Published in The Australian (Sydney), 29 August 2023
New Zealand was on the brink of an abyss. Its smug and reckless government had burdened the economy with top-down planning, lost control of public finances and created a crisis of confidence in the Kiwi dollar.
A young deputy governor at the Reserve Bank at the time warned that the country’s currency was vulnerable to speculation in the event of a “significant political event”. And, sure enough, that event materialised in the turmoil of the 1984 election, creating a foreign exchange crisis.
But New Zealand’s 1984 crisis was also a moment that sparked a wave of reforms: an immediate devaluation of the currency, a comprehensive deregulation agenda, and – eventually – the floating of the dollar.
These measures proved transformative. They pulled New Zealand back from the edge and set it on a course of economic recovery. For a time, New Zealand became the poster child of economic reform.
Fast forward to 2023, and one cannot help but feel a sense of déjà vu.
New Zealand Prime Minister Chris Hipkins and his Finance Minister Grant Robertson may not quite look like Sir Robert Muldoon, who held both offices in 1984. But both Messrs Hipkins and Robertson have the same tendency to bask in self-congratulatory glory even when the cold, hard economic data tell a different story.
Just like their predecessor nearly 40 years ago, Hipkins and Robertson believe they have the economy under control. More than that, they keep telling the public that their economic management of the Covid crisis was somehow world-leading.
But beneath the Government’s rhetoric, an economic storm is brewing – one that could play havoc with the Kiwi dollar once again. New Zealand’s tax revenues are dwindling, export prices are weakening, and the current account deficit is alarmingly high.
While the circumstances differ, the song remains the same: New Zealand is once again at a precarious economic juncture. This time, though, it will play out quite differently than in 1984.
That is because, unlike in 1984, the Kiwi dollar is no longer fixed but floats freely, subject to market forces. This also means that, instead of running out of foreign exchange reserves, New Zealand’s currency will simply depreciate. In that sense, there will be no foreign exchange crisis.
But make no mistake, a run on the New Zealand dollar would be painful. It would make imports more expensive, from petrol to pharmaceuticals, and it could lead to even more inflation, further squeezing household budgets.
Market analysts will therefore watch the upcoming PREFU, due on 12 September with interest. For those unfamiliar with the term, PREFU stands for Pre-Election Economic and Fiscal Update. It is a report that provides an overview of the government’s financial position before an election. And this year’s PREFU is likely to be a wake-up call because economic circumstances are far from rosy.
According to the Reserve Bank of New Zealand, the GDP growth rate is expected to hover around a modest 2.5%. Unfortunately, it looks likely to fall next year. In May, the International Monetary Fund issued its growth forecast for 159 countries. New Zealand came second last at a projected growth rate of just 0.8 percent for 2024. Only Equatorial Guinea fared worse.
Public debt is another area of concern. The government’s borrowing has skyrocketed in recent years, largely to fund its various Covid-19 response measures. From under NZ$60 billion in 2019, public debt has shot up to NZ$156 billion today – equivalent to about NZ$80k per household.
Unfortunately – and this is where PREFU comes into the picture – tax revenues are also on a downward trajectory.
Before Covid, in their 2019 Budget, the Government predicted both tax revenue and expenses at 28.8% of GDP by 2023 – a balanced budget. By Budget time in May this year, both figures had increased. The Government now expected a slightly higher tax revenue of 29.3% of GDP and expenses at 32.5% – so a moderate deficit.
However, over the past few months, it has become clear that this was optimistic. By July, the government was already more than NZ$2 billion short of the tax revenue they had predicted in May.
It is going to get worse. And so, according to Westpac calculations, the government will now need to borrow NZ$135 billion over the next four years. That is NZ$15 billion more than Robertson expected in May and NZ$35 billion more than he thought last December.
No wonder the Government is now scrambling to cut spending – somewhat. On Monday, they announced some modest cuts to the bloated public service. But these cuts only amounted to NZ$4 billion, over four years: a mere rounding error in the grand scheme of things.
The considerable deterioration of New Zealand’s public finances is linked to unfavourable export conditions. During the Covid years, the New Zealand economy was helped by record merchandise terms-of-trade, meaning the country received good prices for its exports.
However, from their peak in 2021/22, export prices have come down substantially. For example, the Farmgate milk price of NZ$9.3 per kilogram of milk solid in 2022 has given way to a forecast of just NZ$7 for the current year.
Weakening export prices can have a cascading effect on the economy, affecting everything from farm incomes to rural communities.
The current account deficit is another red flag. A high current account deficit can be a sign of an economy living beyond its means. It often puts downward pressure on the national currency.
In New Zealand’s case, the annual current account deficit was NZ$33.0 billion in the year ended 31 March 2023. That was 8.5 percent of GDP – the highest in the developed world.
When you put all these factors together, they form a toxic cocktail that poses a significant risk to the stability of the Kiwi dollar.
New Zealand’s economy has plummeted along with its exports. It is highly dependent on access to international funding to pay for its consumption. Government has blown out its spending, while tax revenues are collapsing.
No wonder, the Kiwi dollar is already looking wobbly. Over the past year, it lost 3 percent against the US dollar, 8 percent against the British Pound, and 11 percent against the Euro.
Four decades ago, it was a similar melange of issues that swept away the Muldoon Government in the wake of New Zealand’s forex crisis. This time around, the reason there cannot be a forex crisis is because there is no fixed exchange rate for the Reserve Bank to defend.
That said, markets could well decide they have had enough of New Zealand – and send the Kiwi dollar down a slide.
Unsurprisingly, Westpac just reported that its customers “perceive the risk distribution around the exchange rate as strongly skewed to significant depreciation.” Or, in short, a hard landing for the Kiwi dollar.
On its campaign website, New Zealand’s Labour Party claims, “Our strong COVID response has seen our economy recovering faster than almost any other country in the world.”
Markets do not seem to agree.
