the future of nz s current account

8/10/2019 the Future of Nz s Current Account

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New Zealand has a current account deficit problem.

Its a comment thats sometimes thrown around, but is

it true? More importantly, why should it matter?

It is true New Zealand has tended to run a current account deficit

more often than not, partially due to structural factors, partially

due to competitiveness, but mostly to do with savings. To answer

the second question, it matters because the risks pose significant

implications for the economy, credit rating, currency and financial

market outlook. In this regard the current account can be a key

indicator about a countrys willingness and ability to service its

debts.

What is the current account?The current account is the net result of a countrys

transactions with the world. Primarily it comprises net

investment income (i.e. how much New Zealanders earnfrom investment abroad minus how much overseas investors

earn from investment in New Zealand), and net exports (i.e.

exports minus imports). The flipside of the current account

is the capital account which is the flow of capital required

to fund the deficit or surplus. For example, if a country is

running a current account deficit, other countries must

provide the necessary capital to fund that deficit. The two

make up a countrys balance of payments.

The current account deficit: a brief synopsis

New Zealand has more or less persistently run a current accountdeficit since the 1970s. During the financial crisis and global and

domestic recessions the current account made some tentative

improvements. However much of that improvement could be

attributed to cyclical factors. For example during the recession in

New Zealand the income (i.e. profits earned by foreign investors

in New Zealand) reduced, driving a transitory improvement in

the balance of international investment income. At the same

time New Zealand demand for imports dropped off, while strong

terms of trade drove a positive movement in net exports. These

forces have begun to reverse as the domestic economy has

improved.

Through the cycle, imports and exports of goods and services

have been reasonably finely balanced, while investment income

has consistently showed the largest disparity. This comes down to

a few key factors: foreign ownership of companies, international

borrowing and implied earnings yield differential. The foreign

ownership of companies is a key driver of outgoing investment

income, while the earnings yield differential is also important.

SEPTEMBER 2012

The future ofNew Zealandscurrent account

Investment insights

Current account as a percentage of GDP

-12

-10

-8

-6

-4

-2

0

2

1988 1991 1994 1997 2000 2003 2006 2009 2012

Current account balance

Goods and services balance

International investment income

Source: Statistics NZ, AMP Capital

0

2

4

6

8

10

12

14

16

1820

Incoming Outgoing

$B

illions

Current account components(average last five years)

InvestmentIncome

Services

Goods



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The gap between the implied earnings yields partly reflects arisk premium that foreign investors demand for investing in New

Zealand. While New Zealand can be considered less risky than some

countries, New Zealands economy is relatively small, concentrated,

and vulnerable to global events and trends. But part of this gap is

somewhat self-reinforcing as the persistent current account deficit

and consequent increase in foreign liabilities increases the perceived

riskiness.

Implied earnings yield

0%

1%

2%

3%

4%

5%

6%

7%

8%

2001 2004 2008 2012

Yield on NZ Assets

Yield on Foreign Assets


Current account deficit: structural vs cyclical

New Zealands large negative net international investmentposition goes a long way to explaining why New Zealand has

a persistent current account deficit. But its not all to do with

foreign ownership of companies. Its also the fact that New

Zealanders, as in many developed nations, have embarked on a

dissaving debt binge. Thats thanks in part to a booming housing

market yes, that old chestnut about overinvestment in housing.

The other point is that it shows New Zealanders dont invest

enough in their own businesses, or rather we just dont invest

enough at all.

The structural part: investmentInvestment income and net IIP % of GDP

-90

-85

-80

-75

-70

-65

-60

-55

-50

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

2000 2003 2006 2009 2012

International investment income

Net International Investment Position


As long as New Zealand has a large negative net internationalinvestment position the net investment income component of

the current account will be a drag, as it generally means greater

interest and dividend payments to foreign investors. To make

matters worse, the net international investment position can

essentially be thought of as the sum of past current accounts. This

is also known as the compounding effect in investing.

Why national savings matter

National savings (i.e. the net sum of household, corporate and

government sector savings) but particularly private savings matter

for the current account because they are more or less one and the

same. A negative current account implies a positive capital account,i.e. an inflow of funding. Logically, greater inflows of funding over

time will also increase outflows of investment income to the source

of those funds (dividends and interest), compounding the effect.

New Zealand has typically run a negative household savings rate,

particularly during the housing boom where increasing household

debt levels were offset by rising property prices. This period of

dissaving meant an increase in demand for funding, which ultimately

had to be met from offshore investors.

Source: RBNZ, Statistics NZ, AMP Capital

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

1988 1991 1994 1997 2000 2003 2006 2009 2012

Saving and the current account

NZ Private Savings Rate

Current Account % of GDP

The future of New Zealands current account


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The circuit breaker or solution for New Zealand is simply to increasethe rate of savings. In the context of the current account this would

mean:

> Increasing the volume and value of exports of goods and

services

> Reducing, holding constant, or growing at a slower pace imports

> Paying down external debt

> Investing abroad and getting a better balance of inward/

outward foreign direct investment (FDI)

> Reducing the gap between the higher return on domestic versus

foreign assets.

