Reserve Bank: Large current account deficit unlikely to cause major problems

Governor Adrian Orr speaking to media about why the Reserve Bank is keeping the OCR at 5.5 per cent. Photo /Mark Mitchell

The Reserve Bank believes New Zealand’s large current account deficit will “narrow in an orderly manner”.

“At this stage, the risk of a deterioration in the economic or financial stability outlook arising from the current account deficit is viewed as low,” the central bank said.

It canvassed the issue in the “special topics” section of its quarterly Monetary Policy Statement, in which it explained its decision to keep the official cash rate (OCR) at 5.5 per cent.

The Reserve Bank also shared its view that immigration spurs inflation. But in the current environment, where employers are struggling to find the right staff, immigration isn’t as inflationary as it was pre-Covid.

“In an environment of acute labour shortages, it is unlikely that net immigration contributes even more to the supply of labour than otherwise, and is therefore less inflationary,” the Reserve Bank said.

“[T]he composition of net immigration also influences the extent to which it is inflationary.”

The issue is topical, as immigration is spiking following a period of Covid-related travel restrictions. Annual net migration rose to 86,800 people in the year to June. In the year to June 2019, this figure sat at 52,100.

Economists recognise that on the one hand, immigrants fill skill shortages, which reduces employees’ abilities to bid up wages and businesses’ abilities to push up prices. But on the other, immigrants need to eat, shop, travel, pay for housing, etc, so spur economic demand, putting upward pressure on prices.

Westpac chief economist Kelly Eckhold is among those who believe the overall effect of high immigration is inflationary to the extent it will be a key factor in prompting the Reserve Bank to lift the OCR again in November.

Other economists, like Kiwibank chief economist Jarrod Kerr, believe further OCR hikes were completely unnecessary.

The Reserve Bank said it would keep investigating the impact of immigration on inflation, suggesting it might not cut the OCR until early-2025.

As for the current account, the deficit was worth $33.0 billion in the year to March, which was equivalent to 8.5 per cent of gross domestic product (GDP).

The deficit has averaged at around 4 per cent of GDP since 2000.

The Reserve Bank recognised the gap between the value of what New Zealand imports and exports shows the country is spending more than it’s earning.

“Persistently large current account deficits could make New Zealand more vulnerable to changes in the availability or cost of funding from overseas,” it acknowledged.

However, it noted much of the deficit was caused by temporary Covid-related factors, which would dissipate and see the deficit narrow to 4 per cent of GDP over the next three years.

The Reserve Bank recognised tourists are returning to New Zealand, meanwhile, the Government plans to eventually get the books back to surplus.

“Higher interest rates are also encouraging households and businesses to save more and invest less,” it said.

While credit rating agencies are keeping an eye on the current account deficit, the Reserve Bank believed it was unlikely to destabilise the economy or financial system.

“New Zealand’s external debt position is relatively sustainable, with a significantly lower ratio of net foreign liabilities to GDP than during the GFC [2009 Global Financial Crisis],” it explained.

“The share of bank funding that is core – such as longer-term wholesale funding and deposits – is high, and much higher than it was before the GFC. This minimises the risk of a sudden funding withdrawal or that a large share of debt will roll over at a time when funding conditions are stressed.

“As was also the case before the GFC, the vast majority of New Zealand debt is either denominated in New Zealand dollars or is hedged.”

Jenée Tibshraeny is the Herald’s Wellington Business Editor, based in the parliamentary press gallery. She specialises in government and Reserve Bank policymaking, economics and banking.