KEY POINTS:
Two of this week's big business stories, the huge current account deficit and the sale of Telecom's Yellow Pages Group, are related.
The burgeoning current account deficit is primarily caused by a negative investment balance as the outflow of dividends and interest payments from New Zealand is far greater than the inflow. The sale of profitable companies to overseas interests exacerbates the deficit.
The problem with Telecom's sale of Yellow Pages is that it could add more than $100 million a year to the current account deficit and increase the gap between the country's international assets and liabilities.
There won't be a material improvement in the current account deficit until we stop selling assets to overseas interests, our companies make more profitable overseas investments and we rely less on foreign lenders to fund our residential housing market.
The current account is the sum of all New Zealand's receipts from trade, services, investment and transfers minus the outward payments on these items. A positive current account usually increases the net surplus of a country's international assets over its liabilities; a deficit does the opposite.
This week's figures revealed that New Zealand had a current account deficit of $14.4 billion last year compared with $13.9 billion for 2005 (see top table). The deficit has steadily increased in recent years although it has eased slightly from an annual high of $15.1 billion for the June 2006 year.
The deficit also peaked at 9.7 per cent of GDP in the June 2006 year and had fallen to 9 per cent of GDP by the year's end.
The huge investment deficit, which has risen for 13 consecutive quarters, is the main contributor to New Zealand's deteriorating overseas financial position.
In the December 2006 year, $14.3 billion of investment income flowed out of the country and only $2.2 billion came in, leaving a net investment deficit of $12.1 billion. New Zealand achieved a return of only 2.3 per cent on its overseas assets during the year while foreign investors had a return of 6.2 per cent on their investments in New Zealand.
The other important statistic in this week's balance of payments figures is the statement of the country's international assets and liabilities (see bottom table).
One of the consequences of the current account deficit is that New Zealand's international liabilities have blown out from $195.6 billion to $255.3 billion in the past three years. The net international deficit has escalated from $106.1 billion to $143.2 billion during this period because assets have grown much more slowly than liabilities.
The most startling feature of the international liabilities figure is that total overseas bank borrowings, which are mainly used to finance the housing market, have risen from $76.1 billion to $112.6 billion in the past three years. Overseas bank borrowings now represent 44.1 per cent of New Zealand's international liabilities compared with 38.9 per cent at the end of 2003.
We are becoming increasingly dependent on Australia as our four major banks are based in either Sydney or Melbourne.
The level of direct investment, which is defined as an interest representing 10 per cent or more of a company, also shows the extent to which the domestic economy has become dominated by Australia.
Australian direct investment in New Zealand surged by $18.3 billion in the five years ended March 2006 (the latest available figures). New Zealand's direct investment in Australia increased by $100 million.
At the end of March last year, Australia represented 50.5 per cent of all direct overseas investment in New Zealand compared with just 31.5 per cent five years earlier.
In the light of these figures it is ridiculous for some parties, including the Treasury this month, to claim that New Zealanders are saving enough. The growing current account deficit, the widening gap between international assets and liabilities and the huge increase in overseas bank borrowings clearly show that we are becoming increasingly dependent on overseas savings to fund our lifestyle.
The sale of the Yellow Pages Group for $2.24 billion represents yet another asset sale to overseas interests (the sale does not pass through the current account because it is a capital item). Most of these sales look like a good deal at the time but in retrospect, it is often clear they were sold too cheaply.
Time will tell whether $2.24 billion is a good price for Yellow Pages, but in the meantime the sale will add to the current account deficit and the gap between our international assets and liabilities.
The Yellow Pages sale and our overall investment behaviour contribute to the current account deficit in several ways:
* The willingness to sell control of our companies means that total direct equity investment in New Zealand was $51.6 billion at the end of 2006 compared with inward portfolio equity investments of $16.9 billion. Direct investment has a bigger impact on the current account because dividends and reinvested earnings are taken into account whereas only dividends are included as far as portfolio investments are concerned. By comparison direct equity investment into Australia was A$255.5 billion ($289 billion) and portfolio equity investment A$309.7 billion.
* New Zealand has invested only $16.1 billion overseas through direct equity investment compared with $33.5 billion under portfolio structures. This means most of our overseas equity investments are credited with dividends only, rather than dividends and reinvested earnings. Australians have offshore direct equity investment of A$273.7 billion and portfolio equity assets of A$205.8 billion.
* Many major New Zealand companies have a high dividend payout ratio. This means that overseas portfolio investors obtain a relatively high return from their New Zealand investments. Conversely New Zealand overseas portfolio investors receive a relatively meagre return because of the lower dividend yields in other countries (capital gains and losses are not included in the current account).
The use of the proceeds from the Yellow Pages sale will affect New Zealand's current account, although Telecom's directors will not take this into account when making their decision.
The board has several options regarding the $2.24 billion including:
* A share buy-back.
* A large dividend.
* Repayment of debt.
* Investment in its New Zealand network.
* Participation in the recapitalisation of Hutchison Telecommunications in Australia.
* Funding the acquisition of Powertel in Australia.
The most likely outcome is a combination of these, with up to $1.3 billion returned to shareholders, $400 million through dividends and the rest through a share buy-back.
The best long-term option, as far as New Zealand's current account is concerned, is for a high percentage of the proceeds to be reinvested in Australia and the performance of the group's AAPT, Powertel and Hutchinson Telecommunications to improve dramatically.
Our current account deficit is essentially an investment problem and the best way to solve it is for our major companies to invest and perform much better overseas. We must stop selling our high-earning assets to overseas interests and there has to be a substantial reduction in our dependence on foreign lenders to fund the domestic housing market.
Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Managementw.
bgaynor@milfordasset.com
