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).

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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


Roger Kerr’s last Friday graph demonstrated that New Zealand’s large net external indebtedness today is largely a legacy of the deficits in the external trade balance between 1974 and 1989.

It followed that the savings behaviour of New Zealanders, since 1990 at least, was not a prime cause of the current level of indebtedness.

Once external debt has been accumulated, the second factor that affects its subsequent path as a proportion of GDP is the difference between the earnings rate on the net debt (which drives the rate of growth in the numerator) and the rate of growth in GDP (which drives the rate of growth in the denominator).

This week’s Friday graph fleshes out the external indebtedness story a bit more by illustrating the degree to which the differential between the earnings rate and the rate of growth in GDP may explain the path taken for net external indebtedness as a percentage of GDP) since 1989.  The indicative calculations suggest that it has probably played a very significant role.

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The chart uses the Reserve Bank’s time series on the one-year government stock rate as a proxy for the earnings rate on the net external liability.  The green bars at the bottom of the chart show the annual difference between the interest rate on government stock and the rate of growth in nominal GDP during the year.  The label for this differential in the chart is (i-y).

The uppermost line in the chart shows how the ratio of the net external liability to GDP would have increased after 1989 if (i-y) had been the only factor affecting it.  Specifically, the ratio would have risen from 63.9 percent of GDP in March 1989 to 98.6 percent of GDP in March 2005.  That is a major potential influence.  Since rates of return are determined in world markets, the only effective way for a New Zealand government to reduce the magnitude of this effect during that period would have been for it to increase the (real) rate of economic growth.

The lowest line in the chart is the same line as in the earlier graph.  Trade balance surpluses since 1989 had the potential to lower the net indebtedness ratio to 43.2 percent of GDP by March 2005.

The dotted line in the chart represents the combined effects on these two influences.  From 1989 to 2002, it tracks the heavy line very closely.  (The heavy line plots the actual ratio of the net external liability to GDP as reported by the RBNZ in its May 2011 Financial Stability Report.  Note that there have been some data revisions since then.)  The chart casts no light on why the dotted line diverges from the heavy line for a period around 2005.  Perhaps the government stock interest yield was a particularly poor proxy for the actual net income accruing to non residents  in these particular years.

The next important point from the chart is the effect of loss of external competitiveness from 2004 in returning New Zealand to deficits in the balance of trade causing this factor to start increasing external net indebtedness for the first time since the 1974-1989 period.  The loss of competitiveness was associated with a major increase in government spending on goods and services as a percentage of GDP.  Recession restored a balance of trade surplus in the year ended March 2010, but this could be temporary unless external competitiveness is restored.

It follows that concerns about New Zealand’s high net external indebtedness relative to GDP could usefully focus on raising the real rate of economic growth and improving the competitiveness of our exporting and import-competing industries.

Since neither external competitiveness nor the rate of growth in GDP are primarily savings rate stories, it follows that the evolution of the path for net external indebtedness is not primarily a savings rate story.

Dr Bryce Wilkinson
Acting Executive Director
New Zealand Business Roundtable