Risks Remain Despite Reduced Australian Exposure
BMI View: The New Zealand economy has evolved since the financial crisis in 2008/09, and changes in the composition of trade and economic structure suggest that the country is less vulnerable to economic deterioration in the Australian economy. With the effect showing up more prominently in recent data releases, we have upgraded our growth forecasts, expecting real GDP to come in at 2.5% in 2013. That said, the structural transition in the Chinese economy and possible correction in the domestic housing market remain key threats to growth over the next few years.
The relationship between Australia and New Zealand has changed over the past decade. While a strong Australian economy provides a larger market for New Zealand businesses to expand, we note that the growth drivers in the New Zealand economy are now from agriculture and tradable services, a move from the manufacturing sector. Trade composition between the two countries has evolved and changes adopted by the financial sector since the financial crisis in 2008/09 is likely to have limited the impact from the ongoing deterioration in the Australian economy on the domestic businesses. The effect of these changes have become more prominent in recent economic releases, and as such, we believe that consumer spending is likely to remain strong for the rest of the year and have upgraded our forecast for real GDP to come in at 2.5% versus our previous estimate of 2.2%. However, this does not mean that the economy is in the all-clear, as we see vulnerabilities stemming from a slowdown in Chinese consumer spending (see, 'Consumer Not Immune As Downturn Intensifies', August 02) and a steep correction in house prices, which could push the economy into recession.
|Changing Times, Changing Demands|
|New Zealand - Main Categories of Exports In 2000 & 2012 (LHS, % of Total) & Machinery Exports (RHS, USDmn)|
Trade: Crude Replacing Machinery Exports
Although the proportion of trade to Australia has remained relatively stable, hovering around 21% over the past decade, the composition of outbound goods from New Zealand has changed dramatically. Crude and fuel are now the main exports to Australia, overtaking machinery exports that dominated trade between the two countries in the past. A growing proportion of machine ry exports now head to destinations other than Australia, hitting a high of 59.8% in 2012 versus 51.6% in 2000. This would provide manufacturers some buffer as the Australian economy slows, as the second and third largest export destinations, the US and Canada respectively, are forecasted to record moderate growth.
Crude extracted in New Zealand is of a lighter grade, making it a valuable input in the production of petrochemicals. So while the deterioration in Australia may weigh on fuel exports, there may be scope for the sale of New Zealand crude to other big refining players such as Singapore (which only accounted for 4.1% of crude exports in 2012). Moreover, given that the industry in New Zealand is a far smaller employer compared to many other industries, with the broader mining group accounting for just 0.3% of the total workforce as of 2012, a decline in this segment, although hurting the country's external balances, would have limited impact on the domestic economy.
|New Zealand - Banks' Funding Sources (LHS) & Proportion Of Funding From Associates, % of Total|
Banks: Diversifying Funding Sources
Because New Zealand's largest financial institutions are subsidiaries of Australia's four largest banks, financial linkages between the two countries run deep. Given that Australian parent companies, alongside the Reserve Bank of New Zealand (RBNZ) came to the rescue of these subsidiaries during the financial crisis in 2008/09 (according to a Standard & Poor's report), there is a possibility that these subsidiaries would be hit in the event that the Australian parents require support. Given that the deterioration in the Australian economy is likely to weigh on financial institutions there due to their large exposure to the housing market, a downgrade to parent companies credit ratings, by extension, would likely impact the cost and ease of obtaining funding of its New Zealand subsidiaries.
However, data from the central bank has shown that local outfits are diversifying their funding sources while lengthening the maturity profile, with funding from associates (i.e. related companies which own at least 20% of the bank's equity, which would include Australian parents) declining since the height of the crisis. The stricter regulatory requirements (which are even more stringent than Basel III's core funding ratios) dictated by the RBNZ ha ve also increased the banking sector's resilience should a liquidity crisis occur, and this was reconfirmed in an IMF report at the start of 2013.
|The Old Is Fading...|
|New Zealand - Number Of Business (LHS) And Employees By Industry Groups, % Of Total|
Structural Change Away From Manufacturing
The economy is also slowly moving towards services and away from manufacturing, and tradable services provide an avenue in which the country can overcome the distance barrier that has constrained its growth so far. The increasing number of technology companies seeking to use New Zealand as a space to test new releases has also bolstered this sector, although we highlight that insufficient skilled labour could weigh on the speed of development in this area. Together with the growing agriculture sector, whose growth has also led to the increase in the number of food manufacturers, New Zealand economy could see a much smaller impact from a slowdown in its neighbour Australia as compared to previous downturns. Indeed, even as Australia remains a key source of foreign investment, for both direct and portfolio flows, other countries such as the US and China now have an increasingly larger impact on the New Zealand economy.
Risks Still Abound - China's Structural Transition and House Prices
Although the risks of a fall-out due to severe deterioration in the Australian economy have lessened, the risks stemming from Chinese and US markets have increased. In particular, we believe the structural transition underway in the Chinese economy will have a large impact on New Zealand, especially since the Chinese consumer accounts for more than a fifth of sales of dairy exports.
The persistent divergence in the trajectory of house prices and incomes remains a key source of risk for the economy, as steep declines in house prices could deal significant damage to highly indebted households and the financial sector through its large exposure to mortgages. Indeed, the ratio of house prices to disposable income is now just slightly below its Q108 peak of 12.3 times, while household debt has hit 94.8% of GDP, beyond the highs recorded before house prices declines in Q108 (93.2% of GDP). While the government and central bank are putting in place speed humps to restrain house price growth, a commendable effort to prevent overinvestment in this sector, the risk of a steep price correction remains high. Indeed, such a correction could restart the deleveraging process in the country and result in a slower but more sustainable pace of real GDP growth.