.
 
Which leaves us with a housing bubble and a rebuild.

Cameron you say:
Around 86% of loans and advances to the domestic financial system are being funded domestically or for terms longer than one year.
In the last crisis, the ANZ had to be saved by the government deposit scheme in Australia and New Zealand - was that not  in effect a bailout, if not in as many words? Hopefully I am wrong, but it seems to me that depositors are now sacrificial lambs due to the OBR provisions if a significant counterparty to a chunk of the  ANZ's near trillion dollar derivative portfolio should fail (as counterparties routinely do in a financial crisis). Is the above provision enough?

don't forget 'covered bonds'. leaving local depositors more exposed.
http://www.reuters.com/article/2015/01/28/idUSFit90796220150128
 

I wonder if we will get a reply?

But depositors have always had a risk, just the OBR makes it obvious and in a way quantifiable.   i t also means chequing accounts stay open and hence we get to eat, kind of important.
So as a right winger Roger you think its OK that the assumption has always been and will be that the tax payer will bail out the depositor?
Just remember though, the depositor has a big advantage, timing and speed.  Unless your money is tied in for meny months or years you can jump to short term Govn bonds or whatever looks safer in I assume a few days, covered bonds cant do that.
So to me the ones carrying the risk are the shareholders and tax payer.  Maybe that's the indicator? When bank shares start to drop its time to move.
regards
 
 
 

So as a right winger Roger you think its OK that the assumption has always been and will be that the tax payer will bail out the depositor?
 
Ouch! Okay, I'll take the bait. Fundamentally I think the problem is not right wing versus left as you seem to characterise it. I think the supposed conflict between "workers" and "bosses" is nonsense. The conflict is between the productive sector (goods and services excluding finance) and the bloated financial sector.
 
My central thesis is that a civilised society depends on a balance of interests - effective  owners of businesses are essential, as are effective workers and effective civil servants and effective financiers.
 
Our problems are that the financial sector has accumulated excessive privilege at everyone else's expense. In order to distract us from the dangers and destructiveness of our excessive debt load we are encouraged to fight amongst ourselves. Your characterisation of me as a stupid right wing nut job would suggest they are succeeding!
 
 
 

Most Kiwi investors with a term deposit probably still believe it is government guaranteed and have no idea what the OBR means to them. If they did know then they would probably pull their term deposit and buy a rental property. 10% to 12% return is now possible in many small provinicial towns and it is easy to get tenants as the LVR rules have made it impossible for first home buyers to enter the market in those same small towns. The alternative to spread risk of activation of OBR would be to break the term deposit up and spread across several banks. How safe would you feel right now with a term deposit of $150,000 fixed for the next 24 months with say ANZ?

That is why I began to take an interest in this stuff. I sold my house in 2008 as I saw a severe recession coming; only to realise that having all my money on deposit at the ANZ just might not be so clever  when the run on Northern Rock started.

I had money in NR, lost 90% of it and then they took fees off.
:(
I have not sold my house working on the principle that its not likely to drop to what I paid for it, ergo Im making a paper loss but I can live at a fraction of the money needed for a rental and I cant lose my capital form an OBR.  KISS keep it simple and stupid.

crazy....
 

The reason the OBR would be triggered is primarily from property losses making the bank insolvent IMHO.
ergo buying property is even more silly than having it on deposit.
Also having it across several banks is a bad idea, they all have monolithic risks, though the BNZ is supposed to be worse than most apparantly.
Ergo you want to be out of banks when its looking bad.
 

"How safe would you feel right now with a term deposit of $150,000 fixed for the next 24 months with say ANZ?"
 
I would feel very safe indeed.
Please tell us....
If OBR was triggered by an event, what effect would this same event have on provincial housing market ?

For the OBR to trigger I would expect that the bank is insolvent because its assets are significantly imparred.  Therefore I think you have the cart before the horse. The housing and/or dairy farming market has to tank first that triggers the OBR.  Whether that triggers further house prices, well yes probably.
regards
 

Precisely steven.
 
