There Has Not Been A Balance of Payments Crisis for Over A Decade. Will Our Luck Run Out?
Listener: 6 April, 1996.

Keywords: Macroeconomics & Money;

It is that time in the economic cycle when the more experienced economists begin muttering “balance of payments crisis”, albeit with a question mark. Such crises occur when the current revenue the country obtains overseas (mainly from exports) is much less than the current payments the country makes (for imports and foreign debt servicing) to the extent that foreigners are no longer willing to lend sufficient capital to cover the deficit.

A balance of payments crisis is not the same as the currency crisis which occurred in July 1984, when the Reserve Bank almost ran out of foreign currency while defending a fixed exchange rate. Nowadays the currency is not pegged to any given rate, and the Bank is not required to buy and sell foreign exchange, so we cannot have a currency crisis. But foreign lenders can become reluctant to cover the nation’s overspending.

Because balance of payment’s crises involve confidence of those foreign lenders, they cannot be readily predicted. However the fundamentals which underpin them can. We can look at the value of exports, imports and debt servicing. The data jump around because of irregular effects but the recent figures suggest the trend deficit is deteriorating. Exports are not rising as fast as imports, while debt servicing continues to rise (since total debt is rising).

Forecasts are more problematic, since assessments have to be made of such things as the future export prices, and the ability of exporters to increase their sales. The forecasters may be little on the optimistic side. Even so their projections suggest that the current account deficit – the measure of our over-spending – is going to remain above the 3 percent of GDP level, which is sometimes considered to be sustainable in the long run. Foreign lenders may accept a higher deficit in the short run if they think it will come down. But that does not seem likely in the near future.

It is true that we have had no balance of payments crisis for over a decade, but this partly reflects luck. Various investments which took place before 1984 – forest and horticultural planting, the major energy projects – increased export revenue or reduced import spending after 1984. We also had an export boomlet from meat sales when we ran down the sheep and beef herds in the 1980s, while second hand equipment from closed factories was sold overseas. The economic stagnation of the first eight years of rogernomics reduced the flow of imports. Altogether the balance of payments looked reasonable in the 1980s.

In the 1990s there was the manufacturing export boom to Australia, and a terms of trade hike of our export prices relative to import prices. These were sufficient to cover the rise in imports as the economy began to expand.

What of the future? Will the Australian economy continue to suck in New Zealand exports, or will it stagnate and reduce its demand for our products? Will primary product prices remain high (some are already weakening)? Will the boost to the economy from the mid-year tax cuts also increase imports? Will exporters continue to increase sales, or does the high exchange rate discourage them, while deterring firms from investing in additional capacity for production? Will the high exchange rate (which reduces import prices) encourage New Zealanders to buy foreign, and turn away from New Zealand alternatives? In summary: will our luck run out?

An increasing deficit need not immediately lead to a crisis, if foreign lenders are happy to continue to make up the difference. When might enough of them change their minds? The balance of payments may well be looking much worse at the end of the year. The cynic observes that they always look worse just after an election than during the campaign. In the interim we may see domestic interest rates rise in order to attract foreign investors. (At the same time the exchange rate may even rise, for markets can be perverse in the short run.)

The most likely scenario is that there will be increasing signs through the year of some external problem. Some foreign investors will get increasingly uneasy. Market signals will become mixed, undermining confidence. And as investors try to pull their money out of New Zealand, the exchange rate could fall quickly – “collapse”. Whether this will lead to a one off increase in the price level, or ongoing inflation will depend on how well the economy is managed. If the inflationary boom can be avoided, the additional profitability in the external sector should generate sustainable growth.

Business commentators will ignore the deterioration of the fundamentals and blame it on the election and MMP. But elections in other MMP countries do not cause balance of payments crises. There is an abundance of political innocence in the financial community. Perhaps the Electoral Commission should be targeting them, for their ignorance is a major threat to economic stability. There is a real danger we shall interpret the next balance of payments crisis as a political problem, ignoring that the fundamentals have been (and are) deteriorating.