Ballooning External Debt causes concern

Stephen Toplis – BNZ Shoot 2 Photo by Mark Tantrum | www.marktantrum.com

New Zealand’s annual current account deficit stood at 3.5% of GDP in the year to June. That looks a bit better than the 3.7% anticipated by the market (and us), but mainly on (a host of) historical revisions.

The deficit for the year to March was revised to 3.4% of GDP, from 3.6% previously published.

Therefore, the annual deficit widened a touch from its (now) smaller starting point.

But it is decimal point stuff.

The more interesting thing is, ‘Where to next.’

We remain of the opinion that the current account deficit will widen over the coming year.

Widening deficit

It will perhaps push out to around 5% of GDP through 2016.

This reflects the balance of goods trade moving into deficit as the full impact of the previously very weak dairy prices filter through (with some offset from markedly lower oil prices).

It also includes our expectation that dairy production will be lower in the current season than the year prior. Meat production will also be under pressure, given fewer sheep, lambs and cattle (both beef and dairy) numbers.

We expect lower dairy and meat export volumes through 2016.

We continue to watch the still strengthening El Nino weather pattern, which is usually negative for New Zealand pastoral agriculture.

Rising risks

There are clear risks to 2016 production.

On the positive side, we anticipate the annual surplus in services trade to expand over the coming 12-18 months, from the $2.8 billion it reached in the year to June 2015.

Ongoing growth in tourism exports is part of this view as is the lagged influence of a lower New Zealand Dollar.

Rapidly improving dairy prices (witness the large 16.5% gain at the auction overnight) might yet prevent the annual current deficit from getting as wide as we currently forecast.

But even getting to around 5% of GDP through next year, our view is markedly different to the near-7% published by the Reserve Bank of New Zealand (RBNZ) for the year-to-March 2017. A good chunk of the difference in view between us and the RBNZ seems to stem from the terms of trade (and most likely dairy prices, given the RBNZ commentary around such).

Declining trade

Over coming quarters, the RBNZ sees the terms of trade bottoming out at about 15-16% below year earlier levels. We see the trough at about -6%.

 

However, we should note the decline in the terms of trade may not have a one-for-one influence on the current account balance. The ultimate impact of the terms of trade on the current account balance depends on its influence on savings and investment.

Lower income or purchasing power from a lower terms of trade is likely to reduce saving (in one form or another). That would widen the current account deficit. But lower income would also be a drag on investment. That would reduce the current account deficit.

Moreover, policy implications of a smaller-than-expected current deficit would not be straightforward.

But, if the current account does not balloon as big as the RBNZ currently anticipates – presumably it would reduce the Bank’s discomfort with any given level of the currency and/or may limit the Bank’s view on how low the NZD would need to be.

Lowering Cash Rate

That does not necessarily mean if the RBNZ were now to see a stronger NZD compared to its September projections that it would have to compensate by lowering the OCR by more than currently signaled. More to the point, stronger-than-anticipated terms of trade (and likely narrower current account deficit) would argue for tighter monetary conditions than would otherwise be the case. But there are many moving parts.

And we need to be wary of what, at least in part, is driving the likes of the dairy price rebound. That is, expectations of lower New Zealand milk production.

In short, while we think the terms of trade will be higher than the RBNZ forecast over the coming year, we also think GDP growth will be lower than the Bank’s projections.

We still expect the RBNZ to cut the OCR by 25bps by the end of the year.

We formally have it occurring in October, but we are becoming less convinced on the timing.

Today’s current account data do not change our +0.8% pick for Q2 GDP, but the details confirm there is more downside risk to our view than upside.

Indicative of such is that our estimate of growth via the expenditure side of GDP remains at +0.6%. Today’s data suggest a bigger fall in goods export volumes that we have penciled in for the quarter, but higher services export volumes and lower services import volumes keeps the bottom line on the expenditure side largely the same.

Stephen Toplis is Head of Research at BNZ, the Title Sponsor of the Indian Newslink Indian Business Awards 2015 and Sponsor of the ‘Best Large Business’ and ‘Supreme Business of the Year.’

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