New Zealand’s economy: vulnerable but not quite Iceland

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By Mantik Kusjanto (Reuters)

 The economy is in its worst recession on record, the current account deficit is ballooning, the government faces a sea of red ink and credit ratings firms have the country under the microscope — is New Zealand the sick man of the South Pacific?

Once a darling of foreign investors because of high interest rates, the country appears almost like Iceland judging from the current account deficits it has accumulated over three decades.

Since weathering the Asian economic crisis and drought in 1997/98, the $95 billion economy enjoyed its strongest growth since the 1970s thanks partly to soaring commodity prices and debt-fueled consumer spending.

Now the economy of world's biggest dairy exporter is shrinking as the once-hot housing market stalls, skyrocketing fuel and food prices turned consumers cautious, and the credit crunch hit.

Unlike Iceland's banks, which were brought down by aggressive and highly leveraged growth, or European banks rescued by their governments, New Zealand's banking industry shows no signs of stress yet.

The big Australian banks — National Australia Bank, Westpac Banking Corp, Australia and New Zealand Banking Group and Commonwealth Bank of Australia — dominate the market and have so far escaped the global meltdown.

Sue Trinh, a currency analyst at RBC Capital Markets in Sydney, said the likelihood of New Zealand becoming a customer of the International Monetary Fund was still low given banks' strong capital.

But she warned that it shows many symptoms that usually lead developing countries to seek IMF help and this will not ease investor perceptions of an imminent sovereign credit downgrade.

"NZ is one of the most heavily indebted developed economies, as measured by the net international investment position as a percentage of GDP," Trinh said in a note to investors.

At the end of March last year, New Zealand's national debt, as measured by a negative net international investment position, was 86 percent of GDP, second to Iceland in the OECD.

The country's banks are rated AA by Standard & Poor's and have funded a shortfall in savings with commercial paper issues, which have been renewed every few months. They minimised risk by hedging their foreign exchange exposure in the futures market.

Meanwhile, Britain, the United States, Germany, Greece, Austria, Belgium and Ireland bailed out banks with taxpayer cash.

EXTERNAL IMBALANCE

Because of its perilously low household savings New Zealand has long lived on foreign borrowings to fund spending.

Household borrowing stood at NZ$174.5 billion ($86 billion) at the end of December, which was financed largely by the "big four" Australian banks. About 40 percent of bank borrowing is due for renewal this year.

By the end of September, the annual current account deficit was 8.6 percent of gross domestic product, compared with the peak of 9.3 percent in the first quarter of 2006.

The saving grace had been the strong fiscal position of successive governments, with budget surpluses and falling debt.

That is changing. Market watchers expect large deficits as spending rises and tax revenues fall because of the deepening recession. At the same time, borrowing rises to cover the shortfall, which triggered warnings from rating agencies.

"We are worried that international investors may lose confidence in New Zealand's ability to meet its obligation. That would present a risk at the sovereign level," S&P credit analyst Kyran Curry said.

S&P has downgraded the outlook on New Zealand's AA plus foreign currency rating to negative from stable in January on concerns over its rising fiscal and external deficits.

But the economy's former strength, may be its future saviour.

"Even though sizeable fiscal deficits are projected, new Zealand's starting position is good, compared to other nations," said Dean Spicer, ANZ's head of debt capital markets, in a note.

Finance Minister Bill English told Reuters the economy and government finances have deteriorated since the Treasury's forecasts in December.

He said the worst-case scenario of the deficit growing to 4.5 percent of GDP and government gross debt at 29 percent of GDP over the next three years had become more likely.

That compares with Ireland's expected budget shortfall of 9.5 percent of GDP this year that would rise to up to 12 percent in the years to 2013 without a cut in government spending. In Spain, the deficit could reach about 6 percent of GDP this year.

STABILISERS

While the risks remain, analysts say its currency's ability to adjust quickly makes things easier for New Zealand compared to euro zone countries in trouble, such as Ireland, Spain and Greece, whose monetary policy is set by the European Central Bank.

S&P cut ratings on Spain, Greece, and Portugal, and lowered Ireland's outlook to negative, just like New Zealand, as their finances worsened, economies slowed, and prospects are gloomy.

Those countries have lost competitiveness relative to their European peers in the absence of flexible exchange rates, leading to a rise in their external imbalances, it said.

"The fact that the currency is allowed to move means that the external imbalances are able to adjust more efficiently and more effectively," S&P's Curry said.

The New Zealand dollar lost more than a third of its value against the U.S. dollar since it hit a 23-year post-float high of $0.8215 last year, with the most recent Reuters poll of economists putting it at around $0.52 by mid-year.

But compared to others, New Zealand still looks to have enough underlying strength and resilience to ride out the storms.

"New Zealand's deficit and borrowing are going to be small potatoes compared to what we see globally," said BNZ senior markets economist Craig Ebert.

"It will be a difficult path … but we might get out on the other side with greater growth potential than a lot of other economies."