Brian Fallow: Deficit — from bad to much worse

OPINION:

Moves to reopen the border come not a moment too soon, given the news this week that New Zealand spent $20.2 billion more than it earned in its dealings with the rest of the world last year.

That figure — the annual deficit in the current account of the balance of payments — is up from just $2.7b in 2020.

It is the equivalent of 5.8 per cent of the economy’s output, or about twice the average for that ratio over the past seven years.

Coming on top of decades of current account deficits, it leaves us with net external debt of $173b —$17b more than a year ago and $30b more than on the eve of the Covid-19 shock.

The cost of servicing that debt is set to rise as central banks increase interest rates in the face of rapidly rising inflation.

Even in a year in which interest rates were historically low, servicing the external debt, and providing a return to foreigners with direct or portfolio equity investment in New Zealand, cost $8.6b last year, $1.8b more than in 2020.

A bigger contribution to the widening of the current account deficit was the balance on services.

In 2021 it was $5.4b in the red, compared with surpluses of $1b in 2020 and $4b on the eve of the border closure in March 2020.

Driving that decline was the collapse in travel exports, largely inbound tourism, to $1b from $5b in 2020 and more than $10b before the border was closed. Business and education-related travel also declined.

The decline in the services balance was not all about tourist flows. Freight costs rose $1.4b to $4.6b.

But the biggest driver of the blowout in the current account deficit last year was in the balance of goods.

That was $6.2b in the red last year compared with a surplus of $3.1b in 2020.

“The value of imports has continued to grow in recent quarters due to strong ongoing domestic demand for imported goods, and rising prices and transport costs internationally,” Statistics NZ’s Paul Pascoe said.

In the December 2021 quarter, the value of goods imports was $19b, compared with $12.5b in the June 2020 quarter.

As has been the case internationally, Covid-related lockdowns and voluntary reluctance to congregate have switched consumer demand from services to goods.

“While the demand for goods has been strong during the Covid-19 pandemic, production in some industries slowed globally, resulting in supply shortages and price increases for many goods,” Pascoe said.

The $9.3b deterioration in the goods balance last year was all the more striking given that New Zealand enjoyed exceptionally strong terms of trade. That is the ratio of export prices to import prices. Think of it as how many smart TVs you can get for a container-load of milk powder. Last year it was the most favourable since at least 1987.

Underpinning that have been strong export commodity prices. The ANZ’s commodity price index rose 27.8 per cent in New Zealand dollar terms last year, and as of last month was 29.3 per cent up on February last year.

But “have been” is the right tense. The outlook is clouded by the fog of war.

The fallout — hopefully not literal — from the war in Ukraine on global oil prices on the one hand, and agricultural commodity prices on the other, is uncertain.

On top of that are the disruptions to supply chains arising from China’s evident determination to stick to a policy of Covid elimination even in the face of so highly transmissible a variant as Omicron.

These challenges have sideswiped a global economy that was showing encouraging signs of regaining momentum.

The collective gross domestic product of the 20 largest economies — the G20 – rose 6.1 per cent last year, albeit after a contraction of 3.2 per cent in 2020.

The Reserve Bank’s forecasts in last month’s monetary policy statement, made before the outbreak of Russian President Vladimir Putin’s war, have GDP growth among New Zealand’s trading partners declining to 4.4 per cent in the year ahead, on an annual average basis, and then 3.4 per cent for the following two years.

It expects the current account deficit to widen further, averaging around 6 per cent of GDP over the next three years.

Why should we care?

Because the deficits have to be funded either by borrowing from, or selling assets to, the rest of world.

Servicing that debt, or generating a return on those assets, pre-empts future national income, just as the legacy of past deficits takes a bite out of current income.

Economists can demonstrate with a bit of algebra that the current account balance must equal the difference between national saving and investment.

New Zealand does not do enough investing, as evident in infrastructure deficits, a shortage of housing and the capital shallowness of the business sector, which crimps productivity and incomes.

But inadequate as investment spending is, it is still more, much more, than we are willing to fund from our own saving.

The Government’s deficit is part of that.

But so is our really low household saving rate. Between 2007 and 2021 we managed to save only 0.9 per cent of our disposable income.

Thrift and providence are not the words that spring to mind.

Source: Read Full Article