New Zealand may find it difficult to service higher debt levels even though it has room on its balance sheet for more borrowing, S&P Global Ratings says

S&P Global Ratings says New Zealand needs to make progress balancing its revenue and spending before borrowing more money, even though public debt remains relatively low. 

The credit rating agency held a panel discussion in Wellington on Wednesday where its analysts discussed a wide range of issues with the Institute of Financial Professionals NZ (INFINZ).

Martin Foo, a director and lead analyst, said when overseas investors look at the Crown’s finances they think: “Great balance sheet, but crap profit and loss”. 

He said public debt was relatively low by global standards, particularly compared to other developed countries, but it had increased more than average during the pandemic.  

“I would say that debt is not a concern, per se, but it's the cost of servicing debt that is more of an issue. We are in a situation now where New Zealand spends a lot more on interest expenses than it does on other major items, such as defence.” 

Foo said he was aware some economists and parts of the public sector had called on the Government to further leverage its strong balance to support the economic recovery. 

“We would say … although the absolute level of debt is low, the ramp up in debt has been substantial. Ideally, you'd want to have some fiscal buffers for the next crisis. The stock of debt is not so much a concern as is the cost of that debt,” he said. 

New Zealand’s mismatch between revenue and spending means having to service higher debt levels would reduce the Crown’s ability to continue other kinds of day-to-day spending. 

“The Government has given a lot of the right signals around trying to crowd in private sector investments, do more public-private partnerships, and novel transaction structures. But so far we’ve yet to see the evidence of those working at scale,” Foo said. 

The analyst said New Zealand had a stable outlook on its AA+ foreign currency credit rating, the second highest possible, which means it was unlikely to be downgraded in the next two years.

New Zealand's domestic currency rating is AAA, the highest possible rating, with a stable outlook. The Government does the vast majority of its borrowing via Treasury's New Zealand Debt Management Unit in NZ dollar denominated bonds.

Key risks the rating agency was watching include the ongoing fiscal deficit, which it measures as the cash deficit not OBEGALx, (the operating balance before gains and losses excluding ACC), and the current account deficit. 

“We have this twin deficit situation, and as long as there's sort of reasonable assurance that both are going to normalise over the course of the next couple of years, then I think the rating is safe,” Foo said. 

Other countries are not so fortunate. France received a credit rating downgrade last year due to “hugely unruly parliamentary dynamics” which made it very hard for them to pass budgets.

Foo said there were likely to be more sovereign rating downgrades in the future as developed countries struggle to manage financial and political challenges. 

“What we have observed over the past couple of years is this theme—across basically all of the developed markets, including New Zealand—there are these enormous underlying structural spending pressures related to population, population ageing and climate change and the need to spend more on defence and etc, etc.”

“And you're seeing these public debt burdens grow and grow. By contrast, a lot of the corporate and household sectors have de-leveraged, but all of the strain and all of the crap, if I may, has ended up on public balance sheets,” he said.

*Martin Foo was a guest on the Of Interest podcast talking about the current account deficit and sovereign credit ratings in 2023.