New Zealand Ratings Outlook Remains Stable

Stocks and Financial Services Press Releases Friday January 20, 2017 09:21
S&P Global Ratings--20 Jan--S&P Global Ratings

On Jan. 20, 2017, S&P Global Ratings affirmed its 'AA' foreign currency and 'AA+' local currency long-term sovereign credit ratings on New Zealand. We also affirmed the 'A-1+' short-term rating, and maintained our transfer and convertibility risk assessment on New Zealand at 'AAA'. The rating outlook remains stable.


The rating affirmation on New Zealand reflects the country's monetary and fiscal policy flexibility, economic resilience, and public policy stability. Moderating these strengths are New Zealand's very high external imbalances, its high household and agriculture sector debt, its dependence on commodity income, and risks to its financial system stability.

Underpinning the ratings on New Zealand are its strong institutions. We believe that the checks and balances in government are effective, and New Zealand ranks near the top of many surveys on governance, government efficiency, and business promotion. The Reserve Bank of New Zealand has strong credibility regarding its inflation mandate and its supervisory role.

New Zealand benefits from a high-income and resilient economy, which we believe draws from decades of structural reforms and wage restraint. In the year ended June 30, 2016, the country's GDP per capita was US$34,000. We expect it to rise to about US$39,000 in fiscal year 2017, reflecting solid economic growth and currency appreciation during the past year.

Economic growth has been solid over the past few years, despite global and domestic challenges. Growth in fiscal year 2016 was 2.7%, in line with our forecast, and we expect it to remain around this rate over the next few years.

We expect strong net migration to continue to support growth, through strong residential investment and solid consumption growth, while business investment is also likely to remain firm. Ongoing strong residential investment may alleviate housing supply pressures over time. Home prices in Auckland, the largest city, have spiked during the past few years, creating some concern. This strength is now spilling over to housing markets in other regions of the country.

Along with strong population growth, New Zealand's free-floating exchange rate, which has depreciated sharply since mid-2014, is helping to sustain solid economic growth. Services exports, especially tourism, have become an important contributor to growth. Prices for New Zealand's key export commodity--dairy--have improved sharply during the past six months, though they remain well below 2013 levels. While supporting higher terms of trade, dairy production and export volumes will likely be lower in the coming year, broadly offsetting the impact on export trade values.

Many of these factors, along with low import prices, have supported a narrower current account deficit, which stood at 2.9% of GDP in fiscal year 2016. We expect the current account deficit to remain in the range of 3% to 4.5% of GDP for the next few years; during the past few years we have expected the current account deficit to reach 5% to 6% of GDP or more. Still, while such deficits are not out of the ordinary for New Zealand from a historical perspective, they are greater than the equivalent of 10% of current account receipts and still relatively large, in our view.

With current account balances in this range, we expect the economy's external debt--net of official reserves and financial sector external assets--to be broadly stable, at about 190% of current account receipts, over the next few years. This remains a very high level of external indebtedness. In addition, there is a large market for nonresident offshore issuance in New Zealand dollars (the Eurokiwi and Uridashi markets), which affects the demand for New Zealand dollars. This market totaled about NZ$34 billion, or nearly 60% of New Zealand's annual current account receipts, as of December 2015. And nearly half of nonresident onshore issuance (Kauri bonds), which amounted to NZ$24 billion, or 40% of current account receipts, is held by nonresidents. These markets contribute to the liquidity of the New Zealand-dollar foreign-exchange market, but by the same token could exacerbate a currency correction if offshore demand were to fall.

We also forecast New Zealand's gross external financing needs to remain high, at more than double its current account receipts and reserves. However, somewhat mitigating these risks are the depth of the New Zealand dollar foreign-exchange market and its exchange-rate flexibility. The 'Kiwi' is ranked 11th of actively traded currencies in the 2016 Bank for International Settlements' triennial survey of foreign exchange trading.

New Zealand's current account deficits are traditionally associated with external borrowings by its banks to fund its growth. The parent companies of the four major banks in New Zealand are headquartered in Australia. Our ratings on the four major New Zealand banks are equalized with those on their Australian parents, given our view that they are core parts of their parents' groups. Our ratings on these Australian banking groups face downward pressure over the next two years from the negative outlook on our local currency sovereign rating on the Commonwealth of Australia (see "Outlooks On Australian Major Banks And Strategically Important Subs Revised To Negative On Similar Sovereign Action," published July 7, 2016), the increasing likelihood that we will revise downward our assessment of the government's supportiveness toward Australia's banking sector to supportive from highly supportive, and the increasing economic risks facing all banks operating in Australia (see "Outlooks On 25 Australian Financial Institutions Revised To Negative On Rising Private Sector Debt And Property Prices," and "Credit FAQ: Buildup of Economic Imbalances Weighs on Australian Banks' Creditworthiness," published Oct. 30, 2016). A downgrade of our ratings on the Australian major banks would have a flow-on impact on the ratings on their New Zealand subsidiaries, and possibly their cost of funding.

The possibility that foreign investors become less willing to fund banks at reasonable interest rates poses a risk to the banking system, the broader economy, and, in turn, government finances. However, we believe that New Zealand's banks will retain ready access to external markets. The risks to the banking sector due to the possibility of a disruptive housing market correction remain elevated, in our view, but we currently believe that these risks are unlikely to heighten in the next two years (see "New Zealand Financial Institution Ratings Unchanged Despite Property Price Concerns," published Aug. 22, 2016). We believe the recent trend of higher repricing of home loans, in response to margin pressures and rising global yields, is likely to remove some cyclical demand from New Zealand's housing market, though we expect a number of structural challenges will ensure risks remain elevated. We also believe some of the downside risks to the New Zealand banks have diminished because dairy prices recovered through the latter part of calendar 2016. Nevertheless, we expect that many dairy farmers will remain reliant on the extraordinary support of their lenders, given the surge in dairy sector debt in recent years.

Our rating affirmation and stable outlook are premised on our expectation that the central government will maintain or improve its budget performance during coming years. The New Zealand government has made substantial headway in improving its fiscal performance since the negative effects of the 2008 global recession and 2010–2011 Canterbury earthquakes. The general government cash deficit peaked at 6.8% of GDP in fiscal year 2011 and improved to a deficit of 1.2% of GDP in fiscal year 2016.

We expect the general government sector fiscal deficit to be broadly unchanged in fiscal years 2017 and 2018, at around 1.5% of GDP. The fiscal impact of the 7.8 magnitude earthquake on Nov. 14, 2016, is likely to be a fraction of that related to the 2010–2011 Canterbury earthquakes. The fiscal deficit could narrow significantly beyond that, with the central government running cash surpluses from fiscal year 2019 onward.

With this outlook, we expect net general government sector debt to peak at about 22% of GDP before gradually declining, and interest expense to be about 8% of revenues.

We have maintained a one-notch distinction between the long-term foreign currency and local currency ratings in light of the credibility of the country's monetary policy, the freely floating currency, and the depth of domestic debt markets. Monetary flexibility can underpin a sovereign's greater debt-servicing flexibility in its own currency.


The stable outlook balances the stabilization in the government's debt profile and the risks associated with the country's high external debt. The outlook is premised on our expectation that New Zealand's financial system will remain sound and its government finances robust.

We could lower our ratings on New Zealand if its fiscal, external, or banking metrics turn out weaker than our current expectations. On the other hand, upward pressure on the ratings could emerge if stronger export performance and higher public savings markedly reduce external debt and the government's debt   burden.

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