Current Account Deficit
What it means for New Zealand
from The Jobs Letter No.76 / 14 April 1998
The current account deficit has clearly replaced inflation as NZ's major economic
problem. And it will be the main influence on any potential for job creation in the near future.
The current account deficit is a bit like the nation's overdraft telling us how much we earn as
a country compared to how much we are spending overseas.
Late last month, the government released its December quarterly figures and they were
something of a shocker for the financial community. The deficit now stands at $7.5 billion, or 7.7%
of gross domestic product (gdp). Financial analysts were expecting a figure of about 7% for
the year, and this was already leading to a rise in interest rates and a dip in the value of the
dollar. Latest predictions for the current account deficit: it could exceed 8% for the year to March 1998.
The 7.7% figure for December is particularly worrying when you consider that
international economists believe that anything over 5-6% of gdp is a problem. It is sobering to realise that
one of the catalysts for the Asian financial crisis was Thailand's current account deficit figures of
8.2% of gdp.
- The current account deficit is a bit like the nation's overdraft. It means that NZ is
spending and investing _ eg buying more new business equipment, or buying newer houses _ but we are
not saving enough money to pay for it. Bankers need overseas investment to pay for the difference
... and in order to attract the investors, they set higher interest rates.
This all means that NZ has become dangerously reliant on overseas capital. The main
economic concern: the size of our accumulated overseas liabilities makes us vulnerable to
unpredictable external shocks such as the Asian financial crisis, or a sudden loss of business confidence.
- In recent months, Reserve Bank governor Don Brash has pointed out some sobering
statistics to illustrate our position:
the country's net external liabilities, which are about 80% of gross domestic product (gdp),
are probably the highest of any developed country.
the ratio of household sector debt to household sector income has risen dramatically
from about 40% in 1990 to around 90% today.
Don Brash has reacted to this environment by loosening up the monetary levers he holds on
the economy. This has served to drive the value of the kiwi dollar down further. A weaker kiwi
dollar pushes up the prices of overseas goods and reducing their appeal to consumers.
In the last year the value of the kiwi dollar has fallen by almost 20%. This represents a
devaluation exceeding the size of anything promulgated by Sir Robert Muldoon, and comparable to
the "crisis" days of the 1984 Lange government.
- Until the 1980s, overseas borrowing was a
government problem as it was the government who was borrowing heavily overseas to finance its deficits. But the government these days runs
a surplus and repays its overseas debts. The problem today is with the borrowing in the
private sector which has become heavily dependent on overseas funds to finance its activities. And a
lot of this overseas borrowing has gone into the speculative residential housing market which
does not generate overseas earnings, and therefore acts as a drain on the current account.
- Could an Asian-style financial melt-down happen here in NZ? Dr Brash believes there is
no such similar threat to NZ. His reasons: the NZ banking system is much stronger here than in
Asia, and foreign lenders support the government's current economic policies. In other words:
But it is a confidence not shared by all economic observers. Brian Gaynor of the
New Zealand Herald points to the parallels between the NZ current account situation, and that of our
troubled Asian neighbors: "In a number of ways the situation here is similar to South-east Asia. Banks
in that region borrowed overseas and lent to property developers for shopping malls and
condominiums, hotels and commercial buildings. The outcome of these massive foreign currency
borrowings, used to finance non-productive property assets, is large current account deficits
throughout the region"
Government statistician Len Cook says that despite the December current account figures
being higher than expected, they in fact show little impact yet of the Asian economic downturn.
He expects this to start showing up in the March figures.
- How does all this affect job creation? The deficit blowout will almost certainly mean
slower job growth and threaten more job losses. This is because the markets will respond to the
high deficit figures by setting higher interest rates and the dropping of property and asset prices.
This in turn will lead to a drop in incomes with less money available to be invested in new
businesses and their potential new jobs. And if the market "adjustment" goes on long enough,
many more people will be in danger of losing their jobs, businesses and houses.
On the other side of the coin, a lower kiwi dollar will mean better prospects for exporters
(our goods are cheaper to overseas buyers), and businesses competing against imports (overseas
goods will become more expensive to local buyers). This all holds the potential for more jobs if
the manufacturers can be convinced to pay the high interest rates on loans for any new
equipment they may be buying.
- NZ has had serious current account deficits before and all of this is nothing new to
our economic history. The trouble is that the traditional cure for a ballooning current account
deficit has been that dreaded word: recession. An economic recession generates a fall in levels of
demand in the economy, and this in turn lowers the pressures on the current account. It also,
however, means rising levels of unemployment.
In the past, the Labour and National governments have relied on foreign exchange and
import controls to regulate the demand for goods and services requiring overseas funds. This tended
to keep the current account under control and meant that the government didn't have to resort
to drastic recessionary cures.
But in today's globalised economies, there seems no place for such "fortress-style" solutions.
The economic reforms of the last 15 years have taken these political levers away from politicians.
Source "NZ's Balance of Payments Deficit: Does it Matter?" by Don Brash at http://www.rbnz.govt.nz ; and New
Zealand Herald 7 January 1998 "Housing money-pit a poor place to sink our savings" ; The Independent 18 February 1998
"Two women put paid to state paternalism" by Chris Trotter; The Independent 25 March 1998 "RB clips $Kiwi's wings" by
Bob Edlin; National Business review 27 March 1998 "Why I Believe in home ownership" by Don Brash; The Dominion 28
March 1998 "Current account deficit worsens" by James Weir; New Zealand Herald 28 March 1998 "Current Account figures
a shocker" by Brian Gaynor
- VOICES: ON THE CURRENT ACCOUNT DEFICIT
"A shocker it is just horrible."
-- Tony Alexander, Bank of NZ chief economist.
"It is probably fair to say that today's deficit is in part the result of the enthusiasm which
foreigners have had for investing in New Zealand "
-- Don Brash, Reserve Bank governor
"These figures are an absolute disaster. What we are staring down the barrel of is the highest
real interest rates in the western world and rising."
-- Jim Anderton, leader of the Alliance
"It's the result of three years of very flat export performance, and a government growth
strategy which depends upon tax cuts and consumption rather than exports and sooner or later it
was going to lead to these kinds of chickens coming home to roost"
-- Michael Cullen, Labour finance spokesman
"All this highlights the problems NZ faces with a lack of domestic savings"
-- Winston Peters, Treasurer
"Sir Robert Muldoon tried to keep the world out and failed. Labour let the world in, but
could find no way to pay for the consequences. National's solution has been to recover NZ's
fiscal position by shrugging off more and more of the state's obligations _ specifically its obligation
to protect the living standards of workers through labour market regulation, and its obligation
to provide an adequate income to the unemployed, the sick, the aged, and solo parents "
-- Chris Trotter, political commentator writing in
"NZ's dependence on Britain has largely gone, economically if not emotionally. NZ now
exports to many more countries, and has a greater range of exports. Yet all that NZ has succeeded
in doing is dispersing its dependence. NZ has virtually no autonomy as an economy. Virtually
every enterprise of importance in NZ is owned or substantially owned overseas.
"Over half the sharemarket is owned overseas and something like 60% of the bond market.
Politicians and businessmen frequently assert that one third of this country's jobs depend on
foreign investment. The NZ economy has become a branch economy, and our leading businessmen
branch managers. This is not just a matter of the interdependence characteristic of the modern
global economy, but is something that is quite abnormal"
-- Bruce Jesson, co-editor of NZ Political Review
"Until we start to fall in love with savings to a greater extent as NZ'ers, the balance of
payments is going to continue to be a problem"
-- Jenny Shipley, Prime Minister
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