For bigblue to suggest OBR as a reason why people should withdraw from bank deposits and invest in provincial rentals is laughable...IMO.

A rental at 12% will pay the mortgage from a 20% deposit regardless of property price, with a bit of cash in hand, youll be getting well over whatever whatever the interest rates will be in a savings account.  Even if you just paid cash for the rental, 12% is far in excess of what you will ever get from the bank.  The trick is, you don't have to book a loss at those kind of yields, so what if house prices dive, you are still getting 15-20k per year of rental income.  This is the importance of understanding cashflow.

skudiv
I was not comparing the two different types of investment...a rental property to a TD.
 
I was laughing at bigblue suggesting that just because we have OBR provisions, that it then means rentals are safer investments than TDs.
 

I've always felt more comfotable with physical assets then paper.

Sure, but once again not what I was refering to.
As far a RISK in NZ goes, I have no doubt there is less risk of losing any of ones capital in a NZ Bank as compared to in a provincial rental property.

Well you can get a 100% return on equity in 3-5 years with a rental, so I guess it depends on your timeframe. 

Sure, but to do that you would be leveraged.
 
So I return to my orginal reason for laughing at bigblue in this lttle discussion.
(6th @ 5:04pm)
If there was an event to trigger OBR, then I have liitle doubt those with leverged provincial rentals will lose even more as the banks force them to sell in a rapidly falling market.
 
Provincial rentals are riskier than bank deposits.
 

In any downturn yep, provincials will get hit hardest I think (maybe not OBR, long before that as diary suffers).

I think whichever has the highest leverage will be hit hardest.
 
An OBR event at a major bank in NZ will force interest rates to jump up to attrack money back into the system, and leverage works both ways. Many places in the provinces havn't raced up in price and are more in line with incomes. In a crash I think there is less downside for them (like Germany - houses didnt race up in price, nor did they crash like parts of Spain, Ireland etc). Auckland is another matter, there is plenty of downside, while it may recover faster, due to demand exceeding supply, that demand will evaporate faster with interest rates jumping. 

Spottie:  How do you pick out regional rentals.  Explain please. 
Why not the zombie suburbs of Auckland?
Or come to think of it.  Why not the central suburbs, with history of out of kilter price changes ?

KH
I only mentioned provincial because this is what bigblue posted.
"and buy a rental property. 10% to 12% return is now possible in many small provinicial towns"
 
If I am going to laugh at bigblue posts then I need to quote reasonably accuratly.
 
 

I wouldn't be so fast to laugh at bigblue. OBR provisions mean rentals maybe safer than TDs in cases where rentals are held with low LVRs. If you have a TD you are exposed to large downsides in the property market (via the OBR) with no upside exposure to this market. This is what the OBR does. If you think you have no exposure to the property market by just having a TD, you are very mistaken.
 
In an OBR event - those with say at least 25%+ equity will just refinance with another bank/institution, which could pick up significant market share, those with less equity will find it near impossible to refinance (as no bank will want them, or by law just not be able to(RE 80%LVR restrictions)) and they will be forced into selling. Those with term deposits will then be next in line for any bank losses.
 
Those with low LVRs will ride out the storm until it bounces back. As banks leverage around 10 to 1 those with TDs may have more exposure to bank losses (eg a bad down turn in property) than most owner occupiers or/and investors, as those with TDs will be forced to 'sell' in the market low, and realise the loss.

"In an OBR event - those with say at least 25%+ equity will just refinance with another bank/institution,"
 
I don't believe it will be anywhere near as you suggest.
For the OBR to be triggered in any of our top 5, it would follow there is some MAJOR liquidity crises.
A systemic financial  failure.

1. 'A systemic financial failure' and all your TD is gone. At least with rental property with low LVRs you have a much better chance than with a TD (and a worse chance with high LVR).
2. Although I think it very unlikely an OBR would be caused by just a property downturn (as I mention below), it is possible. Banks can (and do) go insolvent without there being any liquidity crises at all, just like any business can go broke. Central banks can step in and fix liquidity crises (ctrl-p), insolvency they can't fix, if you go broke, you go broke.
 
