Articles by Infometrics
Borrow and hope
14 November 2008
In a world increasingly wary of debt New Zealand is vulnerable, possibly very vulnerable. We are one of the most indebted nations in the
developed world with net foreign debt hovering around 100% of GDP. As a country
we have been chalking up external account deficits for 35 years and now have an
IOU bill to the rest of the world of around $160bn, or about $40,000 for every
New Zealander. We are not the most indebted, but we are exceeded only by Iceland whose net foreign debt per head is a massive $100,000. But then Iceland is now virtually bankrupt.
Not since 1973 has New Zealand earned more from the world
than we have spent buying goods and services (imports) and paying dividends to
foreign owners of many of our businesses.
The annual cost of servicing the accumulated external deficits
is now around $14bn, with a large proportion of that debt servicing bill being in
the form of dividend payments to foreigners who have bought our businesses.
Essentially we’ve been pawning our businesses (including farms) to finance a
life style we haven’t really been able to justify. Or, put another way, we have
mortgaged our asset base to fund day-to-day consumption of imports.
Our slide into debt began with the first oil crisis as
governments borrowed first to cushion the effects of the crisis (borrow and
hope) and then to invest our way out of the problem (Muldoon’s flawed Think Big
In the mid 1980s the government floated the currency, freed
up financial markets and left the private sector to take on whatever debt was
required. Since then the government has used the proceeds of state assets
sales to reduce its net foreign debt position, which fell to around zero by
What is surprising is just how much foreign debt New Zealand has been allowed to amass given our obvious lack of acumen in using it to lift
our export earnings. The inflow of foreign capital, which was largely
channelled into property, pushed up the currency scuppering export
profitability and in some cases forcing exporters out of business or offshore.
The legacy has been a stack of foreign debt (fortunately denominated in New Zealand dollars) and a battered export sector.
Despite the cavalier way in which we have used other
people’s savings the sky appears not to have fallen in. But the risk of it
doing so has just risen in two important ways. The world financial crisis is
making it a lot more difficult for delinquent borrowers to roll over existing
credit facilities. Secondly, a worldwide recession has sunk our chances of exporting
our way out of trouble.
Our stock of net foreign debt is held almost entirely by the
private sector. But it is not solely a function of business borrowing, although
many businesses have been sold to foreigners who have structured their
purchases using a substantial dose of debt. In that sense a significant portion
of our foreign debt is in fact owed by foreign owned companies operating in New Zealand.
One of the biggest bulges in foreign borrowing over the past
decade has been led by the major trading banks tapping into New Zealand denominated foreign retail bond markets. Rather than limiting mortgage lending to their
domestic deposit base, banks have helped themselves to the savings of Japanese
housewives and Belgian dentists. There is currently around $57bn of Uridashi
and Eurokiwi bonds on issue.
The doubling in house prices over the six years ended 2007 looks
dangerously dependent on the willingness of these foreign savers to keep
investing in New Zealand denominated bonds. Given the recent sharp fall in the New Zealand dollar these savers are about to reap a big loss (in some cases more than 20%) on
their three-year investment. That will stunt their enthusiasm for rolling over
these bonds. If that happens, banks will be starved of funding and the credit
crunch could get a lot worse yet.
Banks of course were eager to persuade households, farmers
and businesses to take up the foreign-backed credit. People gorged themselves
on it, buying holiday homes or sections, adding a boat, or a car, and in some
cases a business to their mortgages. But banks are now in the process of
reeling in that credit and that is driving heavily indebted households and
business to the wall. That process has a while to run yet.
One of the biggest challenges the new government faces is
managing the aggressive unwinding of debt that is now underway. The focus to
date has been on cushioning the personal effects of this process as politicians
have been desperate to win favour with voters. But the harsh reality is that
New Zealanders must earn more foreign income or slash what we spend – foreign
savers are going to be a whole lot less keen to keep extending us the credit to
finance our spending. Fasten your safety belts for a much lower currency and/or
higher interest rates. Debt and deficits really do matter when people and
institutions become scared to lend, especially to those who appear to have
squandered the debt.
This article is written by Andrew Gawith.
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