Interest rates to rise if credit rating cut

The move by Standard and Poor's caught the Government by surprise yesterday. Photo / Mark Mitchell

Standard and Poor's has put the country on notice of a possible downgrade to its credit rating - which would be likely to raise interest rates across the board - unless it reduces its reliance on imported savings.

The New Zealand Government has the second-highest possible rating, AA+, but the revision of its outlook from stable to negative means there is about a one-in-three chance it could be downgraded.

The move caught the Government by surprise yesterday and led to the dollar dropping almost 1c against the US dollar.

New Zealanders collectively always want to borrow a lot more than other Kiwis are willing to lend. The difference is imported, with the result that the net international liabilities of the country (as distinct from the Government) at the end of June were $164 billion.

Relative to the size of the economy this puts us in the same neighbourhood as the "Pigs" (Portugal, Ireland, Greece and Spain) and has long been pointed to by the credit rating agencies as a problem.

It has been offset by other factors, however, including (until the recent recession) Budget surpluses and low Government debt, an independent Reserve Bank, a free-floating and actively traded currency which can act as a shock absorber, and the fact that the banks hedge the exchange-rate risk when they borrow abroad, so that someone else takes the hit if the rate has moved against the borrower when the loan has to be repaid.

The combination of recession at home and good commodity prices overseas has seen the annual external deficit improve to $5.6 billion from $16.2 billion two years ago.

Standard and Poor's executive Kyran Curry acknowledged NZ's external position had improved over the past couple of years - though not as much as the agency had expected - but said it seemed likely that as the economy strengthened, the problem of big deficits and ever-rising overseas debt would return, "and possibly with a vengeance".

"If the net external liabilities of the banking sector continue to grow, it doesn't matter how strong the Government's balance sheet might be, it will provide quite a challenge to them."

Prime Minister John Key said he thought the ratings move, which was unexpected, did not reflect any new information about New Zealand but rather a heightened focus on the risk associated with high international debt, in light of the tenor of financial markets in the wake of Ireland's problems.

The need to lift savings rates was one of the reasons for the Budget's shift in the tax burden from income tax to GST and for the establishment of the savings working group, due to report in the new year, Mr Key said.

Last week, Treasury Secretary John Whitehead urged the Government to return to operating surpluses within three or four years, rather than the five envisaged in May's Budget.

But Mr Curry said a year one way or the other was not a driver of the rating. "The most important thing is we believe the Government will make the right sort of decisions to return to surplus over the medium term."

- additional reporting: Adam Bennett