For the OBR to be triggered at any of our main banks I think will create bank runs accross the board. I think the OBR is a bad idea. But would I rather have a TD or rental? I'd choose the TD over a high LVR rental, and a rental with a low LVR over a TD.
 

"'A systemic financial failure' and all your TD is gone."
 
No,most certainly nowhere near all.
Under OBR the Govt has taken over to provide liquidity and guarantee the remainder well before that.
 
 

UM, no that isnt my understanding of the OBR the complete opposite.  When an OBR triggers the bank splits into chequing and investment the Govn can keep clear.  The checking stays operational, the investment part is would up.  I see no mention of any stated guarantee by the Govn?
TDs are shaved to cover the losses, the losses might be 10% or 50% or 100%.
 
 

"The bank will re-open for ordinary transaction business on the next business day after it is placed under statutory management.
At this point, depositors will have full access to the unfrozen portion of their accounts.
These funds will be subject to a government guarantee."
http://www.rbnz.govt.nz/regulation_and_supervision/banks/policy/4368385....

1. I doubt you will have any access the following day to your term deposit. I look after cashflow at work and manage numberous term deposits at various banks. They have all sent notice that to break a term deposit will require a months request in writing and then the bank may decide to decline your request - meaning you have to wait till it matures. (You used to be able to break them and take a discount to the interest).
I would be interested to know if under the OBR all terms on term deposits are immediately cancelled allowing you to access 'an unfrozen part' of your term deposit (I doubt it), I think its referring to on call, transactional accounts, ie cheques, etc
2. When a bank leverages its capital 10 to 1, and like the ANZ has almost a trillion in derivative exposure, if counterparties failed, as would be the case in a global systematic failure, it wouldn't take a lot of failures to wipe out your TD, and the unfrozen part only comes after conservatively freezing amounts to cover losses.

I think we are cross purposes here, or a mis-understanding..  In the event of an OBR, only the desposit/investment side (or a % of it) is frozen and subject to loss.  Also "The initial amount frozen is expected to be sufficiently conservative to ensure that the losses of the bank do not exceed the level of funds available in the frozen portion of account balances." which is interesting.  So if the Govn thinks its 100% loss you get nothing teh next day.   though I'd assume that such an event would be "obvious" and people would already be moving out, though where is the Interesting Q.
 
 
 
 
 
 

My understanding is that the OBR provides no government guarantee at all.
 
My experience of receiverships and liquidations is that pretty much the creditors normally get very little in the end, usually less than the receivers think at the beginning as the assets turn out not to be worth what they first thought when it comes to realise them (its very hard to get book value). Given the leverage of a bank is much much higher than a normal business, I think this would be true. It seemed to be certainly true of the finance companies that fell over. But who knows, we havent had a chance to use the OBR yet. If it was ever used on a main bank I think it would be a disaster IMHO it would be far cheaper and less risky for the government just to inject capital to make it solvent (eg like the Labour government did with the BNZ back in the 80s).

"My understanding is that the OBR provides no government guarantee at all."
 
This is not correct.
Non-frozen funds are guaranteed.
See my post above.

I'm far from an expert on this, just wanting to clarify something for my own understanding...
 
In practice though - given that fractional reserve banking occurs in NZ, and most banks could easily have larger loans in the market than they have deposits on hand...
 
Would this not mean that if the event was significant enough for the OBR to be triggered in the first place - that the haircut/frozen portion, could easily be 100%?
 
And if this is the case - then maybe cash is king and I shoul stuff the mattress sooner rather than later ;)

I guess 100% could be frozen initially.
Then however, the Statutory Manager will immediately set about calling in ALL the mortgages which the banks holds as assets.
As these are repaid, it will enable him/her to repay  bank liabilities (deposits)

And if all those mortgages were called in...  we'd be talking (potentially) about 15-20% of the homes in NZ either being put up for sale, or switching banks (assuming the event that triggered the OBR wasn't significant enough to cause a run on all the other banks)...
If that quantum of properties were put on the market - watch the downturn in property overnight...
Either way - if 100% was frozen for only a month (and that would be a short period of time for the Statutory Manager to get everything lined up) - that's a month without cash for a lot of people in the population...  
Not a pretty sight...

