Cheese prices have fallen to their lowest in five years. Photo / Sylvie Whinray
OPINION
Welcome to Inside Economics. Every week, I take a deeper dive into some of the more left-field economic news you may have missed.
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If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.
Q: Hi Liam,
In last week’s column, you mentioned that we need to worry about our relatively low [Crown] debt level partly due to high private debt. Why does private debt impact Crown debt? Is private debt a factor for rating agencies?
Also, doesn’t the fact that the Reserve Bank holds a high percentage of Crown debt mean we need to worry less about it? Does keeping the debt level low with a massive infrastructure deficit makes sense?
Kushlan Sugathapala
A: Great question, Kushlan. It has become a feature of Kiwi economic debate that when someone points out how bad our sovereign debt is, someone else will counter that (as a percentage of GDP) it is much lower than other wealthy nations. At that point someone else will explain that we can’t afford that level of Crown debt because our private debt levels are so high... and around it goes...
Your question made me wonder how the rating agencies actually view it all. So I asked S&P directly.
S&P primary sovereign analyst for New Zealand, Martin Foo, explains:
“A credit rating, by definition, is a forward-looking opinion about an obligor’s capacity and willingness to meet its financial commitments (i.e. its debts),” Foo says.
“For sovereign governments, public debt clearly matters. The more public debt a sovereign has, the less creditworthy it will generally be. This said, public debt isn’t as central to sovereign credit ratings as many observers think it is. We consider factors such as a sovereign’s institutional settings, economic wealth, external balance sheet and monetary policy credibility as more important than a sovereign’s public debt burden, and our criteria therefore assigns higher weighting to these factors.”
“Private debt is not an explicit metric in our sovereign rating methodology,” Foo says. ”But we monitor private debt because of its indirect influence on other factors, such as our economic assessment. For instance, when private credit is expanding quickly and indicating a credit bubble, we would typically penalise the economic assessment. An overleveraged domestic economy might also manifest in a high current account deficit, and this would typically result in a weaker external assessment.”
“In addition, a high level of private-sector debt may create financial sector vulnerabilities and transmit shocks through the economy (eg the 2007-2008 global financial crisis). Any subsequent deleveraging could also hamper economic growth.”
So, essentially if the economy is well structured and can keep generating enough money, then it is possible to maintain a strong credit rating with high sovereign debt.
New Zealand does okay on this front but is hampered by large current account deficits and the perceived financial risks around how highly leveraged our housing market is.
Kiwis owe about $400 billion in mortgage debt – about double core Crown borrowing. We mostly owe that to Australian banks, which means there is a constant drain on the nation’s current account by way of interest payments, which feed those giant bank profits.
As to the Reserve Bank’s ownership of all those Government bonds, well, they still have to be counted on the balance sheet and there is an expectation that they will be paid down over time. It does help if a nation can cover most of its sovereign debt locally. But that requires much higher levels of savings.
In Japan, government debt to GDP is a staggering 263 per cent (or $US9.2 trillion) but most of the debt is held by either the Bank of Japan or Japanese investors. That takes the pressure off the current account and Japan’s net debt to the world (although it does have a worse credit rating than New Zealand).
Unfortunately, New Zealand relies on foreign capital to fund most of its borrowing. So despite a good reputation around our ability to keep paying it back, we suffer when rating agencies look at the net position. So we need to keep our Crown debt relatively low to keep the rating agencies from downgrading us.
Last week, prompted by news of the French ratings downgrade, I talked up New Zealand’s relative strength in this area. For an economy that regularly gets described as a basket case these days, we continue to maintain the second-highest rating available (AA+) – on par with the US and Taiwan and better than the UK and France.
I hope I didn’t speak too soon.
A good story by Dileepa Fonseka for BusinessDesk has raised the possibility that New Zealand could be facing a post-Budget rating downgrade.
“Krisjanis Krustins, Fitch Ratings’ sovereigns director for Asia Pacific, said poorer growth prospects, and therefore a weaker tax take, was a big factor feeding into the agency’s assessment of the Government’s fiscal position – which it earlier indicated looked weaker after the Budget,” writes Fonseka.
“Looking at the numbers presented in the Budget, it’s difficult to escape the fact that debt is just going to be higher and deficits wider than previously expected and the deterioration is quite stark,” Krustins said.
Krustins wasn’t commenting on the odds of a future downgrade, although Fitch released a report in the wake of the Budget which said it expected to revise its forecasts for New Zealand’s government debt-to-GDP ratio upwards and noted projected debt levels might exceed the “AA” median.
That sounds like there may still be some breathing space. You’d hope so, otherwise, the Government’s decision to prioritise tax cuts over deficit reduction is going to look poorly timed.
But Krustins also highlighted some darker clouds gathering around New Zealand’s economic outlook.
