Bernard Hickey posted on the 10 reasons why Fitch should downgrade New Zealand’s credit rating, it is an interesting post that you should run off and read before looking at this 🙂
Now that you have read that I am, for the sake of argument, going to counter each of these points. I cannot provide a “slamdunk” against anything, but I can raise the other side of the argument so that we can really think about the issues that little bit more.
Note that in many ways I agree with Bernard Hickey about our current situation being slightly precarious. However, I feel that going through these factors on the other side is a useful exercise for understand exactly what we need to look at.
1 and 2: High current account deficit/high debt position
Essentially these arguments are very similar. The current account deficit at its current level implies we are experiencing a large “inflow of net debt”, while the high stock of debt implies that we have a high stock of debt 🙂
There are two ways to view this as a problem:
- Net debt is a concern, as it is what we own in terms of assets – liabilities.
- Debt itself is a concern (absent of the asset level) as it implies that financial stability may be under threat.
Now, in terms of “sustainability” it is common to think of nominal GDP growth as some sort of maximum limit for the current account deficit as a % of GDP. Assuming inflation of 2.5% and long-run growth of 2.5% this implies our CA deficit should average 5% of GDP. It has blown this out of the water.
On the stability side it is an issue of the “concentration of debt” and the “risk associated with debt”. The higher the debt level to income the more likely it is that the debt is concentrated among specific people in the economy. Furthermore, the higher the debt is the more at risk we are from a correction in asset values etc.
My counter to these two points is:
- We KNOW that our net asset position is undervalued, as the assets associated with many small investors are not counted. This could easily account for 3% of GDP per year, implying that our CA deficit is sustainable. Furthermore, our net debt position will be significantly overstated as a result.
- If individuals know the risks associated with the debt it doesn’t really matter if the debt position is relatively high. Furthermore, we know that NZ’s banks are very safe at the moment – as they hold a lot of the debt, financial stability is not a major issue at present.
3: The fiscal balance going into deficit
The concern here is that rising government debt will simply make the debt position worse.
However, the counter here is something I use a lot:
- Ricardian equivalence: When government debt levels increase, households tend to increase savings levels. As a result, a moderate increase in government debt should translate into a moderate decrease in household debt. This will lead to a position where net debt will be unchanged (unless there are other structural factors).
4: Unbalanced economy
The issue here is that the share of GDP going to the non-tradable sector has increased. As we “make our income” as a nation through the tradable sector this might be concerning.
My counter is:
- We have had a rising terms of trade over this period. The income effect of this is not nicely captured by GDP figures. Essentially, an increase in the TOT allows us to buy more imports and the such with the same number of exports. As a result, the “non-tradable” sectors like retail have been able to increase activity with0ut us needing to actually increase export volumes. In such a case, the change in the relative shares doesn’t mean anything!
5: Fiscal position will worsen because of baby boomers
The wave of baby boomers will punish our fiscal position by going on super and using health care.
My main counters here are:
- The important thing is the “dependency ratio” – not just the old people but the very young (as they take up spending on health and education). It turns out this will increase, but not by as much as those over 65. In essence, just looking at older people exaggerates the fiscal hole.
- When the issue comes, the government will find ways to patch the hole. Ultimately, people are going to be pushed into working longer – making this less of an issue.
6: Productivity is terrible
Poor productivity growth implies that we haven’t been getting more “bang for our buck”. Without productivity growth we haven’t been able to fund debt.
- The main issue isn’t productivity measures per see (as they are random averages that are difficult to look at independently of the state of the economy) but growth in our incomes – namely, productivity growth has been weak because employment growth (and capital expenditure) has been so strong, and on increasingly spending has been on “marginal” productivity projects. A rising TOT implies that income growth has been much better than the volume “productivity” measure.
7: Banks and consumers won’t change
Banks and consumers will continue to be an issue. Banks will take on too much risk and consumers will be willing to take on unsustainable debts.
- I do not believe that the banks have taken on too much risk (hence why financial stability is not an issue) and I don’t think consumer debt is necessarily the core issue.
The household debt ratio has gone through the roof. But as we mentioned earlier, some household assets (and therefore the income flow from the assets) is missed in the statistics. Furthermore, household “debt” does not fully take into account some major assets, such as housing.
We know by looking at “nominal GDP” (to get an idea of relative prices) that consumer spending is at around historical averages. This convinces me that there is some issues with the debt statistics, not that there is a fundamental issue with households per see.
- Consumers HAVE reacted.
If we look at real GDP (where people point to in order to say households are spending too much) we know that households have responded rapidly to the worse economic conditions with March household consumption falling 1.4% on December (seasonally adjusted). In per capita terms Infometrics estimates (given assumptions on pop growth) that per person consumption could be around 3.2% lower than its peak in December 2007.
8: Commodity price collapse
Commodity prices and output have fallen, hitting income, and making our debt position even worse:
- Import prices have also collapsed. Yes, the TOT will fall but it isn’t clear that they will fall to the historically low levels we normally see during a global recession. With commodity prices expected to recover (world prices for our goods are already rising), this may not be as large an issue.
- Some industries are already seeing this – with lamb prices now at their highest level ever (depending on what figures you look at of course). Yes dairy is struggling, and there are definite financial stability issues with some dairy farms, but ultimately this card is overplayed.
- On the volume side lets remember that export volume growth has actually been very strong lately, as we have come out of a drought. Sure volume growth in an agricultural industry is never going to be spectacular (but it will also not fall strongly either), but then neither are the inputs required for the industry. As we get more inputs, people will create other industries – hell isn’t tourism one of New Zealand’s biggest export industries now? We cannot ask the government to “create” export industries, they should come about from things where we have a comparative advantage.
9: Domestic inflation is too high
Domestic inflation will continue to cause a disjoint in incentives between types of investment etc keeping our economy unbalanced.
Inflation is always an issue to be sure (discussion of it here). But we have just had a massive recession, and a whole lot of our “capacity” is now freely available.
The fact is that a recession has moderated this “non-tradable inflation” and lower inflation expectations. Now let us assume that the RBNZ will credibly keep inflation down in the future – and we have no underlying issue here.
10: We are not saving enough
Again see 1 and 2.
- It is not clear we are not saving enough. Housing and small asset vehicles are not properly counted in our statistics.
- Furthermore, a country never needs to be a net saver. As long as we have positive nominal GDP growth we can sustain a growing stock of debt forever. With the statistics currently so unclear it is uncertain whether there is an underlying debt problem.
I personally think that there are issues with:
- Incentives to invest,
- Direction of government spending,
- Incentives to produce,
Fundamentally, NZ faces a wedge between the private and social benefits of different investment (as a result of transfers, tax, poor information etc) and we have gradually built up a large debt position as a result.
However, the above discussion of the 10 points on why we need to be downgraded is enough to make me believe that the issue MAY be overcooked.
Ultimately, I hope the issue is overcooked, but I also hope that we can sort out appropriate policy before we really do face a credit downgrade.