Newsflash! New Zealand just got slapped with a debt rating downgrade, suggesting that the nation's finances are in shambles. After having a negative outlook on their AA+ rating for New Zealand, Fitch decided to lower it by a notch to AA with a stable outlook. They cited concerns about the nation's growing level of external debt to justify the downgrade.
In particular, Fitch threw the spotlight on New Zealand's widening current account deficit. They pointed out that the shortfall is projected to swell to 4.9% of its GDP next year and to 5.5% of its GDP in 2013. You see, having a current account deficit means that an economy is using resources from other countries to meet its own domestic consumption. In other words, a country with a large current account deficit is investing more than what it is saving.
This so-called structural imbalance, as Fitch put it, can be attributed to the high level of overseas ownership of New Zealand companies. When these companies make profits, the money flows offshore and not to the domestic economy.
It doesn't help that New Zealand's government recently implemented fiscal measures to help the country recover from the Christchurch earthquake this year. Green Party co-leader Russel Norman, a member of the opposition, blamed the poorly-timed and poorly-designed tax cuts for making it difficult for the government to achieve a surplus.
Even Finance Minister Bill English himself admitted that New Zealand has a high level of private sector debt that isn't being reduced fast enough. It's hard to believe that this was something they've been working on for the past two to three years!
Unless New Zealand's government is able to take steps to trim their current account deficit soon, credit rating agency Standard and Poor's might follow Fitch's lead and dole out a downgrade as well. Bear in mind that Standard and Poor's also has a negative outlook on their AA+ rating for New Zealand.
Another downgrade could give rise to funding pressures for New Zealand, as lenders would demand for higher returns to compensate for the increased default risk. After all, a lower credit rating implies that the government is less likely to pay back its debt. With that, the RBNZ might be forced to delay its rate hikes much further in order to refrain from adding additional pressure to borrowing costs.
On a less downbeat note, Fitch assured that such downside risks remain remote for now. Apart from its bulging current account deficit, New Zealand isn't doing so bad compared to other nations with an AA rating. For one thing, their debt to GDP ratio of 46% is not that far off from the 43% median of AA-rated countries.
Still, with a huge chunk of New Zealand's companies externally owned, their economy is left vulnerable to global economic threats such as euro zone debt problems. How can New Zealand lessen their exposure to these risks? Let us know what you think by dropping a comment below or by voting through our poll.