Cutting debt - we'll be hearing plenty about that in next week's Budget, and the election campaign. But how deep in hock are we? Brian Fallow reports.
We are up to our collective nostrils in debt.
It is risky. It is costly. And the need to do something about it will figure prominently in the rhetoric of next week's Budget.
Finance Minister Bill English has been insistent about getting the Government's books back into surplus, to increase national savings and reduce the vulnerability associated with the country's high external debt.
"The last 10 years was particularly poor for savings in New Zealand," he said in response to a patsy question in Parliament last week.
"Household debt rose to about 160 per cent of income and New Zealand's foreign debt liabilities almost doubled."
But now that households had begun to save it was time for the Government to pull its weight.
"Up until now we have been willing to borrow in order to cushion New Zealanders from the impact of the recession, but now that economic growth is under way it is time for the Government to tighten its belt, reduce its deficit and [then] get back to surplus."
To understand what he is on about, we first need to untangle the connections between foreign or external debt, household debt and government debt.
When people talk about the external debt they are usually referring to the net international investment position, which is the sum of external liabilities - claims that foreigners have on the New Zealand economy - offset by New Zealand assets abroad. Those liabilities include claims against the government, NZ businesses and individual Kiwis.
At the end of 2010, the latest figures available, our gross external liabilities were $312 billion. Four-fifths of that was debt rather than equity and three-quarters of the debt had been incurred by banks.
On the other side of the the ledger, New Zealanders held $152 billion of assets abroad, of which 38 per cent was equity.
So the country is a net debtor to the tune of $159 billion (or $36,000 per capita), of which the banks account for 73 per cent.
This level of debt is the cumulative effect of decades of running deficits in the current account of the balance of payments - that is, earning less from the rest of the world from trade and investment than the rest of the world earns from us.
As with an individual who lives beyond his or her means, the shortfall has to be funded by running up debts or selling assets. We have done both, but mainly the former.
Relative to the size of the economy, net debt is 82 per cent of gross domestic product.
Although down from a peak of 90 per cent two years ago, this level of foreign debt is still very high by international standards and puts us in the same neighbourhood as Portugal, Ireland, Greece and Spain - known to the financial markets as the Pigs.
"Until the global financial crisis it was easier to discount the argument that the level of net foreign liabilities was a problem, but in the wake of the IMF rescues of Greece and Ireland and the recent negative outlook warning on New Zealand's [credit] rating, New Zealand can no longer be so complacent," says the Savings Working Group's report earlier this year.
"Its net foreign liabilities position is similar to Portugal, Ireland, Greece and Spain, countries currently in financial distress. New Zealand's risk is that it suffers a similar fate, with financial markets turning against it, which would cause serious economic hardship to many New Zealanders."
But we are in much better company if you look instead at the government's debt position rather than the country's. On that score New Zealand is at the virtuous end of the OECD league table, bettered only by Australia, Luxembourg and Korea.
For years the the credit rating agencies contrasted the high level of the country's external debt with the relatively strong position of the Crown's accounts, implying - without stating it outright - that it was the latter that allowed us to get away with the former.
Even after the February earthquake, Standard and Poor's noted that net government debt was estimated (pre-quake) to peak at 34 per cent of GDP in 2015, only half of the median level for other AA-rated sovereigns.
But S&P has New Zealand's sovereign rating on negative outlook all the same, citing the external position as its key weakness. "The rating could be lowered if New Zealand's external position deteriorates further, particularly due to rising cross-border funding costs of the banks."
Another rating agency, Moody's, has New Zealand's big four banks, with their Australian parents, on negative outlook because of their heavy reliance on foreign funding for the lending they do.
The Reserve Bank says some 41 per cent of the banks' funding is from offshore.
The perils involved in that were made starkly clear at the height of the global financial crisis when short-term wholesale credit markets, which had become a key source of funding for the New Zealand banks, simply froze, paralysed by the prevailing fear.
Before the crisis passed the Government had felt compelled to underwrite the banks' wholesale funding.
Since then the Reserve Bank, as the regulator of the banking system, has moved to limit the extent to which banks can rely on short-term wholesale funding and is developing more stringent rules for how it will deal with a bank that gets into trouble.
The banks only import money in order to on-lend it, of course.
What has driven their foreign debt levels to these heights is that New Zealanders always want to borrow more money than other New Zealanders want to save, combined with the last decade's booms in residential property and farmland.
Between March 2000 and March 2010, the amount that households, businesses and farmers owed the banks climbed 158 per cent, from $117 billion to $302 billion.
A year later, in March this year, it was still $302 billion, with a little more household debt offset by a little less business debt.
This lack of credit growth, by the way, is part of the evidence that the economic recovery English describes as "under way" exists largely in forecasts rather than being plain for all to see in hard current data.
