Fitch downgrades NZ's credit rating outlook from stable to negative (Update 4)

Credit rating agency Fitch has downgraded the outlook for New Zealand's AA+ sovereign credit rating to negative from stable and has warned that severe economic imbalances mean the government should dramatically tighten its purse strings. (Updates with link to comments on Radio New Zealand from Fitch's James McCormack) The downgrade to New Zealand's outlook, which is closely watched by foreign investors, surprised traders in the New Zealand dollar, who pushed it a full cent lower in afternoon trade to 64 US cents. Fellow ratings agency Standard and Poor's shocked the new National-led coalition government into a budget tightening when it warned of a potential downgrade in January, but the government did enough in the May budget to convince Standard and Poor's to retract its warning. This latest move by Fitch ups the ante again for the government just when it thought the worst might be over. Moody's reaffirmed New Zealand's rating earlier this year. Fitch was scathing in its assessment of New Zealand's economic outlook and warned the government would have to tighten its belt further to ensure New Zealand's foreign debts did not blow out any more.

"The revision in the outlook reflects the agency's concern about the medium-term growth outlook for New Zealand given its persistently large current account deficit and rising foreign indebtedness," Fitch said. "Despite the recession, the current account deficit remains large and is projected to remain above the level necessary to stabilise and reduce New Zealand's net foreign liabilities," it said. New Zealand's current account deficit stood at 8.5% in the March quarter and New Zealand's net debt was a record high 98.2% of GDP. "In Fitch's opinion, a stronger fiscal adjustment than currently planned may be required to raise national savings and reduce the current account deficit, as well as structural reforms to improve productivity," Fitch said. "New Zealand could fall into a low-growth trap as foreigners demand higher returns to incentivise them to continue to lend to New Zealand so it can consume more than it produces, gradually eroding New Zealand's fundamental credit strengths, including strong public finances, and rendering it more vulnerable to future adverse shocks," said Ai Ling Ngiam, Director in the agency's Asia-Pacific sovereign team. Fitch said there were some positives in New Zealand, including the strength of the banking sector and timely policy action by the Reserve Bank of New Zealand, which helped New Zealand navigate turmoil in global financial markets without a crisis. "Nonetheless, severe macroeconomic imbalances, most notably the current account deficit and low household savings, remain in place and adjustment is further complicated by the volatility of the New Zealand dollar that appears more responsive to global financial conditions than to domestic economic fundamentals," Fitch said. "Moreover, the reliance on short-term foreign funding by local banks remains a potential source of risk if a more abrupt adjustment was imposed at some future date on New Zealand by international markets and its creditors." Fitch said it estimated a 4.5 percentage points of GDP turnaround in the current account balance was necessary to bring the net international income deficit below 100% by 2011. "However, with historically low real interest rates and the current accommodative fiscal stance, there is a risk that the required balance sheet adjustment by households and, more generally the private sector, will be insufficient in reducing the current account deficit and foreign indebtedness to a more sustainable and safe level," Fitch said. "Against this backdrop of external vulnerability, more aggressive restoration of public finances through fiscal prudence will be needed to raise the national savings rate to counter weak private savings," it said. Fitch said budget estimates for New Zealand's trend economic growth rate were too optimistic, "given falling labour productivity growth and evidence that the economy may have been persistently expanding above capacity in recent years as reflected in the large current account deficit." Fitch said the rating review could take up to 2 years and implied a greater than 50% chance the rating would be downgraded. BNZ's Danica Hampton said the Fitch report highlighted the "usual factors".

Late yesterday, Fitch affirmed New Zealand's AA+ rating, however, they revised our outlook from Stable to Negative. Fitch chose to highlight the usual factors of external debt rising, the current account deficit and a weak medium-term outlook for growth. Fitch's move surprised the market, especially since the comparably positive reaction to the May Budget from Standard & Poor's and Moody's. Recall that, following the Budget, Standard & Poor's upgraded the NZ outlook to stable from negative, while Moody's confirmed a stable outlook on NZ's Aaa sovereign credit rating. The breaking news immediately undermined the NZD, seeing it lose close to a cent against the USD in frenetic trading. Overnight the NZD has predictably underperformed on cross rates, steadying against the beleaguered greenback at the 0.6450 level, but easing back to 60.5 on a TWI basis from yesterdays levels above 61.0 Our economist"˜s feel that the Fitch announcement is a reminder of some of the broad imbalances that could remain in the economy. The risk is very real that if we do get some growth emerging in the next year or two, the composition might be all round the wrong way, and this is where the currency is quite a big issue. If you believe that global news is going to get better, then in all likelihood the currency is going to keep edging up. It would be seen in over-valued territory. This would mean that we essentially shut our export sector out of any recovery and instead will rely on domestic demand, consumers and housing to fill the gap. That's all the wrong way round and along the lines of commentary from both the RBNZ and elected officials in recent days.

