Monday, November 22, 2010

Standard & Poor's: Right message, odd timing...

After nearly 25 years working in financial markets, I’ve long given up trying to predict the actions and motivations of credit rating agencies. I’m certainly not going to start today. The key point for today is that Standard and Poor’s action of lowering its foreign currency sovereign credit rating outlook for New Zealand from stable to negative highlights the challenges still facing the New Zealand economy.

Not the least of these is that New Zealand is, once again, living with twin deficits. The current account deficit is deteriorating again and the Government is running fiscal (operating balance) deficits. But this is not new news. After improving to around 3% of GDP, the current account deficit will head back towards 6% of GDP over the next year or two. And as we noted at the time of the May Budget, the Government’s projections for economic growth and the forecast track of the operating balance (and therefore cash positions and debt levels) would prove too optimistic.

While the Government did a good job over the last two Budget’s of turning a deteriorating fiscal position around, they could have done more by recognising the structural nature of the problem and dealing with the structural fiscal issues, especially around expenditure (in particular, entitlements). This is essential if we are to return to a position of structural surpluses and prepare the New Zealand economy for the next global crisis (whatever that may be).

On a more positive note, we believe that some domestic economic rebalancing is occurring. Households are changing their behaviour by spending less and getting their balance sheets in order. This is why New Zealand is experiencing a tepid, non-traditional (i.e. one not driven by domestic consumption and residential construction) recovery. It remains to be seen whether this is a temporary of more permanent phenomenon.

The forecasts underpinning today’s decision are a tad odd. Over the last two years we have been happy being at the bottom end of market expectations for economic growth. Over the last 12-months the many forecasters have lowered their forecasts to be more in line with ours. However, S&P’s expectations of 1.6% GDP growth in calendar 2011 seems too pessimistic.

The good news in today’s developments is that it will bring new attention onto New Zealand’s economic challenges, in particular our external imbalances. We believe the New Zealand dollar is significantly overvalued and will, in time fall. Our portfolios remain positioned for that eventuality. Renewed attention from credit rating agencies may be part of that process.