Summery of New Zealands economy for the quarter March 2009
The NZ economy is yet to find a base. Business confidence surveys are either at, or near, historical lows. Employment intentions are tumbling and investment plans are being shelved. Corporate tax revenue – a key timely indicator of economic activity – has capitulated. Consumer sentiment is also very subdued despite falling mortgage rates, tax cuts and lower petrol prices. Car registrations are at their lowest level since 1994 and building consents in January fell to their lowest level since 1965. It is now likely that the recession, which began in the March 2008 quarter, will extend to five, possibly six, quarters as the full impact of recent financial market turbulence is felt. This has been exacerbated by the global downturn and follows a largely domestic and drought driven recession over the first half of last year. The last time NZ experienced such a string of negative quarters was during the oil shock of the 1970s.
Of course the positive spin on this is that we are close to the turning point, considering it is now the end of March. We have some sympathy for this view in terms of the pure numbers and the reality that the bungy-cord tends to come out, which is already manifesting in the housing market with reported uplifts in enquiries. But we also need to be realistic: 2008 was by-and-large a domestic induced recession in response to internal imbalances, a drought, and tight financial conditions. 2009 will have an added global influence.
On top of this, we would be inclined to throw some statistical quirks into the mix. Technically, NZ was in recession in H1 2008 but weakness was heavily concentrated so it didn’t really feel as weak as the normal recession. By late 2009, NZ’s GDP figures are likely to show a rebound into positive territory, but it will be out of sorts with other measures such as the unemployment rate, which is still headed higher. Hence, the H2 2009 rebound will not feel like a recovery at all.
The outlook for 2009 is dominated by four dynamics. These include:
- A credit centric shock. Despite signs that global credit spreads have eased and major central banks are embarking on quantitative easing to keep longer dated yields down, credit markets are still far from normal. It is no longer a question of price. We are in a world where capital is scarce, and this is not about to change for some time.
- A deep global recession, which started at the end of last year and is set to last throughout most of this year.
- A structural change in the pricing of risk, with a clear shift in the balance of power away from borrowers and towards savers and investors. NZ is already seeing this via changes in retail deposit rates, which now sit materially above the wholesale interest rate curve.
- NZ’s heavy reliance on offshore capital, which is evident via a large current account deficit and large net external liability position. The latter, at 93 percent of GDP, is a key source of vulnerability in the current global environment and needs to be reduced.
These issues above manifest in our forecasts via a number of avenues:
- A structural rebalancing for the economy away from debt-fuelled consumption towards more earnings centric growth (i.e. exports). This sees anaemic consumption growth for a number of years and a sharp improvement in the household savings rate.
- An elongated adjustment process, particularly with household balance sheets in most need of repair.
- A requirement for the currency to weaken markedly, and stay low for some time to assist in the rebalancing process.
- The economy to remain void of key engines of growth over 2009, as the combination of de-leveraging restrains the domestic economy, and the flow-on from a weak global environment restricts the earnings sector.
We expect the NZ economy to contract by 2.8 percent this year. By-and-large this reflects the big-picture forces noted above. Confidence remains weak, and we are only now starting to see the flow-on impact from the global scene. As these effects take hold via weaker export demand, falling tourism numbers and lower commodity prices, the recession naturally shifts from its urban focus towards the hinterland. We have already seen residential property prices fall by close to 10 percent from levels a year ago. This year will see much weaker rural land prices in response to a lower dairy payout. The lower payout and land prices will be the main transmission mechanism through which the global recession filters through into the rural regions.
Consumers are no longer the main driving force for growth. Consumption growth may be the weakest it has been since the early 1990s, but we fully expect more weakness to come in the near-term. Household cashflow may be improving thanks to lower mortgage repayments and tax cuts, but the deteriorating labour market and rising unemployment rate (we are forecasting close to 8 percent by the middle of 2010) increase the likelihood that households save any windfall gains, rather than spend them. Despite record low interest rates providing support to cashflow, the aggregate household debt servicing burden relative to income remains around 14.3 percent, well above its historical average of 9.6 percent. Improving this ratio towards historical norms has to come from a lower stock of debt. Negative wealth effects from falling house prices (we forecast a peak to trough decline of 25 percent in real terms) and tighter access to consumer debt are also acting to curb consumption growth, particularly for durables. But even when the economy starts to recover from 2010, we fully expect consumption growth to lag the overall economy. This is part and parcel of the rebalancing process, which sees consumption as a share of GDP fall from its current lofty 62.3 percent towards the historical average of around 59 percent. We are forecasting a 1.4 percent fall in consumption for this calendar year, and only a mild 0.7 percent growth next calendar year.
Businesses will do it tough, as both domestic and external demand wanes. Profitability is well down and firms have already responded by a freeze on hiring and investment at the end of last year. Firms exposed to domestic demand (e.g. retail and housing) have fared poorly as the recession intensified, but increasingly it will be exporters that will feel the effects of the global recession in the form of reduced or cancelled export orders. Thankfully, business sector balance sheets are healthy. But with topline revenues continuing to head backwards, the recession lasting longer than normal and balance sheet preservation becoming a priority, the onus will increasingly turn towards costs in order for firms to stay profitable. We foresee negative employment growth throughout 2009, and likewise for business investment. The latter will reduce the potential growth rate of the economy, and hamper the eventual recovery when it comes. Employment and investment intentions already sit at historical lows, and these are the next leg of the cycle to watch.
