Deficit and debt on the home front

David Tripe

Mortgage interest rates are likely to rise even further if foreign investors become nervous about New Zealand's huge current account deficit, says Massey University head of banking studies David Tripe.

Speaking to the New Zealand Futures Trust in Wellington, Tripe examined links between the housing market, the current account deficit and foreign debt.

He said total housing debt had risen sharply and New Zealand's predominantly Australian-owned banks increasingly relied on foreign funds to lend out to home buyers.

The profits they made on those loans, combined with the cost of servicing the increased foreign debt, had been a significant factor in the current account deficit ballooning to $14.5 billion or 9.3 per cent of GDP.

It was unlikely the country could maintain a current account deficit at present levels without making foreign investors nervous.

"They must lose confidence somewhere," Tripe said.

The balance of payments deficit was so high there was a significant element of risk in investing here.

"The longer this goes on and the worse the position gets, the more risk we have that there will be a negative outcome," Tripe said.

Should foreign investors seek higher returns for their New Zealand dollar-denominated investments, banks would be forced to raise money at those higher interest rates "and that will impact the rates they charge borrowers".

Tripe said the value of investment in housing had grown from $30 billion in 1979 to about $500 billion now with "a large proportion" of that increase having occurred due to house price inflation over the past four years.

Housing lending had risen from $55 billion in 1998 to about $130 billion now. As lending had increased, "we've seen a significant increase in foreign funding of the banking system".

Total non-resident funding of the banking system had gone from about $10 billion in 1988 to more than $80 billion today with a $30 billion increase in the past 2 1/2 years alone.

Between mid-2000 and March 2006, net investment by foreigners - including in banking - increased from $83.7 billion to $132.9 billion.

"It's not necessarily clear that all this borrowing that New Zealand is doing is enhancing our productive capacity, there's a concern that it's being spent on housing rather than on anything else," said Tripe.

The cost of servicing overseas debt and the increased profits earned by foreign-owned companies had significantly contributed to the huge current account deficit.

"The major contributors to the profits of foreign-owned firms are in fact foreign-owned banks," said Tripe.

About $3 billion a year of foreign banks' profits were being remitted out in the balance of payments accounts and the cost of servicing the net foreign funding of the banking system cost about another $5 billion a year.

"We've got about $8 billion a year of outgoings through the investment account in net terms because of the foreign-owned banks and funding by non-residents of bank liabilities."