High overseas debt leaves NZ vulnerable, warns Bollard

Alan Bollard. Photo / Mark Mitchell

New Zealand banks are in good shape and will benefit from the economic recovery, the Reserve Bank says, but a high level of overseas debt leaves the country vulnerable to any renewed deterioration in global financial markets.

A cautious approach to debt accumulation both by the Government and by households is needed to limit those risks, it says in its six-monthly financial stability report.

Releasing the report yesterday, Governor Alan Bollard said global financial markets remained fragile.

"The sovereign debt concerns facing some European economies have weighed quite heavily on financial markets in recent weeks. The European authorities and the IMF have recently announced initiatives to support sovereign debt markets and to start to deal with these underlying problems, but there clearly is a risk of further turbulence if adequate progress is not made there," he said.

"Luckily for us, those are in a completely different part of the world. They are not currently affecting us very much, although we do watch how that has spilled over into bank financing markets in the last couple of weeks a little bit."

Deputy Governor Grant Spencer said that while there had been a tightening in debt markets, so that it had been more difficult to get longer-term funding, that constraint applied mainly to banks with an exposure to Europe, especially southern Europe.

"I think it is fair to say the term market is pretty well on ice at present, but certainly short-term funding is continuing. After the volatility of a couple of weeks ago things have been stabilising and I would say improving."

Bollard said immediate liquidity issues had been plugged by the $1.3 trillion package the European authorities and International Monetary Fund had put in place.

"But that doesn't mask the fact that there is a real structural issue, which is how some of those heavily indebted countries ... are going to pay for it out into the future."

This had been the first tough test of whether the fiscal disciplines associated with European monetary union had worked, and they had not.

Gross Government debt for the OECD countries is expected to exceed 100 per cent of GDP next year - about three times the New Zealand level.

This is likely to have an impact on the cost of funds for private borrowers, the financial stability report says.

"Although the borrowing demands of the New Zealand Government are modest by international standards, fiscal consolidation remains an imperative given New Zealand's high level of private sector debt."

New Zealand's net external debt is 84 per cent of GDP, largely reflecting borrowing by households.

Lately households have been saving more and borrowing less, but it is too early to say if that marks the beginning of a long-lived structural change or is a temporary response to the financial crisis, the bank says.

Debt servicing costs as a share of household income have fallen, but only back to where they were in 2006 and they remain historically high. They are likely to climb as mortgage rates rise sooner and faster than incomes.

Meanwhile the bank regards the continuing decline in business borrowing as reflecting firms' reluctance to borrow rather than banks' reluctance to lend.

"We do need to see more investment in plant and equipment so we will need to start to see business credit pick up" Bollard said. "New Zealand needs it for recovery and I think the banks understand that."