Brian Gaynor: Debt profile puts economy on alert

Debt statistics are normally a good indicator of economic trends and activity. The economic policies of the Lange Administration were in direct response to the borrowing binge by Sir Robert Muldoon's National Government.

The sharemarket and commercial property crash in the late 1980s was primarily due to excessive borrowing and we now have to ask whether the huge increase in household debt has any implications for the New Zealand economy in the years ahead.

The Treasury maintains comprehensive records of the Crown's borrowings, which is known as the public debt. When Muldoon became Prime Minister in November 1975, public debt was only $4.2 billion, but when he departed nine years later it had ballooned to $21.9 billion.

This consisted of $8.2 billion of New Zealand borrowings and $13.7 billion from overseas.

The borrowings were mainly due to National's huge Budget deficits and the Treasury advised the incoming Labour Government: "Chronic imbalances between Government expenditure and revenue can seriously disrupt and destabilise the economy by generating spiralling debt burdens.

"This suggests that action must be taken to reduce the substantial fiscal imbalances that exist in New Zealand. The medium-term objective should be a deficit of less than 2 per cent of GDP."

The Lange Government reduced the deficit, but its financial position continued to suffer from the huge losses incurred by Muldoon's Think Big projects. In 1987 the Crown was forced to borrow heavily overseas to meet debt servicing and capital repayments related to the projects.

As a result, public debt increased from $32 billion in 1986 to $42.5 billion the following year.

At that stage the Treasury began to aggressively promote privatisation. In 1987 shareholdings in Petrocorp and the BNZ were sold to the public and the Crown's asset sales programme was underway.

In a recent article in the Business Herald, Sir Roger Douglas, the Minister of Finance between 1984 and 1988, argued that the objective of the sales programme was to create greater economic efficiency, but he then went on to berate the Muldoon Government for leaving him with a huge burden.

The Treasury promoted privatisation from an efficiency point of view, but this was the secondary objective of politicians. They wanted to repay debt and reduce the Crown's interest charges so that the money could be spent in other areas.

Sir Roger wrote that he was totally opposed to the sale of Air New Zealand to the Qantas/Brierley Investment consortium, but he had set a $2 billion asset sales target for the 1988/89 year and if Air New Zealand had not been sold the target would not have been achieved.

Between 1987 and 1999, the Government realised $19.1 billion from the sale of assets, but the public debt declined only $5.8 billion, from $42.5 billion to $36.7 billion.

Sir Roger argued that the assets were not sold cheaply. He wrote that Telecom was sold for $4.25 billion, or 6 per cent of GDP, "a price unheard of anywhere else in the world".

But a study in 1999 showed that the privatised assets were then worth $35.7 billion, $16.6 billion above their sale price. Nearly 80 per cent of the gain had gone to overseas investors.

The important point is that the huge profits would have remained in New Zealand if the assets had been sold to local investors.

Although the public debt has fallen by less than the $19.1 billion realised from asset sales, it has stabilised and is declining as a percentage of GDP. The overseas portion of the public debt has dropped dramatically and now represents just 19 per cent of the total figure, compared with 51 per cent in 1987.

But private overseas debt has risen sharply, from $27.4 billion in 1989 to $109.9 billion at present. It now represents 92 per cent of GDP, compared with just 41 per cent in 1989.

The banks account for $65.4 billion, or nearly 60 per cent of this debt.

Bank economists conveniently ignore these figures, yet large increases in private overseas debt have been a contributing factor to the economic difficulties experienced by a number of South American countries.

The banks lend a high percentage of this overseas money to the household sector, mainly for residential property. As a result, household debt has risen from $18.3 billion in 1990 to $74.4 billion now, and bank lending to the household sector represents 46 per cent of total bank lending.

Jim Scott, executive chairman of Aquiline Holdings and a former chief executive of Air New Zealand, is highly critical of the banks' lending policies.

He told a recent meeting of the Australasian Institute of Banking and Finance that banks are demanding that all business assets and personal assets be put on the line before borrowings are approved.

He said owners of small- and medium-sized enterprises were highly suspicious of banks because of the security demanded and the fees and interest rates charged. He told the institute that many businesses were averse to having even a prudent level of borrowings and as a result "much of our nation's valuable equity capital is basically locked up and sitting idle when it should be reinvested in growth, development and new enterprises".

The over-investment in housing has big implications for our balance of payments deficit. Money borrowed from abroad and invested in residential housing does not earn any overseas income to pay the interest on the borrowings or repay the principal.

Bank lending policies also have an impact on different sections of the economy.

The banks' preference for housing has boosted the building industry, but the tradeable goods sector, particularly exporters, has found it much more difficult to obtain debt finance.

There are no signs that the high level of private overseas debt and household borrowings are an immediate threat to the economy. But two developments could change the situation: problems in the international banking sector and a slump in the New Zealand residential housing market.

If problems develop in the international banking sector then the overseas banks may start to remit funds back from New Zealand. This could be a headache as 39 per cent of our foreign borrowings are for 90 days or less.

But the biggest potential problem is a slump in the domestic housing market. According to figures compiled by the Institute of Economic Research and Morningstar, New Zealand households have 62 per cent of their gross wealth tied up in housing, compared with 50 per cent in Australia and 28 per cent in the United States.

Household debt as a percentage of disposable income has risen from 83 per cent in 1996 to 112 per cent at present, but this has not been a constraint on consumer spending because interest rates have fallen.

But the institute warns that household spending accounts for 57 per cent of GDP and a fall in house prices or a rise in interest rates would have a negative impact on the economy.

There is no sign of any problems at present, but the high levels of household debt will harm the economy if the residential housing market runs out of momentum.