Published in Insights, The New Zealand Initiative’s newsletter, 14 April 2023
After the Global Financial Crisis of 2008, markets became concerned about Greece’s ability to repay its debts.
Until the crisis hit, rating agencies were relaxed about Greece’s solvency. Fitch rated the country as ‘A’ in October 2008, Standard & Poor’s gave it an ‘A-’ in January 2009, and Moody’s gave it an ‘A1’ in February 2009.
But by 2011, all three agencies had downgraded Greek debt to junk status.
Ratings may seem fine and markets relaxed, but sentiment can change quickly.
The three agencies currently rate New Zealand as AA+, Aaa and A+, respectively. But these high-grade ratings should not give us a false sense of security. There are reasons to be concerned about New Zealand’s economic prospects.
Our current account deficit last month was the largest in over three decades. Given rising price levels, that is not surprising, but the deficit was also the highest relative to GDP, at 8.9 percent.
The result is that every 11th dollar New Zealand spends is a dollar it must borrow abroad.
Even a deficit of 8.9 percent of GDP may not be a problem. But when the rest of the world thinks it is, it becomes one. And New Zealand’s prospects will worry global markets.
New Zealand’s price inflation remains uncomfortably high. The Reserve Bank expressed concern about the economy showing signs of overheating and the labour market being too tight. Both are results of the enormous amount of money created during Covid.
Because of our own policy choices, New Zealand has become a less attractive destination for migration and investment.
A decade ago, New Zealand’s government was much smaller than it is today. Erratic policy making has also created a perception of greater political risk.
Once international markets become alarmed, their worries can become self-fulfilling, as we have seen internationally.
In the event of a credit downgrade, interest rates would likely rise. The impact on household consumption and investment would be significant.
Consumer confidence would be affected by uncertainty about the country’s economic prospects.
In this scenario, the New Zealand dollar may depreciate, increasing the cost of imports and potentially increasing inflation. A weaker currency would lead to higher debt servicing costs.
Furthermore, a downgrade may negatively affect foreign investment since investors may perceive New Zealand as a riskier destination.
New Zealand’s economic circumstances have deteriorated so much over the past few years that a credit rating downgrade would be a lagging indicator of our economic troubles.
This scenario may not be imminent. But it is something to watch out for.