I'd suspect the % would be pretty high and 100% doesnt seem outragious given leverage.
Surely the statutory manager would be far more likely to sell the bank as a going concern I'd suggest than call in mortgages. If that fails then sell the mortgages for those with LVR still positive. Not sure what happens here actually, those in negative territory (who are those who's loss of capital caused the OBR) will have nothing to pony up anyway.  Worst thing the manager can do is declare them bankrupt, it still gets him no cash lump sum.    The rest who are positive just need to re-mortgage or go to court to fight it, way expensive for the SM to do.
Due to leverage I dont think there will be much NET left for depositors myself.
 
 
 

Agreed. If the event didn't cause a systemic failure (which is a big IF), mortgages would be buddled and sold and probably at some bulk discount (houses wouldn't be put on the market). More than likely it would be sold as a going concern though, although at fire sale prices (another loss for TDs to cover I suppose). Although he could sell the mortgages for those with LVR not positive, he'd just sell them at a steep discount, which would be a further loss for those with TDs...

"could easily be 100%?"
I suspect so.
Not a mattress but cash like things. So short term Govn bonds seems to be the thing to consider.
 

Well I stand corrected, in part, spottie. Nice spotting! I suspect the guarantee in reality may only apply to transaction accounts, (not term deposits), although I would like to know for sure. 
I can see the logic in this, otherwise it basically guarantees a full on bank run for sure, as businesses need to pay wages etc so people can pay their own mortgages and bills, and if all funds are frozen, thousands of people reling on salaries etc to pay car loans, mortgages, rent, creditors, etc... will then go into default and the crisis would spread faster than you could write the letter to your bank requesting they consider, over the next month, paying your term deposit early. In such a crisis, by the time your month rolls by your TD is well gone.

The RBNZ primer entitled; Open Bank Resolution (OBR) Pre-positioning Requirements Policy may offer insight.

Thanks. I'll look that up later when I have some reading time. Was talking with our fx dealer on the phone this morning, he didn't know, but is also interested when I find out. May have to email the RBNZ directly.

It's illegal to list assets at a devalued rate because that would require extra write down as depreciation (or to stay legal, an expensive paid for independant report to notify the drop in value).  This results in book values for most items being generous.

Items which gain value quickly, are often either flogged off quickly and/or taxed as "off balance sheet" income.  And single by the time anyone gets in trouble, these little stars are already long gone.... or perhaps they never really existed, which contributes to the management fail.

The other items which tend to hold value, have done so because they're strong performers and are now in the later part of their life, and the depreciation has reduced their book value.  UInderstandably IRD and true accounting method don't want to encourage such happenings because it means the depreciation hasn't been properly proportioned.  However realising their value at market can be an additional challenge because of their life span - even if the item is valuable, parts might be scarce in the near future, and unless they are substantially less than market value, there is a very high chance the more modern version has extra features, better compatiability and warranty prospects.

That's why buildings tend to retain value.  Their primary service to their owner/consumer often doesn't radically change compared to new buildings.  Location is still location, frontage is still frontage (for advertising or image, it needs constant updating/tending no matter the age of the building), and shelter is still shelter.  In fact the modern building and manufacture tend to be lower durability and higher risk than traditional methods.

A lot of those with good equity will be in the covered bond pool.

yes but how many with low equity would also be in the pool?

Enough to guarantee a no loss I believe.  So if the pool becomes less than its face value more mortgages are moved into it until its actual value.

okay, if thats true (and RBNZ limits covered bond issues to no more than 10% of the banks assets), a covered bond is better than a rental or TD, which wasn't the original question. 
 
If the original question was what would you rather have in an OBR event?
a)TD,
b)high LVR rental,
c)Low LVR rental,
d) or covered bond?
My choice would be d) 'COVERED BOND', followed by c) then a) and lastly b).

Wouldn't that depend on what your desirable final objectives are likely to be?

What are the desirable final objectives?  Where are your goal posts?