It’s not all depressing news. We are aware of certain pockets that continue to perform well. NZ’s macro framework has responded via interest rate cuts, expansionary fiscal policy and a lower currency. NZ’s financial system remains sound, a major differentiating factor from the United States and other nations. But all are within the context of the deepest global recession in half a century. NZ still stands out as being vulnerable given our reliance on exports and offshore capital. We are also mindful that monetary policy is rapidly losing traction given fierce competition for deposits and funding in general. And pressure on the Government to maintain our sovereign credit rating means they cannot simply go on an unfettered spending or tax cut binge.
Despite the pressure on businesses, we need to remain mindful that a household debt correction story is at the heart of this economic cycle. It is household balance sheets that need to be repaired. Household debt to income increased from 60 percent to close to 160 percent between 1991 and 2008. Debt servicing increased from 8 percent of disposable income to over 14 percent currently. Housing represents 75 percent of total assets. These dynamics were a reflection of the “old” macro environment where credit was cheap and freely available. This allowed NZ to run large current account deficits. In fact, when you overlay cumulative current account deficits over the past decade with home lending, the relationship is startling.
We are in no doubt that we will see the odd burst of activity, particularly in relation to the housing market, which seems to be occurring already (albeit off a very low base). But we struggle to see it taking hold given the global backdrop, turn in the labour market, and weaker appetite to lending per se. It is simply not credible for NZ to expect to borrow and spend its way out of the current jam.
The seeds of the long awaited current account adjustment have been sown. We see the 8.9 percent annual deficit recorded in December 2008 as the peak, with improvements to come from here on in. But rather than via better export performance, the improvement in the current account initially will be via lower profits generated by foreign owned firms in NZ and a lower overseas debt servicing burden, together with reduced import demand as a result of weak domestic demand growth.
A weaker currency is a prerequisite to the adjustment process and the improvement (and recovery) taking on a sustained look. With fiscal policy somewhat constrained in its ability to provide additional counter-cyclical support and monetary policy losing traction given the reality that borrowing rates are being determined by aggressive competition for deposits, the critical shock absorber that must adjust is the currency. Years of the currency remaining above its historical average has led to a deteriorating goods and services balance. We simply see the reciprocal going forward, as the currency follows its normal path of moving further than what is typically expected as the adjustment takes time. This has already occurred, and together with weak consumption growth curbing import demand, we envisage a return towards surplus in the goods and services balance by the end of this year. It’s essential for providing some much needed spine and balance to growth, particularly given the de-leveraging process we envisage for the household sector. We also should not forget that while commodity prices have fallen, the net effect has been muted via the terms of trade, and this is in fact giving us some comfort towards a better medium-term story for New Zealand.
We will be looking at a broad array of indicators over the coming months in terms of any recovery. We are in no doubt that we will see a recovery. Natural population growth, improved migration and easier monetary conditions are support factors that will gain traction as the global scene gradually improves. Business and consumer confidence, along with dwelling consents will be key to watch. But not until we see a sustained improvement in structural indicators; such as the ratio of consumption as a share of GDP, better mix to imports (more investment, fewer consumption goods) and improved savings rate; can we look towards any recovery taking on a sustained look. This looks a way off still.
The economy will come out of recession in the second half of the year, but a sustained recovery will be a mid-2010 story. Though we expect positive growth rates from the second half of this year, it will not feel like a recovery initially. Indeed, growth will be subdued heading into early 2010 as the economy remains in the de-leveraging process. It will not be until mid-2010, by which time the unemployment rate would have peaked and the global economy has started to mend, that the economy will embark on a sustained recovery and start posting strong quarterly growth rates. Pend up demand will fuel the initial rebound, as building consents play catch-up to underlying housing demand, consumers replace durable goods, and businesses upgrade their depreciated plant and machinery equipment. All are natural pro-cyclical forces that once unleashed will see the economy temporarily expanding well above its trend growth rate.
And let us not forget the Rugby World Cup being held in NZ in 2011. Preparations in the lead-up for the event will further add to activity, and we can expect a surge in visitors for the event, leading to a boost in services exports. We see the economy performing strongly in 2011.
Don’t forget the medium-term story. The sacrificial lamb in a de-leveraging environment is growth. Reality needs to set in as it’s a process that will take time. But the medium-term outlook remains strong. NZ still producers the goods (and services) that the world (increasingly Asia) demands and this sets us in good stead for the future. The rebalancing away from the spending towards the earnings sectors will put the economy on a firmer footing to grow at a more sustainable fashion. As firms get back to basics and focus on what they do well (and get assistance via small changes in the microeconomic arena) the seeds of better productivity growth are being sown. This is a dynamic we are already detecting and expect to become more pronounced as the year moves on.
source: National bank of New Zealand