It is sometimes said that the private sector is to blame for New Zealand’s large external net indebtedness because it is the private sector that owes the money.
In fact, government overseas borrowing played an important role in the major increase in external indebtedness that occurred between 1974 and 1989.
Today’s Friday Graph shows that external net public debt (which is government overseas borrowing in foreign currency denominations, net of official overseas reserves), rose sharply from 2.6 percent of GDP in March 1974 to 28.5 percent of GDP in March 1986 (see the red line in the chart).
The increase occurred because the government borrowed heavily overseas during this period in order to fund both its own fiscal deficits and the portion of the large current account deficits in the balance of payments that was not funded by a net private capital inflow.
But for that borrowing, the government would have had to allow the exchange rate to depreciate, likely improving external competitiveness, and reducing the deficit in the balance of trade in the balance of payments. New Zealand’s level of net external indebtedness today would have been lower if balance of trade deficits had been lower during this period and on a sustained basis.
The exchange rate was floated in February 1985. This eliminated the pressure on governments to borrow overseas in order to defend an administratively-determined exchange rate.
It is primarily the large ongoing fiscal deficits that lifted the total net public debt to 40.4 percent of GDP in March 1986 and to 50.1 percent in June 1992 (see the black line in the chart). Thereafter, fiscal surpluses and asset sales reduced the overall net public debt ratio. A paper prepared for the Business Roundtable by Wellington economist Phil Barry titled Does Privatisation Work? assessed that privatisation proceeds reduced the net public debt ratio to GDP by around 15% of GDP between 1992 and 2000.
Returning to the red line, after 1986 it became government policy to eliminate the Crown’s exposure to currency risk. Between 1986 and 1992 this was achieved in good part by replacing overseas currency debt by domestic currency debt (see the rise in the blue and black lines). The Crown’s net external debt was eliminated by 1997.
Reducing the Crown’s net external debt in such a manner does not reduce New Zealand’s net external indebtedness. This is because the Crown must give the foreigner a claim on New Zealand of equal value, for example, cash borrowed from New Zealanders or ownership of a commercial enterprise.
It follows that the level of New Zealand’s net external indebtedness today is in part a legacy of the ‘fixed’ exchange rate regime that applied during the 1974-1985 period. That regime arguably prolonged New Zealand’s loss of external competitiveness, aggravating the cumulative trade deficits in the balance of payments.
Dr Bryce Wilkinson
Acting Executive Director
New Zealand Business Roundtable