The game is up on the 'fill-yerboots with borrowing offshore' modus operandi – sustaining NZ investment is going to require more domestic saving to finance it, ANZ chief economist says

ANZ’s chief economist Cameron Bagrie is calling time on the practice of funding NZ investment with offshore borrowing and he says households need to start saving more.

In the ANZ’s latest Property Focus publication, Bagrie says New Zealand has a considerable pipeline of investment needs, which largely reflects some catch-up and the necessities of catering for a rapidly growing population.

He says the Government and business sectors are doing their share – but households are not. And consumption will need to be reined in. He references the “housing-centric borrowing” of Kiwis, and says this has “hardly done much” to add to the country’s productive base.

“Given a domestic saving shortfall, New Zealand’s typical modus operandi has been to fund its investment needs through offshore borrowing (running a large current account deficit). While that is still possible to a degree, it is facing far more challenges now given prudential restrictions, credit rating agency attention and financial stability considerations.

‘Onus on saving’

“The onus is falling more on the saving side of the ledger to pull its weight to fund domestic investment needs. While a decent income growth backdrop will assist, there will still be trade-offs. In order for the investment wheels of the economy to continue to turn at the rate necessary, domestic saving will need to lift, and ultimately more saving equals less consumption, with the latter the sacrificial pawn to allow stronger investment. 

“…The game looks to be up on the old ‘fill-yerboots with borrowing offshore’ modus operandi. While it is a lever that can be pulled, it can’t be yanked as enthusiastically as in the past. Sustaining New Zealand’s investment needs is going to require more domestic saving to finance it. The numbers don’t stack up otherwise.”

Bagrie says there is nothing fundamentally wrong with borrowing. “It’s cheaper than equity!” Borrowing, he says, is also society expressing its preference to spend today (or buy a bigger, flasher house) as opposed to investing for tomorrow.

“Offshore capital (saving) is typically readily available, at a price. Now you can’t borrow indefinitely of course, but for a country with an open capital account and developed financial system like New Zealand, it does mean that you can make choices about the timing of spending, saving or investing.

Housing-centric borrowing

“Unfortunately in New Zealand’s case, the borrowing has been housing-centric. It might well have been a logical response to expectations of capital gain, and housing is a critical ‘need’, but it’s hardly done much to add to the economy’s productive base.”

Bagrie says that the country has typically financed its investment needs through a mixture of domestic saving and borrowing overseas.

“In fact, since the GFC (and up until recently) we have been leaning more and more on the former. We have documented this extensively of late, but with deposit growth largely matching accelerating credit growth within the banking system for the majority of the post-GFC years, in many ways the system was self-financing. Banks didn’t have to tap international markets to the same extent as we have seen in the past, which is a key reason the economy’s net external debt position fell from 84% of GDP in 2008 to 55% of GDP now.

“However, that changed around 12 months ago when deposit growth started to slow sharply while the demand for credit remained strong. To keep the economy’s investment wheels turning, banks were forced to turn more to offshore sources for funding. In September 2016, offshore bank funding had increased by over $11bn compared with 12 months prior.”

Bagrie says banks are attempting to mitigate this challenge (funding gap) through competing more aggressively for domestic funding and restricting credit. As such, deposit rates are rising (and with them, lending rates), and credit is increasingly being rationed.

“That is a logical response. However, credit rationing is hardly a factor that is going to assist with the likes of boosting housing supply or infrastructure more generally. Credit is the grease in the economy’s investment wheels.

“In many ways, the funding pressures that banks are currently facing can also be thought of as a current account constraint. If it is becoming harder, or we should be more wary about funding a saving shortfall through overseas borrowing, then simple maths would say that either national saving needs to lift or investment has to fall. Now admittedly, that’s probably a little too black and white; there is of course scope to fill the gap with a little more offshore capital. Our current account deficit is only 2.7% of GDP. We’ve run far larger deficits before. Perhaps something up to 4% of GDP would be manageable given the economy’s investment needs. But anything larger than that and the net external debt position relative to the size of the economy would start to rise again and that will get [negative] attention.”

Bagrie says the “downstream implications” of the existing tension between national saving and investment are meaningful. Stronger saving across the business and government sectors can be seen already.

“We estimate that in the year to March 2016, the business sector’s net saving totalled over $13bn (which is close to twice the size of the current account deficit itself).

“However, household net saving has been a clear laggard. In fact, households were dissaving to the tune of over $15bn over the same period.”

Strong business sector saving is “thus unlikely to be enough”.

“Households will need to pick up the baton as well. Higher deposit rates will of course help in this regard. But ultimately more saving equals less consumption, and consumption is a big part of the economy (around 60% in fact – for private consumption at least). Within our forecasts, one of the key overriding themes is that investment’s share of GDP continues to rise, while consumption’s share continues to fall off highs.”