Saturday, March 25, 2006

Brian Gaynor: We're going broke but nobody cares

The major event this week was the dreadful result from New Zealand Incorporated.

The country reported a current account deficit of $3.9 billion for the December quarter, compared with $3.2 billion for the December 2004 quarter.

The 2005 calendar year deficit was $13.7 billion, representing a whopping 8.9 per cent of gross domestic product.

New Zealand has reported a current account deficit for 32 consecutive years and has the third-worst deficit, on a percentage of GDP basis, among the 30-country Organisation for Economic Co-operation and Development. It ranks ahead of only Iceland and Portugal.

Australia also has a current account problem, but its deficit represents only 5.9 per cent of GDP.

New Zealand seems to be heading down the same path as GDC Communications, the former high-flying listed technology company that was placed in receivership this week.

The only difference is that GDC has no more borrowing capacity and has sold most of its assets while New Zealand has substantial borrowing capacity and a huge number of assets available for sale.

New Zealand's international balance sheet shows that we have borrowed and sold assets to finance our huge deficits. The country has $232.6 billion of international liabilities, comprising $164.8 billion of borrowings and $67.7 billion of assets owned by overseas interests. The $136.5 billion international balance sheet deficit represents a frightening 88.7 per cent of GDP.

Australia's international balance sheet deficit represents 60.4 per cent of the country's GDP.

New Zealand's share price, the kiwi dollar, rose after Thursday's announcement but fell back to its pre-announcement levels once investors had a chance to study the figures.

Most investors realise that over the longer term share prices always reflect the performance of the entities they represent. This is the reason why most forecasters believe the kiwi will fall further.

The current account comprises four items: trade, services, investments and transfers.

The country's trade balance has gone from a surplus of $400 million in 2002 to a deficit of $3.9 billion in the latest year. There are a number of reasons for this including buoyant import growth, higher oil prices, falling agriculture commodity prices and our poor non-agriculture export growth performance.

World Trade Organisation figures show that New Zealand's exports are growing more slowly than the world average and we are still highly dependent on primary exports.

Since 1980, the country's share of total world exports has fallen from 0.27 per cent to 0.22 per cent while our share of world agriculture trade has grown from 1.30 per cent to 1.55 per cent. Unfortunately, international agriculture exports are growing far more slowly than non-agriculture trade.

WTO statistics show we remain heavily dependent on primary exports as they represent 59.7 per cent of the country's total exports compared with 71.8 per cent in 1980.

Over the same 25-year period, the Southern Hemisphere's two other major agriculture countries, Argentina and Australia, have reduced their reliance on the primary sector from 71.6 per cent to 49.6 per cent and from 44.8 per cent to 25.6 per cent of total exports respectively.

The New Zealand agriculture sector continues to perform extremely well, but it is becoming increasingly difficult for it to carry the rest of the country, particularly when a high percentage of the urban population has embraced a borrow-and-spend philosophy.

The other major contributor to the current account problem is the investments deficit, which has grown from $6.9 billion in 2002 to $10.8 billion in the latest year.

The investment figures reflect the difference between what we earn from our offshore investments and the earnings and interest attributable to foreign investors in New Zealand.

Overseas direct equity investors do very well in New Zealand. This group achieved an after-tax return of 10 per cent on their investments in 2005 whereas New Zealand's direct offshore equity investments achieved a miserable return of 0.9 per cent.

This latter figure reflects the poor performance of The Warehouse, Telecom and others in Australia.

The other big contributor to the investment deficit is the interest payments on our offshore borrowings. Much of this borrowed money is invested in the residential housing market and is a major contributor to the country's burgeoning current account deficit.

The major difference between New Zealand and GDC Communication is that the latter ran out of assets to sell whereas New Zealand still has plenty of companies, land and other assets available for sale.

Unfortunately, the bigger the deficit the more we have to borrow and sell. Based on the 2005 current account deficit of $13.7 billion, we now have to sell 20 Trade Me organisations every year to bridge the gap between our international payments and receipts.

But the more we sell, the worse it gets because the earnings and dividends accruing to overseas owners adds to the current account deficit in future years.

The net earnings of the four major foreign-owned trading banks, ANZ National, ASB, Bank of New Zealand and Westpac, contributed an estimated $2.5 billion to the 2005 deficit. This figure does not include the interest payments on money borrowed from the banks' Australian parents to lend to New Zealand residential property investors.

The latest current account figures are even more worrying than the record deficit of $1.4 billion, representing 13.4 per cent of GDP, in the December 1975 year. Thirty years ago, the trade deficit was the major contributor to the current account deficit, but imports declined between 1975 and 1979 as consumer spending contracted and oil prices eased.

An investment-led current account deficit is much more difficult to fix because foreign investors are not going to sell their companies back to New Zealanders and the repayment of our offshore borrowings could lead to a collapse in the housing market.

The most effective way to correct the current account problem is for the country's share price, the kiwi dollar, to fall.

The dollar has held up longer than expected because overseas investors have been attracted by our high interest rates. High dividend yields also attract investors to listed companies, but their interest dissipates when these companies are perceived to have fundamental problems.

The same seems to be happening with the kiwi. Our high interest rates attracted investors but the huge current account deficits are having a negative impact on dollar sentiment.

The next current account figures, which will also be fairly bleak, will add to this negative sentiment.

A lower dollar will reduce import demand and boost the export sector, but substantial progress will not be made until there is more investment in the non-agriculture export sector and we abandon our borrow-and-spend mentality.

One of the more frustrating aspects of New Zealand's latest poor financial result is the almost total disinterest of the country's directors, our members of Parliament. They seem to be far more concerned with speeding motorcades, the behaviour of a teacher 20 years ago and signatures on pro-forma company documents.

Maybe our MPs are a reflection of us. We are more interested in detail discussions on trivial issues that are quickly forgotten whereas serious economic problems, which will affect generations, are rarely mentioned.

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