Dollar tipped to take fresh hit next year

New Zealand will struggle to finance its current account deficit next year, triggering a second leg of currency depreciation, says ANZ National Bank's acting chief economist, Cameron Bagrie.

The deficit for calendar 2005 widened to $13.7 billion or 8.9 per cent of GDP, from $13 billion and 8.5 per cent of GDP in the year to September, Statistics New Zealand reported yesterday.

Although in line with market expectations, it is the widest the deficit has been relative to the size of the economy for 30 years.

"It is probably close to its nadir but it will improve only slowly," Bagrie said. And there were only two ways of funding the deficit: foreign direct investment or debt finance attracted by the difference between interest rates available here and those on offer in other markets.

As for FDI, the family silver had largely been sold off already. And the yield gap - how much higher New Zealand interest rates are than elsewhere - would narrow as overseas interest rates were set to rise, especially those in the key Japanese market.

In recent years, much of the deficit has been funded by eurobonds, especially uridashi, issuance snapped up by investors attracted by the high interest rates and, especially in Japan's case, making substantial gains on the currency. But the exchange rate has fallen lately - catching up with the economic fundamentals, Bagrie said - and interest rates are expected to fall too.

Meanwhile $14 billion worth of uridashis - New Zealand dollar bonds issued to Japanese investors - are due to mature next year.

"We are looking at a big current account funding hole next year."

Bagrie concludes that what will give is the exchange rate with a likely second leg to the kiwi dollar's depreciation next year, to the low 50USc. That, in turn, would limit the extent to which the Reserve Bank could cut interest rates.

Economists said the fall in the dollar since the start of the year and signs of a cooling in domestic spending suggested the deficit was close to its worst.

In the short term, a weaker currency would widen the trade gap as expressed in New Zealand dollars, but as export competitiveness improved and imports became more costly to domestic consumers it would improve.

Bagrie said without a recession, the improvement would be gradual.

Bank of New Zealand economist Dean Ford said an improving current account position would be part of a realignment and rebalancing between the external and domestic sides of the economy over the next few years. "But we are still a long way from any sort of sustainable level [in the current account deficit]."

The trade balance in the December quarter improved on a seasonally adjusted basis - to a deficit of $858 million against $1.57 billion in September. That caused the overall current account deficit to improve for the quarter as well, to $3.38 billion from $3.84 billion in September.

But Ford said the quarterly data were fairly volatile and improvements in the seasonally adjusted figures had occurred from time to time all through the recent run-up in the deficit.

The cumulative effect of decades of deficits is a net international debtor position of $136.7 billion, of which $23.7 billion is equity and $112.7 billion is debt. Servicing that debt resulted in an investment income deficit of $10.3 billion last year or 7 per cent of GDP.

In the December quarter, the net investment income outflow increased to $2.8 billion from $2.6 billion in September. Statistics NZ said: "This was largely due to a rise in profits within the banking industry, though other sectors' profits also rose."


Current chasm

* Trade in goods: $3.9 billion deficit in 2005 ($2 billion in 2004).
* Trade in services: $400 million surplus ($1 billion in 2004).
* Investment income: $10.8 billion deficit ($9.1 billion in 2004).
* Net international liabilities: $136 billion or 89 per cent of GDP ($126 billion in 2004).