Opinion: Why less 'hot' foreign borrowing means a more stable NZ$

By Bernard Hickey Last week I gave a presentation (see below) to the annual President's function of the New Zealand Manufacturers and Exporters Association in Christchurch in which I argued that the introduction by the Reserve Bank of its Core Funding Ratio would help make the New Zealand dollar more stable and lower over the long term. One of the reasons for the relative strength of the New Zealand dollar from early 2006 to late 2007 when it rose from 50 USc to 80 USc was the huge amount of 'hot' short term wholesale funding that was sucked in from overseas by our major banks to fuel the final lending spree to property buyers at the end of the housing boom. Now the Reserve Bank and the banks themselves are working hard to reduce their reliance on this 'hot' money. They are trying to lift their 'Core Funding Ratios', which measure the amount of funding from local and longer terms sources to total lending, from as low as 55% to over 75% by 2012. This is forcing the banks to raise more money from term deposits locally and from long term foreign bond issues. This is more expensive and harder to get, which is forcing the banks to restrain their lending, and their foreign borrowing. This 'trickle' of foreign borrowing is lessening demand for the New Zealand dollar. The Reserve Bank has already signaled this change in bank behaviour means it is unlikely to lift the Official Cash Rate as high and as quickly as in the past. The New Zealand dollar's relative stability around 71 USc since September last year suggests this new policy is already having an impact. I was relatively upbeat about New Zealand's exporting prospects in the presentation, given this potential for a more stable currency, our stable financial system and the luckiness of being so close to Australia and therefore China. I concluded that New Zealand faces a long period of de-leveraging with relatively slow GDP growth with slow bank lending expansion. I see an increasing (and welcome) skew in our economy to an Asian-focused export sector. The caveats to this outlook are; * some sort of major contraction in China in the event its housing bubble bursts, * the risk that our locally generated skill base is hollowed out further by an exodus to Australia where wages and opportunities are growing faster, * the failure of central and local government to enact reforms that improve housing supply, boost productivity and redirect investment to productive investment and away from property investment. PS Many thanks for the invitation to NZMEA Chief Executive John Walley (a regular commenter on interest.co.nz) and NZMEA President Gordon Sutherland, who is also the Chief Executive of AW Fraser Ltd, a Christchurch-based manufacturer that makes and machines bronze alloys and brass. Many thanks also to  AW Fraser's Chief Financial Officer Paul Isitt, who showed me around AW Fraser's Christchurch plant on Friday morning. It's hard to believe that a New Zealand-based metals manufacturer can compete globally, but they're doing a fantastic job melting down scrap copper and turning it into bronze and brass components for companies such as Caterpillar. It reinforced to me the importance of the Chinese economy in New Zealand's future. Even though AW Fraser sells few products directly to China, many of its components go into the construction equipment used to build all the infrastructure being developed there. It was also great to meet up with Paul because he played basketball for years in the Canterbury Rams with Rob Hickey, my brother, who was also a member of the Tall Blacks team that got to the semi-finals in the World Champs in 2002. This is my main claim to fame. I welcome your views below on this presentation.