“In our assessment, we see some of the growth drivers that New Zealand had in, say, the decade before the Covid-19 pandemic; it seems that these have run their course and may not be tailwinds to growth in the decade to come.”
So, we can’t rely on a dairy boom, Chinese consumer demand or tourism to deliver the kind of dramatic growth they did. What exactly will the new growth drivers be?
It’s a big question. Probably the biggest this current Government is facing.
One great hope for generating new sources of foreign income is the tech sector. Specifically, there is plenty of hype about New Zealand being a base for giant data centres required to maintain all the information the internet is gathering and help artificial intelligence (AI) make humans redundant.
Data centres require a lot of power to run, which raises issues about how many can handle them. New Zealand’s capacity to generate carbon-neutral renewable energy for them (if they are built in the right location) could help. Fans of The Matrix movie series will recall this issue is eventually solved when AI turns redundant humans into battery cells to power the data centres and keeps us blissfully unaware by plugging us into the virtual reality of the “Matrix”.
Microsoft and Sydney-based DCI Data Centres are building giant data centres in Auckland’s northwest. Now, NZX-listed investment firm Infratil has announced a $1.15 billion capital raise to fund its data centre expansion.
The capital raise will be one of the biggest in the New Zealand market in recent years.
Data centres are a “red-hot” investment area right now, Matt Goodson, managing director at Salt Funds, tells the Business Herald’s Jamie Gray.
There is anticipation that the offer will be well received by investors, and also hope that Infratil is well placed – with significant renewable energy assets already – to handle the energy demands (no need for human battery cells just yet).
Speaking of foreign export earners, what’s up with the price of cheese? Apparently, it is the cheapest it has been in five years.
“Despite overall food prices increasing in the 12 months to May 2024, the fall in cheese prices was the largest contributor to any individual food item. The price for a 1kg block of cheese was $10.02 per kilo in May 2024, down from $13.60 in May 2023,” Stats NZ said last week.
It seems like the whole country goes crazy when cheese prices spike. We see endless media headlines and vox pops in supermarkets and letters to the editor.
But when it comes back down, nobody seems to notice.
The Stats NZ selected price index last week was a good one for consumers. The index captures about 45 per cent of total consumer price index inflation – including food, rent and transport costs.
It came in lower economist expectations. Food prices in New Zealand increased 0.2 per cent in the 12 months to May 2024, the smallest increase since September 2018.
Fruit and vegetables were down more than 11 per cent for the year.
Of course, there has always been an aspect of “be careful what you wish for” with cheese prices. What we pay at the supermarket is loosely correlated to global dairy prices.
So when we’re paying a lot for cheese, that usually means the economy is benefiting from a dairy boom. Conversely, when prices are low... well, we’ll see how the economy is going with GDP data on Thursday (probably not good through).
That GDP data on Thursday will probably show we are still in recession. Or, if we do get a small bounce of growth, we will still be very deep in a per capita recession.
Engineered by the Reserve Bank with high interest rates, the trade-off should be that we beat inflation. It’s the same story all over the world right now. People are grappling with the pain of rising unemployment and business failures while still feeling angry about the last vestiges of high inflation.
So which is worse recession or inflation? Last week the Financial Times took a look (republished in the Herald) at the research on how people feel about the two economic bogeymen.
Recent studies have found people dislike inflation a lot more now than they did a decade ago. Not surprising, given we’re living through a lot more of it.
But the results were far from clear-cut and there is some evidence that when it comes to policy trade-offs (as opposed to general anger), people are still prepared to tolerate some inflation to ensure unemployment doesn’t rise too high.
This week’s graph is the BNZ/BusinessNZ Performance of Services Index (PSI) and shows activity in April hitting its lowest level on record, outside of Covid-19 lockdowns.
The PSI for May was 43.0 (a PSI reading above 50.0 indicates that the service sector is generally expanding; below 50.0 that it is declining). This was down 3.6 points from April and the lowest level of activity for the sector for a non-Covid lockdown month since the survey began in 2007.
“The speed of decline is as worrisome as its size over the past three months. There is weak and then there is very weak. Overall, this tells of a services sector in reverse, at pace,” said BNZ senior economist Doug Steel.
Grim as is this for the immediate economic outlook, it may be heartening for the Reserve Bank and others watching the inflation fight. The services sector falls very much within the “non-tradeable” side of the inflation ledger. It’s the domestic stuff that remains stuck at 5.8 per cent. Non-tradable inflation – stuff, fuel and food prices – has fallen to just 1.6 per cent (giving us a topline CPI inflation rate of 4 per cent).
It seems likely the big gains have already been made on the tradeable side now – if we want CPI inflation under 3 per cent so interest rates can fall, then we need to see the non-tradeable side fall away fast.
The latest PSI offers one sign that this is happening now.
Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003.
To sign up to my weekly newsletter, click on your user profile at nzherald.co.nz and select “My newsletters”. For a step-by-step guide, click here.
If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.
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