The New Zealand dollar is overvalued by between 5 and 15 per cent, the International Monetary Fund reckons, but it counsels caution in changing the Reserve Bank Act in the hope of addressing that.
The IMF's annual check-up on the health of the New Zealand economy concluded yesterday.
Even with the terms of trade at a 40-year high the dollar is stronger than would be consistent with stabilising the country's net foreign liabilities over the long run, it said, and on that basis the kiwi appeared to be overvalued.
The head of the IMF mission, Brian Aitken, put the overvaluation between 5 and 15 per cent, a range that reflected the uncertainty involved in quantifying such things.
In addition to the strong terms of trade, factors contributing to the dollar's strength are the gap between New Zealand and foreign interest rates, the country's favourable growth outlook and an appetite for what are seen as relatively safe assets.
If any of those factors were to ease the exchange rate would be likely to depreciate.
When asked about proposals to amend the Reserve Bank Act, which Opposition parties advocate as a means of reducing pressure on the non-farm export sector, Aitken said he had seen no concrete proposals but added that the freely floating exchange rate and inflation targeting had both worked well for the country over the years.
The monetary policy framework had built up a lot of credibility and that credibility was an asset, he said. "There might be ways to innovate but you would want to be careful."
The current account deficit, a longstanding weak spot among New Zealand's economic indicators, reflects a chronic gap between investment and national savings.
"Reducing pressure on the exchange rate and limiting the current account deficit in a lasting way will require structural measures to address the savings-investment gap, rather than being the task of short-term macro-economic management," the fund's draft report says.
Although an orderly exit from quantitative easing by the United States and other advanced economies could have the welcome effect of weakening the exchange rate, it says, "a bumpy exit and repeated episodes of financial market could lead to widespread contagion and raise the cost of New Zealand banks' offshore borrowing".
The other external risk it mentions to New Zealand's fairly bright near-term outlook is a sharp slowdown in China.
Neither is the fund's central forecast, however. It is supportive of the monetary and fiscal tightening which the Reserve Bank and Government have embarked on.
The main domestic risk it sees is the housing market. Aitken said the rise in Auckland house prices in particular was the market working in response to low mortgage rates and a surge in net immigration on the demand side and zoning and other restrictions on the supply side.