Dialogue: Debt leaving us vulnerable

It's time for households to lower debt and save more, argues Reserve Bank governor DON BRASH.

Since the mid-1970s, New Zealand has consistently spent more on goods and services from abroad than it has earned from exports. This includes the costs of imports and the income we pay to foreigners who have provided us with capital.

We have consistently run a current account balance of payments deficit, which has had to be financed by capital inflows.

Many countries run persistent deficits, so does this matter? I think the answer is yes, in that the more indebted a country is, relative to its income and wealth, the more vulnerable it is if things go wrong.

Deficits accumulate, and in New Zealand the numbers are large.

At last count, our total net use of foreign capital was around $88 billion, or about 80 per cent of GDP.

Most mature and highly developed economies in Europe and North America are either net lenders to the rest of the world or use financing from abroad equivalent to only 20-30 per cent of their GDP.

Australia uses quite a lot of foreign capital, but is only about half as dependent on foreign capital as we are.

This might not matter if we had generated exceptional growth as a result, as Singapore did on the back of sustained external borrowing, but, unfortunately, we have not.

It is true that our GDP growth has been better in the 1990s than in the 1970s and 1980s. However, because we have become increasingly reliant on finance from foreign savers, an increasing share of the income that the economy generates goes overseas to the people who have financed us.

The better measure of how New Zealand is doing is thus our gross national product (GNP). This is what New Zealand produces, plus returns from any investments New Zealanders have overseas, minus what we send overseas in profits and interest accruing to foreigners.

Unfortunately, GNP per capita in New Zealand has barely increased at all during the past 10 or so years.

In recent years, the returns from much of the growth in the New Zealand economy have gone to those foreign savers and investors who have allowed us to maintain and increase our spending faster than we have increased our incomes.

Government borrowing is not the issue. Our net public debt is now among the lowest in the developed world.

Nor is privatisation to blame. If we had not sold Government-owned assets to foreigners, we would have had to finance New Zealand's deficits by going even further into debt, so the effect on the current account would have been very similar.

The culprit has been the private sector and New Zealand households in particular. The share of our incomes that we save has fallen away markedly.

Savings are notoriously difficult to measure, but however you tweak the numbers, New Zealanders still look to be poor savers in comparison with the citizens of other developed countries.

Fifteen years ago, our household saving rate was reasonable by international standards, but by 2000, we had slipped to the bottom of the OECD (developed-country) class.

In 2000, the OECD average household saving rate was 8.4 per cent, but we were spending more than we earned.

New Zealand households net financial wealth - deposits, shares, unit trusts, pension funds, etc, less household debt - is estimated to be around 70 per cent of household annual disposable income.

In the larger developed countries, that ratio averages around 270 per cent. That is a large and sobering difference.

Why have we cut our savings rate to such a low level?

Part of it, of course, is simply that we could. Following financial deregulation, households have run their debt levels up quite substantially. Refinancing and drawing down the equity in one's house has become much easier.

With revolving mortgage facilities, people now put the groceries on the mortgage and the boat on the house.

Households have been on a spending spree, with household borrowing increasing from 57 per cent of disposable income in 1990 to 110 per cent in 2000.

This level of borrowing in itself is not unusual internationally, but we differ markedly from other similar countries in that our households have far fewer financial assets.

In recent years, the range of goods and services available to us has increased dramatically, but our incomes haven't kept pace. Our tastes - our demand for goods and services - have grown faster than our incomes, and so savings, inevitably, have fallen.

Hopefully, this imbalance will resolve itself gradually and without undue disruption.

There are some encouraging signs. Credit growth rates are now much lower than they were in the mid-1990s, the debt-to-income ratio for households has stopped increasing, and the ability of households to service their debt continues to be good.

Nonetheless, we cannot be complacent about the possibility of a more abrupt and painful adjustment.

This could occur if those who are providing us with finance from abroad reassess their willingness to do so, possibly for reasons that have nothing to do with New Zealand.

In that event, increased costs of overseas finance could dramatically alter the situation facing many New Zealand households.

Let me be clear. I am not predicting some sort of financial crisis for New Zealand.

By far the most likely outcome will be a gradual and voluntary adjustment in household balance sheets, which will reduce our external indebtedness relative to our income and wealth.

But, in the meantime, we are more vulnerable if things go wrong. This is something that firms, households, the Government, and a central bank focused on financial stability need to be aware of.