Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most
cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of
discussions of staff monitored programs, and as part of other staff reviews of economic developments.
New Zealand- 2012 Article IV Consultation Preliminary Concluding Statement
April 2, 2012
Overview. The authorities’ current macroeconomic policy stance is appropriate. With output below potential and expected inflation
within the target range, monetary policy should remain accommodative for now, and should act as the first line of
defense against near-term adverse shocks. The authorities’ planned deficit reduction path strikes a balance between the
need to limit both public and external debt increases while containing any adverse impact on economic growth during the
recovery. The financial sector is currently sound, and the authorities should ensure that banks’ liquidity and capital
buffers are adequate given banks’ dependence on offshore wholesale funding and their exposure to highly leveraged
households and farmers.
Supporting Near-Term Recovery
Output and inflation. The pace of New Zealand’s economic recovery is likely to remain modest. Output growth should pick up somewhat in 2012
as earthquake reconstruction spending is expected to gain pace, although the size and timing of this spending is still
uncertain. Other sources of demand will remain soft, however, as global growth prospects have worsened and households
are still highly leveraged and will need to save to strengthen their balance sheets. The spare capacity and elevated
unemployment will contain wage and inflation pressures in the near term.
Monetary policy stance. Under these conditions, the current accommodative monetary policy stance is appropriate. The Reserve Bank of New
Zealand (RBNZ) lowered the policy rate in March 2011 to cushion the impact of the February earthquake, and has since
kept the rate on hold given a stronger exchange rate, soft domestic demand, and benign inflationary expectations. With
the shift toward floating rate mortgages in recent years, household consumption should be more sensitive to interest
rate changes, allowing the RBNZ to remove the monetary stimulus fairly quickly when required.
Managing near-term risks
External risks. Emerging weaknesses in the global economy and a possible upheaval in the global financial system pose risks. The main
channels are:
• Lower export demand. Australia and China are the top two destinations for New Zealand exports, leaving growth
prospects vulnerable to their economic outlook.
• Worsened terms of trade. Prices for New Zealand’s commodity exports are largely underpinned by demand from global
markets. Falling demand could significantly weaken the terms of trade from recent historically high levels. However,
declines in commodity prices in the past have been offset to some extent by a weakening of the exchange rate, helping to
buffer the impact on the domestic economy.
• Increased cost of external funding. While New Zealand banks have little direct asset exposure to European borrowers,
they do rely heavily on offshore wholesale funding. A worsening of global financial conditions could raise the cost of
this funding, putting upward pressure on interest rates for domestic firms and households.
• Rollover risks. Banks’ persistent reliance on offshore wholesale funding leaves them vulnerable to the tail risk of a
temporary shutdown of global funding markets. While the probability of this event is difficult to determine, it has
fallen since late 2011. In addition, banks are less vulnerable than during the market disruption in late 2008, as the
share of retail deposits and the average maturity of bank liabilities have been steadily increasing over the last three
years and the source of funding is diversified across different regions and products.
Housing sector risks. Although affordability ratios and debt servicing ratios have recently improved, house prices still remain elevated. A
sudden price correction, possibly triggered by higher borrowing costs or a shock to household incomes, could reduce
consumer confidence, worsen banks’ balance sheets, and impair the economic recovery. The likelihood of this risk
materializing in the near term, however, is low.
Tail risks and downside scenarios. Many of the above risks are highly linked—for example, a hard landing in China, which would negatively affect
Australia, would consequently reduce demand for New Zealand exports, worsen terms of trade, and could trigger a sudden
decline in house prices. This could in turn weaken consumer demand and growth, and negatively affect banks’ balance
sheets. The downside macroeconomic impact of such a scenario could be substantial.
Managing risks. The authorities have policy space to respond to near-term shocks, with monetary policy serving as the first line of
defense. The RBNZ has the scope to lower interest rates and loosen monetary conditions to help buffer against a downside
scenario. As evident during the crisis, the free-floating New Zealand dollar provides an additional cushion against
external shocks, including disruptions to offshore funding and a negative terms of trade shock. The authorities would
also be able to provide emergency liquidity support to banks, a measure which proved effective when wholesale markets
shut down in the wake of the 2008 crisis. Moreover, New Zealand’s relatively modest public debt gives the authorities
some scope to delay their planned deficit reduction path in the event of a sharp deterioration in the economic outlook.