The risks of a high current account deficit

The current account is very much a reflection of the

structure or habits of the wider economy. It reflects export

competitiveness, national savings, (external) debt levels,

etc. Its no surprise then that countries with current account

surpluses tend to be in better positions than those with

deficits. Such countries tend to have strong export sectors,

high national savings and lower external debt. Its also no

surprise to see the relationship in the chart below, as countries

with higher current account deficits have tended to come

under greater pressure during times of financial stress.

Source: OECD, Bloomberg, AMP Capital

15 10 5 0 -5 -10 -15 -20

Greece

IcelandHungary

0

1

2

3

4

5

6

7

8

9

10

Current account balance vs borrowing costs

Portugal

New Zealand

Spain

USGermany

Switzerland

Sweden

Norway

JapanLuxembourg10y

earsovereignb

o

ndy

ield(

five

yearaverage)

While other factors are also important, the current

account balance can have a significant bearing on

borrowing costs, particularly relative to other countries.

One transmission mechanism or catalyst for this can

be a change to the credit rating. Indeed, a key risk to a

countrys sovereign rating can be a high current account

deficit. This reasoning, along with high external debt

(which is a related factor as interest costs appear in the

current account), has been cited in the past when New

Zealand has received a credit rating downgrade. The

sovereign credit rating of New Zealand remains at risk

as long as the current account deficit is large, and this

could be a catalyst for drastic movements in the New

Zealand dollar and bond yields. While we dont think

a downgrade is imminent for New Zealand, high and

rising external debt paired with a high current account

deficit, impacts negatively on our perceived willingness

and ability to service and eventually repay debt.

Some of these activities are more practical than others, butit comes down to increasing incomes (exports), reducing

debt servicing costs and increasing our outward FDI. This set

of activities falls under the increasingly mainstream idea of

economic rebalancing where the theory is that countries with

large current account surpluses need to import more and save

less, while countries with large deficits need to export and invest

more and consume less. Such imbalances have become recognised

as a key vulnerability in the global economy. For New Zealand a

key challenge is to improve the quantum as well as the quality of

savings and investment.


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...

Markets: why the current account mattersBy now it should be clear that the current account is an

important feature of the economic landscape. It also makes

sense to assume it is an important factor in thinking about the

investment outlook. This line of thinking can be affirmed through

the fact that the current account is a barometer of the structure

of an economy, and consequently will reflect fundamental

changes and trends in the economy.

Whats probably nearer to investors minds is the question how

will the current account impact on financial markets?

> Currency

A deterioration of the current account, particularly relative to

other countries, tends to have a negative impact on the exchange

rate, albeit lagged. So as the current account deficit increases, it

would be reasonable to expect a weaker New Zealand dollar to

follow eventually.

> Bonds

Similar to the currency, a marked worsening of the deficit should

see bond yields rise. There are a couple of ways this could happen:

a downgrade of New Zealands sovereign credit rating, or an

increase in the risk premium that investors demand for investing

in New Zealand.

> Equities

The picture for equities would be a little more mixed. On the

one hand a higher current account deficit could simply reflect

a stronger domestic economy, which would likely be positive

for equities. However if the country risk premium and bond

yields increased then this would likely have a negative effect on

valuations.

Contact us

Wellington office

AMP Capital Investors (New Zealand) Limited

Ground Floor, PWC Tower

113 - 119 The Terrace

PO Box 3764 Wellington

Telephone: +64 4 494 2200

or visit ampcapital.co.nz

Auckland office

AMP Capital Investors (New Zealand) Limited

Level 7, Zurich House

21 Queen Street

PO Box 5346 Auckland

Telephone: +64 9 927 1615

Important note: While every care has been taken in the preparation of this document, AMP Capital Investors (New Zealand) Limited makes no representation or warranty as to the

accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has

been prepared for the purpose of providing general information, without taking account of any particular investors objectives, financial situation or needs. An investor should,

before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investors objectives,

financial situation and needs. This document is solely for the use of the party to whom it is provided

OutlookThe most recent current account data (June 2012) showed the

current account deficit as a percentage of GDP deteriorated slightly

to 4.9%. We expect this key metric will deteriorate over the next

couple of years as cyclical factors come into play, i.e. improving

corporate profitability and rising import demand. However, we

expect the deterioration to be tempered by structural forces

such as the governments commitment to return to surplus and

higher household savings rates (and debt deleveraging). But that

is no cause for complacency, as New Zealand presently still runs

twin deficits, i.e. current account deficit and government budget

deficit. Deficits could pose a risk to perceptions of New Zealands

ability to service debts. Normally when the current account deficitdeteriorates, it also impacts negatively on the New Zealand dollar,

but in this environment factors like the US quantitative easing

programme have greater weight in the short term.

Callum Thomas

Research Analyst

CITY

09-12-49346

the future of nz s current account

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