Gaping deficit leaves NZ vulnerable

By BRIAN FALLOW

Do we have to worry about New Zealand's gaping current account deficit? After all, economic forecasters are picking a strong rise in exports as the world economy continues to gather strength.

Unfortunately, yes.

Although the trade balance (including services such as tourism) is expected to return to the black next year and stay there, the surpluses are only expected to be around $1 billion or 1 per cent of gross domestic product.

They are dwarfed by ongoing deficits in net investment income - non-residents earn about $7 billion more a year from their investments in New Zealand than New Zealanders earn from investments overseas.

The resulting shortfalls of around 6 per cent of GDP leave New Zealand vulnerable to a major shift in sentiment by international money markets. From being relaxed about our current account deficit, the markets could turn nervous and drive the kiwi dollar down and interest rates up.

To reduce the deficit, politicians focus on improving New Zealand's export performance. In particular, they are almost unanimous that we should develop high-tech export industries. Tomorrow's Business Herald will analyse assorted policies being offered in that area.

But exports alone cannot cure the current account deficit. To be sustained, an export boom requires imports of capital goods. The boom can also lift personal incomes, which in turn would spur greater demand for imported goods.

The key to reducing the current account deficit, says Institute of Economic Research director Alex Sundakov, is to reduce the extent to which we rely on other people's savings to finance investment in New Zealand.

National savings rates have been falling dramatically. For the year ended March 1999 national savings (the difference between income and spending by the Government, business and household sectors combined) fell to the lowest level for 20 years.

For the second year in a row households collectively were net dis-savers. They spent all their incomes, and then some, funding consumption by borrowing more.

How can the poor savings rate be turned around? National argues that boosting disposable incomes through economic growth and tax cuts will boost people's ability to save. The Government has also been talking to the savings industry to unearth any anomalies and impediments to saving thrown up by the current tax system.

Labour says the first step is to put the public superannuation scheme on a more secure footing, particularly because the population is aging.

Secondly, Labour's planned comprehensive review of the tax system will have increasing savings as one of its key terms of reference.

National Bank chief economist Brendan O'Donovan says it is the investment side that is crucial for economic growth, not savings. There is nothing wrong in principle with relying on foreigners' savings to fund investment, if the investment is of good quality.

A good proportion of the investment has been of high quality, he says.

Corporate balance sheets are generally healthy and, unlike in the Muldoon era ,the current account deficit has not been funding Government spending.

But much of the blowout in the current account deficit over the past seven years went to finance a property price boom in the residential and rural sectors. Mr O'Donovan says asset price booms are not particularly productive investments but the big increase in household sector borrowing has tapered off in the past couple of years, as debt-to-income ratios rose to levels similar to other OECD countries.

Households will probably be reluctant to push up their debt levels again as fast as they did in the mid-1990s, although the Reserve Bank in particular will be watching closely for signs to the contrary.

If offshore investors perceived the current account deficit as a problem the markets will take corrective action, Mr O'Donovan says. New Zealand's country risk premium would go up, meaning higher interest rates and a lower exchange rate.

"That makes imports more expensive and exports more competitive, which tends to help the trade balance. Equally, higher interest rates tend to encourage saving and discourage investment, again helping the current account."

He says concern over the current account is one of the factors weighing the kiwi dollar down.