Reducing External Vulnerability
Current account. Reflecting low national saving relative to investment, New Zealand has run persistent current account deficits
resulting in large net external liabilities. Deficits are expected to widen this year as terms of trade decline and
earthquake reconstruction activity gathers pace. Increasing national saving would be an important part of reducing net
external liabilities, and much will depend on whether the recent increase in the household savings rate represents a
structural break from the past. Fiscal deficit reduction (discussed below) would also contribute to raising national
savings and reducing future current account deficits.
Exchange rate assessment. New Zealand’s free floating exchange rate regime is expected to play a role in reducing external vulnerabilities. Our
analysis suggests that the New Zealand dollar is currently stronger than would be needed to bring the current account
deficit to a level that is sustainable over the longer term. However, part of the current strength of the New Zealand
dollar reflects the positive interest rate differentials with major currencies which may dissipate with eventual
tightening by the central banks.
Increasing Public Savings
The government’s deficit reduction plan. Reflecting the recession, past revenue and spending decisions, and the impact of earthquake-related spending, the
fiscal deficit (on an accrual basis) reached a record high of 9¼ percent of GDP in 2010/11, raising net government debt
to 20 percent of GDP by mid-2011 from a low of 5½ percent in 2008. The government’s medium-term deficit reduction plan
is aimed at limiting the increase in public debt to preserve the fiscal space to guard against future economic risks and
at contributing to lowering external debt. To this end, the 2011/12 budget plans to reduce the fiscal deficit to about 6
percent of GDP, and return to budget surplus by 2014/15, mainly through spending control. According to this plan, net
government debt would peak at about 30 percent of GDP in 2015, and decline to 20 percent of GDP by 2021. We support the
government’s ongoing efforts to keep the deficit reduction path on track.
Benefits of this plan. The pace of deficit reduction entails an improvement of about 5 percent of GDP in the structural balance over the next
five years. In our view, this strikes the right balance between the need to limit public debt increases while containing
any adverse impact on economic growth during the recovery. Specifically:
• It contains the aggregate demand impact by withdrawing fiscal stimulus in line with expected increases in private
sector and earthquake-related reconstruction spending.
• It creates fiscal space to help the country cope with a possible sharp reduction in domestic economic activity or
potential liabilities associated with future adverse shocks. Over the longer term, it will create space to deal with
aging and rising health care costs.
• It will limit pressure on monetary policy and therefore the exchange rate, helping reduce the current account deficit.
• It could contribute to containing the increase in New Zealand’s large net foreign liabilities.
Maintaining Financial Stability
The banking sector is dominated by four large subsidiaries of Australian banks that have proved resilient to the recent turbulence in the
global financial markets. Since then bank profits have increased and nonperforming loans have fallen to less than 2
percent of total loans. Banks’ balance sheets remain fully hedged against exchange rate risks. Capital adequacy has
improved since 2007, and all banks are well positioned to meet the Basel III capital requirements. In fact, the RBNZ
currently requires that capital ratios be determined using more conservative risk weights and loss-given-default
standards than in many other countries. The RBNZ has continued to strengthen regulation and supervision of nonbanks.
Balance sheet risks. On the asset side, banks’ large exposure to highly indebted households and to the agriculture sector is a key
vulnerability. Household debt remains high at about 150 percent of disposable income, and a rise in mortgage rates
together with an increase in unemployment could lead to an increase in nonperforming loans. A large fall in dairy and
meat prices would reduce the quality of agricultural loans but the capital requirements for these loans have been
strengthened since mid-2011. On the liability side, banks have made steady progress in lengthening the maturity profile
of their wholesale funding since 2008 and increasing the share of retail deposits, but the total stock of banks’ gross
external liabilities remains above 70 percent of GDP and loan-to-deposit ratios remain high.
Prudential measures. We support the authorities’ intention to implement key features of Basel III in early 2013. At the same time, we
encourage the authorities to assess on an ongoing basis the balance between banking sector soundness and efficiency to
ensure that the systemically important banks’ large wholesale funding needs and their exposure to highly leveraged
households and farmers do not pose a sizable potential fiscal liability. The proposed Open Bank Resolution framework
could help ensure business continuity and limit the fiscal costs of bank failure. Other options to strengthen prudential
norms could include setting banks’ capital requirements above the Basel III minimum or raising the core funding ratio
more than the planned 75 percent. The IMF’s upcoming review of the Australian financial sector (FSAP), which will also
cover New Zealand banking subsidiaries, should be useful for New Zealand in assessing appropriate prudential norms.
Stress tests. Stress tests of banks in 2009-10 (conducted together with the Australian authorities) show resilience to higher
unemployment and a sharp fall in property prices, but did not include funding shocks. Future stress tests could be more
stringent and include a disruption to bank funding and a large increase in longer-term interest rates.
ENDS