New Zealand may be particularly vulnerable to sudden shifts in global investor sentiment, partly because of the high amount of NZ dollar-denominated debt issued offshore, the OECD said in a report today.
The Reserve Bank has been forced to raise interest rates 10 times in three years to7.50 per cent, the highest level among industrialised countries, to try and quell inflation.
That has boosted the kiwi's allure to offshore investors, but also put pressure on exporters who are seeing the currency eat into profits in foreign currency.
"For global investors -- Japanese retail investors in particular -- the high yields on NZD offshore bonds provide attractive investment opportunities," the OECD said.
That offshore-issued debt -- called eurokiwi and uridashi bonds -- reached $53 billion in late 2006, with $16.9 billion maturing this year.
Unless those bonds are rolled over into new NZ dollar-denominated bonds or other NZ dollar assets, they will exert considerable pressure on the exchange rate and interest rates, the OECD said.
"The Reserve Bank is relatively sanguine about the risk of sudden withdrawal by foreign retail investors, but this depends on a number of assumptions about the ongoing preferences of foreign investors."
The current situation of abundant global liquidity could change, or the opinion of New Zealand's economy could worsen.
Offshore markets have provided an important channel for New Zealand banks to increase the availability of credit, but may also have driven real estate prices higher than they otherwise would have reached, the OECD said.
New Zealand households are highly indebted, with the share of mortgage debt to household debt the highest across OECD countries.
The present restrictive stance of monetary policy will eventually reign in household spending and lead to more stable house prices, while the high exchange rate has already put a considerable squeeze on exporters' profits, the report said.
The New Zealand dollar has, on average, been the most volatile among OECD currencies between 2001 and 2005, and the third-most volatile between 1996 and 2000, trailing the Japanese yen and Australian dollar.
