24 October 2000 Media Statement

Moody's votes confidence in Govt's fiscal strategy

Moody's reconfirmation of our Aa2 foreign currency ceiling and judgement that New Zealand's monetary and fiscal policies are both on a "sound footing" were today welcomed by Finance Minister Michael Cullen.

He said Moody's assessment of the country's sovereign risk rating was based firmly on its perception that "the objective of maintaining a surplus position over the business cycle remains well-anchored in the policy framework."

"That amounts to a vote of confidence in the Government's fiscal discipline," Dr Cullen said.

"Moody's rightly expresses concern at our low national savings levels and at our weak external accounts. But the Government has acknowledged these structural problems and put in place a strategy to address them."

Dr Cullen also welcomed Moody's comments on the Government's plans to partially prefund future superannuation costs.

"Moody's is correct that the proposed scheme relies on the public sector saving rather than creating incentives to increase the household savings rate.

"However I have already signalled that the Government is working on changes to make private superannuation savings more attractive," Dr Cullen said.

ENDS

Rating Rationale
Moody’s Aa2 foreign currency country ceiling and its Aaa rating on the domestic currency debt obligations of the government of New Zealand reflect the country’s sound monetary and fiscal policy frameworks, a low level of public sector debt and an open and flexible economy. At the same time, the country ceiling continues to be affected by large current account deficits and a high level of external indebtedness.

Macroeconomic Policy
Both monetary and fiscal policies are on a sound footing. The Reserve Bank of New Zealand has succeeded in holding inflation to an average annual rate of 2% during the 1990s, which is well within its 0-3% explicit target band. Inflation is currently about 2% and monetary policy remains responsive to the underlying trends and conditions in the economy. Some changes in the management of monetary policy could occur next year as a result of a review initiated by the Labor coalition government that came to power at the end of 1999. However, since the government has excluded the examination of the price stability objective and operational independence of the Bank from the terms of the review, Moody’s expects those aspects of policy formulation to remain unchanged.
New Zealand’s track record in managing public finances has been impressive over the last six years, with the fiscal position averaging a surplus equal to 2% of GDP during the period. Sustained budgetary surpluses and privatization proceeds have cut down public sector debt very sharply, to levels well below the OECD average as a percentage of GDP. New Zealand’s gross general government debt to GDP ratio was estimated at 35% at the end of last year compared to the OECD average of about 70%. The budget surplus has been reduced in the last three years, reflecting the impact of tax cuts and a decline in government revenue as the economy slowed as well as higher expenses. By increasing spending and doing away with some of the planned tax cuts, the new labor government has departed somewhat from the policy framework of the previous administration. Nonetheless, the objective of maintaining a surplus position over the business cycle remains well anchored in the policy framework.

Open and Flexible Economy
Over the past fifteen years, New Zealand has undertaken a wide range of structural reforms that have increased the country’s flexibility in adapting to external shocks and created a stronger foundation for economic growth. Trade liberalization, tax reforms, privatization of state-owned enterprises, deregulation of key industries and labor market reforms are among the major initiatives undertaken.
Although these reforms have had a positive influence on the economic life of the country, the extent of the benefits have been somewhat less than what was anticipated at the beginning of the reform process. Studies published recently point to the country’s small population base and its isolation from large external markets as some of the factors behind the less than optimal results. Today, New Zealand continues to lag significantly behind the OECD average in terms of income levels and its exports, while fairly diversified within the sector, remain heavily dependent on agriculture. This, in turn, leaves the country particularly vulnerable to seasonal supply constraints, changes in external conditions and volatility in commodity prices.

External Profile Constrains the Country Ceiling
The country ceiling of Aa2 is constrained by New Zealand’s heavy reliance on foreign capital, which stems from a structural imbalance between national saving and investment. This imbalance has led to a significant rise in the level of external debt over the last 20 years which, in turn, explains the high investment income account deficit in the country’s balance of payments. Unfortunately for New Zealand, the large influx of foreign capital has not led to sufficiently large increases in export capacity to offset the investment income deficit and maintain the country’s current account deficit at more moderate levels.
The high level of dependence on external debt elicits concern regarding the possible impact that shifts in market sentiment could have on the balance of payments, through pressures on the exchange rate and a rising risk premium associated with the country. These concerns are somewhat mitigated by the widespread practice of hedging against exchange rate changes and the floating exchange rate regime. It is also essential to note here that although external debt has been rising, a significant part of it is in domestic currency and about half of the total external debt is accounted for by inter-company loans. In addition, and mirroring the situation in other advanced countries, the short-term component of New Zealand’s debt stock is high but most of the short-term debt is owed by subsidiaries of large strong international banks and a significant proportion of bank debt is owed to its own parent company. This reduces the rollover risk of short-term debt even when there is a shift in market sentiment. Thus, a close examination of the nature of external capital financing for New Zealand’s current account deficits alleviates some concerns about the extent of the country’s vulnerability to external shocks and shifts in market sentiment.
Nevertheless, the size and recent trends in the savings-investment gap indicate that the country’s savings rate is far less than the investment it needs to generate growth to improve income levels. Given this situation, the government’s adherence to fiscal responsibility is crucial to maintaining confidence and sustaining the inflow of foreign investment on which the country relies for its investment needs. While the turnaround in government dissavings since the early nineties has been impressive, policy measures have not succeeded in turning around the low household savings rate.

Rating Outlook
Concerns regarding New Zealand’s current account deficit and the external debt profile led to a downward adjustment in the country ceiling on foreign currency debt from Aa1 to Aa2 in 1998. Since then, the outlook for this rating has been and remains stable, being well supported by the underlying structure of the economy and current macroeconomic policy framework. The stable outlook is also predicated on the expectation that the country’s current account deficit position will improve over the medium term horizon. As for the Aaa rating assigned to the government’s domestic currency debt, it remains well anchored by the existing fiscal policy framework, positive budgetary trends and a low public sector debt burden.
In the near term, a narrowing of the current account deficit could be helped by the recent improvement in the merchandise trade balance, although a continuation of high oil prices may prevent a rapid return to the trade surplus levels of the past. Over the medium term, continued fiscal prudence and improved private savings will be necessary to retain market confidence, address the large external deficit and debt position and eventually accelerate the pace of growth to achieve income levels more in line with other comparable OECD countries.
Similar to the situation in other advanced countries, New Zealand’s demographics indicate that in about ten years the aging of the population will begin to exert significant pressure on public finances due to increases in health and pension related expenditure. The government has announced plans to partially pre-fund future pension costs by setting up a superannuation fund financed from government accounts. If it is to pass in parliament, the plan will require the support of parties that are not part of the governing coalition. Although the proposed reform could help easing the long-term fiscal challenge stemming from an aging population, it should be noted that it relies on higher public sector savings rather than creating incentives to increase the household savings rate.

Rating History

Date Foreign Currency Bonds and Notes Foreign Currency Bank Deposits
Short Term Long Term Short Term Long Term
05/21/1979 P-1 -- P-1 --
04/12/1985 P-1 Aa P-1 Aa
08/15/1986 P-1 Aa3 P-1 Aa3
03/16/1994 P-1 Aa2 P-1 Aa2
01/03/1996 P-1 Aa2* P-1 Aa2*
02/26/1996 P-1 Aa1 P-1 Aa1
06/04/1998 P-1 Aa1** P-1 Aa1**
09/23/1998 P-1 Aa2 P-1 Aa2

* Placed on Review for possible upgrade; ** Placed on review for possible downgrade.

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