The increase in private sector debt over the decade to March 2010 was largely driven by households' mortgage debt, which rose 167 per cent to $169 billion and which represents more than half of all bank lending.
Business debt to the banks doubled over the same period and farm debt nearly quadrupled, from $12 billion at the start of the millennium to $47 billion 10 years later.
That surge in farm debt means the record export prices farmers are now enjoying won't give the economy as much of a boost over the next 12 months as they normally would, says Bank of New Zealand chief economist Tony Alexander.
"The farmers aren't going to spend up large. They are going to concentrate hard on repaying debt and that will limit the flow-through to the wider economy of their higher incomes."
More broadly, the cost of servicing the country's external debt would not be a problem if the borrowing had gone towards productive activity, Alexander says.
"But it hasn't. It has gone towards simply buying each other's houses and farms and towards high levels of consumption."
High external debt leaves the economy vulnerable the next time an event like the collapse of Lehman Brothers happens and banks cannnot refinance their own maturing debt overseas, Alexander says.
"But for me the the greater concern about our low savings rate is that when companies look to expand it is hard to go and raise equity, so they end up borrowing from friends and family and putting the house on the line. That makes them cautious about their business venture."
Relying on banks rather than investors for their financing reduces the pressure on businesses to make the most of the opportunities before them, Alexander argues.
"Instead of having investors on their back, they have bankers who just want to be sure the loan gets serviced and repaid."
Low savings means higher interest rates than would otherwise be the case, he says, and higher exchange rates as well.
The NZ Institute of Economic Research's director, Jean Pierre de Raad, says it is questionable whether international investors can, or want to, differentiate between whether the external debt is driven by the private or the public sector.
"Is it just that the nation has got debt and it implies something about what might happen to the exchange rate down the track, and therefore the amount of risk premium [in the interest rates they require]?"
There is also a vicious circle dynamic which the Reserve Bank has fretted about: that high debt means the economy is getting ahead of itself, spending money it has not earned, which is inflationary and means the bank has to raise the official cash rate, which means more foreign money flows in attracted by the higher interest rates on offer, further fuelling inflation, requiring even higher interest rates, and so on, round and round.
"Whichever way you look at it, you end up with a cost of capital higher than it otherwise would be," de Raad says.
How much higher is hard to say. The NZIER estimates that if New Zealand reduced its external debt from over 80 per cent of GDP now to 60 per cent, which is about where Australia's is, it would cut the cost of capital by about 0.4 percentage points. Some other estimates are higher.
The OECD's biennial report on New Zealand last month warns of long-lasting impacts from the global financial crisis on the country's already relatively high cost of capital.
Global interest rates would not remain at stimulatory levels indefinitely and financial regulation was becoming more restrictive in response to pre-crisis excesses.
New Zealand's high net external debt makes it more vulnerable to those developments, the OECD says, so a relatively high cost of capital will continue to weigh on the economy's potential growth rate.
Council of Trade Unions economist Bill Rosenberg says government debt is low by world standards. "It is always good in the long run to get it down, but there are times when you need debt to tide the country over a recession. In itself - and even the credit rating agencies are saying this - it is not a risk. The real risk is private foreign debt.
"The way they see this as a risk to New Zealand's sovereign rating is that somehow private debt will get heaped onto the Government, as it has with South Canterbury Finance and as it threatened to during the financial crisis when the Government was guaranteeing not only deposits but wholesale bank finding."
So as the CTU sees it, the Government should not be too worried about increasing its level of debt while the economy is still effectively in recessionary times, with unemployment high and so on.
It agrees that we need to address foreign debt. In that connection increasing national savings is part of the answer, but slow and uncertain, Rosenberg says.
"If the real threat is is of another financial crisis - which is what Bill English hints at from time to time and which should not be discounted - what we need to do is put in place some protections that make it less likely that (a) the Government gets loaded with all that debt and (b) the money can be withdrawn so quickly that it constitutes a danger to the New Zealand economy."
The Reserve Bank is working on that, Rosenberg says.
"It is an interesting question whether the increase in debt was driven by New Zealanders demanding more credit so they could buy ever more pricey houses - which is the story we are told - or whether it was fed by the banks accessing cheap money overseas and then allowing that huge increase in property values to occur, which just couldn't have if credit had only been available from our own sources."
The banks must take some responsibility for the ballooning of household debt, Rosenberg says. "And the policy consequence is that the Government has to look quite closely at controlling banks' behaviour so that it doesn't repeat itself."
There is a risk it will recur, he believes.
"Maybe not this year or next year, but if the economy isn't turned around so that there is money to be made in investing in the productive sectors, then we will go back to the old ways of speculating in property prices. "
Brian Fallow is the Herald's economics editor
