In a world increasingly wary of debt New Zealand is vulnerable, possibly very vulnerable. We are one of the most indebted nations in thedeveloped world with net foreign debt hovering around 100% of GDP. As a countrywe have been chalking up external account deficits for 35 years and now have anIOU bill to the rest of the world of around $160bn, or about $40,000 for everyNew 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 worldthan we have spent buying goods and services (imports) and paying dividends toforeign owners of many of our businesses.
The annual cost of servicing the accumulated external deficitsis now around $14bn, with a large proportion of that debt servicing bill being inthe form of dividend payments to foreigners who have bought our businesses.Essentially we’ve been pawning our businesses (including farms) to finance alife style we haven’t really been able to justify. Or, put another way, we havemortgaged our asset base to fund day-to-day consumption of imports.
Our slide into debt began with the first oil crisis asgovernments borrowed first to cushion the effects of the crisis (borrow andhope) and then to invest our way out of the problem (Muldoon’s flawed Think Bigprogramme).
In the mid 1980s the government floated the currency, freedup financial markets and left the private sector to take on whatever debt wasrequired. Since then the government has used the proceeds of state assetssales to reduce its net foreign debt position, which fell to around zero by1996.
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 liftour export earnings. The inflow of foreign capital, which was largelychannelled into property, pushed up the currency scuppering exportprofitability 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 otherpeople’s savings the sky appears not to have fallen in. But the risk of itdoing so has just risen in two important ways. The world financial crisis ismaking it a lot more difficult for delinquent borrowers to roll over existingcredit facilities. Secondly, a worldwide recession has sunk our chances of exportingour way out of trouble.
Our stock of net foreign debt is held almost entirely by theprivate sector. But it is not solely a function of business borrowing, althoughmany businesses have been sold to foreigners who have structured theirpurchases using a substantial dose of debt. In that sense a significant portionof 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 pastdecade has been led by the major trading banks tapping into New Zealand denominated foreign retail bond markets. Rather than limiting mortgage lending to theirdomestic deposit base, banks have helped themselves to the savings of Japanesehousewives and Belgian dentists. There is currently around $57bn of Uridashiand Eurokiwi bonds on issue.
The doubling in house prices over the six years ended 2007 looksdangerously dependent on the willingness of these foreign savers to keepinvesting 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%) ontheir three-year investment. That will stunt their enthusiasm for rolling overthese bonds. If that happens, banks will be starved of funding and the creditcrunch could get a lot worse yet.
Banks of course were eager to persuade households, farmersand businesses to take up the foreign-backed credit. People gorged themselveson it, buying holiday homes or sections, adding a boat, or a car, and in somecases a business to their mortgages. But banks are now in the process ofreeling in that credit and that is driving heavily indebted households andbusiness to the wall. That process has a while to run yet.
One of the biggest challenges the new government faces ismanaging the aggressive unwinding of debt that is now underway. The focus todate has been on cushioning the personal effects of this process as politicianshave been desperate to win favour with voters. But the harsh reality is thatNew Zealanders must earn more foreign income or slash what we spend â€“ foreignsavers are going to be a whole lot less keen to keep extending us the credit tofinance our spending. Fasten your safety belts for a much lower currency and/orhigher interest rates. Debt and deficits really do matter when people andinstitutions become scared to lend, especially to those who appear to havesquandered the debt.
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