Brian Fallow on the economy
Brian Fallow is the Herald's Economics Editor

Brian Fallow: Chorus of caution warns us to tune up

Expert voices seem to be singing in unison about New Zealand's woes. Photo / Supplied
Expert voices seem to be singing in unison about New Zealand's woes. Photo / Supplied

You might almost think we were being set up to expect a grim Budget next year, or perhaps a wave of electorally timely relief if it turns out to be less austere than feared.

Over the past week we have been treated to a cautionary chorus from the great and the good about the need to mend our improvident ways.

First there was Finance Minster Bill English talking about the "dangerously lopsided" state of the economy by the end of the boom, with debt-fuelled consumption at unsustainable levels, while the export sector shrank and the country's overseas debt climbed.

Increasing our national savings, he said, is one of our biggest challenges.

Prime Minister John Key has said a couple of times that increasing national savings "may well" be the focus of the next Budget and the Government awaits with interest the recommendations of the Savings Working Group, chaired by Kerry McDonald, which is due to report in the new year.

The group does not have a clean slate, however.

English said the "Government has an open mind about what might be required to lift our savings further and we don't want to prejudge the outcome".

But off limits are any changes to New Zealand Superannuation, though it is obvious some are needed, or addressing the hole in our tax system where a capital gains tax should be.

English has also said that there is "no room, no room at all" for any financial incentives to increase savings. And even a revenue-neutral repeat of last Budget's formula of increasing GST and cutting income tax - an option tax officials seem to favour - looks to be off the cards, with English telling Parliament unequivocally that he has no intention of increasing GST further.

All this suggests that the heavy lifting in terms of raising national savings will fall to the government sector rather than households.

Some of McDonald's comments on the subject sound as if the committee he chairs should really be called the Public Sector Savings Working Group.

Treasury Secretary John Whitehead last Thursday said that the global financial crisis had exposed deep structural weaknesses in the economy.

Much of the additional borrowing of the past decade had not been used to finance productive investment, but instead to bid up the prices of houses and farms.

The legacy is assets that "appear overvalued" and a household debt-to-income ratio which is historically - and, he might have added, by international standards - high.

The Government needed to rebuild the buffer of low net public debt, Whitehead said and he called for a return to fiscal surpluses one or two years earlier than the five years forecast in the last Budget.

As that Budget already included a $1.1 billion annual cap on new discretionary spending, tough by the standards of recent years, the implications of the Treasury's views for the providers - and recipients - of public services are pretty bleak.

"A faster exit from expansionary fiscal policy settings over the next few years would mean interest rates will not need to rise as fast as they otherwise might, which will in turn assist to dampen the exchange rate cycle in the economic upturn," Whitehead argued.

For his part, Reserve Bank governor Alan Bollard last Friday warned that the rebalancing of the New Zealand economy (towards growth driven by the export sector, not debt-propelled domestic consumption) was progressing, but very slowly.

The fiscal deficit which had softened the blow of the recession would need to be closed, Bollard said, but unwinding support would subtract from growth for a number of years.

Meanwhile private demand remained "impaired" with the housing market and consumption weak, businesses cautious and balance sheets fragile.

Recessions triggered by major financial crises showed a consistent pattern, he said: "A long period of building up stresses, averaging a decade, a rapid unwinding then an equally long period of gradual recovery." Oh dear.

Finally there was Standard & Poor's' announcement on Monday that it has put New Zealand's sovereign credit rating (back) on a negative outlook.

It reflected the risks stemming from the widening external deficits and rising international debt expected as the economy recovers "in the context of the country's weakened fiscal flexibility", it said.

A negative outlook represents a one-in-three chance of an actual downgrade over the next couple of years, if the country's external position did not improve.

"Rising public [ie government] savings will be an important component of such an improvement," S&P said.

But the main risk to the ratings would be in a significant weakening of the credit quality of New Zealand's banking sector, which is largely owned by the big Australian banks, it said.

It would be nice to be able to shrug off this development.

After all, the ratings agencies' own reputation has been battered by their complicity in the lead-up to the global financial crisis.

But as long as investors in international credit markets continue to outsource the task of judging the creditworthiness of borrowers chasing their finds, the agencies' capacity to do us harm will remain.

Ironically the latest warning came hard on the heels of official statistics showing that the national savings rate has improved.

Better, unfortunately, does not mean good. National savings barely exceeded depreciation of the existing capital stock and remain low by international, including Australian, standards.

National savings reflect the behaviour of the household, business and government sectors.

Household borrowing has been growing slowly by comparison with the double digit annual rates of the boom years and households have flipped from net equity withdrawal from housing back to net equity injection (reducing their spending power by abut 10 per cent in process).

Government by contrast, which for 15 years made a positive contribution to national savings by running surpluses and paying down debt, has gone into reverse.

The Budget forecast an operating deficit of $8.6 billion this financial year and a cash deficit of $13.3 billion.

But, high as they are, those numbers now look like underestimates. For the first three months of this year the tax take has been running well below forecast and there is a fiscal hit from the Canterbury earthquake.

Key said on Monday that on the other hand the Treasury was revising upward its growth forecast for next year to, he thought, 3.5 per cent. That is also where some private sector forecasters are.

The net effect would be to take economic activity to roughly the same level in three years' time, he said.

Perhaps the most ominous element of the Standard & Poor's announcement, however, was its reference to the banks.

One factor moderating the impact of the global financial crisis on this country was the fact that its major banks' Australian parents remained in good shape and among the mostly highly rated in the world.

"But we have seen governments which formerly had very strong fiscal positions get routed because of stresses in their banking systems," S&P's New Zealand watcher, Kyran Curry, said.

"New Zealand has a very high dependence on foreign capital and if investors start to worry about one of the banks being able to meet their obligations, that could come back to bite the sovereign rating."

If one of the large Australian banks blew up, they would have to look at the New Zealand sovereign rating as well, he said.

Let's hope something more sturdy than commodity and housing bubbles are providing buoyancy to the Australian economy, for our sake as well as theirs.

- NZ Herald

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