Standard and Poor's holds NZ's credit rating with stable outlook; Warns of pressure if external imbalances keep deteriorating; Says high debt might see investors exit NZ$

Ratings agency Standard and Poor's has affirmed the New Zealand Government's AA foreign currency and AA+ local currency credit ratings with a stable outlook, but warned pressure on the ratings would emerge if the New Zealand's external accounts kept deteriorating.

It also said the country's debt levels were still high and there was a risk that investors might reallocate their portfolios away from New Zealand-dollar-denominated assets.

This could lead to: a sharp depreciation in the New Zealand dollar; higher costs for external bank borrowings; rising interest rates to attract higher domestic savings; and lower potential economic growth, S&P said.

Current account worries

In September last year Standard & Poor's followed another ratings agency, Fitch, in cutting the government's credit rating. S&P cut its long-term foreign currency ratings on New Zealand to 'AA' from 'AA+' and its long-term local currency rating on New Zealand to ‘AA+’ from ‘AAA’.

At the time, it said upward pressure would emerge if New Zealand "sustained current account surpluses, led by a stronger export performance and higher public savings, markedly reduced external debt.”

New Zealand's latest current account figures, released in June, showed a deficit in the year to March 2012 equivalent to 4.8% of GDP. This was the largest deficit as a proportion of GDP since June 2009, Statistics New Zealand said.

Following the figures, economists said New Zealand was still vulnerable to the "whims of its creditors" after the data showed the current account deficit was heading back to the "danger zone" where credit ratings agencies would start to worry about the state of the country's external accounts.

(Updates first par including foreign currency rating and that the AA+ rating is New Zealand's local currency rating)

See the release from Standard & Poor's below:

Standard & Poor's Ratings Services said today that it has affirmed its 'AA' foreign currency long-term rating on New Zealand. At the same time, we affirmed the local currency long-term rating at 'AA+'. We also affirmed the local and foreign currency short-term ratings at 'A-1+'. The rating outlook is stable.  The Transfer & Convertibility assessment remains 'AAA'.

"The rating affirmations reflect our view that New Zealand's credit metrics will continue to feature moderate fiscal flexibility, a resilient economy, and strong political and economic institutions conducive to swift and decisive policy reform," Mr. Curry said. "These strengths are offset by the country's high external debt and weak external liquidity, vulnerability to swings in commodity income, high household debt, and an adverse demographic profile."

New Zealand's public finances have worsened as a result of the global recession and the unavoidable repair and reconstruction costs associated with the Canterbury earthquakes. We estimate that the general government (the Crown plus local and regional governments) recorded cash deficits of 8.2% and 7.8% of GDP in 2011 and 2012, respectively. Excluding the direct costs of the earthquakes (such as search and rescue, temporary welfare and housing payments, and demolition and repairs to infrastructure), the deficits would be about 3.6% of GDP and 4.4% respectively.

Assuming there is no significant weakening in prices and demand for New Zealand's exports, we expect the Crown to return its budget balance to a modest surplus in the June 2015 fiscal year. Reflecting additional borrowings to fund the earthquake-related expenses, the gross general government debt burden is estimated to have risen by 9.2% and 3.4% of GDP in 2011 and 2012, respectively, to reach 43.8% in 2012. Based on our forecast of deficits of 5.6% and 3.4% of GDP in 2013 and 2014, respectively, we project that New Zealand's gross general government debt burden will average around 43% of GDP through to 2014, before trending lower as the deficit shrinks further.

Nevertheless, New Zealand has high external liabilities, which in our view will weigh on the country's economic and fiscal performance over the medium term, as households look to reduce their debt.

In addition, New Zealand's debt burden is high, and there is a risk that investors may reallocate their portfolios away from New Zealand-dollar-denominated assets. This could lead to: a sharp depreciation in the New Zealand dollar; higher costs for external bank borrowings; rising interest rates to attract higher domestic savings; and lower potential economic growth. The sovereign's fiscal position could come under pressure if revenues weaken and expenditure associated with automatic stabilizers (such as unemployment benefits) increased, along with possible stimulus spending. Borrowings to fund any future stimulus may further undermine the sovereign's weakened fiscal flexibility.

The risks associated with New Zealand's high private-sector external debt are ameliorated by the country's financial system that appears to be performing soundly. We consider that while loan loss provisions of the New Zealand banking system are likely to remain low by international standards, cautious consumer sentiment, intensifying competition for retail deposits, and stricter regulatory requirements may continue to dampen lending growth and profit margins in the sector.

Nevertheless, we expect that the credit profile of New Zealand's banking sector would remain sound, supported by the banks' conservative risk appetite and good capitalization, and the country's sound economic outlook. In addition, we believe that the banks' Australian parents will continue to regard New Zealand as a core market for their global operations.

Furthermore, we observe that New Zealand has an independent monetary policy with a free-floating currency that allows external imbalances to adjust. The New Zealand dollar is also actively traded, and we observe that a large portion of the nation's external debt is denominated in New Zealand dollars, while much of the remainder finances companies with revenues in foreign exchange or is hedged. In sum, we view New Zealand's financial and capital markets as well developed and supportive of the rating.

Mr. Curry added: "The stable outlook balances the stabilization we expect between the government's debt profile over the medium term and the risks associated with the country's high external debt. We expect the New Zealand major banks' credit profiles to remain sound by international standards. Moreover, the strength in government finances is an important mitigating factor to the risks associated with the external position."

Downward pressure on the New Zealand ratings could emerge if New Zealand's external position continues to deteriorate. Rising public savings will be an important component to keep the country's current account deficit in check. On the other hand, upward pressure on the ratings could eventually emerge if sustained current account surpluses, led by a stronger export performance and higher public savings, markedly reduced external debt.