Contact sale bad for deficit

By Brian Gaynor

The country has spent more than it has earned every year since the mid-1970s and the 1997 and 1998 deficits exceeded 5 per cent of gross domestic product.

A deficit in excess of 5 per cent of GDP is generally considered to be a problem.

As far as balancing income and expenditure is concerned, a country is no different than an individual household. When a household spends more than it earns it has to either sell assets, borrow or use its cash reserves to make up the deficit.

New Zealand has been in a similar situation over the past two decades. The country has either sold assets, borrowed or used its overseas reserves to finance the continual excess of expenditure over revenue.

These asset sales and increased borrowings have been a major contributor to the recent deficits.

First to this week's figures. The current account deficit for the December 1998 year was $5.9 billion or 6 per cent of GDP. This was better than the consensus forecast of $6.5 billion or 6.6 per cent of GDP.

The 1998 merchandise trade surplus rose by nearly $0.5 billion as export growth to United States and Australia more than offset lower exports to Korea and Japan.

The service balance, which consists mainly of transportation, tourism and insurance, deteriorated by $0.4 billion. The major reason was that outbound travel expenditure grew more rapidly than inbound tourist revenue.

A $1 billion plus improvement in the investment deficit was due to:
a rise in New Zealand's overseas investment earnings because of the strong performance of most western economies; foreign investors in this country experiencing a fall in income because of our domestic recession. This outflow will increase again as the economy picks up.

The transfers surplus, which is predominantly money transferred by migrants and other individuals, has stabilised at $0.8 billion. The lower surplus, compared with the mid-1980s, is due to the decline in Asian immigration.

Although the investment income deficit fell by more than $1 billion it is still the main contributor to the overall deficit. In 1998 overseas investors received $6.7 million more in dividends and interest from their investments in this country than we received from our overseas investments.

This large investment income is largely a product of the current account deficit in previous years. Statistics New Zealand releases a capital account statement which shows how the current account deficit is financed.

This statement is now released quarterly but as some surveys are only done on an annual basis the most accurate figures are to 31 March 1998.


In the five-year period $20.4 billion of direct investment came into the country whereas New Zealand companies made direct offshore investments of only $2.5 billion.

The net balance of $17.9 billion effectively funded the current account deficit over the five-year period.

Direct investment can come in two forms, it can be the purchase of an existing asset or the establishment of a greenfield operation by a foreign enterprise.

Evidence suggests that there was far more of the former than the latter. For example in the second half of 1998 the Overseas Investment Commission issued 117 consents, 115 were for the purchase of an existing asset.

In other words, New Zealand's $17.5 billion current account deficit was mostly financed through the sale of existing assets to overseas interests. The other major item funding the current account deficit was portfolio investment with a net inflow of $5.9 billion.

Because of the large inflow of capital total international investment liabilities rose by $41.9 billion in the five years ended March 1998 whereas international investment assets increased by only $16.3 billion. The increase in overseas dividends and interest payments associated with the capital inflow is now having a major impact on the investment income deficit.

Unfortunately the large investment deficit is not easily resolved. As at 31 March 1998 the country had international investment liabilities of $124.7 billion and assets of only $35.2 billion.

The net result is an international investment deficit of $89.5 billion.

Unless the domestic savings rate increases we will continue to depend on foreign capital to finance the current account deficit. This in turn will add to the investment income deficit.

This begs the question; why was there so much euphoria this week when the Government announced the sale of 40 per cent of Contact Energy to foreign interests?

Contact is a domestic electricity utility with no export sales. Consequently this week's sale will add to the country's current account deficit because
Contact has no export earnings to counterbalance the dividend payments to overseas owners.
It is true that Government offshore interest payments will fall if the $1.2 billion is used to repay foreign debt.

However, in a few years time 40 per cent of Contact's earnings should far exceed the reduction in Government interest savings.

Contact Energy is an ideal company for a 100 per cent domestic sale particularly as 250,000 potential shareholders have registered their interest in the public float. A 100 per cent domestic sale would have real benefits: it would boost domestic savings; reduce the dividend payments made to offshore investors; keep most of the wealth generated by Contact in New Zealand; investors who took up the issue would have less to spend on items such as imported goods and foreign travel which have a negative impact on the current account deficit.

Many other countries have a different approach to foreign investment.

They are reluctant to sell non export orientated state owned enterprises to foreign investors because of the negative impact of this strategy on the current account.

Instead they encourage foreign investors to build greenfield export orientated operations. This is a more practical approach because the export earnings of the greenfield operations will far exceed the dividends remitted to the plant's overseas owners.

Government officials in Wellington have spent an enormous amount of time and effort selling 40 per cent of Contact Energy to a North American company. Why can't these officials put the same effort into convincing a major international computer manufacturer to establish a $1.2 billion export orientated plant in New Zealand?

It is only when Wellington starts putting some effort into stimulating export growth, instead of flogging off the country's assets to foreign interests, that we can start thinking about achieving a current account surplus for the first time since the mid-1970s.