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International confidence matters

Published in Insights, The New Zealand Initiative’s newsletter, 22 May 2020

This week, opinion polls revealed that the Government is more popular than ever. On current figures, Labour could comfortably govern alone, the Prime Minister’s ratings are stratospheric, and nine in ten New Zealanders approve of the Government’s handling of the public health crisis.

The Ardern Government has no problems pleasing the domestic crowd, for now. But harder times lie ahead. One risk from the dire fiscal outlook is that international markets could lose confidence in New Zealand.

Several factors should make us worry about New Zealand’s international standing. New Zealand has one of the weakest Net International Investment Positions (NIIP) in the world. Put simply, as a nation we owe the world more than the world owes us.

At the end of last year, New Zealand’s NIIP stood at a negative $171 billion, more than half our annual economic output. Even Mexico, Nigeria and Venezuela are not as indebted to the rest of the world as New Zealand.

The Covid-19 crisis will deteriorate this position further, not least because it hurts two important export industries, tourism and education.

To be clear, a high NIIP can be sustained if the rest of the world has trust. New Zealand’s NIIP used to be higher a decade ago and did not cause trouble back then.

But there is a difference, and that difference is the alarming signals New Zealand is sending to the world today.

Over the past couple of months, the Reserve Bank has embarked on a virtual money printing exercise. By August, ANZ believes quantitative easing could reach $90 billion – about a third of GDP. This may not only destabilise the NZ dollar, it also conflates monetary and fiscal policy.

The Government is also making it harder for foreigners to buy New Zealand assets by changing the Overseas Investment Act – another warning sign for international investors.

Meanwhile, the Reserve Bank has stopped banks from paying dividends to their overseas parents for this year. Again, that is not what international investors or analysts like to hear.

All this, of course, follows other abrupt policy changes over the past couple of years such as the ban on oil and gas exploration.

Those watching from outside will soon begin to wonder what is going on in New Zealand: Is this still a place in which they really want to be invested?

New Zealand experienced once before how abruptly analysts in Sydney, London and New York can give a country the thumbs down. Though S&P maintained New Zealand’s triple A rating until 1983 and Moody’s until 1984, these ratings were worth nothing once market participants lost trust in New Zealand around the time of the 1984 election. Markets always have trust in a country right until the moment they don’t.

The situation today is different because New Zealand no longer has a fixed exchange rate. But that does not mean we can relax.

To see what happens when international markets lose faith in a country with a free-floating currency, just look at Turkey. Incidentally, Turkey is a country with an NIIP nearly identical to New Zealand’s.

For a while, Turkey was a rock-star economy. The Turkish Lira was moving towards parity with the US dollar in 2008. But then, an erratic and interventionist Government combined with a compromised central bank wreaked havoc. Today, the Turkish economy is a shamble, and the Lira only buys 15 US cents.

It hardly needs spelling out what a currency collapse means. A country experiencing it will be materially poorer as its people can no longer afford the goods and services they took for granted. And as people’s savings devalue, a plunging currency brings pain and misery to countless families.

New Zealand is not Turkey, but to avoid the same fate we must be more cautious.

We are a small country that barely matters to the world. For investors, New Zealand is a nice-to-have, not a must-have.

Through our negative international debt position, as a country we are vulnerable to international markets suddenly withdrawing support. New Zealand has far less leeway than larger economies. To keep international investors’ trust, we must remain squeaky clean in our fundamental economic institutions.

If we are not, New Zealand will come out of the Covid-19 crisis as a broken economy and a failed state.

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