Thursday, December 7, 2023

Good news for farmers as S&P waves downgrade stick

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Export earnings will be key if NZ heeds warning to return to economic fundamentals.
S&P Global Ratings points out that New Zealand’s real exports are slowing following strong growth in 2022.
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Farmers should be swinging from the chandeliers following last week’s current account figures and credit rating warning from Standard & Poor’s.

The laws of economics are coming back into play. Wellbeing needs an economic base. A major chunk of it is provided by the rural community and pastoral exports. New Zealand cannot continue to borrow and spend our way to growth.

By hook, or by crook, the NZ economy needs to change tack, earn more and spend less.

S&P’s comments are the first sign of market discipline. When you are in unsustainable zones economically, market forces eventually send signals. You either respond to them, or markets start to drive outcomes. Former United Kingdom prime minister Liz Truss found out the hard way, as financial markets torched “Trussonomics” when the British pound dived and interest rates increased. Exit Liz Truss.

NZ’s current account deficit has surged to 8.9% of gross domestic product, the highest on record, and a nominal deficit of $33.8 billion. That is a massive shortfall between what we earn via exports relative to what we spend on imports, and involves a huge investment income deficit of around $12bn too. The includes debt servicing on borrowings and net profit flows on foreign-owned NZ assets, including banks.

The current account trade deficit was $12.5bn. To put that in perspective, that is roughly the combined value of red meat and kiwifruit exports we are “short” on the export side of the trade equation.

The current account deficit is equivalent to 33% of all current account receipts covering exports of goods, services, and investment income.

The latest gross domestic product figures show stagnant to falling export volumes since 2018.  The dollar value of goods exports has increased 14.6% between December 2018 and December 2022 with a lower currency assisting. Meanwhile, goods imports have risen 41.2%.

“We would need to see the current account deficit narrow over the next 12 to 18 months and if it doesn’t there is going to be increased pressure on the AA+ rating,” noted the S&P analyst.

We are on notice.

Would a downgrade really hurt? Initially, no. NZ’s current foreign currency credit rating is currently AA+, indicating very low credit risk. S&P upgraded NZ’s credit ratings in 2021 so any potential reversal needs a sense of perspective.

A change would be a margin of credit excellence adjustment.

The NZ dollar reacted slightly negatively to S&P’s comments but without a dramatic move. Other countries face debt challenges too.

Round one is the polite tap on the shoulder saying get your house in order.

NZ could be in serious trouble if the terms of trade – the ratio of export prices to import prices – recedes.

The current account will improve on some levels. A weaker economy will dampen import demand. A recovery in inbound tourism will support services exports, though NZers are travelling too. Are tourists getting the same pre-covid experience, meaning they will return? That is debatable.

The current account reflects a mismatch between investment and saving. We need to import the latter to fill a lack of savings locally. Cyclone Gabrielle and improving our climate change readiness just added to the investment line.

Households are struggling to save, and the government is running deficits constraining the national savings line.

Government policy is holding back pastoral growth, and sectors offering opportunity such as pipfruit and horticulture just took backwards steps and will take time to get back on track. It is essential these sectors are given support to recover and re-invest. Forestry, one of the identified potential stars along with horticulture in the Ministry for Primary Industries Fit for a Better Word document, faces challenges. The document needs to be re-written to include some real aspiration, and given a high execution priority. 

All major structural shifts take time.

The current account figures and S&P comments merely mark the start of a journey.

That journey starts with the market providing the right signals, such as the NZ dollar settling in a lower trading range. The NZ dollar versus the United States dollar appears to be settling in a mid-60s zone, compared with averaging in the low 70s over the prior two decades.

From here, industry players and businesses will need to respond. Credit and capital will need to flow. NZ’s housing-centric banking model needs to change. Sectors with strong growth potential, including horticulture and pipfruit, will need to be supported to drive a fast recovery from Cyclone Gabrielle. We cannot let those sectors stagnate.

Government policy will need to be supportive. You do not boost exports by lumping cost after cost onto businesses – and 15% farm cost inflation is absurd. Science and research development will be essential. Same with the education system and lifting our global connectivity. Poor infrastructure dents productivity. We need to calibrate NZ more towards earning our way to growth as opposed to spending it. That will take a lot of work and need more do-fests and less talk-fests.

The more industry and the government can calibrate a better earnings backbone across the economy, the less the market will need to adjust to drive it. Market mechanisms are a lower currency and higher interest rates. The former makes us poorer globally and few want the latter.

This will not happen overnight. The current account ballooning well into the danger zone and S&P’s comments expressing more concerns and waving a downgrade stick just signal we need to get the ball moving before market forces start driving us that way.

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