Brian Gaynor: Savings big issue for capital-starved NZ

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One of the important questions facing the new Savings Working Group is does New Zealand need to earn before it saves or do we need to save more before our earnings and standard of living increase?

Phil O'Reilly, the chief executive of Business NZ, believes that we have to earn more before we can save.

He wrote this week: "I believe New Zealand's greater priority is to overcome our smallness and remoteness, and export more branded, high-value goods overseas. We have to start earning more in international markets. Savings is a priority too, but a lesser one, since we need to earn before we can save."

O'Reilly argues that Australia is a successful economy because it is internationally competitive and it's wrong to assume that compulsory super is the main reason for our neighbour's success.

The Treasury views it differently in this week's "Savings in New Zealand - Issues and Options" paper. Analysis shows New Zealand has a low savings rate and "domestic resources have shifted from investment and exporting to supplying non-tradeable output to satisfy government and household consumption. Higher imports have been necessary to meet demand".

Although O'Reilly makes some good points, New Zealand companies are capital starved and it is extremely difficult to be successful on international markets with a limited equity base. There is also a strong argument that our boom and bust mentality, recently reflected through the finance company debacle, is due to a shortage of savings and capital.

The latest managed funds statistics, for the end of the June 2010 quarter, reflect this dearth of equity capital compared with Australia.

At the end of June, we had only $6.3 billion of managed funds invested in domestic equities compared with A$495.4 billion ($630 billion) across the Tasman (see accompanying table).

The situation has deteriorated over the past decade. For example:

* The total amount of New Zealand managed funds invested in domestic equities has declined from $7.2 billion in June 2000 to $6.3 billion

* Over the same 10-year period, the amount of Australian managed funds invested in domestic equities has surged from A$188.9 billion to A$495.4 billion.

* New Zealand's negative growth has had a dramatic impact on the NZX as shown by the following figures:

* The total value of all domestic companies listed on the NZX has risen from $49.7 billion in June 2000 to just $50.0 billion 10 years later while the value of ASX companies has leaped from A$682.0 billion to A$1,253.7 billion in the same period

* Meanwhile, the number of domestic listed New Zealand companies has risen from 120 to 137 since mid-2000 compared with an increase from 1260 to 1893in listed Australian companies.

The good news, according to the latest Goldman Sachs ownership study of the NZX, is that offshore interests now own only 36.1 per cent of our market compared with 47.2 per cent ten years ago.

The bad news is is that many of our companies with large offshore shareholders in 2000 have either been taken over, left the country or had to be bailed out by the Government.

These include Air New Zealand, Baycorp, Brierley Investments, Carter Holt Harvey, Fletcher Challenge Energy, Independent Newspapers, Lion Nathan, Nufarm and Tranz Rail.

There is little evidence that we are expanding high-value exports leading to higher earnings and more savings, as suggested by the chief executive of Business NZ.

New Zealand's total exports have declined from 23.8 per cent of GDP in 2000 to 21.9 per cent at present, whereas Australian exports have risen from 14.7 per cent of GDP to 16.0 per cent over the same period.

Meanwhile New Zealand's total gross overseas debt has surged from 98.3 per cent to 130.0 per cent of GDP in the same period while Australia's overseas debt has gone from 63.5 per cent of GDP to 96.7 per cent.

Australia has benefited hugely from the emergence of China and its demand for natural resources while we have struggled to keep up.

My experience from more than 30 years analysing and visiting Australasian companies is that one of the main problems on this side of the Tasman is the shortage of equity.

Young entrepreneurs struggle to attract start-up capital and many of them have to borrow against their residential property to fund their companies. This places a huge burden on them, as do the student loans that many of them have.

These young entrepreneurs, together with most other New Zealand business people, are always on the back foot because they have to generate earnings before they can invest in their businesses. They usually cannot invest before they earn because of a shortage of capital.

This makes it difficult to grow a business because there aren't sufficient funds to create the internal structure and expertise essential to expanding without taking on too much financial risk.

Examples of the many companies that have made acquisitions offshore and have been unsuccessful include The Warehouse, Air New Zealand and Telecom.

They didn't invest in strong implementation teams, which require individuals with the expertise and experience to ensure an acquisition is successful, and as a result their offshore expansions were unsuccessful.

But the biggest problems occur during boom periods when a sudden increase in demand and activity has a devastating impact on organisations that haven't built an organisational structure to cope with this growth.

That is why there were a huge number of company collapses in the 1980s and so many finance companies have gone bust in recent years.

Most finance companies were little more than sales organisations - trying to attract new money from investors - rather than companies that invested in their lending side, particularly as far as credit analysis was concerned.

When they were inundated with money in the early 2000s they hadn't invested in sufficient credit analysis expertise to enable sensible lending decisions.

This under-investment has become a feature of New Zealand businesses because directors and management have become used to operating on bare bones due to a shortage of capital. The country's infrastructure has also been neglected as this under-investment culture has evolved.

There have also been a huge number of related party transactions in New Zealand. These transactions, which have destroyed substantial investor wealth, have been partly due to our scarcity of capital.

Business people have set up deposit-taking operations with the clear objective of obtaining funding for themselves because they cannot acquire it elsewhere, while others have started with good intentions but granted themselves large loans because that's their only source of funding.

Finally, there is the issue of our high interest rates and exchange rates, which are largely driven by our lack of savings.

According to the Treasury, "A permanent increase in national savings will take pressure off domestic resources which will allow, on average, lower interest rates to maintain low inflation. As the premium on New Zealand interest rates relative to interest rates elsewhere would be smaller, it would be expected that the exchange rate would be lower. This would be beneficial to the export and import-competing sectors."

Most of the members of Mr O'Reilly's Business NZ would be jumping for joy if higher national savings delivered lower interest rates and a lower NZ dollar.

* Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.