'low equity' being any LVR over 65% (meaning in a property crash would put them at well over LVR80%).

If an OBR event was triggered at a major NZ bank I think it would cause a bank run on all the banks in NZ (I for one would withdraw funds, no matter which bank I had them with). I think the OBR in NZ context is a very bad idea, despite in reality being unlikely to happen, esp due to property exposure. Thats why I'm all for the LVR restrictions, its got nothing to do with controlling property prices, more bank stability and protection for depositors. I would go further and ban outright 90%+ LVR loans for the same reason (except bridging loans, new house builds etc).
 
If property tanked banks would not renew interest only loans for those close to 80% LVR (generally PIs) and probably all increase their margins as all banks would be in the same spot, (being heavily exposed to property). Thus tightening credit with interest rate rises (regardless of what the OCR did). Its unlikely property would suddenly decrease by 25% overnight (esp in the provinces where the interest on most mortgages is well less than the cost to rent - why would you sell in a downturn?), so the banks could muddle their way through....

Its very very unlikely an OBR event at a major bank would be triggered due to a property market downturn, losses on derivative exposure is another story... and the only way I think it would happen.

 Agree a property downturn would probably be a longer term thing, some muliple months. 

If property tanked, then there would be very little reason for banks to "rush" the property owners, and many reasons not to (even looking the other way).

 If a couple of owners/developers get in trouble then there is good reason to chase the funds to hold values up.

But if the market tanks, then banks would be foolish to do so as it would collapse their own books and secured debt.  Pouring more equity into a softening market, suicidal.  They'd only do so if   a  bank was going under, and they're far more likely to get help from others (banks, government, FEDs)  if it was just property drop, in order to keep the market held up (to stop the cascade).
   If they did sell, that would cascade and a dropping property market (with a few bank owned loans) would be a drop in the bucket, as entire banks shares dropped, investment and holding company values dropped.  You'd get a SCF on a GFC-wide scale.
 Before that happened you'd see a "Fanny Mae" or government step in to buy the toxic debt.

And the security, once issued isn't a real problem to the bank, as long as the projected debt servicing is good.  Which outside of natural disaster or war shouldn't be an issue.

"In the last crisis, the ANZ had to be saved by the government deposit scheme in Australia and New Zealand - was that not  in effect a bailout, if not in as many words?"
 
No Roger, it was not a bailout .
The NZ Govt made a profit from the fees paid by the Banks with this scheme.

Yes, well, I was being a bit aggressive in the hope that I might actually get a reply. These are important issues and Cameron is a good bloke who serves those at the top table - I hoped he could convince me that I was talking nonsense. Unfortunately he has not done so.
 
One of the Rothschild's said something like "Give me control of the money supply and I care not who makes the laws" and it does sometimes seem to me that we have ceded soveriegnty to the four Aussie banks. After all the job of the RBNZ is to adjust interest rates to a level that allows us to pay the interest on our debts but not pay them off. From this point of view the job of the government is to make sure we have jobs that pay enough so we can service our debts but not buy a house without them.

Including SCF?

Of course not; as they were not a Bank.

Exactly, and not eligible to be smothered with this morally hazardous nonsense, and yet the National Government still took it upon itself to extend the government deposit guarantee scheme to embattled crony SCF creditors.

Meanwhile the a Sale of NZ continues unabated - Christchuch as well as Auckland
http://www.stuff.co.nz/the-press/business/65894003/wealthy-chinese-buyers-snap-up-property

And not just here: Stream of Foreign Wealth Flows to Elite New York Real Estate
 
They have been able to make these multimillion-dollar purchases with few questions asked because of United States laws that foster the movement of largely untraceable money through shell companies. Sound familiar?

Seems to me the indicator they missed is how much of the countries assets the NZ citizens own.
Apparently it is diminishing.   We are transforming into a "Plantation Economy".
Kinda important for the analysis I thought.

Debt,
http://www.bloomberg.com/news/articles/2015-02-05/a-world-overflowing-wi...
Great big gobs of it, followed by not enough energy to pay it off = default on it.