Dialogue: Export growth lags booming prices

By BRIAN FALLOW

Despite high commodity prices and a weak currency, New Zealand's exports shrank in the first three months of this year.

The Reserve Bank has been scratching its collective head over this paradox. Normal historical patterns suggested that export volume growth should now be accelerating, it said in the May monetary policy statement, and import-competing firms flourishing.

But the indicators were pointing in the opposite direction.

Figures out last week reinforce these concerns.

Export volumes shrank 1.7 per cent, seasonally adjusted, in the March quarter with only dairy products (up 8.5 per cent) and non-food manufacturing (1 per cent) posting gains.

Even with dairying's strong showing, the pastoral sector as a whole shipped only 0.6 per cent more in the March quarter than it had in the same period last year.

There are, of course, biological limits on how much and how fast farm production can respond to favourable market conditions.

Commodities still make up the lion's share of New Zealand's exports.

But manufacturers managed only 0.2 per cent more exports than a year ago in volume terms.

Overall, though export receipts in the March quarter were 18.5 per cent higher than in the same period last year, export volumes were only 1.4 per cent higher.

Such annual growth figures are not much to show for a period in which the exchange rate, trading partner growth and commodity prices were all extremely favourable.

But economists are still inclined to take a sanguine view: it won't happen overnight but it will happen.

The Reserve Bank in its May monetary policy statement said the simplest explanation was that the lags between the favourable combination of low exchange rate with good export prices flowing through to a widespread expansion of export activity might be longer than had been thought.

"The lags may be long because there is value in waiting to see if export prices and the exchange rate will remain at levels which make investing in new plant and machinery profitable."

Business New Zealand economist Peter Crawford said that last year's depreciation was at first expected to be followed by a sharp rebound, but the banks had now significantly scaled back their forecasts of how far and how fast the dollar would recover.

"Most don't think it will get far past 50USc by the end of next year now," Mr Crawford said.

"If the dollar stays where it is long enough you will see a pickup in confidence."

Anecdotally, several exporters are stuck with foreign exchange hedging at around 50USc and have yet to benefit from the past year's depreciation.

Worse, they may be unhedged on the import side and have seen their input costs rise.

Bank of New Zealand chief economist Tony Alexander said that fundamentals should see the kiwi regain some strength relative to the United States dollar, but not the Australian, over the next couple of years.

The expected recovery in world growth would benefit "commodity" currencies, while improving current account balances and relatively high interest rates would also be positive for the kiwi dollar.

But Mr Alexander qualifies those observations by pointing out that market economists do not have a good track record in forecasting the exchange rate.

Over the past five years, economists' exchange rate forecasts one year ahead have been on average 8USc too high.

"Obviously the New Zealand dollar's decline from 71USc to 51c over 1997-98 was a surprise, as was the subsequent decline to 40USc over 2000.

"Hopefully, now that the New Zealand dollar has, in our opinion, completed a structural decline, the errors will diminish."

The Reserve Bank has revised down its expectations of export volume growth for the year to June 2001 to 2.5 per cent from the 8 per cent it was expecting in March. Most of this weakness is in manufactured exports.

Part of the explanation, it suggests, may lie in the "hollowing-out" of the manufacturing sector in the 1990s as manufacturers retrenched in the face of stiff competition from imports.

"As conditions have returned to more favourable settings there is simply less capacity left to respond, and the set-up cost for new firms and their necessary supporting suppliers might be larger than it would have been for an existing firm to expand."

Last week's March manufacturing data recorded no increase in manufacturing output and a 5 per cent fall in capital expenditure by manufacturers compared with the previous quarter.

This was despite surveyed capacity utilisation being maintained at historically high levels.

But Mr Crawford said that when primary food manufacturing (dairy factories and meat works) was excluded, investment was up nearly 6 per cent on an annual basis.

"What has hit the sector hardest has been the weakness of the domestic market. It is harder for firms to export when they are struggling in their home market.

"They don't go out and export just because they can't sell in the domestic market."

Rather than hollowing-out, Mr Crawford offers a simpler explanation of the lacklustre growth in manufactured exports: Australia.

Still New Zealand's largest export market even if its share is falling, it has suffered an economic slowdown but its outlook is improving.

Mr Crawford said nominal manufactured exports to Australia in the 12 months ended April were only $5 million higher than for the 12 months ended December.

Australia's own manufacturing sector struggled in the March quarter, with real sales falling 2.1 per cent and stocks increasing 0.9 per cent.

The residential construction market is only starting to show signs of shaking off a GST-induced hangover.

And then there is third-country competition. "Australia is getting the same flood of imports from China and Southeast Asia as we are seeing here, so we are having to work harder to retain the market we have got over there," Mr Crawford said.

These days, Australia takes less than a third of New Zealand's manufactured exports, he said, down from 38 per cent two years ago.

Mr Alexander said: "If it wasn't for the Australian economy being so weak we would have seen greater strength in the business investment numbers by now.

"We are reasonably confident we will see some good strength in business investment by next year as the world economy improves, and the Australian economy in particular."