Gareth Morgan, Director of Gareth Morgan Investments
Monday’s balance of payments result confirmed a worsening trend – hardly a surprise given the speed of the domestic economy and the pressure from the real exchange rate. That Winston Peters should feel compelled to inform us that he is keeping an eye on the situation suggests he feels he can do something about it. He can.
His pre-election rhetoric suggested a preference for a managed exchange rate – specifically managing it lower. This could be achieved by either instructing the Reserve Bank to target higher inflation with looser monetary conditions, or even to directly intervene in the currency market through selling NZ dollars. Either course would be a sledgehammer response, but ones the Treasurer once preached.
Alternately, the Treasurer could do what some of the exporters have been lobbying for – run a tighter fiscal situation than is projected in the coalition documents. But again this response has limited efficacy as the recent years of tightening fiscal conditions in conjunction with a rising real exchange rate, bear testimony to.
So if neither sloppy monetary policy nor tighter fiscal policy are really to be backed as credible means of reducing the real exchange rate, what course should the Treasurer pursue? Insofar as solving the overvalued currency problem he has no direct solutions available which don’t compromise other macroeconomic objectives.
Global capital markets have decided that our interest rates provide an attractive return, even adjusting for currency risk – that is why the real exchange rate continues to appreciate. The market doesn’t yet see the current account deterioration as so significant a problem that its financing is problematic. It doesn’t even see the future prospects for funding it as a problem either – otherwise the dynamic of currency appreciation would have stopped already. But beneath this seemingly benign atmosphere of ready funding, change is afoot. The nature of the funding of the current account deficit has changed.
Up until a year ago equity inflows formed a substantive portion of the capital inflow required to finance the deficit. Foreign investor moneys for privatisations, immigrant capital transfers, and retained profits of overseas-owned firms in NZ, augmented the debt- financing inflows. As a consequence the burgeoning current account deficit didn’t necessarily imply ballooning external debt ratios. But more lately, the financing of the deficit have shifted further toward debt – Euorkiwis and Samurai issues being high profile illustrations of this. The equity flows have been discouraged – the anti-foreign sentiment of NZ First has been sufficiently influential to generate a fall in migrant inflows, and to stunt the privatisation programme.
Having made a bed of the fortress NZ edict, it is now for the Treasurer to lie on it. The consequence as he rests will be an easing of the upward pressure on the currency only once NZ pushes its external debt ratios to investment market-alarming levels. A precursor to that should be continued shrinkage in the export sector as the rising currency chews out profitability. In essence the Treasurer’s economics have chosen a high debt-driven correction to the currency over further foreign-driven structural reform of our industrial base. No free lunch.