Current account deficit improves to 5.9% of GDP as BNZ tax case reduces income of foreign investments in NZ (Update 3)

New Zealand's seasonally adjusted current account deficit improved to 5.9% of GDP in the year to June 2009 from a revised 8.1% of GDP in the year to March (revised from 8.5%), figures released by Statistics New Zealand show. (Update 3 includes new interactive chart.) However, despite the headline improvement, economists have questioned its quality and whether the narrowing deficit is sustainable. Finance Minister Bill English, while noting the "positive" news, also expressed concern following release of the figures. The improvement in the current account was driven by a fall in income earned by foreign investments in New Zealand, Stats NZ said, which was influenced by tax charges of NZ$661 million brought against the Bank of New Zealand (BNZ) during the quarter. BNZ made a provision for the ruling, although it is appealing against the case. The improvement was bigger than what had been expected by economists, who were expecting an improvement in the deficit to a range between 6.6% of GDP to 7.8% of GDP. New Zealand's current account deficit in the year to June was NZ$10.6 billion, from NZ$14.6 billion in the year to March and NZ$14.8 billion in the year to June 2008 (8.3% of GDP). In actual terms, the current account recorded a surplus of NZ$124 million in the June 2009 quarter, but in seasonally adjusted terms it was a deficit of $612 million. "This is the first actual dollar surplus since the March 2003 quarter, although if the effect of the company tax transaction affecting investment income was removed, there would be a deficit of $537 million," Stats NZ said. "The decrease in the current account deficit from the year ended March 2009 was due to a decrease in the investment income deficit, combined with a turnaround in the balance on goods from a deficit to a surplus over this time," Stats NZ said. "The investment income deficit was $2,008 million smaller in the year ended June 2009 than in the year ended March 2009. The balance on goods changed from a deficit of $1,336 million for the year ended March 2009 to a surplus of $528 million for the year ended June 2009. This was driven by a large fall in volumes of imported goods," it said. "The investment income deficit, which is not seasonally adjusted, was $1,600 million in the June 2009 quarter, $1,181 million smaller than in the March 2009 quarter. The decrease in the income deficit was driven by a fall in profits earned by foreign direct investors from their New Zealand subsidiaries, while interest paid on overseas borrowing also fell. The fall in profits was mostly in the banking sector and influenced by a large company tax transaction brought into account during the quarter." "Income earned by non-resident direct investors on their New Zealand subsidiaries was $553 million in the June 2009 quarter, the lowest level since this time series began in the June 2000 quarter. This result has been affected by unusually large company tax charges of $661 million brought into account by the Bank of New Zealand in the June 2009 quarter. Company tax is a transaction between the resident entity and the resident tax authority. The income attributable to foreign investors measured by the balance of payments is the net profit after tax." New Zealand's net international liabilities were NZ$171.6 billion (95.2% of GDP) at June 30, 2009, compared to NZ$173.5 billion (96.4% of GDP) at March 31, 2009, Stats NZ said. In dollar terms, this was the first decrease in New Zealand's net debtor position since the March 2006 quarter. The net international liability position comprised of New Zealand's net international equity deficit of almost NZ$12 billion on top of net international debt of just under NZ$160 billion. New Zealand had total international assets of NZ$134.5 billion at the end of the June quarter, down from NZ$143.6 billion at the end of March, a fall of 6.3%. Total international liabilities were NZ$306.1 billion at June 30, from NZ$317.1 billion at the end of March, a fall of 3.4%. International borrowing by banks based in New Zealand fell by nearly NZ$12 billion, or 4.7% over the quarter, to NZ$244 billion at the end of June. The New Zealand dollar shot up from 0.7030 US dollars to around 0.7150 following the news. However, this also followed an announcement by Fonterra that it had lifted its payout forecast for the 2009/10 season by 55 cents to NZ$5.10 per kilogram of milk solids. Stats NZ also said significant revisions were made to the March 2009 quarter investment income balance. "Income from foreign investment in New Zealand was revised down by $489 million from that which was previously published. These revisions also decreased the income deficit for the year ended March 2009. The revisions were made in response to more accurate information provided by survey respondents," it said. Finance Minister Bill English English said the improvement in the current account deficit was "positive" but turned attention to the fact it was led by a big fall in imports and a drop in company profits flowing offshore. He reiterated the government's desire to rebalance the economy. "If we want a strong recovery that provides sustainable jobs and growth we need to lift our export performance, which has remained relatively static," English said. "This Government has set out a comprehensive programme to rebalance our economy around exports and investment," he said. "This will be assisted by Fonterra today lifting its forecast payout to dairy farmers from $4.55 to $5.10 per kilo of milk solids." Economist reaction ASB economists noted the smaller deficit was "not for all the right reasons", with momentum looking like it would wane toward the end of the year and into 2010.

NZ's current account deficit has headed in the right direction in recent quarters, though got a lot of temporary help from BNZ's huge provision. Some of the recent drivers have been positive, such as lower debt-servicing costs. However, many have reflected the trials and tribulations the local economy has experienced. Dairy export volumes have recovered from drought-hammered levels. Both imports and income earned on foreign investment in NZ have been weak because the economy has been deep in recession. Much of the momentum from those recent drivers is tapering off. We expect the annual deficit to shrink further in the second half of 2009, but to then rebound to around 6-7% of GDP beyond the temporary provision blip. The trade balances will struggle to lift further until the global economic recovery becomes entrenched. And as NZ's economy recovers over the next year import demand and domestic corporate profitability will lift. Economic rebalancing will be receiving more scrutiny from the RBNZ and the Government. A still-large current account deficit will remain a risk to NZ's economic stability, as well as a prod for changes in economic policy.

The fact the current account recorded a considerable improvement needs to be acknowledged. The 2.2 percentage point narrowing in the annual deficit as a percent of GDP is the sharpest since at least 1966. Simple arithmetic courtesy of a low Q2 result is likely to see the annual current account deficit fall well below 5 percent of GDP over the coming quarters. However, looking at the main drivers "“ a capitulation in imports, low interest rates (lowering debt servicing costs) and lower profitability of foreign firms owing to some one-off tax treatment, all look to be cyclical in nature. On a seasonally adjusted basis the trade deficit has been improving for four successive quarters. Signs of improving dairy prices will support this further going forward. However, once again we would question the sustainability of the trade balance improvement given the rotation we are seeing in growth in favour of the domestic economy and strengthening currency. For the NZ economy to truly rebalance, the export and earnings sectors, rather than domestic economy, need to be the drivers of recovery.