Investment insights

The future of
New Zealands
current account

New Zealand has a current account deficit problem.

Its a comment thats sometimes thrown around, but is
it true? More importantly, why should it matter?
It is true New Zealand has tended to run a current account deficit
more often than not, partially due to structural factors, partially
due to competitiveness, but mostly to do with savings. To answer
the second question, it matters because the risks pose significant
implications for the economy, credit rating, currency and financial
market outlook. In this regard the current account can be a key
indicator about a countrys willingness and ability to service its
debts.

september 2012

Current account as a percentage of GDP

2
0
-2
-4
-6
-8
-10

The current account is the net result of a countrys

transactions with the world. Primarily it comprises net
investment income (i.e. how much New Zealanders earn
from investment abroad minus how much overseas investors
earn from investment in New Zealand), and net exports (i.e.
exports minus imports). The flipside of the current account
is the capital account which is the flow of capital required
to fund the deficit or surplus. For example, if a country is
running a current account deficit, other countries must
provide the necessary capital to fund that deficit. The two
make up a countrys balance of payments.

The current account deficit: a brief synopsis

New Zealand has more or less persistently run a current account
deficit since the 1970s. During the financial crisis and global and
domestic recessions the current account made some tentative
improvements. However much of that improvement could be
attributed to cyclical factors. For example during the recession in
New Zealand the income (i.e. profits earned by foreign investors
in New Zealand) reduced, driving a transitory improvement in
the balance of international investment income. At the same
time New Zealand demand for imports dropped off, while strong
terms of trade drove a positive movement in net exports. These
forces have begun to reverse as the domestic economy has
improved.

-12
1988

1991

1994

1997

2000

2003

2006

2009

2012

Source: Statistics NZ, AMP Capital

Through the cycle, imports and exports of goods and services

have been reasonably finely balanced, while investment income
has consistently showed the largest disparity. This comes down to
a few key factors: foreign ownership of companies, international
borrowing and implied earnings yield differential. The foreign
ownership of companies is a key driver of outgoing investment
income, while the earnings yield differential is also important.

Current account components

(average last five years)

$ Billions

What is the current account?

Current account balance

Goods and services balance
International investment income

20
18
16
14
12
10
8
6
4
2
0

Investment
Income
Services
Goods

Incoming

Outgoing

Source: Statistics NZ, AMP Capital

The future of New Zealands current account

The gap between the implied earnings yields partly reflects a

risk premium that foreign investors demand for investing in New
Zealand. While New Zealand can be considered less risky than some
countries, New Zealands economy is relatively small, concentrated,
and vulnerable to global events and trends. But part of this gap is
somewhat self-reinforcing as the persistent current account deficit
and consequent increase in foreign liabilities increases the perceived
riskiness.

As long as New Zealand has a large negative net international

investment position the net investment income component of
the current account will be a drag, as it generally means greater
interest and dividend payments to foreign investors. To make
matters worse, the net international investment position can
essentially be thought of as the sum of past current accounts. This
is also known as the compounding effect in investing.

Implied earnings yield

Why national savings matter

8%

National savings (i.e. the net sum of household, corporate and

government sector savings) but particularly private savings matter
for the current account because they are more or less one and the
same. A negative current account implies a positive capital account,
i.e. an inflow of funding. Logically, greater inflows of funding over
time will also increase outflows of investment income to the source
of those funds (dividends and interest), compounding the effect.
New Zealand has typically run a negative household savings rate,
particularly during the housing boom where increasing household
debt levels were offset by rising property prices. This period of
dissaving meant an increase in demand for funding, which ultimately
had to be met from offshore investors.

7%
6%
5%
4%
3%
2%
1%
0%
2001

Yield on NZ Assets
Yield on Foreign Assets

2004

2008

2012

Source: Statistics NZ, AMP Capital

Current account deficit: structural vs cyclical

Saving and the current account

New Zealands large negative net international investment

position goes a long way to explaining why New Zealand has
a persistent current account deficit. But its not all to do with
foreign ownership of companies. Its also the fact that New
Zealanders, as in many developed nations, have embarked on a
dissaving debt binge. Thats thanks in part to a booming housing
market yes, that old chestnut about overinvestment in housing.
The other point is that it shows New Zealanders dont invest
enough in their own businesses, or rather we just dont invest
enough at all.

8%
6%
4%
2%
0%
-2%
-4%
-6%

-10%

The structural part: investment

Investment income and net IIP % of GDP

-1

International investment income

-55

-2

Net International Investment Position

-60

-3

-65

-4

-70

-5

-75

-6

-80

-7

-85

-8
2003

Source: Statistics NZ, AMP Capital

2006

1988

1991

1994

1997

Source: RBNZ, Statistics NZ, AMP Capital

-50

-9
2000

NZ Private Savings Rate

Current Account % of GDP

-8%

2009

-90
2012

2000

2003

2006

2009

2012

The circuit breaker or solution for New Zealand is simply to increase

the rate of savings. In the context of the current account this would
mean:
>> Increasing the volume and value of exports of goods and
services
>> Reducing, holding constant, or growing at a slower pace imports
>> Paying down external debt
>> Investing abroad and getting a better balance of inward/
outward foreign direct investment (FDI)
>> Reducing the gap between the higher return on domestic versus
foreign assets.

