KEY POINTS:
Standard & Poor's has put the Government on notice that the country's sovereign credit rating is at risk of downgrade, now that our parlous external accounts have been joined by rapidly deteriorating fiscal ones.
It is a timely reminder that the country is up to its neck in debt to the rest of the world and that limits the Government's room for maneuvering now, even though the debt has very largely been run up by the private sector.
In the year to September 2008 the current account deficit was $15.5 billion or 8.6 per cent of GDP.
Years, nay decades, of such deficits have pushed the country's net international investment position deep into the red. At $165 billion (net of New Zealand assets abroad) it is equivalent to 92 per cent of GDP.
Among developed countries only Iceland's ratio is higher. The United States' net debtor position, about which there has been so much hand-wringing, by contrast is about 20 per cent of GDP.
It is an uncomfortable position at the best of times and these are among the worst of times.
For some years the rating agencies, S&P particularly, have in effect been warning that we could only expect to get away with external accounts in this state because the Government's accounts, by contrast, were a model of providence.
A decade and a half of fiscal surpluses has reduced gross Government debt to 18 per cent of GDP and net debt to zero.
But that was before the global economic crisis.
It has been startling how fast the fiscal outlook has deteriorated, as outlined first in the pre-election opening of the books and then in the December update.
In the latter's downside scenario, which increasingly looks more likely that its central forecast, a string of deficits will see gross Government debt climb from $31 billion to $81 billion by 2013, or 38 per cent of GDP. The taxpayer's interest bill would rise accordingly.
"Although we view such deficits as not uncommon given the cyclical weakening of tax revenue and counter-cyclical measures taken by the Government, market confidence may wane until policymakers articulate a plan for medium-term fiscal consolidation," S&P said.
It would be looking to the next Budget for an indication of medium term expenditure cuts and reprioritisation of policy initiatives the Government intended.
In the absence of a "credible" medium-term fiscal plan, combined with an easing of the country's external imbalances, the credit rating on the Government's foreign currency debt could be lowered, it said.
Normally a lower sovereign credit rating would flow through to every other borrower, raising the cost of debt across the board.
Finance Minister Bill English was quick to point out that Spain, Ireland and Greece had also had their ratings outlooks changed over the past few days.
"The Government is committed to the kind of fiscal policy consolidation Standard & Poor's has referred to," he said.
"In that regard any calls for further fiscal stimulus need to be weighed against the consequences of taking on further debt."
That comment could be taken as a reminder, both to his Cabinet colleagues and to every lobby group with pet projects to peddle as "timely fiscal stimulus", that the Government does not have an open cheque book.
If you just look within the four corners of the Crown's balance sheet there appears to be ample scope for further borrowing.
But put it in the context of a high level of external indebtedness, and the ticking fiscal timebomb of ageing babyboomers, and it is a very different story.
It suggests any further fiscal measures would need to be time-limited or easily reversible - in a way income tax cuts are not.
And what about the other leg to Standard & Poor's criteria of preserving the country's AA+ credit rating - an improvement in the external accounts?
Imploding demand within our trading partners and plunging commodity prices suggest that exporting our way out of trouble is not an option in the near term.
Improvement in the trade balance is more likely to come on the import side, as a weaker kiwi dollar makes imported wares more expensive while mounting job insecurity and declining housing wealth encourage households to spend less and save more.
More generally, economists can demonstrate algebraically that the current account deficit is the difference between domestic investment and domestic saving.
So narrowing the deficit to more sustainable proportions can be achieved by reducing investment - not good for the economy's growth potential - or increasing savings, which is no good for businesses based on consumer spending. Or both.
The composition of the capital inflow which fund the current account deficit also matters.
Of the current account deficits of the past decade (a cumulative $88 billion) the great bulk ($80 billion) was funded by an increase in banks' net foreign liabilities.
Overall the banking system accounts for around 60 per cent of New Zealand's gross international debt, some $140 billion.
Much of that is funds the banks have borrowed from their Australian parents, but much of it is raised directly on the US commercial paper market, which all but froze in September and October.
And typically much of the debt is short-term. Statistics New Zealand reports that as at the end of September 2008, $84 billion or 36 per cent of the country's international financial liabilities matured within three months.
Nor was that a reflection of the exceptional times. A year earlier it had been 38 per cent.
Fortunately there are signs international credit markets are returning to normal.
The "Ted spread", which is the difference between the rate (Libor) at which banks will lend to each other for three months and the rate at which they will lend to the US Government, has fallen back to the sort of levels prevailing for most of last year, before it spiked to paralytic levels in September and October. Libor has also fallen.
More importantly a couple of the New Zealand banks have been able to get away some longer-term (three- or five-year) issues.
But availability is one thing, cost is another.
Spreads remain high from a longer-term historical perspective, and in addition the banks now have to cover the cost of the Government's guarantee, the fees for which were set at levels to encourage them to invoke it no longer than they absolutely need to.
In addition there is a potential crowding out effect in credit markets generally as the governments of major economies seek to fund their rapidly burgeoning deficits.
President-elect Barack Obama will inherit a deficit for 2009 of US$1.2 trillion ($2.2 trillion), according to the Congressional Budget Office, even before the cost of his own stimulus package.
The moral of the story is that we are in this fix because of a reckless attitude towards debt.
Measures which transfer debt and risk from the private to the public sector may be necessary to stop the problem from getting even worse - though even that depends on how it is done.
They do not constitute a solution.
