Gareth Morgan, Director of Gareth Morgan Investments
One of the oft-heard points of dissatisfaction expressed by the Reserve Bank, is the persistance of high real interest rates in NZ, despite their obvious commitment to price stability. Despite this official frustration, market reluctance to “co-operate” is no mystical matter. The country’s risk premium depends not just on our long term inflation performance, but also on a demonstrated inability to apply capital provided us by foreigners, to investment and output, rather than to consumption.
Coming as we do, from a long history of inflation at rates above the world average, it seems reasonable that markets require demonstration of a commitment to price stability over a sustained period, before putting their money on the line via accepting lower yields at a given exchange rate. We have now maintained inflation within the 0-2% band for all of 4 quarters, so to expect reward now, is perhaps a biased ambition.
Secondly, poor performance by this economy over recent decades has seen expansion of national debt ratios – both the external ratio and the public debt ratio. Both of these underpin a reticence on the part of international investors to risk their capital funding such trends. The price of exchange rate stability under such circumstances is often the imposition of high interest rates – a feature of NZ financial markets over recent years.
To the future, and there is reasonable chance that NZ will maintain an external debt-reducing balance of payments performance for the next couple of years, bringing closer the time when international investors conclude that the country is deserving of a lower risk premium (ie; lower real interest rates). But the external debt trend is by no means the only factor. The trend in the public debt factor is also relevant, as credit gradings of the private sector tend to be marked up from the base of the sovereign grading. On this front, there has to be ongoing consternation about the ability of the government to improve its performance. The budget deficit is being talked higher by the Minister of Finance; positively though, there appears to be genuine recognition now that its ongoing intransigence will not be just as a result of corporate tax trends, but far more a result of other revenue trends.
So, before the RB and some like-minded commentators conclude the day has arrived for the NZ dollar to assume its status as the Deutschmark of the South Pacific, perhaps a thought for the foreign investor called on to accept less of a risk premium as a result. They have to do this despite the achievement of low inflation still being in its infancy and yet to be tested by a rise in global inflation; despite a residual overweighting in NZ anyway; despite an export recovery still in early stages; and despite a budget position far from improvement. Patience never hurt any long term investor- the risk premium is justified. Firmer measures to address the structural budget deficit would sponsor an earlier reduction in it.