Some of these activities are more practical than others, but

it comes down to increasing incomes (exports), reducing
debt servicing costs and increasing our outward FDI. This set
of activities falls under the increasingly mainstream idea of
economic rebalancing where the theory is that countries with
large current account surpluses need to import more and save
less, while countries with large deficits need to export and invest
more and consume less. Such imbalances have become recognised
as a key vulnerability in the global economy. For New Zealand a
key challenge is to improve the quantum as well as the quality of
savings and investment.

The risks of a high current account deficit

The current account is very much a reflection of the
structure or habits of the wider economy. It reflects export
competitiveness, national savings, (external) debt levels,
etc. Its no surprise then that countries with current account
surpluses tend to be in better positions than those with
deficits. Such countries tend to have strong export sectors,
high national savings and lower external debt. Its also no
surprise to see the relationship in the chart below, as countries
with higher current account deficits have tended to come
under greater pressure during times of financial stress.

10 year sovereign bond yield (five year average)

Current account balance vs borrowing costs

10

Greece

9
Hungary

8
7

Portugal

New Zealand

Spain

Norway

Sweden

US

Germany

Switzerland

2
1
0

Iceland

Japan

Luxembourg
15

10

Source: OECD, Bloomberg, AMP Capital

-5

-10

-15

-20

While other factors are also important, the current

account balance can have a significant bearing on
borrowing costs, particularly relative to other countries.
One transmission mechanism or catalyst for this can
be a change to the credit rating. Indeed, a key risk to a
countrys sovereign rating can be a high current account
deficit. This reasoning, along with high external debt
(which is a related factor as interest costs appear in the
current account), has been cited in the past when New
Zealand has received a credit rating downgrade. The
sovereign credit rating of New Zealand remains at risk
as long as the current account deficit is large, and this
could be a catalyst for drastic movements in the New
Zealand dollar and bond yields. While we dont think
a downgrade is imminent for New Zealand, high and
rising external debt paired with a high current account
deficit, impacts negatively on our perceived willingness
and ability to service and eventually repay debt.

Markets: why the current account matters

Outlook

By now it should be clear that the current account is an

important feature of the economic landscape. It also makes
sense to assume it is an important factor in thinking about the
investment outlook. This line of thinking can be affirmed through
the fact that the current account is a barometer of the structure
of an economy, and consequently will reflect fundamental
changes and trends in the economy.

The most recent current account data (June 2012) showed the
current account deficit as a percentage of GDP deteriorated slightly
to 4.9%. We expect this key metric will deteriorate over the next
couple of years as cyclical factors come into play, i.e. improving
corporate profitability and rising import demand. However, we
expect the deterioration to be tempered by structural forces
such as the governments commitment to return to surplus and
higher household savings rates (and debt deleveraging). But that
is no cause for complacency, as New Zealand presently still runs
twin deficits, i.e. current account deficit and government budget
deficit. Deficits could pose a risk to perceptions of New Zealands
ability to service debts. Normally when the current account deficit
deteriorates, it also impacts negatively on the New Zealand dollar,
but in this environment factors like the US quantitative easing
programme have greater weight in the short term.

Whats probably nearer to investors minds is the question how

will the current account impact on financial markets?
>> Currency
A deterioration of the current account, particularly relative to
other countries, tends to have a negative impact on the exchange
rate, albeit lagged. So as the current account deficit increases, it
would be reasonable to expect a weaker New Zealand dollar to
follow eventually.
>> Bonds
Similar to the currency, a marked worsening of the deficit should
see bond yields rise. There are a couple of ways this could happen:
a downgrade of New Zealands sovereign credit rating, or an
increase in the risk premium that investors demand for investing
in New Zealand.

Callum Thomas
Research Analyst

>> Equities
The picture for equities would be a little more mixed. On the
one hand a higher current account deficit could simply reflect
a stronger domestic economy, which would likely be positive
for equities. However if the country risk premium and bond
yields increased then this would likely have a negative effect on
valuations.

Contact us
Wellington office
AMP Capital Investors (New Zealand) Limited
Ground Floor, PWC Tower
113 - 119 The Terrace
PO Box 3764 Wellington
Telephone: +64 4 494 2200

Auckland office
AMP Capital Investors (New Zealand) Limited
Level 7, Zurich House
21 Queen Street
PO Box 5346 Auckland
Telephone: +64 9 927 1615

or visit ampcapital.co.nz

...

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