Asian crisis compounded economic woes

By Brian Fallow

WELLINGTON - Even without the Asian crisis, 1998 was never going to be much fun for the New Zealand economy.

It was heading into a cyclical trough and had to contend with a summer drought, whose impact on gross domestic product brought home how reliant New Zealand remains on its farmers.

But above all, it was shockwaves from the financial crisis in Asia which drove the economy into its first recession since 1991.

New Zealand was especially vulnerable to the Asian crisis, not only because about a third of our trade is with the region, at least in normal times, but also because the export sector represents an unusually large proportion (about a quarter) of the overall economy.

By one crude measure of exposure - the ratio of Asian exports to GDP - New Zealand and Australia, at around 8 per cent, were three or four times as exposed to the Asian implosion as the United States or Europe.

Exports have taken a hit. Export volumes in the September 1998 quarter were 3 per cent down on a year earlier.

But the fact that the impact was not worse testifies to two things: the agility with which those exporters who could do so switched to other markets outside Asia, and the extent to which the kiwi dollar has depreciated. On a trade-weighted basis the dollar fell 11 per cent during 1998.

It needed to. The high exchange rate of the mid-1990s had hammered the export sector and contributed to a blowout in the balance of payments to a perilous $6.8 billion, or 7 per cent of GDP, by the end of 1997. By September 1998 it had narrowed slightly, to 6.6 per cent of GDP.

At these levels the external deficit will continue to act as a drag on the economy. Other things being equal, it will make for higher interest rates and a weaker dollar.

Although the Reserve Bank was in easing mode all year, for the first half of 1998 it seemed from the standpoint of the domestic economy to be a Clayton's easing, in that it all took place through the exchange rate while interest rates, in fact, rose.

By mid-year the bank had realised its mistake and began easing more aggressively, enough to accommodate not only the fall in the dollar (dragged down by falling commodity prices) but to leave room for interest rates to fall as well.

The Treasury was even slower to realise the gravity of Asia's impact and produced a Budget in May whose economic forecasts were widely ridiculed for their optimism. Within three months the Government admitted it had got its forecasts badly wrong and, perversely, tightened its belt a notch.

Overall, however, and more by good luck than good judgment, fiscal policy was stimulatory last year.

The second round of tax cuts, delayed a year, kicked in on July 1, and the coalition agreement's $5 billion fiscal spendup (or most of it) continued, even as the coalition itself disintegrated.

Political instability was one of the factors knocking confidence about last year. Business confidence suffered violent mood swings. In September and October especially, it hit lows not seen since the last recession as the international news got worse, with the Asian contagion spreading to Russia, sharemarkets falling and US Federal Reserve chairman Alan Greenspan publicly fretting about the prospects of a credit crunch.

For a time the talk was of a global recession.

But the crisis passed.

A flurry of easing by the Fed restored confidence to bond and equity markets.

The Japanese passed legislation to enable them to start dealing with the hideous bad debt problems of their banking system. The International Monetary Fund was re-armed and a support package agreed for Brazil, allaying immediate fears of an Asia II in Latin America.

The combination of a less menacing international outlook and lower interest rates saw a revival in business confidence, to four-year highs, by the end of the year.

Other indicators of confidence were not so good, however.

Migration flows turned negative. In the year ended November, long-term departures exceeded arrivals by more than 5000. Over the previous three years there had been net inflows of 10,000, 25,000 and 28,000.

While people were voting with their feet, foreign investors were voting the same way with their dividend policies.

All the $3.2 billion profit earned on foreign direct investment in New Zealand was taken out in dividends; net reinvestment was nil.

In a survey of foreign-owned firms conducted for the American Chamber of Commerce, just over half said they had considered pulling up stakes and quitting the country. MMP was cited as the main change for the worst.

Consumer confidence started to revive in the September quarter (December's results are not in yet), but remained in negative territory.

One of the main drivers of consumer confidence, the housing market, was showing signs of having bottomed out by year's end. Sales volumes were starting to recover, though not enough to move prices. The decline in permits for new dwellings, which had been falling since mid-1997, picked up in November.

But the other major influence on consumer confidence - job security - is expected to get worse before it gets better.

The unemployment rate dipped to 7.4 per cent in September, from 7.7 per cent three months earlier, but that was entirely due to people saying they were no longer in the market for a job and therefore falling out of the official definition of unemployed. Employment remained flat.

The unemployment rate is expected to peak around 8.2 per cent early this year, up from its lows of around 6 per cent at the height of the mid-90s boom, but well down on its previous peak of over 11 per cent in the last recession.