IMF warns debt-loaded housing market could topple the economy, if rates rise

The housing market could drag down the economy. Photo / Ben Fraser

The IMF has given the economy a cautious seal of approval, noting that we have rebounded from the pandemic well, but it warned that downside risks dominate the outlook in the near term.

The IMF warned New Zealand's highly indebted homeowners are very exposed to rising interest rates, which would and should rise - it said the Reserve Bank should pencil in "significant" increases to the official cash rate. It said a housing crash poses a risk to the country's financial stability, given borrowers' and banks' level of exposure.

It also suggested some fixes to the economy, like cutting the relatively high corporate tax rate and substituting it for a proper capital gains tax or a land tax.

Each year, the IMF looks at our economy as part of its "Article IV" mission, applauding what has gone well and warning against what might be about to go wrong.

Its preliminary report for this year, released this morning warned of clouds on the horizon - clouds that are mainly out of our control.

These included "further outbreaks of Covid-19 variants and further intensification of geopolitical tensions which could adversely affect economic activity and inflation in New Zealand through weaker external demand and higher commodity prices".

The IMF also warned that we would be hit by further global supply chain disruptions, and a possible slowdown in growth from China, given that country's importance as a trading partner.

There were some domestic risks too. These are mainly around the threat the housing market poses to financial stability.

New Zealanders' astronomically high household debt, thanks mainly to high house prices, means the country is vulnerable to rising interest rates. The IMF warned that this, combined with the high exposure of our banks to housing, poses a financial stability risk. However, it praised the work of the Reserve Bank in beefing up the stability of our trading banks in preparation for any downturn.

The IMF also praised the Government's housing efforts, saying steps "taken to mitigate investors' demand for existing housing have helped moderate near-term price pressures".

One area the Government was strongly reprimanded for is a lacklustre climate change ambition.

The IMF welcomed the recent rise in carbon prices, a result of reforms to the ETS market, but said stronger efforts would be needed to meet emissions goals, particularly around the vexed issue of agricultural emissions.

"Addressing agricultural emissions — the largest single emissions source — will require the successful implementation of planned agricultural emissions pricing," the IMF said.

The IMF said proceeds from emissions should be spent on addressing the social consequences of transition - something the Government has promised to do at the Budget through emissions trading scheme revenue hypothecation.

Another policy to get the IMF tick is the Government's social unemployment insurance scheme, which, under a plan currently out for consultation, would give people seven months of income after losing their job for the price of a levy on people's income.

The IMF said this was "welcome as it closes an important gap in social protection".

"Its parameters should be calibrated carefully to address trade-offs between insurance and disincentives," the IMF said.

The report cautioned that minimum wage increases were becoming "increasingly binding" and said further increases should "be aligned with underlying labour productivity growth to avoid unintended impact on employment".

The comments come from the first take of the IMF's mission to New Zealand. The final report will be published in May.