The global financial markets remained “fragile”, Reserve Bank governor Alan Bollard said when releasing the latest Financial Stability Report.
The sovereign debt concerns facing some European economies presented “a risk of further turbulence” and New Zealand happens to have whopping external debt, making it vulnerable to any renewed deterioration in global debt markets.
The good news for financial stability was that New Zealand households had increased their savings, but households must remain cautious about piling up more debt as the recovery continued.
This theme was echoed in the Budget speech. Finance Minister Bill English said the economy had spent more than it earned and borrowed to make up the difference.
New Zealand’s “largest single vulnerability” was its large and growing net external liabilities. New Zealand owed the world $168 billion, or around 90 percent of GDP.
The dangers of too much debt, English warned, were well illustrated by number of European nations where “painful changes” involved higher taxes, reduced public services, or both. The Key Government was committed to policies that would reduce our vulnerabilities “by tilting the economy away from debt and consumption toward savings, investment and exports”.
But those policies will take time to kick in. The Treasury’s forecasts show the current account deteriorating over the next several years, not improving.
At that time, the M3 money supply in the United States was shrinking at pace unmatched since the Great Depression, mainly because regulators around the world were pressing banks to raise capital asset ratios and shrink their risk assets. The IMF was warning that the gross public debt of the US would reach 97 percent of GDP next year and 110 percent by 2015.
Across the Atlantic, analysts were gauging the prospect of Greece defaulting on its debt and musing on the implications for the global financial system (frightening, at best). Eurozone leaders were looking for ways to prop up weaker member countries and the long-term future of monetary union was under question.
Murray Sherwin, director general of the Ministry of Agriculture and Forestry and former deputy governor of the Reserve Bank, considered how these forces might affect the development of this country’s vital primary sector late in May at the New Zealand Agricultural and Horticultural Outlook Summit.
Fundamentally, he pointed out that because New Zealand doesn’t save we end up selling our interests in all sorts of ventures offshore. More particularly, this was difficult country in which to nurture strong capital-intensive, conventionally structured companies. If they were heavily export-oriented, they were exposed to the volatility of exchange rates, international economic conditions, and so on.
If they tried to expand but were caught by sudden downturn they would need white knight from abroad to pick them up. Before too long, they were lost to us.
Sherwin wasn’t surprised that New Zealand’s business sector was dominated by state-owned enterprises or by farmer-owned cooperatives. Cooperatives had their faults, but were effective risk-spreading devices with the balance sheets of 10,000 or so dairy farmers (in the case of Fonterra) through which to spread the ups and downs.
Because there was no competition for ownership, the cooperatives remained in New Zealand hands.
Fonterra was an example of cooperative with good international capability and potential. But it could not make the most of that potential on debt finance alone. It would need more equity.
“There is the challenge,” Sherwin said. Farmers’ primary assets were their farms. All they wanted from their cooperatives was the assurance they would add value to the farms. They were unlikely to want to pour piles of capital into the co-op.
But if farmers didn’t want anyone else involved in their companies, the money would have to come from them.
Growing the economy was one concern for Sherwin. Dairying (accounting for almost 25 percent of our export revenue) especially was sector where New Zealand had big comparative advantage, but the need for equity was constraint.
Balance sheet strength was becoming more important for another reason: competition for finance would become more intense as result of the burgeoning sovereign debts troubling other countries and the scale of the fiscal deficits to be closed. Hence competition for savings would become intense. This put premium on strong balance sheets back here in New Zealand, country which must feed off the stock of international savings.
New Zealand has well-earned reputation for paying its bills (or paying its debts by selling assets to our foreign debtors). But when investors become more risk averse – Sherwin cautioned – they will back away from lending here “as quick as flash”.
Bob Edlin is leading economic commentator and NZ Management’s regular economics columnist.
