Anoop Singh: Global outlook positive for NZ

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Asian growth will help counter domestic headwinds, including the drought, writes Anoop Singh.

China will remain an important and growing market for agricultural exports, says Singh. Photo / Thinkstock
China will remain an important and growing market for agricultural exports, says Singh. Photo / Thinkstock

The New Zealand economy has proved relatively resilient during the global financial crisis and will benefit from the more benign international outlook that is emerging in Asia and globally.

This backdrop is positive for New Zealand and will help offset some of the more domestic headwinds that are emerging - especially given the impact of the drought and fiscal consolidation.

The latest IMF Asian Regional Economic Outlook notes that the global economy shows signs of improving as risks emanating from the advanced economies have receded.

In particular, Asia faces better prospects after a year of subdued economic performance.

Growth in Asia is set to pick up gradually in the course of 2013 to about 5 per cent on strengthening external demand and continued robust domestic demand.

Inflation is expected to remain contained allowing interest rates to remain low.

The Asian outlook suggests that New Zealand's key trading partners - China and Australia - will continue to do well.

China, in particular, will remain an important and growing market for agricultural exports, especially dairy products.

Despite the better international outlook, the New Zealand growth forecast for 2013, currently at 2.25 per cent remains subject to uncertainty and remains below trend growth.

An increase in construction activity is offset by headwinds from budget deficit reduction, the strong New Zealand dollar, and the recent severe drought.

However, the spare capacity and soft labour market will limit wage and inflationary pressures in the near term.

This will allow the current low interest rate environment to continue in line with the Asian experience.

The monetary policy stance may need to tighten if house price and credit expansion begin to fuel excessive consumption spending and inflationary pressures.

Already there are signs that house prices are rising, especially in Auckland and Christchurch as rebuilding continues.

Prices are already high by standard measures and there are growing concerns that they could increase further.

This could lead to an increase in debt-financed household spending, which could be inflationary and so increase the higher interest rate hikes, and an abrupt price correction.

Under these circumstances the authorities are considering the selective and temporary adoption of certain macro prudential measures to cool the housing market - in line with the experience in other economies in Asia.

The Reserve Bank of New Zealand's credibility and the effective monetary transmission mechanism in New Zealand should allow for a nimble response should circumstances change.

One of the lessons of the global financial crisis has been the need to bolster resilience and credibility upfront to create the policy space for offsetting actions in case of emergency.

In this regard, the policy to move to fiscal surpluses strikes the right balance between sustaining aggregate demand and limiting public debt growth that could otherwise reach unsustainable levels.

It withdraws fiscal stimulus at the right time by making room for the expected increases in private sector and earthquake-related reconstruction spending, it has improved the macroeconomic policy mix by reducing pressure on monetary policy, it creates fiscal space to help deal with future spending pressures and cope with any negative shocks, and could help raise national savings.

New Zealand's relatively modest public debt gives the authorities some scope to delay their planned deficit reduction path in the event of a sharp deterioration in the economic outlook.

Another longstanding vulnerability has been the persistently large current account deficits that reflect low household savings. As a result, net foreign debt remains high by international standards.

Given a structural savings-investment imbalance, limiting current account deficits in a lasting way will require policies that can raise savings, for example by running government surpluses rather than being the task of short-term macroeconomic management.

IMF staff analysis suggests that the New Zealand dollar is stronger than is consistent with the medium-term fundamentals.

Aside from the structural savings investment imbalance, there are a number of short-term factors contributing to the currently overvalued exchange rate, including a continuing gap between domestic and foreign interest rates and more recently, increased portfolio flows into New Zealand.

If global monetary conditions were to become less stimulatory as the global economy stabilises, the exchange rate would likely depreciate over time, reducing the current account deficit over the medium term.

The lowering of global risks will also be very positive for the local banks as the likelihood and potential impact of a shutdown in overseas funding markets has declined in recent months.

Banks are now less vulnerable than during the market disruption in late-2008, as the share of retail deposits and the average maturity of bank liabilities have been steadily increasing over the past two years and the source of funding is diversified across regions and products.

Banks have been taking advantage of the relative calm in global markets to pre-finance their upcoming funding needs at relatively low borrowing rates.

In addition, the benign Asian outlook will support growth in Australia and strengthen the Australian banks whose subsidiaries comprise the top four banks in New Zealand.

This will help boost confidence, lower funding costs, and further underpin their resilience to any shocks.

Anoop Singh is director of the Asia and Pacific Department at the International Monetary Fund.

- NZ Herald

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