Why Finance Minister Bill English is more positive about NZ's current account deficit track than Treasury; 'World will punish us if it hits 7-8% of GDP'

By Alex Tarrant

Foreign lenders will punish New Zealand if the current account deficit gets back to the 7-8% of Gross Domestic Product (GDP) range seen last decade, Finance Minister Bill English says.

Appearing before Parliament's Finance and Expenditure Select Committee on Wednesday, English said that kind of level would likely force a sharp adjustment in the exchange rate and interest rates in New Zealand.

But he was optimistic that the deficit - the difference between what New Zealand earns from the rest of the world and pays out to it - would peak lower than what forecasters like the IMF and Treasury were projecting.

Treasury forecasted in the May Budget that the current account deficit would head back to 6.7% of GDP in the year to March 2016 from a low of 1.9% of GDP in 2010, which itself had come down from over 8% between 2006 and 2009.

Treasury will release an updated set of forecasts in its Half Year Fiscal Update on December 18.

The latest current account figures from Statistics New Zealand for the year to June 2012 showed a deficit of 4.9% of GDP, just off the 5% mark ANZ economists warned was the "danger zone" where international creditors would take much more notice of the economy’s external liabilities.

More optimistic

English has consistently been saying over the last year that he expects the current account deficit to peak lower than what Treasury was forecasting, drawing questions from Labour Party MPs on the Committee as to why he thought that.

“What do you base your prediction on? Evidence, data, crystal ball, best guess?” Labour's Clayton Cosgrove asked.

“I’m just a bit more optimistic, that’s all,” English said.

“Forecasters work on...wherever you are, they forecast that you’re going to go back to the average or the norm.

“Their view about New Zealand is that we have a persistently high current account deficit, so they always forecast we’re going to go back to it. It’s like looking at their foreign exchange forecasts. They always forecast we’ll go back to the long-run average," English said.

“The fact is, we’re in a world that is pretty different, because everyone’s trying to reduce debt, and I think New Zealanders have responded in a fairly resilient way to the different pressures that are on them," he said.

“I think their savings behaviour is shifting. I think you’re starting to see some systemic change in the government, which ensures that its long-run savings behaviour’s going to be improved.

Punishment & optimism

“And I don’t think the world’s going to let us run seven and eight percent current account deficits. It just won’t. I think you’ll get the kind of sharp adjustment that the textbooks tell you would happen in the exchange rate or interest rates if that happened," English said.

“The world’s just not going to let us run an extreme current account deficit,” he said.

“That’s two reasons. One is I think the world will punish us more quickly if it gets out of line, and the other is, I’m a bit more optimistic about the way New Zealanders are adjusting to a deleveraging world.”

“If you exclude the earthquake [effect on Statistics New Zealand's current account deficit reporting] and we peak somewhere between five or six percent, then that’s quite a bit lower than the eight percent peak just three or four years ago.”

Second worst only to Greece

Earlier, Labour Party finance spokesman David Parker asked English whether it was a time to change settings that influenced investment and savings patterns, and the exchange rate, given that, "this year according to the IMF [New Zealand's current account deficit is] the second worst in the developed world after Greece, and next year it’s projected to be the worst in the developed world.”

English said he did not particularly agree with those views on the current account deficit.

“But time will tell.”

“I just think their views are a bit more negative than has turned out to be the case. All of these entities, for instance, forecast that New Zealand household savings behaviour wouldn’t change, and actually it’s changed quite dramatically,” English said.

“Looking ahead on the current account deficit, there’s a statistical issue which is the way that the statisticians have decided to record the impact of the earthquake. They don’t count the inflows, but they do count the spending. So they’re only counting the negative bit,” he said.

Parker noted about 1 percentage point of the forecast 6% current account deficit was expected to be earthquake related.

“Let’s say that’s all correct,” English said.

“Then you would end up with a current account deficit peaking at about 5%, at the time where nominal GDP will be fairly similar to that. That’s getting much closer than we used to be to what would be regarded as a rule of thumb for sustainability of it [the current account deficit]," he said.

“I think we’d all be worried if we saw an obviously unsustainable current account deficit building up external liabilities in a world where no one likes that much."

While there would be no dramatic turnaround in the direction the deficit was heading, the peak looked like it would be a bit lower than might have been expected a couple of years ago.

“In terms of policy settings, there aren’t too many long-run policy settings that you can alter dramatically. Because New Zealand’s had thirty years of these [current account deficits] and has had every argument about every variation on every possibility of policy settings," English said.

“Looking ahead, improvements in savings rates for the household sector, and for the government, are going to have an impact. Sound microeconomic policy that is going to help businesses in the export sector deal with the significant headwinds they face [is] going to make a difference," he said.

“Would it make a difference if you changed the [Reserve Bank’s] Policy Targets Agreement? No I don’t think it would, and I haven’t seen any convincing argument that it would.”