Here is the full release from Fitch below.

Fitch Ratings has today affirmed New Zealand's Long-term foreign currency Issuer Default Rating (IDR) at 'AA+', Long-term local currency IDR at 'AAA', Short-term foreign currency rating at 'F1+' and the Country Ceiling at 'AAA'. The Outlook on the ratings has been revised to Negative from Stable. The revision in the Outlook reflects the agency's concern about the medium-term growth outlook for New Zealand given its persistently large current account deficit and rising foreign indebtedness. Despite the recession, the current account deficit remains large and is projected to remain above the level necessary to stabilise and reduce New Zealand's net foreign liabilities. In Fitch's opinion, a stronger fiscal adjustment than currently planned may be required to raise national savings and reduce the current account deficit, as well as structural reforms to improve productivity. New Zealand's ratings have been affirmed reflecting its strong credit fundamentals, notably a credible commitment to low inflation, strong public finances and track record of policy and structural adjustment. "New Zealand could fall into a low-growth trap as foreigners demand higher returns to incentivise them to continue to lend to New Zealand so it can consume more than it produces, gradually eroding New Zealand's fundamental credit strengths, including strong public finances, and rendering it more vulnerable to future adverse shocks," notes Ai Ling Ngiam, Director in the agency's Asia-Pacific sovereign team. The strength of the banking sector, underpinned by strong foreign parents and supervisory regime, as well as timely policy action by the Reserve Bank of New Zealand (RBNZ), has helped New Zealand navigate turmoil in global financial markets without a crisis. Moreover, strong initial public finances provide the government with room to moderate the severity of the recession by allowing automatic stabilisers to take effect and with some discretionary easing. Nonetheless, severe macroeconomic imbalances, most notably the current account deficit and low household savings, remain in place and adjustment is further complicated by the volatility of the New Zealand dollar that appears more responsive to global financial conditions than to domestic economic fundamentals. Moreover, the reliance on short-term foreign funding by local banks remains a potential source of risk if a more abrupt adjustment was imposed at some future date on New Zealand by international markets and its creditors. On a four-quarter rolling sum basis, New Zealand's CAD declined marginally to 8.5% of GDP for the year to March 2009 from 8.9% of GDP in the year to 2008. Ongoing reliance on offshore debt-financing by banks and the private sector to fund the savings-investment imbalance will further worsen the deficit on New Zealand's net international investment position (NIIP). Fitch estimates that a sizable 4.5 percentage points of GDP turnaround in the current account balance is necessary to bring the deficit on the NIIP back down below 100% by 2011. However, with historically low real interest rates and the current accommodative fiscal stance, there is a risk that the required balance sheet adjustment by households and, more generally the private sector, will be insufficient in reducing the current account deficit and foreign indebtedness to a more sustainable and safe level. Against this backdrop of external vulnerability, more aggressive restoration of public finances through fiscal prudence will be needed to raise the national savings rate to counter weak private savings. At end-March 2008, expansionary fiscal policy resulted in the first decline in (general) government savings in seven years, with the 1.2 percentage point drop to 8.2% of national disposable income almost fully offsetting the improvement in the household dis-savings rate. Moreover, Fitch believes that estimates of the potential trend rate of growth and level of output that underpin the government's medium-term fiscal projections may prove too optimistic given falling labour productivity growth and evidence that the economy may have been persistently expanding above capacity in recent years as reflected in the large current account deficit. Confidence that a sustained improvement in the current account and external debt position can be achieved without a prolonged period of sub-par growth would support a revision in the Outlook to Stable. Conversely, a continuing deterioration in the net external debt and liability position would likely lead to a downgrade of New Zealand's sovereign ratings. The typical duration of a Fitch sovereign rating Outlook is 12-24 months and implies a greater than 50% chance that the rating will be downgraded.