WikiLeaks: Visit of US Treasury Undersecretary, Part 2

This is one of the diplomatic cables about New Zealand held by Wikileaks.

October 25, 2006

SUBJECT: VISIT OF U.S. TREASURY UNDER SECRETARY FOR INTERNATIONAL AFFAIRS, TIMOTHY ADAMS

Classified by DCM David J. Keegan. Reasons 1.4 (b) and (d).

1. (C) Summary: On his recent trip to New Zealand, U.S. Treasury Under Secretary, Timothy Adams consulted with officials, private economists, academics and business people to ascertain the current state of the NZ economy. Consensus among experts was that NZ is relatively stable and in the midst of a standard business cycle downturn. Last year growth slowed to around 1.5 percent and is projected to remain at this level for the near future. To ease inflationary pressure, the Reserve Bank of New Zealand (Central Bank) is expected to raise the official interest rate soon which will also serve to keep the currency "overvalued." Consumer confidence will be tested by fears of a burst in the housing bubble and dealing with record personal debt. Officials plan to introduce a new "compulsory" savings plan next year to help improve savings rate. Despite exports growth being hampered by the high NZD, China has moved into third position as a destination for Kiwi products. Even so, efforts to conclude a timely free trade agreement with the Chinese are proving difficult.

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Minister Cullen Predicts a Soft Landing

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2. (C) Under Secretary Adams' called on the Minister of Finance and Deputy Prime Minister, Dr. Michael Cullen who opined that New Zealand's economy was slowing after a period of expansion but believed it would make a soft landing while overall demand would remain relatively strong. He forecast economic growth to slow to 1.5 percent both this year and next, before recovering to 3.7 percent in 2007-08. Per budget predictions released in May estimated a 7 billion NZD budget surplus for 2005-06 dropping to 5.8 billion NZD in 2006-07 and bottoming out at 3.6 billion in 2008-09. Cullen said his most significant concerns for the NZ economy were low household savings rates, high consumer debt and weak export performance. Cullen proffered that the GNZ planned to introduce a new savings scheme next year with an op-out mechanism to help improve savings rates. He was also worried that a failure of the Doha round would have a long-term negative impact especially for NZ exports to the Asia-Pacific markets. This was especially important since China was moving into third place after Australia and the U.S. as a destination for NZ exports.

3. (C) Cullen said that the NZD is currently overvalued by ten percent (currently trading in the .66 to .68 range to the USD) which is hurting export performance. He believes the housing market will remain stable because net gains in immigration will help support demand. Inflation worries have eased a bit as gas prices dropped as much as 15 percent in the past few months. In the longer term, NZ needs to find alternate sources for natural gas after depletion of domestic reserves anticipated in 2009.

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Mortgage Policy hinders Inflation Fight

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4. (C) Governor of the Reserve Bank of New Zealand (RBNZ), Dr. Alan Bollard, offered a similar assessment of the NZ economy. He said that current monetary policy is trying to bring the economy to a soft landing but with NZ having one of the highest interest rates in the world further adjustments are only expected to have a small marginal effect while continuing to keep the currency overvalued. One of his biggest concerns is finding ways to improve household savings rate.

He felt that both corporate and government savings were good but noted the increased costs for government when an aging population begins drawing down social security/pensions. He felt that current private sector funding for pensions in NZ "doesn't look healthy." This comment tracks with Cullen's reference to the new savings scheme to address the low rate of household savings.

5. (C) Treasury Secretary, John Whitehead took a more technical cut at the issue of soft landing noting that government efforts to increase interest rates (currently at 7.25 percent) to correct inflation will only lag because most home mortgages are set at fixed rates, renegotiated every two to three years. On the issue of pension reform, Whitehead mentioned that the state system has moved the retirement age from 60 to 65 resulting in more people remaining in the workforce thereby easing some of the pressure on government's need to increase expenditures on pensions. Whitehead's assessment of savings rates among households, firms and government echoed Cullen and Bollard. Whitehead further stressed that greater export access to the Asian markets and the viability of the WTO process was critical for the health of the NZ economy. He admitted that the free trade negotiations ongoing with China had proved difficult but reaffirmed the need to better integrate the NZ economy over the next 10 years with the Asian markets.

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Housing Bubble Waiting to Burst

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6. (C) Economists representing some of the major banks in Wellington offered U/S Adams a somewhat pessimistic assessment of the housing market and seemed certain that the bubble will burst but can't forecast exactly when the downturn is likely to occur. Because of the 2-3 year terms of the typical mortgages in NZ, banks will begin to experience a 48 billion NZD churning in the refinancing of these mortgages which will certainly be set higher than the rates last set in 2004. They predicted an announcement by the RBNZ, in a matter of weeks, of a rate increase necessary to address this refinancing wave.

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Immigration helps Economy, but Politics hurts

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7. (C) A panel of academics challenged the conventional wisdom that New Zealand was suffering a brain drain. They maintained that current immigration policy which stresses skills through a point system has resulted in NZ being in the net plus range for population/talent gains. On the negative side they worried that, despite the free market reforms of the 1980's, consecutive Labour governments have undertaken a creeping re-regulation with absorption of talent away from the private sector and increasing bureaucracy. They feared that NZ would slip on the international index of competitive economies if this trend continues. They theorized that the electorate adopted a mixed-member proportional (MMP) system in 1996 to elect parliament -- resulting in more power shared by "marginal groups" thus slowing further economic reforms -- because they were reacting negatively to the pain of the economic restructuring in the 1980's.

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Need to Improve Productivity

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8. (C) Business people from the agriculture, oil and gas, financial/accounting, and business consulting sectors noted that, as a relatively small economy, NZ must realize substantial increases in labor productivity to sustain high rates of growth. This will require much greater levels of exports and foreign investment. They worry that only a small number of NZ companies are adequately engaged in international markets because of NZ's small size and remoteness.

Increases in labor productivity could lead to higher wages which could go far in attracting and keeping talent in NZ. They remarked that it is far easier to secure capital than it is to secure talent in this market. Hope among this group is that political factions will move away from in-fighting and focus more on improving overall economic potential.

9. (C) This cable has been cleared by U/S Adams' office.

McCormick

ENDS

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