KEY POINTS:
The outlook for the New Zealand economy next year is heavily dependent on you and me and the amount we are prepared to borrow and spend over the next 12 months.
This is because the economy has been driven by consumer spending in recent years and shows little
sign of shifting to an export-led situation.
As the accompanying table shows, the country's GDP, or total expenditure on goods and services, is now $157.9 billion, or 18 per cent, higher than three years ago as measured in current money terms.
In real terms - after adjusting for inflation - the economy has grown by 8.5 per cent over the same three-year period.
The most notable feature of the economy in recent years has been the huge increase in household and credit card debt, which has risen from $100.1 billion to $149.6 billion since 2003.
Individuals have been on a borrowing and spending binge that shows no sign of abating.
Household debt increased by $14.8 billion in 2004, by $17.4 billion in 2005 and $17.3 billion in the past 12 months.
On a per head basis, including every man, woman and child, New Zealanders now have $36,000 of debt compared with $25,000 three years ago.
Who are we borrowing from and what are we doing with the money?
Most of the household debt is sourced from banks, which borrow most of the funds abroad because of the low level of savings at home.
According to Statistics New Zealand, the total amount of overseas borrowings sourced through the banks has risen from $72 billion to $104.4 billion over the past three years.
As total household debt has increased by $49.5 billion since 2003 and overseas loans sourced through the banks have risen by $32.4 billion, about two-thirds of the additional household borrowings have been sourced from abroad. Overseas lenders, whether individuals or institutions, are willing to lend to us because of the high interest rates we are prepared to pay on our borrowings.
It is difficult to know precisely what we do with our additional borrowings, but most of it is probably spent on housing, day-to-day living expenses and one-off items such as overseas holidays or imported four-wheel-drives.
As individuals borrowed an additional $17.3 billion over the past 12 months and the total amount of residential building permits, including apartments, alterations and additions, was only $7.2 billion, then a reasonable percentage of the new loans went into general spending.
The New Zealand economy now resembles an individual who is spending up large in the hope that the parents or grandparents will leave a large legacy to repay the debts.
The household borrowing binge is having a big impact on the country's current account deficit and overseas balance sheet as demonstrated in the accompanying table.
Exports have increased by only 17 per cent, to $34.1 billion, in the past three years whereas imports have grown by 25 per cent, to $37.3 billion. The poor performance of the export sector is a major concern as far as the long-term outlook for the New Zealand economy is concerned.
But the biggest worry is the escalating gap between the country's investment payments (interest payments and dividends remitted offshore) and investment receipts (interest receipts and dividends received from abroad).
Over the past three years New Zealand's annual investment payments have surged from $9 billion to $13.8 billion whereas its investment receipts have fallen from $2.3 billion to $2 billion.
As a result, the country's annual investment deficit has grown from $6.7 billion in 2003 to $11.8 billion and the total current account deficit has risen from $5.9 billion to $14.4 billion.
New Zealand's balance sheet also reflects the large increase in overseas borrowing, the sale of assets to overseas investors and the country's low level of savings and overseas investment.
Over the past three years the New Zealand's overseas assets have risen by $21.7 billion to $107.6 billion while overseas liabilities have grown by $52.1 billion to $244.7 billion. As a result the net deficit between overseas assets and liabilities has increased from $106.7 billion to $137.1 billion since 2003.
This net overseas deficit of $137.1 billion represents 87 per cent of GDP, one of the highest net overseas deficits to GDP ratios in the developed world.
Neither countries nor individuals can continue to borrow, spend and live beyond their means and New Zealand is no exception to this rule.
Week after week Reserve Bank Governor Alan Bollard emphasises this message but little attention is paid to his words of warning.
Bollard has raised the official cash rate from 5 per cent to 7.25 per cent over the past three years in an attempt to curtail household borrowing but to no avail.
Higher interest rates make it more attractive for overseas lenders to lend to us, particularly through the Australian-owned banks, and we are happy to borrow more and more money at higher and higher interest rates.
The high interest rates, and resulting flow of funds into the country, have underpinned the value of the New Zealand dollar. The high kiwi has had a negative impact on the export sector, which offers the best prospect of sustained and healthy long-term economic growth.
There are three main potential economic scenarios for New Zealand in 2007 and beyond. These are:
* Residential housing prices level out and there is a substantial reduction in the growth of household debt. Under this situation, which is the preferred scenario, the Reserve Bank will begin to reduce interest rates in the second or third quarter of 2007 and the dollar will ease slowly. A lower kiwi will boost the export sector and signal the long-awaited shift from a borrow-and-spend to an export-led economy.
* The second scenario is that house prices, personal debt, interest rates and the dollar continue to increase and the economy stays stronger for longer. This will have a positive impact on GDP growth in 2007 but raises the odds of a hard landing in the second half or later.
* The last, and least attractive scenario is a hard landing. This is where house prices fall, lenders demand additional security, consumer spending slumps and the economy flattens or contracts.
Economists are not expecting the third scenario in 2007 but if we continue to borrow and spend, and fail to develop a strong export sector, then a hard landing for the New Zealand economy is a strong possibility in the medium term.
