Deficit shrinks by $1.5b as BNZ takes hit

The current account deficit shrank by $1.5 billion in the June quarter as returns to foreign investors in New Zealand crumpled.

The deficit is the broadest measure of the gap between what New Zealand earns by trade and investment from the rest of the world and what the rest of the world earns from us.

Adjusted for seasonal effects, it was a deficit of $600 million in the June quarter, down from $2.1 billion in the March quarter, Statistics New Zealand said. The unadjusted balance was a surplus of $124 million, the first quarterly surplus since 2003.

It brought the annual deficit down to $10.6 billion or 5.9 per cent of gross domestic product from $14.6 billion and 8.1 per cent of GDP in March.

Measured against the size of the economy, it is the lowest the annual deficit has been since September 2004.

But the improvement in the quarterly deficit owed nothing to any improvement on the merchandise trade front. A $772 million drop in the value of imports was almost entirely ($771 million) offset by a drop in the value of exports, as falling export prices - the steepest for 52 years - more than offset an increase in export volumes as dairy shipments in particular recovered from drought-hit levels.

Instead, most of the improvement in the deficit ($1.2 billion of the $1.5 billion) was a decline in the investment income deficit and most of that ($661 million) reflected the Bank of New Zealand booking a provision, in case it should lose its litigation with Inland Revenue over structured finance transactions. It still has two layers of appeal up its sleeve.

In another respect, too, the quality of the improvement is less impressive than the quantity. Normally some of the profits of foreign-owned companies are retained in the enterprises which generated them, even though all of it is booked to the current account.

But over the year ended June every dollar of the cumulative $4.6 billion in equity income on foreign direct investment in New Zealand was repatriated as dividends.

The $2 billion foreign investors earned from their investments in New Zealand in the June quarter was half what it had been a year earlier, and the lowest since March 2001.

ANZ National Bank economist Philip Borkin said the annual deficit was likely to fall well below 5 per cent of GDP over the coming quarters, courtesy of the June quarter's steep fall.

"However, the main drivers - a capitulation in imports, low interest rates which lower debt servicing costs, and lower profitability of foreign firms owing to some one-off tax treatment - all look to be cyclical in nature."

ASB chief economist Nick Tuffley expects further declines in the annual deficit to run out of steam by the end of the year. "Beyond 2009 we expect the deficit to range between 6 and 7 per cent of GDP. Export earnings will be constrained by the global environment, while the stabilising domestic economy will soon halt the slide in imports and domestic profitability," Tuffley said.

"A still-large current account deficit will remain a risk to New Zealand's economic stability, as well as a prod for changes in economic policy."

Deutsche Bank chief economist Darren Gibbs has a more upbeat view of the outlook.

"In our view the annual deficit is likely to fall to around 3.5 per cent of GDP by the end of this calendar year thanks to weak imports and continued temporarily low returns on foreigners' investments in New Zealand.

"We would expect to see the deficit widen back towards 5 per cent of GDP in 2010 as the economy recovers, bringing with it stronger import demand, improved corporate profitability and higher interest rates," he said.

"At the margin international credit rating agencies will probably take some comfort from today's report. However, an improvement in the goods and services balance, driven by a sustained improvement in net exports, would have a much stronger influence on the rating."

ON BALANCE
* The balance of payments deficit shrank much more than expected in the June quarter.
* The improvement was not on the trade front: exports fell as much as imports did.
* The lower deficit mainly reflected weaker returns to foreign investors, though much of that was the BNZ provisioning against the possible loss of a tax case before the courts.