Country Report New Zealand
Economic growth is slowly decelerating in New Zealand due to prolonged low commodity prices. Low milk prices put a strain on the dairy sector. Meanwhile, the RBNZ in general softened its LTV restrictions, but tightened it for the Auckland area.
Strengths (+) and weaknesses (-)
(+) Stable and reliable public institutions
Governance, rule of law and transparency indicators confirm the stability of the government. There is a strong motivation across all political parties to pursue fiscal consolidation. The central bank is independent and highly credible in its inflation mandate and its supervisory role.
(+/-) Strong position as agricultural commodities producer
The primary sector accounts for only 7% of GDP, but for more than 50% of export earnings. Dairy and meat alone consists of 42% of export revenues. The dependence on primary exports makes the country subject to volatility in the global commodities market.
(-) Large external debt
New Zealand has a long history of current account deficits resulting in a large negative international investment position. This is mainly financed through debt, with net external debt at 59.9% of GDP in the third quarter of 2014. The persistent gap between private savings and investment induces higher domestic interest rates and thereby an elevated exchange rate.
(-) Banking sector is highly concentrated and dependent on foreign funding
The four biggest banks together have a 84% market share (in loans). The low household savings rate (2.1% in 2014) makes the banks reliant on foreign wholesale markets for funding, though tighter regulations have reduced the dependence to 29% of total funding, down from 39% in 2008.
1. Growth is decelerating
Economic growth is expected to slow down to 2.9% in 2015 and 2.7% in 2016 (IMF WEO) from 3.3% in 2014. Given the disappointing growth figure in the first quarter of 2015 (0.2% q-o-q instead of the expected 0.6% q-o-q), it is likely that the growth forecast for 2015 will be adjusted downwards to around 2.5%. Moreover, leading indicators like the purchasing managers index (PMI) support the view that growth is decelerating. The PMI averaged at 53.1 over the period January to March 2015 compared to an average 56.0 over 2014. Another signal of slowing economic growth is that the central bank (RBNZ) reduced its interest rate with 25 bp to 3.25%, last June. They also forecasted further easing in the near future. That said, GDP growth is still relatively strong thanks to domestic demand. A large net immigration flow, strong disposable income growth and high demand for residential investment will remain supportive to growth. Meanwhile, the prolonged low commodity prices (especially the low dairy prices) results in low inflation levels and slower (farmers) income growth. Given that the dairy sector provides 30% of the country’s export products and meat exports another 12%, the low prices will likely result in a widening of the current account.
2. Dairy sector under stress
The financial position of many dairy farmers will likely be under pressure in the coming season, due to a declined payout, while debt levels remain high (figure 1). As a result of the sharp drop in global dairy prices, the dairy payout for the season 2014-2015 is much lower than in the previous season. Given weak global demand and ample supply, global dairy commodity prices are expected to remain weak till at least early 2016 according to Rabobank Food & Agri Research. In accordance with the global data, the 2015/16 opening milk price forecast also remains at a relatively low level. It ranges from NZD 4.70 to NZD 5.60/kgMS (excluding dividend payments), which is just a little higher than the current season payout. Meanwhile, debt levels in the dairy sector remain high, but reduce gradually as percentage of the milk production. Dairy debt is however highly concentrated among a small number of farmers. According to RNBZ and DairyNZ, 10% of dairy farms account for about one-third of total dairy farm debt. Based on this data and estimates of working expenses, they expect that about 25% of the farms will have negative cash flows in the 2014-15 season. Moreover, according to their data, there is a significant correlation between farms with negative cash flows and high LTV-ratios. This increases the risk that the negative farm income developments will spill over into lower land values. During the Global Financial Crisis, falling farm incomes led to lower liquidity in the market and to a sharp decline in farm prices. A mitigating factor is that the farm price-to-income ratio is now lower than prior to the GFC.
3. New LTV-restrictions on Auckland mortgage lending
The imbalances in the housing market have risen further. House price inflation rebounded strongly in the Auckland region, while in the rest of New Zealand the house price development has eased significantly since the introduction of the LTV-restrictions in October 2013. House price inflation in Auckland was 16.9% yoy compared to 7.7% yoy across the whole country in the period Jan-Mar 2015. In the Auckland area, new building has been low, while demand kept growing strongly due to net immigration and falling interest rates. As a result, housing is becoming less and less affordable in Auckland (figure 2). Nationwide, the price-to-income ratio was 30.8% above the historical average in 2014. The house price growth is even more excessive compared to the rents, the price-to-rent was 69.4% above the historical average in 2014. Moreover, the risen house prices increase the risk of a sharp price correction in case of a severe economic downturn. A decline in Auckland would be amplified by reversed immigration flows or a pulling out of speculative demand. In response to these regional developments, the central bank (RBNZ) announced changes to its restrictions on mortgage lending. It retained its speed limit (maximum of 10% of total new lending) on high LTV loans (>80%) for owners-occupiers in the Auckland area. For the rest of New Zealand, the limit has been raised to 15% to acknowledge the more subdued housing market conditions outside of the Auckland region. The RBNZ also introduced a new 30% deposit requirement for residential property investors in the Auckland area that use bank loans, as they noticed that lending to investors is riskier than to owners-occupiers. Moreover, the share of investors in the Auckland housing market was on the rise.
The public institutions of New Zealand have a good reputation. The government ranks high on themes like democratic institutions, government transparency and absence of corruption. The central bank is independent and highly credible. GDP per capita (at PPP) is 88% of the OECD average or 73% of the Australian income level, reflecting below-average productivity, distance to export markets, and the small size of the economy which limits opportunities for scale advantages. Economic growth was and still is mainly based on private-sector borrowing and terms-of-trade gains. In the future, the economy needs to rebalance towards more sustainable growth, for which productivity growth is necessary. This structural challenge is reflected in the long history of current account deficits, which has resulted in a large, negative net international investment position. The shortfall of private savings has generated higher interest rates than in comparable countries, and therefore led to an overvalued exchange rate. The exports of New Zealand are highly concentrated both in products (food & agri) and destinations (China and Australia).
The banking sector is also highly concentrated. The four biggest banks have a market share (in loans) of 84%, making each of them too-big-to-fail. These banks are subsidiaries of the biggest Australian banks, but in general do not get funding from their parents. Historically, the banking sector has been highly reliant on foreign wholesale markets, but tighter regulations have reduced this dependence. Above-average capital ratios make the banking sector more resilient to economic stress. According to the IMF, the banking sector can withstand a shock to either its residential mortgages or its corporate lending book. A combined shock, though, would pose problems to their capital position, of which the risks are ultimately borne by the government.